Essays on fiscal policy, external balance, and trade linkages of the Omani economy

For many developing oil exporting economies, oil revenue contributes to a relatively high percentage of government revenue and to the value of export commodities. The high dependency on oil revenue has raised concern about the impact of oil price shocks on these economies and their vulnerability to oil price fluctuations. In the modern Omani economy, petroleum is a vital economic sector. In 2018, the petroleum sector contributed (i) 40.8% to Omani real gross domestic product (GDP), (ii) 65.3% to Omani’s total exports, and (iii) 78.2% to Omani’s government revenue (NCSI, 2019). A survey by the Central Bank of Oman highlighted a drastic fall in oil prices could be a threat to financial stability in Oman (CBO, 2016b). The first essay of this thesis studies the impact of oil price shocks on fiscal policy and real GDP in the Sultanate of Oman. It employs a Structural Vector Autoregressive (SVAR) model with quarterly frequency data from 1989Q4 to 2016Q4. Impulse responses, variance decomposition analysis, and historical decomposition show that an oil price shock can have a significant impact on government revenue and GDP. An oil price shock explains around 22% and 46% of the variation in the government revenue and GDP, respectively. Decomposing the government revenue and GDP further into petroleum and non-petroleum related components, we find that an oil price shock explains around 26% of the variation in petroleum revenue and 90% of the petroleum-GDP. Petroleum and non-petroleum GDP respond positively to oil price shocks, while they respond negatively to oil price volatility. Government expenditure is not affected by oil prices, but it is affected by government revenue. This result demonstrates that government revenue is the channel through which oil price shocks impact government expenditure. The results also illustrate that the Omani government uses its reserve fund, and local and international debt to smooth, and reduce the impact of oil price fluctuations. The second essay examines the Twin Deficits Hypothesis on the relationship between fiscal and trade balances for Oman, where the fiscal balance heavily relies on oil export revenue. According to the twin deficit hypothesis, the casual effects run from fiscal balance to trade balance. For example, a rise in the budget deficit through tax cuts or government expenditure increases, raises the domestic absorption through import expansions, leading to current account deficit. Therefore, the Twin Deficit Hypothesis may hold for countries where the government expenditure is largely funded through tax revenue. Compared to that, for oil-reliant economies like Oman, taxes contributed only 9.18% of the government revenue in 2018 while oil contributed 78.24% of the revenue. In this paper, we use the SVAR model and a Structural Vector Error Correction (SVECM) model to assess the relationship between Oman’s fiscal and trade balances in the short and long-run. The results show that in the short run, Oman’s trade balance and fiscal balance are mostly determined by oil price movements, where both balances respond positively to oil price shocks and negatively to oil price volatility shocks. The trade balance’s response to oil price shocks is quantitatively larger compared to fiscal balance, while fiscal balance’s response to oil price volatility shocks is larger than trade balance. The fiscal balance responds positively and is statistically significant to trade balance shocks, while the responses of the trade balance to the fiscal balance shocks are statistically insignificant. In the long-run, oil price shocks have a statistically significant positive impact on fiscal revenue, exports, and imports. These results provide strong evidence that in Oman, the casual effect runs from the trade balance to the fiscal balance. In comparison, the fiscal balance is more endogenous, and the Omani government is able to adjust the fiscal policy in response to fluctuations in the oil price and trade balance, thus contradicting the traditional twin deficit hypothesis. We argue that for an oil-dependent small open economy, like Oman, policies that help to diversify away from depending heavily on oil revenue would help the economy to absorb international oil price shocks more effectively. The third essay of the thesis investigates the impact of the global shocks on the Omani economy through trade linkages using the Global Vector Autoregressive (GVAR) model. The main objective is to assess the impact of shocks originating from Oman’s main trading partners, namely China, Japan, Korea, Singapore, Thailand, and the United States. To our knowledge, this is the first study to use the GVAR model to assess shock transmissions to Oman. The GVAR framework allows us to present augmented VAR models that include both domestic and foreign variables such as output, inflation, short-term and long-term interest rates, and exchange rates along with oil price as a global variable. The period of study is from 1989Q4 to 2016Q4. The GVAR model enables us to carry out a rich analysis of the direct and indirect impact of shocks from Oman’s trading partners on its real GDP, petroleum GDP, and non-petroleum GDP. In addition, the use of different trade weights enables us to account for the changing trade patterns over time. The empirical results highlight that any unexpected shocks originating from East Asian economies will have a significant impact on the Omani economy. The impact of China is growing over time and currently has the largest effect, while the impact of Japan is declining. In general, the impact of the United States is modest and similar across times. The trade concentration and over-reliance on a particular destination and commodity could be risky for Oman and thus the Omani government should consider diversifying its trade relation and the composite of products that it exports