February 10, 2017

Oman’s Fiscal Management Problem

View of the seafront in Muscat, Oman (AP Photo/Christophe Ena)

Omani foreign policy is deft; its fiscal policy, however, is struggling. Balancing domestic pressures against necessary economic reforms is proving difficult. In foreign policy, Oman has managed to maintain favorable trade and political relations with both Iran and its Gulf Cooperation Council neighbors in a time of increasing tension. In fact, much of Oman’s economic development planning now consists of increasing trade and investment ties with Iran. Oman is increasingly reliant on ties with Iran to meet Oman’s infrastructure needs and to stimulate its non-oil sector. It is also reliant on the GCC for financial support, most notably in aid commitments since 2011. To maintain good relations with its GCC partners, especially Saudi Arabia, Oman has recently made a (nonspecific) commitment to join the Saudi counterterrorism alliance. Oman spends heavily on defense and arms purchases, ramping up spending considerably after 2011, yet has little ability or visible intent to use them, particularly in military operations abroad. There has been some slow down in military spending between the 2016 and 2017 budgets, consistent with broader spending cuts. Yet for its size and defensive posture in the region, the outlays are increasingly difficult to justify. Most notably, Oman refuses to be militarily involved in the Saudi-led operation in Yemen, though Oman has hosted peace talks. These foreign policy choices have been nimble and carefully made, yet the looming challenge Oman faces is domestic.

There were reports of protests on February 2, along with trade union pressure, in Oman over the rising price of gasoline. Gasoline prices have been subsidized by the government for years, but by 2015 the government began to reduce some subsidies with the mounting pressure on government revenue due to declining oil prices. Prices have fluctuated, still managed and at subsidized cost by the government, over the last year and a half.

Source: Trading Economics | Ministry of Oil and Gas

By February 8, the government bowed to protest pressure and capped gasoline prices at 186 Omani baisa per liter (about $.48), essentially making a commitment not to raise prices again, but not necessarily a commitment to return to pre-2015 prices. The subsidization of gasoline is just one link in a long chain of spending commitments (and possible areas of savings) the Omani government must evaluate as it faces the reality of diminished state oil revenue. As with all fiscal policy, there is some prioritization taking place, in where to make cuts and where to maintain promises. The problem is that there seems to be some significant discrepancies in the government’s estimation of its 2017 budget gap, and in its sources of foreign reserves. A recent report by Standard Chartered analysts estimates that official foreign reserves were $18.7 billion at the end of November 2016, up $1.2 billion from the end of 2015. The question is the source of these additional reserves, which is not explained by export receipts, debt issuance, or the use of sovereign wealth fund assets. In order to meet its projected spending needs, Oman is increasingly reliant on debt (both in international and domestic bonds and borrowing through loans); yet, its spending needs will continue to face a shortfall, with break even prices for Oman’s spending needs at about $80 per barrel. Analysts at Commerzbank have predicted that Oman has about two years worth of foreign reserves to meet its spending needs if oil prices continue to be in the range of $40 per barrel. Reserve assets are of course one source of funding, and the general trend among GCC states is to seek external funding through debt, privatization, or asset sales before using reserves. A continued debt cycle will eventually become very burdensome.

There is a looming gap in Oman’s fiscal planning for 2017. Projected spending cuts for the 2017 budget are likely insufficient to contain the deficit, which Standard Chartered projects at $7.8 billion or 12 percent of gross domestic product. One of the reasons why the deficit has grown considerably between 2015 and 2017 is that Oman’s official oil selling price was both discounted from the Brent average, and also lower than the government’s own budget target of $45 per barrel. If the government cannot move forward with cost-saving measures, and if it cannot secure alternate sources of revenue through loans and debt issuance, Oman will have to concentrate on boosting revenue through privatizations and new nonhydrocarbon revenue. Increases in taxes and fees are also expected, including the implementation of the GCC-wide VAT in early 2018. New debt could account for as much as 70 percent of Oman’s deficit financing needs in 2017.

Oman finds itself at a crossroad, mainly in its mechanisms of financial governance, which of course relate directly to its state-society relations. If continued protests derail spending cuts, the government will be pushed to finance its spending via debt and asset sales, which are not long-term development solutions. Increasing fees and taxes and the cost of currently subsidized services like electricity and water provision will require some delicate political maneuvering in the domestic sphere. Scholars have long argued that control over fiscal policy, especially the ability to fund military and security needs, and plentiful social spending are key sources of regime stability. If fiscal policy is consistently threatened by domestic protest, and limited funds, there will likely be some political consequences.

Market Watch is a blog conceived by AGSIW Senior Resident Scholar Karen E. Young seeking to provide insights from the crossroads of Gulf politics and finance.