Central Bank of Oman. Mid-Year Review of the Omani Economy. INTERNAL i

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2 Central Bank of Oman Mid-Year Review of the Omani Economy 2014 January 2015 i

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4 Contents Foreword... 1 Overview and Macroeconomic Outlook... 3 I. Global Economic Situation II. Domestic Output Growth III. Price Situation IV. Fiscal Position V. Monetary and Banking Conditions VI. Financial Markets VII. Foreign Trade and Balance of Payments Appendix Tables iii

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6 Foreword The macroeconomic situation in the Sultanate has remained favorable in recent years. The major drivers of growth in Oman in the recent years have been increase in the price of crude oil in the international markets and sustained domestic demand, mainly supported by large public expenditure and accommodative monetary policy pursued by the Central Bank of Oman. While growth momentum has been sustained, inflation was also fairly contained in the Sultanate. Monetary policy continue to be formulated against the backdrop of easy liquidity conditions, lower inflation, low Rial Omani interest rates on deposits and surpluses in fiscal and balance of payment positions. The higher oil prices and increase in production resulted in comfortable fiscal and external balance of payments situation. However, the current phase of lower international oil prices presents enormous challenges to the Omani economy. Against this backdrop, the Mid-Year Review of the Omani Economy for 2014 covers developments related to global economy, output growth, price situation, fiscal position, monetary and banking conditions, financial markets, foreign trade and balance of payments and macroeconomic outlook during the year so far. Feedback on the Mid-Year Review of the Omani Economy 2014 may be sent to On the basis of the feedback likely to be received from the users, the coverage of the publication would be widened. We hope that the endeavor of the Research Department in bringing out this review regularly by December every year is likely to benefit the general public as well as other stakeholders. Hamood Sangour Al-Zadjali Executive President, Central Bank of Oman 1

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8 Mid-Year Review of the Omani Economy 2014 Overview and Macroeconomic Outlook Overview Global economic growth scenario has changed with signs of robust recovery in some advanced economies (AEs) and moderating economic growth in the emerging markets economies (EMEs). The International Monetary Fund (IMF) in its January 2015 World Economic Outlook (WEO) update, projects global growth to remain at 3.3 per cent in 2014, the same growth recorded in The advanced economies (AEs) are projected to grow at 1.8 per cent in 2014 as compared with 1.3 per cent in GDP growth for Emerging Market and Developing Economies (EMDEs) are projected at 4.4 per cent in 2014, marginally lower than 4.7 per cent in The growth rate of countries in the Gulf Cooperation Council (GCC) is expected to grow by 4.4 percent in 2014 as compared to 4.1 percent in International oil prices have fallen substantially in the recent months on abundant supply, slowing demand growth, a strong US dollar and disagreement among OPEC members to cut down supply. The macroeconomic situation in the Sultanate has remained favorable in recent years. After a negative growth in 2009 as a fall out of the global financial crisis, the average growth rate of Gross Domestic Product (GDP) at current price during the three years from 2010 to 2012 was around 16.5 per cent. In the subsequent year 2013, the GDP at current price grew at a modest pace of 2.4 percent primarily due to weaker crude oil prices in the global market. The Sultanate s nominal GDP grew by 5.2 percent in the first three quarters (January-September) of 2014 over the same period in The petroleum sector Nominal GDP increased marginally by 1.4 percent as Omani crude oil price increased by 0.9 percent. In contrast, Non- 3

9 petroleum sector Nominal GDP grew by 8.2 percent. The Sultanate s crude oil production during the first three quarters of 2014 (January-September) increased by 0.9 percent to million barrels from million barrels during the same period in The daily average production of crude oil increased to thousand barrels during January-September 2014 from thousand barrels during January-September The international crude oil prices averaged US$ per barrel during the January-September 2014 as compared to US$ per barrel during January-September While growth momentum has been sustained, inflation was also fairly contained in the Sultanate with the average inflation based on CPI for the Sultanate being lower at 3.4 percent during the three year period 2010 to The year 2013 continued to witness low inflation with the average inflation registering an increase of only 1.1 percent. The average inflation based on CPI for the Sultanate stood lower at 1.0 percent during the January-September 2014 as compared to 1.1 percent in The Omani crude oil fetched average price of US$ 98.7 per barrel during the last four years from 2010 to During the same period, oil production in the Sultanate increased by an average of 3.8 percent, while oil exports increased by an average rate of 5.9 percent. The higher oil prices and increase in production resulted in comfortable fiscal situation which helped the Government and the Central Bank of Oman (CBO) to build foreign assets as well as large domestic deposits. The fiscal surplus during January-September 2014 stood at RO million compared to a fiscal surplus of RO million during January-September The external sector continued to remain in surplus in Oman with a current account surplus of RO 3.0 billion (10.2 percent of GDP) during 2012 and RO 2.0 billion during 2013 (6.5 percent of GDP). The balance of payments situation remains comfortable with current account surplus during first two quarters of Monetary policy in the recent period was formulated against the backdrop of easy liquidity conditions, lower inflation, low Rial Omani interest rates on deposits and 4

10 surpluses in fiscal and balance of payment positions. The evolution of monetary aggregates in Oman has been consistent with the accommodative policy stance of CBO aimed at ensuring adequate liquidity in the system, maintaining orderly conditions in the markets and supporting faster growth. Reflecting sustained growth of the Omani economy, broad money supply M2 registered an annual increase of 8.5 percent, while total credit expanded by 6.0 percent during Year on Year, broad money supply M2 registered an annual increase of 15.1 percent in September 2014 as compared to a rise of 4.6 percent during the same period last year. Year-on- Year, total credit expanded by 8.8 in September 2014 as compared to 8.7 percent during the same period of last year. Reflecting comfortable liquidity condition, domestic interest rates softened considerably. Oman s banking sector comprises 7 Local Commercial banks, 9 foreign banks, 2 specialized banks and 2 full-fledged Islamic banks together with 6 local commercial banks operating separate Islamic windows for banking operations. As at end 2013, Commercial banks had 493 branches and 1100 ATMs. The financial health of banks in terms of assets quality, provision coverage, capital adequacy and profitability remained strong. The balance sheet of commercial banks further strengthened in 2014 due to the robust growth in both deposits and credit. Total assets of commercial banks increased by 9.5 percent to RO 24.6 billion in September A notable development and an important milestone in the banking sector in the recent period was the introduction of Islamic Banking in Oman, which would diversify banking services and promote financial inclusion. Outlook In its January 2015 update of World Economic Outlook (WEO), the IMF expects the growth to strengthen in 2015 to 3.5 percent. It expects that global growth will receive a boost from lower oil prices, but this will also be offset by negative factors including investment weakness. In AEs, raising growth will require continued 5

11 support from monetary policy and fiscal adjustment attuned in pace and composition to supporting both the recovery and long-term growth. In a number of economies, an increase in public infrastructure investment can support demand in the short-term and help boost potential output in the medium-term. The strongest rebound in growth is expected in the US, whereas the crisis legacy brakes would ease only slowly in the euro area, and growth in Japan would remain modest. Among other countries, including in other Asian AEs, Canada, and the UK growth is projected to be stronger. Growth in EMEs is projected to increase modestly in the second half of 2014 and into 2015, supported by stronger domestic demand as also due to new measures to support activity (notably in China) as well as a recovery in external demand associated with faster growth in AEs. As in the past years, EMEs would continue to account for the major share of global growth even at market exchange rates. In EMEs, the scope for macroeconomic policies to support growth, if needed, varies across countries and regions, but space is limited in countries with external vulnerabilities. In the near future, co-ordination of policy and communication challenges stemming from normalization of monetary policy will become more complex than during the past tightening cycles, given an unconventional starting point with policy rates near zero and large central bank balance sheets. Effects on spillover-recipient countries would depend on the extent of their domestic vulnerabilities as well as on the smoothness of the external normalization process. This sensitization of systemically important countries might also enhance the necessary global cooperation in the conduct of their macroeconomic policies (World Economic Outlook, IMF, 2014). As the international oil prices continue to fall, it is expected that there will be sustained drop in oil revenues in GCC countries and the fiscal buffers available in these countries will be eroded. The GCC countries will have to undertake several policy adjustments to cope with lower oil prices. It is also expected the current account balance will turn negative for some of these countries. The IMF expects 6

12 inflation to remain moderate in most GCC countries because of decreasing international commodity prices. Among all the GCC countries, Oman is likely to be affected more at these levels of lower oil prices and will have to face several challenges. The economy of Oman relies on oil as the main source of export and fiscal revenues. Oil and gas revenues as a percentage of GDP stood around 40 percent in 2013 and accounted for around 86 percent of government revenues and about 66 percent of total merchandise exports. The high reliance on oil revenues means that the economy is exposed to developments in the global oil market. According to the IMF, Oman s fiscal breakeven oil price is among the highest in the region. Hydrocarbon prices are volatile and a key source of macroeconomic instability. The diversification of the economy would reduce exposure of the economies to volatility and uncertainties in the global oil market. The Sultanate s fiscal trend in recent years has been characterized by rising public expenditure and more so in the areas of current expenditure and expenditure on participation and other expenses, a significant share of which consists of subsidies to electricity and petroleum products. Favorable crude oil prices have allowed for fiscal surpluses in recent years, which cannot be sustained in the medium or long term given the present trend in oil prices. The fact that the Sultanate s fiscal position is still robust, potential risks in the future associated with the lower oil prices provides an opportunity to start introducing meaningful fiscal reforms. Oman has the resilience and inner strength to withstand lower oil prices and sustain its growth process. For example, during the recent global crisis, the average price of Omani crude oil declined to US $ 56.7 per barrel in 2009 from US $101.1 per barrel in 2008, an equivalent decline of 44 percent. As a result, total government revenues declined by about 12 percent with oil revenues declining by a similar rate while fiscal balance registered a deficit of RO million. It is worth noting that Sultanate did not face any major downside risk during that phase of lower oil prices. 7

13 Thus, the Government should take this as an opportunity to reform some of the structural impediments of the economy at this juncture. It is expected that meaningful fiscal reforms based on efficient and effective resources allocation would benefit the economy even further. On the revenues side the government could improve its tax collection and customs revenues through effective infrastructure, trainings and possibly introduction of new taxes. On the expenditure side, controlling expenditure on subsidies is important. Moreover, the objective should be to rein current expenditure, which is mainly in the form of current consumption. It has to be noted that increases in current expenditure are harder to reverse, which could lead to fiscal vulnerability when oil prices fall. Again, the spending pattern of the Government as the year progresses tends to be highly correlated with the oil prices. The rationalization and prioritization of government expenditure through mandated expenditure limit under the approved budget could be appropriate. Moreover, on the financing part, Government could finance potential fiscal deficits by expanding its long term borrowing in the domestic market through government bonds/sukuk. Borrowing domestically would also help financial deepening, developing a yield curve and making lending and borrowing more efficient. The Government could also re-introduce short-term borrowing through treasury bills of different maturities. Borrowing from the domestic market would minimize or eliminate the need to draw from reserve funds as a mean to finance current account deficit. Taking advantage of country s good international credit rating, Government could also consider international borrowing more to finance its deficits rather than drawing from reserves. With lower oil prices, the balance of payments situation of the Sultanate would be affected. Promoting and diversifying non-oil exports vigorously is one option to increase exports. Developing large scale tourism and attracting more tourists could be an option to reduce imbalances in services accounts of balance of payments. Moreover, Oman has also been focusing to attract foreign investment in industries 8

14 which could use local raw materials, employ Omanis and promote traditional industries. Thus, improving foreign investment scenario could help Oman improving its external position in the wake of lower oil prices. The Central Bank of Oman plays an important role in maintaining financial stability, pursuing appropriate monetary policies, developing financial markets and providing an environment aimed at ensuring exchange rate stability. The CBO will continue to enhance the role of the banking sector in the economic development by encouraging credit growth to productive sectors including small and medium enterprises (SMEs) and promote saving behavior among the population. The regulatory outlook will aim at increasing the role of the private sector in the national economy by stimulating domestic and foreign investment for the growth of the economy and Oman s financial sector will play a leading role in achieving this objective. Islamic banking is expected to assume an important position in the financial sector of the Sultanate. It is expected that Islamic banks will complement the current conventional banking in promoting growth in the economy and will diversify banking services and augment financial inclusion. There is no doubt that financing Small and medium enterprises (SMEs) is a challenge, but given the concerted efforts of the Government and the CBO, it is expected that banks will be able to turn the lending option to SMEs commercially attractive so that that there is more incentive on the part of the banks to lend to this sector. There are also efforts in terms of capacity building of prospective entrepreneurs, identifying key areas for SME finance, facilitating public-private cooperation and improving upon forward and backward linkages of these entities. Given high real economic growth averaging over 5 percent since 2007 and a supportive demographic profile of the population in Oman, it is expected that the demand for banking products will continue to increase. It is interesting to note that Oman has one of the youngest population with around three-fourth of total population being in economically active group (15-64) and more than two-third of 9

15 population below 30 years, which augurs well for the future growth prospects. Thus, it is expected that there will be harmonious growth of both conventional and Islamic banking. The market size as a whole has immense prospects for all given the pace of economic growth of the country and various initiatives of the Government and private sector for new business investments, diversification of the economy, financing large projects, development of small and medium enterprises (SMEs) etc. The development of financial markets in the Sultanate is a critical element in development of financial sector. More so in the environment of lower oil prices when the Government needs to finance its fiscal deficit through borrowings from domestic and international markets, apart from drawing down on its reserves. Thus, the financial markets should become more efficient, stable and healthy to enable the Government and the banks to be more proactive in raising resources from the market. In the State General Budget 2015, the Government proposes to finance the budget deficit by issuing long-term Islamic bonds and instruments so as to activate the domestic capital market. The financial markets should be able to channelize financing in an efficient manner at lower cost. In order to be able to carry on this important task, the markets should be deeper, liquid and vibrant. There is also a need to enhance linkages among the money, government securities and foreign exchange markets. In the current situation, addressing the challenges emanating from lower oil prices should be the matter of priority and as such needs to be tackled from expenditure as well as revenues sides with relevant policies in order to create fiscal space for the government and promote fiscal sustainability in the future. The overall objective during the period of low oil prices could be to undertake systematic and coordinated policy responses. There should be proper coordination and consensus among the concerned authorities in formulating the reform measures as the situation warrants. The objective should be to avoid any slowdown in the growth process and continue with the diversification process. Moreover, if proper mix of financing options is 10

16 used, there will not be much problem in financing higher fiscal deficits envisaged under the scenario of lower oil prices. The Government is already prioritizing reforms aimed at diversification, broadening and rationalization of revenues. There is an attempt by the Government in the State General Budget 2015 to rationalize and control Government spending to sustainable limits and at the same time enhance the sources of non-oil revenues. The Budget also focuses on reducing the dependence on oil through enhancing the contribution of promising sectors like tourism, agriculture and fisheries. The State General Budget 2015 endeavors to continue the investment spending, implement the development projects as per their schedule and raise the efficiency and productivity of oil and gas sector. The State General Budget 2015 envisages that with continued of investment spending, the Omani economy will be able to grow in real terms by 5.0 percent during 2015, supported by non-oil sector, which is expected to grow by 5.5 percent. 11

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18 Mid-Year Review of the Omani Economy 2014 I. Global Economic Situation Global growth recovery though uneven, continues despite few setbacks in the form of growth halt in the euro area, lackluster domestic demand in the emerging market economies (EMEs) and other geopolitical tensions. In the advanced economies (AEs), the legacies of the pre-crisis boom and the subsequent crisis, including high private and public debt, still cast a shadow on the recovery. The EMEs are adjusting to rates of economic growth lower than those reached in the pre-crisis boom and the post-crisis recovery. Overall, the pace of recovery is becoming more country specific. The International Monetary Fund (IMF) in its January 2015 update of World Economic Outlook (WEO), projects global growth to remain at 3.3 per cent in 2014, the same growth recorded in The forecast for global growth for 2015 is at 3.5 per cent, lower than projected in October The AEs are projected to grow at 1.8 per cent in 2014 as compared with 1.3 per cent in GDP growth for Emerging Market and Developing Economies (EMDEs) are projected at 4.4 per cent in 2014, marginally lower than 4.7 per cent in The growth rate of countries in the Gulf Cooperation Council (GCC) is expected to recover to 4.5 percent in 2015 as compared to 4.4 percent in 2014 and 4.1 percent in Inflation in the GCC countries continued to remain low at around 2.8 percent in 2014 and is expected to rise marginally to 3.1 percent in 2015 (Table 1). The recovery in the United States is broadening on the back of stronger domestic consumption, rising investment and industrial activity. Real GDP increased at a healthy annual rate of 5.0 percent in the third quarter of 2014 as compared to 4.6 percent in the second quarter. Notwithstanding the cessation of asset purchases by the US Fed, financial markets have remained generally buoyant on abundant liquidity stemming from accommodative monetary policies in the advanced economies (AEs). The search for yield has driven global equity markets to new highs, with investors shunning gold and commodities. Capital flows to EMEs 13

19 recovered from market turbulence in the first half of October 2014, although some discrimination on the basis of fundamentals is becoming discernible. Table 1: Global Economic: Key Indicators (Percent) * 2015* 1. World Output (Growth Rate) Advanced Economies United States Euro Area Japan United Kingdom Emerging and Developing Economies Emerging and Developing Asia China India Latin America and the Caribbean Middle East and North Africa GCC Countries World Trade Volume (goods and services) Consumer Prices Advanced Economies Emerging and Developing Economies GCC Countries * Projection Source: World Economic Outlook, October 2014 and January 2015 Update, IMF and Regional Economic Outlook, Middle East and Central Asia, October, 2014 In the Euro area, headwinds from recessionary forces continue to weaken industrial production and investment sentiment. The European Central Bank stress test results published on October 26, 2014 revealed that only 13 banks out of 130 major banks in the Eurozone showed shortfalls in their ability to withstand a sharp recession or other crisis. In Japan, growth may be picking up again on the back of stronger exports, helped in part by further quantitative and qualitative easing that has led to a depreciation of the yen. However, Japan s seasonally adjusted real GDP contracted during the third quarter of 2014 by 1.1 per cent compared to the same quarter for the previous year. Amidst forecasts of slowing economic growth, there is huge pressure of public debt warranting an increase in taxes very soon. Under a huge public debt which is already more than 200 percent of the GDP, there is not much room for big 14

20 fiscal stimulus. The Bank of Japan has expanded its quantitative easing programme despite failure to achieve its desired inflation target. In China, disappointing activity and still-low inflation have prompted rate cuts by the People s Bank of China. China s GDP is projected to decline marginally from 7.7 per cent in 2013 to 7.4 per cent in In other major emerging market economies (EMEs), downside risks to growth from elevated inflation, low commodity prices, deteriorating labor market conditions and stalling domestic demand have become accentuated (World Economic Outlook, IMF, 2014). The growth in world trade volume continues to be low. According to the Press Release issued by the World Trade Organization in September 2014, the world goods and services trade volume growth will be lower at 3.1 percent in 2014 (down from 4.7 percent forecast made in April 2014) and reduced its estimate for 2015 to 4.0 percent (from 5.3 percent estimated in April 2014). In its January 2015 update of the World Economic Outlook, the IMF predicts that the growth in world trade volume in goods and services will be at 3.1 percent in 2014 and 3.8 percent in International financial markets are experiencing a generalized ebbing of volatility since early 2014 as taper fears subsided, and a widening of the search for returns triggered a resurgence of capital flows. The financial markets in the emerging market economies have been buoyed by the search for yields. The latest Global Financial Stability Report of the IMF (October 2014) notes that the EMEs appear to be more vulnerable to shocks from advanced economies (AEs) on account of the increased share of these economies as destination of portfolio flows from the AEs as search for yield in the advanced economies is on the rise. Changes in the risk perceptions, or disorderly exit from accommodative monetary policies in the AEs are expected to cause significant capital outflows from EMEs, thereby increasing the financial stability risks International oil prices have fallen substantially since June 2014 when turmoil in Iraq lifted prices to U$ 116 per barrel. Among the several reasons cited, abundant 15

21 supply, slowing demand growth, a strong US dollar and disagreement among OPEC members to cut down supply are major factors leading to spiral fall in oil prices. Reduced tensions and a recovery in output from affected areas including the Islamic Republic of Iran and Libya have also led to lower oil prices. The increase in production of shale oil in the USA increased supply of oil in the global economy. The demand was affected due to sluggish revival in global growth. The International Energy Agency (IEA) has revised downwards the forecast of global oil demand for 2014 and 2015 on reduced expectations of economic growth and the weak recent trend. On the other hand, global supply rose on higher OPEC and non-opec output. In its January 2015 update of World economic Outlook, the IMF indicates that the average crude oil price was US$ 96.3 per barrel in 2014 and based on future markets, the assumed price for 2015 is US$ 56.7 per barrel and for 2016 is US$ 63.9 per barrel. There are several risks which need to be taken into account while assessing the current state of the global economy. First, risks to activity from low inflation remain relevant for the euro area and Japan. Inflation continues to undershoot the target in the euro area with inflation expectations further drifting down. With policy rates close to or at the zero bound, the room to lower rates is limited and negative shocks can lower inflation or expectations further or even push the economy into deflation. Second, as the recovery in US economy proceeds, there are risks related to the normalization of the US monetary policy. There is a probability that monetary policy will need to be tightened faster than previously envisaged. Against the backdrop of increased financial market optimism, such surprises could trigger abrupt financial market corrections. Third, there are also near-term growth risks in China. These risks are mainly associated with the likelihood of a more severe real estate market correction than envisaged in the baseline. Fourth, the geopolitical risks remain and large global spill-overs could result from developments in the Middle East and Ukraine. Finally, for EMEs, the risk remains that the projected increase in growth by IMF for next year (January 2015) may fail to materialize and that potential growth is lower than currently projected. 16

22 II. Domestic Output Growth According to preliminary data on national accounts, the Sultanate's Gross Domestic Product at current prices increased by 5.2 percent during the first three quarters (January-September) of While nominal GDP emanating from the hydrocarbon sector registered a marginal increase of 1.4 percent, that from non-hydrocarbon activities witnessed a growth of 8.2 percent during January-September The fact remains that despite growth in non-petroleum activities, GDP growth behavior still remains dependent on the oil price cycle. Lower crude oil prices which registered a marginal increase of 0.9 percent between the two periods under review accounted for the small increase of 1.4 percent in the petroleum sector GDP. The contribution of the hydrocarbon sector to the nominal GDP remained characteristically high at 48.3 percent or RO 11.4 billion over the period January- September 2014 (Appendix Table 1 and Charts 1 and 2). In Million Barrels Chart 1: Oil Production and Prices Sep.2014 Production Price (right scale) US$ / Barrel Growth Rate (%) Chart 2: Nominal Growth Rate of Petroleum and Non-Petroleum GDP & Crude Oil Prices Sep2014 Petroleum GDP Non-Petroleum GDP Average Crude Oil Price (right scale) US $ per barrel Source: Ministry of Oil and Gas and National Center for Statistics and Information. The aggregate oil production for the Sultanate stood at million barrels during January-September 2014 expanding by 0.9 percent. Omani average crude oil price in the global market averaged US$ per barrel during January-September 2014, or 0.9 higher than similar period last year (Table 2). During January-September 2014, the daily average production of crude oil in the Sultanate increased to thousand barrels from thousand barrels in January-September The oil 17

23 sector continued to remain the major contributor to the overall petroleum sector with 45.2 percent of value addition to the nominal GDP in contrast to a modest 3.2 percent value addition from the natural gas sector. Year Oil Prices (US$ per Barrel) Table 2: Oil Prices, Production & Exports % Change Oil Production (Million Barrels) % Change Oil Exports (Million Barrels) % Change Jan-Mar Jan-June Jan-Sept Source: Ministry of Oil and Gas and National Center for Statistics & Information Analyzing the trend in economic diversification, the period January-September 2014 pointed to a reversal insofar as the industrial sector is concerned as it contracted by 3.5 percent from similar period in Among the non-petroleum industrial activities, manufacturing sector declined by 8.6 percent. Despite registered increase in other major non-petroleum industrial sectors such as electricity and water supply and construction which grew by 8.4 percent and 2.5 percent, respectively, they fell short of lifting the overall industrial activities. The Government has been taking initiatives to diversify the economy, promote business environment in the Sultanate, increase employment opportunities and attract local and foreign investment. Unlike the downward trend witnessed under the industrial sector recently, the services sector grew by 12.6 percent between the two periods under review. Key services sector such as wholesale and retail trade grew at 2.2 percent, hotels and 18

24 restaurants at 8.5 percent, transport and communications at 7.0 percent, public administration and defense at 14.2 percent, financial intermediaries at 10.9 percent, and real estate services at 6.3 percent. The Government has been pursuing the policy of augmenting domestic supply of efficient services at competitive prices. The Eighth Five-Year Development Plan ( ) emphasizes the development of software and tourism industries, among others. 19

25 III. Price Situation The price situation in the Sultanate of Oman continued to remain comfortable with inflation rate hovering around 1 percent since Annual inflation rate measured by movement in the average CPI for the Sultanate stood at 1.1 percent in 2013 as compared to 2.9 percent in During the first three quarters of 2014 (January- September), the average inflation based on CPI (base 2012) was lower at 1.0 percent (Chart 3). The CBO and the Government have been keeping a close watch on the price situation and taking necessary measures as and when necessary. There has been effort towards increasing market awareness of consumers, proper monitoring of supply situations and diversifying imports. Chart 3: Inflation Rate (CPI for the Sultanate) 1.5 a) Average Inflation Rate 2.0 b) Point-to-Point Inflation Rate Percent Percent Source: National Center for Statistics and Information. Commodity-wise, inflation rate remained low for most of the commodities during January-September 2014 except in case of Furnishings, household equipment and routing household maintenance (5.4 percent), health (5.1 percent) and education (6.3 percent). (Appendix Table 2 and Table 3). On the other hand, there were decline in prices of groups like transport and communication. There was also marginal decline in prices of groups clothing and footwear and recreation and culture. 20

26 Table 3: Sultanate Consumer Price Index: Annual Percent Change (Base 2012=100) (Percent) Sep Items of Consumption Weights Food,& non- alcoholic beverages Tobacco Clothing & Footwear Housing, Water, Electricity, Gas and Other Fuels Furnishings, household equipment & routing household maintenance 6 Health Transport Communication Recreation and Culture Education Restaurants and Hotels Miscellaneous goods and services GENERAL PRICE INDEX Data pertains to January-September, Source: National Center for Statistics and Information. In 2013 and the first three quarters of 2014 (January-September), though the overall inflation remained low, the contribution of the group Foods & non-alcoholic beverages to overall inflation had been high and explained around 45.6 percent of increase in prices during the period January-September, Also, the contribution of the two groups Housing, water, electricity, gas and other fuels and furnishing, household equipment and routing housing maintenance to overall inflation have increased to 31.3 percent and 18.9 percent, respectively, during January-September, Overall, these three commodities have contributed 95.8 percent of increase in 21

27 inflation during the first three quarters of 2014 (Table 4). On the other hand, contribution to inflation of the groups transport and communication were negative during January-September 2014 offsetting the increase in prices of other commodities. Thus, policy makers will have to devote attention in controlling the prices of three groups - Foods & non-alcoholic beverages ; Housing, water, electricity, gas and other fuels ; and furnishing, household equipment and routing housing maintenance. Table 4: CPI Sultanate (Base 2012=100): Weighted Contribution in Percent (Percent) Items of Consumption Weights * 1 Foods& non-alcoholic beverages Tobacco Clothing & Footwear Housing, water, electricity, gas and other fuels 5 Furnishings, household equipment & routing household maintenance Health Transport Communication Recreation & Culture Education Restaurants and Hotels Miscellaneous and Services General Index Data pertains to January-September, Source: National Center for Statistics and Information. Global commodity prices continued to fall in There has been substantial decline in international crude oil prices in the second half of 2014 on weak demand and ample supply. Metal prices have also declined in recent period. According to the IMF latest estimates, metal prices are projected to decline by 7.5 percent in 2014 and 22

28 by 1.8 percent in 2015, before rising 0.6 percent in Food prices have also been low during 2014 on improved supply prospects. The IMF projections indicate that food prices will decline by 4.1 percent in 2014 and by 7.9 percent in 2015 and to remain broadly unchanged in The larger weight of food items in the consumer price index of the Sultanate is expected to keep inflation lower in

29 IV. Fiscal Position The Sultanate s fiscal trend in recent years has been characterized by rising public expenditure and more so in the areas of current expenditure and expenditure on participation and other expenses, a significant share of which consists of subsidies to electricity and petroleum products. The rising public expenditure reflects higher oil revenues which has been accounting for around 70 percent of government revenues. Favorable crude oil prices have allowed for fiscal surpluses in recent years. The Sultanate s fiscal position remained strong during January-September 2014 period with a fiscal surplus of RO million as against a surplus of RO million over the same period last year, albeit with some weakening signs on the revenues side (Chart 4 and Appendix Table 3). The continued favorable fiscal position prevailing during the period under review owed to a negligible increase in overall government expenditure, but equally important is the fact that a share of Omani crude oil is sold on forward contract price which has been more favorable than the oil sold on spot price, resulting in higher government revenues than would have been otherwise. In fact, average Omani crude oil price during January- September 2014 stood at US $ per barrel higher than US $ per barrel registered over the same period in 2013, while average daily oil production also increased by about 0.9 percent to barrels or a cumulative million barrels during the nine months of current year. Chart 4: Government Expenditure and Overall Fiscal Balance In Million R.O Components of Government Expenditure Sep.2014 Source: Ministry of Finance. Participation & Other Expenses Investment Expenditure Current Expenditure In Million RO Overall Fiscal Balance Sep.2014 Total Revenue Deficit/Surplus Total Expenditure 24

30 Table 5 : Fiscal Balance in Oman (Rial Omani Million) Jan-Sep * I. REVENUES (i) Oil and Gas Revenues (ii) Other Revenues II. TOTAL EXPENDITURE Current Expenditure (i) Defence & Nat. Security (ii) Civil Ministries (iii) Other Expenditure Investment Expenditure (i) Civil Ministries (ii) Oil Production (iii) Gas Production Participation & Other Expenses III. SURPLUS/DEFICIT(I-II) Note: Total expenditure for January-September 2013 includes RO 2,028.5 million as actual expenditure under settlement. For 2014 R.O million was included as expenditure under settlement. * Provisional. Source: Ministry of Finance. Despite the margin realized through forward contract prices, net oil revenues (gross oil revenue minus transfers to reserve funds) declined by 1.2 percent to RO 7,808.3 million while revenues from natural gas declined even further by 4.1 percent to RO 1,045.8 million with similar downward trend witnessed in other current revenues declining by 3.9 percent to RO 1,387.5 million. What is of note is that all three major sources of government revenues pointed to downward trends during January- September 2014 when compared to similar period in 2013 (Table 5). 25

31 The aggregate government expenditure during January-September 2014 increased by 1.8 percent to RO 10,327.3 million, reflecting primarily a significant decrease in actual expenditure under settlement which amounted to RO 1,000 million or over half of what it had amounted to a year earlier. Another contributing expenditure item in lowering total government expenditure during the period under review related to expenditures on participation and other expenses which declined by 6.4 percent to RO 1,178.3 million. However, current expenditure surged by 23.2 percent to RO 5,935.8 million, driven mainly by notable increases in key items such as defense and national security which increased by 17.1 percent, while expenditure on civil ministries witnessed an even larger increase of 31.1 percent. Capital expenditure also increased by 8.8 percent to RO 2,213.2 million with expenditure on civil ministries rising by almost 15 percent, gas production by 4.7 percent, while expenditure on oil production decreased by about 1 percent (Chart 5 and Table 6). Chart 5: Pattern of Government Expenditure Breakdown of Current Expenditure for Jan-Sep % Breakdown of Investment Expenditure for Jan-Sep % 50% 6% Defence & Nat. Security Civil Ministries Other Expenditure Source: Ministry of Finance. 1% Civil Development Expenditure Oil and Gas Production Expenditure Civil Capital Expenditure 41% The Sultanate s aggregate government debt stood at RO 1,433.7 million as of the end of September 2014, corresponding to a decrease of 3.6 percent from the aggregate debt at the end of December The decline in aggregate government debt between the two periods under review reflected the drop in total external debt which stood at RO million or a decrease of about 8.0 percent. As regards, government development bonds issued to residents, the outstanding amount remained at RO 830 million as of the end of September The total debt to GDP ratio at 4.9 percent in 2013 (4.6 percent in 2012) continued to remain low, which 26

32 augurs well for the economy of the Sultanate. Debt services ratio stood at 0.5 percent in 2013 as against 0.4 percent in 2012, which reflected sustained higher exports together with small amounts on principal and interest payments in both years. Table 6 : Growth in Revenue and Expenditure (Percent) Jan-Sep * 2014/2013 I. REVENUES (i) Oil and Gas Revenues (ii) Other Revenues II. TOTAL EXPENDITURE Current Expenditure (i) Defence & Nat. Security (ii) Civil Ministries (iii) Other Expenditure Investment Expenditure (i) Civil Ministries (ii) Oil Production (iii) Gas Production Participation & Other Expenses Memo Item Crude Oil Prices (US$ per barrel) Note: Total expenditure for January-September 2013 includes RO 2,028.5 million as actual expenditure under settlement. For 2014 R.O million was included as expenditure under settlement. * Provisional.Source: Ministry of Finance. 27

33 State General Budget 2015 The State General Budget 2015 endeavors to continue the investment spending required for maintaining real economic growth at 5 percent supported by non-oil sector, which is expected to grow by 5.5 percent in real terms. The Government will continue to implement the development and infrastructure projects as per their set schedule in sectors like hospitals, schools, airports, roads, ports, electricity and water. New priority projects approved under the current Five Year Development Plan will also be implemented. The Government will also continue to raise the efficiency and productivity of oil and gas sector. Given the actual trend in revenue and expenditure during 2014, the projected increase in total revenue and total expenditure during 2015 are lower as compared to projected increase in 2014 Budget (Table 7). ITEMS 2013 Budget Table 7: Budget Estimates 2014 Budget 2015 Budget % change Budget 2014/ Budget 2013 (Rial Omani Million) % change Budget 2015/ Budget 2014 TOTAL REVENUES (i) Oil and Gas Revenues (ii) Other Revenues TOTAL EXPENDITURE (1+2+3) 1. Current Expenditure (i) Defence & National Security (ii) Civil Ministries (iii) Other Expenditures Investment Expenditure (i) Civil Ministries (ii) Oil Production (iii) Gas Production Participation & Other Expenses SURPLUS/DEFICIT Source: Ministry of Finance 28

34 The State General Budget for 2015 projects the total revenue of the State for the year at RO 11.6 billion, a marginal decline of 0.9 percent over the total revenue of RO 11.7 billion estimated for 2014 Budget. According to the State General Budget 2015, the actual public revenue for the fiscal year 2014 is estimated at RO 13.9 billion compared with budgeted amount of RO 11.7 billion, which reflects an increase of around 19 percent. The projected oil revenue for 2015 is RO 7.7 billion, which constitutes around 66 percent of total revenue. The projected gas revenue at around RO 1.5 billion for 2015 represents 12.6 percent of total revenue. The non-oil revenue is projected at around RO 2.4 billion, an increase of around 19 percent over the budgeted amount for Total Government expenditure has been projected at RO 14.1 billion during 2015, an increase of 4.4 percent over budgeted expenditure of RO 13.5 billion during According to the State General Budget, the actual expenditure during 2014 was around RO 14.5 billion, an increase of around 7.0 percent over the budgeted amount for 2014 as additional allocations were approved during the year to cover emerging needs. Current expenditure at RO 9.6 billion represents around 68 percent of total expenditure. The projected increase in current expenditure is 10.5 percent during 2015 as compared to 6.6 percent projected in the 2014 Budget... Investment expenditure at RO 3.2 billion comprises 22.8 percent of total expenditure. Investment expenditure mainly covers spending on development projects and capital expenses for the production of oil and gas. The investment expenditure is projected to decline marginally by 0.4 percent during The expenditure category participation and other expenses includes all Government subsidies to housing loans, public sector companies and subsidies relating to food, electricity and petroleum products. The expenditure on participation and other expenses at RO 1.3 billion is projected to decline by 18.5 percent. The major decline at 32.6 percent from RO 860 million in Budget 2014 to RO 580 million in Budget 2015 is projected in subsidies relating to the petroleum products, while other subsidies are expected to be almost at the same level as previous year. 29

35 In the State Budget for 2015, the projected allocations for social sectors will continue. The allocations include RO 3.0 billion for education, RO 1.6 billion for health, RO 2.3 billion for housing and RO 1.8 billion for subsidies. The State General Budget 2015 will also continue to implement the ongoing and new infrastructural projects. There is a plan to privatize a number of state-owned companies during 2015 to The budget includes a net borrowing of RO 600 million, out of which RO 400 million will be from domestic market and RO 200 million from abroad. Based on total revenue and expenditure, the projected budget deficit for the year 2015 is RO 2.5 billion as compared to RO 1.8 billion projected in the 2014 Budget for the financial year The Government endeavors to improve the quality of public services and support social welfare schemes relating to health, education and housing. The Government will continue to support small and medium enterprises and improve quality of public and university education. The Government proposes to finance the budget deficit by issuing long-term Islamic bonds and instruments so as to activate the domestic capital market. Public debt as percent to GDP, however, will be maintained at safe level so as to support stable prices and reduce burden on future generations. 30

36 V. Monetary and Banking Conditions The primary objective of the Central Bank of Oman (CBO) is to ensure monetary and financial stability and constantly strive to promote a sound macroeconomic environment for enhancing investment and growth of the Omani economy within the framework of a fixed exchange rate with the US dollar and open capital account. The fixed exchange rateregime limits CBO s independence in setting domestic monetary policy rates. Although twin objectives of monetary and financial stability are complementary to each other, monetary stability is achieved essentially through fixed exchange rate and monetary policy while financial stability is ensured through appropriate regulatory and supervisory policies. The fixed exchange rate is the nominal anchor through which monetary stability is achieved. The exchange rate of the Omani Rial has been pegged to the US dollar since 1973 and the peg has remained unchanged at US $ per Rial Omani since The credibility of the peg is critical which not only imparts monetary discipline but also promotes investment and trade of the country. In view of the fixed exchange rate regime, the primary focus of the operating procedure of the monetary policy is to ensure appropriate level of liquidity so as to avoid internal and external imbalances. Interest rates in Oman are expected to be closely aligned to the corresponding rates prevailing in the US in view of the fixed exchange rate of Rial Omani with the US dollar. In fact, the current policy rates i.e. repo rate and CBO CD rates are aligned to the corresponding LIBOR rate. The CBO uses both direct and indirect instruments for liquidity management and thereby try to achieve monetary stability. As regards direct instruments, the CBO uses the cash reserve requirement and the lending ratio from time to time depending on the circumstances. Among the indirect instruments, CBO is currently using the weekly issuance of 28-day CDs as its main instrument to absorb liquidity. The issuance is based on a multi-price auction method. The target rate is linked to LIBOR. The CBO CDs are only issued to banks. They can be used as collateral for 31

37 vertical repos with the CBO, but they cannot be rediscounted before maturity. The CBO uses repo operation to inject liquidity in domestic currency and reverse swap operation for lending in foreign currency to the domestic commercial banks in case of need. A Master Repurchase Agreement (MRA) between the CBO and the banks has been signed to regulate repurchase (repo) transactions. The repo rate was reduced from 2 to 1 per cent in May The absence of an active government securities issuance program limits the amount of collateral available. Besides operationally active CBO CDs and repos, the CBO also provides discounting facility to the commercial banks against eligible securities. This facility is more regarded as last-resort source of central bank funds in extraordinary liquidity situations and is not considered a liquidity management tool. The monetary aggregates in Oman during the first three quarters of 2014 remained consistent with the accommodative monetary policy stance of CBO aimed at ensuring adequate liquidity in the system, maintaining orderly conditions in the markets and supporting economic growth with low inflation. As at the end of September 2014, narrow money stock (M1) when measured on year-on-year basis, grew by 18.1 percent driven mainly by the increase in currency with the public by 23.7 percent as well as increase in demand deposits by 16.0 percent. Quasi-money witnessed a growth of 13.6 percent during the period with the share of quasi-money to the total money stock at 65.9 percent in September 2014 compared to 66.7 percent a year ago. Broad money supply M2 (i.e. M1 plus quasi-money) stood at RO 12,933.4 million, up from RO 11,241.1 million a year ago registering an increase of 15.1 percent during the period (Table 8 and Chart 6). 32

38 Table 8: Select Monetary Indicators September Monetary Indicators Reserve Money In RO million 1, , , , ,195.0 Annual Growth Rate Narrow Money M1 In RO million 3, , , , ,412.8 Annual Growth Rate Broad Money M2 In RO million 9, , , , ,933.4 Annual Growth Rate CBO's Foreign Assets In RO million 5, , , , ,471.6 Annual Growth Rate Source: Central Bank of Oman The key drivers of monetary expansion during the year and as at the end of September 2014 was the increase in bank claims on the private sector by RO million (9.0 percent) followed by claims on public enterprises by RO million (9.7 percent). Net claims on the Government, however, declined by RO million during the one year period ended September 2014, mainly due to the increased level of Government deposits parked with commercial banks. Monetary expansion was also driven by the increase in net foreign assets of the banking system by RO million (2.2 percent). While CBO s net foreign assets rose by RO million, those of commercial banks declined by RO 72.7 million during the period under review (Appendix Table 5). 33

39 Chart 6: Monetary Indicators (Y-o-Y Growth in percent) 40 a) Narrow Money Supply (M1) 20 b) Broad Money Supply (M2) Percent Percent Source: Central Bank of Oman. Commercial Banks Operations During 2014, the continued GDP growth and supporting monetary and financial policies had a favorable impact on business growth and performance of commercial banks. The balance sheet of commercial banks further strengthened due to the growth in both deposits and credit. Total assets of commercial banks increased by 9.5 percent to RO 24.6 billion in September 2014 compared to RO 22.5 billion a year ago (Appendix Table 6). Of the total assets, credit disbursement accounted for 67 percent and increased by 8.8 percent over the year to reach RO 16.5 billion as at the end of September 2014 (Chart 7). While credit to the Government declined by 1.1 percent, credit to the private sector and public enterprises increased by 8.9 percent and 8.4 percent, respectively. Credit to the private sector stood at RO 14.4 billion as at the end of September Of the total credit to the private sector, the share of non-financial corporate sector stood at 47.9 percent, closely followed by the household sector at 45.4 percent, financial corporations at 4.7 percent and other sectors the remaining 2 percent. Commercial banks overall investments in securities increased by 19.8 percent to RO 3.0 billion at the end of September While investments in Government Development Bonds increased by 9.8 percent to RO million, investments in CBO CDs increased by 22.1 percent to RO 1,427.1 million in September 2014, 34

40 reflecting a balancing investment pattern between short term and longer term maturity. Commercial banks investments in foreign securities also increased to RO million in September 2014 from RO million a year ago. The core capital and reserves of commercial banks increased by 8.0 percent during the period to RO 2.9 billion, while supplementary capital elements stood augmented by 10.1 percent to reach RO million as at the end of September Chart 7: Banking Indicators (Y-o-Y Growth in percent) Percent a) Deposits Growth Jan Mar May Jul Sep Nov Percent b) Credit Growth Jan Mar May Jul Sep Nov Source: Central Bank of Oman. Aggregate deposits held with commercial banks registered a significant increase of 13.5 percent to RO 17.1 billion in September 2014 from RO 15.1 billion a year ago. Private sector deposits, which constituted 62.6 percent of total deposits, increased by 15.5 percent. The increase was more in saving deposits by 23.4 percent, while demand and time deposits grew by 18.9 percent and 5.3 percent, respectively. With regard to sector-wise deposits, bank deposits held by the household sector increased to 49.3 percent of total private sector deposits at the end of September 2014 from 48.3 percent at the end of September In absolute terms, bank deposits held with the household sector increased from RO 4.48 billion at the end of September 2013 to RO 5.29 billion by the end of September There was a decline in the share of bank deposits held with financial corporations from 23.7 percent at the end of September 2013 to 21.0 percent at the end of September 2014, while the share of non-financial corporates increased from 26.3 percent to 28.1 percent during the same period. The Government deposits held with commercial 35

41 banks increased from RO 4.5 billion at the end of September 2013 to RO 5.2 billion at the end of September The behavior of credit to private sector in terms of percentage share did not see much change from September 2013 to September The share of credit to the household sector, which comprises mainly personal loans including residential housing, remained almost unchanged at around 46 percent during the two periods. In absolute terms, however, credit to the household sector increased from RO 6.04 billion at the end of September 2013 to RO 6.55 billion at the end of September The share of credit to non-financial corporations increased to 47.9 percent at end-september 2014 from 46.9 percent at the end of September 2013 (Chart 8). Chart 8: Share of Private Sector Deposit & Credit (September 2014) a) Share of Deposit 1.5% b) Share of Credit 4.7% 2.1% 21.0% 49.3% 45.4% 28.1% 47.9% Households Financial Corporatins Non-Financial Corporations Others Households Financial Corporatins Non-Financial Corporations Others Source: Central Bank of Oman. Banking Sector Developments In its capacity as the country s monetary agency, as well as the regulator and supervisor of its financial institutions, the Central Bank of Oman (CBO) has been in the forefront in promoting the financial sector. The CBO has put in place appropriate prudential and regulatory framework, instilling confidence in the banking sector and promoting economic growth and development in the economy. As part of the ongoing efforts to strengthen the banking system and bringing about greater financial inclusion, CBO initiated various measures in the recent period in line with 36

42 international norms and best practices. These measures have helped improve the efficiency of the Sultanate s financial system in general and the banking sector in particular. In order to provide thrust and rigor to the supervision process of the banks, all onsite bank examinations done by CBO are now undertaken using the more risk sensitive risk-based supervision methodology. Again, in order to strengthen the risk assessment procedures, the CBO had issued guidelines to banks for the implementation of the Internal Capital Adequacy Process (ICAAP), which has been operationalized by all banks in Oman from December 31, Moreover, as financial stability has emerged as a global issue, a financial stability department has been set up within the CBO for macro-prudential supervision of the financial system, which is now producing stress testing and financial stability reports. It is comforting to note that the latest Stress Testing Report suggest that the overall banking system appears to be quite resilient to withstand various shocks. As regards regulation of banks, the Central Bank of Oman is well ahead in the implementation of Basel III framework. As in other cases, the CBO has followed a consultative approach in the implementation of this framework. The CBO had issued the roadmap for implementation of Basel III framework in August The final guidelines for implementation of Basel III framework were issued in November Some of the main features of these final guidelines prescribed by CBO include: minimum common equity Tier 1 ratio has been prescribed at 7 percent of risk weighted assets, while minimum Tier 1 capital ratio has been prescribed at 9 percent of risk weighted assets and the minimum total capital adequacy ratio has been prescribed at 12 percent of risk weighted assets. The norms outlined for the banks through this framework are in line with international best practices prescribed by Basel III. The CBO is also making efforts, in coordination with the Government, to promote small and medium enterprises (SMEs), as they play a major role in promoting 37

43 employment and creating a supply chain for the industrial sector. CBO advised banks to formulate a liberal lending policy for the SME segment and mandated that they should allocate at least 5 percent of their total credit to SMEs and this target is to be achieved latest by December The prudential requirements for banks to lend to SMEs have also been relaxed in terms of general provisioning requirements and risk weightage. There are also efforts in terms of capacity building of prospective entrepreneurs, identifying key areas for SME finance and facilitating public-private cooperation. Given the concerted efforts of the Government and CBO, it is expected that banks will be able to turn the lending option to SMEs commercially attractive so that there is an added incentive on the part of the banks to lend to this sector. Banks are also efficiently and effectively building up their capacity in terms of higher capital, exposure and leveraging abilities, technological capabilities and foreign currency funding sources all of which play an important catalytic role in promoting sustainable growth. The Central Bank of Oman, too, has defined exposures of banks to joint ventures of national importance in a liberal way. Thus, banks are playing a very active role in promoting Government investment programs and financing infrastructure projects. The Central Bank of Oman also provides an efficient and reliable payment and settlement system by relying on the latest technology, which supports business activities in Oman. Islamic Banking A notable development and an important milestone in the banking sector in the recent period was the introduction of Islamic Banking in Oman since December The Government and the CBO have since then vigorously pursued to promote Islamic banking in the Sultanate. Within the short span of issuing enabling legal and regulatory requirements in December 2012, two full-fledged Islamic banks have commenced operations in the Sultanate. Out of the seven local banks, six of them have established Windows for practicing Islamic banking. All these institutions have 38

44 established their own Sharia Supervisory Boards to guide them in sharia-related matters. There has been considerable increase in the number of branches and assets held by these banks. The Islamic banks and Windows operated with 29 branches as at the end of December With a relatively very short history of Islamic finance behind us, we are witnessing that Islamic banks are opening up new segments and players and thus will add to the competitive environment not only in terms of efficiency and innovation, but by also providing the consumers the benefit of choosing between both conventional and Islamic banking products. It is expected that healthy competition among conventional and Islamic banks will benefit the population at large with larger reach in terms of technology, products and services. Islamic banking Entities, by their business philosophy itself, should find SME finance more attractive. Islamic banking will also open up possibilities for investors from abroad and thus providing opportunities for new foreign investments. Performance of the Banking Sector Oman s banking sector comprises 7 Local Commercial banks, 9 foreign banks, 2 specialized banks and 2 full-fledged Islamic banks together with 6 local commercial banks operating separate Islamic windows for banking operations. As at end 2013, Commercial banks had 493 branches and 1100 ATMs. The financial health of banks in terms of assets quality, provision coverage, capital adequacy and profitability remained strong. During the year 2014, the balance sheet of commercial bank s strengthened further due to the robust growth in deposits and credit. As mentioned earlier, the total assets of the commercial banks increased in September 2014 compared to a year ago. Total credit and total deposits expanded by 8.8 percent and 13.5 percent, respectively, in September 2014 as compared to September The core capital and reserves of commercial banks increased by 8.0 percent during the period to RO 2.9 billion, while supplementary capital elements was augmented by 10.1 percent to reach RO 0.7 billion as at the end of September 2014 (Table 9). 39

45 Data available up to September 2014 indicates that provisional net profits continued to remain high in Table 9: Select Commercial Banking Indicators September Banking Indicators Assets In RO million 18, , , , ,605.0 Annual Growth Rate Deposits In RO million 12, , , , ,113.5 Annual Growth Rate Credit In RO million 12, , , , ,511.3 Annual Growth Rate Gross NPLs (Percent) Capital Adequacy Ratio (Percent) Source: Central Bank of Oman The most significant achievement has been improvement in the financial health of banks in terms of asset quality, provision coverage, capital adequacy, and profitability. Despite increase in the size of the balance sheets, the gross nonperforming loans (NPLs) continued to remain low. The NPLs as percentage of total credit at the end of 2013 stood at 2.1 percent same as in the year The ratio of NPLs to total loans stood at 2.2 percent in September The capital adequacy ratio stood at 15.1 percent of risk-weighted assets in September 2014, which was higher than the minimum regulatory requirement of 12 percent prescribed by CBO. The banking sector s outlook remains positive, supported by favorable oil prices and large expenditures planned by the Government as part of the Eighth Five Year Plan. With greater participation of commercial banks in the development process together 40

46 with large investments by the Government, the balance sheets of commercial banks are expected to remain healthy. Interest Rate Developments The CBO s liquidity injection policy rate i.e., repo rate remained unchanged at 1 percent since March 2012, consistent with LIBOR rate. The ceiling interest rate on personal and housing loans was reduced by one percentage point to 6 percent with effect from October 2, The CBO s policy interest rate for absorption of liquidity in the form of CBO CDs of 28 days maturity marginally declined from percent in September 2013 to percent in September With respect of domestic interest rate structure of commercial banks, the weighted average interest rate on Rial Omani deposits declined from percent in September 2013 to percent in September 2014, while the weighted average Rial Omani lending rate decreased from percent to percent during the same period (Chart 9 and Appendix Table 7). Chart 9: Weighted Average Rial Omani Deposit and Lending Rates (%) Percent a) RO Deposit Rate Percent b) RO Lending Rate Source: Central Bank of Oman Since December 2008, banks have been offering lower interest rate on foreign currency deposits compared to Rial Omani deposits. Interest rate on foreign currency deposits declined from percent in September 2013 to percent in September The lending rate in foreign currency, which was percent in September 2013, rose modestly to percent by September Commercial banks spread in foreign currency lending over the foreign currency deposit rate rose to in September 2014 from in September Interest rates on foreign 41

47 currency deposit and lending were mostly governed by those prevailing in the international markets, while domestic deposit and lending rates were influenced by domestic demand nd supply conditions. 42

48 VI. Financial Markets It is a well-known fact that the financial structure of any country is composed of a variety of markets and financial products, and development encompasses not only monetary aggregates and interest rates but also financial openness, regulation and supervision, and institutional capacity. In recognition of the critical role played by the financial sector, Oman has been focusing on developing deeper, liquid, vibrant and integrated banking system and financial markets. It is now recognized that domestic financial system is important to support the growth momentum and diversification of the Omani economy. This also allows risks to be shared more broadly and facilitates the flow of capital to the productive sectors. Typically, for a small open economy like Oman, financial development is measured by a small set of quantitative variables, such as the ratio of broad money to GDP and the ratio of private sector credit to GDP. The ratio of broad money to GDP is conventionally used as a measure of financial sector deepening, however, such indicators may not be comprehensive enough. When we look at the level of financial deepening based on the simple indicators like ratio of broad money to GDP and ratio of credit to GDP, we find that these ratios have been increasing gradually in Oman. The ratio of broad money to GDP stood at 38.7 percent during Similarly, the ratio of bank credit to GDP was 49.6 percent during 2013, while the ratio of bank deposits to GDP stood at 50.9 percent in Another indicator that is quite often looked at is the ratio of market capitalization to GDP. With respect to the Omani stock market, this ratio has come down in the last few years in line with other markets of GCC countries and it stood at 46.2 percent in Looking at these ratios indicate that there is a scope for further financial deepening in Oman. In Oman, the money market, Government securities market and the foreign exchange market fall within the jurisdiction of the CBO, while the capital market, corporate debt market and the insurance market are regulated by Capital Market Authority (CMA). It is recognized in Oman that the development of vibrant 43

49 Government securities market and the corporate bond market are important to raise resources from the market in a cost effective manner. The Government, the Central Bank of Oman (CBO), the Capital Market Authority (CMA), and the market participants have been laying emphasis to develop a deep and liquid domestic Government securities and corporate debt markets. The existence of an efficient government securities market is seen as an essential precursor, in particular, for development of the corporate debt market. Reforms in these markets are focusing on the development of appropriate market infrastructure, elongation of maturity profile, increasing the width and depth of the market, improving risk management practices, efficient payments and settlements mechanism and increasing transparency. The primary aim of CBO s operations in the money market is to ensure that the liquidity and short-term interest rates are maintained at levels consistent with its monetary policy objectives. CBO influences liquidity and interest rates through the cash reserve ratio for banks, operations in CBO CDs, repo transactions and at times through foreign exchange swap operations. The CBO undertakes liquidity management operations to smooth out short-term fluctuations in bank liquidity to avoid excessive adjustment cost to the banking system. For absorption of liquidity from the banking system, CBO issues on weekly basis its certificates of deposit (CDs) while injection of liquidity is mainly done through repurchase agreements (Repos) in government securities and CDs of the CBO. An intra-day liquidity facility by way of Repos is also provided to banks. The domestic inter-bank call money market continued to lack sufficient depth with transactions mostly confined to overnight tenors. In the over-night call money market in Oman, the average daily turnover during the first nine months of 2014 was lower at RO million compared to RO million during the same period of the previous year. In the background of excess liquidity, the overnight domestic inter-bank call money rates softened to percent per annum in September 2014 from percent a year ago. They however remained higher than the CBO CD rates ruling out any possibility of interest rate arbitrage (Chart 10). While structural 44

50 excess liquidity has been mopped up by weekly auction of the CBO CDs, frictional liquidity found its equilibrium among banks in the overnight call money market at a modest premium over the CBO CD rate. Percent Chart 10: Policy Rate and Inter-Bank Call Rate Jan-13 Mar May Jul Sep Nov Jan-14 Source: Central Bank of Oman. Mar-14 May-14 Jul-14 Sep-14 CBO CDs Rate (right scale) Repo Rate (left scale) Inter-bank Overnight Call Rate (right scale) Percent Index Chart 11: MSM Index and Market Capitalization MSM 30 Share Price Index Market capitalization (RO Million) (right 0 RO Million The activities of the Muscat Securities Market (MSM) reflected a positive trend in general. The Muscat Securities Market Index, also known as MSM-30, as at the end of September 2014, increased by 12.6 percent over the end-september 2013 level. The market capitalization increased by around 16.0 percent to reach RO 15.6 billion in the three quarters (January-September) of 2014 from RO 13.5 billion during the same period of The turnover increased by 3.4 percent to reach RO 1.71 billion during January-September, 2014 from RO 1.65 million during the same period of the previous year. The total number of securities traded during January-September 2014 declined by 20.9 percent to million as compared to million shares traded during the 9 months in The financial sector was the most active sector with a share in total turnover at 54.1 percent during January-September 2014, followed by services sector with a share in total turnover of around 33.3 percent and industrial sector with a share in total turnover at 11.9 percent during the same period (Chart 11). The foreign exchange market is predominantly dollar based as it acts as the main intervention currency for international trade and is the anchor currency under the fixed exchange rate regime. Foreign exchange market by and large worked smoothly 45

51 during the first three quarters of 2014 despite turbulence in the international financial markets. Government continued to remain the main supplier of foreign exchange due to its dollar denominated oil revenues which it sells to the CBO for its local currency requirements. Commercial banks, on the other hand, purchased foreign exchange from the CBO to meet the customers demand for foreign exchange arising from transactions related to imports, workers remittances and other capital account transactions. The foreign exchange market is predominantly dollar based as it acts as the main intervention currency for international trade and is the anchor currency under the fixed peg. Commercial banks also accept foreign currency deposits, bulk of which is denominated in the US dollar. While foreign currency deposits mostly finance foreign currency lending, commercial banks can borrow from the overseas markets within the aggregate gap limit prescribed by the CBO. The Government is the main supplier of foreign exchange due to its dollar denominated oil revenues which it sells to the CBO in lieu of its local currency requirements, while commercial banks are the main buyers of foreign exchange from CBO to meet its customers import payments, remittances and other capital account transactions. During January- September, 2014, CBO purchased US $ 21.4 billion from the Government while sale of US dollar to commercial banks amounted to US $ 21.7 billion. NOMINAL EFFECTIVE EXCHANGE RATE (NEER) The Rial Omani NEER index decreased from 95.7 in March 2014 to 95.1 in June, rising again to 98.4 in September 2014, indicating an appreciation of the Rial Omani between June 2014 and September 2014 against a basket of currencies of the Sultanate s importing partners. The appreciation in Omani NEER index witnessed between June and September 2014 mirrored the trend in US dollar as the US economy rebounded in the second quarter and growing faster than expected in the third quarter of Real GDP in the US grew by 4.6 per cent in the second quarter and by 5.0 percent in the third quarter, which was higher than the expected. The higher economic growth witnessed in the US in the third quarter of the current year 46

52 contrasted with a timid growth in the Euro zone during the same quarter and two successive quarters of contraction of the Japanese economy, prompting the US dollar to gain strength against a number of major currencies (Table 10). TABLE 10 EFFECTIVE EXCHANGE RATE INDEX OF RIAL OMANI (1999 = 100) End of Period Weighted Average March 92.1 June 93.5 September 91.9 December 92.9 March 95.2 June 96.6 September 95.5 December 96.2 March 95.7 June 95.1 September 98.4 Note: It may be noted that when the index of Rial Omani NEER rises, it indicates an appreciation of NEER and when the index falls, it indicates a depreciation of NEER. The index of Rial Omani NEER rises when the US dollar appreciates against the major currencies. Similarly, the index of Rial Omani falls when the US dollar depreciates against the major currencies. Source: Central Bank of Oman. 47

53 VII. Foreign Trade and Balance of Payments The estimated balance of payments position of the Sultanate of Oman pointed to a favorable condition during the first two quarters of 2014 (January-June) despite marginally lower average Omani crude oil price and lower exports and imports. Total merchandise exports during the first two quarters (January-June) of 2014 were lower by 9.6 percent mainly due to lower oil exports and re-exports. Crude oil exports declined by 9.2 percent, while natural gas exports declined by 14.2 percent during January-June Oil and natural gas exports accounted for 66 percent of total merchandise exports during the January-June 2014 (Table 11 and Appendix Table 8). Table 11: Oman s Foreign Trade (Rial Omani Million) January-June Merchandise Trade % Change Total Merchandise Exports 20,047 21,697 11,072 10, Oil Exports 12,352 12,678 6,466 5, Natural Gas 1,615 1, Other Exports 3,594 3,807 1,787 1, Re-Exports 2,486 3,541 1,973 1, Imports (c.i.f) 10,811 13,201 6,462 5, Trade Balance 9,236 8,496 4,610 4, Note:Imports figure in this table are on c.i.f. basis. As a result, trade balance figure given in this Table will not match with balance of payments Table given in the Annual Report. Source: Directorate General of Customs; National Center for Statistics and Information; Ministry of Oil and Gas. Merchandise imports declined by 13.6 percent during January-June 2014 mainly due to lower demand for re-export of mineral products. The bulk of imports included mineral products, electrical machinery and mechanical equipment and transport equipment. There was a trade surplus of RO 4.4 billion during the first two quarters of 2014; lower by 4.1 percent over the first two quarters of 2013 (Chart 12). 48

54 Chart 12: Oman s Merchandise Trade and Trade Balance 2500 Oman's Merchandise Trade 1000 Oman's Trade Balance Million Rial Omani Million Rial Omani Total Exports Total Recorded Imports Trade Balance Source: Directorate General of Customs; National Center for Statistics and Information; Ministry of Oil and Gas. There was a marginal increase in non-oil exports by 3.2 percent led mainly by mineral products and plastic and rubber products. Exports of plastic and rubber products increased by 34.3 percent, while that of mineral products increased by 4.6 percent. There was sharp decline of 20.8 percent in re-exports during January-June, Although quarterly balance of payments data are not available in the public domain, the recent trend in merchandise trade indicates that current account surplus in the first half of 2014 will be almost at the same level or marginally lower over the same period last year. The services, income and current transfers will continue to be in a deficit mode, given the nature of the Omani economy. On the capital and financial account front, it is expected that there will be net inflow mainly due to net inflows under other investment on account of draw down on Government s bank balances abroad. Component-wise, although firm data are not available on foreign investments, it is expected that there will be a very small outflow under foreign direct investment, while net inflows under portfolio investment will be higher. 49

55 Even with deficits in services, income and transfers account and outflows under capital and financial account, it is expected that the overall balance of payments will register a surplus in the first half of 2014 mainly due to large surplus in merchandise trade account. Reflecting the country's overall balance of payments position which seems to have remained comfortable, the foreign assets of the CBO during the first three quarters of 2014 increased by 5.5 percent to RO million compared to RO million at the end of December Foreign Investment in Oman Oman is committed to a policy of open market economy based on free competition in which the private sector is encouraged and facilitated to play a leading role. The policy is to encourage foreign capital that will enhance the overall development of the country. In recent years, with very favorable investment climate, the Sultanate of Oman has emerged as an attractive destination for foreign direct investment due to its free market system, stable macroeconomic environment and political stability. The Sultanate offers an investor-friendly legislative environment, flexible tax system and transparent corporate governance. Oman's Foreign Capital Investment Law has been liberalized, permitting 70 percent foreign participation in companies automatically in most of the sectors and even 100 percent foreign capital investment is permitted for projects of national importance. There is low tax on profits and no personal income tax. The flexible tax system allows exemption on tax on profits for 5 years, renewable for a further 5 years for certain sectors. There are no restrictions on repatriation of capital and profits. An array of incentives in the form of plots of land at nominal lease charges in specified areas, reduced utility charges and exemption from taxes are offered to the foreign investors. The Ministry of Commerce & Industry provides a "One-Stop-Shop" for assisting the domestic and foreign investors in obtaining all required clearances quickly and from one window. Foreign Investors are also allowed to own real estate in Oman within specified integrated tourism complexes. Given the fact that Oman is a free economy, there is 50

56 no restriction on remittances abroad of equity, debt, capital, interest, dividends, profits and personal savings. Moreover, the fixed exchange rate of Omani Rial provides certainty of returns to the foreign investors in the absence of exchange rate risk. 51

57 Appendix Tables 52

58 Appendix Table 1 Gross Domestic Product at Current Market Prices (Rial Omani Million) Activities * Jan - Sep % change 2013* 2014** (2014/13) 1. Industry ( ) Petroleum Activities Crude Petroleum Natural Gas Non-Petroleum Industrial Activities Mining and Quarrying Manufacturing Electricity & Water Supply Construction Agriculture & Fishing Services Wholesale & Retail Trade Hotels & Restaurants Transport, Storage & Communication Financial Intermediation Real Estate & Business Activities Public Administration & Defence Other Services (Education, Health, Community/Personal Services, and Private Household) Total Non-Petroleum Activities ( ) Less Financial Intermediation Services Indirectly Measured Gross Domestic Product at Producers Prices ( ) Plus :Taxes Less Subsidies on Products Gross Domestic Product at Market Prices (6+7) * Provisional. ** Preliminary. Source: National Center for Statistics & Information. 53

59 Appendix Table 2 Sultanate Consumer Price Index (2012 = 100) Items of Consumption Weights Jan - Sep % change (2014/13) 1 Food & non-alcoholic Beverages Bread & Cereals Meat Fish & Seafood Milk, Cheese & Eggs Oil & Fats Fruits Vegetables Sugar,Jam,Honey & Confectionary Food Products n.e.c Non Alchoholic Beverages Tobacco Clothing & Footwear Housing, Water, electricity, gas and other fuels Furnishings, household equipment & routing household maintenance Health Transport Communication Recreation & Entertainment Education Restaurant and Hotels Miscellaneous goods and Services General Price Index Note:1. The weights produced from the Household Expenditure and Income Survey, Data collected from all regions of the Sultanate excluding (Musandam Governorate and AL Wustta Region). 3. The collection is based on items of goods and services from 1721 selected sources, while rent is collected from a sample of 1150 rented units. Source: National Center For Statistics & Information-Directorate General of Economic Statistic Monthly Surveys of Consumption Goods. 54

60 Appendix Table 3 Public Finance (Rial Omani Million) Items Estimated Budget 2014 Jan - Sep % change (2014/13) REVENUES Net Oil Revenues Gas Revenues Other Current Revenues Capital Revenues Capital Repayments TOTAL EXPENDITURE Current Expenditure Defence & National Security Civil Ministries Interest Paid on Loans Gas Production Expenditures Oil Production Expenditures Investment Expenditure Development Expenditure for Civil Ministries Capital Expenditure for Civil Ministries Oil Production Expenditures Gas Production Expenditures Participation & Other Expenses Actual Expenses under Settlement** SURPLUS/DEFICIT FINANCING Net Grants Received Drawing from Reserves Net loans Received Development Bonds(Net) Remaining Surplus Change in Government Accounts * Provisional. ** Amount already allocated but not yet disbursed. Source: Ministry of Finance. 55

61 End of Period Currency with Public Appendix Table 4 Money Supply (Rial Omani Million) % Change in M2 Over Previous Year Demand Deposits Money Supply (M1) % Change in M1Over Previous Year Quasi- Money* Money Supply (M2) (1) (2) (3) =(1+2) (4) (5) (6)=(3+5) (7) 2009 Mar June Sept Dec Mar June Sept Dec Mar June Sept Dec March June Sept Dec March June Sept Dec March June Sept *Quasi Money = Resident Time and Savings Deposits, Margins & Foreign Currency Deposits. Source: Central Bank of Oman. 56

62 Appendix Table 5 Factors Affecting Broad Money (M2) (Rial Omani Million) 1. Broad Money (A+B) A. Money (M1) a) Currency with public b) Demand Deposits B. Quasi Money (Of which foreign cy. deposits) 2. Foreign Assets (Net) Central Bank Commercial Banks 3. Domestic Assets A) Claims on Government (net) (i-ii) i) Government borrowings ii) Government Deposits (-) b) Claims on Pvt. Sector c) Claims on Public Enterprises d) Other items (net) (-) Sep Sep Absolute Change in RO Million Sep.2014/2013 % Change Sep. 2014/ Source: Central Bank of Oman. 57

63 Appendix Table 6 Combined Balance Sheet of Commercial Banks (Rial Omani Million) Sep Sep % Change Sep.2014/13 Cash and deposits with CBO 1, , , , Due from H/O, branches and affiliates abroad Due from other banks abroad 1, , , , Total Credit 14, , , , a) Credit to Government b) Credit to public enterprises 1, , , , c) Credit to private sector 12, , , , (Of which in foreign currency) (1,206.5) (1,341.1) (1,305.6) (1,589.1) 21.7 d) Credit to non-residents Securities 2, , , , a) Treasury Bills b) Government Development Bonds c) CBO CDs , , , d) Domestic Shares e) Other domestic securities f) Foreign securities Net fixed assets Other assets , , , TOTAL ASSETS / LIABILITIES 20, , , , Total Deposits 14, , , , a) Government deposits 3, , , , b) Deposits of public enterprises c) Deposits of Private Sector 9, , , , i) Demand 2, , , , ii) Savings 2, , , , iii) Time 3, , , , iv) Commercial prepayments (Of which in foreign currency) (629.6) (681.6) (654.7) (736.3) 12.5 d) Deposits of non-residents Due to H/O, branches and affiliates abroad Due to other banks abroad 1, , , Core capital and reserves 2, , , , Supplementary capital elements Specific provisions and reserved interest (Of which general provisions) (189.8) (197.2) (197.9) (211.5) 6.9 Other Liabilities 1, , , , Source: Central Bank of Oman. 58

64 Appendix Table 7 Weighted Average Interest Rates Deposits Lending (Percent per annum) Total Total RO Total FCY Deposits Total RO Total FCY Total Lending Deposits Deposits (RO+Fcy) Lending Lending (RO+Fcy) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Source: Central Bank of Oman 59

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