From the late 1990s until 2014 Oman’s fiscal balance had consistently remained in positive territory, according to IMF figures, with the sole exception of a small deficit of 0.3% of GDP registered in 2009. However, amid a decline in international oil prices towards the end of 2014, public finances moved into the red for the year, to the tune of 1.1% of GDP. As the oil price slide picked up pace in 2015, the deficit grew, hitting 21.6% of GDP the following year. This was accompanied by a decline in hydrocarbons’ contribution to total government revenue, from 84.3% in 2014 to 68.2% in 2016.
Lower oil prices and their impact on government finances have resulted in a number of downgrades in the sultanate’s sovereign debt ratings. In May 2017 Standard & Poor’s cut their rating for Oman by one notch, to “BB+”, making it below investment grade. Moody’s followed suit two months later, cutting their rating for long term issues and senior unsecured debt – though in its case the rating remained within the investment-grade range, at “Baa2”. Standard & Poor’s followed with a further downgrade in November, to “BB”, with a stable outlook. In December the third major international rating agency, Fitch, cut its rating by a notch to “BBB-”, its lowest investment-grade rating, with a negative outlook, saying it expected government spending to be higher than budgeted.
Financing Remains Available
However, such downgrades do not appear to have affected investor appetite for recent debt issues, uptake of which has been strong, even for transactions that came following the credit ratings changes in 2017.
Between 1997 and 2016 the government did not tap into international bond markets. However, since mid-2016 the authorities have been seeking to finance the deficit primarily through international borrowing, in part to avoid unbalancing the local banking sector and crowding out private sector borrowing by drawing down the sultanate’s substantial domestic deposits (see Banking chapter). In June 2016 the government raised $2.5bn through the issue of a mixture of five- and 10-year eurobonds. The issue followed a $1bn syndicated loan from 11 regional and international banks, which was arranged in January 2016.
In March 2017 the sultanate returned to the market with the sale of $5bn worth of eurobonds, which covered 90% of its demand for foreign financing for the year. This was composed of a mixture of five-, 10- and 30-year tranches. Despite the issue totalling around twice the size of market expectations, it was oversubscribed by a factor of eight, which is an indicator of relatively strong investor appetite for paper from the sultanate.
The government followed this with a $2bn sukuk (Islamic bond) sale in May 2017, which was its first issue of sovereign Islamic debt. High levels of demand for the instrument helped bring down the profit rate from an initial proposal of 270 basis points to 235 above the mid-swap rate. Despite this, the issue was oversubscribed by a factor of three. In August 2017 the sultanate was reportedly in talks with banks to arrange further loans and issues, and in January 2018 it issued its largest bond ever, worth $6.5bn. This was interpreted as a sign of higher oil prices, leading to increased investor confidence in energy-exporting countries.
In conversations with OBG, market observers said that with two of three investment grade-level ratings still in place and with international investors continuing to chase yields, the country should remain able to finance the deficit by borrowing. “The government still has room to borrow and should be able to sustain current levels of debt issue for some time, as debt to GDP remains low, and in our view oil prices are likely to improve further,” Hettish Karmani, head of research at Ubhar Capital, told OBG.
Indeed, despite recent downgrades, there are signs that public finances are taking a positive turn. The 2017 budget aimed to reduce the deficit to 12% of GDP, and in the October 2017 update of its World Economic Outlook database, the IMF forecast that the authorities would come close to hitting this target, predicting a figure of 13%. The IMF anticipates the deficit will decline further in 2018, to 11.5% of GDP, and gradually continue shrinking over the 2019-22 period.
In alignment with such expectations, public finances improved in the first nine months of 2017. According to figures from the National Centre for Statistics and Information, government revenue was up 20% over the same period a year earlier, to OR5.97bn ($15.5bn). This was largely a result of a 34.8% rise in the value of net oil revenue (OR3.31bn, $8.6bn), due to higher oil prices; the average export price for the sultanate was $50.60 per barrel during the first nine months of 2017, up 38.3% year-on-year. Total public expenditure also rose, but at a slower rate of 4%, to OR8.43bn ($21.9bn), which allowed for a narrowing of the deficit to OR3bn ($7.8bn), from OR4.43bn ($11.5bn) during the same period of 2016.
While the oil price recovery has helped to improve public finances, fiscal consolidation is also reducing reliance on oil revenue. The IMF puts the break-even oil price for the government budget at around $83.60 a barrel in 2017, down from $88.90 the previous year and from above $100 several years ago. The IMF forecast the figure will continue on a downward trajectory to $76.30 a barrel in 2018. Karmani told OBG he thought it could go as low as $70 in coming years, thanks to factors such as subsidy cuts and increased gas production projects coming on-line (see overview and analysis). “The government is also focusing more on public-private partnership projects, which should require less expenditure on the investment side,” he told OBG.
The 2018 budget plans for a deficit of OR3bn ($7.8bn); however, in January 2018 the price of Brent crude hit a three-year high of $70 per barrel, indicating that government revenue was set to be higher than anticipated, as the budget had assumed $50 per barrel. If oil prices remain around this level for the remainder of the year, the country could break even or even run a surplus for the first time since 2014.
Such improvements in the break-even oil price and other fiscal indicators are the result of a range of measures taken in recent years to boost public finances. Prominent among these have been utility price increases, which curbed subsidy spending. In January 2015 the government doubled the price of gas for industrial consumers, and the following year the authorities moved to reform fuel subsidies, with domestic prices linked to international oil price movements. In March 2016 the government also raised water prices for state-owned, commercial and industrial clients, and in January 2017 electricity prices were raised for large consumers, defined as those using more than 150 MWh of power per year. The new tariffs reflect the hourly cost of producing electricity, which incentivises more efficient energy use.
In a further bid to raise revenue, in February 2017 the government issued a decree amending the country’s income tax law. Prominent among these changes was broadening the scope of withholding tax and increasing the tax on corporate profits, from a previous rate of 12% to 15%. Local investment firm Ubhar Capital told media it expected the corporate tax rise to generate an increase in public income of approximately OR33m ($85.7m).
Many prior tax exemptions were also eliminated, though a five-year exemption from corporate tax for manufacturing firms remains in place, subject to certain conditions. An exemption from corporate tax for the first OR30,000 ($77,900) of profits was abolished; however, a 3% rate was introduced for certain small establishments with fewer than 15 employees, registered capital of less than OR50,000 ($130,000) and gross income of under OR100,000 ($260,000). The changes also saw the extension of the sultanate’s withholding tax to cover dividends, interest payments and payments for services.
The elimination of the exemption on the first OR30,000 ($77,900) of income, and the introduction of the 3% tax rate for smaller companies will bring a substantial number of businesses under the tax umbrella for the first time. Speaking to OBG, Adnan Haroon, managing director of Universe Chartered Accountant, an audit, accounting and consulting firm, said it would take time for these businesses to adapt to the tax system. “Many small companies will not be aware of the new taxes and will not know how to go about paying them, as this will be the first time for many of them to do so,” he told OBG.
Haroon said the broadened tax base would not only bolster and diversify public revenue, but also develop small and medium-sized enterprises (SMEs), forcing them to keep proper records and accounts, thus improving their management and access to finance. “The more the economy is documented, the more opportunities banks and other financial institutions – including SME funds – will have to lend, which will be better for economic development and diversification,” he added.
Some others warn the rises could negatively affect investor sentiment. “The government must certainly generate more tax revenue, but it also needs to avoid deterring foreign direct investment inflows,” Mukhtar Hassan, chairman of local investment firm Al Barij, told OBG. “Focusing less on corporate taxation and more on consumption taxation would be a better tool when it comes to reaching these goals.” He argued that while the tax system is competitive in global terms, the country should work to compete with its regional neighbours, which generally operate low- or no-corporate-tax environments.
Sanjay Tiwari, acting CEO of Al Anwar Holdings, echoed this sentiment. “Though the recent increase of the corporate tax rate was necessary and relatively small, a major component of a country’s attractiveness is the perception of a competitive tax rate, and any increase in corporate taxes chips away at that perception,” he told OBG.
Contrary to this, Pankaj Khimji, director of Omani conglomerate Khimji Ramdas, said he thought the rises were the right decision. “Oman must move away from being a rentier state and start to collect taxes from individuals and businesses like other countries,” he told OBG, arguing that the increased rates would not reduce the country’s attractiveness to investors, given its high levels of security and infrastructure.
As part of more general regional plans to establish a harmonised consumer tax system, the government is also planning to introduce a value-added tax (VAT), at a rate of 5%. Observers estimate that the move should generate around $500m per year for the government. GCC countries initially agreed to implement a VAT beginning in January 2018, but this has been postponed in a number of member countries, including Oman. In late December 2017 it was announced that VAT would not be fully implemented in the sultanate until 2019. By mid-2018 it is expected that the tax will be applied to certain products.
As with the aforementioned increases in corporate taxes, Haroon said that VAT implementation would likely prove challenging for smaller enterprises. “Many companies are not geared up for it, and even with the delay, implementation will not be easy,” he told OBG. However, he said that Oman would be able to benefit and learn from the experiences of the UAE and Saudi Arabia in this respect – both of which successfully implemented the VAT law in January 2018 – and that such challenges would amount to little more than teething troubles.
The government’s ability to borrow and its borrower ratings are supported by substantial fiscal assets, which Moody’s estimated to be worth 67.9% of GDP at the end of 2016. These include two sovereign wealth funds: the State General Reserve Fund and the Oman Investment Fund.
The State General Reserve Fund is primarily focused on foreign investment and has assets estimated at about $18bn, according to the Sovereign Wealth Fund Institute. Meanwhile, the Oman Investment Fund works mainly as an anchor investor for major domestic projects, with estimated assets of $6bn. In April 2017 the authorities were reported to be considering a merger of the two funds, following a similar step taken by GCC peer Abu Dhabi.
The government has been considering partially privatising a portion of its assets to raise further revenue. In April 2017 it announced plans to sell stakes in several downstream subsidiaries of the state-owned Oman Oil Company, including an unspecified drilling unit and Salalah Methanol Company, via listings on the country’s stock exchange, the Muscat Securities Market.
In late 2016 the authorities announced plans to sell a 49% holding in Muscat Electricity Distribution Company through a combination of a stock market float and a private sale, but the following June it said that “regional economic conditions” were causing these plans to be reconsidered. Observers told OBG that such sales are likely to begin in late 2018 (see Capital Markets chapter). Other potentially promising candidates for such partial privatisation include national flagship carrier Oman Air – though this is unlikely to happen in the near term – and the 51% stake the authorities hold in the sultanate’s largest telecoms operator, Oman Telecommunications.
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