Question

Of all the GCC nations, Oman is the most worrying from a fiscal and financial perspective. Ever since the collapse in global oil prices from their highs above $100 a barrel in 2014, the country has maintained a consistent fiscal deficit. This has resulted in a dramatic rise in the government debt to GDP ratio from just 5 per cent to around 60 per cent.

At the heart of the problem is the sultanate’s heavy reliance on oil receipts and its limited non-oil and private sector diversification despite its low volume of oil output and relatively large population. None of this stands it in good stead in the face of low prices.

Oman’s debt is nevertheless manageable, and pales in comparison to the debt levels in many mature economies. But Muscat has so far been unable to tackle the underlying causes of its fiscal imbalance, and in 2020 is projected to backslide on recent progress with a widening of the fiscal

deficit to -8.4 per cent, from -6.7 per cent in 2019.

In its ability to tap foreign capital, Oman’s junk-grade sovereign creditworthiness places it in a not dissimilar position to Bahrain. The difference is that the government in Manama is much better positioned to call upon its neighbours for emergency financial support, whereas Muscat needs to find its own way out of its predicament.

One answer may be its ongoing investment in upstream gas projects, as the market for gas enjoys a more positive forecast than the market for oil.

The country’s bullish renewable energy programme may be another, as this will bring down the cost of producing energy and reduce the use of otherwise exportable gas. Plans for an energy spot market could further encourage this growing industry.

The logistics sector also remains a key strategic imperative for the country, although infrastructure remains a work in progress. The country’s ports and free zones still needs clients and it is still too early to tell how recent bilateral deals with the Chinese will turn out.

There is undoubtedly a great deal of potential in Oman, but Muscat needs to face its fiscal

challenges head on for growth to prevail.

6. As per the case a dramatic rise in the government debt to GDP ratio from just 5 per cent to around 60 per cent. What is government debt and how does it affects the economic development? This dramatic rise in the debt is good or bad for the economy. Justify your answer. [2+2+1= 5 Marks]

7. According to the article there is bullish investment in the renewable energy program, explain what will be effect on consumer spending and aggregate supply.

[2.5+2.5=5 5 Marks]

8. Explain the role of central bank in such scenario to minimize the fiscal deficit. Explain the steps to be taken by central bank to control fiscal losses. [2+3=5 Marks]

Answer 1

6. The government debt is the public and intragovernmental debt owed by the federal government.It consists of two types of debt. The first is debt held by the public. The government owes this to buyers of its bonds. Those buyers are the country’s citizens, international investors, and foreign governments.The second type is intragovernmental debt. The federal government owes this to other government departments. It often funds government and citizens’ pensions. An example is the U.S. Social Security retirement account. The federal government adds to the debt whenever it spends more than it receives in tax revenue. Each year's budget deficit gets added to the debt. Each budget surplus gets subtracted.

Moderate increases in the debt will boost economic growth and development. But too much debt increases growth too fast. If growth is faster than the ideal range of 2%-3%, it will create a boom, which leads to a bust. An ever-increasing national debt slowly dampens growth over the long term. Debt holders know in the back of their minds that it must be repaid one day. They demand larger interest payments. They want compensation for an increasing risk that they won't be repaid. That slows the economy because businesses borrow less. They don't have the funds to expand and hire new workers. That reduces demand. As people shop less, firms slash prices. As they make less money, they lay off workers. If interest rates continue to rise, it can cause a recession.

And so the dramatic rise in the govt debt is bad for the economy.

7. The country’s bullish renewable energy programme will bring down the cost of producing energy and reduce the use of otherwise exportable gas. This would make energy available at cheaper rate. Because its highly consumed, citizens would recieve higher utility from this. Aggregate supply would likely increase because of lower cost of production, but it would be possible only if logistics, infrastructure, ports and zones are well developed and fully functionable.

8. The only way the central bank can reduce the debt is to either raise taxes or cut spending. Either of those can slow economic growth. They are two of the tools of contractionary fiscal policy.Cutting spending has pitfalls. Government spending is a component of GDP. If the government cuts spending too much, economic growth will slow. That leads to lower revenues and a larger deficit. The best solution is to cut spending on areas that do not create many jobs. Tax increases beyond the 50% bracket can slow growth. The industries or groups that pay higher taxes will get angry. Politically, they often end a politician's career. Government bonds finance the deficit.As long as the debt is below the tipping point, creditors believe the government will repay them. Government bonds remain attractive than riskier corporate bonds. When debt is moderate, government interest rates can remain low. That allows governments to keep running deficits for years.