Public Information Notice No. 08/57

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

May 21, 2008

On January 30, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Brunei Darussalam.¹

Background

Brunei continues to benefit from high global energy prices. The oil and gas sector accounts for around 50 percent of real GDP and generates more than 90 percent of total export earnings and government revenues. Wealth from oil and gas provides Brunei's small population with a high standard of living, with GDP per capita estimated at US$30,185 in 2006.

The economy contracted during the first half of 2007. This was driven by a drop in oil production following a strong outturn in 2006, reflecting cutbacks to optimize oil field utilization as well as ongoing facilities maintenance. The government and private nonenergy sector, on the other hand, provided a positive impetus to growth benefiting from energy-related income spillovers.

Inflation is subdued and credit growth has only recently picked up. Inflation remains low at 0.1 percent (year-on-year) through the first nine months of 2007, partly due to price controls and declining prices on clothing and recreation. Credit growth rose by around 5 percent in the first half of 2007 following a contraction in 2006, reflecting base effects and more broad-based credit expansion. Although nonperforming loans (NPLs) in the banking sector remain high, these mostly relate to credit losses incurred in the late 1990s following financial problems in the corporate sector; provisioning appears broadly adequate and the generation of new NPLs is low. Moreover, local banks' capital adequacy ratios remain high at close to 20 percent.

High oil and gas prices continue to drive large fiscal and current account surpluses. As in the past, energy-related revenue windfalls are being largely saved and invested abroad. The primary fiscal surplus reached 21½ percent of GDP in FY2006/07 (April-March) as oil and gas revenues remained very high. The current account surplus reached 56 percent of GDP in 2006 for the most part reflecting high nominal energy exports.

Growth will remain weak in the near term, but recover over the medium-term. Output is projected to slow to around ½ percent in 2007 and decline fractionally in 2008 due to extensive oil sector facilities upgrading as well as the maturation of oil fields; nonenergy private growth is expected to remain solid. The main risk to the near-term outlook is a global slowdown leading to lower energy prices. Over the medium term, growth is expected to recover and reach around 3 percent as oil production returns to current levels, with new and upgraded facilities coming on stream, and government capital spending is stepped up with improved implementation. There are upside risks to this outlook related to possible new hydrocarbon discoveries.

Executive Board Assessment

Executive Directors commended the Brunei authorities' sound economic management, which has led to robust growth of the non-oil economy, low inflation, and large fiscal and current account surpluses. Directors expected overall economic growth to be flat in the near term as oil production declines, but to pick up in the medium term as oil production returns to current levels and government capital spending is stepped up.

Directors considered economic diversification to be Brunei's main medium-term challenge. This will require a reduction of the government's role in the economy and more determined implementation of structural reforms to attract private investment. Key reforms will include developing domestic capital markets, introducing education and training programs to achieve a more appropriate labor skills mix, and improving the business environment.

Directors commended the government's prudent strategy of saving most energy-related revenue windfalls, and encouraged the authorities to strengthen fiscal management by introducing a formal medium-term fiscal framework. Such a framework should encompass a fiscal goal consistent with long-term sustainability, a fiscal rule to guide fiscal policy, and expenditure and revenue reforms. Directors observed that fiscal management could also be strengthened by improving the framework governing the Consolidated Fund and the General Reserve Fund.

Directors agreed that the currency board arrangement has helped to promote price and financial stability. To further strengthen the Brunei Currency and Monetary Board's credibility, they encouraged the authorities to gradually reduce price controls and conclude the audit of the Board's accounts. Directors supported plans to increase the minimum statutory foreign exchange cover to 100 percent of the money base, and to raise the ceiling for the Board's retained profits to help build a reserve margin.

Directors welcomed the process of setting up a new monetary authority. They suggested that initial priorities for the authority should be to modernize the payments system and develop the capacity to analyze and manage liquidity. Further steps could be to provide settlement banking services, set up government accounts, and conduct limited monetary operations. Directors noted that any role as lender of last resort should be governed by international best practice.

Directors welcomed the strengthening of the financial supervisory and regulatory framework, including the anti-money laundering regime and the harmonization of the Islamic Banking and Insurance Orders with conventional regulation to create a level playing field for all financial institutions. They encouraged the authorities to expand the coverage and reliability of macro-financial indicators and to increase supervisory training and staffing.

Directors generally agreed with the finding that the real effective exchange rate of the Brunei dollar is broadly aligned with its estimated equilibrium level. They viewed the sizeable current account surplus as largely explained by structural and cyclical factors, including prudent fiscal policy, few domestic investment options, and high energy prices.

Directors welcomed the important steps to improve Brunei's statistical framework, and encouraged the authorities to address the remaining deficiencies to enhance effective surveillance.

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.