Foreign Trade and Balance of Payments. Chapter Six

Transcription

1 Foreign Trade and Balance of Payments Chapter Six

2 FOREIGN TRADE AND BALANCE OF PAYMENTS Balance of payments developments are of vital importance to every open economy as the performance of the overall economy hinges critically on the strength and resilience of its balance of payments. Higher the degree of openness, larger could be the contribution of export of goods and services to national GDP, and at the same time higher could be the potential for leakage of domestic income on import of goods and services. Transmission of the effects of global shocks could also be faster in such economies. Oman is an open economy, providing unhindered scope for cross-border transactions in both current and capital account of its balance of payments. Its high degree of trade openness is amply demonstrated from the fact that merchandise exports and imports together were as high as 89.2 per cent of GDP in Due to the high degree of trade openness, Oman benefited from favourable global developments during 2004, particularly strong global growth in output and trade, as well as high oil prices. The impact of strong growth in exports, both oil and non-oil, was however offset to a large extent by a surge in imports, which partly reflected the import needs of large ongoing investment projects, as well as significant increase in prices of certain import items. The current account and overall balance continued to be in surplus in 2004, imparting strength and comfort to the domestic economy. For the fourth consecutive year, however, the magnitude of the surplus in the current account declined. To the extent that this fall in current account surplus has been accounted for by increase in imports meant for large investment projects, the contribution of the balance of payments to the growth and diversification process could be viewed as much stronger in 2004 than in previous years. Moreover, such increases in imports have been financed by adequate inflows in the financial account, relieving thereby any major pressure on the foreign exchange reserves of the CBO. It is also important to note that most of the ongoing large investment projects are export-intensive, implying that the presently incurred external liabilities can be serviced in future without any pressure on the balance of payments. Stronger capital and financial account with significant inflows in 2004, as against net outflows in the previous years, is another notable development in Oman's balance of payments for These net inflows could become even stronger over time as the progress of work on the new investment projects gather momentum. Foreign Trade Merchandise trade continued to be the dominant component in Oman's balance of payments, with the degree of trade openness at 89.2 per cent indicating the extent to which Oman could be exposed to the benefits and challenges of integration with the global economy. With limited current degree of diversification within the economy, and given the unrestrained access to international products from all over the world due to the absence of any major trade restrictions, imports occupy a prominent position in meeting domestic demand, both for consumption and investment. A convertible currency with a fixed and credible exchange rate also makes the trade frontier of Oman extremely porous. Openness at the same time offers a larger global market, which can be used to diversify the economy while reaping scale economies. Central Bank of Oman Annual Report

3 Chapter Six The degree of concentration on oil, however, continues to be high, with oil exports accounting for about 69 per cent of total exports in 2004, and oil and natural gas exports together accounting for as high as Chart 6.1: Oman's Merchandise Trade 81 per cent (Table-6.1). Recent policy initiatives have 3000 been directed at promoting diversification and 2000 privatization, which aim at not only efficiently replacing imports by domestic products to meet domestic demand, but also at diversifying the export basket so as to effectively use openness as an instrument of higher economic growth. Exports (of goods) Exports Imports Merchandise Trade Balance The merchandise trade balance of Oman, which is the difference between merchandise exports and imports (both recorded and unrecorded), registered a surplus of RO million in 2004, which is about 18.3 per cent of GDP. Since 2000, however, the surpluses in the trade balance have generally been declining every year, and the decline looks even sharper as percentage of GDP (Table-6.1 and Chart- 6.1)). Exports registered a strong growth of 14.4 per cent in 2004 (as against 4.4 per cent in 2003), fetching export income of RO million. The export performance, however, varied widely across major categories, with non-oil exports growing by about 38.2 per cent on the one hand, and re-exports registering a negative growth of about 10.4 per cent on the other (Table-6.1). Moreover, dependence on oil and LNG exports increased somewhat in 2004 as evidenced by the fact that oil and gas taken together Table 6.1 Trade Transactions Millions of R.O % Change 2004/03 Imports (c.i.f.) Exports ( f.o.b.) Crude oil Refined oil LNG Non-oil Re-exports Trade Balance (Exports+Imports) % of GDP Trade balances as % of GDP Non-oil Exp. as % of GDP Note: Import figures in this table are on c.i.f. basis and, therefore, may not tally with import and trade balance figures in other tables where imports could be on f.o.b. basis. Source : Directorate General of Customs and Ministry of National Economy 92 Central Bank of Oman Annual Report 2004

4 Foreign Trade and Balance of Payments accounted for 81 per cent of total exports during 2004 as against 80 per cent in 2003 and 77.0 per cent in Rising oil prices primarily explain this growing (Table-6.1) Once the new Sohar refinery becomes fully operational, export of refined oil products will get a major boost. levels of concentration, which otherwise would not have happened in view of the fall in oil production and visible progress on new projects for diversification. Oil Exports Despite the 5.4 per cent fall in quantity of oil exports, crude oil export earnings rose by 17 per cent during 2004, which could be ascribed to 23.6 per cent increase in average prices of Omani crude during 2004 over Thus, the adverse impact of a decline Natural Gas Exports Close to 50 per cent of the natural gas produced in Oman is used by Oman LNG, which operates with a two-train liquefaction capacity of 6.6 million tonnes. Export realization in 2004 increased by 15.6 per cent to RO 620 million from RO 536 million in As the third train comes into operation with an additional capacity of 3.3 million tonnes, the export performance will improve drastically over time. in quantity of oil exports on export earnings was more than offset by the higher prices at which Omani crude Non-Oil Exports of Omani Origin was exported during Export of refinery products showed a negligible growth of 0.2 per cent in 2004 (as against a sharper growth of 60.3 per cent in 2003), reflecting the decline in oil refining production during the year (on account of temporary "turnaround" of the refinery plant for maintenance purpose) in the face of rising domestic demand. The diversification goal to be achieved through higher exports targeted at global market largely depends on the performance of non-oil exports of Omani Origin (i.e. exports excluding oil, gas, and re-exports). In 2004, 38.2 per cent increase in non-oil exports has been the most encouraging feature of Oman's balance of payments. As percentage of total exports, the share Table 6.2 Value of Non-oil Exports of Omani Origin * Millions of RO % 2004/03 0. Live Animals and animal products Vegetable products Animal or Vegetable Fats & oil Foodstuffs, beverages, tobacco & related products Mineral products Products of chemicals & allied industries Plastic, Rubber & Articles thereof Textiles & articles thereof Base metals & articles thereof Others Total * Excluding re-exports Source: Directorate General of Customs and Ministry of National Economy Central Bank of Oman Annual Report

5 Chapter Six of such exports also rose from 6.8 per cent in 2003 to 8.2 percent in 2004, indicating healthy progress towards diversification of the export basket in the face of strong oil prices. In the basket of items, live animals and animal products as well as base metals and articles thereof accounted for majority shares. Commodity wise, sharper growth was recorded in categories such as "base metals and articles thereof" (81.5 per cent), "plastic, rubber and articles thereof" (64.9 per cent), "live animals and animal products" (49.2 per cent), and "animal or vegetable fats and oil" (44.4 per cent). Export of "textiles and articles thereof" recorded a negative growth of about 8.1 per cent (Table-6.2). This decline in textile exports could be primarily due to the termination of the Multi Fibre Agreement (MFA) related Quotas under the WTO that affected all the textile exporting and importing countries. The phasing out of MFA could have affected domestic production of textiles in Oman as well. Re-exports Re-exports exhibited a strong negative growth of 10.4 per cent during 2004, over and above the 17.3 per cent decline witnessed in In terms of the magnitude of decline having strong effect on the overall size of re-exports, the two major items were "beverages and tobacco" (which fell by 70.4 per cent from RO 82.8 million in 2003 to RO 24.5 million in 2004), and "manufactured goods" (which fell by 71.5 per cent from RO 61.8 million in 2003 to RO 17.6 million in 2004.) Re-export of textiles and related articles came down from RO 49.7 million in 2003 to RO 28.9 million, largely on account of the phasing out of MFA related quotas that were so far guiding world pattern of trade in textiles. Re-export of transport and machinery equipments, however, increased by 18 per cent. Destination of Non-Oil Exports UAE and Saudi Arabia continued to be the prime destinations for non-oil exports of Oman, in terms of both share in total exports as well as rate of growth in exports to individual countries (Table-6.4). USA, which is in the process of entering into a Free Trade Table 6.3 Composition of Re-Exports Millions of R.O /03% 0 Food and Live Animals Beverages and Tobacco Crude Materials Inedible Except Fuels Minerals, Fuels, Lubricants and Related Materials Animal and Vegetable Oil and Fats Chemicals Manufactured Goods Machinery & transport equipment, of which Road vehicles and other transport equipments. 8 Miscellaneous Manufactured Articles Commodities and Transactions not Classified Elsewhere Total Source: Directorate General of Customs and Ministry of National Economy 94 Central Bank of Oman Annual Report 2004

6 Foreign Trade and Balance of Payments Agreement (FTA) with Oman, accounted for only 7.6 per cent of Oman's non-oil exports. Most notably, advanced countries whose currencies appreciated against the US dollar (such as the Euro-area, Japan and the UK) offering thereby major exchange rate induced competitive advantages to Omani exports, were not among the leading export destinations for Omani non-oil exports. Destination of Re-exports Like in case of exports of Omani origin, UAE and Saudi Arabia were among the leading destinations for re-exports, even though Iran also had a high share in total re-exports, with advanced countries like UK, Hong Kong, Singapore and Belgium also appearing among the countries importing re-exported items from Oman (Table-6.5). It is particularly important to note that despite the 10.4 per cent fall in total reexports, re-exports to UAE and Saudi Arabia rose by 8.2 per cent and 5.2 per cent, respectively, increasing thereby further the degree of market concentration in respect of re-exports. Imports Imports exhibited a major surge in Total recorded imports of Oman on c.i.f. basis rose by 31.1 per cent during 2004 (with recorded and unrecorded imports together rising by 29.3 per cent). On f.o.b. basis also imports registered an increase by 29.3 per cent, because of the constant adjustment factors used for segregating insurance and freight components from imports on c.i.f. basis to arrive at the f.o.b. basis import figure. This high growth in imports could be ascribed primarily to two factors: (a) significant increase in the prices of import items, and (b) increased investment related imports by large ongoing Table 6.4 Destination of Non-oil Exports Millions of R.O Country Non-oil % of Non-oil % of Exports Total Exports Total UAE Saudi Arabia U.S.A Jordan Yemen Kuwait Qatar Iraq Pakistan Syria India Somalia Bahrain Taiwan Iran Others Total Note: Please see Table No. 3.2 in Chapter-3 for data on destination of oil exports. Source: Directorate General of Customs and Ministry of National Economy Table 6.5 Destination of Re-Exports Millions of R.O Country Re- % of Re- % of Exports Total Exports Total UAE Iran Saudi Arabia UK Hong Kong Singapore Belguim Yemen China Iraq Libeya Germany India Sudan Kagakhstan Others Total Source: Directorate General of Customs and Ministry of National Economy Central Bank of Oman Annual Report

7 Chapter Six projects. According to the WTO, in 2004 even though the value of world trade expanded by 21 per cent, this machines and manufacturing inputs also contributed to the high growth in imports. was largely possible because of 11 per cent increase in the prices of traded goods. As further elaborated in the section on terms of trade of this Chapter, even though Oman's imports in value terms increased by 31.1 per cent, the quantity of imports rose by only 1.3 per cent, implying that about 29 per cent higher prices were paid for Omani imports in 2004 compared to While part of this could be on account of the The evidence of increased investment demand is visible from the commodity-wise distribution of imports (Table-6.6). Machinery and transport equipments that account for close to 47 per cent of total imports, exhibited a growth of as high as 43.9 per cent. Similarly, manufactured goods that account for close to 18 per cent of total imports, rose at an even higher rate of 50.4 per cent. Since part of this high depreciation of the US dollar against other import was necessary for launching several large international currencies (forcing non-dollar countries to jack up the prices of their exports to Oman in US dollar terms to counter the effect of appreciation of their currencies on their profit margins), the strong price effect for Oman also reflects the general strong growth in prices of certain products internationally such as metals. Over and above this price effect induced surge in imports, increased investment linked scale projects, this development has to be seen in the context of its contribution to future growth and the process of diversification. Moreover, most of these projects are export-intensive, implying thereby the fact that current imports can enhance the country's capacity to export in future. At the other extreme, import of beverages and tobacco products fell by 63.1 per cent from RO million to RO 43.5 million. import demand, particularly in the form of heavy Table 6.6 Composition of Recorded Imports (Millions of R.O.) Classifications /03% 0. Food and Live Animals Beverages and Tobacco Crude Materials, Inedible Except Fuels Minerals, Fuels, Lubricants, and Related Materials Animal/Vegetable oil/fats Chemicals and Related Products Manufactured Goods Machinery and Transport Equipments Miscellaneous Manufactured Articles Commodities and transactions not classified elsewhere Total Notes: 1. Import figures presented in this Table are on c.i.f. basis and do not agree with those presented in Table 6.11 as they are on f.o.b. basis. Source: Directorate General of Customs and Ministry of National Economy 96 Central Bank of Oman Annual Report 2004

8 Foreign Trade and Balance of Payments Table 6.7 Sources of Recorded Imports Country Imports (RO Million) % of Total Imports (RO Million) % of Total UAE Japan Italy UK Germany USA France India Netherlands South Korea Australia China Saudi Arabia Singapore Belgium Others Total Source: Directorate General of Customs and Ministry of National Economy This decline largely reflects the corresponding decline in re-export of beverages and tobacco products, which also fell by 70.4 per cent. UAE, the Euro-area and Japan continued to be the major sources of imports in 2004 as in The share of UAE, however, rose sharply from 21.6 per cent in 2003 to 32.4 per cent.(table-6.7 & Chart 6.2) The share of Euro-area at about 20 per cent, of Japan Chart 6.2: Sources of Recorded Imports in % 22.8% at about 14 per cent, and of the UK at about 5 per cent suggest that in the eventuality of depreciation of the US dollar against the Euro, Yen and Pound Sterling, dollar prices of close to 40 per cent of Oman's imports could increase under the pressure of depreciation of the US dollar. Thus, the commodity composition of recorded imports is particularly relevant for Oman because large volatility in international key currencies like the Euro and Yen in the face of a fixed peg to the US dollar could affect the terms-of-trade expressed in Rial Omani as well as the domestic inflation environment. 2.5% 4.9% 3.7% 4.0% 4.9% 5.0% 5.9% 14.0% UAE Japan Italy UK Germany USA France India Netherlands Others Trade with AGCC Regional trade integration with the creation of bilateral/multilateral trading blocks is on the rise all over the world. Higher intra-block trade is often Central Bank of Oman Annual Report

9 Chapter Six viewed as a precondition to further the process of economic integration among the block partners. In respect of Oman, AGCC member countries continued to be major trading partners of Oman, accounting for about 50.2 per cent of total non-oil exports (45 per cent in 2003), and about 35 per cent of imports (28 per cent in 2003). The rising share in respect of both exports and imports suggest that the process of closer trade integration with AGCC members is moving ahead. Not withstanding the healthy progress on trade with the AGCC members as a group, two notable aspects of this development could be that: (a) export and import markets of Oman may be less diversified at the global level, and (b) within the AGCC group also there is a tendency for greater concentration in favour of UAE. During 2004, the share of UAE in total imports of Oman from AGGC group and total non-oil exports of Oman to AGCC group turned out to be 92.6 per cent and 74.2 per cent, respectively (as against 77.6 per cent and 72.4 per cent in 2003) (Table 6.8). Such concentration, however, reflects the consistently growing economic relationship between these two countries. prices on the one hand, and the dominance of price effect over the volume effect in driving the fast growth in value of world trade on the other. In 2004, value of recorded imports rose by 31.1 per cent whereas quantity of imports rose by only 1.3 per cent, implying that Oman had to bear with a huge negative terms-of-trade shock in the sense that its imports turned out to be 29 per cent costlier (assuming homogenous import baskets over time). Due to high oil prices, however, Oman also experienced a major positive terms of trade shock. While oil prices of Omani crude rose by 23.6 per cent, import prices also rose simultaneously by more than 29 per cent (Table- 6.9). The positive effect of oil prices was thus offset to a large extent by the negative term-of-trade shock, which can also be approximately gleaned from the fact that while Oman's oil exports rose by RO 506 million, recorded imports rose higher by RO 786 million. In 2003, however, the terms-of-trade had remained favourable for Oman both in respect of oil export and imports, as oil prices rose by 14.6 per cent, and value of imports rose by 9.4 per cent against 15 per cent increase in quantity of imports implying thereby that import prices fell. Terms-of-trade The global economy came under major terms-of-trade shock during 2004, on account of high oil and metal Table 6.8 Trade with GCC Countries in 2004 (RO Million) GCC Countries Non-oil Exports* Recorded Imports Value % of Total Value % of Total UAE Saudi Arabia Bahrain Kuwait Qatar Total * Include re-exports Nominal Effective Exchange Rate The Nominal Effective Exchange Rate (NEER) of the Rial Omani depreciated by 3.7 per cent during 2004, over and above the 6.6 per cent depreciation witnessed in This large order of cumulative depreciation over two consecutive years had notable impact on imported inflation as well as non-oil exports. Due to the fixed peg of the RO with the US dollar, movements in US dollar exchange rate vis-àvis currencies of major trading partners of Oman directly condition the course of NEER for the RO. The exchange rate of Rial Omani has been pegged to 98 Central Bank of Oman Annual Report 2004

10 Foreign Trade and Balance of Payments Table 6.9 Value and Quantity of Exports / Imports Non-oil Exports, including re-exports Value (Million RO) Weight (000) Ton Recorded Imports Value (Million RO) Weight (000) Ton Million Barrels Oil Exports Average Price (US $ pb) Source: Directorate General of Customs, Ministry of National Economy and Ministry of Oil and Gas the US dollar since In 1986, as a result of the devaluation the parity was changed from US $ per RO to US $ per RO, and since then the parity has remained unchanged. With the Euro-area, Japan and UK accounting for about 20, 14 and 5 per cent of Oman's imports in 2004, the large appreciation of these currencies against the US dollar in 2003 and 2004 translated directly into appreciation against the RO, which yielded significant depreciation of the NEER for RO (Table 6.10). The depreciation of the NEER could have been much higher but for the fact that Oman's imports from UAE were about 32 per cent (whose exchange rate is also pegged to the US dollar) and imports from the US were about 5 per cent. Analytically, import-weighted index is more relevant for Oman in order to assess the price pass-through effect of exchange rate changes operating through Table 6.10 Nominal Effective Exchange Rate (NEER) (1999 = 100) Period Import Weighted Non-weighted End of Period Month-end 2004 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Note: A rise in the index indicates an appreciation of the RO. Source: Central Bank of Oman Central Bank of Oman Annual Report

11 Chapter Six Chart 6.3: NEER and WPI Chart 6.4: NEER and Non-Oil Exports NEER (1999=100) Muscat WPI (1995=100) NEER (1999=100) Non-oil Exports ( RO million ) RO Million imports. Countries whose currencies appreciate vis-àvis the US dollar, their exports in US dollar terms become costlier, which for the importing countries like Oman means higher prices in US dollar for similar imports. In the case of Oman, the impact of NEER depreciation on prices was clearly visible, even though it was much stronger in the case of WPI rather than CPI in view of the fact that WPI better captures the impact of higher import prices due to its wider coverage. (Chart-6.3) Till 2001 when the NEER was appreciating, inflation as measured by annual change in Muscat WPI remained negative (i.e. the index was falling). When the NEER started depreciating from 2002, the lagged effect on inflation became evident in 2003 and 2004 when the WPI rose by 1.3 per cent and 3.1 per cent, respectively (i.e. the WPI index started rising). Even in terms of Muscat CPI, annual inflation rose by 0.4 per cent in 2004, as against negative inflation experienced in the previous four years. The depreciation of the NEER also strengthened the external competitiveness of Oman, even though due to small share of non-oil exports in total exports, the magnitude of the beneficial effect arising from exchange rate induced competitiveness was not very large. As could be seen from Chart-6.4, the appreciation of the NEER up to 2001 led to a marginal fall in non-oil exports in 2002, reflecting the lagged effect of exchange rate appreciation on exports. The depreciation of the NEER in 2002, 2003 and 2004 clearly coincided with an up trend in non-oil exports, which registered a high growth of 38.2 per cent in Even though this strong performance in non-oil exports could have resulted from many factors such as strong global growth in output and trade as well as progress in Oman on diversification, NEER depreciation certainly operated as an additional conducive factor for providing a boost to non-oil exports. Balance of Payments Presentation and Coverage Taking into consideration the growing import and external financing needs of a number of new large ongoing investment projects in Oman, it was felt appropriate to better reflect their external transactions in the balance of payments through a sample survey. Using the information reported through this sample survey, balance of payments data have been revised since 2000, with the extent of revision appearing considerable in respect of foreign direct investment, other financial investment, and investment income. Moreover, with a view to meeting the international norm, Oman's balance of payments data are presented 100 Central Bank of Oman Annual Report 2004

12 Foreign Trade and Balance of Payments as per the format recommended in the fifth edition of the IMF's Balance of Payments Manual for the period 1996 through In terms of coverage, major improvements have been introduced in the recent years in compiling statistics on trade in services, particularly travel, transportation, insurance and communication services through specifically designed surveys. In 2003, there was also a change in the methodology to compile statistics on travel data keeping in view the findings of a new tourism survey. As a result, data on travel payments had been revised even for past years, and the same methodology was used for Current Account Sustained decline in the magnitude of surplus in the current account has been the most striking aspect of Oman's balance of payments, with the decline appearing particularly sharp as percentage of GDP (Chart 6.5) Preliminary estimates of balance of payments data for 2004 indicate that the current account recorded a surplus of RO 170 million, as against RO 339 million in Major components of the current account (i.e. merchandise trade, services, income and transfers) suggest that while the trade account remained in surplus, the other three accounts continued to be in deficit. Moreover, while the surplus in the trade account declined modestly, deficits in the services and transfers accounts rose, giving rise to a lower surplus in the current account. Surplus in the merchandise trade account of about RO 2104 million in 2004 was lower by just about 2.0 per cent over the surplus position of RO 2147 million recorded during Net outflows under worker's remittances at RO 702 million were moderately higher than that of RO 643 million recorded during Invisibles account (comprising services, income and transfers accounts) RO Million Chart 6.5: Current Account Current Account Surplus ( RO million ) Current Account Surplus as % of GDP exhibited a higher deficit of RO 1934 million as against RO 1808 million in Any deterioration in the current account position resulting on account of investment driven imports could be viewed as growth supportive, and hence need not be viewed as a sign of building pressure on balance of payments. Moreover, these current imports when used for investment in export-intensive projects, could augment future exports, imparting thereby sustainability to balance of payments in the medium-run. The fall in current account surplus on account of a surge in imports could also be partly explained as the result of high nominal GDP growth at 14.4 per cent, which directly would have led to higher demand for imports, both for consumption and investment purpose. The fall in current account surplus on account of higher deficit in the services account indicates the impact of growing service orientation of the economy. As per capita income grows over time, the share of income spent on services is expected to rise. In Oman, the share of services in GDP was close to 45 per cent in 2004, and the services sector value addition recorded a growth of 9.8 per cent in In an open economy, it is expected that the services account in the balance of payments will correspondingly assume growing importance over time reflecting the increasing service Percent Central Bank of Oman Annual Report

13 Chapter Six orientation of the economy. In the services account, travel receipts increased by 34.5 per cent, reflecting the growing importance of Oman as a tourist destination for foreign travelers. Travel payments (for purposes such as education, health, Haj and Omrah, pleasure travel, etc.) rose by only 6.7 per cent. While transportation receipts rose to RO 111 million in 2004 from RO 92 million in 2003, transportation payments rose sharper from RO 315 million to RO 390 million reflecting the impact of Chart 6.6: Oman's Balance of Payments Current Account Balance Capital and Financial A/c Balance Overall balance surge in imports. Insurance payments, which include outward premiums as well as outward claims, rose from RO 85 million in 2003 to RO 99 million in In the income account, payments under direct investment income continued to be high, though declined to RO 548 million in 2004 from RO 632 in 2003 due to lower repatriation of profits and dividends. Payments under other investment income category (i.e. interest payments on foreign debt capital) increased on account of higher interest payments by the government on their foreign debt liabilities. While the Government restructured a major part of its external debt, banks reduced their foreign liabilities. Despite the very low international interest rates, receipts under the head "other investment income" (comprising primarily of income earned on foreign assets of the CBO, Government, commercial banks, etc.) rose from 80 million in 2003 to RO 85 million in 2004 because of the increase in foreign assets of both commercial banks and the Government. In the transfers account, outgo under worker remittances increased from RO 643 million in 2003 to RO 702 million in Capital and Financial Account Significant surplus in the capital and financial account, as opposed to deficits seen in the previous years, is another notable development in Oman's balance of payments for 2004 (Table-6.11 & Chart- 6.6). This became possible primarily because of major inflow of debt capital to finance the investment and import needs of large ongoing projects, as well as a major jump in inward portfolio investment. Another aditional factor contributing to this surplus was the net inflows of debt capital on the Government account, as opposed to net repayment of Government loans in the previous years. In the capital and financial account, there was a net surplus of RO 387 million, as against a deficit of RO 104 million in Such a surplus position indicates that Oman's external liabilities increased more than its foreign assets. In the financial account, there was a net outflow under foreign direct investment of RO 7 million in 2004 as against a net inflow of RO 203 million in This was primarily because several non-financial firms reduced their retained earnings significantly to remit profits abroad. But for these fall in the stock of retained earnings, there would have been net inflows under FDI. FDI data in Oman's balance of payments for the past years may not exhibit any clear trend because of the retained earnings component in FDI; while in some years current year profits are used to beef up retained earnings, in other years retained earnings are drawn down to repatriate profits. 102 Central Bank of Oman Annual Report 2004

14 Foreign Trade and Balance of Payments Under portfolio investment, there was almost a fivefold increase in net inflows from RO 21 million in 2003 to RO 106 million in This became possible due to higher investment by non-residents in securities listed in MSM (in terms of increment in the share of non-residents in total market capitalization), and increase in the share of non-residents in the fresh issues (net of redemptions) of government development bonds made during the year Other investments yielded a net inflow of RO 280 million in 2004 as against outflows in the previous years. This broad head of "other investment" includes important transactions such as net loans raised by the Government and other non-financial corporates, change in the foreign assets and liabilities positions of commercial banks, trade credits, etc. Net inflows under other investment was primarily driven by: (a) large foreign loans taken by some of the ongoing investment projects in Oman, and (b) increase in net foreign loans of the Government as opposed to net repayments of previous years (Table-6.11). The only major outflow, in turn, was on account of significant change in the asset liability profile of the commercial banks, partly in response to the emerging short-term interest rate differentials resulting from the rising US interest rates. Foreign assets of commercial banks rose by RO 228 million in The overall balance position (adjusted for errors and omissions) showed a surplus of RO 198 million in 2004 as against RO 257 million in In 2004, errors and omissions appear to be somewhat on the higher side in view of the fact that while net-inflows in the financial account have beeen better captured through the survey of non-financial firms, the survey could not cover adequately corresponding outflows from the non-financial sector. This anomaly will be addressed over time as the coverage and scope of the survey gets expanded gradually. The overall balance represents the combined effect of the net flows emerging out of current, capital and financial accounts taken together, and it is the most crucial variable from the standpoint of monetary management for a country like Oman that operates with a fixed exchange rate. The money supply process is directly conditioned by the magnitude of the surplus or deficit in the overall balance. The overall balance surplus or deficit, however, does not affect the reserve money aggregates on a one-to-one basis in Oman because the impact of the overall balance position is shared between the foreign exchange reserves of the CBO and the SGRF assets of the Government. To the extent that the movements in SGRF balances absorb part of the impact of overall balance developments, the money supply process gets partially insulated. In essence, SGRF helps in sterilising partially the expansionary monetary impact of a surplus in the overall balance. Whatever part of the overall balance surplus is not absorbed by the SGRF, it leads to corresponding increase in the foreign exchange reserves of the CBO, which in turn leads to equivalent primary creation of monetary liabilities by the CBO. In 2004, since the surplus in the overall balance was almost entirely absorbed through increase in SGRF balances, there was no expansionary monetary implications of the overall balance surplus for Oman. Reserve assets The overall balance surplus of RO 198 million in 2004 led to corresponding increase in the foreign assets of the CBO and the Government together (excluding valuation changes). With the net increase in SGRF at RO 221 million being higher than the total overall surplus, CBO's foreign exchange reserves fell Central Bank of Oman Annual Report

15 Chapter Six by RO 23 million (net of valuation gains). Including valuation gains, however, CBO's foreign exchange reserves rose modestly by RO 1.5 million from RO million at the end of 2003 to RO million at the end of Since reserve assets are held in both US dollar and non-us dollar currencies, if the US dollar depreciates vis-à-vis other currencies, then valuation gains could be booked (and vice versa). Since during 2004 the US dollar depreciated against other major international key currencies, valuation gains were booked for both SGRF assets and CBO's foreign reserve assets. Even though balances under SGRF do not strictly conform with the definition of foreign exchange reserves presented in the fifth edition of the Balance of Payments Manual of the IMF, as a matter of convention SGRF assets are being presented as a below the line entry in Oman's balance of payments, which is also viewed as analytically consistent. The fall in CBO's foreign exchange reserves (net of valuation gains) in the face of rising SGRF assets has to be seen in the context of the fact that while the benefits of higher oil export revenue in foreign exchange accrue to the Government, the pressure of a surge in imports and the associated increase in demand for foreign exchange primarily falls on the foreign exchange reserves of the CBO. But for the surplus position in the financial account in 2004, the import induced pressure on CBO's foreign exchange reserves could have been substantial. Despite the surge in imports in 2004, the CBO's foreign exchange reserves at the end of 2004 remained comfortable in terms of providing cover for about 5 months of merchandise imports. 104 Central Bank of Oman Annual Report 2004

16 Foreign Trade and Balance of Payments Table 6.11 Balance of Payments (RO Million) Items A. Current Account ( ) Goods Exports (F.O.B) Oil Natural gas Other exports Re-export Imports (F.O.B) Services Services (Credit) Travel Transportation Insurance Communication Other Services Services (Debit) Travel Transportation Insurance Communication Others services Balance on goods & services (1+2) Income Income (Credit) Compensation of employees Other Investment Income Income (Debit) Direct Investment Income Other Investment Income Balance on goods, services & income(1+2+3) Current Transfers Current Transfers (Credit) Current Transfers (Debit) Worker Remittances Contd... Central Bank of Oman Annual Report

17 Chapter Six Table 6.11 (contd.) Balance of Payments (RO Million) Items B. Capital and Financial Account (5+6) Capital Account Grants (Credit) Grants (Debit) Financial Account (i+ii+iii) (i) Direct Investment In Oman (ii) Portfolio Investment Liabilities (iii) Other Investments (a) Assets Trade Credit Currency & Deposit (banks) Other Assets (b) Liabilities Loans General Government (net) Other Sectors Currency & Deposit (banks) C. Net Errors & Omissions D. Overall Balance (A+B+C) E. Reserve assets Foreign exchange Central Bank Government Reserves Note: Based on improved reporting of information by non-financial firms through a survey, data in respect of foreign direct investment, other investment, and investment income flows have been revised for past years. Source: Central Bank of Oman 106 Central Bank of Oman Annual Report 2004