Mission Concluding Statement 

Oman: Staff Concluding Statement of an IMF Staff Visit

February 12, 2021

Washington, DC – February 12, 2021: An International Monetary Fund (IMF) mission, led by Mr. Daniel Kanda, conducted a virtual mission to Oman from January 17 to 31 to review economic developments, the outlook, and policies. Discussions focused on the impact of COVID-19 and related oil price shock, and policy priorities during the recovery phase and beyond. The Omani authorities indicated that they will be favorable to the publication of future IMF reports. The IMF staff team would like to thank the Omani authorities and other counterparts for the open and candid discussions.

Economic Developments and Outlook

1. The authorities of Oman responded rapidly in 2020 to contain the spread of COVID-19 infections. Measures included closure of non-essential businesses, social distancing requirements, and border restrictions, while increasing health and medical support and social assistance to the population. The swift and well-coordinated response effectively limited the spread of the coronavirus in the latter part of 2020, but the social distancing and other restrictions weighed heavily on economic activity, particularly those requiring close human contact.

2. Substantial measures were also implemented to mitigate the impact of the COVID-19 and oil sector shocks on households, firms, and banks. In addition to the direct impact of COVID-19 on economic activity, sharp declines in oil prices triggered by the global spread of the pandemic, and cuts to oil production under the OPEC+ agreement, weighed on the oil sector. Fiscal measures to support the economy included interest-free emergency loans, waiving or reducing selected taxes and fees, flexibility to pay taxes in installments, and establishing the Job Security Fund to support citizens who lost their jobs. In addition, the Central Bank of Oman (CBO) eased financial conditions through lower interest rates and liquidity injections, deferred loan installment payments, and relaxed macro prudential requirements on capital buffers and liquidity ratios.

3. Nevertheless, the shocks took a heavy toll on the economy in 2020. Overall GDP contracted by 6.4 percent (revised up from the previous IMF forecast of -10 percent), with non-hydrocarbon GDP estimated to have contracted by 10 percent and a shallower decline in hydrocarbon GDP—due to strong oil condensate production not covered by the OPEC+ agreement. Construction, hospitality, and wholesale and retail trade sectors were particularly hard-hit. Inflation turned slightly negative owing to subdued demand. Employment conditions due to the economic slowdown were mostly relieved by a 15.7 percent reduction in expatriates and the flexibility to negotiate temporary wage cuts. The external and fiscal positions also weakened substantially:

· The current account deficit is estimated to have widened from 5.4 percent of GDP in 2019 to 10 percent in 2020, mostly owing to lower hydrocarbon exports. International reserves declined slightly to around US$15 billion (6.5 months of imports), reflecting stable FDI inflows and a Eurobond issuance.

· Government hydrocarbon revenues fell by 3.4 percent of GDP, reflecting the oil sector shocks. Non-hydrocarbon revenues fell by 0.2 percent of GDP reflecting declining economic activity and measures such as suspension of penalties on late tax filings and some government fees. Despite significant attempts to constrain expenditure, the sharp decline in nominal GDP implied a rise in the expenditure-GDP ratio. Overall, the fiscal deficit rose by 10.6 percentage points to 17.3 percent of GDP and was financed by external bond issuance, drawdown of deposits and sovereign funds, and privatization proceeds. As a result, central government debt rose to 81 percent of GDP, from 60 percent in 2019.

4. To address rising fiscal vulnerabilities, the authorities announced an ambitious medium-term fiscal adjustment plan and broad public-sector reforms . The fiscal adjustment plan (Tawazun) targets the elimination of the fiscal deficit over 2021-25 by boosting non-oil revenues while keeping nominal fiscal expenditures broadly constant. To improve public asset management, the government established the Oman Investment Authority (OIA) with a mandate to strengthen the governance and efficiency of public enterprises. Also, a new holding company—Energy Development of Oman (EDO)—was created to manage and finance government investments in oil, gas, and renewables.

5. Financial soundness indicators appear healthy. As of December 2020, banks’ capital adequacy ratios averaged 19.1 percent and the Liquidity Coverage Ratio was around 200 percent, comfortably above regulatory minima. Nonperforming loan ratios increased slightly to 4.2 percent, with specific provisioning coverage of 63 percent and total coverage of 98 percent. Nonetheless, profitability indicators declined reflecting the impact of COVID-19 on economic activity, loan repayment deferment, and risk provision charges.

6. A modest recovery is anticipated for 2021, with further strengthening of growth over the medium term, but there is substantial uncertainty around the outlook. While the roll-out of vaccination and the easing of social distancing restrictions would support increased activity globally as well as in Oman, substantial medium-term fiscal consolidation would weigh on growth. Overall, a mild recovery of 1.5 percent in non-oil GDP growth is projected for 2021, rising thereafter to 4 percent by 2026 as the drag from fiscal adjustment subsides. Steady implementation of fiscal adjustment plans would strengthen fiscal and external balances substantially over the medium term. Upside risks to the outlook could come from a stronger rebound in global activity with the ending of the pandemic, the boost to confidence from successful implementation of fiscal adjustment plans, and the successful implementation of plans to strengthen public enterprise governance. On the downside, the emergence of COVID-19 variants could prolong the impact of the pandemic and potentially intensify economic scarring of the most affected sectors. Finally, volatility in oil prices would have a significant impact on the outlook and macroeconomic balances.

Policy Considerations

7. Combating the pandemic and mitigating its effects should remain a priority until the recovery is firmly underway. Short term policies should continue to address the health crisis, including vaccine rollout, support the recovery, minimize long lasting economic scarring, and mitigate risks to financial stability. Premature and overly rapid retrenchment could hurt early recovery and pose even larger costs on the economy. In this regard, withdrawal of the various types of fiscal, monetary, and financial sector support measures should be carefully coordinated and calibrated to continue to support hard-hit but viable sectors, while gradually reducing support for those that no longer need it. With substantial fiscal adjustment planned for 2021, the fiscal support measures should be prioritized, thus also supporting social safety net, and accommodated by streamlining other spending rather than expanding the deficit. Once the recovery is firmly established, financial policies should be increasingly targeted to reinforce fiscal and external sustainability, safeguard financial stability, and boost potential growth.

Reinforcing Fiscal Sustainability

8. The Medium-Term Fiscal Balance Plan is welcome, and its successful implementation is key to reinforcing fiscal sustainability and alleviating financing pressures . Key revenue measures include: (i) introducing VAT in 2021; (ii) a personal income tax on high-income earners being developed; and (iii) full-year impact of the expansion of the excise tax base in 2020. Key expenditure measures include: (i) containing the wage bill via civil service reforms; (ii) targeting energy subsidies to the most vulnerable groups; (iii) streamlining capital expenditure; and (iv) broad-based improvements in expenditure efficiency. These policies would also help mitigate structural weaknesses in public finances, notably heavy reliance on hydrocarbon revenue and rigidities in expenditure. Given the impact of fiscal consolidation on economic activity and household incomes, sustained commitment and active outreach to build broad support to the proposed measures would be needed to successfully implement the plan. Inadequate implementation of the fiscal adjustment plan could trigger a negative shift in investor sentiment, heightening financing risks. Finally, establishing a sound medium term fiscal framework and a clear fiscal anchor would help in achieving the targeted consolidation, and the IMF stands ready to provide technical assistance in this area.

9. The 2021 budget entails a significant fiscal consolidation . The budget envisages reducing the deficit (excluding oil condensate revenue and oil and gas related expenditure hived off to EDO) by about 6 percentage points of GDP to 7.5 percent. The launching of the VAT in April 2021, expansion of the excise tax base, and improvements in tax administration are expected to strengthen non-hydrocarbon revenue. On the expenditure side, civil service reform (including obligatory retirement scheme for long serving employees and lower salaries for new hires) and a 5 percent cut of other expenditure are envisaged. Gross financing need is projected at 14.5 percent of GDP, with the bulk of the financing expected to come from external sources. IMF staff projections incorporating the envisaged measures are broadly consistent with those of the authorities, with an upside from higher than budgeted oil prices.

10. A sovereign asset and liability management framework should be developed given eroding financial buffers and rising contingent liabilities. Sovereign assets and liabilities should be managed and coordinated in an integrated way to assess sustainability and vulnerabilities in the public sector from the risk-return perspective. With public debt rising, foreign assets declining, and explicit contingent liabilities of state-owned enterprises at about 9.5 percent of GDP in 2019, it will be important to manage potential mismatches in the financial characteristics of sovereign assets and liabilities to safeguard the sovereign balance sheet from risks of interest rate and exchange rate fluctuations. Information sharing and coordination among relevant government entities should help to detect and mitigate sovereign risk exposures. Further, adopting a medium-term debt strategy should help incorporate the government’s preferences regarding cost-risk tradeoff between alternative financing options and provide predictability to the financial system. Technical assistance from the IMF could support in this regard.

Safeguarding Financial Stability

11. Banks entered the crisis from a position of strength but face challenges. Despite high capital buffers and liquidity, banks face headwinds from the impact of the pandemic on asset quality, a low oil environment, and high credit and deposit concentration. However, the authorities’ stress test indicated that domestic banks would be able to remain above minimum capital adequacy under severe scenarios.

12. Policy responses to the pandemic should strike a balance between supporting the economy and containing potential risks to financial stability. Deferred loan installment payments and associated risk classification could obscure deterioration in asset quality in the banking system, and thereby emerging potential credit risks should be closely monitored especially for hard-hit sectors. In this regard, the case-by-case approach adopted by banks to evaluating applications for loan deferrals appears appropriate. The timing of ending the loan deferral policy should be carefully calibrated to maintain needed support to hard-hit but viable sectors without undermining banking system buffers, taking also into account the availability of other policy tools to support households and businesses.

13. Careful management of the sovereign-bank nexus over time would support banking system resilience . At the end of December 2020, deposits from government and government-related entities constituted around 28.3 percent of total deposits. Banks’ claims on government and government-related entities increased rapidly from 10.3 percent to 19.1 percent of total assets during 2014-2020. Strengthening the public sector balance sheet would help reduce public sector financing needs that may otherwise crowd out private sector lending during the recovery phase and would facilitate management of sovereign-bank interlinkages.

Boosting Potential Growth

14. Steadfast implementation of structural reforms is paramount to promote economic diversification and job creation for Omanis, and support fiscal and external sustainability . In this regard, areas for reform, in line with Oman Vision 2040, include restructuring public administration, strengthening governance of state-owned enterprises, improving the flexibility of labor markets, and strengthening corporate restructuring mechanisms. Well designed social safety nets would also support the reallocation of labor toward expanding sectors as economic diversification proceeds.