CENTRAL BANK OF OMAN - Polymer Bank Notes of the World

CENTRALBANK OF OMANA N N U A L R E P O R T 2 0 0 7

P.O. Box 1161, Ruwi, Postal Code 112, Sultanate of OmanTel: (968) 24702222 Fax: (968) 24788513Website: http://www.cbo-oman.orgE-mail: cboresb@omantel.net.om

Central Bank of OmanAnnual Report2007July 2008

H.M. Qaboos bin Said, Sultan of Oman

CENTRAL BANK OF OMANBoard of GovernorsH.E. Dr. Ali Mohammed MoosaThe Deputy ChairmanH.E. Mohammed Nassir Al-KhusaibiMemberH.E. Hamood Sangour Al-ZadjaliMemberH.E. Yahya Said Abdulla Al-JabriMemberMr. Mohsin Haidar DarwishMemberDr. Hatem Bakhit Al-ShanfariMember

ORGANISATION CHART (CBO)The Board of GovernorsAudit CommitteeExecutive President’s OfficeInternal AuditBanking Oversight,Market Operations & AccountingEconomic Research& StatisticsFinance, Payments &Corporate SupportSettlementsBankingInvestmentExaminationEconomicResearch &Payments CurrencyStatisticsHumanResourcesManagementBankingDevelopmentTreasury Gulf CooperationCouncil/InternationalFinancialFinance Salalah BranchBankingResearch &OrganizationsInternationalSohar BranchSurveillanceMarket AnalysisSettlementsInformationTechnologyMonetaryLegalCBFSOperationsAccounting& BankingOperationsSystems, Projects& OrganizationDevelopmentAdministration &Corporate RelationsCommunication& CorporateRelationsAdministration

CONTENTSPageForeword.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1Chapters1. Overview and Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52. Output, Employment and Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153. Oil and Gas. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .374. Public Finance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .475. Money, Banking and Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .656. Foreign Trade and Balance of Payments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95Central Bank Accounts and Regulations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117Statistical Appendix.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139

FOREWORDThe Central Bank of Oman considers it a privilege and takes pleasure in presenting its Annual Report for theYear 2007 to His Majesty, Sultan Qaboos bin Said, Sultan of Oman.Oman’s macroeconomic performance in 2007 continued to remain impressive, characterized by strongeconomic growth, further acceleration in the diversification momentum, significant creation of additional jobopportunities, large surpluses in the fiscal and balance of payments positions, and stable domestic monetaryand financial conditions. Oman’s nominal GDP growth at 12.9 percent in 2007 represented a phase of robustgrowth over 4 consecutive years. The growth process was also driven by non-petroleum activities, whichregistered a growth of 18.3 percent in 2007. Progress on economic diversification was also evidenced by the58.9 percent growth in Oman’s non-oil exports. Reflecting the strong balance of payments position, CBO’sforeign assets expanded by RO 1733.9 million during 2007 to RO 3662.1 million at the end of 2007, which wasequivalent of 7.2 months of cover for merchandise imports. The sound fiscal policy environment was evidentin strong expansion in capital expenditure, low Government debt in relation to GDP, sustained surpluses, andfurther addition to Government’s foreign assets. Oman’s inflation at 5.9 percent in 2007 was part of the globalas well as regional trend, and high food and commodity price inflation remained as a global policy challengein 2007.The monetary condition in 2007 was characterized by strong growth in broad money supply (M2) andcommercial bank credit to the private sector by 37.2 percent and 38.8 percent, respectively, which thoughreflected the demand for money and credit in a fast growing economy. CBO used its liquidity absorptioninstruments prudently to manage the persistent surplus liquidity conditions in the banking system. Despiteglobal financial market uncertainties, Oman’s banking system remained stable and resilient, with strongercapital levels, improved asset quality, and noticeable surge in profits. Net profits of commercial banks, whichhad almost doubled over a period of two years from RO 79.4 million in 2004 to RO 162.9 million in 2006, rosefurther to RO 213.7 million in 2007.The Central Bank of Oman acknowledges with utmost appreciation the cooperation and support it has beenreceiving on a sustained basis from the Government, commercial banks and other institutions in Oman. Italso takes this opportunity to place on record its deepest appreciation for the management and the staff of theBank for their commitment to work and excellent and progressive contributions to the smooth and efficientfunctioning of the CBO.Dr. Ali Mohammed MoosaMinister of Health& The Deputy Chairman, Central Bank of OmanCentral Bank of OmanAnnual Report 2007

Overview and OutlookCHAPTER ONE

OVERVIEW AND OUTLOOKInternational Economic SettingFor an open and oil dependent economy like Oman, whichalso operates with a fixed peg to the USD, internationaleconomic developments could have a significant conditioninginfluence on the performance and prospects of the domesticeconomy. In 2007, the international economic environmentwas dominated by concerns associated with high food andenergy prices, sub-prime related stress in global financialsystems and subsequent slowdown in global economicgrowth, large volatility in asset prices and exchange rates,and the sharp easing in monetary policy stance in the US.While world growth remained high for the fourth consecutiveyear, economic activities started decelerating sharply in thelast quarter of 2007 in the advanced countries, led by strongrecessionary forces operating in the US. According to theIMF Projections in its April 2008 World Economic Outlook,world growth could fall significantly from 4.9 percent in2007 to 3.7 percent in 2008, with the US expected to slideinto a mild recession. For a country like Oman, which aims atstrengthening export-led economic diversification, slowdownin global growth could operate as a deterrent. Unlike theadvanced economies, however, growth in developing andemerging market economies has been projected to remainstrong, and because of greater energy and commodityintensity of growth in these economies, oil and commodityprices have been projected to remain high. According to theIMF, inflation could increase from 2.2 percent in 2007 to2.6 percent in 2008 in advanced economies, and from 6.4percent to 7.4 percent in developing and emerging marketeconomies during the same period. For an open economylike Oman, worsening global inflationary conditions couldpartly influence the domestic inflation outcome.International oil markets witnessed further price pressures,with price of West Texas Intermediate (WTI) crude rising fromabout USD 60 per barrel at the beginning of 2007 to USD 95per barrel by the end of 2007, and then accelerating to aboutUSD 135 per barrel in May 2008. The international oil pricedevelopments exerted considerable pressures on globalinflationary conditions, despite many national Governmentstaking measures to prevent full pass-through of oil priceincreases to domestic inflation. Oil exporting countries likeOman, while benefiting from the high oil prices in terms ofhigh growth in GDP and large fiscal and balance of paymentssurpluses, had to also face the indirect consequences of highoil prices. While higher World inflation under the pressureof high oil prices could partly get imported to oil exportingcountries, high oil prices may often facilitate higher expansionof aggregate demand in the oil exporting countries while alsooperating as a key source for easy liquidity expansion.Unprecedented increases in the prices of food articles in2007-08 emerged as a key global policy concern, and nationalinflation conditions of most countries of the world cameunder the pressure of high food prices. According to the FoodPrice Index of the Food and Agriculture Organisation (FAO),food prices increased by 57.1 percent in March 2008 overMarch 2007, with cereals (i.e. wheat, rice and maize) pricesrising by 88.1 percent, edible oil and fats by 106.5 percent,dairy products by 48.4 percent, sugar by 26.1 percent andmeat by 9.9 percent. According to the IMF, increase in foodprices accounted for almost 45 percent of the overall globalheadline inflation in 2007 for major industrial and emergingeconomies. Reflecting the global trend, Oman had to contendwith 10.8 percent inflation in food articles in 2007.In addition to worsening global inflationary conditions,Central Bank of OmanAnnual Report 2007

CHAPTER ONEsustained depreciation of the USD and sharp monetaryeasing policy adopted by the Fed created additional pressureson countries operating with fixed exchange rate regimespegged to the USD, as they were exposed to both importedinflation as well as imported easy monetary policy. Whilethe Fed reduced the Fed Funds Target Rate sharply by 325basis points between August 2007 and April 2008 to as lowas 2 percent, leading advanced country central banks alsoinjected large volumes of liquidity into the global financialmarkets. IMF’s Regional Outlook for the Middle East andCentral Asia highlighted in this context in May 2008 thatboth high oil prices and low interest rates could stimulatedomestic demand further in the GCC region, and thereby addto inflationary pressures.The sub-prime related financial turmoil had global systemicramifications, as the crisis turned deeper and broader overtime. According to the estimates presented in April 2008Global Financial Stability Report, the global financial systemhad already suffered losses and write-offs of about USD 945billion by March 2008. Oman’s financial system remainedlargely resilient and insulated, even though regulatory andsupervisory responses that may evolve from this crisis couldhave common relevance for every country.Domestic Macroeconomic DevelopmentsThe strong macroeconomic performance of Oman in 2007was evident in robust economic growth, large creation ofadditional employment opportunities, significant progresson economic diversification, sustained surpluses in the fiscaland balance of payments positions, low and declining levels ofpublic debt, comfortable levels of foreign exchange reserves,and a sound and resilient banking system. In recognitionof this impressive performance, Capital Intelligence raisedOman’s foreign currency ratings by one notch to A(longterm)/A1(short-term)in April 2008; Moody’s reaffirmed theirA2 rating with a stable outlook in March 2008; and Standard& Poors (S&P) also reaffirmed the rating of A with a stableoutlook in March 2008. Global Peace Index for 2008 alsoranked Oman as number one in the Middle East and NorthAfrica (MENA) region, while assigning a rank of 25 in theoverall world relative ranking. The Heritage Foundation’sIndex of Economic Freedom also ranked Oman at 3rd placeamong 17 countries in the region, while giving 42nd rankin the world, which reflected Oman’s congenial investmentatmosphere ensuring freedom to start, operate and closebusiness, low tariff and trade barriers, and low taxes andattractive foreign investment policy. The World Bank’sDoing Business Report for 2008 also ranked Oman at 49among 178 countries. Oman’s policy emphasis on opennessas an instrument for promoting “efficiency, competitionand productivity”, and liberal commitments given underWTO and bilateral free trade agreements, have deepened theprocess of globalization and opened up new opportunitiesand challenges for Oman. The domestic policy emphasis on“diversification, privatization and Omanistaion” alongsidegreater “openness” has created dynamic growth impulsesin the system that could make the growth process moredurable and sustainable. This is evident from the impressiveperformance of different sectors of the economy in 2007.Economic GrowthFor the fourth consecutive year, Oman experienced robusteconomic growth, which was also highly employmentintensive. Most notably, the 12.9 percent GDP growth in2007 was driven by significant acceleration in non-oilactivities. Non-petroleum activities witnessed 18.3 percentgrowth in 2007, and the share of non-petroleum GDP in totalGDP was as high as 56 percent. Despite the healthy progresson economic diversification in recent years, the dependenceon oil and gas continued to be substantial, since besidesthe direct contribution of oil and gas to GDP, the indirectcontribution to diversification has also been considerablein the form of oil and gas based industrialization as well as Annual Report 2007 Central Bank of Oman

Overview and Outlookexpansion in aggregate demand through fiscal spending ofoil and gas income that generates supply response in themanufacturing and services sectors.Employment GrowthThe high growth phase in Oman has been particularlyremarkable because of its employment-intensity, which hasalso facilitated better distribution of the benefits of growthin the economy. According to data on registrations with thePublic Authority for Social Insurance (PASI), employmentof Omanis in the private sector increased by 15.3 percentin 2007. In view of the persistent challenge of creatingadequate gainful employment opportunities for the Omanis,sustaining an employment-intensive growth process in theprivate sector assumes critical importance at the level ofmacroeconomic planning and policy making. In view of thehigh demand for labour during this robust economic growthphase, there was an unprecedented increase in the numberof expatriate labour by 213,659 in the private sector over twoyear period 2006 and 2007 to a total of 638,447 at the endof 2007 (which increased further to 680,099 at the end ofMarch 2008). Employment growth for the expatriates, thus,remained very high at 25 percent in 2007, over and above 20.2percent growth seen in 2006. While such high dependenceon expatriate labour was an unavoidable necessity forsustaining high growth and economic diversification, it hadits adverse implications for the economy as a whole in termsof pressure on inflation from the wage-rent spiral, as wellas large increase in outflow of foreign exchange from thecountry in the form of remittances.InflationInflation remained as the key macroeconomic policy concernin 2007, since besides its direct effects in terms of erodingpurchasing power of income of the public in general, it alsooperated as a constraint to higher economic growth. Inflationas measured by the annual percentage change in the averageConsumer Price Index (CPI) for the Sultanate has exhibited arising trend, from 0.7 percent in 2004 to 1.9 percent in 2005,3.4 percent in 2006, 5.9 percent in 2007 and 10.5 percent inthe first quarter of 2008. Several external and supply sidefactors have largely conditioned this inflation trend, andthese sources of inflation are not sensitive to domestic policyactions. That has been a major challenge for anti-inflationarypolicy making in Oman. The entire world came under thepressure of a food crisis in terms of large increases in pricesof basic food items, and like many other open economiesOman had to import this external effect. Moreover, while thedepreciation trend of the USD persisted in 2007, the US hadto sharply reduce the domestic interest rates to deal with thesub-prime related concerns for economic recession. Given thefixed peg of the RO to the USD, in addition to the importedinflation stemming from USD depreciation, Oman had to alsoimport the easy monetary policy stance of the Fed. Therewere also several supply side constraints domestically, thattested the absorptive capacity of the economy. Large increasein employment opportunities for expatriates had its effectsin terms of wage-rent spiral, which played a significantrole in worsening the inflation conditions. On the demandside, high economic growth raised the overall per-capitaincome in the country, and favourble oil prices facilitatedhigh growth in public expenditure. Reflecting the growth indemand resulting from high economic growth, money andcredit growth also remained high. Strong rally in the MSMin 2007 created positive wealth effect, which added furtherpressure on aggregate demand.In the sphere of policy making, based on the assessmentof different sources of inflation, and given the constraintof insensitivity of most external and supply side factorsto domestic policy changes, the Government and the CBOadopted appropriate policy measures in several areas. TheGovernment measures were broadly in the form of higherwages and salaries to offset the impact of inflation inducedCentral Bank of OmanAnnual Report 2007

CHAPTER ONEerosion in purchasing power, administrative caps on rent,and subsidized provision of certain basic essential fooditems. Despite the constraint on independent monetarypolicy because of the fixed peg, CBO raised the ReserveRequirement and increased the volume of CD auctions forabsorption of surplus liquidity from the system.Oil and GasThe overall structural character of the economy continued tobe dominated by the oil and gas sector, accounting for 45.3percent of GDP, 75.9 percent of merchandise exports and75.8 percent of net oil revenue in 2007. The declining trendin oil production that had started in 2001 continued in 2007,with 3.7 percent fall in production. In relation to the peaklevel of oil production of 350 million barrels in 2000, thelevel of oil production in 2007 had fallen to 259.4 millionbarrels, representing a decline of 25.9 percent over the lastseven years. The first quarter of 2008, however, witnesseda healthy reversal in this trend as production increased by4.8 percent. The oil sector in general benefited from thefavourable international oil prices, and the average price ofOmani crude rose further by 5.6 percent in 2007, extendingthe trend of 22.7 percent increase in 2006, 46.0 percent in2005 and 23.6 percent in 2004.Natural gas has been a key source for economic diversificationin Oman, adding resilience to the economy through severalupstream and downstream gas-based mega projects and theassociated wave of industrialization. While production ofnatural gas rose by 1.8 percent in 2007, domestic demandfrom upstream and downstream projects has also been risingconsistently. Of the total natural gas produced in 2007,about 45.8 percent was used for LNG production by OLNGand QLNG, another 16.0 percent was used for fuel and reinjectionpurposes in the oil fields, and the government gassystem required 25.5 percent (for use in power generation,industrial estates, mining, etc.).Government FinanceFiscal policy has been a key driver of economic growthand economic development in Oman, and the strength andsoundness of the fiscal position is a major leading indicator ofthe overall macroeconomic environment of Oman. In 2007, thesound fiscal position of the country was reflected in sustainedsurpluses, significant moderation in the Government’s debtliabilities in relation to the GDP, additional large accretionto Government’s financial assets, and significant spurt ininvestment expenditure, which is essential to sustain thehigh growth impulses and the diversification momentum.While total expenditure increased by 19.1 percent in 2007,there was a healthy change in the composition of this growth,as investment expenditure rose by 41.5 percent in relationto moderate 9.2 percent increase in current expenditure.Another healthy development on the fiscal front relates to25.3 percent increase in non-petroleum current revenuesin 2007, which include both tax and non-tax revenues. Asregards tax revenues, reflecting the strong performance of thecorporates, income tax revenue increased by 119 percent fromRO 85.4 million in 2006 to RO 187.1 million in 2007, andcustoms revenue increased by 39.3 percent from RO 114.6million to RO 159.6 million, primarily on account of 46.6percent growth in merchandise imports in 2007. Under nontaxrevenues, income on government investments also rosefrom RO 369.6 million in 2006 to RO 393.3 million in 2007.Government’s outstanding debt, both external and internalcombined, fell to as low as 6.5 percent of GDP in 2007.Monetary ConditionsThe monetary and credit conditions were influenced bystrong demand for money associated with high economicgrowth, while large fiscal and balance of payments surplusesamplified the pressures on money supply. As the Fed FundsTarget Rate was also eased sharply from 5.25 percent to 2.0percent between August 2007 and April 2008 to deal with the Annual Report 2007 Central Bank of Oman

Overview and Outlooksub-prime led concern for recession, given the fixed peg ofthe RO to USD, Oman had to import the easy monetary policystance, which was reflected in sharp easing in CBO’s policyrates and inter-bank money market rates. While the weightedaverage interest rate on CBO CDs declined from 3.634 percentin December 2006 to 1.975 percent in December 2007, theovernight domestic inter-bank lending rate fell from 3.399percent to 1.470 percent during the corresponding period.Fast expansion in money and credit growth, easy domesticliquidity conditions, and declining interest rates in the faceof rising inflation created testing conditions for monetarypolicy operations of the CBO, which remained constrainedby the limitations on monetary policy independence becauseof the fixed peg of the RO to USD. While broad money (M2)and credit increased by 37.3 percent and 38.3 percent,respectively in 2007, reserve money rose by 70 percent. Thisorder of money and credit growth remained in excess of thenominal GDP growth at 12.9 percent. In the face of strongbull run in the stock market, that exhibited 61.9 percentgrowth in the MSM Index during 2007, and the generalupbeat real estate market, the need for restraining moneyand credit growth along with adequate absorption of surplusliquidity guided the conduct of CBO’s monetary policy, anddespite limitations on monetary independence, it raised thereserve requirement and the volume of absorption of surplusliquidity through CDs.higher than the regulatory minimum capital requirement of10 percent. Recognising the importance of adequate capitalfor banks operating in an open financial system, the CBOhad raised in April 2007 the entry level capital requirementfor local banks to RO 100 million and to RO 20 million forforeign banks. Commercial banks’ core capital and reservesincreased by 62 percent over the year to RO 1,458.2 millionat the end of 2007. Aggregate assets of the banking systemrose by 42.5 percent in 2007 to RO 10.3 billion, while grossNon-Performing Loans (NPLs) recorded an absolute declineby RO 33 million to just about 320 million in 2007, whichsignifies the extent of improvement in asset quality in 2007.Gross NPLs as percentage of gross loans declined to 3.2percent at the end of 2007 from 5.2 percent as at the end of2006. On account of significant past emphasis on adequateprovisioning from profits for NPLs, and the additionalgeneral provisioning policy, the loan loss coverage (i.e.available provisions in relation to outstanding NPLs)increased further from 102 percent in 2006 to 107.6 percentin 2007. Net profits of commercial banks, which had almostdoubled over a period of two years from RO 79.4 million in2004 to RO 162.9 million in 2006, rose further to RO 213.7million in 2007. Even the Non-banking Finance and LeasingCompanies (FLCs) registered a sharp 52.5 percent increasein their profits from RO 8.61 million in 2006 to RO 13.13million in 2007.Financial SystemBalance of PaymentsWhile the global financial system remained under stress onaccount of the US-sub prime related severe credit squeezeand sharp global market corrections, the banking system inOman witnessed yet another year of impressive performancein 2007, in terms of capital adequacy and improved assetquality despite fast growth in assets, besides strong furtherexpansion in profits. Capital levels of commercial banks inrelation to risk weighted assets remained adequate at 15.9percent as at the end of 2007, which was considerablyIn the face of favourable international oil prices, the currentaccount of the balance of payments continued to be insurplus, even though as percentage of GDP current accountsurplus fell significantly from 14.2 percent in 2006 to 4.8percent in 2007. This order of deterioration in the currentaccount position was driven by three major factors, namely,46.6 percent increase in merchandise imports, 31.6 percentrise in remittance payments, and 21 percent growth in incomepayments on Oman’s aggregate foreign investment liabilities.Central Bank of OmanAnnual Report 2007

CHAPTER ONEWhile oil and gas exports fetched foreign exchange incomeof about RO 7,212 million, combined foreign exchangeoutgo under import of goods and services, remittances andincome payments were much larger at RO 9,995 million. Itis largely because of strong performance of non-oil exportsand income earned on country’s foreign assets that Oman’scurrent account in the balance of payments for the year 2007still ended up with a surplus of RO 737 million. A notablehealthy development in the current account was the 58.9percent increase in non-oil exports of Omani origin to thelevel of RO 1,290.7 million in 2007. Re-exports also exhibiteda robust growth of 30.9 percent.While the current account surpluses declined by almost 62percent in 2007 over the 2006 level, the capital and financialaccount witnessed a major trend reversal, yielding netinflows of RO 1,234 million in 2007 as against net outflowsof RO 1,122 million 2006. This reversal resulted fromreduction in foreign assets and increases in foreign liabilitiesof banks as well as non bank entities, partly in response todeclining US interest rates and the market expectations of arevaluation of the RO; higher portfolio investment in Omandriven by 61.9 percent increase in MSM index in 2007;and sustained increase in inflows under foreign directinvestment. The overall balance position in the balance ofpayments, which reflects the combined effect of current,capital and financial accounts, showed a larger surplus ofRO 2,418 million in 2007 in relation to RO 849 million in2006. Reflecting the large magnitude of the overall balancesurplus, CBO’s foreign exchange reserves (net of valuationeffects) increased by RO1,710 million in 2007, besides theincrease in foreign assets of the Government. CBO’s foreignreserves at the end of 2007 stood at RO 3,662.1 million,providing cover for 7.2 months of merchandise imports and4.4 months of all gross current account payments. The 2007trend of large accretion to CBO’s foreign reserves continuedin the first quarter of 2008, and at the end of March 2008 thelevel stood at RO 4,001.7 million.OutlookContaining inflation while sustaining high growth couldremain the key macroeconomic challenge for Oman, besidesthe need for providing further momentum to economicdiversification, promoting financial stability in an open andcompetitive environment, and creating adequate productiveemployment opportunities for the Omanis. Managementof surpluses, both from the stand point of enhancing thecountry’s absorptive capacity as well as for contending withthe implications of large surpluses for domestic monetary andcredit conditions would also remain as a policy challenge,as in other similarly placed countries in the world. As anopen economy, the prospects for the global economy and theworld monetary and financial conditions could significantlyinfluence the outlook for Oman’s economy in 2008.According to July 2008 projections of Energy InformationAdministration (EIA), oil prices (i.e. West Texas Intermediate– WTI variety) in 2008 could remain 76.2 percent higher atUSD 127.39 per barrel over the average of USD 72.32 perbarrel in 2007. This order of increase in oil prices couldensure yet another year of high economic growth, whichwill be the fifth year of high growth in succession. Oman’soil production in fact increased by 4.8 percent in the firstquarter of 2008, with the average prices of Omani crudealso rising by as high as 59.8 percent. The first quarter oilsector developments in Oman, along with oil prices crossingUSD 145 per barrel in July 2008 suggest that 2008 growthprospects remain strong.The downside risk, however, could be the concern fordomestic inflation, particularly if world inflation and worldfood and commodity prices remain high, the USD continuesits depreciation trend and the US maintains its easymonetary policy stance. Deceleration in global growth andtrade could also be another downside risk, from the standpoint of affecting the prospects for Oman’s non-oil exports,which otherwise exhibited high growth in last few years,10 Annual Report 2007 Central Bank of Oman

Overview and Outlookproviding leading contribution to economic diversification.Despite notable projected slowdown in global GDP growthfrom 4.9 percent in 2007 to 3.7 percent in 2008, as per theIMF’s May 2008 outlook for the Middle East and CentralAsia, GCC countries could register a growth of 6.1 percent in2008, which in fact would be higher in relation to 5.6 percentgrowth achieved in 2007. On account of high food prices,strong domestic demand and supply bottlenecks, however,inflation in the GCC has been projected to edge up from6.1 percent in 2007 to 7.1 percent in 2008. Actual inflationexperienced in the first half of 2008, however, remainedhigher than what was expected earlier.The potential negative real effects of financial turmoil, asbeing actually experienced by the global economy in responseto US sub-prime related global financial stress, highlight theimportance of stable and resilient financial systems for everycountry. The international regulatory response to deal withthe challenges that came to the forefront from the sub-primecrisis is yet to emerge clearly, and the CBO would constantlymonitor the international best practices as they evolve overtime. The large magnitude of increase seen in oil prices inthe first half of 2008 has a notable downside risk for domesticliquidity situations in Oman, as well as for domestic moneyand credit growth. Given the fact that domestic liquidityconditions and global inflationary conditions may movein tandem with international oil prices, CBO’s monetarymanagement operations would remain constantly vigilant,with timely introduction of appropriate policy measures, asand when considered necessary.Central Bank of OmanAnnual Report 2007 11

CHAPTER TWOOutput, Employment and Prices

OUTPUT, EMPLOYMENT AND PRICESThe sound macroeconomic environment of Oman in 2007was reflected in the robust GDP and employment growthfor the 4th consecutive year, led by sustained accelerationin activities in the non-oil sectors and favourable oil prices.While the inflationary pressures continued, the benefits ofhigh growth were visible in major progress on economicdiversification, sharp increase in per-capita income andsignificant creation of additional employment opportunitiesfor the Omanis. Gross Domestic Product (GDP) at currentmarket prices registered a growth of 12.9 percent in 2007,which though reflects some deceleration in relation to 24.8percent and 15.5 percent growth achieved in 2005 and 2006,respectively. This growth deceleration largely resulted fromlower rate of increase in oil prices in 2007 in relation toprevious two years, in addition to the impact of gradual fallin oil production (Chart 2.1 and 2.2). Despite strong growthin non-petroleum activities, GDP growth behaviour stillremains dependent on the oil price cycle, and the impressiveprogress on diversification in recent years has to some extentbeen overshadowed by the large contribution of high oilprices to GDP.Petroleum activities expanded by 7.0 percent in nominalterms in 2007, but the share of petroleum activities in GDPremained high at 45.3 percent. Non-petroleum activities, inturn, registered a robust growth of 18.3 percent, powered by14.4 percent and 20.3 percent growth in industrial activitiesand services, respectively (Table-2.1). Moreover, thebuoyant economic activity was also employment intensive,as employment of Omanis in the private sector almostdoubled in 5 years, from 65,879 in 2002 to 131,775 in 2007.The aggregate demand conditions expanded considerablyunder the influence of both rising per-capita income andfast growth in employment opportunities for both Omanisand expatriates. As high economic growth coincided witha phase of adverse inflationary pressures from the externaland supply side factors, overall domestic inflationaryenvironment also changed accordingly. As measured by thechange in annual average consumer price index (CPI) for theSultanate, inflation accelerated gradually from 0.7 percent in2004 to 1.9 percent in 2005, 3.4 percent in 2006 and furtherto 5.9 percent in 2007. Management of inflation has emergedas the key policy challenge in recent years, within theChart-2.1: Nominal GDP Growth and Annual %Change in Oil PricesChart 2.2: Falling Oil Production & RobustNon-Petroleum ActivitiesCentral Bank of OmanAnnual Report 2007 15

CHAPTER TWOTable 2.1Output IndicatorsItems 2003 2004 2005 2006* 2007**GDP at current market price (RO mln) 8375.9 9524.9 11889.8 13737.7 15512.0Annual Growth (%) 7.2 13.7 24.8 15.5 12.9GDP at constant 1988 prices (RO mln) 6354.6 6694.7 7095.8 7609.1 NAAnnual Growth (%) 2.0 5.4 6.0 7.2 NAGDP deflator 131.8 142.3 167.6 180.5 NAAnnual Growth (%) 5.1 8.0 17.8 7.7 NAContributions to GDP (in per cent)#1. Petroleum activities 40.9 42.2 48.7 47.8 45.31.1 Crude Petroleum 38.3 39.6 45.1 44.3 41.51.2 Natural Gas 2.5 2.6 3.6 3.5 3.82. Non-Petroleum activities 61.0 59.4 52.7 53.6 56.22.1 Agrl. and Fishing 2.0 1.9 1.6 1.4 1.32.2 Industry 12.4 12.8 12.1 14.2 14.42.3 Services Activities 46.7 44.7 39.0 38.0 40.5Components of GDP (in per cent)a. Private consumption 43.7 44.1 35.8 38.8 NAb. Government consumption 22.1 21.3 19.3 17.9 NAc. Capital formation (investment) 15.6 20.6 17.9 18.5 NAd. Exports-Imports (goods and services) 18.6 14.0 27.0 24.8 NA*Provisional, ** Preliminary, NA: Not Available# Shares may not add up to 100 because two items are not considered here, i.e. net import taxes and financial intermediation services indirectly measured.Source: Ministry of National Economy.overall policy emphasis of attaining a pattern of sustainablehigh growth that reflects strong momentum on economicdiversification and adequate employment generation.Petroleum ActivitiesDevelopments in the oil and gas sector are discussedseparately in Chapter-3 in view of the predominant roleof this sector in the overall economic affairs of Oman. In2007, while production of crude oil declined by 3.7 percent,production of natural gas rose by 1.8 percent. Benefiting fromthe favourable price developments, the petroleum sectoroutput expanded by 7.0 percent in 2007, as value addition incrude oil and natural gas sectors rose by 5.8 percent and 21.7percent, respectively. As increasing part of crude oil andnatural gas gets used for value addition within the economy,ranging from use in refineries to gas based industries likefertilizer, petrochemicals and aluminum, as well as forpower generation and water desalination, the associatedvalue addition could get reflected in the performance of nonpetroleumindustrial activities. The oil and gas endowmentof the country, thus, is a prime source for industrializationand diversification, and the indirect contribution of oil andgas to national GDP needs to be seen along with the directcontribution in terms of the petroleum sector GDP. With thenew refinery becoming operational, the percentage of crudeproduction used for domestic refining also increased; as aresult, while total crude production in 2007 was about 259.316 Annual Report 2007 Central Bank of Oman

Output, Employment and PricesTable 2.2Gross Domestic Product at Current Market Prices(Million RO)Activities 2004 2005 2006 2007% Change(07/06)1. INDUSTRY (1.1 + 1.2) 5237.5 7227.8 8517.7 9259.0 8.71.1 Petroleum activities 4018.8 5784.6 6571.5 7033.3 7.0– Extraction of crude petroleum & incidentalservices to oil & gas extraction3771.0 5362.8 6082.1 6437.5 5.8– Extraction of natural gas 247.9 421.8 489.4 595.8 21.71.2 Non-Petroleum Industrial activities 1218.7 1443.2 1946.2 2225.7 14.4– Mining and Quarrying 21.1 24.4 23.7 33.7 42– Manufacturing 802.2 983.1 1421.7 1557.9 9.6– Electricity & Water supply 122.5 143.6 151.3 163.5 8.0– Construction 272.8 292.1 349.5 470.7 34.72. AGRICULTURE & FISHING 176.5 184.7 195.9 204.9 4.63. SERVICES 4260.4 4641.6 5225.9 6289.1 20.3– Wholesale & Retail Trade 1145.9 1240.9 1478.9 1948.6 31.8– Hotels & Restaurants 73.3 86.7 103.2 114.2 10.6– Transport, Storage & Communication 661.5 684.0 847.1 1046.5 23.5– Financial intermediation 333.3 374.8 451.6 552.9 22.4– Real Estate services 338.0 343.1 352.9 377.3 6.9– Public administration & defence 848.2 926.1 922.8 1017.4 10.3– Other Services (Education, Health Community/personal services, and Private household)860.3 986.0 1069.4 1232.1 15.24. Total Non-petroleum activities (1.2 + 2 +3) 5655.7 6269.4 7368.0 8719.7 18.35. Less: financial intermediation services indirectly measured 220.6 252.7 316.4 387.2 22.46. Gross domestic product at producers prices (1.1 + 4-5) 9453.9 11801.3 13623.1 15365.8 12.87. Plus :Import taxes 71.0 88.5 114.6 146.3 27.68. Gross domestic product at market prices (6+7) 9524.9 11889.8 13737.7 15512.0 12.9Source : Ministry of National Economy.Central Bank of OmanAnnual Report 2007 17

CHAPTER TWOmillion barrels, export of crude was about 14.4 percent lessat 222 million barrels. Similarly, out of total natural gasproduced in 2007, about 45.8 percent was used in LNG trainsand another 25.4 percent was used under the Governmentgas system for power and industrial projects. In terms ofdirect contribution to the GDP, oil accounted for 41.5 percentof GDP at current market prices in 2007 and natural gasaccounted for an additional 3.8 percent (Table-2.1 & 2.2).Non-Petroleum Industrial ActivitiesDespite limited domestic market, export-intensive industrialgrowth has been an important objective of planned economicdevelopment, which is evidenced from the fact that the“Vision 2020” has set a target of raising the manufacturingbase of the country from 5 percent of GDP in 1995 to 15percent of the GDP by 2020, and accordingly, the SeventhFive Year Development Plan (2006-10) aims at an annualaverage growth of 7.8 percent in the non-oil sector, driven by13.1 percent growth in gas-based industries. In view of thelimited domestic market size, industrialization in the formof a number of mega projects also aims at export-intensiveindustrialization. The performance of the industrial sectorin 2007 remained in tune with the planned objectives,recording a growth of 14.4 percent. Manufacturing activitiesaccounted for close to 70 percent of all industrial activities,and about 10 percent of total GDP, suggesting that the 2020vision is attainable if the progress on new gas based andother down steam projects could be sustained with furthermomentum. Strong growth in the manufacturing sector wasled by the contribution from the new oil refinery, whichis reflected by 149.2 percent increase in manufacture ofrefined products, from RO 48.2 million in 2006 to RO 120.1million in 2007. The major thrust to the manufacturinggrowth came from 20 percent increase in the output of othermanufacturing industries. Electricity and water supply alsoregistered a growth of 8 percent, reflecting rising demandfor electricity and water in a growing economy. 34.7 percentgrowth in the construction sector output reflected the resultof large scale public and private investment in infrastructuredevelopment, industrial and tourism projects, as well asother commercial properties.The Sixth Five Year Development Plan had set a target for newinvestment of about RO1.2 billion in both public and privatesectors on five major projects, i.e. Sohar Refinery Project,Sohar Methanol Project, Oman-India Fertilizer Project, Ferro-Chrome Project, and Sohar Fertilizer Project. The SeventhPlan (2006-10) aims at carrying the process forward witha targeted annual average growth of 7.8 percent in non-oilsectors, led by 13.1 percent growth in gas-based industries.In the public sector, the investment plan for the gas basedprojects amounts to RO 3.3 billion, which include majorprojects like the Sohar Aluminum Smelter, Ployethylene andOman Aromatics. The private sector investment plan for gasbasedindustries amounts to RO 1.6 billion.Agriculture and FishingFor an open economy like Oman, and given the limitedavailability of cultivable land with irrigation facilities, theprogress on agriculture and fishing is influenced by the easyavailability and relative costs of imports. In the context ofsharp increase in world food prices and the associated costsfor the economy in terms of imported inflation, there is animperative need for increasing domestic production to makethe growth process of Oman more resilient to external priceshocks. The agriculture and fishing sectors, however, havebeen going through a phase of stagnation in recent years, asper data on real output. In terms of nominal GDP, however,agriculture and fishing sector showed a growth of 4.6 percentin 2007, which largely explains the effect of rising pricesrather than increase in real output. As per the vision set forthe agricultural sector in Vision 2020, its contribution toGDP is expected to be raised to 3.1 per cent by 2020, with anannual growth rate of not less than 4.5 per cent. The Vision18 Annual Report 2007 Central Bank of Oman

Output, Employment and Pricesfor the fishing sector also aims at raising its contribution toGDP to about 2.0 percent by 2020, with a targeted averageannual growth of 5.6 per cent. In 2007, however, the shareof agriculture and fishing sectors together in GDP was onlyabout 1.3 percent. Moreover, in last four years, nominaloutput in the agriculture and fishing sector increased byabout 16 percent from RO 176.5 million in 2004 to RO 204.9million in 2007, but in real terms at constant price the outputlevel has remained almost unchanged.ServicesWith the near doubling of aggregate GDP over last five yearsand the associated sharp increase in per-capita income,demand for services has seen a fast growth, which facilitatedstrong growth in services in recent years. Augmentingdomestic supply of efficient services at competitive prices isessential to contain the leakage of domestic income throughhigher services imports in an open trade environment. Whileliberal commitments given under WTO and trade agreementsare expected to raise the availability of services by foreignservice providers in Oman, that could make the domesticmarket for services more competitive as well. The larger thepercentage of demand for services that could be met in thedomestic market, the higher could be the scope for strongergrowth of services and its contribution to Oman’s GDP. Tothe extent that demand for services depends on the oil-pricedriven increases in per capita income, services sector growthcould be conditioned significantly by oil price cycles. Thissignifies the importance of insulating growth in per-capitaincome from the oil price cycle so as to make the growthprocess more sustainable and resilient. Given the high shareof services in GDP at 40.5 percent (66.2 percent in constantprices), and the high dependence of services sector’s growthon domestic demand, stabilizing domestic demand could becritical to sustain the high growth in services sector GDP. In2007, value added in the services sector registered a growthof 20.3 percent as against 12.6 percent in 2006. “Wholesaleand retail trade”, accounting for about 31 percent of servicessector GDP, registered a high growth of 31.8 percent in 2007.“Transport, storage and communication” and “hotels andrestaurants” also registered high growth at 23.5 percentand 10.6 percent, respectively, and together accounted forabout 18.8 percent of service sector GDP. These three sectorsaccounting for close to 50 percent of total services sector GDPremain highly sensitive to domestic demand fluctuations.Growth in “financial services” sector has been impressivein recent years, with value addition in this sector morethan doubling in last six years, driven by sharp increases inprofits, particularly in 2006 and 2007. Performance of thefinancial sector, to some extent, is also conditioned by thefavorable oil prices and high overall economic growth inthe country, and hence, greater deployment of bank financesfor productive activities that could strengthen the forcesof economic diversification may be necessary to make thefinancial sector more resilient and stable.Tourism sector has received considerable policy focus inrecent years, based on its strong potential as a key source forsustainable economic diversification. The Sixth Plan had seta target of achieving annual growth of about 6.1 percent in thetourism sector. The actual average growth performance at 9.9percent per annum exceeded the Plan targets, but at the end ofthe Sixth Plan in 2005 the share of “hotels and restaurants” inGDP remained modest at only 0.7 percent. The Seventh FiveYear Development Plan (2006-10) retains the priority focus ontourism, with a planned annual growth target of 7.0 percent,and proposed investment of RO777 million in the publicsector and RO 563 million in the private sector.GDP at Constant PricesGDP at constant prices, implying GDP of the current yearvalued at the prices prevailing in the base year 1988, registereda growth of 7.2 percent in 2006 as against 15.5 percent growthin GDP at current prices in the same year. (It may be notedCentral Bank of OmanAnnual Report 2007 19

CHAPTER TWOthat data on GDP at constant prices for 2007 are not availableas yet.) Unlike the GDP at current prices, which reflects thecombined effect of output produced and price increasesrecorded during a period, GDP at constant prices shows onlythe output effect, and hence, this concept of GDP is oftenviewed internationally as the appropriate reference indicatorfor growth analyses. In the case of oil exporting countries likeOman, however, petroleum sector has a large contributionto GDP and high international prices of petroleum productsin essence add real purchasing power to part of the nominalGDP, and therefore, both nominal as well as real GDP couldbe used for macroeconomic analysis in such countries.Published GDP data for Oman, both at current and constantprices, relate to market prices and not factor costs. As couldbe seen from Table 2.2 and 2.3, since net import taxes are verymodest, annual growth rates in GDP at market prices and atfactor costs turn out to be more or less similar.The 7.2 percent real growth achieved in 2006 showsacceleration in growth momentum in relation to the past,even though nominal growth shows deceleration in both2006 and 2007 in relation to 2005. The robust real growth in2006 could also be achieved because of strong accelerationin growth in the non-petroleum activities, as the petroleumsector’s performance continued to be affected by the decliningtrend in oil production.While petroleum activities (with 23.2 percent share in realGDP) increased only modestly by 0.5 percent, non-petroleumactivities registered a high real growth of 9.4 percent in2006. Moreover, while petroleum sector real GDP was aboutRO 1761.6 million in 2006, corresponding nominal GDP forthe petroleum sector was at RO 6571.5 million, or 273 percenthigher, which reflects the effect of high international pricesfor oil and gas in recent years. In relation to the 2001 levelof peak oil production of 349 million barrels, production hasconsistently declined to 259 million barrels in 2007, i.e. by25.7 percent over past 6 years, which is reflected in absolutedecline in real GDP in the petroleum sector. Petroleumsector real GDP has declined from RO 1971.4 million in 2001to RO 1761.6 million in 2006, despite consistently risingcontribution of natural gas to the petroleum sector real GDPfrom RO 144.4 million in 2001 to RO 290.4 million in 2006.The progress on economic diversification is more strikinglyvisible from the fact that non-petroleum sector real GDP in2006 was about 240.7 percent higher than the petroleumsector real GDP, and non-petroleum sector real GDP has alsoincreased by about 42 percent from RO 4229.3 million in 2001to RO 6001.9 million in 2006. In terms of key componentsof the non-petroleum sector, while the industrial sector andservices sector registered robust growth of 11.5 percent and9.3 percent, respectively, in 2006, agriculture and fisheriescontinued to exhibit stagnation (Table-2.3). Among theindustries, manufacturing and construction sectors attainedhigh growth of 14.0 percent and 10.3 percent, respectively, in2006, reflecting the benefits of large investments in gas-basedand other industries as well as the impact of construction boomin response to growing demand for residential, commercialand infrastructure related construction activities. Value addedin electricity and water supply registered a growth of 3.43percent, and in the context of rinsing demand for electricityand water, real growth in this segment may attain someacceleration over time. Among the services, value addition in“transportation, storage and communications” surged by 27.1percent, indicating that in the absence of adequate expansionin these services, the pressure on country’s absorptivecapacity could have been even higher. “Wholesale and retailtrade” and “hotels and restaurants” exhibited high growth of10.4 percent and 7.9 percent, respectively, largely in responseto growing demand associated with strong growth in percapitaincome in the face of high and rising oil prices. Theshare of services sector in total real GDP rose to 61.7 percentin 2006 from 56 percent in 2001, suggesting the increasingdominance of services in the economic activities in Oman.Since services growth could be largely sustained by adequate20 Annual Report 2007 Central Bank of Oman

Output, Employment and PricesTable 2.3Gross Domestic Product at Constant (1988) Prices(Million RO)Activities 2003 2004 2005 2006% Change(06/05)1. INDUSTRY (1.1 + 1.2) 2586.2 2659.3 2765.4 2891.2 4.551.1 Petroleum activities 1752.7 1720.9 1752.3 1761.6 0.53– Extraction of crude petroleum &incidental services to oil & gas extraction1576.0 1513.2 1490.9 1471.2 -1.32– Extraction of natural gas 176.8 207.7 261.4 290.4 11.091.2 Non-Petroleum Industrial activities 833.5 938.4 1013.1 1129.6 11.5– Mining and Quarrying 11.6 17.6 18.2 16.7 -8.24– Manufacturing 500.4 519.9 572.7 652.9 14.0– Electricity & Water supply 121.0 135.4 140.0 144.8 3.43– Construction 200.5 265.5 282.1 311.2 10.322. AGRICULTURE & FISHING 175.7 177.4 176.6 176.6 –– Agriculture 133.6 136.3 135.8 136.5 0.52– Fishing 42.0 41.1 40.8 40.1 -1.723. SERVICES 3731.9 3990.7 4294.5 4695.7 9.34– Wholesale & Retail Trade 932.4 1017.4 1090.4 1203.6 10.38– Hotels & Restaurants 68.5 85.4 91.0 98.2 7.91– Transport, Storage & Communication 685.5 761.7 825.7 1029.3 27.14– Financial intermediation 298.4 293.1 322.6 365.9 13.42– Real Estate services 384.4 405.2 425.8 441.4 3.66– Public administration & defence 749.0 775.0 825.7 806.3 -2.35– Education 360.1 390.2 444.0 461.7 3.99– Health 130.9 137.9 152.7 156.4 2.42– Other community/personal services 100.0 102.3 110.3 110.4 0.09– Private household with employed persons 22.5 22.5 22.5 22.5 –4. Total Non-petroleum activities (1.2 + 2 +3) 4741.1 5106.5 5484.2 6001.9 9.445. Less: financial intermediation servicesindirectly measured6. Gross domestic product atproducers prices (1.1 + 4-5)-198.0 -193.5 -216.2 -250.7 15.966295.8 6633.8 7020.3 7512.8 7.027. Plus :Import taxes 58.7 60.9 75.5 96.3 27.558. Gross domestic product at market prices (6+7) 6354.6 6694.7 7095.8 7609.1 7.23Source : Ministry of National Economy.Central Bank of OmanAnnual Report 2007 21

CHAPTER TWOdemand growth, and given the fact that demand growth issignificantly conditioned by the oil price scenario, there is aneed to ensure that the non-petroleum sector strengthens itsown growth dynamics over time, so that irrespective of theoil price cycle, the growth process of the country becomessustainable. Contribution of several sectors to the high overallreal growth of 7.2 percent in 2006 clearly suggests the benefitsof diversification. Even though strong growth performanceof these sectors generally gets overshadowed by the oil andgas sector on account of windfalls arising from high andrising oil prices, and despite the partial dependence of thenon-petroleum sector on the performance of the oil income,sustaining the growth momentum in the non-petroleum sectoris critical for long run growth sustainability and resilience.Saving and Capital FormationThe growth process in an economy is conditioned largelyby both factor endowment and factor productivity. Capitalis an important factor of production, and higher levels ofcapital formation generally add to the production capacityof a country. Recognizing the importance of annual capitalformation to sustain the growth process in Oman, the SeventhFive Year Development Plan (2006-10) aims at raising theinvestment rate to 24.4 percent of GDP from 16.3 percent ofGDP in the Sixth Plan.Gross fixed capital formation represents the value of allacquisitions, less disposal, of fixed assets by all producingunits in a country. Fixed assets for this purpose representboth tangible and intangible assets that are produced asoutput from the processes of production, but subsequentlythey get used repeatedly or continuously in other processes ofproduction for more than one year. Thus, these fixed assets areproduced as part of output to be used for production of outputin the subsequent years. Annual gross capital formation, thus,adds to the capital stock of the country, net of depreciation.Tangible fixed assets produced as part of capital formationprimarily include buildings and other construction structures(such as roads, ports, dams, etc.) as well as plant, machineryTable 2.4Gross Capital Formation and SavingItems 2003 2004 2005 2006*A. Gross Capital Formation at Current Prices (RO mln.) 1306.6 1958.1 2130.2 2545.7(i) Building and Construction 450.7 675.2 711.7 908.5(ii) Plant, Machinery, & Vehicles 537.6 949.2 1102.0 1270.1(iii) Intangible Fixed Assets 304.4 324.0 323.9 354.4(iv) Change in Inventories 13.9 9.8 -7.3 12.7B. Gross Capital Formation as % of GDP 15.6 20.6 17.9 18.5C. Gross Domestic Saving (RO mln.) 2863.6 3295.1 5342.2 5953.7Net primary income from abroad -358.0 -342.0 -753.0 -668.0Net current transfers from abroad -628.0 -687.0 -853.0 -1057.0Gross National Saving 1877.6 2266.1 3736.2 4228.7D. Gross Domestic Saving as % of GDP 34.2 34.6 44.9 43.3E. Gross National Saving as % of GDP 22.4 23.8 31.4 30.8*ProvisionalSource: Ministry of National Economy.22 Annual Report 2007 Central Bank of Oman

Output, Employment and Pricesand transport equipments. Intangible fixed assets, in turn, mayinclude the value of expenditure on exploration of minerals,including oil and gas, computer software, entertainment,literary or artistic originals, etc. Both tangible and intangiblecapital formation add to production capacity of the country.Chart 2.3: Oman’s Saving & Investment RatesInformation on Oman’s gross capital formation is availableup to 2006 (Table-2.4). Gross capital formation as percentageof GDP remained at about 18.5 percent in 2006, and theinvestment level itself rose by 19.5 percent. The 7.2 percentreal GDP growth achieved in 2006 with an investment rate of18.5 percent implies an implicit incremental capital outputratio of 2.6, which represents the high productivity of capitalin Oman. However, while capital formation in the form of“building and construction” increased by 27.7 percent in2006, those in the form of “plant, machinery and vehicles”rose by 15.3 percent. Growing public investment in creationof physical infrastructure in the country and the generalconstruction boom, thus, have contributed to strengthen thecountry’s capital formation. In 2006, the share of gross capitalformation in the oil and gas related activities alone was about35 percent, and the remaining part of the investment was innon-oil activities. While Government investment accountedfor 37.8 percent of total capital formation, the shares ofGovernment enterprises and the private sector in the totalwere about 21.7 percent and 36.5 percent, respectively,which explain the predominant role of the Government insustaining the investment growth in the country.The investment needs of an open economy could be financedby both domestic saving and inflows of foreign capital. Inthe case of Oman, domestic savings exceed the investmentlevels, leading to net outflows of financial savings from thecountry for creation of foreign assets aboard. Oman’s grossdomestic saving as percentage of GDP rose significantly from34.6 percent in 2004 to 44.9 percent in 2005, and then fellmodestly to 43.3 percent in 2006. This level of increase indomestic saving was primarily driven by the large fiscalsurpluses resulting from favourable oil price developments.Part of the gross domestic saving (which is GDP minusconsumption), however, leaked out of the system in the formof current transfers (i.e. remittances by expatriates workingin Oman) and primary income (i.e. interest and dividendpaid on external liabilities). As a result, Oman’s grossnational saving as percentage of GDP was much lower at30.8 percent, implying leakage equivalent of as high as 12.5percent of GDP under “net primary income” and “net currenttransfers”. Even after the leakage, the national saving rate of30.8 percent of GDP still exceeded the domestic investmentrate of 18.5 percent of GDP in 2006, leading to creation offoreign assets to the extent of 12.3 percent of GDP (Chart-2.3). Oman has generally been a net exporter of capital, withpart of its national saving getting invested abroad, whichis also corroborated by the surpluses seen in the goods andservices account in Oman’s balance of payments.EmploymentOne of the most congenial effects of high economic growth inrecent years has been the creation of large scale employmentopportunities for the Omanis, which not only led to theirCentral Bank of OmanAnnual Report 2007 23

CHAPTER TWObetter participation in the economic development process butalso helped them in sharing the benefits of growth. Demand forlabour in fact has remained so high that it had to be met fromexternal labour markets, which is evidenced from the sharpgrowth in expatriate labour force in both 2006 and 2007.Chart 2.4: Growth in Employment for OmanisPublic SectorCreation of adequate employment opportunities for theOmanis in a fast growing economy has been a majormacroeconomic objective of the Government. Even though agreater percentage of the new jobs are expected to be createdin the private sector because of the progress on diversificationand the encouragement being provided to private investment,the Government sector employment opportunities alsocontinued to expand. Employment in the Government sectorcomprising civil services, Diwan of Royal Court, Royal CourtAffairs and Public Corporations rose by 4.8 percent to 138,806in 2006, as against 4.2 percent in 2005. While employmentof Omanis rose by 6.1 per cent to 116,054 in 2006, that of theTable 2.5Employment Scenario in OmanItems 2003 2004 2005 2006 2007A. Public Sector Employees (A1+A2+A3+A4)* 123,045 127,121 132,414 138,806 –Omanis 99,076 104,223 109,424 116,054 –Expatriates 23,969 22,898 22,990 22,752 –A.1 Civil Service 95,158 99,386 103,707 108,995 –Omanis 79,099 83,883 87,891 93,507 –Expatriates 16,059 15,503 15,816 15,488 –A.2 Diwan of Royal Court 7,424 7,654 7,919 8,282 –Omanis 4,573 4,764 5,010 5,261 –Expatriates 2,851 2,890 2,909 3,021 –A.3 Royal Court Affairs 12,212 11,890 12,388 12,884 –Omanis 9,084 9,198 9,959 10,504 –Expatriates 3,128 2,692 2,429 2,380 –A.4 Public Corporations 8,251 8,191 8,400 8,645 –Omanis 6,320 6,378 6,564 6,782 –Expatriates 1,931 1,813 1,836 1,863 –B. Private Sector EmployeesOmanis** 74,816 87,064 98,537 114,311 131,775Expatriates 407,168 424,319 424,788 510,713 638,447* Excluding security and defense personnel. Source: Ministry of National Economy.**Registered with Public Authority for Social Insurance (PASI).24 Annual Report 2007 Central Bank of Oman

Output, Employment and PricesTable 2.6Employment of Expatriates* in the Private Sector2006 2007Shares ofsectors 2007 %Agriculture and Fishing 51,254 60,850 9.53Mining and Quarrying 9,987 12,544 1.96Manufacturing 58,238 68,753 10.77Electricity, Gas and Water Connections 2,109 2,094 0.33Construction 156,266 221,432 34.68Whole Sale, Retail Trade and Car Repairs 92,474 103,316 16.18Hotels and Restaurants 31,666 38,143 5.97Transport, Storage and Communication 5,877 8,276 1.3Financial Intermediaries 1,630 1,883 0.29Real Estate and Renting Services 6,014 11,274 1.77Education 5,542 4,876 0.76Health and Social Work 11,597 12,176 1.91Community and Personal Services 6,256 6,921 1.08Domestic Servants 67,163 63,609 9.96More than One Activity 566 16,560 2.59Not Stated 4,074 5,740 0.9Total 510,713 638,447 100*With valid labour cards.Source : Ministry of Manpower.expatriates fell modestly by 1.0 percent to 22,752 (Table-2.5and Chart-2.4). The share of Omanis employed in the publicsector has consistently increased from 78.6 percent in 2002,to 80.5 percent in 2003, 82 percent in 2004, 82.6 percent in2005, and further to 83.6 percent in 2006. The consistentfall in the share of expatriates working in the public sectorindicates the progress on Omanisation in the public sector.Private SectorIn view of the expatriate-heavy employment pattern in theprivate sector, enhancing prospects for higher employmentgeneration for Omanis in the private sector has been a keypolicy focus of the Government. While high economic growthis a necessary precondition to creation of employmentopportunities, the actual composition of the labour demandin the private sector is generally conditioned by marketforces. The composition of the labour force in the privatesector continued to remain expatriate-heavy, even though interms of growth in employment opportunities, both Omanisand expatriates witnessed sharp increases. As per data onnumber of Omanis registered with the Public Authority forSocial Insurance (PASI), their employment in the privatesector increased by 15.3 percent in 2007 to 131,775, over andabove 16.0 percent, 13.2 percent and 16.4 percent increasesseen in 2006, 2005 and 2004, respectively. While the publicsector continues to dominate the employment generationscenario for Omanis, faster growth in employment forOmanis in the private sector in recent years has brought theoverall employment level in the private sector closer to thelevel in the public sector.Central Bank of OmanAnnual Report 2007 25

CHAPTER TWODemand for expatriate labour exhibited an unprecedentedgrowth in 2006 and 2007, with the size of the total expatriatelabour force growing by as large as 213,659 in just two yearsto 638,447 by the end of 2007. Employment for expatriates,growing at 25 percent in 2007 over and above 20.2 percentgrowth seen in 2006, could have been necessitated by theneed to sustain the high growth process, but this trend had itsassociated costs for the economy in terms of wage-rent inducedcost push pressure on domestic inflation, in addition tosignificant leakage of foreign exchange from the country in theform of remittances of as high as RO1.4 billion in 2007 (whichwas about 25 percent of total crude oil export earnings in2007). More strikingly, the employment growth for expatriatesin both 2007 and 2006 exceeded even the corresponding ratesof growth in nominal GDP. The construction sector not onlywitnessed 41.7 percent growth in employment for expatriatesin 2007, but also accounted for 34.7 percent of the totalexpatriate labour force in Oman’s private sector (Table-2.6).The number of expatriates working in the “wholesale, retailtrade and car repairs” sector at 103, 316 (16.2 percent of total)and in the “hotels and restaurant” sector at 38,143 (6 percentof total) suggest the scope for Omanisation and creation ofgreater job opportunities for Omanis in the private sector.As could be seen from Chart- 2.4, growth in employmentfor Omanis in the private sector has remained consistentlyhigher in relation to the public sector, but the dominance ofthe expatriates in the private sector employment scene, bothin terms of level as well as annual growth indicates that withgreater skill acquisition and training there could be muchgreater absorption of Omanis in the private sector.Pricesand 5.9 percent in 2007. Other price indices for Oman alsoexhibit similar trends, with inflation as measured by Muscat-WPI and the cost of building materials rising by 6.1 percentand 8.0 percent in 2007, respectively (Chart-2.5). Much ofthese inflationary pressures reflect partly the regional trendas well as the impact of global food, energy and commodityprice inflation. The dominance of external and supply sidesources of inflation also makes the inflation process a difficultchallenge at the policy level.As could be seen form Table-2.7, both demand side as wellas supply side factors, and domestic as well as externalsources of inflation together condition the overall inflationenvironment, and in recent years, the pressure from theexternal and supply side factors have been significant, inthe face of rising demand in a fast growing economy. Strongannual nominal GDP growth and the high expansion infiscal expenditure, which was necessary to sustain thegrowth momentum and the diversification process, haveexerted sustained demand pressures. In an open economy,the domestic demand pressure could often be relieved fromexternal sources of supply; however, it is the adverse externaland supply side factors that have become more prominentin exerting pressures on domestic inflation. The extent towhich the external environment has turned adverse in recentyears is manifested from the sharp increases in world food,metal and other commodity prices. This adverse trend alsocoincided with sustained depreciation of the USD, addingfurther intensity to imported inflation. As could be seenfrom Table-2.7, annual depreciation of the country’s importweightedNominal Effective Exchange Rate (NEER) has beenabout 4 to 6 percent, and the cumulative depreciation since2001 has been about 16.7 percent up to the end of 2007.Oman has been witnessing a trend of rising inflation since2004, with annual inflation as measured by the averageConsumer Price Index (CPI) for the Sultanate rising by 0.7percent in 2004, 1.9 percent in 2005, 3.4 percent in 2006,Reflecting the impact of high inflation in many tradingpartners of Oman, particularly in the Middle East region, andthe rising world food and commodity prices as well as largecumulative depreciation of the NEER of the RO, imported26 Annual Report 2007 Central Bank of Oman

Output, Employment and PricesChart 2.5: Annual Inflation in Oman(2003-2007)inflation generally remained much higher than the averageinflation for the Sultanate. For example in 2007, while theinflation in Oman was about 5.9 percent, imported inflation(arrived at by dividing the value of imports by the quantityof imports) was about 15.4 percent. In other words, despitestrong imported inflation, domestic inflation remainedrelatively much lower. The domestic inflation trend wasalso conditioned by domestic absorptive capacity, i.e. theunavoidable cost-push impact associated with rising demandfor all factors of production to sustain the growth momentumin the country. As presented in Table-2.7, demand of theprivate sector for expatriate labour was so strong that over andabove the additional increase of 85,925 in 2006, there was anincrease of 127,734 in 2007 alone, and much of this increasealso might have happened at higher costs. The impact of thishigh labour import at high cost not only contained the riskof wage push inflation, but in the face of such large influxof expatriate labour, there was considerable pressure on thesupply of residential accommodation, which was reflected inTable 2.7Broad Sources of InflationItems 2003 2004 2005 2006 2007Rising Demand(a) Annual GDP Growth 7.2 13.7 24.4 15.6 12.9(b) Annual Increase in Fiscal Expenditure 8.5 19.5 10.4 17.3 19.1Monetary Expansion(a) Annual Broad Money (M2) growth 2.5 4.0 21.4 24.9 37.2(b) Annual Credit growth 1.2 6.0 11.1 20.7 38.5Supply Constraints/External Shocks(a) World Food Prices 1 (Annual % increase) 8.5 11.8 2.6 8.5 23.6(b) World Metal 2 Prices ( % increase) 11.8 34.6 22.4 56.2 17.4(c) Rising Rent (Oman) 3 -0.6 -0.6 -0.1 1.0 8.5(d) Regional Inflation (Middle East) 4 6.1 7.0 6.2 7.0 10.4(e) NEER* Depreciation (annual % change) -6.6 -3.6 6.3 -3.1 -4.0(f ) Import Price 5 ( annual % change) -5 29.5 5.1 18.0 15.4(g) Foreign labour in Pvt. Sector (annual absolute increase) 32,166 17,133 469 85,925 1,27,7341: Source: FAO (include cereals, edible oil, meat, sugar and dairy products, etc.)2&4: Source-IMF.3: Source- Ministry of National Economy (Rent component in the CPI for the Sultanate).5: Derived from MONE data on value of imports and quantity of imports.Central Bank of OmanAnnual Report 2007 27

CHAPTER TWOTable-2.8Sultanate Consumer Price Index (2000 = 100)Items of Consumption Weights 2006 2007% change07/061 Food, Beverages, and Tobacco 30.4 111.8 123.9 10.8Cereals Products 3.933 105.4 119.1 13Meat and poultry 5.898 115.7 137.2 18.6Fish & Sea Products 1.783 119.7 132.7 10.9Milk, milk products 3.221 102.8 109.3 6.3Eggs 0.424 121 144.3 19.2Oil and fats 0.997 104 113.5 9.1Fruits 3.718 121.3 135.4 11.6Vegetables 2.347 135.4 146.6 8.3Dry & Canned Leguminous 0.372 106.4 118.3 11.2Nuts 0.483 99.7 107.2 7.5Spices and Salt 0.376 104.5 112.3 7.5Sugar and Sugar Products 1.085 118.4 122.7 3.6Tea and Coffee 0.471 96.6 101.8 5.4Other Food Preparations 2.854 101.6 109 7.3Beverages - Non Alcoholic 1.961 100 100.6 0.6Tobacco Products 0.462 97.5 102.8 5.52 Clothing Textiles, and Footwear 7.211 96.8 98 1.23 Furniture and housing materials 4.989 94.5 97.4 3.14 Medical care 1.727 91 91.3 0.35 Transport and Communication 22.194 103.1 103.5 0.46 Recreation and Entertainment 2.673 91.2 93.1 27 Educational services 3.322 107.6 113.5 5.58 Personal care and other services 6.085 125.3 135 7.89 Rent, Maintenance, electricity, water, fuel, etc. 21.414 100.2 106.6 6.3Rent 15.326 99.6 108.1 8.5GENERAL PRICE INDEX 100 105.2 111.4 5.9Note: 1. The weights are based on Household Expenditure and Income Survey, 1999-2000.2. Data are compiled on the basis of 8101 items of goods and services from 1571 selected sources. Data on Rent are collectedfrom a sample of 1100 rented units.Source: Ministry of National Economy.28 Annual Report 2007 Central Bank of Oman

Output, Employment and PricesTable-2.9Consumer Price Index for Muscat (2000 = 100)Items of Consumption Weights 2006 2007% change07/061 Food, Beverages, and Tobacco 23.877 108.7 119.0 9.4Cereal products 2.968 108.1 121.9 12.8Meat and poultry 3.681 114.3 133.5 16.8Fish & Sea Products 1.322 109.0 108.8 -0.2Milk, milk products 2.471 103.5 112.2 8.3Eggs 0.323 123.6 157.4 27.4Oil and fats 0.772 111.3 122.4 10.0Fruits 2.637 116.2 128.1 10.3Vegetables 1.987 118.8 124.4 4.7Dry & Canned Leguminous 0.328 105.4 118.0 11.9Nuts 0.423 93.2 106.8 14.6Spices and Salt 0.267 101.4 113.2 11.7Sugar and Sugar Products 0.834 117.8 122.1 3.7Tea and Coffee 0.331 97.8 100.2 2.4Other Food Preparations 3.438 101.6 110.1 8.3Beverages - Non Alcoholic 1.684 99.2 100.3 1.1Tobacco Products 0.411 92.0 96.9 5.42 Clothing Textiles, and Footwear 6.309 98.8 99.1 0.33 Furniture and housing materials 4.624 95.0 97.8 3.04 Medical care 2.699 90.5 90.8 0.35 Transport and communication 23.57 101.9 102.1 0.26 Recreation and entertainment 3.288 89.9 93.2 3.77 Educational services 4.204 106.1 112.8 6.48 Personal care and other services 6.635 127.5 139.1 9.19 Rent, Maintenance, electricity, water, fuel, etc. 24.794 99.0 104.7 5.7Rent 18.928 98.7 106.1 7.5GENERAL PRICE INDEX 100.0 103.5 108.7 5.0Note: 1. The weights are based on Household Expenditure and Income Survey, 1999-2000.2. Data are compiled on the basis of 907 items of goods and services from 907 selected sources. Data on Rent are collectedfrom a sample of 700 rented units.3. Annual values of the indices are the average of respective monthly indices.Source: Ministry of National Economy.Central Bank of OmanAnnual Report 2007 29

CHAPTER TWOTable-2.10Muscat Wholesale Price Index (2000=100)Items of Consumption Weights 2004 2005 2006 2007%change07/060 Agriculture, Forestry 5.427 118.6 130.6 150.8 154.9 2.71 Ores & Mineral; Electricity; Gas & Water 0.086 101.6 107.7 107 111.3 42 Food Products, Beverages & Tobacco; Textiles,Apparel & Leather Products 32.028 103.5 107.5 112.2 125.4 11.8– Meat, fish, fruits, vegetables, oils & fats 7.792 106.7 113.7 129.4 150.5 16.3– Dairy products 4.996 105.9 111.5 113 124.3 10– Grain Mill Products, Starches & Starch Products;Other Food Products 4.905 109.0 116.0 126.1 133.9 6.2– Beverages 1.729 112.5 114.5 113.7 115.3 1.4– Tobacco Products 5.567 102.6 103.4 106 110.2 4.0– Yarn & Thread; Woven & Tufted Textile Fabrics 5.488 91.7 92.3 85.5 109.5 28.1– Textile Articles Other Than Apparel 0.484 97.6 97.5 95.0 98.4 3.6– Knitted or Crocheted Fabrics; Wearing Apparel 0.137 98.3 97.9 98.8 98.8 -– Leather & Leather Products; Footwear 0.93 97.1 95.9 94.4 96.4 2.13 Other Transportable Goods, Except Metal Products,Machinery & Equipment 43.692 102.1 112.3 117.2 119.7 2.1– Products of Wood, Cork, Straw & Plaiting Materials 1.781 120.2 125.3 141 162.7 15.4– Pulp, Paper & Paper Products; Printed Matter & Related Articles 1.827 95.0 95.9 100.1 96.6 -3.5– Refined Petroleum Products 24.999 100.2 116.0 121.4 122 0.5– Basic Chemicals 0.474 98.3 108.0 117.3 126.7 8.0– Other Chemical Products; Man-Made Fibres 7.089 94.1 93.9 96.6 99.3 2.8– Rubber & Plastics Products 2.517 104.5 108.8 113.9 117.0 2.7– Glass & Glass Products & Other Non-Metallic Products Nec. 4.795 119.0 124.4 125.9 131.7 4.6– Furniture; Other Transportable Goods Nec. 0.21 101.5 104.4 105.6 101.1 -4.34 Metal Products, Machinery & Equipment 18.767 118.2 123.1 151.0 161.6 7.0– Basic Metals 8.33 137 144.5 195.1 211.5 8.4– Fabricated Metal Products, Except Machinery& Equipment 1.185 121.1 124.1 128.4 134.1 4.4– General Purpose Machinery 2.526 99.1 98.0 96.1 99.8 3.9– Special Purpose Machinery 1.074 97.8 97.3 91.2 92.6 1.5– Electrical Machinery & Apparatus 3.774 105.7 113.2 141.1 153.1 8.5– Radio, Television & Communication Equipment & Apparatus 0.73 82.6 80.5 77.6 72.4 -6.7– Medical Appliances, Precision & Optical Instruments,Watches & Clocks 1.148 103.8 106.9 109.5 113.8 3.9GENERAL PRICE INDEX 100 106.5 113.8 123.8 131.3 6.1Note: 1. Data are compiled on the basis of 787 items from 102 selected sources.2. Annual values of the indices are average of respective quarterly indices.Source: Ministry of National Economy.30 Annual Report 2007 Central Bank of Oman

Output, Employment and Pricesthe rising trend in rent. The wage-rent spiral was a reflectionof capacity constraint in a growing economy.A commodity wise analysis would reveal that annualincrease in prices in just two items explain the major partthe inflation trend in Oman in 2007. “Food, beverages andtobacco”, with 30.4 percent weights in Oman’s CPI, rose by10.8 percent, broadly reflecting global price pressures onfood items and commodities, and in fact price increases inthese items in Oman were relatively less than the comparableincreases elsewhere in the world. As per the Muscat WPI,prices of “meat, fish, fruits, vegetables and oils” rose by 16.3percent in 2007, with dairy product prices also increasingby 10.0 percent (Table-2.10) The second important factorcontributing to the inflation trend, i.e. rent, with 15.3percent weight in the CPI for Oman, rose by 8.5 percent in2007, under the pressure of spurt in demand for residentialhousing, resulting from large scale addition to the expatriatelabour force in the private sector in both 2006 and 2007.Both these components clearly suggest the importance ofexternal and supply side factors in Oman’s inflation process,and the resultant limited policy options that could be usedeffectively to contain domestic inflation.High growth in demand for money and credit has been anatural offshoot of high economic growth, and given theconstraint on independent use of monetary policy arisingfrom the fixed peg of the RO to the USD, money supplyand credit growth generally remained strong. In 2007, themonetary condition was characterized by availability ofample surplus liquidity, as growth in money supply andcredit remained far in excess of the demand underlyingthe growth in nominal GDP. Recognizing the need forappropriate monetary tightening, despite the constrainton independent conduct of monetary policy, the CBO hasintroduced two major anti-inflationary measures in therecent past: (a) the reserve requirement has been raised from3 percent to 5 percent, effective from February 2008 (whichwould permanently impound about RO 160 million from thebanking system, and to that extent could curtail the abilityof banks to lend to finance aggregate demand in the system);and (b) the volume of absorption of surplus liquidity fromthe banking system through issuance of CBO CDs has beenraised considerably, from about RO 500 million as at the endof October 2007 to about RO 1341 million as at the end ofFebruary 2008 (implying additional liquidity absorptionof RO 841 million over a period of just 4 months). Whenthe excess liquidity from the banking system is moppedup adequately, that reduces correspondingly the scope foreasy liquidity financing inflationary demand and asset priceinflation. In June 2008, anti-inflationary monetary policymeasures were activated further, with the decision to raisethe reserve requirement from 5 percent to 8 percent and totighten the lending ratio from 87.5 percent to 82.5 percent.Imported inflation, driven by the sustained depreciation ofthe USD against major international currencies, has oftenbeen highlighted in many quarters as an important sourceof inflation in Oman, with accompanying expectations thata revaluation of the current peg could help in addressing thechallenge of inflation. It is not hard to recognize that whilemany emerging as well as developed countries have allowedsignificant appreciation of their currencies against the USD inrecent years, they continue to face inflation pressures. Whensources of inflation originate primarily from the supply side,whether internationally in the food and commodity markets,or domestically in respect of rent, any revaluation couldat best entail a temporary salutary effect on inflation. Theadverse effects of the revaluation, however, could be severeand more permanent. Moreover, under the pressure of supplyshocks, as inflation reverts quickly to the higher level, therecould be demand for further revaluation, which in turn wouldmake the exchange rate of the country highly unstable. For anopen economy like Oman, exchange rate stability is a criticalcomponent of the sound macroeconomic policy framework ofthe country, and any exchange rate instability not only wouldCentral Bank of OmanAnnual Report 2007 31

CHAPTER TWObe detrimental for investment and growth, but could also be asource for speculative capital flows.Given the uncertain benefits of a revaluation in termsof the extent and duration of its favourable impact ondomestic inflation, the costs to the economy, however,could be numerous and more certain. At the macro level,diversification is a key requirement to ensure sustainableexport led growth in Oman, and a revaluation would severelydent the diversification process. Most of the mega projectsinvolving large investments are export-intensive in nature,and a revaluation could erode the export competitiveness ofthese projects. In recent few years non-oil GDP as well asnon-oil exports have exhibited high growth, symbolizing theprogress being achieved on diversification, and a revaluationcould dampen this trend. On the import side, a revaluationcould make imports cheaper, and resultant high growth inimports may exert severe pressures on the country’s balanceof payments. In 2007, Oman’s import growth was already ashigh as 46.6 percent, and any revaluation could only worsenthe balance of payments situation by encouraging cheaperimports. One needs to recognize that as against the only majorinflow of foreign exchange in the form of petroleum exports,there are large outflows of foreign exchange in the currentaccount under import of goods, net services payments,remittances, and income payments, and these outflows arealso rising significantly in recent years.At the more disaggregated level, a revaluation would involvecorresponding decline in RO revenue in fiscal accounts ofthe Government, whereas expenditure in RO may comeunder the pressure of the ratchet effect. In the absence ofappropriate wage-price flexibility, the adverse effect of anyrevaluation on the fiscal situation could be permanent, andfor an economy in which fiscal policy continues to be thedriver of growth and investment, such contractionary fiscaleffects of revaluation on the economy could be hard to avoid.In the sphere of monetary policy also a revaluation per sewould not give rise to any monetary policy independence,and hence, the constraints on independent use of monetarypolicy under a fixed peg would continue. It is also importantto take note of the international investment position of Oman,which suggests that Oman’s foreign assets for all sectors of theeconomy exceed the foreign liabilities. Hence, any revaluationwould have a large valuation loss for Oman’s foreign assets,which are meant to be used in future for financing investmentand growth in Oman. Being an open economy which alsodepends on external capital, technology and labour to ensurefaster economic growth and development, a significant partof the payments made to these factors of production are inRO, while considerable part of these incomes are remittedoutside the country, rather than being spent domestically.A revaluation would involve large proportionate outflow offoreign exchange from the country in the form of remittancesand repatriation of dividend/profits and technical knowhowpayments, while also making Omanisation an evenmore difficult challenge to implement as a revaluation couldenhance the competitive advantage of expatriate labourvis-à-vis the local labour force.Recognizing the constraint on independent use of monetarypolicy, and the possible asymmetric consequences of anyrevaluation for the economy, a number of other policymeasures were introduced to contain the intensity as well asimpact of inflation. Besides the cap on the extent of permittedincrease in rent, the Government used an appropriatecompensatory mechanism involving higher wages andsalaries for the public sector employees, which ranged from43 percent (for employees coming in the low salary bracket)to 5 percent (for senior level employees coming in the highsalary bracket). With a view to moderating the impact ofinflation on the common man, while it was decided by theGovernment to introduce a subsidy of RO 25 per tonne offlour, steps were also taken to make available basic essentialitems (like rice, sugar, dal, edible oil, tea, etc.) in value packsat prices that were less than the comparable market prices,32 Annual Report 2007 Central Bank of Oman

Output, Employment and Pricesand the price discount was a compensation against the impactof annual inflation in these items. Some of the specific itemsalso received direct policy attention, which led to lifting ofban on import of certain items like fish, with the requirementof greater domestic availability of local production in localmarkets. Arrangements were put in place with suppliers/producers (of items like cement) to ensure better domesticavailability without much artificial scarcity driven pricemanipulation in the market. “Origin Oman” campaignwas also given a vigorous push, to enhance awarenessamong consumers about local products as opposed to moreexpensive imported items. The Government, thus, adopted aprudent policy combination that helped in avoiding the costsof revaluation for the economy, preventing growth sacrificeassociated with fiscal contraction as an option to compressaggregate demand, while at the same time compensatingthe public for the inflation induced loss in purchasingpower. This prudent policy approach was based on realisticassessment of the sources of inflation, and the medium tolong-term growth and development needs of the country.Central Bank of OmanAnnual Report 2007 33

Oil and GasCHAPTER THREE

OIL & GASThe oil and gas activities continued to dominate theeconomic performance of Oman in 2007, accountingfor about 45.3% of nominal GDP, 62.1% of net fiscalrevenue, and 58.4% of merchandise exports. Theindirect contribution of the oil and gas sector in theform of oil and gas-based industrialization has alsoincreased considerably in the recent years. Despite thevisible sustained progress on economic diversificationand the gradual decline in oil production since 2001,this continued dominance of the oil and gas activitiesin the economy has essentially resulted from the surgein oil prices in last several years. In relation to the peaklevel of oil production of 350 million barrels in 2000,the level of oil production in 2007 had fallen to 259.4million barrels, representing a decline of 25.9 percentover last seven years. The impact of this decline in oilproduction was more than offset by 183.3 percent increasein average prices of Omani crude over these seven years.This oil price driven economic expansion has facilitatednot only general increase in the purchasing power of theeconomy as a whole with rising per-capita income, butalso created the preconditions for undertaking ambitiousinvestment plans while accumulating growing financialreserve assets. The large scale investment plans, besidestheir overall emphasis on economic diversification,also aim at greater value addition to crude oil andnatural gas, through investments in new refineries, LNGtrains and gas-intensive mega projects like fertilizers,petrochemicals, aluminum, etc. Thus, this phase of thefavourable oil price cycle, has been effectively used as anopportunity for ensuring an economic transformationprocess in Oman that could make the growth anddevelopment process much more durable and sustainable inthe long-run.The extent of large volatility that was witnessed in oilprices in 2007 indicates the importance of faster economicdiversification to insulate the economy from the effects ofsudden swings in oil market conditions. According to theIMF, the oil prices had reached a record high of USD 76 perbarrel in August 2006, but subsequently fell to about USD 50per barrel in early 2007. This represents a downwardcorrection of close to 35% in just over few months. Eventhough oil prices have recovered subsequently sinceAugust 2007, touching record high levels in mid-2008, theuncertainty continues to persist. According to June 2008estimates of the Energy Information Administration (EIA),despite some moderation in demand, overall world demandis projected to increase by 1 million barrels per day, whilethe supply conditions may still remain tight, with non-OPECsupply rising by 0.3 million barrels in 2008. The oil price hasbeen projected to increase from USD 72.3 per barrel in 2007to USD 122.2 per barrel in 2008, i.e. by 69 percent.Oil exporting countries, including Oman, recognizethe scope for value addition arising from investment indownstream projects, and accordingly, Oman has not onlyinvested in a new refinery (the Sohar Refinery), but it hasOmani Crude Oil Prices and ProductionCentral Bank of OmanAnnual Report 2007 37

CHAPTER THREEalso taken up several mega gas-based projects involving largeinvestments, which could help in diversifying the economyand thereby gradually reduce the excessive dependenceon oil. International oil firms are also being encouragedto develop difficult blocks in the country, whether by wayof joint-development programmes or through concessionsagreement on production sharing basis. A number ofexploration and production agreements have already beensigned with international oil firms in the recent period. TheSeventh Five Year Development Plan aims at an investmentof RO 14.1 billion during the plan period (2006-2010), ofwhich capital expenditure for oil and gas production isabout RO 4988 million, and investments on gas-basedindustries is about RO 3258 million. In Oman, thus, thereis evidence of considerable additional investment responsein both upstream and downstream oil and gas projects.The year 2006 had witnessed the signing of the first everoil future contract in the Middle East. Oman’s Ministryof Oil & Gas had signed this contract with the DubaiMercantile Exchange (DME), after signing a memorandumof Understanding in February 2006. It became operationalduring 2007. The contract could streamline Omani crudeoil trading transactions, with crude oil contract usershaving the option of either settling the contract financiallyor taking physical delivery. Given the quantity of Omani oiland other Middle Eastern crude exported to Asia every day,Omani crude seemed to be a logical choice for serving as abenchmark for a regional pricing mechanism on the DME,signaling thereby a break from relying only on standardsset in the west. This move marks a notable shift away fromthe West Texas Intermediate (WTI) and Brent standards,which are more commonly used internationally, mirroringfluctuations in “sweet crude”, as opposed to the “sourcrude” produced in the Middle East. On the DME, unlikethe Omani oil futures contracts meant for physical delivery,there will be financially settled contracts: i.e. Brent-Omanspread contract and WTI-Oman spread contract.Crude OilProduction:The policy pursued by the Omani Government towards oilproduction is two-fold; namely, optimization of the ratioof low-cost oil production to total oil production and themaintenance of a sustainable level of production over themedium and long-term. Keeping these broader objectives inview, Petroleum Development Oman Co. (PDO), together withother oil producing companies (Occidental Oman, OccidentalMukhaizna, Daleel Petroleum, Rak Petroleum, BTT Omanand Petrogas) produced some 259.3 million barrels of oil andcondensates during 2007 as compared to 269.2 million barrelsin 2006, representing a decrease of 3.7 percent. Averageproduction per day thus decreased from 737.6 thousand b/d in2006 to 710.4 thousand b/d in 2007 (Table 3.1). Out of a totalnumber of 125 oil producing fields during 2007, 106 belongedto PDO, constituting 84.8% of the total. The declining trend inproduction that started in 2001 continued even in 2007, andthe PDO has planned for increasing use of costlier enhancedoil recovery techniques to reverse the production trend.According to PDO, however, the company has continued itsefforts to promote excellence in its operations and to manageits wells and reservoirs with increased attention. Suchconcerted efforts enabled the company to reverse the declineof production in the Marmul field during 2005 and 2006.Some of the action plans launched for reversing the overallproduction trend involve gestation lags and may yieldtangible benefits over time. PDO’s Study Centre continued tocarry out thorough field studies that underline robust fielddevelopmentplans. Over half of PDO’s oil reserves in Omanis now covered by such studies. With a view to reversing thedecline in oil production, PDO has planned for major newinvestments in the coming few years. Smaller and widelyscattered oil wells, along with rising costs of exploration inOman also influence the plans in the oil sector for reversing38 Annual Report 2007 Central Bank of Oman

Oil & GasTable 3.1Oil Production & Exports(Million Barrels)Direction of Oil Exports 2007Year Production % Change Exports % Change2003 299.0 -8.8 278.5 -8.82004 285.0 -4.7 263.6 -5.42005 283.0 -9.0 262.1 -6.02006 269.2 -4.7 233.2 -11.02007 259.2 -3.7 222.0 -4.8Source: Ministry of Oil and Gas and Ministry of National Economy.the production trend. Half of PDO’s current productioncomes from secondary recovery techniques, which involvesextraneous injection of fluid, such as water, to maintainreservoir pressure and to displace hydrocarbons towards theproducing wells. Increasingly, PDO is relying on applicationof enhanced oil recovery (EOR) – which refers to productionby thermal means (by heating the reservoirs with steam toreduce the oil’s viscosity), by chemical means (by injectingchemicals into the reservoirs to alter the oil’s flow properties)and by means of miscible displacement (by injecting gas intothe reservoirs into which the oil can dissolve). PDO is oneof the few companies in the world aiming at use of all threeEOR techniques in its field development projects.PDO announced that its exploration operations during2007 have led to new discoveries of oil and natural gas atthe Budour northeast field. The oil is in the Birba area ofsouth Oman and gas in the Saih Nihayad field. “Rabab” wasanother new field in south of Oman. It is believed to havesignificant volumes of oil and gas.ReservesBecause of continued efforts to discover new oil fields,Oman’s proven oil and condensate reserves stood at 4.860billion barrels in 2007.It is worth mentioning that during 2005 the partners of PDO,Shell, Total and Partex as well as the Government of Omanwhich holds 60 percent of PDO’s share capital, agreed foranother 40 years extension of their contract. As a resultof the agreement, it is expected that liquid reserves in thePDO block would be around 4.7 billion barrels of oil andcondensates over the extended contract term.New ProjectsReflecting the policy of encouraging international oilcompanies to invest in the oil industry in the Sultanate ofOman, the Ministry of Oil & Gas signed 3 new agreementsin 2007 with international oil companies, such as: BritishOil Co., Rak Petroleum and Reliance Industries. Theseproduction sharing agreements cover exploration anddevelopment activities in specified areas. These agreementswill involve investments worth USD 660 million (aboutRO 254 million). Moreover, PDO carried out various projectsduring 2007 aimed at both developing existing oil fields anddiscovering new ones within the country’s overall strategyof enhancing reserves and raising production levels whenrequired. Various new advanced oil recovery projects werealso implemented, including Mukhaizna field projectwhich aims at extracting heavy crude from the field usingthermal recovery technology, and Harweel field projectCentral Bank of OmanAnnual Report 2007 39

CHAPTER THREEwhich started producing crude oil in early 2003 by usingmiscible gas injection technology.Petroleum Development Oman (PDO) has given the finalapproval for the company’s first full-scale enhanced oilrecovery (EOR) project at the Zalzala field – the US$600million Harweel Phase 2A/B project - in the south ofthe county. The project builds on Harweel Phase 1,which brought four oilfields in the cluster on-stream in2004, beginning with Zalzala and is now producing at15,000 b/d. The other fields to be developed in Phase2A/B include Sakhiya and Dafaq, although they will bedeveloped using conventional recovery for now. PDO’stotal capital expenditure stood at USD 1.5 billion (aroundRO 577 million) during 2006.ExportsTotal crude oil exports reached 222.0 million barrels in 2007as compared to 233.2 million barrels in 2006, registeringa decrease of 4.8 percent, partly on account of increase indomestic use of crude in the new refinery. However, the shareof oil & gas exports in total exports of Omani origin decreasedfrom 89.2 percent in 2006 to 84.8 percent in 2007, while theshare in total exports (including re-exports) decreased from81.0 percent in 2006 to 75.9 percent in 2007. China occupiedOil Production and Exportsthe first place as the main importer of Omani crude oil, asits share in Oman’s total exports of crude oil increased from39.5 percent in 2006 to 44.7 percent in 2007. Thailand came2nd, with 17.7 percent share in 2007. The share of Japan,which ranked 3rd, was 13.1 percent in 2007, followed byKorea, with a share of 7 percent. Few other countries alsoimported oil from Oman during 2007. (Table 3.2).Oil RevenuesThe Government’s net oil revenues increased during 2007by 14.0 percent to reach RO 3678.2 million from RO 3225.9million in 2006. However, the share of net oil revenues stoodlower at 62.1 percent of total revenues in 2007 as against64.8 percent in the previous year, mainly because of stronggrowth in non-oil and non-tax revenues, and the conservativerevenue realization policy adopted by the Government,keeping in perspective the importance of long-run fiscalsustainability.Country ofDestenationTable 3.2Direction of Oil Exports(In Million Barrels)2003 2004 2005 2006 2007Japan 60.8 40.8 43.1 22.7 29.0China 77.2 106.4 84.3 92.0 99.3Korea, South 43.0 41.9 41.1 34.2 15.6Taiwan 4.9 12.1 16.0 11.2 8.1Thailand 51.9 43.4 44.0 43.2 39.3Malaysia 13.7 – 6.9 12.0 6.3USA 8.2 4.8 – 10.5 6.1Singapore 9.7 3.1 7.5 5.3 2.1Others 9.1 11.1 19.2 2.0 16.2Total 278.5 263.6 262.1 233.2 222.0Source: Ministry of Oil and Gas and Ministry of National Economy.40 Annual Report 2007 Central Bank of Oman

Oil & GasRefinery1) Oman Oil Refinery:Oil refining in the Sultanate of Oman started, for the firsttime, in November 1982 through Oman Oil RefineryCompany, with a capacity of 50,000 b/d, which increased to80,000 b/d in 1987. The Refinery’s output that had reached31 million barrels in 2003 fell to 28.9 million barrels in 2004,but increased to 31.6 million barrels in 2005, and decreasedmodestly to 31 million barrels in 2006 and to 24.7 millionbarrels in 2007. At present, the Refinery produces five typesof products: LPG butane, Jet Fuel, Gas oil and two grades ofgasoline, plus residual. The details of inputs and outputs ofthe refined products are shown in Table 3.4.2) Sohar Oil Refinery:In 2003, work started on Sohar Refinery Company, which is100 percent Government-owned. The refinery has a crudeTable 3.3Oman’s Oil Prices(US $/B)2003 2004 2005 2006 2007January 29.27 29.91 39.26 58.94 50.99February 31.33 29.32 41.25 58.06 54.96March 28.75 31.63 47.55 58.18 58.16April 24.67 32.28 48.76 64.53 63.45May 25.40 35.45 46.85 65.39 64.17June 26.40 34.19 52.07 65.62 65.30July 27.35 35.48 53.47 69.59 69.26August 28.31 39.00 56.97 69.21 66.05September 26.21 36.05 57.00 59.95 70.17October 28.40 38.50 54.39 56.21 68.34November 28.80 35.93 51.80 56.30 73.49December 29.16 35.28 53.60 58.28 77.51Average Jan-Dec 27.84 34.42 50.26 61.69 65.15Source: Ministry of Oil and Gas and Ministry of National Economy.Table 3.4Oman Refinery Company - Crude Oil Input and Output by Type of Product*(In Thousand Barrels)Input/Output 2003 2004 2005 2006 2007Input 30963.9 28945.3 31573.4 31027.4 24669.7Crude Oil 30963.9 28945.3 31573.4 31027.4 24669.7Output 30963.9 28945.3 31573.4 31027.4 24669.7GasolineRegular 90 1293.0 1269.1 1356.9 1374.3 1013.8Super 97 4506.8 3945.6 4079.4 3703.7 2893.8DP Kerosene 1728.2 1406.9 1770.4 2338.9 2160.0Gasoline 6602.1 6442.4 7089.3 6750.4 2848.6Butane 545.4 472.8 580.2 630.0 914.5Long Residue (Bunker) 15306.3 14246.6 15445.2 14946.8 13177.4Change in intermediate products -24.4 66.3 8.00 139.1 344.2Fuel and Uses of ORC 1006.5 1095.4 1244.0 1144.2 682.6*Provisional and excludes Sohar Refinery.Source: Ministry of Oil and Gas and Ministry of National Economy.Central Bank of OmanAnnual Report 2007 41

CHAPTER THREEunit with a capacity of 116,400 barrels of oil per day anda Residue Fluid catalytic cracking unit with a capacity of75,260 barrels per day. It started its operations in 2006. Itis an export-oriented project. The first consignment of itsproducts, amounting to 500 cubic meters of gas oil, wasexported on 23 July 2006. However, the refinery produced14.25 million barrels of different products in 2006 and 24.2million barrels in 2007, out of which 1.5 million barrels weresold locally and 19.7 million barrels were exported.Natural GasNatural gas is another important source of energy in theSultanate of Oman. For the 29th year in a row, PDO providedan uninterrupted supply of natural gas to the GovernmentGas Network. The successful commissioning of the gasprocessing plant at Saih Nihayda and the completion of the265-kilometer “loop” pipeline were the major highlights ofthe year 2005. Those projects allowed PDO to increase itssupply capacity to the nation’s gas-liquefaction plants by30 percent. As a result of the exploration programmes, theSultanate’s proven natural gas reserves (associated and nonassociated)reached 19.14 trillion cubic feet in 2007. In 2007some 1070.7 billion c.f. of natural gas was produced (218.6billion c.f. associated and 852.1 billion c.f. nonassociated), asagainst 1068.9 billion cubic feet (243.1 billion c.f. associatedand 825.8 billion c.f. nonassociated) in 2006. The number ofnon-associated gas fields during 2007 was 14, out of which 5fields belonged to PDO and 7 to Occidental Oman Company,and one each to Rak Petroleum and BTT Oman.At present, besides the use for LNG trains, gas is largelyutilized for reinjecting it into the oil reservoirs to maintainpressure and sustain oil production. An increasing part ofthe natural gas is being used as fuel to generate power, andin desalination plants, cement factories and other industrialprojects. Over time, domestic industrial use of gas willincrease further as demand increases from gas-based projectssuch as fertilizer, aluminum, cement and petrochemicals.During 2007 also, some 31.2 billion c.f. of natural gas (i.e.only 3% of total gas production) was exported to UAE. Theremaining 97 percent of natural gas, thus was used for LNGproduction and exports, and in domestic industries as wellas oil fields.Table 3.5Production & Uses of Natural Gas(million cubic feet)New Gas projects2006 2007*% Changes2007/2006Production 1,051,755 1,070,736 1.8– Associated 233,746 218,651 -6.5– Non Associated 818,009 852,085 4.2Uses: 1,051,755 1,070,736 1.8A- GovernmentGas System 240,737 271,484 12.8B- OLNG 359,107 351,802 -2.0C- QLNG 121,855 138,368 13.6D- Exported (UAE) 46,534 33,829 -27.3E- Oil Fields 163,969 171,499 4.6– Fuel 68,891 72,352 5.0– Re-injection 95,078 99,147 4.3F- Flared 50,612 49,607 -2.0G- Other 68,941 54,117 -21.5*ProvisionalSource: MONE, Monthly Statistical Bulletin, Jan2008.During 2003 and 2004, “Oman Gas Company” implementedseveral gas projects, among which was Al Mahdha - Al Ainpipe line (45 kilometers) to provide UAE with Omani gas.A 676 kilometers gas pipeline from Sehroll to Salalah wasbuilt during 2003. The total capacity of the pipeline is about5 million cubic meters per day. It will provide the requiredenergy to the Raysut Industrial Zone and Raysut Cementfactory. The third gas pipeline which was inaugurated during42 Annual Report 2007 Central Bank of Oman

Oil & Gas2003 runs from Fahud to Sohar. The work on the projectstarted in 2000 and operations started in January 2003. Apartfrom these projects, Oman Gas Company executed severalprojects during 2003-2004, such as a central control project,intelligent scrapers, optical fibre glass cables from Fahudto Sehrol and pressure reduction station in Sohar. In 2005and 2006, work on previously planned projects continued,among which was Qalhat LNG (Third Train) that startedproduction at the end of 2005. Other projects implementedinclude enhancing the efficiency of infrastructure in orderto increase the productive capacity of gas to meet increaseddemand; providing industrial projects and facilitiesoperating with gas in required quantities; the establishmentof a central unit for gas processing in “Seeh Nahida”; theexpansion of gas plants in “Gebal” and “Sehroll”; a new gaspipeline to connect the projects coming up in “Sur”, andmany more. Major drilling campaigns and other engineeringprojects were also executed according to schedule at manyof PDO’s fields in 2006. Because of such efforts, the Kauthergas field and its associated processing plant will be ready forcommissioning in 2008.LNG ExportsDuring 2007 LNG exports amounted to 9.1 million tons (6.5million from Oman LNG Company –first and second Trainsand2.6 million tons from Qalhat LNG Co. -3rd Train), thesame as in 2006. LNG was exported to Korea, Japan, China,Taiwan and India. Some 273 thousand metric tons ofbyproducts of LNG were also exported to UAE in 2007.Central Bank of OmanAnnual Report 2007 43

Public FinanceCHAPTER FOUR

PUBLIC FINANCEGeneral AssessmentThe Sultanate’s fiscal position remained strong in 2007,which is part of a healthy trend that has been prevailingsince 2003. The strong fiscal position achieved in 2007 wascharacterized by a surplus (net of transfers to Reserves), furtherdecline in public debt in relation to the GDP, and additionalaccumulation of government financial assets. Sustainedincrease in oil prices significantly contributed to the year’sfiscal surplus, which in turn allowed the Government to boostthe Country’s reserves as well as reduce its public debt. Overall,non-oil revenues such as those generated from the gas sectorand other sources have also been growing since 2003. It is worthnoting that while growing public revenues has been matchedby increases in public expenditure in the last five years, thefiscal surplus has also been sustained during the same period,reflecting an increasingly prudent fiscal policy, which puts dueemphasis on public spending prioritization and expansion ofeconomic development, benefiting from rising governmentrevenues from oil exports. In essence, one important featureof this spending approach is its focus on curbing currentexpenditure growth while channeling additional resources toinvestment expenditure. Accordingly, investments pertainingto long-term development, including those relating to publicinfrastructure, oil and gas production became the mainbeneficiaries of additional budgetary allocation in 2007.The role of the Government in the domestic economycontinued to feature prominently in 2007. This feature wasmanifested by the influence of the fiscal expenditure indriving and generating aggregate demand during the year.Thus, fiscal policy continued to be a potent instrumentbehind the Country’s economic growth in 2007. The publicsector also remained the dominant sector of the Sultanate’seconomy in 2007, notwithstanding the growing contributionfrom the private sector.Table 4.1Indicators of Fiscal ManagementItem 2003 2004 2005 2006 2007*Fiscal Balance as % of GDP 1.4 2.4 2.6 0.3 0.3Total Revenues as % of GDP 39.5 42.4 38.0 36.2 38.2Oil Revenues as % of GDP 27.7 30.5 26.7 23.5 23.7Total Expenditure as % of GDP 38.1 40.0 35.5 35.9 37.9Current Exp.as % of GDP 28.3 28.0 26.8 25.7 24.9Investment Exp.as % of GDP 8.4 10.9 8.2 8.7 10.9Share of Oil Revenues in Total Revenues 70.1 71.9 70.1 64.8 62.1Share of Current Exp.in Total Expenditure 74.4 69.8 75.6 71.5 65.6* Provisional.Central Bank of OmanAnnual Report 2007 47

CHAPTER FOURKey fiscal indicators in Table 4.1 point to the robustnessof fiscal position in 2007. Fiscal surplus (net of transferto Reserves) as percentage of GDP stood at 0.3 percent in2007 as well as in 2006. Total revenues (net of transfer toReserves) increased from 36.2 percent of the GDP in 2006to 38.2 percent of the GDP in 2007. The increase in totalrevenues was matched by the increase in total expenditure,which grew from 35.9 percent of the GDP in 2006 to 37.9percent of the GDP in 2007. In absolute terms, fiscal surplus(net of transfer to Reserves) slightly decreased, from RO 43.8million in 2006 to RO 40.2 million in 2007. During the sameperiod, total revenues increased by RO 940.7 million, or by18.9 percent, from RO 4,979.9 million to RO 5,920.6 million.As shown in Table 4.2, the increase in total revenues in2007 resulted from increases in oil revenues as well as othersources of revenues to the Government.Aggregate expenditure also increased in 2007 from thepreceding year, but at a slightly higher rate of 19.1 percent thanthe 18.9 percent increase realized in total revenues. In 2006,total expenditure stood at RO 4,936.1 million as compared toRO 5,880.4 million in 2007. At the component level, year 2007witnessed a boost in both current and investment expendituresfrom the preceding year. Current expenditure increased fromRO 3,531.0 million in 2006 to RO 3,857.5 million in 2007,representing an increase of 9.2 percent, which is relativelylower in comparison to the 11.1 percent increase recorded in2006. Investment expenditure on the other hand increased bya much higher rate of 41.5 percent, from RO 1,199.5 millionin 2006 to RO 1,697.3 million in 2007, up from 24.1 percentincrease in 2006. In an effort to promote the private sector,the Government continued to provide some support in theform of participation and subsidy. This expenditure grewfrom RO 205.6 million in 2006 to RO 325.6 million in 2007,representing a remarkable increase of 58.4 percent.The Sultanate continued to follow the tradition of highlyconservative crude oil price estimates for preparing its 2007budget. Reflecting this tradition, while the annual averageOmani crude oil price estimated for the 2007 budget wasUS$ 40.0 per barrel, the actual annual average price stoodat US$ 65.15 per barrel, representing an increase of almost63.0 percent per barrel of oil. Given that the 2007 budgetwas compiled based on highly conservative crude oil pricesassumption, together with the fact that a significant portionof government income is still generated from oil exports, thebuilt-in strong fiscal impulses resulted in a major increase inactual public revenues in 2007.In regards to the Sultanate’s 2008 budget, the sameconservative approach with respect to the crude oil priceestimate has been adopted, at US$ 45.0 per barrel. Thisbudget also attempted to balance between rising domesticinflationary pressure and the need to undertake andimplement projects, which are necessary for the Country’sdevelopment and economic growth. Striking this balanceposed some challenges to the Government, particularlygiven the growing windfalls in public revenues on accountof historically high oil prices in the global market, which hascreated expectations of higher living standard for the public.In fact, given that the Sultanate’s economy continues to bemainly state-driven, the allocation of resources in 2008 andthe size of the overall budget have notable ramifications forthe various sectors of the economy, including the domesticinflationary situation.The 2008 approved budget carried an estimated deficitof RO 400.0 million, which is similar to the deficit thatwas estimated in the 2007 budget. Projected increase inboth revenues and expenditure between the 2007 budgetand the 2008 budget amounted to RO 910.0 million. Theadditional RO 910.0 million in revenues and expenditurerepresented an increase of 20.3 and 18.6 percent increase,respectively. Under the 2007 budget, the projected deficit ofRO 400.0 million amounted to 8.9 percent of total revenuesas compared to 7.4 percent under the 2008 budget.48 Annual Report 2007 Central Bank of Oman

Public FinanceTable 4.2Public Finance(Millions of R.O.)ITEMS 2003 2004 2005 2006 2007*EstimatedBudget 2008REVENUES 3305.3 4040.2 4510.5 4979.9 5920.6 5400.0Net Oil Revenues 2316.4 2904.9 3161.9 3225.9 3678.2 3610.0Gas Revenues 87.0 250.9 393.6 613.5 810.9 620.0Other Current Revenues 875.4 850.0 888.3 1073.4 1344.9 1130.0Capital Revenues 10.2 16.6 35.0 49.0 66.2 32.0Capital Repayments 16.3 17.8 31.7 18.1 20.4 8.0TOTAL EXPENDITURE 3188.9 3809.9 4207.6 4936.1 5880.4 5800.0Current Expenditure 2373.1 2661.2 3179.4 3531.0 3857.5 3550.0Defence & National Security 1009.6 1143.6 1404.2 1549.6 1663.4 1360.0Civil Ministries 1184.3 1304.4 1531.9 1735.0 1898.7 1905.0Interest Paid on Loans 59.9 74.4 66.8 55.6 77.7 55.0Gas Production Expenditures _ 22.2 46.4 51.1 54.9 50.0Oil Production Expenditures 119.3 116.6 130.1 139.7 162.8 180.0Investment Expenditure 700.0 1034.8 966.5 1199.5 1697.3 1865.0Development Expenditure for Civil Ministries 360.9 422.3 475.1 576.4 800.2 725.0Capital Expenditure for Civil Ministries 23.0 24.8 26.0 28.4 38.3 20.0Oil Production Expenditures 242.0 257.4 249.5 322.5 476.9 670.0Gas Exploration 13.6 12.4 _ _ _ _Gas Production Expenditures _ 235.7 171.2 272.2 381.9 450.0Program on Human Res.Development 42.7 51.2 44.7 _ _ _Cost of Buying & Transporting Gas 17.8 31.0 _ _ _ _PARTICIPATION & SUBSIDY TO PRIVATE SECTOR 115.8 113.9 61.7 205.6 325.6 385.0SURPLUS/DEFICIT 116.4 230.3 302.9 43.8 40.2 -400.0FINANCING -116.4 -230.3 -303.0 -43.8 -40.2 400.0Net grants Received 3.8 8.3 -5.6 -36.8 4.6Drawing from Reserves _ _ _ _ _ 490.0Net loans Received -159.2 -84.9 -151.1 195.5 3.2 70.0Development Bonds(Net) 174.4 88.5 -8.0 -80.0 -130.0 -160.0Remainig Deficit from 2002 -124.0 _ _ _ _ _Remainig Surplus Brought from 2006 _ 11.4 _ _ 100.0Change in Government Accounts -11.4 -253.6 -138.3 -122.5 -18.0 _* Provisional.Source: Ministry of Finance.Central Bank of OmanAnnual Report 2007 49

CHAPTER FOURRevenuesNet government revenues grew by RO 940.7 million, fromRO 4,979.9 million in 2006 to RO 5,920.6 million in 2007,representing an increase of 18.9 percent. All revenue subcomponentsincreased in 2007 from the preceding year.Net oil revenues rose from RO 3,225.9 million in 2006to RO 3,678.2 million in 2007, amounting to additionalrevenues of RO 452.3 million and representing an increase of12.3 percent. The windfall from oil revenues in 2007 owedmainly to 5.6 percent increase in average crude oil pricesdespite an overall decline of 3.7 in production. Similar topast years trend, net oil revenues represented the lion shareof total revenues, accounting for 62.1 percent in 2007. In aneffort to further diversify the sources of government revenues,significant resources had been channeled to the gas sector.This investment continued to pay off with the revenuecontribution growing from RO 613.5 million in 2006 toRO 810.9 million in 2007. The added gas revenues realizedin 2007, which represented an increase of 32.2 percent oversimilar revenues generated in 2006, owed to increases in bothproduction and prices. Other current revenues, which includetaxes and fees and non-taxes revenues, rose from RO 1,073.4Ratio of Revenue to GDPmillion in 2006 to RO 1,344.9 million in 2007, representinga remarkable increase of RO 271.5 million, or 25.3 percent.The remaining sources of public revenues, namely capitalrevenues and capital repayments were fairly small in relationto the other sources of revenues. The former increased fromRO 49.0 million in 2006 to RO 66.2 million in 2007, and thelatter from RO 18.1 million to RO 20.4 million during thesame period. The following section discusses the breakdownof other current revenues.Other Current RevenuesThe RO 271.5 million increase in Other current revenuesrecorded in 2007 was driven by increases in taxes and feesrevenues, as well as revenues from non-taxation sources.Growing revenues from customs duties, fees on licenses, taxes,airport revenues, income from government investment, andinterest on bank deposits and lending, have all contributedto higher other current revenues in 2007 over the precedingyear. The aggregate of taxes and fees revenues and non-taxrevenues, classified as other current revenues, accounted for22.7 percent of total revenues in 2007 as compared to 21.6percent in 2006. Although the difference between the twoOverall Fiscal Balance(In Million R.O)50 Annual Report 2007 Central Bank of Oman

Public Financeyears’ ratios amounted to a modest 1.1 percent, the growthin absolute term is notable, at RO 185.1 million in 2006 ascompared to RO 271.5 million in 2007. The steady increase inother current revenues witnessed since 2005 is indicative ofexpanding economic activities, which yield the Governmentadditional income through taxation and fees.Under other current revenues, taxes and fees revenuesincreased by RO 171.3 million while non-tax revenuesincreased by RO 100.2 million in 2007. The formerrepresented an increase of about 48.0 percent and the latteran increase of approximately 14.0 percent. Under the subcomponentof taxes and fees revenues, all items posted someincreases in 2007 except for licenses fees on communicationservices, which were non-existent between 2003 and 2007,except for the year 2005 when Nawras entered the market inOman and had to pay the licensing fees. Revenues generatedthrough custom duties increased from RO 114.6 millionin 2006 to RO 159.6 million in 2007, which representedan increase of 39.3 percent. The increase in revenues fromTable 4.3Breakdown of Other Current Revenues(Millions of R.O.)Items 2003 2004 2005 2006 2007*A. Taxes and Fees Revenues 213.5 240.5 337.2 357.2 528.5Income Tax on Companies and Establishments 61.5 65.3 79.0 85.4 187.1Payroll Tax ** 43.1 49.1 71.2 78.2 90.9Fees on Licences and Others 43.9 55.1 58.9 79.0 90.9Licences Fees on Communication Services 0.0 0.0 39.6 0.0 0.0Custom Duties 65 71.0 88.5 114.6 159.6B. Non-Tax Revenues 661.9 609.5 551.1 716.2 816.4Electricity Revenues 118.6 116.1 14.0 0.0 0.0Water Revenues 32.8 32.3 36.2 40.4 42.3Postal Revenues 3.6 3.4 3.5 3.2 3.1Airport Revenues 16.4 18.6 1.3 8.5 0.8Port Revenues 0.2 0.2 0.2 0.3 0.3Public Communication Services Toll 0.0 0.0 24.0 68.8 33.1Surplus from Public Authorities 16.6 15.0 7.6 5.4 5.9Rent from Government Real Estate 6.6 5.9 6.7 8.0 6.1Income from Government Investments 370.4 319.8 302.0 369.6 393.3Interest on Bank Deposits and Lending 6.1 9.7 37.3 73.2 46.0Others 90.6 88.5 118.3 138.8 285.5Total 875.4 850.0 888.3 1073.4 1344.9* Provisional.** Company participation in technical/training projects.Source: Ministry of Finance.Central Bank of OmanAnnual Report 2007 51

CHAPTER FOURcustoms duties reflected, in most part, a surge in the levelof imports, which increased by a remarkable 46.6 percentbetween 2006 and 2007. Revenues from income tax oncompanies and establishments accounted for the largest shareof taxes and fees revenues in 2007 and recorded a significantincrease as well, from RO 85.4 million in 2006 to RO 187.1million in 2007. The difference amounted to RO 101.4million and represented a large increase of 119.0 percent.The year 2007 also witnessed some increases in payroll taxrevenues and revenues from fees on licenses. At the macrolevel, the overall increase in taxes and fees revenues in 2007mirrored the 12.9 GDP growth recorded during the year, aswell as a growing private sector from which most of theserevenues were generated. In fact, and as shown in Table 4.3,the growth in revenues generated from taxes and fees havesteadily increased since 2003.The 14.0 percent increase in non-tax revenues witnessedin 2007 was driven by two of its largest sub-components,namely, revenues generated from income on governmentinvestments, which increased from RO 369.6 million in2006 to RO 393.3 million in 2007, representing 6.4 percentgrowth, and revenues generated from what is classified asother non-tax revenues, which grew from RO 138.8 million in2006 to RO 285.5 million in 2007, representing a remarkableincrease of 105.6 percent. As shown in Table 4.3, some ofthe remaining sub-components under non-tax revenuesrecorded increases while others recorded decreases between2006 and 2007.Expenditurecontinued to witness increase in investment expendituregrowth in contrast to decrease in growth in currentexpenditure. In fact, investment expenditure surged fromRO 1,199.5 million in 2006 to RO 1,697.3 million in 2007,representing a notable increase of 41.5 percent as comparedto 24.1 percent increase in 2006. Current expenditure on theother hand grew by a lesser rate of 9.2 percent in 2007 ascompared to 11.1 percent growth in 2006. The 9.2 percentcurrent expenditure growth represented an increase fromRO 3,531.0 million in 2006 to RO 3,857.5 million in 2007.Similar to previous years, current expenditure for civilministries continued to account for the largest share ofcurrent expenditure in 2007. With regard to the investmentexpenditure, development expenditure for civil ministriesconsistently took the lion share in the last five years. Bothcurrent and investment expenditures have been risingsince 2003 with the exception of 2005 when investmentexpenditure had decreased from the preceding year,mostly on the account of the reduction in gas productionexpenditure and the phasing out of gas explorationexpenditure. Expenditure variations in the hydrocarbonsector usually reflect the level of activities, the challengesand opportunities faced with regard to production andexploration, and opportunities or lack thereof prevailingin the global market. In fact, rising oil prices witnessed inrecent years and the growing global demand for natural gasrepresented additional investment opportunities for theSultanate, which in turn triggered additional activities aswell as challenges for the sector, in particular as a numberof Omani oil fields continued to age and progressed fromprimary, to secondary and tertiary recovery.Aggregate government expenditure witnessed a growth of19.1 percent, rising from RO 4,936.1 million in 2006 toRO 5,880.4 million in 2007. The 19.1 percent expendituregrowth recorded in 2007 was somewhat higher than the17.3 percent growth witnessed in 2006. As part of resourceprioritization policy adopted in recent years, the year 2007Current ExpenditureThe increase in current expenditure in 2007 owed to allits sub-components. Expenditure on civil ministries rosefrom RO 1,735.0 million in 2006 to RO 1,898.7 million in2007, representing a growth of 9.4 percent as compared to a52 Annual Report 2007 Central Bank of Oman

Public FinanceCompositional Shifts in Total ExpenditureComponents of Fiscal Expenditure(In Million R.O.)greater growth of 13.3 percent in 2006. Next to spending oncivil ministries came expenditure on defence and nationalsecurity, which increased from RO 1,549.6 million in 2006to RO 1,663.4 million in 2007. The difference amountedto 7.3 percent growth, which compared to 10.4 percentgrowth in 2006, and represented a deceleration. Expenditureon oil production rose from RO 139.7 million in 2006 toRO 162.8 million in 2007 while spending on gas productionincreased from RO 51.1 million in 2006 to RO 54.9 millionduring the same period. In terms of annual growth, currentexpenditure on oil production increased by 16.5 percent andby 7.4 percent on gas production in 2007. In 2006, currentexpenditure on oil production increased by 7.3 percentwhile similar expenditure on gas production also increasedby 10.1 percent. As for the interest paid on loans, it increasedfrom RO 55.6 million in 2006 to RO 77.7 million in 2007,representing a growth of 39.7 percent in 2007, as against adecrease of 16.8 percent in 2006.In sum, while current expenditure pointed to a nominalabsolute increase in 2007, it actually declined whenmeasured in terms of relative growth. The decline incurrent expenditure growth related to civil ministries,defence and national security. Growth in investmentexpenditure, on the other hand, witnessed an increase,testifying to the emerging fiscal policy pattern under whichincreasing resources are being channeled to long-termdevelopment projects.Other fiscal soundness measures such as current expenditureas a share of total expenditure and as a share of the GDP alsoindicated a downward trend between 2006 and 2007. As shareof total expenditure, aggregate current expenditure decreasedfrom 71.5 percent in 2006 to 65.6 percent in 2007. Whenmeasured as share of the GDP, this expenditure decreasedfrom 25.7 percent in 2006 to 24.9 percent in 2007. At the subcomponentlevel, current expenditure on defence and nationalsecurity declined from 31.4 percent of total expenditure in2006 to 28.3 percent in 2007 while current expenditure oncivil ministries also declined from 35.1 percent in 2006 to 32.3percent in 2007. As shares of the GDP, current expenditure ondefence and national security declined, from 11.3 percent in2006 to 10.7 percent in 2007. By the same measure, currentexpenditure on civil ministries also declined from 12.6 percentof the GDP in 2006 to 12.2 percent of the GDP in 2007.Civil Current ExpenditureThe breakdown of civil current expenditure by expenseis shown in the Table 4.4 and consists of three maincomponents, namely, total wages, salaries allowances andothers; expenditure on goods and services; and subsidiesCentral Bank of OmanAnnual Report 2007 53

CHAPTER FOURand other current transfers. The largest category undercivil current expenditure is that of total wages, salaries,allowances and others. This expenditure, which rose fromRO 1,227.5 million in 2006 to RO 1,347.9 million in 2007,amounted to an additional RO 120.4 million in spendingand represented an increase of 9.8 percent. The RO 120.4increase owed to increases realized under all the subcomponentsunder this category, except for the contributionto the pension fund, which decreased from RO 276.1million in 2006 to RO 213.9 million in 2007. It is worthnoting that the decrease in contribution to the pension fundfollowed a remarkable increase of 332.0 percent in 2006. Asshare of total wages contribution to pension fund stood at22.5 percent in 2006 as compared to 15.9 percent in 2007.Large fiscal surpluses built on the back of rising oil pricesin recent years allowed the Government to maintain largecontributions to the pension fund in 2006 and 2007.The largest sub-component under total wages, salaries,allowances and others, related to salaries and wages whichincreased from RO 518.4 million in 2006 to RO 639.7 millionin 2007, representing an increase of RO 121.3 million, or 23.4percent. In 2006, this expenditure increased by a much smallerrate of 3.7 percent. The significant growth in salaries andwages in 2007 owed to two main factors, namely, additionalabsorption of public servants by the Government as well asupward public salaries adjustments introduced in 2007 tooffset the impact of rising domestic inflation. In 2005, salariesand wages had also witnessed a double-digit growth of 16.7percent, compared to 5.6 percent growth in 2004 and 5.9percent growth in 2003. The second largest sub-componentafter salaries and wages related to allowances, which grewfrom RO 360.9 million in 2006 to RO 398.9 million in 2007and represented an increase of 10.5 percent. Expenditureunder this category has also witnessed sustained increasesTable 4.4Breakdown of Civil Current Expenditure by Type of Expenses(Millions of R.O.)Items 2003 2004 2005 2006.0 2007*A. Total Wages, Salaries Allowances and Others 758.9 805.6 938.1 1227.5 1347.9Salaries and Wages 406.0 428.9 500.4 518.4 639.7Allowances 255.0 274.1 310.9 360.9 398.9Other Remuneration 57.4 61.0 62.9 72.1 95.4Contribution to Pension Fund 40.5 41.6 63.9 276.1 213.9B. Expenditure on Goods and Services 325.5 353.2 345.2 381.8 405.5Purchase of Goods 144.9 141.5 98.2 88.9 99.5Purchase of Services 148.3 173.1 199.9 235.6 253.9Expenses of Government Services 32.3 38.6 47.1 57.3 52.1C. Subsidies and Other Current Transfers 99.9 145.6 248.6 125.8 145.3Total Civil Current Expenditure 1184.3 1304.4 1531.9 1735.1 1898.7* Provisional.Source: Ministry of Finance.54 Annual Report 2007 Central Bank of Oman

Public Financesince 2003. As for spending related to other remuneration, itincreased from RO 72.1 million in 2006 to RO 95.4 millionin 2007 and has witnessed continuous growth since 2003.Breakdown of Total Salaries, Wages,Allowances and Others for the year 2007The second largest component under civil current expenditureby types of expenses in 2007 was on goods and services. Thisexpenditure increased from RO 381.8 million in 2006 toRO 405.5 million in 2007, representing an expansion of 6.2percent. The increase in this expenditure was driven by twoof its main sub-components, namely, purchase of goods andpurchase of services. Unlike these two sub-components, thesub-component of expenses of government services recordeda decrease. In aggregate, expenditure on the purchase ofgoods and services has been increasing since 2003, exceptfor a decline registered in 2005. At sub-component level,expenditure on the purchase of goods rose from RO 88.9million in 2006 to RO 99.5 million in 2007, representingan increase of 11.9 percent. Expenditure on the purchaseof services also increased, from RO 235.6 million in 2006to RO 253.9 million in 2007, which was equivalent of anincrease of 7.8 percent. As for expenditure of governmentservices, it recorded some decrease, from RO 57.3 million in2006 to RO 52.1 million 2007.The smallest component under civil current expenditure byexpense pertained to subsidies and other current transfers.Expenditure under this component indicated a growing trendbetween 2003 and 2005, only to fall in 2006 and rise againin 2007. In fact, this expenditure increased from RO 125.8million in 2006 to RO 145.3 million in 2007, representing anincrease of 15.5 percent.Table 4.5 provides a breakdown of civil current expenditureby function, which indicated continuous increase at theaggregate level between 2003 and 2007. At the componentlevel, increases were observed under the majority of theitems during the same period, except for expenditure relatedto fuel and energy, which took a significant cut that startedin 2005, and a reduction in spending on social security andwelfare between 2006 and 2007. In 2007, as has mostly beenthe case since 2003, the large spending items under civilexpenditure by function included education affairs andservices, followed by general public services sector, socialsecurity and welfare, housing, and health. The remainingcomponents were under RO 70.0 million and their respectiveannual trends can be observed in Table 4.5. Expenditure oneducation affairs and related services rose from RO 559.9million in 2006 to RO 654.0 million in 2007, representing anincrease of 16.8 percent. Spending on general public servicessector increased from RO 249.0 million in 2006 to RO 328.3million in 2007, amounting to an expansion of 31.8 percent.Costs associated with social security and welfare decreasedby 22.4 percent, from RO 335.0 million in 2006 to RO 259.8million in 2007. Expenditure on housing grew from RO 217.8million to RO 246.1 million in 2007, representing an increaseof almost 13.0 percent. The health care sector also witnessedan increase in spending, which grew from RO 199.5 millionin 2006 to RO 223.8 million in 2007 with the differencerepresenting an increase of 24.3 percent. When measured asshares of the GDP, expenditure on two key sectors, namelyeducation and health remained almost the same between2006 and 2007. In 2006, expenditure on education stood at4.1 percent of the GDP as compared to 4.2 percent of the GDPin 2007 while expenditure on health slightly decreased, fromCentral Bank of OmanAnnual Report 2007 55

CHAPTER FOURTable 4.5Breakdown of Civil Current Expenditure by Function(Millions of R.O.)Items 2003 2004 2005 2006 2007*General Public Services Sector 167.5 199.2 223.2 249.0 328.3Public Order and Safety 36.9 38.7 40.3 43.7 49.9Education Affairs and Services 382.0 418.1 489.5 559.9 654.0Health 152.5 160.2 183.4 199.5 223.8Social Security and Welfare 98.4 91.7 262.5 335.0 259.8Housing 117.3 124.7 168.9 217.8 246.1Cultural and Religious Affairs 38.9 43.5 50.1 56.0 64.6Fuel and Energy 143.3 180.9 62.0 6.2 3.6Agriculture, Forestry & Fishing 16.6 16.7 18.8 20.7 23.5Mining, Manufacturing and Construction 0.0 0.0 0.0 0.8 0.0Transport and Communication 17.3 17.7 19.1 25.1 23.7Other Economic Affairs 13.6 13.0 14.1 21.3 21.4Total Civil Current Expenditure 1184.3 1304.4 1531.9 1735.0 1898.7* Provisional.Source: Ministry of Finance.1.5 percent of the GDP to 1.4 percent of the GDP betweenthe two respective years. In sum, and as shown in Table4.5, although civil current expenditure has been steadilygrowing since 2003, there has been some reprioritization,at least nominally, with expenditure on key sectors such aseducation, public services, and health absorbing additionalresources and growing at notable rates.Investment ExpenditurePublic investment expenditure has been witnessing asustained growth since 2003 with a noted exception in2005 when it slightly decreased from the preceding year.This expenditure, which grew from RO 1,199.5 million in2006 to RO 1,697.3 million in 2007, represented a notedboost of 41.5 percent. As share in total expenditure,investment expenditure grew from 24.3 percent in 2006to 28.9 percent in 2007. When measured as share of theGDP, this expenditure also pointed to an increase from 8.7percent in 2006 to 10.9 percent in 2007.Investment expenditure on civil ministries developmenthas been accounting for the largest share since 2003. Thisexpenditure rose from RO 576.4 million in 2006 to RO 800.2million in 2007, representing a remarkable growth of 38.8percent. In 2006, civil ministries development expenditureaccounted for 48.1 percent of total investment expenditureas compared to 47.1 percent in 2007. In order to respond tothe growing activities in the oil sector, meet the challengesposed by some aging fields, and capitalize on surging oilprices in the global market, investment expenditure on oilproduction grew from RO 322.5 million in 2006 to RO 476.9million in 2007, representing a notable increase of almost 47.9percent. As global demand for cleaner energy and domesticconsumption grew, investment spending on gas productionalso witnessed a fairly significant increase, growing from56 Annual Report 2007 Central Bank of Oman

Public FinanceShare of Investment Expenditure on Oil & GasProduction in Total Investment ExpenditureInvestment Expenditure for the Year 2007RO 272.2 million in 2006 to RO 381.9 million in 2007, or anincrease of 40.3 percent. In aggregate, investment expenditureon oil and gas production increased from RO 594.7 millionin 2006 to RO 858.8 million in 2007, representing a growthof 44.4 percent. The aggregate spending pertaining to thetwo sectors amounted to 49.6 percent of total investmentexpenditure in 2006 as compared to 51.2 percent in 2007.The smallest item under investment expenditure relatedto capital expenditure on civil ministries. Spending underthis item increased from RO 28.4 million in 2006 to RO 38.3million in 2007, representing an increase of 34.9 percent.Civil Development ExpenditureThe breakdown of civil development expenditureclassified by function is shown in Table 4.6. Under thisclassification, the large components include transport andcommunication, housing, general public services sector,and education affairs and services. The remaining itemsare under RO 25.0 million except for items falling underthe umbrella of other economic services, which increasedfrom RO 25.5 million in 2006 to RO 68.5 million in 2007,representing a remarkable expansion of 169.0 percent.Civil development expenditure on transport andcommunications has been growing since 2003 to reachRO 170.3 million in 2006 and RO 264.2 million in 2007.The increase between 2006 and 2007 represented a growthrate of 55.1 percent and is indicative of the importancethe Government attached to the development of the publicinfrastructure. Similar spending on housing has alsobeen growing in the last five years and between 2006 and2007, it grew from RO 151.7 million to RO 231.4 million,representing an increase of 52.5 percent in one year. Civildevelopment expenditure on general public services sectorhas also been on the rise since 2003, except for a slightdecline in 2006. Spending under this sector increased fromRO 58.9 million to RO 87.8 million in 2007, amounting to49.1 percent growth. Unlike the three other componentsdiscussed above, civil development expenditure oneducation affairs and related services recorded a slightdecrease in 2007. Spending under this expendituremoderated from RO 83.3 million in 2006, down to RO 81.0million in 2007, representing a decline of 2.8 percent.Participation and Support to Private SectorPublic spending on government participation and supportto the private sector witnessed significant surges in 2006and 2007 after a slight fall in 2004 and a significant decreasein 2005. As shown in Table 4.7, the increases witnessedin the last two years owed mostly to government subsidyCentral Bank of OmanAnnual Report 2007 57

CHAPTER FOURTable 4-6Breakdown of Civil Development Expenditure by Function(Millions of R.O.)Items 2003 2004 2005 2006 2007*General Public Services Sector 36.7 44.6 59.3 58.9 87.8Public Order and Safety 1.6 2.1 5.4 8.9 8.8Education Affairs & Services 34.7 42.4 47.4 83.3 81.0Health 17.6 20.3 14.6 8.0 14.3Social Security and Welfare 1.5 1.5 1.1 1.9 2.5Housing 94.0 108.3 126.7 151.7 231.4Cultural and Religious Affairs 7.4 7.4 11.7 11.8 12.8Fuel and Energy 79.8 68.5 36.7 48.7 21.9Agriculture, Forestry and Fishing 8.2 13.7 11.2 5.1 5.6Mining, Manufacturing and Construction 3.3 2.8 1.7 2.3 1.4Transport and Communication 59.8 88.4 139.5 170.3 264.2Other Economic Affairs 16.3 22.3 19.8 25.5 68.5Total Development Expenditure 360.9 422.3 475.1 576.4 800.2* Provisional.Source : Ministry of Finance.to the electricity sector, as well as significant increasein government participation in domestic, regional, andinternational interest. Total participation and support to theprivate sector by the Government increased from RO 205.6million in 2006 to RO 325.6 million in 2007, whichrepresented a growth of 58.4 percent. At the componentlevel, participation in domestic, regional and internationalinterests dramatically increased, from RO 62.6 million in2005 to RO 187.9 million in 2007, representing an increaseof almost 200 percent. The smallest expenditure componentunder government participation and support to privatesector pertained to subsidy on soft loans to private sectorand housing. Spending under this item fell from RO 15.1million in 2006 to RO 13.8 million in 2007.Government DebtThe Government stock of debt declined by RO 126.7 million,from RO 1,127.6 million in 2006 to RO 1,000.9 million in2007. This reduction was facilitated by the increase inpublic revenues, most of which generated from higher oilprices. As the Government continues to pursue its debtrestructuring policy, principal repayments also increasedsignificantly, from RO 105.6 million in 2006 to RO 324.8million in 2007. Interest payments also increased duringthe same period, from RO 55.6 million to RO 77.7 million.The indicator of debt to GDP ratio has been improvingconsistently in the last five years, from 15.6 percent in 2003to 8.2 percent in 2006, and further down to 6.5 percent in58 Annual Report 2007 Central Bank of Oman

Public FinanceTable 4.7Government participation and Support to Private Sector(Millions of R.O.)Items 2003 2004 2005 2006 2007*Participation in Domestic, Regional and International Interest 101 99.3 46.6 62.6 187.9Subsidy on Soft Loans to Private Sector and Housing 14.9 14.6 15.1 15.1 13.8Government Subsidy to Electricity Sector _ _ _ 127.9 123.9Total Participation & Support to Private Sector 115.9 113.9 61.7 205.6 325.6* Provisional.Source : Ministry of Finance.2007, reflecting the overall strong fiscal position realizedover this period. In contrast, debt services ratios, whichconsists of principal repayments and interests related toexternal debt over exports of goods and services, have beenfluctuating below 5.0 percent range in the last five yearsand stood at 2.3 percent in 2007. Nonetheless, the overalllevel of the government debt in terms of the debt to serviceratios indicator in the last five years is considered to befairly small, corroborating the robustness of the governmentfiscal position.Budget for the Year 2008The 2008 government budget was prepared in the face ofrising domestic inflation concerns. Accordingly, the fundingof various items under this budget attempted to strike abalance between containing domestic prices and the need toimplement projects that are essential to the Country’s socialdevelopment and long-term economic growth. These projectsare part of the various economic objectives incorporatedunder and the Seventh Five Year Development Plan (2006-Table (4.8)Government Debt IndicatorsItems 2003 2004 2005 2006 20071. Stock of Debt (RO mn.) 1304.9 1319.1 1018.0 1127.6 1000.92. Principal Repayments (RO mn.) 388.5 373.3 538.6 105.6 324.83. Interest Payments (RO mn.) 59.9 74.4 66.8 55.6 77.74. Debt Indicators*(a) Debt to GDP ratio (%) 15.6 13.8 8.6 8.2 6.5(b) Debt Services Ratio (%)** 4.9 3.4 4.9 0.6 2.3*Since non-Government debt is not included in deriving these indicators, they do not reflect the debt of Oman as a whole, and hence, they are strictly notcomparable with standard published debt indicators for other countries.** Relating to external debt of the Government Only. Debt- service ratio implies ( principal repayments plus interest payments) as percentage of export of goodsand services.Central Bank of OmanAnnual Report 2007 59

CHAPTER FOURGovernment Debt to GDP Ratio2010) and in a broader context, constitute steps toward theVISION 2020 economic objectives.One of those long-term objectives is to promote private sectorgrowth and minimize government economic participation inthe market. Nonetheless, in 2008, the Sultanate’s economycontinues to be driven mainly by state activities albeit with agrowing contribution from the private sector. Consequently,priority in terms of resource allocation and the size of theoverall budget would continue to influence significantly thevarious sectors of the economy.Government revenues for the fiscal year 2008 are estimatedat RO 5,400.0 million as compared to RO 4,490.0 millionestimated under the 2007 budget. The difference representedan increase of RO 910.0 million, or 20.3 percent. Similarto the previous years budgets, the hydrocarbon sector,primarily the oil sector, is expected to contribute thebiggest share to the government coffers in 2008. Giventhe Government’s considerable reliance on the oil sectorin generating its revenues, overall revenue projections for2008 took into account the rising Omani crude oil price inthe world market, but conservatively assumed at an annualaverage price of US$ 45.0 per barrel, and an average dailyoil production of 790.0 thousand barrels.At the components level, net oil revenues are projectedto grow from RO 3,015.0 million in the 2007 budget toRO 3,610.0 in 2008, representing an increase of RO 590.0million, or 19.7 percent growth. Revenues from gas are alsoexpected to increase, from RO 550.0 million in the 2007budget to RO 620.0 million in the 2008 budget, amounting toan increase of RO 70.0 million and representing a 12.7 percentgrowth. The combined share of estimated revenues from oiland gas revenues to total estimated revenues in 2007 stoodat 79.4 percent against 78.3 percent under the 2008 budget.While the share of hydrocarbon to total revenues is projectedto fall by 1.1 percent between 2007 and 2008 budgets, itsoverall amount is expected to increase by RO 665.0 million, or18.7 percent. The decrease in projected share of hydrocarbonrevenue share to total revenue between 2007 and 2008 ispartly explained by a RO 240.0 million projected increase(i.e. 27.0 percent increase) in other current revenues, whichare estimated to reach RO 1,130.0 million in 2008, up fromRO 890.0 million estimated under the 2007 budget.Aggregate public expenditure under the 2007 budget wasestimated at RO 4,890.0 million as compared to RO 5,800.0million under the 2008 budget. The difference, whichamounts to an increase of RO 910.0 million, is also equivalentof the increase in estimated aggregate revenues between thetwo years budgets. In terms of percentage growth, estimatedaggregate expenditure between the two respective budgetsstood at 18.6 percent.Estimated current expenditure consists of spending ongovernment operation expenses, basic government services,and expansion of social services. This expenditure increasedby RO 407.0 million, or 12.9 percent, from of RO 3,143.0million in 2007 budget to RO 3,550.0 million in 2008 budget.In 2007, similar expenditure as share of total expenditure stoodat 64.3 percent as against 61.2 percent in 2008, representing acontraction of 3.1 percent. Projected expenditure for defenseand national security is to increase by RO 125.0 million, or by10.1 percent, from RO 1,235.0 million in 2007 to RO 1,360.0million in 2008. As a share of total expenditure, this item60 Annual Report 2007 Central Bank of Oman

Public Financeaccounted for 25.3 percent in the 2007 budget, but decliningto 23.4 percent under the 2008 budget.Anticipated current expenditure on civil ministries amountedto RO 1,603.0 million in 2007, as compared to RO 1,905.0million in 2008, which amounted to a notable increase ofRO 302.0 million, or 18.8 percent growth. This expenditureaccounted for 32.8 percent of total expenditure under the 2007budget as well as under the 2008 budget. Other expenditureitems under current expenditure include interest paid onloans, whose estimate decreased by RO 20.0 million, fromRO 75.0 million in 2007 to RO 55.0 million in 2008. Thistrend reflected the sustained fiscal surpluses witnessed inrecent years realized on the back of surging crude oil prices,thereby allowing the Government to reduce its public debt.The combined current expenditure on oil and gas productionwas projected to remain the same under the 2007 and the2008 budgets, at RO 230.0 million, with the oil productionexpenditure increasing by RO 5.0 million and the gasproduction expenditure decreasing by similar amount.The 2008 investment expenditure budget witnessed aremarkable jump from the preceding year budget. Thisexpenditure estimate, which increased from RO 1,492.0million in 2007 to RO 1,865.0 million in 2008, amounted toa RO 373.0 million boost, which represented a 25.0 percentincrease. While oil production expenditure accounted forthe largest item under the 2007 investment expenditure,which was followed by development expenditure on civilministries, the reverse held true under the 2008 budget. Thebudget for development expenditure for civil ministriesincreased from RO 500.0 million in 2007 to RO 725.0 millionunder the 2008 budget, representing an increase of RO 225.0million, or 45.0 percent.Budgeted investment expenditure for oil production in2007 stood at RO 575.0 million as against RO 670.0 millionin 2008, amounting to an increase of RO 95.0 million, or16.5 percent growth. The rising investment expenditure onoil production reflected strategic undertakings as well asgeological challenges. Strategically, resources are channeledtoward increasing oil reserves as well as developing existingnew fields and discovering new ones. Geologically, as existingoil fields mature, the challenges increase and so do the costs.The third largest investment expenditure item under the2007 as well as the 2008 budget relates to gas production andamounted to RO 400.0 million and RO 450.0 million duringthe two respective years. The difference of RO 50.0 millionrepresents an increase of 12.5 percent under this item. Thecombined budget on investment expenditure on oil and gasstood at RO 975.0 million in 2007 as against RO 1,120.0million in 2008. With regards to capital expenditure for civilministries, the budget was increased from RO 17.0 million in2007 to 20.0 million in 2008.The budget for government participation and subsidy tothe private sector was increased, from RO 255.0 millionin 2007 to RO 385.0 million in 2008. The RO 130.0million increase under this item consisted of increasesin government participation in domestic, regional andinternational institutions, as well as continued subsidies tothe electricity sector. The projected level of deficit for 2008is the same as 2007, at RO 400.0 million. Taken as share oftotal revenues, this projected deficit is lower in 2008, at 7.4percent as compared to 8.9 percent in 2007. Since the 2008actual oil price outcome could be much more favourablethan the price assumption of the budget, as has been thecase in recent past, the fiscal position could be expected toend up with another surplus.Central Bank of OmanAnnual Report 2007 61

Money, Banking andFinancial InstitutionsCHAPTER FIVE

MONEY, BANKING AND FINANCIAL INSTITUTIONSFinancial stability represents an essential precondition tosustainable growth in an open economy that operates witha fixed peg, and in 2007, the external environment turnedincreasingly adverse, particularly in the second half, asmanifested by the severe global credit squeeze that startedin response to the US sub-prime crisis, rising inflationconcern all over the world under the pressure of escalatingcommodity and energy prices, general concern of a globalrecession led by the US, and sustained further depreciationof the US dollar against key international currencies. WhileOman’s financial system generally remained resilient to suchadverse external developments, money and credit growthremained high reflecting the domestic demand conditionsdriven by high economic growth, and the domesticinflationary pressures also increased further. In the sphere ofmonetary management, while falling value of the USD wasrecognized as one of the sources of imported inflation, sharpcut in US interest rates by 325 basis points over a period ofjust about six months between September 2007 and April2008 clearly brought to the fore the challenges of lack ofmonetary policy independence associated with the fixedpeg in the face of domestic inflation concerns. Recognizingthe clear continued relevance of the fixed peg of the RO tothe USD for an open and oil dependent economy as the keymeans to stability, growth and investment, and also becauseof the dominance of supply side factors in the country’sinflation process in the face of high growth driven demand,the CBO repeatedly reaffirmed its commitment to the fixedpeg. Despite the lack of monetary independence, it not onlyraised the reserve requirement to stem the growth in moneysupply, but also added further momentum to its liquidityabsorption policy by significantly raising the volume of CBOCDs. Well functioning financial markets and sound financialinstitutions are essential not only for effective conduct ofmonetary policy, but also for promoting the cause of growthand stability. Given the risk of external developmentstransmitting to an open economy, CBO remained constantlyvigilant about global monetary and financial marketdevelopments.The appropriate regulatory and supervisory response to dealwith the causative factors and the subsequent ramifications ofthe severe global credit squeeze is still to evolve, which couldbe expected to serve as a guide for national policy makers overa period of time. Current international assessment clearlysuggests that credit risk transfer instruments in the markethave led to weakening of standards at the level of origination ofcredit, and stronger prudential framework would be essentialfor securitization and off-balance-sheet activities. Enhancedtransparency could also aid in more credible valuation andaccounting of transactions, and capital adequacy requirementsmust be based on more appropriate assessment of risk. Assetprice bubbles could be expected to receive much greaterattention in the financial stability analyses, even though theappropriate monetary policy response to asset price bubblesmay still elude any global consensus. The challenge of riskmeasurement measures and risk management capabilitiesnot keeping pace with the growth in complex financialinnovations would constantly engage the attention of thenational regulators as well as the international standardsetting bodies. The CBO has always strived to adopt relevantinternational standards and best practices, while also keepingin view the specific needs of the country, and this approachwould continue to underpin its goal for promoting andpreserving financial stability in Oman.While oversight of the banking sector with a view toensuring financial stability is one of the major objectives ofCentral Bank of OmanAnnual Report 2007 65

CHAPTER FIVEthe Central Bank, yet another focus has been development ofthe banking system so that banks can play a positive role andcontribute to the economic development of the country. Theyear 2007 witnessed the Central Bank of Oman continuingits catalytic role in this area. Its two-pronged approach hasbeen the strengthening of the organizational structure of thefinancial sector coming under its jurisdiction and takingforward its progressively deregulatory vista in operationalaspects of financial institutions. There have been new banks,branches and other outlets like ATMs, so as to enhance thereach of banks. This has enabled more and more people toavail of banking services and products and come withinthe fold of the organized financial sector. The Central Bankadopted a more liberal stance with regard to the inductionof foreign banks as branches and in encouraging significantforeign shareholding in local banks so as to optimize synergy,enhance capacity, attract foreign expertise as well as promotecompetition. Local banks were also allowed to expand tooverseas markets through direct presence and significantand strategic share-holdings in affiliates.The institutional framework of the financial sector comingunder the jurisdiction of the Central Bank of Oman comprisedmainly the commercial banks, specialized banks, nonbankfinance and leasing companies and money exchangeestablishments dealing exclusively with money exchange anda few authorized to engage in remittance business as well. Asat the end of 2007, the number of commercial banks stoodat 17, of which 7 were locally incorporated and 10 werebranches of foreign banks. Bank Sohar SAOG and a branch ofQatar National Bank started their operations during 2007 andAlliance Housing Bank, a specialized bank, was convertedinto a commercial bank with the name of Ahli Bank SAOG.Commercial banks operate in Oman with a branch network of362 branches. In addition, local banks had 11 branches andone representative office abroad. The locally incorporatedcommercial banks were Bank Muscat, National Bank of Oman,Oman International Bank, Oman Arab Bank, Bank Dhofar,Bank Sohar and Ahli Bank, while the foreign banks includedHSBC Bank Middle East, Standard Chartered Bank, HabibBank, Bank Melli Iran, Saderat Iran, National Bank of AbuDhabi, Bank of Baroda, State Bank of India, Bank of Beirut andQatar National Bank. Commercial Banks had 666 ATMs (ofwhich 304 were off-site), 12 on-site banking facilities, 3 kioskmachines and 43 cash deposit machines. Ten commercialbanks had approval to engage in specific investment bankingactivities on a tiered licensing system. As at the end of 2007,the largest three local banks accounted for 65 percent oftotal assets, 66 percent of total credit, and 60 percent of totaldeposits, and had combined assets of RO 6.74 billion (US$17.53 billion). Commercial banks’ liabilities continue to bedominated by deposits. At the end of 2007, deposits accountedfor 63 percent of total liabilities followed by core capital andreserves at 14 percent. On the assets side, total credit accountedfor 63 percent of total assets, which was equivalent to 42percent of GDP and 75 percent of non-oil GDP in 2007. As atthe end of 2007, there were 2 Government owned specializedbanks in operation, namely, the Oman Housing Bank andOman Development Bank, together operating with a networkof 22 branches. Six finance and leasing companies licensed bythe Central Bank were engaged in leasing, hire purchase, debtfactoring and similar credit based operations. They had 31branches, all within Oman. Money exchange establishmentsstood at 50, of which 12 operated under the license of moneychanging and draft issuance business. There were in total 110branches of these twelve exchange establishments, includingfourteen new branches opened in 2007. Besides the above,the non-bank financial intermediation sector also includedthe insurance companies, public and private sector PensionFunds, capital markets, brokerage companies and the MuscatSecurities Market.Monetary and Banking IndicatorsSound macro-economic policies, stable financial system,forward looking banking regulations and fine-tuned monetary66 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial Institutionspolicy measures have supported the financial system’sstrength and resilience, aided the development of financialproducts and markets, and led to gradual financial deepeningin the economy. The financial sector in Oman has witnessedgreater deregulation, strides in the use of technology, growthin private sector holdings of financial assets, increasedcompetition and transparency associated with globalization,WTO and FTA agreements. Advances in the payment andsettlement system such as RTGS and ACH have also addeddepth and sophistication to the financial system. The widespread use of internet banking, phone banking, paymentof utilities and other transfers through electronic means,increased use of ATMs, credit and debit cards, smart cardsand other similar instruments have become common place.The increased provision of financial services with a widerchoice of services by competing institutions, geared to alllevels of society, has resulted in providing greater thrust tothe financial deepening process. This could be seen from thefew indicators that have been summarized and presentedin Table 5.1.Both commercial bank deposits and credit registeredsignificant growth over the years as the banking systemsuccessfully engaged in its financial intermediation role.Money supply growth responded to the growing moneydemand associated with high growth in nominal GDP, nonoilGDP, and per-capita income in the country. With sizableincrease in foreign assets of the Central Bank and surplusliquidity with commercial banks, reserve money registereda sharp increase during 2007. Under a fixed exchange rateTable 5.1Select Monetary and Banking Indicators2003 2004 2005 2006 2007Number of Commercial banks 14 14 13 14 17Number of branches of Commercial banks 327 330 329 338 362Commercial Bank deposits (in RO million) 2853 3078 3761 4685 6491Commercial Bank credit (in RO million) 3308 3506 3896 4703 6505Number of cheques cleared (in 000) 1817 1772 1800 1873 2158Average amount per cheque 1195 1240 1394 1496 1672Reserve money (in RO million) 443 503 526 727 1235Currency with public (in RO million) 304 329 383 471 563Narrow money M1 (in RO million) 804 907 1128 1230 1921Broad money M2 (in RO million) 2831 2944 3573 4461 6120Ratio of NFA of CBO to Reserve money 3.1 2.7 3.2 2.7 3.0Ratio of NFA of banking system to M2 0.5 0.6 0.6 0.6 0.6Indicators of dollarizationCommercial bank deposits in forex to total deposits (%) 16.0 18.5 23.4 28.8 17.3Commercial bank credit in forex to total credit (%) 23.1 21.8 21.3 20.4 23.6Financial deepening indicatorsBank credit to GDP (%) 39.5 36.8 32.9 34.2 41.9Bank deposits to GDP (%) 34.1 32.3 31.7 34.1 41.8Quasi-money to GDP (%) 24.2 21.4 20.6 23.5 27.1Broad money to GDP (%) 33.8 30.9 30.1 32.5 39.5Currency with public to GDP (%) 3.6 3.5 3.2 3.4 3.6Currency with public to reserve money (%) 68.6 65.4 72.8 64.8 45.6Currency with public to broad money (%) 10.7 11.2 10.7 10.6 9.2Income velocity of broad money 2.9 3.2 3.3 3.1 2.5Money multiplier (M2 over reserve money) 6.4 5.9 6.8 6.1 5.4Central Bank of OmanAnnual Report 2007 67

CHAPTER FIVEregime, the ratio of net foreign assets of the Central Bank toreserve money indicates the extent of hard currency backingof the Rial Omani and the confidence imparted to the peg.Net foreign assets of the Central Bank to reserve moneywas comfortably placed at three times the level of reservemoney in 2007. Since 2004, the ratio of net foreign assets ofthe banking system to broad money has remained stable at0.6, giving credibility and strength to the monetary system.The rising trend in the share of foreign currency depositswitnessed during the period 2003 to 2006 reversed in theyear 2007. The perception of a possible revaluation of thelocal currency, coupled with a narrowing of the interestrate differential between the home currency and the anchorcurrency under the peg, led to the decline in foreign currencydeposits of customers with banks.Demand for bank credit denominated in foreign currency alsoincreased during 2007, with its share in total credit risingfrom 20.4 percent in 2006 to 23.6 percent in 2007. The marketperception of revaluation and the lower cost of borrowing inUS dollar in relation to the Rial Omani, also partly encouragedthis trend. This brings to the fore the importance of exchangerate stability and the need to stem speculative rumours aboutthe exchange rate. The ratio of bank credit to GDP increasedsignificantly in the year 2007 from 34.2 percent in 2006 to41.9 percent. When seen in relation to non-oil GDP, the ratioaccelerated from 64 percent to 75 percent. Bank deposits toGDP ratio also registered an upward shift moving up from34.1 percent in 2006 to 41.8 percent in 2007. Increase in theratios of both credit and deposits to GDP indicate furtherfinancial deepening in the economy. The financial saving inthe economy, which is sometimes measured by quasi-moneyto GDP ratio, is also seen to have improved from 23.5 percentin 2006 to 27.1 percent in 2007. Currency with the public toreserve money declined sharply in 2007 to 45.6 percent from64.8 percent, as commercial bank deposits with the CentralBank increased significantly during the year. Broad moneygrew by a whopping 37.2 percent during 2007 on the backof 24.9 percent in the previous year. It must be noted thatwith money supply growing faster than the nominal GDP inrecent years, the velocity of money (ratio of nominal GDPto money stock) declined from 3.3 in 2005 to 3.1 in 2006and further to 2.5 in 2007. The money multiplier defines therelationship between the money supply and the monetarybase, and is usually defined as the ratio of broad money toreserve money. The decline in the money multiplier from 6.1in 2006 to 5.4 in 2007 was mainly due to the high level ofexcess reserves held by banks with CBO, given the surplusliquidity scenario.CBO’s Monetary PolicyMonetary Policy is the means by which the Central Bankstabilizes demand supply disequilibrium, and by regulatingthe volume and price of money and credit, monetary policyhelps in achieving the macroeconomic objectives in theform of low and stable inflation, high and sustainablegrowth, and financial stability. Oman operates with a fixedexchange rate tied to the US dollar since 1973. The parityunderwent a change in January 1986 and since then thepeg to the US dollar has remained unaltered at $ 2.6008per Rial Omani. The fixed exchange rate automaticallyconditions the monetary policy framework, whose mainobjective is to protect and defend the peg. The peg also hasto be seen in the larger context of overall macroeconomicrequirements of the country. For a small open economy likeOman, fixed peg to the US dollar works as the strongestsource of stability, which is so essential for promotingtrade and investment. The fact that the credibility of theexchange rate regime has been sustained for many years,has provided considerable degree of certainty to foreigninvestors by limiting risks often associated with currencyexposure. Imported monetary discipline embodied in thefixed peg has been a strong source of monetary and financialstability and the certainty of the exchange rate has created aconducive environment for investment and growth. Sharp68 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial Institutionseasing in the Fed’s monetary policy stance that started in thesecond half of 2007 and sustained depreciation of the USdollar have led to not only imported easy monetary policystance in Oman but also imported inflation. The resultantpressure on domestic inflationary conditions, however, hasto be seen in the context of benefits and continued relevanceof the fixed peg for Oman.With an open capital account, the fixed peg nonethelessimposes certain limitations on the conduct of an independentmonetary policy. Because of the fixed peg, it is the balanceof payments developments that largely determine the moneysupply process and it is the US interest rates that influencethe domestic interest rate environment. Because of thisconstraint, the primary focus of monetary policy dovetailsinto liquidity management, so that excess supply of domesticliquidity is absorbed by the CBO and excess demand forliquidity is met by the CBO through injection of liquidity.In the absence of such liquidity operations, inflows andoutflows of capital could exert pressures on the balance ofpayments, and hence on the exchange rate peg.For liquidity management purpose, a number of instrumentsare used by the CBO, which primarily include issuance ofcertificates of deposits (CDs) by the CBO to absorb excessliquidity, and repo transactions by the banks with the CBO,which lead to injection of liquidity to meet the excessdemand. Direct instruments, primarily in the form of reserverequirements and lending to deposit ratios, supplementthe indirect instruments of monetary policy. To stem theacceleration in credit growth and mop up liquidity, the CBOraised the reserve requirement from 3 percent to 5 percentCentral Bank of OmanAnnual Report 2007 69

CHAPTER FIVEeffective from February 2008, following an earlier decisionto exclude cash balances from the calculation of acceptedreserves. In June 2008, the decision was taken to raise thereserve requirement further to 8 percent. The CBO alsoremoved the cap on the total outstanding stock of certificatesof deposit, thereby increasing its scope to further mop upliquidity. The lending ratio, which was set at 87.5 percent,aims at modulating credit flow in the system while alsoattaining the objectives of growth and employment throughthe credit channel. The stipulated maximum permissibleratio, is however, non-binding on many banks at present,since several banks are operating at well below the ceiling.With a view to contain fast growth in credit, and given thepotential greater effectiveness of credit policy measures, itwas decided in June 2008 to reduce the lending ratio from87.5 percent to 82.5 percent.In addition to the above direct and indirect instruments,the CBO uses several prudential regulations to influence theintermediation process in the banking system. To encouragethe allocation of credit to the corporate sector, personalloans are limited to 40 percent of a bank’s total credit, withan additional 10 percent allowed for residential housingpurposes. The quantitative ceiling along with an interestrate ceiling of 8 percent also helps in limiting excessiveconsumption demand. A bank’s net open position in foreignexchange is restricted to 40 percent of its capital and reserves,and there is a cap on different maturities for foreign borrowingsby banks linked to net worth. Specific regulations are in placeto contain risk arising from bank’s single and related partyexposures, lending to finance purchase of shares, investmentin real estate, etc.Monetary AggregatesFunded mainly by customer deposits, commercial bank’sbalance sheets registered increased volumes of demand,savings and term deposits in the recent years, mainly fuelledby large inflows of oil revenues into the banking system.During 2007 alone, both deposits and credit expanded byaround 38 percent, while nominal GDP and non-oil GDPincreased much less at 12.9 percent and 18.3 percent,respectively. Expansion in commercial bank’s balance sheettogether with the significant increase in CBO’s net foreignassets led to monetary expansion with broad money growingat 37 percent during the year.Monetary BaseThe monetary base (Mo) consists of all currency and coinsissued by the Central Bank as well as other depositorycorporations’ (i.e. commercial banks) deposits held with theCentral Bank. This aggregate is often referred to as “high poweredmoney”, because increases in the volume of the monetary basecould usually lead to significantly larger increase in moneyand credit due to the multiplier effect. During the year 2007,as could be seen from Table 5.2, Mo increased by almost 70percent, from RO 726.7 million to RO 1234.9 million.The increase in the monetary base was on account of bothincrease in currency issued by CBO by RO 102.5 million andhigher levels of clearing balances held with the Central Bankby RO 405.7 million. On the sources side of reserve moneycreation, the large increase in net foreign assets of CBOcreated the momentum, resulting from surplus positions inOman’s overall balance of payments.Narrow and Broad MoneyThe money supply or money stock refers to the totalamount of money held by the non-bank public at a pointin time in an economy. Various measures of money supplyare closely monitored because of their potential effects onreal economic activity and the price level. Because moneyis anything that can be used in settlement of a debt or aspayment for any transaction, there are varying measures of70 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsTable 5.2Monetary Base and its Sources(in Million RO)2005 2006 2007Absolute Change06/05 07/06Currency Issued 459.5 560.6 663.1 101.1 102.5Banks deposits with CBO* 66.3 166.1 571.8 99.8 405.7Monetary Base (M0) 525.8 726.7 1234.9 200.9 508.2Central Bank AssetsForeign assets 1675.9 1928.2 3662.1 252.3 1733.9Claims on Government 0.8 0.3 0.3 -0.5 –Fixed and other assets 149.7 202.7 170.4 53.0 -32.3Less:Central Bank LiabilitiesNet Worth (capital and reserves) 739.8 823.2 975.5 83.4 152.3Government deposits 168.3 204.5 398.1 36.2 193.6Foreign liabilities 1.0 0.6 0.8 -0.4 0.2Other liabilities 391.5 376.2 1223.5 -15.3 847.3*Excludes CDs issued by CBO which are shown under other liabilities.Table 5.3Money SupplyM1M2End of PeriodMillion RO% Change overprev. period% Change over12 MonthsMillion RO% Change overprev. period% Change over12 Months2003 804.1 4.5 4.5 2831.3 2.5 2.52004 907.4 12.8 12.8 2944.3 4.0 4.02005 1128.1 24.3 24.3 3573.1 21.4 21.42006IQ 1267.5 12.4 22.2 3799.4 6.3 20.3IIQ 1322.3 4.3 19.7 3979.8 4.7 20.1IIIQ 1196.1 -9.5 12.7 4215.6 5.9 27.9IVQ 1229.6 2.8 9.0 4461.3 5.8 24.92007Jan 1358.4 10.5 17.2 4544.8 1.9 27.7Feb 1287.1 -5.2 7.5 4579.3 0.8 26.7Mar 1420.4 10.4 12.1 4871.4 6.4 28.2Apr 1421.5 0.1 11.4 4925.0 1.1 28.3May 1486.2 4.6 13.3 5106.6 3.7 30.9June 1568.0 5.5 18.6 5240.9 2.6 31.7July 1524.4 -2.8 23.7 5159.1 -1.6 31.2Aug 1558.1 2.2 30.7 5282.3 2.4 28.0Sept. 1649.5 5.9 37.9 5465.0 3.5 29.6Oct. 1724.2 4.5 39.6 5608.9 2.6 30.3Nov. 1786.6 3.6 47.5 5789.7 3.2 32.6Dec. 1921.3 7.5 56.3 6119.8 5.7 37.2Source: Central Bank of Oman.Central Bank of OmanAnnual Report 2007 71

CHAPTER FIVEMoney Supply(Amount in Million R.O)Monetary SurveyThe framework of the Monetary Survey is designed to facilitateanalysis of broad money and its components, credit aggregatesand their components, and depository corporations’ foreignassets and liabilities and other assets and liabilities. TheMonetary Survey (Table 5.4) is structured to show that broadmoney liabilities equals the sum of net foreign assets, domesticcredit and other items net. It can be seen that the increase inbroad money during the one year period ended 2007 by RO1658.5 million was mainly driven by the rise in net foreignassets of the banking system by RO 1149.4 million and to amoney supply. While constructing monetary aggregates, thedegree of liquidity of the instrument has to be determined.In Oman, narrow money (M1) is defined as the aggregateof currency held by the public and local currency demanddeposits of the private sector and public enterprises. During2007, M1 registered a sharp increase of 56.3 percent on ayear-on-year basis to reach RO 1921.3 million. In terms ofthe components of M1, the main thrust was on accountof the significant growth in Rial Omani demand deposits,which rose by 79 percent followed by 19.6 percent increasein currency with the public. Quasi-money (Rial Omanisavings, time deposits, certificates of deposit issued bycommercial banks, margin deposits and foreign currencydesignated deposits) witnessed an impressive growth of29.9 percent over the year to reach RO 4198.5 million asat the end of December 2007. However, as a percentage oftotal money stock, quasi-money declined to 68.6 percent in2007 from 72.4 percent in the previous year. Within quasimoney,both Rial Omani time deposits and saving depositsalso witnessed growth rates of 84.7 percent and 39.7percent, respectively. A notable exception to the growthpattern was seen in the case of private sector deposits inforeign currency, which declined during the year by 21.4percent, partly in response to the fall in US dollar interestrates and the speculation on the strengthening of thelocal currency.lesser extent due to the increase in domestic assets by RO509.1 million. Within net foreign assets, contrasting positionsemerged, with CBO’s NFA increasing by RO 1733.7 millionwhile that of commercial banks declined by RO 584.3 million.Within domestic assets, claims on the private sector exertedan expansionary effect on broad money with credit expandingby 36.8 percent or by RO 1619.7 million. Net claims on theGovernment, however, declined by RO 501.4 million duringthe period. Other items net, comprising the non-monetaryliabilities of the banking system increased by 34.8 percent,mainly due to higher accretions to capital and reserves of theCentral Bank and commercial banks.Financial MarketsFinancial markets operated in an environment of uncertainlyworldwide. The crisis in the US sub-prime mortgage marketand its spill overs into other markets, downturn in the USinterest rate cycle, heightened inflationary pressures and thedepreciation of the US dollar against major currencies ledto concerns about global financial stability. From a macroeconomic point of view, well functioning financial marketscould have a crucial role in mitigating the financial fragility,and thereby contributing to the growth development processin the economy. The size and stability of financial marketsbecome crucial in facilitating mobilization of savings and72 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsEnd of PeriodTable 5.4Monetary Survey(in Million R.O)2003 2004 2005 2006 2007Change inmillion RO2007/06% Change2007/061. Broad money (A+B) 2831.3 2944.3 3573.1 4461.3 6119.8 1658.5 37.3A. Money 804.1 907.4 1128.1 1229.6 1921.3 691.7 56.3a) Currency with public 303.7 329.1 383.2 470.9 563.4 92.5 19.6b) Demand deposits in RO 500.4 578.3 744.9 758.7 1357.9 599.2 79.0B. Quasi Money 2027.2 2036.9 2445.0 3231.7 4198.5 966.8 29.9(of which foreign cy. deposits) (399.7) (421.1) (764.8) (1213.1) (954.0) (259.1) (-21.4)2. Foreign Assets (net) 1421.6 1639.4 2259.8 2745.3 3894.7 1149.4 41.9Central Bank 1381.8 1382.8 1674.9 1927.6 3661.3 1733.7 89.9Commercial Banks 39.8 256.6 584.9 817.7 233.4 -584.3 -71.53. Domestic Assets 1409.7 1304.9 1313.3 1716.0 2225.1 509.1 29.7a) Claims on Government (net)(i-ii) 53.6 -83.8 -457 -652.1 -1153.5 -501.4 76.9i) Government borrowings 422.1 443.5 254.9 228.9 151.8 -77.1 -33.7Less: ii) Government deposits(-) 368.5 527.3 711.9 881.0 1305.3 424.3 48.2b) Domestic claims on Pvt. Sector 3058.4 3258.8 3666.8 4405.6 6025.3 1619.7 36.8c) Claims on Public enterprises 69.0 87.3 111.8 195.8 364.8 169.0 86.3d) Other items (net) (-) 1771.3 1957.4 2008.3 2233.3 3011.5 778.2 34.8i) Monetary authorities 1013.8 971.3 1124.1 1252.4 2700.1 1447.7 115.6ii) Commercial banks 757.5 986.1 884.2 980.9 311.4 -669.5 -68.3Source : Central Bank of Oman.channelizing them to support economic development whilestrengthening the price discovery process. Domestic financialmarkets remained broadly stable during 2007, facilitated byCBO’s liquidity management and sound regulations.Money MarketThe money market is a segment of the financial marketin which financial instruments with high liquidity andshort maturities are traded. The money market is used byparticipants for borrowing and lending in the short term. Ina well functioning money market the liquidity mismatch inthe system gets reflected first in the money market rates, andhence CBO’s liquidity management operations primarily aimat keeping the money market rates around CBO’s policy ratesthrough timely and appropriate injection / absorption ofliquidity into the system. A developed money market not onlyenhances the effectiveness of monetary policy transmissionbut also facilitates development of bond markets and theoverall financial system. The market consists of short-termdebt instruments such as negotiable certificates of deposit,treasury bills, borrowings between banks and from theCentral Bank (Repos), among others. The money market isthe focal point for CBO’s operations to manage liquidity inthe banking system and thereby transmit monetary policyimpulses. The CBO undertakes liquidity management tosmooth out short-term fluctuations in bank liquidity toavoid excessive adjustment costs to the banking system. Forabsorption of liquidity, CBO conducts weekly auctions ofcertificates of deposit (CDs) while injection of liquidity ismainly done through repurchase agreements (Repos) in CBOCDs, as well as through an intra-day liquidity facility by wayCentral Bank of OmanAnnual Report 2007 73

CHAPTER FIVETable 5.5Components of Broad MoneyA. (In Million R.O)End of the Period 2003 2004 2005 2006 2007Money Supply (M1) 804.1 907.4 1128.1 1229.6 1921.3Currency with public 303.7 329.1 383.2 470.9 563.4Demand deposits in local currency 500.4 578.3 744.9 758.7 1357.9Quasi Money 2027.2 2036.9 2445.0 3231.7 4198.5Savings deposits in local currency 646.5 734 851.3 1008.6 1408.6Time deposits in local currency 952.8 850.4 791.2 962.6 1778.3Deposits in foreign currency 399.7 421.1 764.8 1213.1 954Margins 28.2 31.4 37.7 47.4 57.6Broad Money (M2) 2831.3 2944.3 3573.1 4461.3 6119.8B. (Percentage To Total)End of the Period 2003 2004 2005 2006 2007Money Supply (M1) 28.4 30.8 31.6 27.6 31.4Currency with public 10.7 11.2 10.7 10.6 9.2Demand deposits in local currency 17.7 19.6 20.9 17.0 22.2Quasi Money 71.6 69.2 68.4 72.4 68.6Savings deposits in local currency 22.8 24.9 23.8 22.6 23.0Time deposits in local currency 33.7 28.9 22.1 21.5 29.1Deposits in foreign currency 14.1 14.3 21.4 27.2 15.6Margins 1.0 1.1 1.1 1.1 0.9Broad Money (M2) 100.0 100.0 100.0 100.0 100.0Source: Central Bank of Oman.of Repos. Rediscount facility and buyback of CBO CDs aretechnically still in operation, although they have not beenused for a long time. The CBO foreign exchange swap facilityis also available to banks in amounts upto individuallyprescribed limits as determined by the CBO, although therehave been rare instances of it being used of late.During the year 2007, the CBO’s monetary operationscontinued to be characterized by more absorption thanprovision of liquidity, given the existing liquidity surplusin the system. Banks accessed CBO only for short-termfunds on an occasional basis, through repos. There were norediscounting of commercial paper or premature sellback ofCBO CDs by banks during the year. Demand for CDs weremainly concentrated in the 28-days maturity; relatively smallamounts of 91 and 182-days CDs were issued during 2007.Month-wise details of the liquidity absorption and injectionby CBO during the year 2007 are presented in Table 5.6(a).The domestic inter-bank call money market continued tolack sufficient depth with transactions mostly confined toovernight tenors. The average daily volume of transactionsduring 2007 was around RO 24 million. The main impedimentto inter bank activity was the abundance of liquidity in themarket. Although the main function of the call money marketis to recycle liquidity among banks, commercial banks choseto invest in CBO CDs rather than making serious attemptsto clear liquidity mis-matches in the inter-bank market first.74 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsTable 5.6 (a)Absorption and Injection of Liquidity by CBO during 2007MonthAmountIssuedDuringtheMonth(ROMillion)Liquidity Absorption (CBO CD’s)OutstandingCDs at theend of theMonth*Liquidity Injection28 Day CDs 91 Day CDs 182 Day CDs (Repos With CBO)**WeightedAverageInterestRate(% P.A)AmountIssuedDuringtheMonth(ROMillion)WeightedAverageInterestRate(% P.A)AmountIssuedDuringtheMonth(ROMillion)WeightedAverageInterestRate(% P.A)AmountRepoedDuringThe Month(RO Million)REPORATE***(% P.A)January 308.6 3.660 0 – 0 – 308.6 42.8 6.326February 319.7 3.683 0 – 0 – 319.7 – 6.320March 454.3 3.638 0 – 0 – 454.3 – 6.320April 526.6 3.598 0 – 0 – 526.6 – 6.320May 697.0 3.598 0 – 0 – 615.5 – 6.320June 379.3 3.578 5.0 3.650 0 – 384.3 – 6.320July 270.6 3.377 16.0 3.605 0 – 291.6 – 6.320August 396.4 3.128 132.0 3.532 16.5 3.610 430.1 135.0 6.456September 136.1 3.093 76.0 3.493 22.0 3.575 398.6 4.0 6.558October 292.1 2.780 38.0 3.190 9.0 3.405 499.6 – 6.022November 536.0 2.178 92.5 2.737 19.0 2.853 809.0 – 5.730December 787.1 1.960 96.0 2.410 3.0 2.600 1083.1 – 6.022* Includes CDs of all maturities.** Includes repos in all instruments such as CBO CDs, GDBs, and T.Bs which are mostly of one to two day durations. Excludes intra-day repos.*** The repo rate from June 2006 is set independent of the CDs rate. The rate given in the column is simple average of the rates applicableduring the month.Because of persistent large surpluses in the system, evenafter CBO’s significant absorption through CD’s and reserverequirement, the inter-bank rates have generally remainedvery low and below the CBO CD rates.Capital MarketStrong macroeconomic fundamentals kept the capitalmarket buoyant during 2007. The primary segment benefitedfrom the positive sentiment in the secondary market andan upbeat investment climate. Equity issues by corporatesthrough initial public offerings and debt instruments bycompanies dominated the primary market segment. Since2005, however, the Government ceased issuance of newGovernment Development bonds, given its large surplusfiscal position. As on December 31, 2007, the outstandingGovernment Development bonds amounted to RO 432million. The holding pattern (based on primary issuance) ofthe outstanding bonds is given in Table 5.6(b).Muscat Securities MarketRoyal Decree No. (53/88) issued in June 1988 establishedthe Muscat Securities Market (MSM) as a governmentalentity, both to regulate and to provide operationalfacilities and mechanisms for licensing of intermediariesand trading, settlement, and registration of securities.The Market commenced operations on May 20, 1989.Central Bank of OmanAnnual Report 2007 75

CHAPTER FIVEIn November 1998, a new Capital Market Law waspromulgated vide Royal Decree No. (80/98) separating theregulatory and exchange functions of the MSM. Thus,the Capital Market Authority (CMA) was established asthe Government regulator with the mandate of regulatingthe capital market, including licensing intermediaries,approving offer documents and supervising tradingoperations, while the MSM provided facilities for tradingof securities.The CMA has focused its efforts on establishing MSM as aglobally bench-marked securities market in the region andensuring a stable, transparent and efficient capital marketconsistent with international best practices. To this end, theCMA amended some provisions of the Capital Market Law videRoyal Decree No. (5/2007) issued on 21st January 2007 andintroduced new rules and guidelines on disclosure in 2007.The revised “Rules and Guidelines on Disclosure by Issuer ofSecurities and Insider Trading” introduced by the CMA cameinto force with effect from 1st October 2007 and is seen asa significant step towards achieving greater transparency indisclosures made by public joint stock companies.During the period under review, MSM also became an affiliateat the International Organisation of Securities Commissions(IOSCO). Another significant development for the MSM isthe recent agreement with Dow Jones which includes thedevelopment of two indices, namely the DJ MSM CompositeIndex and the DJ MSM Chip Index. The move has enhancedOman’s appeal to international investors. The MSM alsolaunched Internet-based trading in the first quarter of2007 and participated in several regional meetings andinternational conferences and forums, such as the WorldFederation of Exchanges and the Federation of EuropeanAsian Stock Exchanges (FEAS).As could be seen from Table 5.6(c), the MSM has been makingrapid growth in the past few years. The stock market hasBanksTable 5.6 (b)Holding Pattern of Outstanding GovernmentDevelopment Bonds (2007)performed strongly in tandem with Oman’s economic growthand has achieved the largest gains among the GCC financialmarkets in 2007. The General Price Index (MSM 30) roseby 3,453.91 points to reach 9,035.48 points by the end of2007 compared with 5,581.57 points in the previous yearend, reflecting a rise of 61.9 percent. This marks the highestlevel ever since the beginning of the market operations andis reflective of the confidence in the Market with the risinginternational oil prices, large corporate profits and increasedgovernment revenue.Amount(R.O. Million)PercentageLocal 72.0605 16.68Abroad 62.6056 14.49Govt Entities (local) 3.6500 0.85Pension FundsLocal 183.4873 42.47Abroad 22.2738 5.16Other Financial InstitutionsLocal 15.8126 3.66Abroad 11.3338 2.62Non Financial InstitutionsLocal 33.0805 7.66Abroad 3.2835 0.76IndividualsLocal 20.3192 4.70Abroad 4.0932 0.95Total Local 328.4101 76.02Total Abroad 103.5899 23.98Total Local + Abroad 432.0000 100.00%The rise in the index was accompanied by a similar surge inmarket capitalization. The market capitalisation of the listedsecurities rose by 65.1 percent to reach RO 10,272.9 million atthe end of December 2007 compared with RO 6,220.8 millionat the end of December 2006. The market capitalization ratio,76 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsTable 5.6 (c)Stock Market Indicators2003 2004 2005 2006 2007Number of issues in the Primary Market 35 45 66 61 69Value of listed issues (in RO Millions) 385 339 679 377 464Secondary Market Activity (in RO Millions)Value of trading 593 759 1407 1128 2663Number of shares traded 315.20 345.4 515.4 1113.0 3424.0Average value of trading per day 2.381 3.056 5.517 5.437 11.243Market capitalisation 2790 3587 5878 6220 10272The general share price index at the end of the year (points)* 272.67 3375.05 4875.11 5581.57 9035.48* The base (points) to calculate the MSM indices has been changed from 100 points to 1000 points with effect from June 1, 2004.Source: MSM Annual Report 2007 & MSM Annual Statistical Bulletin 2007.which can be measured as market capitalization divided byGDP, is indicative of the size of the market. On this basis,it may be seen that the market capitalization ratio rose from0.45 in 2006 to reach 0.66 in 2007 reflecting the positiveperformance of the MSM during the year.The primary market registered significant activity during2007. The primary market witnessed the listing of two InitialPublic Offering (IPOs) with an aggregate value of RO 75million (one for a newly formed company and the other fora converted company), in addition to rights issues, privateplacements and bonus shares by public joint stock companiesamounting to RO 236 million. As regards the secondarymarket, the market turnover rose by 136 percent to reachRO 2.66 billion in 2007 compared with the previous year.Strong macroeconomic fundamentals and healthy corporateearnings helped to boost the market sentiments. Meanwhile,the number of traded securities rose by 208 percent to reach3.4 billion shares compared with the previous year.The strong growth in the performance of the MSM indexduring the year was also reflected on all the sector-wiseindices. The ‘banks and investment companies index’recorded the highest growth at 71.5 percent in 2007 to closeat 12312.80 points at the end of December 2007 comparedwith 7179.27 points at the end of 2006. The ‘industrialsector index’ rose from 5072.80 points at the end of 2006to close at 8137.06 points at the end of 2007, reflecting anincrease of 60.4 percent, while the ‘services and insurancesector index’ rose to 3533.14 points in 2007 from 2323.92points in the previous year, i.e. an increase of 52 percent.Foreigners participation in the capital of the listed jointstock companies has risen steadily in recent years, from 16.2percent at the end of December 2005 to 23.3 percent in 2006,and further to 27.6 percent in 2007.Foreign Exchange MarketThe foreign exchange market in Oman is relatively significantas the economy is mainly foreign trade oriented with nocurrent or capital controls. The Government is the mainsupplier of foreign exchange with its dollar denominatedoil revenues, while commercial banks are the main sourceof foreign exchange demand. Bank’s demand for foreignexchange are related to various transaction such as for imports,workers and profit remittances, and for other capital accounttransactions. The foreign exchange market is predominantlydollar denominated as it acts as the main intervention currencyCentral Bank of OmanAnnual Report 2007 77

CHAPTER FIVETable 5.7 (a)Weighted Average Interest Rate On Rial Omani Total DepositsPercent per annumRate of Interest (% PER ANNUM)December-2005 December-2006 December-2007Amt in RO Mln % Share Amt in RO Mln % Share Amt in RO Mln % ShareUpto 2% 2,005.9 69.6 1,829.1 54.9 2,707.0 50.4OVER 2% TO 3% 210.3 7.3 373.7 11.2 768.4 14.3OVER 3% TO 4% 325.6 11.3 304.7 9.1 487.4 9.1OVER 4% TO 5% 273.7 9.5 741.6 22.2 871.4 16.2OVER 5% TO 6% 40.4 1.4 74.1 2.2 492.5 9.2OVER 6% TO 7% 8.8 0.3 7.7 0.2 39.7 0.7OVER 7% TO 8% 14.2 0.5 0.7 0.0 0.7 0.0OVER 8% TO 9% 2.4 0.1 2.6 0.1 2.8 0.1OVER 9% TO 10% 0.0 0.0 0.0 0.0 0.0 0.0OVER 10% 0.0 0.0 0.0 0.0 0.0 0.0Total 2,881.3 100.0 3,334.1 100.0 5,369.9 100.0Weighted average interest rate 1.409% 1.855% 2.065%Rate of Interest (% PER ANNUM)Table 5.7 (b)Weighted Average Interest Rate On Rial Omani Total LendingPercent per annumDecember-2005 December-2006 December-2007Amt in ROMln% ShareAmt in ROMln% ShareAmt in ROMln% ShareUpto 5% 848.8 27.7 428.4 11.4 446.0 9.0OVER 5% TO 7% 335.3 10.9 990.8 26.5 1,450.5 29.2OVER 7% TO 8% 257.9 8.4 385.0 10.3 702.0 14.1OVER 8% TO 9% 612.7 20.0 1,281.0 34.2 1,867.9 37.6OVER 9% TO 10% 492.3 16.1 313.8 8.4 248.6 5.0OVER 10% TO 11% 203.3 6.6 131.6 3.5 94.7 1.9OVER 11% TO 12% 152.4 5.0 87.8 2.3 57.2 1.2OVER 12% TO 13% 121.9 4.0 79.7 2.1 55.3 1.1OVER 13% 41.3 1.3 45.6 1.2 47.0 0.9Total 3,065.9 100.0 3,743.8 100.0 4,969.2 100.0Weighted average interest rate 7.066% 7.404% 7.290%for international trade and is the anchor currency under thefixed peg. Dollar deposits account for over 85 percent of thetotal foreign currency deposits held with commercial banks,while dollar denominated credit as a proportion of totalforeign currency credit stood at around 97 percent as at theend of 2007. In the foreign exchange market, the US dollardepreciated against the major currencies in the internationalmarket during 2007, reflecting US sub-prime crisis, fed fundrate cuts and lower than expected economic activity.Interest Rate Structure and DevelopmentsIn view of the fixed exchange rate peg to the US dollar and fullcapital account convertibility, interest rate levels in Oman are78 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsRate of Interest (% PER ANNUM)Table 5.7 ( c )Weighted Average Interest Rate On Rial Omani Time DepositsPercent per annumDecember-2005 December-2006 December-2007Amt in RO Mln % Share Amt in RO Mln % Share Amt in RO Mln % ShareUpto 2% 176.9 17.0 85.0 6.7 139.4 6.5OVER 2% TO 3% 206.0 19.8 70.0 5.5 242.1 11.2OVER 3% TO 4% 323.9 31.2 302.2 23.7 380.1 17.6OVER 4% TO 5% 267.7 25.8 735.6 57.6 859.0 39.8OVER 5% TO 6% 39.0 3.7 74.1 5.8 492.0 22.8OVER 6% TO 7% 8.7 0.8 7.7 0.6 39.7 1.8OVER 7% TO 8% 14.2 1.4 0.7 0.1 0.7 0.0OVER 8% TO 9% 2.4 0.2 2.6 0.2 2.8 0.1OVER 9% TO 10% 0.0 0.0 0.0 0.0 0.0 0.0OVER 10% 0.0 0.0 0.0 0.0 0.0 0.0Total 1,038.8 100.0 1,277.9 100.0 2,155.7 100.0Weighted average interest rate 3.300% 4.001% 4.144%Table 5.7 (d )Weighted average Interest Rates(percent per annum)End ofPeriodPrivateSectorRO TimeDepositsDepositsTotal ROdepositsLendingTotal PrivateTotalDeposits Sector Total RO Lending(RO+Fcy) RO LendingLending(RO+Fcy)Spread Spread Spread(1) (2) (3) (4) (5) (6) (4)-(1) (5)-(2) (6)-(3)Mar-20052.5901.1351.4077.6117.3826.3455.0216.2474.938Jun-20052.6751.1761.4897.4347.2736.3194.7596.0974.831Sep-20052.9401.3571.7207.2897.1456.3894.3495.7894.669Dec-20053.2051.4091.9067.2097.0666.5664.0045.6574.660Mar-20063.4141.4771.9617.1117.0686.6893.6975.5914.728Jun-20063.5671.5312.0657.4057.3517.0683.8385.8205.003Sep-20063.8911.8112.5357.5457.4657.1653.6545.6534.631Dec-20063.9381.8552.6337.5267.4047.1223.5885.5484.489Mar-20074.0301.8162.4547.4547.3937.0763.4245.5774.622Jun-20074.1231.9162.5077.4017.3867.1023.2785.4714.595Sep-20074.2351.9952.5457.3507.3387.0633.1155.3434.517Dec-20074.0662.0652.3637.3097.2906.9733.2435.2254.610Central Bank of OmanAnnual Report 2007 79

CHAPTER FIVEPeriodTable 5.7 (e)Overnight Domestic Inter-Bank Lending RatesDialy avg.Amount inRO Mln2006 2007MonthlyWeightedavg InterestRate*Dialy avg.Amount inRO MlnMonthlyWeightedavg InterestRate*Jan 16.1 2.116 34.8 3.579Feb 21.6 2.307 23.4 3.481March 20.0 2.748 26.0 3.394IQ Avg 19.3 2.390 28.1 3.484April 14.0 2.923 27.0 3.249May 10.7 3.455 14.7 2.738June 14.0 3.719 13.6 2.636IIQ Avg 12.9 3.366 18.4 2.874July 9.4 4.141 12.1 2.323August 15.6 3.675 44.1 3.436September 17.2 3.786 46.0 2.601IIIQ Avg 14.1 3.867 34.1 2.787October 16.4 3.290 22.2 2.250November 16.0 2.256 13.0 1.893December 32.4 3.399 8.3 1.470IVQ Avg 21.6 2.981 14.5 1.871* Weighted by individual transaction amounts.expected to be broadly in line with the interest rates of themarket was largely interest rate inelastic. An interest rateceiling of 13 percent per annum in 1999 for the personalloan segment has been progressively reduced over the yearsand currently stands at 8 percent per annum with effect from14 June 2008.Although some firming up was evident in the Rial Omaniinterest rates on deposits, they still lagged behind in termsof their alignment with US dollar interest rates. While theweighted average interest rate on total Rial Omani depositsstood at 2.065 percent at the end of December 2007, foreigncurrency deposit rates averaged 3.788 percent. Lower USdollar interest rates associated with the recent cuts in Fedfunds rate could exert downward pressures on the domesticinterest rate structure in Oman. With a weighted average RialOmani time deposit interest rate of 4.066 percent per annumin December 2007, an inflation rate of 5.9 percent (basedon CPI for Oman) implied a negative real interest rate ondomestic savings in local currency deposits. Negative realreturn on deposits could encourage higher consumption,speculative asset prices build up, as well as motivation foroutflow of funds in search of better returns. The pricingaspect of deposits thus assumes critical importance.anchor country. However, interest rate differentials persist,mainly in the short end of the market. Various factors mayreduce the efficiency of arbitrage in response to divergencein interest rates. Such factors may include informationWeighted Average Interest Ratesasymmetry, transaction costs, perceptions on exchange rateparity, regulatory considerations such as net open positionlimits for banks, structural imperfections, presence of lotteryschemes etc.Prior to 1993, the Central Bank of Oman relied on directinstruments to manage liquidity and regulated interestrates. The era of deregulation of interest rates on depositsand lending (except for personal loans) commenced in1993. Interest rate ceilings continued to remain in force forthe personal loan category, given that this segment of the80 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsAn analysis of the distribution pattern of Rial Omanideposits and lending by interest rate ranges, throws up someinteresting features. Almost half of total Rial Omani deposits(50.4%) at the end of December 2007 earned an interestof 2 percent and less. This could largely be attributed tothe negligible interest rates paid on Rial Omani currentand saving deposits, which together constituted about 60percent of total Rial Omani deposits. The prevalence ofcertain lottery schemes in lieu of explicit interest rates forattracting deposits was also a factor which resulted in lowinterest rates. On the other hand, a large share of Rial Omanilending (37.6%) was effected in the over 8% to 9% interestrate bracket. An interesting aspect in the distribution patternof Rial Omani lending was the impact of the personal loaninterest rate ceilings, and the tendency for the bulk of thepersonal loans to be contracted at the ceiling rates.The spread between average lending and average depositrates in Oman given in Table 5.7(d), has consistentlyremained high, although the magnitude of the absolutespread narrowed in recent years. While analyzing the interestspread, it is worth keeping in mind the practice of prize andlottery based schemes offered to depositors in lieu of interestpayments, which to some extent distort the actual interestrate spread figures. The average interest rate spread betweenlending and deposits in Rial Omani narrowed from 6.440%in December 2004 to 5.657% in December 2005, 5.548% inDecember 2006 and further to 5.225% in December 2007. It isperceived that the interest rate spreads would narrow furtherwith banks pricing deposit and loans more competitively,given the fact that Omani corporates can borrow in USdollars at lower cost in the international market if banks donot moderate their lending rates in local currency.Another aspect linked to the liquidity conditions of thebanking system is the domestic overnight inter-bank lendingrates. The major part of domestic inter-bank transactionstakes place in the form of overnight lending. As could be seenfrom Table 5.7(e), the weighted average overnight domesticinter-bank rate continued to decline during the year, from anaverage of 3.484% in the first quarter of 2007 to 1.871% forthe last quarter of the year. The general softening of interestrates played a role in the downward movement of inter-bankrates. With regard to the CBO policy rates, the weightedaverage interest rate as at the end of December 2007, on28 days CDs, 91 days CDs and 182 days CDs stood at 1.960percent, 2.410 percent and 2.600 percent, respectively. Theweighted average repo rate on instruments repoed with theCentral Bank stood at 6.022 percent in December 2007.Regulatory and Supervisory Initiatives of the CBOIn pursuance of its commitment to adopt the global bestpractices in supervision, and taking into account the specificlocal conditions, the Central Bank of Oman had spearheadedthe implementation of Basel II (International Convergence ofCapital Measurement and Capital Standards), with the activeco-operation of banks, effective from January 01, 2007. theBasel II guidelines for implementation in Oman incorporateadoption of Standardized Approach for credit risk and marketrisk and Basic Indicator Approach for operational risk. Banksdesirous of migrating to advanced approaches could apply tothe Central Bank of Oman for prior approval. Considering theimpact levels and the fact that under Basel II, banks would bemaintaining capital additionally for market risk and operationalrisk, the minimum capital requirements for banks under theBasel II regime was moderated to 10 percent from 12 percentwith effect from January 2007. Regarding Pillar III (MarketDiscipline) requirements, after extensive consultations withthe Auditing community in Oman, the modalities and formatsfor the Pillar III disclosures under Basel II were finalized andissued for implementation in 2007. It was decided that thedisclosures would be part of the annual financials and thatthe Auditors would review the disclosures as an agreed uponprocedure. All banks have complied with the requirementwhile submitting their 2007 audited financials. The PillarCentral Bank of OmanAnnual Report 2007 81

CHAPTER FIVEII of the Basel framework covering ‘Supervisory Review’ isexpected to be focused in 2008. In this context, the CentralBank has taken initiatives to adopt risk-based supervision tosupplement the objectives of Basel II.With a view to enhancing dissemination of informationon regulatory and supervisory functions of the CBO anddevelopments in the market a ‘Report of the Banking OversightDepartments’ was issued in 2007. The Report, which isenvisaged to be issued annually, covered the regulatoryand supervisory framework of the CBO, performance of thebanking system, and initiatives of the Central Bank relatingto the banking sector along with information on the evolutionof the banking system in Oman.The Central Bank’s initiatives in promoting financialstability continued during the year. A framework formanaging country and transfers risks had been issuedto banks in January 2007 and the associated supervisoryreporting to CBO on the risk exposures stabilized duringthe year. The entry level minimum capital requirementwas enhanced to RO 100 million for local commercialbanks and to RO 20 million for foreign banks. Regulationson Bank Credit and Statistical Bureau and Cheque ReturnSystem were issued during the year formalizing the existingarrangements. Offsite supervision in respect of finance andleasing companies (FLCs) and specialized banks was alsostrengthened during the year. A Master circular on lendinglimitations and exposures to connected / related parties,was issued in 2007. The supervisory developments in theyear have been guided by the Central Bank’s strong resolvein adopting the international best practices, standards andcodes, the recommendations of the IMF / World Bank underthe Financial Sector Assessment Program (FSAP), keeping inview the country-specific challenges.The Central Bank of Oman institutionalized the practice ofmeeting the Board of Directors of locally incorporated bankson an annual basis. Such meetings are likely to enhancethe level of consultation with banks and serve as a usefulforum to exchange candid views with the Board of banks.It is expected that such initiatives would help in furtherimprovement in the corporate governance practices andoverall functioning of the banks. The annual meeting withthe Chief Executive Officers of banks has now emergedas a key forum for exchanging views on issues of mutualinterest to CBO and banks managements. Matters discussedin these meetings include developments in the monetaryand banking sector, challenges and plans for maintainingfinancial stability, systemic issues and supervisory concerns,and international developments. Annual meeting with theexternal auditors is another useful interaction with theoverall objective of enhancing the level of assurance forfinancial stability. In addition, the annual tripartite meetingswith commercial banks / FLCs and the external auditorsat the time of finalization of financials are also proving tobe useful for discussing issues of relevance. Overall, thedialogue process with the banks has improved significantlyin the recent past, exhibiting the growing maturity of thefinancial system.The year 2007 was yet another progressive year for thebanking sector, marked by robust growth in assets, significantimprovement is asset quality, higher provision coveragesupported by increasing level of general provisions andrecord level of profits. Capital adequacy, one of the criticalsupervisory indicators, continued to be at comfortable levelsand well above the minimum requirement. The overallcapital adequacy ratio of the commercial banks stood at 15.9percent (under Basel II) as at December 2007 compared to17.2 percent (under Basel I) as at December 2006. Helped bythe buoyant economy, the asset quality of the banking systemimproved during the year. In 2007, the gross non performingloans (NPLs) of commercial banks recorded an absolutedecline of RO 33 million or 9.3 percent from RO 353 millionin 2006 to RO 320 million in 2007. The reduction in NPLs82 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial Institutionsis significant and banks could focus on the recovery effortswith the strong performance of the economy. The gross NPLs(net of reserve interest) declined significantly and accountedfor 3.2 percent of gross loans (net of reserve interest) at theend of 2007 compared to 5.2% of gross loans (net of reserveinterest) at the end of previous year. The loan loss coveragetaking into account general provisions improved from 102percent in December 2006 to 107.6 percent in December2007. Banks operating in Oman had accumulated generalprovisions of RO 87 million as at the end of 2007.Central Bank OperationsThe balance sheet of the Central Bank of Oman for the period2003 to 2007 is given in Table 5.8(a). The financial statementshave been prepared in accordance with the Banking Law of2000 and International Financial Reporting Standards (IFRS),except for the accounting treatment of revaluation gainsand losses on foreign currencies, bullion and derivativeswhich are recognized through the statement of changes incapital and reserves in accordance with the requirements ofthe Banking Law of 2000. The presentation of the balancesheet shown in Table 5.8(a) may marginally differ from thepresentation of the audited financial statements appearingseparately under “Central Bank Accounts and Regulations”Section, in order to be consistent with the requirements ofmonetary statistics analysis.Total assets of the Central Bank registered a significantincrease of 79.8 percent, from RO2131.2 million at the endof 2006 to RO 3832.8 million as at the end of year 2007.Foreign assets, which constituted over 95 percent of the totalassets, increased by 89.9 percent to reach RO 3662.1 million.The level of CBO’s foreign assets could change primarilyon account of three factors, viz, Government transactionswhereby foreign currency is tendered to the CBO to meettheir local currency requirements, sale and or purchase offoreign currency to or from commercial banks arising fromimport demand, exports and various remittances, etc, as wellas variations in the amount of foreign currency deposits of theGovernment and local banks held with the CBO. If the latter,i.e. the foreign currency deposits of the Government and localbanks which are placed by CBO abroad are netted out, theCentral Bank’s own foreign assets position stood at RO 3313.6million as at the end of 2007 compared to RO 1917.8 milliona year ago (See Table 5.8 b). Within the components of foreignassets, placements abroad as at the end of 2007 stood at RO1391.6 million, which was significantly higher (169.4%)over the level at the previous year end. The Bank holdsthese placements mostly in US dollars and with approvedcounterparties. Investments in foreign securities by the CBOincreased consistently over the years from RO 948.6 millionin 2003 to RO 2255.5 million as at the end of 2007. The Bankinvests only in securities which carry a minimum credit ratingas specified by the Bank’s investment guidelines.In the liability side of the balance sheet, currency issuedby the CBO registered an increase of 18.3 percent, from RO560.6 million as at the end of 2006 to RO 663.1 million atthe end of 2007. The increase was of a slightly lesser orderthan in the previous years, partly on account of the growingavailability of alternative non-cash payment methods. Thenet worth of the Bank increased from RO 823.2 millionto RO 975.5 million. While capital was enhanced by RO100 million to reach RO 400 million, the general reservecomponent increased from RO 191.1 million to RO 229.1million. The increase of RO 100 million in the Bank’s capitalwas made through capitalization of part of the existingreserves. The Banking Law of 2000 requires that the generalreserves of the Bank should be maintained at not less than25 percent of the currency in circulation. As of 31 December2007 the general reserve was 34.55 percent of the currencyin circulation. Central bank liabilities to banks and otherinstitutions mostly in the form of clearing balances (as partof Reserve requirement) and capital deposits increased fromRO 166.1 million to RO 571.8 million. As part of monetaryCentral Bank of OmanAnnual Report 2007 83

CHAPTER FIVETable 5.8 (a)Central Bank of Oman Assets and Liabilities(In Million R.O)2003 2004 2005 2006 2007Growth (%)06/05 07/06Foreign Assets 1382.2 1383.7 1675.9 1928.2 3662.1 15.1 89.9a) Gold 0.1 0.2 0.2 0.3 0.3 50.0 0.0b) IMF Reserve assets 48.8 43.4 19.0 16.9 14.7 -11.1 -13.0c) Placements abroad 384.7 315.4* 334.4 516.6 1391.6 54.5 169.4d) Securities 948.6 1024.7 1322.3 1394.4 2255.5 5.5 61.8Due from Government 4.3 3.6 0.8 0.3 0.3 -62.5 0.0Due from Banks and other Institutions - 0.3 15.4 55.7 0.4 261.7 -99.3Fixed Assets 5.3 5.1 5.2 5.4 5.6 3.8 3.7Other Assets 94.7 104.8 129.1 141.6 164.4 9.7 16.1Total Assets / Liabilities 1486.5 1497.5 1826.4 2131.2 3832.8 16.7 79.8Currency Issued 351.3 382.2 459.5 560.6 663.1 22.0 18.3Net Worth 720.1 750.8 739.8 823.2 975.5 11.3 18.5a) Capital 300.0 300.0 300.0 300.0 400.0 – 33.3b) General Reserves 99.8 123.5 150.3 191.1 229.1 27.1 19.9c) Others 320.3 327.3 289.5 332.1 346.4 14.7 4.3Due to Government 68.5 85.9 168.3 204.5 398.1 21.5 94.7Due to banks and other institutions 91.2 121.0 66.3 166.1 571.8 150.5 244.3Foreign Liabilities 0.4 0.9* 1.0 0.6 0.8 -40.0 33.3Other Liabilities 255.0 156.7 391.5 376.2 1223.5 -3.9 225.2a) CDs 170.0 59.0 273.7 249.0 1083.1 -9.0 335.0b) Others 85.0 97.7 117.8 127.2 140.4 8.0 10.4*includes an amount of RO 0.5 million forward receivable/payable.Source: Central Bank of Oman.Table 5.8 (b)Central Bank’s Own Foreign Assets(In Million R.O.)Dec. 2006 Dec. 2007Absolute Change2007/20061. Gross Foreign Assets 1928.2 3662.1 1733.9a) Gold 0.3 0.3 –b) IMF Reserve Assets 16.9 14.7 -2.2c) Placements abroad 516.6 1391.6 875.0d) Securities 1394.4 2255.5 861.1Less:Foreign cy. deposits from Government 10.4 348.5 338.1Foreign cy. deposits from local banks – – –2. Central Bank’s own foreign assets 1917.8 3313.6 1395.8Source : Central Bank of Oman.84 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial Institutionspolicy operations and liquidity management, the CBO issuedits own certificates of deposit and the outstanding amount atthe end of 2007 rose significantly to RO 1083.1 million. Netprofit of CBO for the year 2007 rose by 66 percent to RO81.02 million from RO 48.77 million in the previous year.Commercial Bank OperationsFavourable macroeconomic conditions continued to underpinthe business and financial performance of commercial banks,which is evident from very strong balance sheet expansionduring last three years. The ratio of assets of commercial banksto GDP at current prices increased significantly to 66.6 percentin 2007 as compared with 52.8 percent in 2006, suggestinga faster growth of the banking system in relation to the realeconomy. The credit growth underlying this balance sheetexpansion clearly remained ahead of the business cycle of theeconomy, with total credit increasing by 38.3 percent during2007 on top of the increase of 20.7 percent in the previous year.Within the credit portfolio, while credit to the Governmentdeclined by 64.2 percent, credit to the private sector increasedby 38.8 percent and to public enterprises by 86.3 percent.In absolute terms, the accretion to credit channeled to theprivate sector, stood at RO 1704.2 million during 2007, toreach an outstanding figure of RO 6505.4 million as at theend of December 2007. Commercial banks’ holdings of cashon hand and deposits with CBO rose by 167.9 percent, fromRO 248.9 million at the end of 2006 to RO 666.7 million atthe end of 2007, largely reflecting the excess liquidity in thesystem. Investment in various securities accounted for nearly14 percent of the total assets of commercial banks in 2007.The increase in investment was mainly on account of bank’sinvestment in CBO CD’s which stood at RO 244 million at theend of 2006 and rising significantly to RO 1083.1 million at theend of 2007, suggesting the extent to which CBO was engagedin mopping up the excess liquidity in the banking system.Bank’s also increased their investments in domestic sharesand securities during the year to reach RO 87.1 million.On the liabilities side, total deposits held with commercialbanks increased by 38.6 percent to reach RO 6491.4 million.Deposits of the private sector, which constituted 82 percentof total deposits, increased by 37.4 percent. Within privatesector deposits, demand deposits rose by 72.5 percentfollowed by saving deposits at 40 percent and time depositsby 19.8 percent. The element of foreign currency depositswithin private sector deposits, however, declined by 27.6percent (from RO 1191.4 million to RO 862 million) in 2007,a sharp contrast to the trend in the previous years whenforeign currency deposits were consistently rising. Thereversal is partly explained by the declining interest rates onUS dollar deposits, and the market perception of a possibleRial Omani revaluation. Commercial banks’ capital levelsremained strong with core capital and reserves increasing by62 percent over the year to RO 1458.2 million as at the endof December 2007.Sources and uses of funds statement as analyzed in Table5.9(b) indicate a net accretion of RO 3083.8 million in 2007,mainly due to the sharp rise in deposits amounting to RO1806.5 million, followed by increase in banks ‘capital,reserves and provisions’ by RO 678.9 million. Internationalliabilities of banks mainly in the form of foreign currencyborrowings increased by RO 570.9 million. These fundswere mainly utilized in the expansion of credit by RO 1802.5million and increased investments of RO 678.4 million.Sectoral flow of Bank creditTable 5.10 gives the break down of outstanding bank creditto different sectors of the economy. Personal loans continueto occupy the major share of total credit at RO 2599.7 million(39.9%). This was followed by the manufacturing sector(9.6%), import trade (7.8%), mining and quarrying (6.1%),construction (5.8%) and the services sector (5.7%). The patternof credit flows become more clear from the incremental bankcredit during the year. The major increase during the yearCentral Bank of OmanAnnual Report 2007 85

CHAPTER FIVETable 5.9 (a)Combined Balance Sheet of Commercial Banks(In Million R.O)2003 2004 2005 2006 2007% Change2007/2006Cash and deposits with CBO 133.7 167.8 140.3 248.9 666.7 167.9Due from banks abroad 350.5 545.6 741.3 1209.6 1350.2 11.6Total Credit 3308.3 3505.7 3896.4 4703.0 6505.4 38.3a) Credit to Private Sector 3089.9 3274.1 3658.6 4397.0 6101.2 38.8b) Credit to public enterprises 69.0 87.3 111.8 195.8 364.8 86.3c) Credit to Government 149.4 144.3 126.0 110.2 39.5 -64.2Securities 544.0 503.1 597.5 723.1 1401.5 93.8a) Treasury Bills 138.0 149.0 6.0 0.0 0.0 –b) Government Bonds 130.4 146.5 122.1 118.4 112.0 -5.4c) Other domestic securities 25.1 30.9 44.4 51.6 87.1 68.7d) Foreign securities 83.4 121.7 154.8 302.5 92.6 -69.4e) Others * 167.1 55.0 270.2 250.6 1109.8 342.8Fixed assets 36.6 35.4 37.4 36.5 73.8 102.4Other assets 117.5 131.1 217.0 330.9 338.0 2.1Total assets / liabilities 4490.6 4888.7 5629.9 7251.9 10335.7 42.5Total Deposits 2852.6 3078.3 3761.5 4684.9 6491.4 38.6a) Government deposits 299.9 441.4 543.5 676.5 907.2 34.1b) Deposits of public enterprises 166.4 136.8 137.9 144.4 275.2 90.5c) Deposits of private sector 2386.3 2500.1 3080.1 3864.0 5309.0 37.4i) Demand 594.4 625.8 854.1 894.3 1542.9 72.5ii) Savings 667.4 757.5 876.7 1035.4 1449.2 40.0iii) Time 1124.5 1116.8 1349.3 1934.3 2316.8 19.8(of which in foreign currency) (404.1) (433.2) (748.9) (1191.4) (862.0) (-27.6)Due to banks abroad 398.9 313.5 194.7 539.6 1110.5 105.8Core Capital and Reserves 548.7 587.3 781.7 900.0 1458.2 62.0Supplementary Capital 110.1 100.3 119.2 122.8 282.7 130.1(of which general provisions) (5.4) (22.7) (46.9) (60.5) (87.0) (43.9)Specific provisions and reserved interest 371.2 357.0 278.1 255.9 216.7 -15.3Other liabilities 209.1 452.3 494.7 748.6 776.2 3.7Source : Central Bank of Oman.stemmed from the personal loan category with an additionalnet credit disbursement of RO 775.1 million, mainly towardsconsumer durables and to a lesser extent for financingresidential housing. Outstanding credit for manufacturingstood at RO 623.3 million, giving a rise of 70 percent overthe year, i.e., an additional credit outlay of RO 256.9 million.Other important sectors that availed of additional incrementalcredit included the construction sector by RO 101.7 million,services sector by RO 57.5 million and wholesale and retailtrade by RO 36 million. Non-resident lending, mainly tocorporates outside Oman, registered a sharp rise during theyear, with an additional incremental credit offtake of RO 12086 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsSource of FundsTable 5.9 (b)Sources and Uses of Bank Funds(In Million R.O)Dec.2006Dec.2007Uses of FundsTotal deposits 923.4 1806.5 Cash on hand and Deposits with CBO 108.5 417.8Balances due to banks abroad 344.9 570.9 Balances due from banks abroad 468.3 140.6Capital, Reserves and Provisions 99.8 678.9 Total Credit 806.6 1802.5Other liabilities 253.8 27.5 Investments including CDs 125.7 678.4Dec.2006Dec.2007Net fixed assets -0.9 37.4Other assets 113.7 7.1Total sources of funds 1621.9 3083.8 Total uses of funds 1621.9 3083.8million to reach a total outstanding of RO 169.6 million. Asat the end of December 2007, the level of non-performingloans (net of reserve interest) under ‘agriculture and alliedactivities’ was high at 36 percent, followed by ‘wholesale andretail trade,’ at 14.6 percent, ‘transport and communication’at 11.5 percent, ‘construction’ at 5.3 percent, ‘manufacturing’at 4.8 percent and ‘services’ at 3.4 percent. Non-performingTable 5.9 (c)Non-Resident Assets and Liabilities ofCommercial Banks(In Million R.O)Foreign AssetsDec.2006Dec.2007 ChangeDue from banks abroad 1209.6 1350.2 140.6Credit extended abroad 49.6 169.6 120.0Investment in foreign securities 302.5 92.6 -209.9Other assets 11.4 13.0 1.6Total 1573.1 1625.4 52.3Foreign LiabilitiesDeposits 65.5 85.4 19.9Long term bonds 105.9 111.7 5.8Due to banks abroad 539.6 1110.5 570.9Other liabilities 44.4 84.4 40.0Total 755.4 1392 636.6Net Foreign Assets 817.7 233.4 -584.3Outflow during the 12 monthperiod232.8 -584.3loans in the personal loan category (net of reserve interest)stood at 1.6 percent.Commercial Banks’ ProfitabilityProfitability of banks is an important indicator of thesoundness of the banking system, both at the micro aswell as macro level. With high economic growth, as couldbe evidenced from nominal GDP, the profitability ofcommercial banks remained buoyant. With the economydoing well, recoveries on previous loan loss provisions havesignificantly aided the enhancement of bank profits in recentyears. Further, banks have steadily shifted away from overdependence on traditional sources of revenue such as fromloans and advances to investment income, fee based income,foreign exchange income etc. Non-interest income is also lesslikely to be dependent on business cycles thereby reducingthe cyclical variations in banks’ revenues and profits.Commercial banks’ profits (after provisions but beforetaxes), registered a growth of 32.5 percent in 2007, fromRO 188 million in the year 2006 to RO 249 million in 2007.Net profit after taxes rose from RO 162.9 millio n to RO213.7 million, giving a rise of 31.2 percent. Net profits oflocal banks stood at RO 198.9 million (93.1%) while thatof foreign banks amounted to RO 14.8 million (6.9%). Theinterest income from core activities including loans andCentral Bank of OmanAnnual Report 2007 87

CHAPTER FIVESectoral Distribution ofCommercial Bank Creditadvances, investments and placements with banks, remainedthe dominant component of revenues. Total interest andinvestment income of commercial banks increased by 34percent to RO 517.2 million in 2007 as compared to RO385.9 million in the previous year. On the other hand,interest expenses increased from RO 144 million to RO 225.3million. Net interest income thus increased by 20.7 percentduring the year 2007 to reach RO 291.9 million, mainly dueto the significant expansion in the volume of credit and thehigh interest rate spreads. Foreign exchange earnings peakedduring 2007 registering a growth of nearly 60 percent to reachRO 19 million, mainly the outcome of valuation changes.With the increase in business, fee based income such ascommissions on letters of credit and guarantees, remittancebusiness etc. increased by 44.7 percent to reach RO 36.2million. Other income, constituting mainly recoveries onprevious loan loss provisions and to a lesser extent incomefrom rentals, lockers, insurance and other service chargesincreased by 37.2 percent to RO 128.3 million.Operating expenses of commercial banks rose by 33.6 percentduring 2007 compared with 14.1 percent in the previous year.The main item under this head constituted administrativecosts. Within this group, salaries and other staff costs rosyby 26.7 percent from RO 78.9 million in 2006 to RO 99.9million in 2007. Rents paid and other occupancy costsamounted to RO 13.8 million, giving a rise of 25.2 percentover the year. Depreciation charges on banks’ property andequipment increased by 18.3 percent to RO 10.5 million.Gross provisions made during the year continued to declinefrom RO 54.5 million in 2005 to RO 46.7 million in 2006and further to RO 42.6 million in 2007. This decline togetherwith major recoveries from previous provisions had apositive impact on banks profitability levels in recent years.Provision for taxes increased by 40.6 percent during the yearto RO 35.3 million. Cash dividends paid by local banks to itsshare holders registered a significant increase of 50 percentin 2007 amounting to RO 110.3 million. Stock dividends,on the other hand declined from RO 34.8 million in 2006 toRO 24.4 million in 2007. Despite the profits of foreign banksincreasing to RO 14.8 million, their remittances out of profitsTable 5.10Distribution of Commercial Bank Credit by EconomicSectors(In Million R.O)End of Period 2005 2006 2007Import Trade 394.6 416.4 505.4Export Trade 9.8 14.0 26.9Wholesale & Retail Trade 193.5 202.4 238.4Mining and Quarrying 109.0 188.1 396.7Construction 256.0 274.5 376.2Manufacturing 309.0 366.4 623.3Electricity, gas and water 160.5 172.4 176.0Transport and Communication 44.9 65.5 55.5Financial Institutions 201.9 234.0 277.3Services 237.0 313.1 370.6Personal Loans 1482.7 1824.6 2599.7Agriculture and allied activities 40.2 38.6 40.6Government 126.0 110.2 39.5Non-Resident lending 43.1 49.6 169.6All Others 288.2 433.2 609.7Total Credit 3896.4 4703.0 6505.4Source: Central Bank of Oman.88 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsTable 5.11Profitability of Commercial Banks(In Million R.O)2005 2006 2007% Change2006/2005% Change2007/20061. Interest Income 297.0 385.9 517.2 29.9 34.02. (Interest Expenses) (93.6) (144.0) (225.3) (53.8) (56.5)3. Net Interest 203.4 241.9 291.9 18.9 20.74. Foreign Exchange 9.7 11.9 19.0 22.7 59.85. Fees and Commissions 22.0 25.0 36.2 13.6 44.76. Other Income 84.5 93.5 128.3 10.7 37.27. Gross Income (3+4+5+6) 319.6 372.3 475.4 16.5 27.78. Operating Expenses 120.6 137.6 183.8 14.1 33.6a) Administrative Costs 115.6 128.1 171.9 10.8 34.2b) Depreciation 8.5 8.9 10.5 4.7 18.3c) Others -3.5 0.6 1.49. Gross Profits (7-8) 199.0 234.7 291.6 17.9 24.310. Provision for doubtful debts * 54.5 46.7 42.6 -14.3 -8.811. Profits after provisions (9-10) 144.5 188.0 249.0 30.1 32.512. Provision for Taxes 21.3 25.1 35.3 17.8 40.613. Net Profit after Provisions & Taxes (11-12) 123.2 162.9 213.7 32.2 31.2* Gross provisions made during the year. Recoveries on previous loan loss provisions are reflected under other income.Source : Central Bank of Oman.stood at only RO 1.224 million, mainly due to the settingaside of profits for increasing the capital in line with highermandated capital requirements.Specialized Banksof OHB stood at RO 176.5 million, of which mortgage loanaccounts amounted to RO 146.2 million. The capital of OHBremained at RO 30 million while total share holders equitycomprising capital, reserves and retained earnings amountedto RO 90.9 million.At the end of 2007, there were two specialized banks with abranch network of 22 branches operating in Oman. Both ofthem are Government owned specialized banks, namely, theOman Housing Bank (OHB) and Oman Development Bank(ODB). The erstwhile privately owned specialized bank,Alliance Housing Bank, converted into a commercial bankwith the name Ahli Bank SAOG in December 2007. OmanHousing Bank provides finance by way of long term softhousing loans to all segments of Omani society in variousregions for the construction of suitable housing. Total assetsOman Development Bank is primarily engaged in providingloans to development projects, including the activities ofagriculture, fisheries, livestock, health, tourism, professionalactivities, workshops and traditional craftsmanship in Oman.Interest on loans and advances is charged to customers atsubsidized rates. As at the end of 2007, the total net loansand advances including staff loans, stood at RO 33.2 millioncompared to RO 19.15 million a year ago. The share capitalof ODB was raised to RO 40 million in 2007 from RO 20million in the previous year.Central Bank of OmanAnnual Report 2007 89

CHAPTER FIVEMoney Exchange CompaniesMoney exchange business is carried out by two types ofinstitutions in Oman, namely, those who are engaged inmoney exchange and remittances, and the others who areexclusively dealing in money exchange activity. As at the endof December 2007, money exchange establishments stood at50, of which 12 operated under the license of money changingand draft issuance business. There were in total 110 branchesof these twelve exchange houses including 14 new branchesopened during 2007. In addition to the above, there were 38firms doing the business of money changing only. Exchangecompanies undertaking the activity of draft issuance areannually examined by the Central Bank of Oman to ensurethat they keep proper books and records and comply withthe regulations and remain solvent. The total assets of thetwelve establishments engaged in money exchange and draftissuance amounted to RO 23.65 million as at the end of 2007.The asset profile mainly included balances held with banks atRO 13.83 million and cash on hand at RO 7.35 million. Thetotal capital and reserves of these companies amounted to RO13.77 million as at the end of 2007.Finance and Leasing Companies (FLCs)There are currently six finance and leasing companies operatingunder the license of the Central Bank of Oman. They mainlyoperate in three market segments, namely, retail financing,where the financing is to individual customers mainly forpurchase of automotive and electronic goods; equipmentleasing, where the financing is to SMEs (Small and MediumEnterprises) for expansion, modernisation and replacementrequirements; and factoring and working capital financing toSMEs for cross border or domestic trade, or for the execution ofprojects, usually against an assignment of receivables.The robust macroeconomic growth witnessed by the Sultanateduring 2007 accelerated the growth of the finance and leasingsector. The retail vehicle financing industry continued to be themost competitive segment of the market. The SME equipmentfinance market also witnessed significant growth and strongbusiness confidence. In 2007, the FLCs continued to pursuetheir geographic expansion plans and increased the numberof branches to 31 from 27 in the previous year. Furthermore,some FLCs are looking to regional markets to diversify theiroperations and take advantage of the emerging opportunities.The overall performance of FLCs improved in 2007 with profitsand asset quality indicators showing significant improvements.Net profits (after tax) of FLCs reached RO 13.13 million in 2007as against RO 8.61 million in 2006, reflecting an increase of52.5 percent. The quality of FLCs loan portfolio improvedduring 2007 in addition to a marked growth in assets. Totalcombined assets of finance and leasing companies surgedto RO 413.8 million in 2007 from RO 277.6 million in 2006,constituting a rise of 49.1 percent.The continued government thrust on economic diversificationand development of infrastructure to meet the needs ofindustrialization, tourism, commercial and residentialprojects opened up opportunities for diversified growthand expansion of credit by the financial sector during 2007.Total outstanding credit (net of provisions) extended in theform of hire purchasing, lease financing and factoring roseby 48.9 percent from RO 267.3 million in 2006 to RO 398.2million in 2007.On the liabilities side, the FLCs have been steadily increasingtheir paid up capital primarily through stock dividends andrights issues in order to meet the minimum paid up capitalrequirement of RO 10 million before the end of June 2009as stipulated by the CBO. The consolidated paid up sharecapital of all six finance and leasing companies amounted toRO 57.46 million in 2007 as compared to RO 49.63 millionin 2006, up by RO 7.83 million over the previous year. Theaggregate capital and reserves of FLCs as at the end of 2007stood at RO 87.89 million as against RO 73.51 million at the90 Annual Report 2007 Central Bank of Oman

Money, Banking and Financial InstitutionsTable 5.12FLC Indicators (In Million R.O)2003 2004 2005 2006 2007Total Assets (Liabilities) 180.4 189.0 219.7 277.6 413.8Net Investment in Financing and Leasing Activities 165.2 175.3 201.2 267.3 398.2Cash and Bank Balances 10.19 8.68 13.04 2.76 4.70Loan Loss Provisions (net of reserve interest) 16.77 19.64 22.05 24.11 24.43Loan Loss Provisions (net of reserve interest) as % of GrossFinancing and Leasing Activities (net of reserve interest)9.2 10.1 9.9 8.3 5.8Borrowings from Banks & Financial Institutions 106.82 97.73 113.43 155.31 222.99Paid Up Capital 35.64 39.28 47.97 49.63 57.46Capital & Reserves* 49.64 57.77 69.90 73.51 87.89Net Profit After Tax for the Period 5.47 6.50 7.71 8.61 13.13Weighted Average Rate of Interest Charged (% perannum)12.29 12.01 11.05 11.27 11.44Number of Branches (Including Head Office) 23 24 27 27 31* Includes proposed cash dividends.Source: FLC Annual Reports, 2007.end of 2006, constituting a rise of 20.1 percent. The levelof loan loss provisioning earmarked for finance and leasingactivities stood at RO 24.43 million in 2007 as against RO24.11 million in 2006. Specific provisions (inclusive ofreserve interest) registered a decline from RO 28.53 million in2006 to RO 28.01 million in 2007. The deposit base of theindustry also rose during 2007 as FLCs utilized their limitedauthorization to accept deposits from corporates. It may benoted, however, that while FLCs have sought new avenuesfor diversifying borrowing portfolios and optimizing interestcosts, borrowings from banks and other financial institutionsremains the main source of funding for the finance and leasingsector. As regards the annual interest rate charged on aggregatecredit, it may be seen that the weighted average rate of interestcharged per annum on overall credit stood at 11.44 percentduring the year 2007 as against 11.27 percent in 2006.The institutional and regulatory framework of the financeand leasing industry has been strengthened over the pastfew years by CBO with the phased introduction of stricterprovisioning norms in 2004. Rules on submission of auditedannual financial statements were strengthened in 2005. In2006, some of the reporting requirements were modifiedwith a view to strengthening off-site surveillance of FLCsas recommended by the FSAP mission of the IMF. FLCswere also mandated to raise the minimum paid up capital toRO 10 million before the end of June 2009. More recently,the norms on vehicle loans in the personal segment havebeen strengthened by CBO, particularly in the area of downpayment and insurance, as personal loans for the purchaseof vehicles have increased substantially.Payment and Settlement SystemAn efficient payment and settlement system represents a keycomponent of the institutional architecture in the financialsystem, and the CBO has strengthened this area considerably,as per the blue print set out in its Payment System StrategyCentral Bank of OmanAnnual Report 2007 91

CHAPTER FIVE2003. Real Time Gross Settlement System (RTGS), a highvalue payment system providing settlement facilities not onlyon transaction to transaction basis but also to deferred netsettlement system (DNSS) like cheque-clearing and ATM/PoStransactions, became operational in 2005, addressing concernsrelating to counterparty and systemic risks. AutomatedClearing House (ACH), offering an electronic platform forpresenting interbank retail payments, such as payroll, utilitybills, dividends/interest payment etc. in batches, for deferrednet settlement became operational in 2006. Earlier, thesetransactions were not part of any organized payment system.All banks operating in Oman are members of RTGS and ACH.Select Ministries and Government agencies have also beenprovided full-fledged access to these systems.Other new National Payment System (NPS) projects underimplementation are the Cheque Imaging System (CIS) andEnhancements in the ATM Switch. The CIS project is currentlyat the stage of finalization, and when it becomes operationalby the end of 2008, it could, with the truncation provision,revolutionize the cheque processing and clearing procedures inthe Sultanate. The work on enhancements in the ATM Switchis at consultation stage. The improved switch is expected toincorporate the latest in credit/debit/smart card technologies,while complying with international security standards. Thecurrent ATM system consist of two switches patronized bytwo different set of banks. These switches are linked togetherfor better customer access and are also connected to GCC Net.A third ATM network is proprietary of a single bank.Table 5.13(a) and 5.13(b) exhibit the trends in RTGS and ACHbusiness, both in terms of volume and value. It could be seenthat RTGS volumes have stabilized while the volumes inACH have seen a steady rising trend. The CBO’s three chequeclearing houses (Head office, Salalah and Sohar branches)continued to be part of the NPS, serving the clearing of paperbased instruments of transfers. The cheque clearing house atCBO Head office is automated. During the year 2007, CBOClearing houses processed and cleared 2,158,189 chequesfor a total value of RO 3.611 billion. Table 5.13( c ) gives thecheque clearing trends since the year 2001.Payment and Settlement SystemsQuarterTable 5.13 (a)RTGS BusinessNo. ofTransactionsValue(RO Millions)QIV-05 91,671 17,489QI-06 90,551 18,079QII-06 97,503 15,125QIII-06 91,650 14,347QIV-06 83,536 15,917QI-07 79,813 18,516QII-07 88,701 22,645QIII-07 85,701 24,101QIV-07 92,088 20,763QuarterTable 5.13 (b)ACH Business TrendsNo. ofTransactionsValue(RO Millions)QIV-06 63,878 24,136QI-07 79,839 39,963QII-07 96,851 42,878QIII-07 116,633 45,389QIV-07 132,253 51,728YearTable 5.13 (c)Cheque ClearingNo. of ChequesValue(RO 000)2001 1,589,364 1,919,1202002 1,817,689 2,127,3222003 1,816,851 2,161,2562004 1,772,193 2,211,3822005 1,799,921 2,497,9172006 1,873,446 2,792,4612007 2,158,189 3,611,36492 Annual Report 2007 Central Bank of Oman

Foreign Trade andBalance of PaymentsCHAPTER SIX

CHAPTER SIXFOREIGN TRADE AND BALANCE OF PAYMENTSFor an open economy like the Sultanate of Oman, whichoperates with a fixed exchange rate regime, the strengthof the balance of payments is critical for entrenching thecredibility of the peg, as well for sustaining the commitmentto openness as a key vehicle for attaining diversified growthand development in the economy. The higher the degreeof openness, the greater could be the importance of tradedgoods and services as well as capital flows in shaping thecourse of the economy, because the transmission of theeffects of global shocks could be faster and stronger in sucheconomies.In 2007, Oman’s balance of payments position wasconditioned by external developments like global growthand oil prices, and by internal factors like growth of domesticdemand and domestic absorptive capacity constraints. Onaccount of high global growth in output (4.9 percent) andfavorable movements in oil prices, Oman’s rising oil andnon-oil exports added further strength to the economy. Theimpact of strong growth in exports, both oil and non-oil, washowever offset to a large extent by a surge in imports, whichpartly reflected the investment needs of ongoing projects,strong growth in domestic demand in the face of robusteconomic growth, as well as the significant increases in theprices of certain types of imports. In terms of percentageof GDP, the current account surplus fell sharply from 14.2percent in 2006 to 4.8 percent in 2007. The deteriorationin the level of the current account position was mainlyattributable to a 46.6 percent increase in merchandise importsand a 31.6 percent rise in worker remittances. The capitaland financial accounts, however, witnessed a significanttrend reversal, recording net inflows during 2007 as againstnet outflows in the preceding year. Net inflows amountedto RO 1,234 million in 2007 owing to higher net inflows ofFDI and portfolio investments, as against net outflows ofRO 1,122 million in 2006. The overall balance position inthe balance of payments, which reflects the combined effectsof the current, capital and financial account showed a largesurplus of RO 2,418 million in 2007, thereby strengtheningthe foreign exchange reserve position of Oman. As at theend of 2007, the gross official reserves of the Central Bankof Oman stood at RO 3,662.2 million, providing cover for 7.2months of imports of goods.Foreign TradeBy and large international trade results from the interactionsbetween economic agents in a home country with otheragents abroad, who exchange goods, services, and factors,across national borders. Developments in Oman’s balanceof payments during 2007 continued to be dominated bymerchandise trade, with the overall standing of the balanceof payments still being highly contingent on the trade balanceposition. The degree of concentration in terms of dependenceon oil exports continued to dominate merchandise tradetransactions in 2007. In particular, oil exports accounted forabout 63.3 percent of total exports while oil and gas exportstogether accounted for 75.9 percent (see Table 6.1 and Chart6.1). Conditioned by the open characteristics of the economyand the associated lack of major protectionist policiesor trade barriers that distort international trade, importscontinued to occupy a prominent position in meetingprivate consumption and investment demand. In 2007, theimport bill for Oman increased significantly by an estimatedRO 1,917.1 million (45.2 percent) to RO 6,161.5 million on ayear-on-year (yoy) basis (see Table 6.1).There was notable acceleration in the degree of the “tradeopenness” in 2007. Both ratios, i.e. merchandise exports toGDP as well as merchandise imports to GDP, highlightedthe relative significance of international trade in aggregatedomestic output. In nominal terms, merchandise exportsCentral Bank of OmanAnnual Report 2007 95

CHAPTER SIXTable 6.1Trade Transactions(Millions of R.O.)2004 2005 2006 2007% Change2007/06Imports (c.i.f.)3381.93449.34244.46161.545.2Exports (f.o.b)*5130.67186.98299.59505.714.5Crude Oil3490.95071.15528.35553.50.5Refined Oil61.588.347.4466.0883.1LNG619.7888.41144.61192.24.2Non-oil420.3555.3812.31290.758.9Re-exports538.2583.8766.81003.330.8Trade Balance1748.73737.64055.13344.2-17.5(Exports+Imports) as % of GDP89.489.591.3101.0Trade Balance as % of GDP18.431.429.521.6Non-oil Exports as % of GDP*10.19.611.514.8*Includes re-exports.Notes: Import figures in this table include both “recorded” and “unrecorded” imports, and hence, they may not tally with import figures in some other tableswhich may relate only to recorded imports. Similarly, import figures in this table are on c.i.f. basis and, therefore, may not tally with import and trade balancefigures in other tables where imports could be on f.o.b. basis.Source: Directorate General of Customs and Ministry of National Economy.Chart 6.1: Oman’s Degree of Opennessand Domination of Oil ExportsOver the years, the Government of Oman has strived toimprove the coverage, performance, and competitiveness ofnon-oil exports of Omani origin. Moreover, Government hasintroduced various incentives including policies aimed atproviding an investment climate that is conducive enoughto bolster tourism in Oman. Notwithstanding the risingcontribution of non-oil exports (excluding re-exports) todomestic economic activities, which increased by 58.9percent in 2007, the value of non-oil exports however stillremained modest at 8.3 percent of GDP as at end of 2007.Merchandise Trade Balance(f.o.b) stood at about 61.3 percent of GDP, denoting theexported share of domestic production, whereas merchandiseimports (c.i.f.) amounted to roughly 39.7 percent of GDP,corroborating the extremely important influence of foreignsources of consumption goods and intermediate products onthe overall level of economic activity in Oman.During 2007, merchandise trade for Oman grew at a healthypace, on the back of robust economic growth. While importgrowth remained high on account of a declining US Dollarplus strong domestic demand, non-oil export receiptsregistered marked increases, reflecting the sustained96 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of Paymentsprogress being made on diversification of Oman’s non-oilexport basket (see Chart 6.2). As regards crude oil exports,there was further marked improvement in the balance, onaverage, owing almost exclusively to higher international oilprices; especially since oil production declined in 2007 by3.7 percent due to the diminishing productivity of existingoil wells. Though Oman recorded a merchandise tradesurplus of RO 3,344.2 million in 2007, the trade balancesurplus receded by RO 710 million (17.5 percent) in relationto RO 4,055.1 million in 2006 (see Chart 6.3 and Chart 6.4).This outcome was led by an almost 45.2 percent expansionin imports (by RO 1,917.1 million) that exceeded the healthy14.5 percent growth in merchandise exports during 2007.For the review year, the surplus position in the trade balancein terms of nominal GDP stood at 21.6 percent as against theratio of 29.5 percent in 2006.The decline in trade surplus could be a source of concernif it develops into a trend, caused by structural factors.Since a large part of imports during 2007 was necessary forlaunching several industrial projects, the emerging trendin imports has to be assessed in context of its contributionto sustainable future growth as well as to the economicdiversification process in Oman. Moreover, since mostof these projects are export-intensive, current importsChart 6.2: Growth in Importsand Non-oil Exportsshould not be a major policy concern because they couldbe expected to enhance the country’s capacity to export inthe future.Exports (of goods)The nominal value of total merchandise exports roseby RO 1,206.2 million to RO 9,505.7 million in 2007(made up of crude oil, refined oil, liquefied naturalgas (LNG), non-oil exports, and re-exports), exhibitinga combined annual growth of 14.5 percent on yearon-yearbasis. While refined oil exports witnessed anexponential growth rate of 883.1 percent on accountof commencement of operations by the Sohar RefineryCompany, re-exports registered a growth of 30.8 percent,LNG exports experienced a modest growth rate of 4.2percent, and crude oil exports posted a marginal growthof 0.5 percent in 2007. In terms of growth rates, both,non-oil exports and re-exports outperformed oil andgas exports in 2007. Nonetheless, the share of oil andgas exports in total exports continued to dictate theperformance of Omani merchandise exports in 2007.Oil ExportsThe persistent rise in oil prices, which continued in thesecond half of 2007, most likely reflected the impact ofrising demand for oil stemming from ongoing expansionin the world economy, particularly in China and India,and the supply side constraints, such as the limitedspare capacity and the rising geopolitical tensions in theMiddle East region. Furthermore, investments in buildingspare capacity of crude oil production have not beensufficient as of yet to sustain the growing pace of worlddemand for energy. Against this backdrop, the averageprice of Omani oil for the year 2007 rose to an average ofUSD 65.15 per barrel compared to USD 62.06 per barrel ayear earlier.Central Bank of OmanAnnual Report 2007 97

CHAPTER SIXChart 6.3: Merchandise TradeChart 6.4: Oman’s Trade BalanceOver the years, the Omani Government has attempted to reversethe downward trend in oil production being experiencedsince 2001 through increased investment activities for newexplorations in the oil sector. In view of the normal gestationlags in such investments, Oman’s falling oil production wasreflected in declining domestic crude oil exports in 2007,which in value terms though increased marginally by RO 25.2million to RO 5,553.5 million primarily on account of thetrend in world oil prices.Natural Gas ExportsNatural gas in Oman is mainly exported in the form ofLNG, with a modest percentage of total production beingexported to UAE as natural gas. Export realization fromLNG production in 2007 increased by 4.2 percent fromRO 1,144.6 million in 2006 to RO 1,192.2 million andaccounted for about 12.5 percent of total export earnings. Both,OLNG and QLNG combined, utilized roughly 45.8 percent ofthe natural gas produced during 2007. The remaining share ofnatural gas was used domestically in the public gas system,as well as for industry and power plants, and in the oil fieldsfor enhanced oil recovery (EOR) purposes. As many of thegas based industrial projects become operational in the nearfuture, the growing demand for natural gas may increasefurther causing pressure on domestic supply. Reflectingthis concern, the Government of Oman signed a long termagreement with Qatar to meet the growing demand for naturalgas in Oman. Furthermore, a memorandum of understandingwas initiated with Iran for the same purpose.Non-Oil Exports of Omani OriginOver the past few years, the Omani Government has used its oilincome prudently to diversify the country’s economic base. Asa result, the resilience of Oman’s economic growth to stagnantoil production has improved significantly, driven by thestrong growth in the non-oil sectors of the domestic economy.Moreover, based on the prospects of a large number of exportorientedindustrial projects commencing their operationsshortly, it is anticipated that the impetus from non-oil exportscould be sustained in the medium to long run term.In 2007, total non-oil exports of Omani origin registereda robust growth of 58.9 percent, over and above the 32.1percent recorded in 2006. Higher receipts of non-oil exportsduring 2007 were not entirely attributed to performancein any specific commodity or basket. Leading the nonoilexport growth performance were “plastic, rubber andarticles thereof” registering a growth of 253.9 percent,followed closely by “mineral products” which recorded agrowth of 108.3 percent in 2007 (see Table 6.2). The rapid98 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsTable 6.2Value of Non-oil Exports of Omani Origin*(R.O. Millions)2004 2005 2006 2007% Change2007/060Live animals and animal products91.990.674.586.916.61Vegetable products15.216.112.915.419.42Animal or vegetable fats & oil17.928.528.836.225.73Foodstuffs, beverages, tobacco & related products26.035.532.138.118.74Mineral products42.750.5216.1450.1108.35Products of chemicals & allied industries28.089.2138.7176.727.46Plastic, rubber, & articles thereof31.033.031.9112.9253.97Textiles & articles thereof23.914.210.97.2-33.98Base metals & articles thereof72.695.8123.7120.7-2.49Others71.1101.9142.7246.572.7Total420.3555.3812.31290.758.9*Excludes re-exports.Source: Directorate General of Customs and Ministry of National Economy.acceleration in exports of “mineral products” stemmed fromglobal price hikes that were in line with heightened externaldemand. In addition, most of the other items, including“animals or vegetable fats and oils”, “products of chemicalsand allied industries”, and “others” recorded steady annualgrowth rates of 25.7 percent, 27.4 percent, and 72.7 percent,respectively. Furthermore, several commodities, including“live animals and animal products,” “foodstuffs, beverages,tobacco and related products,” as well as “plastic, rubber,and articles thereof,” exhibited reversals in their growthtrend. Exports of “textiles and articles thereof,” however,continued to display the ongoing negative trend that startedin 2004, most likely a result of the termination of the MultiFiber Agreement related quotas under the WTO.Re-ExportsRe-exports essentially reflect imports meant for exportto other countries, with or without value addition, andhence such exports tend to have strong import content.The positive growth in re-exports was once again drivenprimarily by “machinery and transport equipments,” whichrepresented 88.1 percent of total re-exports, and exhibiteda positive growth of 33.4 percent in 2007 (see Table 6.3).Even though not significant in terms of their magnitudeand impact on the levels of re-exports, other items suchas “manufactured goods,” “beverages and tobacco,” and“miscellaneous manufactured articles” also witnessedpositive growth rates in 2007. In contrast, re-exports of“food and live animals” and “crude materials inedibleexcept fuels” displayed negative growth of 5.0 percent and1.5 percent, respectively.Destination of Non-Oil ExportsA fundamental concept in international trade theory iscomparative advantage. The economic characteristics ofa country, including endowments and factor productivityCentral Bank of OmanAnnual Report 2007 99

CHAPTER SIXTable 6.3Composition of Re-exports(R.O. Millions)2004 2005 2006 2007%Change2007/060Food & Live Animals19.08.817.917.0-5.01Beverages and Tobacco24.513.89.612.126.02Crude Materials Inedible Except Fuels2.25.26.56.4-1.53Mineral, Fuels, Lubricants and Related Materials0.10.90.11.71600.04Animal and Vegetable Oil & Fats-0.1-1.1-5Chemicals7.87.86.88.423.56Manufactured Goods17.615.413.520.451.17Machinery & Transport Equipment, of which398.8502.4663.0884.433.4road vehicles & other transport equipments8Miscellaneous Manufactured Articles30.519.936.245.425.49Commodities & Transactions n.i.e.*37.79.313.16.4-51.1Total538.2583.6766.71003.330.9*n.i.e stands for not included elsewhere.Source: Directorate General of Customs and Ministry of National Economy.combine to explain the pattern of international trade. At firstglance, the export market for Oman may appear reasonablydiversified in terms of the number of countries to whichit exports. However, assessed in nominal volume or valueterms, the extent of market concentration remains high.The destination of non-oil exports of Omani origin in 2007remained relatively unchanged, as evidenced by the fact thatUAE and India together accounted for close to 54.1 percent oftotal non-oil exports of Omani origin (see Table 6.4). On onehand, non-oil exports to UAE nudged upwards registeringa robust growth of 40.5 percent in 2007, which was largelydriven by higher exports of LPG and cables. India, on theother hand, remained for the third year in a row as the secondmost important destination market for Omani exports, witha share of 13.6 percent of total non-oil export on account ofhigher exports of fertilizer from OMIFCO in 2007.On the whole, free trade agreements, bilateral and regional,have gained due importance in determining access to keyinternational markets, and in influencing bilateral tradeflows between partner countries. Above all, significantreduction in tariffs and the removal of non-tariff barriersgenerate substantial welfare gains for partner countries.Over the years, Oman has made considerable efforts toenter into trade agreements with a number of countries. Inaddition to the 2005 Oman-US free trade agreement (FTA),similar agreements have been initiated with Japan, Korea,Australia, Singapore, etc. The potential benefits from theOman-US free trade agreement are yet to materialize whichis evident from the fact that the share of the United Statesin Oman’s total non-oil exports, declined further to 1.5percent in 2007. As far as exchange rates are concerned,the induced export competitive advantage to Omanarising from sustained depreciation of the US Dollarwas not clearly evident from country-wise informationon Omani exports. That is, the ongoing decline of the USDollar did not fuel a steady increase in non-oil exports ofOmani Origin.100 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsDestination of Re-ExportsSimilar to the destination markets for non-oil exports ofOmani origin, the re-export markets were many, thoughhighly concentrated in few countries. During 2007, reexportsremained relatively buoyant, with no significantchange taking place in the top three destination countriesfor Omani non-oil re-exports. Most Omani non-oil re-exportswere exported to three major countries, namely the UAEfollowed by Iran and Saudi Arabia. These three countriesaccounted for 71.5 percent (see Table 6.5) of total re-exports,relatively unchanged from last year. Re-exports to the UAEwere mainly dominated by vehicles, and as a result, theshare of UAE alone in total re-exports stood at as high as55.6 percent, whereas Iran remained as the second mostimportant destination market for Omani-re-exports, holdinga share of 12.1 percent of total re-exports in 2007.ImportsBroadly speaking, in a small-open economy like theSultanate of Oman, high import growth could be positivelycorrelated with nominal GDP growth, in particular growth inconsumption demand and investment expenditures on capitalTable 6.4Destination of Non-oil Exports of Omani Origin*(R.O. Millions)CountryNon-oilExports2006% ofTotalNon-oilExports2007% ofTotalCountryTable 6.5Destination of Re-Exports(R.O. Millions)2006Re-Exports% ofTotal2007Re-Exports% ofTotalUAE320.939.5522.740.5UAE431.756.3558.355.6Saudi Arabia49.06.059.24.6Iran70.89.2121.912.1U.S.A15.61.919.51.5Saudi Arabia36.74.837.63.7Jordan4.40.54.30.3U.K.21.92.916.81.7Yemen20.92.627.52.1Hong Kong20.12.632.83.3Kuwait15.71.917.11.3Singapore10.51.416.81.7Qatar31.93.951.24.0Belgium13.61.811.01.1Iraq11.21.416.21.3Yemen8.31.112.21.2Pakistan16.02.035.22.7China1.80.212.81.3Syria3.00.410.10.8Iraq4.30.66.00.6India124.515.3175.913.6Libeya15.02.05.10.5Somalia16.32.014.41.1Germany7.41.06.00.6Bahrain6.60.89.30.7India10.01.39.81.0Taiwan8.01.026.32.0Sudan8.81.14.80.5Iran12.21.57.30.6Kagakhstan7.71.013.21.3Others156.219.2294.522.8Others98.112.8138.213.8Total812.3100.01290.7100.0Total766.8100.01003.3100.0*Excludes re-exports.Source: Directorate General of Customs and Ministry of National Economy.Notes: See Table 3.2 in Chapter 3 for data on destination of oil exports.Source: Directorate General of Customs and Ministry of National Economy .Central Bank of OmanAnnual Report 2007 101

CHAPTER SIXTable 6.6Composition of Recorded Imports(R.O. Millions)Classification2004200520062007%Change2007/060Food & Live Animals369.1340.3382.1509.133.21Beverages and Tobacco43.531.232.942.529.22Crude Materials Inedible Except Fuels105.088.5123.0114.5-6.93Mineral, Fuels, Lubricants and Related Materials83.8141.0139.2214.454.04Animal and Vegetable Oil & Fats26.025.028.245.962.85Chemicals and related products246.1284.6280.6395.641.06Manufactured Goods587.3569.1799.41283.560.67Machinery & Transport Equipments1565.01637.42085.03165.351.88Miscellaneous Manufactured Articles183.2198.3239.4340.842.49Commodities & Transactions n.i.e.*105.078.880.232.6-59.4Total3314.03394.24190.16144.246.6*n.i.e stands for not included elsewhere.Notes: Import figures presented here include recorded imports only & hence, they may not tally with import figures in Tables 6.1 & 6.11.Source: Directorate General of Customs and Ministry of National Economy.goods. Imports of capital and consumption goods during 2007soared. The recorded import bill for the year (on c.i.f basis)amounted to RO 6,144.2 million, 46.6 percent above the levelrecorded in the previous year (see Table 6.6). The sizeableexpansion in the levels of nominal imports during 2007 canlargely be explained by (1) significant increase in the priceof imported items due to rising trend in global inflation, (2)increased investment related imports linked to large ongoingprojects, and (3) the pass-through inflationary implicationsof the US Dollar depreciation against other major currencies.The composition of recorded imports for Oman (see Table 6.6)indicated that increases in imports during 2007 were reflectedin almost all categories of imported items, but more particularlyin the “machinery and transport equipment,” “manufacturedgoods,” and “minerals, fuels, lubricants and related items”categories. Machinery and transport equipment exhibiteda strong annual growth of 51.8 percent, and accounted for51.5 percent of aggregate recorded imports in 2007, whereas“manufactured goods,” the second most prominent item inthe import basket, also recorded a high growth of 60.6 percentdue to higher construction related demand for copper, wires,iron pipes, etc. Moreover, the upward world trend in foodprices was also partially reflected in import prices of “foodand live animals” which increased by 33.2 percent in 2007. Incontrast, imports of “crude materials, inedible except fuels”decreased by 6.9 percent to RO 114.5 million in 2007.Relevant information on country-wise sources of imports ofOman revealed that the UAE, Euro-area, and Japan continuedto be the major three sources of imports in 2007. Both thevalue and relative share of imports from all three sourceshave more or less remained unchanged in comparisonwith 2006 (see Table 6.7). In 2007, imports from the UAEamounted to RO 1,625.2 million or 26.4 percent of totalimports compared with RO 1,083.7 million, which wasequivalent to 25.8 percent of imports in 2006. Despite theimpact of the US Dollar depreciation on domestic inflation,a large proportion of imports were from Japan and Germany,102 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsCountryUAEJapanItalyUKGermanyUSAFranceIndiaNetherlandsSouth KoreaAustraliaChinaSaudi ArabiaSingaporeBelgiumOthersTotalsignifying the price inelasticity of imported items likemachineries and vehicles. The recorded imports from theUnited States amounted to RO 354.8 million in 2007, up byRO 219.3 million (61.8 percent) from 2006, partly due to theappreciation of the Euro, which led to partial displacementof costlier imports from the Euro-area (see Table 6.7).Trade with GCCTable 6.7Sources of Recorded Imports(R.O. Millions)Imports1083.7724.086.8142.1212.0219.373.6222.283.7147.783.2141.7144.849.254.1722.04190.12006% ofTotal25.917.31625.2969.1144.9181.7325.8354.8149.2400.1131.2212.6121.8183.4149.742.257.21095.36144.226.515.8Although Oman has withdrawn from the GCC CommonCurrency process, it remains committed to strengtheningtrade and promoting economic integration in the GCC region,and recognizes the potential benefits of economic integrationin the form of Customs Union and a Common Market.2.13.45.15.21.85.32.03.52.03.43.51.21.317.2100.0Imports2007% ofTotal2.43.05.35.82.46.52.13.52.03.02.40.70.917.8100.0Source: Directorate General of Customs and Ministry of National Economy.Despite the relatively low degree of product diversificationacross member states, trade between Oman and GCC membercountries remained high, owing to several regional features,such as low transportation costs, common language, andfree borders. Omani non-oil exports (including re-exports)to member GCC countries as a group increased by almost39.9 percent from RO 906.0 million in 2006 to RO 1,267.4million in 2007 (see Table 6.8). At the same time, Oman’scombined recorded imports from GCC countries, increasedby RO 568.8 million (44.3 percent) from RO 1,285.1 millionin 2006 to RO 1,853.9 million in 2007, with recorded importsfrom GCC members representing 30.2 percent of total Omaniimports in 2007. The United Arab Emirates continued to beOman’s main trading partner during 2007. The share of UAEmarket in total imports of Oman from GCC States turned outto be 87.7 percent, while its share in total non-oil exports ofOman to GCC member countries was 85.3 percent.Terms-of-TradeTerms-of-trade could be usually measured as the priceof the goods a country exports in terms of the price of thegoods it imports. For the most part, an improvement in theterms of trade increases a country’s national welfare, whileGCC CountriesUAESaudi ArabiaBahrainKuwaitQatarTotalTable 6.8Trade with GCC Countries in 2007(R.O. Millions)Non-Oil Exports*Value1081.096.810.118.161.31267.485.37.60.81.44.8100.0Recorded Imports% of Total Value % of Total1625.2149.756.311.810.91853.987.78.13.00.60.6100.0*Includes re-exports.Source: Directorate General of Customs and Ministry of National Economy.Central Bank of OmanAnnual Report 2007 103

CHAPTER SIXa deterioration in the terms of trade reduces the same. Thus,based on the nature and magnitude of shocks, changes inprices of traded goods could inflict significant terms-of-tradeeffects on individual trading nations.Chart 6.5: Oman’s Terms-of-TradeThe global economy has been witnessing significant adverseterms-of-trade shocks in recent years stemming from higheroil prices, while oil exporting countries like Oman havebeen reaping the welfare benefits of such favorable terms-oftradeshocks, even though the corresponding adverse termsof-tradeshocks associated with imports and non-oil exportsof such countries may be offsetting a part of the favorableeffects stemming from higher oil prices. Notwithstandingthe changes that can take place in the relative price of thebasket component, the underlying concept derived from thebehavior of implied terms-of-trade can be inferred from thetime-series data on value and quantity of trade transactionsfor Oman (see Table 6.9). With regard to oil exports, thepositive welfare effects from terms-of-trade shocks (that ishigh oil prices) on oil exports are evident in lower quantitiesof oil being exported at higher oil prices. Conversely, thenegative impact of terms-of-trade shocks on non-oil exportsare reflected in relatively higher quantities of non-oil exportsbeing exported at lower prices. And with respect to imports,the negative terms of trade shocks are reflected in lowerquantities of imports valued at higher prices (with priceeffects dominating quantity effects).As illustrated in Chart 6.5, the price of Omani crude oilin 2007, increased to about 254.0 (expressed as an indexwith the base period 2003=100), implying an improvementof 1.5 times in oil income over the 2003 levels on accountof favorable terms-of-trade. In addition, the non-oil exportprice index for Oman, which was deteriorating till 2006,increased to 93.57 in 2007, exhibiting a 26.4 percent impliedwelfare gain over the previous year. These favorable gains,however, were partially offset by deteriorations in terms-oftradecorresponding to higher prices paid on imports. Theindex of import prices increased to around 185.5 in 2007,signifying more than 85 percent increase in imported pricessince 2003, which could have partly contributed to risinginflation in Oman.Nominal Effective Exchange RateThe nominal effective exchange rate (NEER) is measured as aweighted average index of overall movement in the nominalexchange rate of the domestic currency vis-à-vis currenciesof the domestic economy’s major trading partners. In otherwords, NEER captures the combined effects of fluctuationsin the exchange rates of the currencies of trading partners inrelation to the currency of the domestic economy. In the caseof Oman, NEER represents an import weighted average indexof the Rial Omani exchange rate, mainly on grounds thatOmani imports far exceed non-oil exports of Omani origin.The pass-through effects of exchange rates on inflation viaimports –associated with US Dollar depreciation– assumesgreater significance for the assessment of inflationaryconditions in Oman, which explain the emphasis of importweights in the construction of the NEER index.While the exchange rate of the Rial Omani remains fixed to theUS Dollar, the exchange rates of the currencies of some of themajor trading partners of Oman – who operate with flexibleexchange rate regimes – undergo changes in relation to the104 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsTable 6.9Value and Quantity of Exports / ImportsNon-Oil Exportsincluding re-exportsRecorded ImportsOil ExportsValue(RO Million)Weight(000) TonnesValue(RO Million)Weight(000) TonnesMillionBarrelsAvg. Price(USD pb)1992350.2446.11449.22440.9252.6018.001993442.8594.31581.83178.8267.4015.611994503.9708.01505.32746.8270.5015.171995503.9846.91633.62772.6284.6016.391996560.3949.61760.23416.5296.2019.421997710.2923.91932.53760.8303.2018.621998692.61267.92184.53556.9300.2011.921999656.81243.51797.13362.3308.5017.352000746.41704.71937.63841.9326.9026.712001843.41976.42229.34429.8331.5223.122002988.32203.02309.14901.0306.1524.292003904.92463.02527.05643.1287.7127.842004958.52468.03312.75712.0263.6434.4220051139.13351.83394.05566.0262.1350.2620061579.25806.34190.15822.4233.1761.6920072294.16673.66144.27395.4221.9965.15Source: Directorate General of Customs, Ministry of National Economy and Ministry of Oil and Gas.US Dollar. In turn, the exchange rates of these currenciesalso vary in relation to the Rial Omani. Stated differently,a depreciation of the US Dollar implies a correspondingdepreciation in the Rial Omani, whereas an appreciationof the US Dollar entails an analogous appreciation in theRial Omani. In view of this relationship, Omani exportsand imports are not entirely insulated from the effects ofvolatility in international key currencies.Exchange rate developments during 2007 on a year-on-yearbasis were characterized by further weakening of the US Dollaragainst most major currencies, primarily due to a combinationof factors, including the continued narrowing of interest ratespreads between the United States and other major economies,and the greater uncertainty surrounding the economic outlookin the United Stated, particularly in the aftermath of theUS sub-prime related global financial crisis. The US Dollardepreciated by 1.3 percent against the Pound Sterling, by 9.6percent in terms of the Euro, and by 6.1 percent relative toJapanese Yen in December 2007 on a year-on-year basis.The weakening of the U.S. Dollar against other majorcurrencies led to further depreciation of Oman’s Nominaleffective exchange rate during 2007. The 2007 year-endposition of the NEER represented a cumulative depreciationof about 26.9 percent over the end 2001 level (see Table 6.10).The plausible effects of this cumulative NEER depreciationcould be abstracted from the movements of both domesticCentral Bank of OmanAnnual Report 2007 105

CHAPTER SIXinflation as well as non-oil exports of Omani origin (seeCharts 6.6 and 6.7).The external competitive advantage resulting from thecumulative depreciation of the NEER remains moderate forOman in view of the low share of non-oil exports of Omaniorigin in total exports. Despite the low base, the cumulativedepreciation of the NEER might have contributed favorably toTable 6.10Nominal Effective Exchange Rate (NEER)(1999=100)PeriodImport Weighted Non-WeightedEnd of year2001111.0112.62002104.0101.4200397.191.3200493.586.6200599.493.7200696.387.7200792.482.3Month-end (2007)sustained expansion in the magnitude of non-oil exports overthe period 2002-2007, with 2007 alone exhibiting a robustgrowth of 58.9 percent (see Chart 6.7). Unlike the favorableimplications for non-oil exports, domestic inflationaryconditions seem to have come under the influence ofimported inflation induced by substantial depreciation ofthe NEER; with the impact being more pronounced in termsof WPI rather than CPI for the Sultanate (see Chart 6.6). TheWPI index has been experiencing a rising trend since 2003,and the 26.9 percent cumulative depreciation in the NEERup to 2007 coincided with an annual WPI inflation of about8 percent in 2007, as against somewhat lower but risingCPI inflation of about 5.9 percent for the same period. Thetrend behavior depicted in Charts 6.6 and 6.7 suggests thatthe NEER depreciation is one factor among many others thatcould influence the behavior of rising inflation and stronggrowth in non-oil exports of the domestic economy.Chart 6.6: NEER and WPIJanuary97.188.6February96.287.7March95.787.1April95.385.9May95.986.5Chart 6.7: NEER and Non-Oil ExportsJune95.886.2July94.885.3August94.686.1September93.383.4October92.982.5November91.681.7December92.482.3Note: A rise in the index indicates an appreciation of the Rial Omani.Source: Central Bank of Oman.106 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsBalance of PaymentsStatistical Presentation and CoverageCompilation of the balance of payments statistics in any openeconomy with free convertibility in both current and capitalaccounts is a major challenge, since the required informationhas to be collected from multiple sources through varioussurveys, and the reported information has to also be compiledand presented as per the guidelines and concepts set out inthe 5th edition of the Balance of Payments (BoP) Manualof the International Monetary Fund (IMF). Until recently,dominance of the oil sector and Government transactionsin the economy implied that coverage of these two sectorscould be most crucial for compilation of balance of paymentsstatistics. In recent years, however, Oman has been passingthrough a gradual transformation from public sector oildependent nature of the economy to a more diversifiedstructure, with an increasing role played by the privatesector. Growing domestic income and liberal commitmentsgiven under the WTO and FTA have also expanded thescope for greater international transactions in services andcross-border capital movements. As an outcome, some ofthe sub-accounts of the balance of payments which werenot that relevant earlier are assuming increasing relevancenow, exerting greater challenges for collection of additionalinformation from the parties involved in the transactionsdirectly through surveys. In terms of coverage, significantimprovements have been made with respect to services datain the balance of payments, which are becoming increasinglyrelevant in relation to the earlier complete dominance of thecurrent account by merchandise goods. Income paymentsand remittances have also exhibited sharp growth.A notable improvement has also been there in the area ofthe financial accounts, since financial transactions of nongovernmentand non-banking entities in Oman have gainedconsiderable importance in the recent years. In last fewyears transactions of “non-financial corporate entities” and“non-banking financial entities” with non-residents havebeen covered through sample surveys to improve data withrespect to foreign direct investment, portfolio investment,and other investment, on both assets and liabilities side, aswell as with respect to current payments associated withexternal asset liability positions, such as interest, dividend,profit, technical know-how payments, etc. The results ofthe 2007 comprehensive survey conducted by the Ministryof National Economy, Ministry of Commerce and Industryand the Central Bank of Oman on foreign investment, havealso been incorporated into the revised BoP statistics for theperiod 2003-2007. Another particular feature of the data thatis worth mentioning is the information on all Governmentforeign assets and liabilities which are now fully covered inbalance of payments compilation. This has helped in firmingup data presented in the income account, financial accountand official reserves account.In 2004, Oman volunteered for a comprehensive assessmentof its macroeconomic statistics by the IMF under the DataROSC module, and its recommendations with respect tobalance of payments statistics have been prioritized forphased action. Furthermore, recommendations by severalpast statistical missions to Oman from the IMF have alsobeen taken into consideration while designing the prioritizedaction plan. The improvements being achieved in compilationof balance of payments statistics clearly demonstrate Oman’scommitment to international statistical standards, and theimportance attached to undertaking improvements inmajor statistics that are relevant for conducting effectivemacroeconomic policy.Current AccountThe strength of the balance of payments position in Oman hasbeen driven by current account surpluses, with merchandisetrade surpluses dictating the overall current account positionCentral Bank of OmanAnnual Report 2007 107

CHAPTER SIXfor Oman. While merchandise trade has remained in surplusover the last several years, other major components of thecurrent account including services, income, and currenttransfers continued to be in deficit, with the magnitude ofthe deficit rising considerably each year, thereby giving riseto declining surpluses in the current account. Preliminaryestimates of the balance of payments data for 2007 indicatethat the current account surplus declined to RO 737 million,down 62.3 percent year-on-year, and representing only 4.8percent of nominal GDP, as against 14.2 percent of GDP in 2006(see Chart 6.8). The persistent decline in the magnitude of thecurrent account surplus was primarily caused by strengtheningdomestic demand for raw materials supported by an upturn indemand for capital goods, which led to a surge of 45.2 percentin merchandise imports that overshadowed the 14.5 percentgrowth in merchandise exports in 2007. In addition to theyear-on year decline in the merchandise trade surplus, higherservices payment related outflows, including transportationand other business charges on account of higher imports, aswell as higher current transfer (worker remittances) outflowsexacerbated the current account surplus position during2007. In particular, recorded net outflows under the servicesaccount amounted to RO 1,474 million, a 31.3 percent growthover and above the net services payments of RO 1,122 millionrecorded in 2006; whereas net outflows associated withworker remittances increased by RO 339 million in 2007.The rising deficits in the services, income and transfersaccount reflect the structural characteristics of the economy.Oman has been a net importer of services as demand forservices are growing faster than what can be provideddomestically. In Oman, the share of services in GDP wasclose to 40.5 percent of GDP in 2007, and the services sectorvalue addition recorded a growth of 20.3 percent in 2007.As per capita income grows over time, the share of incomespent on services is expected to rise. While transportationand insurance services grow in response to developmentsin merchandise trade flows, travel payments (relating toeducation, health, business travel, pleasure travel, Hajjand Omrah, etc.) have been consistently increasing. As theeconomy continues to grow with diversification, paymentsrelating “other services” such as construction services (i.e.payments to short term foreign contractors), business servicesrelating to projects by foreign management units, royalty,technical know-how and license fees payments, informationservices, and professional and technical services (such aslegal, accounting, consulting, etc.) will also continue toincrease. This was evident from the 40.1 percent growth inother services payments witnessed in 2007. On the flipside,the only major category under services income that has beenconsistently increasing in the recent period has been travel,which reflects the relevance of the policy importance beingassigned to tourism in Oman.Similarly, the revised statistics on the income account withimproved coverage for the period 2003 to 2007 indicatethat payments have exceeded receipts on a consistent basis.On the receipts front, the growing trend in foreign assets,particularly of the Central Bank of Oman (CBO) and theGovernment, as well as corporate entities, banks, pensionfunds, finance companies, etc. have led to rising incomerelated inflows in the income account. The underlyingincome from these foreign assets have increased from RO 183million in 2006 to RO 764 million in 2007 representing a31.5 percent annual growth. As regards payments relating toincome account, outflows of foreign direct investment in theform of dividends and profit repatriation as well as increasein the share of foreign investors in retained earnings, thereturns in the oil and gas sector have been high in thewake of high oil prices. Direct investment income relatedpayments also include payment of interest on external loansof the Government, non-resident holding of Governmentdevelopment bonds, and interest on external debt liabilitiesof the financial sector as well as the non-financial corporatesector. A large deficit in the income account shows excessiverecourse to external liabilities by any country. In the case108 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsChart 6.8: Current Account SurplusesChart 6.9: Remittance Outflowsof Oman, however, instead of large external liabilities, it isthe very high return on modest level of external liabilitiesthat contributes to the growing deficit in the income account.Direct investment income related payments have emergedas a major drain on the country’s foreign exchange incomein the recent years, with such payments rising from RO 571million in 2005 to RO 767 million in 2006 and further toRO 903 million in 2007.The persistent deficit position in the current transfer accountcontinued to widen, driven by 31.6 percent increase inremittances from RO 1,072 million in 2006 to RO 1,411million in 2007. The sharp increase in absolute magnitude ofremittance in the last three years has also coincided with anincreasing share of remittances as percentage of total exportearnings (see Chart 6.9). Remittances as percentage of totalexport earnings stood at 14.1 percent in 2007, as against 12.9percent and 12.1 percent in 2006 and 2005, respectively. Useof foreign labor and foreign capital involves an unavoidablecost in the form of significant outgo of foreign exchange,even though dependence on foreign labor and foreign capitalembodied technology reflects in essence the requirements ofthe country for achieving higher growth and development.Overall, the combined deficits in the services, income andcurrent transfer accounts amounted to RO 3,254 million, andwere as high as 21 percent of nominal GDP in 2007.Capital and Financial AccountThe capital and financial accounts witnessed a significanttrend reversal during 2007. While there were capitaloutflows in the form of foreign direct investments abroad(assets), there were even larger capital inflows from abroadin the form of foreign direct investments (liabilities) intoOman, as well inward portfolio investments in the form ofboth increases in foreign liabilities and reductions in foreignassets of resident entities. This reversal resulted partly inresponse to declining interest rates in the United States,market expectations of a revaluation of the Rial Omani, andhigher inward portfolio investment into Oman driven by 61.9percent increase in the MSM index. Larger FDI inflows owingto increased equity investments and real-estate purchasesby non-resident as well as debt funds raised by corporate tofund major projects, increasing portfolio investment by nonresidentsin the MSM, and increases in foreign liabilitiescoupled with reductions in foreign assets of banks as wellas non-bank entities were some of the key factors that led tolarger capital inflows during 2007. The surplus in the capitaland financial account turned out to be of the order RO 1,234million. With regards to the three major components of thefinancial account, while the “Foreign direct investment”and “portfolio investment” accounts yielded net surplusesof RO 695 million and RO 1,088 million, respectively, theCentral Bank of OmanAnnual Report 2007 109

CHAPTER SIX“other investment” account exhibited a net deficit of RO 867million during 2007. The capital account, under the “capitaland financial account” showed large inflows in the form ofgrants (see Table 6.11).On a gross basis, the revised figures for inward FDI intoOman in 2006 and 2007 amounted to RO 624 millionand RO 914 million, respectively, whereas outward FDIinvestments turned out to be RO 126 million in 2006 andRO 219 million in 2007. It is noteworthy to mention thatthat FDI related inflows not only include fresh inflows ofequity from investors, but also include the increase in theshare of foreign investors in retained earnings during anyyear as well as any loans from the direct investor. Thus,the figure of RO 914 in 2007 had a major retained earningscomponent, which was not a fresh inflow during the year.It has been the experience in the past that certain majorforeign direct investors at times decide to transfer largerprofits by drawing their retained earnings, and some evenlower their equity stake once the projects start yieldingreasonable profits. This not only explains why the FDI stockof Oman may not increase considerably every year, but alsosuggests why FDI figures could be volatile from year to year.FDI in highly profitable unlisted companies in the oil andgas sector could have a preference for debt capital with verylow equity, and as a result, the return on FDI could be higheven though the level of inward FDI into the country mayremain modest. It is clearly evident in the financial accountthat debt related inflows of FDI and other corporate firmshaving operations in Oman exceeded the inflows of capitaltaking place in the form of FDI both in 2006 and 2007. Manyof the upcoming mega projects are resorting to external debtcapital to meet initial financing needs, which has beenreflected in other investment liabilities in 2007. This orderof annual increase in external debt is not a matter of concern,since most of the projects which use these debt capital areexport-intensive, implying that debt servicing are unlikelyto exert any pressure on Oman’s balance of payments.With regards to the portfolio investments during the referenceyear, net inflows amounted to RO 1,088 million in 2007 asagainst outflows of RO 265 million in 2006, due to higherinward portfolio investments by non-residents into Oman,as well as reductions in foreign assets of resident portfolioinvestors, such as commercial banks, pension funds, nonbankingfinancial entities, and corporations etc., abroad.Portfolio investments by foreign investors in MSM weremuch higher at RO 790 million as against RO 310 million in2006, as the share of non-resident in market capitalizationincreased significantly from 23.28 percent in 2006 to 27.55percent in 2007. Conversely, the stock of Omani resident’sfinancial investments in the rest of the world (assets) declinedsharply during the same period (see Table 6.11).Unlike foreign direct investment and foreign portfolioinvestment, the “other investment” exhibited a net outflow(deficit) of RO 867 million in 2007. The deficit was mainlyinfluenced by an increase in gross foreign assets by RO 1,974million as against a lower increase in foreign liabilities ofRO 1,107 million. The increase in foreign assets was onaccount of the creation of foreign assets (outflows of capital)by the Government, financial, corporate and household sectorscombined. The creation of foreign assets in the governmentsector reflected the impact of large surpluses in the gross fiscalposition. On the liability side, corporations raised RO 185million of additional debt capital in 2007 as against RO 164million in 2006 to fund various upcoming projects.The overall balance of payments position (adjusted forerrors and omissions) displayed a large surplus of RO 2,418million in 2007 in comparison to RO 849 million in 2006.The overall balance surplus represents the combined effectof the net flows emerging out of the current, capital, andfinancial accounts taken together, and it the most crucialvariable from the standpoint of monetary management fora country like Oman that operates with a fixed exchangerate, since the money supply process is directly conditioned110 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsChart 6.10: Overall BoP Surpluses and CBO’sForeign Exchange Reserve Levelsnatural sterilization process embodied in SGRF assets,CBO’s foreign exchange reserves have not expanded everyyear by the magnitude of surpluses recorded in the overallbalance position (see Chart 6.10).Reserve AssetsThe more robust overall balance of payments surplusposition of RO 2,418 million in 2007 led to correspondingincrease in foreign assets of the CBO (excluding valuationchanges) and the Government together. With SGRF assetsincreasing by RO 708 million, CBO’s foreign exchangereserves rose by the remaining amount of RO 1,710 million(net of valuation changes). Adjusted for valuation changesby the magnitude of the surplus or deficit in the overallbalance. The overall balance surplus or deficit, however,does not affect the reserve money aggregates on oneto-one-basisin Oman because the impact of the overallbalance position is shared between the foreign exchangereserves of the CBO and the State General Reserve Fund(SGRF) assets of the Government. It might be worth notingthat unlike SGRF assets which are shown below the line,any other foreign assets of the Government may appearabove the line in the financial account of Oman’s balanceof payments. To the extent that the movements in SGRFbalances absorb part of the impact of overall balancedevelopments, the money supply process gets partiallyinsulated, which could be viewed as a natural process ofsterilization. In essence, SGRF helps in sterilizing partiallythe expansionary monetary impact of a large surplus inthe overall balance. Whatever part of the overall balancesurplus remains unabsorbed by the SGRF, it leads tocorresponding increase in the foreign exchange reservesof the CBO, which in turn leads to equivalent primarycreation of monetary liabilities by the CBO. In 2007, sincethe surplus was to an extent absorbed through increase inSGRF balances, the expansionary implications of overallbalance surplus could be partly contained. Because of thisarising from movements in the exchange rates of currenciesin which CBO’s reserves are invested, however, CBO’sforeign exchange reserves rose by RO 1,733.6 million fromRO 1,927.6 million at the end of 2006 to RO 3,661.3 million atthe end of RO million. In terms of standard reserve adequacyindicators, CBO’s reserves at the end of 2007 were equivalentto about 7.2 months cover for merchandise imports and about4.4 months cover for all gross current account payments.Even though balances under SGRF do not strictly conformwith the definition of foreign exchange reserves presentedin the fifth edition of the Balance of Payments Manual ofthe IMF, as a matter of convention SGRF assets are beingpresented as a below the line entry in Oman’s balance ofpayments, which may have to be viewed as analyticallyrelevant in Oman specific context.Foreign Direct InvestmentThe Foreign Direct Investment (FDI) climate in Omanremained attractive in 2007, given the very liberal FDI policyand the high return prospects on FDI in a fast growing openeconomy. Foreign ownership, up to 70 percent, is permittedunder WTO and Oman-US FTA commitments, which can goup to 100 percent in specific cases. The capital account ofCentral Bank of OmanAnnual Report 2007 111

CHAPTER SIXChart 6.11: Stock of ForeignInvestment in FDI EnterprisesChart 6.12: Annual Income on FDI StockOman being open, there are no restrictions on repatriation ofcapital or income earned on invested foreign capital. Thereis no personal income tax in Oman, and FDI enterprisesare eligible for 5 years tax breaks, that can be extendedup to 10 years. With tariff rates being very low in Oman,imported capital goods and raw materials can be used byFDI enterprises at competitive price. Oman also offersquality physical infrastructure, in terms of roads, sea ports,airports, electricity and water supply, besides natural gas.The financial sector is also resilient and strong.Available information on outstanding stock of FDI in Omanup to 2006 shows that the FDI level has increased graduallyin recent years in Oman, and other foreign investment flowsof FDI enterprises (in the form of debt capital raised by FDIenterprises) have exceeded the FDI flows (see Chart 6.11).As per the preliminary results published by the Ministry ofNational Economy in February 2008, the outstanding FDIstock of FDI enterprises in Oman at the end of 2006 was aboutRO 2,260.2 million (see Chart 6.11), whereas the incomeearned on this level of FDI in 2006 (in the form of repatriatedprofits/dividends as well as profits retained from investment)was as high as RO 748.7 million (see Chart 6.12), suggestingthe very high rate of return that could be earned on FDI inOman. Moreover, the stock of foreign direct investment maynot have increased by the expected magnitude in the past,because of the preference of some FDI enterprises to dilutecapital once the venture starts yielding high returns.112 Annual Report 2007 Central Bank of Oman

Foreign Trade and Balance of PaymentsTable 6.11Balance of Payments(R.O. Millions)Items20032004200520062007 Prel.A. Current account559348189819557371. Goods21472118410045013991Exports (F.O.B)44875145718783009506Oil30463553516055766020Natural Gas53663488811451192Other exports3044205558121291Re-export6015385847671003Imports (F.O.B)-2340-3027-3087-3799-55152. Services-737-918-961-1122-1474Services (Credit)252284290358447Travel148159154207248Transportation92111115122148Insurance11223Communication78142029Other Services455719Services(Debit)-989-1202-1251-1480-1921Travel-242-258-266-274-286Transportation-315-391-404-485-663Insurance-85-92-109-128-147Communication-11-14-16-17-18Other Services-336-447-456-576-807Balance on goods & services (1+2)141012003139337925173. Income-208-150-373-352-369Income(Credit)122293319596779Compensation of employees1515151515Other Investment Income107278304581764Income(Debit)-330-443-692-948-1148Direct Investment Income-276-356-571-767-903Other Investment Income-54-87-121-181-245Balance on goods, services & income (1+2+3)120210502766302721484. Current Transfers-643-702-868-1072-1411Current Transfers (Credit)-----Current Transfers (Debit)-643-702-868-1072-1411Worker Remittances-643-702-868-1072-1411Central Bank of OmanAnnual Report 2007 113

CHAPTER SIXTable 6.11 (Contd.)Balance of Payments(R.O. Millions)Items20032004200520062007B. Capital and Financial Account (5+6)-96146-560-112212345. Capital Account48-6-37318Grants (Credit)4800331Grants (Debit)00-6-37-136. Financial Account (i + ii + iii)-100138-554-1085916(i) Foreign Direct Investment-2427559498695Assets(FDI abroad)-34-16-90-126-219Liabilities (FDI in Oman)1043649624914(ii) Portfolio Investment-88-516-2651088Assets-93-67-168-575298Liabilities562184310790(iii) Other Investment12116-1129-1318-867(a) Assets-53-376-1241-2326-1974Trade Credit& Other receivables-10-19-26-46Currency& Deposits-20-243-200-639-209Other Assets-32-133-1022-1661-1719(b) Liabilities6549211210081107Trade Credit & Other payables2226293340Currecy & Deposits-8711-105395639Loans-52224-23360188General Government (net)-16275-1691963Other Sectors110149146164185Other Liabilities182231211220240C .Net Errors & Omissions-206-161-26116447D. Overall balance25733310778492418E. Reserves assets-257-333-1077-849-2418Foreign Exchange-257-333-1077-849-2418Central Bank-11223-330-224-1710Government Reserves-145-356-747-625-708Note: Based on improved reporting of information through the annual survey, data in respect of foreign direct investment, other investment, andinvestment income flows have been revised considerably for past years. Since the coverage of the survey increases every year, with new respondentsreporting data for past few years as well, this annual revision process may continue till the survey becomes comprehensive with full coverage.Source: Central Bank of Oman.114 Annual Report 2007 Central Bank of Oman

Central Bank Accountsand Regulations

Central Bank Accounts and RegulationsIndependent auditor’s report to the Board of Governorsof the Central Bank of OmanThe accompanying extracts from financial statements, comprising the balance sheet and income statement,have been derived from the financial statements of the Central Bank of Oman (the bank) for the yearended 31 December 2007. These extracts from financial statements are the responsibility of the bank’smanagement. Our responsibility is to express an opinion on whether these extracts from financial statementsare consistent, in all material respects, with the financial statements from which they were derived.We have audited the financial statements of the bank for the year ended 31 December 2007, from which theseextracts from financial statements were derived, in accordance with International Standards on Auditing.In our report dated 19 April 2008 we expressed an unqualified opinion on the financial statements fromwhich the extracts from financial statements were derived.In our opinion, the accompanying extracts from financial statements are consistent, in all material respects,with the financial statements from which they were derived.For a better understanding of the bank’s financial position and the results of its operations for the period andof the scope of audit, the extracts from financial statements should be read in conjunction with the financialstatements from which the extracts from financial statements were derived and our audit report thereon.24 May 2008Muscat, Sultanate of OmanNote The maintenance and integrity of the Central Bank of Oman website is the responsibility of the bank’smanagement; the work carried out by the independent auditors does not involve consideration ofthese matters and, accordingly, the independent auditors accept no responsibility for any changesthat may have occurred to the extracts from financial statements since they were initially presentedon the website.Central Bank of OmanAnnual Report 2007 117

AssetsCentral Bank of OmanBalance Sheet at 31 December 20072007RO ’0002006RO ’000Bullion 321 259Reserve holdings abroadForeign currency placements 1,391,565 516,642Foreign securities 2,255,463 1,394,386Other assets 54,712 95,820International Monetary FundReserve tranche 7,555 10,451Currency quota 110,320 101,767117,875 112,218Special drawing rights holdings 7,194 6,422125,069 118,640Premises and equipment 5,644 5,404Total Assets 3,832,774 2,131,151LiabilitiesCurrency in circulation 663,063 560,616Deposits and current accounts 2,053,752 620,176Other liabilities 26,318 21,698International Monetary FundNon-interest bearing demand notes 50,000 50,000Other accounts 60,345 51,791110,345 101,791Special drawing rights allocation 3,805 3,622Capital & Reserves114,150 105,4132,857,283 1,307,903Capital 400,000 300,000General reserve 229,088 191,070Other reserves 346,403 332,178975,491 823,248Total liabilities and capital and reserves 3,832,774 2,131,151H.E. Hamood Sangour Al ZadjaliThe Executive PresidentMahboob Al MoosaSenior ManagerAccounts and Banking Operations Department118 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and RegulationsCentral Bank of OmanIncome Statement for the year ended 31 December 20072007RO ’0002006RO ’000Interest income 116,934 73,073Interest expense (29,585) (15,854)Net interest income 87,349 57,219Net other income 10,359 4,733Net operating income 97,708 61,952Staff costs and administrative expensesStaff costs (11,328) (9,434)Currency expenses (1,075) (790)Administrative expenses (3,651) (2,369)Depreciation (636) (587)Net operating expenses (16,690) (13,180)Profit for the year 81,018 48,772Central Bank of OmanAnnual Report 2007 119

9 April 2007CIRCULAR BM 1019To:All Licensed BanksOperating in the Sultanate of OmanAfter Compliments,Re:Minimum Capital Requirement1. Reference is invited to Circular BM 995 dated 14 January2006.2. The Board of Governors of the Central Bank of Oman,pursuant to the provisions of Article 60 of the BankingLaw (RD 114/2000) and on considerations of strengtheningfinancial stability and facilitating financing of largerprojects, enhancing public confidence and credibilitywith the public and raising the capacity of licensed banksto have larger share of economic activities, have resolvedto increase the minimum paid up capital requirement oflocal commercial banks from RO 50 million to RO 100million and assigned capital of foreign banks in Omanfrom RO 10 million to RO 20 million.3. While the above will apply to all new banks, we encourageexisting banks to meet the enhanced requirementprogressively.Best regards,Hamood Sangour Al ZadjaliThe Executive President120 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulations16th April 2007MASTER CIRCULAR BM 1021To:All Licensed BanksOperating in the Sultanate of OmanSub: Deposits in Foreign Currencies with the Central BankThe Central Bank of Oman has in place, since March 19,1979, a foreign currency deposit facility for licensed banks.This Master Circular consolidates the currently applicableinstructions and replaces all the preceding Circulars/Instructions on the deposit facility.The Central Bank of Oman will accept deposits in foreigncurrencies from the Licensed Banks in Oman on the followingterms and conditions.1. CurrenciesDeposits will be accepted in U.S. dollar, Euro and PoundSterling.3. TenorThe deposits will be accepted for a minimum duration ofone day to the maximum of one year.4. Interest RateThe interest rates shall be in conformity with thoseprevailing in the international markets less a margin setby the Central Bank of Oman from time to time.5. The Central Bank of Oman reserve right to reject anydeposit without giving any reason thereof.Best regards,2. AmountsThe minimum acceptable amount will be one millionunits of respective currencies (i.e., US $ 1 million, Euro 1million and £ Sterling 1 million).Hamood Sangour Al-ZadjaliThe Executive PresidentCentral Bank of OmanAnnual Report 2007 121

September 22nd, 2007Circular BM 1024To:All Licensed Banks Operating in the Sultanate of OmanSub: Master Circular on Lending Limitations and Exposures toConnected / Related Parties1. Introduction1.1 Diversification of risk is a key precept in banking.Experiences indicate that substantial loan losses,sometimes leading to bank failures, in the past, in manyjurisdictions, were triggered by credit concentrationsto connected counterparties or related parties. Besidesindividual exposures, credit concentrations also involveover-exposure to sectors, industries, regions, countries, etc.,which too have implications for the risk profile of banks’loan books. In this context, supervisors across variousjurisdictions, in the interest of maintaining financialstability, set prudential limits and rules aimed at limitingthe potential losses arising out of excessive concentrationof credit risk on a stand alone basis and also including theconnected parties.1.2 Core Principles for Effective Banking Supervisionreleased by the Basel Committee also requires supervisorsto set prudential limits to restrict bank exposures to singlecounterparties or groups of connected counterparties.Further, in order to prevent abuses arising from exposuresto related parties and to address conflict of interest,supervisors are required to put in place requirementsthat banks extend exposures to related companies andindividuals on an arm’s length basis, these exposuresare effectively monitored, appropriate steps are takento control or mitigate the risks and write-offs of suchexposures are made according to standard policies andprocesses.1.3 As a prudential measure towards moderation ofconcentrated credit risk, Articles 68 (b), (c) and (d) of theBanking Law 2000 place restrictions on banks’ exposureto a “person and his related parties” (hereinafter referredto as “connected counterparty”) and senior member in themanagement of banks and his related parties (hereinafterreferred to as “related party”), which were supplementedwith Regulations and Circulars. In the interest of achievinggreater transparency and consistency in prudentialregulations on such exposures, the following updated andconsolidated instructions, in supersession/modification ofinstructions contained in the Regulations/ Circulars, as listedin Attachment I, have been issued for strict compliance bylicensed banks. The set rules are aimed at preventing thebanks from assuming excessive credit risk, due to assetconcentrations to groups of connected counterparties and /or related parties.2. Measure of Credit Exposure2.1 The measure of credit exposure should encompass themaximum amount of credit risk arising from both actualclaims and potential claims of all kinds. Thus, the measureof exposure should include,122 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulationsa) All Funded facilities;b) The par (100%) values of credit substitutes, such asguarantees, acceptances, letters of credit, and othertransactions with recourse, and all other forms ofcontingent liabilities, notably credit commitments,which are not cancelable;c) The credit equivalent amount used for determiningregulatory capital in respect of contracts andderivatives, such as forward contracts, forward rateagreements, swaps, options, futures, etc, where thelender is not exposed to credit risk for the full facevalue of their contracts, but only to the potential costof replacing the cash flows (on contracts showingpositive value) if the counterparty defaults .Thus, the measure should reflect the maximum loss thatcould arise should the counterparty fail or the loss that mayarise in the realization of any assets, or other exposures oroff-balance sheet positions.2.2 Exposures shall also include investment exposure(investments, underwriting commitments, etc). As a generalrule, all exposures shall be determined on a gross basiswithout netting credit risk mitigants, loan loss provisions,and reserve interest. Further, the authorized limits oroutstandings, whichever are higher, shall be reckoned fordetermining the exposures. However, in the case of fullydrawn term loans, where there is no scope for re-drawal ofany portion of the authorized limit, the outstanding amountcould be reckoned as credit exposure.2.3 Bank’s exposure to securities trading operations shall becalculated as its net long position in a particular security (along position in a security should not be netted off againsta short position in another issue of the same issuer). Thenet position in a security refers to the commitment to buy asecurity together with its current holding of the security, lessits commitment to sell the security.2.4 The total exposure to a connected counterparty or a relatedparty shall be determined by aggregating the exposurescomputed in terms of paragraphs 2.1, 2.2 and 2.3.3. Definition of Connected Counterpartyand Related Party3.1 Proper identification of potential linkages betweenexposures to banks’ counterparties is important for restrictingcredit concentrations. It is quite possible that separatecounterparties, despite dealing on an independent basiswith banks, represent a single risk inasmuch as they are sointerconnected legally or economically with the likelihoodthat if one of them experiences financial difficulties, theother or all of them are likely to encounter problems. Thus,repayment difficulties could arise for all parties if any oneof them experienced financial problems. The relationshipshould ideally, therefore include connection through closefamily relation/ common ownership / control, or management,cross-guarantees and direct commercial interdependencywhich cannot be substituted in the short-term.3.2 In the Sultanate, the connected counterparty and relatedparties are defined in Regulations 47 and 48/ 2/ 2000respectively. While the structure of the definition remainsthe same, some modifications, as stated in paragraphs 3.3and 3.6 have been made to capture the full risk associatedwith lendings to connected counterparty / related party.Group of Connected Counterparties3.3 Group of connected counterparties, as per internationalbest practices, shall be a group of persons and / or companiesrelated financially or by close family relation, commonownership, management or any combination thereofCentral Bank of OmanAnnual Report 2007 123

constituting a single risk. Further, two or more natural orjuristic persons would be considered as connected even ifthere is no relationship of control between themselves, asindicated above, but who are regarded as constituting asingle risk, as they are so interconnected (captive customersor suppliers) that, if one of them were to experience financialproblems, the others would likely encounter paymentdifficulties.3.4. Banks may assess a group of connected counterparties bytreating one of the connected counterparties as the ‘principal’(who is a natural or juristic person) and by determining othercounterparties with reference to the principal connectedparty. A connected counterparty for compliance with thisCircular thus may comprise of:i) the ‘principal’ connected party (A natural or juristicperson);ii) Associates of the principal connected party, wherethe associates shall includea) close member of the family i.e. parents, spouses,sons and daughters, including legal adoptions andb) business entities wherein 25% or more of the votingpower is controlled individually or collectivelywith the associates;iii) Associates of the principal connected party,where the associates includes parent company,subsidiaries, fellow subsidiaries and other businessentities where the concerned juristic person ownsor controls either directly or indirectly 25% or moreof the voting power.connected party, as a major customer or supplier,which cannot be substituted in the short-term.Related Parties3.5 As per international best practices, the related partiesshall include bank’s subsidiaries and affiliates, and anyother parties that the bank exerts control over or a party thatexerts control over the bank. It will also include the bank’smajor shareholders, directors, senior management and keystaff, their direct and related interests, and their close familymembers as well as corresponding persons in affiliatedcompanies.3.6 The related parties for a bank, for compliance withthis Circular, would include:i) Chairman and Directors on the Boards, includingproxy Directorsii) Parent entities, subsidiaries, fellow subsidiaries ofthe bank;iii) Chief Executive Officers and other line management– Deputy Chief Executive, General Managers, DeputyGeneral Managers, Assistant General Managers andany other key management personnel (only thosehaving authority and responsibility for planning,directing and controlling the activities of the bank,directly or indirectly) who are reporting directly tothe Board or the CEO.iv) Any natural / juristic person who holds or controls,directly or indirectly, 10% or more of the votingpower of the bank.iv)Persons or companies that have dependenceeconomically or operationally on the principalv) An associate of any of the natural persons shallinclude124 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulationsa) close member of the family i.e. parents, spouses,sons and daughters, including legal adoptions andb) business entities wherein 25% or more of the votingpower is controlled individually or collectivelywith the associates;vi) An associate of any juristic person shall includeparent company, subsidiaries, fellow subsidiariesand business entities where the concerned juristicperson controls 25% or more of the voting power.It shall also include companies whose majority ofthe Directors acts as per the wishes of the concernedcompany.3.7 Banks may consider the above definitions as theminimum for establishing linkages amongst the connectedcounterparties or related parties. In real practice, it ispossible that a few customers may disguise linkages betweentwo or more parts of the same connected group. The banksshould, therefore, strengthen their surveillance mechanismin detecting subterfuges designed to disguise relationshipsbetween borrowers.4. Prudential Limits on Large Exposures4.1 The international best practice on limiting large exposuresenvisages that credit exposures are fixed in relation to banks’capital funds, as defined under capital adequacy. The creditexposure limits in the Sultanate also are expressed in termsof the banks’ total capital (Tier 1, Tier 2 and eligible Tier 3) orglobal net worth , as approved by the Central Bank.shall not at all times exceed 10% of the total capitaland that the aggregate of credit exposure to all therelated parties shall not exceed 35% of the banks’total capital.c) The aggregate exposures of overseas branchesof locally incorporated banks to a connectedcounterparty, who is a resident in the respectivecountries of operations, shall not exceed 5% ofthe total capital (global net worth) or the singleobligor legal lending limitation imposed by the hostsupervisory authority, whichever is less.4.2 Exposures to related parties are justified only whenundertaken for the clear commercial advantage of the banksand extended on an arm’s length basis. Thus, any exposuresto the related parties, in the nature of capital investments ormade particularly at favourable terms (not on arm’s lengthcommercial basis) – with relaxation in risk assessment,interest rates, amortization schedules, requirement ofcollateral, etc., should be deducted from Tier 1 capital ofbanks. Banks are also precluded from lending to their ownexternal auditors or to any partners thereof or to any of theemployees of such audit firms.4.3 Banks are generally not encouraged to assume exposuresto connected counterparties or related parties beyond theprudential limits. The loan policy should delineate thephilosophy and approach on the management of creditconcentration.5. Credit Risk Mitigantsa) The aggregate exposure to a connected counterpartyshall not at all times exceed 15% of the total capitalof the banks.b) In the case of a related party, the total credit exposureThe limitations on exposures to connected counter partiesand related parties shall not apply to:a) Exposures secured in cash or in cash equivalent notsubject to withdrawal.Central Bank of OmanAnnual Report 2007 125

) Exposures guaranteed, including by standbyletters of credit or warranties or participations orrepurchases, etc, in a manner satisfactory to theCentral Bank, by a bank or financial institutionwithin or outside the Sultanateii.The projects should be in the core sector, suchas power, roads, telecommunication, seaports,airports, industrial/knowledge parks, fishing,tourism, health, education, water treatment, LNG,fertilizers and petro-chemicals;c) To the extent that the payment of the principal andinterest of such exposures have been guaranteed bythe Government of the Sultanate or any Ministrythereof.d) Inter-bank exposurese) Exposures arising from underwriting obligations,which are held in the trading book.6. Large Joint Venture Projectsiii. The projects should be viable, supported by strongcash flows and financials;iv. The local partners’ equity stake in the project shouldnot exceed 49% of the total paid-up capital ;v. The creditworthiness and/or default history of thelocal partners should be satisfactory;vi. The overseas partners should have strong financialsand have sound experience in the proposed projects;6.1 Certain large projects, involving large outlay of funds arebeing executed in the Sultanate in the core sector towardspromoting the overall development of the country. Theseprojects are expected to be self-supporting with high internalrate of return and are generally managed professionallywith substantial foreign collaboration and/or investment.The amount involved in such projects is huge and ofteninvolve substantial bank lending with some Governmentparticipation. A special treatment for financing of suchprojects is considered necessary in the context of theirnational importance and low credit risk.6.2 Accordingly, the proposals, which comply with thefollowing conditions, could be treated on a standalonebasis, subject to specific prior approval of the Central Bank,without aggregating with the credit exposures of local groupsor sponsors or partners/promoters:vii. The maximum exposure per project should notexceed 15% of the net worth of banks; andviii. The maximum maturity of the loans should notexceed 15 years and should be financed out of longtermsources of funds to avoid serious asset liabilitymismatches.6.3 Banks may approach the Central Bank with brief detailsabout the proposals, particularly shareholding pattern,technical expertise of the foreign collaborator, projectedcash flows and profitability, bank’s risk assessments, etc., forseeking prior permission for not aggregating the exposureto such projects with that of the local partners/sponsors/promoters.7. Exposures to Government Companiesi. Significant shareholding by the Government of theSultanate of Oman and/or reputable international bodies;7.1 The Government of the Sultanate has been promotingcompanies, either as fully owned or majority or minority126 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulationsowned, in green field projects like oil, gas, fertilizers andother downstream projects. These companies serve indiversifying the economy and also in generating employmentopportunities.7.2 Considering the significant role played by suchcompanies in the overall development of the economy andpotentially lower credit risk associated with such projects,the Central Bank shall consider, on a case-by-case basis, thebanks’ proposals to assume exposures upto a maximum of25% of their total capital, provided the Government holds,either directly and/or indirectly, a minimum of 25% of theshareholdings in such companies.7.3 The additional exposures shall be allowed, on specificreferences, with brief details about the proposals, particularlythe shareholding pattern, project specifics, projected cashflows and profitability, banks’ risk assessment, etc., to theCentral Bank. The exposures to such counterparties thatare in the core sector, as indicated in para 6.2 need not beaggregated with the local groups/partners/sponsors.8. Exposures to SAOG CompaniesIn the normal course, exposures to connected counterparties/ related parties should be aggregated and the total exposuresshould be within the prudential limits, as indicated inparagraph 4. Considering the fact that SAOG companies aregenerally run on professional lines and are more transparentin their operations, the credit exposures to SAOG companiesneed not be aggregated with the exposures of connectedcounterparties / related counterparties and may be reckonedas a single risk, on a standalone basis. However, the prudentiallimits, as relevant, should be applied, on a standalone basis.9. Substantial Exposure9.1 The aggregate substantial exposure (i.e. credit exposureindividually of 10% or more of the total capital of the bank,on a gross basis without adjusting for the credit risk mitigants,as referred to in para. 5) to all the connected counterpartiesand all the related parties shall not exceed 600% of the totalcapital of banks.9.2. Banks have no discretion in incurring credit exposures,in excess of the above limits, without the prior permissionof the Central Bank.10. Other Credit Concentrations10.1 Apart from concentration of credit to counterparties,significant exposure, particularly to economic sectorsmakes the banks vulnerable to weakness in a particularindustry/sector. Banks should, therefore, systematicallyidentify and measure their exposures to different sectors,regions, countries, currencies, etc., and if necessary adjustthe portfolio to moderate the risk profile. The loan policyshould stipulate prudential limits on exposures to sectors/industry/region/country, having regard to the performanceof different sectors and the perceived risks, which may helpbanks to evenly spread their exposures over various sectors.The risk management policies and procedures shouldestablish thresholds for acceptable credit concentrations.The prudential limits may be revisited at periodical intervalsto capture evolving situations.10.2 The large exposure limits are not applicable to thecredit exposures on other banks and banks are expectedto put in place appropriate exposure limits on individualbanks, considering their financial strength, rating etc.However, banks exposure in the form of credit risk mitigantsexacerbates the concentration problem. Currently, bankshave been extending guarantees, back to back guarantees,standby letters of credit, warranties, participations,repurchase agreements, etc., on behalf of their counterpartiesand associates in Oman or overseas as credit risk mitigantsCentral Bank of OmanAnnual Report 2007 127

against credit facilities extended in excess of large exposurelimits. In order to avoid concentration of such credit riskmitigants, indemnifying banks should limit such facilities toeach beneficiary bank upto 25% of the indemnifying bank’stotal capital.11. Indemnity Agreements11.1 Any exposure in excess of the connected party exposurelimits of 15% and related party exposure limits of 10% ofthe total capital could be covered by eligible collaterals,indemnity guarantee, back to back guarantees, standbyletters of credit, warranties, participation or repurchaseagreements, etc obtained by banks, acceptable to the CentralBank, as indicated in paragraph 5 (b).11.2 It may be noted that guarantees/indemnities issued infavour of a customer need to be aggregated along with anyother facility provided by the indemnifying bank to the samecustomer, for adherence to the connected party or relatedparty lending limits.11.3 While the banks are primarily responsible for properlegal documentation of the indemnity agreements orother credit risk mitigants, the Central Bank has drawnup a proforma Indemnity Agreement (Attachment – II),which provides the minimum essential coverage forthe use of banks. The banks are free to make suitablechanges/additions in consultation with their lawyers,to the document. Banks should also exercise cautionin proper execution of the documents includingthorough verification of signatories for safeguarding theirinterests.12. ReportingExposure to connected counterparties, in excess of 10% ofthe total capital of a bank, without adjusting for the eligiblecollaterals and other credit risk mitigants may be reported inthe attached format (Attachment – III), on a quarterly basis.Exposure to related parties should be reported on a quarterlybasis in the enclosed format (Attachment – IV). Banks shouldalso report, on a quarterly basis, the indemnities and otherrisk mitigants issued / obtained, as per Attachments V andVI.13. Senior Management ResponsibilitiesThe Board of Directors are primarily responsible formonitoring credit concentrations and devising suchmeasures including articulation of appropriate loanpolicies and loan review mechanism for ensuring that theconcentrations are well within the laid down policies andregulatory requirements. The Board of Directors shouldalways endeavour for ensuring a balanced composition oftheir bank’s loan book. The Board should also put in placeappropriate MIS to assess and manage credit concentrationson a timely basis.Best regards,Hamood Sangour Al-ZadjaliThe Executive President11.4 The aggregate amount of the indemnity and other riskmitigants, covered by various agreements should not at alltime exceed 25% of the indemnifying/credit protectionproviding bank’s total capital.128 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulations31st December 2007CIRCULAR BM 1030BM/REG/51/11/2007Cheque Return SystemPursuant to the provisions of the Banking Law issuedby Royal Decree 114/2000) and the Resolution No.BOG/1982/137/3/07/10 of the Board of Governors of theCentral Bank of Oman, adopted at its meeting held on 2theMarch 2007, the following have been decided.referred account holders. The Central Bank may also provideaccess to other licensed finance companies for their exclusivecredit-related uses.ARTICLE 4Article 1Licensed banks shall implement the provisions of thissystem to monitor and disseminate information on chequesreturned for non availability or insufficiency of funds or forany other reason indicating intention of non-payment.Article 2Licensed banks shall provide the Central Bank with allinformation relating to returned cheques including accountholderscausing two or more cheques returned in a month,four or more in six months and six or more in a year, suchreturns occurring in a licensed bank or more than onetogether. Information also includes the name and identitydetails of the drawer, number, dates of issue and return,amount and payees of the returned cheques and the reasonsfor return, and any other data, as specified, for the purposesof analysis and policy formulation.ARTICLE 3The Central Bank, based upon the licensed banks’submissions, prepares a consolidated caution list of theThe system of information sharing regarding returnedcheques may be by electronic or any other mode set by theCentral Bank. The Central Bank and licensed banks andfinancial institutions shall maintain utmost confidentiality,security and control in the operation and use thereof, accessbeing limited to specifically authorized persons suitable andresponsible for the associated tasks. It shall be mandatory toensure integrity of the system also by such other means astimely, accurate and effective inputs and use.ARTICLE 5Licensed banks and financial institutions shall utilize theinformation exclusively for the purpose of implementationof this System.ARTICLE 6Licensed banks shall exercise caution in dealing with accountholders whose names are listed in the Consolidated CautionList and shall withdraw cheque book from them and denythem Checking accounts for a period of one year from the dateof return of the last cheque, without prejudice to any monetarysanctions or other procedures specified by the Central Bank.Central Bank of OmanAnnual Report 2007 129

ARTICLE 7ARTICLE 9The Sanctions specified in BM/REG/12/5/78 shall beapplicable on Licensed banks and financial institutions onviolation of the provisions of the Regulation.This Regulation shall be published in the Official Gazette.Issued On 11 November 2007ARTICLE 8The Executive President of the Central Bank is authorized toissue necessary instructions for the implementation of theprovisions of this Regulation.130 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulations21st January, 2008CIRCULAR FM 22To :All Licensed Finance &Leasing CompaniesOperating in the Sultanate of OmanAfter Compliments,Sub: Vehicle Loans in the Personal Segment1. Personal loans for purchase of vehicles have beenmounting significantly.iii)Comprehensive insurance should not be insistedupon, as a credit term.2. With a view to improve prudence and moderation,Central Bank of Oman advises the following :3. All Licensed Finance and Leasing Companies shallcomply accordingly.i) There shall be a minimum of 20% down-paymentof the cost by the borrower.Best regards,ii)Finance and Leasing Companies should arrangefor insurance on the borrowers covering life andtotal disability so as to avoid hardships for thesuccessors.Hamood Sangour Al ZadjaliThe Executive PresidentCentral Bank of OmanAnnual Report 2007 131

‎2008‎ 11th JuneCIRCULAR BM 1037To:All Licensed BanksOperating in the Sultanate of OmanAfter Compliments,Re: Interest Rate Ceiling on Personal Loans1. Reference is drawn to Circular BM 1035 dated 31st March 2008.2. Taking into consideration the overall domestic and global interest rate scenario and the need to respond to the genuinerequest of all concerned to reduce the burden of the personal loan borrowers correspondingly, the Central Bank of Omanhas decided to reduce the ceiling on interest rate from 8.5% p.a. to 8% p.a. on all new personal loans (including housingloans) extended by banks from 14th June 2008.3. All banks shall comply accordingly.Best regards,Hamood Sangour Al ZadjaliThe Executive President132 Annual Report 2007 Central Bank of Oman

Central Bank Accounts and Regulations‎2008‎ 11th JuneCIRCULAR BM 1038To:All Licensed BanksOperating in the Sultanate of OmanAfter Compliments,Sub: Reserve Against Deposits1. Attention of banks is invited to Circular BM 1031 dated 31 December 2007.2. In the light of continued and growing ease of banks credit, money supply and liquidity, Central Bank of Oman hasdecided to raise reserve ratio from 5% to 8%. Accordingly, licensed banks shall maintain reserve at 8% of depositliabilitiescommencing from the computation period starting from 1 August 2008.3. All other instructions as regards reserve maintenance remain the same (clearing account balances alone shall constitutereserve asset and base of deposit-liabilities shall cover all resident and non-resident deposits, including margins accountsand excluding local inter-bank deposits).4. Licensed banks shall comply accordingly.Best regards,Hamood Sangour Al ZadjaliThe Executive PresidentCentral Bank of OmanAnnual Report 2007 133

‎2008‎ 11th JuneCIRCULAR BM 1039To:All Licensed BanksOperating in the Sultanate of OmanAfter Compliments,Re: Lending Ratio1. Attention of licensed banks is drawn to Circular BM 887dated 18th April 2000.2. The Board of Governors of Central Bank of Oman, in themeeting of 9th June 2008, reviewed Bank Credit growthand related matters and decided that lending ratio oflicensed commercial banks shall stand reduced frompresent 87.5% to 85% with effect from 1st August 2008and to 82.5% with effect from 1st November 2008.3. Banks are advised to note the above for promptcompliance, noting that all over instructions on thesubject remain unchanged (Article 1 of Regulation BM/REG/44/7/98 is being suitably amended).to orderly and reasonable level and mitigate risks ofexcessive credit growth in general and in sensitive/unproductive sector in particular. Accordingly, banks arerequired to lend to productive sectors with no difficultyor hardening of credit terms and moderate growth inpersonal loans and sensitive sectors and the like of lesserpriorities and value-additions.Best regards,Hamood Sangour Al ZadjaliThe Executive President4. Central Bank adds that it is effecting the changes inthe context of overall macro economic and largerconsiderations, among others, to moderate credit growth134 Annual Report 2007 Central Bank of Oman

Statistical Appendix

Statistical AppendixList of TablesPageDomestic and National Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139Structure of Interest Rates on Commercial Banks Deposits. . . . . . . . . . . . . . . . . . . . . . . .140Structure of Private Sector Time Deposits by Rate of Interest and Maturity. . . . . . . . . . .141Structure of Interest Rates on Commercial Banks Credit. . . . . . . . . . . . . . . . . . . . . . . . . .142Combined Balance Sheet of Exchange Houses Licensed to Issue Drafts. . . . . . . . . . . . . .143Structure of Private Sector Time Deposits by Rate of Interest and Maturity. . . . . . . . . . .144Licensed Banks In the Sultanate of Oman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145Expenditure on Gross Domestic Product at Market Values – Current Prices . . . . . . . . . .146Oman Development Bank SAOC Balance Sheet. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .147Oman Housing Bank SAOC Balance Sheet. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .148

Statistical AppendixDomestic and National Savings(in Millions of Rial Omani)Items 2002 2003 2004 2005 2006(Prov.)1- GDP at Market Prices7815.18375.99524.911889.813737.72- Total Final Consumption5230.85512.36229.86547.67784.03- Domestic Savings (1-2)2584.32863.63295.15342.25953.74- Net Factor Income (transfer)-1082.0-986.0-1029.0-1606.0-1725.05- National Savings (3-4)1502.31877.62266.13736.24228.76- Percent Of Domestic Savings to GDP (3/1)33.1034.1934.6044.9343.347- Percent of National Savings to GDP (5/1)19.2022.4223.8031.4330.79Source: Central Bank of Oman.Central Bank of OmanAnnual Report 2007 139

Rates ofInterest(Per Annum)Structure of Interest Rates on Commercial Banks Deposits(Amount in Thousands of Rial Omani)December - 2007Total Rial Omani Depositsa Total Foreign Currency Deposits Total DepositsNo of A/Cs % Amount % No of A/Cs % Amount % No of A/Cs % Amount %Nil Interest 1,365,600 89.2 2,158,945 40.2 12,175 58.0 116,795 10.4 1,377,775 88.8 2,275,740 35.1Over 0% To 2% 149,634 9.8 543,599 10.1 4,846 23.1 112,914 10.1 154,480 10.0 656,513 10.1Over 2% To 3% 3,997 0.3 769,905 14.3 307 1.5 11,673 1.0 4,304 0.3 781,578 12.0Over 3% To 4% 4,563 0.3 487,444 9.1 785 3.7 83,459 7.4 5,348 0.3 570,903 8.8Over 4% To 5% 6,213 0.4 871,365 16.2 2,322 11.1 574,432 51.2 8,535 0.5 1,445,797 22.3Over 5% To 6%731 0.0 492,480 9.2 505 2.4 214,679 19.1 1,236 0.1 707,159 10.9Over 6% To 7%316 0.0 39,712 0.7 31 0.1 7,461 0.7 347 0.0 47,173 0.7Over 7% To 8%14 0.0 684 0.06 0.0 21 0.0 20 0.0 705 0.0Over 8% To 9%1 0.0 2,809 0.10 0.00 0.01 0.0 2,809 0.0Over 9% To 10%0 0.00 0.00 0.00 0.00 0.00 0.0Over 10% To 11%0 0.00 0.00 0.00 0.00 0.00 0.0Over 11% To 12%0 0.00 0.00 0.00 0.00 0.00 0.0Over 12%0 0.00 0.00 0.00 0.00 0.00 0.0Total1,531,069 100.0 5,366,943 100.0 20,977 100.0 1,121,434 100.0 1,552,046 100.0 6,488,377 100.0Weighted Average Rate of Interest2.0673.7882.364Source: Central Bank of Oman.140 Annual Report 2007 Central Bank of Oman

Statistical AppendixStructure of Private Sector Time Deposits by Rate of Interest and Maturity(Amount in Thousands of Rial Omani)December - 2007Rates ofInterest(Per Annum)7 Days to Less than 6 Months 6 Months to Less than 1 Year 1 Year and Above TotalRial Foreign Total Rial Foreign Total Rial Foreign Total Rial ForeignOmani Currency Omani Currency Omani Currency Omani CurrencyUp to 2%109,102 14,394 123,496 9,485 300 9,785 17,959 283 18,242 136,546 14,977Over 2% To 3% 167,150 5,377 172,527 28,426 1,270 29,696 21,599 505 22,104 217,175 7,152Over 3% To 4% 151,357 54,777 206,134 71,084 7,968 79,052 116,602 5,104 121,706 339,043 67,849Over 4% To 5% 175,698 271,802 447,500 134,589 48,108 182,697 284,563 21,678 306,241 594,850 341,588Over 5% To 6% 32,345 79,846 112,191 63,752 19,387 83,139 308,395 42,244 350,639 404,492 141,477Over 6% To 7% 2,266 5,657 7,923 95 1,445 1,540 37,351 338 37,689 39,712 7,440Over 7% To 8%8 21 29000 676067668421Over 8% To 9%000000 2,8090 2,809 2,8090Over 9% To 10%00000000000Over 10% To 11%00000000000Over 11% To 12%00000000000Over 12%00000000000Total637,926 431,874 1,069,800 307,431 78,478 385,909 789,954 70,152 860,106 1,735,311 580,504Weighted Average Rate of InterestRate of Interest3.198 4.443 3.701 4.184 4.637 4.276 4.720 5.011 4.744 4.065 4.538Source: Central Bank of Oman.Central Bank of OmanAnnual Report 2007 141

Structure of Interest Rates on Commercial Banks Credit(Amount in Thousands of Rial Omani)December - 2007Rates ofInterest(Per Annum)Total Rial Omani Depositsa Total Foreign Currency Deposits Total DepositsNo of A/Cs % Amount % No of A/Cs % Amount % No of A/Cs % Amount %Nil Interest29,700 7.8 97,428 2.0 664 31.5 15,446 1.0 30,364 7.9 112,874 1.7Over 0% To 5% 7,770 2.0 351,624 7.1 123 5.8 64,016 4.2 7,893 2.1 415,640 6.4Over 5% To 7% 11,950 3.1 1,453,247 29.2 781 37.0 1,361,321 88.6 12,731 3.3 2,814,568 43.2Over 7% To 8% 22,775 5.9 703,373 14.1 142 6.7 64,140 4.2 22,917 6.0 767,513 11.8Over 8% To 9% 169,734 44.3 1,868,165 37.5 96 4.6 14,623 1.0 169,830 44.1 1,882,788 28.9Over 9% To 10% 16,553 4.3 248,561 5.0 13 0.6 273 0.0 16,566 4.3 248,834 3.8Over 10% To 10.5% 705 0.2 26,818 0.51 0.0 745 0.0706 0.2 27,563 0.4Over 10.5% To 11% 23,005 6.0 67,905 1.4 55 2.6 1,705 0.1 23,060 6.0 69,610 1.1Over 11% To 11.5% 356 0.1 8,349 0.25 0.2 302 0.0361 0.1 8,651 0.1Over 11.5% To 12% 7,757 2.0 48,827 1.0 56 2.7 8,643 0.6 7,813 2.0 57,470 0.9Over 12% To 13% 13,992 3.7 55,332 1.1 89 4.2 2,472 0.2 14,081 3.7 57,804 0.9Over 13% To 14% 290 0.1 3,559 0.1 19 0.9 2,797 0.2309 0.1 6,356 0.1Over 14% To 15% 5,468 1.4 5,511 0.1 64 3.096 0.0 5,532 1.4 5,607 0.1Over 15% To 16%0 0.00 0.00 0.00 0.00 0.00 0.0Over 16% To 17% 37,230 9.7 15,620 0.30 0.00 0.0 37,230 9.7 15,620 0.2Over 17% To 18% 35,565 9.3 22,355 0.40 0.00 0.0 35,565 9.2 22,355 0.3Over 18%0 0.00 0.00 0.00 0.00 0.00 0.0Total382,850 100.0 4,976,674 100.0 2,108 100.0 1,536,579 100.0 384,958 100.0 6,513,253 100.0Weighted Average Rate of Interest7.2855.9466.969Source: Central Bank of Oman.142 Annual Report 2007 Central Bank of Oman

Statistical AppendixCombined Balance Sheet of Exchange Houses Licensed to Issue Drafts(In Thousands of Rial Omani)As December 31 - 2007Rial OmaniForeignCurrencyTotalAssets1- Cash &Precious Metals on Hand3,1674,1807,3472- Capital Deposits with CBO96009603- Balance due from Banks,Branches & Money Changers6,6496,22312,8724- Investments35003505- Fixed Assets1,15101,1516- Other Assets9700970Total Assets13,24710,40323,650Liabilities1- Capital, Reserves & Retained Earnings13,766013,7662- Borrowing from Banks0003- Balances due to Banks,Branches & Money Changers2,3006,3648,6644- Drafts & Cheques Issued& Outstanding0005- Other Liabilities1,22001,220Total Liabilities17,2866,36423,650Source: Central Bank of Oman.Central Bank of OmanAnnual Report 2007 143

Structure of Private Sector Credit by Rate of Interest and Maturity(Amount in Thousands of Rial Omani)December - 2007Rates ofInterest(Per Annum)RialOmaniOverdraft Other Loans and Advances TotalForeignCurrencyTotalRialOmaniLess than 1 Year 1 Year and aboveForeignCurrencyTotalRialOmaniForeignCurrencyTotalRialOmaniForeignCurrencyNil Interest27,347 616 27,963 34,802 8,370 43,172 35,279 4,662 39,941 97,428 13,648Over 0% To 5% 36,721 1,884 38,605 186,224 31,667 217,891 118,933 13,176 132,109 341,878 46,727Over 5% To 7% 124,686 15,344 140,030 370,096 275,038 645,134 924,215 729,757 1,653,972 1,418,997 1,020,139Over 7% To 8% 52,684 2,591 55,275 67,129 19,587 86,716 583,560 41,962 625,522 703,373 64,140Over 8% To 9% 68,115 197 68,312 53,081 3,280 56,361 1,746,969 11,146 1,758,115 1,868,165 14,623Over 9% To 10% 78,757 114 78,871 32,7478 32,755 137,057 151 137,208 248,561273Over 10% To 10.5% 12,7650 12,765 7,4980 7,498 6,555 745 7,300 26,818745Over 10.5% To 11% 24,179 226 24,405 16,450 308 16,758 27,276 1,171 28,447 67,905 1,705Over 11% To 11.5% 3,279 35 3,314 3,943 267 4,210 1,1270 1,127 8,349302Over 11.5% To 12% 14,143 2,282 16,425 8,287 557 8,844 26,397 5,804 32,201 48,827 8,643Over 12% To 13% 19,169 107 19,276 13,608 690 14,298 22,555 1,675 24,230 55,332 2,472Over 13% To 14% 1,579 113 1,692 1,579 297 1,876 401 2,387 2,788 3,559 2,797Over 14% To 15% 4,099 44 4,143 1,41152 1,463101 5,51196Over 15% To 16%00000000000Over 16% To 17% 7410 741909 14,8700 14,870 15,6200Over 17% To 18% 4,6730 4,673 9,3490 9,349 8,3330 8,333 22,3550Over 18%00000000000Total472,937 23,553 496,490 806,213 340,121 1,146,334 3,653,528 812,636 4,466,164 4,932,678 1,176,310Weighted AverageRate of Interest7.5496.4587.4985.8585.6765.8047.5916.1087.3217.3035.990Source: Central Bank of Oman.144 Annual Report 2007 Central Bank of Oman

Statistical AppendixLicensed Banks In the Sultanate of OmanAs at 30 December - 2007Name of the BanksDate Of Authorised OperatingEstablishment Offices OfficesLocal Banks1. National Bank of Oman197352492. Oman Arab Bank197339373. Oman International Bank197586824. Bank Muscat19811131065. Bank Dhofar199050496. Bank Sohar2007557. Al Ahli Bank199777Foreign Banks1. HSBC Bank Middle East1948662. Standard Chartered Bank1968113. Habib Bank Ltd.1972884. Bank Melli Iran1974115. National Bank of Abu Dhabi1976646. Bank Saderat Iran1976117. Bank of Baroda1976338. State Bank of India2004119. Bank of Beirut20061110.Qatar National Bank200711Specialised Banks1. Oman Housing Bank1977992. Oman Development Bank19771413Total404384Source: Central Bank of Oman.Central Bank of OmanAnnual Report 2007 145

Expenditure on Gross Domestic Product at Market Values – Current Prices(In Million of Rial Omani)Items 2002 2003 2004 2005 2006(Prov.)1. Final Consumption Expenditure5230.85512.36229.86547.67784.0Households3430.43659.24198.04258.65326.8Government1800.41853.12031.82289.02457.22. Gross Fixed Capital Formation977.21306.61958.22130.22545.7Building Construction383.5450.7675.2711.7908.5Plant, Machinery,Vehicles322.1537.6949.21102.01270.1Intangible Fixed Capital264.9304.4324.0323.9354.4Change in Inventories6.713.99.8-7.312.73.Net Exports of goods & services1607.11557.01336.93212.03408.0GDP at Market Prices7815.18375.99524.911889.813737.7Source: Ministry of National Economy.146 Annual Report 2007 Central Bank of Oman

Statistical AppendixOman Development Bank SAOCBalance Sheetas at 31 December 20072007RO2006ROAssetsCash and balances with Central Bank of OmanBank placements and due from banksLoans and advances to costomersInvestmentsStaff housing loansProperty and equipmentOther assets21,59621,571,65532,275,2653,797,639961,5661,214,765318,85834,0649,476,69818,163,4034,530,390986,2651,162,584228,489Total assets60,161,34434,581,893Liabilities and Shareholders’ FundsLiabilitiesDue to the GovernmentOther liabilities441,5031,218,192968,517759,706Total liabilities1,659,6951,728,223Shareholders’ fundsShare capitalStatutory reserveSpecial reserveInvestment revaluation reserveRetained earnings40,000,0002,055,4001,047,2251,751,36813,647,65620,000,0001,462,97040,0941,027,68910,322,917Total shareholdres’ funds58,501,64932,853,670Total liabilities and shareholders’ funds60,161,34434,581,893Contingent liabilities2,623,901542,852Net assets per share (RO)1.4631.643Source: Oman Development Bank SAOC.Central Bank of OmanAnnual Report 2007 147

Oman Housing Bank SAOCBalance Sheetas at 31 December 20072007RO’ 0002006RO’ 000AssetsCash and balances with banksTerm depositsMortgage loan accountsProperty and equipmentOther assets12428,300146,1791,031908981,400157,3521,134561Total assets176,542160,545Liabilities and EquityLiabilitiesCustomers’ depositsLoans from the GovernmentOther liabilities7,61872,8305,2446,75864,8304,892Total Liabilities85,69276,480EquityShare capitalLegal reserveSpecial reserveRevaluation reserveRetained earnings30,00010,20234,06218916,39730,0009,34330,79918913,734Total equity90,85084,065Total liabilities and equity176,542160,545Commitments25,09626,244Source: Oman Housing Bank SAOC.148 Annual Report 2007 Central Bank of Oman

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