Oman—2010 Article IV Consultation Concluding Statement of the IMF Mission
December 18, 2010
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
This statement represents the preliminary assessment of the 2010 Article IV mission to Oman. The mission met with H.E. Ahmed Macki, Minister of National Economy and Supervisor to the Ministry of Finance, H.E. Dr. Ali Mohammed Moosa, Deputy Chairman of the central bank, H.E. Hamood Sangour Al Zadjali, Executive President of the central bank, and other senior officials as well as representatives of the financial and non-financial private sector. The mission thanks the Omani authorities for their excellent collaboration, productive discussions and generous hospitality.
1. Oman was well prepared to confront the global financial crisis. This reflected prudent macroeconomic management of oil wealth, appropriate regulatory and supervisory policies, and implementation of structural reforms to enhance non-oil growth.
• Sound macroeconomic management. The government strengthened its balance sheet by reducing public debt over the last decade. Public debt relative to GDP declined from about 39 percent in 1998 to below 8 percent in 2009. At the same time, the central bank increased its gross foreign assets while the government continued to accumulate savings.
• Resilience of the financial sector. Rigorous oversight of the financial sector has promoted prudent risk management, reinforced capital buffers, and enhanced banks’ resilience to macroeconomic shocks.
• Raising living standards. The 2010 UN Human Development Report ranked Oman first in improving human development over the last four decades. Oil wealth was utilized to enhance economic and social infrastructure, resulting in an extensive and efficient road network and substantial improvements in the quality of health and education.
II. Recent Economic Developments
While the economy was affected by the global financial crisis in 2009, ongoing infrastructure spending and the swift and decisive actions aimed at preserving financial stability and stimulating credit contributed to a recovery in 2010.
2. The economy weathered the global financial crisis well. After slowing to 1.1 percent in 2009, growth supported by public sector investment and accommodative monetary conditions has begun to rebound and is projected to reach 4.1 percent in 2010. Oil and non-hydrocarbon GDP growth are projected to reach 6.2 percent and 3.0 percent respectively. Inflation after falling to about 1 percent year-on-year in December 2009 picked up and is projected to increase to about 3½ percent year-on-year at end-2010. Both the fiscal and external accounts are projected to return to surplus in 2010 of 6¼ percent and 11½ percent of GDP respectively, due mainly to a recovery in oil prices.
3. The banking system has proved resilient and maintained profitability in the first nine months of 2010. Bank capitalization at 15 percent exceeds the new regulatory minimum of 12 percent that will become effective at end-December 2010. NPLs remain low at 3.3 percent at end-June 2010. Banking system return on assets and return on equity were about 1.5 percent and 11.4 percent respectively during the first nine months of 2010 with profits remaining stable. This good performance is also due to the limited impact the global crisis had on the profitability of listed nonfinancial corporates.
III. Outlook and Risks
The outlook is favorable. Lower oil prices pose the main risk.
4. The outlook for 2011 is positive, supported by favorable oil prices. Real GDP growth is projected to reach about 5 percent, reflecting both a continued ramping up of oil production and a further increase in non-hydrocarbon growth to 5 percent. The construction, manufacturing and water and power sectors and a sustained pickup in credit to the private sector will drive non-hydrocarbon growth. Inflation is projected to average about 3½ percent. Increased oil prices and higher oil output are the main drivers of the fiscal and external current account surpluses of 9½ percent and 12 percent of GDP, respectively.
5. The medium-term outlook is broadly positive, reflecting improvements in the external environment and a strong public investment program under the 8th Five Year Plan. Continued public investment should help non-hydrocarbon GDP growth move toward a medium-term level of 6½ percent. Inflation is projected to remain at around 3 percent. Fiscal and current account surpluses will decline gradually from 2012.
6. The main risk to the outlook arises from a fall in oil prices. The tail risk of a collapse in hydrocarbon prices would have adverse implications for hydrocarbon revenues, which could result in an uncertain outlook for investment, and thereby affect Oman’s growth prospects. Other downside risks include those posed by higher global interest rates and by capital inflows. An upside risk is Oman’s ability to utilize technological advances in enhanced recovery techniques to extract difficult oil and gas and, thus, production levels might be maintained over a longer period of time.
IV. Policy Discussions
A. Maintaining Macroeconomic Stability
Short-term policy mix
7. An expansionary fiscal stance that places emphasis on capital spending and accommodative monetary conditions remains appropriate in support of the recovery. The draft 2011 budget envisages the implementation of growth-enhancing social and economic infrastructure projects and should crowd in activity in the non-oil sector. Easy monetary conditions and a pickup in private sector credit will support non-hydrocarbon growth.
8. Aggregate demand should be monitored carefully, however, to avoid the reemergence of inflationary pressures. While a fiscal tightening would be the first line of defense under the peg, in light of ample liquidity in the banking system, the central bank will need to be vigilant and mop up liquidity rapidly should pressures emerge.
Medium-term fiscal issues
9. Fiscal savings provided valuable buffers to mitigate the effects of the crisis and should be increased over the medium term.
• Break-even budgetary prices. While spending has been allocated appropriately toward growth-enhancing capital expenditures, real expenditures doubled during the recent oil boom (2003–08). As a result, the higher spending levels will push budgetary break-even prices higher and will expose the fiscal position to significant downside risks in light of the high volatility of oil prices and expected lower hydrocarbons production.
• Intergenerational equity. While estimates for long-term fiscal sustainability are highly sensitive to assumptions, the mission estimates that fiscal savings should be increased further in the medium term, by about 5 percent of GDP.1
10. Savings could come from both revenue and expenditure measures. There is scope to increase non-oil revenues which are lower than those in neighboring Gulf Corporation Council (GCC) countries. At the same time, untargeted subsidies—notably petroleum product subsidies (2 percent of GDP)—are an inefficient way of protecting the most vulnerable and a targeted system could provide savings. Moreover, the sharp rise in consumption of hydrocarbons products fostered by low prices will, if not contained, erode Oman’s fiscal and external position over time.
11. To mitigate boom bust spending cycles, the mission encourages the authorities to continue implementing reforms aimed at casting spending within a multi-year framework and consider the role of alternative fiscal rules to ensure sustainability while serving as a demand management tool. In light of the rapid scaling up in government expenditures, the mission recommends that the authorities institutionalize a process for regular reviews of the productivity of spending to ensure efficiency. The mission also suggests enhancing expenditure management, including through proper budget classification consistent with Government Financial Statistics Manual (GFSM) 2001, and the establishment of a macrofiscal unit to help guide fiscal policy.
B. Monetary and Exchange Rate Policy
12. The peg to the dollar has provided Oman with a stable nominal anchor. The mission’s analysis suggests that the rial is broadly in line with fundamentals, and forward currency premia show no signs of pressure. Nevertheless, the mission encourages the central bank to accelerate the development of its technical and operational capacity to conduct a more independent monetary policy in the event that a switch to an alternative exchange rate regime becomes desirable. Developing a well functioning money market would be a key step in this direction.
13. Macroprudential policies should be further developed since monetary policy is constrained by the peg. Macroprudential tools could help to contain excessive credit growth, limit asset price bubbles, maintain healthy household balance sheets, and improve the resilience of the financial system to external shocks.
14. Although the current operational framework for managing liquidity is adequate, there is scope to improve liquidity management through more accurate liquidity forecasting. The Central Bank of Oman (CBO) is currently managing liquidity through a weekly auction of 28-day certificate of deposits for absorbing liquidity, in addition to the reserve requirements, and an overnight to 28-day repo window to infuse liquidity to the banks. To project the sources of demand and supply of bank reserves, it is critical that the government provide information to the CBO on a regular basis. The mission urges the authorities to foster coordination on the issue of liquidity forecasting, and to initiate efforts to develop an active interbank money market in line with past technical assistance recommendations. Moreover, to facilitate liquidity management, the authorities might wish to consider establishing a treasury single account.
C. Financial Sector Issues
15. The authorities’ swift implementation of measures during the global crisis were instrumental in preserving financial stability. These encompassed changes to the reserve requirements and lending ratio, the introduction of a direct lending/reverse swap facility in U.S. dollars by the central bank for local banks, and an increase in government deposits with the banking system.
16. The banking system remains well capitalized and stress tests conducted by the FSAP update mission suggest that the banking system could cope with severe macroeconomic shocks. The stress tests explored banks’ resilience to credit, market, operational, concentration and liquidity risks in the context of an oil price shock and a global double dip scenario. The analysis indicated credit risk to be the dominant risk as lending is concentrated in a few large businesses. To mitigate this risk, the mission reiterates the FSAP recommendations regarding the application of capital charges using Pillar II under the Basel framework and encourages the authorities to continue monitoring risk through regular stress testing. In this regard, the mission welcomes the central bank’s ongoing regular stress testing of banks, enforcement of single obligor exposures and plans to establish a Financial Stability Unit to monitor and analyze systemic risk. The mission indirectly explored the credit-worsening scenarios for banks that could arise from listed non-financial corporate sector vulnerabilities to short term interest rate and to income shocks. Although listed non-financial corporates as a group were found to be resilient to interest rate shocks of between 200 bps to 500 bps, continued vigilance is warranted as some firms could face debt servicing difficulties.
17. Strengthening the crisis resolution framework is key to ensure appropriate and timely responses to potential adverse developments in the financial sector, and to minimize their economic and fiscal costs. The CBO’s regulatory and monitoring framework for banks is well designed and has proven effective at maintaining financial stability. It also encompasses informal interagency cooperation agreements. Formalizing these arrangements through a memorandum of understanding (MOU) that clarifies procedures and legal responsibilities which could be tested periodically, would strengthen the regulatory toolkit in responding to crisis situations.2
18. The mission welcomes measures taken by the authorities to align their regulatory and supervisory framework with ongoing global initiatives. In particular, the mission welcomes measures that raised the minimum capital adequacy ratio. The authorities noted that this measure was in keeping with the spirit of the Basel III initiative and that Omani banks satisfied the recommended minimum threshold for common equity of 4.5 percent, and have Tier 1 capital over the prescribed 6 percent.
19. Over the medium term, the authorities should continue their efforts to promote the development of the financial system to improve its efficiency and further increase its resilience. Interest rate liberalization and a calibrated removal of ceilings on lending are important prerequisites for the development of financial markets. The existing limits on interest rates, as well as on the quantity of credit available for personal loans, imply a rationing of credit to retail customers, with consequent distortions of market conditions, as well as on the risk-based pricing of assets and thus on proper risk management by the banks. The existing measures that set limits on interest rates do not give banks proper incentives to select, price and monitor their credit exposure adequately.
20. The development of a domestic debt market could provide the basis for long-term financing to support economic diversification. Fixed income instruments could serve as means of managing short-term liquidity and for institutions to match long-term assets and liabilities. In particular, an actively traded government bond market could provide a base from which to price rial-denominated corporate bonds and help address maturity mismatches that restrict long-term bank lending. As Oman advances its diversification agenda, against the backdrop of scarcer hydrocarbons reserves, the availability of long-term financing will become even more important.
21. The authorities have made steady progress in combating money laundering and financing of terrorism. A new law was issued in 2010 that widened its scope to include combating the financing of terrorism, thus closer aligning the anti-money laundering and (AML/CFT) framework with Financial Action Task Force (FATF) recommendations.
D. Economic Diversification
22. The main medium-term challenge is to ensure strong and sustainable growth in the non-hydrocarbon sector to provide jobs for a rapidly growing population. Fostering an enabling environment for private sector development is key to improve employment prospects for Omanis. Diversifying the economy with a view to reducing the employment gap will depend on reforms in education, stepped up training, and enhancing productivity. In this connection, the mission welcomes the emphasis on education and health as set out in the 8th Five Year Plan.
23. The mission underscores the need to improve productivity to achieve both sustainable growth and diversification. Preliminary results from a growth accounting exercise suggest that there is scope to raise productivity. While lower productivity may be a natural consequence of Oman’s current phase of development that concentrates on developing physical infrastructure using a large unskilled labor force, the mission encourages the authorities to continue to build on its reform agenda aimed at raising the quality of human capital and improving the business environment. Enhanced usage of public private partnerships (PPPs) can be an effective means to upgrade infrastructure to support growth as was successfully demonstrated in the electricity sector. Nevertheless, the increasing use of PPPs needs to be supported by a clear legal framework to mitigate associated risks. Improving the efficiency of spending through the ongoing evaluation of projects could raise productivity further.
24. Improving the quality and coverage of statistics remains an important priority for the authorities. The mission notes that the authorities are working to improve the quality and coverage of general economic statistics. The mission urges the authorities to continue their efforts to strengthen their statistical capacity, particularly the compilation of a comprehensive International Investment Position (IIP). Priority should be given to improving data quality, timeliness, and dissemination.
1 The results are sensitive to the assumptions especially the rate of return on financial assets and oil reserves.
2 The CBO has formalized MOUs with external regulators and supervisors in monitoring cross-border risk.