Oman’s economic environment has improved significantly
Published: 14/06/2017 12:00 pm
A review of Oman’s economic position in light of the S&P credit downgrade
Oman’s sovereign credit is rated by the Big three dominant credit agencies; Standard & Poor's (S&P), Moody Investor Services and Fitch Ratings. On May 12, 2017 S&P lowered Oman’s long and short-term rating to ‘BB+/B’ from ‘BBB-/A-3‘with a negative outlook. Moody’s rating update announced March 23, 2017 for Oman reiterated a Baa1/P-2 rating with a Stable outlook. imilarly, Fitch in January 2017 restated a BBB/F2 rating with a stable outlook.
S&P downgrade rationale
According to S&P, the rationale given for Oman’s downgrade is that Oman’s external buffers have weakened to the extent that they are no longer sufficient to mitigate the risk from volatile oil prices. S&P’s Negative outlook reflects their view that there is a potential for Oman’s income level, fiscal and external position to deteriorate beyond their current assumptions.
The consequences of a sovereign credit downgrade
A nation’s sovereign credit rating is one basis for establishing the interest cost of its borrowings. This is often reflected in the country’s sovereign bonds yields and prices. A lower credit rating usually translates to higher yields and lower prices. Also, sovereign bond yields are the basis for pricing most risky assets. For example the risk premium placed on equities is derived from the sovereign bond yields
The downgrade impact on markets
After a 19-year absence, Oman approached the inter-market sentiments improved markedly after that, as seen by the sharp continuous fall of the forward rate – currently at RO 0.0475 above the spot rate of RO 0.38501, well off the RO 0.170 peak in January 2016.
What market price action is telling us
In our view, one can establish a number of inferences from the muted market response to the downgrade:
1. S&P is the only credit rating agency that has downgraded Oman’s credit to ‘non-investment speculative grade’, while national bond market in 2016 and, over two tranches in June 2016 and March 2017, raised about RO3.5bn (US$9bn) debt to finance its fiscal deficit.
Following the S&P’s downgrade the yields on these sovereign bonds from the sultanate have remained mostly unchanged till date across maturities. Similarly the MSM30 Index marginally moved subsequent to the downgrade, with only a 0.6 per cent decline till date. Another market sentiment pointer worth observing is the 12-month forward USD/OMR exchange rate, which reflects market expectation of future exchange rates based upon a number of economic factors: interest rates, inflation, current account balances, government debt and economic stability.
The 12-month forward USD/OMR exchange rate reached its peak in January 2016 and both Moody and Fitch have reaffirmed their ‘lower medium grade’ rating earlier this year with a stable outlook
2. Market participants have anticipated a downgrade hence the news is already been priced into yields
3. Oil prices have recovered from their 2016 lows, consequently Oman is in a better economic position than 2016
4. According to Reuters monthly consensus poll of 35 analysts, crude oil price forecast for 2017 is US$57pb (as of April 28, 2017). Oman’s 2017 budget is based on a US$45pb oil price. This translates to a potential revenue surplus of US$12pb, if these forecasts materialise.
Oman’s current economic position
To put the recent downgrade into perspective we review some of Oman’s latest published key economic indicators:
Nominal GDP fell 5.1 per cent to RO25.5bn in 2016 compared to a double-digit drop of 14 per cent in 2015. Oman’s crude oil prices averaged US$40.1pb in 2016.
Oman’s Average crude oil prices rose 53 per cent to US$51.6pb YoY as of April 2017
Total sovereign debt (both local and international) is 32 per cent of nominal GDP (as of 2016). This is expected to increase to 49 per cent by 2022 before it starts to decline according to IMF forecast (as of April 2017)
Foreign trade account maintained a surplus but fell by 46 per cent to RO1.2bn in 2016
In 2015 current account recorded a deficit of RO4.1bn, which is 15 per cent of nominal GDP. According to the IMF this is expected to gradually decline from 2017, reaching levels of 6.6 per cent by 2022
As of 2016 net foreign assets1 are RO 3.6bn (FY2015: RO4.9bn), equivalent to approximately 4.9 months of imports (FY2015: 5.4 months). A rule of thumb usually followed by central banks is to hold foreign reserve equivalent to at least three months of imports.
Oman has foreign reserves of RO7.79bn in 2016 (30 per cent of nominal GDP), with an estimated sovereign wealth fund of approximately between RO7bn to RO10bn, nearly 2.5 times the projected fiscal budget deficit for 2017.
Our review of Oman’s economic position reveals that Oman’s economic environment has improved significantly in the last two years. We think this view is shared by investors too, as shown by the muted market reaction to the recent sovereign credit rating downgrade.
We believe some of the drivers of this change is cyclical (oil price recovery) and some structural/secular (Government policy/fiscal reform and regulatory/tax changes). We recognise that more is to be done in the area of fiscal consolidation.
For now, however, we believe that current austerity measures and structural reforms and the continued drive towards economic diversification are laying the groundwork for more sustainable spending and growth frameworks.