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July 4, 2000
Mr. Horst Köhler
International Monetary Fund
700 19th Street NW
Washington, D.C. 20431
Dear Mr. Köhler:
The attached Memorandum on Economic and Financial Policies reviews recent economic and policy developments, updates the medium-term framework set out at the time of the first review under the extended arrangement, and specifies the government's macroeconomic and structural policies constituting the 2000 program. The government believes that performance in relation to the 1999 program was successful, and that the policies proposed for the current year are consistent with sound medium-term economic objectives. Accordingly, we hereby request completion of the second review.
The program envisaged that legislation modifying the General Sales Tax (GST) to convert it into a value added tax would be submitted to parliament before the end of March 2000. However, the last ordinary session of parliament had to consider first other amendments to the GST law in the context of Jordan's accession to the WTO. As approval of the WTO-related amendments took longer than expected, submission of those related to the VAT was delayed. We have recently submitted them to an extraordinary session of parliament, and they are currently under consideration. On this basis, the government requests a waiver for the non-observance of the end-March structural performance criterion.
The government stands ready to take, in consultation with the Fund staff, any additional measures that may be required to achieve the program's objectives. The government will also continue to provide the Fund staff with any information that may be relevant to the assessment of policy implementation and performance under the program.
Minister of Finance
Ministry of Finance
Central Bank of Jordan
Attachment: Memorandum on Economic and Financial Policies
Memorandum on Economic and Financial Policies, 2000
1. This Memorandum reviews key economic and policy developments thus far under the extended arrangement, updates the medium-term framework, and specifies the government's macroeconomic and structural policies constituting the 2000 economic program. As detailed below, the government believes that performance under the 1999 program was successful, and that the policies proposed for the current year are consistent with sound medium-term economic objectives.
I. Developments Under the 1999 Macroeconomic Program
2. The government is satisfied with the progress made in strengthening macroeconomic policies in 1999, although economic growth was adversely affected by the severe drought and the continued impediments to regional trade. The adoption of the new program in early 1999, and its steady implementation on a broad policy front, contributed most notably to a rebound in the demand for the Jordanian dinar, which was translated into a substantial buildup of official foreign exchange reserves and lower interest rates. At the same time, year-on-year CPI inflation amounted to only 0.6 percent in 1999, substantially below the 1998 level (3.1 percent). Real GDP growth is estimated at 1.6 percent, compared with the original forecast of 1.2 percent, as better-than-projected performance of non-agricultural sectors more than offset a 20 percent decline in agricultural output due to the drought.
3. The fiscal target for 1999 was achieved with a comfortable margin. The overall fiscal deficit amounted to 7.4 percent of GDP, compared with the program target of 7.9 percent of GDP. The deficit after grants was equivalent to 3.6 percent of GDP, 0.6 percent of GDP below the program projection; also excluding rescheduled interest from expenditure, the deficit amounted to 2.2 percent of GDP. This, combined with an increase in external loan disbursements, contributed to a sharp reduction in the government's domestic borrowing requirement, from 6.2 percent of GDP in 1998 to 1.6 percent in 1999.
4. Prudent monetary policy during 1999 contributed importantly to the recovery in confidence and the rebound in the demand for the dinar after the uncertainties of late 1998 and early 1999. The principal source of monetary expansion, which totaled 12 percent over the year, was a rapid accumulation of net foreign assets by the banking system, reflected mainly in a pronounced growth of dinar deposits. The banking system's net domestic assets increased only marginally due to low recourse to bank borrowing by the budget and relatively slow growth in credit to the private sector. The Central Bank of Jordan's (CBJ) net foreign asset position strengthened substantially, while its net domestic assets contracted, reflecting the absorption of liquidity by the CBJ and the low government borrowing needs. With the return of confidence and the strengthening of the external position, the CBJ was able to reduce the benchmark 3-month CD rate to about 6 percent, more than 400 basis points below the level prevailing early in the year; retail interest rates began to decline as well.
5. Regarding the balance of payments, the external current account recorded a surplus of 5.2 percent of GDP in 1999. This high surplus included UN compensation transfers of 3.3 percent of GDP to Jordanians who had incurred losses stemming from the Gulf crisis. The trade deficit was narrower than projected, as lower growth of exports of phosphates, fertilizer, and agricultural products was more than offset by lower imports, especially in the first quarter. The current account outturn also reflected a higher than anticipated level of foreign grants. Strong private capital inflows started in the second quarter of the year as confidence returned, contributing to a substantial capital account surplus. Official foreign exchange reserves reached an unprecedented US$2 billion (almost 7 months of imports and more than 25 percent of JD broad money) by the end of 1999; reserves were boosted in early 2000 by the sale of shares in the Jordan Telecommunications Company (JTC), and they now stand at US$2.6 billion.
II. Implementation of Structural Policies
6. Over the past year, the government has made sustained efforts in structural reform, emphasizing fiscal transparency, steps to raise efficiency in the public sector, financial sector reform, trade liberalization, and privatization.
- In the fiscal area, the government accounts with the banking system have been reclassified, and the fiscal monitoring unit created last March is publishing a monthly report on budgetary developments.
- Regarding the public sector, the operations in the Amman area of the Water Authority of Jordan (WAJ) have been placed under private management, and the Aqaba Railway has been leased to a foreign company. Moreover, as a prelude to privatization, the Royal Jordanian airline (RJ) and the National Electric Power Company (NEPCO) are undergoing major restructurings.
- In the area of financial sector reform, we introduced last fall a regular series of government securities auctions, which has become the main form of domestic borrowing for the budget, and allowed the stock of non-interest bearing credit from the CBJ to government to be reduced significantly. In an effort to promote competition between banks and reduce lending rates, we have recently required banks to publish their prime lending rates, deregulated their commissions, and reduced reserve requirements (from 14 percent to 12 percent). In October, to help stimulate the interbank foreign exchange market, the CBJ reintroduced a spread of 0.3 percent between its buying and selling rates for the U.S. dollar (it had bought and sold dollars at its official selling rate since 1996); since then, the interbank foreign exchange market has become noticeably more active.
- In the trade area, the maximum import tariff rate was reduced to 35 percent in July 1999 (from 40 percent), and a further reduction to 30 percent was implemented in April 2000. Tariffs on imported inputs have been cut to low levels or eliminated, and taxes on imported cars have been cut by almost half.
7. Jordan became a member of the WTO on April 11, 2000. As part of the membership process we have undertaken several reforms, notably enactment by parliament of legislation harmonizing GST rates on domestic and imported goods, amendments to the customs law, and passage of a new law on intellectual property rights.
8. The privatization program has picked up momentum. Following the privatization of Jordan Cement Factories in late 1998, the Jordan Investment Company (JIC) divested its shares in 10 companies during 1999 and, in the largest privatization to date in Jordan, the government sold last January a 40 percent stake in JTC to a French-led consortium that will play a leading role in the company's management. In addition, the Social Security Corporation bought an 8 percent stake in the company, and a further 1 percent of shares will be sold to the employees. Meanwhile, enabling steps have been taken for the sale of RJ and privatization in the power sector. The legislation necessary to create the RJ airline company and privatize it was presented to parliament late last year and is currently under consideration. Concurrently, bids for the duty-free shops and for the flight training operations have been received, and potential strategic partners for the airline have been approached. In the power sector, the above-noted restructuring of NEPCO has entailed the transfer of its former generation and distribution functions to two newly created companies—the Central Electricity Generation Company (CEGCO) and the Electricity Distribution Company (EDCO), which operate independently and are targeted for privatization. Moreover, legislation was passed that will allow a strengthening of the regulatory framework for the sector, and the government has received bids from prospective independent power producers (IPPs) for construction of a power plant.
III. Medium-Term Setting and Policies for 2000
9. The government's economic program aims to raise substantially economic growth, reduce unemployment, and fight poverty. Maintaining financial stability and enhancing the environment for private sector activity are essential for improving growth performance. Accordingly, we remain committed to bringing down the fiscal deficit, lowering the public debt burden, and continuing to pursue a prudent monetary policy as essential elements of our strategy to increase investor confidence in the Jordanian economy. In addition, the government will further advance its wide-ranging program of structural reforms.
10. As regards the medium-term macroeconomic outlook, we hope that real GDP growth will accelerate to at least 3 percent in 2000 and to 4 percent or more by 2002, on the basis of a rebound in agricultural production, the impact of large mining projects, development of the tourism sector, and investment stimulated by the structural reforms. Favorable developments in the region could enable substantially higher growth to be achieved. Inflation should remain subdued throughout the period. Following the large increases during 1999 and early 2000, official foreign exchange reserves are targeted to remain at comfortable levels.
11. A prudent fiscal stance is central for the achievement of our macroeconomic objectives. A key consideration in this regard is the need to diminish steadily Jordan's high public debt burden. However, we are also mindful that an unduly rapid fiscal adjustment would have a negative effect on growth and employment. Taking these considerations into account, we have targeted a budget deficit before grants of 7.0 percent of GDP in 2000 (2.2 percent of GDP after grants). Looking ahead, we intend to reduce the budget deficit before grants to 6.0 percent of GDP in 2001 and 5.0 percent of GDP by 2002. In addition to the budget deficits, there will be limited spending from privatization proceeds as detailed in paragraph 23. On this basis, the ratio of total public and publicly guaranteed debt to GDP should decline substantially over the same period. The government believes that the proposed path for the deficit is appropriately ambitious if account is taken of the budgetary costs associated with structural reforms and of the likely levels of grant finance in future years.
A. Macroeconomic Policies
12. In the absence of measures, the fiscal position ran the risk of deteriorating substantially in 2000. This was due, most importantly, to the sharp increase in the import price of oil and the associated reduction in the projected "oil surplus" accruing to the budget, by about 2 ½ percent of GDP compared with 1999, which was not fully anticipated at the time of the budget exercise. In addition, several important structural reforms—the reduction in customs tariffs, the privatization of JTC, and the issuance of government securities to replace interest-free advances from the CBJ—will result in net losses to the budget of about 1 percent of GDP. The budget adopted by parliament in January contained measures that would offset these losses by about 1 percent of GDP, including elimination of the remaining food subsidy, increases in a number of fees, and land sales by the Jordan Valley Authority; subsequently, the government has introduced a tax on airline tickets and increased jet fuel prices, with a combined yield of JD 12 million (0.2 percent of GDP) in 2000. To close the remaining gap in relation to the budget deficit target, we are committed to expenditure savings relative to the budgetary allocations totaling 2.0 percent of GDP, evenly split between the public investment program and current expenditure. In the first quarter of 2000, the budget deficit amounted to 1.3 percent of annual GDP, and we are confident that the deficit target for the year will be reached.
13. As regards the financing of the budget deficit, all domestic borrowing is being conducted according to the announced schedule of government securities auctions. We are committed to auctioning, during 2000, at least JD 644 million in treasury bills and JD 80 million in treasury bonds, as a result of which the outstanding stocks of these securities will increase, respectively, by JD 90 million and JD 40 million by the end of the year. Auction proceeds in excess of the government's domestic financing needs are being allocated to the retirement of interest free advances obtained in the past from the CBJ as a further step towards their eventual elimination.
14. Monetary and in particular interest rate policy will continue to be guided primarily by the objective of maintaining the stability of the Jordanian dinar. Consistent with this approach, we have recently raised official interest rates slightly in reaction to the rise in U.S. interest rates, which has contributed to the stability of international reserves. For the year as a whole, we will target an increase in the CBJ's net international reserves by at least JD 258 million (Table 1), largely reflecting receipts from abroad related to the JTC privatization. Since the recovery of money demand after the uncertainties of early 1999 is believed to have run its course, and based on developments in the first four months of 2000, broad money growth is expected to decelerate this year to about 8 ½ percent. This would still allow for ample credit to the private sector to finance the prospective pick-up in investment and business activity. Consistent with the objectives for monetary policy and international reserves, and in the light of the reduction in reserve requirements as of March, the net domestic assets of the CBJ are expected to contract over the year by at least JD 262 million (Table 1). With the decline in money market interest rates over the past year, we expect that commercial bank lending rates will come down further during the next few months, a trend that should encourage economic expansion.
15. In 2000, the surplus on the external current account is expected to fall from the high level in 1999. Higher oil prices, the reductions in customs tariffs, the import of capital goods for mining projects, and the weak outlook for the world market for phosphates will likely outweigh the expected growth in nontraditional exports and a substantial increase in foreign grants. Indeed, the trade deficit in the first four months of 2000 was US$150 million larger than in the corresponding period in 1999, with imports rebounding by 17 percent and exports rising by 3 ½ percent in value terms. These factors will be significantly offset by a higher inflow of UN compensation transfers in 2000, as evidenced by developments in the first quarter, when US$219 million of such transfers were received. In contrast, the capital account surplus is expected to increase, primarily on account of the large inflow resulting from the recent sale of JTC shares. This places us in a position to use debt buyback operations at discount and debt swap arrangements, as favorable opportunities for such transactions arise, to reduce the debt and interest burden. Given the high level of official foreign exchange reserves and the outlook for the balance of payments, the program will target the maintenance of reserves at around their present level.
B. Structural Policies
16. We envisage that the pace of structural reforms will intensify in the period ahead as we build on the foundation laid down since early 1999. This will touch, inter alia, the areas of taxation, energy pricing, pensions, public debt management, development of the money and capital markets, bank soundness, and privatization.
17. In the area of tax policy, we intend to convert the General Sales Tax (GST) into a full-fledged VAT and to reform the income tax. The government has submitted to parliament during the extraordinary session convened on May 21 the "second stage" amendment to the GST law, which will convert this tax into a VAT. According to the proposed amendment, the list of exemptions under the GST will be reduced substantially. The amendments to the income tax law are being finalized in time for their submission to parliament at the start of the next ordinary session in November, with a view to implementing the reform in the context of the budget for 2001. Their purpose is to rationalize the income tax system by harmonizing and simplifying tax rates, and broadening the tax base.
18. Recent developments in the oil market have demonstrated the vulnerability of the budget to fluctuations in oil prices. We are requesting Fund technical assistance to help design a mechanism to address this vulnerability. We expect that the government will adopt later this year an oil pricing strategy drawing on this study.
19. The public pension system, in its current form, poses a steadily increasing burden on the budget. In recognition of these drawbacks, the government is preparing a reform of the public pension system, with the ultimate goal of bringing public sector employees within the framework of the Social Security Corporation (SSC), while preserving the financial viability of the SSC. A draft strategy will be prepared by the Ministry of Finance to be presented to the cabinet by end-December 2000.
20. The government is at the early stages of designing, with technical assistance from the World Bank, public sector reforms whose primary objectives would be to improve the delivery of public services, in particular in the areas of health and education. In this context, action plans are being prepared in the areas of, inter alia, service delivery, financial management, procurement procedures, human resource management, institutional accountability, and judicial reform.
Financial sector reforms
21. Priority is being attached to the further development of the money and capital markets. As noted, we are implementing during 2000 a schedule for auctioning government securities within the limits of the public debt law. However, as these limits hinder public debt management, we intend to prepare and submit to parliament, at the start of the next ordinary session in November, a revised public debt law that will provide a more comprehensive framework for the issue or assumption of public debt in all forms within prudent limits, and rationalize the tax treatment of different instruments for government borrowing. Concerning the interbank foreign exchange market, we will make merely indicative rather than mandatory the CBJ's announced exchange rates of the Jordanian dinar against currencies other than the U.S. dollar; and increase the minimum size of foreign exchange transactions between the CBJ and commercial banks. To upgrade the large value payment system, we plan to begin installing a real time gross settlement system later this year, and have it operational in the first half of 2001.
22. We will continue to strengthen the prudential regulation and supervision of the banking system so as to promote the sound development of the sector. In particular, we will introduce a new regulation defining commercial banks' maximum foreign currency exposure relative to their capital, in accordance with international best practice. We are also phasing in over three years a requirement for banks to classify as impaired, and make provisions against, all loans more than 90 days past due, as against 180 days previously; already in 2000 we have reduced the criterion to 150 days past due. The current special session of parliament is considering the new banking, deposit insurance, and insurance companies laws.
23. The government regards privatization as one of the centerpieces of its structural policy agenda. The Privatization Law just approved by the Lower House of parliament establishes a Privatization Council to oversee the privatization strategy and to decide on the use of privatization proceeds, an Executive Privatization Commission, and a Privatization Proceeds Fund. It also specifies the purposes for which privatization proceeds can be spent, namely: infrastructure projects; social programs; and support to workers affected by the privatization process. Consistent with the government's strategy to avoid unsustainable increases in public expenditure as a result of privatization, the bulk of the proceeds will be invested in financial assets or used to retire public debt. However, in support of its growth and poverty reduction objectives, the government intends to use up to 15 percent of the proceeds for high quality spending on infrastructure and social sectors. In this context, an amount of up to JD 27 million could be spent in 2000; in selecting projects, we will ensure that due consideration is given to the implications for future recurrent costs. Spending in later years out of privatization proceeds will be the subject of the next program review in light of the amount spent in 2000, possible additional privatization proceeds, and the opportunities for debt buybacks. At this stage, we project that the overall fiscal deficit, which includes spending out of privatization proceeds, will not exceed 7.5 percent of GDP in 2000, 6.3 percent of GDP in 2001, and 5.3 percent of GDP in 2002. Spending from the Privatization Proceeds Fund will be specified in the budget law, subject to the normal budgetary audit procedures, and reported to parliament.
24. Following the successful sale of JTC shares in early 2000, the main focus of the privatization program will be on the Royal Jordanian airline and the power sector. Concerning RJ, we hope to complete the sale of its duty free subsidiary by end-July, of the flight training subsidiary by end-September, and of its catering, engine overhaul, and aircraft maintenance subsidiaries, as well as of various shareholdings by the end of the year. Proceeds from these sales will go to retire RJ's domestic debt. RJ flight operations were profitable in 1999, and we are continuing to improve its route structure and financial structure so as to increase future profitability. We are actively marketing the airline to potential strategic partners, but if no attractive partner can be found we will pursue the option of offering shares to a consortium of financial investors and airline management consultants. In the near future we expect parliament to revoke Decree Number 10 of 1969 (which chartered RJ as a public entity), so that RJ can be formally corporatized prior to privatization.
25. The next steps in the reform of the power sector are selecting the IPP, completing the process of separating EDCO and CEGCO from NEPCO, and putting in place the regulatory commission. The IPP will be chosen by end-July, which will allow groundbreaking for the new power plant in early 2001. The government has retained a consultant to review the separation effected last year of the assets of NEPCO, CEGCO, and EDCO, and to help design a definitive power purchasing agreement between CEGCO and NEPCO that will be in effect in early 2001. Meanwhile, the government is in the process of retaining an advisor to help in specifying, by the end of the year, the steps that will be needed to make the regulatory commission fully operational, and the modalities for privatization of CEGCO and EDCO.
26. We are also pursuing privatization schemes in a number of other sectors. We are already in the process of corporatizing the operation of Ministry of Industry and Trade storage facilities such as silos and cold storage units with a view to their privatization later this year or early in 2001. The JIC expects to sell its shares in an additional eight companies during 2000. WAJ is preparing to offer a private management contract for its operations in the Wadi Mussa region, and a build-operate-transfer arrangement for the development of a waste-water treatment facility in the region of Amman; WAJ management is also studying the scope for the introduction of private management and capital into other projects, such as a desalination plant. Before year-end, we will conduct a preparatory study for the awarding of a private management contract for operation of the postal service.
27. The Social Productivity Program remains the cornerstone of our anti-poverty efforts. To ensure effective implementation, a special unit has been established at the Ministry of Planning to coordinate, monitor, and evaluate the implementation of the program's four components—the National Aid Fund, the Small and Micro Enterprises Development Program, the Training and Employment Support Program, and the Community Infrastructure Development Program. In addition, a Family Income Supplement scheme has been introduced with the objective of bridging the gap between the current income levels of poor working households and the absolute poverty line.
IV. Program Monitoring
28. Purchases under the extended arrangement will continue to be subject to the observance of performance criteria, completion of program reviews, and a continuous performance criterion on the non-accumulation of new external payments arrears. In addition, the government will not impose restrictions on payments and transfers for current international transactions, introduce multiple currency practices, conclude bilateral payments arrangements that are inconsistent with Article VIII of the Fund's Article of Agreement, or impose import restrictions for balance of payments reasons.
29. The quantitative performance criteria for end-September and end-December 2000 are specified in Table 2. They apply to changes in net international reserves and net domestic assets of the CBJ; the change in net bank claims on government; spending out of privatization proceeds; stock of public and publicly guaranteed short-term external debt; and the contracting of nonconcessional medium- and long-term public and publicly guaranteed external debt (with a sub-ceiling on the contracting of debt with a maturity of up to and including 5 years). Table 1 also specifies indicative targets for the budget deficit after grants and for domestic budgetary revenue excluding grants and privatization receipts. The program also includes structural performance criteria and benchmarks, which are specified in Table 2. Progress in implementing the domestic oil pricing strategy will be the subject of program reviews. Quantitative performance criteria and indicative targets, and structural performance criteria and benchmarks, for 2001 will be specified in the context of the third program review.