Breaking new ground: With already high credit ratings the sultanate stands to benefit from an enlarged debt market

Petroleum wealth in Oman means the government has little need to sell bonds, which is the primary reason a robust market for debt securities has yet to develop. While the sultanate does sell bonds from time to time, the amounts are usually small and there are no regular schedules for any instruments other than short-term debt used by banks to manage their books. However, the authorities are looking to develop a more mature and varied financial services sector and as part of that appear to be undertaking efforts to develop a public debt market.

Recognising A Need

A fully developed government system for bond sales could help lead to a corporate debt market, create greater competition in financial services, drive efficiency and innovation, and add resilience by reducing pressure on banks to be the dominant providers of credit. “It is now realised that deep and liquid financial markets play a key role in allocating resources in an efficient manner among competing uses in an economy, thereby contributing to productivity gains and higher economic growth,” according to the 2012 annual report from the Central Bank of Oman (CBO).

Talk of establishing a more robust bond market is nothing new. In 2008, for example, the IMF advised Oman to consider such reforms, though it did note a willingness to further enhance the government securities market. Several years later in 2011 the CBO commissioned an internal study on how this should be accomplished. In the resulting report, it was recommended that the government enact a public debt act and draw up a schedule for the regular issuance of Treasury bills and dated securities, among several other suggestions.

However, as of late 2013 it remained unclear the extent to which Oman is ready to change its approach to debt – though there were several indications that nurturing a debt securities market is higher on the agenda than ever before. One example is the government’s intention to sell US-dollar-denominated sovereign bonds in 2014. This would mark the end of an almost 20-year absence from international debt markets for the country.

Another instance of the move towards opening up markets is the increase in the issuance of development bonds. There have been four sales in 2012 and 2013, whereas in the late 2000s the market saw no sales for years. And with the introduction of Islamic banking and insurance, demand for sukuk, sharia-compliant bonds, is also expected to rise.

Room To Grow

The government’s total debt reached OR1.36bn ($3.5bn) in 2012, up 9.1% from 2011. As a percentage of GDP it declined slightly, from 4.6% to 4.5%. With one of the lowest debt-to-GDP ratios in the world, Oman enjoys a credit rating well above investment grade from the major ratings agencies and has plenty of room to borrow further without triggering any concerns about its ability to pay back its debt. In June 2013 Standard & Poor’s affirmed the country’s “A” rating for foreign currency and “A-1” rating for local currency, as well as maintained its outlook at stable. In September 2013 Moody’s Investor Service also maintained the sultanate’s “A1” rating with a stable outlook.

Most mature debt markets started out with government issuances followed by corporate bonds, as setting interest rates for bonds is based on measuring the risk of repayment. In almost any market the sovereign government is seen as the least risky borrower because it alone has the power to print money if necessary to pay its debts.

Determining the correct price for public bonds is determined by basic factors such as the country’s fiscal health and growth prospects. Pricing for any other issuer, be it a quasi-state agency, a city, province, or corporation, is based on how much riskier that agency is perceived to be in comparison to the sovereign. When investment banks charged with underwriting corporate bonds canvass potential buyers, they are looking to arrive at the right balance between the buyer’s perception of risk and the desired return, as well as the seller’s desire for a low cost.

This makes it important for a sovereign government that wants to encourage a robust debt market to issue bonds of many types and maturities on a regular basis, regardless of whether the money is needed or not. Having a variety of outstanding bonds provides more points for comparison, and therefore gives investors a greater ability to determine the risk of default. If the state chooses to sells bonds maturing in one, three, five and seven years, then all others entities can easily sell bonds at those maturities as the tools for comparison needed to figure out a fair return on investment are available. If the sovereign decides to see only one-year bonds, corporations that need to borrow over longer periods and investment banks will have more difficulty determining a fair interest rate. Potential buyers may even decide not to participate if there are no government bonds to serve as an easy benchmark, while others that do enter the market will likely err on the side of caution by demanding a higher interest rate to make up for the lack of pricing comparison. A bond market is considered an efficient one when sufficient sovereign bonds are floated for the country to establish a smooth yield curve.

Schedule Sales

Regular debt sales by the CBO are actually certificates of deposit (CDs) in small amounts and with short tenures. These are not aimed at portfolio investors but are intended to serve as tools for the central bank and the banking system overall. The CBO uses them to manage liquidity in the economy in order to head off inflation, and does so by offering CDs as a way to offers better returns than a savings account. CDs are sold weekly in CBO auctions and mature in 28 days. Buyers generally include the country’s banks, which use them as a short-term source of funds when balancing books. The excess of the deposit base not accounted for by loans or investments can be used when the bank lacks liquidity by selling back CDs on its balance sheet to the CBO. The central bank can also issue long-term Treasury bills, which can have maturities of 91, 182 or 364 days; however, as of yet no set schedule exists for their issue.

If Oman were to move forward on a plan to develop its debt markets, a regular debt schedule would likely start with issuing these three types of Treasury bills on a rotating basis, with one class of issue in a month for a three-month cycle. This would ensure that there would be four annual sales for each type of bond, staggered throughout the year. The country could then, according to the CBO’s study on the bond market, sell long-term securities with three-, five-, seven- and 10-year maturities, also on a monthly rotating basis. Such a schedule would provide a regular flow of sales. If the sultanate followed this system, corporations would have a point of reference for their own bond sales. Those wishing to sell bonds maturing in a year or less would have to look back no more than three months to find a recent government bond sale for base pricing, and for maturities of more than a year the comparison point would be four months or less. Eventually, a secondary-trading market could develop in which bonds’ value rose and fell on a daily basis, making pricing data even more up-to-date for corporate issues.

Investment Fund

In this scenario the government would be able to accumulate OR350m ($906.5m) in outstanding debt within a year and OR1.05bn ($2.72bn) at the end of five years. This is less than the current amount of outstanding debt, suggesting that the system could be implemented without weakening the country’s balance sheet or making existing creditors and ratings agencies nervous about Oman’s ability to repay. According to the CBO’s study and IMF recommendations, the receipts could be managed by establishing a fund to invest them in, with the proceeds aimed at covering the cost of interest from the bonds. That fund could also be converted into dollars and invested in a mix of developing and developed country securities or other assets. The government may elect to establish a parallel system and schedule for sukuk sales in order to facilitate a private sukuk market.

However, for 2014 the focus is likely to be on Oman’s return to the international debt market. Terms had not yet been set as of the end of the third quarter, but the issue was expected to be worth at least $500m. The last bond issued in 1997 was a $225m eurobond with a five-year maturity, and investors bought them at a premium of 73 basis points over US Treasury bills. The difference was small enough to underscore international perceptions of the sultanate as having a low risk of default. Darwish Al Balushi, Oman’s minister of finance, told local media in May 2012 that the sale was intended to develop the bond market. “This is not because of our immediate borrowing requirements but because we want to pave the way for the private sector,” he said. “We want to establish a benchmark.”