OVERVIEW OF THE ECONOMY. International Economic Setting. In This Issue

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1 A Bi-Monthly Publication of the Central Bank of Oman Jamadil Al-Akhar 1422 H June / July 2001 Issue No. 3, Volume 26 OVERVIEW OF THE ECONOMY Annual Report of Central Bank for the Year 2000 Oman s Gross Domestic Product (GDP) at current market prices rose in 2000 by 26.7%. Level of prices as measured by consumer price Index dropped by 1.2 %. In This Issue Subject Page Scientific Research in Oman : A Quick Review 6 IAS 39 Financial Instruments : Recognition and Measurement 14 OVERVIEW International Economic Setting The world economy expanded further in 2000 posting handsome output gains on top of a significant output expansion in the preceding year. Encouragingly, the output growth was higher in the developing countries and countries in transition, with low rate of inflation. The relatively strong growth in world output in 2000 was due to the combined effect of higher order of growth in the US, rebound in economic activities in the European Union, recovery in the Japanese economy and consolidation of output gains in the Asian countries. While world real output grew significantly, world trade volume in goods and services improved alongside impressively as compared to the preceding year. Although the performance of consumer prices across the globe was mixed, underlying inflationary pressures remained subdued. The world prices of oil stayed high brightening the growth prospects of oil exporting countries. However, the global interest rates climbed up during the year. Real world output expanded by 4.8 percent in highest in the last few years since the recent economic crises around the globe. While the group of advanced economies registered output gains of 4.1 per cent, developing countries recorded larger economic growth of 5.8 per cent. In terms of regional groups, Developing Asia posted highest growth at 6.9 percent

2 in 2000 followed by the group of Middle East, Malta & Turkey at 5.4 percent. Africa recorded a growth of 3.0 percent, while the countries of Western Hemisphere grew impressively by 4.1 percent as compared to that of 0.2 percent in the preceding year. The volume of world trade in goods and services expanded markedly by 12.4 per cent in 2000 as compared to that of 5.3 per cent in the preceding year. In the case of advanced countries, the volume of both exports and imports improved individually by 11.4 per cent. For the developing countries, the volume growth of trade in goods and services was more pronounced in 2000; export volume rose by 15.7 percent, while volume of imports expanded larger by 16.9 percent. As world trade prices of oil also improved during the year, the terms of trade for fuel exporters improved significantly by 45.6 per cent in On price front, the rate of inflation recorded was different as between the group of countries. In the case of advanced countries, the inflation rate as measured by consumer prices was higher in 2000 at 2.3 percent. Developing countries as a group recorded a lower rate of inflation at 6.1 per cent as compared to 6.7 percent in the preceding year. Interestingly, all the groups of developing countries registered decline in the escalation of prices in The prospects for global Al Markazi Mailing Address economic performance in 2001 appear to be hazy. The marked slow down in the US, limping recovery in Japan, moderating growth in Europe and lower growth momentum in Asian countries seem to dampen the growth prospects in the year The world output is expected to grow lower by 3.2 per cent in 2001 while the fuel exporters are expected to record a lower output expansion of 5 percent. The inflation rate is projected to soften to 2.1 per cent and 5.7 percent in the advanced and developing countries, respectively. The volume of world trade in goods and services is estimated to expand by 6.7 per cent in the current year. However, the terms of trade for the fuel exporting countries may decline as the average price of oil is expected to be lower than that in the preceding year. Domestic Economic Development Omani economy performed better in Higher international oil prices combined with prudent public policies strengthened the Omani economy further. Strong world economic growth in 2000 improved the global demand for oil which mainly helped international oil prices stay high during the year. The average oil price for Omani crude which was US $ per barrel in 1999 rose to US$ per barrel in Escalation in oil prices coupled with the moderate improvement in the oil production increased Government revenue and export earnings which strengthened Government's fiscal balance besides building up international assets significantly. Gross Domestic Product Preliminary estimates show that the Gross Domestic Product (GDP) at current market prices rose in 2000 by 26.7 per cent over and above 10.8 percent in The rise in national output was mainly attributable to the higher contribution of the petroleum sector to GDP by 57.7 per cent. Non-petroleum sectors including agriculture and services too expanded by 7.7 percent. In 1999, these sectors had contracted by 3.5 per cent. Among nonpetroleum sectors, the growth pattern in 2000 was quite uneven. While 'manufacturing' rose by 56.7 percent, 'construction' activities contracted by 16.9 percent. 'Agriculture' expanded by 2.8 percent and 'fishing' rose by 3.7 percent. While the general level of prices dropped by 1 per cent, gross domestic as well as national savings are estimated to have improved significantly in 2000 reflecting higher output expansion. Opinions expressed in Al-Markazi do not necessarily represent those of the Central Bank of Oman. CENTRAL BANK OF OMAN P.O.Box 1161 Ruwi, Postal Code112 Sultanate of Oman Tel.: (968) or Ext Fax: (968) MCP

3 Government Finance The Government fiscal position improved substantially in 2000 with the significant rise in the contribution of Government saving to overall domestic saving. Actual fiscal deficit contracted to RO 324 million from RO 473 million in the preceding year. Total revenue receipts showed an increase of 27 per cent to RO 2284 million. Net oil revenue at RO 1721 million was higher by 43 per cent as compared to that in the preceding year, 'Other current revenues' under non-oil revenue receipts declined by 14 per cent from RO 520 million in 1999 to RO 449 million in On the expenditure side, the buoyant revenue position enabled the Government to stretch the public expenditure in order to stimulate the economy and to complete several ongoing projects which were put on hold in the earlier years due to slump in international oil price. Accordingly, total expenditure rose by 15 per cent from RO 2269 million in 1999 to RO 2608 million during the year under reference. While 'current expenditure' showed a small rise of 13 per cent, the 'investment expenditure' rose faster by little over 15 percent in Expenditure on account of 'participation & subsidy to private sector' stood higher by around 15 percent in The deficit of RO 324 million was entirely financed by drawing down the SGRF balance. In fact, draw down of SGRF balances at RO 346 OVERVIEW OF THE ECONOMY million was larger than the deficit as other items of financing showed net payment during the year. As percent of GDP, the fiscal deficit declined from 7.9 percent in 1999 to a near sustainable level of 4.3 percent in Monetary and Banking Developments Narrow money (M1), expanded by 4.8 percent over the year to RO 534 million. The currency with the public rose by 1.2 per cent and Rial Omani demand deposits jumped up by 8.9 per cent. Broad money (M2), expanded by 6.0 per cent to RO 2404 million as at the end of December 2000 as the quasi money stock rose by 6.4 per cent. In terms of factors affecting the money supply (M2), net foreign assets declined by 6.7 percent while net domestic assets rose by 13.4 per cent. The increase in net domestic assets was brought about by moderate expansion in bank credit to private sector by around one percent. While domestic interest rates on deposits softened somewhat, those of aggregate 3 bank lending edged up during The weighted average rate of interest on all deposits at 5.43 per cent as at the end of December 2000 was lower as compared to that of 5.79 percent in the preceding year. Weighted average interest rates on Rial Omani deposits were lower at 5.45 per cent as at the end of December 2000 as compared to 5.89 per cent a year ago. However, while Rial Omani lending rate came down by 258 basis points to percent, the weighted average interest rate on commercial bank total lending was a shade higher at 9.68 percent as at the end of December 2000 as compared to that of 9.64 percent a year ago. The spread between the banks' total deposit and lending rates widened by 394 basis points to percent as at the end of December. However, spread between private sector deposits and lending to the private sector rose only by 133 basis points, reflecting softening of interest rate charged particularly on personal loans. Although the interest rate spread has increased, the profits of the commercial banks were moderated during the year mainly because of the provisioning for diminution in the values of investments. To enumerate important AL-MARKAZI June - July 2001

4 policy developments in the banking and financial system, the overall ceiling on personal loans was relaxed to 35 percent of the total credit portfolio of the banks with effect from October The Commercial Bank of Oman was allowed to merge with the Bank Muscat in order to mainly achieve synergy in banking business. The Banking Law was revised and updated to take into account the recent developments in the domestic and international banking and financial sector. The Law, interalia, grants greater investment powers to the AL-MARKAZI June- July OVERVIEW OF THE ECONOMY

5 banks; elaborates banking business to cover new areas; and streamlines the exposure towards loans secured by real estate and holding real estate securities. The Muscat Securities Market remained bearish in The General Index of share prices dropped from as at the end of 1999 to as on December 31, 2000 reflecting a loss of around 20 percent over the year. Prices The level of prices declined in The prices measured in terms of consumer price index dropped by 1.2 percent. In 1999, the consumer price index had registered an increase of 0.5 per cent. Group-wise, fall in the index under 'recreation & entertainment' by 3.9 percent was sharper, followed by 'transport & communication' (2.2 percent) and 'housing material & furniture' (2.1 percent). Balance of Payments The preliminary estimates of balance of payments for 2000 which are presented in the new format being followed from the current year, showed that merchandise trade account recorded a significant surplus of RO 2586 million due to surge in export earnings because of pick up in international oil price. In 1999, there was a trade surplus of RO 1130 million. While services account showed a net payment of RO 468 million, income account and current transfers recorded outflow of RO 276 million and RO 560 million, respectively. As a result, the current account showed a marked surplus of RO 1282 million during 2000 as against a moderate deficit of RO 142 million in the preceding year. In terms of percentage to GDP, current account surplus accounted for 16.9 percent. On capital and financial account, there was a net outflow of RO 153 million. All the current, capital and financial transactions put together, yielded a positive overall balance of RO 869 million after making allowance of RO 260 million (negative) for net errors and omissions, which accrued to the reserve assets. While Government reserves (balances under SGRF) showed a healthy increase of little over one billion Rial Omani, the foreign exchange assets of the Central Bank of Oman declined by RO 133 million in 2000 mainly because of withdrawal of a part of SGRF funds parked by the Government with the Central Bank. OUTLOOK The short-term prospects for global economic growth appear to be relatively weak with the expected slow down of US economy. The decline in world economic growth may slacken the global demand for oil. As a result, oil price scenario though looks promising at this juncture, remains uncertain. The performance of the Omani economy in 2001 hinges broadly on the behaviour of international oil price. Assuming that the level of oil price prevailing in the first half of the year would stabilise, Omani economy is expected to register continued strong growth in Higher level of oil price would render fiscal administration easier and yield balance of payments surplus helping to build international assets further. Inflationary tendencies are expected to remain under control. With the liquidity conditions remaining comfortable, interest rates may not show greater volatility. OVERVIEW OF THE ECONOMY 5 AL-MARKAZI June - July 2001

6 Scientific Research in Oman : A Quick Review When Tony Blair assumed the position of British Prime Minister, he explained the main task of his government as the rehabilitation of the country to the 21st Century while focusing on sciences as the pillar of success. He described the policy of his government saying "it will be shortsightedness to neglect the scientific base which represents the tool for economic development because it generates skills knowledge and technology and enables Britain to compete favorably in the international market in the years to come." That Blair has placed science and technology as top priority for the pursuit of economic success for an industrial giant like his country, clearly reflects the indispensable need for developing countries to devote greater emphasis to science and technology as a tool for societies to maintain their material and economic growth let alone cultural expression Prepared by : Mohammed Rashid Al Jahwari AL-MARKAZI June- July Scientific Research in Oman : Quick Review

7 T he inability of the society to produce the needed technology for its status quo and entertainment facilities forces it to live under the mercy of the ready-made commodities it imports to meet its consumption needs. Being over-powered by dependence on others for consumer goods creates societies with weak will, unable to resist external pressure. Therefore, the progress in scientific and technical research would not only boost economic prosperity but also social stability and pride in national identity. When Ahmed Zoweel won the Nobel Prize in Chemistry in 1999, a lot of questions were raised pertaining to the retrogression of Arabic societies in spite of the presence of many talented individuals. The answer always centered around the fact that the Arab World lacks a national policy for scientific research and technology. There is no doubt about the ability of individuals to learn and excel but the scientific research and technology activity demands continuous effort. The scientific research expert, Antowan Zahlan, says in this respect, "there is the need for collective solid effort before individuals can promote their gifts to higher levels. This fact is partly dictated by how cultural and Scientific Research in Oman : Quick Review social heritage can motivate individuals and partly by how the infrastructure and financial set up can support the scientific activities. (The Arabs and the Challenges of Scientific Research and Technology, 1999, Page 33). Scientific Research in the Gulf The current development model in the oil producing countries created a situation of total dependence on importing manufactured goods paid by the income from exporting crude oil. Even when these countries adopted policies aiming at diversifying the sources of national income by establishing industries, what most of these countries did was to call outsiders to build the demanded factories through what is known in the business world as "turnkey contracts". That is, the executing foreign company handles the establishment of the factory and the choice of techniques. If we take into consideration the fact that the administration of the facilities in the Gulf countries, for instance, is also entrusted to foreigners who shouldered the responsibility of establishing them, we can imagine the limited financial returns the oil economies gain from what they consider industrialization. 7 Therefore, scientific research and development (R&D) might be the appropriate way out of the type of development situation in the oil producing countries, specially the Gulf, are suffering from. These countries suffer from structural economic crises stemming from the fluctuations of the oil prices in the international market which dictates a large portion of their income, the perpetual increase in job searchers, the increase in foreign labour, the scanty returns of diversified economic plans, the educational weakness of the out put of the educational system, the ever increasing cost of importing ready-made technology and the difficulty of adapting this technology to the climatic and social conditions. On the micro-economic level the Gulf countries suffer from limited national labour productivity, absence of competitive capability of the private sector in the local and international markets, exhaustion of the water resources, the immense cost of alternative water resources, meager productivity of the Agricultural sector and the unsatisfactory progress in industrial output relative to the huge expenditure laid on it. From these facts steps the importance of promotion of national skills in R&D to enable AL-MARKAZI June - July 2001

8 the Arab Gulf Countries to correct the infrastructure drawbacks from which their economies are suffering and to reach a stage where a stable active development can be achieved. Economic success that relies on industry would not be achieved through wide use of raw materials and cheap foreign labour but on the amount of the added value resulting from development of production techniques. In this respect many specialized institution in scientific research and development have been established, such as Kuwait Institute for Scientific Researches, King Abdul Aziz City for sciences and Technology in Saudi Arabia, the Centre for Scientific and Technical Research in Qatar, Bahrain Centre for Studies and Researches and the Emirates Centre for Research and Strategic Studies. SCIENTIFIC RESEARCH in OMAN Only a few Omani Public or Private Institutions show interest in R&D. This is very clear from the absence of any institutional set up in this respect. There is no higher council for scientific research and technology nor a national centre for applied sciences. There is also absence of AL-MARKAZI June- July 2001 departments of R&D in the Ministries and governmental establishments. Where such departments exist, most of the work is concentrated on routine office work. This is manifested in the fact that there are no scientific research work published from those departments. When those authorities talk about studies in the process of preparation on future schemes they only mean studies shouldered by foreign consultant companies. The Private sector is worse than the public sector in this respect. There aren t any research laboratories or innovative development departments in the industrial or services private sector establishments. Agricultural research centres, Sultan Qaboos University (SQU) and Ministry of Health can be excluded from the above mentioned situation. 1. Agricultural Research Oman started its first experience with Scientific Research in the late 50 s when it established an experimental farm in Nizwa and another in Sohar in That interest was due to the fact that the agricultural sector played on essential part of the society in that 80% of the 8 Omanis were involved in agriculture for their living. Therefore the desire to increase the national income would have been impossible in the absence of agricultural research stations which specialize in running scientific experiments in different types of products, promotion of combating agricultural pests and analysis of water and soil. In the recent decades expansion in the establishment of research stations and agricultural guidance centres has been achieved. Reports of the Ministry of Agriculture indicate that there are two agricultural research centres. One is for products and the other to protect plants. Various specialized Laboratories, stations and research farms are attached to each centre. In respect of animal research, there is a centre for veterinary health and another for animal production, attached to them are a number of research laboratories. There are also two fish research centres, one for marine and fish sciences and the other to guarantee fish quality. It is difficult to determine the returns on the national income from establishing these centres mainly because the exact budget allotted to these centres and how it is utilized remains unknown to the public. What is more is the fact that Scientific Research in Oman : Quick Review

9 there are no documented research work from these centres, which could indicate the amount of research work done, due to the absence of scientific periodicals issued by the concerned Ministry even though the Ministry s information circulars states that there was an annual increase in Omani Agricultural Production of 6.9% between The Ministry states that this is due to the technical recommendations issued by Agricultural Research in the field of plant production and plant protection. (Oman Newspaper, 25 July, 2001). 2. Scientific Research at Sultan Qaboos University SQU started its second decade by claiming that scientific research and technical development would be given due attention and that there are future plans to be implemented to encourage researchers. The University administration made it clear that a radical change would take place. After spending a decade in teaching the students and organizing its internal matters was to turn to the local society by studying its problems and cooperating with it to open new horizons for its new generations. It has been made clear that the scientific Scientific Research in Oman : Quick Review establishment has a plan to widen its sources of income by making researches for private and public establishment in both internal and external levels. It is expected that by the year 2005 the SQU will be able to earn 10-15% of its expenditure from the returns of consultation and scientific research. (Oman News Paper, November 8, 1999). The University has been successful in responding and meeting the needs of governmental establishments and other business sectors. On the level of infrastructure and legislation a number of specialized research centres have been established; such as the centre for environmental researches and studies, The Centre for Remote Sensation, a centre for detecting earthquakes. In addition to these there is a site for experimenting solar cells and a site for water desalination. A department of higher studies and research is also established to supervise higher studies and scientific research programmes. The University has also been assigned as a consultant for private and public centres in scientific and social projects. An agreement has also been concluded between the university and UNESCO to establish a chair for the latter at SQU in the field biotechnology 9 The Academic Researches The academic researches aim at promoting sciences and humanities and not making money. However, the implementation of these researches may lead to economic and social gains. These researches are financed by grants from Academic establishment. Researchers in the field enjoy some freedom and flexibility in the choice of topics that interest them and suit their capabilities. These researches generally find their way to publication in journals and the University is helped by specialists inside and outside the Sultanate to judge the research plans according to International standards pertaining to scientific value and the expected impact on the society. The priority in financing is given to researches done collectively by a number of researchers. During the previous 3 years ( ) 215 researches have been accepted with an annual budget of RO half a million as shown by the table. The various accepted Research Schemes in the fiscal years 1999 covered the following areas : 6 researches in humanities, 6 researches in AL-MARKAZI June - July 2001

10 Table (1) Details of Academic Researchers of the University. Year The Number of Research Schemes The Number of Research Source: Sultan Qaboos University, Higher Studies and Scientific Research, May 2001 economics and commerce, 15 researches in applied science, 9 researches in Medicine and 20 researches in engineering researches. Published works by the academic members in 2000 in the Scientific periodicals went up to 500 papers with an increase of 18% over the previous year. Applied Researches:- The applied researches aim at finding solutions for economic or social problems, promotion of products or creation of new methods and means. The research findings are translated into useful commercial commodity through promotion after taking into consideration the economic and local conditions. SQU encourages concluding AL-MARKAZI June- July 2001 scientific research contracts between researches and local and international establishments to implement applied research projects. This was organized during declaration of agreement for the secrecy before assuming negotiations for these contracts. It also protected the intellectual property rights which result at later stages of research. Research activities increased between SQU and local establishments during the last two years. The number of research contracts increased from 9 in 1997 and 1998 to 21contracts in 1999 and 25 before the end of the first half of The total cost of the contracts signed with SQU went up from RO 96 thousand and RO 90 thousand in 1997 and 1998 respectively to nearly RO half million before the end of the second half of The researches cover a number of fields that include, power, water, 10 agriculture and fisheries. Fields of applied researches also include bilateral agreements between SQU and foreign establishments to develop some industries. Those agreements provide importation of laboratory equipment and training of employees. These establishments have the total supervision on expenditure from the budget of these researches. It is very clear that this type of researches brings to the Sultanate the technology in these fields. The University has concluded four agreements with Japanese establishments for a total cost of nearly RO 3.5 million. These agreements are divided as follows: research scheme in solar energy started in the year 1998 estimated to take 10 years for a cost of RO million. Research scheme in desalination of water-started in 1998 continuing for 7 years for a total cost of RO 2.7 million. Scientific Research in Oman : Quick Review

11 Research project in Heat energy started (2001) for one year for a cost of RO 90 thousand. Research scheme in environmental studies started in 2001to continue for 5 years for a total cost of RO 180 thousand. Strategic Researches:- Those involved in executing strategic researches do not get quick financial returns because do these researches study main issues facing the state and industrial establishment. The importance of this kind of research stems from the fact that it looks into one or some of future developmental programmes or investigates the extent of the success of solutions offered. These type of researches lead the country to become more advanced in specific field, which leads to scientific and technical excellence which in the long run leads to greater financial returns. The projects presented for financing from the budget allocated by his Majesty Sultan Qaboos have been specified as part of the strategic projects of SQU. The University has sanctioned 9 research projects under specification covering medicine, technology, environment, agriculture, and applied science. Five of these projects have been chosen for execution during The first stage of these projects will take 3 years for a total cost of a RO half million in the first year. This might be followed by stages of research and development before the stage of marketing the results to be adopted in economic and social development. The five projects are:- *The main components of hereditary and environmental blood pressure disease: The studies show that about 27% of the Omani s above 20 years of age have this disease. The cost of -combating this disease is a heavy burden because the disease follows the patient all through this life and may lead to serious disease such as heart attacks, stroke, and renal failure. The research carried out by the college of medicine in collaboration with the Ministry of Health, aims at finding the environmental elements causing the disease and the types of cure with those used in the advanced world. The research also tries to find the inherited elements that cause the disease by using Gene Chips which is the best findings of Genetics so far available to find those who are liable to this disease to protect them. * The hereditary componants of blood cancer:- This disease represents one third of the children who develop Leukemia. This research which a joint venture between SQU College of Medicine and Texas Medical Centre in the USA aims at making comparisons between the type of cure adopted in both countries. Differences have been noticed in the disease between children suffering from the same disease in the Texas Medical Centre and Oman. While in USA, relapse occurs in children after treatment with the possibility of a good chance of recovery after renewal of treatment, in Oman relapse occurs during treatment and the chance of recovery is very low. Therefore through comparison of Genetic Medicine in Omani and American patients the causes of difference in the results of treatments and the reasons for early relapses in Omani patients will be discovered and thereafter treatment methods would be improved for better results. In addition to the above mentioned aims the project tries to introduce new techniques by training Omani researches and Scientific Research in Oman : Quick Review 11 AL-MARKAZI June - July 2001

12 technician in advanced genetics studies. This will make the corner stone for scientific research in this respect at the Sultan Qaboos University. * Establishing a Strategic Policy for Information Technology:- This study which is conducted by college of Engineering includes four aspects:- - Infrastructure For Information Technology, E-Commerce, E- Government And Manpower Training. The research team will modernize the basis of national infrastructure for information and make a dynamic design for it. It will then build a strategy to fully utilize the information technology in all spheres of national economy. The team will also suggest means of utilizing the information technology by the government and be friend it to the public and keeping it under control. The team will also establish a lab for information technology to be used in promoting the national infrastructure for information technology and make available training of high standard for Omani cadres, AL-MARKAZI June- July 2001 This project conducted by the College of Science at the university aims at utilizing the various living things to discover the raw-materials of medical and agricultural value. Therefore the research team will study and investigate the plants used in popular medicine to treat disease and to identify the microorganisms from different environments to study the antibiotics found in them. - Promotion of quality and productivity of the date - trees:- Dates are one of the most important harvests of Oman. The total production in 1994 was about 173 thousand tons of which 45 thousand tons were consumed locally and 2.2 thousand tons were exported. Therefore 72.7% of the total production remains outside the economic circle. The research project aims at strengthening the role played by the date tree in the promotion of the national economy by raising the productivity, promoting quality, industrialising and utilize it in the promotion of agricultural products and utilizing the residue or remains in animal feeding The variety of living things in Oman and the possibility of finding compounds of medical and agricultural value:- Final Recommendations:- 1. There is the persistent need to adopt a national strategy for R&D on condition that a national independent team controls the implementation of the strategy. That is due to the importance of the scientific research activities in achieving the development goals represented by: diversification of national income, building of human cadres, strengthening the competitive capability of production and services sectors. This set up is supposed to be administered by academics known for their contributions in scientific research. The centre decides on the priorities of scientific research and works on generation of local technology and importing it from abroad. 2. Quickly increasing the scientific research budget as the level of the present expenditure is very low. Scientific Research in Oman : Quick Review

13 Experiences of other countries have proved that states which want to achieve constant and competitive development have to allocate not less than 2 percent from its Gross Domestic Product (GDP) to meet the needs of R&D (South Korea for instance spends 5% of its GDP on R&D). In the case of the Sultanate the amount allocated for R&D in the year 2000 was supposed to be RO 150 million. It is important that SQU should look for ways of allocating the greatest possible amount of its budget to be spent on scientific research so that it can reach the international level of 35% of Universities budgets. It is also vital to give incentives to the private sector to benefit from the services of R&D to ensure that researches meet the actual needs of the society. 3. Investment in human capital is the corner stone in the establishment of a national scientific capability which would quickly change the situation of a country. It is therefore important to adopt plans to increase the number nationals involved in research to reach at least 1000 in each 1 million citizen. The Sultanate has one of the lowest levels in the region. It is important to mention that UNESCO advises countries whose capita per head is 100 to 200 dollars to have at least 1400 researcher in every million citizen and at least 10% of these researchers work in R&D. The world Bank report for the year 2001 states that the percentage in Sweden 3826 researches in every million citizen and in Singapore, 2318 researcher and in Cost Rica 532 researcher in every million citizen. It is also very important to train the assistant academics and technicians. 4. Concentration on establishment of scientific centres of specialization is needed in the country as a means to help in diversification of national income to sources such as desalination of water, cultivation of arid lands, information technology, utilization of solar energy and cultivation of sea. It is better to concentrate on two fields only spending money and effort on them for excellence and perfection. 5. Establishment of research competitions in applied sciences and mathematics at various levels. The declaration of Sultan Qaboos competition for mathematics was a great hit. It is possible to develop the prize to include other scientific fields such as (Physics, Chemistry, Engineering sciences, Medicine, information technology and it include generation of both researchers and students. In addition to that it is important to give special care to scientific journals beside scientific magazines for the general public or special groups. It is also important to issue series of books in different scientific specialization and to motivate transaction of scientific books into Arabic Scientific Research in Oman : Quick Review 13 AL-MARKAZI June - July 2001

14 IAS 39 Financial Instruments: Recognition and Measurement By Nasser al Mughairy, FCCA Partner Abu Timam Auditing & Accounting Services The IAS 39, Financial Instruments: Recognition and Measurement, issued in March 1999 establishes principles for recognising, measuring, and disclosing information about financial assets and financial liabilities. The standard is effective from period commencing 1 January 2001, although adoption of the standard is encouraged at the earliest. In light of the sensation it has caused in town especially as result of its early implementation by one or two organizations in Oman, Al Markazi has Nasser Al Mughairy explaining why the standard is needed and the key features involved. AL-MARKAZI June- July IAS 39 Financial Instruments : Recognition and Measurement

15 Background O man laws require that all financial statements of commercial entities should be prepared in accordance with International Accounting Standards (IAS) issued by International Accounting Standard Board (IASB). There are now 41 International Accounting Standard all together. They are all mandatory if the financial statements prepared using IAS are to be considered fairly stated. In fact, auditors are under obligation to state in their report even if a single standard is not complied with by the reporting entity. Many countries already endorse International Accounting Standards as their own either without amendment or else with minor additions or deletions. Furthermore, important developments have taken place in the last two years in the European Union. Austria, Belgium, France, Germany, Italy, and Spain have passed laws allowing certain companies to use IASB standards for domestic reporting purposes, subject to certain conditions. In June 2000, the European Commission issued a Communication proposing that all listed companies in the European Union would be required to prepare their consolidated financial statements using International Accounting Standards. Already, both inside and outside the EU, many leading companies have stated that they prepare their financial reports in accordance with International Accounting Standards. When the IASC Board voted to approve IAS 39 in December 1998, the Board noted that, at about the same time, the United States had adopted new standards on derecognition, derivatives, and hedging, and that other countries did not have comprehensive standards on accounting for financial instruments. Consequently, the IASC Board recognised that there is little experience in applying principles similar to those in IAS 39 in most countries. Therefore Oman is not alone in facing difficulties in implementing IAS 39. Although the standard applies to all companies, its affects will be more felt by companies with large investment portfolios, dealing in derivatives and/or use derivatives in hedging their financial risk exposure. Banks and other financial institutions in Oman are certainly on the front of the industries to be effected. Why a standard is needed for the financial instruments? Before the introduction of IAS 39 there were no rules in IAS on either measurements of derivatives and hedge accounting. The requirements in IAS 25 for investments were highly flexible. IAS 39 sets outs, for the 15 IAS 39 Financial Instruments : Recognition and Measurement AL-MARKAZI June - July 2001

16 first time, requirement for the recognition, derecognition and measurement of derivatives, all monetary assets and liabilities (collectively known as financial instruments) on the company s balance sheet and its equity investments. The need for measuring financial instruments especially the derivatives (previously kept off balance sheet all together), increased its importance when many financial institutions such as Baring were failing resulting from derivative instruments. The concern in the increase risk exposure as a result of increased use of derivatives especially in hedging of financial transactions got the IASB and other national standard setters to develop a standard specifically dealing with financial instruments. instruments in That effort led first to Exposure Draft E 40 (1991) and then E 48 (1994), neither of which was finalized due to critical comments received. In 1994 the Board decided to approach the project in phases. The first phase dealing with disclosure and presentation was completed in March 1995 when IAS 32 was issued. Phase two of the project is dealing with recognition and measurement of financial instruments. In March 1997, the Board published a comprehensive discussion paper proposing measurement of all financial assets and financial liabilities at fair value with fair value adjustment included in the net profit or loss. the reliability of the fair value measure; whether investors and creditors will find those measure useful for all types of financial assets and liabilities, including those with fixed maturities; and the prospects of including unrealised gains and losses, particularly on an entity s own debt, in the Profit and Loss Account The Board acknowledged that adopting the standard along the lines of the discussion paper a realistic possibility in the short term. However, because of the shortcomings and the continuing growth in the use of financial instruments the Board went ahead with and issued an interim standard. IAS 39 is the result of that effort. The IASB began developing a comprehensive standard on financial Concerns were expressed by respondents about: Is IAS 39 the ultimate solution on financial instruments? The answer is Measured at fair value (unless the fair value cannot be reliably measured) Measured at fair value (unless the fair value cannot be reliably measured) Maintained at amortised cost, less reductions for impairment or uncollectibility Maintained at amortised cost, less reductions for impairment or uncollectibility Financial assets held for trading Available for sale financial assets Held to maturity investments Loans and receivables originated by the enterprise and not held for trading AL-MARKAZI June- July IAS 39 Financial Instruments : Recognition and Measurement

17 probably not. As I mentioned earlier, IASC is constantly reviewing the standards with the aim to improve them. Next phase will be to remove the inconsistencies in measurements which exist in IAS 39 by ensuring that all financial instruments are carried at fair value and that all gains and losses are taken to net profit or loss. IASC is working in with other national standard setter to come up with a comprehensive standard on financial instruments. But until such time the new standard is set IAS 39 is the only available standard on measuring financial instruments. What are the key features of IAS 39? Under IAS 39, all financial assets and financial liabilities are recognized on the balance sheet, including all derivatives. They are initially measured at cost, which is the fair value of whatever was paid or received to acquire the financial asset or liability. The broad categories of the financial assets and how to remeasure them after the initial recording is given below: As can be seen from the above table how you classify the financial assets will determine their value in the balance sheet. Identification and classification is therefore very important as manipulation can take place depending on management s intention. For instance, Company A and Company B holding same type of investments can measure them differently depending on the intention whether available for sale or held to maturity. It is important to note that the sprit of the standard is to measure all financial instruments at fair value. Measurements other than fair value allowed by the standard should be considered as exceptions. As for most financial liabilities, subsequent to initial recognition their fair value will be the same as the original recorded amount less principal repayments and amortisation. Only derivatives and liabilities held for trading (such as securities borrowed by a short seller) are remeasured to fair value. IAS 39 establishes conditions for determining when control over a financial asset or liability has been transferred to another party (known as derecognition). The significance of setting conditions for derecognition is to avoid off balance sheet finance. A simple example would be for Company A to sell a receivable (factoring) to Company B but retain control of the debt. Before IAS 39 Company A could remove the receivable from its balance sheet and not to recognize funding in the liabilities. How to treat the adjustment to fair value? For those financial assets and liabilities that are remeasured to fair value, an enterprise will have a single, enterprise-wide option either to: (a) recognise the entire adjustment in net profit or loss for the period; or (b) recognise in net profit or loss for the period only those changes in fair value relating to financial assets and liabilities held for trading, with the non-trading value changes reported in equity until the financial IAS 39 Financial Instruments : Recognition and Measurement 17 AL-MARKAZI June - July 2001

18 asset is sold, at which time the realised gain or loss is reported in net profit or loss. For this purpose, derivatives are always deemed held for trading unless they are designated as hedging instruments. In my view the standard should not have given organizations choices of treatment otherwise performance between organization choosing different treatments may not be comparable. On initial adoption of IAS 39, adjustments to bring derivatives and other financial assets and liabilities onto the balance sheet and adjustments to remeasure certain financial assets and liabilities from cost to fair value will be made by adjusting retained earnings directly. How to measure fair value? Where there is quoted market price for a financial instrument the fair value of the instrument will equal to its quoted market price on the date of valuation. Where there is no active market price for the instrument the standard has the following recommendations: The market price for similar instrument Other reliable measure such as net present value of future cash flow Where the fair value of the financial instrument can no longer be measured because reliable measure ceases to exist, In such rare situations, the standard allows the existing fair value to be treated as amortised cost with no adjustment for the gains or losses previously taken to the Profit and Loss Account. What are derivatives? IAS 39 defines a derivative as a financial instrument: (1) whose value changes in response to the change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or similar variable (sometimes called the underlying ); (2) that requires no initial net investment or little initial net investment relative to other types of contracts that have a similar response to changes in market conditions; and (3) that is settled at a future date. The definition itself is enough to confuse an average layman. However, derivatives is a specialized subject we can be forgiven if we admit not understanding them. How do you initially measure and include derivatives in the balance sheet as the definition states that they require little or no initial investment? If we take a forward contract as an example, the contract will initially be recorded at zero cost and subsequently measured at fair value and the gain or loss recorded in the Profit and Loss Account. Using derivatives for hedging financial risks is another complex subject covered by the standard. In short the standard gives strict guidelines that limit the use of hedge accounting. AL-MARKAZI June- July IAS 39 Financial Instruments : Recognition and Measurement

19 Conclusion For entities affected by the standard in a big way will have to make certain changes, which may or may not, include change their accounting systems in preparation for the implementation of the standard. Some of the issues to be addressed are: Financial instruments in particular derivatives are specialized financial assets and liabilities and not many organization or even their auditor get to deal with them on a daily basis. Changes in the systems and procedures may be required in preparation for implementation the standard; Accounting and classification of investments and other financial assets will need to be reconsidered; Collection and flow of information will definitely change; Training will be needed to ensure the concern employees are prepared for the changes. You can imagine the complexity of recognizing and measuring financial instruments, especially derivates and hedging accounting and the task of incorporating them in the financial systems. I do not claim to understand how they all work, for that matter not many organizations in Oman will ever have to deal with such transactions. However, when one reads IAS 39 and sees all these terminology one gets the impression that life is being complicated unnecessarily. Unfortunately the standard setters do not prepare simplified versions of standards for countries or organizations with less complex transactions. IAS 39 Financial Instruments : Recognition and Measurement 19 AL-MARKAZI June - July 2001