Public Information Notice No. 01/35

Public Information Notice: IMF Concludes Article IV Consultation with Oman

April 11, 2001

On March 26, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Oman.¹

Background

Within a framework of open trade and exchange system, Oman has continued to use its relatively limited oil resources prudently for rapid social development and economic diversification over the past decade. Amid low inflation, real GDP grew, on average, by about 5 percent a year, spurred by rising oil output and services, and, more recently, by the liquefied natural gas (LNG) and the Salalah container port terminal projects, while maintaining relatively low fiscal and external current account deficits. Also, the country's total external debt has remained manageable at below 45 percent of GDP. Nonetheless, the economy continues to depend heavily on oil, which contributed to some 40 percent of GDP and to about 70 percent of fiscal and export receipts in the past few years.

Following a major financial setback in 1998 owing to the collapse in oil prices, Oman was able to reduce drastically financial imbalances in 1999, reflecting the strong recovery in world oil prices and prudent policies. The overall fiscal balance shifted from a deficit of almost 6 percent of GDP in 1998 to a surplus of about 1 percent in 1999—with part of the surplus used to repay the government's short-term external debt—while expenditures, including net lending, increased by less than 3 percent.² This moderate expenditure growth and higher non-oil revenue led to a decline in the non-oil fiscal deficit to 27 percent of GDP in 1999.³ The external current account deficit improved as well, narrowing from 23 percent of GDP to some 3 percent over the same period, with lower imports of both consumer and capital goods also contributing to this improvement. Meanwhile, real GDP declined by 1 percent in 1999, owing to the completion of the LNG and Salalah port projects and lower private consumption spending hit by tighter personal credit conditions. Faced with prospects of low oil prices and a deteriorating current account in early 1999, the authorities limited personal loans to 30 percent of private sector credit and temporarily removed the ceiling on the interest rate for such loans. Consequently, the pace of growth of total private sector credit was halved to about 9 percent from end-1998, with broad money growing by some 6 percent.

Continued strong oil prices in 2000 led to a sizeable buildup of official foreign assets and a strengthening in the country's financial position. In fact, the overall fiscal balance reached an estimated surplus of about 12 percent of GDP in spite of larger-than-budgeted increases in government spending and the decline in non-oil revenue as the authorities reversed the previous year's rise in import tariffs. Higher oil prices together with the coming on stream of LNG exports resulted in an estimated external current account surplus of 13.5 percent of GDP. In addition, real GDP recovered in 2000, growing by almost 5 percent, underpinned by rising infrastructure investment—to support an ambitious investment program on gas-based industries—and export volumes, while inflation remained low. On monetary developments, the authorities maintained tight personal credit conditions in 2000, leading to a moderate broad money growth. Meanwhile, despite the sharp improvement in macroeconomic performance and the measures adopted in November 2000 to boost confidence in the stock market, after a short rebound, the latter fell by 20 percent by the end of 2000—in line with most other markets in the region. On other developments, Oman became a member of the World Trade Organization in November 2000. In addition, the Central Bank of Oman's self-assessment of its supervisory practices revealed that it was largely in compliance with the Basel Committee's Core Principles, while the banking sector appeared to have remained sound despite declining bank profits.

The sharp increase in oil revenue in recent years has not deterred the authorities to move resolutely on economic reforms, particularly privatization. A comprehensive divestment program for the power sector is underway on a fast track. Oman's Telecommunications Company is currently finalizing its search for a strategic foreign partner. Other sectors targeted for privatization include water and sanitation, cement, hotels, wheat milling, and airport services and maintenance. Also, following the trend in the region, the Omani authorities adopted new incentives to attract foreign investment. These include 100 percent foreign ownership of companies and the reduction in the gap between the income taxation of foreign and local companies. On the labor market, the Omanization has moved ahead with measures to strengthen education and training and limit employment of expatriates in certain areas. On other reforms, the financial system was further strengthened with the adoption, in line with best international practices, of a law separating trade, regulatory, and depository functions of the Muscat Stock Market (MSM), while efforts were underway to improve corporate governance.

Executive Board Assessment

Directors welcomed the strengthening of economic performance since 1999, which was underpinned by rising world oil prices and prudent policies. Real growth recovered in 2000, following a small decline in 1999 largely as a result of the completion of major investment projects. Oman's long record of price stability continued, and the fiscal and the external balances strengthened significantly. Directors commended the authorities' prudent use of additional oil revenues to accumulate assets in the State General Reserve Fund (SGRF) and to retire short-term central government debt in 1999, as well as their ongoing efforts to strengthen the non-oil fiscal balance.

Directors saw further diversification of Oman's oil dependent economy and job creation for a rapidly growing labor force as the main challenges facing the authorities over the medium-term. They endorsed the authorities' response to these challenges, which focuses on the development of industries in which Oman has a comparative advantage, such as gas-based industries and tourism; the creation of a business-friendly environment to encourage local and foreign investment, the deepening of the financial sector; the orientation of government expenditure toward education and training; and the broadening of the non-oil revenue base to enhance fiscal resiliency. Directors recognized that the authorities have taken concrete steps in implementing this strategy. They completed the liquefied natural gas and transshipment port projects; moved resolutely on economic reforms, particularly privatization in the power sector; and significantly reduced the bias against foreign corporate ownership. Although the tax bias against foreign investment has declined, Directors suggested that the adoption—in appropriate consultation with other member of the Cooperation Council of the Arab States of the Gulf (GCC)—of a single low corporate income tax rate for both local and foreign companies could help boost investment further.

In view of the projected decline in oil prices in the medium term, and to ensure intergenerational equity in the distribution of the oil and gas wealth, Directors stressed the importance of further strengthening the fiscal position, particular the non-oil balance. On the revenue side, they encouraged the authorities to increase water and electricity tariffs to cost recovery levels, and—in coordination with other GCC partners—to consider the introduction of other measures to enhance revenue. Directors considered that expenditure restraint is also an important part of the appropriate fiscal strategy. They emphasized the need for targeted transfers to replace price subsidies, and for other steps to increase expenditure efficiency and improve budget implementation. Directors noted that the primary purpose of the SGRF is to preserve resources for future generations. While recognizing that fiscal strategy would naturally need to be reassessed periodically in light of evolving oil sector developments, they generally emphasized that ad hoc recourse to SGRF resources to finance budget deficits is undesirable.

On labor market reforms, Directors agreed with the authorities on the need to increase employment opportunities for national in the private sector through training and education while maintaining a flexible policy on the hiring of expatriate workers. They therefore welcomed the large resources earmarked to finance training and education of nationals over the next few years, which would lead to an increase in the supply of skills demanded by the private sector and thus promote employment of nationals.

Noting that non-oil export volumes have increased rapidly over the past decade, Directors endorsed the authorities' commitment to the exchange rate peg. They stressed that continued fiscal discipline and a sound banking system will be needed to support the peg, particularly under high capital mobility.

Regarding monetary developments, Directors welcomed recent steps to ease personal credit regulations. They encouraged the authorities—as part of their strategy to rely more on indirect instruments to manage liquidity—to go further and simultaneously remove the interest rate and quantitative ceilings on personal loans in order to increase bank competition and overall economic efficiency. At the same time, they encouraged the banks to develop a modern credit analysis infrastructure.

Noting that the banking system appears to be sound and well supervised, Directors commended the authorities for their continuous efforts to improve prudential regulations and bank supervision, and supported their decision to carry out a Financial Sector Assessment Program. Directors welcomed the ongoing efforts to improve corporate governance, which should help support a recovery in the declining stock market. However, they advised the authorities to resist pressures to prop-up the market, especially through the bailout of investors.

Directors praised the authorities' efforts to improve Oman's statistics. They suggested further enhancing data availability and transparency by publishing comprehensive data on the external debt, the labor market, and the consolidated fiscal accounts, including the financial transactions of the SGRF and the Oil Fund. Directors commended the authorities for their decision to participate in the Fund's General Data Dissemination System.