Oman - Recent economic developments and prospects (Vol. 1 of 2) : Volume one

Report No. 6899-OM Sultanate of Oman Recent Economic Developments and Prospects (In Two Volumes) Volume I Steptember 12,1988 Country Operations Division Country Department III Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This report has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  OMAN EXCHANGE RATE EQUIVALENT US$/R.O. 1975-1985 2.8952 1986 - 2.6008 FISCAL YEAR January 1 - December 31  FOR OMCAuL USE ONLY PREFACE A Bank economic mission visited Oman in March-April 1987. This report is based on the findings of the mission comprised of Gabriel Sciolli (Chief), Sawai Boonma (General Economist), Maurice Boissiere (Manpower Specialist), Bharat Krishna (Manpower Specialist), Bertil Walstedt (Consultant, Industrial Economist), and Clyde Adams (Consultant, Agricultural Economist). Research assistance was provided at Headquarters by Jeanine Giddings. This document has a restrictd distribution and may be used by recipients only In the performance of their offlcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  SULTANATE OF OMAN RECENT ECONOMIC DEVELOPMENTS AND PROSPECTS VOLUME I TABLE OF CONTENTS Page No. COUNTRY DATA SUMMARY AND CONCLUSIONS .. .............................. . i-xiv INTRODUCTION .....@***..*..**..***.**.***....**....**.. 1 CHAPTER I - RECENT ECONOMIC DEVELOPMENTS ................. 3 A. Background .................................... . 3 B. Developments During 1981-85 ...................... 3 i. Sectoral Growth Performance ............... 4 ii. Use of Resources .......................... 4 iii. Public Finance ..... ..................... .. 6 iv. Monetary Developments ..................... 9 v. Balance of Payments .................... ... 11 C. The 1986 Crisis ...,.............................. 13 CHAPTER II - THE DIVERSIFICATION PROCESS ............... 16 A. Manufacturing and Mining ......................... 16 i. Growth and Structure 16 ii. Constraints on Industrial Growth .......... 20 iii. Investment Opportunities ................... 24 iv. Institutional Support ..................... 25 v. Industrial Incentives ..................... 28 vi. Construction ...... ..................... ... 30 B. Agriculture ......... o.................. o.............. 32 i. Natural Resource Base and Constraints ..... 33 ii. Growth Potential ..0.......0..0...0..... 0 0....... 34 iii. Policy Requirements and Recommendations ... 34 a. Water ... .............................. 35 b. Land . ................................. 36 c. Farm Labor ..........o............. 37 d. Livestock ............................ o000"4..0*0 37 e. Crops .... ................... ..... 38 f. Subsidies o............................ 39 g. Research, Education and Training ...... 39 C. Regional Development ..... ........ ... ........... .. 40 i. Urban/Rural and Regional Disparities ..... . 40 ii. Issues, Prospects and Recommendations ..... 42  -2- Table of Contents Co:.tinued Page No. CHAPTER III - HUMAN RESOURCES .. ........... ........ . . . .. . . . . . 45 A . Introduction . . .. ... . .. .... . . .......* *.. *. * *. * * *** * 45 B. Background ........................................ 45 i. Population and Labor Force ................. 45 ii. Deployment of the Labor Force .............. 46 iii. Occupational Distribution of Employment .... 47 iv. Sectoral Distribution of Employment ........ 49 C. Manpower Imbalances through 1995 .................. 49 D. Issues, Recommendations and Suggested Action Plan ......... 53 CHAPTER IV - PROSPECTS: FURTHER DECLINE IN PER CAPITA INCOME AND EROSION OF THE STANDARD OF LIVING ............ 57 A. The Revised Third Plan ............................ 57 B. Growth, Creditworttiness and the Standard of Living .........................*.............. 59 C. Toward a Long-Term Development Strategy ........... 62 MAP VOLUME II - ANNEXES AND STATISTICAL APPENDIX  LIST OF TEXT TABLES Table No. Page No. 1 Indicators of Oman's Position in World Development ..... 1 1.1 Average Sectoral Growth Rates and Shares in GDP ........ 5 1.2 Growth and Use of Resources ........................... 6 1.3 Government Finance, 1981-85 ............................ 7 1.4 Sources of Government Revenues ......................... 8 1.5 Pldnned and Actual Government Expenditures, 1981-85 .... 9 1.6 Factors Affecting Changes in Domestic Liquidity ........ 10 1.7 Bplance of Payments Estimates, 1981-85 .......... *....... 12 1.8 Omani Domestic Exports, 1980-85 ........................ 13 1.9 1986 Expenditures: Budget and Outcome ................. 14 2.1 Gross Fixed Investments in Manufacturing and Mining, 1978-1985 ...... ..... ......... ........... 16 2.2 Value Added in Manufacturing and Mining, 1978-1986 ..... 17 2.3 Private Sector Manufacturing Establishments, by Size of Employment and Size of Investment ......... 19 2.4 Comparision of Selected Industrial Costs in the GCC .... 21 2.5 ODB Loan Commitments and Disbursements and Disbursements Under the Government Soft Loan Scheme, 1979-1985 .... .................. 27 2.6 Construction Sector ... .. .... .......... 31 3.1 Omani Share of Employment in Public and Private Sectors ... ........................... *.. 48 3.2 Cieil Service Employment by Nationality and Sex, 1985 .. 48 3.3 Distribution of Omani, Non-Omani and Total Employment by Sector of Economic Activity, 1985 ...... 50 3.4 Projected Development of Omani Stock, 1986-)0, and Omani Share of Total Employment by Occupations, 1990 ............ ........................ 52 4.1 Budget of 1987 Compared to 1986 Out Turn ....... o ........ 58 4.2 Revised Expenditures for the Third Plan, 1986-90 ....... 59 4.3 Balance of Payments and External Debt Projections ...... 61  P Ge I t2 .-,UITRY DATA- mII mu POPULATION almst A LAt I 300.000 sq. km. 1.00 thousand (mid-1986) S.0 psr square km Rate of growth: 4.1% POPULATioN CHARACTERISTICS I/ HEALTHI 1/ Crude birth rate (per 1,000) 4S.0 population per physician 1,700 Crude death rate (per 1,000) 13.0 Population per hospital bed 600 ACCESS TO PIPED WATER MM976) ACCESS TO ELICT occupied dwellings without X of population - urban piped water (M) 68.0 - rural - total NUTRITION 119701 EDUCATIONI . Calorie intake as X of requirements ... Adult literacy rate X Per capita protein intake (grams/day) ... Primary school enrollment X 89 Index of food projection (1977) per capita (1969-70.100) G.. P PER CAPITA 1/ US$S,776 GRoss NATIONAL PRODUCTION 11(mi A&MUAL RATE OF GROWTH (percent eonstant prices) USt NLl]Uon% Percent 1982-84 1SA4-U GNP at market prices 6.397 100.0 1l.S 11.0 Gross domestic investment 2,006 31.4 28.2 -9.2 Gross national savings 1,377 21.5 70.4 7.7 Current account balance -761 11.9 n.a. n.a. Exports of goods. NFS 2.757 43.1 6.4 13.2 Imports of goods. NFS 3.787 59.2 2.1 0.8 OUTPUT, EMLOYMNT AND PROIJTIVITy IN IG Value Added Labor Force V.A. Per Worker US Millions Percent Thousands Percent US Percent Agriculture 232 3.2 ... So Industry 3.138 43.7 ... 22 Services 3S A.1 -t Total/Average 7.180 100.0 ... 100 PUBLIC FINMIC R0 hIm1ions Percent of GOP Jl M 1f2"- Current receipts 1,873 54.2 48.3 Current expenditures 1,358 39.3 40.1 Surplus/Deficit (-) 515 14.9 8.2 Investment 570 16.S 16.0 1/ Most recent estimates (1986). 1745S  Pan 2 of 2 COUNTRY DATA OMAN MONEY. CREDIT AID PRICES M4ERCHANDISE EXPCRTS I1984-I 6 i M1illons of Rials Omani outstanding at end periad USA Bilflins Percent luno 12fl 1912 9M 184 1185 Money supply 158.7 243.1 272.0 291.4 327.2 304.0 Oil 3.7 90.2 Bank credit to public sector 3.2 42.2 31.3 22.7 65.9 53.3 Total 4.1 100.0 Bank credit to private sector 282.7 376.0 466.4 554.6 673.0 674.5 EXTERNAL PUELIC DEBT. DEC. 21, 1905 Percentace of Index Numbers USI Mi4111ps Money as percent of GOP 7.7 9.3 9.9 9.6 9.5 10.9 Disbursed only 1.946 GOP deflator (1978=100) 197.1 191.2 171.7 163.6 162.8 129.0 Including undisbursed 2.879 Annual percentage change in: GOP deflator SO.' -5.8 -10.2 *-4.7 -O.S -20.e lank credit to public sector -23.8 6933.3 -25.8 -27.5 190.3 -19.1 Bank credit to private sector 27.5 12.7 24.3 18.9 21.3 0.2 DEST SERVICE RATIO FOR 1985 JS Millions of US Dollars Pernt 198 I= Iim 1985 1986 Exports of goods. NFS 3.746 4.435 4.435 4,986 3.208 Puolic Debt 4.7 Inports of goods, NFS 2.284 .283 3.112 3Z717 3.229 Resource Gap (deficit 1 -) 1.462 l,152 1,123 1.269 -90 Net factor income -165 153 84 78 269 Net transfers 3 -556 819 -iD6 -4 Current account balance (deficit = -) 935 749 388 441 -762 IIRD/IDA LENDING. DEC. :1. 1985 US milHihon IM IDA Grants to government 101 43 211 174 0 Outstanding and Nonmonetary capital -34 -36 244 -85 872 disbursed 39.6 Net errors and omissions -61 26 -478 -533 -732 Undisbursed 43.0 Overall balance (deficit = -) 941 782 365 -3 -622 Outstanding incl. Gross reserves (end year) 581 872 900 1.090 968 undisbursed 82.6 Petroleum imorts 152 272 39 53 1/ Denominator includes workers' remittances. 1745S  SlIUMARY AND CONCLUSIONS Introduction: Per Capita Income and Development Stage: A Misleading Equation i. Despite its relatively high per capita income, Oman presents social and economic indicators substantially less favorable than those observed among low income countries. Two main factors explain the relatively low social and economic standing of the country. First, Oman has become a 20th century country only fifteen years ago as the combined result of the coming to power of the present Sultan and of the oil price increases of the early and late seventies. While the Government has made remarkable progress in providing public goods and services to the people and in developing oil based and oil financed activities, no one could expect the country to have attained a development stage comparable to even .he middle income group in such a short time. Second, the geographical configuration of the country, a series of mountainous regions with only a nar.ow flat landstrip along the sea and desertic plateaus, and the dispersion of the majority of the population in. these areas, has made the distribution of public goods extremely difficult and expensive. ii. The differences in terms of living standards between the Capital Area and the rest of the country are currently quite sharp, essentially because the development effort over the last fifteen years concentrated in the Capital Area. Even after discounting some excesses, this by and large has been a reasonable strategy which has created a "critical" mass in terms of the modernization of the country. The issue for the future is to formulate the appropriate strategy in trying to have increasing segments of the population, especially rural, to participate in a development effort faced by serious financial constraints. iii. The task is made more difficult by the fact that the production base of the economy remains narrow, depending overwhelmingly on oil. The country is highly susceptible to external shocks as clearly demonstrated by the 1986 sharp drop in oil prices which brought down its per .apita income by 25 percent to about US$4,900. This narrow production structure also continues to depend largely on expatriate expertise and workers. In a given year, 10-15 percent of national income is remitted abroad to pay for these foreign expertise and workers, while Omanis are being trained to replace them. Because it takes time to diversify the production structure and to acquire skills, the Omani economic base will remain very narrow, supported by a large contingent of expatriates for many years to come. Recent Developments: Declining Growth and Rising Indebtedness iv. At the launch of the Second Five-Year Development Plan (1981-85), oil prices reached close to US$40/barrel compared to less than US$13/barrel five years earlier. Those prices began to decline thereafter to a level of about US$27/barrel by the end of the Plan in 1985. The Omanis were able to overcome  - ii - the price decline by stepping up production by about 52 pet-cent from 328,000 b/d in 1981 to 498,000 b/d in 1985. At the same time, government expenditures continued to increase, providing a major stimulus for the rapid growth of the economy. But with the stagnating revenues, expenditure growth led to large budget deficits after 1981, necessitating a net withdrawal from the State General Reserve Fund (SGRF) for the first time in 1985. v. All sectors performed well during 1981-85. Value-added in crude petroleum production increased by about 12 percent per year, while that of gas went up by almost 25 percent. The manufacturing sector also performed very well with an average growth rAte of over 46 percent per year. The coming on stream of large manufacturing plants contributed principally to this good perfo.^mance, i.e., a major cement plant, an oil refinery, and a copper smelter. Medium-size factories such as those set up in the just completed Rusail Industrial Estate to produce consumer products, also contributed substantially to the growth of this sector. As a result, manufacturing in 1985 accounted for about 3.2 percent of GDP, compared to less than 1 percent in 1980. Growth in agriculture was equally high at an average annual rate of over 11 percent. In particular, the crop and livestock subsectors, with about 14 percent annual growth rate, was an important contributor to this good performance. Despite the high growth, agriculture remains quite small contributing less than 3 percent of GDP in 1985. Finally, rapid growth in the goods-producing sectors was accompanied by rapid growth in the service sectors. This led to the overall growth rate of GDP at over 15 percent per year, a remarkable achievement. vi. Because oil accounts virtually for all exports, the decline in oil prices significantly affected the external accounts. While export earnings declined to R.O. 1.5 billion in 1982-84 from the R.O. 1.6 billion level of 1981, imports continued to increase (from R.O. 800 to 1,100 million). At the same time, outward remittances by t,reign workers, contractors, and partners of the state oil company, Petroleum Development Oman (PDO), also continued to increase. A net result was a drastic decline in the balance of payments surplus,.from R.O. 425 million in 1981 to only R.O. 38 million in 1985. vii. The unfavorable trends recorded during the Second Plan were sharply accelerated by the dramatic decrease in oil prices from US$27/barrel to US$13.5/barrel during 1986. Despite production increase of over 11 percent, oil revenues dropped from R.O. 1510 million in 1985 to R.O. 929 million in 1986. Although other revenues increased, total revenues still declined by about one-third. Such a decline, given the difficulty for the government to substantially adjust the expenditures, forced the use of reserves together with increased borrowing to finance the large deficit. Although only projects that were carried-over from the Second Plan were implemented, and the Third Development Plan (1986-90) was halted pending further revision, the fiscal deficit in 1986 was R.O. 700.2 million, about 25 percent of GDP. Only R.O. 12 million of grants were available. The government therefore withdrew R.O. 526.3 million from the reserves and borrowed R.O. 215.9 million (R.O. 88 million to repay existing loans). As a result, the debt service ratio attained almost 13 percent (5 percent in 1985). It is obvious that this level of deficit cannot be sustained for long without creating major creditworthiness problems.  - iii - Prospects, Issues and Recommendations (i) The Diversificatior Process (a) Manufacturins and MininR: Limited Scope for Expansion viii. Though Oman has made remarkable progress in manufacturing over the last half a dozen years, this has occurred on a narrow front. For the most part, industry consists of medium and small establishments producing a limited range of consumer goods, i.e. one clothing plant and one shoemaking plant, both with a very limited range, and no durable consumer goods, except for furniture. There are virtually no intermediate goods industries, such as textile yarns and fabrics, leather, paper or steel, and very few metal-working establishments. ix. In meeting the challenge of industrialiaation, Oman was handicapped by its L.-5e start, the scarcity of important industrial raw materials and, in coamon with its partners in the Gulf Cooperation Council (GCC), a relatively small market (particularly for intermediate products, durable consumer goods and machinery and equipment) and relatively high manpower costs, reflecting the high dependence on imported manpower. Less than 10 percent of the manufacturing establishments went into production before 1980. Oman also lacked mercantile and emerging industrial groups comparable to those of Kuwait or Dubai, Jeddah or Dahran. x. Thus far, industrial growth in Oman has been based almost exclusively on domestic markets. For a country with a population of about 1.5 million, the domestic markets can sustain only a narrow range of industries, i.e. local food processing, beverage bottling, various construction materials and small metal working establishments and cement. In short, the domestic market is entirely too small for an industrial takeoff and hence, the wider regional GCC area has to be the main focus. xi. Two aspects of the CCC market are worth noting. For all GCC countries, imports of manufactured products represent a very high proportion of their total consumption of such products. Secondly, in spite of differences in per capita GDP, all countries show a striking similarity in import structures. If we exclude machinery and transport equipment as offering scant opportunities for production in Oman at this stage, remaining manufactures represented a GCC import volume in 1985 of roughly US$ 16 billion. The extent to which Oman manu,acturers may hope to participate in the replacement of these imports and also capture an increased share of the market for manufactures already produced in the GCC area is discussed below. xii. In planning industrial development for Oman, one has to look at least a decade ahead. With a few exceptions, Omani industries will not be- competitive outside the GCC area. Within the margin, one would normally have expected a per capita gross national product of less than one half of the regional average to be associated with a similar difference in pay scales. This would have provided Oman with a significant edge in relatively labor-intensive lines of production. Unfortunately, because of its reliance  - iv - predominantly on imported labor, this is not true for Oman. Furthermore, within the GCC, Oman suffers some transitional disadvantages due to i.s late start and the overcapacity in the region of many, mainly consumer goods oriented, industries. The problems are accentuated by recession due to the fall in crude oil prices and the completion of much of the basic infrastructure and the aggressive competition that has followed from this. In several ases, Oman has parried this market imbalance with the imposition of temporary, relatively high duties. xiii. In energy and capital-intensive industries, like steel, fertilizers and basic petrochemicals already established in other member countries with more favorable resource and/or market conditions, Oman is likely to remain at a competitive disadvantage. In many other industries, however, it should be able to compete on reasonably equal terms, taking into account also the principle of initial differential support for Oman, sanctioned by the GCC treaty. xiv. Manufacturing industries in Oman are the beneficiaries of a number of incentives, including subsidized rates for water, power and gas, subsidized sites at the Rusail Industrial Estate, finance at subsidized rates and a degree of industrial protection. The standard duty on imported products from the beginning of this year is 5 percent (previously 4 percent) but quite a few important products draw a duty of 20 percent. The latter rates apply as well to products imported from GCC member countries according to a special escape clause in the GCC treaty. Otherwise trade within member countries is, in principle, free from import duties. The combinstion of these various subsidies and a 20 percent import duty translate into a very high protection of induistrial value added. xv. There seems to be substantial agreement within the GCC that harmonization of protection and subsidies within the region is desirable. On protection, some progress has been made. The principle has been established that tariffs against the rest of the world shouid be a minimum of 4 percent and a maximum of 20 percent; from September 1983 on, this policy has been implemented. In contrast, there has been no implementation as yet of the decision that a common tariff schedule should be introduced after five years nor of another decision that all custom& duties should be collected as a GCC source of revenue. On subsidies, there is as yet no agreement. xvi. The most controversial points of the present and proposed support structure are the high reliance on protective duties and the bias favoring capital-intensive investments. In the long run, when GCC manpower increasingly replaces imported manpower, one would expect Oman's comparative advantage within th. GCC to be in relatively labor-intensive industries (i.e. in relation to other GCC countries). The ideal incentives structure for Oman would be one based primarily on uniform GCC subsidies of industrial and agricultural value added but which would allow Oman, during a transitsn period, to provide these subsidies at higher rates. In principle, an attractive solution would be to do away with subsidies on power, water, industrial land and capital, allowing these resources to be priced correctly and to replace them with subsidies on value added, payable at, say, three  - v S different rates, according to the indirect benefits ("external e-onomies") that a particular industry might be expected to bring to the region--whether slight, significant, or exceptional. It is recommended that Oman study the appropriateness of such an incentives structure and eventually plead for its adoption within the GCC. Should the balance of forces within the GCC be against such a structure, Oman should retain the freedom to structure its own differential subsidies in such a manner that the combination of the common incentives with Oman's special incentives would compensate for any anomalies in the GCC structure and promote development in line with Oman's long-run industrial development goals, quantitatively and qualitatively. xvii. In the mission's view, the Ministry of Commerce and Industry, under the general guidance of the Development Council, should become more active in the formulation and implementation of industrial strategy and policies as distinguished from discretionary interventions. Specifically, this would involve the formulation and publication of industrial targets, the design of an incentives and support structure where privileges would be carefully tailored to prospective benefits to the economy and, finally, a specific timetable for the progressive integration of Omani manpower in manufacturing. In this context, the Ministry would present the Development Council with estimates of the overall levels of support required to achieve specified levels of industrial growth and Omanization of manpower. (b) ARriculture and Livestock: Growth Through Institutional Changes xviii. Oman's agriculture has changed at a rapid pace over the past fifteen years. It is at present neither a traditional subsistence sector, as it had been for centuries, nor a fully modernized one. Despite the rapid change, current production remains mostly inefficient and falls far short of potential. The Falai systems, for a long time the most advanced rural organizations and water distribution arrangements, are in need of urgent modernization to raise water use efficiency. With large government investment over the past decade, basic infrastructure such as the road network is in place but to reach full potential, national policy needs to be defined and implemented with regard to efficient utilization of natural resources and determining alternative product mixes. xix. Omani economic planners are aware of the potential and constraints of the agricultural sector. They have targeted agriculture to play a major role in economic diversification programs. For that potential to be realized, substantial changes will need to be made on top of those that have already been done. Since the natural resource base indicates that Oman cannot conceivably be self-sufficient in all agricultural products, it would make sense for Oman to focus efforts and scarce financial resources on areas that prima facie offer the best promise. xx. For the most part, the government policies already point in the right direction. With respect to water utilization, additional measures are, however, needed: (i) Data collection should be expanded on meteorological and hydrological trends, pumping rates and quality of water. Metering of water pumps should be widely instituted.  - vi - (ii) Due to limited data on meteorology, geohydrology and siltation, it is recommended that further investment on recharging dams await data on the existing ones as well as comprehensive studies of new sites. (iii) Government assistance in Falai rehabilitation should continue but ways be found to require changes in water use method. Storage tanks, lined channels, and plastic pipes should be considered. (iv) Additional desalination should be built only as a last resort. Since domestic water has the highest priority, underground water with suitable quality and proximity to urban centers should be allocated to domestic use first. Those water resources which are unsuitable for domestic use or too far away to be economical to transport to urban centers may be considered for irrigation. (v) Eliminate subsidies for water pumps. Instead, fees should be levied on pumps in lieu of water charges which are difficult to impose under the present social conditions. (vi) Prohibit or restrict wells close to the sea along the Batinah coast. (vii) Water availability should be assessed before allocating new land. sxi. Fragmentation of land ownership and inefficient use of basic inputs, from water to mechanization, are an issue. A solution to this problem appears to be corporate farming. This would allow land to be consolidated, allowing some landholders to pursue other occupations while a selected few stay in the farm to fully engage in agricultural activities; they will in a sense become hired managers as they will be paid from the corporate funds over and above the shares of their land in the corporation. Should none want to remain in the farm, a professional manager can be hired. Full time work, and, in case there is a need for expatriate labor, close supervision, should lead to increased productivity and allow for easier extension service, etc. Promotion for this type of venture could conceivably be done in conjunction with water policies such as the Falal rehabilitation and restriction on pumping of water, with agricultural loan programs, and with labor policy. The above applies mainly to crop land. Range land is discussed under livestock. xxii. Livestock is another problem area. The government's purcharing of animals at a high price and reselling at a loss may have given a wrong signal to the private sector. The government programs to reseed the range and work with local shieks to rotate grazing areas appears promising and should be pursued more intensively. To attempt to breed dairy cow, however, appears prima facie to be an expensive undertaking. Experience shows that it would take a long time even under extremely good management to achieve a productive breed well adapted to local conditions. This is an area in which Oman could possibly draw on the experience of the neighboring countries with similar climatic conditions. Requirements for milk can easily be met by imports. Regarding camels, promotion of meat marketing and export should be intensified.  - vii - xxiii. With respect to crops, Oman has done reasonably well in this subsector and has produced some exportable surpluses in dates and limes. Some alfalfa and vegetables are also exported. Since water and manpower are major constraints, crops that lend themselves to water and labor savings would appear to be the ones with higher potential for expansion. In addition costs of production and market channels are also important criteria when examining their potential. xxiv. Subsidies are limited mainly to inputs such as seeds, equipment, etc. Crop protection, such as spraying of pesticides and veterinary services are also carried out by the government. Output subsidies are much more limited: an ongoing program is the Public Authority for Marketing of Agricultural Produce (PAMAP) which buys all grades of produce from farmers at relatively high prices, some of which could not be resold. Although PAMAP has provided a significant incentive to farmers by maintaining relatively high prices for their produce, in the long-run, it should be run on a self-supporting basis without financial transfers from the budget. Loans from the Agricultural Bank are also subsidized. To allow the market forces to operate more fully and also reduce the burden on the budget, the government should lower those subsidies and concentrate on providing infrastructure such as farm-to-market roads, marketing facilities, research, studies, education, extension, crop protection and veterinary services, seed and breeding stock improvement, marketing news, credit and produce processing facilities. xxv. Finally, with a recent addition of a full-fledged agricultural faculty in Sultan Qaboos University to existing research/experiment stations around the country, Oman is already institutionally equipped to do research/studies to support the plan for agricultural expansion. Research should concentrate exclusively on technical and economic feasibility of crops and livestock species that will produce well in Omani conditions beginning with existing ones that could substantially increase their output. Two studies that should be implemented immediately are technical and economic feasihaility of setting up an animal by-products processing plant and a fish meal plant. At present most animal by-products have gone to waste and small fish caught by local fishermen have been sun-dried along the beaches and used for animal feeds. (c) Regional Development: The Need for a Gradual Approach xxvi. The solution to the issue of regional disparities is made particularly difficult by the financial constraints that are looming large on the country's development programs as a result of stagnating oil revenues. Can Oman afford over the coming five years a bold expansion of its regional development effort? Unfortunately, the unit costs of most social programs, from edutation to health, from housing to basic infrastructure and electrification, are much higher than those borne to develop these services in the Capital Area and in the major urban centers in the rest of the country. As indicated earlier, the geographical configuration of the country and the high dispersion of the population are the two factors principally responsible for these higher costs. xxvii. A basic choice in solving the problem is between "pursuing" the target groups in the most remote areas or concentrating the government  - viii - intervention in the smaller towns, therefore, encouraging the population of those areas to "cluster" around such towns. Already ncw, commuting between the small villages and the larger centers is common practice, even at the cost of lengthy trips and infrequent visits home. The reason for this is a deep-rooted attachment of many Omanis to their native environment. To further promote commuting requires that large amounts be spent to provide the families remaining in the villages with the basic infrastructure. This is, therefore, a costly policy, the benefits of which can only be measured in terms of "people" attachment to traditional values. It also raises the question of whether it is more disruptive, in terms of social texture, to have heads of family spend lengthy periods away from their families as against having the whole family resettled in a more structured urban environment. xxviii. With respect to productive activities, and in particular, to industrial development, the Ministry of Commerce and Industry is exploring the feasibility of establishing industrial estates at strategic locations, specifically Sohar on the North Batinah Coast, Salalah-Raysut in the South and Sur and Nizwah in the Eastern Region and the Interior. These would be industrial zones, based on a different concept from the Rusail Industrial Estate, with more modest infrastructure and administrative overhead and only a few ready-made buildings. The motivation for building the estates is to ensure rational urban development while at the same time expediting and facilitating the growth of manufacturing activities. It is recognized that for the estates to be viable, there is a need for a minimum critical nucleus of industries ready to settle there. For example, in the case of Sohar, which the Government wants to make into a development pole for the North Batinah Coast, the industries envisaged would be either processing local agricultural products or catering to the local market, such as bakeries, dairies, concrete blocks and ready mix concrete suppliers, doors, locks and windows, soft drink bottlers, a machine shop, etc... xxix. To conclude, only a gradual and, in part, experimental approach to the solution of the country's regional social and economic disparities seems viable at this stage. Regional development experiences in other countries, developing and industrialized as well, indicate a high risk of large programs with modest results, mostly because of the failure of reaching the critical mass at the local level with ensuing migration to urban centers for lack of real economic opportunities. (ii) Human Resources: Overhaul of the Education System to Avoid Unemployment of Nationals and Reduce Dependence on Expatriates xxx. Given the size of non-Omani workforce needed in 1985 (about 60 percent) and the relatively low Omani share among skilled and higher level occupations, it is unlikely that even under a no-growth scenario (discussed below) Omanis will be able to replace even a majority of foreign workers in the next ten years. Omani population is small and young, with about 45 percent of them under 15 years of age. Thus, there is modest scope for improving the crude labor force participation rate in the short run, although female labor force participation will slowly rise with education attainment level. Also, the gestation period required for acquiring many of the skills in shortage is ten years or more. Therefore, there would simply not be enough  - ix - Omsnis in numbers or with needed skills to be able to shed dependence on foreign workers in the medium term. YXxi. Under the current pattern of enrollments and progression rates, nearly 185,000 non-Omani workers are likely to be needed in 1990 to achieve the planned sectoral GDP. This would represent 40 percent of the total demand. While Omani share would improve from 43 percent in 1985 to 60 percent in 1990, it should be borne in mind that this would be under the conditions of depressed economy and resultant reduced total employment. Furthermore, 28,000 Omanis qualified only for Unskilled occupations would go unemployed by 1990 under the assumptions set forth in this analysis, unless their skills were upgraded through on-the-job training. With the closing of vocational training centers at the intermediate level of education, the only formal source of Semi-Skilled manual workers has been cut off. Without a vigorous on-the-job training programs, Omani economy would become almost totally reliant on foreign workers in this class of occupations. xxxii. Unless still higher proportion of students are steered into technical streams and dropout rates are reduced further, the picture is expected to become even more bleak by 1995. While nearly 190,000 fpreign workers are expected to be needed in Oman, 82,003 Omanis are likely to have skills unsuited for available jobs in 1995. There is a clear need to further improve the retention rate of students at the primary level, as indeed at the other levels, coupled with skill upgrading programs. Among skilled office occupations (general secondary education), a surplus of 18,000 Omanis is projected. These too would have to be provided technical on-the-job training so they could replace non-Omani workers in the other skill categories. Even among non-science technician occupations (dropouts from the non-technical faculties), a surplus of unallocated Omani workers is shown for 1995. Omani share of semi-skilled manual occupations is expected to drop to six per(.ent. Overall, Omani workers' share is expected to rise to 63 percent and even further with above-mentioned skill upgrading programs. xxxciii. At the higher levels of education, Omani students' preference appears to be towards non-technical studies leading to a desk job in the Government. As result, mismatches of skills vs. job opportunities are likely to take place among the non-technical occupations in the early 1990's. A deliberate and sustained effort is needad to redirect Omani students at the secondary level and above towards the technical fields along with improvements in retention and progression rates throughout the education and training ladder. Omani representation in the scientific and technical professional occupations is likely to be only 20 percent in 1990 and only a third of the total in 1995. XYXiv. It is clear that the Education and Training Council (ETC) should formulate polices designed to reduce repetition 4nd dropout rates to levels that are consistent with differences in individual abilities and motivation. Some of the policy actions employed in these cases to reduce wastage and prevent the development of an unemployable class include: a. Evaluation of existing methods of testing and test standards to assure their appropriateness to the objectives and context of the education system;  -x- b. The development of alternative forms of student evaluation more appropriate to a student body heterogeneous in terms of age and environmental background; c. Creating a series of in-service training seminars on testing and evaluation for the current teaching staff and enhancement of curriculum elements in these areas in teacher training institutions; d. Establishment of an extensive system of student and family counseling to encourage retentioa in school and provision of in-service training in student counseling for the teaching staff; e. Actions to improve the quality of the teaching staff and methods of instruction at all levels with initial priority for elementary education. At this level curriculum emphasis is usually placed on the acquisition of learning skills; f. The development of an adequate system of labor market itiformation and vocational guidance and an appropriate structure of labor market incentives. xxxv. The wide disparity in wages in public and private sector offered to an Omani school leaver at a given education/training attainment level tends to invariably pull him towards the civil service employment and create imbalances. Indeed even entry into education and training programs is Influenced by the existence and level of stipends available to get on the civil service rolls as soon as possible. If the Omanis are to meaningfully participate in the private sector employment, the disparities in compensation between public and private sectors need to be reduced. In addition, the Diwan of Personnel Affairs under the Civil Service Councii should restrict Omani employment to those jobs where there is a genuine need and raise standards of entry into the civil service. xxxvi. The recommendations detailed above would require difficult policy decisions, some would involve short-term costs, others may sou.ad too harsh for the young Omani labor market entrants. However, the long-run Costs of neglecting steps required now to deflect the growing mismatches between the Omani skill profile and available jobs will be much higher, both in human terms for the Omanis and in financial terms for the treasury. It is, therefore, imperative that the ETC, the Diwan of Personnel Affairs and the Ministry of Social Affairs and Labor (MOSAL) concentrate on improving the efficiency of the ETS. Only then would Omani participation in their own labor market be meaningful and rewarding. (iii) The Macroeconomic Prospects: Stagnation, Rising Debt Service and Decline in Per Capita Income xxxvii. As discussed above, Oman faced critical financial problems in 1986 as revenues drastically declined while u"penditures, due to commitments already made, remained relatively high. As the oil market picture and revenue prospects became clearer toward the end of 1986 and early 1987, the government was able to respond to the situation more concretely. For 1987, the  - xi - Government increased oil production from 560,000 b/d in 1986 to about 582,200 b/d in 1987. At the same time the government expenditures in the original budget of 1987 (Revised Plans Estimates) were reduced from the (actual) 1986 level by 14.1 percent followed by a drastic reduction in defense and national security by 21.7 percent. Development expenditures of civil ministries were cut back by 25.6 percent. Despite the estimated increase in total revenues by 12.5 percent, the state budget deficit is expected to be 273.8 million or about 10 percent of GDP projected estimates. xxxviii. Although oil prices have recovered somewhat from the low level of 1986, the prospects for a further sharp increase are not encouraging. The planned level of oil production of 575,000 b/d during the remainder of this Plan period (1988-90) will not increase oil revenues substantially. In response, Oman has revised the Third Plan by scaling down total expenditures by 11.7 percent. Of the three major items, development expenditures are expected to be cut by 12.6 percent, civilian recurrent by 14.1 percent, and defense and security by 11.7 percent. Despite the cutback, the deficit during the Plan period is expected to more than double to over R.O. 1.67 billion. Most of this deficit is to be financed by withdrawal from the reserves (R.O. 1,026 million) and external borrowing (R.O. 291 million). xxxix. Despite the revision, part of the Plan has remained unfunded. The government has examined ways to diversify sources of domestic revenues and financing funds. First, it will continue to charge a premium on crude oil sold to the domestic oil refinery, which began after the export prices declined. In 1986, the premium averaged about US$8.7/barrel. With expected recovery of export prices, the premium will decline to US$7.2/barrel. Second, the price of electricity will be increased based on a three-tier system, with the large consumers paying a premium. Third, the corporate income tax on Omani companies,1/ which has been postponed until now, will be implemented beginning in 1988. Fourth, it plans to borrow domestically by issuing short-term treasury bills and regional development bonds which are tied specifically with regional development projects. xl. These programs, however, may not be sufficient to reduce the level of deficit that will be viable in the longer term. The government, therefore, should consider an additional avenue of raising domestic revenues - a personal income tax. This tax could be designed not only to raise revenues but also to addreas the issue of equity in the sense that past development (and oil revenues) has benefitted mainly the urban sector which is now relatively well off. As the government wants to extend development into the rural, and much poorer areas, but is being constrained by financial resources, those who have benefitted greatly in the past should consider paying more for future development. Although the government considers this tax out of the question at the present time, it appears that it cannot be avoided in the future. In this sense it may be time to start discussing it and working toward a consensus later, considering the long lag time required for this kind of reform. 1/ Only foreign-owned companies currently pay a corporate income tax.  - xii - xli. The revised Third Development Plan projects a decline of about 2.4 percent per year, in real growth during the plan period 1986-90 but positive growth of 2.3 percent per annum from 1987-90. This is probably the only scenario that is likely to happen for many reasons. First, the international oil market is expected to continue to stagnate and Oman can expect to increase production only marginally. Second, with a projection of slow increases in prices in the medium-term, oil revenues will by 1990 be only marginally higher than the depressed level of 1986. The resulting financial constraint, necessitating reduction in government expenditures, will adversely affect major sectors such as construction and trade. Third, growth in manufacturing is expected to continue but at rates lower than in the past. Major plants are now completed - oil refinery, cement, copper smelter; no others are coming on stream. Furthermore, those closely tied to construction - cement blocks, bricks, tiles, etc. - will be adversely affected by lower construction activities. Smaller manufacturing plants mainly in consumer goods and food processing are expected to expand, partly substituting for current imports. Agriculture is expected to grow also. But these two sectors, with combined contribution to GDP of less than 7 percent cannot totally offset the decline in others. The decline in real GDP, together with a. relatively rapid population increase of about 3 percent per year, will lead to considerable reduction of the per capita income in the medium term. By 1990, the real per capita income at 1985 prices is expected to fall below $3,600. xlii. Projections of the external sector carried out on the basis of this growth scenario for 1986-90 and to achieve a modest 2 percent real growth rate during 1991-95 show, first, that by 1995 the debt service ratio will reach 26.6 percent and the reserve level will decline to only about 5 months of import. These are probably the upper and lower limits, respectively, beyond which Oman should not go but which appear inevitable if Oman is to achieve some real growth. Alternatively, if we assumed that Oman would continue to receive grants at about US$150 million per year, a level similar to that of the early 1980s, the debt service ratio will continue to rise to about 22 percent by 1995. Therefore, even if part of external borrowing came at highly concessional terms, vis-a-vis commercial terms as Oman expected, the debt service burden would still be quite high. Second, while the debt service ratio during the present plan period remains in a reasonable range (about 17 percent in 1990), the gross borrowing required annually is quite large, rising tc over US$1 billion in 1990. Third, without real growth during the period, per capita income will continue to decline to about US$ 3,590 by 1990. Fourth, in order to provide for capital formation, partly to replace worn-out existing equipment, partly to provide new investment for further diversification in the productive sectors and partly for basic necessities such as housing, (gross investment at about 15 percent of GDP in the next three years and rising to about 21 percent by 1995), what is available for per capita consumption will substantially decline in real terms during the next few years. Fifth, because part of the Plan remains unfunded, the government's plans to increase tax or borrow domestically from the private sector may in fact lead to even lower levels of resources available for consumption. Although in terms of absolute amount, the consumption level will remain higher than in most developing countries, an erosion of the standard of living of Omanis in the years ahead seem unavoidable.  - xiii - The Longer-Term Scenario: Trade-Offs and Priority Interventions xliii. The preceding discussion has brought out the need for the Government to carefully assess the trade-offs implied by various policy orientations in several areas and to move on the ensuing priority interventions. A first trade-off is between economic growth and dependence on foreign labor. As indicated earlier, with the exception of moderate growth prospects in manufacturing and agriculture, all other sectors of the non-oil economy are bound to show negative growth rates over the coming years. Any attempt by the Government to reverse tnis trend through expanded public expenditure affecting the infrastructure sector would hardly broaden the productive basis of the economy while requiring a larger number of expatriate workers with consequent additional remittances and probably further decline in per capita income. Furthermore, a higher growth rate will need additional external borrowing leading to higher debt burden which would not be sustainable. xliv. Therefore, growth per se should not be the primary objective of the Government policy. The welfare of the Omani population, as measured in terms of per capita consumption and of provision of public goods and services, should rather constitute the policy target. Within the framework of declining GDP, only an accelerated substitution of expatriate workers with Omanis can prevent Oman's per capita consumption from declining as implied by the present growth scenario. By the same token, this would enable the Omani population to see their share of public goods and services remaining unchanged and possibly increase. This policy makes the adaptation of the education system to the requirements of the labor market the single most important priority area of the Government action. Ylv. Another trade-off is between expansion of existing infrastructure and maintenance of existing physical assets in a situation of limited financial resources. While the need for additional infrastructure, especially outside the Capital Area, remains quite high, the implications of any major expansion in terms of the already mentioned dependence on foreign workers and, even more so, in terms of future maintenance costs to the Government are stark. Ensuring, through adequate budgetary allocations, maintenance of existing infrastructure in a country where climatic and geographical configuration factors tend to lead to rapid deterioration is of critical importance. Furthermore, maintenance activities, as in all other Gulf countries, are becoming a key sector to absorb national manpower in a variety of skills providing gainful employment. xlvi. The trade-off relating to regional development programs--fragmented intervention to reach the target groups vs. regrouping people around concentrated actions-has already been discussed above. One might add that the lesson of experience in most developing and developed countries shows how difficult, if not impossible, it is for the less developed areas to reduce the social and economic gap vis-a-vis the more developed ones. Raising the absolute level of living standards in the less favored regions of the country is a more realistic target and one that will avoid launching expensive programs with modest impact in terms of reducing "relative" disparities. xlvii. Finally, there is the crucial trade-off faced by all oil, capital-surplus countries, i.e., the diversification of the productive  - xiv - structure of the country away from oil and oil-related activities towards manufacturing. In other words, imports of manufactured product vs. domestic production. Foreign exchange is increasingly becoming a scarce resource in the country. However, import substitution beyond its present limited scope and expansion of export-oriented industries beyond the narrow boundaries dictated by the laws of comparative advantage, could be a very risky policy once the import requirements in terms of physical and human inputs are deducted from the expected value added of these activities. Oman in its present and future conditions can afford less than most other oil rich countries to use domestic industry as a training ground for nationals said as a vehicle for efficient backward and forward linkages, especially considering the current wage levels to which Omanis aspire. xlviii. Such aspirations are dictated by the prevailing salary and benefits levels of the public sectoL which are incompatible, when "transferred" to the private sector, with a competitive production system and, in more general terms, with the financial situation of the country. The public sector can no longer exert its parallel function of redistribution of oil wealth among the population. A freeze in its size, its gradual transformation into an employer of administrative and technical "excellence" and a reduction in its real wages are required to allow the market forces to operate efficiently, thus responding to the Government stated economic philosophy.  INTRODUCTION 1. Oman's per capita income, while four times the one of middle income economies in 1984, is accompanied by social and economic indicators substantially less favorable than those observed in those countries and also among low income ones. Table 1 shows this eloquently. Two main factors explain the relatively low social and economic standing of the country. First, Oman has become a 20th century country only fifteen years ago as the combined result of the coming to power of the present Sultan and of the oil price increases of the early and late seventies. While the Government has made remarkable progress in providing public goods and. services to the people and in developing oil based and oil financed activities, no one could expect the country to have attained a development stage comparable to even the middle income group in such a short time. Second, the geographical configuration of the country, a series of mountainous regions with only a narrow flat landstrip along the sea and scattered desertic plateaus, and the concentration of the majority of the population in these areas, has made the distribution of public goods extremely difficult and expensive. Table 1: INDICATORS OF OMAN'S POSITION IN WORLD DEVELOPMENT Comparative Indicators, 1984 Low Middle Industrial Income Income Market Economies Economies Economies Oman Per Capita Income (US$) 260 1,250 11,430 6,490 Manufacturing's Share of GDP (X) 15 22 25 3 Per Capita Energy Consumption (kg. of oil equivalent) 288 743 4,877 2,405 Urban Population (X) 23 49 77 27 Life Expectancy at Birth (years) 60 61 76 53 Crude Birth Rate (per thousand) 29 33 14 45 Crude Death Rate (per thousand) 11 10 9 14 Infant Mortality (per thousand) 72 72 9 110 Child Mortality, 1-4 years (per thousand) 9 8 nil 17 School Enrollment Ratios (2 age group, 1983): Primary 91 105 102 83 : Secondary 31 47 85 28 Source: World Bank, World Development Report, 1986.  -2- 2. The differences in terms of living standards between the Capital Area and the rest of the country are currently quite sharp. The country's development effort oter the last fifteen years has been concentrated in the Capital Area. Even after discounting some excesses, this by and large has been a reasonable strategy which has created a "critical" mass in terms of the modernization of the country. The issue for the future is to formulate a strategy aimed at having increasing iegments of the population, especially rural, participate in a development effort which has been made more complicated by inereasingly serious finar:ial constraints. 3. The 1986 oil price fall has forced the Omani Government to drastically revi;e the l