IMF Executive Board Concludes 2015 Article IV Consultation with Oman
On April 30, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with Oman and considered and endorsed the staff appraisal without a meeting.
The non-hydrocarbon growth rate is forecast to drop from 6.5 percent in 2014 to 5 percent in 2015–16 consistent with the government’s spending plans, and thereafter to 4.5 percent in 2017-20, with risks tilted to the downside. The average inflation rate remained at 1 percent in 2014, given low non-food inflation. Consistent with the dollar peg, benign global inflationary environment, and elastic supply of foreign labor, inflation is projected to remain below 3 percent in the medium term. Oil market developments present the main risk to the medium-term outlook. A further drop in oil prices would worsen the fiscal and economic outlook.
The decline in oil prices is expected to push Oman’s fiscal and current account balances to deficits from 2014/15. The increase in total spending, particularly during 2010–14, mainly in response to social demands, has pushed the breakeven oil price to US$108 per barrel in 2014. Ongoing efforts to pursue economic diversification are becoming more critical in the lower oil price environment.
The overall fiscal deficit is projected at 14.8 percent of GDP in 2015 and would remain in double digits over the medium-term in the absence of fiscal reforms. Without further fiscal adjustment, financing the projected cumulative fiscal deficit between 2015 and 2020 would exhaust fiscal buffers and raise debt to about 25 percent of GDP, or increase government debt to over 70 percent of GDP by 2020 if buffers were to be preserved.
The capital adequacy ratio of banks stood high at 15.1 percent, supported by low net nonperforming loans and high provisioning ratios of 0.6 percent and 136 percent, respectively, at end-September 2014. Stress tests suggest that under a combination of interest rate and market shocks, the solvency of the banking system would be preserved, although some banks would be required to raise capital to meet the central bank’s regulatory capital requirement. Banks’ liquidity situation augurs well for meeting emerging private sector credit demand, and for further financial deepening.
Executive Board Assessment
In concluding the 2015 Article IV Consultation with Oman, Executive Directors endorsed staff’s appraisal, as follows:
Economic growth remained strong in 2014 but is projected to moderate over the medium term. The decline in oil prices is expected to push Oman’s fiscal and external current account balances to deficits from 2014/15 and keep them in double digits as a percent of GDP over the medium term.
It would be prudent for Oman to begin the fiscal adjustment process early, given limited buffers and high breakeven oil prices. Because much of the oil price decline is expected to be sustained, any delay in starting medium-term fiscal reforms would further worsen the fiscal outlook and force deeper and less gradual adjustments later with a larger impact on growth. A reversal of the recent oil price decline would enable saving the windfall revenues for intergenerational equity.
Achieving fiscal sustainability will require measures to contain expenditure growth and increase non-oil revenues. On the expenditure side, curtailing the increase in government jobs in civil and defense services and keeping the growth in government employee compensation constant in real terms; gradually phasing out subsidies, complemented by a social safety net, other targeted mitigating measures, and a well-designed communication strategy; and rationalizing defense spending, would generate savings. Undertaking these reforms in a phased manner and preserving room for capital expenditures would limit the downward drag on growth.
There is large potential for raising non-oil revenues by expanding tax categories and reconsidering tax rates and exemptions for corporates, identifying new sources such as selected excises, VAT, and property taxes. Implementing a tax on outward remittances is not an efficient way of raising revenues because it has an insignificant revenue-generating potential while it could reduce the overall competitiveness of Oman’s private sector. Instead, introducing income tax for nationals and expatriates would be less distortive.
Efforts to establish fiscal sustainability should be underpinned by reforms to modernize the current budget system. There is a need for integrating the dual budget, establishing a medium-term budget framework that is integrated with the medium-term macroeconomic framework, and improving the public financial management system. Strengthening the macrofiscal unit will provide expertise in some of these areas.
The banking system is resilient but the Central Bank of Oman (CBO) should remain vigilant in monitoring and managing evolving risks. The central bank should consider measures to enhance capital cushions to equip banks to face potential further oil price declines, including strengthening banks’ risk management capacity. A sudden sharp withdrawal of government deposits would induce liquidity pressures in banks. Avoiding such a situation warrants close coordination between the CBO and the government, and would require the CBO to inject temporary liquidity into the system, if the need arises.
Efforts toward economic diversification should be strengthened, to reduce dependence on oil and to generate jobs for nationals. Oman needs to improve the business environment by removing impediments to physical, legal, and business infrastructure. Although the government is making serious efforts to develop the SMEs segment, greater coordination between the agencies involved would be beneficial. Developing domestic debt markets will strengthen the diversification process and reduce concentration risks of banks.