IMF 1 st Standby Agreement Review Critical Overview …

1. IMF 1st Standby Agreement ReviewCritical Overview … May 2013

2. Main Highlights 4 2 6 3 5 1 7 Growth is expected to reach 3.3%, and inflation to stabilize at an average of 6% for 2013. Focus on energy and water strategies, to address widening deficit of own budget entities. Uncertainty took a toll on FX reserves, but confidence is improving with expectation for end the year at $9 billion NEPCO: The delay in the electricity tariff hikes and repayment of accumulated arrears will be compensated through more austerity The government was broadly in line with the performance criteria of the program, with a few exceptions IMF staff supporting current high JOD interest rates, & suggesting hikes if needed to contain inflation • Capital spending and structural economic reforms are essential to mitigate negative effects of fiscal consolidation

3. Economic outlook • Growth momentum is expected to pick up in 2013. Real growth is projected at 3.3% for 2013 with demand boosted by higher capital spending and the inflow of Syrian refugees. • Growth is then projected to return to the estimated potential of 4.5% by 2016, aided in part by the structural reforms and infrastructure investments funded by the GCC. • Headline inflation is expected to rise on the back of the anticipated increases in fuel and electricity prices. The IMF expects that fuel and electricity price increases in late 2012 and mid-2013 will likely push up average annual inflation to 6% in 2013. • The fiscal and external positions are projected to improve with higher grants and gas inflows from Egypt, as well as a result of the planned policies. • Nevertheless, further escalation of the regional unrest and disruption in the supply of natural gas from Egypt remain key concerns. • The government will continue to seek external financial support, and stand ready to take additional measures to safeguard the economy as needed.

4. Overall Outlook and Expectations **IMF Staff mentioned that reserves may reach 120% of its projected target; a figure close to USD 9 billion in 2013.

5. Targets summary: The program remains broadly on track

6. Current account deficit deteriorated substantially in 2012 • The current account deficit deteriorated substantially in 2012 to 18% of GDP. Some of this deterioration was expected under the program, reflecting lower grants and higher energy imports. • However, the increase in the number of Syrian refugees has put additional pressure on imports—with food imports increasing by nearly 20% — while lower potash prices and strikes have depressed export earnings. • Moreover, exports to Syria declined by 22% in 2012, and transit trade halted to Turkey, Lebanon and Europe (accounting for 11% of exports and 30% of imports). • Nevertheless, a stronger capital account, reflecting continued strong FDI inflows and a rebound in trade credit, helped bring the overall balance of payments to just below the program projections. • With higher grants and gas inflows from Egypt, the current account deficit (including grants) would improve to 10% of GDP in 2013. • This also reflects lower global food and fuel prices, a rebound in exports (with potash and phosphate production normalizing), fiscal restraint, and further improvements in travel receipts. Challenging external environment, though for 2013 the focus is on external financing

7. Challenging external environment,,,Jordan continues to face high uncertainties • International oil and food prices have been higher than anticipated, and forecasts suggest that they will be slightly higher as well over the medium term. • Also, the conflict in Syria has escalated, resulting in an acceleration of influx of refugees, currently estimated at over 500 thousand and expected to register almost one million by end-2013. • The humanitarian assistance is preliminarily estimated to have absorbed about 0.7% of GDP in central government spending, including through higher health, education, and security costs, in 2012. • These developments have put further pressure on Jordan’s external and fiscal accounts. • On the positive side, the flow of gas from Egypt has increased significantly since early November 2012 to an average of about 130 million cubic feet (mcf) per day, compared with 42 mcf per day during January–October. • In addition, $1.2 billion in grants were received from GCC countries in early 2013.

8. Current account deficit deteriorated substantially in 2012 • The current account deficit deteriorated substantially in 2012 to 18% of GDP. Some of this deterioration was expected under the program, reflecting lower grants and higher energy imports. • However, the increase in the number of Syrian refugees has put additional pressure on imports—with food imports increasing by nearly 20% — while lower potash prices and strikes have depressed export earnings. • Moreover, exports to Syria declined by 22% in 2012, and transit trade halted to Turkey, Lebanon and Europe (accounting for 11% of exports and 30% of imports). • However, a stronger capital account, reflecting continued strong FDI inflows and a rebound in trade credit, helped bring the overall balance of payments to just below the program projections. • With higher grants and gas inflows from Egypt, the current account deficit (including grants) would improve to 10% of GDP in 2013. • This also reflects lower global food and fuel prices, a rebound in exports (with potash and phosphate production normalizing), fiscal restraint, and further improvements in travel receipts.

9. Uncertainty took a toll on FX reserves, but confidence is improving • Rising regional and global uncertainty in 2012 along with reduced public confidence led to pressures on official reserves toward the end of the year. • Dollarization increased substantially during October-November, as depositors started to convert dinar deposits into foreign currency, some of which was kept in cash. • This resulted in a decline in JOD liquidity, pushing the central bank to take measures such as repos and outright purchases and USD/JOD Swaps. • While the international reserves target for end-September was met with a significant margin, the target for end-December was missed. • Since its peak in early December, dollarization has started to decline in recent month.

10. External Borrowing, Donor Support, & CBJ Measures are expected to Boost Reserves in 2013 • The authorities managed the episode well, rebuilding reserves through an increase in interest rates and by attracting donor funds (including a deposit of $1 billion in January 2013 from the UAE, a budgetary grant of $200 million from Saudi Arabia) as well as a successful issuance of a $500 million dollar-denominated domestic bond. • The planned Eurobond issue and further donor support will further increase reserves. • Accordingly, FX reserves are expected to meet its 2013 target ($7.5 billion), and actually exceed the target to above $9 billion. • FX reserves by the end of May are expected to reach $9.7 billion according to the central bank. • The central bank stands ready to further tighten monetary policy and take additional appropriate actions as needed to attain these targets.

11. Current account deficit deteriorated substantially in 2012 • The current account deficit deteriorated substantially in 2012 to 18% of GDP. Some of this deterioration was expected under the program, reflecting lower grants and higher energy imports. • However, the increase in the number of Syrian refugees has put additional pressure on imports—with food imports increasing by nearly 20% — while lower potash prices and strikes have depressed export earnings. • Moreover, exports to Syria declined by 22% in 2012, and transit trade halted to Turkey, Lebanon and Europe (accounting for 11% of exports and 30% of imports). • Nevertheless, a stronger capital account, reflecting continued strong FDI inflows and a rebound in trade credit, helped bring the overall balance of payments to just below the program projections. • With higher grants and gas inflows from Egypt, the current account deficit (including grants) would improve to 10% of GDP in 2013. • This also reflects lower global food and fuel prices, a rebound in exports (with potash and phosphate production normalizing), fiscal restraint, and further improvements in travel receipts. Fiscal policy geared towards growth-friendly consolidation and energy reform

12. Fiscal policyAdjustment in the central government is well underway • The central government was broadly on track with 2012 fiscal balance targets thanks to revenue over-performance coupled with tighter cash spending control. • Substantial measures have been taken since the approval of the program last August: • The authorities eliminated fuel subsidies, raised electricity tariffs, and cut non-priority capital spending and transfers • In January 2013, the monthly pricing adjustment for fuel product was reinstated. • However, NEPCO was unable to raise funds – which necessitated that the government service the company’s debt – resulting in the central government primary deficit to marginally exceed its end-December target (by 0.03% of GDP). • NEPCO’s losses, together with a more expansionary government stance in the last two years, have been driving up the debt-to-GDP ratio to 80% of GDP at end-2012.

13. Replacing fuel subsidy with cash transfers • The authorities removed the general fuel subsidy on November 14, 2012. • Retail prices were increased for gasoline 90 (14%), LPG (54%), and diesel and kerosene (33%). • The authorities resumed on January 1 the monthly price adjustment mechanism that had been suspended in early 2011. • A cash transfer (estimated at 1.1% of GDP in 2013) is compensating families with an annual income below JD10,000 (70% of the population) if the oil price is above $100 per barrel. • Based on an average oil price of $100 per barrel, the elimination of the subsidy yields gross savings of about 2.5% of GDP. • But this does not take into account the compensatory cash transfers and that NEPCO does not anymore receive fuel products at subsidized prices.

14. Fiscal policy focused on growth friendly consolidationCorrection will come from energy sector policies and other measures on the revenue side • The 2013 budget projects primary deficit of 5.5% of GDP compared with a programmed 6.3% of GDP. This reflects mostly revenue over-performance in 2012 carrying over into 2013 as well as tighter spending to compensate for a delay in electricity tariffs. • The 2013 budget is expected to include significant fiscal consolidation measures (about 4% of GDP) to be implemented in a growth-friendly matter: • Current spending has been cut in favor of development spending (The 2013 budget envisages a large reorientation in spending towards an increase in capital spending of 2% of GDP). • The targeting of the cash transfer scheme is being strengthened • On the revenue side, taxes on luxury goods have been raised and tax exemptions eliminated. • The income tax law which is awaiting parliament approval, along with tighter tax incentives, is expected to further increase revenues in 2014. • On the structural front, tax administration measures are expected to reduce tax arrears and a commitment control system will help to prevent the incurrence of arrears. • The authorities will also start tackling the losses of the water companies. Currently, annual losses could be about 1% of GDP, reflecting inefficiencies as well as weak revenue collection.

15. Fiscal deficit outlook,,, • The combined central government primary deficit and NEPCO operating losses are expected to be slightly below the program target at 9.8% of GDP in 2013, down from 12.9% of GDP in 2012 (excluding arrears repayment). • NEPCO’s adjustment in 2013 is less ambitious than expected because of the delay in implementing tariff increases. • The resulting higher NEPCO losses will be more than compensated by a tighter central government budget.

16. NEPCO stayed in line with program but failed to repay its arrears • NEPCO’s losses were as projected, partly helped by gas inflows from Egypt increasing to more than twice the programmed level during November-December. • However, bank lending to NEPCO was limited with NEPCO’s debt, which is guaranteed by the government, reaching 9% of GDP. As a result, NEPCO’s borrowing was lower than projected in 2012, and the company did not pay its arrears. • In 2013, NEPCO is expected to repay about 2/3 of its arrears (JD 450 million), as the central government will provide direct transfers to cover NEPCO’s operating losses. • Despite the doubling of gas inflows from Egypt since November 2012, NEPCO’s operating losses remain substantial, though declining, and they are driving up public debt. • Due to expected increases in tariffs and better than programmed gas supplies, NEPCO losses are now projected at 4.3% of GDP (around JD 1 billion), down from the previously programmed 5.8% of GDP.

17. Energy sector reforms are at the center of fiscal effortsDelays in formulating and announcing the energy strategy were economically costly • To address NEPCO’s losses, the government has prepared a medium-term energy strategy with World Bank support to bring NEPCO back to cost recovery by 2017. • The new strategy has a clear path for tariff increases, a plan for diversifying energy sources, with a focus on liquefied natural gas, and measures to enhance energy efficiency and the use of renewable energy. • Nevertheless, for 2013 the focus is on gradually raising tariffs while protecting the poor. The strategy recognizes that tariff increases are the only way to reduce NEPCO losses in the short term. • Thee first tariff increase was initially planned for April, but later delayed to July allowing for sufficient time for Parliament consultation. To offset the resulting higher NEPCO losses, the central government has taken additional measures of 0.25% of GDP. • Meanwhile, if NEPCO is unable to meet the ceilings on its losses due to higher oil prices or low gas supplies, the government should be ready to take offsetting fiscal measures; through further increase in tariffs among other measures such as timed blackouts.

18. Uncertainty took a toll on FX reserves, but confidence is improving • Nevertheless, the IMF stated that the authorities managed the episode well, rebuilding reserves through an increase in interest rates and by attracting donor funds (including a deposit of $1 billion in January 2013 from the UAE, a budgetary grant of $200 million from Saudi Arabia) as well as a successful issuance of a $500 million dollar-denominated domestic bond. • The planned Eurobond issue and further donor support will further increase reserves. • Accordingly, FX reserves are expected to meet its 2013 target ($7.5 billion), and actually exceed the target to above $9 billion. • FX reserves by the end of May are expected to reach $9.7 billion according to the central bank. • Furthermore, the central bank stands ready to further tighten monetary policy and take additional appropriate actions as needed to attain these targets. Monetary policy will continue to focus on maintaining the peg and monitoring inflation

19. IMF staff support current high JD interest rates & suggest hikes if needed • In line with our analysis, the IMF cited concern that interest rates have room to increase in order to maintain attractiveness of the JD. • "The CBJ is rightly focused on rebuilding reserves. The CBJ is seeking to recoup the reserve losses incurred in late 2012. In this regard, instilling confidence in the program through enhanced outreach will play an important role, though further interest rate increases might be needed. The authorities’ intention to seek additional external financing, possibly through a Eurobond, is appropriate.“ • "The interest rate hike in early December is a step in the right direction. It appears to have calmed markets and already resulted in a substantial reversal in dollarization...To ensure that the NIR targets can be met, staff suggested that, unless de-dollarization continues at the current pace and financing comes in as projected, the CBJ consider tightening monetary policy further using all available tools, including interest rates.“ • In contrast with IMF views and recommendations, market Interest rates have fallen by more than 2.0% since the beginning of the year. 1-year bills have fallen by 1.40%, 2-year bonds have fallen by 1.91% and 3-year bonds have fallen by 2.14%.

20. Monetary authorities assure that inflation & peg as main focus • The central bank of Jordan (CBJ) will continue to anchor monetary policy on the exchange rate peg. The peg has served Jordan well by anchoring inflation expectations, supporting macroeconomic and financial stability, and encouraging FDI. • However, inflation picked up in late 2012 due to the withdrawal of fuel subsidies by the government. During the year, higher food and energy prices and public sector wage increases weighed on inflation. Following the liberalization of fuel prices in mid-November, inflation picked up further to 7% at end-Aril. • The rise in fuel and electricity price increases in late 2012 and mid-2013 will likely push up average annual inflation to 6% in 2013. • With the peg as an anchor, the central bank has asserted to continue to use the policy tools (including those introduced in 2012) to improve liquidity conditions and build needed buffers.

21. Central bank introduces new tools • The central bank introduced new tools to the market in order to maintain JOD liquidity and recoup reserve losses incurred due to the dollarization wave witnessed last year. • The interest rate hike in early December was a step in the right direction as it appears to have calmed markets and already resulted in a substantial reversal in dollarization. • Forward contracts, or swaps, worth $1.6 billion were conducted with the CBJ, boosting JOD liquidity in the market and recovering foreign currency reserves. • On the other hand, the CBJ introduced weekly and monthly repo agreements. This provided banks with the essential liquidity it needed to meet financing needs. • However, recently the amount of repo agreements has gone down by about 50% from a high of 800 million JD, to 400 million JD.

22. Uncertainty took a toll on FX reserves, but confidence is improving • Nevertheless, the IMF stated that the authorities managed the episode well, rebuilding reserves through an increase in interest rates and by attracting donor funds (including a deposit of $1 billion in January 2013 from the UAE, a budgetary grant of $200 million from Saudi Arabia) as well as a successful issuance of a $500 million dollar-denominated domestic bond. • The planned Eurobond issue and further donor support will further increase reserves. • Accordingly, FX reserves are expected to meet its 2013 target ($7.5 billion), and actually exceed the target to above $9 billion. • FX reserves by the end of May are expected to reach $9.7 billion according to the central bank. • Furthermore, the central bank stands ready to further tighten monetary policy and take additional appropriate actions as needed to attain these targets. Structural issues continue, with more improvement needed

23. Structural policies need to be stronger and more inclusive growth • Improving Business Environment: According to the World Bank’s Doing Business 2013 report, Jordan ranks around the median of MENA countries and as 106th out of 185 countries covered by the report. • Growth Oriented Spending: The substantial increase in central government capital spending in 2013 and over the medium term is expected to raise Jordan’s growth rate and private sector productivity. • More focus on job creation: The authorities should concentrate on supporting growth of skill-intensive sectors (such as financial, education, and health services), where Jordan has a comparative advantage. Also, addressing skills mismatches, in particular of university graduates, could go a long way toward reducing youth unemployment. • New Investment Law: This law will enhance the transparency of rules related to the investment process, streamline tax incentives, and pave the way for a one-stop-shop. • Stronger focus on improving access to finance: Access to finance for SMEs and low-income individuals is hampered by the high perceptions of risk and high collateral requirements. • The authorities are also developing new insolvency legislation and seeking international support to secure resources for SMEs. The OPIC fund is providing a 75% guarantee for SME loans up to JD 1 million with a portfolio limit of JD 500 million, and $70 million from the World Bank.

24. Uncertainty took a toll on FX reserves, but confidence is improving • Nevertheless, the IMF stated that the authorities managed the episode well, rebuilding reserves through an increase in interest rates and by attracting donor funds (including a deposit of $1 billion in January 2013 from the UAE, a budgetary grant of $200 million from Saudi Arabia) as well as a successful issuance of a $500 million dollar-denominated domestic bond. • The planned Eurobond issue and further donor support will further increase reserves. • Accordingly, FX reserves are expected to meet its 2013 target ($7.5 billion), and actually exceed the target to above $9 billion. • FX reserves by the end of May are expected to reach $9.7 billion according to the central bank. • Furthermore, the central bank stands ready to further tighten monetary policy and take additional appropriate actions as needed to attain these targets. But challenges remain,,,

25. Downside risks Syrian refugees : the conflict in Syria imposes a significant burden on Jordan. The economy is primarily affected through a massive inflow of refugees and disruptions to bilateral and transit trade. Tariff hikes: the further the government delays a hike in electricity tariffs, the tighter the central government budget will be in the following years to meet fiscal deficit targets set by the IMF Egyptian gas supplies: though gas supply has improved and more than doubled since the end of 2012, the supply remains volatile, and any decrease could add pressures on NEPCO losses, as well as fiscal and external balances. Social unrest: Tariff hikes and the influx of Syrian refugees is putting upward pressure on the labor market and on inflation rates. If the situation gets worse, we expect social unrest as Jordanians will find it hard to find a job and prices will soar.

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