What
does a devaluation in 1986 tell us about the likelihood of another devaluation
today?
Of all countries in
the Gulf, Oman carries the highest risk of devaluing its currency. Last year,
it ran a large current account deficit (roughly trade deficit plus remittances) of around 21% of GDP, a large budget deficit worth 12% of GDP, and
it has the lowest reserves among its neighbours. History shows that devaluation
is not impossible: Oman devalued its currency by 10% in 1986 when oil prices
collapsed. Why did Oman devalue its currency then? And what does that tells us
about the likelihood of devaluation today?
The fundamental
reason behind the 1986 devaluation was that Oman’s foreign currency reserves
were not sufficient. At the very least, a country should be able to back every
unit of currency in circulation with US dollars to maintain the peg, similar to
the gold standard. In 1985, just before the devaluation, Oman had $441
million dollars of reserves. And although there is no official money supply data going
back to the 1980s, I estimate currency in circulation to have been also around
$400 million in 1985. With the decline in oil prices in 1986, Oman had to use
its reserves to finance its deficit, which meant that it was no longer able to
provide dollar coverage for its currency in circulation and was therefore
forced to devalue.
Does Oman have
sufficient means today to avoid a similar devaluation?
· Oman’s reserves today are enough to
last the country for two years. Oman has $38 billion of reserves, which is more than
enough to back the $13 billion of Omani Rial currency and deposits. Moreover,
the remainder $25 billion of reserves could be used to finance two years of
external deficits (trade plus remittances), estimated to have reached $13
billion in 2016.
· Oman could also safely borrow from
international markets to finance the deficit for an additional year given its
low public debt ratio. Oman could still borrow around $13 billion while
keeping its public debt ratio relatively moderate at 30-40% of GDP. The
additional borrowing could finance its needs for one more year.
· The recovery in oil prices and support
from other Gulf countries could double the survival time of Oman. The recovery in
oil prices, which have bottomed out in 2016, will shrink Oman’s deficits and
financing needs. This means that the same amount of reserves and debt would
last the country longer. More importantly, other Gulf countries are likely to
step in to support Oman when needed to avoid the risk of contagion on their own
currencies. Indeed, recent reports suggest that Oman was in talks with Kuwait,
Qatar and Saudi Arabia to receive
a multi-billion dollar deposit. And although Omani
authorities subsequently denied the report, other Gulf
authorities have not. Interestingly, Oman
joined the Islamic Military Alliance, led by Saudi Arabia, around the same
time of the alleged talks.
Reserves, the
ability to raise debt, the expected recovery in oil prices and support from the
rest of the Gulf mean Oman could maintain the value of its currency for the next
5-6 years. There might be issues such as questions about the illiquidity of
reserves, the impact of a potential credit rating downgrade on Oman’s ability to
raise debt or concerns about political transition (although these
have abated lately). But all in all, a devaluation in Oman is unlikely
in the medium term.