Oman: Lower crude revenues have left Oman’s finances in a precarious position and while spending cuts and additional taxes will help narrow its soaring budget deficit, the sultanate could require support from its Gulf neighbors unless oil prices rebound.

The coronavirus disease (COVID-19) pandemic has roiled Oman’s economy, with real gross domestic product (GDP) poised to shrink 5 percent this year, according to S&P Global Ratings. Gross government debt will soar to 84 percent of GDP in 2020 from 60 percent in 2019, S&P estimates, predicting oil prices will average $50 next year and $55 in 2023.

“Oman needs the Brent price to rebound to above $60 per barrel to reach a comfortable fiscal zone,” said Fabio Scacciavillani, a partner at Dubai investment bank Emintad and former chief strategy officer at Oman Investment Fund.

“Until the oil price exceeds $80, Oman won’t be completely out of the woods — it’s really as simple as that. In essence, until the oil price reaches Oman’s fiscal breakeven level, its debts are poised to swell further.”

Hydrocarbons provide 35 percent of GDP, 60 percent of current-account receipts and 75 percent of fiscal receipts. Oman’s oil production in November averaged 720,789 barrels per day (bpd), just above its quota as part of the OPEC+ cuts that crude exporters agreed in April in response to dwindling demand and tumbling prices.

Such price and production levels have weakened Oman’s already fragile finances, with government income down by one-fifth in the first seven months of 2020. The sultanate has borrowed internationally and spent some of its foreign reserves in order to fund a budget shortfall that has worsened over the past half-decade; Oman’s combined fiscal deficit from 2014 to 2019 was 20 billion rials ($52 billion) as government debt soared from 1.5 billion rials to 17.6 billion rials over the same period.

Oman’s fiscal deficit will double to 18 percent of GDP in 2020, from 9 percent in 2019, according to S&P and Fitch Ratings.

“That’s a very difficult starting position and even substantial reforms and spending cuts will only bring the budget deficit down to 11.3 percent in 2022,” said Jan Friederich, senior director, sovereigns, at Fitch Ratings.

This year, the major credit ratings agencies — S&P, Moody’s, and Fitch — each downgraded Oman by two notches. Oman’s 2020 to 2024 fiscal plan, published in November, warned that further downgrades were likely over the following six to 12 months unless the country did more to narrow the gap between its income and expenditure. Oman has $10.7 billion of external debt maturing in 2021 to 2022.

“Most likely markets will demand higher interest rates thereby impacting on the debt servicing costs,” said Scacciavillani.

In the Gulf, the single-most important indicator for sovereign creditworthiness was sovereign net foreign assets, said Friederich.

“Oman’s position has turned negative because it has substantial debts and no longer has the large asset positions it did several years ago,” he added.

The country’s interest payments jumped from 35 million rials in 2014 to 1 billion rials this year, according to the fiscal plan which acknowledged that debt servicing costs had hit “unsustainable” levels.

The current account deficit was pressuring Oman’s foreign reserves and the rial’s dollar peg and maintaining the peg could depend on support from Oman’s Gulf neighbors, said Friederich.

“For the lower-rated (Gulf) sovereigns — Bahrain and increasingly Oman — the stability of the peg comes down to the belief of markets that other members of the GCC would stand behind them,” added Friederich.

Fitch believes Oman will receive sufficient support to maintain its access to capital markets, although its economy is around twice the size of Bahrain’s, so “continuously bailing out Oman will start to become a fairly costly exercise for other GCC members,” he said.

Sultan Haitham bin Tariq al-Said, who became ruler in January, has enacted wide-ranging reforms since assuming power. These have included so-called fiscal consolidation measures to cut the government deficit and reduce its debts, merging Oman’s two main sovereign wealth funds, and bringing all government-related entities, aside from the state oil company, under the control of the newly launched Oman Investment Authority (OIA).

Oman aims to increase government revenue to 12.1 billion rials in 2024 from 8.6 billion rials this year. This would reduce the fiscal deficit to 1.7 percent of GDP in 2024, the government has predicted.

Muscat also plans to reduce its 1 billion annual subsidy bill so that only “vulnerable” and “deserving” people receive such support, with electricity and water tariffs set to increase further. The fiscal plan noted that further spending cuts would have a “temporary socioeconomic impact,” but predicted the measures would bolster economic activity, foreign and domestic investment in Oman, and create jobs.

The government has streamlined its processes, slashing the number of days it takes to open a business and obtain labor visas for foreign workers. Housing fees have been cut to 3 percent from 5 percent and the laws around foreigners owning property have been relaxed. Oman also now allows citizens from more than 100 nations to enter the country visa-free.

“Reliance on oil and gas for income and insufficient past savings limit the extent to which Oman can stimulate the recovery,” said Scott Livermore, chief economist and managing director at Oxford Economics Middle East.

In order for foreign capital and private companies to invest in Oman, the labor market must become more flexible, while the education system must better equip young Omanis with skills to compete globally, Scacciavillani said.

“These are politically hard choices: The policy recipes to jumpstart the private sector and diversify aggressively the economy have always been well known, (but) while oil prices were high enough to pay for Omanis’ wellbeing these measures never became a priority,” he added.

To diversify state income, Oman will introduce a 5 percent value added tax (VAT) next April 2020, although 90 basic products will be exempt along with healthcare and education. As well as raising product and services prices, VAT also imposes a sizeable administration and accounting burden, especially on small businesses, Scacciavillani said.

“VAT is a way for Oman’s government to diversify and increase its revenues, so for bondholders it’s a positive development as it will enable the state to raise taxes flexibly and quickly if the need arises — for example, VAT might increase to 10 percent temporarily if the oil price doesn’t rebound substantially,” he added.

The government also plans to introduce income tax for higher earners, which would be the first time it had been levied in the GCC.

“An income tax creates a subtle political problem. In the Gulf, foreign workers do not receive public services such as education or healthcare, but if you introduce an income tax can you continue to exclude them from these services?” said Scacciavillani.