A Necessary Loan

As Jordan’s $2 billion dollar stand-by arrangement with the world’s lender of last resort comes to an end, the International Monetary Fund’s mission chief for Jordan Kristina Kostial said the Kingdom has by and large stuck to its promise of introducing painful, but necessary, economic reforms.

By Dina al-Wakeel

KRISTINA-KOSTIAL

Like most countries in the Middle East, Jordan has been through some tough economic times over recent years. A global financial crisis, quickly followed by the civil unrest of the Arab Spring and the subsequent disruption of Egyptian natural gas supplies have all exacted a heavy toll on the Kingdom’s economy.

To overcome these shocks, in 2012 Jordan successfully sought out a loan from the IMF in return for introducing a series of tough economic reforms. The IMF has just endorsed the seventh and final review of the $2 billion standby arrangement it struck with Jordan, paving the way for the release of the remaining tranche of funding.

Kristina Kostial, the IMF’s mission chief for Jordan, commended the Kingdom’s “bold” fuel subsidy reforms, in addition to energy and water sector reforms that have reduced the combined public sector deficit significantly. Yet she expressed her organization’s disappointment at the new Income Tax Law, which failed to bring more taxpayers into the tax net.

To increase Jordan’s chances of a better fiscal future, Kostial outlined a roadmap that includes further reforms that must be introduced to stave off future economic crises.

NSK

Why was it so necessary for Jordan to seek out the IMF?

Jordan was hit by major exogenous shocks. Starting in 2011, repeated damage to the Arab Gas Pipeline reduced gas inflows from Egypt and prompted an increase in imports of more expensive fuel products for electricity generation. As a result, the public electricity company started to make large losses, amounting to about 5 percent of GDP in 2011. Moreover, growth dropped sharply to 2.6 percent in 2011 in the wake of the global economic downturn, from an average of 6.5 percent during 2000–09. This, together with tax policy choices and a rise in spending, led to an increase in the central government’s primary deficit (excluding grants) by 5 percent of GDP to 9.6 percent of GDP in 2011. At the same time, the current account deficit (excluding grants) widened to over 17 percent of GDP in 2011 from about 11 percent of GDP in 2010. Macroeconomic challenges and pressures intensified in the first half of 2012. This triggered a loss in confidence, in turn leading to a loss in international reserves.

In response to these negative external shocks, the Jordanian government adopted a national reform program in May 2012. To avoid sharp adjustments that could hurt growth and the vulnerable parts of the population, and to guard against additional shocks, the government asked for financial assistance from the IMF under a 36-month Stand-By Arrangement. The IMF has provided liquidity during 2012–15 to allow the authorities to gradually implement their program. The key objectives of this program have been to correct macroeconomic imbalances in an equitable and fair way while strengthening growth prospects.

Is the IMF confident that Jordan achieved everything it set out to do as part of the stand-by agreement? Was there anything that Jordan could have done better?

Given the difficult starting position and subsequent shocks, especially the Syrian and Iraq crises, we believe that the authorities’ program has been a success. Initially, the program focused on crisis management and re-instilling confidence. After confidence had come back at end-2012, the program’s focus turned toward medium-term consolidation. And indeed, the authorities have substantially lowered fiscal imbalances while ensuring that vulnerable segments of the population are protected. They took budgetary measures—most notably, bold fuel subsidy reform—as well as started energy and water sector reforms to return the utilities to operational cost recovery in the medium-term. These actions reduced the combined public sector deficit of the central government and the electricity company NEPCO from 14.5 percent of GDP in 2011 to 9.2 percent of GDP in 2014, and, aided by lower oil prices, to a projected 3.5 percent of GDP in 2015. While this adjustment was difficult and implied hardships for the population, it also was necessary. It ensured that public debt (in percent of GDP) is broadly stabilizing this year. Reining in the increase in debt is good news not only because it bolsters confidence in the economy and makes it cheaper for the private sector to borrow, but also because it ensures that future generations do not have to pay for an unduly large debt burden.

There has also been some progress, albeit uneven, in making policies more equitable. Poorer households were protected when general subsidies were eliminated. While taxes on luxury goods were raised, we think that the limited reform of the income tax was a missed opportunity to bring more taxpayers into the tax net (less than 3 percent of the population are paying income taxes). The authorities also undertook some reforms to improve the business climate and to strengthen public institutions, though we believe that these reforms could have been more forceful and should have included broad labor market reforms.

As part of our own due diligence, we in the IMF are currently assessing how well the program worked in terms of achieving its objectives. This is to learn lessons from our engagement and to make sure that we can continue to serve well Jordan and its citizens.

What does the monitoring process actually involve? And how much access did you have?

We conduct quarterly reviews of the program. A typical review involves: an evaluation of the performance of the economy and policies over the previous quarter; and, most importantly, a discussion of current and prospective policies to ensure that they continue to stay in line with the program’s objectives.

During any of our visits to Jordan, we look jointly with the authorities at economic developments and analyze data. This is a very important process because, the better access we have to economic data, the better our understanding is of the economy so that we can help the authorities in outlining policy options, tailored to their specific situation. We work the closest with the Ministry of Finance and the Central Bank of Jordan often having late nights, and meet as well with other ministries, including Energy and Mineral Resources, Planning and International Cooperation, Trade and Industry, and Labor. We also discuss with many other stakeholders in the economy, including banks, the private sector, parliament, civil society, and academia.

The reviews were particularly challenging in Jordan because the economy has been subject to major shocks while the program was ongoing, such as the escalation of the Syria conflict, the Iraq conflict, and further disruptions to gas from Egypt. So, every time we come, we review performance in light of new circumstances and re-assess whether policies (be it in the fiscal, monetary, energy, or structural areas) have delivered the expected/desired outcomes or will need to be adjusted. We believe that a substantial element in the success of the program was its flexibility, including by widening deficit targets to mitigate the impact of the shocks on the economy and by providing time for critical consultation with stakeholders.

Looking forward, how optimistic are you now about Jordan’s economic prospects?

Jordan is demonstrating resilience in a difficult regional environment, particularly the conflicts in Syria and Iraq. The fiscal and energy sector positions are strengthening, the current account deficit is narrowing, international reserves have been rebuilt to an adequate level, and inflation is low. Absent any further external shocks, sustaining public sector consolidation and accelerating structural reforms will help ensure that such resilience would continue and be further fortified. At the same time, there is a need for the international community to sustain its support and help Jordan shoulder the burden of regional conflicts.

That said, Jordan needs more jobs. Unemployment is structurally high, particularly among the youth and educated, at about 31 percent and 17 percent, respectively. This, combined with low labor force participation—especially among females—which, at 13 percent, is lower than the MENA average of 22 percent—has resulted in very low employment to working-age population ratios. Indeed, only 32 percent of working-age people are employed, a rate that is lower than the MENA average of 44 percent and way short of the world average of about 60 percent. Therefore, it is paramount to further improve Jordan’s economy.

How concerned are you with Jordan’s ballooning debt, which currently stands at 90 percent of GDP?

We project Jordan’s gross public debt at 90 percent of GDP at end-2015 (net public debt is estimated at about 82 percent of GDP). This is high relative to average debt levels in emerging market economies, which are in the range of 50-60 percent of GDP.

What is important to note is that public debt is broadly stabilizing in 2015. Going forward, the authorities are committed to reducing debt gradually to about 70 percent of GDP by 2020.

What else does the IMF think a country in Jordan’s position could do to improve its economy? Do you think Jordan should work harder to reduce its huge public sector wage bill?

We believe that further reforms are needed to generate high and sustainable growth and improve the standard of living of the Jordanian people. We see here two key challenges: Public debt is high, and low employment is a chronic problem.

Though much has been achieved, continued public sector adjustment is needed to put debt firmly on a downward trend. The authorities are committed to reduce public debt as a ratio to GDP. Why is this important? It will lower the debt burden for future generations and allow the government to spend more on social protection and investment. And, it will make room for banks to lend to the private rather than the public sector, which is expected to boost growth and create jobs.

So how would the public sector adjustment come about? First, reforms to return the electricity and the water companies to cost recovery need to be completed. Second, there is scope for sustained consolidation efforts from the central government, where reforms could come from both the revenue and the expenditure side.

Jordan lost 9 percent of GDP in revenue during 2007–11, much of which reflected policy choices. Deep tax reform could recoup these revenue losses, and we see sizable scope for improvement in three main areas. First, the Income tax Law could be more ambitious, in particular by introducing a minimum corporate tax to avoid evasion and lowering the personal income tax threshold. Simply stated, people with a higher ability to pay should shoulder more of the tax burden. Second, there is a need for streamlining tax incentives, which would make the tax system fairer. And third, tax administration needs to be strengthened, aiming at improving efficiency.

On the expenditure side, there is room for further containment of the public sector wage bill. This could be done by making the private sector the engine of job creation, which would relieve some of the pressure on the public sector of absorbing new labor market entrants. At the same time, Jordan needs to reform its public sector hiring practices and compensation to place greater emphasis on skills and competition and less on paper qualifications. Adjustments in government pay scales would strengthen the link between compensation and productivity.

But as important as fiscal adjustment is that Jordan works on enhancing its potential growth, and thus creates more jobs.

Labor market reforms should be broadened not only to put the currently unemployed into jobs, but also to ensure that young graduates have the skills needed in a modern labor market. We believe that there is a need for a wider set of policies aimed at: reducing skill mismatches, including by modernizing schools and vocational training curricula and strengthening the involvement of local business communities in school life; and unlocking the constraints to female labor force participation, including by introducing more flexible work arrangements, strengthening the enforcement of maternity benefits, and establishing affordable and reliable day care.

We see scope for reducing the cost of doing business and cutting red tape to encourage investment, including from abroad. Also, improving access to credit will help stimulate economic activity and create employment opportunities. The credit bureau, which will become operational by year-end, will improve banks’ ability to monitor and assess borrowers’ creditworthiness. And there are initiatives to bolster financial inclusion such as strengthening the microfinance industry, developing payments systems, enhancing consumer protection, and improving financial literacy.

There is room to improve the quality of institutions. Jordanians continue to perceive social connections as important in obtaining employment and securing preferential treatment by government entities. Containing the impact of such connections can level the playing field so that all firms and workers can compete fairly and have equal access to opportunity. Also, more transparency would enhance the effectiveness and accountability of the public sector. Further strengthening of public financial management and the prioritization of public investment are key in this regard.

Vision 2025—the government’s 10-year framework for economic and social policies—is an opportunity to address all these challenges. Successful implementation will hinge on setting clear deliverables and timelines for execution, including an accountability framework as well as effective communication and inclusion of all stakeholders.

What are your terms when it comes to Jordan paying back its debt and over how many years?

Since late 2012, Jordan has been borrowing from the fund under the Stand-By Arrangement (SBA). This money has been helping Jordan strengthen its international reserve position and meet its fiscal financing needs. Including the last disbursement, Jordan’s debt with the Fund is about $2 billion. Jordan will repay this debt over six years with the first tranche due this year and the last due in 2020. The interest rate is below the market rate; total interest payments are about $170 million, $30 million of which have already been paid, with the remaining $140 million payable over 2015-20.

Regionally, what other countries are you monitoring? When will Egypt start and how healthy is their economy?

The IMF’s mission is to ensure the stability of the international monetary system. To this end, we keep close engagement with all of our 188 member countries, including countries in the region. We do so in three ways: keeping track of the global economy and the economies of member countries, through regular (usually annual) consultations; lending to countries with balance of payments difficulties; and giving practical help to members through extensive technical assistance projects. As far as ongoing lending programs, in addition to Jordan we currently have agreements with Morocco, Tunisia, Yemen, and more recently Iraq.

Regarding Egypt, we are not in talks on a new program or a loan. So far, the authorities have not requested IMF financing, but we would be ready to consider such a request if the authorities feel it is opportune. The Fund stands ready to help Egypt and its people.
.