IMF Executive Board Concludes 2005 Article IV Consultation, Post-Program Monitoring Discussions, and Ex Post Assessment with JordanPublic Information Notice (PIN) No. 06/02
January 5, 2006
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. The staff report for the Article IV consultation with Jordan may be made available at a later stage if the authorities consent.
On November 21, 2005 the Executive Board of the International Monetary Fund (IMF) concluded the 2005 Article IV Consultation, Second Post-Program Monitoring (PPM) Discussions, and the Ex Post Assessment (EPA) of Longer-Term Program Engagement with Jordan.1
Jordan graduated from a series of Fund-supported programs in 2004. Its performance was mixed in the first three Fund-supported programs following the 1989 crisis, but improved after 1998. This turnaround reflected greater ownership by the authorities, combined with a critical mass of fiscal policy and structural reforms under a medium-term strategy, supported by substantial external grants and an exit rescheduling agreement with the Paris Club. The Jordanian economy grew at an exceptionally strong pace in 2004, with real GDP increasing by 7.7 percent, largely on account of a surge in domestic demand. Inflation remained low at 3.4 percent and unemployment fell to 12.5 percent. The Amman stock exchange (ASE) index rose by 62 percent; real estate prices also increased dramatically. The privatization program has been accelerated in 2005. In addition, important progress has been made on the construction of a new natural gas pipeline between Egypt and Jordan, which will reduce dependence on costly petroleum products for power generation.
The budget deficit, including external grants, remained low at 1.7 percent of GDP in 2004. Domestic revenue grew faster than expected on account of the buoyant economic activity and improvements in tax administration. Despite expenditure overruns, mainly on capital outlays, the total debt/GDP ratio fell by 10 percentage points of GDP to 88 percent at end-2004; external debt fell to 66 percent of GDP. However, the fuel subsidy increased sharply to over 3 percent of GDP. Moreover, little progress was made in reducing the deficit excluding grants, which remained high at about 12.5 percent of GDP. Dependence on grants remained very large at 10.8 percent of GDP.
Although the external current account (including grants) deteriorated sharply to a small deficit in 2004 from a surplus of 12 percent of GDP in 2003, official external reserves remained comfortable. Merchandise export growth remained robust at 26 percent of GDP, but the trade deficit widened on account of a 43 percent increase in imports, reflecting strong domestic demand growth as well as higher oil prices and the high import content of exports. With current transfers (including external grants) broadly unchanged, the current account deficit was financed by capital inflows, including direct foreign investments and portfolio inflows, primarily from the region. In the process, the Central Bank of Jordan's (CBJ) gross usable external reserves increased moderately to US$4.8 billion, equivalent to about five months of prospective imports and 43 percent of broad money.
During 2000-04, the Jordanian dinar depreciated by about 10 percent in real effective terms, while the terms-of-trade deteriorated by 13 percent reflecting mainly higher oil prices. Monetary policy has remained focused on maintaining the peg of the Jordanian dinar to the U.S. dollar. The interest rate on three-month CBJ's CDs was raised by 75 basis points during the course of 2004, in line with U.S. rates. Broad money growth slowed to about 12 percent in 2004, or slightly below nominal GDP growth. Net domestic assets grew sharply as credit to the private sector increased by 17 percent, reflecting economic recovery. The capital of banks increased to 18 percent of risk-weighted assets, and banking supervision was strengthened; Jordan generally observes international standards and codes in banking, payment systems, securities, and insurance. The last remaining bank under temporary CBJ administration was merged with a larger bank in mid-2005.
Macroeconomic pressures started to build up after the first quarter in 2005. Macroeconomic policies became expansionary while external grants started to drop sharply, oil prices continued to increase rapidly, and the multifiber arrangement (MFA) quotas lapsed. Driven by domestic consumer demand, the economy continued to expand at a robust pace (7.6 percent) in the first half of 2005. However, despite the strong increase in domestic revenues, the overall fiscal balance did not improve relative to the same period in 2004 as grants declined and expenditures rose, in part, to cover payment delays in 2004 and higher oil subsidies. At the same time, the external current account deficit rose, mainly reflecting a wider trade deficit and lower external grants. It was, however, more than financed by private capital inflows, which allowed the CBJ's external reserves to increase slightly. At the same time, broad money growth picked up, mainly on account of a sharp increase in credit to the private sector and government. The ASE index increased by 158 percent in the 12-month period to September 2005 and inflation started to increase from a low base: the CPI rose by 5.7 percent in September on a 12-month basis.
The authorities have intensified fiscal adjustment in the second half of the year under a strategy centered on eliminating fuel subsidies and maintaining expenditure restraint. Notwithstanding these efforts, the budget and the external current account deficits (including grants) for 2005 are estimated at over 6 and 14 percent of GDP, respectively. These compare with a budget deficit of 1 percent of GDP and an external current account surplus of almost 12 percent of GDP in 2003. At the same time, while the terms-of-trade have deteriorated, mainly reflecting higher oil import prices, the real effective exchange rate is expected to appreciate. Under current policies, the fiscal and external current account deficits are projected to remain large over the medium term, growth is expected to decelerate and inflation is likely to pick up further. In these circumstances, pressures on the exchange rate peg could emerge.
Executive Board Assessment
At the outset, Directors expressed their deepest sympathy to the government and people of Jordan on the recent tragic bombings. Directors noted that significant progress has been made in Jordan over the past several years toward macroeconomic stabilization and economic restructuring, supported by external debt rescheduling. Directors commended the authorities for the impressive economic performance in 2004, with an exceptionally strong economic recovery and fall in unemployment, low inflation, and a continued strong external reserves position. This favorable outcome reflected the pursuit of sound macroeconomic policies and strong ownership of the reform efforts, as well as the positive impact of large external grants. Directors emphasized that, notwithstanding these achievements, there is a need to sustain strong policies as the economy remains vulnerable to external shocks.
Directors noted that, in 2005, some of these vulnerabilities have materialized and that the macroeconomic situation is likely to deteriorate in the near term under unchanged policies. Although the economy has continued to grow briskly in the first half of 2005, mainly on account of higher domestic consumption, the rapid increase in oil prices and the sharp decline in external grants have significantly weakened the macroeconomic outlook. Jordan has suffered a durable terms of trade loss. The budget and the external current account deficits (including grants) are set to widen significantly in 2005, and could deteriorate further in the medium term if external grants decline further and oil prices remain high. Against this background, adjustment to the sharply reduced level of foreign grants and reducing fiscal rigidities remain the key challenges for Jordan going forward.
Directors commended the authorities for their determination to address the emerging challenges. They welcomed the thrust of the authorities' new reform strategy that was launched in July 2005. The strategy aims at containing aggregate demand by eliminating politically sensitive subsidies for petroleum products by March 2007, curbing government expenditures, and mobilizing revenues in order to gradually reduce the fiscal deficit over the next four to five years, supported by a tighter monetary policy. At the same time, a number of Directors noted that the new strategy may not be sufficient to address simultaneously the emerging imbalances and sustain high growth. These Directors noted that, in the absence of additional external financing, further expenditure cuts and intensified revenue mobilization might be required to meet the official plans for containing the fiscal deficit. They also considered that a tighter fiscal stance and monetary restraint would help to provide the basis to keep the economy growing at a fast pace with price stability. A number of other Directors, however, considered the authorities' medium-term reform agenda broadly appropriate and that it strikes the right balance between short-term macroeconomic goals and long-term growth objectives. They welcomed the authorities' intention to take additional measures as warranted by future developments.
Directors supported the authorities' bold plan to eliminate petroleum product subsidies by March 2007, but a number of them considered that the price adjustments should be rules-based and more frequent. These Directors encouraged the authorities to adopt a quarterly, or even monthly, formula-based automatic petroleum product price adjustment system in place of semi-annual discretionary increases. A number of other Directors, however, considered the authorities' gradual approach to adjusting fuel prices to be appropriate given the associated social and political constraints. Directors broadly agreed that, in order to mitigate the likely adverse effects of such reforms on the poor, the social safety net should be reformed expeditiously as recommended by Fund technical assistance and with the support of the World Bank to better target support through the National Aid Fund to the most vulnerable segments of the society.
While the authorities have made commendable efforts to reduce and rationalize capital outlays, Directors noted that there is scope for significant further reductions in current expenditures through early civil service reforms and limiting capital spending to projects with firm financing and high economic returns. Moreover, concerted efforts are needed to improve expenditure management, macro-fiscal forecasting and analysis, and to strengthen fiscal management through the introduction of a government financial management information system and closer coordination of fiscal and monetary policies.
Directors noted the importance of additional revenue mobilization, including through specific excises on selected petroleum products, realignment of the General Sales Tax (GST) rate with the standard rate, elimination of GST exemptions, and an early reform of the income tax as envisioned by the authorities. Consideration should also be given to improving real estate taxation. Continued Fund technical assistance in improving the tax system and expenditure policies will be helpful. Directors also emphasized that the momentum of privatization should be maintained in order to improve resource allocation and support market-oriented private sector-based economic growth.
Directors supported the CBJ's efforts to tighten monetary policy since 2004, in view of the rapid growth of domestic credit, and consistent with maintaining the dinar peg to the U. S. dollar. They welcomed the CBJ's intention to take further action as necessary to support price stability. Directors stressed the need for improved coordination of monetary and fiscal policies.
Directors discussed Jordan's exchange rate policy and expressed various views on the role of greater exchange rate flexibility in helping the country to adjust to external shocks. The prevailing view was that while the peg has served the country well, the authorities should continue to develop institutional capacity regarding monetary policy with the help of Fund technical assistance, which might facilitate a future shift toward greater exchange rate flexibility. Such a shift should be preceded by careful consideration and preparation, including in order to assess the effects of exchange rate movements on inflation and debt levels. Some Directors considered that the peg should be maintained, pointing to various factors that can be expected to help safeguard competitiveness and improve the external position, including the recent pick up in productivity growth, and the benefits to the export sector of the ongoing trade liberalization and other reforms.
Directors commended the authorities for the progress made in consolidating the banking sector. They supported the CBJ's cautious approach toward the licensing of new banks, and agreed that stricter regulation of concentration ratios and a better assessment of guarantees-in addition to safeguards on personal consumer loans-would help further improve risk management. Directors recommended closer supervision of commercial banks' balance sheets to protect against the impact of negative wealth effects in the event of a correction of asset prices and a migration of private capital. They called for an early enactment of the anti-money laundering/counter financing of terrorism legislation, which would fill an important gap in the regulatory system.
Directors considered the deepening of domestic financial markets as essential for sustained growth. While sound and sustainable macroeconomic policies will be a critical element in the development of the domestic financial markets, the volatility of capital flows and asset prices would need to be addressed through strengthening domestic financial institutions. In addition, the development of Jordan's securities markets will be crucial to serve as an alternative source of funding and managing of the financial risks associated with asset price volatility. In this context, Directors supported the authorities' plans to develop new instruments and to lengthen the maturity structure of government debt that will facilitate the development of the much needed secondary market and a longer yield-curve. The regulatory system should be simplified and modernized to encourage investment in productive, tradable activities.
Directors recognized the progress made in the development and dissemination of economic data and urged the authorities to subscribe expeditiously to the Special Data Dissemination Standard.
Directors were in broad agreement with the staff's Ex Post Assessment of the Fund's engagement in Jordan. They agreed that, in a difficult geo-political situation, significant progress has been made in macroeconomic stabilization, but long-standing vulnerabilities to external shocks remain. While noting that the authorities have chosen to discontinue the use of Fund resources, Directors echoed the staff's recommendation that the authorities continue to collaborate closely with the Fund in tackling the remaining challenges. They supported the EPA's emphasis on adjustment to the sharp decline in grants, addressing fiscal rigidities, and reforming petroleum pricing. Directors also endorsed the staff's call for further technical assistance in the areas of tax administration, fiscal policy, financial sector issues, and exchange rate policy. They agreed that improved ownership had been a key factor in turning around Jordan's performance in the late 1990s, and underscored, more generally, the importance of striking a balance between ownership and sufficiently ambitious objectives in Fund programs.
Directors supported the authorities' intention to continue their Post-Program Monitoring with the Fund.