* Fiscal sustainability becomes significant challenge
* Spending restraint, higher non-oil income needed
* Cuts in fuel subsidies necessary
* Budget break-even oil price seen at $120/barrel by 2018
* Oman should issue T-bills, set up govt issuance plan
By Martin Dokoupil
DUBAI, June 12 (Reuters) - Oman needs to contain state spending and raise non-oil revenue in the medium term to keep its fiscal balance sustainable, the International Monetary Fund said on Wednesday.
"Spending restraint and non-oil revenue enhancing measures are needed to support a sustainable fiscal policy in the medium term," the IMF said following annual consultations with Oman.
"The mission recommends an initial adjustment of 1 percent of GDP (gross domestic product) in 2013 by rationalising the planned increase in workforce, and restraining goods and services spending," it said on its website (www.imf.org).
The sultanate needs to adjust its fiscal balance by around 10 percent of GDP in total over the medium term as its budget health is becoming a significant challenge, the IMF added.
Oman finance ministry officials could not immediately be reached for comment. The finance minister hinted in April that budget policy would become more conservative.
The IMF painted a bleak outlook for Oman's public finances in April, predicting the budget could slip into a deficit of 3.8 percent of GDP as soon as 2015, with the gap widening to as much as 13.3 percent in 2018. On Wednesday, it predicted a 2015 shortfall of 0.9 percent, widening to 6.8 percent in 2018.
The small non-OPEC oil exporter raised its planned budget spending by nearly 20 percent this year compared to last year's plan, to 12.9 billion rials ($33.5 billion), partly to help keep social peace after street protests demanding jobs and action against corruption in 2011.
Steep rises in government hiring and a rise in the minimum wages of Omani citizens in the private sector have reduced the government's room to respond to economic shocks, the IMF said.
The oil price which Oman needs to balance its budget rose to $80 per barrel in 2012 from $62 in 2008. It is expected to climb further to $120 per barrel by 2018, exceeding currently projected oil prices, the IMF said. Brent crude oil is currently around $103.
The IMF said a projected decline in oil prices would bring a turnaround in fiscal and current account surpluses after 2015 and 2016 respectively.
"The accumulated fiscal buffers would provide initial cushion but would erode quickly," it said. "The increasing wage bill and current spending, if not contained, could endanger the government's longer term fiscal sustainability."
The IMF also said it would be difficult for Oman to put its state finances on a sustainable footing without changing subsidies, mainly on fuel, adding that domestic fuel prices should be raised gradually.
The government of Sultan Qaboos bin Said, who has ruled the country since 1970, created 100,000 new jobs in the civil and defence sectors in 2011-13, the IMF said. Gradual cuts in high public sector wages would help make private sector jobs more attractive to Omani nationals, it said.
Such measures would be politically difficult for the government, and it is not clear how Oman will respond to the IMF's advice.
In April, finance minister Darwish al-Balushi said state spending growth would slow in coming years and that in contrast to last year, Oman did not expect this year to spend more than it had originally budgeted. He did not elaborate.
While Oman's currency peg to the dollar is a strong and credible anchor, it should develop its money market and set up an issuance programme for government securities, the IMF said.
"Regular issuance of domestic treasury bills in a range of maturities would help strengthen the CBO's (central bank) ability to manage liquidity in the banking system.
"The CBO could also consider expanding the range of maturities for CDs (certificates of deposit). In addition, there is a need for introducing liquidity management tools for Islamic banks and windows."
The government is considering a proposal to issue dollar-denominated sovereign bonds sometime in 2014, the first such issue since 1997, and this could lead to regular debt sales in the future to cover any budget deficits.