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D&B Country Report Oman

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Contents

Country Risk Analyst Monica Malik 01494 423883 Email: [email protected] Sales Email: [email protected] Telephone: UK 01494 422700 US 1 800 932 0025 Rest of World contact your local office or call +44 1494 422700 Published by Dun & Bradstreet Ltd Holmers Farm Way High Wycombe Bucks HP12 4UL United Kingdom Tel: 01494 422000 Fax: 01494 422260 Email: [email protected] While the editors endeavour to ensure the accuracy of all information and data contained in this D&B Country Report, neither they nor Dun & Bradstreet Limited accept responsibility for any loss or damage (whether direct or indirect) whatsoever to the customer or any third party resulting or arising therefrom. © All rights reserved. No part of this publication may be reproduced or used in any form or by any means graphic, electronic or mechanical, including photocopying, recording, taping, or information storage and retrieval systems without permission of the publisher. This D&B Country Report was prepared in January 2006.

Global Economic Outlook 2

Country Risk Indicator DB3a 3

Key Information 4

Executive Summary 5 Political Risk 5 Macroeconomic Risk 5 External Economic Risk 6 Commercial Risk 6

Political Risk 7 Recent Developments 7 Political Environment 7 Socio-Political Risk 11 External Political Risk 12 Political Risk Outlook 14

Macroeconomic Risk 15 Short-Term Economic Performance 15

Components of Growth 16 Monetary Environment 23

Short-Term Economic Outlook 26 Long-Term Economic Potential 27

Population 28 Technological Progress 28 Investment 28

Long-Term Economic Outlook 29

External Economic Risk 30 Balance of Payments Performance 30 Current Account 31

Export Profile 32 Import Profile 33

Financial and Capital Account 34 Foreign Debt and Default Risk 38

Foreign Exchange Reserves 39 Exchange Rate Risk 40 External Economic Risk Outlook 41

Trade Environment 42 Trade Overview 42

Current Account Exchange Regulations 42 Tariff Barriers 42 Non-Tariff Barriers 44

Commercial Risk 47 Credit Risk 47 Financial Sector Risk 48 Corruption 50 Other Commercial Risks 51 Commercial Risk Outlook 52

Investment Environment 53 Investment Overview 53

Capital Account Exchange Regulations 53 Foreign Direct Investment Environment 54 Portfolio Investment 56

Additional Sources of Information 57

Country Risk Indicator Definition 58

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Global Economic Outlook Real GDP growth forecast World, %

2006 3.2

Interest rates and oil price US interest rate, %

Jan. 2006 4.25

US, % 3.3 ECB interest rate, % 2.25 Euroland, % 1.9 Japan interest rate, % 0.10 Japan, % 1.5 Oil price (Brent crude), USD p/b 62.9

%

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6.0

2000

2001

2002

2003

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2005

e

2006

f

2007

f

Asia/PacificMiddle East & AfricaEuropeLatin AmericaNorth AmericaWorld

Sources: International Monetary Fund; D&B

World Growth We expect world growth of 3.2% in 2006, on an exchange-rate-based weighting. The US and China will remain the main engines of the world economy. However, we forecast a deceleration of the US economy; in turn, its contribution to global expansion will diminish slightly. Western Europe will contribute more to global output growth than in 2005, owing to the nascent recovery in Euroland. While this will result in a slight narrowing of the growth differential between Western Europe and the US, we see little scope for a significant correction of existing global economic imbalances, in particular the vast US current account deficit. Thus, the risk of short-term currency volatility persists.

%

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-07

Actual US interest rate

Forecast US interest rate

Actual ECB interest rate

Forecast ECB interest rate

Sources: US Federal Reserve; European Central Bank; D&B

US and Euroland Interest Rates US: Despite some upside risks to inflation, the federal funds rate now appears be close to a neutral range, within which economic growth is neither encouraged nor hindered. We expect one more 25 basis point hike on 31 January followed by a further 25 basis point rise on 28 March. The probability of further increases beyond this point is low but cannot be ruled out if inflation or economic growth prove to be stronger than expected. Euroland: The ECB left interest rates at 2.25% at its January meeting. We expect modest tightening to continue over 2006, as the euro-zone economy appears to be strengthening. That said, second-round inflationary effects from past oil price hikes have so far remained negligible.

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Actual price

Forecast priceUSD p/b (ave.)

Source: D&B

Oil Price (Brent Crude) Our oil price forecast stands at USD56.7 per barrel (p/b) for 2006. Many of the factors that supported the oil price in 2005 will continue in 2006, namely low international spare capacity and robust global economic growth. The price will remain sensitive to geopolitical instability, weather conditions and natural events. In January, the price strengthened in response to the upset to Russian gas supplies and increased concerns that Iran’s nuclear programme could result in international sanctions. Nevertheless, overall global spare capacity should rise with increased production from OPEC and non-OPEC countries. US stocks have continued to increase with the seasonally mild weather.



Country Risk Indicator DB3a

For Country Risk Indicator Definition see page 58

Slight Risk Enough uncertainty over expected returns to warrant close monitoring of country risk. Customers should actively manage their risk exposures. The DB indicator is a comparative, cross-border assessment of the risk of doing business in a country. The indicator seeks to encapsulate the risk that country-wide factors pose to the predictability of export payments and investment returns over a time horizon of two years.

Overall Outlook • In the short term, Oman’s economic fortunes will continue to fluctuate in line

with world oil prices and government spending. • There are no internal or external challenges to the country’s political stability or

security. Sultan Qaboos bin Said al Said enjoys a high degree of genuine popularity and respect. The slow process of political reform and liberalisation will not affect the political outlook over the two-year forecast period.

Positive Risk Factors

+ Private sector involvement in the economy has risen sharply in recent years, enabling several key infrastructure projects to take place.

+ Strong oil prices have supported Oman’s risk outlook since 1999 and the oil prices will remain high in the two year outlook.

+ The economic fundamentals will remain strong in the outlook period. + Liquefied natural gas (LNG) exports started in April 2000, marking a major step

in the country’s economic diversification; LNG export levels will increase in 2006.

+ Oman signed a free-trade agreement with the US in 2006, which will boost trade and investment between the two countries.

+ Despite severe imbalances in the current account, there is little risk of a balance of payments crisis.

+ The banking sector has strengthened, supported by improved supervision and lending practices.

Negative Risk Factors

− In the absence of an heir, there is concern about Qaboos’ successor. Moreover, the government is highly personalised and political institutions remain weak.

− State dominance of the economy inhibits economic development and is increasingly unsustainable. In the short term, there is little prospect of an end to state control of the major economic sectors.

− There needs to be an increase in employment opportunities for the growing population.

− The current account is fragile and dependent on oil exports to lessen the impact of imbalances.

− The commercial environment is subject to sudden changes in regulations and lacks transparency.

− There is a need to diversify the economy, with 20-25 years of commercially exploitable oil reserves left.

Regional Risk

Indicators

UAE DB1d

Kuw ait DB2a

Qatar DB2a

Tunisia DB2c

Morocco DB2d

Bahrain DB3a

Israel DB3a

Oman DB3a

Saudi Arabia DB3a

Jordan DB3c

Egypt DB3b

Lebanon DB4c

Algeria DB5a

Iran DB5b

Libya DB5b

Syria DB5d

Yemen DB6a

Iraq DB7

End-2003 DB3a

End-2004 DB3a

End-2005 DB3a

Comparative Risk

Indicators

S. Korea DB3a

Latvia DB3a

Mexico DB3a

Oman's Risk

Indicator History



Key Information

Economic and Development Information

2003 2004 2005e 2006f 2007f

GDP (nominal)

OMR billion 8.3 9.5 11.5 12.1 12.7

USD billion 21.7 24.7 29.9 31.4 33.0

Breakdown of GDP

Agriculture (%) 2.8 2.6 2.1 2.0 2.0

Industry (%) 41.3 49.2 52.0 53.6 53.6

Services (%) 55.9 48.2 45.9 44.4 44.4

Economic indicators

Real GDP growth (% change) 4.5 4.5 5.7 5.5 5.0

Inflation, annual average (%) -0.4 0.3 0.8 1.0 0.9

Government balance (% GDP) 4.4 4.7 6.0 3.2 3.0

Oil price (Brent crude, USD per barrel) 28.8 38.3 54.3 56.7 52.7

Current account balance (% GDP) 3.7 1.8 6.2 4.1 3.2

Long-term real GDP growth potential, annual average, 2006-15: 2-5%

Development indicators Kuwait Oman Qatar S. Arabia UAE

Population, 2005 (m) 2.5 2.7 0.6 24.0 2.8

Population, 2015 (m) 3.0 3.4 0.7 30.8 3.2

Population, 2050 (m) 3.7 5.2 0.8 53.7 3.7

Proven oil reserves (billion barrels) 96.5 5.7 15.2 262.8 97.8

GNP per capita (USD) 18,030 4,940 n.a. 7,230 n.a.

GNP per capita (USD PPP) 18,690 8,680 n.a. 11,390 n.a.

Life expectancy (years) 77.0 74.0 75.0 73.0 75.0

Urbanisation (%) 98.0 94.0 n.a. 86.0 86.0

Dependency ratio, 2005 0.35 0.74 0.36 0.74 0.37



Political Information

Head of state Sultan Qaboos bin Said al Said

Political system Absolute monarchy

First elections held Consultative Council: 1997

Last elections Consultative Council: 2003

Next elections Consultative Council: 2007

Miscellaneous Information

Religion Muslim Shi'a (65.8%); Muslim Sunni (21.9%)

Capital (population) Muscat (2.72 million)

Timezone GMT +4 hours

Sources: International Monetary Fund, International Financial Statistics; Arab Monetary Fund, Foreign Trade for the Arab Countries; World Bank, World Development Report; United Nations Development Programme, Human Development Report; BP, Statistical Review of World Energy; D&B



Executive Summary

Political Risk

Despite undergoing rapid economic and social change since 1970, Oman enjoys a well-deserved reputation as a politically stable and pro-Western country. Despite the arrest and later release of 30 Islamists, including prominent academics and members of the military, in early 2005, the domestic political position remains stable with little risk. No links to Al-Qaeda were found and extremist groups have not established a foothold in the country. However, Oman’s strong links to the West make it a target for terrorist attacks by Al-Qaeda. Both the country’s stability and its rapid economic and social transformation are attributable to its ruler, Sultan Qaboos bin Said al Said. Although there are no serious challenges to his authority, Qaboos refuses to publicly nominate a successor and there are concerns over the lack of an heir; this remains the key area of concern. Moreover, there are rumours about the sultan’s ill health. Political risk and uncertainty would increase if Qaboos died suddenly; even in this worst-case scenario, we do not expect a turbulent or violent transition. The political system is expected to be refined over the coming decade in order to clarify the process of succession and make the transition smoother. Furthermore, Qaboos is probably trying to develop a constitutional monarchy ahead of the succession. In an important step towards political reform, in November 2002 voting rights were extended to all citizens aged over 21 (excluding naturalised Omanis). These provisions were applied to the consultative Shura Council elections held in October 2003. Although this move marked a step towards developing a democratic process, it will not change the political environment significantly or affect political risk in the short term; moreover, it will not dilute the sultan’s power or challenge his ultimate authority in the short to medium term. The political environment will remain stable and decision-making will continue to be highly centralised. The consultative council is only permitted to question ministers and review (but not amend) legislation in specific areas, namely economic development and social services. Although the political environment remains stable, the level of voter apathy highlights a growing frustration, especially among young urban Omanis who are looking for greater political say.

Macroeconomic Risk

The production and export of crude oil (and increasingly liquefied natural gas, LNG) drives economic growth, leaving the economy vulnerable to fluctuations in the world oil market. This degree of uncertainty, combined with state dominance of the economy, has inhibited the country’s economic development. We estimate that real GDP growth accelerated to 5.7% in 2005. According to preliminary government estimates, nominal GDP increased by 21.7% in 2005, against 12.5% in the previous year. However, falling oil production will have again resulted in Oman not maximising the benefit from the high oil price. Average oil production levels fell to 744,000 barrels per day (bpd) in the first ten months of 2005, down 1.4% year on year. However, as with 2004, a stronger oil price in 2005 supported the net export position; the price of Omani oil in 2005 was USD49.4 per barrel (p/b), an increase of 45.7% from the 2004 average. LNG export earnings also continued to increase in 2004. Higher government spending will have also supported private consumption and gross fixed capital formation. Real GDP growth is forecast to fall marginally in 2006, with net exports making a lower positive contribution to real GDP growth (see Short-term Economic Outlook), owing to the lower forecast marginal increase in the oil price and



continued strong import growth. Economic expansion will be driven by higher government spending and continued strong sentiment, which will support private consumption and investment levels.

External Economic Risk

Given the dominance of oil exports to the economy, Oman’s external position is particularly vulnerable to changes in world oil prices. Benefiting from strong oil exports from early 1999 until 2004, Oman has tended to record merchandise trade surpluses. Although the oil price is forecast to be lower over the two-year outlook period, it will still remain strong. Furthermore, Oman’s external position will be supported by higher LNG exports. LNG export revenue will especially increase after the third 3.3 million tonne-a-year train at Qalhat comes on stream in early 2006. However, severe imbalances in the other components of the current account mean that Oman occasionally records a current account deficit. Oman has to buy in most professional services. In addition, the repatriation of expatriate workers’ remittances and foreign company profits and dividends vastly exceed the value of transfers and income from abroad. The capital account appears to be in a stronger position, but definitive figures are unavailable. A high degree of secrecy surrounds the government’s investment overseas as part of its State General Reserve Fund, which is designed to act as a safety net in a post-oil-dependent economy. However, the capital account usually posts a surplus. Meanwhile, Oman’s low level of debt, good debt repayment record and strong foreign exchange reserve position mean that a balance of payments crisis or a default on the country’s external obligations are highly unlikely in the short to medium term. Furthermore, Oman is unlikely to default on its obligations or seek a rescheduling of its debts, as foreign debt levels remain manageable. The upturn in oil prices from 1999 enabled the government to debt levels and increase reserves. Oman’s excellent debt servicing and repayment record mean that it has ready access to short-term credit lines, project debt facilities and export credit cover. Currency stability is one of the government’s prime concerns and it therefore maintains the rial at a fixed peg against the US dollar. However, as a result of economic diversification, the peg is likely to come under pressure in the medium term (especially if the US dollar weakens further) as goods exported and imported will increasingly be dominated by currencies other than the US dollar.

Commercial Risk

Public sector domination of the commercial environment generates a level of payment and regulatory risk. Government earnings and the state’s ability to pay bills are dependent on international oil prices. When oil prices are low, there is an increased risk that the government will delay payment for goods or services received to protect its own liquidity. However, commercial risk should remain positive in the outlook period driven by strong hydrocarbon earnings and higher government spending. The build up of reserves and increased government spending have improved the commercial outlook for the private sector, which will continue in 2007, despite a lower oil price forecast. Meanwhile, strict regulation of the banking sector has reduced commercial risk and a banking crisis is not expected. Furthermore, the banking sector is coming out of the difficulties caused by growing non-performing loans and increased provisioning in the early 2000s. As a result of the central bank’s adequate policy for loan-loss provisioning, the sector will become stronger. The banking sector’s profitability has improved since 2004, owing to lower provisioning requirement, sound macroeconomic fundamentals, which have increased the demand for banking products, and improved lending practices. In addition, the reduced need for provisioning has allowed banks to increase lending.



Political Risk

Key Point: In the absence of significant external or internal threats, Oman’s political outlook remains highly stable, despite holding the first-ever Majlis al-Shura elections. However, there are concerns over the succession given the lack of an appointed heir.

Recent Developments

By 1970, Oman, under the ultra reactionary Sultan Said bin Said al Said, had developed into highly conservative society with no relations with other Arab countries. However, in 1970 Sultan Qaboos bin Said al Said overthrew his father in a bloodless coup. Qaboos, who was educated in the UK, was determined to turn Oman into a modern state, a project that, in economic terms, has been highly successful. Unlike other Gulf Arab states, Oman does not have a large ruling family. Thus, the sultan is the focus of the political system. Qaboos’ attitude towards government is highly paternalistic; he takes considerable efforts to be personally accessible to his subjects and is keen to protect them from adverse economic, political and social conditions. In line with this aim, he conducts an annual tour of the sultanate during which he receives petitions and hears grievances and complaints. Qaboos has attempted to create a modern and stable state while respecting the conservative nature of many Omanis. Initially, this involved using Oman’s oil wealth to construct a modern infrastructure including transport links, schools, hospitals and other facilities. Since the mid-1990s, he has also embarked on a series of reforms to build political institutions and create a basis for a smooth transition of power. Qaboos has also used his extensive patronage to secure government and wider political stability by ensuring that the various ethnic and religious communities are represented in government. In addition to merit, appointments to the Council of Ministers (cabinet), other key posts and less senior government posts are made on the basis of ethnic or religious affiliation. This ensures that all communities and tribes have a stake in government. Few members of the sultan’s family hold positions of authority; this is very different from other Gulf Co-operation Council (GCC) states, where key posts are given to members of the ruling family to maintain control and loyalty. In addition, unlike its counterparts in the region, the Omani royal family is not perceived to be corrupt (perceptions of corruption have fuelled support for Islamist groups in countries such as Saudi Arabia). Qaboos has achieved a high degree of stability during his reign. Nevertheless, Oman remains a tribal country, with various ethnic and religious divisions, which could have serious negative consequences for stability under a less carefully managed system.

Political Environment

Plagued by tribal strife, Oman had rarely been a united entity. Traditionally, the main battle for supremacy has been between mountain and coastal tribes. Despite being defeated by 1976, rebels from the Dhofar region (southern Oman) persisted in a secessionist campaign against the central government until the early 1980s. Since then, Oman has enjoyed a highly stable political environment, almost entirely due to the efforts of Qaboos, who has been careful to balance the competing interests of the various ethnic, tribal and religious groups.



Slow Political Reform

Oman has been taking small steps towards political reform and the development of a more democratic system: • In 1996, a written constitution was promulgated (the first in a GCC country). • In October 1997, the first elections were held for the 82-seat consultative council,

the Majlis al-Shura, which was first established in 1991 as an appointed council. Direct elections for the consultative council were first held in September 2000 (previously, voters had to choose from candidates approved by Qaboos).

• In December 1997, an appointed upper house, the Majilis al-Dawla, was created. • In November 2002, voting rights were extended to all citizens aged over 21

(excluding naturalised Omanis). These provisions were applied to the elections for the Majlis al-Shura elections held in October 2003. (Under the old system, only around one quarter of the population over the age of 21 was allowed to vote; these people were selected by the government and included tribal leaders and prominent businessmen and those close to the regime.)

Although the extension of voting rights is a step towards developing a democratic process, it will not result in a major change in the political environment or affect political risk in the short term; moreover, it will not lead to a dilution of the sultan’s power or challenge his ultimate authority in the short to medium term. Ultimately, Qaboos is probably seeking to develop a constitutional monarchy ahead of the succession. However, progress on this front has been and is forecast to remain slow, as with the 2003 Majlis al-Shura elections, the 2007 elections will have little effect on the political arena. The political environment will remain stable and decision-making will remain highly centralised. Although the October 2003 elections were conducted with universal suffrage, the level of interest was low (both in terms of registration and voter turnout). Out of approximately 800,000 eligible voters, only 262,000 registered to vote and less than 200,000 actually voted. This was despite a concerted campaign by the government to encourage people to vote and register, including an extension of the registration period, changing the polling day and giving a paid holiday to every voter. One of the reasons behind the low level of voter participation is the limited power of the consultative council: the Majlis al-Shura is only permitted to question ministers and review (but not amend) legislation in specific areas, namely economic development, the budget and social services. (With regards to the 2005 budget, the Majlis sent recommendations and amendments to the government following a review of the budget.) Although the political environment remains stable, the level of voter apathy highlights a growing frustration, especially among young urban Omanis who are looking for greater political say; the urban areas witnessed the poorest voter turnout in the 2003 Shura Council elections. The outlook for government stability will not be affected by the results of the last election (see Government Stability) or in the 2007 election, nor will government policy. Despite the changes to the electoral law and the shift in the social balance of the electorate, the election bought little change to the political make-up of the consultative council, with tribal loyalties and family relationships still strongly influencing voter behaviour. A further reason for the substantial lack of change in the composition of the Majlis was the fact that campaigning for the election was highly restricted, with meetings, advertising and political parties not permitted. The election was contested by 540 candidates, with a larger proportion of younger contenders than in the previous election. However, out of the 83 members of the consultative council, 51 members were re-elected for a five-year period. This result was partly due to the fact that voter turnout was higher in the country’s interior where the population tends to be more conservative, with voters following local leaders who are appointed by the government. Consequently, although universal suffrage has strengthened the mandate of the Majlis, the conservative nature of the body suggests that it is unlikely to obstruct the government’s agenda (although it is



unlikely to be as proactive as the last in trying to come up with ideas to promote economic reform).

The Succession

While Qaboos remains in power, there are no significant threats to government stability; the sultan remains highly popular (see Government Stability). However, there are concerns over the lack of a successor. There are rumours about the sultan’s health; however, Qaboos has not appointed an heir, has no children and has not prepared anyone to replace him. Although the process of succession is outlined in the Basic Law, it remains ambiguous, complicated, impractical and untested. The sultan has laid down a complex procedure for the Ruling Family Council, which has to choose a successor from the family within three days of Qaboos’ death. He has also made provision for the appointment of a successor should the royal family fail to agree: Qaboos will place the name of a suggested heir in a sealed envelope, which is to be opened after the Council of Ministers has satisfied several conditions. The Defence Council is in charge of making sure that Qaboos’ wishes are followed. It is in the royal al-Busaidi family’s interest that the succession occurs smoothly and peacefully. However, the sultan may clarify the situation if the issue appears to threaten Oman’s national interest. The Basic Law stipulates a number of conditions: succession must pass to a male descendant of the al-Turki branch; the new sultan must also be a Muslim and of Omani Muslim parents. There is increasing speculation that the two most likely candidates for the succession are Sayyid Haitham bin Tariq al Said and Sayyid Asaad bin Tariq al Said, both first cousins of the sultan. In 2002, both were given more prominent positions with seats in the cabinet, thereby giving them greater experience in government. Previously, they had low profile positions. Sayyid Shihab bin Tariq al Said (Commander of the Royal Navy of Oman), also a first cousin of the sultan, is another possible successor to the sultan. However, these possible contenders are not in a position to build up a power base and have not yet held high office. As a result, little is known of their political views or personal qualities. It is also possible that their lack of experience will hamper their ability to take over the highly personalised power structure currently centred on Qaboos. The Basic Law is expected to be refined in the medium term in order to clarify the succession process and make the transition smoother. Political risk and uncertainty would increase if Qaboos died suddenly; however, even in this scenario, we do not expect a turbulent or violent transition. The Ruling Family Council would be likely to reach a decision, not least as there are indications that Qaboos has decreed that the military should be mobilised if a successor is not named within a given time.

Government Stability

The highly stable regime is supported by the strong popularity of the sultan and the high standard of living. The main threat to political risk in the medium term relates to the ability of the economy to provide employment for the growing population. The government estimates that in 2001-05, 134,000 Omanis entered the workforce (see Policy Agenda). Although unemployment data are unavailable, the Institute of International Finance estimates that around 20% of the population is seeking work. This is likely to get worse in the medium term as around 50% of the Omani population is under 15 years old. Oman is highly dependent on expatriate workers, who account for around 25% of the population. The government has urged the private sector to employ more Omanis; however, expatriates are typically cheaper to employ and more experienced. It is vital that Oman continues with its diversification programme to maintain the living standards of the population. Political tension may also increase if the process of political reform fails to meet expectations. There are already signs that the younger generation is looking for greater political participation. If the economy is unable to provide jobs and the political reform process stalls, political risk will increase in the medium term.



In terms of external risks to stability, popular tension has grown in the recent past, such as with the upsurge in Israeli-Palestinian violence and the US role in the conflict, as well as the US war against terrorism and in Iraq. This resulted in anti-US sentiment rising in Oman. However, unlike in some countries in the region, this has not prompted anti-government feeling. Although anti-US sentiment is present, it does not threaten the government or government stability. So far, protests and demonstrations have been peaceful. Despite its position on these matters, Oman has been able to maintain strong relations with the West (see External Political Risk). While this has not affected government popularity directly, it could make Oman a possible target for Al-Qaeda affiliates. The US State Department names Oman as one of the states where Al-Qaeda could have established, or be seeking to establish, operative cells, and the government remains vigilant to ensure that violent Islamist movements do not take root in the sultanate.

Political System The Executive: Oman is an absolute monarchy headed by Qaboos. He heads a highly centralised and personalised system of government. This results in a slow and secretive decision-making process. Most decisions are made at the highest level; the sultan plays a significant role in managing the day-to-day affairs of the country. Qaboos heads the Council of Ministers, the primary decision-making body in the country. In theory, the executive consists of the sultan and the cabinet, but in practice the cabinet is subservient to the sultan, who sets the policy agenda for ministers to implement. Qaboos takes all major political decisions and sets the outline for the country’s foreign and economic policies after consulting non-ministerial advisers. The sultan also makes all key appointments, including the governors of the country’s 59 districts (wiliyats), who represent the central government. He also makes key judicial appointments and heads the armed forces. The absolutist nature of the government leaves considerable scope for arbitrary decision-making. The government can impose new regulations or alter policy at extremely short notice. In practice, this rarely occurs, but the government reserves for itself wide ranging powers. Although no separate legislature currently exists, in time one may emerge from the 82-seat consultative council, the Majlis al-Shura, and/or the 57-seat upper house, the Majlis al-Dawla. Members of the upper house are appointed by the sultan, while members of the lower house are elected by universal suffrage for a five-year term. In the meantime, the executive has almost unlimited powers and is subject to no checks and balances. There are few formal channels for consultation on legislation or to lobby for reform. Companies, business organisations and other groups must rely on informal contacts with ministers and officials to influence policy debate. The Judiciary: The legal system has been restructured in recent years in order to reduce political interference. Among other things, the public prosecution service has been separated from the police, and an independent attorney general has been appointed. The judicial system now has three tiers, headed by the Supreme Court based in Muscat, with separate lower courts for civil, commercial, Sharia and criminal matters.

Oman has developed a system of regulatory laws, which is generally derived from the English model. In 1997, the Commercial Court was reorganised and given jurisdiction over business disputes as well as tax and labour cases. The Commercial Court can hear cases involving a government body but has no power to enforce judgements against the government. For this reason, companies may have difficulty enforcing a favourable decision. The most effective method of settling a dispute is to accept mediation by a mutually acceptable third party. This is usually a chamber of commerce or a respected member of society.



Policy Agenda

In 1995, the government drew up a long-term development plan entitled Vision for Oman 2020. The document proposes to diversify the economic base and reduce the country’s dependence on oil. The oil sector’s share of GDP is forecast to drop to less than 20%, while gas will account for 10% of GDP and other industrial activities 29%. The plan also aims to develop and upgrade the skills base of the workforce and to integrate Oman into the wider global economy. The plan sets ambitious targets, such as average annual growth of 7.4% by 2020, but it also addresses a real need. Oman is running out of oil and needs to diversify its economy, increase private sector participation and attract inward investment. The plan represents a serious and public commitment on behalf of the government to live up to its goals of economic diversification. On the economic front, the government emphasises economic diversification, privatisation and low inflation. It also aims to rationalise government spending and oversee the provision of 100,000 jobs to Omani nationals. The government is attempting to increase employment through its ‘Omanisation’ programme, which sets targets for the percentage of Omani nationals employed by companies; increasing employment for Omanis will be crucial for long-term political stability. Meanwhile, in the budget for 2006 and the Seventh Five Year Development Plan (2006-10) the government has emphasised human resource development and education. We feel that this is positive as one of the key challenges for Oman is to increase employment opportunities for the growing population. These factors are reflected in the higher and direction of spending of the 2006 budget (see The 2006 Fiscal Plan). The salient points of the Seventh Development Plan include: improvement in the standard of living of citizens; upgrading education and expanding higher education; providing employment opportunities for nationals; and social welfare and infrastructure development.

Socio-Political Risk

Internal Stability

There are no terrorist or other extremist groups active in Oman and politically motivated violence is virtually unknown. Non-violent Islamist groups have failed to establish a presence in the country or gain any popular support. Crime levels, particularly levels of violent crime, are low, especially in urban areas. The rare cases of violent crime are usually domestic in nature or the result of a personal feud. Although there were two shootings of Europeans in 2003 and in 2004, these do not seem to have been politically motivated. Although there has not been a situation in Oman as in Saudi Arabia, where Islamic militant groups are targeting the expatriate community or trying to overthrow the government, Oman continues to remain a target owing to its strong links with the West. Concerns were raised in 2004 after an Al-Qaeda website called for attacks on foreigners in the Gulf states. In early-June 2005, Sultan Qaboos bin Said al Said pardoned the 31 coup plotters who were convicted in May of trying to overthrow the government and establish an Islamic state. Six had been jailed for 20 years, with the remainder receiving sentences of between one and ten years. The group includes Islamic scholars, academics and government figures. The lawyers for the defendants had maintained that they had been trying to spread the teachings of Ibadi Islam, a conservative stream of Islam that most Omanis follow; no links to Al-Qaeda were found. The Ibadi caliphate had exerted authority in parts of Oman until the 1950s.



Furthermore, in January 2005, the security forces arrested more than 30 Islamists, including prominent academics and members of the military. Authorities had moved against them after a cargo of arms were discovered when the truck carrying them was involved in an accident near the Yemeni boarder. The arrests are rumoured to be in response to a plot by Islamists to sabotage the Muscat Festival, a month-long shopping and cultural event.

Interest Groups

The ruling family does not dominate Omani politics to the extent that the ruling families of other states in the GCC dominate their respective political systems. Instead, the political elite are comprised of a number of influential families that rose to prominence either because of their importance in tribal groupings or because of their success as merchants. The sultan makes appointments to most senior government posts from among these families, with the aim of maintaining a balance of power between the various social interest groups. As well as wielding political power, most of these families have extensive private commercial interests. There is often little separation between public and private interests, which can result in conflicts of interest. Companies establishing strategic relations with prominent families should conduct thorough research into the reputation and political standing of their potential partners (see Commercial Risk).

Labour Relations

Labour relations are tightly controlled. The government also tightly regulates the working environment. The ministry of social affairs and labour sets guidelines for wages and working conditions. There is a statutory minimum wage of OMR120 per week (including benefits for private sector employees). There is also a statutory right to medical treatment and strict health and safety regulations. Oman passed a new labour law in 2003 (Royal Decree No. 35), allowing for the creation of worker representative committees for the first time. The 2003 decree detailed procedures for dispute resolution and removes a 1973 prohibition on strikes. The provisions of the new labour law apply equally to women and prohibit the dismissal of women during pregnancy or maternity leave. Significantly, the protections of the labour law apply equally to foreign workers. Foreign workers must be at least 21 years of age to obtain a work permit in Oman. Both nationals and non-nationals may belong to the worker representative committees and participate in the leadership. Oman’s free-trade agreement with the US, signed in January 2006, (see Trade Environment) contains provisions reaffirming the two country’s commitments as members of the International Labour Organisation (ILO), and pledges the effective enforcement of domestic labour laws that provide for internationally recognised worker rights. Furthermore, the annex to the Labour Chapter creates a co-operative mechanism to upgrade labour standards. Oman has indicated that it will introduce measures on this front to become ILO consistent.

External Political Risk

The stability of the Omani regime means that the country’s foreign policy will remain unchanged. While maintaining its strong ties with the West (Oman and the other smaller Gulf states allowed the US to use bases in their countries during its campaign against Iraq in 2003), the government is also intent on developing its relations within the Middle East.

Relations with the Arab States and Iran

Oman faces no external threats to its security. Indeed, the country has played an important but low profile conciliatory role in a number of regional disputes. It has



mediated in intra-GCC disputes and played a crucial role in establishing the United Nations (UN) oil-for-food programme in Iraq in 1996. Despite strongly supporting the US-led coalition that countered Iraq’s 1990 invasion of Kuwait, Oman maintained relations with Iraq and used its two-year membership of the UN Security Council in the mid-1990s to mediate between the UN and Iraq. As with many Middle Eastern countries, Oman opposed strikes against Iraq in 2003 (see Government Stability). Oman is likely to have strong relations with the new regime. Elsewhere, Oman has improved its relations with Iran (Tehran was accused of inciting coup attempts as late as 1994). Talks were held in 2001 to further bilateral economic and political ties. More recently, the two countries have started talks on the joint development of a condensate field in the Straits of Hormuz. Iran is also important economically, being one of the main destinations for Omani re-exports. Relations have improved between Oman and Yemen following the end of the Dhofari insurgency (Yemen had supported the Dhofari rebels) and the signing of an agreement in 1997 officially demarcating the border. Economic rivalry remains a problem as both states hope to exploit their geographic position to become the leading regional transhipment hub: Yemen has ambitious plans to revive the fortunes of Aden port, while Oman has developed Salalah as a major port. However, relations with Yemen should improve following the GCC’s decision to allow Yemen to join some of its institutions. Agreement over Oman’s 1,000-kilometre border with the United Arab Emirates (UAE) has helped to remove another source of tension. In June 2002 the two countries signed an agreement delineating their common border and in October 2003, Oman and the UAE ratified the border agreement. Trade tension between Saudi Arabia and the smaller GCC states increased at the end of 2004 and in 2005, due to the smaller Gulf country’s free-trade agreement with the US (see Trade Environment). However, this is unlikely to result in an increase in external risk.

Relations with Israel

Oman was one of the first Arab states to open formal relations with Israel after the Israeli-Palestinian agreement of 1993. Indeed, Oman had long maintained covert relations with Israel and acted as a mediator; it also refused to break relations with Egypt when it was ostracised by the rest of the Arab world for its 1979 peace deal with Israel. However, Oman’s relationship with Israel has cooled following the latest escalation of violence between Israel and the Palestinians. In October 2000, Oman saw its first demonstration in support of the Palestinians. Subsequently, Oman broke off formal diplomatic relations with Israel, closed Israel’s trade office in Muscat and shut its own mission in Israel. At the end of 2003 the sultan repeated his call for the formation of a Palestinian state and declared that land occupied by Israel should be returned to Arab sovereignty.

Relations with the UK

Oman has long had close ties with the UK, and a pro-British bias continues to influence Omani affairs. Throughout the 19th and most of the 20th centuries, the UK exerted a strong influence on Oman as part of its policy to protect its Indian empire. British nationals still retain posts in the administration as special advisers. The UK remains the model for much of the legal and regulatory framework, including the setting of quality standards and other business-related issues. Qaboos was educated in the UK and retains a strong emotional attachment to the country. This pro-UK bias gives British companies an advantage in winning business in the country.

Relations with the US

Oman is less threatened by Iran and Iraq than its Gulf neighbours, and as a result is less reliant on the US military. Nevertheless, Oman is firmly part of the pro-US camp



in the region. Oman has made it clear that it believes the US and the international community could do more to resolve the Israel-Palestinian problem. However, following the terrorist attacks in the US in September 2001, Oman acted as a useful staging post for the US-led campaign against Afghanistan. In addition, despite opposing a military campaign against Iraq in 2003, Oman’s opposition became more muted once the conflict had started, with the government allowing US-coalition partners to use Omani airbases in Thumrait and Masirh. Oman and the US have a facility agreement, which should see relations strengthen on the financial, trade and strategic fronts. Oman has bought large quantities of military equipment from the US, boosting defence spending. On the commercial front, Oman views the US as an important source of investment. US companies have played a key role in developing Salalah port as well as other important infrastructure projects. Commercial and economic links with the US will increase following the signing of the free-trade agreement in January 2006.

Relations with Asia

The Omani economy is increasingly oriented towards Asian markets. Asian states such as South Korea and Japan are set to become major consumers of Omani gas and have already played a vital role in developing the country’s gas infrastructure. However, while Oman will benefit from increased gas exports, it will also become more exposed to downturns in East Asia’s economic cycle. Economic ties with India are also becoming more important as a result of the USD1.1 billion Omani-Indian joint venture fertiliser plant planned in Sur. Oman is particularly keen to increase trade relations with China as an export destination.

Political Risk Outlook

Oman is highly stable with virtually no political risk from either domestic or external factors. The sultan dominates the political system, and his paternalistic policies and efforts to ensure that Oman’s diverse communities have a stake in government have created a high degree of stability. However, they have also created dependency on the sultan and ensured that the decision-making process is often lengthy and opaque. Although voting rights have been extended to all citizens aged over 21, this will not result in increased government instability or a weakening in the government; the consultative council only has the ability to review legislation. Thus, changes in stability or economic policy are not expected. Owing to the slow progress in economic reform, voter turnout is again forecast to be low in the 2007 election. In the medium term, some development of the political structure and clarification of the succession process are expected. The Basic Law is likely to be refined over the coming decade in order to clarify the succession process and make the transition smoother. Political risk and uncertainty would increase if Qaboos died suddenly; however, even in this worst-case scenario, we do not expect a turbulent or violent transition. The royal family is likely to reach a decision, not least because there are indications that Qaboos has decreed that the military should be mobilised if a successor is not named within the given time. A further factor that will affect Oman’s long-term political stability is the pace of economic reform. Economic diversification and real income growth will be crucial given the country’s growing population and the need to provide jobs for the expanding Omani workforce. Meanwhile, the September 2001 terrorist attacks on the US and subsequent US policy have not substantially increased political risk within Oman, although Muscat has downplayed its involvement in both the US-led campaign against terrorism and the war against Iraq. So far, there have been some anti-US demonstrations, which were peaceful and not directed at the Omani government. However, Oman’s strong links to the West makes it a likely target for terrorist attacks.



Macroeconomic Risk

Key Point: Although the economy benefited from the strong global oil price in 2005, it did not feel the full benefit owing to lower production levels. Real economic growth is forecast to remain strong in the outlook period albeit marginally weaker.

Short-Term Economic Performance

Oman’s short-term prospects are linked to oil prices and, increasingly, the export of liquefied natural gas (LNG), as well as government spending of hydrocarbon revenues. However, over the last decade the government has used its limited oil supply prudently and introduced measures to diversify the economy and increase foreign investment. These moves have included the development of gas and related projects (e.g. using gas to provide feedstock to new industry and as a cheap energy source for heavy industry), exporting LNG and developing the Salalah port (see Long-Term Economic Potential).

Chart 1 Yearly GDP Growth Contribution by Demand

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Private consumption Gross fixed capital formation

Government consumption Net exports

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Sources: International Monetary Fund, International Financial Statistics; D&B The hydrocarbon sector accounts for 49% of GDP and around 80% of both exports and government revenue. In turn, the government controls most of the major economic sectors and is the largest employer. However, Oman’s commercially exploitable oil reserves are expected to be depleted in around 20 years. Moreover, the economy’s dependence on oil makes it vulnerable to shifts in world prices. Although LNG exports are an important move towards diversification, the economy will remain dependent on hydrocarbon exports in the short to medium term, with LNG prices linked to those of oil. Negatively, the oil sector has suffered from falling oil production levels since 2001 and levels are forecast to fall until 2006. This is a result of the technical difficulties experienced by Petroleum Development Oman (PDO) brought about by the maturing of its oil fields, which resulted in lower production levels; PDO produces 85% of Oman’s oil. Lower levels of oil production prevented the Omani economy from benefiting fully from the strong oil prices in 2003.



The International Monetary Fund (IMF) estimates real GDP growth of 4.5% in 2004, which we feel is realistic. Despite the continuing fall in oil production levels (from 823,000 barrels per day, bpd, in 2003 to 784,000 bpd in 2004), net exports are estimated to have made a positive contribution to real GDP growth as the increase in oil price compensated for the fall in production. Furthermore, higher LNG export earnings boosted export earnings. Along with net exports, real GDP growth will have been supported by increased investment spending and private consumption levels. We estimate that real GDP growth accelerated to 5.7% in 2005. According to preliminary government estimates, nominal GDP increased by 21.7% in 2005, against 12.5% in the previous year. However, falling oil production would have again resulted in Oman not maximising the benefit from the high oil price. Average oil production levels fell to 744,000 bpd in the first ten months of 2005, down 1.4% year on year. However, as with 2004, a stronger oil price in 2005 supported the net export position; the price of Omani oil in 2005 was USD49.4 per barrel (p/b), an increase of 45.7% from the 2004 average. LNG export earnings also continued to increase in 2004. Higher government spending also supported private consumption and gross fixed capital formation. Real GDP growth is forecast to fall marginally in 2006, with net exports making a lower positive contribution to real GDP growth (see Short-term Economic Outlook), owing to the lower forecast marginal increase in the oil price and continued strong import growth. Economic expansion will be driven by higher government spending and continued strong sentiment, which will support private consumption and investment levels.

Components of Growth

Table 1 Contributions to Growth

2003 2004e 2005e

Real growth rate (%):

Private consumption 6.1 1.3 2.2

Gross fixed capital formation 28.2 2.7 3.4

Government consumption 0.7 4.7 4.3

Exports 2.4 4.3 5.7

Imports 9.1 0.6 1.3

Real GDP 4.5 4.2 5.7

Share of GDP (%):




Net exports 18.4 19.8 19.4

Contribution to real GDP growth (percentage point):




Net exports -1.9 2.4 0.7Sources: International Monetary Fund, International Financial Statistics; D&B

Price Deflator The Gulf states use a price deflator to even out the volatility in export earnings and make growth more representative over time. Thus, when oil prices are high, as in 2000, nominal GDP can grow by 26.2%, while real GDP growth of 5.1% is recorded, despite negligible inflation. In the same way, when oil revenues decline, nominal GDP could contract or be significantly lower than real GDP.



Private Consumption

Surges in private consumption typically occur after a sustained rise in oil prices as confidence in the economy grows and government spending increases. Despite recent changes in the structure of the economy, growth and private consumption are still affected by the government spending multiplier. Rapid population growth and the government’s willingness to maintain employment levels and resist cuts in wages also help to buoy private consumption. Private consumption is expected to have made a positive contribution to real GDP growth in 2005. Furthermore, sentiment has continued to remain high with the oil price strengthening; this is reflected in the performance of the Muscat Stock Market (MSM). The strong performance of the stock market has in turn added to improved sentiment as the wealth effect increases. Moreover, private sector confidence would have been underpinned by expansionary budgets in 2004 and 2005 (see Government Consumption).

Chart 2 Private Consumption

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Sources: International Monetary Fund, International Financial Statistics; D&B

The pick-up in economic activity in 2004 has also resulted in an acceleration of employment in the private sector. According to data from Public Authority for Social Insurance, the number of Omanis registered as working in the private sector increased by 16.4% to 87,064 by the end of 2004. The growth in the number of Omanis employed in the public sector was weaker at 5.1%. This trend continued in 2005, with the number of Omani employees in the private sector increasing to 96,400 at the end of October, a growth of 10.7% year on year. Meanwhile, the improved position of the banking sector and better lending practices have resulted in increased credit to the private sector; this was supported by the relatively low, albeit rising, interest rate. Private consumption is also expected to make a positive contribution to GDP growth in 2006 (and in the outlook period), as the budget for the year was again expansionary (see Government Consumption). Many of the trends of 2005 will continue, such as the high oil prices, accommodative interest rates, increased lending from banks and continued employment growth.

Gross Fixed Capital Formation

Although the government has traditionally been the largest investor in the economy, the private sector is now becoming the prime driver, pushing up levels of investment



and making a significant contribution to GDP growth. Since 1996, private sector investors have undertaken major investments in the LNG sector and in power and transport, particularly the development of Port Salalah as a major transhipment hub. Positively, the economy is benefiting from Oman’s investment and diversification programme, which continues to help Oman’s export position. Gross fixed capital formation is estimated to have made a positive contribution to real GDP growth in 2004 and 2005. A key aim of the government’s spending plan was to increase spending on investment projects, including, infrastructure and oil and gas. Furthermore, higher government and private investment will result in gross fixed capital formation making a positive contribution to real GDP growth over the two-year outlook period. In 2005, increased domestic and international demand resulted in increased private sector investment. This was supported by increased profitability of Omani companies and bank lending to the private sector (see Commercial Risk). In the first 11 months of the year, bank lending to the private sector increased by 13.2% year on year.

Chart 3 Gross Fixed Capital Formation

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Source: Central Bank of Oman, Annual Report

Private and foreign investment is expected to increase, as many projects will require additional financing. Foreign investors are operating power plants currently under construction on a build-own-operate basis. Meanwhile, projects are continuing in a number of areas, and include the Sohar Refinery and the third gas train. The new refinery in Sohar (forecast to be completed in the third quarter of 2006) will have a 116,400 bpd capacity crude unit and a residue fluid catalytic cracking unit with a capacity of 75,260 bpd. The finance ministry owns 80% of the Sohar Refinery project, while the Oman Oil Company owns the remaining 20%; 10% of its products will be used in Oman, while the remaining 90% will be exported. Going forward, the government also has plans to expand Port Salalah and develop a free-trade zone (FTZ) there (the first phase of which will cost in the region of USD100 million). Oman is also finalising a number of agreements for the construction of a new petrochemical plant, an aluminium smelter and a fertiliser factory, with foreign investors. For example, in September 2003, the government announced that it was reviving a five-year-old plan to build a USD2.5 billion aluminium smelter, which is to begin operation in 2007. The government is investing in the petrochemical sector, with international private partners such as Dow Chemicals. The joint venture will be owned 50% by Dow, 25% by the Omani government and 25% by the government-owned Oman Oil company. The complex



will be located in the Sohar industrial port area and will include feedstock production facilities and three polyethylene production units. The government is also aiming to develop the country’s tourism-related infrastructure, as well as other infrastructure. Furthermore, the government is also promoting private sector investment, such as the planned independent water and power project (IWPP) at Barka, which is expected to start producing in 2009. This will be the second IWPP in Barka, the first started commercial operations in 2003. Gross fixed capital formation will be one of the main positive contributors to real GDP growth over the two-year forecast period, as the government intensifies investment spending, both to increase oil and gas production levels and to diversify the economy. PDO intends to invest USD1.5-2.0 billion a year over the next five years to increase production levels, with a further USD2 billion to be spent on expanding gas production. Furthermore, Oman is looking to expand in other fields such as petrochemicals, power and tourism.

Government Consumption

As with other Gulf states, government consumption is a key contributor to GDP growth and will remain so in the short to medium term as the government retains control of most key economic sectors and employs the majority of the workforce. Current expenditure accounts for around 75% of total government spending, the majority of which is allocated to the public sector payroll. Current expenditure tends to remain intact (especially public sector wages), even when lower oil prices bring about a cut in overall spending. However, if oil prices remain low for a number of years, stringent cuts in current spending will be required to bring a greater degree of stability to fiscal policy and keep the deficit under control; such measures would be highly controversial and could risk instability. The government’s financial position has been boosted by the stronger oil prices recorded since 1999. This in turn has enabled the government to adopt a looser fiscal policy following spending cutbacks in the late 1990s.

Chart 4 Government Balance

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Oman Kuwait

Qatar Saudi Arabia


In 2004, government spending accelerated by 19.5% from the previous year. Increased public expenditure boosted private consumption and gross fixed formation levels, with current spending increasing by 12.1% year on year and investment spending by 47.8%. Government consumption is again estimated to have made a



positive contribution to real GDP growth in 2005, with public expenditure growing by 8.2% year on year in the first eight months of the year to OMR2.4 billion. Despite this increased spending, we forecast that the budget surplus will increase to 6.0% of GDP in 2005 due to strong hydrocarbon revenues. This is compared with a surplus of 4.7% of GDP in 2004 and 4.4% of GDP in 2003. Overall government revenue increased by 44.1% year on year to OMR6.6 billion in the first eight months of the 2005; net oil revenues increased 47.6% year on year over the same period, while natural gas income increased by 88.2%.

The 2006 Fiscal Plan Oman’s economic outlook will continue to be supported in 2006 by higher government spending. The expansionary budget was approved in January and set expenditure at OMR4.2 billion, up 15.1% from the previous budget. The aim of the budget is to boost economic growth, support the country’s future development potential and social development. The budget plans to increase investment in the oil and gas sector to enhancing the production capacity. Investment in the oil and gas sector is set to increase by over 39% from the 2005 budget. Current expenditure will account for around 33% of total spending, with emphasis on education (up 17% from the previous budget) and new development projects (up 14%). Meanwhile, revenue is set at OMR3.6 billion, resulting in a deficit of OMR650 million. Although the budget envisages a deficit of 6.0% of GDP, this is based on a conservative estimate for the oil price of USD32.0p/b; we forecast a stronger oil price. The current price for Omani oil is around USD54.0p/b. The oil production level is again forecast to fall (albeit marginally) in 2006 to an average of 746,000 bpd, compared to an estimated 750,000 in 2005. Nevertheless, we expect the budget to post a surplus in 2006 given the higher than forecast oil revenue. The surplus is forecast to fall to 3.2% of GDP, owing to the increased expenditure. In addition to boosting government spending, stronger oil prices have led to a sizeable build-up of official reserves (see Foreign Exchange Reserves). In the past, the government has financed deficits by drawing on the State General Reserve Fund (intended as a ‘pension’ scheme for the economy when oil runs out) or by issuing government bonds. Any above-budgeted revenues are deposited in the fund or used to repay debts rather than boost recurrent expenditure. The budget surpluses between 1999 and 2005 have resulted in accumulation of the Fund, although its exact size is a state secret. The government’s fiscal position has improved since 1999 and is healthy. However, the government’s dependence on oil exports remains an area of risk; economic risk would increase substantially if oil prices remained low for a number of years. Depending on the oil price, oil revenues account for 70-85% of government revenues. In 2004 net oil revenue accounted for just under 70% of GDP; however, this figure will fall from 2006, when LNG exports increase will increase. Moreover, taxes and customs tariffs, which account for much of the remainder, are indirectly dependent on oil earnings feeding into the economy via government spending. Positively, the government wants to improve the budget structure by reducing non-productive spending (e.g. on defence) and redirecting it towards social areas such as education. The government has also taken steps to consolidate a large number of the state pension funds in order to improve efficiency. There are indications that the government is in the process of reviewing its tax legislation, including reducing the corporate income tax level, simplifying procedures and ensuring appropriate implementation. Although the reduced corporate income tax will benefit the investment environment and help attract foreign direct investment (FDI), it is also crucial for the government to introduce new forms of taxation along with other measures to strengthen the government’s fiscal position; corporate income tax and customs duties account for most of the government’s tax revenue. The government has noted that for greater regional



integration an income or value-added tax can only be introduced on a GCC-wide basis. The GCC is currently carrying out a study on the introduction of value-added tax (VAT) and the organisation has indicated that it plans to impose a VAT on cigarettes, cigars and other tobacco products. The VAT is due to be imposed by 2007. A Dubai Chamber of Commerce and Industry (DCCI) economic bulletin in 2005 also indicated that this will probably be followed by a nominal VAT on other consumer products in the GCC. However, widespread VAT is not forecast in the short term. The IMF has suggested that the government should seek to maintain a strong fiscal position and has urged it to adopt an excise tax on luxury goods and services, and a simple property tax in the short term, before introducing a broad-based value-added tax and personal income tax in the medium term. However, a broad-based tax system is not expected to be introduced in the short to medium term; instead, government revenue, and the country, will remain dependent on the hydrocarbon sector. An income tax would be very unpopular and, as with other Gulf countries, require a reworking of the social contract between the royal family and the Omani people.

Privatisation

The privatisation of state owned enterprises would have a number of benefits, such as increasing the role of the private sector, increasing private investment (either foreign or domestic) and increasing the efficiency in the running of the organisation. In mid-2004, Sultan Qaboos bin Said al Said issued two decrees promulgating privatisation laws: the first lays down policies and regulations for the sale of government-owned assets; and the second regulates and privatises the electricity sector and water related to it. The government is planning for the privatisation of the power and water sectors, including power generation and water distribution. Opening these sectors to foreign competition is a key commitment to the World Trade Organisation (WTO). It is also expected to privatise the national grid. In April 2005, the government transferred existing power-generating assets to government owned companies from the Ministry of Housing, Electricity and Water as an initial first step. Going forward, a key tenet of the 2006 budget and the Seventh Development Plan is to forge ahead with the privatisation plan. The cabinet has already given its approval for the sale of the government’s share of in Oman Flour Mills. Furthermore, the government is carrying out a number of studies for a number of other companies and the privatisation of the post and telegraph sector. Positively for the government’s reform programme and for the development of the capital market, the 30% initial public offering (IPO) for the Oman Telecommunications Company (Omantel) was finally launched in June 2005; prior to the sale Omantel was 100% government-owned. The state has been trying to part-privatise Omantel for a while; the IPO was originally delayed from 2003 and then was expected before the end of 2004. The sale raised OMR288 million (USD748 million), with 225 million shares being sold at an offer price of OMR1.28 per share. Investors applied for a total of OMR706 million worth of shares. Omani nationals will were able to buy 70% of the issue, with the remaining 30% for pension funds and charity organisations. Each investor will be limited to a maximum holding of 5%. Foreign investors and institutions were allowed to acquire shares from the secondary market three months after the firm was listed on the Muscat Securities Market (at end-July). However, there were indications that some investors are taking out loans to buy Omantel shares. This could lead to growing debt levels for both individuals and banks if there is a fall in the share price in the future. The government launched a campaign to discourage this. The IPO was the largest ever public issue in Oman and, following the sale, Omantel is expected to emerge as the largest entity listed on the Muscat Stock Market in terms of market capitalisation.



Debt

As with the fiscal deficit, debt fluctuates with the oil price. However, Oman’s overall debt position is sustainable and not a risk to the country’s risk outlook. Positively, despite frequent fiscal deficits during the 1990s, the government’s debt situation remained manageable; moreover, the higher oil prices since 1999 have allowed the government to reduce debt levels. According to IMF figures, overall government debt levels have fallen from 32.3% of GDP in 1998 to 16.0% of GDP in 2002; interest on loans accounts for just 4.0% of total expenditure. The higher oil price is expected to have resulted in the government reducing its debt levels; we forecast an overall debt level of 13.9% of GDP in 2005. Meanwhile, overall external debt fell by 15.1% in 2005 to USD2.86 billion, from USD3.37 billion (9.5% of GDP) in December 2004. This compares with an external debt level of 22.2% of GDP in 2002 and 40.2% in 1998. The government repaid loans used to develop the LNG sector and to repay government debt in 2002 (see Foreign Debt and Default Risk). Furthermore, the government has used the oil revenues to repay debt, along with building up reserves. The government has intervened in the financial markets to absorb extra liquidity using development bonds. The government has also increased domestic borrowing to finance industrial projects; this is expected to continue in the short term, despite strong government revenue. This was most likely to ensure that the market remains liquid and to repay maturing bonds. Furthermore, the government has borrowed at low interest rates, which will be especially beneficial if oil prices fall.

Chart 5 Public Debt

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Net Exports

The dominant position of hydrocarbons in Oman’s export profile means that net exports make a cyclical contribution to GDP growth (see Export Profile). At times of weak or modest oil prices, import growth tends to outstrip export growth. Oman’s dependence on imports means that this demand does not diminish at times of weak oil prices. Oman has little manufacturing, which combined with a rapidly growing population (and one that is becoming increasingly sophisticated), is driving up demand for imports. However, exports are benefiting from the government’s diversification programme, especially from LNG. In 2004 LNG export receipts reached USD1.6 billion, compared with USD0.48 billion in 2000, the first year of LNG exports.



Net exports are estimated to have been the main positive contributor to real GDP growth in 2005 owing to strong oil prices throughout the year; this was despite lower production levels. Oman’s net oil revenues increased 47.6% year on year in the first eight months of the year, while natural gas income increased by 88.2% year on year. Meanwhile, imports were driven by higher domestic demand. Net exports are forecast to make a weaker positive contribution to real GDP growth in 2006 given continued lower production levels and forecast acceleration in imports (see Global Economic Outlook).

Chart 6 Export and Import Growth

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Monetary Environment

Inflation

Historically, Oman has had low inflation, reflecting the effects of government price controls and the rial’s pegged exchange rate, which reduces the risk of imported inflation (see Exchange Rate Policy). Inflationary pressure will increase in the medium term: liberalisation and the ending of subsidies in line with World Trade Organisation (WTO) requirements will reduce the government’s power to control prices. Inflationary pressures and trends are partly dictated by the oil market. As oil earnings provide a large part of the liquidity in the economy, inflationary pressures rise and fall with the price of oil and the trend in government spending. During the 1998 slump in oil prices, inflation fell as liquidity in the market declined. However, at times of higher liquidity, the government issues bonds to absorb extra liquidity, reducing inflation. Despite strong domestic demand and the weakening of the US dollar to other major currencies such as the euro, inflation remained weak in 2004 at 0.3%. Nevertheless, these factors resulted in the reversal of the trend of falling prices, which occurred in the previous four years. However, the increase in inflation levels was limited by price controls on a number of a number of goods in Oman; increasing direct and indirect subsidies has limited the impact of imported inflation. Furthermore, some importers switched from more costly EU imports to cheaper imports. However, the weakness of the US dollar resulted in an increase in the cost of a number of goods, most notably investment related imports.



The low inflationary environment continued in 2005, although there was a pick-up in the rate. In the first five months of the year, the consumer price index rose by 0.7% year on year. The price increase was partly driven by the increased demand in the economy and higher prices linked with the weakening of the US dollar against other major currencies, such as the euro, feeding through. Furthermore, the government raised diesel prices, in order to reduce the considerable level of smuggling to the UAE (where diesel is more expensive). This has increased the transport costs of many goods. Inflationary pressure will remain benign over the two-year outlook period and staying substantially below the government target of 2.0%. However, upward price pressure will increase marginally with the higher government spending and increased demand in the economy.

Chart 7 Consumer Price Inflation

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Sources: International Monetary Fund, International Financial Statistics; Arab Monetary Fund, Economic Indicators for Arab Countries; D&B

Money Supply

The central bank’s ability to control money supply is constrained by the economy’s dependence on oil and the pegged exchange rate. The government’s primary goal is to maintain the peg against the US dollar, with the aim of achieving price stability and, in the medium term, monetary union with the other GCC countries. Liquidity is highly dependent on earnings from oil exports. However, the central bank absorbs excess liquidity primarily by issuing certificates of deposits (CDs). As a result of the ample liquidity in the economy with the higher government spending and oil revenue, money supply (M1) and broad money (M2) registering strong growth of 23.5% year on year and 19.8% year on year in the first 11 months of 2005. The rate of growth of M2 picked up in 2005 compared with the previous year due to the increase in interest rates, which made term deposit its more attractive. The Central Bank of Oman issued CDs in order to absorb the liquidity; commercial banks’ investments in CDs rose from OMR59 million in December 2004 to OMR273.7 million in December 2005.



Chart 8 Money Supply

% change

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Money Quasi-money

Source: Central Bank of Oman, Annual Report

Interest Rates

Interest rates are one of the government’s main instruments in its efforts to control inflation and money supply. However, they have only a limited effect given the impact of oil earnings on both of these factors. The government’s ability to use interest rates is also constrained by its exchange rate policy. Maintaining a fixed peg between the rial and the US dollar means that the US Federal Reserve effectively sets the overall direction of interest rates.

Chart 9 Interest Rates

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Source: International Monetary Fund, International Financial Statistics

The key lending rate has been in decline since the third quarter of 1999, in line with interest rate developments in the US. By August 2004, the lending rate and deposit rate had fallen to 7.91% and 2.18% respectively, from 10.79% and 6.45% in the third quarter of 1999. However, from 2005, in line with US interest rates, the Central Bank of Oman started increasing Omani rates. The overnight inter-bank lending rates increased from 0.6961% at end-2004 to 1.986% at end-2005. The average interest rate on deposits also increased through out 2005. However, commercial lending rates



fell from 7.57% at end-2004 to 7.10% at end 2005. This was due to central bank pressure to reduce the spreads between lending and deposit rates: the interest rate spread narrowed to 4.0 percentage points in December 2005, compared with 5.25 percentage points a year earlier. Nevertheless, the difference between the lending and deposit rate will still provide a health margin for bank profitability. The central bank will continue to adjust interest rates in line with movements in the US. We forecast that interest rates will continue to increase in the first four months of 2006 before stabilising.

Chart 10 Real Interest Rates

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Short-Term Economic Outlook

Real GDP growth will remain robust in 2006, albeit slightly weaker than in 2005. This will partly be a result of the strong base effect from 2005 and a smaller forecast marginal increase in the oil price. Net exports will make a lower positive contribution to real GDP growth (see External Outlook), due to the weaker oil production and strong import growth; net exports will still make a small positive contribution due to the higher forecast oil price and increased LNG export levels. The main positive contributors to real GDP growth will be gross fixed capital investment and private consumption. The government will intensify investment spending, both to increase oil production levels and to diversify the economy. Private consumption will be driven by higher government spending following the strong budgetary performance in 2005. Furthermore, the continued strong oil price will maintain positive sentiment. With increased investment levels and strong commercial performances, Omani employment will continue to grow. The same factors will also drive real GDP growth in 2007. The expansionary 2006 budget set expenditure at OMR4.2 billion, up 15.1% from the previous budget; this is markedly above the increases in previous budgets and highlights the government’s intention to fuel growth and social development. We expect the budget to post a surplus in 2006 given the higher than forecast oil revenue; however, given increased expenditure, the surplus will fall to 3.2% of GDP.



Table 2 Short-Term Economic Forecasts Forecast 2006f 2007f

Real growth rate (%):

Private consumption 3.6 5.3

Gross fixed capital formation 12.6 15.2

Government consumption 8.1 4.6

Exports 1.2 -0.9

Imports 1.3 1.2

Real GDP 5.5 5.0

Contribution to real GDP growth (percentage points):

Private consumption 1.5 2.2

Gross fixed capital formation 2.0 2.6

Government consumption 1.8 1.0

Net exports 0.2 -0.9

Inflation, annual average (%) 1.0 0.9

Interest rate (deposit, %) 3.3 3.2

Interest rate (lending, %) 7.5 7.2Source: D&B

Meanwhile, inflation will remain benign over the two-year forecast period. We forecast a minor increase in inflation, owing to higher government spending and increased demand in the economy. Interest rates will increase gradually in first four month of 2006, before stabilising.

Long-Term Economic Potential

The economy is undergoing changes that will reduce both its dependence on oil and the role of the public sector. The government owns majority stakes in (or wholly controls) most of the major economic sectors, including the oil and financial sectors, and transport and utilities. It is also the largest employer and offers citizens an extensive social services and welfare programme. However, Oman’s commercially exploitable oil reserves have an estimated life of 20-25 years, and this is spurring efforts to diversify and attract greater inward investment. The government is pinning the country’s future economic prosperity on its extensive gas reserves and its position as a transport hub between Europe, Africa and Asia. In addition, Oman is also developing other industries, such as tourism. Liquefied Natural Gas: Oman has some of the largest gas reserves in the world and has ambitions to become a major exporter of LNG. The major markets are in East Asia and the Indian subcontinent; Oman has signed several long-term supply contracts with South Korea and Japan as well as the US. Work on the third LNG train project commenced in 2003, and will expand output to 9.9 million tonnes annually from 2006 from 6.6 million at present. Union Fenosa Gas will purchase half of the output of the new train. Oman also hopes to develop its export-oriented chemical industries, using gas as a feedstock. The government has developed the infrastructure in the Sohar, including the building of a pipeline to carry natural gas from the producing fields. A number of projects are based (and developing) in Sohar. Transhipment Hub: The country is exploiting its location on the Arabian Sea near one of the world’s major shipping lanes to become a transhipment hub. Salalah has emerged as one of the leading container ports in the region. It lies near the main Europe-Asia shipping routes and is the only port between Europe and Singapore that can handle the largest class of container ship.



Population

Oman’s dependency ratio (those aged 0-14 and over 64 to those aged 15-64) is expected to decrease in the coming decades, from 0.87 in 2000 to 0.49 in 2050. The rapid growth in the workforce could boost long-term economic growth by increasing private demand. However, this will be hindered if the economy cannot utilise new entrants productively. Rapid population growth has resulted in a very young population, with around 50% of the population aged 15 or under, and some 20,000 school leavers entering the labour market each year. Meeting rising demand for jobs is proving a challenge. In theory, the government guarantees every graduate employment, but the public sector already suffers from overstaffing. Moreover, the government no longer has the resources to act as the employer of first choice. Pressures will also arise as a result of social changes, in particular the entry of women into the workforce. Although the workforce remains male-dominated, and levels of female participation lag far behind those in Western Europe and North America, there are indications that younger women are more inclined to work. However, the labour market is not yet of sufficient size to accommodate increased female participation. Substantial economic growth will be required to satisfy the economic aspirations of all of Omani society. The government is attempting to address these issues through its ‘Omanisation’ programme. This sets targets for the percentage of Omani nationals employed by companies, which vary from sector to sector. The programme also bars the employment of foreigners in some jobs, mainly low skilled and semi-skilled posts, although the government aims gradually to expand the list. The programme has had some success, with many sectors meeting their targets. However, the programme places an additional burden on companies; Omanis are often more expensive to employ as they demand higher wages and usually require more training than foreign labour.

Technological Progress

Although no reliable figures are available on labour productivity, anecdotal evidence suggests that productivity is low and there is considerable scope for greater efficiencies and increases in productivity. The state sector, which dominates the economy, is overstaffed and inefficient. However, increased private sector involvement should introduce more efficient and productive working patterns and lead to technology transfer: Skills Gap: The government prioritises training to address the existing skills gap. The government has adopted the British General National Vocational Qualification scheme and offers incentives for the establishment of private universities. The government also prioritises education spending. Technology Transfer: Oman has little research and development capability of its own, making technology transfer especially important. Technology transfer has suffered from Oman’s reputation as a poor protector of intellectual property rights; however, with Oman’s accession to the WTO, this area should improve (see Intellectual Property Rights). Meanwhile, Oman is developing a reputation as an innovator in water resource management (including desalination). Oman was selected as the site for the Middle East Desalination Research Centre, an initiative that grew from the Israeli-Arab peace process.

Investment

The government no longer has the resources to finance the country’s economic development and has had to encourage private investors. Sustainable growth in



capital investment is vital for Oman’s long-term economic growth prospects, particularly in terms of diversifying the economy. There are signs that this trend has started: private investment, including foreign investment, has been instrumental in establishing the LNG industry and redeveloping Salalah. Oman was also the first country in the region to allow the private sector to finance and construct a power generation plant (see Foreign Direct Investment Environment). Further investment is required in power generation and transmission, water, transport and telecommunications. Much of the existing infrastructure was built in the 1970s and early 1980s and is now under strain due to age and the demands of an expanding population. Government plans for the diversification of the economy envisage private investment in industrial projects such as petrochemicals and aluminium production. This is in addition to plans to privatise some state-owned enterprises (see Gross Fixed Capital Formation). The need to both update existing infrastructure and invest in economic diversification will drive future expansion in capital investment and should underpin long-term economic growth. Fluctuations in domestic savings rates largely reflect oil earnings. In years of high earnings, savings rise as Omanis have greater liquidity; in austere times, savings are spent. The slump in oil prices in 1998 saw a significant drop in the rate of domestic saving. However, as expected, the surge in oil prices in 1999 was accompanied by a rise in the domestic saving rate.

Long-Term Economic Outlook

If Oman is to achieve strong, sustainable economic growth in the medium to long term, it will need to reduce the economy’s dependence on oil and encourage economic diversification and increased productivity. To these ends, the government is encouraging the private sector to invest in non-oil industries and to construct the infrastructure needed to service these industries. This includes implementing a more liberal and investor-friendly environment, with measures to enhance the skills base. The government views the private sector, including foreign companies, as the main provider of finance and expertise to undertake investment projects. The dominant position of the private sector in diversification will reduce the state’s economic role and weaken the link between world oil prices and Oman’s economic performance. Nevertheless, the government will retain a significant role in directing economic development and ensuring maximum benefit for Omani nationals. Oman should be able to achieve sustained annual real GDP growth of 5-6% over the medium to long term. In a more realistic scenario, Oman will be able to match its recent growth record but on a more even and sustainable basis (between 2-5%). In a scenario of weak oil prices, Oman will find it difficult to achieve any real growth and the economy could contract. Although there are indications that the structure of the economy is changing as a result of the increased contribution made by private investment and consumption, this will have a limited effect in the short term.



External Economic Risk

Key Point: Although there are imbalances in the current account, these remain manageable and are unlikely to trigger a balance of payments crisis in the outlook period with oil process remaining high. The external position in 2006 will also be supported by higher gas revenue.

Balance of Payments Performance

As with the rest of the economy, Oman’s external position is dependent on the oil sector and, increasingly, on gas exports. Positively, the price for Brent crude averaged USD54.3 per barrel (p/b) in 2005 and is forecast to remain above the USD50p/b mark over the two-year outlook period. Furthermore, exports are benefiting from the government diversification programme: in 2004 liquefied natural gas (LNG) export receipts reached USD1.6 billion (around 18% of crude oil exports), compared with USD1.07 billion in 2002 and USD0.48 billion in 2000, the first year of LNG exports. The balance of payments has witnessed a surplus since 1999, driven by higher oil and gas revenue. The balance of payments surplus increased in 2004 to an estimated 1.8% of GDP, supported by the stronger oil price and capital and financial inflow into the country. The positive capital and financial inflows was a departure from the previous years and was due to increased portfolio inflows into the country. The balance of payments surplus increased to 2.5% of GDP in 2005 as a result of the higher trade surplus. The capital and financial balance was also in surplus due to foreign direct investment (FDI) and increased equity inflows from the part privatisation of Oman Telecommunications Company (Omantel). However, despite the higher forecast trade surplus in 2006, the overall balance of payments is forecast to be weaker in 2006. This is will be a result of the widening invisible deficit on the current account and increased financial and capital outflows.

Chart 11 Balance of Payments

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Dependence on the hydrocarbon sector remains an area of risk. Although Oman has attempted to diversify its economy and export base, the balance of payments will remain dominated by oil and gas exports in the short to medium term. The focus on



the hydrocarbons sector and refined goods has also resulted in limited industrial development, leaving Oman dependent on imports. Further areas of vulnerability include the considerable deficit on the service and transfer balance. Since 2000, the capital account has also been in deficit owing to a rise in investment overseas.

Current Account

Despite trade surpluses, Oman typically recorded current account deficits during the 1990s. In recent years, the transfer, income and service balances have become a structural drag on the current account, with the trade surplus a swing factor in determining the magnitude of that drag. A period of high oil prices is sufficient to balance the current account or produce a surplus, but low oil prices result in a large deficit, requiring additional capital financing. Current account deficits have usually been manageable and rarely exceed 5% of GDP. However, in 1998, the current account deficit deteriorated sharply, reaching 22.5% of GDP as a result of a poor trade performance. This again highlights the risk derived from the economy’s dependence on oil exports. Positively, strong oil prices from 1999 resulted in an improvement in the current account position.

Chart 12 Current Account Balance

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The current account balance is thought to have weakened in 2004 to 1.8% of GDP (from 3.7% in 2003). An increase in imports and a higher deficit in the invisible components of the current account resulted in a lower overall surplus. Despite the higher export earnings in 2004, the trade balance declined to 20.7% of GDP in 2004, from 22.2% of GDP in the previous year. In 2004, exports realised strong growth of 14.3% to USD13.3 billion, driven by increased oil income; although average price for Omani crude was USD33.9p/b in 2004 compared with USD27.8p/b the previous year. However, the continued difficulties faced by Petroleum Development Oman (PDO) and the subsequent lower production levels meant that the Omani economy could not take full advantage of the strong oil price. Total crude all earning increased by 17.0% and LNG exports increased by 15.6%. However, with higher government spending, ongoing investment projects and higher demand in the economy, imports increased by 29.4% to USD7.9 billion. The value of imports also surged with the weakening of the US dollar against other major currencies such as the euro. We expect that a current account surplus of 6.2% of GDP was recorded in 2005. Oman’s net oil revenues increased 47.6% year on year in the first eight months of the



year, while natural gas income increased by 88.2% year on year. The higher crude revenue was a result of the stronger oil price, as oil output fell by 1.4% y/y over the same period. However, imports rose with the higher investment levels and demand in the economy. The higher export earnings and trade surplus are estimated to have caused an increase in the invisible components of the current account. In terms of the other components of the current account, the deficit on the services account reflects Oman’s need to buy professional services from overseas. The balance tends to be pro-cyclical, expanding during periods of strong economic growth following increased oil prices and government spending. With regard to the income balance, the repatriation of profits and dividends by foreign companies operating in Oman tends to outweigh income credits, reflecting the role of foreign companies in the oil and banking sectors. Finally, the transfers account tends to experience substantial imbalances because of Oman’s continued reliance on expatriate workers, who remit their earnings overseas. All the non-oil components of the current account regularly post a sizeable deficit, a trend that is unlikely to change in the short to medium term. The current account surplus is forecast to fall in 2006, with imports continuing to increase owing the higher investment spending (linked to Oman’s diversification programme) and higher private and government spending. The outflows on the invisible components will also increase. Nevertheless, despite the lower oil production forecast by the government, exports will be supported by a higher average oil price and increased LNG exports.

Export Profile

Despite attempts to diversify the economy and increase the range of exports, crude oil continues to dominate Oman’s export profile, accounting for over 70% of exports in 2004. However, this was a fall from around 80% of export earnings in 2000. The increase in LNG exports (which amounted to 13.5% of exports in 2004) has reduced the proportion of oil to total exports. However, hydrocarbon exports still account for over 80% of total exports. Non oil exports account for 8.9% of GDP.

Table 3 Principal Exports % of total exports 2003 2004

Oil 78.7 77.6

Liquefied natural gas 13.8 13.5

Animals & animal products 1.6 2.0

Base metals & articles 1.0 1.6

Other 1.3 1.6

Mineral products 0.9 0.9

Plastic, rubber & articles thereof 0.5 0.7

Chemical products 0.7 0.6

Foodstuffs, beverages, tobacco & products 0.5 0.6

Textiles 0.7 0.5

Vegetable products 0.3 0.4Source: Central Bank of Oman, Annual Report

Non-oil merchandise exports mainly comprise animal products, metals, textiles, mineral products and chemical products. Non-oil exports will increase in the medium term; Oman hopes to develop export-oriented industries based on gas-derived products such as fertilisers. However, oil will remain the dominant export. The major customers for Omani oil exports are the energy-hungry Asian states such as South Korea (the top destination for Omani exports in 2004), China and Japan. Asia has grown in importance as an export market since the early 1990s, despite the crises in the East Asian economies. The top three countries for Omani crude exports



account for over 58.5% of total crude exports. Asia is also the main market for LNG. This increased dependence will make Oman more vulnerable to economic downturns in the region. However, there is also growth in other markets: in 2004 Spain accounted for 1.4% of Omani exports, compared with 0.1% in 2000, with the increase explained by a rise in LNG exports. Indeed, Spain is forecast to become a larger importer of Omani LNG as Union Fenosa Gas will purchase half the output of the planned third train, which will start exporting from 2006. Three major Japanese buyers (Itochu, Mitsubishi Corporation and Osaka Gas) have also agreed to buy gas from the third train.

Table 4 Exports by Destination % of total exports 2003 2004 South Korea 18.7 29.5

China 18.5 17.5

Japan 16.2 11.5

Thailand 12.2 10.6

United Arab Emirates 7.8 7.2

US 4.1 3.9

Iran 3.3 2.8

Malaysia 3.3 4.0

Spain 0.6 1.0

Saudi Arabia 0.6 1.0

UK 0.6 1.0Source: International Monetary Fund, Direction of Trade Statistics

With regard to non-oil exports, the main destinations are other Middle Eastern countries. The US and UK are also important destinations for non-oil exports, accounting for 7.6% and 3.3% of non-oil exports respectively in 2004.

Import Profile

Given its underdeveloped industrial and agricultural capacity, Oman has to import the vast bulk of its needs. High machinery and transport imports (48.4% of total imports in 2004) reflect the oil industry’s demand for equipment and spare parts, along with equipment required linked with the higher investment spending (see Gross Fixed Capital Formation). In addition, a lack of manufacturing capacity means that all vehicles have to be imported. Manufactured items accounted for 18.2% of imports in 2004 and food 11.4%. Rapid population growth will boost import demand. Furthermore, over the two-year outlook period, imports are forecast to increase as a result of higher investment levels.

Table 5 Principal Imports % of total exports 2003 2004

Machinery & transport equipment 43.0 48.4

Manufactured goods 15.4 18.2

Food & live animals 11.4 11.4

Chemicals 7.5 7.6

Miscellaneous manufactured articles 6.2 5.7

Beverages & tobacco 4.7 1.3

Crude materials except fuel 4.4 3.2

Minerals, fuels, lubricants, etc. 3.3 2.6

Animal & vegetable oil fats 0.8 0.8

Other 3.2 0.7Source: Central Bank of Oman, Annual Report



Most of Oman’s imports originally derive from the EU, US and Japan; however, this is only partly reflected in the import statistics, as many of these goods enter the country as re-exports from the United Arab Emirates (UAE), and particularly Dubai. The UK accounts for around 7.4% of the EU’s trade with Oman. The strong historical links between Oman and the UK make British companies preferred suppliers. However, other EU member states are increasingly successful in exporting to the country, accounting for the slight rise in the EU’s share of Oman’s total imports.

Table 6 Imports by Source % of total imports 2003 2004

United Arab Emirates 27.4 21.6

Japan 16.1 17.1

US 6.6 6.2

UK 6.1 5.7

India 4.5 4.4

Germany 4.4 4.4

Saudi Arabia 3.7 3.4

South Korea 1.9 3.3

Italy 3.1 2.4

France 2.4 2.4

Australia 1.8 2.4Source: International Monetary Fund, Direction of Trade Statistics

Financial and Capital Account

Capital account trends have proved less volatile than those of the current account; however, the figures made available by the authorities are incomplete. A high level of secrecy surrounds the government’s investment activity, especially with regard to the State General Reserve Fund (SGRF). Positively, the majority of capital inflows tend to be in the form of direct foreign investment (rather than portfolio investment), which has positive implications for stability. The capital account tends to be in surplus during times of increased government investment since this is typically accompanied by higher levels of foreign investment; foreign investors are particularly keen on involvement in oil, gas, petrochemical and power projects. However, as with other oil exporting countries, deficits often occur at times of strong oil revenues as the government increases its overseas investment; deficits of this nature do not add to balance of payments risk. After four years of deficits on the financial and capital balance, there was a significant surplus in 2004. This was a result of increased international borrowing to finance the investment and import needs of ongoing large-scale projects. Furthermore, there was a fall in the government’s debt repayments, as well as a substantial increase in portfolio inflows and international and domestic (from overseas) increased their investment in stocks and bonds on the Muscat Securities Market (MSM). A capital account surplus is also expected for 2005 as foreign investment and funding is estimated to have increased. Portfolio investment will also have remained strong with the part privatisation of Omantel (see Privatisation). Although the capital and financial account is forecast to fall into deficit, as the government invests its oil revenue overseas, the shortfall is forecast to be lower than between 2000 and 2003 (when it averaged a deficit of USD484 million) as progress is made in number of large projects that have attracted foreign involvement and financing.



Foreign Direct Investment Flows

Levels of FDI have been modest and have been concentrated in the hydrocarbon sector. Oman is unique among the Gulf states in allowing substantial foreign participation in its oil sector. Royal Dutch Shell Oil owns a 34% stake in the national oil company PDO, as well as a 30% stake in Oman Liquid Natural Gas. This makes Royal Dutch Shell by far the biggest foreign investor in the country. Furthermore, Oman has led the way in private foreign investment in the power sector. Foreign investment in areas such as the LNG sector, infrastructure and utility projects is becoming more pronounced.

Chart 13 Foreign Direct Investment Inflows

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FDI reached its peak in the mid-1980s, when the vast bulk of foreign investment in the oil industry was made. The subsequent fall in FDI levels reflects the completion of a number of projects. However, the government is keen to attract foreign investment in a number of oil and non-oil activities in order to diversify the economy. It hopes that such investment will bring new technology and skills to the country, thereby improving efficiency and productivity. Particular attention has been paid to the exploitation of Oman’s huge gas reserves. There was a marked increase in FDI in 2003, which was mostly a result of higher investment from oil companies, compared with redemptions. There was net outflow under the FDI component in 2004; however, this was a result of several companies remitting profits abroad. Without this, there would have been new inflows under FDI. Positively, there are signs that investment activity picked up into 2005 and FDI is expected to remain strong in the two-year outlook period as a result of various projects to diversify the economy (see Gross Fixed Capital Formation).

Equities

Foreign involvement in the MSM remains small; however, foreign participation has increased from 9.3% of ownership in listed joint stock companies in 2001 to 17.3% at end-September 2004. A deepening and diversification of the market and efforts to improve business transparency will be required if the MSM is to attract investment and become a major source of financing.



Chart 14 Stock Market Performance, Year-End

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Source: Muscat Securities Market

Positively, the MSM has been supported from 2002 by the improved performances by many of the companies listed, which in turn reflected higher government spending and stronger oil prices. In addition, investor confidence was improved by moves by the government and capital market authorities to upgrade the MSM (see Investment Environment). As with other Gulf stock markets, the MSM witnessed a strong performance in 2003, with the index increasing by 42.1%. The market was boosted by the upturn in confidence brought about by end of the war in Iraq, strong oil prices and an improvement in corporate performances. The MSM was also supported by the low interest rate. The index continued to increase in 2004. High oil prices along with strong corporate earnings were the main factors behind the increase in the index. The high oil prices resulted in a surge of liquidity in Oman’s oil-dominated economy and investment in the MSM was also supported by low interest rates. New initial public offerings (IPOs), such as Al Maha Petroleum, Dhofar University, Al Kamil Power Company and AES Barka, helped improve market activity. Al Kamil Power Company (Oman’s first build, own and operate power company) was listed on the MSM in mid-September with a share capital of OMR9.6 million. This followed the floatation of 3,368,750 shares to the public through an oversubscribed IPO. Following the offering, the Omani public own a 35% stake in the company. Dhofar University was also listed on the market in September. The development of the capital markets continued to be supported by IPOs; Omani independent power provider AES Barka’s USD29 million IPO in early January 2005 was 17 times oversubscribed and attracted over 13,000 applications, making it one of the most successful public issues ever in Oman. AES Barka is the largest independent power and water generation company in Oman established on a build, own and operate basis. Furthermore, the 30% IPO for Omantel was launched in June 2005 (see Privatisation). The MSM reached to a new all time high of 5,699 in mid-2005 before reverting and closing the year at 4,875.11, a gain of 44% over the year as a whole. Unlike the previous year, the banking and investment sector index was the best performing index with a gain of 51.4%. The industry sector index followed with a year to date gain of 34.3%, while the service sector recorded a gain of 29.9% for the year.



Debt

The MSM has a small but growing government bond market. The government issues bonds to finance the budget deficit, raise money for development projects, develop the capital market, encourage Omanis to save and to reduce excess liquidity in the market. The bond issues tend to be over subscribed with competitive rates for the government. The central bank issued USD135 million government bond in January 2005, which was oversubscribed by 53%. The subscription for the 5% bond was available to local and international investors and will mature on 1 November 2010. Between August 1991 and January 2005, Oman has issued OMR1.6 billion worth domestic of bonds. The government has also raised money on the international markets. In 1997, Oman issued a USD225 million five-year Eurobond, priced at 75 basis points over US Treasuries. However, plans to raise USD4 billion in September 1999 were cancelled because of the oil-driven improvement in government finances. Meanwhile, the corporate bond market remains underdeveloped. In general, the corporate sector raises financing through loans from banks. Nonetheless, in 2001, Bank Muscat issued a bond, totalling OMR39.6 million. More recently, Bank Muscat launched the first issue of ten-year corporate bonds in the Gulf Co-operation Council (GCC) in May 2003. The issue, which sought to develop the regional corporate bond market, was available to local and GCC investors. The bond carried a fixed coupon of 7% and was rated one notch below the sovereign rating by Moody’s Investors Service (Baa3) and Fitch Ratings (BBB). The bond was oversubscribed, raising OMR175 million, indicating ample liquidity in the financial system. It also reflected investor confidence in the risk-free fixed income instrument; the bank had aimed to issue OMR10 million, with an option to retain an additional OMR15 million over subscription. The bond was listed on the MSM in July 2003 and most of the secondary trading has been linked to Bank Muscat bonds. The overwhelming response to the bond issue has created a new interest in the debt market, which was almost non-existent at the beginning of the current decade. Furthermore, in May 2004 BankMuscat successfully issued part of its USD800 million medium-term Euronote programme; the unsubordinated note was approved by the bank’s shareholders in March. The Euronote programme was the first of its type for an Omani company. The first tranche, worth USD250 million, was oversubscribed by 40%, with 50% of the interest coming from the Middle East, 43% from Europe and the remainder from Asia (the issue was not open to US investors). The note has a maturity of five years and coupon rate of 70 basis points over Libor. One of the aims of the issue is to diversify the bank’s funding base, especially in light of its need for medium to long-term funds for lending to investment projects in the sultanate. The bank has been involved in financing a number of large projects in Oman, such as the Sohar refinery and the Oman-India fertiliser company. Oman National Dairy Products also issued a bond worth USD3.9 million, with a guaranteed rate of 5.85% in 2004. In an important step to increase access to international capital, Bank Muscat issued its maiden Global Depositary Receipt (GDR) in Oct. According to the bank, the USD149m GDR issue was substantially oversubscribed. The GDR, which will be traded on the London Stock Exchange, was priced at USD23.75 per share. The bank plans to use the proceeds to finance domestic growth and its international expansion plans. Each GDR represents one ordinary share of Bank Muscat, which trades on the MSM.

Bank Lending

Oman’s foreign borrowing tends to fluctuate according to oil prices: a fall in prices requires additional foreign financing. However, foreign borrowing is generally relatively low. The higher oil earning in 2004 and increased liquidity in the economy



and increased corporate sector profitability, resulted in Omani individuals, companies and the government reducing their foreign liabilities. This debt repayment has limited the increase of foreign borrowing. However, there has been an increase in foreign borrowing to finance the growing investment plans as well as financing imports. The majority of short-term borrowing is related to trade credits. Nevertheless, the structure of external debt is favourable, with some 60% of lending with maturities above two years. Table 7 Maturity and Sectoral Distribution of Bank Lending to Oman USD million Dec-04 Mar-05 Jun-05

Maturities:

Up to & including one year 1,284 1,320 1,514

Over one year & up to two years 57 132 116

Over two years 2,118 2,432 2,724

Unallocated 67 67 77

Total 3,526 3,951 4,431

Sectors:

Banks 627 626 701

Public sector 587 424 515

Non-bank private sector 2,312 2,901 3,211

Unallocated 0 0 4

Total 3,526 3,951 4,431Source: Bank for International Settlements, International Banking and Financial Market Development, http://www.bis.org

Foreign Debt and Default Risk

Traditionally, the government has relied on domestic borrowing to raise funds and has only relatively recently resorted to international capital markets. In 1997, the government raised USD225 million in its first Eurobond issue. The government tends to borrow when oil prices are low or when seeking financing for projects (finance for the LNG sector is often rated higher than sovereign debt). Positively, in 2001 and 2002 with the repayment of government debt and loans related to the development of the LNG sector, total external debt as a proportion of GDP fell to 27.1% of GDP and 22.2% of GDP respectively. Overall external debt fell by 15.1% in 2005 to USD2.86 billion, from USD3.37 billion in December 2004. Oman is unlikely to default on its obligations or seek a rescheduling of its debts, as foreign debt levels remain manageable. It has healthy foreign exchange reserves and the government can call on the SGRF. Although the exact size of the fund is not known, the government is believed to have added to the SGRF from 1999-2005 as a result of strong oil prices and government prudence. Positively, the global oil price will remain strong in the outlook period, staying above USD50.0p/b. Positively for Oman’s credit outlook, Standard and Poor’s raised Oman’s long-term foreign currency sovereign credit rating to ‘BBB+’ from ‘BBB’, and its long-term local currency rating to A- from ‘BBB+’ in November 2004 (see Foreign Debt and Default Risk). Meanwhile, Moody’s upgraded the country ceilings for long-term foreign currency bonds and bank deposits to ‘Baa1’ from ‘Baa2’. The government’s long-term foreign currency and domestic currency issuer rating was also raised to ‘Baa1’ from ‘Baa2’. The agency acknowledged that the country’s economic fundamentals, including the fiscal position, have significantly improved in recent years; further improvements in ratings will be seen if the country manages successful diversification.

http://www.bis.org



Chart 15 Foreign Debt

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Sources: World Bank, Global Development Finance; International Monetary Fund; D&B

Foreign Exchange Reserves

The level of Oman’s foreign exchange reserves directly relates to the price of oil. When oil prices are high, reserves accumulate; when oil prices are low, reserves are run down. Positively, the government has used its budgetary surpluses from 1999 to accumulate foreign assets and reduce debt levels. Furthermore, the government also holds foreign assets in the SGRF. According to data from the Ministry of National Information, contributions to the SGRF and the Oil Stabilisation Fund amounted to OMR2,244 million between 1996 and 2000. Some OMR2,056 million was directed to the SGRF during 1996-2000; however, during this period the government withdrew OMR1,445 million to fund budget deficits. As such, the net contribution to the funds between 1996 and 2000 was OMR799 million.

Chart 16 Foreign Exchange Reserves

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Foreign exchange reserves have continued to increase from 1999 with higher oil and LNG revenue, reaching a peak of USD4.5 billion in September 2005. However,



reserves fell in October and November 2005 to USD4.2 billion; this was probably a result of funds being placed in the SGRF. We estimate import cover of 45.0 months in the first quarter of 2006. However, import cover is forecast to fall in the two-year outlook period owing to increasing imports and lower oil revenues in 2007. Nevertheless, Oman’s external position will remain comfortable. Given its medium- and long-term earnings potential, Oman has little difficulty in securing short-term finance. Although the sultanate’s oil reserves will be exhausted in the next 20-25 years, exports of natural gas have commenced. The income from LNG exports should allow Oman to maintain healthy foreign exchange reserves even at times of low oil prices.

Exchange Rate Risk

Since 1986, the government, through the Central Bank of Oman, has maintained a fixed exchange rate between the Omani rial and the US dollar at OMR0.385:USD. The pegged rate was set after a devaluation of the rial from OMR0.345:USD following a collapse in oil prices. However, the government ruled out a further devaluation in 1998 when oil prices again slumped, and believes that the advantages of a predictable exchange rate outweigh the disadvantages. In real terms, the Omani rial’s movements depend on oil price fluctuations. The government has sufficient reserves to support the currency, although a sustained dip in prices to the levels seen in 1998 would bring renewed calls for devaluation. In 2000, the rial strengthened slightly owing to higher oil earnings. This upward trend continued in 2001, owing to cross-currency movements (the strengthening of the US dollar against other currencies). However, the rial depreciated in real terms in 2003 and 2004 as the US dollar weakened against other major global currencies. As the majority of Oman’s exports are priced in US dollars (crude oil and natural gas), the advantages of this fixed exchange rate system (including currency stability and a high degree of predictability) continue to outweigh any disadvantages. The disadvantages include the loss of control over some monetary factors. For instance, the government cannot use interest rates to control money supply; the movement of Omani interest rates must reflect those of US interest rates in order to maintain the relative value of the currencies. In addition, fluctuations in the value of the US dollar can create significant disparities between export earnings and the import bill. The GCC countries’ terms of trade have deteriorated (the majority of Oman’s imports originate from the EU and Asia, while most of its exports are denominated in US dollars), with the weakening of the US dollar in 2004 and to a lesser degree in 2005. The weakening of the riyal will also increase imported inflationary pressure (see Monetary Environment). Arguably, a real effective peg would mitigate these risks by fixing the currency to a trade-weighted basket of currencies. Historically, the pegged rate has helped to reduce inflationary pressures by preventing imported inflation during a critical period in the country’s economic development. Moreover, the business community has become accustomed to operating with a predictable exchange rate. Consequently, liberalisation of the exchange rate regime would have an unsettling effect and could incur short-term volatility until the rial found its true market level. Thus, the Omani rial will remain pegged to the US dollar in the short term. Further ahead, the GCC aims to introduce monetary union in 2005 and a single currency in 2010. However, the single currency is also expected to be pegged to the US dollar, limiting the impact of the move.



External Economic Risk Outlook

In the short to medium term, Oman does not face serious external economic risks, despite the imbalances in the current account. In addition, there is very little risk that Oman will default on its external debt obligations. However, long-term external risk will depend on Oman’s success in diversifying its exports. Positively in this regard, Oman has started to export LNG and is also taking steps to diversify the economy in other directions; however, there is a danger that export dependence on oil will simply be replaced by a dependence on LNG. The current account surplus is forecast to fall in 2006, with imports continuing to increase owing to higher investment (linked to Oman’s diversification programme) and private and government spending. The outflows on the invisible components will also increase. Nevertheless, despite the lower oil production forecast by the government, exports will be supported by a higher average oil price and increased LNG exports. We forecast a current account surplus of 4.1% of GDP in 2006. The current account surplus will narrow further in 2007 as imports remain high.

Table 8 External Forecasts % of GDP 2006f 2007f

Current account balance 4.1 3.2

Financial & capital account balance -0.4 -0.9

Overall balance of payments 3.7 2.3

Import cover (months) 5.0 4.8Source: D&B

The other components of the current account will continue to record deficits. Although the capital and financial account is forecast to fall into deficit (after two years of surplus), as the government invests its oil revenue overseas, the shortfall is forecast to be lower than between 2000 and 2003 as progress is made in number of large projects that have attracted foreign involvement and financing. The currency will remain stable, with the government determined to maintain the peg with the US dollar at least in the short term.



Trade Environment

Key Point: The trade environment is characterised by high levels of bureaucracy and regulation. However, there has been some reform following Oman’s accession to the World Trade Organisation. Trade links with the US will increase following the signing of a free-trade agreement in early 2006.

Trade Overview

Although Oman has stated its commitment to free trade, it regulates the trade environment in favour of national interests and has been hesitant to allow foreign companies unfettered access to the domestic market. Originally, this reflected the country’s deeply conservative nature, but more recently has derived from a desire to protect vested interests. There is little separation between the political and commercial interests of leading Omanis and many prominent merchants have established near monopolistic control over the import of specific goods, which would be threatened by substantial liberalisation of the trade environment. The impetus for liberalisation increased with accession to the World Trade Organisation (WTO) in 2000. In joining the world trade body, the government was motivated by its need to attract foreign investment, diversify the economy and become more closely integrated in the world economic system. Compliance with WTO membership requirements will drive substantial liberalisation, including the establishment of a tariff structure approved by the WTO, reduced subsidies and the use of licences. Ahead of joining the WTO, Oman introduced a number of new laws, including one abolishing import fees. Oman has now entered a transitional period in which it is expected to implement the changes required by the WTO; this period will also allow local industries to prepare for a more open economy. In the meantime, the trade environment will remain characterised by high levels of bureaucracy and opaque decision-making processes. However, these challenges are partly offset by Oman’s dependence on imports. Oman’s trade policy is also influenced by its membership of the Gulf Co-operation Council (GCC). The GCC launched its Customs Union on 1 January 2003 as a first step towards a monetary union by 2005, a common market by 2007 and a single currency in 2010. In December 2005, the GCC countries’ central bankers approved criteria similar to the Maastricht criteria; on the fiscal side budget deficits can not exceed 3% of GDP and public sector debt has to be less than 60% of GDP. On the monetary front, inflation should not exceed the weighted average of the six countries’ by more than 2% and interest rates should not be higher than the lowest three countries by more than 2%. Furthermore, each country should have foreign reserves above 4.0-6.0 months of imports

Current Account Exchange Regulations

Oman has accepted International Monetary Fund (IMF) Article VIII status and has no exchange control legislation. There are almost no restrictions on current account operations, including financing requirements for imports and exports, and no repatriation requirements. The only restrictions relate to transactions with Israel; all transactions with Israel are banned. In addition, commercial banks require prior approval from the Central Bank of Oman for remittance of profits and dividends.

Tariff Barriers

The GCC customs union sets a single rate of 5% on all imports, which can subsequently be transported freely throughout the region without the payment of additional tariffs. In April 2003 the National Assembly passed measures to



implement the customs union. Essential products are to be zero rated. There are 53 specified exemptions to the common external tariff (CET) approved by the GCC. These items include basic foodstuffs, live animals, fresh and frozen fish, and vegetables, among other items. Products such as pork and alcohol, which are banned from certain states and highly taxed in others, will not be subject to the CET. In the case of Oman, pork and alcohol products will attract a 200% tariff. The union also abolishes customs duties for products manufactured in the region. However, goods moving from free-trade zones to other GCC states will now attract customs duties; previously, goods re-exported from a free-trade zone to another GCC state were exempt from customs duties. In June 2002, the GCC states reached agreement over the method for the distribution of customs revenues, with revenues distributed on the basis of the ultimate destination of imported goods. In October 2005 the finance ministers of the GCC recommended that the transitional period of the custom union, which was due to end at end-2005, should be extended. There are indications that a large number of goods still remain outside the unified tariff system of the customs union.

Chart 17 Weighted Mean Tariffs in Selected Countries, 2006

0 4 8 12 16 20 24 28 32 36

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Yemen

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%

Sources: D&B, Exporters’ Encyclopaedia; World Bank, World Development Indicators

The GCC customs union is the first step towards reaching a free-trade agreement with the EU. The EU had insisted that the GCC develop its own customs union before it moved towards free-trade talks; following the formation of the GCC customs union, the EU approved a negotiating mandate for free-trade discussions. Oman has agreed a maximum tariff rate of 15% with the WTO, which applies to around 85% of imported industrial and agricultural goods. The government has also negotiated a number of exemptions for agricultural and industrial goods. Some essential goods are exempt from customs duties, including fertilisers, seeds, agricultural machinery, some basic food items, books and refined petroleum products. Following accession to the WTO, tariff rates for agricultural and industrial products have been bound at 15%, while a 75% levy applies to eggs and liquid milk as they are locally produced; petroleum products are levied at 20%. In most cases, the bound rates are higher than the rates already in place; where the bound rates are equal or lower, Oman has a five-year transition period in which to implement them. All customs duties are calculated on a carriage, insurance, freight (c.i.f.) basis. Meanwhile, Oman and US began free-trade negotiations in early 2005 to promote US President George W. Bush’s goal of creating a Middle East Free-Trade Area. Oman signed a Trade and Investment Framework Agreement (TIFA) with the US in



July 2004, which was aimed at strengthening economic ties between the two countries and leading to a comprehensive free-trade agreement (FTA). Positively, for its trade and investment outlook, Oman reached an FTA with the US in early October 2005, after just after seven months of negotiations. This is the second trade agreement that Washington has finalised with a GCC country, the first being with Bahrain. The two sides formally signed the agreement at end-January 2006, as the US requires a 90-day notice to be given to Congress before any deal is approved. The FTA will also boost US investment in Oman. On the trade front, once the deal comes into effect, tariffs will be lifted on industrial and consumer products, except textiles. Agricultural trade will be liberalised over a ten-year period. Furthermore, the deal will substantially increase market access across the service sector and market liberalisation, which Oman began undergoing as a part of its WTO accession. Muscat is particularly interested in increasing petrochemical exports to the US; the government has been developing its petrochemical and gas-based industries to diversify the economy away from oil. In addition to increased US investment, Oman will also benefit in areas such as technical co-operation and project finance. So far, trade links between the US and Oman have remained relatively small, amounting to USD748 million in 2004, and US foreign direct investment in 2003 in Oman was USD358 million. Saudi Arabia has expressed concern over uncoordinated FTAs between GCC members and the US. Riyadh is worried that US goods imported tariff free to the smaller GCC countries would then enter the Saudi market. In 2005 Saudi Arabia indicated that it would consider imposing customs duties on foreign goods imported duty free through the other GCC countries. However, three other regional countries are negotiating FTAs with the US (UAE, Qatar and Kuwait), leaving Saudi as the only country in the bloc not to have signed a bilateral trade agreement with Washington. Oman cited two advantages of signing an individual pact with the US: a bilateral agreement is quicker to conclude; and a bilateral agreement will include wider components such as service sector liberalisation. Oman and the GCC held the first round of negotiations with India at the end of 2004. India has the strongest ties with Oman out of all the GCC countries and there are indications that Delhi hopes to use Oman as a stepping stone into the GCC. A trade agreement with India would be beneficial for Muscat considering India’s strong energy demand. In addition, in July 2004, the GCC countries signed a framework agreement for economic, investment and technical co-operation with China. This is particularly important for Oman and the other Gulf states owing to China’s importance as an energy consumer. The agreement highlights co-operation between the GCC countries and China in the oil and gas sector. So far, commercial co-operation between Muscat and Beijing has been modest. Japan has also expressed an interest in starting trade negotiations with the Gulf countries; the GCC countries are becoming increasingly important to industrial producing countries owing to their strong energy reserves and the potential for market expansion.

Non-Tariff Barriers

The government imposes a number of restrictions that act as barriers to trade. Over time, these have led to the development of monopolies and other anti-competitive practices. The extensive bureaucracy concerning business transactions reinforces the restrictive nature of the trade environment. However, with accession to the WTO, many of the barriers to foreign trade have either been removed, or will be eradicated in future (see Investment Environment). Some restrictions are also imposed for religious or political reasons, notably the censorship of all printed and electronic media. Although Oman no longer enforces the Arab boycott of Israel, its tolerance of trade and other business contacts with Israeli entities varies according to the level of tension between the Arab world and Israel.



Licences

All goods require import licences and some goods, including alcohol, firearms, narcotics and explosives, require special licences. However, import fees on goods entering by land, air or sea have been abolished, and Oman is removing all non-customs obstacles to agricultural imports. All importers must be licensed by the Ministry of Commerce and Industry (MCI) and all exporters must have an Omani agent. Only Omani nationals and companies with at least 51% Omani ownership can import goods and act as commercial agents. The Oman Chamber of Commerce and Industry must approve all agency agreements, and these must be registered with the MCI. Ensuring compliance with the regulations concerning agents and imports is highly bureaucratic and obtaining local legal advice is strongly recommended.

Import Bans

Although there are few permanent bans on imports, the government imposes temporary bans on goods that compete with local products. The most significant permanent bans relate to some refined petroleum products and some transactions with Israel. The ban on petroleum products will remain in place as long as the local refinery is deemed to produce sufficient quantities to meet local demand. Seasonal bans are imposed on fruit and vegetables in order to protect local producers. Although Oman no longer enforces the Arab boycott of Israel, its provisions remain in place and it also imposes some requirements and restrictions on exporters. A steamship company or airline certificate is required to demonstrate that the carrier has not passed through Israeli territorial waters or airspace and has not visited an Israeli port or airport. US companies should take care that they do not infringe US anti-boycott laws in complying with such requirements. Restrictions also remain in place on currency and bullion transactions with Israeli individuals and entities.

Quotas

The only quotas regarding trade concern Oman’s oil exports. Although not a member of the Organisation of Petroleum Exporting Countries (OPEC), the government shadows OPEC policy on oil production and exports and usually participates in OPEC summits as an observer.

Documentation

Documents must be certified by an appropriate chamber of commerce before legalisation by the relevant Omani consulate. There have been moves towards requirements that all correspondence with the government is in Arabic, but this is not strictly enforced. English remains the primary business language, although Arabic translations will expedite matters. Bill of Lading: No special requirements. The original and one copy must be certified and presented along with other shipping documents to the appropriate Omani consulate for legalisation. Certificate of Origin: The original and one copy must be certified and submitted for legalisation. The certificate of origin is to be issued by the manufacturer or exporting company and must contain a statement to the effect that the product is wholly and exclusively the product of one country and that the certificate is true and correct. If the goods are not solely the product of one country, the certificate must specify the percentage of foreign components and the country of origin of each specified percentage. The complete name and address of the manufacturer must be shown in addition to all the usual/requested particulars. With a few exceptions, goods produced in GCC states enter duty free if accompanied by a certificate of origin.



Commercial Invoice: The original and one copy must be submitted for certification and legalisation. Invoices generally require detailed and accurate description of the goods with weights, quantities and value, in addition to any information that is peculiar to a particular trade, is requested by the importer or is required for banking or letter of credit purposes. The full name and address of the manufacturer must be given. If the item or items contain components originating from more than one country, the origin of each component and the percentage should be given. The invoice must contain a signed statement that the invoice is true and correct. Insurance Certificate: Oman follows normal commercial practices in this area. Follow instructions of the importer or letter of credit clause. Packing List: Use will facilitate customs clearance. This document must be submitted for certification and legalisation. Preshipment Inspection: May be requested by importer. Pro-Forma Invoice: May be requested by importer as an aid to opening a letter of credit or as the first step in negotiating an import contract. Steamship Company Certificate: Exporters should obtain advice from an appropriate chamber of commerce or consulate on the current requirement. The certificate must be presented to the Omani consulate in duplicate; one copy will be retained for the consulate’s files. Omani law does not require certification or legalisation but an importer may request this. The certificate is to be issued by the steamship company and must state that the ship will not go through Israeli waters or stop at any Israeli port. When shipping by air, obtain a certificate from the airline. US Shipper’s Export Declaration: Required for US exporters if the value is more than USD2,500 (USD500 for shipments through the US postal system). Declarations are required for all shipments requiring US export licences. Oman is subject to special chemical and biological restrictions. Other Documents: Health certificates are required for vegetables, fruit, birds and livestock. A halal certificate is required for meat products.

Countertrade and Offset

Oman has an extensive defence procurement programme and is keen to attract inward investment to offset this expenditure. The government is in the process of putting the Partnership for Development offset programme on a more formal basis. Since the end of 2000, all offset contracts must adhere to the following guidelines: • The offset is a requirement of all contracts and sub-contracts placed with

contractors based outside the sultanate for the supply of goods and services with a value over OMR3 million.

• The value of the offset commitment should normally be less than 50% of the total contract value.

• Most projects should be defence related, but civil projects will be considered if defence related projects cannot be identified.

• Generally, projects have to be new and for products and services not produced in Oman.

• Projects have to be self-funding and not involve additional costs to the main supply contract.



Commercial Risk

Key Point: Payments performance in Oman is forecast to remain positive owing the two-year outlook period owing to an expansion in government spending. There have been improvements in the banking sector, supported by improved supervision and lending practices.

Credit Risk

There is no reliable information on the level of bankruptcies or liquidations or on other indicators of credit risk such as dishonoured cheques. However, the commercial environment is highly susceptible to fluctuations in the oil price. The downturn in the oil price in 1998 and the sharp fall in the Muscat stock exchange had an adverse effect on the creditworthiness of many companies and individuals. Weak oil prices negatively affected liquidity in the market and led to an economic slowdown, damaging the business prospects of companies in both the private and public sectors. Many private sector companies remain family-owned or owned by a small group of close associates, with the personal wealth of owners and their extended families used to overcome short-term cash flow problems. However, the surge in world oil prices from March 1999 has seen the credit environment improve. Higher revenues for the government and public sector companies enabled them to meet their payment obligations. An increase in fiscal reserves also enabled the government to pay off some of its debts to the private sector, which has further benefited from increased government spending in areas such as infrastructure. Strong real GDP growth and demand in the economy support the profitability of Omani companies, and have improved credit risk and payments outlooks. The profitability and health of the private sector has improved as a result of increased government spending, higher private and public investment levels and greater private consumption. In the first half of 2005, net profits of the companies listed on the Muscat Securities Market (MSM) increased by 41% year on year. This included an acceleration in the profits of the banking sector (see Financial Sector Risk). The strong performance of the banks is leading to an overall improvement in the sector with higher provisioning against non-performing loans (NPLs), and there are signs of progress in recovering NPLs. On a wider level, Omani companies have benefited from growth in sales, better operational efficiency, a reduction in costs and a favourable macroeconomic environment With the continued strong oil price and higher government spending in 2006, private sector payments performance and the credit risk outlook will remain positive. The private sector is also being supported by the improved performance of the stock market, although the strong growth of the stock market over the last few years has increased the risk of the bubble bursting. A key area of credit risk is linked to increased borrowing by the public to invest on the stock market. This was witnessed in the run up to the initial public offering (IPO) of Oman Telecommunications Company (Omantel). However, the banking sector, having tightened its lending criteria, has become more cautious regarding private sector lending (see Financial Sector Risk). Although oil revenues are forecast to fall in 2007, we forecast that the commercial and payment risk outlook will remain stable owing the government spending remaining buoyant and the continuation in the investment projects. Continued confidence in the economy will also support the commercial outlook.



Payments Experience

Usual Terms: Usual terms are sight drafts for established customers. However, given the lack of business information, we advise letters of credit for new customers. Payments delays tend to be longer when dealing with public sector entities. Given the considerable bureaucratic regulations and delays, some exporters may ask for usual terms of up to 90 days, although 30-60 days is average.

Usual Terms Minimum Terms: Sight Draft Recommended Terms: Sight Draft Usual Terms: 30-90 days

Transfer Situation: There has been a sizeable build-up of foreign exchange reserves as a result of the strong oil price since 1999 and increased gas exports. The government has used its higher revenues to increase foreign assets and reduce debt levels. We estimate import cover of 5.0 months in the first quarter of 2006. Import cover will remain above the 3.0 month recommended level by the International Monetary Fund (IMF) over the forecast period.

Transfer Situation Local Delays: 0-1 month Foreign Exchange/Bank Delays: 0-1 month Import Cover: 5.0 months

Export Credit Agencies: The low level of risk means that a wide range of cover is available.

Export Credit Agencies US Eximbank Full range of cover available Atradius Full cover available ECGD Short-term cover available, restricted medium-

term cover Euler Hermes UK Full short-term cover available

Financial Sector Risk

The central bank regulates the banking sector and has acquired a reputation as a prudent and capable supervisor, with some of its regulations exceeding internationally accepted standards. The central bank has taken steps over the last few years to strengthen the supervision of the banking sector. In December 2000, a new banking law was put in place. Omani commercial banks are now required to have a minimum capital of OMR20 million (previously OMR10 million), while foreign banks must have a minimum capital of OMR3 million. Banks must also limit their lending to shareholders, and since 1 January 2001, must follow the International Accounting Standards (IAS) 39. The law also empowers the central bank to object to the appointment of the board of directors, executive officers and general managers of a bank if it deems it necessary to protect the depositors’ and bank’s assets. The central bank raised the minimum capital requirement of Omani banks to OMR50 million (from OMR20 million) in December 2005. Out of the five local banks, three have already increased their capital to over the new minimum. Banks that do not have the stipulated capital have three years to meet the new level. The new capital level is aimed at increasing domestic banks’ competitiveness both locally and abroad, and to prepare domestic banks for the new capital adequacy criteria (Basel Pact II). Furthermore, the central bank has raised the regulatory capital requirement of foreign banks to OMR10 million, which is aimed at encouraging them to increase financing for the private sector.



With regards to other regulation, in 2001 the central bank introduced accountancy practices that require bank assets to be valued at market price, rather than book price, thereby improving transparency and increasing conservative provisioning. The central bank’s provisioning policy also indicates that banks are not permitted to distribute any unearned profits in the form of dividends in order to provision against potential provision loss, and to protect sound capital adequacy and future profit levels. Positively, the IMF has noted that Oman’s financial sector remains strong and commended the central bank for its compliance with international standards. Omani banks are well capitalised and provisioned, and tend to exceed the central bank’s requirement. Furthermore, the banking sector is coming out of the difficulties of growing NPLs and increased provisioning in the early 2000s. By the end of 2003, banking sector NPLs had risen to 12.8% of total lending. However, as a result of increased provisioning, the banking sector’s uncovered NPLs as a percentage of net loans declined to 3.1% from 4.8% in 2002. Positively, loan loss coverage for the top five banks increased to 86.2% of total NPLs at end-March 2005, compared with 84.7% a year earlier. In addition, Omani banks have tightened their credit monitoring, reduced their exposure to single borrowers and improved their asset quality (although these measures have also impeded growth in corporate lending). However, lending concentration and asset quality continue to be a major cause of concern. Positively, banking sector activity has been boosted by increased financing opportunities related to the large scale projects in Oman. In a positive move aimed at arresting the fresh creation of bad loans and improving the quality of banks’ assets, the Central Bank of Oman has asked banks to make certain provisions for loan losses by 31 December 2006. Accordingly, banks will have to set aside a minimum of 1% of the value of loans as provision against losses on general loans. For personal loans, banks will be required to make a minimum loss provision of 2% of the standard and special mention personal loans. The executive president of the central bank, Hamood bin Sangour Al Zadjali, indicated that the increased percentage of provisioning for personal loans has been set because of the heightened risks inherent in such loans.

Table 9 Top Three Omani Banks by Tier One Capital, End-2004 Bank Tier One Total Capital Pre-tax Return on

capital assets assets profit/loss assets

(USDm) (USDm) ratio (%) (USDm) (%)

Bank Muscat 409 4,818 8.5 103 2.1

Oman International Bank 272 1,867 14.6 41 2.2

National Bank of Oman 266 1,867 14.2 137 7.3Source: The Banker

However, the provisioning affected profitability in the sector. The domestic banking industry witnessed one of the biggest-ever falls in profit levels in 2003, when they declined by over 84% to a meagre OMR9.6 million. Auspiciously, the banking sector’s profitability has improved since 2004, owing to the new provisioning requirement, sound macroeconomic fundamentals, which have increased the demand for banking products, and improved lending practices. The banking sector has also taken steps to reduce operating costs. Importantly, the combined provisional profits of the banking sector increased by 31.4% year on year to OMR106.2 million in the first 11 months of 2005, against OMR80.79 million a year earlier. The National Bank of Oman (NBO) announced its net profit for the whole of 2005 as OMR20.329 million, compared with OMR5.221 million in 2004. Highlighting the improvements in the banking sector and following a sovereign upgrade in October 2005 (to Baa1 from Baa2), Moody’s upgraded the short-term



and long-term foreign currency deposit ratings of Bank Muscat, National Bank of Oman and Oman Arab Bank to Baa1/Prime (P)-2 from Baa3/P-3, and Alliance Housing Bank to Baa2/P-3 from Baa3/P-3 at the end of 2005. Positively, the sector has also been diversifying, consolidating and expanding beyond Oman: • At the end of 2000, Bank Muscat and the Commercial Bank of Oman merged,

creating the largest bank in Oman, with roughly one third of total assets; the new entity then merged with the Industrial Bank of Oman in 2001.

• In January 2002, Bank Dhofar and Majan International Bank formalised the terms and procedures for their merger.

• In July 2005, the Commercial Bank of Qatar completed a strategic alliance with NBO, through the acquisition of a 34.9% stake in NBO. The deal included increasing the bank’s capital by USD116 million from USD390 million through a private placement. This is the first cross-border strategic alliance between banks from Oman and Qatar.

Competition in the banking sector will increase as a result of Oman’s accession to the World Trade Organisation (WTO); the banking sector has to be opened to 100% foreign ownership. Omani banks will need to diversify their revenue base, improve efficiency and seek further mergers if they are to compete effectively. Fortunately, greater private sector involvement in the economy and government plans to increase privatisation and infrastructure projects should improve the outlook for the sector: it will provide opportunities in corporate and project lending, thereby reducing the sector’s dependence on retail lending and improving its asset quality.

Anti-Money Laundering Legislation

In 2002, a new law to tackle money laundering was issued. The law defines money laundering and penalties imposed against offenders. In addition, the central bank has circulated a US list of suspicious accounts related to international terrorist groups. The commercial banks are obliged to provide information to the central bank if any of these accounts are discovered.

Corruption

Corruption is perceived as being lower in Oman than in most other African and Middle Eastern countries according to the latest Corruption Perceptions Index produced by Transparency International. The 2005 rankings show that Oman was ranked the most transparent among Arab countries, placed 28th along with Israel and above some European and major emerging markets. Nonetheless, the small size of the political and business elites and the close ties between the two have led to suspicions of unethical practices. The opaqueness of the political decision-making process has fuelled these suspicions. Since 1996, the government has made efforts to create a more transparent business environment, including the promulgation in 1996 of the Basic Law, Oman’s first written constitution. This calls for a separation between the private and public interests of ministers and obliges ministers to resign from directorships and other positions in publicly quoted companies. In 1999, these measures were extended to deputy ministers. However, the level of compliance is unclear. Moreover, such regulations fail to address the issue of using public positions for private gain.



Chart 18 Corruption Perceptions for Selected Countries, 2005

0.0=most corrupt 10.0=least corrupt

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0

UK

US

Oman

UAE

Qatar

Italy

Brazil

Saudi Arabia

Egypt

China

Source: Transparency International, Corruption Perceptions Index, http://www.transparency.org

Foreign companies are most likely to become embroiled in the complex web of political and business connections when competing for government contracts; the public sector dominance of the economy means that this is the most likely entry route to the Omani market. Companies will find that the strength of their political connections will be a decisive factor in gaining or losing a contract. However, companies that compete directly with an established monopoly or a company with strong political connections are likely to be thwarted. On a smaller scale, companies and individuals will find that they have to pay small bribes to expedite bureaucratic procedures.

Other Commercial Risks

The opaque nature of the political decision-making process and the lack of formal channels for lobbying government mean that companies face the risk of sudden and arbitrary changes in regulations. Foreign companies entering the Omani market for the first time should also be aware of ‘agents’ who claim to have powerful political connections. All such claims should be treated with a high degree of scepticism and thoroughly researched before any agreements are made. However, the government has indicated that it aims to allow 100% foreign ownership in certain sectors, which will remove the need for a local agent (see Investment Environment).

Intellectual Property Rights

The government has emphasised improving intellectual property rights, a key criterion for joining the WTO. Oman has signed the WTO’s Trade Related Aspects of Intellectual Property (TRIPS) and is a member of the World Intellectual Property Organisation (WIPO). In May 2000, Oman revised its trademark law to be compliant with TRIPS and in 2000 updated its copyright laws. The government has also stepped up efforts to curtail software piracy, especially since 2004. In November 2000, Oman was removed from the US Trade Representative’s Priority Watch List.

http://www.transparency.org



Commercial Risk Outlook

The profitability and health of the private sector has improved as a result of increased government spending, higher private and public investment levels and greater private consumption. With continued strong oil price and higher government spending, private sector payments performance and credit risk outlook will remain positive in 2006. However, a key area of credit risk is linked to increased borrowing by the public to invest on the stock market. Although oil revenues are forecast to fall in 2007, with a lower price, we forecast that the commercial and payment risk outlook will remain stable owing to government spending remaining buoyant and the continuation in the investment projects. Continued strong confidence in the economy will also support the commercial outlook. Meanwhile, strict regulation of the banking sector has reduced commercial risk and a banking crisis is not expected. Omani banks are well capitalised and provisioned and tend to exceed the central bank’s requirement. Furthermore, the banking sector is coming out of the difficulties of growing NPLs and increased provisioning in the early 2000s. As a result of the central bank’s adequate policy for loan-loss provisioning, the sector will become stronger. The banking sector’s profitability has improved since 2004, owing to the new provisioning requirement, sound macroeconomic fundamentals, which have increased the demand for banking products, and improved lending practices. Furthermore, the reduced need for provisioning has allowed banks to increase lending.



Investment Environment

Key Point: Far-reaching measures have been taken to liberalise the investment environment with the aim of attracting foreign investment. However, foreign companies face considerable bureaucratic obstacles.

Investment Overview

In an effort to attract greater inflows of foreign investment and speed up its accession to the World Trade Organisation (WTO), the government took steps in 2000 to liberalise the business environment. The state views foreign investment as important to the country’s future, particularly as regards financing economic diversification; as in most other countries in the region, banks remain the main intermediaries and capital markets are underdeveloped. As a result of the government’s initiatives, foreign firms are now able to establish their own representative offices. In addition, foreign equity participation has increased from 49% to 70%. In 2003 the government announced its plans to allow 100% foreign ownership in certain sectors. This is already allowed in theory for projects valued over OMR500,000 that contribute to developing the economy; however, in practice, foreign companies struggle to obtain the necessary permission. Even if a company succeeds in establishing a wholly owned operation, it faces a discriminatory tax regime. The government has introduced various measures to encourage investment, including a new patent law, a crackdown on copyright piracy and the enforcement of the second phase of the international property rights law (which bans the use of pirated software). In addition, the sultanate offers incentives through tax holidays and soft loans. On the whole, the level of preference given to local companies has been reduced (subsidies to local industries and exports have been ended in accordance with WTO membership); however, there remain many informal barriers that give local firms an advantage. For instance, strong links exist between the government and local merchant families; considerable bureaucratic obstacles remain, with government ministries occasionally acting in contradictory ways; and the tender board evaluates Omani tenders as 10% lower than the actual bid.

International Arbitration

Omani law insists that all foreign companies accept the Commercial Court as the arbitrator of disputes. In theory, Oman accepts the jurisdiction of the International Centre for the Settlement of Investment Disputes and international arbitration clauses in contracts, but this has not been adequately tested. In considering contracts and other documents, the court will only accept the Arabic original as definitive and all proceedings must be conducted in Arabic. The Commercial Court’s decision in cases where the value is less than USD26,000 is final; a Court of Appeal exists for cases of higher value and again its decisions are final. Foreign companies tend to use litigation as a last resort. As well as being slow and expensive, there is a risk of not obtaining a favourable judgement, particularly when the dispute involves the government or well-connected individuals.

Capital Account Exchange Regulations

There are no restrictions on the repatriation of capital, interest or dividends or on the liquidation of direct investment. However, local banks can lend a maximum of 30% of their loan portfolio to non-residents, with a sub-limit of 5% for individual non-resident. Banks may also only hold open foreign exchange positions up to a limit of 40% of their capital and reserves. However, the government will continue to relax



restrictions on foreign ownership in compliance with its WTO membership and to meet the demands of investors.

Foreign Direct Investment Environment

The Omani authorities have indicated that they plan to reform the 1994 Foreign Capital Investment Law in the near future, in line with pledges made to the WTO. The plan aims to allow 100% foreign ownership in the banking and insurance, information technology and securities sectors; foreign equity participation is currently limited to 70%. The opening up of these activities will be beneficial as regards improving competition and promoting efficiency in the financial system. However, in order to compete, domestic companies will need to consolidate and improve their products. Importantly, the permitted level of foreign ownership in privatisation projects increased to 100% in July 2004, based on a Royal Decree providing an updated privatisation framework. By privatisation, Oman refers not only to the conversion of a state-owned or mixed enterprise into a private sector firm, but also to the establishment of any new firm providing a commercial service that had previously been provided by the state (e.g. electricity). A Commerce Ministry spin-off, the Omani Centre for Investment Promotion and Export Development (OCIPED), opened in 1997 to attract foreign investors and smooth the path for business formation and private sector project development. OCIPED also provides prospective foreign investors with information on government regulations, which are not always transparent – and sometimes contradictory. Nevertheless, despite OCIPED’s efforts to become a ‘one-stop shop’ for government clearances, the approval process for establishing a business can be tedious, particularly with respect to land acquisition and labour requirements.

Chart 19 Corporate Tax Rates in Selected Countries, 20061

0 10 20 30 40 50 60

Kuwait

Qatar

Yemen

Israel

Iran

Egypt

S. Arabia

Oman

UAE

Bahrain

%

0.0

0.0

Note: 1In Kuwait, foreign investors enjoy a ten-year tax exemption once projects are on stream. Sources: KPMG, Corporate Tax Rate Survey; PriceWaterhouseCoopers, Corporate Taxes; D&B Oman’s tax rate is one of the lowest in the region. In August 2000, Oman’s income tax legislation was amended so that companies with 70% or less foreign participation were treated as Omani national entities for tax purposes; previously this rate was 49%. A zero charge applied to the first OMR30,000 of income, and a rate of 12% above that. However, in September 2003, Sultan Qaboos bin Said al Said promulgated three royal decrees amending the tax law. All companies registered in Oman under the Commercial Companies Law now pay a uniform tax rate of 12%, irrespective of the level of foreign ownership (companies with over 70% foreign



ownership, local branches of foreign companies and companies owned by foreigners previously paid up to 30% tax). The 12% rate (after the basic deduction of OMR30,000) was effective from 1 January 2003. There are tax exemptions for profits made by companies from the sale of shares and for all mutual funds effective from 1 January 2003. However, the loss made on the sale of securities is not allowed as a deductible expense. Companies operating in the petroleum sector are assessed separately and the tax rate is specified in their operating agreement with the government.

Investment Incentives

The main investment incentive available to foreign investors is a five-year tax holiday. This is open to companies investing in the industrial, mining, tourist, fishing, agricultural and utility sectors. The tax holiday can be extended at the government’s discretion. The government also offers soft loans for both new and existing projects in these sectors. Foreign companies entering joint ventures as a minority partner are also subject to a less onerous tax regime (if not eligible for the tax holiday). Investment incentives also include exemption from custom duties on imported equipment and raw materials. The government may impose protective customs tariffs on imports that compete with the project. Oman’s investment incentives focus on industrial development and include the following: • a five year tax holiday, renewable once; • low-interest loans from the Oman Development Bank (now available on a very

limited basis, and only for small firms); • low-interest loans from the Ministry of Commerce and Industry; • subsidised plant facilities and utilities at industrial estates; • feasibility studies supplied by the Ministry of Commerce and Industry; and • exemption from customs duties on equipment and raw materials during the first

ten years of a project.

Company Organisation

In 2002, a new Commercial Companies Law was approved. The law defines the role of the board in managing corporate entities and safeguarding company and shareholder interests. The government has also issued circulars informing board members and senior managers that their actions should not be self motivated but for the benefit of the company and shareholders. Foreign firms may establish their own representative offices in the areas of commerce, industry and services. Foreign representative offices can only be used for promotion, improving distribution and to field complaints; they cannot import, export or sell goods and services and may not deal directly with the customer. In addition, they are not allowed to represent goods or services that are not from their company. A foreign representative is able to obtain residence permits for its foreign staff, open local bank accounts and have its assets registered in its name. Foreigners can own up to 70% of a local company (automatic approval will be given to these ventures) and there are plans to allow 100% foreign ownership in some sectors. The exception is the petroleum sector, which requires approval from the Council of Ministers or a recommendation from the Ministry of Commerce and Industry for new companies with over 65% foreign ownership. Previously, foreign companies were allowed to operate in Oman only as a minority shareholder (49% or less) in a majority Omani-owned joint venture. For most foreign companies this is the most convenient method of operating. Establishing such a joint venture requires no special registration aside from the normal processes. Foreign firms can also participate in limited liability companies or joint stock ventures.



Portfolio Investment

The prospects of the Muscat Stock Market (MSM) attracting investment and becoming a major source of financing will depend on the deepening and diversification of the market and on efforts to improve business transparency. Positively, the government has taken steps to restore international and domestic confidence in the MSM. In January 1999, a Capital Markets Law was issued, establishing an independent regulatory body and tighter reporting regulations, while in November 1999, the MSM signed a co-operation pact with the London Stock Exchange, giving the MSM access to London’s expertise and allowing the cross-listing of shares. The direct incentives to attract foreign investment in Omani listed companies include: restriction-free repatriation of capital or profit; free convertibility of the rial at a fixed exchange rate with the US dollar; and no tax on dividends or capital gain. Positively for the investment environment, Oman has liberalised its financial market to allow foreign firms to apply for brokerage licences to trade on the stock market. Oman hopes to bring international standards to domestic brokerage in the hope that foreign involvement will bring expertise to the financial market. The Capital Market Authority in Oman is issuing a licence to a Kuwaiti firm, while there are indications that several other foreign firms are exploring new opportunities.



Additional Sources of Information

Ministry of National Economy PO Box 506 Muscat 113 Tel: 968 738 201 Fax: 968 737 068 http://www.modevelop.com

Ministry of Commerce and Industry PO Box 550 Muscat 113 Tel: 968 774 240 Fax: 968 794 239 http://www.mocioman.org

Muscat Securities Market PO Box 3265 Ruwi 112 Tel: 968 771 2607 Fax: 968 771 2609 http://www.msm-oman.com

Central Bank of Oman PO Box 1161 Ruwi 112 Tel: 968 702 222 Fax: 968 707 913 http://www.cbo-oman.org

Oman Chamber of Commerce and Industry PO Box 1400 Ruwi 112 Tel: 968 707 674 Fax: 968 708 497 http://www.omanchamber.org

American Business Council of Oman PO Box 121 Barqa 320 Tel: 968 597 730 Fax: 968 597 730 http://www.abcgc.org

Oman Centre for Investment Promotion and Export Development PO Box 25 Wadi al-Kabir 117 Tel: 968 771 2344 Fax: 968 771 0890 http://www.ociped.com

Ministry of Oil and Gas PO Box 551 Muscat 113 Tel: 968 603 333 Fax: 968 696 972

Credit Information

D&B provides information relating to over 100 million companies worldwide. Visit www.dnb.com for details. Additional information relevant to country risk can also be found in the following services: International Risk & Payment Review: Provides timely and concise economic, political and commercial information and analysis on 132 countries. Available as a subscription-based internet service (www.dnbcountryrisk.com) and monthly update journal, the IRPR carries essential information on payment terms and delays. It also includes the unique D&B Country Risk Indicator to help monitor changing market conditions. Exporters’ Encyclopaedia: Information on 220 world markets to help customers decide where they can safely and profitably do business. Data provided include key contacts, transportation information, legislation affecting export commerce and tips on foreign business travel. Published annually in August plus ad hoc updates. English language edition.

http://www.dnb.com

http://www.dnbcountryrisk.com

http://www.modevelop.com

http://www.mocioman.org

http://www.msm-oman.com

http://www.cbo-oman.org

http://www.omanchamber.org

http://www.abcgc.org

http://www.ociped.com



Country Risk Indicator Definition

D&B’s Country Risk Indicator provides a comparative, cross-border assessment of the risk of doing business in a country. The indicator seeks to encapsulate the risk that country-wide factors pose to the predictability of export payments and investment returns over a time horizon of two years. The risk indicator comprises a composite index of four over-arching country risk categories:

Political risk - internal and external security situation, policy competency and consistency, and other such factors that determine whether a country fosters an enabling business environment;

Macroeconomic risk - the inflation rate, government balance, money supply growth and all such macroeconomic factors that determine whether a country is able to deliver sustainable economic growth and a commensurate expansion in business opportunities;

External economic risk - the current account balance, capital flows, foreign exchange reserves, size of external debt and all such factors that determine whether a country can generate enough foreign exchange to meet its trade and foreign investment liabilities;

Commercial risk - the sanctity of contract, judicial competence, regulatory transparency, degree of systemic corruption, and other such factors that determine whether the business environment facilitates the conduct of commercial transactions.

The DB risk indicator is divided into seven bands, ranging from DB1 through DB7. Each band is subdivided into quartiles (a-d), with an a designation representing slightly less risk than a b designation and so on. Only the DB7 indicator is not divided into quartiles.

Indicator Meaning Explanation

DB1 Lowest risk Lowest degree of uncertainty associated with expected returns, such as export payments, and foreign debt and equity servicing.

DB2 Low risk Low degree of uncertainty associated with expected returns. However, country-wide factors may result in higher volatility of returns at a future date.

DB3 Slight risk Enough uncertainty over expected returns to warrant close monitoring of country risk. Customers should actively manage their risk exposures.

DB4 Moderate risk Significant uncertainty over expected returns. Risk-averse customers are advised to protect against potential losses.

DB5 High risk Considerable uncertainty associated with expected returns. Businesses are advised to limit their exposure and/or select high-return transactions only.

DB6 Very high risk Expected returns subject to large degree of volatility. A very high expected return is required to compensate for the additional risk or the cost of hedging such risk.

DB7 Highest risk Returns are almost impossible to predict with any accuracy. Business infrastructure has, in effect, broken down.

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