IMF Concludes 2008 Article IV Consultation with JordanPublic Information Notice (PIN) No. 08/55
May 19, 2008
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On May 12, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the 2008 Article IV consultation with Jordan.1
The economy continued to perform well in 2007 in a more challenging external environment. Output grew by 6 percent and the unemployment rate declined further. Foreign direct investment (FDI) inflows remained strong and international reserves increased substantially. However, rapidly rising world fuel and food prices put pressure on the fiscal and external accounts in the second half of the year. Inflation started to pick up in late 2007 and jumped in early 2008 following a 47 percent average increase in petroleum product prices. Core inflation also picked up, but remains below 5 percent.
The fiscal position deteriorated in 2007, mainly reflecting the higher cost of fuel and food subsidies and a shortfall in external grants. The overall deficit for the year is estimated at 6.2 percent of GDP, against an original target of 2.8 percent. Higher fuel and food subsidies on account of increased world prices, and lower-than-anticipated grants were partly offset by lower capital expenditure and net lending, and overperformance on domestic revenue. Increased domestic borrowing to finance the larger deficit resulted in only a marginal decline in the overall public debt stock to 73 percent of GDP.
Despite a sizable deterioration in the external current account, the reserves position strengthened. The current account deficit increased to 17½ percent of GDP in 2007, reflecting higher import costs, a slowdown in export growth, and a shortfall in external grants. Continued strong FDI and portfolio inflows financed the current account deficit. Reserves rose to US$6.9 billion by year-end, equivalent to five months of prospective imports, from US$6.1 billion at end-2006. Following a US$2 billion buyback of nonconcessional Paris Club debt in early 2008, the external debt stock declined by 11 percent of GDP.
Monetary policy remained geared toward maintaining the exchange rate peg. The overnight interest rate was cut by 50 basis points in September 2007, following the reduction in the Fed Funds rate. Since then, despite a further 250 basis point cumulative cut in the Fed Funds rate, the Central Bank of Jordan (CBJ) has lowered its key policy rate by only 25 basis points (in early February) to avoid an excessively accommodative monetary stance. So far, there are no indications that the widening interest differential has attracted significant short-term capital inflows. Bank prudential indicators have remained steady, with the average risk-weighted capital adequacy ratio easing to a still healthy 19 percent in mid-2007. Although private credit growth moderated to 15 percent by end-2007, the banking system's loan-deposit ratio continued to edge up.
Executive Board Assessment
Executive Directors commended Jordan's continued strong economic performance in an increasingly challenging external environment. Directors noted that higher international food and fuel prices, given Jordan's high dependence on food and fuel imports, have pushed up inflation and widened the fiscal and external deficits. They therefore emphasized the importance for the authorities to adhere to their current plan of macroeconomic policy tightening, in order to reduce vulnerabilities and ensure a continued favorable outlook.
Directors strongly supported the authorities' intention to tighten fiscal policy. They welcomed the authorities' bold step to remove fuel subsidies and introduce a monthly fuel price adjustment mechanism, which has greatly reduced the vulnerability of the budget to oil price developments. Directors observed that sizable compensatory spending measures, including an increase in public sector salaries, on a progressive scale, have been implemented to gain public acceptance and protect vulnerable groups. Nevertheless, significant budgetary savings have been achieved on a net basis. Some Directors noted that the public sector salary increase could fuel inflation further. Directors considered that achieving the targeted narrowing of the budget deficit entails significant tightening, and encouraged the authorities to resist additional spending pressures. They emphasized that the lower deficit would be critical for bringing inflation down, reducing the external imbalance, and preventing a crowding out of private credit.
Directors recommended that the authorities continue with consolidation of the public finances over the medium term. They agreed that, given the high level of government spending relative to the size of the economy, fiscal expenditure restraint would create needed space for the private sector and strengthen medium-term growth prospects.
Directors noted that the new public debt ceiling limiting total public debt to 60 percent of GDP by 2011 should help to anchor the budgetary position over the medium term. However, given the upfront debt reduction provided by the Paris Club buyback, they recommended gearing fiscal policies to a more ambitious debt target that would leave some cushion for possible unforeseen demands on the budget.
Directors noted that current account adjustment would be facilitated by tighter fiscal policy. A gradual unwinding of transient factors and some softening of world commodity prices would likely narrow the external deficit over the medium term. Directors emphasized that, while private capital inflows were expected to fully cover the deficit, Jordan would remain vulnerable to a slowdown in capital inflows, and stronger fiscal adjustment would help limit risks to external stability.
Directors indicated that the exchange rate peg continues to serve as a strong anchor for monetary policy, and there is no clear evidence of exchange rate misalignment. Given inflation risks, they agreed that the recent widening in interest rate differentials against U.S. dollar rates had been warranted. Directors recognized that, as long as short-term capital inflows remain limited, there could be scope to let interest differentials widen further to keep inflation in check. Higher policy rates would also help prevent a further increase in banks' loan-deposit ratios.
Directors noted banks' strong performance, and supported the authorities' commitment to strict financial sector supervision. They welcomed further enhancements in the regulatory and institutional framework, including the recent implementation of Basel II standards and the passage of a new anti-money laundering law. They looked forward to the Financial Sector Assessment Program update mission later this year, which would help prioritize future reforms.
Directors emphasized the importance of structural reforms in sustaining strong macroeconomic performance. They welcomed the resolution of the long-standing issue of the government's overdraft facility with the central bank, as well as recent structural measures in the fiscal area, including the new chart of accounts and the medium-term expenditure framework. Going forward, Directors suggested attaching priority to further strengthening public financial management, establishing a regulatory environment for public-private partnership projects, and full liberalization of the petroleum sector over the medium term. Directors also urged early progress in addressing data issues to allow the authorities to move ahead with Special Data Dissemination Standard subscription.