Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Jordan—Aide-Mémoire for the Fifth Post-Program Monitoring (PPM) DiscussionsApril 30, 2007
We would like to thank the authorities for their warm hospitality and for the excellent policy discussions. We look forward to continued valuable dialogue in the future.
I. Recent Developments and Outlook for 2007
1. Jordan's economic performance remains strong. Real GDP grew by almost 6½ percent last year, mainly due to robust domestic demand. Although headline inflation is high, reflecting steep fuel and food price increases last year, core inflation remains low. With strong policies and continued strong inward investment, 2007 should be another good year, with 6 percent growth and a modest reduction in inflation, to less than 6 percent. (This assumes annualized monthly inflation of about 3½ percent for the remainder of the year.)
2. Although still high—almost 13½ percent of GDP last year—the current account deficit has narrowed at a more rapid pace than earlier envisaged. A broad-based slowdown in import growth and strong export performance and remittances underpin this turnaround. Reflecting ample capital inflows—mainly foreign direct investment (FDI)—the overall balance of payments surplus reached about US$1.7 billion in 2006, allowing the Central Bank of Jordan (CBJ) to increase its reserves to US$6.1 billion at end-year, equivalent to more than five months of prospective imports. Looking ahead, the underlying current account is likely to narrow by 1½ percent of GDP this year, but the overall deficit (including grants) is expected to remain practically unchanged—since budgetary grants intended for 2007 were received last year. Reserves should be close to US$6½ billion at year end.
3. The fiscal position is also sound. Stronger revenue performance, and the authorities' decision to raise domestic fuel prices last April, reduced the budget deficit to an estimated 4.4 percent of GDP, 0.9 percent of GDP lower than in 2005. The public debt-to-GDP ratio fell by more than 10 percentage points of GDP, to 72.7 percent of GDP by end-2006. Strong fiscal performance appears to have continued through the first months of this year. For 2007, the government has committed to cutting the deficit further, to 2.7 percent of GDP, including through spending cuts to offset the costs of the recent increase in public sector wages and pensions (0.7 percent of GDP in 2007).
4. Meanwhile, monetary policy remains geared towards maintaining the currency peg, by keeping interest rates in line with U.S. rates. Assuming a sound monetary policy, and the withdrawal of excess liquidity from the banking sector, broad money is expected to increase in line with nominal GDP, mainly due to net foreign asset growth, while private sector credit growth is expected to soften following large increases in recent years.
II. Policy Discussions
5. Against this positive backdrop, discussions focused on three key macroeconomic and financial challenges: (i) a large current account deficit, (ii) still-high public debt, and (iii) rapid private sector credit growth. The policy framework agreed during the recent Article IV mission remains valid, including continuing with policies that help bring public debt to below 60 percent of GDP by 2011, maintaining the peg (and tightening monetary policy should inflationary pressures become entrenched), and implementing policies that help narrow the current account deficit.1
6. Jordan's current account deficit is expected to narrow further as long as supportive economic policies are in place. These policies include sustained fiscal adjustment, cautious monetary policy, and supporting structural measures. The recent slowdown of imports is expected to persist (a return to normal import patterns in the wake of the sharp FDI- and fuel price-related increases in recent years), aided in part by an expected decline in international import prices forecast over the medium term. By contrast, exports should grow strongly, to be supported by large recent investments in the mining sector. On the capital account side, available information suggests that FDI inflows will continue to remain strong for the foreseeable future. These patterns support staff's view that the dinar remains fairly valued.
7. With a narrowing current account deficit and strong FDI inflows, Jordan's external debt burden could be halved in five years (to 26 percent of GDP) and international reserves should remain strong. Updated staff debt sustainability analysis also suggests that the external position should be robust to major shocks.
8. Assuming prudent fiscal policies, Jordan's debt burden should fall below 60 percent of GDP by end-2011, the target recently announced by the government. Under current baseline projections, the target could be reached even earlier than this. The authorities intend to reach a lower-than-targeted debt ratio by 2011. However, the cushion provided for relative to the new target—projected at about 5 percent of GDP—offers some scope to respond to large negative shocks. The mission views the achievement of Jordan's public debt target as instrumental in supporting Jordan's macroeconomic adjustment process. Given its importance, the authorities intend to incorporate this new target in a revised Public Debt Management Law soon after the new parliament convenes, following the November parliamentary elections. A medium-term path for the primary balance excluding grants will be set (including as part of the annual budget law) in line with reaching this debt target.
9. The amended 2007 budget, which targets an overall deficit of 2¾ percent of GDP, is in line with the new limit, although downside risks remain. In the absence of a fully automatic price adjustment formula for all fuel products, Jordan's budget outcome will be highly sensitive to oil price developments (these prices have increased since the budget was formulated). (Staff calculates that an oil price increase of US$5 a barrel adds about 1 percentage point of GDP to the budget deficit on an annualized basis, in the absence of corresponding domestic fuel price increases.) Higher food prices may further add to these risks, as most of the budgeted food subsidy has already been disbursed in the first quarter of 2007. Also, spending pressures may increase in an election year.
10. These short-term risks could be mitigated in a variety of ways. One step would be to introduce soon an automatic formula-based fuel price adjustment mechanism. While this may not be possible in the next few months, as a stop gap measure, consideration should be given to setting in advance a specific oil price trigger, beyond which, compensatory domestic fuel prices would be increased (the 2007 budget provides for fuel price-related social safety transfers). The mission also recommends that a set of further specific contingency measures be identified, and that these be applied as soon as the budget target appears in danger of being breached. These measures might include pre-specified cuts in transfers, and nonpriority current and capital spending. At the same time, any overperformance of revenue, including as a result of expected transfer of own-budget agencies' surpluses to the treasury as mandated by a recent law, should be saved.
11. Looking to the medium term, containing spending is key to supporting the fiscal adjustment process. Total government spending is targeted to fall by 4¼ percentage points of GDP over 2006-11. A comprehensive set of expenditure measures will be adopted to help support the debt and spending targets. Supporting structural measures, including on public financial management and improving efficiency of spending should also be put in place as soon as possible. At the same time, revenue could be enhanced by introducing petroleum product taxation, reforming the income tax regime, and further strengthening revenue administration.
12. With domestic financing requirements set to increase (winding down of Paris Club rescheduling and privatization) the authorities could expand their set of debt instruments. In particular, consideration should be given to issuing a JD-denominated international bond (including in sukuk form). Given Jordan's favorable economic circumstances and ample regional liquidity, demand for such an instrument could be high. Such a move would widen the investor base and help minimize private sector crowding out. If launched successfully, it would also mark the first domestic currency international bond issued in the region. Consideration could also be given to issuing domestic sukuks, which would likely lower funding costs. Finally, the yield curve should be extended beyond five years should conditions permit, to reducer rollover requirements and establish longer-term benchmarks for the financial sector. The Fund is willing to provide technical assistance as needed to help with the debt management process.
13. Finally, the CBJ and the Ministry of Finance (MoF) should continue to coordinate closely. In particular, the full and early disclosure of government debt instrument issuance would assist the CBJ with liquidity management and in the conduct of monetary policy more generally. The mission welcomes the ongoing discussion on issuing long-term government securities to address CBJ balance sheet weaknesses. This action will maintain the CBJ independence and credibility. Following this, and in line with the practice of most independent central banks, a clear prohibition on further government borrowing from the CBJ should be enshrined in law.
Private sector credit growth
14. While bank prudential indicators remain sound, despite last year's stock market selloff, Jordan's rapid private sector credit growth in recent years, from an already high base, calls for continued vigilance. Particular care is required with new forms of lending, which carry greater risks, such as margin and noncollateralized loans, which have been growing rapidly. Also, since the rapid lending increase of recent years has taken place during robust economic conditions, banking profitability and other indicators have yet to be tested in an economic downturn.
15. To this end, the CBJ should continue to build on the major progress it has already made in improving the supervisory framework. The measures that have already been taken by the CBJ on this front include stepped up on- and off-site supervision, and the introduction of an early warning system and a prompt corrective action framework. Banks have also been required to strengthen their risk management systems and stricter provisioning rules have been introduced. Looking ahead, the planned introduction of electronic checking clearance will help strengthen the payments system. To complement these actions, it is important that the new Credit Bureau and Anti-Money Laundering legislation be adopted as soon as possible. To help build on this progress, the authorities could request soon a focused Financial Sector Assessment Program (FSAP) update for the second half of the year.
16. On a related issue, the mission welcomes the CBJ's plans to simplify the interest rate structure and thus enhance the conduct of monetary policy. For a start, the mission supports the CBJ intention to narrow its interest rate corridor (which could help stabilize interbank interest rate volatility and allow for stronger monetary signals), and suggests to bring the repo rate slightly below the discount rate to reflect differences in maturity. Clear communication to the public, commercial banks, and other market players that this does not represent an easing of monetary conditions is critical. The use of collateralized, as opposed to unsecured (using the Master Repurchase Agreement), together with continued removal of excess liquidity by the CBJ through the issuance of certificates of deposit, would help promote a deep interbank market.
17. Decisive steps are needed to accelerate public financial management reforms. For a start, and following the initial progress made, the remaining steps for establishing a Treasury Single Account should be completed soon. Budget coverage and classification could also be improved to make the budget a more comprehensive tool for macrofiscal management. Other outstanding reforms include fully operationalizing macrofiscal function at the MoF, developing medium-term expenditure framework, and implementing a government financial management information system (GFMIS). Finally, in view of the potential private sector involvement in new infrastructure projects, the primary focus should be on strengthening public investment planning, creating appropriate legal and institutional framework with proper accounting and transparent disclosure of fiscal risks, as well as a strong role for the MoF in safeguarding public finances.