Jordan Times
Friday, March 18, 2005

Jordan urged to continue monitoring developments to ensure effectiveness of exchange rate policy  

Officials should be prepared to respond expeditiously to any negative impact of the elimination of textile quotas under the multifiber arrangement

Following is the second of a two-part article summarising a 54-page report by the Middle East and Central Asia Department of the International Monetary Fund. The first part was published on Thursday, March 17, 2004

EXTERNAL COMPETITIVENESS appears adequate, as evidenced by the robust export performance in recent years, the International Monetary Fund (IMF) said in a report issued this week about Jordan

Entitled “Post-Programme Monitoring Discussions,” the report indicated that a comparison of real effective exchange rate developments with other countries in the region shows a gain in Jordan's external competitiveness since 2001.

“The [Jordanian] authorities argue that the high confidence in the dinar has contributed to a substantial strengthening of the Kingdom's international reserves position,” the IMF said. “They will, however, continue to monitor developments related to this issue in the period ahead.”

Nevertheless, the (IMF) mission noted that the current pegged regime could make it difficult to quickly adjust to potential vulnerabilities arising from the elimination of textile quotas, the loss of oil grants, or other significant adverse real shocks.

It stressed that an eventual move to a more flexible exchange rate regime, particularly from a position of strength, could potentially help Jordan adjust to such shocks.

According to the report, efforts to strengthen the institutional capacity with respect to monetary policy instruments and foreign exchange markets would be necessary to implement increased flexibility.

The government intends to pursue cautious monetary policy and adjust interest rates in line with global developments in order to ensure adequate foreign reserves and the maintenance of the exchange rate peg to the US dollar.

Under the monetary programme developed with the financial authorities, broad money growth in 2005 is projected to be close to nominal gross domestic product (GDP) growth.

While net foreign assets are projected to grow by only about two per cent of broad money stock, net domestic assets would increase in line with economic activity, allowing for ample credit growth to the private sector of about 10 per cent.

“With significant projected privatisation proceeds of about JD300 million (3.5 per cent of GDP), there would likely be no need for domestic bank financing of the budget,” the report said.

It added that the ratio of foreign deposits to overall deposits is likely to decline towards historical averages as the demand for foreign currency deposits by Iraqis stabilises.

Given the current comfortable level of international reserves, the report said Jordanian officials will continue their policy of adjusting interest rates in line with international interest rates.

The (IMF) mission agreed with the monetary policy stance and noted the importance of monitoring international interest rates and reserve developments closely to be able to react promptly to changing circumstances.

In highlighting the on-going progress towards the development of a sounder banking sector, the report indicated that the capitalisation and profitability of the banking sector has improved substantially throughout 2004 and is expected to continue during 2005.

“The Central Bank of Jordan (CBJ) has issued guidelines on bank corporate governance in early 2004 and it has intensified its on-and off site examination programme, which has contributed in part to an increased provisioning for non-performing loans,” the repot elaborated.

According to the IMF, banks have almost fully provisioned for these loans, and the related financial risk is negligible.

As part of its strategy to consolidate the banking industry, the CBJ intends to gradually raise the minimum capital requirement for banks to JD100 million from the current JD40 million by the year 2010. Preparations are also under way for implementing Basle II, with a readiness report expected during 2005.

Under the category “ Structural Policies,” the report mentioned that the IMF team, which visited the Kingdom last November, supported the government's decision to fully integrate the Socio-Economic Transformation Plan into the budget, effective 2005, with the aim of improving efficiency and reducing spending.

The individual projects will be allocated to the responsible spending agencies within their overall expenditure ceilings, the team indicated pointing out at the same time that the Ministry of Finance will integrate all budget preparation and execution functions under its authority to improve budget management.

“The authorities intend to deepen cooperation between the Ministry of Finance and the CBJ to improve the design and implementation of macroeconomic policies,” the report said, adding that “such collaboration could also facilitate coordination in the issuance of government bonds, which should replace the CBJ's CDs over the medium-term as the primary instrument of monetary policy.”

Other “Structural Policies” mentioned in the report referred to the government's intention to privatise electricity generation during 2005. This step will be followed by the privatisation of the electricity distribution companies.

In addition, transactions related to two non-core businesses of Royal Jordanian, Jordan Post and the Civil Aviation Authority are expected to be completed.

According to the report, the government intends to follow a sequential approach in the period ahead, under which the establishment of appropriate regulatory agencies to protect against the creation of private monopolies and adherence to market prices by privatised entities will precede privatisation.

Under the category “Statistical Issues and Technical Assistance,” the report listed the following three points:

A) The authorities are committed to meeting the fund's Special Data Dissemination Standard within the next two to three years.

B) The authorities expressed interest in technical assistance in reserve management and developing the domestic bond market.

C) The continuation of the ongoing technical assistance in tax administration and expenditure management will be crucial

For the data dissemination, the IMF team indicated that Jordanian officials are “implementing the recommendations of the update to the report on the Observation of Standards and Codes in order to achieve this goal.”

Following the publication of revised balance of payments statistics according to the fifth edition of the Balance of Payments Manual and the International Reserve Template in May 2004 with the benefit of a fund technical adviser, a strategy has been adopted to compile the international investment position, with a view to commencing its regular publication by early 2005, the report detalied.

“Further improvements in the balance of payments statistics relating to regular surveys in the transportation and investment areas would also be desirable,” the IMF team recommended.

In line with the recommendations by the recent Fund Statistics Department mission, the Ministry of Finance is now publishing general government statistics on a quarterly basis.

With regard to technical assistance, the IMF team indicated that the authorities expressed interest in technical assistance in reserve management and developing the domestic bond market.

“Given the large reserve position of the CBJ and the government's large foreign currency liabilities, it is becoming more important to manage reserves and hedge liabilities in order to achieve the highest risk-return profile,” the report said.

“Moreover, the authorities reiterated their interest in receiving assistance for developing a domestic government bond market as part of their strategy to shift government financing towards domestic debt instruments and to develop a yield curve for the domestic capital market,” it added.

On technical assistance in tax administration and expenditure management, a follow-up FAD mission is planned for early 2005 to assess progress made in unifying the income and the General Sales Tax (GST)departments and to look at other issues related to further integration of tax administration.

The aforementioned mission will be in addition to another planned to advise on modifying the existing social safety net. Furthermore, two assignments for tax administration experts are scheduled for early 2005: One to follow-up on large and medium taxpayer reforms; and the second to provide advice in modernising domestic excise administration.

“Improving macro-fiscal coordination, budget classification, and cash management, as well as introducing a Government Financial Management Information System in the medium-term, remain priorities,” the report emphasised.

In their overall appraisal, the IMF staff said the Jordanian economy continued its good performance in 2004.

“Spurred by rising domestic demand, global economic recovery, restoration of trade links with Iraq, and the continued implementation of prudent macroeconomic policies, real GDP in 2004 is expected to grow by about six per cent as compared with three per cent in 2003 under low inflation,” the IMF staff wrote.

They expected the external position to remain strong with usable gross official reserves comfortable at the equivalent of over six months of prospective imports.

Reflecting buoyant tax revenues and tight expenditure management, the fiscal position has strengthened, they observed while estimating the overall budget in 2004 to post an overperformance compared with the budget target.

Total public debt/GDP ratio was projected to drop to 92 per cent of GDP by end-2004 in line with the target under the Public Debt law (PDL).

According to the report, these developments have strengthened financial stability and improved investor confidence, resulting in increased inflows of foreign direct investments (FDIs).

The second point in the staff appraisal said that over the medium-term, Jordanian officials are appropriately focusing on the twin objectives of reducing the public debt burden and maintaining high economic growth.

“However, the achievement of these objectives may be constrained by a number of important external and domestic factors,” the report cautioned.

Given the currency composition of public debt, its planned reduction is vulnerable to the potential adverse impact of valuation effects in the event of further effective depreciation of the Jordanian dinar, according to the IMF staff.

In the fiscal area, continued reliance on foreign grants remains an important vulnerability. Moreover, failure to adjust domestic fuel prices, coupled with higher-than-expected world oil prices, would result in a significant widening of the fiscal deficit and could delay meeting the debt reduction target by 2006.

Setbacks in privatisation was also mentioned in the report as posing another important risk for the debt strategy.

According to the IMF, the authorities are fully aware of these risks and are taking decisive steps to address them.The official strategy aims at a sustained reduction in the fiscal deficit supported by structural reforms to stimulate private sector investment, including FDI, and a judicious implementation of the privatisation programme under market-based prices.

“In particular, it [the strategy] aims to strengthen fiscal adjustment through both revenue and expenditure measures, by realigning domestic petroleum product prices with international levels, and by shifting government borrowing towards domestic currency-denominated debt,” the report pointed out.

The staff expressed broad support for the thrust of the official strategy for the 2005 budget which calls for restricting the overall deficit to JD270 million (3.2 per cent of GDP)in line with the debt target under the PDL.

However, according to the IMF, it is crucial that the authorities take advantage of progress made in 2004 to sustain the reform momentum.

In particular, the staff encouraged the authorities to take steps to introduce the automatic petroleum product price adjustment mechanism to close the gap between domestic and international petroleum product prices by 2008.

The planned fund technical assistance will help strengthen the existing social safety net in order to cushion the impact of the price increases on the vulnerable groups.

“Realigning the non-standard GST rates with the basic rate and broadening the GST coverage will also be critical,” the staff emphasised. “There is also scope for reducing and rationalising capital spending.

In this regard, the integration of the Socio-Economic Transformation Plan with the regular budget was described as a critical step towards minimising duplication and improving expenditure management.

The IMF staff viewed the continued fund technical assistance in tax administration and expenditure management as useful in facilitating ongoing reforms.

“It is also critical that electricity generation is privatised in 2005 as planned, and proceeds are used to retire debt,” the IMF team stressed.

The staff supported the authorities' plans to proceed carefully with privatisation and link it to the establishment of appropriate regulatory agencies to protect against the creation of private monopolies and to ensure adherence to market prices by privatised entities.

In the period ahead, restructuring the income tax would make it more equitable and would improve resource allocation, in addition to generating higher revenue, the report stated.

Another point in the staff appraisal said Jordan's exchange rate policy of pegging to the depreciating US dollar, combined with prudent financial policies, has ensured competitiveness.

“The planned pursuit of a tighter monetary policy in 2005 and adjustment in domestic interest rates in line with international rates should facilitate maintenance of competitiveness,” the report added

The staff encouraged the authorities to continue monitoring developments in external reserves, interest rate developments in the international capital market, and export competitiveness to ensure the effectiveness of their exchange rate policy.

“The authorities should be prepared to respond expeditiously to any significant negative impact of the elimination of textile quotas under the multifiber arrangement,” they remarked.

The staff commended the government for steps being taken to support development of a strong banking sector especially an early merger of the one remaining bank under CBJ administration with another larger bank.

The planned gradual increase in the minimum capital requirements for banks over the medium-term is consistent with the official strategy for a sounder and more consolidated banking sector, the report remarked.

The staff supported the authorities' intention to develop the domestic government bond market as part of their strategy to shift budgetary financing towards domestic debt instruments, which would also help in developing a yield curve for the domestic capital market.

Fund technical assistance for developing such a market will be beneficial, the report concluded.

Following is the full text of the Public Information Notice issued by the External Relations Department of the International Monetary Fund (IMF) after the IMF Executive Board concluded its first Post-Programme Monitoring Discussions with Jordan
THE GOVERNMENT'S policy stance during 2004 aimed at promoting growth while consolidating the fiscal position in order to reduce the public debt-to-GDP ratio.The macroeconomic policy mix included prudent budgetary management and a credit policy supportive of economic expansion.

The economy recovered strongly during 2004,with real GDP growth estimated at over six per cent.The unemployment rate decreased from 14.5 per cent in 2003 to 12.5 per cent in the first half of 2004.

Reflecting the economic recovery, the Amman Stock Exchange index increased by 64 per cent during the year.

Inflation remained under control; average consumer price index inflation for 2004 was 3.4 per cent compared with 2.3 per cent in 2003.

The fiscal position strengthened during 2004, with tax revenues growing strongly and current expenditures being curtailed.

For the year as a whole, the overall deficit is estimated at about 3.4 per cent of GDP — an overperformance of about 0.5 per cent of GDP compared to the original target.

The debt-to-GDP ratio is estimated to have declined by almost eight percentage points to 92 per cent of GDP.

Jordan's external position remained sound.The external current account in 2004 is estimated to be broadly in balance, as higher imports were compensated by a brisk pickup in exports and sharply higher transfers.

The capital account is estimated to record a small surplus for 2004, owing to significant private inflows, including foreign direct investment (FDI).

The gross usable reserves of the Central Bank of Jordan (CBI) increased to $4.8 billion at end-December 2004 — equivalent to seven months of prospective 2005 imports.

The Jordanian dinar depreciated by 3.9 per cent in real effective terms over the 12 months to September 2004.

Monetary developments reflected the brisk growth in credit to the private sector on account of the buoyant economic activity and government domestic financing needs related to delays in privatisation.

Thus, broad money growth for end-2004 is estimated at about 11 per cent, somewhat above nominal GDP growth.

Domestic interest rates were adjusted in line with developments in the global capital markets to support the peg with the US dollar.

Steps were also taken during 2004 to strengthen the capital position of banks and to improve supervision. The share of non-performing loans declined substantially during 2004.

Further progress has been made in structural reforms, including the privatisation of the management of the Aqaba container port in early 2004.

Jordan has also embarked on an ambitious improvement in the health and education sectors, supported by a World Bank loan.

Jordan's medium-term outlook remains positive, with a growth rate of around six per cent per year.

Trade liberalisation and increased market access have set the stage for strong export-led growth over the medium-term, and exports are expected to continue growing at 6-8 per cent per year.

Large private sector-led infrastructure projects, including in water, gas, and electricity generation, are likely to boost investment.

Structural reforms, the enhancement of health and educational standards, and poverty alleviation are likely to have a positive impact on growth over the long-term.

Achieving the public debt target will entail fiscal tightening over the next three years. During this period,the external current account is expected to shift to a manageable deficit, while gross usable external reserves would remain at a comfortable level.

Executive board assessment

Over the past few years, the Jordanian economy has made impressive progress.

Spurred by rising domestic demand, global economic recovery, restoration of trade links with Iraq, and the continued implementation of prudent macroeconomic policies, economic growth has picked up sharply in 2004 while inflation remained moderate.

The external position is strong, with usable gross official reserves presently comfortable at the equivalent of about seven months of prospective imports.

Reflecting buoyant tax revenues and tight expenditure management, the fiscal position has strengthened and the total public debt/GDP ratio has fallen.

In the period ahead, the Jordanian economy will continue to face important challenges.

Public debt is large,and the economy continues to rely on external grants and remains vulnerable to exchange rate fluctuations.

Moreover, inadequate adjustments in domestic fuel prices, coupled with higher-than-expected world oil prices, could result in a significant widening of the fiscal deficit and could delay meeting the debt reduction target.

Delays in privatisation pose another important risk for the debt strategy.

The official strategy regarding these challenges is appropriate; it focuses on the twin objectives of reducing the public debt burden and maintaining high economic growth.

A sustained reduction in the fiscal deficit — supported by structural reforms to stimulate private sector investment, including FDI — and a judicious implementation of the privatisation programme would help place Jordan on a higher growth path consistent with a sustainable external position.

The thrust of the official strategy for the 2005 budget is sound and its overall deficit target is consistent with the debt limits under the Public Debt Law.

The authorities should take advantage of progress made in 2004 to sustain the reform momentum. In addition, it would be critical to realign the nonstandard General Sales Tax (GST)rates with the basic rate and to broaden the coverage of the GST.

Moreover, restructuring the income tax would make it more equitable and would improve resource allocation, while generating higher revenue.

There also is scope for rationalising capital spending. In this regard, the integration of the Socio-Economic Transformation Plan with the regular budget is a critical step towards minimising duplication and improving expenditure management.

Structural reforms continue in several areas. The privatisation of electricity generation in 2005 is important, and the authorities appropriately plan to proceed carefully and link privatisation to the establishment of proper regulatory agencies, which would protect against the creation of private monopolies.

The authorities should also take steps to introduce an automatic petroleum product price adjustment mechanism to close the gap between domestic and international petroleum product prices by 2008.

The planned fund technical assistance should be useful to strengthen the existing social safety net so as to cushion the impact of the fuel price increases on vulnerable groups, and to facilitate ongoing reforms in tax administration and expenditure management.

Jordan's policy of pegging to the US dollar, combined with prudent financial policies and continued structural reforms, has ensured competitiveness.

The planned pursuit of a tighter monetary policy in 2005 and the adjustment in domestic interest rates in line with international rates should facilitate the maintenance of competitiveness.

The authorities are encouraged to continue monitoring developments in external reserves, interest rates in the international capital markets, and export competitiveness to ensure the effectiveness of their exchange rate policy.

In this regard, the authorities should be prepared to respond expeditiously to any significant negative impact of the elimination of textile quotas under the multifiber arrangement.

The steps that are being taken to support the development of a strong banking sector are appropriate. An early merger of the one remaining bank under the CBJ administration with another larger bank would send an important signal to the financial market.

In addition, the authorities' intention to develop the domestic government bond market is timely. It forms part of their strategy to shift budgetary financing toward domestic debt instruments, which would also help in developing a yield curve for the domestic capital market.

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