April 2, 2004

1. The authorities would like to express their thanks to Management and the Executive Board for their support to Jordan, and staff for their excellent work and helpful policy advice over the course of this program. Given the strong balance of payments position, the authorities intend to treat the remainder of the Stand-By Arrangement as precautionary.

2. The Jordanian economy has once again proved its resiliency to external shocks, thanks to its solid fundamentals and the swift response to mitigate the adverse impact of the war on macroeconomic stability and growth. Prudent macroeconomic policies, supported by the introduction of key structural reforms as well as generous aid from the international community, helped Jordan withstand the repercussions of the disruption of trade with Iraq during the war, the loss of the Iraqi oil grant, as well as the sharp decline in tourism and foreign investment. Underpinned by the strong recovery in exports following the end of the war, GDP growth remained healthy and exceeded population growth in 2003. Inflation was low and the external current account improved appreciably, allowing the central bank to accumulate sizeable foreign reserves. Performance under the program continued to be strong, with Jordan meeting all performance criteria and structural benchmarks, and the fiscal outturn outperformed the program target by a wide margin.

3. The outlook for the Jordanian economy is promising. With the recovery of trade with Iraq and the revival in tourism and investment, growth is expected to resume an upward trend in 2004. Over the medium term, the wide-ranging structural reforms undertaken over almost a decade and a half, and intensified in the past few years focusing on enhancing the investment climate, laid a solid foundation for Jordan to move to a higher and steadier growth trajectory. The authorities nonetheless realize that the reform agenda is still unfinished, and are determined to continue the reform effort after graduating from Fund-supported programs, in order to remove the remaining impediments to higher growth and a reduction in the still high unemployment. Their economic policy strategy for the period ahead focuses on preserving macroeconomic stability and bolstering productivity and competitiveness, including through improving infrastructure and human capital, further enhancing the legal and regulatory framework, speeding up the privatization process, and strengthening the financial system. A crucial component of this strategy is a fiscal framework that aims at achieving further fiscal consolidation and improving the structure of public finance, with a view to ensuring fiscal sustainability and a continuation of the reduction in public debt.

4. The fiscal overperformance, despite the difficult regional environment, attests to the authorities’ commitment to fiscal consolidation. Expenditures during the last quarter were sufficiently tightened to offset part of the expansion in security outlays early in the year, compensation payments to sectors affected directly by the war, as well as capital expenditure to help temper the impact of the war on growth. Additionally, significant efforts were made in 2003 to lower the public debt and reduce its burden, including through the prepayment of the Brady bonds, but valuation losses equivalent to 6 percent of GDP arising from the depreciation of the dollar caused the level of the debt to edge up by 1 percentage point of GDP.

5. The 2004 budget contains important tax and expenditure measures consistent with the targeted budget deficit of 3.9 percent of GDP. Higher GST receipts are expected to more than offset trade liberalization-related revenue losses, and envisaged cuts in non-essential spending will amount to 3 percent of GDP. Reform measures aimed at achieving these targets have already been initiated. This week, Parliament approved an increase in the GST rate from 13 to 16 percent, an extension of the GST to alcohol and tobacco, and a 9 percent increase in petroleum product prices. The temporary tax laws passed in 2003 subjecting interest income to tax and imposing an income withholding tax on imports have been recently ratified by Parliament. The Ministry of Finance has unified the income tax and sales tax departments, and work on establishing large and medium taxpayer offices to increase the effectiveness of the new unified department is underway. In addition, expenditure control is being further strengthened and a unified treasury account has been established.

6. Over the medium term, reducing the public debt to comply with the limits specified in the Public Debt Law by 2006 is a paramount objective of the fiscal strategy. The authorities aim at further fiscal consolidation relying on durable fiscal measures, including through further broadening the tax base and eliminating the remaining subsidies on petroleum products. They will also continue to pursue an active public debt management strategy to reduce its level and improve its dynamics, particularly by balancing its composition in favor of local currency-denominated instruments. To reduce the public debt vulnerability to fluctuations in the value of the dollar, the authorities are exploring means to hedge against exchange rate fluctuations and are considering further diversification of foreign currency reserves in line with the currency composition of the external public debt.

7. Monetary policy has been geared to provide some stimulus to temper the slowdown in growth, while maintaining price stability and confidence in the dinar. Inflation remained low despite the impact of the depreciation of the dinar (which is effectively linked to the dollar) on import prices, and foreign exchange reserves reached a record high. The environment of tight fiscal stance and enhanced confidence, reflecting for the most part the strong track record of the central bank, provided scope for a monetary policy easing to boost domestic demand. The CBJ overnight window facility rate was reduced twice, bringing about some reduction in lending rates in the banking system. Going forward, monetary policy will continue to support price stability in the context of the fixed exchange rate framework. The central bank will continue its effort to enhance the effectiveness of monetary policy in line with the FSAP recommendation, including by further improving the structure of interest rates on its instruments and addressing the structural problems impeding flexibility of interest rates in the banking system. These efforts will benefit from the envisaged quarterly program to auction bonds with different maturities, which will go a long way in deepening the capital market and improving the yield curve.

8. The effective peg of the dinar to the US dollar has served Jordan well. For almost a decade since its adoption, Jordan has been able to maintain inflation at industrial country levels. Confidence in the dinar has strengthened, and capital flight and pressures on foreign currency reserves were virtually absent. Furthermore, Jordan’s past experience clearly indicates that the economy is prone to shocks that are usually associated with short-lived uncertainties, and that the fixed exchange rate proved useful in insulating the economy from the adverse impact of these shocks. The authorities believe that a change in the exchange rate policy at this stage is not warranted and could be seen as a sign of weakness given the uncertainties arising from the current tense regional situation.

9. The recent FSAP mission confirmed that the banking system in Jordan is generally sound and well supervised. Most banks are profitable and well capitalized. This reflects the central bank’s relentless effort over the past few years to strengthen the regulatory and supervisory framework in line with best international standards. This effort has been stepped up recently to address the remaining weaknesses identified by the FSAP mission. The central bank issued regulations to double the minimum capital requirement by 2007 and introduced a minimum leverage ratio of 6 percent. Measures have also been initiated to improve corporate governance and financial disclosure, and bank supervision has been significantly strengthened with the development of an early warning system and the adoption of a prompt corrective action framework. Furthermore, competition has been enhanced by licensing three foreign banks to operate in Jordan, which bodes well for the effort to reduce interest rate spreads and enhance financial intermediation.

10. The central bank was prompt in dealing with the few undercapitalized banks. One bank has been restructured, including through new capital injection by the shareholders and a strengthening of its management and board of directors, while the restructuring of the other undercapitalized banks is underway according to the agreed time-bound restructuring plan. In the meantime, the central bank is closely monitoring the financial positions of these banks and their compliance with prudential regulations. The authorities do not believe that there is any significant risk of moral hazard as a result of the restructuring process of the first bank, especially since the amount of liquidity support provided to the bank was modest and the original shareholders bore the largest share of restructuring burden. Furthermore, a prompt corrective action framework has been adopted and the authorities have made clear their determination to apply it strictly in order to avoid the use of public funds.

11. On other structural reforms, important pension reforms aimed at reducing long-term pressures on the budget have been undertaken. These included the tightening of military disability benefits and the shifting of the new military recruits to the Social Security Corporation (SSC). The authorities intend to strengthen the financial viability of the SSC drawing on the findings of the actuarial review to be finalized this year. Furthermore, significant strides were made in the privatization process, thereby supporting investment and reducing inefficiencies as well helping reduce the public debt. The government sold half its share in the Arab Potash Company, privatized the management of the container handling at the port, and approved the planned privatization of the electricity generation and distribution companies late this year. Plans are also in place to privatize other major public enterprises, including selling an additional portion of the government’s share in the Jordan Telecommunication Company and the majority stake in the Jordan Phosphate Company. Proceeds from privatization will be used only for debt reduction operations while the Plan for Social and Economic Transformation, which used to be financed partly from privatization proceeds, will be financed exclusively from external grants.