Muscat’s policymakers are intent on pushing through an ambitious project pipeline worth close to $100bn, even if that means eroding the government’s fiscal comfort zone.

While the sultanate has one of the region’s highest level of budget breakeven oil prices, estimated at $105 a barrel, it is likely to avoid near-term cuts in spending, although some rationalisation is likely next year if oil prices stay at their current levels.

Analysts predict growing pressure on public finances in 2015-16, given the sovereign’s continued strong reliance on hydrocarbons as a source of economic growth and income generation.

US ratings agency Moody’s Investors Service sees Oman’s fiscal deficit widening from 2015 onwards as hydrocarbons-related revenues drop by more than 40 per cent this year. Moody’s forecasts that Oman’s GDP growth will slow to about 3 per cent over 2015-16, down from the 4.9 per cent average between 2005-14. This is attributed to pressure on the oil and gas sector. The industry accounted for 48 per cent of nominal GDP on average between 2005-14.

Growing deficit

The Washington-based IMF sees Oman’s fiscal deficit reaching 14.8 per cent of GDP this year, and remaining in double-digit territory over the medium term in the absence of fiscal reforms. More spending discipline, however, should contain the shortfall at 11.6 per cent of GDP. This compares with a significantly smaller deficit in 2014 of 1.5 per cent.

The 2015 budget, released at the start of this year, forecasts that public spending will rise by 4.5 per cent, leaving a deficit of RO2.5bn ($6.5bn). However, this is likely to be exceeded. National Bank of Kuwait (NBK), in a research note on Oman’s economy, forecasts a deficit of RO4bn, given that oil prices are lower than official projections by more than half; also, spending should remain elevated in pursuit of the sultanate’s development goals, and politically sensitive expenditures maintained.

Absent any meaningful expenditure cuts, the deficit will be about 12 per cent of GDP

Steffen Dyck, Moody’s Investors Service

The question is how sustainable this will be if oil prices do not recover their former strength.

The IMF for one appears wary. Earlier this year, it issued a coded warning that without further adjustment, financing the projected cumulative fiscal deficit between 2015 and 2020 would exhaust fiscal buffers and raise debt to about 25 per cent of GDP, or increase government debt to more than 70 per cent of GDP by 2020 if buffers were to be preserved.

Although Oman’s sovereign balance sheet is strong, mitigating pressures from lower oil prices, this position will deteriorate as sovereign wealth funds are drawn down. 

Some legroom

That is not to suggest an immediate crisis faces Muscat. “Oman’s debt-to-GDP ratio was less than 5 per cent last year, so even if they issue more debt it will still leave it at a low basis compared with other regional economies,” says Steffen Dyck, a sovereign analyst at Moody’s.

“Absent any meaningful expenditure cuts, the deficit will be about 12 per cent of GDP and that already takes into account lower subsidy payments and some rationalisation of public spending,” Dyck tells MEED. “We expect revenues will be lower by about 35 per cent this year, mainly driven by the drop in hydrocarbons revenue as these account for the largest share of revenues, at more than 80 per cent. Non-oil revenues on the other hand are small.”

In addition to drawing on its reserves and accessing donor grants, the government will likely seek funding from debt markets and international lenders, taking advantage of its low debt levels and healthy credit rating to support spending, predicts NBK. The Central Bank of Oman plans to borrow at least RO600m this year on behalf of the treasury, and government development bonds have already reached RO500m in 2015.

A mooted debt sovereign sukuk (Islamic bond) issue – initially expected in mid-2015, but which had yet to materialise by September – would raise another RO200m. The government is looking to encourage local financial institutions to participate in the sultanate’s development process, especially in building major infrastructure projects.

The difficult conditions in recent years have forced a steady rise in spending from historic levels, with the IMF noting that public expenditure grew to an estimated 50.3 per cent of GDP in 2014, from 36.5 per cent in 2010. Domestic banks have expressed interest in helping to finance projects.

Other means of raising much-needed funding for critical economic projects would be to consolidate the RO2bn-a-year subsidy reduction programme, particularly energy subsidies, which account for about three-quarters of the total. Muscat has already eliminated some gas subsidies to industrial producers, doubling prices charged to them, and more cuts are being eyed in other areas such as consumer goods.

The government is also looking to release privatisation proceeds, with the mooted sale of state-owned refiner Oman Oil Refineries and Petroleum Industries Company (Orpic).

There is more that Oman can do to limit expenditure. One option is to keep down costs related to government jobs and hold off salary increases, although this is a sensitive subject following the protests and strikes of 2011-13.

“There’s been a big increase in the public sector workforce in the past three years, and they will avoid triggering a social backlash in what they do,” says Dyck. “But they could think about a more targeted subsidy regime, along with capping the growth in the wage bill, and some renegotiations over the procurement of goods and services.”

Public jobs

The IMF has urged limiting the increase of public jobs in civil and defence services, and keeping the growth in government employee compensation constant in real terms. In addition, a rationalisation of defence spending would also generate savings. Some cuts have been seen, such as a reduction in government aid to Oman Development Bank, which is funding several schemes.

[Muscat] continues to make the case that continued capital spending is necessary

Steffen Dyck, Moody’s Investors Service

Undertaking these reforms in a phased manner and preserving room for capital expenditures would limit the downward drag on growth, the IMF said in May.

For now, however, there is still some tentativeness in the authorities’ response to the fiscal pressures confronting Muscat.

“The main attitude across the region has been one of let’s wait and see what oil prices do,” says Dyck. “But Oman has a cushion to continue spending, and they continue to make the case that continued capital spending is necessary.”

Certainly, capital spending outlays will not be easy to downscale, should the pressure on the state prove too much. Compared with previous periods of low oil prices, Oman’s project portfolio is large, although not excessively; many of the diversification schemes centred on the Sohar port have been completed.

“A lot of capital spending is allocated in infrastructure, which is necessary to complement the government’s diversification strategy,” says Dyck. “Duqm special economic zone and the national rail plan are important projects that will support economic diversification.”

One source of potential financing that has so far remained untapped is the $10bn that sits in the GCC development fund, created in 2011 by Saudi Arabia, the UAE, Qatar and Kuwait to provide support to Oman and Bahrain during the recent regional unrest.

The fund will disburse that $10bn over a span of 10 years, targeted at development schemes, but none of this funding has been drawn down yet. However, the proposed national rail project – which is part of a broader GCC-wide network – presents an ideal candidate.

Local banks will inevitably also play a role in helping to fund schemes. Omani lenders have sufficient liquidity to meet private sector credit demand, with credit growth of commercial banks rising sharply this year. Central Bank of Oman figures showed this increased by 10.6 per cent to RO17.5bn in the period to the end of April 2015.

But doubts remain about how much capacity there is among lenders to support the full range of projects. Lower oil revenues have caused government liquidity to fall as governments draw down on their deposits in banks.

Central Bank of Oman executive president Hamood bin Sangour al-Zadjali has said Muscat expects to seek finance from regional and international markets. Up to $30bn might be required to finance Oman’s public and major projects in the next 10 years. An inter-ministerial finance committee has been established to coordinate borrowing and smooth out the process.

Development financing

Banks have shown willingness to step up to the plate. In September 2015, local players BankMuscat and Bank Dhofar provided development financing for a $275m loan for UAE-based Saraya Holdings. The firm is developing the $600m Saraya Bandar Jissah tourist resort in northeastern Oman, for completion in 2017.

There is a steady flow of schemes being awarded that will need financing. Of the RO3.2bn the government intends to invest in 2015, more than half will be geared towards non-oil projects. Regional projects tracker MEED Projects says contracts worth almost $14bn in total could be awarded in 2015, which is only slightly down on the figure in 2014.

Priorities will now not focus so much on the industrial hardware, but on areas such as healthcare and education. Oman has a growing need for expanding schools and hospitals. Power is another area where more spending is required.

According to NBK, although slightly less than 2014’s spending, as weaker revenue prospects may streamline investments, the forecast is in line with past expenditures and reaffirms the government’s commitment to implementing its stated development plans. 

The progress of public and private investment will therefore continue in 2015, particularly in the Duqm special economic zone, which includes the construction of a port, a logistics hub, an airport and tourist infrastructure. The national railway project is another key scheme. Oman’s Transport & Communications Ministry has already prequalified 17 groups to bid for the conventional scope of the network.

New industrial projects such as the Liwa Plastics scheme will figure prominently in projects spending this year. Banks are preparing proposals to take part in the financing of the $5.2bn project, which is to be the country’s first steam cracker, leading to output of a range of products and providing opportunities for downstream industries. 

The government’s backing for Liwa makes this an attractive scheme for lenders. Orpic plans to provide 30 per cent equity and raise 70 per cent of the project costs through debt. This implies project finance of more than $3.6bn will be required. Banks are submitting offers individually and Orpic will allocate tranches based on the interest rates they offer. Orpic signed a $2.8bn financing deal to support the expansion of the Sohar refinery in May 2014. It also closed a $909m loan from a consortium of mainly local banks in May to finance future growth.

Infrastructure schemes

In infrastructure, water and electricity will continue to demand at least $1bn-worth of capital investment annually. There is also a huge road scheme in the shape of the Batinah Expressway project, which is budgeted at $3.9bn. This will stretch for 265km to the UAE border, and should be completed by 2018. State-owned Haya Water is also planning to invest RO1.25bn on projects to improve and expand Oman’s wastewater network.

The Omani government is present across a range of sectors and, although spending is likely to slow down in 2016, it is unlikely to make any rash or unexpected moves. The emphasis will be on making more efficient use of the money available, rather than cutting carefully planned and mission-critical projects off in their prime.