Open to change: The government is working to ensure the economy continues to diversify

The sultanate’s economy continues to enjoy the benefits of its petroleum wealth, which has provided budget surpluses in most years and served as a backbone for growth. Planning is well under way for an era in which oil will not be the main economic driver, with the twin goals of diversification and creating more private sector jobs at the top of the government’s agenda. Increased and specifically targeted government spending is now expected to help create new opportunities. In 2014 the economy is set to continue on its current pace of growth, and proactive regulation in the financial services sector is intended to boost access to credit in segments where it is most in demand.

Oman has been successful at turning its oil wealth into broad-based economic growth. The country began exporting petroleum in 1967 and the revenue has been used to help the sultanate develop from a poor country into a middle-income one. While there were only a few paved roads when oil and gas production began, the country now has excellent transportation infrastructure. By spending petroleum revenue on public assets that will generate more opportunities, Oman is able to build facilities up to international standards in order to capitalise on this potential in a variety of sectors, such as tourism, shipping and logistics.

Facing The Future

Yet, the government is aware that hydrocarbons reserves will not last as long as elsewhere in the region. Oman’s oil reserves-to-production ratio, which measures how long resources will last at current production rates, is at 16 years, although exploration and enhanced oil recovery (EOR) could push this further. The cost of production is high, in a regional context, because of the country’s geology. Oil is spread out across many minor fields instead of in one major one, and most of these productive fields and prospective deposits are in mountainous areas.

However, spending the receipts from this limited petroleum wealth has translated into more developed infrastructure and social services, such as education and health care. The government is also investing in the workforce, with the expectation that eventually the private sector will replace oil as the mainstay of economic growth. Long-term data support the visible and anecdotal measures of progress: non-oil activity accounted for 50% of GDP in 2000 and 70% in 2012, according to a 2013 report by Qatar National Bank (QNB). For the time being, however, oil wealth remains the major catalyst in the Omani economy and creates budget surpluses in most years.

Grassroots Participation

Small and medium-sized enterprises (SMEs) have been identified as a group of particular importance. SMEs are expected to provide jobs for nationals and serve as a platform for Omanis to start their own ventures. The country’s geography, labour laws and the mix of raw materials available locally make this a greater challenge than in most economies. There is limited scope for SMEs that benefit more as participants in a value chain, providing semi-finished goods to larger manufacturers or industries. Instead, areas of high potential in Oman’s SME segment include construction; a variety of service sectors, such as tourism or supplying equipment and gear to the energy sector; health care; and trading. The definition of an SME in Oman has been split into three categories by the government. Firms with five employees or less and an annual turnover of under OR25,000 ($56,980) are classified as microenterprises. The small enterprises category includes firms with between five and nine employees and a turnover of OR25, 000-250,000 ($56,980-647,500). The definition of medium-sized enterprises in Oman includes companies with between 10 and 99 employees and annual turnover ranging from OR250,000-1.5m ($647,500-3.8m).

For foreign investors and locals alike, there are practical considerations that must be taken into account due to the current focus on SMEs and expanding in private-sector employment for Omanis. In most sectors of the economy there are proscribed caps on the number of expatriates that can be hired, commonly referred to as Omanisation rates. Increasingly, contractors who win tenders for large-scale public-sector projects are also expected to favour Omani-owned and controlled SMEs when hiring subcontractors. In 2014 one of the more specific government directives designed to help SMEs will feature incentives and regulations that boost their access to credit from Omani banks, as well as foreign bank branches operating in the sultanate.

One of those moves comes from the Central Bank of Oman (CBO), which regulates lending. It has mandated that banks must dedicate 5% of their outstanding credit to SMEs by the end of 2014. Until recently SMEs have typically been serviced by non-bank financial companies that follow an asset-backed lending model, and the CBO’s decision to require banks to increase their participation in this market should create greater competition. Furthermore, it could also spur loan growth across the banking sector not only by the increase in lending to SMEs, but also by pushing more banks to consider lending to other types of borrowers. Banks that are facing across-the-board rises in lending may therefore end up looking for foreign investment to boost their capital bases (see analysis.) PLANNING CYCLES: Oman’s current economic focus is rooted in long-term planning. The sultanate has been mapping out its economic development strategy in five-year cycles, and has already started its eighth five-year plan for 2011-15. The major targets include a floor of 3% GDP growth on an annual basis with inflation rising no more than 4%. Public investment is outlined at OR30bn ($78bn), a 113% leap over OR14bn ($36.26bn) for the seventh five-year plan for 2006-10. At the time of the plan’s approval in early 2011 annual revenue in the relevant period was expected at OR7.5bn ($19.4bn) and spending at OR8.5bn ($22.01bn). Revenue was based on oil production targets and oil price assumptions lower than what has transpired since then, which has provided budget surpluses and additional safeguards against any potential deterioration in economic conditions. Since 1996 the five-year plans have been designed to comply with Vision 2020, an economic-planning strategy that outlines the country’s long-term outline for economic diversification, labour-sector development and other key goals.

Overall real GDP growth in 2012 is estimated at 5% by the IMF, up from 4.5% in 2011, while the pace of expansion outside the oil sector was 5.8%. By sector, oil accounted for 49% of GDP and gas 3%. The services sector accounted for 33%, manufacturing 10% and construction 5%. According to Oman’s economic goals, outlined in Vision 2020, oil and gas together should account for 19% of GDP by 2020, with services at 46.9%, industry at 30% and agriculture at 5%.

Still Central

Oman’s proven reserves of oil are estimated at 5.5bn barrels, according to BP’s “2013 Statistical Review of World Energy”. The country produced 900,000 barrels per day (bpd) in 2002, and 922,000 bpd in 2012. This rise in production indicates that the increased share of the non-oil sector in the economy is due to growth in those segments rather than as a result of a contraction in the oil sector. Oil production had indeed slumped for most of the early 2000s, before a concentration on EOR techniques reversed this trend. Production bottomed out in 2007, at 713,000 bpd, BP figures show, but has climbed every year since then. As of early 2013 there were 18 upstream operators, eight of which had reached the production stage.

Petroleum Development Oman (PDO), the government-owned upstream explorer and producer, accounts for 70% of crude oil and gas production. The state owns a 60% stake and main minority investor Shell has a 34% share. France’s Total also owns 4%, followed by Partex of Portugal with 2%. The company’s ownership structure makes it the largest foreign investor in Oman.

New Balance

Looking ahead, it seems that the potential is greater for gas production than for oil. Natural gas reserves are estimated at 900bn cu metres, and daily production in 2012 was 29bn cu metres, up from 26.5bn cu metres in 2011. BP’s Block 61 in central Oman containing the Khazzan-Makarem gas fields is considered among the region’s largest deposits of tight gas, which is found in dense rock formations with compacted rock or sand and from which gas is difficult to extract. Exploration continues and the fields’ potential has been estimated to be 28.3bn cu metres. As gas becomes available, the energy industry itself is expected to be a major customer. EOR efforts to boost oil production are gas intensive, as are the electricity and water desalinisation sectors. Oman is currently importing 5.6m cu metres of gas per day from Qatar. As of early 2013, according to QNB, 55% of gas production in Oman was exported as liquefied natural gas (LNG), 22% went to generate electricity and to power industry, 12% was used for upstream oil and 10% flared.

Foreign Investment

Oman is increasingly open to foreign investment, although relevant legislation mandates that foreign entities working with an Omani partner cannot have an ownership stake that exceeds 35%. Exceptions can be sought and are granted when the investment is considered to involve national interests. Foreign bank branches, for example, can be wholly owned. Other exceptions include entities from the GCC and the US, both of which have free trade agreements with Oman that override local ownership rules. However, ownership of real estate is strictly prohibited, save for some tourism developments in Muscat in which foreigners can own apartments or villas.

Oman’s overall ranking in the World Bank’s “Doing Business 2014” survey remained steady at 47th, unchanged from its ranking in 2012 and 2013. The average “Ease of Doing Business” ranking for the Middle East and North Africa (MENA) region is 107. In terms of more specific categories, Oman’s “Access to credit” ranking dropped three spots from 83rd in 2013 to 86th in 2014; however, this still marked improvement from 98th in 2012. The category includes legal protections, transparency and other factors used in calculating credit risk. The sultanate’s ranking slipped slightly in the “Starting a business” subcategory for the time, dropping from 73rd in 2013 to 77th in 2014, though the number of procedures and days required to open a new business remained constant at five and eight, respectively. Whilst the Ministry of Commerce and Industry reports a turnaround time of one day for 95% of new companies registering, a country report by the US Commercial Service found that foreign investors have faced significant delays in some cases.

Oman’s global ranking was also steady in the World Economic Forum (WEF) “Global Competitiveness Report 2013-14” at 32nd. The WEF’s analysis of Oman’s economy and future objectives echoes that of the government: current public spending on infrastructure and social areas should create jobs and foster the continued nurturing of the private sector. “Emphasis has been placed on improving standards and quality of basic education,” the WEF’s researchers concluded in the “Arab World Competitiveness Report 2013”.

The final report also noted the need to continue on the path of reforms in education, highlighting mathematics, science and management as fields where curriculum improvement is needed, as well as noting that enrolment rates in post-secondary schools remain low.

Total foreign direct investment (FDI) reached OR6.48bn ($16.7bn) as of the end of 2012, up 9.6% from OR5.9bn ($15.2bn) at the end of 2011, according to data released in June 2013 by the National Centre for Statistics and Information (NCSI). Of that total 46.4%, or OR3.07bn ($7.95bn), went to the energy sector; 18.3%, or OR1.34bn ($3.47bn), to manufacturing; and 15.5%, or OR914m ($2.36bn), to financial services. New FDI jumped 41% year-on-year (y-o-y) in 2012 from OR404m ($1.04bn) to OR570m ($1.47bn). The UK was the largest foreign investor in 2012, as well as being among the top two investors in the energy sector along with the US. FDI in manufacturing and construction comes primarily from the UAE and India.

Key Indicators

Oman’s economy at the end of 2012 looked primed for further growth. GDP has been rising at a steady pace, with inflation remaining low at 2.9% in 2012 compared with 4% in 2011, and projected at 3.1% in 2013 by the IMF. According to the NCSI, in the second quarter of 2013 inflation rose 1.2% y-o-y, but decreased 1.1% from the first quarter of 2013. External threats of inflation in particular are low as costs worldwide have come down for the commodities Oman commonly imports. For instance, the sultanate is particularly vulnerable to international price fluctuations in foodstuffs because of the limited scope of domestic agriculture (see Agriculture chapter). Food comprises nearly 30% of the country’s consumer price index (CPI) and is first among nine categories. The second-largest category, at 22%, is transport and communication, followed by housing with 21%.

Monetary policy in Oman follows that of the US Federal Reserve because the Omani rial is pegged to the dollar. The exchange rate was set at $1:OR0.3845 in 1986. Government debt stands at 5% of GDP, one of the lowest debt ratios worldwide. Through frequent budget surpluses, the sultanate has been able to reduce the figure from 17% of GDP in 2002. According to QNB’s report, foreign exchange reserves stood at $14.3bn at the end of 2012, which is enough to provide cover for seven months of imports and more than twice the IMF recommended minimum of three months.

The energy sector is the biggest contributor to the country’s current account surplus. Spending on imports counters that trend, and costs for imported goods are rising. Omanis themselves can now afford more imported consumer goods and the sultanate is currently undergoing an infrastructure boom, which means importing more equipment, materials and labour. The surplus was 4.5% of GDP in 2012, according to IMF data, down from 9.1% in 2011. Exports grew 8.9% a year from 2008-12, a rate that includes a contraction in 2009, according to QNB. In 2012 Oman saw record growth in exports, which increased by 13% to $53bn, up from $47bn the previous year. Of this total, about 61% came from oil, 8% from petrochemicals and 7% from LNG. Metals and minerals comprised 6% and re-exports accounted for 14%. Imports reached a high as well, valued at $29bn in 2012, an 11% increase from $24bn a year earlier. The compound annual growth rate of imports in the past five years is 5.8%, according to QNB.

Labour

Over time the development plan includes more jobs in the private sector; however, in 2011 the government announced a payroll increase in the public sector. The sultanate said it would add 50,000 new jobs, 35,000 of which would be in the public sector. About 90% of government jobs go to Omanis, whereas in the private sector the pattern is reversed as nearly 90% of positions are filled by expatriate workers. Actual figures vary because of frequent inflows and outflows of workers as construction projects begin or end. However, the private sector accounted for 82% of employment opportunities, according to QNB’s report. The number of Omanis working in the private sector has climbed 32.2% in the five-year period from 2007 to 2012, going from 131,775 to 174,441, according to figures from Muscat-based firm Gulf Bader Capital Markets. As of July 2013, the figure was 177,143 and has plateaued. This trend may continue in the short term because of the 2011 increase in public sector positions, particularly in policing and security.

The government has also raised the minimum wage for Omanis. This has been done in two increments that have more than doubled take-home pay. The first hike came in mid-2011, when the minimum monthly salary was boosted from OR140 ($362.60) to OR200 ($518). In July 2013 this was further increased from OR200 ($518) to OR325 ($841.75). The impact on Oman’s economy has yet to be fully felt, but is likely to be noticeable in 2014, in particular in the financial sector. Omanis who recently joined the government, as well as nationals that benefit from higher wages, are likely to be seen by banks as excellent candidates for loans.

2013 Budget

Government projections estimated that revenue in 2013 has risen 27% to OR11.2bn ($29bn), from OR8.8bn ($22.8bn) in 2012. Of that total, nearly 84% is identified as coming from oil and gas. The forecast is based on an average price of $85 per barrel, according to KPMG. Oman’s oil-price assumptions for budgeting purposes are conservative and most often result in a budget surplus at the end of the year. In 2012 the assumed price was $75 and the actual realised price was $109. Typically, some of that windfall is set aside to cover planned deficit spending in the next budget cycle. According to KPMG, OR1bn ($2.59bn) from the surplus for 2012 will be applied to that total. However, the accounting firm’s calculations found that as long as the price per barrel remained above $104, revenues in 2013 would match expenditures. Deficit spending in the 2013 budget was estimated at OR1.7bn ($4.4bn) – 15% of revenue and 5% of GDP.

Public expenditure was expected to increase to OR12.9bn ($33.4bn), a hike of 29% over OR10bn ($25.9bn) in 2012, as the government plans to continue expenditures intended to make its economic vision a reality. This includes a 30% jump in costs for infrastructure, 16% more for social security and welfare, as well as for education, and a 32% increase in health care spending. Health care is expected to be a fast-growing area of the Omani economy, and one of high potential for entrepreneurs and SMEs. Omanis working in the private sector are increasingly given medical coverage through group health insurance plans arranged by their employers. Government workers are covered by the public health system, and it is anticipated that there will be a growing demand from this segment for access to the expanding network of private facilities, perhaps through additional coverage options now available.

The 2013 budget is generally seen as representative of Oman’s approach to public expenditures for the medium term, as well as the long term. The strategy is to continue spending on both hard and soft assets that will create the conditions needed to help the private sector develop and empower more Omanis with the skills to take advantage of opportunities. According to IMF estimates, in the 2014-18 period public investment will support growth in the non-oil economy of 5.4% annually. Additional tax receipts may also contribute to revenue diversification. Taxation is not currently a significant source of government income as individuals are not taxed, but corporations are taxed on income earned from activities abroad.

The GCC has considered a plan to implement a value-added tax across its six member countries, although a timeline for implementation is unclear. In Oman the government also intends to realise more tax revenues through the Ministry of Finance’s formation in 2012 of a new unit of tax inspectors that will ensure greater compliance among large taxpayers.

Building Up

Infrastructure is a key element of Oman’s growth plans, as well as a prime opportunity for foreign investors through the tendering process. As much as $65bn in contracts are to be signed through tenders between 2013 and 2017, double the pace in the previous five years. A key highlight is the national railway construction programme. Oman’s railway project is being developed as part of the planned GCC-wide network. Plans include 2244 km of track for both passenger and freight transportation. In August 2013 Italy’s state railroad engineering and consulting company Italferr was awarded a $37.3m contract for the preliminary design of the railroad, and in the same month five companies submitted bids for the project-management role: US firms Parsons Brinckerhooff, Hill International and Parsons International, Tecnicas Reunidas of Spain and South Korea’s Dohwa Engineering.

At a conference for potential bidders in Muscat in September 2013, the government announced that the first segment was to be built in 2014 and would entail a 171-km-long section from Sohar, north of Muscat, to Oman’s border with the UAE. From there it will eventually link up with the GCC-wide network, providing faster and cheaper overland routes to markets for Omani goods. It could also turn Oman into a transit hub for regional exports. Shippers that prefer to avoid the Strait of Hormuz could unload shipments destined for other GCC countries at an Omani port, transferring them to rail cars to complete the trip overland.

Other opportunities through government tenders outside the infrastructure market will come from a variety of state ministries and agencies, with some of the larger ones including industrial facilities such as an expansion of the Sohar steel plant and an oil-and-gas processing plant in Musandam. With regard to tenders in any sector, foreign investors may wish to pay close attention to changes in the oil and gas market intended to promote the increased use of Omani labour and subcontractors. These changes could eventually influence tendering across the spectrum. PDO is serving that goal by evaluating contract bids based on how well they fulfil a project’s needs as well as how they would contribute to the local economy. Referred to as the in-country value (ICV) strategy, this approach encourages firms to utilise Omani SMEs as subcontractors, and hire and train Omanis for key executive positions whenever possible. More specifics on this policy are expected in the future as Accenture Management Consulting has been hired to examine the process and its potential. The evaluation includes a study of supply and demand in relevant oil-and-gas contracting markets through to 2020. Overall, the ICV approach is intended to maximise employment of Omanis, as well as increase the contribution of economic projects and initiatives to the country’s general development.

Diversification

One of the strategies in use to build up economic activity outside the oil sector is a zones-and-ports model, in which export-oriented manufacturers and industries are clustered in free zones with convenient access to ports with significant capacity. These zones offer a mix of tax incentives, waiver of duties on imported equipment and lowered requirements for Omanisation to entice investment, and the government is spending $9bn on their development. One of the largest is at Duqm, on the Indian Ocean on the southern coast of central Oman. The authorities anticipate over $10bn in FDI within the next five years, and are working to make the facility an international logistics centre for shipping, a hotspot for export-oriented manufacturing and a major employment opportunity for Omanis in the central region of the country. A joint venture with the Belgian Port of Antwerp International will see the development of a multiuse port for container and bulk shipping of both liquid and dry goods. The special economic zone at Duqm will also contain an oil refinery, petrochemicals complex, ship repair, construction and dry-dock services, fuel storage, aquaculture and complementary services. The Port of Sohar has also formed a technical partnership with the Port of Rotterdam in the Netherlands that should see the port’s potential developed further.

The strength of Oman’s zones-and-ports strategy is location. The GCC region is roughly midway between Europe and South-east Asia and offers proximity to India and Africa. This position has made the country an ideal centre for trans-shipment and capacity will be increased further once the rail network is complete. The Port of Salalah, for example, is the only facility between Europe and Singapore that can accommodate S-class container vessels. Oman’s unique advantage is that it is located south of the Strait of Hormuz, the potential chokepoint of the Gulf. Any company building its operating model around Omani ports would not have to expose itself to the potential geopolitical risk inherent in passing through the straits, as well as benefit from the convenience of saving time and money.

An example of a firm using Oman as a centre for manufacturing, shipping and logistics is Brazil’s mining giant Vale. It invested $1.36bn in a complex at the Port of Sohar that includes a private jetty and a plant to turn iron ore into pellets using the direct reduction method, a process best suited for places where natural gas is abundant. Vale selected Sohar for its first iron-ore venture outside Brazil because it aims to serve nearby markets such as the MENA region and India.

At the inauguration of the facility’s first phase of operation in May 2011, Roger Agnelli, Vale’s CEO, said the company chose Sohar for its location south of the Strait of Hormuz, as well as Oman’s enabling transportation infrastructure and energy supply.

Tourism may play a supporting role in the sultanate’s economic development strategy. The government believes it has an attractive package to offer sun-seeking tourists, given its combination of beaches, clear skies and cultural offerings. The country has opened up its closed real estate sector to a degree by allowing foreign ownership of homes in select multiuse developments around Muscat. The capital’s new airport is also set to be ready in 2014, with an annual capacity of 12m passengers. Tourism’s contribution to the economy has been growing and was measured at 2.4% of GDP in 2012. The goal is to reach 3% by 2020, and officials are particularly targeting the business travel, and meetings, incentives, conferences and exhibitions segments.

Outlook

Oman’s economic vision has remained consistent and focused on two main goals: nurturing the private sector to eventually take on a leading role and placing the Omani workforce front-and-centre in that transformation. The sultanate is continuing to implement its plans, adjust them as necessary and developing supportive policies. While the necessary increase in spending in recent years to support these broad objectives has been notable, the country’s balance sheet has remained strong. Its budgeting process and global oil markets have combined to make surpluses common. With the oil and gas sector likely to remain buoyant, the sultanate’s economic growth is expected to continue, allowing for the new framework needed to thrive far beyond Oman’s oil-producing years.