Public Information Notice No. 04/46

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Jordan

April 28, 2004

On April 2, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Jordan.¹

Background

Recent economic developments point to a recovery from the disruptions caused by the war in Iraq. Real GDP growth slowed down to 3 percent in the first nine months of 2003, due to the disruption of exports to Iraq and the negative effects of the conflict on tourism and transportation. Economic growth picked up to 3.5 percent in the fourth quarter of 2003, supported by a significant jump in exports in the last two months of 2003. The recovery is being supported by a boom in export growth from the Qualified Industrial Zones, with exports to the United States growing by 56 percent over the last 12 months. A fiscal stimulus through higher public spending funded through grants also contributed to the recovery in domestic demand. Inflation remains subdued. The Amman Stock Exchange reached record highs in February 2004 on expectations of a positive outlook for the medium term. Unemployment, however, remains stubbornly high at 13.9 percent as result of the rapid growth of the labor force, in part due to an increased participation rate.

The fiscal deficit in 2003 was lower than the program limit, as spending overruns in the areas of defense and security and accelerated capital spending were offset by higher foreign grants. The overall deficit was JD 73 million (1.1 percent of period GDP), compared to a deficit target of JD 175 million under the program. Budgetary revenues were somewhat lower than programmed, with higher tax revenues partly offsetting nontax revenue shortfalls. In particular, general sales tax collections increased strongly, boosted by high import growth and improved revenue administration. Capital spending was higher than programmed. Military spending and current transfers registered sizable overruns, reflecting the difficult geopolitical situation in the region and the need to compensate economic sectors adversely affected by the war in Iraq. Capital spending was accelerated by 39 percent in comparison with the preceding year in order to stimulate slack in the domestic demand in the aftermath of the Iraq war.

The external current account registered a large surplus in 2003, reflecting a surge in grant receipts and the underlying strength of the balance of payments. Exports grew by an annual rate of 8.2 percent, despite the disruption of exports to Iraq during the war. Nontraditional exports fared particularly well, including textiles and apparel mainly to the U.S. market. Re-export activity to Iraq rebounded strongly in the second half of the year. The strong export performance was only partly offset by faster-than-anticipated import growth (10.8 percent), reflecting a pickup in domestic demand and higher oil imports. Tourism receipts recovered in the second half due to an increase of regional visitors and official and business travels related to the situation in Iraq, while remittances grew by 4 percent. With grant receipts of almost US$1.3 billion (13 percent of GDP), the external current account surplus for 2003 is estimated at 11.1 percent of GDP. Meanwhile, public sector loan disbursements were lower than programmed and net private capital flows registered a strong surplus of US$694 million. As a result, gross official reserves increased by US$1.2 billion to reach US$4.7 billion, which is equivalent to about 10 months of prospective import cover. The real effective exchange rate depreciated by 8.3 percent in the 12 months to December 2003.

Monetary aggregates expanded at a strong pace, reflecting the strength of the balance of payments. Broad money grew by an annual rate of 12.4 percent in 2003, supported by a surge in the net foreign asset inflows, a large part of which was also channeled into Jordanian dinar deposits. Private sector credit growth continued to be low, as banks remain cautious and demand for credit was met mainly through a utilization of deposits. The large increase in the net foreign assets was only partly sterilized through an increase in bank deposits at the CBJ overnight window facility and bank holdings of CDs. As a result, reserve money grew by an annual rate of 20.7 percent.

Structural reforms are progressing as planned. The government sold half of its holdings (26 percent of total shares) in the Arab Potash Company along with transfer of management to a Canadian corporation for US$124 million (net of privatization-related spending) in mid-October 2003. A management contract for the handling of the container terminal in the port of Aqaba was signed with a well-known port authority in February 2004. The government is also preparing the sale of majority stakes in the electricity generation and distribution companies in the first half of 2004. In the meantime, a new gas pipeline between Egypt and Jordan has been completed by the private sector on a build-own-operate basis and is expected to be extended to Lebanon, Syria, and Turkey. The government has embarked on a substantial improvement of the education system, with support from an education sector reform loan from the World Bank.

Jordan's medium-term outlook remains positive. Trade liberalization and increased market access have set the stage for strong export-led growth over the medium-term. Export growth is expected to continue at about 6-8 percent per year, spurred by the free trade agreement with the United States and the Association Agreement with the European Union. Large private sector-led infrastructure projects, including in water, gas, and electricity generation, are likely to boost investment. Structural reforms, enhancement of health and educational standards, and poverty alleviation are likely to have a positive supply side impact on growth over the long term. Overall, growth is expected to reach 6 percent over the medium term. At the same time, inflation is likely to remain stable at about 2 percent per year. The external current account is expected to remain in surplus, while gross usable reserves of the CBJ remain at a comfortable level of about 7-8 months of prospective import cover.

Executive Board Assessment

Executive Directors welcomed the resilience of the Jordanian economy in 2003 in the face of the disruption caused by the war in Iraq. Following the war, exports have recovered and economic growth has picked up, the fiscal balance has improved, inflation has remained subdued, and international reserves have strengthened. The authorities' prudent macroeconomic policies and their steadfast implementation of structural measures aimed at transforming Jordan into a dynamic market economy—together with significant support from the international community—have contributed to these positive results. Directors welcomed the renewed commitment of the government formed in October 2003 to macroeconomic stability and structural reforms.

Directors welcomed the strong fiscal adjustment undertaken by the authorities in order to achieve the 2003 fiscal targets. They commended the timely implementation of the package of fiscal measures, which included a significant increase in general sales tax collection. Directors encouraged the authorities to continue with plans to adjust petroleum product prices so as to eliminate remaining subsidies.

Directors underlined the importance of continued fiscal consolidation to achieve the authorities' medium-term debt reduction strategy and to meet the debt ceilings mandated for 2006 under the Public Debt Law. The 2004 budget is an essential step in this direction. In light of the expected decline in external grants, Directors encouraged the authorities to sustain their fiscal adjustment efforts through further reforms of the tax system and its administration, improved expenditure management, and an acceleration of privatization. They welcomed the authorities' intention to utilize privatization proceeds solely for debt reduction purposes. They also welcomed the authorities' new fiscal funding strategy aimed at rebalancing the debt profile in favor of domestic debt. This strategy will significantly reduce the vulnerability of the debt profile to exchange rate movements while encouraging the deepening of the domestic financial system.

Directors noted that monetary policy will continue to support the authorities' objective of price stability. Most Directors emphasized that the fixed exchange rate peg to the U.S. dollar continues to serve Jordan well and that competitiveness is adequate, as evidenced by the strong export performance. Some Directors considered that the authorities should continue building up the necessary institutional capacity to conduct an independent monetary policy.

Directors welcomed the generally positive conclusions of the Financial Sector Stability Assessment. They noted that, although the level of nonperforming loans is high, the banking system is basically sound. Following its recent strengthening, the regulatory and supervisory framework generally observes international standards and codes in banking, payments systems, securities, and insurance. Directors urged the authorities to deal swiftly with the few remaining undercapitalized banks on the basis of agreed time-bound restructuring plans. Directors looked forward to the timely approval of the anti-money laundering law.

Directors commended the authorities for progress in structural reforms, including trade liberalization. They noted that the recently completed reforms of the military and the civil service pension systems will strengthen fiscal consolidation over the medium and long term. The integration of the sales and income tax departments into a unified revenue department will also contribute by strengthening tax collections and enforcement. Directors welcomed the sale of the Arab Potash Company and the recent launch of the privatization of the electricity sector, which will help modernize the sector and attract private sector investment.

Directors welcomed the substantial progress that the authorities have made in strengthening the statistical system with a view to subscribing to the Fund's Special Data Dissemination Standard. They urged them to continue in their efforts to improve the quality of their statistical databases, including in the areas of balance of payments statistics and the international reserves template.