For more information, see Jordan and the IMF
August 28, 1999
Mr. Michel Camdessus
Dear Mr. Camdessus:
1. The Jordanian authorities have held discussions with the Fund staff in the context of the first review of the program supported by the extended arrangement. On the basis of these discussions, this letter describes the key developments to date under the program and the outlook for the remainder of 1999. As detailed below, the government believes that performance has been satisfactory and that the program objectives for 1999 set forth in our Memorandum on Economic and Financial Policies of March 31, 1999, will be achieved.
2. Following a pause early in the year, available indicators point to some pickup in non-agricultural activity in recent months. The index of manufacturing output has increased significantly, mining production has risen markedly, and indicators of construction activity are positive. Demand for credit by the hotel, restaurant, and tourism sectors was up sharply in the first half of the year (by more than 40 percent) over the same period last year. The rise in imports in the second quarter also suggests a pickup in activity. For the year as a whole, non-agricultural GDP is projected to grow by about 2½ percent. However, real value-added in agriculture (which accounts for about 5 percent of GDP) is expected to fall by about 20 percent on account of the severe drought. On this basis, the overall growth rate of real GDP is projected to be in line with the program, at about 1½ percent. Regarding prices, cumulative CPI inflation amounted to only 0.6 percent during the first six months of 1999, compared with the program projection of 2.2 percent for the same period. As a result, the forecast for year-on-year CPI inflation in 1999 has been lowered to 1.5 percent (from 1.9 percent).
3. During the first half of the year, the budget deficit (excluding grants) amounted to JD 152 million, substantially below the program indicative target of JD 209 million. Budgetary revenue was slightly higher than programmed, reflecting successful efforts at improving income tax, customs, and GST collection, which more than offset shortfalls in other tax and nontax revenue. Current expenditure was below the programmed level owing to restraint in the first quarter over almost all categories of expenditure. Gross lending to public enterprises was also below the programmed level as some enterprises were able to meet debt service payments without support from the budget. The overall fiscal deficit was virtually the same as the budget deficit as the net drawdown from non-Treasury accounts was close to zero. These developments, combined with higher-than-expected external financing, allowed us to keep government recourse to domestic bank financing at a negligible level, far below the program ceiling for the January-June period.
4. On June 20 Parliament approved an increase in the GST rate from 10 percent to 13 percent, larger than committed under the program, and reduced the number of goods exempted from the GST. At the same time, government and military wages and pensions were raised by JD 10 per month for monthly wages and pensions falling below JD 150, and by JD 7 for those falling between JD 150 and JD 250. These two measures became effective through a royal decree issued on July 20, 1999, and were accompanied by the reduction of the maximum import tariff rate from 40 percent to 35 percent envisaged in the program and a reduction of import tariffs on intermediate goods to 10 percent. Subsequently, tariffs on computer equipment and several luxury goods that are highly prone to smuggling were reduced to 0-5 percent; the latter is expected to have some favorable impact on revenue as a larger share of these imports enters the country through formal channels.
5. Taking into account the developments in the first half of the year and the measures that were not envisaged in the program, we believe that the overall fiscal deficit will be within the target of 7.9 percent of GDP. Budgetary revenue is expected to be broadly in line with the program reflecting the strength in the customs and GST areas, which would offset shortfalls in nontax revenues. Budgetary expenditure is also expected to be higher because of the recent salary increase and outlays on drought relief (estimated, respectively, at JD 16 million and JD 13.6 million). As a result, the budget deficit would exceed the indicative target in the program by JD 21 million. However, this would be more than compensated for by a lower-than-projected net drawdown from non-Treasury accounts, which would contain the overall fiscal deficit to the equivalent of 7.8 percent of GDP in 1999.
6. Monetary data show a reversal of the negative developments earlier in the year, which had been marked by weak demand for the Jordanian dinar and loss of official foreign exchange reserves. Broad money expansion, at 4.8 percent during January-June, was somewhat above the trend envisaged in the program but consisted entirely of a sharp rebound in dinar deposits, while foreign currency deposits remained stable over the same period instead of increasing as assumed in the program projections. The monetary expansion comprised a much lower-than-programmed net domestic asset expansion and a considerably larger-than-programmed improvement in the net foreign asset position of the banking system. Despite a rapid buildup in official foreign exchange reserves, end-June reserve money was only slightly higher than projected in the program, reflecting a concerted sterilization effort by the Central Bank of Jordan (CBJ) through substantial net issues of certificates of deposit (CD) together with additional absorption of liquidity through the overnight facility.
7. As a result of the strong recovery in the demand for the dinar, the CBJ has started to gradually ease interest rates: at the CD auction of August 15, the interest rate on three-month CDS was 7.6 percent, about 175 basis points below the level prevailing at the inception of the program. The CBJ will continue to manage interest rates cautiously, taking into account the growth objective. In this context, the CBJ stands ready to implement upward interest rate adjustments if this were required to maintain confidence in the dinar.
8. In view of the monetary developments thus far, the projected monetary expansion in 1999 is being revised upward to 8.2 percent, compared with 6.0 percent in the original projection. Such a revision would be commensurate with the already realized higher monetary expansion. At the level of the CBJ, reserve money would grow by 8.3 percent, somewhat above the programmed growth of 7.1 percent, and supported by a stronger external position. These considerations would be reflected in the quantitative performance criteria relating to the balance sheet of the CBJ that are to be established in the context of the present review of the program. Specifically, we propose that the end-December floor on the change in net international reserves of the CBJ be set at JD 220 million and the ceiling on the change in CBJ's net domestic assets at minus JD 115 million.
9. Developments in the balance of payments were substantially better than programmed for the first half of 1999, with an external current account deficit (before grants) of US$120 million, compared with the projected deficit of US$319 million. Exports were in line with the program as solid increases in manufactured exports (10 percent) and traditional exports (9 percent) compensated for declines in exports of several food items due to the drought. Imports were substantially below programmed levels, reflecting a sharp, broad-based fall in the first quarter, but import growth returned to a more healthy pace in the second quarter reflecting the return of confidence, as well as a sharp pickup in food imports due to the drought. Receipts of foreign grants amounted to US$141 million. In the capital account, the large private capital outflows recorded in the first quarter were reversed in the second, consistent with the return of confidence, and the private capital account registered a surplus in the first half. The overall balance registered a surplus of US$94 million (compared with the projected deficit of US$209 million). This, combined with the shift in net foreign assets from the commercial banks to the CBJ (associated with the de-dollarization), contributed to a strong buildup of official foreign exchange reserves to US$1.88 billion as of August 12 (compared with the end-June program target of US$951 million).
10. The external current account deficit is projected at 4.9 percent of GDP, somewhat below the programmed level. This would be on the basis of a slight upward revision in projected exports, due mainly to the favorable outlook for traditional exports, the expected positive impact of higher oil prices on regional exports of nontraditional goods, and a continued recovery in imports from the low levels of the first quarter. The pickup in imports would reflect the rise in world oil prices, an increase in food imports due to the drought, and imports for several new and large investment projects in the mining sector. The smaller current account deficit would be accompanied by a more favorable capital account and a larger amount of debt rescheduling provided by the Paris Club agreement than originally envisaged. These factors, combined with the noted shift of foreign assets within the banking system, would bring official foreign exchange reserves to about US$1.8 billion, compared with the original projection of US$1.2 billion.
11. The government has made significant progress in implementing the structural policy component of the program, which emphasizes tax and financial sector reforms, improvements in tax administration and expenditure control, trade liberalization, and privatization. In the fiscal area, 100 assessors and data analysts have been recruited to strengthen the income tax department; and a decision has been taken not to commit new expenditures after December 15 (to avoid an increase in the float). In the financial sector, a new Banking Law and a Deposit Insurance Law have been submitted to Parliament and are expected to be considered in the next ordinary session. In the external sector, import tariffs have been reduced as described above. In the public enterprise reform and privatization area, cabinet has approved the strategies for privatizing the Jordan Telecommunications Company (JTC) and the Royal Jordanian (RJ) airline, as well as an agreement with a private consortium on the operation and extension of the Aqaba railway. In the power sector, the generation and distribution functions have been given to two newly created companies that will be targeted for privatization; the National Electric Power Company (NEPCO) will continue to be responsible for transmission. As programmed, the Jordan Investment Corporation (JIC) sold by end-June its shares in three manufacturing enterprises.
12. The government expects that substantial further progress will be made in structural policy implementation before the end of the year. In the fiscal area, a reform of the income tax is currently being prepared for submission to Parliament in its next ordinary session. The main areas addressed by the reform are: the unification of the corporate tax rates; the simplification of the personal income tax with a view to making it more equitable; the simplification of the tax treatment of dividends and interest income; and the rationalization of investment incentives. Preparation for the introduction of the value-added tax (VAT) during 2000 is underway, and we have recruited 100 assessors for the VAT administration. Given the heavy legislative agenda in the coming months (see paragraph 14 below), we will submit the draft VAT law to the Legislation Council by end-December, and to Parliament by end-March 2000. In addition, we have requested technical assistance from the Fund on civil service pension reform, and intend to move ahead with work in this area in the coming months.
13. In the financial sector, we intend to promote the development of a deeper and more active government securities market, which will not only contribute to the development of Jordan's financial markets but also facilitate a more efficient government debt management, enhance fiscal transparency, and reduce the cost of conducting monetary policy. To this end, we plan to issue government securities (Treasury bills and bonds), covering an appropriate maturity span, through regular auctions starting in September 1999. During September-December 1999, the amounts auctioned will raise the outstanding stocks of Treasury bills and bonds by at least JD 50 million and JD 19 million, respectively. Further increases are envisaged during 2000, by at least JD 50 million for the stock of Treasury bills and JD 80 million for that of Treasury bonds. Treasury bills and bonds will be the sole source of domestic financing for the budget. The proceeds exceeding the financing need will be used to retire the CBJ's ordinary and extraordinary advances to government. The government intends to propose amendments to the Public Debt Law in 2000, with a view to relaxing the limits on the issuance of government securities. It is understood that, in discussing the fiscal plan for 2000 in the context of the next program review, the interest cost (net of profit transfers from the CBJ, if any) associated with increases in the outstanding stocks of government securities over their end-August 1999 levels will be excluded from budgetary expenditure in assessing the degree of fiscal adjustment. The procedures relating to government securities auctions are being specified with Fund technical assistance.
14. In the external sector, the government plans to continue efforts to attain membership in the World Trade Organization. To this end, several laws will be considered in an extraordinary session of Parliament, mainly in the area of intellectual property rights. Moreover, the extraordinary session of Parliament will consider the Euro-Mediterranean Association Agreement.1 The cabinet will continue to refrain from granting new exemptions from customs duties; exemptions previously granted by cabinet are being reviewed with the objective of scaling them back.
15. In the privatization area, the government expects to advance on several fronts during the remainder of 1999:
17. The government is making determined efforts to ensure significant improvements in statistics and fiscal monitoring. Following the creation of the Fiscal Monitoring Unit (as a prior action for the program), the Ministry of Finance is now issuing a monthly bulletin of fiscal statistics. The Department of Statistics is making progress in a number of areas, such as the estimation of a producer price index; the government appreciates the technical assistance that the Fund has been providing in this area. As regards fiscal monitoring, the Ministry of Finance and the CBJ have completed a reclassification of government accounts with the banking system, on the basis of which monthly data is being produced internally and the CBJ plans to introduce changes to its published monthly monetary data beginning in January 2000. The next step in this area is a review of the sources and uses of non-Treasury accounts as a basis for incorporating them, when appropriate, into the measurement of government revenues and expenditures; this work will be undertaken later this year with Fund technical assistance.
18. As regards the program's conditionality, all quantitative performance criteria for end-June 1999 were met (Table 1). In particular, net credit to government (excluding holdings of Brady bonds) based on published CBJ data amounted to JD 11 million, compared with the adjusted program ceiling of JD 117 million. On the basis of the revised classification of government accounts, net credit to government amounted to minus JD 0.5 million, which excludes JD 11.5 million in net credit to entities that are no longer part of the budget (mainly JTC) and includes JD 0.8 million in net credit to entities that have been reclassified as part of the budgetary government, as well as a minor statistical discrepancy. Given that data is available under the revised classification from December 1998, the government proposes that, from now on, compliance with the performance criterion on net credit to government be assessed on the revised basis.
19. With respect to the structural conditionality, the increase in the GST rate and reduction in the maximum import tariff rate (an end-June structural performance criterion) became effective in July. The increase in the GST rate was passed by Parliament in June but the issuance of the corresponding royal decree and the publication of the amended law in the Official Gazette took place in July, which also implied a short delay in the related executive action on the maximum import tariff. In this regard, the government notes that the substance of the commitments under the program have been strictly adhered to, and requests a waiver for the fact that the programmed actions did not become effective by the June 30 test date. In addition, as explained in paragraph 12, submission of the VAT law to Parliament is now expected to take place by end-March 2000; accordingly, the government requests a modification of the corresponding structural performance criterion to reflect the revised date for completion of this action.
20. The government believes that the policies set out in this letter are appropriate in light of the objectives of the program and, on this basis, hereby requests completion of the program review. It stands ready to take measures in consultation with the Fund as may be needed to advance the program objectives.