JORDAN
Memorandum
on Economic and Financial Policies, 2001
1. This memorandum reviews developments under the 2000 macroeconomic program and implementation of structural policies over the past year, updates the government's economic objectives for the medium term, and describes the corresponding macroeconomic and structural policies that are being implemented during 2001. It also discusses issues related to the monitoring of economic performance in the context of the extended arrangement with the International Monetary Fund.
I. Developments Under the 2000 Macroeconomic Program
2. Jordan's economic performance in 2000 continued to strengthen, and was characterized by a pick-up in economic growth, continued very low inflation, a further increase in official international reserves to a comfortable level, and a substantial reduction in the net public debt. Real GDP growth accelerated from 3.1 percent in 1999 to 3.9 percent in 2000, despite the adverse effect of the renewed conflict in the West Bank and Gaza. CPI inflation amounted to less than 1 percent during 2000.
3. Regarding fiscal policy, developments in 2000 were in many respects consistent with our program, with budgetary expenditure held in line with the target and tax revenue generally performing well. However, the recorded budget deficit (7.4 percent of GDP before grants, and 3.2 percent of GDP after grants) exceeded our target, mainly because of shortfalls in nontax revenues. In particular, as a result of the substantially higher cost of imported oil (by 56 percent), the oil surplus was less than expected and almost 3 percent of GDP lower than in 1999. Other shortfalls included receipts from land sales and royalties from the Jordan Phosphate Mining Company (JPMC), which experienced difficulties last year. As measured under the program, the budget deficit in 2000 includes debt for development spending of JD 25 million (on the basis of which foreign creditors reduced Jordan's foreign debt by the equivalent of about JD 40 million), and excludes JD 15 million in profits from the Central Bank of Jordan (CBJ) that were received after the end of the year. Hence, on this basis, the budget deficit amounted to 8.1 percent of GDP before grants (3.9 percent of GDP after grants). It should be noted that, for 2000, net privatization receipts amounting to over 7 percent of GDP (notably from the sale of shares in the Jordan Telecommunications Company) were treated as financing rather than revenue, and thus did not contribute to lowering the recorded budget deficit.
4. The overall fiscal deficit, which includes the change in nontreasury accounts and spending out of privatization proceeds, amounted to 8.9 percent of GDP. While spending out of privatization proceeds was lower than envisaged, there was a drawdown in nontreasury accounts following the buildup in 1999. With budgetary grants broadly as expected, the overall fiscal deficit after grants was lower, at 4.7 percent of GDP, but still more than targeted. Hence, the reduction in net bank credit to government was smaller than programmed. Nevertheless, net government and government guaranteed debt, both domestic and external, declined markedly in relation to GDP during 2000, on account of a buildup of privatization-related government deposits with the CBJ and the government's proactive external debt reduction policy.
5. Monetary developments in 2000 reflected growing confidence in the national economy. The growth in broad money exceeded 10 percent, while credit to the private sector grew by about 4½ percent. The net foreign assets of the banking system rose sharply, in part as a result of substantial privatization receipts. Similar trends were apparent at the level of the central bank, and all end-September and end-December monetary performance criteria were met comfortably. Despite the rise in interest rates in the United States, the CBJ was able to keep the yield on certificates of deposit at about 6 percent through the year and reduce reserve requirements substantially, while retail interest rates continued to fall.
6. The external current account remained in surplus during 2000, despite some widening of the trade deficit as imports grew quite quickly in response to the positive trends in the economy and oil import prices rose sharply. Large inflows of UN compensation payments to those affected by the Gulf war, and higher workers' remittances, contributed to the continued strength of the current account. Private capital inflows, which included large privatization receipts and other foreign direct investment, were substantial in 2000. As a result, official foreign exchange reserves rose from US$2 billion at the start of the year to close to US$2.8 billion, equivalent to 8 months of imports, or one-third of Jordanian dinar broad money.
II. Implementation of Structural Policies
7. Over the last year, we made substantial further progress in implementing our structural reform agenda. In the fiscal area, parliament passed the Second Stage General Sales Tax (GST) law, effectively converting the GST into a VAT, which became operational on January 1, 2001. More recently, parliament approved two additional important laws reforming, respectively, the income tax system and the regime governing the public debt. Regarding financial sector reform, the new Banking Law and a Deposit Insurance Law were enacted; the deposit insurance agency has been established; the CBJ issued a new regulation relating commercial banks' maximum foreign currency positions to their capital; and, from January 2001, the criterion for classifying loans as doubtful has been tightened from 150 days past due to 120 days past due.
8. On privatization, following the successful sale of shares in JTC in early 2000, a consortium has been selected to build and operate a power plant as Jordan's first independent power producer. Also, the duty free, flight training, and catering subsidiaries of the Royal Jordanian (RJ) airline have been sold. During 2000 and early 2001, the Jordan Investment Corporation sold its shares in several additional companies. The design of a pricing formula for the electricity industry to be implemented prior to the privatization of the state-owned generation and distribution companies is now at an advanced stage, and we have begun the process of selecting consultants to advise on the privatization of the generation and distribution companies.
III. Medium-Term Framework and Policies for 2001
A. Medium-Term Framework
9. Building on the progress over the last two years, the government envisions a further strengthening of macroeconomic performance over the medium term. Real GDP growth is projected to rise to 6 percent per year by 2005, even though economic activity may be adversely affected by tensions in the region in the short term. Inflation is expected to remain low in coming years. Continued progress with fiscal consolidation is envisaged to reduce the overall fiscal deficit before grants to 3.0 percent of GDP, and to eliminate the deficit after grants by 2005. Consequently, gross government debt would decline from 101 percent of GDP at end-2000 to under 65 percent of GDP by end-2006, with external government debt expected to fall from 81 percent of GDP to about 50 percent of GDP over the same period. Gross domestic investment would rise gradually, and although gross national savings are expected to decline in 2001 (associated with the tapering off of UN compensation payments), they would increase again in subsequent years. While these trends would initially be reflected in a small current account deficit, the current account is expected to return to broad balance over the medium term. Despite higher payments on external debt following the expiration of the current Paris Club arrangement in April 2002, official foreign exchange reserves should remain at about the current comfortable level.
B. Macroeconomic Policies for 2001
10. The government's macroeconomic objectives for 2001 are to sustain economic growth in the face of a difficult regional situation, maintain low inflation, keep official foreign exchange reserves at broadly their current comfortable level, and achieve further reductions in overall and external government debt. Prior to the recent increase in tensions between Palestinians and Israelis, which have affected tourism and some areas of manufacturing in Jordan, we had envisaged a further significant increase in economic growth in 2001. While we now hope that it will be possible to hold real GDP growth at 4 percent, the situation remains uncertain and we have formulated our economic program for 2001 on the somewhat more conservative assumption of a 3.5 percent growth rate. Despite the impact of the implementation of the VAT system, and the adjustments in petroleum product prices, CPI inflation will remain low in 2001 (around 1½ percent). Achievement of these objectives will be supported by a reduction in the fiscal deficit, prudent monetary policy, and further progress on structural reforms. In this context, the balance of payments position will remain comfortable.
Fiscal policy
11. The government is targeting a budgetary deficit of JD 390 million (6.3 percent of GDP) in 2001. In addition, we intend to undertake spending out of privatization funds amounting to JD 35 million (about ½ percent of GDP). The overall deficit before grants (including privatization spending) is projected at JD 424 million (6.8 percent of GDP), with the deficit after grants at JD 179 million (2.9 percent of GDP), which will allow for a further reduction in the ratio of government debt to GDP. Achievement of these targets will require, in relation to the 2000 outcome, a substantial fiscal effort. On the revenue side, adjustments in the prices of petroleum products will contribute 0.3 percent of GDP in revenue. In addition, revenue will be enhanced by the recent reform of the GST (the record keeping requirements of which will also strengthen income tax administration), increased profit transfers by the Jordan Investment Corporation, the resumption in royalty payments by the JPMC, and higher fees. Government expenditure is to be held to 34.1 percent of GDP by limiting capital expenditure to 5.5 percent of GDP, an increase of 0.6 percent of GDP over 2000. The capital budget includes debt for development spending of JD 35 million (0.6 percent of GDP). The government stands ready to take additional measures to protect the fiscal targets if necessary by, for example, deferring some of the planned increase in capital expenditure. Concerning the domestic financing of the fiscal deficit after grants, the new public debt law enables the government to rely exclusively on the auctioning of government securities; planned auction proceeds in excess of the government financing needs will be allocated to reducing the balance in the overdraft account and to the further retirement of interest-free advances obtained in the past from the CBJ.
12. Adequate provision of social services and alleviation of poverty and unemployment constitute major concerns of the government. Total expenditure on health, education and social programs amounted to about one quarter of total budgetary expenditure, or more than 8 percent of GDP, in 1999 and 2000. This is a comparatively high proportion by international standards, and it reflects the government's emphasis on investing in human capital and social infrastructure. Despite the large targeted reduction in the budget deficit, the government is determined to protect social spending in the current budget. While expenditure on health and education accounts for the bulk of social outlays, the activities of the National Aid Fund (NAF) and the Social Productivity Program (SPP), which have been expanding, are central to the government's anti-poverty effort. The NAF represents the government's main arm for reaching chronically poor households through targeted monthly cash assistance to unemployable poor households lacking a source of income. Spending by NAF rose from JD 22 million in 1999 to JD 26 million in 2000, and the government has allocated JD 30 million to the Fund in 2001, for the purpose of broadening the base of beneficiaries. In addition, the government launched the SPP in 1998 as a national program to enhance the overall social productivity of the nation with a focus on poor households. Besides restructuring and expanding the NAF, the SPP seeks to improve the social and living conditions of the poor through community infrastructure projects, promote small and micro enterprises; and generate productive employment through training and employment support. SPP outlays increased from JD 6 million in 1999 to JD 25 million in 2000 and, are budgeted to increase to about JD 45 million in 2001.
Monetary and exchange rate policy
13. In 2001, the CBJ will continue to target exchange rate stability, consistent with its objective of keeping inflation low and providing a stable financial environment conducive to economic growth. As in the past, the CBJ is ready to adjust interest rates on monetary instruments as needed to ensure achievement of the program's objective for international reserves. Since those reserves are at a comfortable level, we expect to maintain them close to the present level (US$2.6 billion) for the remainder of the year; this is consistent with keeping the CBJ's net international reserves above JD 1,471 million (US$2,075 million). While the objective of exchange rate stability will largely determine the course of monetary policy, the CBJ will adopt, as an additional safeguard, a ceiling of JD 220 million on the change in its net domestic assets. The monetary program has been designed on the assumption of some further decline in the velocity of broad money, and allows for ample credit to the private sector to finance investment and business activity.
C. Structural Policies for 2001
Budget and public sector reforms
14. We intend to sustain the pace of structural reforms following the considerable advances of the last two years. In the tax reform area, the government will focus on ensuring successful implementation of the VAT system, and have requested Fund technical assistance to strengthen its administration. In the area of budgetary financing, the just approved new public debt law provides for greater flexibility in the issuance of government securities (combined with prudent limits on external and total public debt) , which will contribute to more efficient debt management and to the development of the capital market.
15. Developments over the last year have underscored the need to establish a closer link between the domestic prices of petroleum products and the associated import cost, so as to promote efficient energy use and to insulate the budget from large fluctuations in petroleum-related revenue. Accordingly, following the adjustments already made, the government will review the domestic prices of petroleum products every three months, beginning in September 2001, and will adjust them as needed to protect the associated revenue.
16. The net cost of the public pension system, as it is presently structured, is projected to place an increasing burden on the budget over the medium term, and the government attaches high priority to introducing reforms that will put the pension system on a sounder financial footing. The government has recently established a high-level working group and a technical group to design a reform strategy, and intends to adopt such a strategy by the end of the year. We have requested technical assistance from the Fund for this purpose.
17. The government has initiated a program of modernization of the public sector, and in particular of the public administration. Progress has already been made in such areas as simplification of government work procedures; improving client access to government services; introducing electronic-based procedures; revising civil service by-laws; and improving the functioning of the judicial system. Proposals to modernize budget formulation, financial management in government and the audit function are also under consideration. The government is benefiting from financial assistance from the World Bank in support of these reforms, and the first of three annual Public Sector Reform Loans, which was approved recently, is expected to be disbursed shortly.
Financial sector reform
18. The CBJ has made considerable progress in promoting the efficiency of Jordan's financial system, and continues to monitor closely developments in the banking sector and indicators of banking system soundness. Following the enactment last August of the new Banking Law, the CBJ has issued revised bank regulations relating notably to loan provisioning and credit concentration; the latter has eliminated the CBJ's discretion to approve loans in excess of the limit stipulated under the previous regulations. Other regulations are being revised in light of the new law, including those pertaining to bank ownership of equity in financial and nonfinancial enterprises and to the principles governing the establishment of bank branches domestically and abroad. Additional efforts to promote bank soundness include working with banks on upgrading their internal control systems. Moreover, to improve efficiency, the CBJ is exploring with banks the steps that will be required to broaden electronic banking services.
Privatization
19. The focus of the privatization program in the period ahead is on the power sector. The government expects in the immediate future to finalize the power pricing formulas, and fully separate the activities of the generation, transmission, and distribution companies created in 1999. We are also in the process of setting up an effective regulatory body for the industry. These actions will set the stage for privatizing the generation company and the main electricity distribution company, and selling the government's majority shareholding in a regional distribution company in the course of 2002. The next step in this process is the selection of a consortium of legal, technical, and financial consultants to help map out a strategy and procedures; request for proposals have already been sent to a short list of six candidates, and replies are expected shortly. Meanwhile, the government is actively seeking a strategic partner for the Royal Jordanian airline, which has been fully prepared for privatization, and intends to complete the sale of the non-core subsidiaries in the course of this year. We also intend to continue disposing of the minority shareholdings of the Jordan Investment Corporation as market conditions permit.
IV. Program Monitoring
20. Purchases under the extended arrangement will continue to be subject to the observance of performance criteria, completion of program reviews, and a continuous performance criterion on the non-accumulation of new external payments arrears. In addition, the government will not impose restrictions on payments and transfers for current international transactions, introduce multiple currency practices, conclude bilateral payment arrangements that are inconsistent with Article VIII of the Fund's Articles of Agreement, or impose import restrictions for balance of payments reasons.
21. Quantitative performance
criteria have been established for end-September
and end-December 2001 (Table 1).
The performance criteria will apply to
changes in net international reserves
and net domestic assets of the CBJ; the
overall fiscal deficit before grants;
the stock of government and government-guaranteed
short-term external debt; and the contracting
of nonconcessional medium- and long-term
government and government-guaranteed
external debt. We will consult with Fund
staff regarding developments that may
affect external financing and grants,
and any significant deviation from programmed
levels will be a subject of the next
program review.
22. Consistent with the discussion in Section III, cabinet approval of a reform strategy for the public pension system will constitute a structural benchmark for end-December 2001. Progress in the areas of pension reform and petroleum product pricing will be a subject of the next program review. Given the paramount importance of the former, it is expected that, at the time and the next review, we will have made substantial progress in specifying suitable objectives and the main elements of the reform strategy to be adopted by the end of the year. The final review under the arrangement, in addition to covering these two areas, would also focus on the budget for 2002.
