Jordan: Staff Concluding Statement of the 2016 Article IV Mission and First-Review under the Extended Fund Facility

November 14, 2016

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. 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, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

An International Monetary Fund mission visited Amman from October 25 to November 8 to conduct discussions for the first review under Jordan’s economic program supported by an Extended Fund Facility (EFF) arrangement and for the 2016 Article IV Consultation. At the end of the visit, the following statement was issued: 

1. Jordan has achieved substantial success in dealing with adverse shocks over the past several years. The economy has remained resilient and enjoys some strong fundamentals. The exchange rate peg has been an important anchor to the economy, reserves are at comfortable levels, the financial system is sound and well capitalized. Significant progress has been made in reducing the fiscal deficit and interest rates have declined to low levels, helping to revive credit and support growth. These conditions owe much to the authorities’ sustained policy and reform efforts.

2. Several challenges continue to press the economy. Real GDP growth is below potential, unemployment is high and rising, particularly for youth and women, and regional conditions, including due to protracted conflicts and the refugee crisis from Syria, continue to take a toll on sentiment, public finances, investment, and the external current account. At the same time, aside from these adverse conditions, there is evidence that Jordan’s economic performance in terms of productivity and per capita income growth had been lagging those of other emerging markets even prior to those adverse shocks, ever since the aftermath of the global financial crisis. This requires a rethink of policies and the implementation of reforms to effectively boost investment and productivity, put public debt decisively on a downward path toward more sustainable levels, and enhance fairness and socio-economic conditions.

3. The authorities’ program is rightly focused on tackling these challenges. A gradual and steady fiscal consolidation, led by reforms to the tax exemptions framework and income tax, is critical to stabilize and reduce public debt and to help public finances be on a structurally sounder foundation. This stronger foundation would help better buffer against future shocks, address pressing expenditure needs, better balance the burden of taxation among sectors, and enhance income distribution. The current system of tax exemptions is not helping to promote investment and jobs as originally intended, and tends to favor disproportionately upper-income segments of the population, while the large foregone revenues are contributing to keep public debt on an increasing and unsustainable path. With the risks of a difficult external environment persisting over the medium term and concerns about the size of donor assistance, these reforms are essential to preserve macroeconomic stability, bolster investor confidence, and lessen vulnerabilities. These reforms would also provide a solid foundation for other structural reforms that would enhance the conditions for more inclusive and higher growth. The progress being made by the authorities on all these fronts is very encouraging. However, greater focus and specific measures are needed to enhance the difficult and deteriorating conditions in the labor market that would help support more inclusive and higher growth.

Outlook and Risks

4. In spite of lower growth in 2016, economic performance is expected to improve in 2017. Real GDP growth is expected to reach 2.4 percent in 2016, below the 2.8 percent originally envisaged under the program, owing much to the impact from some specific sectors, such as mining, which appear to be recovering. Excluding these sectors, seasonally-adjusted real GDP grew at an annual rate of 3 percent in the first half of 2016, which bodes well for the outlook for 2017. This sustained improvement for 2017 and the next several years very much depends on the expectation that the regional environment does not deteriorate further and on the implementation of the recent agreement with the EU on the relaxation of rules of origin for Jordanian exports. Nevertheless, regional conflicts and the GCC outlook continue to be important sources of downside risks to growth.

5. With Jordan’s economy envisaged to face vulnerabilities and risks over the medium term, the implementation of the authorities’ policies and reforms require timely and continued support from the international community. Recently updated staff estimates of the macroeconomic impact from the Syrian refugees suggest a decreasing but continued negative impact on growth, the balance of payments, and public finances. While concessional financing and off-budget grants committed under the Jordan Compact have stepped up, additional budgetary grants are needed to support refugee-related expenditure pressures and the authorities’ fiscal consolidation. Staff estimates a budget grant shortfall of $610 million for 2018. Without this additional support, there are significant risks to stabilizing and reducing public debt in 2017-18, despite comprehensive fiscal consolidation. 

The Policies and Reforms to Preserve Macroeconomic Stability and Enhance Inclusive Growth

6. The authorities’ program is off to an encouraging start. Staff expects that the combined public sector deficit to be 0.6 percent of GDP below the 5.0 percent of GDP target for 2016. This over performance largely reflects improved conditions in NEPCO and a somewhat lower expected deficit in WAJ, with the central government deficit broadly in line with program projections. As a result, public debt is expected to reach 95.1 percent of GDP in 2016, exceeding the 94.4 percent target, as a result of the lower growth in nominal GDP. Significant progress has also been made toward implementing structural benchmarks, including the publication of a debt management strategy, the preparation of a study on energy cross-subsidies, and the adoption of an electricity tariff adjustment mechanism. However, other important reforms, such as the inspection law to lower associated costs for businesses and the publication of the study of cross-subsidization in the electricity sector, have incurred delays and need to be implemented promptly to enhance transparency and business conditions.

7. Looking into 2017, it is critical that fiscal reforms are implemented to support fiscal consolidation through revenue- and equity-enhancing measures. The authorities are finalizing the details of a reform of the tax exemptions framework for the general sales tax (GST) and custom duties, which is a step in the right direction. This reform should help broaden the tax base and close a significant part of the fiscal gap of about 3 percent of GDP estimated for 2017-18. Other reforms, including to income taxation and greater reliance on private-public participation for investment projects, would be expected to close the gap through 2019. For the reform of the tax exemption framework to proceed as planned, and in light of risks to tax compliance, any reduction to the main GST rate (currently 16 percent) should be gradual in the years ahead and only considered once there are clear signs that revenue-yields are in line with expectations. The reform should also ensure that low-income segments of the population are protected from the up-front costs of removing exemptions during 2017, consistent with the revenue- and equity-enhancing goals of the program.

8. The 2017 draft budget law that is being finalized should be broadly consistent with these objectives. Preliminary information suggests that the draft budget law would present a fiscal program for 2017 consistent with the consolidation envisaged under the EFF. It would be critical for the budget to incorporate appropriations to deal with rising arrears, particularly for health, underpinned by mechanisms to better target related expenditures. In addition, the presentation of estimates for tax expenditures is an important step to enhance transparency and assess their large costs to the economy.

9. Progress with fiscal consolidation will also be essential to preserve monetary conditions that support the economy. The Central Bank of Jordan (CBJ) has skillfully managed monetary conditions in recent years, helping to revive and broaden credit growth to the private sector. Looking ahead, the CBJ’s monetary policy will continue to be anchored by the exchange rate peg and to carefully balance the need to preserve conditions supportive of the economy, in view of subdued inflation, comfortable reserves, and low deposit dollarization, against the need to maintain a comfortable reserves buffer. Staff sees no further scope to ease monetary conditions, with the balance of risks skewed toward some gradual tightening, particularly in light of expected tightening of the monetary stance in the United States. Addressing long-standing weaknesses in public finances would help preserve Jordan’s creditworthiness, help strengthen the competitiveness of the Jordanian economy, and thus facilitate the CBJ’s role in preserving supportive monetary conditions.

10. The authorities are congratulated for the progress and the reforms to restore and protect NEPCO’s operational balance. NEPCO’s efficiency gains stemming from the shift to liquefied natural gas (LNG) seem to have resulted in a significant improvement in its financial outlook, leading to a significant expected profit in 2016. The completion by the Ministry of Energy of the study on options for dealing with cross subsidization and for adjusting tariffs to absorb oil price shocks, as well as the recent enactment of the tariff-adjustment mechanism, are important steps to place the electricity sector on a sounder footing over the years ahead. The recent decision to lower tariff rates for large consumers is a step in the right direction to reduce cross-subsidies, while preserving NEPCO’s operational balance. Staff is of the view that the scenarios assessed in the study provide a good framework for considering some greater reduction in cross-subsidies in the future and for accommodating lower average tariff increases when needed. To effectively preserve NEPCO’s financial condition, it will be critical that the Energy and Mineral Regulatory Commission implements the proposed tariff adjustment mechanism independently. The recent agreement between the Ministry of Finance and NEPCO helps extend the maturity and repayment period of NEPCO’s debt and should be supported by a consistent implementation of the new tariff adjustment mechanism to preserve NEPCO’s operational balance.

11. Staff is encouraged by the progress made in dealing with difficulties in the water sector. Work is underway to finalize the updated action plan on how to reduce the water sector’s losses over the medium term, which the authorities expect to submit soon to the cabinet. Several actions are contemplated on the revenue and cost sides, including the reduction of illegal and “non-revenue” (i.e. infrastructure-related losses) water, the installation of meters, greater efficiency and investment in renewables to reduce their exposure to changes in electricity tariffs, new pumping stations, and physical water loss reduction infrastructure projects. Staff sees a need to pre-emptively assess the risks for water tariffs from potentially higher electricity tariffs in the years ahead.

12. The financial system remains an important pillar of stability for Jordan’s economy and staff is encouraged by the ongoing reforms to preserve its resilience to shocks. The banking system remains well-capitalized, profitable, and with good asset quality, and especially when compared with others in the region. As a result, the banking system’s capitalization is highly resilient to a broad range of sizable shocks. Nevertheless, recent stress tests suggest the need monitor the potential impact from higher interest rates and from the rapid increase in household credit. Were the current difficult conditions facing the economy to exacerbate and lead to severe and protracted new shocks, such as persistently low growth and significantly higher interest rates, the banking system’s asset quality and capitalization could be markedly affected. However, the system’s high levels of capitalization and profitability would continue to provide an important buffer to deal with these shocks. With the move to Basel III, the authorities have chosen to add a capital buffer of 1.5 percent to preserve the resilience of the banking system. The authorities may want to consider an update to the 2008 Financial Sector Assessment Program within the next two years.

13. The authorities’ program is underpinned by reforms to facilitate access to finance, improve the business environment, and promote better conditions in the labor market. These reforms are highly complementary and seek to lower production costs and enhance private sector firm-level productivity, particularly for small- and medium-sized firms. In particular:

  • The work underway to develop a financial inclusion strategy is important to bring access to finance to the level of the economy’s financial depth. There is large scope for Jordan to improve financial access and to increase the synergy with financial deepening and economic development. New micro-credit facilities, the ongoing work of the new credit bureau, along with a much needed enactment of the 2014 secured transactions law standing at Parliament, should help improve credit risk assessment, collateral requirements, and lower borrowing costs in the years ahead. In light of experiences from other MENAP countries, continued efforts to remove administrative hurdles, expand digital financial services, and support youth and women access to finance are critical to accelerate financial inclusion.

  • There is a need to promptly tackle red-tape. Discussions with business sector representatives indicate a pressing need to simplify regulatory process, improve legal stability, predictability, and the rule of law, and enact the inspection law.

  • Comprehensive measures are needed to promote greater employment opportunities for Jordanians. While staff is encouraged by the measures to strengthen part-time employment and to open child care facilities, the pressures from the large number of refugees in the labor market have risen the relative cost of formal employment, which tends to affect Jordanians and smaller firms disproportionately. Reforms to lower the formal cost of labor, such as a fiscally-neutral reduction in social security contributions, could help buffer such impact, and help promote greater formalization of jobs, particularly for youth and women. Staff is concerned that proposals to bring health care insurance for the private sector into the Social Security Corporation would result in significantly higher contribution rates and adversely affect formal jobs. There is also a need to enable legislation to facilitate the establishment of child care facilities and to promote publicly-supported “hubs” for small- and medium-sized companies.

Discussions to complete the first review of the EFF program are well advanced and will continue during the next few weeks toward an IMF Executive Board meeting, tentatively in late December. The mission would like to express its gratitude to the Jordanian authorities, and representatives from the private sector for their cooperation and constructive discussions.

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