Bonds Help These Gulf States Keep Their Heads in the Sand

(Bloomberg) -- Access to a debt market teeming with yield-hungry investors is helping some cash-strapped nations in the Gulf Cooperation Council kick reforms down the road.

Taking advantage of attractive interest rates, Oman raised $6.5 billion in January, its biggest sale on record, to help bridge deficits. And Bahrain, the smallest of the GCC’s six nations, tapped the international bond markets for $3.6 billion in 2017. It may issue this year to help meet funding needs.

Junk-rated Oman and Bahrain have the weakest finances in the GCC and face making politically unpopular decisions such as freezing public sector employment and cut spending significantly. They have been slow to implement reforms compared with their richer neighbors such as Saudi Arabia and Abu Dhabi, which have slashed expenditure, rolled back some subsidies and introduced value added tax.

Easy access to the bond market “is blunting the urgency for reforms, but they also have to take into account political considerations and the debate around the new social contracts they are trying to implement,” said John Sfakianakis, the director of economic research at Gulf Research Center in Riyadh. “The more they delay implementing steps to raise non-oil revenue, the more difficult it will become in an environment of rising interest rates.”

Here’s a closer look at each country:

Oman

As oil prices more than halved in the two years through 2016, Oman’s budget deficit climbed to 21.6 percent of gross domestic product. Still, the nation was reluctant to scale back on infrastructure projects already underway because of the belief that they’ll have a positive impact on the economy, the government said in its bond prospectus in January. It instead relied on borrowing to fund the deficit, which the International Monetary Fund sees narrowing to 11.4 percent this year.

Oman has more than doubled its external debt in the three years through 2017, according to IMF data. Together with its sale in January, the sultanate raised $18 billion from the sale of dollar bonds since the start of 2016, data compiled by Bloomberg show. It’s also considering a loan of as much as $2 billion, people familiar with the plan said in January.

This isn’t to say that Oman hasn’t implemented reforms. Here’s a short list of what it has done to improve its finances:

• Raised corporate tax to 15 percent from 12 percent
• Reduced tax exemptions
• Eased fuel, electricity subsidies
• Deferred non-essential projects
• Imposed excise duties on products such as alcohol

But that hasn’t stopped Omanis from spending. Total expenditure in the 11 months through November 2017 is estimated to have climbed 8.5 percent from the previous year to 10.4 billion rials ($27 billion), according to the bond prospectus.

Bahrain

For Bahrain, selling debt has been critical to maintaining reserves. The central bank’s foreign-currency holdings dropped to a 16-year low of $1.27 billion in July before recovering in September after it tapped the bond market for $3 billion. The nation last year asked Gulf allies for financial help, according to people with knowledge of the talks.

Read More: Even the Smallest Economy in Oil-Rich Gulf Is Too Big to Fail

Bahrain implemented some measures to trim expenditure, mainly reducing subsidies and transfers, which lowered their contribution to total expenditure to about 25 percent in 2017 from 29 percent in 2014, S&P Global Ratings said in a report in December.

It also eased spending, imposed excise tax and increased fuel prices, but the changes haven’t been enough to stabilize its debt-to-GDP, Fitch said in a report this month after it downgraded Bahrain’s credit rating deeper into junk.

Here are some of the issues:

• The government hasn’t “identified a clear medium-term strategy to tackle high deficits and there is no clarity on a timeline towards the development of such a strategy,” Fitch said. “The political environment, embedded social expectations and a lack of experience with taxation severely constrains the government from enacting a sharper fiscal adjustment”
• Bahrain has about $14 billion of outstanding dollar bonds, according to data compiled by Bloomberg, which has helped boost the government’s debt-to-GDP to 91 percent last year, IMF estimates show. The fund sees it rising to 99 percent this year and 107 percent in 2019
• Its fiscal deficit this year is forecast at 11.9 percent of GDP, and economic growth is set to ease to 1.7 percent this year, the slowest pace since 1989, according to the IMF

“Further material support from the GCC would be forthcoming in case of extreme political, financial, or fiscal instability, given Bahrain’s small size and strategic importance,” Fitch said. “The expectation of such support has supported Bahrain’s market access and U.S. dollar peg despite extremely low foreign-exchange reserves.”

To contact the reporter on this story: Arif Sharif in Dubai at asharif2@bloomberg.net.

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Shaji Mathew

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