IMF Executive Board Concludes 2011 Article IV Consultation with OmanPublic Information Notice (PIN) No. 12/30
March, 26, 2012
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On February 22, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with Oman on a lapse of time basis. Under the IMF’s lapse of time procedures, the Executive Board completes Article IV Consultations without convening formal discussions.1
The Omani economy has picked up strongly since 2009 and growth has continued to gather speed over the past year. Driven by increasing government spending and higher oil prices, real GDP growth is estimated to have reached 5.5 percent in 2011, up from 4 percent in 2010 and 1.1 percent in 2009. With higher oil revenue and despite an estimated 16 percent increase in government expenditure, the fiscal and external surpluses are estimated to have increased by about 4 percentage points of GDP to, respectively, 9.8 and 12.7 percent of GDP in 2011. Price pressures have remained moderate, with consumer price index inflation holding steady at an annual rate of about 4 percent during 2011.
The economy has been largely unaffected by recent turmoil in international financial markets. Omani banks are well capitalized and have little exposure to the Eurozone. This combined with an export structure that is dominated by oil and oriented primarily towards fast-growing economies in Asia has limited the impact of the European debt crisis. Although the local stock market fell by 16 percent in 2011, real sector activity has been essentially unperturbed and bank credit has continued to accelerate.
Unemployment among nationals has emerged as a pressing issue. In response to social concerns, the government has since early 2011 increased the number of public sector jobs, raised the minimum wage for Omani workers in the private sector, introduced a new unemployment benefit, and almost doubled the intake for higher education.
Executive Board Assessment
In concluding the 2011 Article IV consultation with Oman, Executive Directors endorsed staff‘s appraisal, as follows:
The medium-term outlook for growth is broadly positive, but the economy remains highly vulnerable to oil price developments and fiscal sustainability is a mounting challenge. While oil production is not expected to continue increasing as has been the case in recent years, the large public investment program underway will support continued robust growth in the non-oil economy. Absent continued increases in oil prices, however, the currently sizeable fiscal surplus is set to disappear within a five-year period. A prolonged drop in oil prices would entail large deficits that could ultimately force cutbacks in government spending and lead to sharply lower economic growth.
Ensuring fiscal sustainability calls for decisive action on a number of fronts. The recent pace of government spending increases will have to come down. A VAT has long been on the agenda and should be vigorously pursued. In addition, the large implicit fuel subsidies are distortionary, increasingly unaffordable, and should be reduced. The strong state of the economy makes this a good time for moving ahead with such measures. Moreover, strengthened budget processes could help provide greater value for money, and targeted cash transfers could help offset any negative social impact of fiscal consolidation. Importantly, starting the fiscal adjustment now would reduce the risk of having to make larger and more disruptive adjustments later in a situation where financial constraints are more acute.
Casting the government budget in a medium-term framework would also help provide stability. Updating the five-year plans regularly and linking them more closely to the annual budgets would reduce the volatility of spending and its high correlation with short-term movements in oil prices. Establishing a macro-fiscal unit in the Ministry of Finance would facilitate such a process. Moreover, a fiscal rule targeting long-term fiscal sustainability could help anchor fiscal policy.
Over the longer run, the economy depends on making greater inroad towards diversification. Oman’s hydrocarbon reserves are limited and alternative sources of income will need to be developed. There is scope to improve the business environment to encourage private investment outside the oil sector. The fact that non-oil exports have increased in recent years should not lead to complacency. The new export industries are mostly energy-intensive and have to a great extent depended on receiving fuel at far below world market prices. As such, the emergence of these new industries has not done much to reduce the economy’s dependence on hydrocarbons.
Effectively addressing the problem of high unemployment among Omani nationals is linked to progress on economic diversification. Neither the hydrocarbon sector nor the new energy-intensive industries provide many jobs. Meeting the need for more well-paying jobs for Omanis outside the public sector will require boosting job creation in the less-capital intensive and more knowledge-intensive parts of the private sector. This depends on progress in education and training to ensure that the labor force has the needed skills. It also depends, however, on resolving the large wage and benefits differentials between the public and private sectors and between Omanis and expatriates. In lieu of outright reductions in public sector compensation, raising fees for work visas or instituting temporary employment subsidies for Omanis in the private sector could be considered as ways of bridging wage gaps and providing the right incentives.
Maintaining macroeconomic stability is a prerequisite for sustained economic growth. Fiscal policy will be key to avoiding potential inflationary pressures, but the Central Bank of Oman (CBO) should continue to proactively mop up excess liquidity and be ready to apply macroprudential measures if credit growth starts to feed into higher inflation, and direct attempts at controlling market prices should be avoided. Regular issuance of government debt in a range of maturities and the establishment of a yield curve would facilitate liquidity management, help corporates diversify their sources of financing, and spur financial market development. Absent greater issuance of government securities, the CBO could expand the maturity range of its CDs.
The current exchange rate regime remains appropriate. The peg to the U.S. dollar has served Oman well by providing a strong and credible monetary anchor, and it is well suited to the oil-dependent nature of the economy. Moreover, staff estimates indicate that the exchange rate is in line with fundamentals. Nevertheless, as economic diversification proceeds, it will be important to develop the financial system and enhance the monetary transmission mechanism to prepare for the possibility of instituting greater exchange rate flexibility in the long run.
The coverage and quality of Oman’s statistics compare favorably with other countries in the region, but there is scope for improvement. Priority areas include strengthening labor market statistics, enhancing budget classification and reporting, and improving the timeliness and dissemination of data.