Tackling the threat of inflation in Oman

18 September 2008
While Muscat’s diversification strategy is fuelling an economic boom, the rising cost of living needs to be brought under control if its success is to be maintained.

As the smallest economy in the GCC, Oman’s progress is often eclipsed by the activities of its neighbours.

But the sultanate is starting to make headlines, with its diversification strategy creating a booming economy.

Successful diversification was behind the 12.9 per cent growth in gross domestic product (GDP) in 2007.

The non-oil sector grew by 18.3 per cent, raising the sector’s share of total GDP to 56 per cent.

Oman’s announcement that it was opting out of the GCC-proposed single currency last year further underlined its commitment to find its own path.

“We have different development goals to the other GCC states who have more oil reserves than us,” says Ali Hamdan al-Raisi, senior manager of economic research and statistics at the Central Bank of Oman.

“We do not want our fiscal policy to be tied up to some rigid convergence criteria.”

Hitting the budget deficit and public debt targets required to meet the single-currency convergence criteria were particular issues for Muscat, which is seeking to take up a fiscal expansionary policy by using some of its budget surplus to actively invest in the economy.

“Fiscal tightening and the associated decreased government spending is not an option for an economy that seeks to develop new sectors,” says Mary Nicola, economist at Standard Chartered Bank in Dubai.

Currency union

The possibility of Oman joining the proposed currency union at a later date has not been ruled out, however.

“The union’s framework can be developed together but we need more time,” says Al-Raisi.

“We need to enhance the GCC common market so that labour, capital and investment can move more freely.”

For the time being, Muscat will lose little by holding back on a single currency.

Trade between the states comprises only 7 per cent of total GCC trade, while for some member states, 90 per cent of exports are to countries outside the GCC.

“A currency union by itself does not increase trade numbers if it cannot build on an existing common market,” says Eckart Woertz, economics programme manager at the Gulf Research Center.

Irrespective of Oman’s decision, it is unlikely that the single currency will be implemented on time.

“I do not think it will be ready by 2010,” says Woertz. “They [GCC states] are too far behind the curve with simple organisational details, such as printing the new money and educating the banks.”

Creating employment

Economic expansion and job creation are Muscat’s priorities. In a country where one-third of the population are below the age of 15, providing employment opportunities is Muscat’s priority.

To date, the government’s ‘Omanisation’ strategy - to increase the number of nationals in the workforce through local employment quotas - is proving successful, at least on paper.

While the public sector continues to lead on Omanisation, the gap between the number of Omanis employed in the private and public sectors is closing.

There were 131, 775 Omanis working in the private sector by the end of 2007, an increase of 15.3 per cent from 2006.

However, the rapid diversification of the economy is triggering increasing demand for professionals with a level of expertise and experience that is rare in Oman. This, in turn, is leading to an influx of expatriates.

In 2007, the number of expatriates working in the sultanate rose by 25 per cent. In May this year alone, the number working in the private sector shot up by 11.2 per cent.

In common with its neighbours, Muscat is struggling with soaring inflation, which in May hit a high of 13.2 per cent.

This has reignited the debate over whether the sultanate should depeg the rial from the dollar.

Oman’s inflation is forecast to average 9.3 per cent in 2008, but differing opinions on the extent to which this inflation is imported have complicated policy-making.

“It is hard to achieve the balance between growing the economy and fighting inflation,” says Al-Raisi.

“It is a dynamic situation because we do not know what the government expenditure will be or the inflow of capital into the country.”

For the time being, Oman has reiterated its commitment to the dollar peg. Certainly, there seems to be less incentive for Oman to depeg compared with the other GCC states that have sizeable overseas assets and earn considerably more petrodollars.

While a weak dollar is contributing to inflation, it will boost Oman’s ambitious export plans. “If you are eyeing more manufacturing and export-oriented growth, an undervalued currency can give you a competitive advantage,” says Woertz.

Oman is taking steps to increase international trade. In January 2007, the US-Oman Free Trade Agreement came into force, establishing the sultanate as the only GCC state, other than Bahrain, to sign a bilateral trade pact with the US.

Aside from encouraging the flow of private sector money and foreign expertise to Oman, it lends further weight to its hopes of becoming a shipment hub, building on its extensive ties with Asia, which was the final destination for more than 70 per cent of Omani exports in 2006.

The sultanate’s domestic economic institutions have also been performing well.

The Muscat Securities Market (MSM) has produced impressive growth over the past five years, with the combined market capitalisation of MSM companies reaching $26.5m at the end of 2007, up from $5.1m in December 2002.

Despite being one of the smaller GCC stock markets in terms of market capitalisation, it is among the biggest in terms of the number of listed securities, with 134 listed companies and 115 closely-held companies.

This fact, combined with the Capital Market Authority’s recent legislative amendments, which require all listed companies to report quarterly and yearly earnings, has ensured that Oman’s capital market is today one of the most transparent and well regulated in the region.

Earlier this month, Oman topped an assessment of corporate governance in the Gulf published by banking group The National Investor (TNI) and the Institute for Corporate Governance (Hawkamah), both based in the UAE.

The report rates all listed companies in the GCC according to 43 parameters within three main areas: trading history, corporate communications and disclosure.

MSM has also outshone the other GCC financial markets by recording the highest growth in 2007, 61.9 per cent, mainly on the back of strong earnings growth.

“The growth was broad-based, with commercial banks registering 35 per cent growth in loans, industrial sector earnings growing by 20 per cent and the services sector by 30 per cent,” says Gigi Tharian Varghese, equity research analyst at Egyptian investment bank EFG-Hermes in Oman.

Recent figures show the number of traded shares increased to 734.5 million in June 2008, from 699.8 million in December 2007.

Strong earnings growth over the past couple of years has also drawn foreign investors to the market.

“Foreign investor trading volume in August 2008 was approximately 45 per cent of the total, testimony to the increasing interest of inter-national investors,” says Varghese.

In an effort to attract more international investors to trade on the bourse, MSM has also joined up with Dow Jones to develop two indices: the DJ MSM Composite Index and the DJ MSM Chip Index.

The Omani government has also been doing a commendable job in attracting foreign investment to the country through capitalising on oil revenue, addressing the skills shortage, and increasing infrastructure spending.

But despite this burgeoning liquidity, the MSM still lags behind markets such as Saudi Arabia’s Tadawul and the Dubai International Financial Exchange (DIFX). One of the key challenges facing the bourse today is a shortage of shares in which Omanis can invest.

Stock shortage

“We are working hard to create more liquidity,” says Suleiman bin Mohammed al-Rashidi, deputy director general of operations and market surveillance at the MSM.

“The shortage is a vicious circle because it means that people who buy shares tend to hold on to them for a long time.”

MSM is now trying to encourage both state-owned and Omani private companies to list on the exchange.

Family-owned businesses account for a huge share of the market in Oman but there are only four local family businesses listed on the MSM: Al-Hassan Engineering, Oman Holding International, Voltamp and Galfar Engineering & Contracting.

Privatisation of these family businesses has been successful.

When Galfar floated 40 per cent of its capital on MSM in October 2007, for example, each share was worth about 600 baisas. Today, they trade at 2.25 rials each.

With so many new projects coming on stream over the next few years, Oman’s economic growth is set to accelerate.

However, the current slowdown in global growth could have a significant influence on the performance and prospects of the domestic economy, especially on its export-led diversification.

Ensuring that the diversification strategy retains its momentum so the sultanate continues to hit its Omanisation targets is crucial for its continued prosperity.

Similarly, containing inflation while sustaining high growth will remain a key macroeconomic challenge for Oman in the immediate future.

Key facts

12.9 %

Oman's GDP growth in 2007

18.3 per cent

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