Qatar–2011 Article IV Consultation Concluding Statement of the IMF Mission
December 1, 2011
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.
Qatar is using its fiscal space, generated from an increase in hydrocarbon production and high prices, to implement a large public spending program to maintain strong growth in the nonhydrocarbon sector in the medium term and improving living standards. Headline inflation remains subdued, but inflation risks have risen somewhat due to a permanent increase in public sector wages, which underscores the need for fiscal policy to monitor aggregate demand and the central bank to manage liquidity. Given the authorities’ objective of fully financing the budget from 2020 onwards from its nonhydrocarbon revenues and returns on investment income, and for building buffers for shocks, it would be prudent for the Government to save more. Credit is also growing at a fast pace, particularly to real estate. The central bank should monitor its growth and stand ready to use macroprudential instruments to prevent the building up of excessive risks. Closing regulatory gaps in the financial system and continuing with efforts to develop the domestic bond market are needed to further strengthen financial stability while developing the financial system. Further improvements in statistics will be essential, which will also require greater coordination between agencies.
1. This statement presents the preliminary assessment of the 2011 Article IV mission to Qatar. The mission met with H.E. Yousef Kamal, Minister of Economy and Finance, H.E. Abdulla Bin Saoud Al-Thani, the Governor of Qatar Central Bank, senior government and central bank officials, as well as representatives of the financial sector and non-financial private sector. The mission thanks the Qatari authorities for open and constructive policy discussions, and wishes the government and people of Qatar all the best in their future endeavors.
II. Current Economic Developments
2. Real GDP growth in 2011 is projected to accelerate to 19 percent, up from 17 percent in 2010. The nonhydrocarbon sector is expected to grow by 9 percent driven by manufacturing, financial services, and trade and hotels. Hydrocarbon sector growth would peak from an increase in its production capacity of liquefied natural gas (LNG) to 77 million tons per annum (Mtpa). Following an average deflation of around 2.5 percent in 2010, inflation is expected to average at 2.0 percent in 2011 (end-period 2.5 percent)–with the negative rental inflation being more than offset by increases in domestic prices of petrol, and the impact of global food prices.
3. The overall fiscal balance remained in surplus of 2.7 percent of GDP in 2010/11, despite the sharp rise in current expenditure and lower than budgeted transfer of investment income from public enterprises, The current account balance is projected to record a surplus of 28 percent of GDP in 2011, up from 26 percent in 2010, reflecting increased exports of LNG and condensates, and higher oil and gas prices.
4. The banking sector is well-capitalized. The banking sector remains profitable and strong with a capital adequacy ratio of 22.3 percent, average return on assets of 2.7 percent, and non-performing loans ratio of 2.3 percent at end-June 2011. The nonfinancial corporates are also in an expansionary phase–profits are at pre-crisis levels, cash is abundant, default rates are low, and financing conditions remain easy.
5. A number of policy measures were taken by Qatar Central Bank (QCB) since the second half of 2010 aimed at strengthening financial stability and managing liquidity. A cap on remunerated deposits of QCB and successive reduction in policy deposit rates to align with US policy rates proved successful in driving out short-term arbitrage funds that were intermediated through the banking system. Issuance of government bonds and sukuk coinciding with the imposition of the cap on central bank deposits, and issuance of treasury bills in lieu of central bank certificates of deposit facilitated the mopping up of structural liquidity from the banking system over a longer period, while shifting the cost from the central bank’s balance sheet to the Government.
III. Outlook and Risks
6. The economic outlook for 2012 remains positive, despite increased external risks. Real GDP growth rate is projected to moderate to 6 percent in 2012. While real hydrocarbon GDP will slow down to less than 3 percent due to the country’s self imposed moratorium on development of new hydrocarbon projects until 2015, large infrastructure investment and increased production in the manufacturing sector will boost growth in real nonhydrocarbon GDP, which will accelerate to 9 percent. The post-budget announcement of salary and pension hikes would add an estimated $1.6 billion to Government expenditure in 2011/12, but the actual fiscal balance is still projected to record a surplus of over 7 percent in 2011/12. Average headline CPI inflation is projected at 4 percent in 2012. The external balance is projected to post a surplus of $47 billion.
7. The outlook for Qatar continues to be positive over the medium term, since most of Qatar’s exports over the medium-term have already been tied up in long-term contracts. The fiscal and external current account balances are expected to continue to record surpluses, as hydrocarbon prices are expected to remain high. Continued government investment will keep growth in the nonhydrocarbon sector between 9 and 10 percent beyond 2011. Average headline inflation is projected at 4 to 5 percent over the medium term, as rents stabilize due to a gradual narrowing of the current excess capacity in real estate and other large investments materialize.
8. The principal risks ahead are lower oil and gas prices as a result of a decline in global demand, disruption in transportation of LNG due to increased geopolitical tensions, but the Government has adequate financial cushions and a policy framework in place that would mitigate potential risks. In particular, a deepening of the banking and sovereign debt problems in advanced economies could result in a significant tightening of global liquidity and impact Qatar through channels similar to those observed in 2008–09. A global foreign funding shock may generate some liquidity tightening in the domestic banking sector, which would need to be managed, particularly at individual bank-level. Nevertheless, risks to banking stability appear much lower now after three rounds of capitalization and asset restructuring since 2008. Even so, the funding channels would hinder the capacity of prospective borrowers to borrow by increasing the cost significantly, and thereby affect the infrastructure investment plans.
IV. Short-term Challenges
9. Headline inflation is projected to remain subdued, but inflation risks have risen due to domestic factors. The potential inflationary effect of the recent fiscal package is estimated to be 1 percentage point. Most of this inflation would come from the nontradable sector, notwithstanding the excess supply in real estate which will keep rents depressed.
10. The expansionary fiscal stance in 2011/12 thus warrants careful monitoring of aggregate demand to ward off risks of inflation. Fiscal policy must continue to maintain a careful balance between spending on infrastructure to sustain non-inflationary growth, and saving and investing hydrocarbon surpluses abroad in order to generate sufficient income to finance future budgets. In the context of the peg, the central bank would need to manage liquidity through reserve requirements, and more frequent issuance of Treasury Bills.
11. The main challenges for monetary policy will be to support credit growth without fuelling inflationary pressures or short-term capital inflows. Developing a more formal and transparent macroprudential policy framework, notably with respect to the definition of objectives, the elaboration of analytical methods, and the policy toolkit will help achieve this. Credit is already expanding at a fast clip–driven by the public sector, and real estate. Continued growth in the nonoil sector and implementation of infrastructure related projects will provide additional demand for credit. Against this backdrop, banks and the QCB need to be cautious that overall credit quality does not weaken, particularly to real estate in view of the prevailing excess supply situation. Collating and disseminating price and volume data on Qatar’s real estate market segments would help banks assess risks better and also enable the central bank to take informed preemptive regulatory measures to preserve financial stability.
12. It would be appropriate for QCB to develop a formal liquidity management framework to facilitate a more proactive strategy in fine-tuning liquidity. In addition, coordination of debt management with the Ministry of Economy and Finance would be helpful in maintaining a stable and adequate stock of government securities for the further development of an interbank repo market, and also to provide a robust benchmark yield curve for the corporate bond market.
V. Medium-term Challenges
The pause in the LNG production ramp-up offers an opportunity for the authorities to focus on laying the foundation for a more diversified economic growth path through reforms encompassing fiscal policy, financial sector development, institution building, and governance.
13. Fiscal policy will need to balance sometimes competing objectives of stabilization, development and generating intergenerational savings. Staff’s medium-term fiscal sustainability exercise shows that compared to the last year, fiscal space has contracted somewhat because of the permanent increase in current expenditure. The bulk of government expenditure is still its current component, and capital expenditure currently constitutes about 35 percent of total government spending. Despite the increase in spending, the high hydrocarbon prices have enabled the authorities to continue to accumulate savings in the sovereign wealth fund. Nevertheless, given the authorities’ objective of fully financing the budget from 2020 onwards from its nonhydrocarbon revenues, and for building buffers for shocks, the mission encourages the authorities to save more.
14. The mission urges the acceleration of steps to establish a macro-fiscal unit that could develop a medium-term expenditure framework to ensure the efficiency of public spending. A solid medium-term expenditure framework would also represent a critical building block for the eventual adoption of a fiscal rule to help manage the path of fiscal spending. The mission also encourages the authorities to sustain efforts to mobilize domestic revenues and strengthen public financial management. In view of the large FIFA 2022 infrastructure related expenditure, the mission underscores the importance of adopting a Public Investment Management System to provide a coherent and rigorous set of procedures for project selection, appraisal, and programming that would enhance efficiency, accountability and governance.
15. The mission’s stress tests indicate that the banking system has the ability to contain credit and market risks. Nevertheless, as also highlighted in the Second Financial Stability Review of QCB, the mission underscores the need to monitor individual banks’ for stress, given the interlinkages in the financial system. Further, the mission concurs with QCB’s analysis that banks’ dependence on wholesale funding, though not significant, needs to be lowered to mitigate potential risks. Enabling a more robust risk assessment culture and conducting regular stress testing of banks, and putting in place a framework for early warning system would help mitigate risks to the banking system and strengthen financial stability. The high credit concentration of Qatari banks underscores the need to for an in-depth diagnostic of bank governance–especially with regard to internal audit and risk management of banks–that would highlight potential areas of improvement.
16. More needs to be done to close the regulatory gaps and strengthen regulation. Central bank regulation to separate Islamic banking and conventional banking activities and imposition of quantitative and price ceilings on personal loans against salary assignment seek to bring greater clarity to the regulatory framework, mitigate the risk in the banking system as well as household debt, and usher in a more orderly credit growth. The mission understands that the proposal to establish the single regulator has been approved by the Council of Ministers, and that the legalities are being worked out to operationalize it.
17. The exchange rate is broadly aligned with fundamentals. The dollar peg has served as an effective nominal anchor. The preconditions to sustain the peg, namely, a strong fiscal position, a sound banking system, and flexible labor and capital markets are in place and should facilitate adjustment. The mission reiterates that it will, nevertheless, be important to enhance the technical, institutional, and operational capacity, in case an alternative exchange rate regime becomes desirable in the context of the GCC monetary union. In this context, the mission notes the steps taken so far in the issuance of Government bonds and Treasury Bills, and encourages the authorities’ to address the regulatory, legal and market infrastructure issues in a more systematic manner.
VI. Longer-Term Issues
18. Reducing Qatar’s vulnerability to hydrocarbon price fluctuations will necessitate diversification into other sectors of the economy and reinforcing competitiveness. This will require raising productivity through greater use of the latest technologies, increasing the efficiency of investments, fostering more openness to foreign competition, and enhancing the quality of labor. These aspects have been articulated National Development Strategy. Improving the efficiency of fiscal spending could help improve productivity during the transition. Opportunities for efficiency gains in the energy, gas, and water use exist by reducing among others, direct and indirect subsidies. It is also opportune to evaluate consider options for deeper pension reforms. Reforms to rebasing of pension payments over the average of the last few years of service instead of the last month’s salary, increasing the retirement age, extending the early retirement age, and changes to the investment policy to improve the risk-return need to be implemented in conjunction with the cash and assets transfers to the pension fund with a view to strengthening it.
VII. Statistical Issues
19. The mission acknowledges the improvements in collation of national accounts, consumer price index, fiscal and balance of payments statistics and notes that there is further scope to improve timeliness, quality, and periodicity of all strands of economic data. The mission underlines the need for greater coordination among the various ministries, QCB, and Qatar Statistics Authority in this regard.