Jordan
Background Information on Selected Aspects of Adjustment and Growth Strategy
Author: International Monetary Fund
Publication Date:
01 Jun 1995
eISBN:
9781451820270
Language:
English
Keywords:
ISCR; CR; debt service; exchange rate; balance of payments; U.S. dollar
Download PDF (7.9 MB)

This paper presents background information on selected aspects of adjustment and growth strategy for Jordan. The paper deals with the key developments in the Jordanian economy since 1989 compared with its developments in the 1970s and 1980s. It presents an overview of Jordan’s economic structure, policies, and developments, particularly since 1989, and provides a setting for the issue-oriented discussions of other sections. Although highlighting Jordan’s recent success, it stresses the importance of appropriate financial policies and structural reforms, together with external financial support, for achieving sustainable economic growth.

Abstract

This paper presents background information on selected aspects of adjustment and growth strategy for Jordan. The paper deals with the key developments in the Jordanian economy since 1989 compared with its developments in the 1970s and 1980s. It presents an overview of Jordan’s economic structure, policies, and developments, particularly since 1989, and provides a setting for the issue-oriented discussions of other sections. Although highlighting Jordan’s recent success, it stresses the importance of appropriate financial policies and structural reforms, together with external financial support, for achieving sustainable economic growth.

Jordan: Basic Data 1/

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Sources: Department of Statistics, Statistical Yearbook 1993; the Jordanian authorities; and staff estimates.

East Bank only.

Commitment basis.

Cash basis.

Based on the revised sectoral classification recommended by the Fund’s Statistics Department; because of reclassification, the changes shown under this column may not be meaningful.

Consists of Central Government (net, general budget) and Central Government (net, own budget).

Also includes claims on municipalities and local governments and on the Social Security Corporation.

Includes claims on specialized credit institutions (for the period up to 1993 under the old classification) and financial institutions.

Excluding grants from the Gulf Financial Coordination Group (GFCG) and transfers of workers’ savings.

Readily unable foreign exchange of the Central Bank of Jordan (CBJ); excluding foreign exchange deposits by residents at the Central Bank of Jordan, gold, and claims on the Central Bank of Iraq; data are for end of period.

Period overages; depreciation (–).

I. Introduction

Jordan has achieved over the past few years major progress in macroeconomic stabilization and transformation in its economic structure. Its impressive performance was the result of a persistent, courageous, and difficult process of adjustment and reform program that started in 1989 and was intensified since 1992. The Fund has been associated closely with the process of adjustment and reform carried out in Jordan since 1989. The association has been reflected in the stand-by arrangements of 1989 and 1992, and currently the extended arrangement that was approved in May 1994. The papers presented in various chapters of this background study have been prepared by staff members who participated in the process of cooperation between Jordan and the Fund over the last three years.

This volume does not seek to present a complete description of policies and developments, but rather focuses on some central aspects of the Jordanian experience of recent years. Included are discussions on macroeconomic policies and developments; an analysis of structural reforms in key areas, such as fiscal, financial system, and trade and exchange regime. Jordan’s external debt management strategy, as well as the dynamics of public debt and its sustainability—taking into account the recent stance of fiscal policy—are also discussed.

Section II deals with the key developments in the Jordanian economy since 1989 compared with its developments in the 1970s and 1980s. It presents an overview of Jordan’s economic structure, policies and developments, particularly since 1989, and provides a setting for the issue oriented discussions of other sections. While highlighting Jordan’s recent success, it stresses the importance of appropriate financial policies and structural reforms, together with external financial support, for achieving sustainable economic growth.

Section III reviews the relationship between macroeconomic environment and investment and growth. Specifically, this section reviews Jordan’s growth and inflation performance over the last two decades; compares this performance with the prevailing macroeconomic environment measured in terms of selected indicators; and explores the link between Jordan’s macroeconomic performance and developments in private sector investment and growth.

Section IV analyzes Jordan’s public debt dynamics and the stance of central government fiscal operations. It describes: the evolution of Jordan’s fiscal imbalances and the growth of public debt in terms of a debt dynamics accounting framework, the fiscal adjustment and reform efforts since 1989, and the implications of these efforts for the sustainability of the public debt. The medium-term fiscal issues that bear on the sustainability of Jordan’s public debt in the longer term are also discussed in this section.

Section V addresses developments in the financial sector during 1970-94. It reviews the use of monetary policy instruments until late 1980s, the use of these monetary policy instruments under the stabilization program since 1989, and improvements in banking supervision and in the regulatory environment. The section concludes with a review of the ongoing and prospective financial reforms.

Section VI deals with Jordan’s external debt strategy, it focuses on the steps taken since 1989 to alleviate Jordan’s official bilateral debt and commercial bank debt burden. This section discusses the key elements of the approach, which together with sustained implementation of appropriate economic policies have made toward improving Jordan’s medium-term debt and debt service outlook.

Section VII supplements the discussion on developments in the external sector policies by reviewing the reforms undertaken in recent years to liberalize the trade and exchange systems. In particular, the section highlights the substantial reduction of tariff barriers undertaken during 1988-94, measures to promote exports, and the authorities’ current strategy for further trade liberalization.

Section VIII focuses on the effects of the 1989 balance of payments crisis on Jordan’s poverty profile, and on the social aspects of the adjustment program, including the program’s social safety net instruments. This section analyzes the extent and distribution of poverty in the post-crisis period, and discusses the poverty alleviation policies adopted by the Government. It reviews the mechanism by which (both temporary and permanent) social safety net instruments were strengthened or established to protect the poor and vulnerable segments of the population during the adjustment and reform period. This section concludes with a review of the Government’s safety net programs in terms of their cost effectiveness and sustainability from the budgetary point of view.

II. The Jordanian Strategy to Achieve Sustained Economic Growth, 1989-94

In recent years, Jordan has made major progress toward achieving macroeconomic stabilization and achieving sustained economic growth. Jordan’s remarkable success in achieving high real growth with continued price stability and a strengthening of balance of payments is attributable to the Government’s stabilization and reform strategy adopted in the wake of the balance of payments crisis of the late 1980s. The strategy was further strengthened in the aftermath of the August 1990 regional crisis when 300,000 Jordanians (about 10 percent of the population) returned from neighboring countries leading to a sharp increase in unemployment, disruption of trade, loss of remittances, and stoppage of aid flows from regional countries.

This section provides a background analysis covering the structure of the economy, the sources of Jordan’s economic difficulties, and recent adjustment and reform efforts. The analysis focuses on two sub-periods. The emergence of financial imbalances in the 1980s and the adjustment and reform efforts since 1989, which were supported, inter alia, by two stand-by arrangements and an ongoing extended arrangement with the Fund and sectoral lending from the World Bank.

1. Structure of the economy

Jordan is a lower/middle-income country of an estimated 4 million inhabitants with an annual per capita income estimated at US$1,370 in 1994. Its economic structure is dominated by trade- and service-related activities (including government services). These account for more than two thirds of GDP at factor costs (Chart 1); manufacturing, agriculture, mining, and construction account for the rest. Construction has been the driving force in periods of strong economic growth. Because of its very narrow production base, the economy is highly dependent on imports, which represent more than 60 percent of GDP. Workers’ remittances from the neighboring oil-rich countries and processed mining-based exports are the primary sources of Jordan’s foreign exchange earnings.

CHART 1
CHART 1

JORDAN STRUCTURE OF THE ECONOMY

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International Financial Statistics, and various Recent Economic Development Reports.1/ Including government services.

The size of the public sector in Jordan is large in relation to the level of domestic economic activity. However, the public sector is not engaged in manufacturing activities; its involvement is primarily limited to the provision of basic services (health and education), public utilities (water and electricity) and of infrastructural support, mainly in the areas of transport, communications, and irrigation. Central government expenditures account for about 35 percent of GDP, although at about 30 percent of GDP the total revenue to GDP ratio is also high in comparison with other non-oil middle-income countries.

The quality of services provided by the public sector in Jordan is generally good and social indicators are satisfactory. Literacy and enrollment rates at primary and secondary school levels are high, and nutrition and health conditions are generally satisfactory.

Prudent expenditure programs, combined with the availability of foreign grants and the regional economic boom associated with a sharp rise in oil prices, 1/ led to economic prosperity in Jordan during the 1970s and the first half of the 1980s. Subsequently, however, as the regional economies entered into a recessionary period in the wake of falling petroleum prices by the mid-1980s, Jordan’s underlying financial imbalances came to the forefront. By 1987-88, these imbalances had become unsustainable and led to a severe balance of payments crisis that seriously undermined the economy’s growth prospects. These problems were compounded by the adverse effects of the August 1990 regional crisis.

2. Origins of Jordan’s economic difficulties in the 1980s

a. Broad strategy during the 1970s-mid-1980s

Since the early 1970s, Jordan’s strategy was to develop itself as a provider of skilled manpower and trade-related services to the Arab countries in the region. Accordingly, the authorities chose a strategy aimed at having the growing number of educated youths in a position to seek employment around the region. At the same time, with the sizable amounts of remittances and aid received from abroad, Jordan was able to maintain income and consumption at levels that exceeded those that could be expected from the available production capacity in the domestic economy.

b. Macroeconomic outcome: an overview

Jordan’s economic growth during the 1970s and through the mid-1980s was robust. Domestic prices were generally stable, reflecting in part prudent monetary policy (Chart 2). 1/ As a result of high recurrent expenditures, large fiscal deficits were incurred (Charts 3 and 4), 2/ but these were largely financed by readily available foreign grants. Fiscal revenues remained highly dependent on international trade-based taxes, even though the revenue to GDP ratio increased to 25 percent of GDP by the mid-1980s. The domestic savings rate was relatively high. Investment remained at comfortable levels (at more than 20 percent of GDP), but much of the domestic private sector investment was directed to housing construction. Despite an unusual import boom, the external current account remained in virtual balance during this period (Chart 5). However, because of inappropriate incentives and price signals, efficient import-competing and export-oriented domestic manufacturing activities could not develop. Moreover, by the mid-1980s, the flow of foreign grants from traditional regional countries and inflows of workers’ remittances started to decline in the aftermath of the oil price collapse. The authorities responded to these developments by: (i) turning to external commercial and domestic bank borrowing to finance budgetary deficits, 3/ and unsustainable levels of domestic aggregate demand; and (ii) maintaining domestic price stability through control of administered prices. As a result, there was a rapid acceleration of external debt service burden, which led to the emergence of serious domestic financial imbalances. Moreover, the sharply higher public sector debt service payments further accentuated Jordan’s medium-term fiscal imbalance. Reflecting a relatively easy credit stance and the effect of large devaluations, by 1988 Inflation started to accelerate. 1/ At this time, commercial banks started to accumulate nonperforming assets, leading to bank failures by the late 1980s.

CHART 2
CHART 2

JORDAN MOVEMENTS IN MONETARY AGGREGATES, PRICES AND THE EXCHANGE RATE

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International Financial Statistics, and various Recent Economic Development Reports.
CHART 3
CHART 3

JORDAN CENTRAL GOVERNMENT OPERATIONS

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International Financial Statistics, and various Recent Economic Development Reports.
CHART 4
CHART 4

JORDAN CENTRAL GOVERNMENT OPERATIONS

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF. International Financial Statistics, and various Recent Economic Development Reports.
CHART 5
CHART 5

JORDAN EXTERNAL SECTOR

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF. International Financial Statistics, and various Recent Economic Development Reports.

Access to external borrowing virtually ceased to exist by 1988, and the authorities decided to initiate corrective macroeconomic policies, including a large devaluation of the Jordan dinar (Chart 6). 2/ By that time, however, Jordan had become one of the most heavily indebted countries in the world, with external debt to GDP ratio increasing to 193 percent of GDP by 1990 (Chart 7).

CHART 6
CHART 6

JORDAN EXCHANGE RATE INDICES, 1988–95 (1980 = 100)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: International Monetary fund, Information Notice System, and International Financial Statistics.
CHART 7
CHART 7

JORDAN EXTERNAL DEBT AND DEBT SERVICE, 1990–2000

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: Data provided by the Jordan authorities.

c. Structural weaknesses

In addition to the limited resource base, Jordan’s economic performance was also handicapped by policy-induced structural weaknesses in various sectors. The tax system in Jordan—although effective in mobilizing resources for government operations—suffered from inefficiencies resulting from cascading, widespread exemptions, multiplicity of taxes and tax rates, and inefficient tax administration. On the expenditure side, high military expenditure, extensive subsidy programs, 3/ and a growing external debt service burden complicated efforts to reduce the fiscal deficit to a sustainable level. Jordan’s trade regime was characterized, until the late 1980s, by a notionally high and complex tariff structure, nontariff barriers, widespread exemptions, and institutional inadequacies which adversely affected its export and industrial sector performance. 4/

In the agriculture sector, subsidized water and domestic producer price support contributed to the inefficient use of scarce water resources, while production controls on major vegetable crops prevented higher production and export of high value horticultural products 1/ (where Jordan appeared to have some comparative advantage). The energy sector also suffered from inadequate pricing policies for petroleum products and electricity, institutional inefficiency in the associated public sector enterprises, and the limited role of the private sector in energy sector development projects. 2/ As regards the financial sector, 3/ availability of financial instruments was limited, and instruments for indirect control had not been developed. 4/

3. Adjustment and structural reform efforts, 1989-94

To address the rapidly growing imbalances, in early 1989 the Government adopted a medium-term growth-oriented adjustment program supported by the Fund and World Bank, which resulted in some initial progress toward the reduction of macroeconomic imbalances and introduction of some structural reforms. However, following the August 1990 regional crisis, real income was reduced, unemployment rose sharply—as a result of the reflux of Jordanians working in the neighboring countries—trade was disrupted, and aid flows from the countries in the region ceased. These adverse developments rendered the attainment of the program targets impossible.

In 1991, the authorities sought to re-evaluate their adjustment and reform effort. This led to the adoption of a second medium-term adjustment program beginning in 1992, supported by the Fund and the World Bank.

a. Performance under the 1989-90 adjustment program

Jordan’s economic and financial performance under the SBA in 1989 was encouraging. All the policy actions contemplated in the program were implemented which, in combination with debt relief and bilateral grants by donors, enabled Jordan to meet all the quantitative performance criteria in 1989. The expansion in the net domestic assets of the banking system, the trade deficit, and the external current account deficit were kept below their respective program targets, allowing the Central Bank of Jordan’s (CBJ) foreign exchange reserves to exceed significantly the program target in 1989. The budgetary situation also improved, although due to higher than expected interest payments, the overall budget deficit exceeded the program target.

On the structural front, following the exchange rate depreciation in 1988, a number of reforms were introduced in the exchange and trade systems and interest rate policy under the 1989-90 program. These included, in particular, abandonment of the dual exchange rate system 1/ and unification of the official and interbank rates at the level of the more depreciated interbank rate; 2/ adoption of a flexible exchange rate management, with the Jordan dinar pegged to a basket of currencies; abandonment of the policy of supporting the interbank rate through intervention; freeing up interest rates; 3/ and phasing out nontariff barriers in stages and replacing these by tariffs initially, and by reducing tariff barriers as a whole subsequently, to lower effective protection and foster a broadly neutral system of incentives. 4/

The Government also adopted a debt management strategy aimed at obtaining debt relief through the rescheduling and lengthening of the maturity structure of debt and reducing the debt burden in relation to GDP in a medium-term context (see Section VI for more details). Consistent with these objectives, the Government: (i) concluded a restructuring agreement with the Paris Club in July 1989 and regularized relations with other official bilateral creditors along terms similar to those obtained from the Paris Club; (ii) initiated negotiations with the commercial banks to obtain a multi-year restructuring of obligations falling due to banks with provisions for new money and options for debt conversion; (iii) limited all new borrowings to longer term maturities and, in many instances, at concessional interest rates; 1/ and (iv) canceled most new commercial borrowings which were in the pipeline, including in particular a military aircraft purchase agreement. 2/

Adjustment policies were continued in 1990 when the authorities implemented various structural measures, including tariff reforms and further interest rate liberalization, and pursued flexible interest and exchange rate policies. However, a number of adverse developments during 1990, including, in particular, the regional crisis, pushed the economy off track.

b. Performance under the 1992-94 adjustment and reform program

The broad objectives of the 1992-94 programs—supported by a second stand-by arrangement and subsequently by the ongoing extended arrangement—were to: (i) achieve a significant reduction in the macroeconomic imbalances; (ii) continue the process of structural reform, despite considerable uncertainties about trade and aid relations between Jordan and its neighboring countries; and (iii) achieve balance of payments viability by 1998 while attaining satisfactory growth performance in the context of stable domestic prices with an increased role of the private sector in the economy.

The key policy elements of the program were to: (i) reduce the fiscal deficit substantially, through revenue enhancements and containment of current expenditures; (ii) contain credit expansion consistent with the external and inflation objectives and with achieving interest rates that were positive in real terms; (iii) continue a flexible exchange rate management, with a view to ensuring competitiveness of exports; (iv) carry forward the process of structural reforms initiated in 1989, particularly the second phase of tariff reform and the reform of the indirect tax system through the introduction of a general sales tax (GST); and (v) prepare a plan of action for reform of the agriculture and water and energy sectors for implementation over 1992-94.

(1) Macroeconomic stabilization and outcome

Jordan’s macroeconomic performance under the program during 1992-94 has been solid. The economy’s real growth, inflation, and fiscal adjustment performance have been much better than anticipated at the inception of the program; and despite a surge in imports associated with the large influx of returnees, the balance of payments adjustment has been stronger than targeted. After several years of decline or virtual stagnation, economic activity gained momentum in 1992. Real GDP growth (at market prices) exceeded 16 percent in 1992, 1/ against a program target of 3 percent, and growth averaged about 6 percent annually during 1993-94. This turnaround is largely attributable to strong activity in construction, but was also facilitated by a solid recovery in the agriculture, trade, and manufacturing sectors. Favorable supply response and import prices, coupled with prudent demand-management policies, contributed to a sharp deceleration of inflation to 4-5 percent range during this period, much below the program targets. The unemployment rate declined to the 12-15 percent range during 1993-94 from a peak of 25 percent in 1990, despite high labor force growth.

The overall fiscal deficit (excluding foreign grants) declined from 17.8 percent of GDP in 1991 to 3.7 percent of GDP in 1992, including the impact of nonrecurrent revenue sources (estimated at 3.5 percent of GDP); this compares with the program target of 13.7 percent of GDP. This sharp reduction in the fiscal deficit reflected the effect of discretionary fiscal measures (2.5 percent of GDP) adopted in the context of the 1992 budget, strict expenditure control, and buoyant revenue collection, including nonrecurring revenues (3.5 percent of GDP). Excluding the effect of nonrecurring revenues, the underlying fiscal deficit is estimated to have declined to about 7 percent of GDP. The authorities’ fiscal policy stance has been further tightened during 1993-94, as the underlying fiscal deficit (excluding nonrecurring factors) declined further to less than 6 percent of GDP in 1994, reflecting the effect of discretionary measures and strong economic growth.

The favorable fiscal outturn and cautious credit policy stance contained the growth of the net domestic assets (NDA) of the banking system to 7.6 percent in 1992, below the program target of 8.5 percent. 2/ Supported by the improved fiscal position, monetary expansion remained well below the increase in nominal GDP since 1992.

The external current account deficit declined to 14.4 percent of GDP (excluding workers’ savings and grants from the Gulf Crisis Financial Coordination Group (GCFCG)) in 1992, despite much higher than programmed imports associated with the economic expansion. The deficit declined further by 3 percentage points to 11.6 percent of GDP in 1993 and thereafter by a further 5 percentage points to 6.5 percent of GDP in 1994. This outcome was attributable to the continuing strong performance of remittances, nontraditional exports, and a strong recovery of tourism receipts. Higher-than-programmed receipts on account of these latter factors largely offset the shortfall in traditional mineral-based exports arising from shipping problems for phosphate rocks, the loss of markets, and collapse in world market prices, and, in addition in 1992, the substantially higher-than-programmed growth of imports associated with buoyant economic activity. Nontraditional exports were strong throughout the period. 1/ With these developments and larger-than anticipated transfers of workers’ savings. 2/ the overall balance of payments deficits were below the program targets in both 1992 and 1993, with the CBJ’s foreign exchange reserves exceeding the program targets in both years. Rescheduling of debt service and overdue obligations to the Paris Club creditors in February 1992 and receipts of exceptional assistance from the GCFCG significantly contributed to the balance of payments financing during 1992-93. However, reflecting the effect of regional uncertainties resulting from the peace process and the potential redemption of Jordan dinars (JDs) circulating in the West Bank, the level of gross official foreign exchange reserves of the CBJ declined sharply in the first half of 1994. The level of reserves improved significantly in the second half of 1994, in response to a substantial tightening of the stance of monetary policy; but by year’s end, it only amounted to the equivalent of about 5 weeks of imports.

Significant progress was also made in normalizing payments relations with external creditors and in reducing outstanding payments arrears. In addition, progress was made in liberalizing the exchange system; in particular, the amount of foreign exchange that can be transferred abroad by residents and nonresidents annually has been increased to JD 35,000 (equivalent to US$50,000), 3/ and the CBJ abolished the regulation under which export proceeds were to be repatriated within a specified period. Jordan achieved the current account convertibility and accepted obligations of Article VIII Sections 2, 3, and 4 in February 1995.

(2) Structural reforms

On the structural front, the second phase of the tariff reform was concluded in early 1992, with a further reduction of the maximum tariff rate (by 10 percentage points) to 50 percent (except for few luxury items) and a further decline in the standard deviation of the tariff rates to 15.9 percent. In the real sector, control of cropping patterns was abolished as part of the reform effort supported by the World Bank Agriculture Sector Adjustment Loan (ASAL), and the axle load regulation was being implemented in the context of the World Bank’s Third Transport Project. Following the implementation of necessary prior actions, including substantial increases in electricity and selected petroleum prices, the World Bank Executive Board approved an Energy Sector Adjustment Loan (ESAL) in October 1993. In September 1993, the authorities also started to issue central bank JD-denominated certificates of deposits, as a new indirect instrument of monetary control.

In order to broaden the domestic tax base and improve elasticity and efficiency of the tax system, the Government replaced the consumption tax system by a GST with input tax credit mechanism to remove cascading of taxes at different stages of production in June 1994. Various elements of the Government’s reform program has been discussed in detail in other chapters as appropriate.

4. Overall assessment

Following a mixed performance under the authorities’ 1989-90 stabilization program—largely attributable to the 1990 regional crisis—remarkable progress was made on the macroeconomic front during 1992-94. Sustained fiscal and external adjustments, coupled with prudent exchange rate and debt management, have contributed to a stable macroeconomic environment conducive to sustained economic growth with price stability. The financial support provided by the GCFCG and from other multilateral and bilateral creditors and the favorable effect of the unexpectedly large transfers of workers’ savings were also instrumental in easing the adjustment process. While the economy has responded very well to the implementation of adjustment and reform policies implemented in recent years, Jordan’s external position still remains weak and vulnerable, especially in light of the persisting, large external debt overhang. The Government is continuing with ambitious adjustment and broad based reform strategy under the extended arrangement. The program supported under the arrangement is comprehensive and it constitutes a decisive move toward addressing the medium-term difficulties facing the Jordanian economy.

III. Macroeconomic Environment, Growth and Investment

This section provides background information on how Jordan’s adjustment and reform programs and the resulting improved macroeconomic policy environment have influenced investment and growth in recent years. Since the source of growth and investment comes mostly from the private sector, it is usually thought that effects of the macroeconomic policy environment on growth and investment work via changing perceptions of confidence and uncertainty. Uncertainty about the macroeconomic policy environment tends to reduce the rate of growth and investment as investors have an incentive to wait until the uncertainty has been resolved before committing themselves to an irreversible course of action. Internal and external imbalances and high inflation rates generate uncertainty because they encourage a perception that a government is losing or has lost control over its economy, and that a remedial course of action is called for. Especially, since the nature and timing of changes in macroeconomic policy are unknown to private investors, they would tend to postpone investment decisions.

The basic indicators of the macroeconomic environment that are employed to examine the potential effect of adjustment programs on investment and growth are the inflation rate, the fiscal balance, and the external current account balance. Movements in the terms of the trade, inflow of workers remittances, and changes in the real exchange rate are basic indicators of external shocks affecting growth and investment. Based on the empirical analysis presented in this section and drawing on inferences from other empirical works, this paper concludes that: (i) real GDP growth is attributable more to increases in physical capital rather than increases in the labor force; (ii) despite impressive growth performance, total factor productivity has declined in recent years due to the need to absorb some 300,000 Jordanian from abroad into the economy; (iii) the most significant policy impact on real GDP growth has been through fiscal policy; accordingly, the negative impact of high fiscal deficits of the past has been declining with the progress made in reducing the deficit, despite falling grants; (iv) the major channel by which fiscal policy has affected real GDP growth is through slowing down the rate of capital accumulation by the private sector; and (v) the most important determinant of private investment in Jordan is the inflow of external financing in the form of workers’ remittances and transfer of savings.

The remainder of this chapter is outlined as follows. Section 1 gives a brief overview of economic developments in Jordan over the period 1976-94 divided into four sub-periods, based on general macroeconomic environment and performance in terms of investment and growth. 1/ Section 2 examines the factors influencing economic growth. In particular, the contribution to economic growth by factors of production are analyzed together with an analysis of how growth is influenced by the macroeconomic policy environment. Section 3 examines the factors influencing private investment.

1. Economic developments over the period 1976-94

a. The boom of the 1970s

Over the period 1976 to 1980, real GDP rose by 9,5 percent per year and investment was 35 percent of GDP (Table 1). During this period, much of the domestic private sector investment was directed to housing construction and partly to transport and mineral-based processing sectors; and therefore, such investments had limited direct impact on the future growth potential of the economy. During this period, Jordan’s growth and investment depended heavily on external financing. Private construction activity was largely financed through workers’ remittances, while grants and loans from oil-exporting countries in the region accounted for a large part of the financing for Jordan’s public sector investment.

Table 1.

Jordan: Macroeconomic Performance, 1976–94

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Sources: Department of Statistics, Government of Jordan; Central Bank of Jordan; and staff estimates.

Period average.

In percent of GDP.

In percent of GDP, excluding foreign grants.

The indicators of macroeconomic policy reflect a mixed situation over the period 1976 to 1980: inflation averaged 11.7 percent; the average fiscal deficit of the central government (excluding foreign grants) was 29 percent of GDP; but the external current account—reflecting receipts of sizable foreign grants—remained virtually in balance (averaging 0.2 percent of GDP). The large budget deficits were a result of the Government’s efforts to improve public utilities and services, together with higher defense expenditure and subsidies for specific basic goods.

b. The slowdown of the early 1980s

By the early 1980s, the terms of trade deteriorated, resulting in the subsequent deterioration in the external current account balance to a deficit of 5.2 percent of GDP. Furthermore, as oil prices and revenues started to decline, the level of external aid (primarily from regional oil producing countries) as a share of GDP dropped from 16.6 percent to 10 percent, which in turn led to a reduction in public sector investment as a share of GDP from 18.9 percent to 13.9 percent (Table 2). While public sector investment bore the brunt of the shock, private sector investment remained steady, at approximately 16 percent of GDP. The decline in investment and inflow of workers’ remittances adversely affected the economy with real GDP growth falling to an average of 6.2 percent over the period 1981-85. The fiscal deficit (excluding foreign grants) declined by more than 10 percentage points, although it remained very high at 18.5 percent of GDP; the reduction in fiscal deficit was largely attributable to cuts in development expenditure. Inflation was contained to an average annual rate of 4.1 percent by maintaining stable nominal exchange rates and due to a moderation in the world rate of inflation.

Table 2.

External Financing and Investment, 1976–94

(In percent of GDP)

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Sources: Department of Statistics, Government of Jordan; Central Bank of Jordan; and staff estimates.

Private investment is constructed from total gross fixed investment less central government capital expenditure.

c. The balance of payments crisis and economic slump in the late 1980s

In the second half of the 1980s, debt service obligations and fiscal imbalance increased sharply. Jordan’s debt service was 45.4 percent of exports of goods and services in 1989, while the average fiscal deficit (excluding foreign grants) increased to 20 percent of GDP. Faced with growing budget deficits, the Government resorted to foreign commercial bank borrowing and to borrowing from the domestic banking sector. The monetization of the deficit led to higher inflation. Jordan’s economy also remained highly vulnerable to the unfavorable fluctuations in income in the neighboring countries as a result of declining oil prices. The decline in workers’ remittances and grants and loans from the neighboring oil-exporting countries led to a growing external imbalance and an associated rapid buildup of debt and debt service burden. By 1988, this external imbalance had reached unsustainable proportions. General financial instability in this period led to bank failures and a reduction in private capital inflows. Reflecting this deteriorated macroeconomic environment, aggregate investment declined to 22.3 percent of GDP, with private sector investment averaging only 7.1 percent of GDP. Real GDP declined at an average rate of 6.4 percent during 1986-1990, with the worst recession in the recent history of Jordan occurring in 1989 when real GDP contracted by 20.9 percent (Chart 8).

CHART 8
CHART 8

JORDAN REAL GDP GROWTH AND INVESTMENT, 1977–94

(Percentage changes)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Source: Department of Statistics, Government of Jordan; Central Bank of Jordan.

d. Macroeconomic stabilization and economic recovery, 1989-94

Since 1989, Jordan has been implementing a medium-term structural adjustment program except for a temporary interruption in the aftermath of the 1990 regional crisis. During the period 1991-94, the macroeconomic policy indicators have shown significant improvement. The inflation rate declined to 3.5 percent in 1994 and for the period the average rate of inflation was 4.8 percent. The fiscal deficit declined sharply averaging 10.8 percent of GDP. Including foreign grants and the effect of debt relief, central general operations on a cash basis was in surplus during most of the years (Chart 9). The improvement in macroeconomic indicators also led to a recovery in investment to 28.7 percent of GDP despite a significant decline in external official financing compared with earlier periods, and real economic activity expanded by about 7.4 percent per annum. The strengthening of Jordan’s macroeconomic performance since late 1991 was attributable to three key factors: (i) the implementation of effective macroeconomic policies, such as restrained fiscal and monetary policy and prudent exchange rate management under the adjustment program; (ii) the regularization of external debt service obligations, a prudent debt management policy which contributed to a sharp reduction in the debt and debt service ratios and substantial external financial support from official bilateral and multilateral creditors; and (iii) the effective absorption of some 300,000 Jordanians from abroad (about 10 percent of the population and a higher proportion of the labor force) into the Jordanian economy, who also brought with them substantial savings and technical know-how to revitalize the private sector.

CHART 9
CHART 9

JORDAN REAL GDP GROWTH, FISCAL BALANCE, AND CURRENT ACCOUNT, 1977–94

(Percentage changes)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Source: Department of Statistics, Government of Jordan; Central Bank of Jordan.

2. Factors Influencing long-term growth

a. An overview

Recent developments in the growth literature have emphasized the role of economic conditions and implementation of proper public policies in influencing the rate of economic growth. Barro, and Barro and Sala-i-Martin 1/ link growth to fiscal variables in their endogenous growth models, which were tested empirically by Cashin 2/ for OECD countries. Fischer 3/ extends the notion that governments can influence growth by creating a stable macroeconomic framework. A stable macroeconomic framework can be created through implementation of a set of macroeconomic policies conducive to growth. 4/ The key macroeconomic policies are considered to be monetary, fiscal and exchange rate policies designed to keep inflation low and predictable, a stable and sustainable government balance, appropriate real interest rates, a competitive and predictable real exchange rate, and a viable balance of payments. One of the key mechanisms by which macroeconomic policies influence growth is via the signaling effect government management has on the private sector. To measure this signaling effect, Fischer recommends using a set of basic indicators of macroeconomic policy, such as the inflation rate, the government fiscal balance and the current account balance.

Fischer used a regression analog of growth accounting to identify the channels through which macroeconomic variables affect economic growth. Growth can be attributed to changes in the supplies of factors of production (labor and capital) or to changes in total factor productivity (reflecting changes in the efficiency with which these factors are used). The idea behind the growth accounting framework employed by Fischer is to measure the relationship between growth and several key macroeconomic variables.

b. Macroeconomic stability and growth

Fischer estimated sets of panel regressions in order to examine the links between growth and indicators of macroeconomic stability. All of the coefficients from the estimated equation of the growth rate of real GDP from 1961 to 1988 on a set of macroeconomic indicators and external shock indicators are significantly different from zero (Table 3). 1/

Table 3.

Summary of Estimated Panel Regression Coefficients from a Growth Accounting Framework 1/2/

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Sources: S. Fischer, “The Role of Macroeconomic Factors in Growth,” Journal of Monetary Economics. 1993, 32, pp. 485–512.

The number of countries in the panel regression is 22. They are: Ghana, Cote d’Ivoire, Kenya, Malawi, Morocco, Zambia, Dominican Republic, Jamaica, Mexico, Argentina, Chile, Colombia, Ecuador, Paraguay, Venezuala, India, Indonesia, Korea, Pakistan, Thailand, Greece, and Turkey.

Figures in parenthesis are t–statistics.

In percent of GDP.

These results are used below to examine the effects of macroeconomic policies on Jordan’s growth performance during the period 1976-94 (Table 4). First, the negative impact on growth of inflation for Jordan is about a third of a percentage point per annum over the period 1976-94. However, most of the impact came in the two periods 1976-80 and 1986-90. Had Jordan been able to maintain price stability in these two periods, the growth rates would have been nearly half a percentage point higher. However, even in the slump years, the restraining effect of inflation on growth is significantly less in Jordan than in all the countries in the sample. This reflects the fact that Jordan experienced relatively moderate rates of inflation over the entire period. Second, the changes in the terms of the trade have had a very limited and mostly positive impact in Jordan’s growth performance.

Table 4.

Jordan: Impact of Macroeconomic Policy on Real GDP Growth, 1976–94 1/

(In percentage change)

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Source: Staff estimates.

The impact on real GDP growth is calculated by multiplying the period mean of the policy indicator (see Table 1) by the relevant estimated coefficient in Table 3.

Based on this analysis, the stance of fiscal policy has been the biggest impediment to Jordan’s growth performance. Over the entire period 1976-94 deficit in the fiscal balance, including grants, restrained growth by an average of over 2 percentage points per annum. Had there been no grants—which have been used largely to finance public investment—growth would have been reduced by nearly 5 percentage points. Jordan’s reliance on grants from oil-exporting countries in the region to finance public sector investment—a significant source of growth—has diminished over the period. If the grants received in the period 1976-80 had not materialized, growth would have been reduced by an average of nearly 7 percentage points. However, if the grants received in the period 1991-94 had not materialized, growth would have been slower by an average of just over 2 percentage points.

c. Total factor productivity residuals

The World Bank 2/ conducted a study of sustainable growth in Jordan, which included an analysis of total factor productivity. The approach uses a production function to examine the relative contribution to growth of factors of production and productivity growth. The approach is a regression analog of growth accounting and allows for identification of the channels through which macroeconomic policies affect economic growth. Growth can arise through increased efficiency which shows up as increased positive residuals in an estimated production function or through increases in factors of production.

For this exercise, two specific types of production functions have been specified and estimated. The first one is a standard Cobb-Douglas production function, in which output is a function of labor and physical capital, while the second also includes a measure of human capital—measured by school enrollment—as an additional factor of production. The restriction that the two factors’ share in the Cobb-Douglas production function are equal and satisfy constant returns to scale cannot be rejected using a standard hypothesis test. Based on the extended production function the estimated factor shares are: physical capital equal 44 percent, labor 23 percent and human capital 33 percent. For the first type of production function, total factor productivity estimates—the “Solow residuals”—are given by:

Solow residuals  = real GDP growth  - 0.5 physical capital accumulation- 0.5  labor force growth;
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and for the second set of production function, total factor productivity estimates—the “Mankiw-Romer-Weil (MRW) residuals”—are given by:

MRW residuals   =  real GDP growth   -   0.44 physical capital accumulation-    0.23 labor force growth  -  0.33 human capital.
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Both the Solow residuals and the MRW residuals show that total factor productivity declined over the period 1981-94, with the largest decline over the period 1991-94 (Table 5). Estimates from the simple two factor production function show that the growth component provided by extra labor is more than offset by the declines in total factor productivity, implying that increased output from a higher labor force was virtually offset by a loss of productivity. However, estimates from the three factor production function, that allows decomposition between an increase in the quantity of labor and the quality of labor, show that for an increase in economic activity due to labor, about 50 percent can be attributed to an increase in quality. A striking feature of the results is that most of the growth in economic activity was generated by increases in physical capital. Below we examine how macroeconomic policy affects investment and thus, overall economic growth.

Table 5.

Jordan: Contributions to Economic Growth by Factors of Production, 1976–94

(Period averages; percentage change in real terms)

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Source: Staff estimates based on the World Bank report– –Jordan: Consolidating Economic Adjustment and Establishing the Base for Sustainable Growth, 1994, Washington, D.C.

A measure of total factor productivity changes; see text for definition.

Data only available until 1987.

3. Factors influencing investment

In view of the importance of investment in physical capital in generating growth in Jordan, this section conducts a detailed time series study of factors influencing private investment in Jordan. The factors chosen include some of the policy indicators that were shown to be important determinants of growth in the previous section as well as some specific variables found to be empirically important for private sector investment behavior in Jordan.

a. The methodology and data

The analysis is based on empirical estimates of a private investment function for Jordan during 1977-94. Private investment is specified to be a function of: (i) private external inflows—measured by worker’s remittances; (ii) a public investment financing constraint—measured by the excess of central government capital expenditure over central government’s available external financing; (iii) a fiscal policy indicator—measured by the fiscal deficit, excluding grants; (iv) an indicator of the sustainability of financial policies—measured by official reserves; and (v) an indicator of macroeconomic uncertainty—measured by changes in the real exchange rate. The rationale for using external inflows, government financing constraint, crowding-out effects, and uncertainty over policies and macroeconomic conditions as key factors influencing investment in Jordan are as follows:

(i) In many countries an important influence in investment decisions is the availability of credit for financing the investment. However, in the case of Jordan, the key source of financing of investment has been through external inflows of private capital, in particular, through transfers of workers’ remittances and savings. Private investment in Jordan has fluctuated with the flows of workers remittances, which depend heavily on the movements in oil prices in the Gulf countries.

(ii) The possibility of public investment, and fiscal policy in general, crowding-out private investment—discussed in Easterly, Rodriguez and Schmidt-Hebbel 1/—may arise from: (i) government preferential access to credit at administered interest rates; (ii) increasing lending rates due to higher absorptions of funds by the public sector; or (iii) lower private rates of return because of government competition with the private sector for investment opportunities. In the case of Jordan, such potential crowding out is represented by the excess of central government capital outlays over available external financing.

(iii) Uncertainty about policy and the general macroeconomic environment give an incentive to investors to wait until the uncertainty has been removed before committing themselves to an irreversible decision. Uncertainty is not a measurable entity, but it is assumed that investors use some indicators to gauge the level of uncertainty. In the case of Jordan, two such indicators are likely to be the level of official reserves and the real exchange rate.

The data used to estimate the private investment equation are all annual time series covering the period 1977-94, making a total of 18 observations. Thus, any conclusions derived from this econometric exercise are tentative and should be considered with caution, given the low degree of freedom afforded by the small sample available. All the series entering the investment equation were expressed in scaled form (as a ratio of GDP or imports) or in rates of change to obtain a meaningful economic interpretation free of spurious correlations caused by unrelated trends in the data. Since a battery of diagnostic tests indicated the possible presence of heteroskedasticity, all standard errors are calculated using a heteroskedasticity-consistent variance-covariance matrix estimator. The diagnostic procedures do not indicate any other problems in the estimation and the estimated model explains 71 percent of the movements in private investment.

b. Empirical observations

The estimates suggest a very strong relationship between the availability of remittance income and private sector investment. The marginal propensity to invest from workers’ remittances is estimated to be 0.85 and is statistically highly significant (Table 6). This finding shows the importance of external financing for Jordan: when the flow of remittances dries-up—as happened in the late 1980s and early 1990s—private investment is constrained and growth is inhibited.

Table 6.

Jordan: Estimates of Private Investment Equation, 1977–94

(Dependent variable: private investment/GDP) 1/

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Sources: Staff estimates based on data provided by the Central Bank of Jordan and the Department of Statistics, Government of Jordan.

Private investment was constructed from gross fixed investment less central government capital expenditure.

Standard errors were computed using White’s heteroskedasticity–consistent variance–covariance matrix estimator.

The government financing constraint is defined as central government capital expenditure in relation to GDP less central government external financing in relation to GDP.

Excluding foreign grants.

P–values shown in parentheses.

Chi–squared test with one degree of freedom.

An equally strong but inverse relationship was found between private investment and the excess of public investment over available grants. The estimated coefficient on this variable was -0.81, nearly equal but of opposite sign to the estimated coefficient on workers’ remittances. Furthermore, an F-test of whether the estimated coefficients of the overall financing flows (workers’ remittances plus the financing constraint) sum to zero is also statistically acceptable. The coefficient estimates and tests show that there is an exact one-for-one correspondence between public and private investment. Virtually all Jordanian investment is financed through external sources. If the Government invests more than its own internal public saving, then it must use financing that would have been available to the private sector. The size of the financing constraint means that the cost of public investment is the foregone opportunity in the private sector and that this cost will be fully reflected.

The estimated coefficients on official reserves and the real exchange rate show that these indicators of uncertainty provide a strong signal to investors about the health of the economy and this in turn has a large impact on investment decisions. The estimated coefficient on official reserves is 1.94 and is statistically highly significant. The implication is that an improved reserve position would clearly enhance the prospects for private investment. The estimated coefficient on the real exchange rate is -0.23 and is significantly different from zero. The implication is that a devaluation is considered by the private sector as a sign of weak economy, and thus deters private investment, while maintaining real exchange rate stability would encourage confidence and thus investment. These results indicate that, Jordan’s continued vulnerability to external shocks and the related perception of uncertainty in the macroeconomic environment tend to discourage domestic investment.

The estimated coefficient on the fiscal balance is 0.5 and is highly significant. The parameter estimate shows that there is a large crowding-out effect and that large fiscal deficits are the most important indicator of macroeconomic policy performance. A lack of fiscal discipline is a major factor which in the past significantly discouraged private investment in Jordan. These findings are consistent with the strategy underpinning the thrust on fiscal adjustment and reserve buildup in Jordan’s recent adjustment programs.

IV. Public Debt Dynamics and Fiscal Policy

The size of public sector in Jordan has traditionally been very large, with the central government expenditures averaging about 43 percent of GDP over the last two decades. 1/ Although foreign grants from the neighboring oil exporting Arab countries were very large, accounting for about 12 percent of GDP during this period, recourse to foreign and domestic debt financing was very large, averaging yearly about 10 percent of GDP over the period 1975-88 (Table 7). In the second half of the 1980s, with rising interest rates and later the depreciation of the Jordan dinar, the fiscal policy turned out to be unsustainable, calling for an urgent and comprehensive fiscal consolidation effort. This section describes: (i) the origin of Jordan’s fiscal imbalances and the growth of public debt in Jordan based on a debt dynamics accounting framework; (ii) Government’s fiscal adjustment and reform efforts since 1989, and their implications for the sustainability of the public debt; and (iii) the medium-term fiscal issues in the public sector.

Table 7:

Jordan—Central Government Operations, 1975-1994

(in percentage of GDP)

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Excluding extrabudgetary expenditure and net lending.

Net lending data are available from 1978 onwards and extrabudgetary ones from 1985 onwards.

1. Historical background and the build-up of public debt (1972-88)

a. Origin of the problem

Jordan’s high fiscal expenditure until early 1980s, equivalent to almost half the GDP, was largely attributable to two major components: capital expenditure and military outlays. Together, those two components accounted for about 62 percent of total central government outlays and 32 percent of GDP. Capital expenditures—a large part of which was financed from external sources—remained extremely buoyant between 1973 and 1983 (averaging 15 percent of GDP) and then declined to a more sustainable level (9 percent on average between 1984 and 1988) (Charts 10 and 11). Like most countries in the region Jordan allocated substantial resources to national defence, which given the very narrow production base of the economy was extremely burdensome. Military expenditures—even with a narrowly defined base—accounted for more than 10 percent of GDP over the 1970s and 1980s. 1/ Such expenditures have accounted for much of the fiscal deficit and accumulation of foreign debt. Not only domestic revenue—21 percent of GDP on average between 1972 and 1988—was largely insufficient to finance the high level of expenditure, but its structure was also unbalanced, with taxes on foreign trade providing nearly two-thirds of total tax revenue (Chart 12).

CHART 10
CHART 10

JORDAN FISCAL BALANCE, 1972–94

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International financial Statistics, and various Recent Economic Development Reports.
CHART 11
CHART 11

JORDAN EXPENDITURE, 1972–94

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International financial Statistics, and various Recent Economic Development Reports.
CHART 12
CHART 12

JORDAN TAX REVENUE, 1972–94

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International Financial Statistics, and various Recent Economic Development Reports.

Jordan could historically sustain such a large public expenditure program largely because of: (i) large receipts of foreign grants, which despite some year-to-year fluctuations remained high until the regional crisis of 1990; and (ii) low interest rate, on average, on public debt (significantly below the growth rate of the economy). Notwithstanding the sizable receipts of grants, the overall fiscal deficit including grants was averaging 10 percent of GDP during 1972-1988, which was primarily financed by external borrowing. In the initial period through 1983, interest payments were relatively modest accounting for less than 2 percent of GDP (Chart 13). Thereafter, interest payments increased steadily in response to the rapid build-up in debt and increases in interest rates in the foreign markets. Interest payments peaked to an unsustainable level of 10.7 percent of GDP during 1990-91, on a commitment basis. The rapid increase in interest payments after 1988 in part reflected the effect of a sharp depreciation of the Jordan dinar in 1988-89 associated with the balance of payments crisis.

CHART 13
CHART 13

JORDAN NONMILITARY CURRENT EXPENDITURE, 1972–74

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Source IMF, International financial Statistics and various Recent Economic Development Reports.

An important feature of the economic environment of the 1980s was the combination of high interest rates in the world market and moderate economic growth in Jordan, which implied a more rapid growth in the debt to GDP ratio than would otherwise be the case. This characteristic of the environment also meant that the Government’s solvency constraint—the condition that the value of outstanding public debt is no greater than the sum of the present discounted values of expected primary surpluses and high-powered money—became binding on the operation of fiscal policy. For example, in 1988, just prior to the balance of payments crisis, tax and nontax revenues amounted to 11.3 percent and 12.7 percent of GDP, respectively, and total expenditure remained at 41.2 percent of GDP, out of which 7 percentage points were attributable to debt service, and capital expenditure accounted for 9 percentage points. With foreign grants equivalent to almost 9 percent of GDP, the overall fiscal deficit, including grants, was 15 percent of GDP. Reflecting the cumulative effect of such policies, the public debt ratio reached almost 100 percent of GDP (Chart 14).

CHART 14
CHART 14

JORDAN DEBT TO GDP RATIO, 1974–94

Citation: IMF Staff Country Reports 1995, 097; 10.5089/9781451820270.002.A001

Sources: IMF, International Financial Statistics, and various Recent Economic Development Reports.

b. Debt accounting framework

In order to analyze the debt dynamics, the growth of the public debt ratio can be decomposed into five major components based on the standard budget financing identity: (i) the structural component as determined by the underlying structural fiscal balance depending on trends in revenue and expenditure; (ii) output variation component reflecting movements in domestic economic activity compared with the trend output; (iii) the evolution of interest payments; (iv) the exchange rate effect; and (v) the annual discretionary fiscal impulse. The structural component is defined as the average primary deficit adjusted for variations in domestic output. The output variation component of the budget deficit reflects variations in revenue resulting from deviations in economic activity from its potential trend level. 1/ The fiscal stance could be defined as expansionary (contractionary) relative to the base year if the actual primary deficit exceeds (falls short of) the cyclically adjusted deficit, where the base year is a period in which actual output and potential are assumed to be equivalent, and the fiscal stance is neutral. The fiscal stance, in this sense, measures the magnitude of the stimulus injected (withdrawn) through the budget into (from) domestic aggregate demand and beyond the primary deficit implied by the structure of budgetary operations in the base period. The exchange rate effect matters in countries where the proportion of public debt denominated in foreign currencies is large and where the exchange rates vis-à-vis currencies in which the external debt is denominated have fluctuated significantly.

Change in the stock of debt (D) on account of central government operations can be decomposed as follows:

(1)⁢Dt⁢  -  Dt⁢-1= -  (ta⁢  -  ga)⁢.⁢YPt⁢   -  ta⁢.⁢(Yt⁢  -  YPt)⁢ + rt⁢.⁢Dt⁢-1+  FDt⁢-1⁢.⁢((ERt⁢-1/ERt)⁢  -  1)⁢  -  IBt
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with ta and ga the average ratio of revenue and primary expenditure, respectively, to GDP over the period 1975-88; Yt and YPt nominal and potential GDP at current prices in year t; rt the nominal implicit interest rate on public debt in year t; Dt the net stock of public debt at the end of year t; FDt the net stock of foreign currency denominated public debt at the end of year t; ERt the average nominal exchange rate (per unit of domestic currency); and IBt the discretionary primary balance in year t. Appendix I provides a detailed methodology. 1/

Right-hand side of equation (1) reflects the five aforementioned components, i.e., respectively, the structural component, the output variation effect, interest payments, the exchange rate effect, and the annual discretionary component. The change in the debt ratio can in a reduced form be expressed as the opposite of overall fiscal balance (Bt, corrected for the exchange rate effect). In turn, the fiscal balance can be decomposed along the same line, as follows:

(3)Bt⁢  = (ta⁢  -   ga).YPt⁢  +  ta. (Y⁢  -  YPt)⁢  -  rt.⁢ Dt-1⁢ + IBt
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The fiscal balance reflects the difference between structural revenue and primary expenditure, the cyclical output gap, the debt service burden and the yearly fiscal impulse.

c. Debt dynamics in Jordan and its sustainability, 1975-88

Between 1974 and 1988, the ratio of outstanding central government debt to GDP increased from 65 percent to 95 percent (Table 8). 2/ A decomposition of annual fiscal balances indicates that out of the average annual fiscal deficit (excluding foreign grants 1/) of 20 percent of GDP during 1975-88, 17.6 percent of GDP was attributable to structural primary deficit (Table 9, Charts 15 and 16). The injection of expansionary stimulus was particularly strong up to 1980, and declined substantially during early 1980s. In response to rapid accumulation of debt burden and external financing constraints, the authorities started to tighten the stance of fiscal policy by mid-1980s, and the fiscal impulse accordingly turned significantly contractionary from mid-1980s. Interest payments on the outstanding public debt was low (at around 1 percent of GDP) during the 1970s, increased significantly in the 1980s in line with the growing debt burden, accounting for 7 percent of GDP by 1988 and 10 percent of GDP by the end of the decade. Based on these considerations, the observed deterioration in the fiscal position between 1985 and 1988 was not the result of discretionary fiscal policy, but of the continued large structural primary deficit, economic slowdown, and markedly higher interest charges.

Table 8:

Jordan—Fiscal Sustainability, 1975-94

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Reconstructed from 1989 debt figure, annual deficits, and exchange rate effect.

Excluding net lending and extrabudgetary expenditure

Negative if depreciation.