IMF Executive Board Concludes 2010 Article IV Consultation with JordanPublic Information Notice (PIN) No. 10/131
September 17, 2010
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 September 15, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the 2010 Article IV consultation1 with Jordan on a lapse of time basis. Under the IMF’s lapse of time procedures, the Executive Board completes Article IV consultations without convening formal discussions.
The global economic downturn adversely affected economic activity in Jordan. Real Gross Domestic Product (GDP) growth fell from almost 7⅓ percent in 2008 to 2⅓ percent in 2009, mainly due to weaker activity in the finance, manufacturing, and trade sectors. Headline inflation declined steadily through 2009 to near zero, in line with lower commodity prices worldwide, although core inflation has remained stable at around 3 percent year on year by December 2009. For 2010 headline inflation is projected to increase in line with imported commodity (energy and food) prices.
Lower commodity prices helped improve Jordan’s external position. The current account deficit narrowed to 5 percent of GDP in 2009 (from 9½ percent in 2008), on the back of strong tourism receipts and remittances and lower oil imports. Foreign direct investment (FDI) and other inflows comfortably financed the current account deficit, and allowed official foreign reserves to reach a record high of US$11 billion (equivalent to eight months of imports) by end-2009.
Similar to many emerging market countries adversely affected by the global growth downturn, Jordan’s already-difficult 2009 fiscal position worsened due to a significant deterioration in external grants. While an increase in capital spending—to support domestic activity—was largely offset by lower commodity subsidies, a cyclical weakening in domestic revenues and a dramatic downturn in external grants induced a widening of the overall deficit by more than 3 percentage points of GDP, reaching 8½ percent of GDP in 2009. As a result, the debt-to-GDP ratio rose to about 56 percent at end-2009.
The government responded to the growth downturn with effective fiscal consolidation measures. Based on the latest developments and macroeconomic assumptions, the 2010 overall deficit is expected to narrow by more than 2 percent of GDP relative to the 2009 outturn, reaching about 6 percent of GDP. With lower projected grant receipts and the continued cyclical decline in tax revenues, the consolidation will come mainly from the spending side—involving greater prioritization of capital spending and savings in current expenditures, including from containment of the public sector wage bill and reductions in the operating costs of public institutions and independent agencies. Implementation of these fiscal plans would result in a modest uptick in the public debt-to-GDP ratio, which would nonetheless remain below the 60-percent legislated debt ceiling.
The Central Bank of Jordan (CBJ) has successfully maintained financial stability by undertaking a series of forceful measures to support growth of private sector credit and moderate the impact of the slowdown. Starting in 2008, the authorities responded to the downturn in domestic credit by: issuing a full guarantee of bank deposits, which has been extended until end-2010; ceasing liquidity-withdrawal operations (through CBJ sales of certificates of deposit) in October 2008; and gradually reducing reserve requirements and policy interest rates between November 2008 and February 2010, thereby reducing the interest rate differential against the U.S. Federal Reserve’s funds rate from 450 to 200 basis points. Deposit growth has remained healthy, and the share of dinar-denominated deposits has continued to increase.
Private sector credit growth turned positive at end-2009, reaching 5½ percent year on year in May 2010. Contributions from credit to construction, tourism, and trade sectors have been increasing since their lowest point in September 2009. Following the latest (February 2010) cuts in the policy rate, the accumulation of excess liquidity in the overnight window of the CBJ has reversed. Encouraged by declining interest rate spreads relative to advanced countries, international reserves have stabilized at historically-high levels. The Jordanian dinar real effective exchange rate has appreciated by 2½ percent between December 2008 and June 2010, mainly due to the strengthening of the U.S. dollar against major currencies.
The Jordanian banking system remains sound and has proven resilient to the global financial crisis. The CBJ’s prudent banking regulation and supervision, and banks’ conservative funding practices (with loan/deposit ratio near 75 percent) have shielded domestic banks from exposure to troubled international banks, structured products, and wholesale financial markets. The banking sector’s macroprudential indicators remain strong—banks remain profitable and well capitalized, deposits continue to be the major funding base, liquidity ratios and provisioning remain high, while non-performing loans (NPL) ratios increased modestly to 6⅔ percent of outstanding loans at end-2009.
Effective banking supervision has strengthened the capacity of Jordanian banks to withstand shocks. The CBJ has taken steps to further enhance its effective banking regulation and supervision by: (i) introduction of Basle II (Pillars I and III) regulations in 2008, and ongoing efforts to ensure compliance of banks with Pillar II guidelines for risk management; (ii) requiring semi-annual stress testing of banks, examining in particular credit risk and concentration risk; (iii) introduction of an automated data collection system, to improve off-site monitoring of banks; (iv) enhanced cross-border bank regulation through regular supervision and on-site inspections of international branches and subsidiaries of Jordanian banks; and (v) improvements to its early warning system.
Executive Board Assessment
In concluding the 2010 Article IV consultation with Jordan, Executive Directors endorsed staff’s appraisal, as follows:
Following a decade of strong growth, the Jordanian economy has slowed, largely due to the global and regional downturn. Economic activity is expected to pick up modestly in 2010, and accelerate further over the medium-term, as growth revives in key regional trading partners, bringing Jordanian output closer to potential.
The authorities have implemented prudent fiscal and monetary policies, which have ensured fiscal sustainability and supported the domestic financial system. Even in the presence of a cyclical downturn in economic activity, the government has proceeded with its fiscal consolidation plans for 2010 and the medium term. Fully implemented, this should contribute to a significant reduction in the debt-to-GDP ratio, and provide for a major amelioration of fiscal vulnerabilities. Similarly, the monetary authorities implemented cautious monetary easing in the period between late-2008 and early-2010, in an effort to raise private sector credit flows, and also took the opportunity provided by abundant capital inflows to bolster international reserves.
In view of the shortfall in external grants and the authorities’ desire to signal to markets their seriousness in ensuring fiscal sustainability, the staff supports the fiscal consolidation envisaged in the 2010 Budget. Staff believes that the decline in the overall deficit of about 2 percent of GDP this year is both appropriate and achievable, and would leave fiscal room for an envisaged increase in social expenditures, while maintaining sizeable capital expenditures. While implementation of these fiscal plans would result in a small rise in the public debt-to-GDP ratio in 2010, it would still remain below the 60 percent legislated debt ceiling.
The authorities’ objective of reducing the fiscal deficit to about 3 percent of GDP over the medium term is critical to achieving private sector-led growth and reducing vulnerabilities. Reducing the overall deficit by about 3 percent of GDP over the next five years is feasible, based on the experience of other countries, and would lead to a further 5 percentage point decline in Jordan’s debt-to-GDP ratio. Such adjustment will be crucial to maintain investor confidence, preserve macroeconomic stability, and create scope for future countercyclical fiscal policy. Efficiency gains in both revenue-raising and expenditure will help durably address Jordan’s main fiscal vulnerabilities. Priorities include removing remaining tax exemptions on commodities, ongoing prioritization of capital spending, and continued moderation of growth in the public sector wage bill.
Significant progress has been made in advancing structural reforms, yet the Jordanian authorities continue to face a number of policy challenges. In the near-term, further improvement in the business environment for the private sector will be key to raising productivity and building upon Jordan’s external competitiveness. Staff supports the recent enhancements to income taxation and investment policy, and recommends that additional reform priorities include further liberalization of important business inputs (particularly energy and water sectors), as well as the achievement of greater public sector efficiencies through implementation of civil service reforms.
The medium-term fiscal strategy should be supported by a number of institutional reforms. These include strengthening tax administration and reenergizing the implementation of public sector financial management reforms. In an effort to relieve infrastructure bottlenecks, the authorities plan an ambitious medium-term program of large-scale infrastructure development, to be largely financed by public-private partnerships (PPPs). As an important prior action, the staff recommends that a strong framework needs to be put in place to minimize the risk of contingent liabilities stemming from PPPs.
Monetary policy has rightly focused on monetary easing in 2009–10 to stimulate domestic demand, yet there should now be a pause on further monetary stimulus. Since late 2008 the authorities have taken several steps to support the domestic financial system, including multiple reductions in the policy rate and cessation of issuance of certificates of deposit. Jordan’s current stock of international reserves is large and stable, and given the growing turnaround in private sector credit flows and some evidence of emerging inflationary pressures, the staff recommends that the monetary authorities stand ready to tighten monetary conditions as appropriate.
The fixed exchange rate regime remains important for financial stability. The Jordanian dinar’s peg to the U.S. dollar has acted as an appropriate nominal anchor for the economy. Analysis by the staff of the real effective exchange rate indicates that the dinar remains broadly aligned with its medium-term fundamentals. In addition, the risk of external instability emanating from the capital account is lowered by the fact that most external debt consists of obligations to official creditors, and reserves far exceed short-term external liabilities.
Bank regulation and supervision should continue to focus on preventing excessive risk taking. The banks’ conservative funding and asset structures, underpinned by effective banking supervision and regulation, have limited exposures to adverse global liquidity conditions. As a consequence, the banking sector’s macroprudential indicators remain strong. Nonetheless, bank supervision and regulation should remain vigilant, as Jordanian banks could be exposed to higher non-performing loans and provision requirements in the coming years, as output growth is likely to remain below trend until 2012.
Given Jordan’s large stock of debt, it will be important to have clear, timely and proactive communication of policy intentions for debt reduction and debt management, in large part to build ownership for necessary fiscal reforms. Communication of the government’s medium-term debt management strategy will be particularly relevant, as will enhancements to the primary and secondary markets for public debt.
While substantial progress in improving data quality and coverage has occurred in recent years, the statistical system needs to be further improved. Jordan is to be congratulated for its January 2010 subscription to the IMF’s Special Data Dissemination Standard. Nonetheless, data inadequacies persist, particularly in the areas of the expenditure side of the national accounts, and in employment and wage statistics, which continue to hamper economic analysis and policy formation. The staff urges greater progress in resolving these inadequacies.