Jordan and the IMF

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Jordan—Letter of Intent,
Memorandum on Economic and Financial Policies

April 15, 2002

The following item is a Letter of Intent of the government of Jordan, which describes the policies that Jordan intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Jordan, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Mr. Horst Köhler

1. The government of Jordan has held discussions with Fund staff in the context of the fourth and fifth reviews of the program supported by the three-year extended arrangement approved in April 1999. Based on these discussions, the attached Memorandum on Economic and Financial Policies (MEFP) reviews macroeconomic developments and implementation of structural policies over the past year, describes the government's economic policies for 2002, including new initiatives under the Plan for Social and Economic Transformation. The government believes that Jordan's economic performance under the 2001 program was strong, exceeding expectations in several areas, and that the policies for 2002 are consistent with sound medium-term objectives. Accordingly, we hereby request completion of the fourth and fifth reviews under the extended arrangement.

2. Notwithstanding the generally strong performance in 2001, the performance criterion for end-December 2001 on the government's overall fiscal deficit was missed. As described in the MEFP, fiscal performance in 2001 was adversely affected by developments in revenues--which suffered from teething problems relating to the extension of the GST at the retail level and the sharp drop in tourism activity and private sector investment--because of the September 11 events and the worsening conflict in the West Bank and Gaza. These developments were unexpected, and we partly compensated for these shortfalls by keeping expenditures below the programmed level. On this basis, we request a waiver for the missed performance criterion.

3. We stand ready to consult with the Fund on the adoption of any additional measures that may be required to achieve the program's objectives. We will continue to provide the Fund with any information that may be necessary for the assessment of policy implementation and performance under the program.

Very truly yours,

Michel Marto
Minister of Finance
Ministry of Finance
Umayya Toukan
Central Bank of Jordan



Memorandum on Economic and Financial Policies, 2002

1. This memorandum reviews economic performance during 2001, outlines the government's medium-term macroeconomic objectives, incorporating the Plan for Social and Economic Transformation (PSET), and describes the government's economic policies for 2002.

I. Developments Under the 2001 Macroeconomic Program

1. Jordan's economic performance in 2001 generally exceeded program objectives. It was characterized by stronger-than-expected growth, low inflation, the maintenance of a comfortable level of official international reserves, and a significant reduction in net public debt in relation to GDP. Real GDP grew by 4.2 percent in 2001, despite the adverse effects of the September 11 events and the worsening conflict in West Bank and Gaza. This growth was fairly broad based, led by strong increases in domestic exports (25 percent), construction (11.1 percent), transport and communication (5.6 percent), and manufacturing (4.9 percent). At the same time, consumer price inflation averaged less than 2 percent. Official international reserves remained stable during 2001 at about US$2.6 billion, equivalent to 7 months of import cover, 30 percent of JD broad money, and over 100 percent of reserve money. Government and government guaranteed net debt declined by 2 percentage points to 94 percent of GDP, a cumulative reduction of 65 percentage points over the last decade. The Amman Stock Exchange index rose by 30 percent in 2001, buoyed by strong performance of the financial sector and the U.S. ratification of the Free Trade Agreement.

2. Significant progress was made in fiscal consolidation in 2001 through the reduction of the overall fiscal deficit of the central government including grants and nontreasury accounts. The deficit so defined fell by 1 percentage point to 3.7 percent of GDP. This was attributable to: firm actions to hold budgetary expenditures below the program level (by ½ percent of GDP) despite privatization and debt-swap related outlays of 1.3 percent of GDP; and an increase in tax and nontax revenues (0.6 percent of GDP) over the preceding year, despite shortfalls relative to targeted levels. The composition of expenditure also improved with, in particular, an increased allocation for capital expenditure. As measured under the program, the overall fiscal deficit included debt for development spending of 0.6 percent of GDP, which reduced Jordan's foreign debt by the equivalent of 1 percent of GDP. The lower deficit and debt for development operations helped to reduce government and government-guaranteed debt by about 2½ percentage points in relation to GDP in 2001.

3. These positive fiscal developments notwithstanding, the fiscal deficit before grants was higher than targeted by 1 percent of GDP because of shortfalls in tax and nontax revenues. Tax revenue was adversely affected by teething problems associated with the extension of GST to the retail sector; the fall in tourism activity due to the Intifada and the September 11 events; and the temporary tax relief provided to the hotel and travel industries. Nontax revenues were much less buoyant than expected as a result of low international prices for phosphate and potash, which affected transfers to the budget from the mining corporations; also, the postponement of plans by foreign investors in the aftermath of September 11 resulted in a loss in royalties/fees. Prompt actions by the government to contain expenditures partly offset the revenue shortfall, and we succeeded in limiting the fiscal deficit (including grants) to 3.7 percent of GDP, which was somewhat below the revised target discussed with the IMF mission in November 2001. We would also note that, at the level of the consolidated public sector (a broader fiscal concept that also includes autonomous public agencies, the Social Security Corporation, and the CBJ), the deficit is preliminarily estimated to have been significantly smaller at about 2 percent of GDP. However, the performance criteria on the overall fiscal deficit (excluding grants) for end-September and end-December 2001 established in August 2001 were missed.

5. Monetary policy continued to support the fixed exchange rate anchor, with developments in 2001 reflecting growing confidence in the economy. The comfortable international reserve position was maintained. Interest rates on three-month CBJ certificates of deposit (CDs) fell by 2 percentage points in 2001, following the decline in U.S. Treasury bill rates, and stood at 3.9 percent at end-January 2002. Credit to the private sector rebounded strongly (by more than 11 percent) in response to lower interest rates and growing investor confidence. Jordanian banks have remained well capitalized and the banking system is sound. In early February, three small banks experienced difficulties as a result of a fraud case involving falsified contracts used as collateral to secure loans. The total amount of the loans involved is limited, some of this amount will be recovered through judicial processes underway, and any residual losses can be absorbed by the banks in question, with no use of public funds. This case will have no macroeconomic implications. Starting in January 2002, the CBJ also brought its loan classification in line with Basle core standards by reducing the period for classifying doubtful loans from 120 days to 90 days.

6. The balance of payments outlook has improved significantly. The strength of the export sector reflects our efforts over the last several years to liberalize Jordan's trade regime and increase foreign market access, including through a Free Trade Agreement with the U.S. ratified in December 2001. Import growth has remained relatively subdued (5 percent in 2001), partly reflecting the decline in oil prices. The shortfall in tourism receipts was partly compensated by strong inflows of remittances. As a result, the external current account (including grants) recorded a modest surplus in 2001, compared to a deficit of 2.7 percent of GDP envisaged under the program.

7. The government has made solid progress with its structural reform agenda, especially after the adoption of the PSET. A consortium has been selected to build and operate a power plant as Jordan's first independent power producer. Consultants have been selected to advise on the privatization of the electricity generation and distribution companies. The duty free and catering subsidiaries of the Royal Jordanian (RJ) airline were sold last year. In addition, the Jordan Investment Corporation (JIC) has sold two companies and shares in another 2 small companies. The terms of sale of the remaining shares of the cement company have been finalized and the sale should be concluded soon. Discussions are continuing on the sale of RJ's remaining noncore operations, but the privatization of the airline itself had to be postponed as a result of the current difficult environment for the airline industry. Preparation and presentation to Cabinet of a strategy for the reform of the public pension system, a structural benchmark for end-December 2001, had to be postponed, partly because of a delay in securing technical assistance from the Fund in the aftermath of September 11. In the meantime, the Cabinet decided in January 2002 to enroll all new military personnel in the Social Security Corporation (SSC) as part of a contributory pension plan.

II. Medium-Term Macroeconomic Framework and Policies for 2002

A. Medium-Term Framework

8. The government's central objective for the period ahead is to raise further economic growth and living standards through the deepening of structural reform and the continued implementation of sound macroeconomic policies, including further fiscal consolidation. This is manifested in the objectives of the PSET. Real GDP growth of about 4 percent recorded during 1999-2001 was well below the 5.5-6 percent growth rate required for the Jordanian economy to absorb large inflows into the labor market, while, at the same time, steadily reducing the unemployment rate from its current level of about 15 percent. Accordingly, the thrust of the government's program--as encapsulated in the Plan for Social and Economic Transformation (PSET) announced by His Majesty King Abdullah II in November 2001--is to stimulate private investment, strengthen economic growth and social development, and consolidate monetary and fiscal stability. This will be achieved through increasing the capacity of the economy to absorb more private sector investment, through human resource development, employment generation, increased quality of basic government services as well as through the implementation of fiscal, administrative, regulatory, and judicial reforms. Moreover, the interlinkages between all the different components of the PSET should strengthen its integrated approach, and ensure that the overall objectives are achieved. The macroeconomic framework will be underpinned by a medium-term fiscal strategy entailing continued fiscal consolidation consistent with a steady decline in the public debt burden. A sizable further reduction in the ratio of the public debt to GDP will be crucial for improving the quality of government expenditures, lowering real interest rates and fostering investor confidence.

9. Achieving our growth and employment objectives will require accelerating the pace of structural reforms, while simultaneously fostering human resource development to promote private investment and employment generation. Key elements of the government's program will include: legislative, legal, and administrative reforms to improve the business climate; accelerated privatization of virtually all remaining commercial enterprises; a private sector-led investment program; human resource (education and health) development; and the alleviation of poverty, including through rural development. The cost of the PSET is projected to be up to JD 275 million (about 4 percent of GDP) per year for the next four years, on top of the existing allocation for social sector programs in the budget. The government intends to finance the additional outlays under the PSET through additional grants and a limited use of future privatization proceeds, with the remainder of the latter used to help reduce the public debt burden. Because the PSET involves a large public sector resource commitment over a number of years and will entail sizable recurrent outlays over a much longer period, the government is seeking multi-year financing from donors in order to ensure achievement of our medium-term macroeconomic objectives.

10. The private sector investments that will accrue as a result of the privatization transactions and the acceleration of the implementation of major projects will enhance prospects for growth. Spending on social sector initiatives associated with the PSET is likely to boost domestic demand and output in the near term. Excluding this temporary boost to output, the medium-term macroeconomic framework envisages: real GDP growth increasing to about 5½ percent on a sustainable basis by 2006; continued moderate inflation (about 2 percent); a small deficit in the external current account; a reduction in external debt in relation to GDP to comfortable levels; and maintenance of external official reserves within a comfortable range of 6-7 months of imports. The overall fiscal deficit (including grants) would decline to less than 3 percent of GDP by 2006 from the targeted 4.1 percent of GDP in 2002, despite an assumed reduction in grants (by about 1 percentage point of GDP). The fiscal deficit (excluding grants) would need to be reduced by 2 percentage points over the 4-year period to 2006, after increasing in 2002 reflecting PSET-related expenditures. The steady reduction in the fiscal deficit, together with the use of sizable proportion of privatization proceeds for debt reduction purposes (in the form of higher bank deposits or debt buybacks or swaps), would reduce total government and government-guaranteed net debt by about 28 percentage points to 67 percent of GDP by 2006. We are aware that achieving these ambitious targets will not be easy and will require determined efforts, given the structural rigidities in the budget (e.g., large debt service payments, military outlays, rapidly growing pension liabilities, dependence on nontax revenues, tariff reforms to liberalize trade), and the spending pressures to meet the needs of our still rapidly growing population.

11. The medium-term outlook for the balance of payments projects a gradual shift back to small current account deficits, largely due to the ending of UN compensation payments and implementation of the PSET. Underlying export growth is expected to remain robust (conservatively projected to be 8½ percent) during 2002-06, reflecting continued growth in manufacturing exports and additional market access through the Free Trade Agreement with the United States and the Association Agreement with the EU. Import growth is expected to expand, particularly in the 2002-03 as the PSET is implemented and a number of large-scale water and energy projects are undertaken by the private sector. The small current account deficit is expected to be partly offset, however, by additional grants and privatization proceeds. Given the expected shift of the current account into deficit, a high level of amortization payments falling due in the coming years, and the need to maintain a comfortable reserve position, financing gaps are expected to appear over the medium term. These gaps reflect: (i) the need to address the high level of unemployment and poverty through accelerated growth, and (ii) the medium-term goal of maintaining a comfortable reserve position to withstand external vulnerabilities arising from the difficult regional environment. We are in touch with the Paris Club and intend to approach it formally regarding a comprehensive restructuring of the stock of debt owed to bilateral official creditors in order to solve the debt problem permanently. We also intend to initiate discussions on a program which could be supported by a new Fund arrangement following the expiration of the current extended arrangement.

B. Policies for 2002

12. Economic policies for 2002 are designed to sustain economic growth in the face of a difficult regional situation, maintain price stability, increase foreign exchange reserves by a moderate amount, and achieve a further reduction in net public debt consistent with our medium-term fiscal strategy. We expect the strong performance of the export sector to continue this year, which, together with the positive growth impact of the PSET, is expected to accelerate real GDP growth to about 5.1 percent, with PSET expenditures contributing about 1 percentage point. Inflation for 2002 is expected to accelerate somewhat to 3.5 percent, mainly as a result of the fiscal measures and market oriented reforms outlined below; underlying inflation will remain at around 2 percent. The external outlook will continue to remain comfortable with the current account roughly in balance and the overall balance of payments continuing to be in small surplus.

Fiscal Policy

13. Consistent with our macroeconomic objectives, the 2002 core budget announced in January aims at further reducing the fiscal deficit (including grants) to 3.6 percent of GDP. The budget also includes, as Chapter II, the expenditure program associated with the PSET, execution of which is subject to availability of additional grants and privatization proceeds. Although PSET-related expenditure was envisaged to be JD 275 million (4 percent of GDP) at the time of the budget announcement, it is now expected to be up to JD 200 million (3 percent of GDP) in 2002, because of delays in securing financing from bilateral donors. Projects are now being prioritized in line with likely available financing. We expect to finance the PSET outlays through additional foreign grants of JD 160 million and privatization proceeds of up to JD 40 million (30 percent of the total expected privatization proceeds of JD 135 million). On this basis, the consolidated fiscal deficit (including the PSET and net change in nontreasury accounts) would be limited to 4.1 percent of GDP. With half of the deficit covered by privatization proceeds, the fiscal stance would still allow for a further significant reduction in the debt to GDP ratio. The proportion of privatization proceeds to be spent, however, would be kept under review, and adjusted downward if receipts from privatization or progress in reducing public debt were less than expected.

14. Achieving the fiscal target, given the structural rigidities on both revenue and expenditure sides of the budget and the adverse impact of several ongoing reforms on revenues, will require substantial additional fiscal efforts. In particular: ongoing trade liberalization initiatives, including the phased elimination of customs duties on industrial imports, would entail an annualized revenue loss of ½ percent of GDP; measures associated with direct tax reforms and increased loan-loss provisioning for banks, granted as part of financial sector reform initiatives, are expected to cost 0.1 percent of GDP annually; and the teething problems associated with broadening the GST base at the retail level through the lowering of the GST threshold could also dampen the revenue outlook.

15. In order to realize the revenue target under the budget, despite the losses mentioned above, the government has decided to implement by May 1 the following measures yielding JD 94 million (1.4 percent of GDP) on an annualized basis. The new measures (with annualized yields in parenthesis) include: (i) increasing the prices of fuel oil, diesel, kerosene, and LPG that are below world market prices by a weighted average of 10 percent (JD 34 million); (ii) extending the GST at a rate of 2 percent to all previously exempted or zero-rated products (JD 25 million); (iii) reducing the tariff rate on industrial inputs to only 3 percent, with a revenue loss to JD 16 million; and (iv) raising the prices of animal feed (chaff and barley) to market levels. For diesel and kerosene, the government will pass a cabinet decision by May 1 for the price increase to take effect by June 1. As discussed below, steps will be taken in the meantime to offset the impact on the poor of the price increases for petroleum products. In addition, we expect that banks will pay part of their income tax payment (JD 10 million) in advance, as in 2001. The government is also committed to raising the price of bread gradually at an appropriate time, so as to liberalize the markets for wheat and bread. Other possible tax reforms will be phased in over the medium term in a broadly revenue neutral manner and will not be considered before the next budget because of their potential adverse revenue effects.

16. Efforts are underway to strengthen GST administration. The GST Department has already sent assessment notices (including penalties) to 2,500 nonfilers. The status of nonfilers will be determined by June 1, 2002 by either canceling their registration (if they have ceased taxable business activities) or by requiring them to file tax returns. The taxpayer data in the computer system has already been brought fully up-to-date. The system will soon be extended to record and control all refund claims. Administration of refunds will also be refocused to ensure that all first-time refund claims above a minimum amount are subject to audit. Moreover, the GST Department will prepare and implement a new audit plan to ensure appropriate coverage of GST taxpayers, using a range of audit techniques and reducing excessive reliance on comprehensive audits.

17. Regarding expenditures, the government will limit budget expenditure in line with the developments in revenue collection with a view to achieving the deficit target under the program. Operationally, this would entail cuts in capital and recurrent outlays from the budgeted levels but still allow for increases in real terms. The stipulated expenditure cuts will be enforced by the Ministry of Finance through limits on expenditure authorizations throughout the year. Notwithstanding the expenditure cuts, we will increase the monthly allowances for civil servants and pensioners by JD 5 in order to compensate them for the above-mentioned price adjustments. The total annualized cost of this measure will be JD 15 million. In addition, the government under the PSET will increase cash transfers to the poor by JD 28 million (0.4 percent of GDP) on an annualized basis by broadening the coverage of the income transfer program and introducing a supplementary cash transfer program. We expect that these measures will adequately protect the poor from the price increases mentioned above.

18. The fiscal measures discussed above are intended to achieve the government's fiscal target, while at the same time reducing distortions in the economy and stimulating growth. The imposition of GST on previously exempted and zero-rated items will improve the structural integrity of the GST system, which is one of the least distortionary ways of raising revenues. Moreover, the adjustment in petroleum prices will bring domestic prices closer to world market prices. The liberalization of prices of animal feed will allow the private sector to provide these products more efficiently; and the reduction in customs tariffs will provide a stimulus to the domestic economy by enhancing competitiveness, and possibly also help to reduce domestic prices. At the same time, the much larger social sector program to be financed through the government budget and the PSET is designed to enhance labor productivity, as well as to help the population adjust to the changes in prices through targeted assistance to those most in need.

19. As regards spending under the PSET, the government has decided that execution of projects will only be initiated when financing for them has been reasonably secured. In this respect, prioritization of projects will be crucial given that financing may not be initially available to cover the full program; also, the sharp increase in social programs may strain our implementation capacity, which will be carefully assessed before new projects are begun. In this regard, the government is working closely with the World Bank, which is reviewing the PSET, to prioritize its social sector programs and evaluate implementation capacity. At the request of the government, the World Bank has agreed to identify four technical experts to assist the government in the areas of education, health, vocational training and public sector reform, and in capacity building of the relevant implementation agencies. PSET spending will be managed by the Ministry of Finance through the normal budget procedures and executed through the treasury system.

Monetary and Exchange Rate Policy

20. Monetary policy will continue to support the fixed exchange rate anchor. We believe that the current peg to the U.S. dollar has served Jordan well, bringing inflation down to industrial country levels and fostering confidence in the Jordanian dinar. The strong export growth in 2001 provides assurance that, despite some real appreciation of the U.S. dollar in recent years, competitiveness is adequate. However, we will continue to maintain a comfortable international reserve position, and stand ready to protect reserves and monetary stability through an active interest rate policy. The monetary program for 2002 is consistent with the objective of continued price stability and will also allow for healthy growth in private sector credit. We tentatively expect broad money to grow by about 10 percent in 2002, slightly more than projected nominal GDP growth, as a result of ongoing financial deepening. Reserve money is likely to grow at about the same rate. However, consistent with our approach to interest rate policy, we will limit the growth in NDA sufficiently to achieve the targeted international reserve position.

21. As part of an ongoing process of implementing the provisions of the new banking law that came into effect in August 2000, we will shortly be issuing regulations and guidelines: (i) strengthening the penalties, including fines, for violations of central bank regulations; (ii) limiting the total holding of shares by banks to no more than 50 percent of subscribed capital (the previous limit was 75 percent of owners' equity), with a subceiling of 10 percent of subscribed capital for holdings of shares in an individual company; and (iii) strengthening guidelines on banks' internal control systems. In addition, we are: (iv) fine tuning our procedures for evaluating banks' risk weighted assets for the purposes of determining capital adequacy requirements; and (v) increasing the frequency and effectiveness of on-site supervision.

Structural Reform

22. As part of the PSET, we will accelerate and broaden the privatization program. For 2002, we are in the process of completing the privatization of the cement company. We also plan to sell a part of the Jordan Potash Company and the Food Silos Company to strategic investors, and a portion of the government's share in Jordan's Telecommunication Company through the stock market. As regards the power sector, the government has separated the activities of the generation, transmission, and distribution companies created in 1999; and established an effective regulatory body for the industry. We have also selected the legal, technical and financial consultants for the privatization strategy. The regulatory and tariff regime for the electricity sector will be approved by the government in the second half of the year. With the completion of these steps, the stage will be set for privatizing the generation and distribution companies in 2003. We will also continue to hold discussions with interested parties on a strategic alliance for Royal Jordanian and its eventual privatization, which had been put on hold in the aftermath of the September 11 events.

23. The government is aware that the rapid growth in pension payments and future liabilities can only be contained through speedy implementation of pension reforms for the military and civil service. Accordingly, pension reform is a critical element of our medium-term fiscal strategy, and the recent Cabinet decision to enroll all new military personnel with the SSC under a contributory pension plan constituted an important first step. We have undertaken actuarial analysis to evaluate the long-term financial implications of various policy options with technical support from a fiscal expert from the IMF beginning in January 2002 in consultation with the World Bank. We intend to evaluate the technical assessments and recommendations of the Fund expert, and expect to present a comprehensive reform strategy to the Cabinet later in the year. We will also review the recommendations of the recent ROSC mission on the data dissemination module and develop an action plan, with a view to meeting the Fund's Special Data Dissemination Standards in the next two to three years.

24. Recent developments in petroleum prices in the world market have underscored the need for establishing a closer link between the domestic prices of petroleum products and the associated import cost, so as to promote efficient energy use and insulate the budget from large fluctuations in petroleum-related revenue. Accordingly, in addition to the upward adjustments in petroleum prices discussed above, the government will continue to review quarterly the domestic prices of petroleum products to protect the level of petroleum-related revenues assumed in the program.

III. Program Monitoring

25. Consistent with the discussion in Section II, cabinet approval and implementation of the fiscal measures listed in Table 1 will be prior actions for staff to recommend Board consideration of the current reviews. We will consult with the Fund staff regarding developments that may affect external financing and grants, and any other significant deviation from the program.

Table 1. Prior Actions for Staff to Recommend Board Consideration of
Fourth and Fifth Reviews under Extended Arrangement

The following measures are to be taken prior to Executive Board consideration of the reviews:

  1. The government will introduce a two percent GST rate and apply it on currently exempted and zero-rated products.

  2. The government will increase the following petroleum product prices:
    • Fuel oil for electricity from JD 60.4 per ton to JD 70 per ton;
    • Fuel oil for industry from JD 72 per ton to JD 77 per ton;
    • LPG price from JD 2.4 to JD 2.5 per LPG gas bottle.

  3. The government will pass a cabinet decision to increase kerosene and diesel prices by June 1, 2002 from 110 fils to 120 fils per liter.

  4. Customs tariffs on industrial product imports will be reduced to 3 percent from rates varying from 5 percent to 10 percent.

  5. The price of chaff and barley will be liberalized, as indicated by an increase from the current levels (JD 60 per ton and JD 75 per ton, respectively) to levels consistent with best available market prices.