Public Information Notice No. 05/165

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Oman

December 9, 2005

On November 11, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Oman.¹

Background

In recognition of its declining level of oil reserves, Oman has been using the revenues from high oil prices in support of a growth strategy based on developing its non-oil sectors and creating employment opportunities for its citizens. Presently, hydrocarbons account for 40 percent of GDP, three-fourths of government revenue, and two-thirds of export proceeds.

Oman's economic performance in 2004 was strong, with real GDP growing at an estimated 4.5 percent and the nonhydrocarbon sectors at 8 percent. The rapid expansion of the nonhydrocarbon sectors was driven by manufacturing exports, construction and services, including tourism. Despite a 5 percent decline in crude oil production, high oil prices ensured robust export earnings and budgetary revenues. Oman's currency is pegged to the U.S. dollar. A 21 percent depreciation of the rial Omani in real effective terms supported the strong export performance. Although import prices rose, consumer price inflation remained below1 percent. Broad money rose by 4 percent, and interest rates continued to follow U.S. rates closely.

The banking system remains strong, bolstered by enhanced supervision, sound lending practices, and a healthy economy. Asset prices continued to strengthen, with the Muscat Securities Market index gaining 24 percent in 2004 and surged another 60 percent in the first half of 2005.

The fiscal budget recorded a surplus of nearly 5 percent of GDP in 2004. Although total expenditures rose by 13 percent, higher oil revenues more than matched this increase. Part of the fiscal surplus was used to build up the reserves of the State General Reserve Fund (a fund for contingencies and future generations). The external current account surplus in 2004, declined to about 2 percent of GDP in 2004, from 4 percent in 2003. Exports increased by 14 percent owing mainly to higher oil prices, while imports rose by 29 percent, in large part due to significant investments in gas-based industries.

The authorities are continuing with their program of Omanization of the labor force, along with technical and vocational training programs. Privatization efforts are also continuing; a new law promulgated in 2004 removed limits on the share of foreign participation in privatized companies. The government divested a significant part of its shares in a petroleum company, Omantel—the state telecommunications company—was partially privatized, and a second mobile telephone company was licensed in recent months.

Executive Board Assessment

Executive Directors commended the Omani authorities for their outward-oriented development strategy and continued sound economic management, which have led to a rapid development of the non-oil economy, a stable monetary and financial system, large fiscal surpluses, and a sizable accumulation of foreign assets. Directors noted that economic growth has been resilient in the face of declining oil production and that significant progress has been made in diversifying the economy, with the sizable growth of the nonhydrocarbon sector more than offsetting the modest decline in the hydrocarbon sector. In this regard, they pointed to the increased levels of public investment in key sectors, such as hydrocarbons, tourism, shipping and infrastructure, which have contributed to strengthening the country's growth prospects.

Looking ahead, and faced with finite oil reserves and rapid population growth, the authorities will need to continue their focus on economic diversification and job creation. Directors therefore welcomed the authorities' intention to strengthen private sector activity and economic growth through continued structural reforms, while preserving their track record of macroeconomic stability.

Directors considered that Oman's medium-term outlook remains favorable, and that the country is in a good position to consolidate the recent gains from high oil prices. Ongoing and planned investments to expand Liquid Natural Gas output capacity, as well as gas-based and nonhydrocarbon industries, should sustain economic growth over the medium term. Several Directors observed that unlocking existing gas reserves in a timely and cost-effective manner to meet rising demand constitutes an important aspect of Oman's diversification program. They recommended that the authorities continue to assess carefully all planned gas-based industries in order to ensure that they would remain viable if Oman were to rely on imported gas in the future. Directors welcomed the authorities' awareness of these challenges and their intention to safeguard the interests of future generations.

Directors stressed that medium-term fiscal sustainability is key for maintaining macroeconomic stability and sustaining high growth. They recognized that significant capital expenditures are required to develop the gas-based and nonhydrocarbon industries, but emphasized the importance of financing these expenditures in the context of a sustainable fiscal policy. In this regard, Directors recommended to conduct an assessment of the sustainability of the nonhydrocarbon fiscal deficit, in view of the country's investment needs, and to adopt a medium-term budget consistent with long-run fiscal sustainability.

Directors highlighted the need to strengthen the budgetary process in order to improve the monitoring of discretionary spending and insulate government expenditure from short-term swings in oil prices. They emphasized the importance of safeguarding spending on education and health, and welcomed the authorities' plans for an eventual privatization of the utilities, which would allow for a reduction in subsidies and additional spending in priority areas. Directors also underlined the need to strengthen and diversify the revenue base, especially as oil prospects weaken. In this regard, they supported the authorities' preparatory actions to coordinate the introduction of a value-added tax with other Gulf Cooperation Council (GCC) countries, and encouraged the authorities to accelerate efforts in this direction.

Directors considered that the present exchange rate peg continues to be supported by strong fundamentals and sound financial policies, and that it provides an adequate anchor for price stability and market confidence. They noted that the effectiveness of monetary policy is very limited in view of the peg and full capital account convertibility. Directors therefore welcomed the authorities' readiness to consider further fiscal retrenchment if inflationary pressures and capital inflows were to pick up. They also welcomed the ongoing work to prepare for the planned GCC monetary union, including the reviewing of pass-through effects of exchange rate changes on domestic inflation.

Directors welcomed the steps being taken to implement the recommendations of the Financial Sector Assessment Program exercise. In this regard, they saw scope for gradually eliminating regulations that could impact adversely on financial intermediation. While Directors noted that direct exposure of the financial system to equity markets is limited, it was recommended that placing appropriate firewalls between banks' commercial and investment activities to ensure that depositors are properly shielded from market risks be considered. Directors welcomed the improvements in the legal framework for anti-money laundering efforts.

Directors welcomed the increased emphasis being placed by the authorities on improving the legal and regulatory framework for private sector-led growth, and encouraged them to intensify efforts to reinvigorate the privatization program.

Directors advised the authorities to apply their Omanization program flexibly, taking into account both the economic and social dimensions of this issue. They recommended that Omanization targets be pursued as broad guideposts rather than strict numerical objectives. Directors commended the strong emphasis being attached to training and education programs, and encouraged the authorities to place a temporary freeze on further increases in Omanization quotas until training is well advanced. In addition, Directors urged the authorities to reconsider plans to impose a matrix of minimum wages by sector and type of jobs; they noted that such an initiative would seriously harm the competitiveness of existing businesses while deterring potential future investors.

Directors welcomed the steps taken by the authorities to improve the coverage of the fiscal accounts, their efforts to compile data on the international investment position, and Oman's participation in a data Reports on Standards and Codes exercise. They encouraged the authorities to improve the labor market statistics, including unemployment data.