Public Information Notice No. 99/62

Public Information Notice: IMF Concludes Article IV Consultation with Oman

July 16, 1999

On June 30, 1999, the Executive Board concluded the Article IV consultation with Oman.¹

Background

Helped by pragmatic macroeconomic management and broader private sector participation, the economy of Oman has performed relatively well in recent years. In a climate of price stability, real GDP growth averaged 5½ percent over the past decade with much of the impetus coming from the non-oil sector. Nonetheless, the economy remains heavily dependent on oil production and exports, with the oil sector accounting for about a third of GDP, some 90 percent of export earnings, and two thirds of budget revenue.

Oman has maintained its oil production capacity in recent years at its current level of about 870,000 barrels per day. Proven reserves have edged upward over the past decade and are currently estimated at about five billion barrels, allowing for a production horizon of some 16 years. Efforts are being made to enlarge reserves and recovery through continued exploration and the application of new technologies, as well as to bring down production costs (currently about US$3.70 per barrel).

As part of its drive toward diversification, Oman is about to begin exploiting its substantial gas potential, with a major liquefied natural gas (LNG) project scheduled to start production in May 2000. Long-term contracts have been concluded with companies in Korea, Japan, and India for the export of 6½ million tons of LNG per year. Moreover, the prospect exists of surplus gas resources (i.e., those not utilized for the LNG project) being piped to coastal areas to feed a number of potential gas-based industries-petrochemicals, fertilizer, steel, aluminum, etc. Feasibility studies for these projects are ongoing.

The exceptional weakness of the world oil market over much of the past 12-18 months has imposed a heavy burden on Oman. In 1998, the export price of Omani oil averaged just under US$12 per barrel-a drop of US$7 per barrel or almost 40 percent compared to 1997-entailing a decline in budgetary revenue of about 10 percentage points of GDP and a loss of US$2 billion in export earnings. The drop in oil revenues largely accounted for the escalation of the external current account deficit (to 21 percent of GDP) and the shift in the overall external position to a deficit of US$0.8 billion (from a surplus of almost US$1 billion in the preceding year).

The increased pressures on the external position and the related deterioration in the budget prompted the authorities to implement a number of fiscal measures in March 1998. These included: a range of revenue measures (increases in customs duties on cigarettes, in the airport tax, and in the payroll tax (Companies' Participation in Technical Training Project), as well as an increase in fees for certain public services and transfers of profits from public entities); and expenditure retrenchment (covering military and civil outlays and postponement of new development projects).

Together, these measures constituted an adjustment of the order of 3 percentage points of GDP (in roughly equal proportions) vis-à-vis the original 1998 budget. Nonetheless, the overall fiscal position in 1998 shifted into a deficit of about 6½ percentage points of GDP (from a surplus of about 3½ percent in the preceding year). The deterioration in the budgetary position mirrored the drop in oil revenues. The deficit was financed by recourse to bank credit, as well as a substantial drawdown of the assets of the State General Reserve Fund (Reserve Fund).

The increase in bank credit to the government in 1998, representing a marked shift compared to 1997, contributed to a significant increase in net domestic asset growth, although the expansion of credit to the private sector-despite a slowdownremained the primary source of NDA growth. Relative to the opening stock of broad money, net domestic assets expanded by 22 percent in 1998 (compared to 16 percent in the previous year). The expansionary impact of the fiscal position was in large part offset by a number of actions taken by the central bank to rein in the growth of bank lending to the private sector-particularly consumer credit. In July 1998, the limit on banks' lending-to-deposits ratio (85 percent) was redefined so as to close a loophole whereby banks could expand their domestic lending base by creating deposits abroad through external borrowing: as a transitional step, the lending-to-deposit ratio is being capped at 87.5 percent through June 1999. In January 1999, the central bank issued a directive requiring commercial banks to bring the share of personal/consumer loans relative to their total portfolio of private sector credit to 30 percent by end-2000, while eliminating the ceiling on interest rates for such credits.

Latest indications are that new bank lending to the private sector came to a virtual standstill in the first quarter of 1999, though there was a sizable increase in bank claims on the government as portfolios were adjusted to the new regulations. Overall, the pace of net domestic asset growth, though declining, remains on the high side (18 percent of the opening stock of M2 in the 12 months ended March 1999). The bulk of NDA growth during 1998 and the first quarter of 1999 was reflected in a decline in net foreign assets of the banking system (principally the commercial banks) with the result that growth in domestic liquidity has been modest (1½ percent in the 12 months ended March 1999).

Oman has made progress in strengthening the supervisory and regulatory framework of the banking system in recent years. By end-1997, all domestic banks had met the mandated capital adequacy ratio of 12 percent of risk-weighted assets. Also, the share of nonperforming loans has been on a declining trend and banks are generally in compliance with other prudential requirements and regulations. A recent survey by the central bank estimated the exposure of commercial banks to the securities market, (both indirectly through personal loans used to invest in securities and directly through the banks' own investment in the market), to be about 8 percent of banks' assets. The deficit between total exposure and the market value of the shares is reckoned to be below the threshold under the International Accounting Standard that would require provisioning.

With a view to strengthening the transparency of stock market transactions, a new capital market law was introduced in February 1999. This provides for the establishment of an independent regulatory and supervisory authority. In addition, a depository and transfer company was set up for record keeping and registration of securities, and prudential regulations were tightened through more stringent disclosure and reporting requirements.

Executive Board Assessment

Executive Directors commended the authorities for the progress achieved in recent years toward developing and diversifying the economy, and promoting social welfare in a climate of financial stability. However, the emergence of large fiscal and external imbalances in 1998 was a reminder of Oman's exposure to the vagaries of the world oil market, and of the challenges this created for policymakers.

Directors welcomed the various fiscal and monetary actions taken by the authorities since March 1998 to contain pressures on the external position and limit recourse to foreign borrowing, and were encouraged by the authorities' stated willingness to take any necessary further measures. They took note of the positive impact on the Omani economy of the recent strengthening of the world oil market. Nevertheless, they stressed that, in setting policies for the medium term, full account should be taken of the inevitable uncertainty regarding oil prices. Directors also noted that drawdowns of the foreign assets of the Reserve Fund had brought it to a low level.

Directors urged the authorities to pursue vigorously their ongoing efforts to develop a broad-based adjustment and reform strategy. They considered that, foremost among the required policy initiatives, should be a balanced fiscal package incorporating a broadening of the revenue base, as well as further restructuring and retrenchment of expenditures. In this regard, they welcomed the authorities' intention to consider various tax reform measures aimed at widening the tax base and improving customs administration. Directors noted the progress that had been made in lowering government expenditure as a share of GDP and welcomed the authorities' continuing efforts to reduce transfers to public enterprises and to rationalize expenditure. They saw scope for further savings through streamlining the civil service, containing government wages, and further improving the overall efficiency of public services. Directors were encouraged by the authorities' decision to earmark part of the oil resources to rebuild the Reserve Fund for future generations.

Directors welcomed the authorities' ongoing efforts to enhance the scope of monetary policy by developing indirect instruments to replace the existing direct credit controls. Directors noted with satisfaction that the banking system continued to be in a sound financial position.

Strengthened macroeconomic policies would, in the view of Directors, need to be accompanied by comprehensive structural reform if the process of diversification was to be sustained and job opportunities created on the scale needed to absorb the country's rapidly growing labor force. While noting the prospective impact of completion of the Liquefied Natural Gas (LNG) project, Directors encouraged the authorities to focus their efforts on expanding the role of the private sector, primarily through stepping up the pace of privatization and maintaining liberal and open external policies. In this regard, Directors considered that the exchange rate regime had generally served Oman well.

Regarding the demographic and employment challenges that Oman faced, Directors stressed the importance of a well-functioning labor market. They praised the authorities' efforts to expand education and training to increase the skills and competitiveness of the Omani labor force. At the same time, the authorities were encouraged to review carefully the quota system for the employment of nationals, which, in its present form, could be a disincentive to a new investment.