Memorandum on Economic and Financial Policies, 2004
1. This memorandum reviews economic performance in the first quarter of 2004 and describes the government's economic policies for the remainder of the year. I. Developments under the 2004 Program 2. The economy is rapidly recovering from the disruptions caused by the war in Iraq in 2003. Real GDP grew by 6.9 percent in the first quarter of 2004, boosted by a surge in exports (29.0 percent year-on-year). The industrial production index—which excludes the higher gains in manufacturing activity in the Qualified Industrial Zones (QIZ)—increased by an annual rate of 14.7 percent during the same period, while imports rose by 32.3 percent. Inflation remained moderate at an average rate of 2.8 percent in the 12 months through March 2004. The Amman Stock Exchange index rose by 5½ percent in the first quarter of 2004, following an increase of 54 percent in 2003. Unemployment, however, remains stubbornly high at 14.5 percent. All quantitative performance criteria at end-March 2004 under the program were met by large margins. 3. Fiscal performance was much stronger than programmed, reflecting the strong pickup in economic activity, better budgetary management, and higher foreign grants. The central government budget registered a surplus of JD 137 million (1.8 percent of expected GDP) in the first quarter of 2004, compared to a targeted deficit of JD 140 million under the program. The revenue over performance resulted from strong GST and customs duty collections reflecting the robust import growth, domestic economic activity, and strengthened tax administration. Income tax receipts were also high as a result of strong corporate earnings in 2003. At the same time, the government held a tight control on current and capital spending and collected significant repayments from onlending operations. In particular, the government issued a budget circular in March 2004 asking all government ministries to cut utility bills by 20 percent. The government also mandated, under the 2004 budget, full payment of taxes for new projects, unless donor financing requires tax exemption. Overall, the fiscal surplus led to a reduction in the net government debt stock in the first quarter of 2004 by 8 percentage points to 93.5 percent of expected GDP, with the foreign debt stock accounting for 69.7 percent of expected GDP. The overall public sector registered a surplus of 2.6 percent of expected GDP, while its net debt declined by 4½ percentage points to 55.2 percent of expected GDP. 4. Jordan's external position remained strong despite a surge in import payments associated with robust domestic activity. The external current account is estimated to have recorded a surplus of US$107 million (1.0 percent of projected annual GDP) during the first quarter of 2004. The trade balance registered a deficit of US$613 million (5.7 percent of annual GDP), somewhat higher than the same period in 2003, reflecting the surge in imports more than offsetting the increase of 29 percent in merchandise export receipts. The rise in imports suggests a stronger-than-anticipated rebound in economic activity but also reflects higher oil prices and the large import content of booming exports. The export boom was broad-based and fueled by growing demand from the Iraqi market as well as by the continued expansion of textile exports, mainly from QIZs, to the United States. Net tourism receipts increased by an annual rate of 31.2 percent during the first quarter of 2004, supported by higher business travel of nonresidents to Jordan and lower travel abroad by Jordanians. Preliminary estimates point to a capital account deficit of US$283 million, with significant capital outflows of around US$300 million, mainly reflecting official transfers. The latter contributed to a decline in gross international reserves by US$194 million during the first quarter of 2004. 5. Monetary conditions continued to be conducive to price stability in the first quarter of 2004. Broad money grew at an annual rate of 8.6 percent at end-March 2004, fueled by an increase in foreign currency deposits in the first quarter. Private sector credit growth recovered to 4.9 percent, but remained somewhat lower than the increase in economic activity. The CBJ maintained a prudent monetary policy, thus allowing for a decline in reserve money in line with the lower NFA. Interest rates on CBJ-CDs increased modestly during the same period, following the global trend in interest rates. 6. The health of the banking sector improved in 2003, reflecting stronger profitability and more prudent credit policies. Net after tax profits of the banking sector reached JD 100 million in 2003, compared to JD 79 million in 2002. Net profits increased to 0.7 percent of total assets and 2.0 percent of total loans. The level of classified loans excluding interest in suspense fell to 15.8 percent of total loans, compared to 17.5 percent in 2002. The underlying risk-weighted capital adequacy ratio (CAR) improved in 2003 by 1.3 percentage points, reflecting a strengthening of the balance sheets of commercial banks. However, because of the inclusion of market risk in the 2003 calculations, the CAR declined marginally to 15.9 percent, compared to 16.6 percent in 2002. 7. Further progress has been made in structural reforms. The Privatization Commission has received strong expressions of interest from potential strategic investors for bidding on the privatization of the electricity generation companies in April 2004. The sale is expected to be completed in the fourth quarter of 2004. The cabinet also approved the privatization of the agricultural marketing company AMPCO. In order to improve domestic competition, customs duties on steel and cement were reduced by 5 percentage points to 25 percent in April 2004. The government also signed a free trade agreement with Singapore that will come into effect in the second half of 2004. On June 2, 2004, the CBJ published revised balance of payments statistics, in line with the fifth edition of the IMF balance of payments manual (BPM5), and a new international reserves template, the last structural benchmark under the SBA. II. Policies for the Remainder of 2004 8. Economic policies for 2004, cast in the context of a medium-term macroeconomic framework, are designed to strengthen economic growth; maintain financial stability and a solid external reserve position through prudent demand management policy; and reduce further public indebtedness through continued fiscal consolidation. Real GDP growth is projected to reach 5½ percent for the year as a whole, which, supported by a strengthened policy agenda, would enable Jordan to reach its full potential of 6-7 percent and achieve a significant reduction in unemployment over the medium term. Inflation is expected to increase somewhat because of upward adjustments in administered prices and certain tax rate increases in early 2004 but is likely to remain moderate at about 3½ percent. The balance of payments outlook is expected to remain strong, supported by export growth and the continued flow of external grants in the aftermath of the war in Iraq. As a result, the external current account is now expected to register a surplus of 5½ percent of GDP, and official external reserves are programmed to remain at a comfortable level of about US$4½ billion by end-2004. Fiscal policy for the remainder of 2004 9. The government will continue its prudent stance of fiscal policy for the remainder of 2004, in order to reduce the debt burden at a pace consistent with the debt ceilings mandated by the Public Debt Law. The fiscal surplus registered in the first quarter of 2004 bodes well for the achievement of the fiscal deficit target of 3.9 percent of GDP at end-2004. However, the sharply higher international oil prices and the government decision to provide universal health insurance coverage for all children under six and to increase the salaries of civil servants and military personnel by JD 5-10 will put significant additional pressures on the budget in the remainder of 2004. Based on current projections, the shortfall in nontax revenue could be at least JD 156 million, which is expected to be fully offset by additional grants from neighboring countries and somewhat higher tax revenues. The government will limit spending in line with the budget and will continue to keep a tight control on recurrent spending, while implementing the capital program for well-targeted projects aimed at improving public infrastructure and education. The government will monitor fiscal developments closely beyond the current SBA, on the basis of quarterly quantitative targets, and will enforce expenditure cuts in certain nonpriority areas, as appropriate in order to achieve the overall fiscal deficit target. In the event the strong revenue performance in the first quarter of 2004 continues, the government intends to save a large portion of the over performance for further debt reduction. The operational aspects of the Plan for Social and Economic Transformation (PSET) will be fully integrated in the budget starting in 2005. 10. Ongoing structural reforms in the fiscal area will continue to support fiscal consolidation. The ministry of finance continues to make significant progress in merging the Income Tax and the Sales Tax Departments to improve revenue administration. After the creation of the Unified Revenue Department in December 2003, an integration project directorate was formed in February 2004, with technical assistance from the Fund, to oversee the development and implementation of the large- and the medium- taxpayer offices; the reform of small taxpayer administration; and the incremental establishment of an integrated head office. The criteria for taxpayers who will be subject to the Large Taxpayer Office (LTO) administration were finalized in April 2004, and the LTO will be fully functional by October 2004. The ministry of finance has adopted a financial management plan for 2004-06 to improve fiscal management in a multi-year context. The 2004 budget law also reduced the limit on increasing budgetary allocations to new projects from 100 percent to 35 percent of the original budgetary allocation. The government intends to review and improve further fiscal transparency, following the recommendations of a fiscal ROSC mission planned for September 2004. The government will also be reviewing the recommendations of the actuarial review of the Social Security Corporation that is expected to be completed in June 2004, with a view to ensuring the long-term financial viability of the corporation. Monetary and financial policy 11. Monetary policy will continue to support price stability. The peg to the U.S. dollar continues to serve Jordan well, by keeping inflation in line with industrial country levels and fostering confidence in the Jordanian dinar. The CBJ will continue to maintain a comfortable international reserve position and stands ready to protect reserves and monetary stability through active liquidity management. The monetary program for the remainder of 2004 is consistent with the objective of continued price stability and also allows for a substantial rebound in credit to the private sector. The CBJ will continue limiting the expansion of its net domestic assets so as to meet its international reserve target in a non-inflationary manner. 12. The government and the CBJ recognize the need to deepen financial intermediation. The government will continue to issue long-term bonds at regular intervals to provide a benchmark and to lengthen the maturity structure for long-term lending by commercial banks and will take appropriate complementary measures to develop the secondary market for bonds with technical assistance from the IMF. Monetary conditions permitting, the CBJ will continue to improve on the structure of interest rates by increasing the spread between the overnight deposit rate and CD yields. This should help revitalize the rather thin interbank market. Stronger competition and improved productivity in commercial banks should also lead to a reduction in the spread between deposit and lending rates. 13. The CBJ is actively considering the options to deal with the small bank under its temporary administration and a decisive action will be taken once the ongoing criminal proceedings are completed. A substantial portion of the nonperforming assets of the bank is now likely to be recovered and it is therefore expected that there will be no use of public funds for the resolution of the bank. In line with the prompt corrective action framework, the CBJ has reached agreement with the only remaining undercapitalized bank on a time-bound restructuring plan, is monitoring closely this bank, and will be ready with corrective measures in the event of deviations from the agreed restructuring. The CBJ will continue implementing the recommendations of the IMF safeguards assessment, which will further strengthen the control framework in the central bank. In this regard, the audit of the CBJ financial statements for 2003 has been completed in accordance with international accounting standards and included a second partner review by a reputable international accounting firm. Structural reforms 14. The government plans to accelerate and broaden the privatization program. Following the privatization of the electricity generation companies in 2004, the government intends to proceed rapidly with the privatization of the electricity distribution companies. It also intends to sell a majority stake as well as management control in the Jordan Phosphate Mines Company to strategic investors and possibly an additional portion of the government's share in the Jordan Telecommunications Company. It will continue to privatize the remaining noncore units of the Royal Jordanian Airlines and will sell the Jordan Post Company to a strategic partner. The fiscal program for 2004 estimates total privatization proceeds of about JD 300 million. 15. The loss of the Iraqi oil grant in 2003 and the recent surge in international oil prices underlines the need to rationalize petroleum product prices and liberalize the domestic market for petroleum products. The government intends to reduce the vulnerability of the budget to world oil price fluctuations and to eliminate the remaining subsidies on diesel, fuel oil, liquefied petroleum gas, and kerosene by end-2006. The government is continuing with a multi-year program entailing discretionary price adjustments with a view to eliminating any remaining subsidies on petroleum products. Once the gaps between domestic and international prices have been closed, a symmetric automatic price adjustment mechanism based on international prices will be introduced. However, the full liberalization of the oil sector cannot be achieved until the exclusive concession rights of the Jordan Petroleum Refinery Company expire in 2008. 16. The government and the CBJ are committed to meeting the Fund's Special Data Dissemination Standard within the next two to three years, and are implementing the recommendations of the Update to the Report on the Observation of Standards and Codes—Data Module in order to achieve this goal. A strategy to compile the international investment position in accordance with BPM5 has been adopted, with a view to commencing regular publication of these statistics by early 2005. To meet these targets, the CBJ is working with an IMF technical advisor on balance of payments statistics. In addition, the ministry of finance will set up a committee in charge of fiscal data which will be mandated to organize and publish general government statistics on a quarterly basis starting in January 2005, in line with the recommendations of the recent technical assistance mission from the Statistics Department of the IMF. |
