Public Information Notice No. 06/137

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Brunei Darussalam

December 7, 2006

On October 16, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Brunei Darussalam.¹

Background

Brunei continues to benefit from high prices for its large energy resources. The oil and gas sector accounts for around 50 percent of real GDP and generates more than 90 percent of total export earnings and government revenues. The government has adopted a prudent fiscal strategy of saving the windfall from the recent increases in energy prices for future generations. Wealth from oil and gas provides Brunei's small population with a high standard of living, with GDP per capita estimated at US$25,754 in 2005.

Economic growth has been modest in recent years, while the external position has strengthened further. Based on the new national accounts data for 2005, annual economic growth is estimated to have been around ½ percent (year-on-year), largely unchanged from 2004. The modest overall expansion primarily reflected output declines in the oil and gas sector due to repairs and upgrades of production facilities. The private non-oil sector, benefiting from the spillovers from higher oil prices, grew by around 4¾ percent year-on-year. Inflation has remained subdued, supported by the currency board arrangement fixing the exchange rate at par with the Singapore dollar. Consumer prices rose by about 1 percent in 2005 and ¼ percent during the first half of 2006. Reflecting the high energy prices, the external current account surplus widened substantially to 56 percent of GDP in 2005 from 48 percent in 2004.

Credit growth slowed in 2005 and bank asset quality has improved slightly. Bank claims on the private sector have increased by 3½ percent in 2005, down from 6½ percent in 2004. While lending to businesses strengthened, personal loan growth (mostly consumer loans) slowed, partly resulting from the introduction by the Ministry of Finance of a directive aimed at curbing personal indebtedness. While non-performing loans (NPLs) as a share of total loans dropped to 12 percent at end-2005 from 13 percent at end-2004, they remain high. However, loan loss provisioning is adequate, reaching 93 percent of NPLs in 2005.

The fiscal position has continued to strengthen. The fiscal surplus for FY 2005/06 was much larger than budgeted due to high energy prices and slow expenditure execution. Energy-related revenues were more than double the budget projections, which were based on an average oil price of US$25 per barrel. Moreover, actual expenditures (excluding royalties) were only around 90 percent of the full-year target, primarily due to slow execution of development spending. The primary budget surplus reached 20 percent of GDP compared with a budgeted deficit of around 5 percent. The FY 2006/07 budget, presented for the first time to the legislative council, is again based on very conservative assumptions about oil and gas prices, suggesting another significant revenue windfall. At the same time, the authorities have taken steps to step up the execution of development spending.

While economic growth has been slow in recent years, it is expected to strengthen. Staff expects growth to pick up in the near term, reaching 3¾ percent in 2006 and 2½ percent in 2007 as capacity in the energy sector is restored and the non-oil sector continues to benefit from a stable macroeconomic environment and high energy-related income flows. The main risks to the short-term outlook stem from a global economic slowdown following a rise in interest rates or a disorderly unwinding of global economic imbalances, a downward correction in oil prices, and/or an avian flu pandemic. GDP growth is projected to average around 2¾-3 percent over the medium term, assuming some productivity growth in the oil and gas sector, development of downstream industries in the energy sector, and stepped-up implementation of government development projects. However, new hydrocarbon discoveries and a resolution of territorial disputes over oil and gas fields provide a possible upside to the outlook.

Executive Board Assessment

Executive Directors noted that economic performance has benefited from high energy prices and praised the authorities' sound economic management that underpinned a strong fiscal position, subdued inflation, and a large current account surplus. Looking ahead, Directors agreed that the near-term economic outlook is supported by high energy prices and a recovery in capacity in the energy sector following repairs. They emphasized, however, that the medium- and long-term outlook will depend on progress toward economic diversification and a fiscal strategy to handle the eventual depletion of hydrocarbon reserves.

Directors commended the government's prudent fiscal strategy. The saving of windfall revenues associated with high energy prices has helped stabilize the economic cycle and provided a comfortable fiscal position. Directors welcomed steps taken to address capacity constraints to accelerate implementation of development projects, which could support domestic demand in a sustainable way by focusing spending on higher-return projects.

Nevertheless, Directors recommended taking additional steps to strengthen fiscal management to minimize the economic impact from short-term revenue volatility and to prepare for the eventual depletion of hydrocarbon reserves. In this respect, Directors welcomed the Ministry of Finance's recently drawn up Strategic Plan aimed at achieving long-term fiscal sustainability. They encouraged the authorities to support the plan with a formalized and rules-based medium-term fiscal framework. This should be based on a fiscal goal and revenue and expenditure reforms aimed at meeting this goal, while supporting economic growth and diversification. Directors also pointed out that fiscal management could be strengthened further by improving the governance framework for the two oil-related funds.

Directors agreed that the currency board arrangement, which remains a key element of Brunei Darussalam's macroeconomic management, has helped promote price and financial stability. To further strengthen the credibility of the currency board arrangement, Directors urged the authorities to publish the audited accounts of the Brunei Currency and Monetary Board (BCMB) for 1999-2001 and increase the minimum statutory foreign exchange coverage from 70 percent to 100 percent in line with international best practices and the actual coverage. Directors judged that the reserve ceiling for retained profits of the BCMB could be raised to help build a sufficient excess margin.

Directors supported the plans to establish a new monetary authority, but advised the need for careful sequencing and prioritization. They supported focusing initially on defining the objective and scope of the new monetary authority, its governance and organizational structure, and legal framework. Directors favored the inclusion of settlement banking services and open-market operations in the mandate of the new monetary authority, and they agreed that these functions should be preceded by a modernization of the payment system, strengthened capacity for monitoring and forecasting liquidity conditions, and the development of appropriate instruments for liquidity management. Directors underscored that a lender-of-last-resort role should build on international best practices and that efforts to promote Brunei Darussalam as an international financial center should be consistent with a strong supervisory framework.

Directors were encouraged by the authorities' progress in strengthening the supervisory and regulatory framework for financial institutions. They welcomed the enactment of the new Banking, Insurance, and Finance Company Orders, which brings the regulatory framework more in line with international standards. Directors were also encouraged by the plans to ensure a level playing field by harmonizing Islamic and conventional banking regulations by end-2006 and suggested that focus should now shift to implementing and enforcing the new regulatory framework. They welcomed the planned establishment of a Financial Intelligence Unit to strengthen the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework.

Directors stressed that economic diversification is key to Brunei Darussalam's medium-term growth prospects. They noted that the various National Development Plans have appropriately aimed at promoting diversification and strengthening economic growth, but that progress has been slow. To further diversification, Directors recommended that the government gradually withdraw from economic activities that are best carried out by the private sector, reduce administrative obstacles for business start-ups, better align education and training with the demands of a diversified private sector, and study further options to increase value added in the energy sector.

Directors welcomed the important steps taken to improve Brunei Darussalam's statistical databases, and stressed that reliable and timely data reporting will enhance effective monitoring and planning.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.