The banking sector in the Sultanate has evolved immensely over the past decade, becoming increasingly competitive, with an assortment of commercial banks — and banks that now exclusively focus on Islamic finance.

The data and empirical evidence make it clear that this is an industry that has matured. Investors would do well simply to keep focusing on the metrics that matter most in a macroeconomic environment where the banking industry is either just beginning to find its feet, or is set in an unstable political climate defined by turmoil.

There is an undeniable impact of oil prices on bank profitability across MENA countries that depend heavily on oil production — a link supported by academic evidence and confirmed by the IMF. Oman is not shielded from this: net oil revenues make up around 70 per cent of the budgeted revenues. Although these have been declining over the last five years and are expected to fall further, to roughly 66.4 per cent in 2015, diversification efforts are already under way.

The good news is that Oman has pegged government spending at RO 14.1 billion for 2015, up about 4.5 per cent on 2014. That sustained spending allows Oman to press forward with major projects, including a $15 billion national railway network and major expansion works at airports in Muscat and the southern city of Salalah.

This was confirmed by Darwish bin Ismaeel bin Ali al Bulushi, Oman's Minister Responsible for Financial Affairs, who noted that the country has no specific plans to reduce state spending this year despite the plunge in oil prices, and that spending is expected to remain well below the level assumed in the government's budget.

"There are no specific plans to cut public expenditure at this time. We are observing the situation closely and the oil prices are still fluctuating."

Where do oil prices settle?

The decline in oil prices has already received plenty of media coverage, and there is little value in adding yet another detailed view on why oil should revert to "normalised" levels. Our position rests on three points: we are not in the business of forecasting where oil prices will end up over the next couple of years; we do not accept that anyone truly understands what "normalised levels" really mean; and most financial pundits who claim to understand where prices will ultimately settle have been proven wrong in the near term. It is therefore not meaningful to speculate on the precise level unless one is among the highly ranked officials who intimately understand the supply-and-demand dynamics of the commodity.

The only bet we are placing is that current levels are unsustainable, and that the price of oil will move higher to correct itself over the next 24 months. We have seen this story play out before, and this "correction" assumption is one of the central macro tenets of our thesis.

History repeating

We believe history will repeat itself: prices will normalise and, as a rising tide lifts all ships, the Muscat Securities Market and the GCC's other market indices — which have been hammered recently — will rebound, with particularly strong growth in the banking sector.

On oil price specifically, it is worthwhile spending a few lines on Oman's projected GDP growth for 2015. According to the just-released 2015 budget, the national economy grew at an estimated real growth rate of 4 per cent in 2013 and 4.4 per cent in 2014. For 2015, the targeted rate of growth is 5 per cent. Good GDP growth in Oman, together with favourable monetary and fiscal policies, has had a positive impact on the growth and performance of the commercial banks. The balance sheets of the banks have strengthened, supported by growth in credit and deposit. Lending to the private sector was fairly balanced between the corporate and retail sectors.

The Omani banking system will remain primarily deposit-funded and liquid over the outlook period. We expect increased revenue from credit growth and stable provisioning requirements to offset pressure on profits from reduced interest-rate margins and from rising operating expenses, as banks continue to build their Islamic banking franchises.

As far as other industries are concerned, corporate earnings have been forecast to continue to grow at mid-single digits during 2015, amid the Government's proposal to increase gas prices for industries. Per the 2015 budget, economic growth depends on the growth of the non-oil activities, strong local demand and higher oil production.

There has been a strong focus on diversification away from oil-and-gas-related activities. The Government expects non-oil activities to grow at a rate of 5.5 per cent in 2015, with the concentration mainly on construction, electricity, water, trade activities, and services of public administration, defence and transfer industries.

The road ahead

This diversification process does not take place overnight. We believe the bleak short-term outlook, as it relates to profitability and loan growth, may lead to continued volatility over the next three to four — even six — months, and as a result may continue to spook investors further. And therein lies the opportunity: to accumulate more of this asset at a favourable price as it continues to grow its book value.

Disclaimer: The views expressed in the article are part of a study conducted by the author duo.

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