Public Information Notice No. 08/50

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Oman

April 30, 2008

On March 17, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Oman.¹

Background

Oman's economic performance during 2007 was strong. The economy withstood well the impact of the June cyclone and real GDP grew by 6.4 percent, supported by high oil prices and rapid growth of non-hydrocarbon sectors such as petrochemicals, trade, and transport and communications. Annual average consumer price inflation increased to 5.5 percent in 2007, from 3.2 percent in 2006. The increase in inflation reflected rising world food prices, supply-side constraints related to the construction boom, upward pressures on wages, and the depreciation of the U.S. dollar. Domestic demand growth was mainly driven by high inflows of foreign direct investment, the fiscal stimulus from previous years, and strong private sector credit growth.

The overall fiscal and external positions are estimated to have registered large surpluses in 2007. The non-oil fiscal deficit (excluding grants) relative to non-oil GDP is estimated to have narrowed owing to an increase in non-hydrocarbon revenues attributable to strong growth in corporate profits and customs receipts, and to lower spending on defense that more than offset a surge in capital expenditure related to the government's development program. With oil production waning, and strong growth of imports for infrastructure investment and consumption, the external current account surplus is estimated to have fallen to 10 percent of GDP in 2007, from 12 percent in 2006. The Omani riyal has depreciated by about 1.6 percent in real effective terms since 2005.

Money growth accelerated in 2007, reflecting the accumulation of foreign assets and strong private sector credit growth. Broad money growth (year-on-year) increased from 25 percent in December 2006 to 34 percent in October 2007, with private sector credit growth rising from 20 percent to 31 percent over the same period. Private sector credit growth was boosted by abundant liquidity in the banking system, partly related to capital inflows triggered by expectations of a near-term revaluation of the Omani rial vis-à-vis the U.S. dollar, and negative real interest rates. In response to the acceleration in credit growth, the Central Bank of Oman (CBO) raised reserve requirements from 3 percent to 5 percent in December 2007; this followed another effective increase in July 2007, when cash balances were excluded from the calculation of accepted reserves. The CBO has also removed the cap on the total outstanding stock of certificates of deposit (CDs), thereby increasing the scope to mop up liquidity.

The banking sector remains sound. Banks are profitable and well-capitalized, and nonperforming loans are being reduced. Pillars I and II of Basle II are being implemented, and the CBO is currently developing a risk-based supervision model which is expected to be implemented in 2008. In addition, in April 2007 the CBO doubled the minimum capital requirement for local banks to RO 100 million, and for branches of foreign banks to RO 20 million.

Oman does not intend to participate in the GCC monetary union. However, it is part of the common market launched in January 2008 and continues to participate in all the technical meetings with other GCC countries, including on the harmonization of financial regulations, statistical frameworks, and payment and settlement systems.

The authorities are moving ahead with the implementation of their diversification plans in the context of the Seventh Five-Year Development Plan, which was started in 2006. The plan aims to expand liquefied natural gas (LNG) output capacity, develop gas-based and non-hydrocarbon industries (manufacturing and tourism), and provide employment opportunities for Oman's rapidly growing population.

Executive Board Assessment

Executive Directors commended the authorities for Oman's strong growth performance over the past few years, despite declining oil production. They welcomed, in particular, the steady progress in implementing structural reforms that has contributed to strong non-oil output growth. Oman's medium-term prospects look favorable, supported by a continued positive outlook for energy prices, a strong investment momentum, and an improved domestic business climate. The key challenge in the period ahead will be to contain inflation while sustaining growth through economic diversification.

Directors observed that inflationary pressures have increased, owing mainly to supply-side constraints related to the construction boom, the strong growth in domestic demand associated with the public investment program, rising international food prices, and to a lesser extent the depreciation of the U.S. dollar against other major currencies. They underscored that fiscal policy constitutes the main tool to moderate domestic demand growth. Directors recognized the importance of increases in capital outlays to address supply bottlenecks, but noted that expenditure increases should be consistent with the country's absorptive capacity. In this regard, Directors called on the authorities to restrain the growth of wages and transfers, phase the implementation of lower-priority projects. They encouraged the authorities to reduce over time the implied subsidy on petroleum products, and supported efforts to increase non-oil revenues through the introduction of a value-added tax. These measures will be essential to reduce the non-oil fiscal deficit over the medium term and safeguard macroeconomic stability.

Most Directors supported the authorities' intention to maintain the current peg of the Omani rial to the U.S. dollar, which has provided a credible monetary anchor and helped sustain investor confidence. Nevertheless, the peg requires that other policies play a supporting role. Directors attached particular importance to a prudent fiscal policy to contain inflation, and to the vigorous implementation of structural reforms to improve efficiency and sustain competitiveness. A few Directors saw merit in reviewing appropriate exchange rate arrangements in the long term. Directors took note of the authorities' decision not to join the Gulf Cooperation Council (GCC) monetary union, but to remain committed to other GCC initiatives and to participate in all GCC-wide forums.

While noting the limited scope for monetary policy under the current peg regime, Directors recommended that the authorities help reduce excess liquidity by more closely aligning short-term interest rates with comparable rates in the United States. They supported the authorities' willingness to raise reserve requirements further to mop up excess liquidity, as well as their intention to invest abroad a portion of the government's deposits currently held in commercial banks. They observed that the development of a government securities market would provide benchmarks for the pricing of corporate debt, and enhance financial intermediation.

Directors welcomed the strength of Oman's financial system, as evidenced by the high capitalization and profitability of financial institutions. They encouraged the authorities to develop a comprehensive licensing policy for the entrance of new banks, involving a thorough review of their business strategy, funding sources, and oversight and internal governance capabilities, in order to help balance banks' growth aspirations against the market's absorptive capacity.

Directors welcomed the authorities' commitment to the structural reform agenda and further economic diversification, including through continued implementation of the privatization program. Progress with these reforms will be crucial to sustain medium-term growth. Directors regarded infrastructure to develop tourism, manufacturing, and gas based non-hydrocarbon industries as key to increasing exports and providing employment opportunities for Oman's rapidly growing labor force. They commended the authorities for attaching high priority to education and training, in order to raise the productivity of the Omani labor force.

Directors commended the authorities for their efforts to improve the quality of economic statistics, especially labor market data, and encouraged them to make further progress in improving and disseminating economic data.

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.