Head of Macroeconomic Research
Summary: In modern history, we have experienced four major phases of sovereign defaults: at the end of the 1820s, in the mid-1870s, at the beginning of the 1930s and from early 1980s to the mid-1990s. The fifth phase of sovereign defaults is certainly about to start on the back of the pandemic. In our view, one of the most vulnerable countries in the GCC economies is Oman. Bahrain is also in delicate financial position, but it has the major advantage over Oman to be financially backed up by Saudi Arabia.
What is our trading focus?
Solid investment grade sovereign vs below investment grade sovereign
SAUDIARABIA-2.375-26OCT21 – Saudi Arabia sovereign bond
SAUDIARABIA-4.5-26OCT46 – Saudi Arabi sovereign bond
ABUDHABI-2.125-03MAY21 – Emirate of Abu Dhabi sovereign bond
The triggers of the crisis:
Oman’s dependence on oil revenue has been reduced over the past years, but it remains very significant. The country is the second most exposed, after Bahrain, to low oil prices in the GCC economies.
The Omani external breakeven – the oil price that it needs to cover the cost of imports – is at around $56 a barrel, double that of the United Arab Emirates. The decline in oil price has already increased pressure on the currency and could put at risk the dollar peg if it lasts longer. Since 1986, Oman has maintained a peg of 0.3849 rial to the USD but, without abundant FX reserves (estimated at US$17bn) and looming debt crisis, the country might be forced to loosen the grip on its currency, as it has been recently the case for Egypt.
The Omani fiscal breakeven – the oil price at which it would balance its budget – is at around $80 a barrel, double that of Qatar, which will increase pressure to cut further domestic spending.
Oman is trapped into a vicious circle of debt. Borrowing needs are particularly consequent to finance the twin deficits: the fiscal deficit is expected to reach 18% of GDP based on an oil price assumption of $35 per barrel, and the current account deficit is expected to climb at 14% this year. Due to the prohibitive cost of dollar debt issuance, Oman has been shut out from bond funding and is unlikely to come back unless yields stabilize. The country is able to meet debt service requirements this year (estimated at $1.2bn) without issuing new bonds, but it faces a great wall of debt from next year with debt service (principal and interest) jumping at $3.4bn in 2021 and almost $4bn in 2022.
As a result of weak fiscal position and stronger reliance on foreign funding, the country’s credit rating has been downgraded to junk status by the three major credit rating agencies (Standard & Poor’s in May 2017, Fitch in December 2018 and more recently Moody’s in May 2020).
The market reaction:
All the GCC dollar bonds have recorded negative returns so far this year as a result of COVID-19 economic uncertainty and the sharp decline in oil prices, but Oman, along with Bahrain, are recording the largest losses. The two countries’ CDS have widened the most among GCC economies. Oman 5-year CDS has increased by 130 basis points since the beginning of this year, at 400 basis points and even reached a peak at 637 basis points in mid-March – the highest level on record. Tensions on Oman 10-year CDS have significantly receded from March peak with an increase of only 40 basis points since the beginning of year, but it is still largely above other GCC economies. The 10-year CDS is close to 400 basis points while that of Saudi Arabia is at 120 basis points and that of Qatar at 80 basis points. Oman’s 10-year CDS is basically four times higher than that of other countries from the GCC, with the exception of Bahrain.
Market perception remains widely negative on Oman dollars bonds and the risk of sovereign default in the next five years have never been priced so higher by investors.
Policy response and evolution of the crisis:
The initial policy response has been too slow and insufficient. It basically comes down to two major decisions: implementing budget cuts by 500 million Omani riyals (around €1.2bn) and closing access to bond market, thus sending a very negative signal to foreign investors.
A debt crisis is very likely by 2021 at the latest if the government does not adjust budget more significantly in the coming months and if oil prices don’t jump back to a level close to the country’s fiscal and external breakeven. In the short term, Oman can stay out of the international debt markets as debt servicing in 2020 is rather low, but it cannot remain so indefinitely especially with regard to the great wall of debt from 2021. If financing conditions deteriorate further, the government has little room to maneuver. The country’s sovereign wealth fund – the State General Reserve Fund – has literally zero liquid assets. The government can potentially draw on its foreign exchange reserves which are already low compared to other GCC economies, but this is not the ideal scenario because it could limit its ability to defend its currency’s USD peg, which is likely to be unstable in the coming months. As such, we think the government will have no choice but to request financial assistance from other GCC countries or, in last resort, from the IMF.
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