Report No. 12645 JO Jordan Consolidating Economic Adjustment and Establishing the Base for Sustainable Growth (In Two Volumes) Volume l: Main Report August 24, 1994 Country Operations Division Country Department il Middle East and North Africa Region t--T C RPOG1APHIC S DoctJment of the World Bank Repo.rt N1,: I 2e- Type: E'O CURRENCY JD 1.0 = 100 fils JD 1.0 = $ 1.45 (1993) JD 1.0 = $ 1.43 (1994) LIST OF ABBREVIATIONS AND ACRONYMS Institutions and Organizations ACC Agricultural Credit Organization AFM Amman Financial Market CVDB Cities and Villages Development Bank ECOC Export Credit Guarantee Corporation EPZ Export Processing Zones GOJ Government of Jordan HUD Housing and UJrban Development Corporation IDB Industrial Development Bank IME International Monetary Fund JEA Jordan Electricity Authority JD Jordanian Dinar AIC Jordan Investment Corporation MIt Ministry of Industry and Trade MOA Ministry of Agriculture MOH Ministry of Health MOS Ministry of Supply PSC Public Shareholding Companies RJA Royal Jordanian Airlines SSF Social Security Fund TCC Telecommunications Company Economic Ratios and Other Abbreviations CD Certificate of Deposit CEM Country Economic Memorandum CES Constant Elasticity auid Substitution DDSR Debt and Debt Service Reductions GDP Gross Domestic Product GNP Gross National Product ICOR Incremental Capital-Output Ratio REER Real Effect Exchange Rate TFP Total Factor Productivity JORDAN: CONSOLIDATING ECONONI0 C ADJUSTMENT AND) ESTA LIESHNG THE BASE FOR SUSTAINABLE GROWTH VOLUME B MAIN REPORT TABlE OF CONTIENS ED= fllA Y ............ .............. ........ i CHAFFER I: INTRODUCTION .................. . . 1 CHAFrER 1: GROWTH, MACROECONOMIC BALANCES AND PRODUCTIVrrY . 3 A. PMtems In Econole Growtl.ih . 3 B. Changes in Ital and External Balan6 ... ... 6 C. Chsanges in Productivity ..... 12 CHAPrER iM: MACROECONOMIC CONDIMIONS AND EXTERNAL DEBT MANAGEMENT . 19 A. I(Aczoesuocr- ObjjectvOvethbeMedhnn-Term .... . .... 19 B. C Issems In the Md_uu-Fen ....... .... 19 C. Managing x.ter.aDebt ... ............... 25 CHAPTER IV: TRADENCENVEGIM ......... ..R 32 A. QuantaveRestrtctonst,Pde ControbandSubsdd .. ................32 B. Tariffiegme ... .... .. ............36 C. Nomnl and Effecive Rates of Protection ............................. 39 D. Tr&d Incentive Rqghn from a Broad Paepecdve . . ............. 45 EL ExpotandImnportRegim ....................................... 47 F. Summuaryandl...........o.... ..... 52 CHAFF'ER V: PUBUC ENTERPRISES AND THE BUSINNS ENVIRONMENT ...57 A. Introduton ..... ....... ............. .57 B. Me PubbEc Povo od Goods and Ser ................... 58 C. PUbbl MEtlseP m ...... 4............... *.. .. .......... 63 D. ltqulatory andledest ....glne...... .. ...... ........... ... 64 E. Summary Fidhand......4......1 65 -I - CHAPTER VI-.: T FINANC1AL SYSE . ...................................... 69 A. Baftgud ................................................. . 69 B. TheStuckrsProblen ............................................ 70 1. Ihe agmenin of the Iket .................................. 70 2. Frgme ionin the Tiem Dimension . .............................. 71 3. ItoeSetoralFrangments ..................... 73 4. Ba's PrudentIStandards and Supervision ...... .................... 80 C. MmeStrucdtu Problenms I theCapltadMarkets ........ ................... 85 1. 'he Functioning of tie Capital Markets ....... . . 85 2. Isues Inong-Termn Savinp siutons ............................. 88 D. TheLonTerm Perspective and Sbrtcgy for Finandal Trxmfonnatlon .. .......... 90 1. Thetegation with theRestofthe World ............................ 90 2. A BlueorintoftieNew FmancalSystem ...................... . 92 3. 'Me Trainsfr on ............................................. 95 4. Pivatization and EiminationofPrlvilege ............................ 96 5. EstablishingaNew RegulatoryandSupervisorySettlg . . 98 6. ThePceand theCostsof eTransitlon ....... ..................... 100 7. Schedule ............................................... 101 CHAPTER Vii: LABOR AU FT AND EMPDLOYI(ENT .... ............. ........ . 104 A. MIm Charatwistics offteLibw biak ............................. 104 B. l11e of the IAbor Market ...............................1 06 C. Pmrpect andPoIdes ........................................ 109 D. Sumnry and das .................................... 113 CHAFF'ER VJLT ECONOMIC REFORMS TO ENELANCE THE PROSPECr FOR GROTH .. 11S List Of Ted Tables In Chapr Table2.1: GDP Gwth andComposition, 1973-1992 ....................... 3 Table2.2: IncrementalCapital - Out1970-91 .. 12 Table2.3: Gross Fixed CapitFormationbyTypeofAssets . .................. 13 Table2.4: Growh ofCapitalandLaborEmployment ...... ................ 14 Table2.5: AnalysisofTotal FactrProductivity P) ...... ................ 17 Ist ft Test Charts ChaIntr Figure2.1: ForeignGrartsandPublic Investmet ...... .................. 5 Figure 2.2: RemItance and Invetmuent ............................... 6 FIgr 2.3: Tota Forip Debt .. ................................... 7 Flgmr2.4: DebtOutstandingandDisbursedt GNPRatdo .................. 7 Figuer2.S: GDPDeflationand ndex ofReal ExchangeRate ................. 8 Figumr2.6: NotForelpnSavinas Percent ofGNPbySector ...... ......... 10 Figre 2.7: Fmncig Grs Domestic Investmn ...... ................. 11 Fi'gum2.8: Revenues and xpend ltasPecngeofGNP ......11........... It -2- Figure 2.9: Labor Productivity ............................ 13 Figure 2.10: Capita Labor Rato ............................ 14 Figure 2.11: Total Productivity .................................... 16 Figure 2.12: Marglna ProductofCapitai ............................ 17 LIst of Text Tables In Chapter m Table 3.1 Key Macroeconomic Indicators (Ie Bae-case Scenario) . .20 Table 3.1A Scheduled Debt and Actual Service on Public & Publily Guaranteed Long-Term Debt . .21 Table3.2 EstimesoflmrtElastlcity ..22 Table 3.3 Investment, Investment Efficiency, and Growth... 23 Table3.4 SourcesofFutureSavings ..24 Table 3.5 Average Terms of New Commitment, 1989-92 . .26 Table 3.6 Debt Serice Ratios of Selected Countries, 1992 . .27 Table 3.7 Debt ndicators Before and After Rewheduling . .30 List Of Text Charts in Chapter m Figure 3.1 Total External Debt Stock (as of end-1992) .26 Figure 3.2 Jordan's Official Bilateral Creditors (as of ead-1992) .27 Figure 3.4 Extern Debt of Paatats (as of end-1992) .28 Figure 3.5 Cash Flow Effects of Rescheduling Scenarios for Official Bilated Debt .30 Text Box In Chapter% m Box 3.1 Assumption on he Terms of Debt Relief .29 Ist of Text Tables In Chae IV Table4.1 importRestrictionsandPermission"Licensiag .34 Table 4.2 Analysis of hmport Restrictions in 1993 . ... 35 Table 4.3 Distribution of Nominal Tariff and Surcharge Rates 1987 and 1992 .... 37 Table 4.4 A alysis of Tariff and Surcharge Rates, 1987 and 1992 .38 Table 4.5 Value of Import Tariffs Exempted in 1990-1992 .38 Table 4.6 Frequency Distribution of Tariffi and Surcharges .39 Table 4.7 Unweighted Average of Tariff and Surcharges, 1993 .. 40 Table 4.8 Frequency Distribution of Nominal Rates of Tariff Protection of Manufacturing3, 199.41 Table 4.9 Average Nominal Tariff Protection by Sector and Sub-Sector 1992 .42 Table 4.10 Implicit Nominal Protection for Selected Commodities .46 Table 4.11 TariffDuty to Import Ratio and Indexes of Effective Exchange Rates ... 47 Table 4.12 Indexes of Domestic Prices of Tradables and Nontradables, 1986-192 .48 Table 4.13 Analysis of Use of Export Promotion Schemes .52 Table 4.14 Matix for Improving the Trade Incentive Regime ..56 Text Box In Chapter IV Box 4.1 'Me Benefk of GATr Membership .54 -3 - It of Ted I I ChIantr V Table S.1 Registered Public and Private nterprises In the Kingdom of Jordan 1987 - 9 ...............2........................ 58 Table 3.2 Government Holding In Public ShareDoding Companies . .......... 59 Table 5.3 Performance of Publicly Traded Companies With and without Signficant Goverment Ownership ................................ 60 Table 5.4 Major Shareholdings of the Jordanian Investment Corporation ........ 61 TableS.5 Mtrbor Improvmg te Bilness Envlonmet. ................. 67 Te Ti ble In Ch a er Table6.1 YieldonInvestments .................................. 84 Text Box In ChaterK I Box 6.1 Financial Sector Issues in the Five Year Development Plan ........ 103 Ut of Text Tables in Chater VE Table 7.1 Employment DistributionbyStatus ................ ........ 106 Table 7.2 Indexed Hourly Earnings of Male Workers, 1991 ...... ......... 107 Table 7.3 Tot and Jordanian Labor Force, 1980-1991 ....... ........... 110 Table 7.4 Annua Rate of Gtowth (percent) in Employment by Sector, 1980t 1989 .111 Table 7.5 Change in Employment and Average Salaries in Manac : Selected Priods 198.1992. ill Table 7.6 Indexed Women's Employment in Manacng and Public Sector ... 112 Text Table in Chapter vm Table 8.1 Jordan - Key Macroeconodc Indicators Under the Enhance-Growth Scenario.. 117 This rpot is the woi of Chang-Po Yn (Task Manage), Mu EHinds (Coltant), Shan Gooptu, David Doo, Isac Dia Zafinis Tnnatos and Ol Risager (Consultat). Axd Stenh (Cosultant), James Bucknal (Constat) and Safwan Batneh (Consultant) provided bacgound report. Benard Hoekma maie importnt continbuton to the analys of trade poicy issues. Khai Nguyen and Gaston Gelos provided valuable research assiston Ataman Aksoy is the peer-viewer and provided valuable suggestikos and comin.ts William Tyler (Lead Economist) jomed the CEM mssion nd poded guidance roughout Most members of dt tam visited Amm duuing July 1993 and we were received under te auspics of de Miter of Planing, H.E Dr. Ziad Fasid Durig he min, e oBak tam was misted by an able counepan tm aseDmbled by tie Government, cssting of Dr. Nabil Amai, Dr. Hasn Saket, Ms. RuIn Salah, Mr. Gbit B-Tal, Mr. Ibralim Sadf, Mr. Mohammad Shouha, Mr. AbdtlHaiim Moasin, Mr. Mobammd K a, Mr. Bassa Abu Amr, and Mr. Bashi Ab Jamous. .4- EXECUTIE SUMRY i. Jordan's close ties with the regional economies have provided markets for Jordanian goods and services, employment for Jordanian worlers and sources of official grants as well as remitance income. These positive aspects of the relation have constituted a powerfiul spur to economic growth, however, it has also left several serious suctural problems; the most important of which are: * the reliance on foreign savings to finance domestic expenditumes, and in vulnerability to external shocks; * the uncertain demand from the Gulf region for income and employment opportumities; and * in the consequences of the Dutch disease, the loss of foreign exchange earnings and transfers since the mid-eighties has left domestic wages above their market clearing levels. ii. The declie in official transfers from abroad and the retu of Jordanians working abroad in the recent years point to the importance for Jordan to pursue a growth strategy, which emphasies attracting private savigs and invesbnent as well as uoig Jordanan _mpower to produce exportable goods and services. Such a strategy has been followed for a few years with some initia success, and it has been affirmed in the Economic and Social Dewelopmen Plan (1993-1997) recenty adopted by the Govemment. The Government has formulated this Plan to complement the economic adjustment and recovery program, and to enhance its prospects of success by encompassing social aspects, and providing decision-makers with a comprehensive view of the socio-economic siuation in Jordan. iii. This Plan differs from the previous economic plans in several important aspects. The Plan views achieving monetary and fiscal stability as prerequisites for restoring growth. Further, the Plan includes a padamge of integrated social and economic policies aiming to enlarge the role of the private sector in investment, production and employment. The Plan has also given consideration to Jordan's "demratic atmosphere" for decision making and policy implementaton Finally, the Plan has embodied a process, and a highiy flexible framework to "enable Jordan to absorb any new international or regional developments that might affect its econumic perfonance", thus "the economic objectives of the Plan, namely, realizing sustainable economic and social development and addressing str ral imbalan through the adoption of economic liberalization policies, wil remain those that Jordan will seek to achieve regardless of changing cimstnces." iv. Achievement of the policy objectives outined in the Plan require that far-reaching strucral reforms be implemented to invigorate the domestic economy and inprove resource effciency. This calls for a strategy built on the policy meams and iniiatives envisaged in the Plan including: * maintaig fiscal and monetary stabilization efforts with particular atention to: a resolution of the external debt problem and mobilization of domestic resources to readdress the long standing imbalances between savings and consumption; * accelerating efficiency-improving reforms to faciLitate: a more open trade regime, thus an unimpeded goods market; more efficient financial imion, thus an unified financial system; and a more dynmic and flexible labor market; and very importanly, JORDAN: CEM rdj 0 restruchtring and reforming the public sector to ensure that economic agents in both public and private sectors have tte same level playing field and respond most efficiendy to market sigals. v. This Country Economic Memorandum (CEM) is addressing issues in the three areas, particularly the more deeply entrenched structural problems, with a view toward formulatig a growth strategy consistent with the goals set forth in the Plan. It stats with the sources of growth, macroeconomic imbalances, and changes in productivity. vi. Past Economic Perfomance and Recat Recovery. The report found that during 1970-91 GDP growth was achieved mainly by increasing factor use and at generally stagnating techncal efficiency; the decline in total factor productivity was particularly pronounced during 1984-1991, in this period, the quality of investmeat declined, extal resources needed to finance domestic expent beame increasingly constained, the ievel of investment fell, and growth in output and employment stagnated. vii. The recent recovery is pardy triggered by the huge population and capital inflows and the associated increase in consumption and housing demand. Besides this, the recovery has been accmpanied with increased trade deficits. Improving the eteal balance could be achieved by maintaining stringent domestic demand maiagement including more restrictive fiscal policies. The benefit of such a policy stance is that the deficit financing via inflation tax can be avoided, thus creatg more conducive macroeconomic conditions for liberalizing trade and finance. The immediate cost, bowever, is that growth may be slowed and unemployment may increase. This policy trade-off points to the need for actively applying trade and other necessary policy vehicles to realign the inentive regime so as to spur export-led growth while alleviating the constraint on the current account. viii. Medim Term Macroeconomic Conditions. The past growth at low resource efficiency can not be sustained-the prospects for subtantily increasing domestic savings in the medium term would be limited, even in the best domestic policy reform cicumstances. Thus, a vast improvement i investment quality would be necessary. This should entail a major sift in investment composition toward the private sector based producive investment while maitanig the total level of investment at above 26 percent of GDP. The copsitional shift and rise in investment quality would also require a more attractive enionment for private capital inflows and investment, which are likely to be predicated on effective reductions of the severe debt overhang. ix. Jordan has well managed its extemal debt with a view to restoring its assess to the financial market. New borrowing has been limited and at most concessional terms. Conmied rescheduling of official bilateral debt, as the report shows, will provide up-front cash flow relief while increasing the debt stock and obligations in the future. The problem could be alleviated by a mix of increasing concessionality in new borowing and achieving more direct debt and debt service reductions. This is particularly important considering that the macroeconomic scenario rests on four critical conditions: * the projected fiscal adjustm will be achieved thus increasing public sector savings and freeing resources for the private sector; * projected increases in exports of goods and non-fctor serices will materialize; CEM: EXECUTIE SUMMARY IW * the current surge in economnic activities will be sustained by a strong recovery of private investment in the productive sectors; and * the level of remitt-nces will stabilize at above US$ 1.0 billion annually. x. All four conditions depend on the extent to which public debt and debt services are incorporated in private investment and consumption behavior (i.e. the Ricardian equivalcnce assumption holds true), thus, a reduction of the external debt overhang would be desirable (in conjunction with highly concessional fmancing) to improve the prospect for encouraging private domestic savings and investment, as well as for attracting private capital inflows. xi. Redressing the macroeconomic imbalances provides for the necessary ingredient to tackle the sectoral and structural constraints on growth and productivity. The success in structural reforms, however, depends on the speed of supply response to the shifting signals coming from both the domestic and the international markets. The speed is a function of the efficiency of the economic system in carrying out three main tasks: (i) in conveying the right market signals-this points to the need for eliminating the rewraining price distortions in the economy and for dismanting the barriers to trade; (ii) in provid- I incentives inside the enterprises for the managers to make economically rational decisions c he basis of market signals-thus, the need for creating a level-playing compedtive environment for all; and (iii) in providing flexibility to the factor markets, so that decisions on resource allocation can be carried out rapidly and efficiently-thus, the need for reforms in the financial and iabor markets. In essence, policy reforms should spur growti and investment by relying on market forces to increase competition1 among domestic producers, competition between domestic and foreign producers (import competition), and export competition in the third country markets (export rivalry). xii. Shuctural Adjustment-Trade. With respect to import competition, the report suggests that distortions in the trade regime still remain despite the trade reforms since 1989. There are a wide variety of non-tariff barriers including: outright bans, licensing requirements, and Goverment import monopoly. These barriers effectively separate the domestic market from the world economy. In addition, Government sets distribution margins on imports of consumption goods, as well as on some consumption goods produced in Jordan. Government also sets retail prices for fresh fruits and vegetables. In total, these price interventions cover the value of goods at about 11 percent of GDP. xfii. The overall tariff level, the number of rates and the degree of tariff differential afforded to different products and industries have not been sufficiently reduced to create an incentive regime conducive to outward-oriented growth. The legal tariff and surcharge structure is sill being undemined by the excessive tariff exemptions. On an average annual basis, over half of all imports enjoyed some form of 'duty-free' status during 1990-92 regardless of the formal tariff and surcharge structure. The tariff protection has also been compounded by the consumption taxes, whose rates on imports are higher than domestically manufactured goods, and by the tendency in over-valuation of imports. I/ Competition or the lack of i, is a major reason for the producdviy gaps among the major industriaized counties, accordig to 9Mmaurgn Productiy', by dhe Mckiney Global Instidte, October 1993. bORDAN: CEM lviv] xiv. The effective rates of tariff protection vary at 5.1 percent in agriculture and 40.9 percent in manufacturing. The low tariff rates for agculture reflect the relative uiWmportance of tariffs in protecting the sector owirg to the wide range of import controls and monopolies. The high tariff rates for manufacturing underscore the benefits that the ranufacturing sector reaps from the relatively low tariffs on raw materials and intermediate goods as well as the extensive use of tariff exemptions. There is also considerable varnation in effective rates of tariff protection within the manufacturing irdustres. Comparison of the domestic prices with the international prices also shows that some of Jordan's producers enjoy natral protection and could survive without the protection of tariffs. The trade regime permits monopolistic profits at the expense of domestic consumers and constitutes a powerful bias against sales to the export market. xv. External competitiveness, which determines the aoility of domestic firms to maintah increase their market share both in domestic and foreign markets, has improved considereb' ore 1989. Export diversification increased, but export sales to the major markets in Japan and countries are still insignificanm. Internal competitiveness, which determines the ability of tradable goods industries to attract resources, also appears to have improved since 1989. The report indicates diat the incentive regime in the past four years has shifted in favor of the production of tradables as opposed to the production of non-tradables, but a clear anti-export bias still exists in the tradable goods sector. Thus far, the export promotion schemes designed to offset the anti-export bias have not been particularly successful. The immediate task, therefore, is to get the basic incentive regime right, while further improving the institutional support for export (specific recommendations smmrized in Table 4.14). xvi. Stucural Adjustment-Public Enterprims. With respect to domestic competition, the report suggests the need to level the competiton between public and private sector enterprises, and to create the internal incentives for all economic agents to rationally respond to the forces of market compWetition. The report found that during the early 1970s and the mid-1980s, the private sector's share of total investment declined precipitously as more and more investment was directed towards public enterprises. A second manifestaton of the public sector crowding out the private sector was the increasing allocation to the latter of domestic commercial credit-which the Government effectively directed, particularly with respect to the housing and constuction industries. Between the early 1970s and the mid-1980s, the average public sector share of domestic credit rose by half, while the emerging private sector enterprises found themselves effectively shut out fTzm the domestic credit market, thus denying Jordan the most dynamic growth opporunities which could have emerged. xvii. Expansion of the Govermment's shareholdings in publicly traded companies has coincided with a marked worsening of economic performance on virtualy every front. While various factors are responsible for this inadequate performance, the fact that wholly privately controlled companies have performed uniformly better, confirms that Government presence in the management of publicly traded companies is impeding their performance and competitiveness (recommendations summrized in Table 5.5). xviii. Shtutural Adjusmnent-Ff iance. The speed of the shift toward an outward-oriented growth would require not only the reconversion of many existng enttrprises, but also, and very importanty, eliciting the emergence of new innovatng entrepreneurs and providing the capital they need to operate. The banking system in Jordan has overcome the crisis of the late 1980s, and the stock exchange is well established and one of the most active in the region. Yet, the financial system is CEM: XECUTIE SUMMARY (vi still far from becoming as flexible and fast as needed by a competitive environment associated with the trade and public sector reforms suggested in this reports. xix. Jordan is receiving large inflows of financial resources from abroad. These inflows, and the policies adopted to deal with them, have resulted in a sharp increase of the net positions of the commercial banks in foreign exchange and in a sharp contraction of the credit to the private sector. The Central Bank has managed to meet the stabilization targets while minimizig the adverse consequences of the direct control over credit expansion. Yet, there are several sources of concern. * First, the banking system seems to be over-exposed in lending to housing construction and tourism-a market downturn could be dangerous to the banks and depositors; * Second, the opportunity presented by the current capital inflow m-.> be wasted as the enterprises in the tradable sectors are not receiving as much resources 2s needed to finance their export diversification; * Third, the large banks, and particularly the two largest ones, have been able to increase their deposits even if they are not in compliance with the capital/deposits ratio. This biases competition in their favor. xx. That the inriton required to finance the transformation of the tradable sectors is not tkig place shows the structural problems in the economy. The structural problems in the banking sector are reflected in market fragmentation: in terms of loan maturity, and in terms of sector activity. xxi. Most long-term debt financing is provided by banks and specialized credit instittions in three ways. For large corporations, banks participate in syndications, using short-term funds to finance long-term projects. Specialized credit institutions onlend long-term funds from either the Central Bank or international institutions. In the case of housing, banks finance mortgages with short-term deposits. Banks lending long with short-term funds carry with them both the interest rate and the liquidity risks. Running these risks is not necessary, since the economy has a substantial supply of long-term funds. But, for the most part the predominance of the specialized credit institations and the privileges they enjoy today segment the market and prevent the effective intermediation in long-term financing. xxii. Each of the sectors targeted for special credit suffer from the typical problem that lending is not an efficient instrument of subsidizailon because loan subsidization does not encourage carring out an activity, but only borrowing to carry it out. As the report shows, the subsidies often go to the large borrowers, not necessarily the activities to be promoted, The small businesses, which do not have the recourse to syndicated loans, must go to the specialized credit instions, whose privileges leave them with little incentive to compete aggressively to increase their operations in order to meet the needs of small businesses. In the meanwhile, commercial banks have their profits assured due to 2! Ihe B most exposed to this rsk Is the Housg Bak, which aties a stantial portfolo of log.m housig loans fiumced with short-tm deposis. JORDAN: CEM [WI the current high liquidity and restriction on credit expansion. They do not compete for deposits, and then lend against heavy guarantees because credit is being rationed. xxiii. The Amman Financial Markets (the stock exchange) have experienced an impressive upturn in recent years. Yet, it is still not a major force in the financing of long-term investment in Jordan. AFM operates under t' e auspices of the Ministry of Finance. It has two kinds of problems: (i) the functioning of the markets themselves, and (ii) the operations of the long-term savings institu-tions as the natural providers of funds in the capital markets. xxiv. Government involvement in APM through the control of its finance, and the control of its Management and Issues Committees create not only undesirable rigidities in the functioning of the markets, but also prevents the Govermnent from taking the detached attitude that an effective regulatory and supervisory agency would have. The absence of such a regulatory and supervisory Government agency has also contributed to the poor disclosure in terms of timing and quality as well as to the lack of ethical codes among the brokers' comnmunity. This has undermiined public confidence and transparency in the capital market. In addition, the market efficiencies have been hampered by the absence of market makers, who trade on their own account or on behalf of third parties. xxv. The functioning of the equity market has been characterized by the reluctance of enterprises to issue new shares. The report found such reluctance to be associated with the following factors: i) the Companies Law sets that the share holding by each of the original promoters of a company to be listed must not exceed 10 percent; ii) the Govermment controlled "Issuing Committee" of the AFM tends to under-price the new shares to be offered to the market; iii) the "Issuing Committee' meetings are infrequent, and new issues are delayed for months, waiting for approval; iv) retained earning when capitalized are taxed at 15 percent; v) high administrative costs due to the small denomination of sbares; and vi) cumbersome registration procedures. xxvi. The bond market is underdeveloped, and there are several reasons, among them: the sudden burst of inflation in the late 1980s (which caused large losses to the holders of fixed-rate bonds); the problems with the long-term savings institutions (to be discussed below); and the pr;.vileges enjoyed by the specialized credit institutions. There are, however, additional problems. Fhist, there is no public information on the prices, volume and key ratios of the bonds traded in the market. Second, there is a lack of benchmark to price bonds. Govermert bonds could provide such benchmark. Housing mortgage-backed bonds could supply a further alternative. In the long mn, the financing of public investments through bonds could also belp. Third, the Central Bank sells its Development Bonds at two prices: at par to non-bank purchasers, and at 120 percent of par to banks. The price discrimnation seriously distorts markets and discourages the banks from selling their Development Bonds. xxvii. The optimal strategy for long-term saving institutions, one that makes them viable, is to invest their funds in the long-term instruments, capturing the extra yield of such investments and the stability they give to their income. The benefits in extra yield and income stability are valid for fixed interest rates as well as for floating instruments. Current regulations and practices, however, hamper the ability of the long-term institutions to pursue this strategy because several of these institutions are forced to subsidize long-term (mainly) housing loans; and to deposit a substantial portion of their funds with institutions owned or controlied by the Government, mainly the Housing Bank. C: EECUiESUWMARY) Eliminating the regulations that force these ipdnet on the long-tem savings institutions would not only improve the financial soundness of these nstiutions but would also provide additional funds to the capital market promoting the edation between long-term savings and investment. xxviii. Improving the efficiency and diversification of the financial system reqires actions in four main areas (specific recommendations summarized in Table 5.5): * The elimination of privileges and the privatization of the financial institutions now controlled by the state; * The establishment of appropriate and compatible regulatory and supervisory settings for the banking and capital markets; * The strict application of new prudential regulations; and * Gradually opening the capital markets to international transactions. xxix. Labor Market and Employment. The outward-oriented growth strategy would also reqiire a good quality labor force at competitive costs and an efficient labor market that allocates labor to its most efficient use. In the past however, the public sector pay and employment policies, the capital bias and the artificially high domestic wages have all compounded the connces of rapid population growth and resulted in high unemployment. In addition, policies which apply diffent rules to different sectors of the labor market have created market segmeon, which impedes labor mobility, retards employmet creation and reduces market efficiency. xxx. Labor market segmentation exists along many lines. There are national Jordans as well as foreign workers. There are Jordanians working in Jordan and Jordanians working abroad. There is considerable difference between the labor force participation and employment of males and females. There are workers who benefit from effective uniordzation or immigration prohibitions while others have to compete with the low-cost irnmigrant worers. Finally, there is the public sector whose size dominates the labor market in pay and employment conditions. xxxi. Jordanian workers can be grouped ino "insiders" and "outsiders". Insiders are already in the privileged sectors (government, independent government bodies, unionized sectors, and modem establisme) or those with family support who can afford to stay unewloyed untl they find a job in one of these sectors. Outsiders are the unkilled Jordanians whose income and savings are low and compete with foreign workers from low wage countries. The effects of such segmentadon on long- term growth are clear: the economy has fered from puctvity loss when many of its eucated are unemployed expecfting to be employed in the privileged sectors or abroad, or they are Underemployed in some parts of the privileged sectors. The economy has also suffered from loss in the growth of investment and output becse of the inability of the labor market to adapt and to be flexible and because the domesdc wages are too high for export-led growth. Thus, unless the structural problems of the labor market are resolved, unemployment among Jordanus will contnue- even if GDP growth of 6 percent is achieved over the medim-term JORDANN: CEM lvVI) xxxii. The Long-erm rpecidve. For a small economy such as Jordan, with a well educae labor force, located in the passageway among three major contnet in the world, size does not mauter so long as the economy i integrated with the world maret. Such integrion would offer Jordan the best prospect for long-term prosperity, and could enable her to overcome the limited domestic market scale, and to increase productivity through specialization. An outward-oriented growth strategy would entail the following: * Domestic producers need to be exposed to competidon at home and abroad. Enterprises in the most successful economies are well exposed to the forces of market competition. Jordanian enterprises cannot be expected to take advantage of its well educated labor force and other factor endowment if they are separated from the forces of market competition- either by market barriers or by the privileges granted from the Government. O Domestic producers and traders need a wide net of financal support, extending around the world to sell their goods and services. Enterprises in the most successful export countries have access to such a network through their financial systems. Jordanian exporters canot be expected to succeed in their competition with these enterprises without equal access to such a network; * Exporte and other producers in the successful economies have access to the deep fiancia markets in fuures, options and other derivative products that can be used to hedge risks, and to all the wide facilities that the developed markets can offer. Jordanian producers should also have an equal access. * Producers and exporters in the successful economies have access to a high quality, as well as flexible, labor force at low costs, and can shift their capital/labor mix as well as skill mix in order to adapt to the fast changing global market condidons. To be successful, Jordanians producers should have these conditions as well. * The successful economies apply purposeful and effective polices to attract foreign investment, promote technology transfer and assist the enmaer domestic industries-these policies when properly implemented create opportunities for the private producers in these countries. Jordanian producers cannot be expected to succeed with the now excessively large public sector and without the same kind of enabling environment. xxxuii. The integration with the world econwzy requires the discarding of the mercantilistic prejudice that imports should be curbed, inflow of foreign workers should discouraged and capital inflows are the only capital flows that are good, and that capital outflows are uniformly bad. As the experience in the world and the current situation in Jordan show, clearly these prejudices are wrong. First, the primary purpose of trade is import not export,3 a tax on import is an equivalent tax on export." 4 Thus, protectionist policies hurt Imporu as wetl as exports. Second, immigrant workers typicay work harder, save more and eam less, tbus compenating for Jordan's disadvantage (compared with if Paul Kiugman What sould we teach suaden abou trde onome, 1993. V In the contx of a to-by4wo equlitm model according to tbe Lemer Symmy Thqeom. lnmer (1936). CEM: EXECUT7VE SUMMARY lic other low-cost exportng economies) in having high domestic labor costs. Third, capital inflows can exceed the country's ability to absorb them, becoming a source of inflaion for nontrzlables and the accompanying appreciation of the currmncy. Also, this prejudice ignores the fact - shown so clearly in the strategies of the most successhl exporting countries in the world - that developing sustainable exports requires heavy investment by the exporting etrpries in their target countries.5 A stable market cannot be created without joint ventures with traders and producers in the importng countries, carried out to develop marketing sklls, to establish a market presence and someimes to produce parts of the exported products abroad. Enterprises failing to do this, and to source inputs as well as market outputs globally are always subject to the vaganes of market uncertainty, and are left in a perpetal price war with potentl and existing competitors. xxxiv. Even more importantly, the ky to success in modern business is the ability to organize and reorganize chains of supply, takdng advantage of the most convenient production facilities, financing, and marketing organizations, wherever they are in the world. This means that, to be competitive, local producers should be able to do the same. There is no gain in forcing the local enterprises to produce locally only to lose their competitiveness. Rather, the physical and legal infrastructure should be such that it becomes profitable to operate from the country. xxxv. But, even if a country has a first-rate infrastructure and an efficient legal and bureaucratic setting, it cannot expect to have comparative advantages in all areas, not even when it comes to a single good or service. The internationalization of car production is well known-a car produced in the United States may have an engine produced in Mexico, with many parts coming from third countries, and other components made locaUly and abroad. The same is happening with almost every product. These combinations are made through alliances, which allow for the participation of all the actors in the design and development of the final products. Jordan is a small economy with little natural resources but with a well educated labor force. If Jordanian producers and exporters are not allowed to invest in these alliances, because of the structural impediments described throughout this report, they are denied the opportuity of participating in the global production of goods and services, and the opporuity to be at the center of the tecbnological revolution. xxxvi. Th Enhanced Growth Presped. The implications of the policy diagnosis in this report are clear: unless the stuctual constrainu to long-nrn growth are effectively taclded, Jordan's growth would continue to be subjected to low efficiency and high exteal uncertnty and could not be sustined. While the prospect for growth can be enbanced with the structural reforms, the success of the stuctura reforms depends on a sensible sequencing and prioritization of the wide-ranging reform agenda. xxvui. The fiM proriy is to refgm the kde regim. There are at least three strategic reasons for Government atention in this area for the next 12-18 months. 7The trade reforms initiated in 1989 have stimuated growth and employment in the man ft sector, and further tariff reforms would consolidate the initdal gains. Moreover, further removal of tariff exemptions could accompany the reductions of high tariffs without adverse effects on the fiscal balance; on the oher hand, replacing A/ ag.. John Pa. Mm as Ask Mired.. Econo Growth ni Publi Policy, Wold Bak Policy Resarch Rq,ph New YoL Oxf Uiversy Prss, 1. JORDAN: CEM [x} tariff exemptions with low or zero tariffs would increase transparency of the tariff regime, and level the playing field for public sector and private-secr alike. Third, further tariff reforms would complement the domestic tax reforms now under implementation tariff reforms when taken together with tax reforms, and with a flexible foreign exchange rate policy stance, would not only redress the macrconoic inbalance by increasing public sector savings in the short nm but also encourage domestic savings and investment in the longer rmn. xxviii. The second prioty is to reform the f ancial ad banking sector. Jordan's successful stabilization efforts have provided a stable environment in which the strucural issues of the financial sector can be addressed. While most of the issues are longer-term in nature, some need immediate attention; for example, the excessive exposure of comercial banks to the real estate market and the lack of financing for investment in the productive sectors. Further attention should be given to reforming and restructuring the specialized credit institutions so as to remove the barriers to market competition. The other longer-term goals concernig the development of capital markets, and its opening to the international transactions should be pursued steadily and gradually so as to avoid financial instability. xxxix. The third porty Is to reform the pubic sector, reducing its scope, involvement, and interventions in the economy and making its provision of public goods more efficient. Not all can be accomplished right away, but at least the following tasks need to be undertaken immediately. The Govermment should initiate a comprehensive civil service reform program with focus on rernching redundant functions first in the next 12-18 monts, while freezing all new recruits. Such efforts will contrbute to the fiscal stabilizaion by gradually reducing Government wage expenditures. Reurnching the civil service and resructung its pay and employment conditions would also improve the efficiency and effectiveness of the civil service, thus increasing the private sector confidence in the Government, and winnmg public support for the overall reform program, indirectly enhancing the growth prospect. xl. Ftrmnore, the Govermment should continue its efforts in commercializing and corporatizing the public enterprises in the energy, agriculture, and telecommunication sectors and in speeding up the privatization of the selected enterprises (e.g., Royal Jordanian Airline) during the next 12-24 months. In addition, the Govermment should expand its efforts by establishing longer-term goals in tsforming the ownership structure of the public enteaprises, by defining credible passages toward these goals and by adoping new regulatory and investment policies which would encourage new entries to compete with the public enterprises. Commercilization and corporatization with a credible path toward privatiation would allow the relevant public entprss (in the energy and telecommunication sectors for example) to proceed with the urgently needed imvestment expansion. But, ultinately only private enterprs who consistently maximize their net wealth, can provide the main engines for sustanable growth. Hence, without a significant shift in Jordan's ownership stucture, Jordan's growth prospect would be fragile and the source of growth would continue to be factor-using rather than efficiency increasing. xli. Jordan's economic prospects can be further enhanced if the regional Peace Process succeeds and its poteal benefits are fully captured. A regional peace settlement would remove one major uncertnty over trade and business opporunities in the region, could result in access for Jordan to the Israeli markets, as well as in business opportnities for development and reconstruction in the Occupied Territories. Jordan would stand to gain subsantialy if Jordan could offer competitive and CEM: EECUT7VE SUMMARY () effcient bakicng and other business sevices and if Jordan could capitale on the new oppormuities for epnding its tourist industies. The economic projections (shown in Table 8.1) rflet the upside of the unfolding Peace Process as well as the expected results of implementing the struca reorms descibed above. This high-case scenario (Table 8.1) may be compared with the base-ce scenario shown in table 3.1 and the two scenarios differ most notably with respect to the outer years of 1996- 2003. CHAPrER k INTRODUCTION 1.1 jordan enjoyed an unprecedented growth in its income (and expenditures) during 1973-1984, boosted by foreign assistance and loans, worker remittances, and export to regional markets. This ended in the mid-eighties as a result of the rapid decline in the price of oil and the subsequent slowdown in regional economies. As a consequence, Jordan experienced a drastic slowdown in growth, which became more pronounced after 1986, and severe fiscal and extemal account deficits. By 1991, real per capita income had declined to about half of its heights during the pre-crisis years: unemployment and poverty increased. The Government responded in 1989 by undertaking policy adjustents to stabilize the economy and to restore growth. The stabilization policies, notwithsanding the disruptions caused by the Gulf crisis in 1991, have been persistent and largely successful. However, major development issues still confront Jordan in the medium to longer term. 1.2 Jordan-which has a long record of consuming more than it produces-must respond effectively to reduced extenal transfers. While nothing can be done to reduce consumption in the short run, strucural reforms to generate sustainable growth offer the only way of re-emerging in the medium term. The task will be challenging. At present, the country has a weak productive structure and a slim industrial base. Jordan's main comparative advantage in the past has been to educate and export highly skilled workers to the Gulf states. 1.3 While this salient feature constitutes a powerful spur to economic growth, It has left a problematic heritage for the economy: * in reliance on foreign savings to finance domestic investment, and in vulneability to external shocks. * in prospects for long-tem growth as the uncertain demand from the Gulf region clouds Jordan's outlook for income and employment opporunities; e in the consequences of the Dutch disease: the loss of foreign exchange eanings and transfers since the mid-eighties has left domestic wages above their market clearing levels. 1.4 With a small home marke, Jordan faces the choice of exporting skilled workers to the region or exporting goods and services to the region as well as the rest of the world. With the Gulf crisis and the subsequent decrease in demand for Jordanian workers, an outward-oriented growth stra with a particular focus on exports of goods and service is needed. 1.5 Ihe Econondc and Socil Development Plan 1993-1997 reflects the broad thrusts of this growth strategy. The Plan has ditinguied itself from the previous Development Plans in a mnmber of important respects. It has strongly emphasized the importance of creating a stable fiscal and monetary environment as necessary conditions for achieving susinable growth. It has further complemented the on-going economic stabilization and adjustment program by giving particular attention to the closely related social and development issues. It has embodied specific policy measures to encourage the private sector to play a greater role in investment and employment. Finally, recognizing the vulnerability of the Jordanian economy to the externa shock, the Plan has adopted a flexible policy framework and planning process in order for the Government to effectively respond to the changes in the external evironment. JORDAN: CEM 12) 1.6 Achievement of the growth and development objectives in the Plan require that far-reching structural reforms be implemented to invigorate the domestic economy and improve the quality of domestic investment. Tbis calls for a strategy built on the policy initiatives outlined in the Plan including: (I) maintning fiscal and monetary stabilization efforts with particular attention to: a resolution of the external debt crisis and the regaining of interational crdworthiness; mobilization of domestic resources to readdress the long standing imbalances between savings and consumption; (i) accelerating efficiency-improving reforms to facilitate: a more open trade regime, thus an unimpeded goods market; more efficient financil intermediation, thus an unified financial system; and more dynamic and mobile labor markets and equally important; (ii) restructuring and reforming the public sector to enstrre that economic agents in both public and private sectors can have the same level playing field and respond most efficiently to market signals. 1.7 Ibis report intends to analyze the issues in the three areas above with a view toward formulating a growth strategy consistent with the goals and objectives set forth in the Plan. Specifically, the report will focus on the following broad topics (from Chapter II to Chapter Vli: * what has been the sources of growth and sources of macroeconomic imbalances in the past, and what are the likely constraints to growth and employment in the future (Cbapter Il)? * what consdues a viable medium-term macroeconomic framework with prospects of readdressing the macroeconomic imbalances and resolving the debt crisis (Chapter Im)? - what is the nature of the current trade incentive regime and what can be done to integrate Jordan with the world and regional economies (Chapter IV)? * what is the prospect for private sector development in Jordan and what needs to be done to create a level playing field for all market participants (Chapter V)? * what is the role of financial intermediation in Jordan and what are the financial maket structures and policy regimes? And what needs to be done to improve risk manament, and to establish the grund rules and market basis for long-term development financing (Chapter Vl)? * how fragmented is the labor mauket, what sort of wage and employment policies should Jordan pursue consistent with Jordan's export-led growth strateg (Chapter V11)? * how each set of the proposed reforms would enforce each other, thus enhancing Jordan's growth prospect in the long-erm (Chapter VI). CHAPTER I GROWTH, MACRO ECONOMIC BALANCES AND PRODUCTIrIY 2.1 Ihis chapter reviews Jordan's economic development from 1970 to 1992. It alms at prviding the backgrou against which the rest of the report is structed as well as drawing lessons for the futue by: i) assessing the main features of the process of growth; ii) analyzing the changes in exteral and interal balances; iii) evaluating the sources of growth, and estimating the changes in labor and capital productivity. The findings suggest that past growth has been largely demined by the availability of extemal resources, with little growth in total factor productivity. Declines in the flows of these resources have not only constrained investment but also led to peristent macroeconomic imbalances. Achieving sustnable growth will require increasing efficiency through the unimpeded operadons of goods, financial and labor markets. A. Palten In Economic Growth 2.2 Table 2.1 summarizes the main measures of growth, investment, and foreign saving (the balance of goods and non-factor services) during the past two decades. Foreign savings peaked in 197345, and then declined to their lowest levels in 1985-Q9. Both boom and bust were dramatic. The links between foreign savings and investment and the level of investment and growth are importan for understanding the economy during these two decades. Equally important, but less predictable, is the relation between the quality of investment and the availability and type of foreign finance. .."'.:.,.;.,.. .'.....*.*. JORDAN: CEM 14) 2.3 nhe Boom of tbe 1970s. 'Me boom of the 1970s had severa didsctive feates. During 1975-79, foreign savings rose to an average about 22 percentage points of GDP higher than the average of 1970-75. Much of this increase In foreign savings accued to the private sector in the form of migrants' remitances. Public sector exteral financing had started to rs earlier, both though bilateral loans and grants. This feature of the boom-increases in funding through both private and public sources-had a direct bearing on the second-the strong association between increases in foreign saving and increases in domesti investment. Investment rose by about 15 percent of GDP, implying that about 314 of the increase in foreign savings was invested. The rise in investment stimulated growth as the efficiency of capital rose, an unusual event during a financing boom. As - result, growth averaged about I 1. I percent per annum during 1973-79. 2.4 The Bust of the 1980s. By the second half of the 1980s the foreign savings boom was significantly reduced and debt service obligaions increased. In 1987-88, the Government sought to supplement faUing resources with increased commercial borrowing from abroad. But sources of new commercial loans were quickly exhausted. The uet effect was a mansive reduction in the flow of foreign savings to the public sector by 1988. During the late 1980s, foreign savings aveaged 30 percentage points of GNP below the level of the early 1980s. In relative terms, the bust was comparable to, if not larger than, the boom. 2.5 Investmet bore the brunt of the adjustment to reduced foreign exchange, although consumptio also fell sharply. The decline in investment led to a deterioratig economy. GDP growth declined from an average of 9.9 percent a year during 1980-85 to an average of -1.2 percen during 1985-89. 2.6 Faced with growng budget deficits as foreign savings shrank, the Government turned to domestic sources, borrowing heavily from the banking sector at regulated interest rates, creaig new fiacW distordons. Increased monedzation of the deficit led to high and variable infltion. The Government reacted by introducing price controls and multiple exchange markets. By 1988, as the deficit reached 24 percent of GDP, the situstion was clearly unsuinale. Reserves were depleted, and the exchange rate depreciated by over 50 percent in real terms between 1987 and 1989. Financial instability during 1987-89 daso increased capital outflows, led to bank failures and reduced private capital inflows. 2.7 ne IJmpnce of Extern Financing. Jordan's boom and bust have been closely related to the fluctuations of oil prices, as the levels of economic activity in the region and the volume of official grants and private flows from the Gulf counties fluctuated with the economic cycles of oil production. Both public and private investment in Jordn osciated with these flows, the former following the levels of foreign official gants, and private investment the volume of remittances. o:tW".ilXs * & * S 3 33 3 0.t114 tli. .4 ill- S R§2 t t}X3~~~00[0 ^|Xtt tgtI? 1 3 0a~~O JORDANI CUM 10 GIGURE 2.2 50t..- e,eg~fttW~ m . ftLwt. awutu "MsO et =P 8~~~s Ut * a n N X4""Is as~~~~~~~~~~. sito - rwas Zn.ta. @dgs* 4ggft D. Chang_ In lnal and External Balances 2.10 major on-I s of nomicbalnes are excessive o of nad debt andhinflatoa lh. soumes of such Imbalances can be taced to th perpeftu g pic and private sect saving deci. Is section starts examinin the of macro imblanes-external debt accumulation and Inflton-and then examines the source of such lmbdances-prhmfiythe net pbiC and pivae secor savinp deft. 2.11 Muutaau . i of bomiabnbanea. Macroeconomic imb m s Isf in eesidve accnilaton of exteenl debt becue e al borowing i used to close gps In extern accounts. In Jordan, thi has occured when flows of emitance decined, officialg reduced and domestic conmpton could not be adj. sted downward to the decline in naional income. 2.12 In the fbolowng pargraphs, excessive indebtness Is measured in hee ways: the debt burden as the ratio of total debt o _utst to GDP; the ability to sevIce the debt oblgon as the ratio of tota debt ounding export", and the composion of debt and debt matit ratI to the quaity of the debtfnanced investment Figur 2.3 shows that most of the debt n occored during 197947, as the total debt outsta and disbursed incread fm beow US$ I b nIonln 1979 to nely US$S b lonby 1990. lhe raft of debt tD GDP and export moved ,ore or less together during 197948. However, the rise in dibtIGDP ratio was less drastic tha t in dWetexport rao because GDP grew than exports during the period ( see Figu 2.3). As etera borrowing contned while the economy stgated in 1989-1991, the debt burden on Jordan Increased drmcaily. By 1991, Jordas debt burden was much lager ta tho on Egypt and GH. n: GROWT, MACRO BALANCES AND PRODVC7TVrTY M Morocco (see Figure 2.4). Purthermore, Jord s ability to service the debt was also affected by the composition of the extertal liabilities. While the short-term commercial debt was low, a bunching of debt service obligations occurred in 1989-90. Aside from tiat, the debt-financed military purdcases added little to generaig export earnings, and as discussed in sections below, the quality of investment also deteriorated. FIGURE 2.3 200.0 171.0 4000.0 110.0 121.0 4"0.0~~~~~~~~~~~~~~~~1. . ""' S 3000.0~~ 1.0...................-- o0 .O; ........ e..e.... 1911tt 192 t8 1 t197 1089 1991 - Et eti fl* Deb (WI1 FIGURE 2.4 et 0 tewm8 OiebUe4 to amP Rtio (WM .~~~~~~049 .9t _1, 300 210.0 ISOA 160.0 110.0 90.6 20.0 0.10 We1 1 19 1 " 11 117 t 1 90 191 _ S:... - 9MrP sos JORDAN: CEM(8) 2.13 Eventually, the public soecr deficits could be not fily financed with nal resources, and the Government resorted to raisg the Inflato tax. Figure 2.5 displays the dme path of the GDP deflator, showing how the price level was on the steady rise dung 1979-1985 and shot up drascally In 1989 as te mIc imbalances culmnated in record fiscal deficits and balance of payments difficulides. The fiscal deficits excluding gran for both 1987 and 1988 were above 20 percent of GDP, and the cur acout deficks at about 14-15 percet of GDP. Also conuibutig to the price leel ireases during 1989-1991 were Wpply shortages resulting from the compression of Imps and a fail in red outpu in 1989. At the same time, the nominal exchange rate, fixed since 1975, eperienced increasing presswes. In October 1988 Jordan adopted a flexible exchange rate, which theaftr has been adjusted contiuosy to achieve a target rate of real depreciation. 'he real d uais shifted the symptoms of excess demand from shortages to a significant rise in domestic inflaton in 1989-1991. FIGURE 2.5 Jordan - GOP Deflator and Index of Real Ehanei Rate (DI$) (1979-100) 250.0 230.0 210.0 190.0 170. 0 150.0 130.0 90.0 19 9 191 1983 1985 1987 1989 1991 R"al ErlIue Rate Index GOP Deflator CH. Hn: GROWTH, MACRO BALANCES AND PROD UCTfVI2Y PI) 2.14 The stabilization measures put in place since the late 1980s bave reduced public sector clam on national income, gradually easing the inflationary forces. On the supply side, the recovery in exports in 1991 (spurred by the real depreciation of JD), the debt rescheduling in 1992 and the increased inflow of remittances in the same year also helped. 2.15 Sources of Macoeconomic Imbane. In tis sb-secton, the pae in the gaps between income and expenditure as recorded in the national accounts is examinad to defrse the sources and magnitude of macroeconomic imbalances over time. Ihe following national income accounting identity Is used to show the extent to which the public sector deficits have been the sources of macroeconomic imbalances: (Sp - Ip) + (Sg - Ig) + Sf = 0 Figure (2.6)1 shows net foreign savings (St), which is equivalent to the current account deficit or change in net external debt. 2.16 IThe most stiking feature of the Jordan economy during the reviewed period is that total net savings was significantly negative in the national income accountig identity. Further, net private sector savings (Sp-Ip) stayed relatively close to zero percent of GNP during 1970-75, fluctuated sharply during 1976-83, reached zero percent of GNP in 1987, and declined from that point onwad. Net public sector savings (Sg-I) was less volale but more negative. It fluctuated in the neighborhood of minus 30 percent of GNP during 1970-82. Strong fiscal efforts were reflected in the reduction of the public sector deficits in 1982-86, and again in 1990-1992. C jerall, the public sector deficit was the primary source of the total savings deficit in 1970s, and the private sector deficit was the primary source of the total savings deficit in some part of the 1980s (see Figure 2.6). 2.17 The contribution of public, prvate, and foreign savings to the financing of gross domestic investment is shown in Figure 2.7. Workermitc were subtacted to indicate the contibtion (defined as gross private domestic savings) of privae domestic residen only. Several notable features appear when comparing Figure 2.6 and 2.7. First, the rise in foeig borrwing (as expressed in Sf shown in Figure 2.6) appes to have resulted from the shap increases in the levd of domestic investment in the early 1980s. Second, the shares of the public sector savings, savitgs of domestic residents and worker remitmnces within the gross natonal savings varied significantly. The divergent trends of primae domestic savings and remittances suggest that that the privat sector regarded remittances as part of the current disposable income in deteminig levels of s rving and consumption. Third, Figure 2.7 also shows that when foreign borrowing came under increasing restaint after 1982-83, the burden of adjustment fell first on the private sector (during 198349) and then on the public sector as the adjustment eCorts stengthened (during 1990-92). L TFwe 2.6 ad 2.7.am de,bi AppaiLt MMb 11.12 I Voum ii of gMG JORDAN: CRM (10) 2.18 Figure 2.8 shows that the fiscal deficit has been a mjor source of macroeoomic Imbala during the 1980s. Official grants, which fiaced a major part of the fical deficit during the 1970s, decined drastically fom about 25 perce of GNP in 1979 to well below 10 percent il 1984. In respoese to the decline in offcial grants, the Government managed t steadily increase Its reve leel, but the increases were not sufficient to march with the expenditure Increses which moved generay upward, except for some fiuctuations in the mid 1980s. Govemment was at first sustned at the expense of reducing capital expendues durig 1981482, but thea it dpped saply as well, although by less tha the decline in revenues. As a result, with the exception of 1992, Govrnment consumption (recurent expenditure) was above tot revenues; the gap was narowed somewhat in 1983 and again in 1986, but enlarged substantially during 1987-91. FIGUlRE 2.6 Jordan - Net savings as Percent of GNP by Sector, 1970-92 90 70 S , : -to 750 - -70 72 74 76 78 so 82 8 a 8 90 92 -Nset Privlate savlings -- x t Forelgn savrinSg .. .. Not Public Savirsi 0 Z e e S - F i -1 ,1~ 0 0 0A ' f" '- ' ' - lUS.. E Ed5*j* F0~ *. 0 0 0!l 0 I JORDAN: CERA1121 C. Chages In Productivity 2.19 inestment EgLd=. 'he effiiency of investmen can be crudely measured by the Ilcremental Capi-Output-Rato (ICOR). Table 2.2 shows five year-ICORS for Jordan, Egypt and Tunisia for 1970-1987. 2.20 As the Table shows, Investment efficiency steadily improved during 1972-75. The positive effects of the regional TABLB 2.2: INCREMENTAL CAPfTAL-OVTPVT 1970.91 boom on productivity (such as (on fve-yea bas) rapid absorption of new icOAN 197974 n.7 776 73-77 74-7 78 7 7M technology, updating of capital sock and expanding the scale of J.ox* - 4.45 a66 2 2.56 27 .8 production) may have 2.83 2.3 Z.6 237 2.48 2.5 3. overweighed the inefficiencies 7WAU& 3.U 8 4.A1 23 5.0V 52 5.1 5.2 induced by the oil bonanza of 19m?-81 ?W 7M3 8M86 81.85 As 83- those years.2 The other .wEo 314 4.67 572 7.8 6.45 7.15 7.43 undelying factor, unique to 74U 7.2 7.33 7 11.4 L4O 8 Jordan, seems to be that the Lebanese Civil War drove many 19888 8A9 86.98 J?-91 internationa companies frcm 6. 1 ?.01 1366 -14j l Beihut to Amman for a short 7b 430 6.9 99 *4.6 period in the mid-seventies, brng with them demand for Cogoof "9 sJe DOOM 0oaWS" goods and services as well as higly productive financil and real sector investments'. 2.21 Durei: the late 1970s and the 1984s, however, there was a sharp decline in Investment efficiency as measured by the ICORs, which might have resulted from two factors. First, some of the public infiastructure projects Implemented during the 1970s and the early 1980s may have failed to produce returns because they were eiter misnceived or because their size became excessive during the dodwnturn of the 1980s. Second, during the slump of the second half of 1980s, equipment invenent in the productive sector was sharply reduced as capacity utltion dropped, while iwnstment in residential housing was relatively protected (see Table 2.3). 2.22 bor gmizaW. The overal output-labor ratlos shows a simlar trend as the chWges in the ICOks: te value added per worker (.e. tota GDP to ttal formal employment) increased onstently from 1975 to 1981, then it dowed down in 1982 (see Figure 2.9) and 1983. Despite Y - Maw, M. m, p.86 CH. n: GROWTH, MACRO BALANCES AND PRODUCTIViTY 1131 some recovery in 1984 and 1985, the ratio decreased sharply, to a level in 1991 that Table 2.3: Gross G xed aplifnnadon by wpe was much lower than that in 1980. of assets 2.23 A most important factor affecting an gg) 19782 1983.87 198- the overall labor productivity was the rising pecentage of Government employees In the Reddna baidi 25% 29% 43% total workforce, which went up from an Non-vezdu bauli already high 39% of employees in 1971 to and other consmcdion 31% 39% 24% 49% In 1991. The rise in public sector nWi eq4pment 22%6 13% 19% employment was found to have contributed MadCnehy equgjmw asd other2% 18% 15% to the decline in labor productivity in the SOW= SAdet Yeabok 1983, I97 1991 public utility industries such as power and water sectors. 2.24 The capital/labor ratio: Jordan has been a labor surplus economy despite the labor shortage Labor Productivity that appeared briefly during the mid 1970s. For Jordan, a country with S4 abundant labor resources and scarce eapital, a growth strategy aiming at maximizing resource efficiency 4 should combine the highly capital- intensive techniques needed in some a acdvities essential for development 4 (such as communications, data processing and industrial production requiring tolerances that can be \ obtained only with ighly sophisticated machney) with the U I creation of labor-intensive activities a s m m I to maximize labor employment. a m This section would address the labor Figure 2. 9 v.s. capital intensity issues building upon the preceding discussions of labor and capital productivity. JORDAN: CEM p14 Capita8lLabor Ratio Table 2.4: Gm,&*h of C$ anad * Labor EmployruwN E L 19702 190% 67% * 1982-91 38% 28% 1i97091 30f% 113% U UN Ufln we U M UN as m UN Figure 2.10 Note so R8m 2la0A mdlW r wnc onie Rarbr (17) s e JJ'8 u hm en"er c dra einde 4id'a hi a*aV e4*b ucaL s sif r 19101992 Is daHW by uwhg th pepe hiwuaoy mwJd a depedadIn rwe f 8 peca 2.25 While labor employment rose by 113% percent from 1970 to 1991, the capital stock increased treefold. For most years, capial grew fister than employmet, specislly during 1976484. Why does capital intensity prevail? A look at the conditions of the labor markets may offer plausible eplanations: afer the oil price increases since 1973, wages In the Guf region multiplied, atracting a growing number of Jordanian workers. In order to compete, wage in Jordan also grew at high rates4. With relatively mobile labor force and increased cost of labor relative to capital producers would react by employing more capital relative to labor.5 This reaction was further compounded by the easy access to cheap credit - interest rates were negative during various periods as a result of reglated rates- and relatively low on capital goods." The problem, however, was not that investmt was growing fast, but that It did not spur an overall increase in productivity, and the0ref, a sustinable increase in the real income of the population. f For an mmub* _ f wae deepmet In Jw*x w AlW 9) V & /e nooks eamle &.atI aSs1 v AwaPM p.46 CH. nH GROWTH, MACRO RALANCES AND PRODUCTIVITY 1S 2.26 Total Factor ProductvityAnalysi. Having examined the past trends In investment efficiency, labor productivity and capital intensity per worker, it would be useful to examine further the total and relative contributions of these factors to the growth of aggregate production. Thus, the analysis of total factor productivity is to be made using the neoclassical growth-accouing-approach. lbis analysis would attemt to address the question: to what extent has past growth been a result of a mere increase in inputs as opposed to improvements in resource efficiency, and/or a resut of technological progress. The analysis should enable us to formulate a growth strategy for the fitre with view to Improving productivity and promoting technological progress. 2.27 The aggregate Cobb-Douglas production function with constant returns to scale is used: with Y, = A,-K* -I[ (Y=real GDP, K= Capital, L=Labor, a+B=L) and, At = Yt-aK,-BL, (where hats denote rates of growth) Is the total factor productivity growth, i.e. the residual captures the improvement In factor productivity as well as the impact of technological progress. Data on factor inputs and GDP used in the estimate seem to suggest that the simplifying assumption of Hicks-neutal technical progress which underlies the TFP analysis is reasonably close to reality. The convex hull metod 7 is applied In order to construct a capacity utilization index, which is multiplied by the estimated series of capital stock. Data on the formal employment are used as labor inputs. The coefficients a and B represent the shares of capital and labor in output on the assumption of constant retums to scale (a+B= 1) and pefect competition, and they have been estimated to be about 0.4 and 0.6 respectively for developed countries; in developing countries, however, the share of capital is considered to be higher.' A regression restricting the coefficients to be a sum of one resulted in a share of capital at 0.52. The shares used in the analysis are therefore 0.5 for capital and labor as a rough approximation. 2.28 Ihe figure below depicts the changes in the level of total factor productivity (CMP) with the init value set to one. See u^ Jauke ad Lea 1991), p.10 L S, for cmnk CYu*we, Łmiap and Jrgev (1980) R Se for eaapk De Gagl (2) for Lad Aefca JORDAN: CEAM 16) 2.29 Table 2.5 shows the results of the Total Productivlty TFP analysis, which captres the entire economic cycle characterized by the boom and the bust (parm 2.3-2.6) as well as the growth of productivity within each period. In the period from 1970-1983, the growth of total factr productivity conributed to GDP growth by 2 percent, while during the post oil boom period of 1984-1991, the contribution of TFP to growth was negative. Overall, the TFP growth was slightly negative between 1970 and 1991 showing a 65 deterioratingtrendinfactorinput as. . productivity despite of the overall growth of . GDP. This was shown in the estimae of Cobb-Douglas function (the lower part of Figure 2.11 table 2.5). 10 2.30 Two regressions were run in order to verify the results. First, the least-square growth rates of productivity (i.e. the long-run productivity trend) was estimated.-" The reslt shows productivity trend growth rates around 0.8 percent though the computed growth rates were higher for the seventies than for the eighties. (See annex for the regressions). The other regression applied the Constant Elasticity of Substituon (CES) formula since the chosen functional Cobb-Douglas form may be too restictive. CES was estimated using non-linear least squares, assuming neutral tedhnical ange4. Although the esmat elasticity of substitution is significantly smaller than one (0.5), the TFP result does not change significandy; the computed growth rate for the whole period is slightly positive 0.3 percent (see Annex 4). The implied margina products of capital for the Cobb-Douglas and CES- formuations are shown in Figure 2.12, which is broadly consistent with the ICOR-series. The marginal product of capital increased until 1975, declined steadily through 1984 and stagated from then on. 2.31 Where does Jordan stand in comparison with other coutries? International comparisons of economic growth and productvity chante suggest that counties can be broadly classified in three groups distinguished by the rate of TFP growth and the contribution of TFP growth to output growth. 3 The early industrialized counties are charcteized by low rates of factor accmulation and TFP I* 27 ee_pbf ab*b ese sw tat ve,e In go auss$e of e*Wa decaSlxe xn aE edute 4(1Ow sthm qf Jlzctr bwput de net alte te bast rasult. W h fater A fe dhe prvd&atf .ea l ca be r*w&= a p, wth wba th gpeWA cite uam a ag a ceawad . IV 2ke techiqw dsews he it imla to dle ame wed by~ law*l and leyehe (1P93) Uf aesy, 1986 aid PIge 1981 CH. H: GROW1H, MACRO BALANCES AND PRODUCTiVIT 1717 growth, but the latter accounts for about one half or more of output growti. UTypicalU developing MtProduof Capra countries exhibit somewhat faster growth rates of factor inpUtS and TFP than Industrialized economies. "Atypicalr developing countries - including the nearly industialized eoonomies such as Hong Kong, Korea, Spain, as weil as Japan-bave bigh rates of input, TP, and GDP ?A growth. As in the case of typical developing counties, however, TFP growth plays a relatively less promiten role in output growth tn in the early industrializing countries. Jordanis 'atypical' amongthe 'typical' developing countties: while it exhibits high rates "f u +W W=In of factor acculation, its TFP growth accounts 2.12 for almost nothing in growth of GDP. Tabe 2.5: Andysis of Total Factor PmoWivky (F Growth of Co,atbadon to GDP chag QE [AkdLf& suf Likr ZE 1970-83 1.42 2.07 0.72 9.73 9.25 0.02 1984W91 9.94 9.17 .2 1.22 1.75 -1.97 1970-91 1.58 2.59 1.13 9.81 0.36 0.17 1979-91 Year TlFP Coa*eldloe rate to GDP growth Avewge raef j yeab* yyer ca. -0.993 -9.954 (Cobb-Donglas) Cobb-Dougls uesuion -0.008 -9.145 CBS Regress on 9.99 O.954 Cobb-Dougls rWesdoaa Q.004 0.073 wIh hwwa aita So=e: Amu .1 In Volme I of Otis repo. 2.32 Ihe above analysis is not yet ucompleteu, since the quity of labor, and the composition in capital formation have not been considered. Thus, we hae expanded the simple TFP analysis by indluding JORDAN: CEM(18) huma capital, following Manldw, Romer and Weilt4. School enrollment rates was used to approximate the quality of human capital, though this does not account for the huge migration flows that Jordan has experiened'. A more meaningful TPP analysis should entail a more accurate measure of human capital including the schooling levels of immigrants and emigrants. Unfortuately, availability of data does not pemit this. In spite of that, a regression using the estimated coefficients was run, showing a TFP trd growth rate of 0.4 percent, (see Table 2.5). By relating the total factor productivity growth to the ratio of machinery and transport eqment Imports (as a proxy for machinery ivesment) to total gross fixed investmentr, (see Annex 4), we also found that the decline in machinery investment is closely related with the decline in TFP (see Table 2.1 and 2.3 for the decline in total investment as shares of GDP, the decline in equipment investment and the relative rise In building and construction). 2.33 Finally, a note of caution should be exercised in interpreting the above results. The estmates of growth In TFP suffers from the typical problem of capacity utilization. A large proportion of output variations may be due to a host of factors not captured in the production function which push actual output growth toward or away from its potentials-this is particularly the case when output growth is subject to cycical changes. However, our anaysis has captured the entire period of rise and decline during 1970-91, I.e. both the near full capability utilization during the boom of 1970-1983 and the uner-capacity utilizatio duming the bust of 1984-1991. It shows that growth of TFP was (relatively) more important to GDP growth during the boom of 1970-1983 than the bust of 1984-1991 and that overall, output growth was factor using rather than efficiency increasing; total factor accumulation increased substantally, but growth of total factor productivity was low throughout this endre period of 1970-91. 2.34 Overall, this analysis suggests that the Jordan economy has been growing on the basis of extensive use of resources. As discussed in the next Chapter, the current circumstances make it unlikely that this pattern of development will continue. An increase in efficiency is essential, and this requires substant retrms in the microeconomic strucure of the county. W4 MUaw, BMW cd We# (192) cVaV 1vwahv (2993) w fow**fwJ*r de4w aweaVuwtabe. T lakg aete fo cr t e Shw s Impi ad IWet of WNdu4 cHAPrER m MACROECONOMIC CONDMflONS AND EXTERNAL DEBT MANAGEMENT 3.1 Given the key finding in Chapter II that stagnating growth in factor productivity has charcterized Jordan's economic performance in the past, this Chapter intends to examine two sets Of issues: the consistency between inral and exn objectives (growth v.s. external accounts balance) in a medium-term macroeconomic framework and the need for an effective resolution of the extemal debt problem It suggests that achieving the growth objective with the given resource constraints requires a significant increase in investment quality, and that even in the best policy reform c the scope of domestic savings is seriously limited, and the macroeconomic scenario would critically depend upon how the private sector incorporates the external debt liablity Into its consumption and investment behavior. To the extent that the Ricardian equivalent assumption holds, thereby, the public debt would be shifted ultimately onto the private sector, the private-sector- based growth stategy would stand little chance of success. lhis points to the importance of maintaining strong efforts in financial stabilization and the need for an effective resolution of the external debt problem. A. Macroeconomic Objectives Over the Medium-Term 3.2 The Economic and Social Plan (1993-1997) envisages a steady GDP growth of 6 percent p.a. with domestic inflation at an amumal rate of 4-5 percent through 1997. It aims by 1997 to further correct the structural imbalances through reduction of fiscal deficits to no more dtan 3 percen of GDP, through reductions of the ernmal debt to GDP ratio to below 100 percent and t grouh eimnation of the extal current account deficits. Furthermore, the Plan envisages reductions of unemployment to below 10 percent by 1997 as well as steady improvement of the living conditions for the poor. Thus, it gives high priority to investing public resources for provision of critical social service in primary health care and education, and it places emphasis on creatng the regulatory regime as well as the necessary public Infastructure so as to enable productive private sector investments. Within this broad fiamework, the Plan includes the following medhm-term objectives: i) Increasng exports of goids and services and maintaining remittace flows at above US$1.0 billion annually; U) maintaining domestic investment at 24-25 percent of GDP; and iii) implementing fiscal and monety policies consistent with the economic growth and stabilization objectives. B. Macroeconomic ban in the Medium-Term 3.3 A consisnt macroeoomic fmework would strike a balance between the objective of growth and the external resource constraint. This section intends to review the ital consistencies implied by the medium-term macroeconomic framework envisaged in the Plan, i.e., the extent to which shifts in resource use and improvement in resource efficiency as well as resource mobilization are needed to ensure a manageable balance between the ial and external objectives. The macroeconomic indicators shown in Table 3.1 are broadly in line with the targets envisaged in the Plan, but with some exceptions, which will be discussed below. The sequentia steps to be taken In analyzing the major elements in the macroeconomic frmework are: i) desired balance of payments position; U) levels of savings and investment as well as their composition required for the targeted growth of GDP; JORDAN: CEM 120) iii) public sector deficits consistent with the differenc (or sum) between net private sector sving and foreign savings (net import of ods and non-factor services); and iv) 6s and monetay policies reding resource use and mobilization. Table 3.1: Key acroeconomic Indicators (The Base-case Scenaro) ..... Actual ----- *- Preoim -- ....... Projecto1n . ..... 1989 1990 1992 1993 1994 1995 1996 199? GDP -rowth (X) -13.5 1.7 1.8 11.3 6.0 5.5 5.8 6.0 6.2 Domestic Inflation MX) 21.5 10.3 4.5 4.6 5.1 5.0 4.5 4.5 4.5 Current Account Balance/GDP CX) 1/ -2.3 -19.1 .17.4 -15.6 *12.5 -9.7 -8.0 -6.0 -4.0 Growth of Exports (in US S) 9.2 -4.1 6.4 7.7 -2.3 15.4 15.8 11.7 11.6 Growth of Imports (in US S) -11.7 13.9 -5.9 29.9 4.3 S.5 7.0 7.2 7.3 Investment/0P (2) 24.0 26.5 21.9 30.3 30.1 28.6 27.4 26.4 25.8 Private Investment/GOP 15.1 20.4 15.9 24.0 23.0 20.7 19.4 18.4 17.8 Public Investment/GOP 8.4 6.1 6.0 6.3 7.1 7.9 8.0 8.0 8.0 Domestic Savings/GDP 6.8 .2.7 0.1 -3.6 -2.2 0.0 2.8 4.9 7.1 Private Savings/UDP 20.7 6.5 8.1 -5.7 -2.3 -2.0 -0.6 0.9 2.4 Pubtic Savings/GDP -13.9 -9.2 -8.0 2.1 0.1 2.0 3.4 4.0 4.7 consuptwtn/UDP 2/ 93.2 102.7 99.9 103.6 102.2 100.0 97.2 95.1 92.9 Consurption Per Capita Growth -28.6 -0.9 -17.4 17.7 -0.7 0.0 0.1 0.3 0.3 Debt/GDP CZ) 179.4 209.9 211.6 166.3 160.0 149.7 140.3 129.3 119.9 Debt Service Ratio - Post-Reseh CX)/3 20.0 18.9 33.? 14.2 24.9 21.4 19.0 16.9 17.8 oebt Service Ratio - Pre-Resch (X) 40.7 38.7 36.9 32.2 30.7 32.3 31.9 29.5 25.1 Budget Deficit(-)/GDP (X) -21.0 -18.7 -17.8 -3.7 -6.2 -5.2 -4.2 -3.6 -3.0 Govermant RevegsaG/P CX) 4/ 24.3 28.1 29.0 36.1 32.7 32.0 31.9 31.5 31.3 Government Expenditures/GDP X) 45.2 46.8 46.8 39.9 38.9 37.2 36.0 35.1 34.3 Nems Item : Incremental Cap Output Ratio (ICOR) -1.9 14.8 16.0 2.1 5.5 5.5 4.9 4.6 4.3 .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 1/ Excluding transfers of workers' savings. including grants. 2/ Conaurptfon in the national sccount has been consolidated with the resource balance In the 8OP account. 3/ To Exports of Goods and Monfactor Services. 4/ Excluding grants. 3.4 BalaTh of EM 'Me Plan has set out ambidous goas in reducing debt seri ratio to below 25 pert, debt4o-GDP ratio to below 100 percent, and in elimiatng c t accon deficits. However, the Plan has not pvd ed speific policy vehicles toward chieing thes objectives. This section as well as the secdons below are intended to complemt the Plan by assessing the medium-tm bal of payments viabiliy and by highlgtg the exten unceaity srounding the Plan's objectives. Our analysis shows that eliminating current account deficks by 1997 does not seem to be plausible and debt-to GDP ratio will remain excessively large in the medium to longer tems (see param 3.16-3.26). The uncetain rem ace flows and the large extemal debt service burden are the centall balance of payments constraints. Additonal uncertaty aries f*om the level of exports, and the t inal prices of potash, fertilizer and phosphate. CH. III: MACROECONOMIC COADIONS P1) 3.5 Ihe level of remtces wl be affected by a number of factors. First, the number of Jordaians working abroad has declined; following the Guf cisis more hn 300,000 JOdna returned. Second, factors underlyig the economic prowecs in the major host countries bave been weakened by both the damage of the Gulf War, and the uncertain prospects of the oil prices in the medium term. Furthenrore, access to the regional labor market has been increasingly reticted, and real wages in the host countries under downward pressure as the job market competiion bas increased. Thus, despite the rapid surge in remittance inecome in the recen two years in response to the flexible interest and exchange rate policy stance, it is only prudent to assume the level annual remittance at about US$ 1 billion -i.e. on the average 10 percent below the high level of 1984. Table 3.1A: Scheduled Debt and Actual Service an Public & Publicly Guaranteed Long-Teot Debt 1989 1992 1989 1990 19M1 1992 Interest 425 452 473 461 Total DS Due 1,379 1,323 1.279 1,291 CZ of Exports of Goods & NFS) 58.7X 52.6X 51.5X 48.4X Interest 230 29 28C 302 Actual Debt Service Paid 446 494 564 669 CZ of Exports of Goods & *FS) 19.0X 19.71 22.71 25.1X Exports of Goodb & Mon-Factor Service 2,349 2,513 2,485 2.667 -8avernnent 180.7 231.3 247.0 285.0 Government Revenues 565.2 734.8 805.2 1150.0 DS Payments as a percent of Government R-evenAes 322 31X 31X 25X Source: Central Bank of Jordan, Vorld Bank DkS and Staff estimates 'Source: Ninistry of finance 3.6 Ihe exena debt and debt service obligations dominate Jordans medium-term prospects in two ways. The large debt stock (table 3.1) even with two Paris Club rescheduling In the fitre, will impose a large burden on the economy, and tend to discourage new investment. he large debt service obligations after the rescheduling will still be sizable. In the past four years acual debt service payments acouned for major parts in the balance of payments and fiscal accounts (see Table 3.1A above). Without more effective debt relief measures, Jordans BOP viability and growth proets can not be folly asured (see par. 3.16-3.26). 3.7 Changes in export earnings of potash, phosphates and fertizer from variatiom in the prices and volumes of exports wil be important, but not significant eugh to alte the whole picture. At US$400 million in 1992, they accounted for rougly 44 pecent of the total domestic eport of merchandize, but only 33 percent of all epots (including re-xpors), 20 percent of eors of goods and non-factor services (Appendix Table 1.8). Over the medium term, the production levels of pos, phosphates and ferlizer are expected to restore to the peak levels of 1988-9 with the rehabilitation of facilities under way. This recovery in output would also be misted by a retur to normal in the market place as the ftic sales from the CIS sources gradually exaust their stock, and prices stabilize. Increases of ouput beyond the peak levels of 1988-89 are also possible tha to the on-going investnt program, and the expected increases in demand from India. However, if phosphate, ferdlizer and potash prices fall into the lower end of the probabiitq rage (Le. drops by JORDAN: CEMP2I 15-30 percent as set by the World Bank commodity forcs), the anticipated increaes in production levds by 20 percent over 1993-97 could be lurgely offset by the decines in prices. 3.8 Wha would be the level of import reuired to support domestc Iestment, consumpdon and GDP growth within the macroeconomic famework? To address this question, demand for imports as a functon of GDP growth, changes In national Income, and in relative prices of foreign and domestically produced goods, and services has been estimated (Table 3.2). 3.9 Overail, both changes in the TABLE 3.2: ESTMATES OF MPORT ELASTICTY relative prices and in GDP show dsgficat relations to changes in Con.toU laefmslsds Capa demand for imports with elasticies 00 a a at (the weighted average ot) -0.85 602 5.6 -1.11 and 0.7 respecuively. Coeffidmt (17) (7) (1 - I g the regression stmate shows that GDP growth is Igd p n.a - 0.3 Isignficant in affecting demand for the Imported consumption goods- Reiaiv p -163 -0.2 thTs result pehaps provides validity (0.3 (OM) to the hypohess that demand for gpd 1.06 conspton goods is dominaed by pfi (0.37) the level of remittace income, the ffe of dmec iome L Inco 0.25 1.16 secondary. The esdmtes of demmd for iod itermediate Re GDP . 0.40 n. goods shows t changes in GDP p exert significant effects on demand 0.81 0.94 .80 for Imported intemedite goods in N 13 17 17 a anticipated direction: one percent p d x o A 3.1, Incras i GDP growth could result volm Ii otiis efpoa in 0.40 perceat increase in demand NOZL for medie goods, sd 29 1) )a s swefal Impu changes In the rel ive prices are 2 a be&wa - mi Wtvbt significand with the execed 3) T* how bem foor am cesw&zfs, emilo. si: one perct increase in the relative prices could result in half a percet decne in demand for imported intermedia goods. I Regrting the dmad for imported capital goods, the resuts show that ch ages in long-r income are sigficat with one percent ncrease relating to 1.2 percen Increases in demad for the imported capital goods. A woud be desiable toeswlato lioky of mbusn betno doused. itudie pods sd InVaded kerWbt CH. 111: MACROECONOMIC CONDMONS 131 3.10 Based on the estimate above, an import elasdcity with respect to GDP growth at 0.7 is applied in projecting import levels in the medium term. This level of imports reflects both the availability of import finance as well as the likely import demand arising from the expected increases in consumption, investment and output. 3.11 Investment and Grwth Assuming that the domestic savings is to be Increased from -2.2 percent of GDP in 1993 to 7.1 percent in 1997, foreign savings is available and per capita consumption is to increase moderately, the domestic investment could then reach 26-29 percent of GDP (table 3.1). This is much higher than the average investment of 24-25 percent envisaged in the Plan. Should the lower investment levels be chosen, stronger and more specific efficiency-increasing and market-friendly policies than those articulated in the Plan are needed to facilitate: i) a shift in investment composition in favor of the private sector, especially the necessay increase in equipment investment in the sectors producing the tradable and exportable goods; ii) a resolution of the external debt problem (to be discussed later in this Chapter); and iii) an enabling financial market for high capit mobility and increased foreign direct investment (to be discussed in Chapter VI). 3.12 DoXmestic Saving. The increase in domestic savings anticipated in the medium-term framework will Tabke 3.3- Invesaemn Iawesat be challenging. Public sector savings could be increased E gney, d Grow. to the required 4.7 percent of GDP in 1997 if Government consumption is reduced sharply and EfCinY Of IMNvOWW revenues maintained at 31.3 percent (table 3.1). The X- oo 5 atcipated switch from fiscal mechanisms taxing savings (% of GDP) 3 4 5 (such as the inflation tax, see Chapter II, para. 2.11- 2.18) to consumption taxes (such as the VAT-oriented generalsales tax) would help in generating private 25 p=rew 6% 5% S% savings. The lack of a tax system aimed at boosting 30 perc 10% 8% 1iA private savings remains a weak link in the medium term 35 perces its 9% 7% framework, and points to the importance of speedy fiscal rorms. Also, it is essential to attract capital flows sOWvW wcdda..kw*fekdat from abroad, which requires improving the country's creditworthiness. Finally, the lack of these fiscal instruments also highlights the need for resource mobilization through sales of public sector assets (Chapter V), and the urgenicy of improving financial intermediation to encourage financial savings (Chapters V}-IX). 3.13 Fiseal Policies. The principal objective of fiscal policies is to maintain stable finaci conditions. Toward this end, Government has set out as its goal in reducing fiscal deficits to 3.0 percent of GDP by 1997, and maintaining the growth of the broad money supply in line with the fiscal objective and the real sector growth target. 3.14 Government expenditures are expected to decline from 39 percent of GDP to 34.3 percent In 1997. This decline would require containment of the wage bil spending, and reductions of recurent expenditures. In addition, the criteria to approve public investments would be made more selectve to improve their quality. The need for fiscal transfers and subsidies should be reduced through the privatization of public sector enterprises. Finally, with the peace in the region, there will be greater scope for further conaining military expenditures. On the other hand, expenditures aimed at basic JORDAN: CEM M4 social services In health and education would have to be protcted. Sable 3.4: Sources of Fauta Savings 3.15 On the revenue side, the main policy (% o 0DP) thrust would be to maintain their volume at i193 1994 199S 1996 1997 about 31 percent of GDP during the medium 9(Au Pc4wftd - term. Ihis is a serious chaltenge, both because the elasticity of fiscal revenm st Exwr 323 28.6 24.6 21.S 18.7 GDP growth Is less than one, and because PdEte -23 -2.0 *0.6 0.9 24 import tariffs should be used primarily as an PblIc 0.1 2.0 3. 4.0 4.7 instrument for trade and industrial policies s5mw Dourvaie TW. 3.1 rather than for fiscal reasons. Thus, it is all the more importat that an effective general sales tax (GS¶) be adopted, and gradually transformed into a full-fledged value added tax. With a widened tax base, tax compliance and the GDP growth elasticity of fiscal revenues would be improved. More importantly, the tax reforms would shift the burden of taxation from savings and investment to consumption, helping in boosting private savings and investment. Ihe tax reform would also make the tax system consistent with a more liberal tariff regime. Finally, as discussed in Chapter V, the sale of the public sector's investment portfolio (including physical fixed assets) would not only facilitate the operation of a more active capital market, but would also provide for an important source of cash income to the Government. 3.16 Montar Poli. Regarding the medium term monetary policy, its objectives would be to: i) maintain domestic currency and price stability; ii) maintain a level of credit expansion consistent with the objective of fcilitating growth while keeping macroeconomic stability; and iii) facilitate structural reforms in the financial system to improve financial intermediation. Thus, monetry and interest rate policies should be guided by the objective of maintaining the rate of inflation at a low level and attng capital inflows. Accordingly, the broad money supply and the credit to the private sector should rise moderately in 1993-1997, in line with the projected growth of real economic activity. Market competition should be encouraged in the credit market (Chapter VI) and domestic deposit rates should be competitive with the internional deposit rates. In additon, more indirect measures need to be put in place to manage the pace of credit expansion, including an acdve bond market and the open market operations. 3. Macro.otT Bhances Ihe Jordanian economy suffers from external and intemal imbalance. As regards the extenal inbalance Jordan has run current account deficits for many years. Jordan's internal imbalance is reflected in high unemployment. While the recent growth performance is impressive, it is, however, pardy triggered by the huge inflow of expatriates and the associated increase in consumption and housing demand. Besides this, high growth often goes hand in hand with large trade deficits. Figure 9 in Annex m. 1 to this report shows the combinations of growth and trade deficits experienced In the past. This relationship, estimted by simple regression, shows the trade-off between trade deficits and growh In Jordan. Jordan has accumulated an enormous debt burden due to its past resort to external borrowing to finance its trade deficits. 3.17 The high debt service burden and the persistent trade deficits lead to excess demand for foreign currency which can only be satisfied through private inflows of capital, Government CH. II: MACROECONOMIC CONDITIONS P5J borrowing and debt relief. In view of the massive foreign debt, and the uncertain capital inflows, this process can, however, not be sustained for very long. Hence, there is an urgent need for achieving external balance, and this is also recognized in the medium-term framework. Ilght management of the aggregate demand including restrictive fiscal policies is clearly one policy measure that can help restore external balance, but this is likely to aggravate the internal imbalance problems in the short-to- medium term insofar as unemployment will rise. A full discussion on this issue is provided in Annex m.1 to this report. 3.18 Concluding Reanrks. In the past decades, the Jordanian economy has grown on the basis of large trade deficits, largely financed with remittances, international grants and externa borrowing. Even if remittances have been high in the most recent past, their sustainability Is in doubt, external aid is expected to decline, and Jordan's external debt has grown to unsustainable levels. In consequence, the maintenance of high rates of growth requires a fundamental change in the country's strategy. The new strategy should aim at three main objectives: * Reducing the country's ICOR through Improvements in the efficiency of investment, thus reducing the volumes of savings and imports required to reach any given rate of real growth; - Increasing the rate of savings to reduce the dependence on foreign savings for the financing of investment; and at • Attracting private capital to subsdtute for the declining official grants. All these objecdves are related to improving the microeconomic efficiency of the country, the subject of the remaining Chapts of this Memorandum. Success in the microeconomic reform of the country would allow Jordan to both accelerate its rate of growth and maintain a stable macroeconomic environment The attainement of these objectives, however, will be affected by the management of the external debt. C. Managng Extenal Debt 3.19 Externai debt, especially that which is public and publicly guaranteed, is a dominant factor in managing growth and macro-economic stability. We intend to address two issues in this connection: Q) what is the size and structure of Jordan's external debt? and (ii) can Jordan 'grow out of its debt problem' through successive Paris Club rescheduling accompanied by concessional fnancing? 3.20 The most important finding is that successive rescheduling (in conjunction with the new concessional financing) will, as expected, lead to up-front cash flow relief in debt serce payment for Jordan, but debt service obligations wil sharply increase in the medium term, and debt stock will continue to rise. Unless effectively dealt with, the increased indebtedness and debt overhang can seriousiy erode lordan's growth prospect in the medium term. Hence, the general conclusion that Jordan can grow out of debt is subject to a set of very restrictive assumptions, and that the debt problem needs to be viewed from a rmuch '.onger-term perspective than the Plan has provided. Annex M.2 provides ddas on &b. Senea! implillons of Jokd. now Loadon Clbb abnd debt seduco ah ith its commercial bak cndoe nd lb official batead debt re_nc ass examined ia his cb. D of thc zoachduhg acouics on offcial bia debt usIng t Wodd Dak De& SgWy Meo are provided i Append MLI. JORDAN: CEM 126 Size and Structu of Extenl Debt 3.21 Jordan owed a tota of US$7.98 billion to its external creditors as of end-1992.3 Ihe stock of public and publicly guaranteed external debt outstnding and disbursed as of end-1992 was about US$6.9 billion, about 63 percent of which was owed to official creditors (bilateral and mnutilatera). Official bilateral loans that are under the Paris Club umbrella amount to about US$3 billion, of which US$1.9 billion is pre-cut off date debt. France, Germany, Japan and the United States together accouwted for about two-thirds of Jordan's debt outstanding and disbursed from official bilateral creditors as of end-1992. Less than half (i.e. 42 percent) of Jordan's long-term public and publicly guarneed debt outstanding and disbursed was on concessional terms and 34 percent consisted of vaiable inrest rate loans at end-1992. Debt that was originally short term amounted to about US$951 million, and US$112 million in IM credit was used as of end-1992 (World Bank, DRSr. Among the private creditors, commercial bank debt outstanding and disbursed at end-1992 was about US$1.5 billion (although as of June 30, 1993 the stock of commercial bank debt has been reduced by about US$390 million through buybacks). 3.22 In the last three years, the terms at which Jordan has received external financing have not improved. Most dramatic has been the sharp increase in the average interest rate on new borrowings by Jordanian entities. This has occurred at a time when international interest rates have been on the decline. As shown In Table 3.5 the average maturity and grace period of new commitments Las decreased between 1991 and 1992. The grant element has also decreased, indicating declining concessionality in newly contracted external loans during this period. Figure 3.1: Total Extenal Debt Stock (as of end-1992) 14% 11 libmo '11 e 11$ _ o hr$ PO t. LT (l/SST .9 aM0 asdc f .os 1992) * SoM So Odebtor Reposin syste Table 3.5 Average Terms of New Commitments, 1989-92 1989 1990 1991 1992 AU Crdio intled S9 4.6 2.0 4.8 Muity (Yea) 18.6 19.8 27.2 18.8 ace Period (Yeaw) SA 6.5 8.8 6A Gruat Mmnt (,roent) 28.2 383 63.6 3.4 Souwsm: World Bak, Worfd Debt Tabs 1993-94. Sron WoU Bok, WD MU TaMe 1993, Volm 2 pp. 222.25. No am dba Wurino have been conated ia 1992. CH. Ilt: ACROECONOMIC CONDMONS 2) 3.23 Jordan's tot external debt wa equvent to 179 pcet of GNP and 223 percent of exports of goods and services In end-I992. (World Bank, DRS data). As shown in Table 3.6, this is weU In excess of the comparable ratios for oth counies with market access, includiAg some of tose in the region. The stock of debt outing and disbursed as a ratio of GNP In 1992 was much higher t the average for the sevrely Indebted middle income counties, In which t belongs. Joda's debt service burden In 1992 was less severe compared with other counties in is category, but that is a deceptive figure glven that the debt service payments on its stock of debt have been pushed forward into the fuitre due to debt rescheduling that the Governent has achieved with its extea creditors. Table S.6 Debt Service Ratios of Selected-Countries. t992 Total DMt to TM Ot to Debt SMi later Coqunta7/orup ONP Ratio bo Ratio to Rapb Paywmt to - ~~Ratio expea Ratio 'evemew l on;= 46 21 31 12 Kw& ANitasl & doMiddle lt 64 216 28 10 Ake&a 61 204 72 17 AWein 30 454 3S 19 Mexco 35 243 44 16 Movooo 78 lA8. OA. 21. TuIaia 56 12S 20 7 Turky 51 193 32 13 Jordan 179 223 20 9 Sm: Wode Duk, Wod Debt Tabl 199394. FIgu 3.2: Jordan's Offidal Bilateral Creditors (as of end-1992) uA (1os) U. (7) GmuuY (4%9M _GS)i )~~~~1% SWoe: W8 . ORS. T*WUdi blWIiddi da * blUes (as of md.W1 ) Debt Service Oblogatons 3.24 Jordan' debt service burden Inceased significanty in 1989 and ares on debt sevice payments began to accumrulate thereafter (Appendix Table M.9-11). The scheduled debt service payments on Jordn's public and publicly gaant long-tem debt was high (about 50 percen of I JORDAN. CEM j8 portS Of goods and nn-facor servic on avge for 1989-92) ad, the Governmen made every defort to devote a larger and larger s of it eport eaWnings towards meetig its debt senice obligaions. Actu debt seice payments incrased fom 19 percen of goods and non-fctor services in 1989 to about 25 perent in 1992, yet the a aton of arroars could not be preventd, given the _rc_usa beig ficed by the Jordanian tories at the time. It is the recen surge in pivae capital Iflow (C 1992) ta enabled the Governmt to deal wih its overall enal debt burden and accumled arrs In a comprehenive and orderly manner; the Jordanian authorities have achieved debt buybacs, and are seeklig debt and debt service reductions from externa creditors. lue 3.3: External Debt of Parastatab (as of end-M992) RO Akl Jar. PapItx.w Co. (9%) aiO(02%) (4%) ~PP D.bOuladlmgk & MOburud aUS"1 bifin) So" omwrRapwgSm Etrnal Debt of the Parastatal Sector 3.25 At end-1992, the pa had an exernal deft outsUmding and disbursed of about US$0.98 bilin, of which thre patals acouned for 84 percent of borrowing from abroad (Figure 3.3). Duig the nex three year8 (1993-95) an amnual aveqge of US$168 million, is shedud to be paid by the Pen erpres. Therear, US$136 million is due in 1996 and an average of US$100 million for the remaining years unti the year 2000. When translated into local acrrency, the paral eprises WI bawe to pay the Governmet about JD 90 million per year5, on average, as debt service for their extnl obligations Q.e. on exten borrowing by the Government and Jordan ti8 onlent o paratas as weU as direct borrowing by these enterprises with sovereign guarate) beween 1993-2000, which aumcally are the contngn liability of the GovernmenL This amount is equivalent to 7 percent of ttie central Goverment revenue in 1992. Bzdzae ml. MD 06X.690 - I US. CH. HII: MACROECONOMIC CONDHTONS P91 Growing Out of its Debt Burden: Is i Viable? 3.26 On the basis of its outstding stock and commtted disbuements of public and publicly guaranteed extemal debt as of December 31, 1992, Jordan Is scheduled to pay about US$910 million, on average, in debt service payments during the period 1993-95 to US$618 million, on average, between 1996-2000. 3.27 Given the current stucture of Jordan's extal debt and its scheduled debt service profile, the attainment of long term balance of payments viability should be directed towards achieving manageable debt service levels In the near term and to ensure contnued availability of external financing (from both official and private sources) in order to fAlfill its extera fincing needs in accordance with the macroeconomic goals. Tis requires a strategy aimed at addressing each category of debt through sequencing of creditor negotiations, and through innovative approaches to DDSRs with a view to regaining access to foreign fiancing. In the following, the treatment of Jordan's official and private debt is examined in line with this strategy which would lead to the long- term BOP viability. For purely illustrative purposes, the debt service implications under alternative scenarios for dealing with Jordan's exal debt burden was examined in order to ascertain whether Jordan can "grow out of its external debt burden" in the foreseeable future. Box 3.1 provides a ummary of the assumptions on the terms of debt relief in the rescheduling scenarios for official bilateral debt Details on the possibilities for dealing with Jordan's official bilateral debt and the Implications of the recent London Club Agreement are provided in Annex m.2. Su 3.1: Amm __ian do Ten of DetA Ins the Ira*oeshdulieng mmmd of Jordan's officia bilateal debt, it is -aned that th Pads Club cred would 4a to reschedule agl ner and pbnpa faiMg due n lt pm-coff daft deb durlog Xh consoUdaon paW beginaI8 July 1, 1993, and 100% of pncp arra and 50% .f Its aramuaId as ifend- h 1993. Mm conoldation pedod b eand to _ Xoinciwh d dration of saother 1 8-nu IMP StuOgy Tbwem _ 1mwwi Pu Club! 4Ve deft i esheduled to ae a aturity of 14 yeas and lree mols and a Sgr perd of 7 yem and 9 monds, at maret . Blob. Offlca De dlopnt Au_o. (ODA) would be eschduled to 20 yar mAuriy wih 10.5 yeat otgo at a fixed concesslodl inte ate of 3 pnea per_ am. Othe eligb debs tha ar owed to non-Pads Club officia blal crdim resdued underh a te aens a te Pais Clb clis an tho smupton ofth indCuon ofa comrbl teatmam cla us by th Pai Club, as was the case foypt ad Poland, among odte. The is a conservative posIon on th ratol dia, given th precden tha bas arady bean aorded ito Jordon, ai sbeqt Poris Club debt retuctu mus be on ter at eat as favoabl the previo rsch ing. In h d sImulaton a socssivero rechduing for a ssequen 18iotAh consoldation p-o und tem term wa assumed. Detas of te resul f these det teschdul scenas ar prvided In th AppeX dx vom to report 3.28 The simulation results indicate that the rescheduling of Jordan's official bilateral debt for another 18-month consolidation period (See Scenario I in Appendix A) on the same terms as the 1992 Paris Club rescheduling, along with assumed new borrowing and gap fil loans, provides Jordan with 1995 substntial cash-flow relief during the next two years (.e. a total of US$475 million during 1993-1994). Ihereafter, the debt service payments become higher than before this rescheduling of Jordans official bilatera claims as interest payments on the rescheduled debt fll due. Payments incease fiurther after the year 2002 as the principal payments on the resheduled debt fall due.' -1-Tandoi n dlub Agemn. JORDAN: CEM PO] When tis rescheduling Is followed by another such rescheduling of offcial bilatal debt (See Scenario I in Annex 1.2), there is significant cash flow relief during the first five years (about US$475 milion between 1993-1997). Once again, however, Jordan's debt service burden wil Increase thereafter when the payments on the rescheduled principal and interest fals due. Figure 3.4 provides a comparison of the two rescheduling scenarios in both the base case and high case.' Jlgre 3.4: Cash flow Effects of Rescedug Scenarios for OfMidal Bilateda Debt 40 yewr ~~~RI II Teabed. 11 dsmsagb SHimsse. O Rd *AW - C 3?. AwVa* . _ TodiwaIiOOP 1607 141. 131.0 121 110.6 102. S5 WA6 44 71 T1 3iW,DOsW3P of GNPS 20* 25. 20 210. 196.2 1842 171.7 122 151.1 141. DdoSuu.Eputo1GNP 307 323 311 20. 2L. 20. 16.0 143 14* as AbR,h*Ag-8.4WCAS TddW SICIO.WUDP 160.0 1497 1403 12. 110* ll3 105.0 100. 08 01 Told uvI Dd*lbt of GNFS 26. 25. 2498 20 21G 199.1 16U 16 174.7 161 DN 8SfW- Of tGNafS 241 21.4 19.0 16.0 17* lea 16.s 141 t144 3. AlbrRe_s*W-MIGHCA*6 TOieSutOOdP 160 149.7 140.3 1s 111.7 on 8S9 80.7 72.4 6SU T7d M 5bruOsWJE5of 0NFS 26* 215 249.8 2212 1952 1732 133. 13SD 12.1 113S eW8W*O6qel GNF S 24J 21.4 19 162 16.4 16u 13.9 11.2 10.7 08 It biftde ;We of 1-95 Landm ,kib. nli IM WM Su*1s in_ 1 fIe baae entl farmwb* gp d about US$ 260 pA. daft 1M-2002 to be losd on db asswado t sfiniuW wauld be avaable on do fowg tes: 25 paeet biaad Vants; 25 pesent biaer eonceuA loan; 25 penmat biated n i , ~ anouloan ad 25 peet commrcW ban loans; hi4gh cm does no mug a" a gqeJJwlanchg. CH. HII: MACROECONOMIC CONDMONS 1311 3.29 In summary, Jordan can grow out of debt rests on the macroeconomic scenaio with four main underpimnng conditions: O) projeed increaes in exports of goods and non-factor services will materialize; (ii) the current surge in economic activities will be sustained by a strong rewovery of private inestment in the productive sectors; (iii) fte level of remittances will stabilize at above USS 1.0 billion amnually; and (iv) a sound macroeconomic enviroment will be maintined. 'he fhrst two conditions depend on the extent which public debt and debt services are incorporated in private investment and consumption behavior, thus, furiher reductions of the external debt overhang may be needed Cm conjunction with the new concessional financing), and the last presumption contains srius uncertainty. In short, successive rescheduling could provide Jordan the cash payment relief up front, but will not be nearly enough to alleviate the adverse consequences of debt overhang on growth and investment. Hence, the immediate actions for prudent external debt management would require that given the need for more debt relief and the reluctance of creditors to set new precedents, the Govermnent should strengthen the bilateral dialogues with an obvious focus on the military debt- against the backdrop of the regional peace process; and the Government may opt for the maximum use of debt swap mechanisms achieving debt relief on both ends of the contract. F X,.. rBak gaff esdow- as do bt for wa is about . WbI or S o. of ebW t as of eNd 19. CIIAPER IV: TRADE INCENTIVE REGIM 4.1 The Government undertook a number of policy changes to rationalize the trade regime during 1989-1992. in this respect, import restricdom and bans were reduced, price controls which had been imposed on a large number of items (eond the essentia consumption goods) were lifted. Direct controls over agicultural production have been removed and subsidies on food production and consumption reduced. ITese reforms have improved the trade regime and entailed increases in domestic export and investment. Jordan's international tade has been caracterized by a number of prominent features. Fir, imports have been about three times larger than exports, have been growing faster than exports in the last five years, and, as a result, the merchandise trade deficit has increased. Second, exports are domined by phosphates, potash and fertilizers, and exports to EC and other industrialized counties are minimal, thus export rivalry in the major third market is insignificant. Third, the large merchandise trade deficits have been offset by remitances, official grans, inoome from non factor services, and recourse to external borrowing. Fourth, imports are widely sourced, but dominated by fooduffs, Inputs for the manuf sectors, and other consumption goods (Appendix tables IV.1, IV.8, and TV. 10). Furthermore its past restrictive trade policies have contributed to the low growth of factor productivity, and prevented the realization of 'scale efficiency' (Chapter 1). 4.2 The Economic and Social Development Plan (1993-1997) has well recognized these structua problems. It has therefore set out *pursuing export-led growth and developing a highly competitive export sector' as its main objectives. The Plan has highlighted a number of principles which should guide policy measures toward those objectives. These principles include: i) increasing inte and exterwal market competition; ii) reducing excessive domestic protection; iii) preventing monopolies; iv) amending the customs tariff structure to remove bias against exports; v) reassessing the efficiency of bilateral tade agreement and protocols in promoting exports; ad vi) improving export incentives, and export support services including adequate export finance. The pecific policy measures envisaged in the Plan include: i) streamlining import and export licensing procedure; ii) reducing tax burden on companies especially nongovernmental thtrough expansion of export and investment exemptions; iii) speeding up duty draw-back at fixed rates; iv) adopting a flexible customs tariff system which allows for the revision of tariff rat according to a fixed critea; and v) gradually iroducing wherever feasible or practical, book auditing to replace on the sport auditing. 4.3 Most of these measures are sensible. But taken together, they are far from sufficient in addressing the structural problems. As shown in ftis chapter, a set of far reaching trade policy reforms (summrized in Table 4.14) is urgentiy needed to strengten the export competitiveness, improve the export support services, level the playing field for market competition, and pursue the outward-oriented growth strategy outlined in the Plan. A. QUANTITATIVE RESrRICTIONS, PRICE CONROLS AND SUBSIDIES 4.4 OutrigTt Probibitions. lhere are outright probhbitions on five major commodities, i.e., the Mimistry of Industry and Trade (M) will not issue an import license for these commodities: Cl) tomato paste; (ii) fresh milk, (iii) certain dairy products; (iv) mineral water; and (v) table salt. The JORDANN: CEM 1331 stated objective of the ban Is to protect local industry. Imports of all of these commodities are banned as a result of Cabinet decisions. Some of these products ar sensitive. Tomatoes, for example, are an important crop in the Jordan Valley and the production of tomato paste is an important outlet for fesh tomatoes. 4.5 Permission-Licensing, Ihere are "permission' licensing requirements on five major categories of goods: (i) fruits and vegetables; (ii) certain chemicals; (iii) medicines; (Iv) many foodstuffs; and (v) telecommunication equipment. In addition to these five categories, there are other numerically less important restrictions as shown in Table 4.1 and 4.2. All of these restrictions are based on legislatiom. 4.6 There is a defacto ban on the imports of al fresh fruits and vegetables as authority is required from the Ministry or Agriculture (MOA) prior to MiT issuing a license. MOA determines on a monthly basis which commodities can be imported from which countries and MfT will only issue a "permission" if the commodity to be imported is on thWs list. The mnmber of commodities on the list is quite restrictive. For example, the July 1992 list contained four commodities (sage, cherries, mango, and apricot) from four countries (Lebanon, Sudan, India, and Mall). The stated purpose of these import restrictions is to protect domestic producers of fresh fruits and vegetables. 4.7 There are some 220 chemicals which require the upennission' of the Directorate of General Secrity of the Ministry of the Interior (MI) before they can be imported. An importer applies to the MIT for a license and then must obtain a letter from the Directorate of General Security before an import license will be issued. Prior to obtaning a license from MIT to Import medicines, an importer must fist obtain a letter from the Ministry of Health (MOH). Thls policy was put in place out of the concern that Jordan could become the recipient of dated medicines and drugs. 4.8 'There are 66 foodstuffs that require permission from the Ministry of Supply (MOS) before an Import license can be issued by MIT. These commodities include a large proportion of basic food iems such as white cheese, barley, animal feedstuffs, meat, fish, butter, fresh juice, beans, cows and sheep. *Permissionsu are granted automatically by the MOS. All telecommunication equipment such as telephones, facsimile machines, telexes, etc., require the prior approval of the Ministry of Telecommunications (MOI) before MIT will issue an import license. 4.9 Certain companies, most of which have some public sector ownrship, are not required to get import licenses. The list of companies enjoying such privileges includes 10 companies such as the Jordan Potash Company, the Jordan Phosphate Company, the Jordan Petroleum Company, and the Jordan Vegetable Oils Factories. 4.10 Specia import licensing requirements are needed to import commodities from 359 of the 2,360 BTN codes in the Jordanian tariff schedule. Of these 359 BTN codes, 312 (87%) were cotitrolled by the Minis"y of Agriculture and the Ministry of Supply. Special Import licensing requirements covered a total of 783 million JI) in 1992 or 35 percent of total imports in that year. CHI. IV: TRADE INCENTiVE 4M 4.11 Table 4.1 descrbes the import licensing system as it existed in July 1993. TABU 4.1: IMPORT RESTRICTIONS AND Table 4.2 shows the scope of the import "PERMISSION LICENSING restrictions. Ministry of Supply and the Oil refinery together accounted for 23.1 percent Tarff Goup lipoit Monopoly " of total imports into the country and the Ban LWesing overall share of imports under the import 0 1 98 restrictions was 35.S%. While most Mining 0 0 5 importers may get the import licensing F*.ff 4 7 170 routinely, the extet of potential interference Beverages 1 0 4 is not insignificant. More importantly, the Tobacco 0 1 1 average import weighted tariff for all goods Textile & Leather 0 0 3 is estimated to be 25% (Table 4.3), and the Ondustrni 0 0 25 Other Chemicals 0 0 15 same average for goods under various types oi Reinery 0 0 0 of import restrictions is only 13% Crable Wood & Cork 0 0 1 4.2) -the difference seems to be more than Electronic Machney 0 4 random distribution suggesting that the Scientific Machinery 0 0 2 restrictions probably have significantly Non-Electic Macbinery 0 0 5 dfected the demand for imports.' Finally, Ote Manuacturing 0 0 13 obtaining a license required the importer to Total 5 18 336 visit MOS each time they needed a license. This required the use of time and resources sm of SW*. mhIuy of Plan sd sbby of Fine - . ~~~~~~~~~Usqg Wall Bank SNINA deA Wmef WMR and io od Lftw 1-2-3 on the part of the private sector and the oddosame daa. rGovernent. 4.12 Government Monopoly. The Government, through the MOS, has a monopoly on the import and iMitia distibution of the following nine commodities: sugar, wheat, flour, rice, dried milk, cigarettes, frozen chicken, lentis and olive oil. Requests for Tender are published, importers quote, one is selected, MOS opens a letter of credit, and the importer, acting as an agent for the MOS, facilitates the import of the commodity. The commodity is owned by the Government and there is a significant portion of consumer subsidy included in the price at which sugar, wheat, rice, and powdered milk is sold to the public. The total subsidy on these four products was 57.5 million JD in 1992 (this is no longer the case in 1994). This represented 4.2 percent of total central Govermnent expendiures and 1.6 percent of GDP in 1992 (See Appendix Table IV.13). - The Govenm is in Ohm proes of devlopi a n imposg systm. a In d&ct do nw , y whc has ala boe approed by MOS and a Cabbit Comm , wsould replace curet syem of individual cses to Impor specified amount of aS oifodwhasystmofegisterdtd Teetade,ofwhmovlle0 aladygserd, wihahautri to iwpwtwithout a Ecense fom M?r. l tho ca of commodities ta culy requr the prior aval of the MOA, MOIL Ml, MOT or MOS, the inper wm sti rq tf thort ro to beig A to mpwot he comodit. JORDAN: CM 135) 4.13 The overall subsidy for sugar, rice and powdered milk bas been small in recent years in comparison with the wheat subsidy. But the subsidy on the individutl unit of these three commodides is high for rice and powdered milk. For example, rice was purchased at 226.1 ID per tonne in 1992 and resold at 145 JD per tonne. A simBiarly large subsidy existed for powdered milk, whereas no subsidy existed for sugar in 1992. Removing the Government monopoly would result in a large increase in the price of both rice and powdered mUk. The Goverment's import monopoly on cigarettes, frozen chicken, lentils, olive oil, apples, potao, onions and garlic were put in place to protect local manufacturers. However, as indiced in paragraph 4.12, the Government sets prices at below import costs for wheat, rice, sugar and dried milk which resulted in subsidized prices significantly below the market clearing prices. 4.14 Pricing Po}icy. The MOS sets prices for nine commodities that are imported by the private sector (see Appendix Table IV.17). There are nine commodities that are direcdy imported by MOS. For the most part, the Government charges or allows commercial mak-ups. 4.15 The Govenment sets distribution marins for TABLE 4.2: ANALYSiS OF IMPORT RESTCTIONS IN 1993 nineteen consumer goods produced in Jordan.2 The MM" Nabe qV Ihpo,t a feew 1v_ Amw Avet methodology for calculating CMati (a JD) Iwoet V_t wee WV u d theretail price is to A 129 71.4 3.2 133 24.1 determine the cost of sUp14 IS8 2273 103 12.0 28. production from field MOS or MOA 16 30.8 1.4 I.9 17.8 surveys and then allow a 17 1 l6h 9 64.1 3.0 11.? 146 Interior 16 4.4 0.2 10.1 36.1 percent margin for Telecoaa. 4 1.1 0.1 95.1 70. performing the normal NM Resouc 2 0 0 27.7 0 marketg fumctions of atY I 0 0 3S.2 35.2 distribution storage, ~ Cunoms 1 1.2 0.1 95.2 95.2 distribution, storage, at Subtol 336 4013 18.2 14.4 26.9 finanmcing. hese controls oi ReSi.y 9 282.6 12.8 11.2 24.1 cover a sgniflcant portion monopoly MOS 9 g8. 4.5 11.8 22.4 of the goods produced in Monpoly Cowp1e Ba 5 0.12 0 74.4 55.2 Jordm he pne coafl i ubtotal 23 381.5 173 12.6 263 Jordan The price control is only on the distrbution TOal 359 782.8 35.5 13.4 26.5 margin but ia bly v -. a t of MNW codeem involves calculating costs of t w*wa bY btYe production because the 17 S M MyMfSSIY .efeft Dw1tdU fWMM*Sl percen has to be 17 percent o. ot ad Imf Low 144 mdel wngtS umm dad. of some base. Calculaing Xt base is often a source of friction between 2V- Soft ddrk, natue 3uces, wb o, maraine, wab powden sd detorg, chickm e, bad nd cale, sho books, vs&Uasketi sal omao paste, clsaarsts dairy products oUl refine prodct, school loe and unifosins bakbn powder, drie powdpi zd di p,- CHi. IV: TRADE iNCENT7VE 136 manufacturer and Goverment officials. In addition, a committee of Govenment officials, including officials from MOA, MOS and MIT, determine market prices in the Amman Central Market for Agricultural Products and use them to set retail prices for these products for the following day. Pries are published dafly in the newspaper. It was alleged that these price controls were easily and rely evaded. 4.16 How important can these price controls be in affecting the effective rates of protection? While data availability does not permit precise esmate, it is clear from a deductive point of view, that the bias resulting from price controls in conjunction with the subsidies is to reduce the domestic prices of the consumption goods from unimpeded market clearing rates. While the Government intervendon is centered on setting distibution margins only, the scope of influence is not insignificant. Appendix Table IV. 17 shows the value of imports under the price control Is at least 7 percent of domestic consumption in 1992, and the value of domestically produced goods is (see footnote 3) estimated at approximately 4.5 percent of domestic consumption. In addition, several studies have indicated that the abovedescnbed Government intervention is very bureaucratic, thwart with problems and delays, results in considerable friction between the Goverment and the private sector, and generally takes up a lot of time on the part of the Government and the private sector. B. TAREFF REGIM 4.17 The tariff sucture figures prominently in any analysis of the trade regime. Import tariffs serve three important functions for the Government. as instruments to implement industrial policies, typically via encouaging import substutng industries; as fiscal tools to raise Government revenues; and simultaneously to influence consumption and savings behavior as well. 4.18 Table 4.3 shows the distnbution of nominal tariff and surchage rates in 1987 and 1992. Out of a total of 2,461 products in the Jordanian tariff schedule in 1987, 798 products (32.0%) had combined tariff and surcharge rates of less than 10.1 percent and accounted for 40 percent of all Imports, 262 products (10.6%) had rates between 40.1 percent and 50.0 percent and accounted for 13 percent of all products, and 424 (17.2%) had rates in excess of 50.0 percent and accunted for 22 percent of all imports. The import weighted averge value of tariffs in 1987 was 34.4 percent. Table 4.3 also shows the new tariff structure and surchages as it exists now.' Out of a total of 2,360 products in the tariff schedule, 5 products (0.2%) had tariffs less than 5.1 percent and accounted for 3 percent of all imports, 788 products (33.5%) had tariffs between 5.1 percent and 10.0 percent and accounted for 33 percent of all imports, 310 products (13.2%) had rates between 40.1 percent and 50.0 percen and accounted for 5 percent of all imports, and 506 products (21.5%) had rates in excess of 50.1 percen and accounted for 17 percent of all imports. lb= has been no usjotC cai m ig. JORDAN: CEM 137) 4.19 'Me principal purpose of the tariff reform of 1989 was to inrease the level of the lowest tariffs nd to decrease the level of the highest tarlffs and reduce the disrimination implied by a more differentated structure, and produce a more uniform tariff regime while at the same time ensuring revemne neutalty. Ihe reform has been successful in several respects. 4.20 'Me import weighted average tari rate was reduced from 34.4 percent In 1987 to 25 percen in 1992. The taM coefficient of variation has been reduced from 167 In 1987 to 88.5 in 1992, thus the degree of tariff discrimination witin each sector and product group has been reduced. The tariff frequency rates have been simplified to multiples of 5 percentage point The import weighted average tariff rate for the groups falling between 5.1 - 10.0 has slightly increased, and the weighted average tariff rate for the groups above 50 percent has been reduced significantly from 86 percent to 72 percent. The tariff restructuring was accompanied by increases In tariff revenues. However, notwithding these gains, the number of products with tariff rates over 50 percent reased from 424 (17.2 percent) in TABLE 43: DIRDUTON OF NOMNAL TARF AND SURCHARGE RATSM 197 AD 19 1987 tD 506 (21.5 percent) in 1992. Yet, Taiff& Suth. Numba of Penage of i1mph WeIghd Coescien Shen of as epectd when high Range PrPducu Total Avage4 Aveap Vatiat M t ted to be prohibive, the share of mi98 tot importU in is 0.0-5.0 120 4.S 3.0 3.1 26.6 15.7 range fll from 22.2 5.1 10.0 678 27.5 7.2 7.2 0.1 24.4 percen in 1987 to 16.6 10.1-20.0 49 2.0 18.1 17.8 10.9 43 et Im 1992. 20.1 - 30.0 266 10.8 2S.4 2S.0 7.8 73 30.1- 40.0 662 26.9 33.8 34X 6.4 13.0 4.21 Tale 4. 40.1-50.1 262 10.6 44.7 45.6 5.9 13.1 4 >50.0 424 172 83.1 85.8 6SA 222 shows the combined TOrAL 2461 100.0 192 34.4 166.9 100.0 taiff plus surc ge for 19 1987 and 1992. The data show ta the 0.0 4.5 5 0.2 .2 0.2 0.0 2.8 combined taiff and 5.1-10.0 788 33.S 7.6 7.5 25.7 32.6 surge ane ube 10.1 -20.0 6 03 103 103 83 18.9 qu 20.1- 30.0 164 7.0 23.9 23.0 8.4 13.8 similar betwee 1987 30.1 -40.0 571 243 33.9 33.0 6. 10.0 and 1992 for the fiur 30.1- 40.0 S71 243 33.9 33.0 6.5 10.0 lowest ranges. The big 40.1 - 50.0 310 13.2 41.S 41.6 53 S.4 >50.0 56 21.5 68.8 71.6 59.2 16.6 bet TJrAL 2360 100.0 33.0 25.0 88.5 100.0 two years shows up in the 40.3 - 50.2 I Defined at dtehods levdl f 1b Busels T1f Nomm (I) codes. percntg ragean 2 Weg ed by impot vaupeneges. 3. Stadar devato divided byd axn_ 4. Simptb ave_ges 1992 a bad an te datm provided by the Gove a in Apil 1993. Soe: BPd an dat prvided by Cuaom D _erm Deatmet of Statatc, ad MIi7 of FIaadg. Devd ui at Wodd Ban SOtA dam bans of tM and Ipot CM. IV: TRADE ICEN7iVE 138) the above 50.2 percent range. In 1987, 10.8 percent of all products fell in the 40.3 - 50.2 percent combind tariff and surcharge rage compared to 19.2 percent in 1992. Likewise, whereas in 1987, 17.1 percent of all products were above 50.2 percent combined tariff and surcharge, this figure fel to 5.7 percent in 1992. 4.22 Thus, the trhff reform implemented since 1989 has resuted in a more unfrm tariff regime widh reduced vaa in taiff rat. The increased uniforit was achieved mainly by reducing the combined tariff and surcharges at the upper eand of the spectrum (rable 4.3 and 4.4). However, sigificant disordons in the tariff regime sdill exist, and the overall tariff level and the degree of tariff differental aforded to different products and industies have not been reduced as much as desWible. Ihe large remainig variance in each tariff category indicates the strong dion among products and sectors. Surcharges are levied unevenly compounding the dism on implied in the taff strsce (see Table 4.6). 4.23 Given the legal tariff and surcharges described above, how effectively are they TAWLS 4.: ANALYSIS OF TARIFF AND SURCHARGE RATes, applied? Table 4.5 shows the value of goods 197 AND 1992 that were imported into Jordan during 1990- 1992 with duties waived. On an verage tiff an Nun Numbe annual basis, the value of -duty-ree imports surdbU of BTN P_roata of BN P _maw duing the period was 1,093 million JD. The Rang. 1987 1987 m2 1992 distibutima across different categories is shown 0.0- 10.2 797 32.4 800 33.9 in table 4.5, which reflects some prominent 10.3 - 20.2 50 2.0 18 0.8 features: 203 - 30.2 265 10.8 308 13.1 30.3 - 40.2 663 26.9 648 27.4 • genetal exe spdm of twiff duties 403 - 50.2 266 10.8 453 19.2 * generl exempions o tariffduties 50.3 - 75.2 29 11.4 26 1.1 accounts for nearly half of the total. 753 - 100.2 48 2.0 32 1.4 However, they may include many zero- 100.3 - 150.2 64 2.6 44 1.9 ratdtksma,d they donwtImply >150.2 27 1.1 31 1.3 exemptions of surcharges; Total 24a61 10. 2.360 100.0 bourg.. Dsd an dta provided by d& Couim Depaift=4W di Dqputmout of * Govement organizaions such as -daat a oNbrnufPkwh*. Dsdvusdi. WoddR nk8ASdt Governmnt ministries, the armed ban of iff nd "ors. forces, the intelligece services, and public ad civil defnse, account for 26.7 percet of all waived tariffi; * organizations coverd by intenaional protocol such as protocol trading counties, the Arab League, diplomatic missions, and int ional orgizaions; acco for 6.6 percen of al waived tariff; JORDAN: CEM (391 * social and parastatal organizations such as univers*ies and colleges, parastatals, charitable TABLE 4.5: VALUE OF IMRT organizDons, and hospitals account for 2.8 percent TARIFFS of all waived tariffs; EXEMPTED IN 1990-1992 (in mllio of current JD) * certain privae companies and account for 13.6 T o Avwg S percent of all waived tariffs; value 9om Taiff Exemptd 519.6 47.5 * special situatio organizations and individuals such O ao O _o 2913 26.7 Protocl Onion 72.0 6.6 as Ogaizations covered by the Encouragement of Socia ognion 30.4 2.8 Investment Law and re ees after the Gulf Crisis compan 149.0 13.6 account for 2.8 percent of all waived tarhls. spni SaSh 30.6 2.8 Total 1,092.9 100.0 Thi infomtion is derived om aw data coaected by do mini fom the Cuams 4.24 The average annual imports into Jordan in 1990- 1992 was 1,883 million JD, of which 1,093 million JD eted under some duty free arrangement. Thus, over half of all imports enjoyed some form of duty free stats regardless of the tariff and surcharges on these items contained in the tariff schedule.4 This shows the extent of revenue loss, but more importantly, to the extent that most of the tariff exonerations apply to raw material and intermediate goods, tariff protection is more biased to final goods than the nominal tariff rates would convey. v Hoeve, auiould beeedIin pringble4.4. nTe timirSgmofprotsool einUNagenies eas dpionm oblige Joranc to Import dutie and vis an goods impoted by dee. oranhatons. CH. MV: TPADE ICENTIVE 401 TAMI 4. FREQUENC DIS3RWJION OF rAPfiSAN FrequPe Freqecy custom TA Distribution Surohaes Disrbuon S s 0.0 S.0 41.0 0.0 5.2 83 5.1 10.0 63 53 10.2 2S.7 10.1 15.0 17.6 10.3 15.2 3.0 15.1 20.0 9.5 15.3 20.2 63.0 20.1 2S.0 3.7 >20.2 0.0 2S.1 30.0 16.3 >30.0 5.6 sour8e. Bond an daa prod by th Custom Departmen, th Department of Stbtistic the Ministry of Panng. Derived using Wodd Bank SITA data oftaff and impots. The sobarp b a combinan of a number of ftea: unherities (4.0%), munPalies (2.05), impo Domes (S.0%), addona 1969 tax 3.0% ar 5.0% If the is no customs taiff appUed to tke Impot, adodi consolidted fe (6.0%), ad usoms fe (0.2%). sb ae chargp is applie to aD Imports which explain whyA aD usoms and surcharge rate ar a fration redher than * whle numbr. here ar no urharg in exam of 20.2%. C. NOMINAL AND EFFECrlVE RATES OF PROTECTION5 4.25 NomalTiff Pott on Table 4.7 shows the average unweighted tariff and surdcarge, the maximum unweighted tariff and surcharge, and the coefficient of variaion for the agricultural, mining and m r - - I ;- -sectors and for the individual manacrin sub-sectors in Jordan in 1993. Nomal tariff protection is lower for agricutre (23.7%) and mining (22.2%) than it is for m or 1i (34.3%). The lowe tariffs for agriculture can be misleadig given the pevasive Import conols and monopolies in the sector. There is considerable vmiation within the ; I Ift sector with regards to the level of unweighted nomind tariff ptection. The level of protection is as low as 16.7 percent in the petroleum and coal products sub-sector to as high as 123.6 perent in the beverages sub-sector. The coeficient of variation also varies considerably between sub-sectors. Thi variation between sub-sectors and within sub-sectors implies that there is still onsiderable variation in protecdon on different commodities. In il scio 'protcaonfe to senea proecD pr db tas, WM , subsies, a. and tariffpotion to dh ,mmw protcti prvid by triffs. JORDAN: CEM 411 TABLE 4.7 UNWEIGITE!) AVERAGE OF TAIRD AND SURCHARGES, 199 Iadustry Tariff Surcar Unweghted Maimum CoeMft Nominal of Variation Protetobn AGRiCULTURE 10.5 13.2 23.7 10.2 81.9 M N 93 12.9 22.2 170.2 14S3 MANUFACrtUING 17.9 16.4 343 340.2 88.8 Prcesed Food 163 IS.7 32.0 100.2 66.9 Bevrges 103.9 19.7 123.6 180.2 55.5 Tobaco 493 18.6 67.9 100.2 41.5 Textiles 14.7 15.8 30.S 100.2 69.2 Wearlu Apparel 28.8 19.7 48.5 50.2 16.9 Leathr Prodts 22.1 20.2 423 50.2 26.1 Footwear 30.0 20.2 50.2 50.2 0.2 Wood, Cork & Products 15.7 17.1 32.8 120.2 66.8 Wood Furniture 30.0 20.2 50.2 50.2 0.0 Paper Products 13.4 17.9 313 120.2 55.4 Psinta& PubIhiog 8.7 113 20.0 50.2 913 ust ialbemioas 7.4 14.0 21.4 50.2 66.8 Oth Cbemical Producs 15.2 16.8 32.0 260.2 111.1 ProuM rofineries 11.9 17.8 29.7 50.2 47.1 Perounm & Coal Product 4.1 12.6 16.7 40.2 74.7 Rubber Product 12.0 17.0 29.0 50.2 46.6 Platc Poducts 233 173 40.6 120.2 70.S Non-mtl Products 24.6 18.8 43.4 170.2 64.7 Non-ekctrc Macbesy 10.4 14.6 25.0 120.2 76.8 Electd Applinces 31.4 18.5 49.9 120.2 62.4 Scientic Bgqu_pa 14.2 18.4 32.6 80.2 45.8 Tnspot Bquipme 57.7 17.1 74.8 340.2 115.8 Fabricated Met P boduct 19.9 18.4 383 120.2 53.7 Bai Mel Indres 6.7 15.9 22.6 50.2 52.8 OteMr Goods 17.1 17.9 35.0 20.2 503 Ovel Economy 16.8 16.1 32.9 340.2 91.0 CONSUMER GOODS 24.9 17.8 42.7 340.2 963 INEBIDIATE GOODS 8.4 IS.0 23.4 170.2 70.2 CAPrrAL GOODS 213 16.6 37.9 160.2 S43 Soutrc: Baed an dat proided by CUom Depatmet, Depaent of StAst, ad Mnty of Panng. Devd using the Wodd Ban SNmA dat bas of tM ad lmts 4.26 In addition, consumption ta raes vary greatly between domesdcally produced goods and imp , thus providing another potential element of protecdon to the nominal rates of tariff and surcharges'. While the consumption tax covers about 100 product groups and generates a respectable ID143.5 milion in 1992 (4.4 percent of GDP), the tax relies hea y on a small number lII& mtaay not be the cas any mssm wI& he adoptin of geSa l lax o 1994. CH. rV TRADE 2NCENIVE 142) of goods to produce the bulk of its revenue. Appendi table IV.18 shows dat about 70 percent of te, total consumption tax revenue in 1992 was derived ftom just four prouct groups: cigaretes, cement, soft drink, and constuction steel bars, and dtat the tax differential between locally produced and imported goods is substna. It should also be noted *a due to the monopoly and restricons over the import of cement, the level of cement import is low and therefore the import tax revenue is very small. Further discriminatory charteiscs of the tariff regime include Icentves under the *Encouragement of Investment Law", special treatment provided tO imports under difere Minitries. 4.27 High tarffs, along with other non-tariff TABLE 4.8 FREQUENCY DISTEION OF protection measures, permit domestic prices to NOMINAL RATES OF TARIFF PROTECTION OF be raised, and the profitability of the products MANUFACTURING, 1993 concerned to be increased. Therefore, domestic Taiff P Numbe of Sub- production is likely to be biased toward those Tf eN f products under high tariffs and imports to be 10.1- 20.0 2 biased toward those commodities which have 20.1 - 30.0 5 lower import tariffs within each ma ing.-40.0 S sub-sector. To determine the ext to which -7o - 5.0 4 this hypothesis is true in Jordan, import >75.0 1 weighted average tarifs and production TOrAL 25 weighted average tariffs for the major sectors s O .,df p yo mDd|X{ Dq|_Dp and sub-sectors of the Jordanian economy were of Sw*im. MM" of Praimh DwW*d af t calculted. The results of this analysis are WoikfSIN dffa m m_ presented in Table 4.9. 4.28 Table 4.9 shows that for man ring overall, the import weighted nomina tariff protecion (29.1%) is lower than the unweighted average tariffprotection (34.3%). The producdon weigbted nominal tariff protection (36.4%) is higher tham the unweighted nominal tariff pr in (34.3%) At the manuf sub-secr level, there is much greater variablity between unweighted, import weighted and production weighted nominal tariff protection. For example, in the food, beverages and tobacco sub-sector, the import weighted average nominal tariff proction is lower (21.4%) and the production weighted average nominal tariff protection is higher (48.3%) than the unweighted average nominal tariff protection (41.1%). JORDAN: CUM 1431 TABLE 4.9 AVERAGE NOMINAL TARIFF PROTECIION BY SECOR AND SUB-SECTOR 1992 sector Unwigted bVpoit Producdon Effective Average Weightd WighXtd Rate of AvemYg AvergeO Ptoction Using 1I0 Coefficients AGRCLTR 23.7 8.4 24.7 5.1 MENMN 22.2 9.4 16.2 8.5 MANUFACrURING 343 29.1 36.4 409 FOOD, BEVERAGES, TOBACCO 41.1 21.4 483 22.S Food Man uring 32.0 193 363 19.4 Beeas 123.6 141.6 101.0 185.0 Tobacco 67.9 96.2 67.9 117.2 TEXTILES & LEATHIR 363 33.4 413 48.6 TOMOes 30.S 24.4 34.9 32.6 Wearhg Appare 48.S 50.0 48.5 78.0 L r Products 423 48.3 45.9 64.0 WOOD & CORK PRODUCIS 33.6 34.1 45.1 S1A Wood, Coat & Product 32.8 33.1 31.6 49.0 Wooden Palgr & Furts SO.2 50. 50.2 97.0 PAPER & PRINTING MATERLL 283 193S 26.6 19.8 pq altoducts 313 20.8 3.9 22.3 PlnIug&Pablldal 20.0 12.6 20.0 9.1 CHWNICALS, PTIROLEW, COAL 24.9 21.4 25A 24.8 hIu Chalenicals 21.4 15.5 13.2 13.8 Odher anicl Product 31.9 21.8 26.S 263 Priolew RefinerI 29.4 23.1 29.4 39.7 broleum A Cod Prduc 16.7 26.7 - 5ubbr Product 29.0 38.6 36.5 S7.S Patc Produt 40.7 46.7 42.5 76.8 NON-MEALLC PRODUCIS 43A 39.1 41.0 485 MAL PRODUCTS A MACHMDERY 40.3 38 33.8 99A Non-lectrical Mabar 25.0 17.2 32.2 14.7 Eler Maciny 49.9 51.7 33.6 - S eatc Bgulpon 32.6 28.8 26.7 76.6 TrnpoNxt E.ulpmmt 74.8 S3.6 38.6 - Fabrad Mim Prducts 38.4 35.2 35.4 57.0 BASIC IuAL INDUSIRIE 22.6 18.8 23.4 18.0 Om MLANUFACrURED GOODS 3S.0 34.9 36.9 SS.6 OVALL BCONOMY 33.0 2S.2 29.4 303 CONSUo M GOoDS 42.7 24.9 - NTERMEIATB GOODS 233 18.1 CAPIALGOODS 37.9 305 'Th wetds wam wet by vale added In domestic prodtonat 4451 SIc. I is sttad ga aIcuIr ad gvsoc pr o acouns f6r 85 perw of tdi vale aded in the acu wr n sect end aburas a for IS pderent. : Bad on dat prvd In Apg 1M by the aCom Dapartet the Dement of Stsabc, th Ministy of ai Depatme of Statia DeIved us4 th WOrd Bank S8NT dat bae of tuifb ad mpots Uad the Dpaent of Sal -' bIndur Surve, 1991. CH. WV TRADE INCEN7IVE 1441 4.29 Ihere are nine main manuating susectors. In eight of these sub-sectors, the production hted average tariff Is higher ta the Import weighted average taiff. In the ninth sub-sector, metal products and machinery, the production weighted average tariff is lower than the import weighted average tariff - this is primaiy due to the fact tha few local producers exi ths domesdc out is virtually nonexistent, indicaing that the tariff are redundant for protecing domestic industries. 4.30 In the food, beverages and tobacco industries, the production weighted average tariff is 48.3 percent whereas beverages and tobacco both have production weighted tariffs lower than the import weighted tariffs. In the case of beverages this is explained by the fact dt the Import weighted average tariff is influenced by imports of beer, wine and spirits which have an average tariff rate of 180.2 percent whereas local production is weighted towards products with lower tariffs. But even so, the production weighted average tariff for beverages of 101 percent is still sufficiently high to protect local production. 4.31 In the textiles & leather industry, the production weighted average tariff is higher (41.3%) than the imported weighted average tariff (33.4%). However, the production weighted average tariff for both wearing apparel and leather products is lower than the import weiged average tariff. Even so, the production weighted tariffs are as high or higher than the unweighted tariff proection. This Implies that both imports and production of these two commodities are weighted towards tariffs at the higher end of the scale in the category. 4.32 Effectve Protetion based on Taif Business profits are affected by changes in (a) the seli price of the final product, (1) the cost of inputs, or (C) a ombination of both. In analyzing effctive rates of protecton, value added is what mauers, not only the comparison between domestic and international prices. Table 4.9 shows the import and production weighted nominal rates of tarff protecton and the effective rates of tariff prtection by major industry, sector and sub-sector. Ihese data show the following: * all effective rates of tariff protection are positive at the major industry, sector and sub-sector levels; * import weighted nominal rates of tariff protection, production weighted nominal rates of tariff protection, and effecdve rates of tariff protection are higher in manu ig than they are in agriculture and mining; * high nominal rates of tariff protection in a given sub-sector tend to lead to high effective rates of tariff protection in the same subsector, e.g. beverages, wearing apparel, wood furniture, transport equipment; and * low nominal rates of taff protection in a given sub-secto tend to lead tD low effective rates of tariff protection in the same sub-sector e.g. processed foods, paper products, pring & publishing, and non-electrical machinery. JORDAN: CEM (4) 4.33 As indicated In para. 4.29, the import weighted average tariff was less than the unweighted average tariff and the production weighted tariff in agriculture, mining and manfcg, was higher man the unweighted average tariff. The reason behind this is that production tends to be in those commodities with a higher level of tariff. However, the effective rates of tariff protection are quite low in agriculture (5.1) and mining (8.5) and significantly higher in m ring (40.9).' This underscores the tremendous benefits that the manufacturing sector reaps from the still relatively low tariffs on raw materials and inWtrmediate goods. A second observation is that there is considerable variation in effective rates of tariff protection within the sectors and the sub-sectors in manufurin. Some sectors such as beverages, tobacco, wearing apparel, leather products, rubber products and plastic products have relatively high effective rates of tariff protection. It Is interesting to note that in all six of these sub-sectors, the production weighted average tariff is relatively high but is less than its corresponding import weighted average tariff. 4.34 Protection based on Price Comparison. sidmating the effective rate of protection accurately is a virtually impossible task. Ihe fundamental methodological problems are associated with the treatment of direct controls and their effects. First, the system of import bans implies that the tariff stmcture provides an inappropriate basis for estiting effective rates of protection. Tbis problem is usualy solved by undertaking direct comparisons between domestic and international prices. But in Jordan the system of price controls blurs the meaning of such comparisons; controlled prices tend to be different from the unknown market clearing prices. Second and theoretically, subsidies received by the domestic producers imply that very likely, controlled prices are below non-subsidized market leing prices. Finally, there is the issue of quality. Even if prices were let free to adjust and subsidies abolished, one should stil provide for appropriate price adjusments to reflect quality differences. In spite of the difficulties, the basis for this price comparison, is that the impact of direct price controls and poor quality are likely to Impart a downward bias on price comparisons. First, the subsidies received by the exportable sectors including agriculture-imply that controlled domestic prices are below market clearing prices that would prevall in non-subsidized markets. Second, the quly problem is another source of downward bias. It is more lilcely that effective rates of protection based on price comparison are under es of the -trues effective rates of protecton; unfortunately, the exent of underesimaion is unknown and may likely vary between sectors. The mission commi ssioned a survey of domestic and international prices of selected goods classified under the headings of raw materials, Intermediate goods, capital goods, and consumer goods. Ihe results are presented in Table 4.10. Several important features stand out: * for intermediate goods, 70 percent of the products had intenatonal prices higher than domestic prices; 7/ a lB effec rt of ptotec is n as high a it f ig appa when ompae wit ctun oUe sue-innduta ecouuios Araiu (969) 89%; Argent 1977)39%; Caiie(961)182X; dIaK 961)313%; Paktn (1964) 271%; PhaIpplm (194 12S%; SudKoea (1968) -I%; Ta (16S) 33%; ad Taad(1971) 40%. Se Litle,Sok avd, Sott (970).duan at al (1971, 1982), and VdV at al (1980). CH. IV: TRADE NCENTIVE (46 * for capital goods, most of the products had inationa prices lower than domestic prices; * for consumer goods, 90 percent of the products had intenadonal prices lower than domestic prices; * when there are Government monopolies but no subsidy, there are high rates of protection (potatoes and tomato paste); * many local agricultura goods are produced and sold at lower costs than intnational prices (frWt juices, oranges and tomatoes). 4.35 The results in Table 4.10 are remarkable. Several important consumption goods produced in Jordan have prices that are lower than international prices. Examples of this include many agricultual commodities such as apple trees, powdered fuit juice, tomatoes and oranges, reflecting significan subsidies on agriculture inputs including irrigation water, and pervasive Govrnment itervention In seig prices of consumption goods. In addition, ths may be due also to diferences in the loss of the Gulf markets quality. In contrast, a mumber of industrial goods enjoy high prmoection including electric cable, extuded aluminum, caustic soda, sheet glass and tomato paste, though the figures are not excessively high. 4.36 A second class of goods which are lower priced in Jordan than Internationally are to be found in the intemediate and capital goods sectors. Examples include ceramic t5les, steam boilers for industrW use, commercial refrigerators and industrial ovens. A common characteristic of each of these products Is that they are bulky, transport costs are high and imported goods would be costiy due to the high cost of transport. This implies that domestic competition might be so strong that domestic prices are well below world priCes, though what really underlies these price differentials is not immediately obvious. 4.37 When one compares the international nominal protection for selected commodities presaeted in Table 4.10 and the tariff protection data presented in Table 4.9, it appears that many of Jordan's companies could survive without the level of protection provided by current tarffs, i.e. many of the tariffs appear to be redundant. This seems to be the case particularly with most of the capital goods, for which there are no price controls nor subsidies. In general, however, It is clear that the effect of the tariff structure would be to enable excessive and monopolisdc profits in domestic sales by reducing or preventing import competion. This is done at the expense of consumers and at the expense of resource efficiency in Jordan, and it constues a powerful bias against sales to the export market. JORDAN: CEM (471 D. TRADE INCENTIVE REGIM FROM TABLE 4.1@r I .LICIT NOMINL A BROAD P PROTE1CTON FOR SELECT COMMODITID, JULY 993 4.38 Building upon the above anaysis of the com er N tariff and non-tariff strucures, this section RatQ Proteci assesses the trade incentive regime from a broader M&NN1ioo perspective, namely the two aspects of being RAW MATSUAU Pi competitive: external competitiveness as reflected Potassium cloiide -23 by the relative price of domestic and foreign Di-AmmoJia phosphate (bul) 19 goods, and interma competitiveness as measured Cacium c17ut 4 by the relative domestic prices of tradable and Wheat -41 non-tradable goods. External competitiveness Fffin pulp or diaper wmanohtur 44 determines the ability of domestic firms to Cin woodWabb or 7 maitain or increase their market share both in Soft white sawn wood for conamctio 21 foreign and domestic market(s) relative to that of 2020M 0 compound pftizer 10 foreign competitors. Internal competitiveness Reino al teel bare 16 determines the ability of Wadable goods industies One mete high appb tee -43 13b density poIyethyI4U -16 to attract resources. - 38 PVC awn -9 4.39 The measure commonly used in Nilga ume ue33 determining external competitiveness is the real IERaMEDIATE GOODS Cocomanethanol aid 17 effective exchange rate (REER); trade-weighted Titanium oxIde 12 bilateral nominal exchange rates vis-a-vis trading Metried abli 60 partner countries adjusted for relative inflation Exrded hbgu 66 Sht &a 33 between these countries and the domestic Timmupaper 2 economy. As can be seen in Table 4.11. SynThet ubber -47 Jordan's external competitiveness as seen in the Cramloc T114s -45 D coo -o REER (profitability of both import-substitution CAPYrAL cOoDS and export production) improved throughout the Steam bole for Industrl us -3S period most remarkably since 1988. BUses -22 Ls uneira suafi -61 Comci reftigerao -24 4.40 Intenal competitiveness is measured in Can 11S terms of the so-alled Salter" ratio, the ratio of COw dUMt GjeDS the domestic price of tradable to non-tradable. PwedfiruitW -36 P.h an -2u Other things being equal, a rise in the Salter ratio Tomatoes -6 implies a shift in the relative incentive regime in Orwee 63 favor of the tradable goods, and that output would Tomato pat 60 increase in the tradable sector more rapidly than it Baked beus -21 would in the non-tadable sector. As Table 4.12 Madlboro cigaretteS -19 shows, the ratio has significantly increased since Houseold -ft 1989 reflecting improved profitability of t le s.wm Dumadc _ Wmwu.m psd good production over non-tradable good caII IV TRMDE INiCENTIVE 1481 production in the economy. Table 4.12 also shows tha following the shf In relative prices, a shift in domestic production of tradable and nontradable goods has also occurred: GlDP from the tradable goods sectors rose by 25 percent between 1986 and 1992, and GDP from non-tradable sectors declined by 8 percent. he contribution of tradable goods to GDP increased from 16.7 percent of GDP in 1986 to 20.7 percent of GDP in 1992, whereas the non-tradables contribution decreased from 51.4 percent of GDP in 1986 to 45.5 percent of GDP in 1992. 4.41 It is evident that the policy reforms since 1989 TABE 4.11: TARIF Dill T IMPORT RATIO AND INDERYS OFFFCTI have enhanced both the EXCHANGE RATES external and internal competitiveness of the YawiTAo JURON RERM Jordanian economy as *weo defined above. Nevertheless, the question 1985 108 100.0 100.0 100.0 100.0 1986 12.9 92.0 91.8 100.5 91.3 remains: within tradable 1981 11.6 82.5 90.9 104.6 86.9 production, what has 1988 112 72.0 99.6 115.0 86.9 hppened to the relative 1989 73 60.8 188.8 165.2 1143 profitability of exports 1990 6.2 54.0 1693 196.5 86.2 1991 7.2 55.2 178.5 20683 863 compared to importable 192 9.1 53.8 179.8 216.8 82.9 (i.e.import-competing goods)? The last column of I - inbSMWi Table 4.11 suggests that a 199). 1aoolinguizSxtoMu St wWW oham"disdCa*d BokefIodmaflmaiug clear anti-export bias still - _ a,, = f of dale. prevails, although it has been reduced considerably N haER =*duor adau -j (uad w*Wft) ex_Ahu ut fe laos (ah4 =-a b adu**Sag for Om 12 majo loa. ooumauiof J(osaniwn fapob and nrayie b*ws,otulaues by the tariff reforms. Anti- (1%. export bias is measured by the extent to which policy T j iterventions lower the price of exportables relative to the price of importables. It is __ _ _ _ _ _ _,_*,__ _ quite possible for a country to be employing specific policy measures that are designed to promote exports, but still have a trade policy regime which includes an overall bias against exports because the meaures to protect import-competing goods dominate the export promotion measures. This seems to be the case in Jordan. At present, import- competing goods still enjoy considerable tariff protection both trough lower tarff on inputs and higher tarffs on final products. Most of the import-competing goods belong to higher tariff brackets. These tariffs are essentially taxing export production. The existing duty-rebate, export rediscouing facilities and odw export promotion measures have not been successfil in redressing this ati-export bias. JORDAN: CEM f491 E. EXPORT AND IEPORT RWGDME8 TABLE 4.1 INDEE OP DOMEIC PRICES OP tADABLES AND 4.42 The Government has developed seve NONTRADALlS 1*6-199& 2 export promotion schemes for qualifying firms in Its efforts to attract foreign investment, Rr GDPr, ONPFr Trabe Noa SalrRao increase manufacturing exports, and promote (10T economic diversification. ITus far, the export promotion schemes in Jordan have not been 19M6 1103 100.0 100.0 100.0 10.06 partcularly successfil in offsetting the anti- 1988 105.4 101.4 104.9 1083 96.9 export bias as intended and in promotng 1989 111.1 83.1 1343 134.0 100.2 export-led growth. 1990 123.8 77. 163. 147.7 110.9 1991 112.9 84.1 181.2 145.2 116.8 1992 125.2 92.2 1893 160.9 117.6 4.43 Duty Drawback Scheme. lhe Jordanian drawback regime is complex, I WmdWN?PsuweumoomiWuidouXtAruuedlmb4adom difficult to adnister, uncompive by of * eak .f odsn*W*a UvIg hdm international standards, and is not popular with 3oms Crad Bek of Wma Abat 3",a 2iafelt, VoL 2S. No. 12. the manufcturers surveyed by the mission in T5S. ie preparation of this chapter. Specific weaknesses include: sJordan utlizes a positive list of materials for duty drawback rather than a negative list, which is more common internationally; * The Government establishes a ma ing equation for every local product using this system. Many manfact surveyed by the mission found that the Government investigations to establish these equWions both time consuming and intrusive; * Imported materials which have local substitutes are not eligible for drawbaks. Some manufactrers stated that they are forced to use inappropriate or higher priced items as a result of this requirement; * The scheme does not include spare parts; * It can only be used by established exporters, thus preventing access to those who are trying to establish themselves in export markets; v sThis eaotWmpost _aime ^dimspontwhe iow igdocumet: US, Trade slandmeatwgPorilyRefrm Agaa, 1992; PIAS, Jard= PoeQ b_ Elni, 1992; and Wol Baok, Bxpo eathed ad TAnoloc C _abHles An Otward- LookIg Sategy for lod", 1992. Ib three asoe an pplnad by inbomaion collected by the mssos injar and mal maWys of manusar:e. CHW. IV TRADE INCENTIVE 1501 4.44 Tempory Adisdsion or Duty Exempton. Jordan's tmporary entry scheme works better dtm the duty drawback scheme, and can be used by small and interlmtent epoter. Even so, considerable shortcomings til exist, including: * Customs officials must be present at al times during the ma process, causing delays and difficulties in the manufcrg process. * 'he importation of spare parts is not allowed under the scheme. Most manufacts surveyed by the mission experienced considerable difficulty when they use the temporary entry scheme. It also seems inconsistent to be so rigorous here while over half of the import taxes are exempted. 4.45 Import and Export Procedures. Import and export regulations in Jordan are unusually complex and restrictive and are followed in a rigid fashion by Government officials. Many manufacturers continue to view the hassles, delays, costs and complications of clearing needed Imports through customs as a leading obstacle to both manufacturing and exporting. The system is centralied in Amman: approvals for drawbacks, temnporary admission and licensing are performed in Amman as are sample tests for products imported through Aqaba. The mission was told by many sam that clearing goods through customs was the single most Important time consuming task of senior management in dealing with Government Some of the problems involved in importig include: * cesg. The Ministry of Industry and Trade is responsible for issuing import and export licenses; * Bank Guartees. The Central Bank of Jordan (CBI) still demands mandatory cash requirements against import documents. The CBJ has waived its requirements for bank guaratees and has intrduced a rediscountng facility for pre and post-shipment export credits as a direct export incentive; * Sgnature Approval. It is reported that import documents sometimes require as many as 50 signatures while export documents often need more than 20 signatures. Many of these sgnatures were introduced as a result of the Gulf Crisis, but are still required even though the regional situation has improved; * Inspection. While inspection is necessary, importers and exporters report extensive delays caused by inspections by the Ministries of Industry and Trade, Agriculture and Health; * Th,al Clearane. A 1988 report indicated that only 23 percent of all imported goods were cleared wihin two days which means that 77 percent took longer than two days. This is a long delay by international standards. JORDAN: CERA1115 4.46 Improving Credit and Guarantee Procedures for Eprts. I-e system of export redit does not yet work particularly well in Jordan. The commercial banks have been slow to expand expo credit to exporters, other than to their most creditworthy customers. The Government has stped in to try to overome tls reluctance by creating a rediscouuting facuity at the Cetral Bank of Jordan. It is also In the process of establishing an Export Credit Guarantee Corporation. 4.47 Ihe preshipment rediscounting facility is currently available to cover up to 60 percent of the fob value of the export order, but no discount can be given unless the exports embody at least 40 percent of local value added. There Is also a postshipment rediscoundng facility to cover up to 80 percent of the value for goods meetig the value added requirement. 4.48 The export fancing sstem has been criticized by participating banks and manuf s on the following grounds: * the present scheme is unproftable for banks; * the rules and procedures limit the interest of both bank and mnuacmfac in using the systen. 4.49 lmprovin Tariff and Tax Treatment of Exports. The tariff rm since 1989 have reduced, but by no means elimied, the anti-export bias In Jordan. A more effective duty drawback and temporary admision program would also help lessen this anti-export bias. Another ar in which the structure of tariffs could be adjusted to help exports is spare pars. Jordan maintai high duties on components and spare parts. Jordanian industry needs good quadity, i onally priced compettive spare parts to compete in the export market. Under international trade rules, duty exemption or duty drawbacks cannot be extended to capital equipment and spare parts. One possible solution is to reduce present import duties. 4.50 It has also been argued that the tax treatment of exports could be improved. Some suggesdons that have been made to improve the tax treatment of exports include: * income taxes on commissions paid by Jordanian exporters to distributors and commission agents abroad should be eliminated; * stamp duties be eliminaed on financial and other transactions of exporters; and * the amount of export eaings that are income tax exempt should be increased. 4.51 Industrlal Estates and Export Proocing Zones. Jordan's experience with the two Inhtrial estates and the two free zones has been mixed. The Industrial Estates Corporaon manages the Sahab estate in Greater Amman and a small industrial estate in Irbid. The Sahab estate is fully operaing, but both cunt operations and fuure expansion are hampered by water shortages and CH. NV TRADE NCENT7VE (521 Inadequate waste management facflities. The Corporaton's new estate in Irbid, and additional small estates being planned in other parts of the country, may not play a significant role in export development in their itial years because of their distance from Amm The Free Zone Corporation manages the Zarqa Free Zone and the Aqaba Free Zone. The former, which is now well on its way to becoming a fully functioning EPZ, is located just outside Amman In contrast, the Aqaba Free Zone appears to be a less attrive option for locating export fms. 4.52 The Role of Protocol Trade. Based on the SlTC classification of commodities, Jordan's exports in the 1988-1992 period were dominated by raw materials such as potash and phosphates (39,0 percent and see Appendix Table IV.7), and chemicals such as fertilizers (30.1 %). The remaining important exports wer- food and live animals (11.7 percent), manufactures (11.3 percent), and other manufactures (5.1 percent). The principal destination of exports were other Arab countries (38.2 percent), India (17.8 percent), EC (4.1 percent), Japan (2.2 percent), all other countries (37.7 percent). There has been some geographic diversification of exports over the last five years, but it is somewhat surprising that the two major industri ized economies (of Japan and EC) are still proportionately such small recipients of Jordan's exports. Several factors might be involved: trade may be detemined more by bilateral trade and barter atem han by free-market forces, instituonal factors may prevent access to these markets, or the quality and price of Jordan's exports may not meet the standards of these markets. A study is required to detemine the reason for this regional distribution of exports, and to doemmine whether the removal of the istional trade -agements and the adoption of a more liberal international regime would be prefrable. 4.53 Private Sector Percepon of the Export Promotion Schemes. Table 4.13 shows tho results of the mail survey conducted by the mission. While the overall rate of utilization was low at less than 42 percent, the level of dissfactions were found to vary from one scheme to another. The first two columns show the number of respondens who have used each particlar form of export support For example, only one of the twelve exporters has used the duty drawback scheme whereas a much higher proportion of exporters use the other five export support schemes. The one exporter who had used the duty drawback scheme has found the program very difficult to use. The temponrry entry program has been used by nine of the exporters and, whereas two have found it easy to use, the remaining seven have found it quite difficult to very difficult to use. The free zone areas facilities have been used by five of the twelve exporters. Two found the facilities easy to use whereas the other three found it quite difficult to very difficult to use. Seven of the respondents had used the facilities of the Enc of Investment Law in their export operations. The response to the program was varied, with some finding it easy and some finding it difficult With regads to the export credit facilities, five export had used these facilities; no major problem was found in using these faciities. Only three respondents have used the income tax deduction scheme. They did not find it particularly difficult to use. 4.54 Export Poedure. It has been argued that the system for obtaing export approvals is complex and time consuming in Jordan. The following parahs desie the process at the time of the mission. JORDAN: CEWM531 * The exporter must obtain a CMcate TAE 4.13: ANALYStS OF US. OF EORT PROMOTION SCJEMES of Origin from either the Chamber epo srt-f of Commerce or the Y D Is 2 3 4 * Totd Chamber of Duty D |a I 11 o o o 0 1 ndustry. TsUpOy 8aby 9 3 2 0 0 4 3 9 PFM Zone Au 5 7 2 0 0 1 2 S * The mrw Must bweuu 7 s I 3 I I 1 7 request an export Expst Crei licese from the Support s 7 0 2 3 0 0 5 Mgnstr of ndusty Deduolom 3 9 1 0 1 1 0 3 and Trade. This requime two * a *Dhl o a signatures and akes less than a day to SOUrCe: roe obtain. * If reqied by the Custonms Department, the export must obtain approval from the Jordanim Mlinisry of Foreign Affiis and the Amman embassy of the foreigp country to which the products are being eported. * If ithe products are being exported to a Protcol country, the exporter wmst go to JEDCO to mange for barter trade. 3 Finally, the exporter must go to tie Customs Department tD obtain many approvals. This is reported to be a time-consuming process. F. SUMlMARY AND RECOMMENATIONS 4.55 Despite the progress in trade liberalization since 1989, sIgnificant distortions in the tarff regime still exist, and the overall tariff level and the degree of triff diff n ffrded to different products and Industries have not been sufficiently reduced to create an Icentive regime conducive to outward-oriented growth. On an average annual basis, over half of all imports enjoyed some form of duty-freeW staus duing 1990-92 regardless of the form taff and surchar strutur.e. Not only does tis reprt a consieable tax revenue loss to the Govenment, but mor impoay, to the exten tat most of the tariff exemptions apply to raw materials and tmediate goods, tariff protection is more biased towards final goods tham Implied by the nominal taiffs and surcharges, and the wide-spread discredonary tarff exemptions have disortd market cowmpetition. CH. :LM TRADE INCENTIE 5M 4.56 The other fctors which Impact on the taff protection to the domestic producers are the way the co_umption tax is levied and imports and custom duties are vahled. In some instnces, the rate of the consumption tax on the imported goods i significantly higer than the domestically produced goods: this adds another layer of protection provided to the domestic producers. Furthermore, there were reports that the value of Impors had been uplifted by an average of 24 perent To the extet that this is the case, the effective import taxes would be much higher. 4.57 Ihe effective rates of tariff protection are quite low in agriculture (5.1) and minig (8.5) relative to manufcg (40.9). This may underscore the benefits that the sector reas from the relatively low tariffs on raw materials and intermediate goods as well as the extensive use of tariff exemptions. There is considerable variation in effecdve rates of tariff protection within the mamnu industries. Furthermore, when one compares the domestic prices with the interational prices, it appears that some of Jordan's producers enjoy natural protection and could suvive without the protectin of tariffs. The resultant monopolistic profits are at the expense of domestic consumers and this tariff stucture constitutes a powerful bias against sales to the export market, and undermines Jordan's trade competitiveness. 4.58 Non-taff barriers in Jordan take the forms of outright import prohibitions, permission- lcesing requirements, and Government monopoly on the import of a number of consumption goods. In addition, the MOS sets distribution margins on imports of consumption goods. The Government also sets distribution margins for nineteen consumption goods produced in Jorda Furthermore the Government sets retai prices for fresh fruits and vegetables. In aggregate, these price iterventions cover about 11 percent of domestic consumption. Finally, the Government provides a consumer subsidy on sugar, rice, powdered mflk and wheat to keep the domestic prices below unimpeded market clearing rates. 4.59 Changes in the external and internal competitiveness of Jordan over the last few years have been analyzed. Exte competiveness, improved considerably. Export diversification increased, however, export sales to the major markets in Japan and EC countries are still insignificant. This may be attributle to the dominant role of the barter and protocol trade, and the efects of the overall incentive regime which discourage Jordan from competing in the third country markets. Internal cope_titiveness also appears to have improved since 1989. k appears that the incenive regime in Jordan in the last three to four years has shifted in favor of the production of tradables versw the pnuctlon of non-radables. However, the incentive regime to prot import-competing industies dominate the export promotion measres, and there is still a clear anti-export bias. Thus far, the export promotion schemes in Jordan have not been particularly successful in offseting the ai-eort bias and in promoig export-led growth. 4.60 The ultimae gol In trade policy refrms is to encourage growth of productivity and resource efficiency by increaig competiive pressures on domesic industries. A real and effecive trade reform program should result in reallocations of resources. Specifically, resources capxured by the Inefficient industries should be liberaized for redibuton toward the efficient indutries, and invstm opportunities disguis so far by the distorted icntve regme should emerge to attract the freed up resources, creating growth and job opportunities in areas never anticipated. The prciW vehicle toward this end is an outward-orientation In trade and investment-to be driven by th 1rces of market competiion. The design of policy refrms should therefore center on increasg JORDAN: CEM 551 competition in the domesdc market among domestic producers (interna competiticn), and between domesdc producers and foreign producers (import competition), and on stengthening the competitive edge of domestic producers v.s. foreigl producers in the third country markets (export rivalry). Box 4.1: Thmiw&n oLfQ gATr p IThre are a numiber of benofis associated whh GAIT membe*. Frtd, it guate Membes are given mt-favored-ation (MR) dawa,s i.e., eaub tading partner is obliged to give a membe coutry tratmet no less favoable than it gives any other county. Thus, It beomes impossble for a trn patner to discrinate agais Jordan by iWposnwg hiher trade baiers again it than are appEed to other countrie SImiladry, Jordanian expoder are guaranteed tmatannt equivalent to tbat gSven to domesdc producu once they have been impoewd In a country. Second, It gves access to GATs dispute setlement procedus, a par in the dsig of mulil trde ndes, and access to varus bodies that fcilite interauional trade. All GATr members have an inerest in seeing GATT obligations enforced, so that Jordan will have support in conesing GA1T violations by a conrAy that adveely affts IL Third, and most important, it helps Govenments lock-in tnde libelzato effror by min it costy for a Gvement to pursue certi types of trade plc t genally are notn its economic ires I in acen to GA'TT a country binds its taIff, at a certain level, trade barien cannot be raised in the Sfar. widhu having to compensae negatvly affcted trading partn. Such compensation cods help Goverm rst domsic Inies seeking the adoption of trade rwtictions that are not in the country's inte. Finally, GAIT les are *net frAy' in that they foster the nondiscriminatory application of price-based Instruments (taiffs). GATrs nAone eatmet requrment ensures that a Government must apply th seme tegulaos and ts to Impoded and dom cally-produced goods. It severely constains the use of quantitatve resctons, favorng mne effiient tIfs as Instruments of protcdon. It imposes restrictions on the use of trade mures - sch as suchar - modvated fo baance of payments re GAIT membeurip an be achieved thrugh negodatons with exist members. Accessn negotations inve an exam of the country's tade policy regime, testing it for GAIT consistenc. Impotant GAIT disciplines are MPN applHation oftade policy and ntonal treatm entof foreig products ciruating wtbhin t couny. The use of quoas is probW, except if necesar for balance of paymet purposs or used to rerict ipotts of agricutu prduce. In the later cas a GAT member is only pennitted to impose qwts if ths is paut of a program intded to lmit domestic production of the good in question (ore close substiute), or to remo teampora splus of the produc GAIT allows memben hip in free trade areas and customs unions (common murets). 4.61 Ihe Plan has strongly endorsed a set of principles which need to be translated into gMpjL= policy actions. The policy measures proposed in the Plan are mixed in this regard. In particar, the proposals for 'wider use of tax exemptions," and for 'a flexible tariff system' should be closely examined. As shown in this chapter, one of the principal problems withb the tariff regime is the already extensive use of tariff exemptions: while legal tariffs are averaged at 25 percent, paid tarff duties are only 9 percent of the import value in 1992. Extending further tax exemptions in 'a flexible tariff system' would result in loss of tax revenue, and more distortions in the incentive regimes. Furthermore, while the principles endorsed in the Plan are commendable, they lack specifics, particulariy in dealing with existing import restrictions, price controls, and import and marketing monopolies, in relating the exchange rate policy to trade reforms, and in defining a schedule for tariff restucturing. The recommendations summarized in table 4.14 are intended to provide the necessary deails as well as the time dimension, and the issues relating to GA1T membership are discussed In Box 4.1. CH. IV TRADE m cCENTVE (56) Table 4.14: M ix fr lm ving the Trade Incetve Regime Squene o Reform L. Quan_Iaie Resrctn, H. ExcsI higb M.acmecoomlc poliy and Price COntDl and Subsdles tariff and buiff and tax institutional suppor for exort- differenals led rowth IMMEDIATE: (1) Elminat all impor cng (1) Lower maximum (1) Maitain flexl exchange ;re e and tarfS to no more than rate policy; and strong (2) End impot and makttiog 50% so as to reduce the manaement of the aregate monopolles in the agiulr taiff poton and to deand so as to enue tb the sector. inreas tariff unf y; bmad icetv regime is not (2) Equae domesti againt tradable and exporable tn on impots and goods; domescally produced (2) Sme and improve goods; instiuona suppot r exports (3) Eliminate and/or by: a) simplfying custom convert all surchare it intpecdon procedure; b) tarf; rationalizing (dut dw-bak and (4) bItat a study on he tmporr admision) approval tarff me includig the and sample tt procedures; c) composion of tariff impving the attractiveness of exemption. the export credit f ; d)reviewing of the export incetve regime with a view to encouraging exports to the non- protocl markts. (4) Simplify export pocedus by. a) reducing siure and icensing requimets; b) removing the custom approval requments for exports; c) ending the de facto QR over exors in time of high domesdic demand; MEDIUM-TERM: (1) Pbas out the rest of the (1) Icease tariff (1) Remove the pockets of impont monopolies; with a nunber nfonrity by loweing rmaiig contrls over the of exceptions to maintain the levs and reducing te aent aount; o n itment already made to myjor aumber of rates. (2) Continue the macro polies investo; dscibed above including the (2) Abolish Government controlB devaluion of ID (if nooded) to over pricing, and margs over the accompany the taiff reductions. 19 consumer goods; MEDIUM- TO (1) Phase out untaretd consum (1) End triff exemptions (1) Gradually tiberalize the LONGR-TEM subsid on sugar, wheat, rice and extended to the major capital accounts; powdered milk as well as other parstb sad sdected (2) bIove labor malret p-r subsidie. prvate companies. inegrain and fbility to (2) Continuing tarff ensure the cost competitiveness of reducdons until the Jordanian idustries in pusuit of maximum ates are expot-led gowth. lowered tD no more than 20% with a few exceptions. CHAPIER V: PUBLIC ENIhRPRISES AND THE BUSINESS ENVRONMENT A. d 5.1 A growing body of evidence indicates that competition is the prime motivation for managers to cut waste, improve technical parameters of production, and allocate resources efficiently. In addition, sub-sector evidence shows that competition is a compelling force for industrial restrucuring as firms-and public enterprises-shed outdated operations, introduce new product lines, and search for new markets. This evidence is particularly compelling in the case of Jordan, where private enterprises continue to well out-perform their public sector counterparts despiie the fact that the latter enjoy a wide range of tax and financial concessions and have been the recipients of a growing share of public investment. What they have not been subject to is fair and open competition-domestic conpetition-and it is therefore argued that a competitive environment is the most effeedve way for Jordan to stimulate growth and structural change. Privatizing public enterprises, as well as selling government shareholdings in publicly traded companies are an essential part of this process, and will facilitate the deepening of capital markets, help reduce the public debt, and will tansfer idle funds from foreign exchange denominated savings and construction to the real sector. Given the size and dominance of the government sector, little progress can be expected without action on this front. 5.2 The Economic and Social Development Plan (1993-1997) has filly recognized the need to deal with the overly-extended public sector, and has adopted the principles of reducing the role of Govermnent in direct production, and substantially expanding the role of the private sector in investment, employment and production of goods and services. Along this line, the Plan has called for measures to: * activate the role of the private sector in the areas of infrastuctu and basic services, and increase private sector participation in the management and ownership of public sector institution; * restructre public sector institutions undergoing financial difficulties; improve their efficiency; and gradually implement measures to eliminate subsidies, recover costs, free prices, and adopt commercial performance criteria; * prevent monopolies and protect the consumer by enacting appropriate legislation, seek to discontinue the renewal of expired concessions granted to enterpses and instutions, leave prices to market forces whenever there is a sufficient and feasible degree of competition; * restore financial and administrative autonomy to public institutions, permit the private sector to provide public services, and proceed with institutional development needed to increase participation of the private sector in communications, roads, tansport, energy and water sectors; * attract foreign investment in the mining sector and accord them with equal atment. 5.3 This chapter is intended to complement the principles embodied in the Plan and build on the analyses in the previous chapters by examining the scope of Government intervention in the Jordanian economy; evaluating the effects of Government investment in private, publicly traded compaes; and assessing the relative performance of enterprises with, and without, significant Goverment shareholdings. The chapter goes into further details than the Plan by reviewing the specific CH. V.: PUBLIC ENTERPRISES (581 constrais on the private sector and by suggesting a matrix of imediate- and longer-term reforms to deepen the role of the private sector and to enhance the prospects for public-private partnership. B. The Public Provision of Goods and Services 1. The Role and Scope of Government Intervention in the Jordanian Economy 5.4 Jordan's economy has been characterized by a strong private enterprise orientation. The majority of the country's productive assets are privately owned, private property is expressly protected by law, and the state-owned sector is small, consisting primarily of public utilities and enterprises deemed to be of strategic iWortance (e.g., defense; mineral exploitation; avionics). In general, the Government is the purchaser of goods and services rather than the supplier of them, and has traditionally preferred to subsidize the private production of goods and services for public consumption. Albeit less distortionary than the outright public ownership of the means of production, the extent of government involvement in the economy-as evidenced by the extent of govermnent shareholdings in publicly traded companies-is adversely affecting corporate governance and the mnternal and international competitiveness of Jordanian industry. 5.5 The private sector in Jordan-defined as private employers and producers-accounts for approximately 80-85 percent of total GDP, with the public sector share divided between the central Govemment and an array of public enterprises and parastatals. As indicated in table 5.1, the number of registered private companies has more than doubled in the past five years, whilst the number of SOE's has declined slightly.' 5.6 Despite the prominent share of private Table 5.1: Regstered Pubic antd Pdvate Entepis In the KXhgm of Jordan, ownership in the Jordanian 1987-1992 economy and the relatively Type of>wnEip 1987 1988 1989 1990 1991 1992 small size of the stete sectn1 (both in absolute terms and Pubfic Shareholfing Company 115 114 113 112 109 112 as a percentage of market nYm nComPies' 1990 1974 1840 2393 4145 4349 share), the state hasateOwfed E grise and shlare), the state has Publc Corporaions2 31 31 30 30 26 25 traditionally exercised TOTAL 2136 2119 1983 2535 4280 4486 significant control over rniat croer Source: Ammn Fnanial market; Ministry of Planning activity. In the case of private, non-traded compane, restrictions on the granting of new operatng licenses have tended to favor exisdng companies over potenal new entrants, and has limited the ability of private comanies to compte agaist state enterprses. The considerable latde graned the Cbamber of Commerce and Industry and Ministry of Commerce in reviewing business licenses also represents a form of state control, with prospective investors being unable to predict whether business license applications will be approved. Registration can be with wmuninkc or loca authorities and is ditinct from licensure. bMany bushmness in the infornul sector are reiseed s wit load audtrities, albeit dhey may not be licnsed by the Govement to tnsact busines. JORDAN: CRM a59) 5.7 Similarly, figures on the number of st-owned enterprises and public corporations seriously underestmate the degree of Goverment itervention in the economy by ignoring Govenment investmen in pnvate, publicly traded corporations-kmown in Jordan as public shareholding companies (PSC's). Between 1960 and 1992, the Govenmenu acquired subanl inrests in private companies, both direcdy, through the Jordan Investment Corpoation (RC), and indirectly, via the Social Security Corporation, The Housing Bank, public corporations and Government Miisies. 5.8 Table 5.2 shows that of the 112 companies currently traded on the Amman Financial Market, the Government has significant ownership interests in 86 (or 76%p, most notably in the industial sector of the economy, and dominates the mortgage lending and housing industries. When minority Govenment shareholdings are included, it is found that the Govemment owns sufficient shares to influence policy (i.e., it has either representation on Boards of Directors or a plurality of shares) in all but 13 of the country's publicly traded companies. Table 5.2: Government Holding In Public Shareholding Companies Sectr Number of Public Number of PSC's with Avera Govenmen Sheholdn Major Govenmem s Companis Sareholdings Il B FI 21 19 33% Services Secr 17 13 21% services 26 18 72% Industri 45 36 61% TOTAL 109 86 (78.8%) 46.5% Source: Amman Financial Maket Jordan I tvesum Corporaton Note: Excludes three comanis for which daa was unavale 1/ As defined by Aman FinailMarke 5.9 Ramifications of Goverment Investment in Private En es. By invesdng heavily in the services and industrial sectors of the economy, the Government has gained effective control over much of the economy's productive assets. A 5% stake can translate to representation on corporate boards of directors and thereby enable one to influence corporate policy. With an average stake of 46%, the Government is the dominant, or often majority, shareholder in all but a dozen or soprwvte companies. This enables the Government to influence corporate govenance and the formulaion of investment, human resources and commercial policy. The result is that non-commercial considerations play a larger role in corporate policy making than would normally be the case, and that private firms tend to mirror the behavior of public enterprises: e.g., according labor retention higher priority than increased efficiency and decling to challenge pubLic enprises in their primy marets. The latter represents a particularly vexing problem from the perspective of the private Al Defined as 5% or more of trluble dsres, or sufficien to commd a smeat on the Boad of Diors or oder polcy-makIng comminee. CH. V: PUBLIC ENTEPISES (60) sector, it being difficuit to formue corporate strategy with rprentatves of compeo fims (i.e., the state sector) sitting on policy making boards. 5.10 But does Government investment in traded compnies affect corporate governance and enterprise perfomnce? To answer this question, the performance of companies listed on the Amman Financial Market were subjected to time-series analysis, and subsequently divided into two groups: those with, and without, major Government shareholdings (defined as shareholdings in excess of 15% of available stock). Detailed analysis of specific company performance is provided later in this chapter, but as indicated in table 5.3, companies with large Govermment shareholdings have performed notably poorer than those with neglgible or no Govenment ownership interests. Table 5.3: Peonnane of Publc Trabde Compans With and Withou Significan Govern Ownesp Compantes With Snffwn Companie Witou Slgnflcant (ovenmet Owtnip Goveumet OwMne sales Growtd 1981-1990 94.0% 188.0% Saes Growth 1986-1990 35.0% 167.0% Fixed Asset Growth 39.0% 87.0% 1981-1990 Fxed Asset Growth (22.0%) 1.0% 1986-1990 Aveuge AnAl PeT 3.6% 7.1% (1981-1990) Anage Amal Pie-Tax 3.0% 9.2% Rer on vesnent (1i98661990 Cggoa 21.3% 83.0% Sourne: Govemnment of Jordan (fime MAlsey) 5.11 Data on company performance also reveals a strong positive correlation between Govermnent ownership or control and diminished finacl performance, suggesting that Government ownership is having an affect on relative prices and inceniv. Companies in which the Govemment has imvested heavily experienced lower growth in sales, lower average ammal pre-tax return on invesm , and significantly lower productivity gains. These trends are evident co-sectoraly, in "declining industries" (e.g., steel) as well as emegent ones (e.g. telec niatios) indicating that ownehip, and not some other exogenous variable such as conmarve advantage, is responsible. Despite the magntue of Government investm public shareholdiog coipanes, those in which the Government had no ownership interests grew faster, ivested more, eared higher returns, achieved larger productvity gains, and genated more employment for each dinr worth of invesment than in the case of either public enterprises or public shareholding companies with sizeable Government sbareholdiDgs. JORDAN: CEM t611 5.12 Intermediation by Parastatas Public Enteprises. In the past, Govenmment Table 5.4 Major Sareholdigs of the investment in public shareholding companies Jordan Inweuniet Corporation occurred primarily through the agency of the As of December 31, 1992 Jordan Investment Corporadton (RIC), the Goverment's investment am. Government Company C Owni Stke investment in traded companies has traditionally -a A Dank 15.0 X been viewed as a means of encouraging JordanHo 7.7 economic activities considered to be of strategic Jordan Himeb sMwals 30.0 importance to the county, and of reassuring Dar Ai&HWaOb P 325. investors who might othewise be retcent to io shipig *im 18.7 invest given the regional security situation. Jordan Touism & Spas 77.9 Whilst never codified into law, the Govermnent MahbIsly Eqpt Co. 27.2 Jordan PrsWAI-Rai 15.0 and Jordan Investment Corporation were Jordan Pablf 15.0 unequivocal in assuring investors that companies Jordan TV & Pado 21.9 in which the Goverment had significant Jon Pou 40.7 interests would never be permied to fa*l, and, Jord1n Tobco 16.7 perun ~~~~~~~Jordan Cement 40.0 indeed, there has never been the failure of a Jorda Pbophat 41.5 public shareholding compan in which the Arb Potah 56.7 Government has invested. Similarly, absent a Jodafn Tanning 15.0 Iordan worsoed Mills 23.9 fully-functdoning capital market, Government Jodan Dairy 12.8 sbhre purchases have been seen as a way of Jordan Prti 15.7 increasing the capitalization of Jordanian Jor Paper 27A enterprise. he PuWc nings 51.0 - J~~~~~~~~~~~~~~~ordan. SpbAn 1 S Jordan Gass 59.4 5.13 Table 5.4 lists the major investments of Jordan LIm 11.5 the Jordan Investment Corporaton as of Jordan Precast Coee 13.1 December 31, 1992. The data show that Soume: Amman Finacl Mase Government investment is heavily concenated in the industrial sector, with the Government being the largest, or majority, shareholder in Jordan's largest industral combines: Jordan Phosphate, Jordan Cement, Jordan Glass and The Public Mining. 5.14 The Government's share portfolio also includes the holdings of the Social Security Corporation and various other public bodies (e.g., Ministry of Health, Ministry of Transport, TCC). In the case of the Social Security Corporation, the SSC's Board of Directors, and not the Jordan Investment Corporation, is responsible for mana8gi the Corporation's portfolio and authorizing additional acquisitions. However, as with all other public bodies, the SSC's management and Board is appointed by, and accountable to, the Governent. The Social Security Corporations legal chuter is explicit in stating that it is a Govermental body whose policy is consonant with Government objectives and subject to Government approbation. When the holdings of the RC, Social Security Corporation and other Govermmental entities are , the Govenment owns over 90% of the CH. V: PUBLIC ENTEPRISES (621 shares of Jordan Phosphate, 40% of Jordan Shipping, 71% of Arab Potash, 70% of Jordan Glass and 91% of Jordan Hotels3. S.15 As discussed previously, the objective of Govermment investment in publicly-traded companies is coaration and market capitalizion and the encouragement of domestic and foreign investment. However, while the total market capitalization of the Jordanan stock market rose from JD 286 million in 1978, to JD 2,266 million in 1992, foreign investment has remained sttic after adjutent for inflation, and domestic private investment is concta in the housing and construction industies. The bulk of invesutent conimes to flow from Government sources, primarily the Jordan Investment Corporation, Social Security Corporation, Housing Bank and other public enterprises. Remitances and repatiated eanings from returning Jordanians are the largest source of domestic investment. Indicative of the lack of investuent opportunities in the private sector is the stock of deposits in commercial banks. At an all-time high in 1993, ventue capital remains scarce and uncollateralized credit is generally unavailable. The latter suggests that investor confidence remains weak and that individuals are unwilling to provide risk capital. S.16 Level Playing Field Issues. The legal and insdtutional environment in which private businesses operate is often un-conducive to the achievement of a level playing field. Whilst as a matter of policy the Government is committed to a competitive, free enterprise system in which economic agents are free to enter and exit, ambiguities in the law and licensing procedures are having the opposite effect in a number of instances. 5.17 A pewliar anomaly of Jordan's licensing regime is the requirement that businesses be members of the Chamber of CommerceChamber of Industry in order to be licensed to operate. As the repesentative and advocate for the country's business sector, compulsory membehip is antithetical to both organization's mission which is to serve the business community, not regulate or control it. Any regulatory or prudendal supervision fumctions exercised by the Chambers are properly the province of the Govemment and public regulatory agencies, and to require that businesses go through what is effectively a double vetting process can be a powerful disincentive to business formation and increased private entrepreneurial activity. 5.18 Similarly impeding the development of the residential mortgae lending industry is the legal ambiguity that surrounds the use of land as collateral. Lega opinion is divided in Jordan as to whether land can be used as collateral for residenal mortgages. Here, the issue concerns primarily whedter the proscription against the use of land as collatral applies to all land, or just agricultual land. In point of fact, a number of legal scholars and Govemment officials mainain that there is no dejure prohibition against the use of land as collateral, and that provisions in the law mitigating the use of land as security (i.e., collateral) were designed to prevent the alienadon of agricultural and farm land. Nonetheless, the fact that no definitive legal opinion exists as to whether land may be IV Da on aregad Govenmen holg was demned by consolidaed th saeholip of ft lordwan snmn Coa. Cent ralad Local Goveuont Authorites, Pblc Eess and arsas. JORDAN: CEI1(63) used as collateral, has dissuaded private lenders from entering the market and caused the banking industry to perceive mortgage lending as been exceedigly hazardou4. 5.19 In addition to enjoying a soft budget constraint, public enterprises and parastatals are accorded privileged status under the law with respect to their financial and legal liabilities. Under the law, the financial obligations (i.e., outstanding loans) of public enterprises are not liabilities of the entepises themselves but rather of the Government. The Ministry of Finance, acting as agent of the Government, incurs the legal liability for the obligations of SOE's and the enterprises themselves are held safe. 5.20 As in the case of other Govermment guarantees, this arrangement poses serious problems with respect to moral hazard. Enterprise managers and directors are aware that they are not responsible for running their concerns in an economical and profit-maximizing manner. They therefore can be quite relaxed in seeking to monitor the performance and efficiency of their operations and have Little incentive to restrain spending. A prime example of this is Royal Jordanian Airlines in the early 1980's. Faced with numerous studies and evidence of declining yields and profitability, the airline nonetheless underwent a major expansion of its fleet and operations, all financed by Govermment- backed debt. This ultimately served to undermine the financial performance of the company, which went steadily from the black ifto the red, leaving the Government with millions of dinas in debt and an airline fleet well beyond its needs. C. Publi Entrrse Performance 5.21 Asset Performance. In 1991, Government-controlled shareholding companies accounted for over 85% of the assets of all listed service companies, and over 60% of the assets of listed manufactures. When the assets of Royal Jordanian are added, the total assets of all Government- owned or -owntrolled finns amount to three times the assets of all other non-financial shareholding companies in the country. Yet, the former lost over 54 million Jordanian dinars during the period 1984-88, whilst wholly privately owned firms recorded profits in excess of 22 million dinars (the equivalent to a return of 21% on the assets they owned). Indeed, as indicated in Appendix v.1 and v.2, the performance of private sector manufacturing companies actually improved during the recession, whilst those of Government-controlled firms worsened susntally5. 5.22 Rate-of-Retumn Analvsis. A review of data on enterprise performance indicates that the rate- of-return on invesments in quasi-public enterprises and parastatal remains significantly below that of companies without major Government investment (2.0% vs. 6.8%) despite the fact that the former enjoy preferential access to credit and a variety of tax benefis and concessions. The productivity of labor and of investment, measured as a ratio of the number of employees per one million Jordanian lordan's Land d Propeity Laws are presently under wvkw, wih an aim to cdarifg th and arbutes and Source: Office of the Prime M r. Figues aken ftom nhe Case for Pdva*tan Jon kr, Safwn Baaleb Economk Advisor to the Prime Minister, (ed.). CH. V: PUBLC ENTERPRISES 164 dinars of investment, is also markedly lower in Government-contro11ed firms (7.9% vs. 29.0%), as is the ratio of output to labor growth for the period 1981-1990 (35% vs. 83%)6. 5.23 Two other important indicators, sales growth and fixed assets growth, also provide unequivocal evidence of the lagging performance of compaies with significant Goverment ownership. Companies with significant Government ownership reported a 94% growth in sales for the period 1981 to 1990, or roughly one-half that of companies with no significant Government ownership (188%). Though somewhat dim nished, private companies continued to out-perform public and quasi-public ones under the recessionary conditions that prevailed during latter years, when the comparable figures were 35% and 167%1. The fact that the private sector experienced on average a 12-15% decline in sales and fixed assets growth during the recession-compared to a decline of almost two-thirds in the case of the state sector-is especially significant given the fact that the GOJ consciously attemed to support public enterprises during this period while private enterprises were left mostly on their own. D. Regulatory and Investent Regime 5.24 Efforts to streamline and simplify the licensing of private enterprises have met with considerable success, and as a result between 80 and 85% of business and opeaing license applications are processed within 3-5 days'. This represents a reduction of over 300% in the amount of time it previously took to process business licenses and reflects the Government's commiment to relaxing bureaucratic and regulatory obstacles to new business formation. On the other hand, the licensing and approvals process remains highly discretionary and the Government apparatus is accorded tremendous leeway in vetting applications. Potental entrepreneurs are often required to obtain the approval of several Government deputmentslministries, any of which can block or delay the application. Foreign investors must go through the added steps of obtaning approval from the Mlinistry of Trade and securing a "no objection" certificate from the ministry in whose purview the proposed activity falls. Only once this has been obtained will the Chamber of Commerce/Chamber of Industry entertain the application for membership registration. 5.25 Efforts to provide regulatory relief to private sector entities have not, however, been accompanied by an appreciable levelling of the playing field between public and private enterprises. Three factors stand out amongst all otiers, placing private enterprises at a major disadvantage vis-a- vis public ones: * The lack of hard budget cotaints in the public sector * The exclusion of public enterprises from bankrptcy and insolvency prceedin * The idemnity from loss ("hold safe") protection afforded public enerprises and patatals under the law, the debts of public enterprises being those of the Ministry of Finance and not the individual enterprises. bd s. Ii. JORDAN: CEMIV 165) 5.26 These provisions place public enterprises in an altogether different situation from private enterprises. Presently, public enterprises canmot be liquidated or declared bankrupt. Rather, when faced with insolvency the Treasury is obliged to re-capitalize them or otherwise secure their debts. Similarly, the debts of public enterprises are not legally the debts of the enterprises themselves, but of the Government of Jordan. This creates a problem of moral hazard and has encouraged the accumulation of debts of the part of public enterprises. Whilst precise data is not available, most of Jordan's public enterprises are in arrears to the Social Security Corporation and public enterprises account for the majority of delinquent commercial accounts with the Telecommunications Corporation. 5.27 These factors also place private enterprise in Jordan in a double bind. First, they are unable to compete against public and quasi-pubic enterprises on a level playing field since the latter are not bound by hard budget constraints, are not responsible for idependently financing their operations or servicing their debts, and are accord substantial protection from competition via a patchwork of licensing requirements, tariffs and import restrictions. On the other hand, as the Government and public sector are the largest purchasers of goods and services, private enterprises must sell to the Government, with the Governuient and not the market often setting the price. E. Summary and Recondati 5.28 The consequence of the bias against the private sector seems to be the relative decline of the private sector investment. From the early 1970's to the mid-1980's, the private sector's share of total investment declined precipitously as more and more investment was directed towarls public enterprises and publicly traded companies in which they Govemment had sizable interests and was desirous of supporting (e.g., Jordan Cement, Jordan Lime & Silicate, Koyal Jordanian Airlines). This contrasts with the situation in OECD countries over the same period, when the private share of investment remained constant at around 83 percent, even while total investment declined from 24 to 21 percent of GDP. 5.29 A second manifestation of the displacement of the private sector by the public sector was the increasing allocation to the latter of domestic commercial credit-which the Government effectively directed, particularly with respect to the housing and construction industries. Between the early 1970's and the mid-1980's, the average public sector share of domestic credit rose by half, with evidence suggesting that this was the result of substitutng domestic for exteral debt. Growing public sector reliance on domestic credit fmancing was particularly deleterious on emerging private sector enterprises, which found themselves effectively shut-out from the domestic credit market. The concomitant reluctance of banks and fiancial institutions to lend risk capital-and the inability to use land as collateral-has made venture capital all but impossible to obtain. 5.30 Expansion of Jordan's public sector has coincided with a marked worsening of economic performance on virtually every front. While various factors are responsible for this iadequate performance, the fact that wholly privately controlled companies have performed uniformly better, confirms that ownership is important and that Government presence in the management of publicly traded companies is impeding their performance and competitiveness. This is in keeping with other 2' SourS: Wodd Bank and IMP, Intemonanal Finnca Sta. CW. V: PUBlIC ENTERPRISES 166) World Bank studies that confirm that economic growth is consistently and significantly associated with private investment and that a strong positive relationship exists between higher levels of private investment and higher GDP growth rates'0. 5.31 This chapter shows that the priorities the Plan has placed on private sector development are well grounded. However, tacling the constraints on the private sector and reforming the regulatory regime are challenging tasks, and require a set of well sequenced actions. Table 5.5 has complemented the principles embodied in the Plan by defining a set of immediate; medium-term; and longer-term, actions that should be taken by the Government of Jordan to improve the efficiency and competitiveness of Jordan's private sector and, thereby, the Jordanian economy. Some of these reforms have been initiated, whilst others are under consideration. There are still other reforms proposed in the Plan, such as according equal treatment to all foreign investors in the mining sector, which have not gone far enough. Nevertheless, we have sequenced reforms as follows. Measures indicated as "immediate" are those that can be readily implemented and that will not require new legislation or any fundament changes in existing law. Similarly, they are not expected to produce any dislocations (i.e., labor displacement) yet will have an immediate effect in simulating further private sector development. Measures indicated as medium- or longer-term will require more extensive legislative and policy changes as well as more fundamental changes to the way of the Government transacts business (i.e., removing the special concessions currently granted The Housing Bank with respect to insolvency procedures and establishing a more level playing field amongst public and private financial institutions). Because such action will take time, it is recommended that these medium- and long-term reforms be undertaken once those of immediate importance are accomplished. 11 C.f., DevopLag Jhe MeSeor: he World Bas*xewdc tppoa5c (ptmber 1991). |j~ "¶ dIiIg WIXiim 3 t0T.,ti *1*' U.1} i 5~~t.I t 13Ri i.:1I I I 12 ia ia E 21g 1111]t CE V PUBLIC ENRPMSNS [68) M__)M- TO (1) Simplify tax code; (1) Enact Civil Service (1) Subject SOB's and parasls LONGER-TERM (2) Proceed with broad-bae R rm, crtig parity to liquidation proceedings on (Implementati wihin priatzation; contue rgulatory between public and private same tms as private sector 18-24 monts) and tax reforms; sector wages; enities; (3) Complete proces of domestc (2) Srengh propery (2) Enable pnvate sector entities (export licens and en ade tigs and collateraliaon to seek legal relief m even of liberalizain. procedures; non-payment by public (4) Privatize Jordan Investment (3) Pemit pldging of enterprises. Corporation (C); agrut land in (5) Reform finaing of public securizaon proceedigs. eteprises (see footnote a): (a) Permit public enerpris to raise capital idendenty but without any Govemment guarantee; (b) Requre that when public enterprises borrow fron the Cenal Bank, they do so only on commercal terms; (c) Phase-out al Central Bank lending to public enerprises. (6) End automatic Government guarantee of all SOE debt (see _aolote a). Footnote a: Implmentato of the recommendati wi require the amenent of existng legila to (1) permtt public enteprises to rase hdr own funds on the capital maes; (2) eliminate the analogous stipulation in the law that public entpiss onl borrow through the Cental Dank or Govemment of Jordan; and (3) eliina the provion in dhe law that the debts of public entpries are the sovereign debt of the Kingdom of Jordan. CHAFPER VI THE FINANCLAL SYSTEM A. BACKGROUND 6.1 The recession of the late 1980s caused deep problems in the Jordanian banking system. By the end of the decade, rough esdmates put the share of doubtfil loans in the portfolio of the banks at 13 percent. Foreclosing on colateral did not resolve the banks' problems, because the recession had eroded the price of real estate - which considtues most of the collateral in the banking system. In these circu ces, several banks were in serious difficulties. In 1989, a major financial insdtion, Petra Bank, failed, tiggering what threatened to be a major banking crisis. The system stood vulnerable to further failures. 6.2 This siuation changed drastically in the last two years. As the Government's mconomc policies succeeded in stabilizing the economy, and as the monetary inflows of the Jordanims retg from the Gulf resulted in higher demand for nontradable goods, the volume of economic activity recovered and the price of land and property went up sharply, bailing out the banking system's debtors and increasing the value of the collater already foreclosed. Also, the spread of the bans widened sbtantially, increasing their profi ity. These events incrased the value of the banks' capital and allowed them to build reserves against losses. According to the Centrd Bank, most of the members of the banks now cofortably meet the capital adequacy rquiements of the Basle committee. 6.3 Ihe. dangers of the late 1980s were thus averted. Now, although some banks may still have to meet the Basle stanrds, the fimanci system confrons a diffrent set of challenges. For decades, the Jordan economy worked under heavy protection and substanti Goverment intervention in the dtermination of prices. Now, the Government has reduced protection and abolished controls on most prices. The newly liberalized environment Is expected to lead to realocations of factor reomurces, and therefore higher rates of growth. On the other hand, it creates a riskier enviroment for Jordanin enterprises, which from now on wil have to face increasing competiton from abroad as well as potenaly varying exchange rates, interest rates, and prices in general. The risks of the enterprises will be transferred to the banking system, which wiLl also face direct risks as a result of the liberalization of the financial variables themselves. Curreny, there are some sources of concern regarding the way the banks are manging their new risks. In particular (for detailed description, se8 Anne VI.1): 0 Fitst, the banking system seems to be taking too many risks in the allocation of the resources it leaves inside the country. A substantial part of these resources are being invested in rea estat, which has been ofrg good profts mainly due to the increased demand for housing prompted by the return of former expatriates working abroad. This boom is expected to end as soon as the exrordinary demand is satified. However, if there is a crash or a drastic realignment of relative prices, the resulting losses would have to be absorbed not only by investors using their own money but also by banks using fn from the depositor. The concentration of domestic credit on nontradable and volatile activities shows an inadequate assessment of rsk In the baking instions. CH. I: FINANCIAL SYSTEM 170) * Second, the concentration in nontradable is also worrying from the point of view of reaping the benefit of trade reforms, and suinin growth in the long-un. The enterpries working in the tradable sectors, having lost their tradidonal neighboring markets, face the need to become more competitive in the world at large. Ihey are receiving much less resources than the real estate sectors. That is, even if the risk of a sudden crash of the real estate market is ignored, it should be a serious concen that the opportunity presented by the current inflow of resources may be wasted. 6.4 From a stgic point of view, the financial system also faces the challenging task of foding the most efficient investments; managing the risks naural in the operation ot the increasingly liberalized goods market; and itegrating with the world markets in trade and financial services. Ibis Chapter intends to examlne the financial system in view of these ftree strategic goas. Part one analyzes the structural problems present in the Banking system; part two deals wifth the stuctr problems in the capital markets; and part tbree presents a vision of how a more efficient financial system would look like, and proposes a strategy for creating such a system. B. THE mUCTURAL PROBLEMS 1. The Fagtation of the Market 6.5 The rigidity of the Jordanian market is largely the result of its fragmentation into several compartmets, each of them isolated from the others by formal laws and regulations; by privileges graned to public sector instions (or private situions that, because of these privileges, are effcdvely part of the public sector) and by the infitmal rules hat develop In the monopolistc and oligopolistic makts thus created. As It is well known, a financl market tends to be more efficient the larger it is. Size provides more oppormnities for savers to meet investors, and more opporunities to diversify risk, thus reducing the cost of financial inmediation. A considerable portion of these advantages is lost in Jordan, because each of the submarkets into which the financial markets are split is much smaller than what an integrated market could be. 6.6 F ta has emerged mainly as the result of the insional seting created to provide credit to specific sectrs and activities, on the asumption that the market would not provide it. In Jordan, such financing is provided by the speciized financial stintons, which lend to agriculre, industry, housing, and to municipal and local Goverments. Each of these insdtuions enjoys certain privieges which give them virtua monopolies in their fields (see paragraphs. 6.20-6.41). 6.7 It should be stessed that the cause of fragmentation is not the speialization of the facial Institutions but the prvileges granted to the specialized istuions and the sectors they serve. Since different kinds of financial operations require different skis, there is a natural tendency in free Markets to generate diffrent kinds of financia hInstio. Such instittio bring diversity to the ma*et, allowing both savers and borrowers to choose among a wide variety of Intumet to meet their needs. Such divesification does not exist in Jordan becase the privieges destroy competio. JORDAN: CEM 1p71 Ihe end result is tha the volume of intermediation in Jordan is lower than it could be, and that the cost of such intermediation is also higher than It should be. 2. Fragmentadon In the lime Dimension 6.8 Ihe natural vehicle for long-term financing is bonds. In all markets, the cost of intemediation of bonds is much lower than that of the banking system's loans, averaging 1 percent against 2.5 or 3 percent for the banks. In Jordan, the bonds market is underdeveloped, and most long term debt funding is provided by the banks and financial institutions created specifically for this purpose. 6.9 The banks and specialized institdons finance long-term operations in three main ways. First, for large corporations, banks participate in syndications, using short-term fimds to finance long-term projects. Second, specialized insttutions onlend long-term funds from either the Central Bank or international institutions. Third, in the case of housing, banks finance the mortgages with shortterm deposits. Most of this financing is carried out by the Housing Bank, which also gets funds from the Central Bank to subsidize some of its loans. Thus, most of the long-term financing is fimded with either domestic short-term or foreign long-term resources. 6.10 The financial system's inability to intermediate genuine domestic long-term funds shows a sructural wealkess in the system. It is often argued that this inability is rooted in the lack of long- term savings in the domestic market. The fact that people store their savings in real estate belies such idea. The transaction costs in the land market are much higher than those in the financial markets, and the risks are much higher. The financial system should be able to capture those long-term svings with the appropriate instruments. The arrangements now used to finance long-term investments cause several problems, among them burdening the system with unnecessary term transformation and foreign exchange risks, increasing the rates of interest paid by the borrowers, and creating an environment which discourages efficiency improvements. 6.11 Unecesary Foreign Exchange Risks. Under the current arrangements, the Government carries a substantal foreign exchange risk, either direcdy or through the Central Bank. This is obviously the case when the Cental Bank borrows funds denominated in foreign exchange from abroad and onlends them in local currency to the specialized financial institutions. It is also the case when the Central Bank prints money to finance those institutions, because any monetar-y expansion increases inflationary pressures and, therefore, the possibility of a devaluation during die life of the loan. If the devaluation takes place, and the interest rate that the Central Bank is charging for the loan does not compensate for the devaluation, the Central Bank takes a loss. 6.12 Ihe Industrial Development Bank started recently to y a 1 percent commission to the Centra Bank to cover the foreign exchange risk. There is no way to know whether this commission is adem'te because there is no forward foreign exchange market in Jordan. However, it is possible to estimate the rate that the market would pay by assuming that the Central Bank is selling one-year fireign exchange fures to DB, at a price equal to the current spot price plus 1 percent. CH. Wh FINANCIAL SYSTEM f72) 6.13 The price of a future contract of any commodity tends to be equal to the current spot price of the commodity plus the net carrying costs. In foreign exchange futres, the net carrying costs are given by the difference between the domesdc and the foreign iterest rates, as expressed in the following formula Fo,teFC*(I +rrdJ)(1 r,) Where: pO,4 = price of the future contract to time t of one unit of foreign exchange FC spot price of foreign currency r = the free rate of interest in the domestic cufrency rt, = rate of interest in the foreign currency 6.14 The formula asumes that the Interest rate is what the market demands to compensate for the risk of devaluation in each currency. In Jordan, the income from interests in a well-negotiated 6- month deposit would be 7.5 percent, and the interests on foreign currency deposits would be about 3.5 percent (the LIBOR rate for 6-month instruments). lben, the price of a one-year contract would be: F;,rl *(1 +.075)I(1 +0.035)=1.0386 6.15 Tbis calculation suests that the premium should be closer to 4 percent, given the current rates of interest. If the Government charged premia on the order of 4 percent for the foreign excge insurance it Is providing, borrowing in the domestic market at rates of interest that would appeal to deposito would become attcive for the institutions now privileged with free or nearly fre insurance. The Government is already discussing the appropriate premium that should be charged for the foreign exchange risk. 6.16 Hir than NHsgy LenfIdingterest Rates. Financing loans directly from the Central Bank also results in a geneaized increase in inteest rates. Ihis is so because the Central Bank has a limited room of maneuver in creatng money without infltionary consequences. This limit is set by the gowth in the population's demand for real cash balances. Since this demand is given at any given level of inflationary expectatios, any monetary creation subtracts from the amount of reserve money tha the Central Bank can safely issue for other purposes. In the curent c ces, the Central Bank is sterilizing heavy volumes of money to prevent a surge in the inflation rate, so tda any monetay creation should be accompanied by the sterilization of an equal volume of money. This means that, whenever the Central Bank extends a credit to a speciaized instituon, it has to further resti the creation of nonpreencll credit, which in tun increases the genera level of lending bnterest rate. Thus, the higher the volume of credit issued by the Central Bank to the specialized hntitons, the higher the level of the lending intert rate in the non-privileged market. JORDAN: CEM 173 6.17 Furthemore, the caTent Institional arrangement also results in excessive interest rates paid by the very same sectors that are supposedly being beneitted by te system. Tnis is the case, fr example, of industrial enerpries. Those of them which have innovative projects may get "subsidized" loans at 9 percent from 1DB, lower than the 11-13.5 percent rate prevailing in the market. Yet, the same enterprises, could float paper at 7-8 percent to mobilize fimds direcdy from the public if a developed bonds market existed. This example shows that the subsidization conveyed by the system does not go to the final beneficiary, but to the financial isiutions themselves, which can operate profitably even if they are not efficient. Even preferential rates include oligopolistic rents. 6.18 The Problems of Term Transformation. Banks lending long with short-term funds carry with them two main risks: First, there is an interest rate risk, which comes from the possibility that the short-term rate (and therefore, the cost of deposits) will go up while the lending rate negotated for the loan remains fixed. This problem can be resolved in two main ways: by carefully matching interest rates and maturities on both sides of the balance sheet, or by lending with floating interest rates. Most loans in Jordan are at floating rates. Second, the liquidity risk, which comes from the possibility that shifts in the liquidity of the market will turn iliquid the institution. This problem cannot be solved with any kind of aangement except matching the maturities of assets and liabilities. An exact matching is not possible, particularly when long-tem lending is involved. However, baks should have a reasonable portion of their deposits at terms which would allow them to adjust to any shift in the liquidity of the market. le bank most exposed to this risk is the Housig Bank, which carries a substantial portfolio of long-term housing loans financed with short-erm deposit. Running these risks is not necessary in Jordan, as there is a substantial supply of long-term funds. (See paragraphs 6.69-6.74). 3. The Sectoral Fr_mts 6.19 It is well known that lending is not an efficient instrument of subsidization. This is true of the subsidization of any activity, becmse loan subsidization does not encourage carrying out an activity, but only borrowing to carry it out. For this reason, It is a regressive form of subdzadon. The more the people borrow, and the more they hold their debt, the more they receive in subsidies. This gives an advantage in the reception of the subsidy to the large beneficiaries. Experience in all countries shows that it is in fact the large and rich concers which receive most of the subsidies conveyed through interest rates. Ihese subsidies also distort the incentives against labor intensive activities and encourage capital-intensive ones. Finally, as shown below, they also discourage what they are supposed to promote. Agdatitur 6.20 P. The Agricultural Credit Corporation (ACC) is the nition specilized in agricultural lending. Credit to agriculture is sbsidized in two main ways. CH. W.- FNANCIAL SYSTEM 174 * FMrst, ACC lends at 7 to 7.spercent ine,us rates, fnanced with reditfm the Central BDan andfiJom haenotonalfinancdal Ittutons (some of whkh lend at effective rates translated to JD tenws t are m h higher than these). * Second, in two oecsions in he last few years,, the Government has forjea pwt or te totalty of thefamneas' obligadons. Cumnaly, the recovery rate of the ACC (the rado of collected to due loans) is about 65 percent, a figure that the curent admunstration of the bank considers exoellent given the bank's tac reconL 6.21 Witiin this environment, it is not attractive for any private lender to try this market, so that the entire burden of financing agriculture falls on the Central Bank, which has other things to be concerned about. As a result, agriculture received the lowest amount of financing among the major sectors. It got 1.4 percent of the total increase in credit granted by the entire commercial banking system in 1989-1992 (JD54.4 million out of a total of JD2.2 billion of additional credit). lhe tot portfolio of ACC is another l)D50 million, which does not do much of a difference for the financing of the sector as a whole. Since this balance has not changed significantly in the last several years, it can be said that the share of agriculture in the growth of the financial system is practically nil. 6.22 The agriculture sector investments are essential for the welfare of the economy and that of the famers, and they require both the involvement of sophisticated businessmen and very large amounts of resources. No private enterprise, however, would idvest in this sector, and no private bank would finance it. as long as it is perceived as a sector which will always be subsidized and bailed out by the Govenment, financially or otherwise, and that all business decisions will be delayed and filtered through political channels. 6.23 The ACC appears to be in a process to be converted into a commercial bank. This could help in the solution of the problems of agricult financing or it could lead to fiarter and more complicated problems, depending on the way the new bank is structured and on how the fiacing of the sector is approached. 6.24 Financing the Sector. The financing of agriculture will improve only to the extent that financial discipline is introduced in the sector. As long as discipline is lacking, the resources flowing toward the sector will be meager. Even if the ACC mobilizes resources from the public and lends al1 of them to the sector, the current lack of discipline would surely lead to a crisis in the new bank, which would be solved at a very high cost to the Government, and to a decision to restrict the powers of the new bank. Ihat is, in the long run, after an Intervening crisis, the financing of the sector would again become a function of the Central Bank's credit. 6.25 In the short term, however, private financWd hnstutions are unlkely to step in, given that the market discipline is lax in the sector as a whole - not only financaly, but also in terms of pricng of inputs and outputs. The solution to the problems of financing agriculture should be part of an overall strategy aimed at enhancing the role of market forces in the sector. JORDAN: CEM 175) 6.26 he Struc of the New Bank. Financial discipline and streth is a must in all financial institutions, but even more so if they mobilize deposits from the public. A finatcial isituion lending exclusively to a risky sector will tend to be weak due to a lack of risk diversification. For this reason, it would be better if the new bank is give a normal charter, allowing it to lend to all sectors in the economy. Also, it should not subsidize credit, for the reasons stated above, and should not enjoy any privilege in its operations. The transfrmation of the ACC into a full-fledged bank would require a thorough cleansing of its portfolio. Quite importandy, the culture of the bank should be changed drastically. Collection standards should be increased sharply, and the administration should be business oriented. These reforms would be lasting only if the bank is operating on commercial basis under the majority private ownership. 6.27 As discussed in the previous subsection, however, a fully private bank would not lend to agricuture. A temporary solution would be to keep in place the credit lines that allowed ACC to operate in the past ACC would manage these lines on behalf of the Central Bank. These credit lines shoud not be increased over their current nominal levels, and should be made available to all banks In the system. The objective would be to diminish them through time, making room for the private sector to step in. The Tiandng of Loal Governments 6.28 Local Government financing is carried out by the Cities and Villages Development Bank. Its objective is to finance infrastructure projects of local councils, of which there are about 600 in the couty (176 urban and the rest rural). The institution also finances 'feasible economic projects, like parking lots and shopping malls. The rates of interest they charge are 6.0 percent for rural councils, 7.5 percent for urban councils, and 8.5 percent for economic projects. The maturity of the loans ranges between 15 and 20 years. The lending volume is very small, on the order of JD10 million anualy. 6.29 The local councbs avoid taxing their communities and as a result they have very small sources of income, so that they have difficulties to pay even their current expenses. They repay their loans with an anma allocation of funds from the central Government (about 1D14 million). All these allocations are deposited in the accoun that each council has with the Cities and Villages Bank. the latter repays Itself the due annual instalments with these fimds. The Bank is not always able to repay itelf with these allocations. In 1987, the Government took over the responsibility for interest payments and in 1989 for all the balances due. In other two occasions, the Government has reduced by half the interest payments of the councils. 6.30 As in the case of agriculture, the local councils have very wk incendves for repayment, and vey high incentives to borrow as much as possible, becau they know that they cannot be forced to pay. They have no collateral pledged, and a Govemment instfiution would not foreclose on it if they had. The result is that the Cities and Villages Bak is not a true financial Instution. It survives only becase of the anmual allocations grmted by the Govemment to the municipalities, from which It collects its loans. CH. W: FINJANCL4L SYSTEM 176) 6.31 In other cunties, the finanig of municipal works is cai out by private investors, who buy municipal bonds In the market. TIis ensures a plentful prvision of funds to the loCal ouncils. Thee, however, the municipalities are subject to the discipline of the market, and raise taxes to meet their responsibilities. If this is not possible in Jordan, the Government could avoid many intermediate steps by fimding the municipal works direcdy, evaluaing them with a small team in the Ministry of Municipal Affairs. industry 6.32 The ownership of the Industrial Development Bank (IDB) is mixed. The Government holds 18.5 percent of the equity in the form of common stock. ITe remainder, 81.5 percent, is owned by private enerpries and state owned institutions, in the shape of preferred shares, which yield a mimm 6 percent per year. The Government gets dividends only when they are higher than 10 percent. IDB has four commercial banks on its 10-member Board. Two of them are there because they own more than 10 percent of the shares (the Arab Bank and the Housing Bank). The other two positions are allocated to the other shareholding banks on the basis of rotation. 6.33 IDB is a small institon, with a total long-term ptrtfolio of 1D43 million, of which JD5 million are in equity investments. Tbe level of approval and disbunt of IDB in the years 1989-1991 averaged JDIS million, a figure th increased to JD26 million in 1992. These levels of financing are clearly too small for the needs of the Jordanian industrW sector in normal circumstances; they look even smaller given the restucturing needs of the sector. 6.34 Even if its volume of financing is small, IDB enjoys subsmtal privileges. The Government guarantes its debts. As is the case of the Housing Bank, the loans owed to the EDB are treaed on a par with state Treasury claims, so tgat the insfitution has collection assured. IDB transfers this privilege to other banks participadtg in the Interbank market, for a fee. Other banks deposit the fnds they want to lend in the interbank market with IDB, and the latter onlends them in that markeL In his way, the lending banks get the blanket cover of IDB in case there is a dewlt in the interbank market. DB chages a commission for sharing its legal privilege. Also similar to the Housing Bank, D)B did not pay any import duties until very recently. It still does not pay income tax. 6.35 Unlike the Housing Bank, but lice the other specialized financial institutions, IDB gets all of its funding from the Central Bank and international financial insuions. In the latter case, the Central Bank carres the foreign exchange risk. As discussed previously, IIDB has recently started to pay a 1 percent commisson for this service, a price that seems to be too low. IDB lends at various rats: 11.5 percent for working capital, 10 percent for normal fied investment, 9 percent for new invten a intersting projects, 7 percent fur smalt projects and 6 percent for handicrafts. As discused eadier, except for the smail and bandicraRs projects, 1DB's irest rates are higher tman those which could be obtained in the bonds and money mare. 6.36 IDB provides steady profts of about 12 percen if measred agist the paid-in capital, and 6 percent if maswred against capital and reserves. If its performance Is compared with what could be JORDAN: CEM 77) achieved In a free market by a true private financial institudon, however, it lacds. First, given the level of inflation, around 5 percent, its profitability In real tms i far too low, barely above zero. Second, this profitability is obtained lending at inte rates whidc, although lower ta the baking market, are higher tan what a developed bond market could offer. Iat is, the interest rates pald by indust enterrises would be lower if the institution did not exist, or competed on a level playing field In the bond markets. Since IIB can operate with lower profits ta any private instution and has access to the financial power of the Government and a11 the comecdom of its members of the boad (the most powerfil banks in the country), outsiders who could compete for a share of the long- term industria credit are quite effectively discouraged. Homsing 6.37 The Privilefed Commercial Bank. Ihe case of the Housing Bank is completely differet fom that of its fellow specialized financial institutions. It provides also only small volumes of subsidized credit, at 5 and 7 percent interest rates. However, it is also a commer= c bank, and this, combined with the privReges that its Law of creation grnted on it, turned it into the second largest bank, and the most powerful financial instuion in the country. 6.38 The following is a list of the privileges granted to the Housing Bank by the Law that created iL * The following funds have to be deposited with the Housing Bank the funds of the Housing Corporation; the Housing Cooperative Soceties; the loans and financW aid obtained by the Government or public instiutions for the Implemention of housing projects or the support of construction activities in the Kingdom; cash and other suritles deposited to the order of the Ministry of Industry and Trade under the control of Insurance Law #5 of 1965; funds of Housing Funds created by the Government or public institutions; a proportion, to be detemined by the Governor of the Central Bank, of the total ca assets of the Postal Savings Fund, the Social Serity Fund, the Savmings and Pension Funds of public intiutions; and any other funds belonging to any other official body which the Council of Ministers may decide on the recommendaton of the Housing Bank board. In fact, most public isftions deposit their funds with the Housing Bank. * lhe following flows will not pay either income or socia security taxes: iterest paid on funds deposited with the Bank (mdividuals do not pay taxes on deposits but enterprises do), interest paid on loan bonds issued to the public, prize monies gaed by the bank; and dividends paid by the Bank and the undistributed profs of the Bank. * The Government shall guartee all the obligations of the Bank to third parties unconditionally. CH. Vl: FNANCIAL SYSTEM 1781 * The Housing Bank can acquire buildings by purchase or expropdaten for the construction of housing, commeial and tourist centers, for sale, lease or lnvestmen purposes, as the Board of the Bank may seem fit. * Subject to the provisions of the laws and regulations which give preferea rgbs to secured credtors and mortgagees, the Bank's loan agreement shall be regarded as enforceable documents, to be execued by the competent authorities on the basis of a letter from the General Manager or his Deputy. * The funds and rights of the Bank should be considered as the fimds and rigts of the State leauy. Accordingly, in respect of all debts and dues, the Housing Bank shall have priority rights over the movable and immovable properties of the debtor and his guarantrs, whether or not such properties are mortgaged or placed as a collateral to secure payments of the debts owed to the Bank. * The transactions of the Housing Bank shall have priority rights of regitration at the Land Registration Department. The officers of the Bank who are duly audtrized shall prepare the mortgage deeds and shall hear and attest the verbal admissions made by the borrowers and their guara . The agreements and deeds prepared by such officers shall be implmented by the Land Registadon and other Government departmenus without recourse to any other proceedings. * The cases presened by the Housing Bank shall have priority in aU courts, and they should be settled before any other cases. 6.39 There are other dimensions to the Housing Bank's privileges. The instkution has been able to increase its deposits even if not in compliance with the mandatory capital/deposits ratio, which applies to it as well as to all other banks. In 1991, the Housing Bank's ratio stood at 5 percut accrtding to its audited reports, which meant that the instion had to either reduce its deposits by 29 pecent or increase its capital by 40 percent while keeping its deposits at the same level. Instead, it incrased its capital and reserves by 9 percent but increased its deposits from customers by 28 percent. As a result, its capitaldeposits ratio went down to 4.3 percent. If smaller banks are forced to comply with this ratio, and the Housing Bank is able to Ignore it, the advantages enjoyed by the latter to acuire market share become even sharper: the competition has to resain its growth to meet the ratio, whUe the Housing Bank can keep on growing, even if its ratio Is going down.' The Govenment is eliminig the capital/deposits ratio in the discussions of a new Banking Law, so tha tis problem will diappear. However, the poin Is that, as a result of its size and privileged status, the Housing Bank has been able to violate a regulation for a considerable period. Ibis discourag compedit 1 Aa Jh afJhe afeAaWJ,J qf th ak 1.gei' Abea WVe & ati mm *uE. JORDAN: CEM 1791 6.40 ITe Monopolistic Behavior. Certainly, in a country with a traditionally strong demand for housing, there is no need for granting any privilege on any institution to finance it. Although the Housing Bank carries out some cross-subsidization, its limited financing of low-cost housing is in any case funded with Central Bank resources. Thus, the privileges of this institution work mainly as powerfil instruments to mobilize deposits and earn profits more easily than any other commercial bank in the market (the Industrial Development Bank shares with the Housing Bank some of the privileges on collections, but is not a commercial bank). Armed with this list of privileges, and with the size that these have afforded it, the Housing Bank is able to exert considerable monopolistic power in the commercial banking market and is currendy expanding its operations by purchasing shares of new ventures unrelated to housing. In this way, its power is growing not only thogh lending volume but also through direct ownership. The rigidity of the commercial banking market owes much to the lack of competition created by the artificial factors which give a domiant position to this institution. 6.41 Forcing the Housing Bank to increase the cross-subsidization of its operations would be wrong. It would weaken it financially, which, given its size, could lead to serious problems. Rather, housing financing could be carried out competitively, at a lower cost than the current 11-12 percent charged by the Housing Bank in its non-subsidized loans, by all financial instittions if a secondary market for mortgages is created as proposed later in this paper. 6.42 The Risks of the Inson. The way the Housing Bank operaes not only restricts competition but leaves it vulne'le to two serious sets of risks. The first set comprises all the rislks that come from the conflicts of interest natural to an institution which owns enterprises it also finances. In most countries, these conflicts of interest result in overfinancing of the bank-owned enteprises, as well as a soft treatment in the case of financial problems. Most of the gravest fncial crises in the last decade and a half were caused or aggravated by such conflicts of interest. ese crises include the cases of Spain, Mexico, Chile, the former Yugoslavia and the Savings and Loan crisis in the United States. In al these places, banks used soft criteria to lend to +heir own entrprises, and kept on lending to these enterprises even it had become clear that such entepris were not solvent. The second risk is that of lending long with short-term funds, a problem we wil discss furiher below. 6.43 Concern about these problems is heightened by the low profitability of the insdtition, vwich makes it difficult to recapitalize through normal profits. According to the audited reports, its profits before taxes in 1992 were JD6.0 milion, equivalent to 17.3 percent of the average net wealth during 1991-1992 (3D36.1). This is low in the Jordanian market. As a comparatr, the ANZ Grindlays Bank makes 26.2 percent before taxes, with a capital/deposits ratio of 11.5 percent, while the same ratio for the Housing Bank is 4.3 percenL If the effect of the leverage is eliminated, the ANZ G(ndlays Bank's profitability is six times that of the Housing Bank. 6.44 That is, a substantial part of the Housing Bank's profitability is attributable to its excessive leverage in terms of the Central Ba's ratios. Given the volume of its deposits, Its capital should be lD58.9 million. With the present assets, the bank would be making only 8.6 percent if it had the minimum capital that other banks are forced to have. This rate of profits is very low, well below the CH. WI: FINANCIAL SYSTE 180) lending interest rate. If the bank stopped growing, keeping its deposits at their urrent level, it would ke it between 4 and 5 years to get in compliance with the Centralank regulations. That is, the capital of the bank is weak both in accounting terms, in terms of its capacity to generate profits, and in comparison with the other banks. 6.45 The smooth functioning of the financial system requires a recapitalization of the Housing Bank. Such recapitalization, however, should not be carTied out by the Government because the lack of capital has not yet produced losses to depositors. Instead, the Housing Bank should be fuly privatized, and the private owners should provide the necessary capital. The Lack of Motivation to Increase Efficlency 6.46 No matter how well these specialized institutions are managed, they enjoy a virtual monopoly in their fields, both because they enjoy privileges that others would not share, and because no privae institution would dare to compete with the Government. As a result, the needs of many individuals are left uncovered. T'is is particularly true of small enterprises without connections. 6.47 This is a grave problem. Most of the investment and employment in economies in transition is generated by small businesses. In Jordan, these businesses do not have the recourse to syndicated loans, and must go to the specialized financial institutions, which provide only a limited range of services. As long as these institutions have a spread and a volume sufficient to cover their expenditures, there is no Incentive for them to improve their efficiency, reduce their costs or compete aggressively to increase their operations. Their monopoly ensures that an enough number of customers will knock on their doors. 6.48 In a competitive environment, where they did not hava their supply of funds assured, these Institutions would be among the premier issuers of long-term instruments, spearheading the development of a flexible market. But, why should they go into the expendres of doing that, if they can rely on the Central Bank and the inteational financial institutions? In addition, they have no incentive to show the way to reduce their customers' interest expenses by cutting through their spreads and those of the banks (as mentoned above, the enteprie could pay lower interest rates for their borrowing and still offer interest rates to the savers that would be more atractive than those offered by the banks). Doing this would reduce the income of their own insituon, both becuse many customers would go directdy to the market, and because this would reduce the lending interest rate and increase the cost of funds. 4. Bank's Prudental Standards and Supervision 6.49 In the wake of the crisis of the late 1980s, the Central Bank escalated its prudental regulation and supervision efforts. While progress has been made on this area, bank inspection still lacks some of the broad scope necesary for the supervision of a modern banking system. It needs to shift its focus from literary compliance with specific regulations to a broad assessment of the soundness of the supervised institutions. JORDAN: CEM PI8 nne Valuatlon of the Portfolio 6.SO Collection Riskm. The Centdal Bank has already put in place a system to evaluate the welection risks of a bank's portfolio, and to force provsions and write-offs on those assets whose risks are higher than certain limits. This system, howemer, concentates on the peformance of the loans and the value of the collateral, rather than on the enterprises' ability to repay their loans on the basis of the financed projects. While past information is useful, the performance of enterprises and entire sectors is likely to change much faster in the new liberalized eAvronment than in the past. The banks should pay more attention to the analysis of the economic trends of the coutry and their implications for credit risks. The supervisors should take these factors into account when analyzing the banks' portfolios. 6.51 Bank inspectors do not analyze the diversification or concentration of risks of the banks, either. This kind of analysis is essental to get a picture of the general soundness of a bank management. The current concentaton of credit on sectors related to real estate, for example, should be a source of concern, and the banks' supervision staff should be monitoring closely the developments of those sectors in order to evaluate more accuntely the exposure of the banks in those activities. 6.52 The Market Value of Assets. Currently, financial institutions adjust the value of their assets only with respect to the probability of collection, building reserves or wrting off only those which have become uncollectible. But the probability of collection is not the only factor affecting the value of the finmcial assets. Anotier crucial factor is the interest rate, which affects the value of an asset inversely, so that the higher the intrest rate, the lower is the present value of the stream of income produced by the instrument, and therefore the lower is its price. Currenty, the financial institutions are allowed to carry their assets at the original value, regardless of the interest rates prevailing in the market. This practice overstates the institutions' ability to generate net profits, and therefore the value of their assets and that of their net worth. 6.53 This problem exists in several long-term institutions in Jordan. The Housing and Urban Development Corporation, for example, holds a substanial portfolio at 5 percent amnual interest rates while the market rate is at least 10 percent. Te value of this portfolio is atually much lower than its book value, which means that the HUDC has lost a substantial portion of its assets. All other institutions working in the long term, including the Housing Bank, 1DB and many commercial banks, still carry in their books loans lent long at fixed iterest rts lower than those prevaiing today. As a result, their balance sheets do not reflect the true value of their capital, which could be negative in some cases. 6.54 The consequence of this is that information is not transparent and serious problems are ignored in the evaluation of the performance of the financial insttutions. These problems include the possibility of insolvency, which becomes apparent only with time, as the institution finds it impossible to generate enough resources to service its obligations. This possibility becomes rapidly a reality in the case of institutions lending long with short-term resources, such as the Housing Bank. The lack of competition in the financial markets, however, has allowed the Housing Bank and other CH. V: FINANCLIL SYSTEM (2) commercial banks to transfer the losses they have on their old portfolios to the new customers, who pay higher interest rates because of this. In the case of institutios borrowing log from te Central Bank and International financial institutions the problem is transferred to the Central Bank, with the comequences discussed previously. 6.55 If the financial markets become more competidve, these artificial solutions will disapear, and institons with substantial losses caused by this problem will have to absorb them and prevent their recurrence. Bank supervision should monitor this dimension of the value of the banks' portfolios, demanding not only the proper valuation of the assets but also the solution of the solvency problems caused by the losses that such valuation may uncover. lquidity Risk 6.56 The matching of maturities should also be a matter routinely monitored by the bank superiso, even if the interest rates are floating, because of the liquidity risks. A perfect matching of maturities is not possible in the real world, and the profitability of the banks can be frequently increased by creating some mismatching on purpose. However, the disrepancy between the maturiies of assets and liabUities should be carefully designed and monitored, so that it does not result inadvertently in an unacceptable level of risk. Matchng of Foreign Exchange Positions 6.57 The Central Bank already has strictly suprvised regulations regarding the exposure of the baking system to foreign exchange risks arising from the currency compositon of the assets and liabilities of the banking system. Capital Adequacy 6.58 While the Central Bank is already aiming at meeting the 8 percent capWtallassets capital adequacy requirement established by the Basle Committee, there is one aspect that is fudamentl t tha requrement that is still not taken into consideration. This is the diffeentiation of the capital requiements according to the risk of the investment. According to the Baste Convention, the capital adequacy ratio is the normalized sum of different ratios that should apply to diflfrent categories of assets, with lower requrements established on the less riskv assets and higher requiements on the rkier ones. Certainly, the banks in Jordan now have a very large share of their assets in very low risk assets, such as deposits abroad. However, some banks also have assets that are obviously high- risk by any international standard, such as investments in shares of enterpises. Currently, relations restrict these investments to 75% of the capital of the banks, and sets a limit of 10% on the share of the capital of any one company th banks can own. These regulations are not enough. The capital adequacy requirements for these investments should be one. That is, the instiion should provide one unit of capital for each unit Invested in shares. This regulation makes sense from both prudena and competitive points of view. JORDAN: CEMR311 6.59 From the point of view of prudent management of a bank, investing in shares should be discouraged becase of several reasons. * Shares do not promise a cerla reurn, while the banhs promise a certain rden on their labies. Ts eates a serious proble of ismathding of mawie and yields In the assets and lable for the banking systen, shull., to the one dcsswed #bove under the headins of idts rte risk ad li yrisk. Te pmoblem is worse because the dividends from the shlas may not only/dal to coinde wi the expenses qued to fnane them: they m even fail to appear. * Since therprice Is naturaUlly volatile, storing liqty in shares Is extremey risky for a bank. If for example, nerest rates go up and dividends do not, the ban faces #lity. If the beak is fomed to sell the shares at Ath panular moment, t will most probably find that e pdes of the shaes have gone down - as t is usual when interest rates go up. This effect is more marked in shares than in shoiftem debt Instnunent. hus, the quty easily tnonW ed into heav losses. Qf come, the prices of shares may dedine for reasons different to the Ierest RAew. * The naturlfuduaons in the pres of shares connuously afet the voine of capita avaiablefor supponIng the nomal lending operations of the banks. If as it should be done, the net wealth ofthe banr is alasted whenever there is a/fal in the prices of shares, the banks' shareholders should be reasingthe capaof the bak or redun Is voluwe ofoperation. * Investng in shares creates the conflcts of inbrest aady discussed In connection with the Housig Bak. 6.60 From the point of view of the overall allocation of resources, the bank's ability to levea their capital to buy shares biases the level playing field that should exist in a competitive system in favor of the banks, tending to concentrate the ownership of enterprises in the banking system. The shareholders of banks could use funds from the population, which receive low ren because they are supposed to be invested in secure assets, to invest in shares, which offer much higher returns against higher risks. If the investment goes well, the shareholders gain in the difference in yields between risky and non-risky assets. If the investment goes badly, most of the losses go to either the depositors or the Government. i.61 People buying stocks on margin also can leverage their investments. However, they pay a much higher rate of interest than the shareholders of banks pay when their bank buys shares (the lending rate versus the deposits rate), their leverage is much lower (50 percent of own funds against 8 percent or less for a bank). When combined, these two factors give a decisive advantage to the shareholders of banks using their banks to buy shares. Table 6.1 shows a hypothetical comparison between the yield over own funds that an investor operating on margin and a shareholder of a bank with the leverage of the Housing Bank (rado of own funds to assets of 3.7 percent) can obtain from a CH. WI: FINANCIAL SYSTEM Pfl share offerig a 15 percent return. The cost of funds is calculated as the weighted average of the interest rates paid on the borrowed funds and die opporunity cost of the own finds, which is asumed to be equal to the deposi ra in the banking system. For the Investor on margi, the cost of funds is equal to the intrest rate on margin operations (13.5 pecent) times 0.5 plus the deposits rate (5.5 percent) times 0.5, while the cost of funds for the ban's shareholder it Is equal to 5.5 percen (the borrowed funds for these sharholders ar. thf, deposits of the population in the bank). On account of the differet costs of funds, the common investor would earn 5.02 percent net on assets while the bank's shareholders would make 9 percent net. Becase of the leverage, however, the common investor would make 10.05 percent on his or her own funds, while the bank's shareholders would make 246.75 percent. TABLE 6.1 YIELDS ON lNVEVMEN7S OWN FUNDS TO COsr OP PUNDS NETr YELD OVER N1;T YELD OVER ASSETS _ ASSETS OWN FUNDS COMMON 0.5 0.09S 5.02 pwmit 10.05 peieu INVESMR ON MARGIN__ _ BANK'S 0.037 0.053 9.00 pwat 246.75 poent SHAREHOLDER 6.62 Of course, the leverage also works bacards. If the yield of the shares becomes negative (as a result of a drop in prices, for example), the financiers of the banks' shareholders would lose more and more rapidly than the financiers of the margin operation. The bank's shareholders share the 96 percent of the risks with the depositors of the bank in the case of Table 6.1, but get 100 percent of the profits with less than 4 percent of the investment Ihis destroys the competition in the capitad markets, ensuring that a very large share of the ownership of the enteprises will end up with the owners of the banks. 6.63 For this reason, if the banlks are allowed to inest in shaes with the same leverage they use for all other assets, the ownerhip of bans becomes atractive as a means to build indusri empires rather than as the ownership of a bona fide finaci Instimion. This eventualy perverts the role of the banking system, and prevents the creation of ventre capital and imvestment companies, the a pt institutions for equ Investments. 6.64 These problems would disappear if the capital requirement for investments in shares is set as 100 percent. he capital left for the normal lending operatons of the bank would be left unaffcted if there is a fail In the price of the Shares, and the unfair advantage that the banks would obtain from leveraging their sharolding with funds frnm the population woul also be eliminated. I the shareholders of a bank want to invest in a company, such a reguation would force them to provide 100 percent of the funds needed as equity capital in order to have th3 bank buying them. This would put them under the same confdions as the common investors in the country. JORDAN: CJM 15 c I= SYNUClEAL IRON I1 CAPITAL AMAf 6.65 Ihe Amman Finanial Market (the stock exchange) has exeienced an impressive development since their establishment in 1978. Yet, it is still not a major force In the financing of investment in Jordan, most of which is financed by bank syndications and by the specialized financial stintons. The evidence points to institutional deficiencies as the main cause of thbis phenomenon. Ti section examines the itutional problems inside the capital markets. A description of the institutional setting is provided in Annex VI.2. 1. The Functioning of the Capital Markets General Issues 6.66 The most Important issue is the lack of a full-fledged Government institution in charge of regulating and supervising the transparency of the stock exchange transactions. lt could be argued that no supervsory agency is needed becwse the Govetment is already involved in the operation of AFM, ftrough the ( ntrol of Its finances, and the appointment of management and the Management and Issues Committees. This arangement, howwer, is inadequate for several reasons. * It creates underable rigidities in the mctioning of the market. The AFMs dependence on the General Budget introduces an undesirable rigidity in the operation of the market. The rapid expansion of the market requires fast decisions to improve the technology of the transactions, which should be fully funded witi the incomes received by AFM and decided upon as soon as the need arises. Appointment by the Government of the managers and most of the members of the Manement and Issuing Commies - the entre management stucture - leaves few degrees of freedom for private initiative in the management of the institution. * It prevets the Government from taking the detached attitude th an effecive regulatory and supervisor ageacy should have. By involving the Goverment in both the operation and the supervision, the present anment createw, serious conflicts of interest that shoud be elimnated. The AFM should become a fuly private entity, supervised by an agency similar to the Securities and Exchan Commiions tat eIst in many countries. Tbis would establish a clear division of responsibilities, which would increase efficiency and ece accountability. AFM is aready working on this problem, trying to make a smaoth transition to a new regime in which regulation and operadon of the stock exchange would be separted. The sategy being considered is to split the Intern management of AFM Into regulation and operaion, work with this anrgement for some time, and then carry out the spi. This would be a satsfctory arrgement, becamse it would minimize the impact of the split in the operation of the market CH. W1: FiNANCIAL SYSTEM 161 There are other important issues: * D icosue While the AFM publsh dmely and detaied Information about the operato carded out in the stock excdange, disclosure is quite poor in Jordan, both in Ums of fiming and quality. In early Jly 1993, the latest information available on the accounts of the participating eerprises was for 1991. According to many of the participants iterviewed, the quaity of the information published by these enterprises vaies widely, with an ave ta would be considered poor in developed capital markets. This problem is related to the need to improve the auditing standards of enterprises in Jordan. * lAck of ethical codes among the brokers' community. In all developed capital markets, the brokerage community and the stock exchange authorities develop a code of conduct, which functions alongside the prudential and ethical regulations established by the supervisory authorities. While such codes include many subjects, they give much importance to controlling Insider trading, both ta Involving funcdonaries of the issuing enterpises and that involving functionaries of the brokerage houses, investment banks, aid other insituons participating actively in the trade. The stock exchange members establish these codes motivated not just by moral reasons, but by reasons of economic survival as well. If the idea that the AFM is rigged by insider trading becomes pervasive, the capital markets will not develop, and would be in danger of collapsing. It is in the iest of the market participants to gve assurances tD the public that the transactions in the stock exchange are conducted in a fair and professional manner. e fle lack of market makers. All developed capital markets allow the operation of agents trading on their own account as well as that of brokers opeaing on behalf of third parties. The market makers maintain a double quotation on a mnber of securities, the bid and the ask prices, and are willing to buy at the fomer and sell at the latter. Their operation is essenal for the smn*t functioning of the market for two reasons. First, they provide liquidity to the markets. Second, they provide pricing information for shares and bonds traded inrequently. Tme lack of these operators in Jordan negatively affects the functioning of the markets. It partiularly depresses the market for smaller, less well known enprises, as potential buyers fear the possibility of not finding buyers for these securities if they decide to sell. This, in tun, discourages new enterprises from going to the market 1aues In the Equity Markets 6.67 The reluctaco of enterprises to issue share Is fiequeny explained as a consequence of the curret Ishareholders' fear of losing control of their entprises. This fear is unwaranted in wmost markts because most shareholders are intersted in the income generated by shares, not in controiling the entepis. In Jorda, however, there is an obJective dimension to the entrepreneurs' reluctance to go to the market. Such reluctance the following pwvisions of the Companies Law. JORDAN: CEM 187 In= a Diludon of ownership. The rules of Companies Law unnecessarily force the dilution of the ownership rights of the original shareholders. According to the Law, the participation of each of the original promoters of a newly listed company must not exceed 10% of the total share capital when taking the company to the market. Also, the promoting group must not take more than 50% of the subscribed capital of bank, finAncial and insurance companies and 75% of other public shareholding companies, but they must take at least 20% of new issues. Furthermore, when Issuing new shares of established companies registered shareholders shall have priority for the urderwriting of not more than 50% of the new shares. The result is that it is impossible for the owners of a public quoted company to grow by issuing new shares and at the same time keep control of the company. There are reports that these rules do not affect the decisions of entrepreneurs because they can make extra-legal arrangements to keep their shares through registering them under the names of other people. This practice damages the transparency of the market, adds a dimension of risk to the transaction and burdens the enterprise with the withholding the truth from its own shareholders and the regulators. The practice of registering shares under the name of another person is called 'parking' in other markets and is a crime. It Is a well known vehicle to conceal insider trading and tax evasion. If the Government wants to prevent and punish insider trading and tax evasion, it cannot allow this to be done. Thus, the companies law shoud be changed in order to aSlow enterprises to float equity while gonly and legnajy retaining control of their enterprises. * Arbitrary pricing of new issues. The 'lssuing Committee' of the AFM calculates a price for the new shares by weighing the book value and the market value of the shares of the company increasing their capital, which tends to under-price new shares, and transfers an unwarranted subsidy to the primary buyers - who realize instantaneous profits without risk. Finally, by setting the price, the Government assumes a responsibility that it should not take. Prices should reflect market conditions. The Government should step out of this. Instead, it should establish the already mentioned Securities and Exchange Commission, which should not price the issues but certif y that the information contained in the prospectus accompanying new issues of both shares and bonds is correct. * Taxaion of capitalized earnings. Capitalization of reserves is taxed at 15 percent, equity enables the company to grow while dividends and capital gains are tax free. The companies should be encouraged to accumulate reserves, which strengthens their growth potentia and future income tax paying ability, and the 15% tax on capitalization of reseves should be abolished. * EIgb administive coss. The Companies Law establishes the minimum denomination of shares certificates as 1 Jordanian Dinar. As a result, the share registration department of the public quoted companies face large and costly worldoad. New issues in 1993 are reported to have attracted more ta 100,000 new investors for the issuing companies. A minimum size of 200 JD would be welcomed by the public quoted companies. * Cumbesom e regItration procedures. The Shareholders Register is kept by the public shareholding company. Each time a share is traded a new certificate is issued by the CH. Vl: FINANCIAL SYSTEM P81 company. Due to the very large number of shareholders and the 1 JD size of ttie certificates, the Shareholders Register employs a large number of people at each public company. The AFM is looking Into the possibility of Imstalling a computeized Central Shareholders' Register. The centra registe would gready enhance the process of registradon of shareholders and transactions. Isues In the Bond Markets 6.68 There are several factors undedlying the underdevelopment of bond markets, among them the sudden burst of inflation of the late 1980s (which caused large losses to the holders of fixed-rate bonds), the lack of development of long-term savings sitions, and the privileges enjoyed by the speciaized credit institutions. The first problem could be easily solved with the issue of floating-rate bonds, and the other two could be solved if the Government carries out a modernization of the financi system. There are, however, some problems that should be solved to frtiher promote the development of bond markets. - InfrmatIon. The prices, volume and key ratios of the bonds traded in the market are not published in the mass media. Ihese data should be published every day. * Lack of bechmarks to price bonds. Government bonds establish the basis for the development of the bonds markets In most countries by providing a measure of the price of riskless obligations at different maturities. However, the progressive reductions of the fiscA deficit and the financing from abroad will limit the requirement for issuing Government bonds, which deprives the market of a benchmark for the pricing of private sector bonds. In the long run, the financing of public investments through bonds could resolve this problem. In the short run, housing mortgage-backed bonds - proposed later in this report to finance housing - could supply an altaive benchmark. 2. Isues In Long-Term Savings Institutions 6.69 e main purpose of long-term sav 5gsl nstlutions is to provide a lump-sum, or a stream of sums, at the end of one period, or throughout a series of flure periods. They promise savers to do so in exchapge for a lump-sum payment, or a series of payments. They can compete against the banking system only if they can offer higher expected yields than those that could be obtained by depositing the savings in short-tetm instuments and rolling over the principal and interests - which the savers can do by themselves withoIt having to pay for the administrative costs of the long-term saving stition. Their main risk is that the savers's payments plus the yields they produce will not be enough to cover their obligations with the savers. 6.70 The long-term saving inituions can compete in a fee market and make se that they wi be able to meet their obligations only by investing in the long-term, for two reasons: JORDAN: CEMR189) * First, aerest rates tend o te higher the longer ematurwt of the instrument. Ibus, long- term institutions can get higher interest income than banks for the sme amount of investment. * Second, long-term Instruments reduce the risks of not generating the amount of money needed to meet the obligations in a fumre date because they maintain a yield throughout their life, making it possible for the Instution to make an accwrate estimation of its fure cash flows. Investing in the short term leaves the institution vunerable to shifts in the shortterm interest rates. Ihe prote'ltion offered by the long-term instruments is complete only when they are zero coupon bonds (obligations promising a lump-sum in the fiuture, with no payments in between). Bonds and other obligations paying periodic sums pose the problem of reinvestng the proceeds of these payments. If the interest rates change over time, the yield on the reinvested payments could be lower than the yield of the original instrument. The errors that this risk could introduce in the estimations of the long-erm savings institutions, however, is much lower than that they could have if the entire amoum were invested in short- term instruments. 6.71 The reasons to invest in long-erm insuments are obviously valid for fixed interest rates. They are also valid for floating instumens, which carry a fixed spread over some interest rate indicator. A saving isttuion investng in floating rate istments should also have floating obiatons, offering not a fixed sum at the end of a period, but a variable sum, ultimal*ly deTmined by the yield of its investments. In this case, the advantage of the longterm instution is that it can obtain higher spreads over the indicator because it invests long. The spread over the indicator, however, can change over time. A long-term instument keeps this spread fixed through the life of the Instrument, which would not be true in the case of rolling over investments In the short term. 6.72 Thus, the opimal strategy for long-term saving institutions, the one that makes them viable, is to invest their funds in the long-term, capturing the extra yield of such investments and the stabilit they give to their income. 6.73 Current regulations and practices, however, hamper the ability of the long-term institutions to pursue this strategy. * Flrnt some of these Institions subsidize bg-term loans for their beneficlarles, mailly for hosing. This destroys the itegrt and purpose of a long-term saving instittion. Each subsidized loan means that the funds available for the rest of the savers will be lower than possible. These practices should be eliminated, allowing the long-term savin institutons to imt in the instruments that offer them the best combination of risks and yields. * Second, sever of these institutions deposit a substail portion of their hinds in short-tem nsbumes and lack a dear investnent strate. For xmple, in mid-1993 the Social Secrity had 47% of its resources deposited in short-term istuments. A new management is already implementing a new Investment strategy which would result in a CH. WV: FNANCIAL SYSTM PO] lengthening of the matrity of its portfolio. Regulatory authorities should make sur8 tt this is done throughout the sector. D. I= WV.G1UM PEuSPrIMVE AND SRATEWY FQO NACIAL TRANSIPORMATON 6.74 The country is now going tbrough a transformation from inward and regional orientio toward an outwd oriented approach to growth. It has taken the first and fundamental steps in dtis direon, by reducing protection, eliminating most price controls and liberalizing trading and financial transactions. These reforms, however, may fail to produce the desired results if other, sectoral aad 5tructr measures are not taken to ensure that the Jordanian markets become truly competidve and open to the forces of the international markets. This section presents a vision of the shape that the financial system in Jordan could take in order to help in meeting these objectives by Improving the efficiency of the allocation of resources, and by improving its abiity to manage risks. The main objectives of reforms in the financial system should be the following: first, to allow for efficient specialization in a unified market, in which the providers and users of funds would compete with each other to find the best instrument to finance each activity; second, carying out this domestic ir ration while integrating the domestic financial system with the international markets. 1. Te Integration with the Rest of the World 6.75 The integration of the domestic financial system with the rest of the world is essent if the system is going to play a role in the integration of the economy with the international markets. Tlis s so for three main reasons: * First, the domestic producers and traders need a wide net of finacial support, going around the world, to sell their wares in foreign markets. Enteprises in the most successful exporting countries in the world have access to such a network through their fiacial systems. It cannot be expected that the Jordanian exporters succeed in their competition against these enterprises if they do not have an equal access to such a network. * Second, exporters and other producers in the successful countries have also access to the deep markets in futures, options and other derivative products that can be used to hedge against risks, and to all the wide facilities that the developed markets can offer. The Jordanian producers should have an equal access as well. * Third, the needs of the domestic savers should be taken into account. In the old, traditional approach to economic development that dominated the policies of developing countries in the last several decades, those needs were ignored, gning absolute priority to the needs of the borrowers, which were supposed to lead economic growth. Hence the policies that artificially reduced the costs of borrowing from the domestic and international markets, at the expense of the real value of the JORDAN: CUI]9 savings of the popuation. In most cases, this resulted In the squandering of the saving of the population, creating severe social problems and defeating the ultxime purpose of economic developmen: improving the net wealth of the popuon, and therefore its welfare. Access to aving abroad would allow the diversification of risk by savers, and would enforce the need to use them properly in the domestic markets. 6.76 The integration of the fincial system with the international markets requires the dicrdi of the mercantlistic prejudice that capital inflows are the only capital flows thit are good, and that capital outflows are uniformly bad. As the current situation of the country shows clearly, capital inflows can exceed the country's ability to absorb them, becoming a source of inflation of nonradables and the accompanying appreciation of the currency. Also, this prejudice igŁ ' he fact - shown so clearly in the strategies of the most successful expordng counties in the wcr '.iat developing sustainable exports requires heavy investment by the exporting enterpses in . _ target countries. A stable market cannot be created without joint ventures wih traders and producers in the importing countries, carried out to develop marketing skills, to establish a market presce and sometimes to produce parts of the exported products abroad. Enterprises failing to do this are always subject to the vagaries of the purchasing decisions of Importers, and are left in a perpetual price war with potntial and existing competitors. 6.77 Even more importantly, the key to success in moden business is the ability to organize and reoranize chains of supply, taking avatag of the most convenient production facilities, financing, and marketg organizations, wberever they are In the world. 'Tis means that, to be competitive, local producers shoud be able to do the same. If the best place to prowdce some part of the final product, or the entire product, is another country, Jordanian entepreneurs should be able to nvet In production faclities in such another country. There is no gain in forcing the local enterprises to produce locally only to lose their compeftiveness. Rather, the physical and legal Infrastructure should be such that it becomes profitable to operate from the coutry. 6.78 But, even if a country has a first-rate infrastructure and an efficient legal and bureaucadc setting, it cannot expect to have comparative advantages in all areas, not even in all the areas relevat in the production of a good or service. The Internationalization of car production is well known - a car produced in the United States may have an engine produced in Mexico, with many parts coming from third countties, and other components made locally and abroad. The same is haening wit almost every product These combinations are made through alliances, which allow for the participation of al the actors in the design and development of the final products. If the local investors are not allowed to invest in these alliances, they are denied the opportnity to paticipa In the production of the goods, and to be part of tha technological revolution. 6.79 The strategy now followed by the Central Bank in its stabilization efforis - allowing and indeed forcing the banks to deposit their foreign exchange deposits abroa - is a step in the right direction regarding the elimination of the mercantiist prejudices. Today, the system is working under the pressure of both the stong capital and remittances flows that followed the Gulf crisis and the macroeconomic adjustment progam. In the future, it can be expected that the system wiU be maret- CI I: FINANCIAL SST P21 based exclusively, hopefilly extended to other fincial Intermediaries, rgulating automacally the inflows and outflows of cash accordig to the financial needs of the ounry. 6.80 The evolution toward this system, however, should be gradual, and timed in accordance with circumstances. Jordan is already moving toward compliance wifth Article VI of the BeF articles of agreement since curre transfers have become largely free of restrictious. Trasfers to non-resident accounts are free, and some capital transfers are allowed, particularly in the case of Arab couies which permit their residents to invest in Jordan. Ihis process of liberalkation, however, could be hindered by moving too rapidly to full opening of the capital account, which should be carried out only when the domestc market becomes more used to the liberal policies, and more resilient to false rumors which could cause undue and irrational flows. Thus, the objective of opening the ficial markets toward the rest of the world should be made consistent w"i the objective of keeping a stable macoeconomic eavironment 2. A Bluqeint of the New FJnancial System The Basic Shape 6.81 Unit% and Dhest h Ibe new system should allow the open competition and complementarity between the different kinds of financial institutons, permitting the development of the natural competitive advnages of each of them and the srauments natral for their operation. In a free market, some specialization develops according to these comparative advantages. Banks tend to concentrte in the short end of the market and in the provision of multiple services for a fee. Long- term fincing tends to become concentrated in the bonds and equit markets, while the management of some Important risks tends to be concentrated in the markets for futures and options that emerge from, or parallel to, the capital markets. The latter are frequendy ealled the derivative markets. The complementarity arises because the banking system usualy becomes one of the important participants in the capital and derivative marets. 6.82 Prhadog. The basis of an efficient market is competiton, which in turn depends on the motivations of the actors In the market and the existece of a level playing field. It is well known that private enterrse tend to be much more competitive than public sector ones becan6a they are moved by the modvation to maximize the net wealth of their shareholders. Even when making profits are part of the mandate of a public sector insttion, the motivation is weaker because, inevbly, public sector institons have other concerns. Also, as it has happened in Jordan, there is the danger that, in order to make profitable the public sector enterprises, the Govemment provides them with prieges that make it easy for them to be profitable even If they are not efficient nor responsive to the needs of their customers. The profits obWned In this way are not profits in the economic sense, because they are obtaned at the cost of the overal market efficiency. 6.83 For these reasons, and for the reasons that argued privatization of the enterprises In the real sector, the report recommends the true privadzion of the financIal Instituons now controlled direcly or indirecy by the Government. For this, detailed studies are needed. JORDAN: CEM [93) The Role of the Bankdig System 6.84 n CTmhve Adv_ o the dns S - lhey are the following: * It intimate knowledge of the enterprises; * the abilty to use this knowledge to make sound credit decisions and to design and offer services requited; * the appats bank has to mage collections; * the broad basis of deposits that ban can gather as a result both of the advantage listed above and of the role they play in the payments mechanisms; 6.85 The main comparative disadvantages are the following: * most of bank deposits are short-term, which tum highly rsky when these deposits are used to finance long-term operations. Lending long can be highly profitable if well managed and adequately hedged, becase it requires sophisticated services that are paid handsomely by the market; * bank costs of intmediation - which include the costs of branch networks, large staffs working on credit analysis and costs imposed by their monetary functions, such as the legal reserve requirements - are higher than those that a sophisticatad investor and a well-known borrower would Incur if they contact each other directly. Whie all these advantges and disadvantages are Inetwined, it is possible to make a separate analysis of each of them to identify profitable opportunities. 6.86 S. Credit s. Undl now, banks have exploited their comparative advanges as mewas to guide their own iweatments. They, however, could exploit the nfowation they have about the markets, and their abiliq to analyze It, without having to commit their resoumnes in lending opations. They can do it by originang loans and selling them to the public thrugh the capital markets. This can be done,and it is actually done In most developed financia makets, through the process known as secrization. In s n, the orifgnafig bank transfers the risk of the operation to the buying public, but provides the collection services. This allows banks to cash in on their credit analysis skills and on their collection facilities without having to commit short-term resources for the financng of long-term operations. Banks can also participate, as they do now, In the syndication of loans, and can compete in the design of capital market operations with bond and equity fiacing, charging a fee for heir services. 6.87 Most of banks' comparative a come from their intimate contact with the enterprises through the various short-term opetions demanded by the latter. The liquid resources avable for these operatio are lower the higher the proportion of long-term loans in the lending portfolio of the bank. On the other hand, the loyalty of a customer to a bank depends on the ability of the bank to meet its needs, which normaly include not only the short-tem opetions but, more occaionally, the provision of long-term fumds. Thus, a bank engging in seurtzation is in a better competidve posion than others lending long with their own resources, becaus it has more resources available to CH. WV: NEVANCIL SYSTEMJ 1P4 meet any short-trm need, while It can also arrange for the provision of long-term fimds. (See alo below). 6.88 &lng Derivafve Produts and Olhe Ses. Derivative products are mainly futures, options, options on futures and currency and Interest rate swaps. Banks in developed countries are obtaning a large share of their income fom their packaging and selling of these products. Some of them camot be expected to emerge in Jordan, because they need the existence of a profound financial market Yet, the banks can become one of the conveyors of these products for the domesdc customers. The Roleo f Capital Markets 6.89 The capital markets have comparative advantage in intermediating between sophisticated and large savers and well-known users of funds. Ihus, the functioning of the capital markets depends crucially on the existence of large and sophisticated savers. As mentioned before, there is a siderable supply of long-term savings in Jordan. There are however, two main problems regarding the use of these funds. - First, there is a lack of adequate financial institutions and instuments to mobilize and allocate them properly. As a result, a substantial portion of these savings are invested directy in unproductive real assets, mainly real estate. The financial system should be able to compete effectively agaist such investments: they are much less risky, have lower trusaction costs, and can be bought and sold in smaller quantities (real este property is frequendy not divisible, so that, when savers need to make liquid a part of their savings, they have to sell their entire property). * Second, the lack of proper instruments and institons is largely caused by reguations that force the existing long-term saving institutions to subsidize long-term borrowing or to behave as if they operated in the short-term. These regulations negatively affact the operation of the social security system, the numerous pension fimds and the life insurance companies, and prevent the formation of new intiutons, such as investment fnds and other capitalization instittions. 6.90 Refoming housing financing could help in solving these problems, because, in all countries, bonds backed by mortgages tend to be the safest longterm instruments not issued by the Governmt. Properly collateraized and managed, securites backed by mortgaes could become the basis for the development of an active bonds market in Jordam 6.91 B and other financial Insiuons could originate the housing loans, put them together In pools, and sell them in the market. The origiaor would keep the responsibility for collecting the loans, for a fee, but the loans would be sold, so that they would disappear from its balance sheeL One fomed, the issued securides may take different sbapes, so that they can respond to different JORDAN: ClM 1) needs In the savings market, while elimat the term-transformation problems of the banking system. 6.92 The functioning of a market on securities Issued by the banking system requires the establishment of an insftutional setting. In developed markets, the originator does not sell the securities directly to the public; rather, it sells the pool to another company, which guarantees the inteity of the pool, converts It into securities and offers the latter to the public. To guaratee properly the securities, such enterprises are highly capitalized, and very frequentdy sell senior obligations, keeping a subordinated risk on the pool. To guartee themselves, these companies perform in-depth anayses of the mortgages they are buying, or purchase them from specialized institutions that put together the pools, buying the mortgages from the originators. Finally, housing loans are not the only ones that can be securitzed. Ihere are thriving markets in many other kInds of seurities, including commercial credit, car loans and credit card loans. 6.93 Another acdon that could improve the functioning and efficiency of the equit shares markets Is the introduction of market makers - members of the exchange operating on their own account. These types of agent provide liquidity to the market and keep the price information up to date. Tbere are many systems under which the market makers can operate. The report recommends the eablishment of a competitive mechanism, which would allow more than one market maker for every issue. The creation of market makers, however, should not be undertaken until the more fimd_men problems of regulation, disclosure and ethics are solved. 3. The Tranformation 6.94 The taformaton can be accomplished steadily through actons in four main areas. - The elimination of privileges and the privatiation of the finandal Istiutlons now controUled by the state. This would level the competition in Jordan, allowing for the emergence of new market institutions, and the integration within the sector of potental borrowers now left out. * The establshment of appropriate and compstible reglatory and supervi settings for the banking and capital markets. The objective of this nEW setting should be twofold: ensure tbe tansparency of the financia transactions and allow for a healthy diversification of the financial instiutions and markets, built on their competitive advantages. This would not only improve the soundness of the financial institons but would also leave the field open for the emergence of truly long-term intermediaries and instruments. * The strict applicatlon of new prudential regulations. Tbe objective of this exercis should be to enhance the perception of the new risks that come with the liberalization of the economy as well as the ability to manage them in the financial Intittons. CXH. W FINANCIAL SYSTEM PO 6.95 Putting In prcce these three sets of actions would 8ileviate 'tie problems now hamperng the efficient allocation of resources. These problem are at the same dm the source of the unnecessary risks in the system, and are the subject of the privieges granted to preferred insdtutions. In this fashion, for example, the strict regulation of term so ation would force the elimination of privileges In this area, would reduce the risks that the banking system i taking in long-term oprations and would also cre the conditions for the development of a long-term market. Equally, the introduction of proper regulation for the long-tetm savings institutions would reduce the risks and losses now taken by the savers, while creating an efficient market for long-term instrumens. These actions would also make possible to carry on with the forth set of reforms: 0 Gradually opening the capital markets to intermational transactions, allowing the investment of foreigners in Jordan, and allowing the investment of Jordanians abroad - - not only through banks but also through the capital markets. This would establish an indispensable link between the local enterprises and their potential markets. 4. Privatzation and Elmination of Privlege 6.96 The elimination of pdvilege requires a series of general measures as well as particular actions to curtail the privileges of individual institutions. With respect to the general measures: e Ihe Government should charge a more realistdc fee for the foreign exchae risk In new operatio. ITis measure would help in improving competition in general and in increasing the appeal of domestic financing relative to funds from abroad. Since most of the financing from abroad is for long-term loans, this measure would particularly help the development of the long-term bond markets. * Any regulation should be applied mnformly to all isttudons, regrdless of their ownership and size. This would be beneficial from both the competitive and the prudential points of view. * ITe apitalassets irement for shares should be one This would benefit the banking system because it would eliminate the conflicts of interest that appear when a bank becomes a holding company, and would increase competition in the stock exchange. This acdon is also mentioned in the subsection dealing with the reform of regulation. 6.97 With respect to particular actions, * The ACC. The aim in this respect should be to gaully increase the participation of the private sector in the fiancing of the agricultural sector, thus eliminatin the ration;ae for the existence of a Government-owned, specialized financial institution in this area. Eventaly, if the decision of allowing ACC to mobilize deposits from the JORDAN: CEM(9 public is taken, the opportnity should be taken to transform it into a truly private commercial bank, without any privileges. Its charter should be like that of a normal commercial bank, and its shares should be sold to the private sector, without any Government participation In Its ownership. * Given the bad state of the portfolio of this bank, and its traditionaly soft attitude toward collections, it will be necessary to clean its portfolio before privatizing it. * 'he culture of the bank should be changed, introducing a commercial approach to its operations. * In the meantime, the fuids that the Central Bank makes available for the finmcing of the agricultural sector should be made available to other banks. To encourage private participation, which is needed to Increase the flow of funds toward the sector, the subsidization embedded in those resources should be phased out. 3 TMe Housing Bank. The best way to improve the profitability of the bank would be to privatize it, thus establishing the incentives now lacking for efficiency improvements. The privatization should be accompanied by the elimination of privileges through the Issue of a new charter equal to those of the fully private banks. mis transformation will not be easy. Since the Housing Bank has attained its large size as a result of its prvileges, the sudden elimination of these could leave it unable to compete with abler and smaller rivals. This, however, should not deter the authorities from restructuring it, not only because the elimination of its privileges is essental for the transformation of the financia system but also because the risks of leaving it as it is are bigger than those posed by its restructuring. Its portfolio has problems of maturity matching, many of its assets seem to be ovevalued, and It has a growing portfolio of shares in other enteprises. The risks posed by these problems could threaten the institution, particularly because both Its capital/deposits ratio and its profitability are very low. And, the restrucuring of the Housing Bank should be coupled with the reform of housing financing proposed above. * he IDB. Given Its expertse on industrial credit analysis, the IDB could become a fully private investment bank. * Since the banking system would be the natural competition of the new insfitution, selling the common stock to the current holders of preferred shares (the main banks in the country) would result In a serious conflict of interests. To avoid these conflicts, the Government should thdnk of seing Its shares to third parties. * The planning of these actions should be the subject of a special study, to be undertaken immediately. CH. VI: FINANCIAL SYSTEM P81 S. Fstabihng a New Regulaty and Supervory Settng 6.98 While the financial system should be deregulated to allow for more competition and freer allocation of resources, it is necessary to strengthen prudential regulation. The purpose of such regulation should not be to ensure that resources are allocated to particular sectors, or that savers do not lose their money. Rather, Its purpose should be twofold: first, to ensure that financial institions work in a transparent fashion, that they disclose the truth about the risks of their investments, and that they report their results according to reality; second, to ensure that free competition prevais in the financial markets. In part, this objective can be attained by allowing competition from abroad. It also requires legislation to punish the use of insider information and attempts to corner the market in the stock exchanges. 6.99 The regulation and supervision of the stock exchanges requires the creation of an instflution, similar to the Securities and Exchange Commissions existing in developed markets. This institution should replace the existng Itrmnisterial Pricing Commission. The role of the Government in determining the price of primary Issues should be eliminated. A regulatory and supervisory commission is also needed to monitor the performance of long-term savings institutions. 6.100 Ba.kn Snerviion On-site examination (as part of the banking supervision) should aim at determiing the status of overall health of the supervised institution, focusing on its ability to generate both cash flows sufficient to cover all Its obligations, and net income enough to generate profits and susinable growth. This exercise should include, but should not be limited to, the analysis of the loan portfolio and the compliance with the regulatory framework. 6.101 CollectionQlak. Awareness of the risks implicit in a liberalized economy should be raised in the financial system through the work of supervisors, seminars and training at all levels. Bankers and supervisors should pay more attention to the cash flow generated by the project being financed and should make a follow up to supervise the effective application of the funds to the declared activities, and their economic performance, and they should measure other factors increasing the risks of the portfolio, such as concentration of credit on specific sectors and subsectors. In this regard, the establishment of a program to qualify inspectors is recommended; this program would comprise training in place as well as travels abroad. 6.102 Ładng to Mar=. Financial institutions should be forced to reflect in their books the true value of their assets. According to the universal accountng principle that gains from assets' appreciation should be recorded only when realized, and losses incurred by price changes as soon as they happen, the loans in the banking system and specialized financial institons should be priced at either the original cost or the market value esdmated with the prevailing interest rate, whichever is lower. Doing this In the formal accounts could exaggerate the volatility of the balance sheet of the banks. To avoid tis problem, banks could be alowed to price their assets as they do now, but should provide notes making explicit the changes in the value of their capital which would arise if their fixed-inrest rate assets were sold at the date of the fincial statements. The supervisory agency, however, should have the authority to dmd the forma repricing of assets whose rate of interest is way below the market yields. Further, pension funds and other institutions with fixed JORDAN: CU199 obligations in the long term frequently make provisions to fulfill them by choosing the intruments ihat wil give them the required income at the desired moment, and keeping them to matuty. If this is the case, thesn insttutions can be allowed to carry those instruments at cost. Shorter term hitument, or insuments hold for liquidity purposes, should be priced at either cost or market value, whichever is lower. 6.103 Mating of Interest Rates. To prevent the occurrence of losses caused by shifts in the interest rate, the financial institdons should be forced to match the structure of Interest rates on their borrowing side with ta on their lending side. Compliance with this requirement does not imply that the intuions should match each and every loan in their portfolio with their obligations, but only that the modified duration of the lending and borrowing portfolios should be approximately the same.2 6.104 Mahing of Foreign Exchang. In most developing countries, the risks posed by the fluctuations of the foreign exchange rate are asymmetrical, because the risks of having an appreciation of the local currency are much less than those of the opposite event. In any case, if such an appreciation exists, it would take place gradually, not suddenly as devaluations of local currencies happen, giving time for any insdtittion with a net position in foreign exchange to adjust its portfolio. For these reasons, allowing financial institutions to hold a net position in foreign exchanp does not entail a big risk, and may be desirable if, as It is happening today, the Central Bank uses such net position to prevent an appreciation of the currency. However, the net position in foreign exchange of the finaci instimutions should be regulated and closely monitored by the Central Bank because it entails risks for the deposits of the population and carries with it macroeconomic Implications. 6.105 Cat Ado . Equity share investments should be subject to a capital/assets ratio of one. 6.106 Accounting and auditing standards should be revised to make them more stringent and more adequate for the control of financial istitutions working in a new and more libel environment. Disclosure should be improved drastically, both in terms of accuracy and in terms of timing. 6.107 Fmally, the development of long-term financing requires that the Government should Immediaty start a time-bound action plan to make securitization possible in Jordan, with an initia emphasis on housing; that regulations should be issued to allow for the participation of compeitive market makers in the Amman Financial Market; that regulations forcing the long-term savin nttons to deposit their funds in short-term instumenh and subsidized loans should be eliminated_ and that regulations to intoduce transparency in the management of these insttions sbould be issued and enforced. vI M.&dJwidakb raJsrtr ofteida 1eIieh rod thw Ia @.dtkof Iutev keenbe CH. W- FINANCIAL SYSTEM (001 6. The Paee and the Costs of the Transition 6.108 There is no need of a shock treatment In Jordan, the strategy proposed here could be applied gradually, allowing a prudental time for bans to adjust to the reforms. Some strain is inevitable, pardcularly in the following areas: * Cleaning up the portfolios and changing the culture of ACC to turn it into a profitable private bank. * Recapitalizing the Housing Bank, eliminating Its privileges, selling its investments in shares and c g its culture through privatization. As discussed before, this recapitalization should not represent any expenditure to the GovernmenLt. Te needed funds should be provided by the private owners. * Enfordng the marking-to-market system In the valuation of assets. Tlls system should be introduced gradually, giving some time for the banks to adjust to It. * Enforcg a valuadon of risks of portfio o which In many cases would mean that banks wvl have to divest In some sectors. This process should also be gradual. 6.109 Ihe report does not anticipate hat these problems would cause any crisis. Furthermore, it should be noted hat the strain would come from three sources independent from the reforms themselves. * First, the discovery of problems oat already exist, and have not been detected because regulation and supervision has not seached for them. Ibis is the case, for example, of the overvaued assets in the books of HUD, and the low profitability of the Housing Bank and other public or semi-public financil lnstions. * Second, the increwed risks of a liberaized market. It takes a while for bankers to adjust to the new environment, in which fundamental variables that used to be fixed suddenly become subject to wide fluctuations. * Third, the rigidity that public ownership and privilege gives to the fnacial system. Although private financi institutons also require a time to adjust, their natural flexibility gives them an advantage over Government-owned ones. 6.110 The reforms, almost entirely based on the intduction of prudential regulations, would bring about to the surfiae these problems and would aim at solving them before they damage the current process of transforation of Jordan Lt~~~1 dIlil1 CH. VI. FINAANCIL SST 1921 Require a hwse Ptan hesn Comftee - me bak detaAmu VddLga t herts Oh va th pereih to aweea te* pocef *s ht ech etgosy of suhag their mmU anmd Wowlds, ndplaso manae or Requ&r a ann to thidr EMaade ruesfoe g Ote ba et wlth a dIsutlbn of ownrship vaato at cee when a cowpy beomns wrofeti ,Vs of stheir IWd htO AFM Lrsu et d libitesf, ad a Planfor cotiaag my capita pv ukena heky Requir a sesit Tmtien of capfiou analsl of the repeat of retaind ambag desw,"bed bo should be phased out ________ 2. LEAL AAfD MISIITJONAL STUDIEs Ora*e a cmmissin to%a h uiniaiuo h aig~tm iigat aging & sneutrd egavMsg bacenive go d4Oerent eceneauk &Wiv&tis, inddba& d4QWren -- - bo *udd* adtk Creat a tckehncalcmmIrssIo to recmmend an action plan of warkke housin Crat a technical ONt a teh Cv* a tchal coRmm*fo to Aecoam d coxmmss to AP coasasead co _mIssi to recomdmd odn, so r fue an aetn pl so create a en aos pla to eawbih ecapte andpata Seacties ad Echag a modemaey to athe H ing BaskD comLon^ is sc8 rga ad su _______________ elmIntIn Its puiieges shap and lega power thes *nWittion Ovate a techica Ovat a techica commissIo to reco _mmd commis go rneommd acios t pbath ICC et eden plwa tp *da Om Amman Fnsacl Craew a adtecnia PMuu the ana* als o i coasatsn to excom d utaddln of ao" whAt sou be doe aea wit th objeeiv regaulin muipald ofdoug t In thed shoa _ _ _ _ _ __ fia8in _ __ __ __ JORDAN: CEM17o31 Ia* anpL m plan crOeate Lb ead Leewa sad Cretr On a newsgulot" pbaik Lb. g Ecang Ceuulnk, wadgu y qgen ank ad ICC whh twdd epf en lawm ndw el - n q wth Lbs foLnfl* abs ____________ conam adind neeed s atebi a =wWbet see wt*d hosasla lan, cHAPrER VU: LABOR MARKEr AND EMPLOYMENT 7.1 The labor market is typically xpected to play two roles. First, it allocates labor to its most efficient use, thus crating growth. Second, it provides income from employment, thus a major deteminn of welfare. A well functoning labor market is a condition for both aliocative and distriional efficieny, hence, maximal growth and social welfare. Ihe Economic and Social Development Plan (1993-1997) has envisaged a number of measures aimed at increasing employment opportniies for Jordanians including: i) providing financing to small and medium-size enterprises; ii) eouaging the establisme of private employment agencies; iii) providing employment assistance to Jordanians seking job opporunmies abroad; iv) regulating the output of the educational system ough incentives and various vocational training progrms in a manner consistent with labor market r6quirement.; v) regulating the inflow of foreign labor by enforcing residency and employment laws in a way consisten with the needs of labor market; and vi) increasing the number of work inspecton teams, developing their roles in regulating and controlling labor. These are important measures the Goverment could undetake on an ad hoc basis with a view to improving the prospects for eVloyment growth. However, the more deeply entrenched structura problems in the labor market remain to be taciked. This chapter is inteded to complement the Plan in this respect. It argues that sectoral wage rigidity inhibits worker mobility and slows down the change of the locus of producdon from the losing to the expanding sectors and that persisting sectoral wage rigidity wfll also conibut to aggregate wage rigidity. It has identified the public sector pay and employment issue as major fictors In keeping Jordanin wages above market clearing levels, and in contnrbuting to the lack of employment growth. A. The Characercs of the Labor Mrket 7.2 The main ch cs of the labor market are: the low participation rate, a sizable public sector, the reiance on regional labor markets for job opporunities, the heavy preence of guest woers, the consequence of the Dutch disease leaving wages at the above market clearing level, a bigh unemployment and lack of domestic employment creation, a small private sector, and a well educated labor force. 7.3 Labor forco Vartiipation is low. Only one-in-five Jordanians work.' This is due to the young agetucture of the population and the low labor force participation rate of women (14 percent). Women drop out of the labor force upon marriage and rarely rejoin. Related to this is the perisence of high fertility - almost six children per woman - which gives Jordan one of the highest population growth rates in the region (nearly four percent per annum compared to 2.8 percent for Egypt and less ta 2 percent in Morocco). Most female workers are educated: two-thirds have a postsecondary qualificaion compared to only one-in-five men. Women are concentratWed in white collar ocpations and in the public sector (most women workers are teachers). The unemplot rate among women (35 percent) is higher tban men by nearly three times (Appendix Table VIL6). JI smdso&l whaam &nw oo to Zwvbynwm, Unwtymu, Ream en Povely &ury (BUP) cocaucd inI 1991 udu Aww "Wd. See Volm U in JORDAM: %y Auun*M Wd , 19nI. JORDAN: CEM OS 7.4 The public sector is sizable. Almost half of !'ordanian workers derive their eamings fom the government sector.2 lhe Civil Service Commission employed 115,000 workers in 1989 but this does not include workers hired on alteive, less permanent, arrangements. Parastals and companies with government stakeholdings should be added In order to arrive at a more broadly defined public se"or as pay and employment conditions therein are similar to (and, in some cae, better than) those set in the civil service. The public sector may account for as much as two-thirds of all Jordanian employees.' The incentive regime in the labor market is, therefore, domiaed by the public secr and this explains why the unemployed (and mostly educated) see the public sector as their pspecwdve employer. 7.5 Jordanians have a tradition of emiatof, Jordanian workers abroad increased fom 265,000 in 1975 to 315,5(X0 in 1983. However, the outflow was stabilized to around 4,000 to 5,000 per anum since the mid-1980s. Before the Gulf war, Jordania workers in Saudi Arabia and Kuwait were estimated to have reached 160,000 and 80,000 respectvely. The regiona total may have reached 275,000 and the world total as many as 340,000 (Appendix Table V11.7). 7.6 Guest workers are a "nerma= ' feature of the labor market. Official statistcs show tha the number of work permits issued to foreign workers increased threefold in the last two years (from 30,000 in 1991 to 90,000 in 1992). This sizeable change reflects very much the recent change in registration procedures and under-reporting in the past. It is widely believed tha the mimber of guest workers is more than double the official figure and, perhaps, as many as 240,000. Ibis compares with only 550,000 employed Jordania workers. Guest workers come mostly from neighboring Arab cuntries (notably Egypt and Syria).4 Agriculture is the major employer of guest workers (Appendix Table VII.8). The average pay for guest workers Is only about 10 percent lower tha that of residents but they work longer hours and more days per week, while their employment falls mostly ouside the provisions of the labor law, and they do not enjoy cetain benefits or leave. 7.7 Unemployment is structural. The low growth of domestic employment pornites acceptable to Jordanians has resulted in rising unemployment. In 1980 the unemployment rate was only 3.5 percent Since then it has increased in every year passing the ten percent level in 1989 and reaching 19 percent in 1991. The underlying demographic changes arm importat during this period, employment among Jordanians increased by neady three percent per ammum aginst a growth of the labor force by 4.5 percent. The unemployed tend to be young. In 1991, 75 percent of unemployed men were below the age of 30. Women above 30 constifute !ess than 5 percent of female unemployment.5 With respect to education atainment, unemployed women are predominandy (70 perctS) qualified at post-secondary level compared to 25 percent of men (Appendix Table VII.6) 21 In 1985 251,000 woe won eoyed in h brad publi ntow, up Sun 197,40 1* 1981 (Amab, 19, Ta 7). Of t. mponved labor foii 78 percent ane emloyed (fth adhwe ame employe u~ ow ccount wrers,thn fami d=kr and so c see Tabl 7.1). fbaof toe a In tbe public , t i of oh d l a all e aod two4lds (O.78). If Accordn to BIawweh (1992) lgpima co8aged $8 percn oftoa inaSmnt labor, oher Araba IS peam, As 26 perenot ad Rapes oae pean in 1989. Sdintm eonmue an bsed oan w pero4, t can be regaed as beI bld agins Aab 1bo, eapecally 8gao and Syan Cfbid. p. 14). See Jordan Povety Aemnt, Volwm 11, Appendx Table A-21e. CY VII: LABOR MARKET AND ELOMYMEff (01) 7.8 Lgr costsare . That labor costs in Jordan ate above its domestc market clearig rates can be supported by stylized facts. First, the tem and conditions of public sector employment reflects the expectadon of employment and Income opporties In the Gulf region. Second, immigrant workers account for a large share of domestic employment reflecting the fact that Jordnian wages are higher compared with the regional economies at comparable level of per capita Income: this dimension of the labor market conditions is also evidenced In the hig employmet of Jordanian workers. Third, the capital intensity is the other aspect of the relatively high cos of labor. Further evidence for the high labor costs can be inferred from the stylized fact that during 1970 - 1983 real wages grew fasr than labor productivity, and since 1983, ral wages sttyed more ar less constant while real national income sharply declined. 7.9 The private sector is small. Private sector employees, the self-employed and Table 7.1: Employmnt Distibution by Sus family workers constitute a smaller (pet): Men and Women, 1991 percentage of the working population: it was 66 perce in 1960, 56 percent In 19796 Mde Female Total and 50 percent today. Table 7.1 shows the Paid Wo 76.8 90.7 78.3 most recent data on the employment Employer 6.8 1.5 6.3 distrbution by worker status. Own Accout 13.3 4.1 12.3 Family worker 2.1 1.6 2.1 7.10 :U labor force is educated and Unpaid woker 0.6 1.0 0.6 skilled, Jordan has a highly educated and Ufpefied 0.4 1.1 0.4 skilled labor force. In the last ten years the Total 100.0 100.0 100.0 male labor force with a post-secondary Soure: Calculated fom BUS 1991. qualification doubled (to 21 percent in 1991) while it reached 63 percent for women. Practically all Jordanians atend basic education till the age of 16 and nearly one-in-four proceed to post-secondary education.7 B. The Functioning of the Labor Market 7.11 The labor market In Jordan has traditionally opeatd within thb national and a regional context. The change of territory, the migration to neighboring countries, the open immigration policy, have resulted in mobility in the labor markeL The mobility has not been mpanied by market flexibility. Expansionary fiscal policies have been resorted to in order to reduce the unemployment To this effect, the favorable terms and conions of public sector employment tend, on the one hand, to provide incentives to those who would have otherwise migrated and, on the other hand, to alleviate the downward pressure on wages exercised by the effectively iily elastic labor fd Al Akc (1955) p. 70. 7Tbis Ixpain i pubt b. sin citb publc ntor. Thl 12 Aios ud in ha deI 1 to 12 an tmau by 52,000 tes wh"e th Miny of ducac has 42,500 embploym (a w37 pem of ad emplobm uer die Chi Sevice Comais( . 11o adlw Imporan mpInes, from an aploymet peopectie, m to Mniry ofTnspxrt a m16,700o 15 percen), Misty of eat (12,a900t c11 percut) do Mniry oaf Aicu (7.CO er7 pee) JORDAN: CEM 1197 supply of foreign labor. Such policies are now clearly unsustainale following the post-1983 macroeconomic development and the Gulf war. 7.12 lhe Inflexibe Waze Settin. The public - sector pay s somewhat more comptesed Table 7.2: hndexed Hourly Eanings of Mdal compared widt the private sector. Table 7.2 Works, 1991 (Eaings for 16-20 goup 100) shows these two points. First, given that private earigs in the base age group (16-25) AubPam pivat are 12 percent lower than public earings, 16-25 loo too private eanings are also practically lower for 26w-30 130 140 all age goups (except the 51-60). Second, the 31-40 16i 190 index for private earnings is grater than that 41-50 214 225 for public earnigs in each age group.' SF60 171 208 Note: he =do of ptvae to pul euamgp *w do 16-20 7.13 The labor market is also affected by usesm" is 55 pecau unions though in a symbiotic and practically sm,, C&Ud fi Bus M strike-free environment. Around one-third of : a f J 1 private sector workers are union members and, with the exception of the transport sector, there are no closed shops. There is no miniumm wage but almost half of al establishment (and the vast majority in certain sectors such as banking, -anuactuing and mining) are unionized and subject to collective agreements. In many caes, collective agreements provide wages and/or benefits that are simlar tc or better than thos found in the pubdic sector (these benefits include provident funds to which employers also con_tte, and separate health or life insurance). 'Te wage/cost effects of unions apply more to the idepndet government bodies, electricity, mining, phosphates, petroleum, banking, insurance companies and so on (where the govermnent is influential) than to small business (of whom only 20 percent are unionized) and further reduce the ability of market to set the right incentives in the prvat sector. 7.14 Qspitaskim. In the last two decades, employment doubled but the capital stock incred by three times. Productivity growth has been low and output growth has been achieved primarily tirough factor using rather than efficiency increasing (see Chapter 11). Subsidized credit and low tariffs on capital goods favored the adoption of capital intensive production tecnigques. In addition, trade policies have contributed, on the one hand, to out-migration because it led to unemployment by favoring capital-intensive industries and, on the other hand, Immigton by enabling production in more resource-constrained and probably less efficient industries, such as agriculture, that requ low- cost labor, notably guest workers, in order to survive.9 Following the oil price increase in the early 1970s, the employment opportwites in the Gulf region attracted many Jordanilas at higer wages that they could fetch at home. This emigration reduced the pottial supply of labor while it ncreased the reservation price of the remaining suppliers of labor. Thus wages for Jordanians started rising. Access to subsidized creit and low tariffs on capital goods held down the prices of capital while the low wages for immigrant workers reduce further the wilingoess of Jordmnas to work in v l is btd *Sreamm ta pubc no wee we to conascd to produdotik (Auzah, 9M p. ) w s ea been siglfian =aaowicg of wag d1Wtetlal in doe publi eowr til do. =WMi-90 Wme lad date IndKnatlc I avallabl; at Al e, 1985, p. 285). And (199 ntd dams eni ad medim sa Inuties Incasd cpitalesy In pumsuitow bab cots. CH VIIK LABOR MARKET AND EMPLOYMENT 0 cetain industries.io The labor market became de facto segented and the overall level of wages was set above market clearing levels due to lack of mobility between various parts of the labor market. Unemployment rose. 7.15 Reliance on EmiUraon. The lack of employment opportunities due to the capital-bias in poduction, was in part oompensated by emigration. Sending workers abroad was facilitated by various government measures though the costs associated with brain drain were also acknowledged." Measures were intoduced to check the outflow of workers, some of which were direct (such as prohibition of civil sevants frm quitting to work abroad) or indirect (such as increases in civil sevans salaries, and gratg new privileges to domestic workers).12 Despite that, worker's remittances reached 20 percent of GDP in the late 198Os13 compared to less than five percent in Egypt and only 1.3 in Algeria. Emigration decreased the domestic labor supply and incrased wages. Wages would have to rise further to enable the public sector to recuit. Beyond these direct price efects, worker remiances increased household incomes at home and pushed the resevation wage of pespective workers. Ihis income effect made domestic workers reluctant to accept work in jobs or secoors of certain stats or in certain geographical areas. Capital-intensity of production followed as well as utilization of low-cost labor from neighboring countries. 7.16 fgnd= on reien Work . The number of foreign workers can be safely put at 200,000 with an upper bound of 250,000.1 Most of them are guest workers and are predomiantly found in agricuture (Appendix Table VI.7). However, some are semi-skilled or even skilled workers. According the 1989 data (Mimistry of Labour, Amnal Report), more than one-in-five foreign workers are qualified at diploma (18 percent) or degree level (4 percent). An econometric anaysis of the data shows that, after standadizing for differences in education, agelexperience, and sector of employment, average eanings of non-Jordanian are only about 10 percent lower than those for Jordanians (Appendix Table VII.1l). 7.17 No restrictions on immigration have been imposed but some conditions apply. In some prfessions the employment of foreign workers is effectively prhibited while in others the employment of foreign workers is subject to the approval by the Ministry of Labor. A fee is levied on aU foreign workers mosty for registration purposes. The employers of Arab workers pay JD 10 or JD 50 depending onwhether it is in the sector of agrculture or in the other sectors. Non-Arabs have to pay a fee of JD 100 and JD 300 respectvely. In 1992 the resuting revenue was JD 8 j2y Over tm jotdanha worbu ceasd to engag in amwn crafts (such as taiorie k Ironmoae, cupents, laat6w rpoduot ad so on) whch ha be bsequelly undtak by imipat wka. UJ jotdnin put towad a ptopos to th Inemnl _omnty in 1977 cagivg for th an ofa Labor Compeneaory faclty unde the Unite NaWo= tha wotUl draw rescurcs on ri eceivin cuntri basd an boums Iwncud to kboaeendag cunties Though the proposal was no adopted It chw. aaems.m tha mome or Ies unilatea relnee n anrla* labor nwl*tsw is iwithefive of coat or risk W EKawnw-ab (12 p.16). ly Foo coison rato of wae ad alars t (MP wa jug unde 50 pnerent In 1(ald Abir of Statsc 197, Tl 0401). W~ I aswah (1992), Appedi Ta 15. JORDAN: CMR 99) million. Foreign workers can be employed if there are no Jordalans available for the work, and Arabs are given priority over non-Arabs. Foreign labor faces the same social security charges as Jordanian labor (about 15 percent of the payroll) but this is rather theoretical as most foreign workers are engaged in a non-covered sector (such as agriculture) or in tablishments with fewer than five employees. Poreign workers' contnbutions are reburable upon request after employment temnae. 7.18 Wmez. Women in Jordan do not face direct economic discmation in the sense that, when employed, they receive the same pay as men. However, women are employed in a limited number of sectors such as health care services and education. Women tend to be highly educated and face high unemployment rates (one-in-three women in the labor force were unemployed in 1991). Non- economic factors may be atributable to the status of women in the labor market C. Prospects and PoNcies 7.19 The above analysis has two inter-related implications. First, the level and structre of wages (and incentives) are influenced by the terms and conditions of public sector employment and by the labor migration. The latter has more to do with immigration than emigration. Immigration is feely affecting wages at the lower end. Emigration is playing a lesser role because it is increasingly more difficult for Jordanians to find jobs abroad as a result of the Gulf war and the increased competiton over fewer Jobs in the Gulf countries. The most important distortion on the wage strucure comes, therefore, from public sector wage policies. 7.20 Second, there is litle mobility in the apparently segmented labor market. There are Jordanian and guest workers; under the distorted wagerncendve regime, Jordanins are unwilling to work In occupation taken up by non-Jordanians, and non-Jordanians are not allowed to work in jobs preserved for Jordanians.' There are public and private sector workers. Among workers in the private sector, some are in 'covered' establishments (such as parastatls or in unionized sectors) and enjoy good employment conditions and pay and others are not. Many *private sector* workers are employed abroad. And men and women have significantly different employment structure and they are not deemed to be substitutable in the major productive sectors such as agriculture, utility and conuction industries. The implications of these fidings are examined below. II Suh pohMed J&bs inbad doomlto , WI , a aowaumb, as wag a o uasdul, admW*a1ve pda&& iM _meUb tdphas^, tnwosoo, aoug adss ftwhiM and ode ael Jos CH VII: LABOR MARKET AND EMPLOYMENT pies 7.21 B. Table 7.3 shows the growth In the labor force and aggregate employment and unemploymen The important feature is that jobs for Jordanians have grown slowly (Column 5). Tabbe 73: Toal a ordania Labor Fme, 1980-1991 TO lordauian of whom Unempi. Annal employe Vate .000 Year 1 2 3 CZ-3)/2 4 5 t991 918684 680000 552000 188 2783 53 1990 79S000 630070 524197 16.8 692 0.1 1989 78000 583S05 523SOS 103 1690 03 1988 S72166 S2181S 8.8 12SIS 2.5 1987 5S5700 509300 83 16800 3.4 1986 53S400 492500 8.0 20200 4.3 1985 502400 472300 6.0 13800 3.0 1984 484700 458S00 5.4 13200 3.0 1983 467700 445300 4.8 13500 3.1 1982 451200 431800 4.3 13400 3.2 1981 435400 418400 3.9 13100 3.2 1980 420000 40S300 3. SOURCE: WnUY of Labour, Annual Raot AAS 15/3 7.22. Based on demogrphic projections and current labor force paricipation rates, the anmual Increase In the Jordanian labor force can reach 50,000.1 Yet the table suggets that the annua increase in Jordaian employment has been on average only around 15,000 in the past decade. Obviously the economy cannot generate enough jobs if the exst labor market stucte peists. 7.23 Se.oral ovwth Table 7.4 shows the amnal rate of sectral employment growth in establishments with five or more workers between 1980 and 1989, not including the agriculture sector. On average employmet increased by nearly 7 percen per annum or 82 percent during the decade. The highest growth was In transport (20%), utilities (10%) and fiancW servIces (8%) whfle comunity and public services did not lag much behind (6%). Commerce and construction, two of the main private sectors, Incresed by only around 5 percet and these two sectrs do not seem to have been part of the rapid growth in fmdem employment. Overall, employment for men icreased by 74 percent compared to 112 percent for women. 7.24 ManufcturIn need be discussed separately as It is the second largest sector and is of importance to tade refrms. Manfcuring employment increased by 11 percent per annum in the 1980s or by about 2,000 jobs. This growth is significantly greater thm the rate of increase in tota employment (6.9). Jg So JORDAN: Povaty Auma.su KapoK 1993. JORDAN: CEMA (ll 7.25 More recent data show that total Table 7A: Annual Rate of Gow6 (prcent) in Empoymen by Seto, 1980 to 1989: employment in Estabishmet with S or mo worIOkets. man cturing and minin increased by Secow men Women Total Disrbution 5,000 between 1991 (198q to 1992 or nearly ten percent C(able Mi8 SW QPLaXs 1.2 IS.8 IA 3.1 7.5). It is Manufactuing 10.7 14.0 11.0 16.1 interesting to note M as/WateW 9.5 19.8 9.8 2.1 average salaries coasuucn 5.0 3.1 S.O 2.1 Comem e 4.S 2.8 43 5.0 decreased, though Trot and Commncation 20.1 22.4 20.3 SS slightly, during the Fiaue and Isrance 8.0 8.5 8.1 S.1 same period. III Comnity and Public 4.8 8.3 S.8 61.0 effect, Tota 6.4 8.7 6.9 100.0 maufcuig employment SDUrc: EmpmtS for Estblishvmens Bngqiq o5 ot ore people, Depa8mea of increased during stics, 1989 1991-92 by as much as during the five __l_l__ __ preceding years. The association between the decline in average salaries and increase in employment shows the likely effects of the recent trade reforms (see chapter 4 and Table 4.13), and points to the possible benefits of fiuther trade reforms. 7.26 Manufacglrin. and Women, Manufacturing has created the greatest Table 7.S: Percent of Change in Employmeot and employment opportunities for women in the Average Salaries in Manufctutwri Seleted Peiods recet years (aRer the public sector, Table 1986-1992 7.6). The former absorbed 35 percent of female recruitment and the latter 61 percent P0i0 1o'mt sa between 1988 and 1990 despite the fact more 19861991 8.0 16.9 than 80 percent of working women are in the 1991-1i 8.6 -1.1 public sector. There have been virhtily no female recruits in agriculture, construction and Compsation of employee divided by total utilities while the services secoor (sales, trade, numboa of aployees. hotels, raurans and so on) that are Soure: Cenatr,!mak of Jodan and Depaitme of Statsic. dominated by the employment of female employees in the other parts of the world is unimportant for women in Jordan. 7.27 Indeed, Jordanian studies have projected that the fiture demand for female employment will outpace that for men and the most important sector will be m rg and have called for economic policies that would help create employment opportunities for women prtiularly in the private sector."' The role of wages for employment expansion cannot be overstated. Women's pay in mgis the lowest than in any other sector. It was JD 64 per month in 1989 compared to JD 91 in public and community services, JD 104 in tourism, JD 125 in transportation, and JD 136 in finance and banking. Also, female relative pay (compared to men) is lowest in manuftring (59 IV Royal Scic Sociy QVh 192) mpbynmn oppouqn for Womein lthe Jonian Lb" i 1990M, Am_u. CH VII: LABOR MARKET AND EMPLOYMENT (121 percen) while the ratio of female to male pay i Table 7.6: Indexod Women's Employment in 76 percent economy wide and 82 percent in the Manufauring and PubUo Sector public sector. u 1970 1980 1989 7.28 le Prhat &M. The low rate of job Muu1tring 100 113 367 creation can be traced to the predom_ne of the ubc SecSr 100 233 476 public sector in term of both Its employmeat polices and Its share holding in the private sector Sauna: Bank eaima film Al Akl. (1985, p.79) and DOS, companies. The government owns sufficient 1989. shares to influence policy in nearly 100 of the 112 publicly traded companies while its operations via the Jordan Investment Corporation, Social Security Corporation, Housing Bank, and other bodies (from Ministies through to the latitude graned to the Chamber of Commerce) affect investment, human resources and commercial outcomes (see also Chapter 5). The performance of companies affected by Government policies has been lower than in companies where no such control is exercised. Of particular importance here is the adverse effect of Government control on productivity (see Table 5.3) which suggests prima facie that overmanning or inappropriate utilization of labor are prevalent. The output/labor growth in government controlled firms rose by less than one-half compared to private companies (35 percent versus 83 percent; see Chapter 5). 7.29 Unempynomn. Jordan's chronic unemployment arises from the lack of growth, (hence the lack of demand) as well as the type of growth characterized by the high capital itensity. lhe preceding analysis suggests that the costs of capital were subsidized and were kept below market prices while Jordanian labor was employed at the higher cost. Thus, reducing unemployment in the fture would require not only sustained investment/growth but equally important strucural changes to deal with unemployment. 7.30 Emigration. Emigration prospects have declined and may never recover. Political considerations aside, the conditions in the oil market no longer require the number of expatriate labor that labor-importing countries in the region used to have.19 As many inflhstrucurae projects in host countries are approaching maturity, and labor-importing countries are improving the quality and diversifying their sources of labor supply, the demand for Jordanian workers wil continme to decline. 7.31 Immigriona. Guest workers cost less to employers than Jordanians partly becse they are employed in sector (such as agriculture) or small frms (with fewer an five workers) that are exempted from social secuity contributions or the provisions of the labor law. This creates a direct pay disadvantage for Jordanian workers equal to the socia security contributions (15 percent) plus the pecuniary equivalent of benefits (such as leave) to which they are entitled. Such provisions reslt il labor market ion that Jordanian workers of the same hman capital characteristics who would have otherwise be wiling to replace the non-Jordanlians are forced to accept inferior employment packages. Thus mobility in the labor market is impeded while the low-cost labor may be enabling margina actvities (such as agriculture that attracts a wide varieties of subsidies) to perpetuate though their overall contribuion to growth and (Jordanian) employment are not as significant. IV Anua Absrat of Sla (I8, Ta ISIS. IV Bgratimi has benecla efio mainl when condWtoa in dhe sndngt county nowe in the Moppo direction in whic conditions In the "0sAW cowutde mov b4t In the Middle East conadions hav eNed to mone In he mum diretion SW=e toe depsndeacy of the rgion on oil. JORDAN: CEMj1131 7.32 It is difficult to detemine whether Jordania workers can or should replace guest workers given the lack of infonnation. Assume guest labor is restricted by law or fees or is even prohibited. Ihis policy will result in vacancies at the level of wages acceptable to foreigners but probably not to Jordanians. The emergence of vacancies will be put upward pressure on wages which will eventually reach a level sufficient to atract Jordanians. The end effect would be higher wages than before, more employment for Jordanians, but lower overall employment and output, while the effect on the export sector is ambiguous. 7.33 These effects alone cannot determine the desirability of immigration policies. If guest workers were used to produce tradables, export earnings would fall in a more restrictive immigration scenario. Against this loss, that part of guest wages that was previously remitted should be deducted as these remittances are saved when Jordanian workers are employed. The final effect depends on a host of other factors such as the slope of the demand curve, the elasticity of the Jordanian labor supply in sectors employing guest workers, the share of labor costs in total costs, the elasticity of demand for exports, and the proportion of guest workers' wages remitted to their home country. 7.34 All that can be said at this point is that more than half (53 percen) of Jordanians worling abroad were (in 1990) production and unclassified workers and that onewin-four had less-than- secondary education and one-in-two had secondary school certificates. In addition, many guest workers are employed in semi-skilled or skilled jobs. Thus substitution should be possible, provided as this chapter argued, that social security provisions do not create a disincentive for employers to hire Jordanians. Again this is an issue that needs to be examined further. D. Summary and Recommendations 7.35 Jordan is a labor surplus economy. High fertlity and declining opporunities for emigration have accelerated population growth in an economy with small domestic productive base. The open immigration policy has been accompanied with the use of large numbers of guest workers. With the exception of brief period in the early 1980s, the economy has been unable to create jobs at a sufficient pace to prevent unemployment among Jordanians. Much of the employment generation in the past has come from an expansion in the public sector that now accounts for half of the employed labor force. Whis is no longer sustainable. 7.36 Jordan's labor market has been hampered from playing an effective allocative role due to the market distortion and segmentation. From a growth perspective, the distortions reduce market efficiency, ignore domestic and exteral constraints, and have increased costs of employment and led to more unemployment Education and training have enabled Jordanians to secure highlr pay and better employment conditons abroad, especially in neighboring countries, than those available in Jordan. Ihis has reduced the domestic supply of workers while, indirectly, increasing the expected wage in the Todaro sense (Todaro, 1969) of those who are waiting to emigrate, or to be employed in the public sector, or are living on remitance income. Thus domestic wages are driven to a level higher than the domestic market clearing rates. This has, in turn, made profitable the use of immigrant workers in low-pay jobs that were no longer taken up by Jordanians. Employment conditions in the public sector have been under pressure to improve in order to retain those who would have otherwise emigrated and public sector employment has been relied upon in coping with increasing unemployment. ay En lUas Xeh (19, Tabl 4. CH VIi: LABOR MARKET AND EMPLOYMENT (1141 7.37 The labor market is therefore segmented between national Jordanians and foreign workers; between Jordanians working in Jordan and Jordanians working abroad; between private sector workers and civil servants; between unionized and non-unionized workers. There are also considerable differences in the labor supply and employment of men and women. These divisions reduce labor mobility which result in unemployment and underemployment, productivity and output loss, higher labor costs and lower export competitiveness, Capital-bias and rationed credit markets restricted further the role the private sector could have played in promoting growth and employment expamsion. 7.3. The success of the outward-oriented growth strategy outlined in this report depends on whether labor can be quickdy reallocated to its most efficient use, and to the expanding sectors. This would require trade and financial sector reforms, and the prevalence of market-based factor prices. Specifically, the realignment of the trade incentive regime would encourage the production of tradable and exportable goods thus encouraging labor-intensive and export-oriented industries which are likely to yield more jobs. The analysis of an exchange rate adjustment accompanied by non-accommodating fiscal and monetary policies (Chapter 3) indicates that rate of employment growth could be somewhat higher than output growth. Thus a six percent increase in output, as envisaged in the base case scenario (table 3.1), could entail steady reductions of unemployment; the validity of this projection of course depends on how flexible is the labor market. Should the current rigidity in the labor market contiue, the past employment-GDP elasticity (at an estimaed 0.4) implies that even GDP growth at 6 percent p.a. would not result in much reductions of unemployment (see para.7.22). 7.39 The recent increase in manufactuing sector employment demonstAes what is feasible. Following the recent trade reforms, employment in the sector increased by 5,000 or nearly ten percent between 19t91 to 1992. This increase was as much as during the five preceding years and was accompanied by a slight decline in the average labor costs. Ihis finding points to the responsiveness of the Jordanian industries to the initia realignment of the trade incentive regime, and likely employment increasing effects of trade reforms. Manufacturing is also becoming an imtportant sector for women's employment and, indeed, it is the view of Jordanian labor economists that with the adjustment policies demand for female employment will increase further-this should have significant effects on productivity as the currendy unemployed women are typically better educated than men. 7.40 The good prospect for expanding employment through an outward-oriented growth strategy is now being clouded by the overly extended public sector employment, which not only imposes an excessive fiscal costs on the economy, a drag on business activities, but also delivers sub-standard public services. Finally, the complex issue of immigrtion needs further analysis. Under the current immigration policy, Jordanians would replace immigrant labor, only if expectatons about alterative opporunities in the public sector and abroad subsided and if the cost-differential imposed by social security contributions were eliminated. Both could be facilitated in order to increase labor mobility in and flexibility of the domestic labor market if the Government would: * undertake the adjustment policies as outlined in other sections of this report; * reduce the size public sector employment; * restructure the pay and employment conditions in the public sector and link it to performance; * apply the provisions of the Labor Code and of the Social Security Act to all workers uniformly. CHAFrER Vm ECONOMIC REFORMS TO ENHANCE THE PROSPECTS FOR GROWTH 8.1 Jordan's pattern of economic growth has been unique. Exporting skiled workers to the Gulf region has allowed it to receive substantial remittances and the close ties with the Gulf states brought large amounts of official grants. The remittances and official gran permitted Jordan to sustain high domestic consumption and investment beyond its level of GDP. Jordan was therefore able to grow at increasing factor use and with low and generally decreasing resource efficiency. The heavy reliance on external inflows has left Jordan particularly vulnerable to extal shocks. The unpredictable shifts in regional demand for Jordanian goods and services discouraged equipment investment in the small domestic market segmented from the world economy, and dominated by the large public sector. 8.2 Jordan faces serious challenges in the future. The demand for Jordanian workers was sharply reduced following the Gulf crisis, and may not recover again given the deteriorating prospect for the regional economies and the increased competition in the regional job markets. The official grants from the Gulf sates were withdrawn as well, and are not likely to be resumed any time soon. The Peace Process offers new hope for Jordan, but it may also entail an environment in which Jordan will no longer be viewed as strategically important as at the height of the regional conflicts. Against this background, Jordan's strategic choice would be to gradually reduce the reliance on external financl inflows: intead of exporting its scarce human resources, those resources could be used at home to produce exportable goods and services for regional as well as for the world markets. Moreover, instead of relying on official transfers, Jordan could strengthen Its ability to encourage domestic savings and to attract private capital investments. Ihis stegic choice would require Jordan to pursue an outward-oriented and private- sector-based approach to growth and employment expansion. This report has considered tackling the following constraaits as necessary for this approach to work: X the reliance on extrnal inflows to finance domestic expenditures, the decline and disruption in such flows have led to macroeconomic instability, accumulation of exter debt, and have left domestic wages above market clearing rates; * a domestic market too small and a trade regime too restrictive to encourage competition and to allow "scale efficiency", both of which are essental in overcoming the diminising returns to factor inputs; * an overly-xtended public sector which prevents the emergence of a dynamic private sector; * a financial system which entails high cost and low volume of intermediation, excessive exposure to the equity and real estate markets, contains rigidity which impedes market competition, and prevents good investment projects from being financed first;1 I King anA Levin (19), howw bee dveloe financine r inras prodct gowt by al6cafM cet to bet firmn; mnag age mouniod; *e firm w the best pos md Xhe be inveats proje ae mded firs. Gnawad ad Stiliz (1989 aru tt ivestm in prodctivot m vums is posby mm dsy Wi finani conai md therefor s the roe of capi markes in tading and dvifyins rb. JORDAN: CEM (1161 0 a labor market characrized by the dominance of public sector employment, the lack of flexibility and low mobility across sectors. 8.3 Taclding these constraints could Improve resource efficiency, increase resource mobility and help resource mobilization, therefore enhancing Jordan's growth prospects. In general, resource efficiency and mobility could be maximized in an environment where markets and market signals are left unimpeded, and market signals are met with flexible shifts in resource allocations and with rapid supply response. For the Jordanian economy, improving resource efficiency and mobility would require dismantling domestic market barriers, integrating with the world economy (in addition to the limited and often unpredictable regional market) and creating a level playing field: at the forefront of this is the need to restructure the trade and regulatory regimes so as to unleash private sector initiatives and to increase market competition. 8.4 Far-reaching trade policy reforms are needed to spur internal and exter competition and to expand market scales. But, trade reforms would be meaningful only if economic agenuts are driven by market forces and respond to market signals. This would be best achieved in an econiomy with unsuppressed private sector initiatives and with limited public sector ownership. Unless the regulatory regime leaves a level playing field between public and private enterprises, between foreign and domestic investors, and between established and emerging enterprises, new entrance into the market and new business initiatives would remain discouraged. Further, the full benefits of trade and public sector reforms would not be realized unless the rigidities and failures in the financial system were effectively redressed. The report has proposed a number policy changes aimed at inteating the financial system in order to reduce the cost and increase the volume of fmancial intermediation so that the flows of capital can effectively respond to the investment decisions in the goods markeL Finally, Jorda's most valuable and reliable assets are its well trained workers. An export-led growth depends on high labor productivity at competitive labor costs. A flexible labor market is essential for Jordan to fully employ its human assets, and for employment decisions to respond efficiently to investment decisions in the goods and financial markets. For this reason, the market segmentation between gender, betwet ei public and private sectors and between Jordanians and non-Jordanis should be minimized. 8.5 Resource efficiency and mobility need to be supported by effective resource mobilization, which is predicated on maintainig a stable and sound macroeconomic environment, reducing public sector consumption, increasing incentives for private savings and a resolution of the external debt problem. 8.6 Jordan's large external debt service burden, persistent trade deficit and unpredictable private capital inflow pose a serious challenge to the macroeconomic management. Maintaining a tight management of aggregate demand, including restrictive fiscal policies, would be essential, but this is likely to slow down growth and aggravate unemployment. This policy conflict reinforces the need for the outward oriented growth strategy aiming to expand external demand for Jordanian goods and services. Thus, market-based exchange rate movements may be critical to complement the proposed tariff reductions, to stimulate worker's remittances, and to provide a market-friendly approach to strengthening Jordan's extrnal competitiveness. In the inmediate short term, however, exchange rate policy needs to be flexibly managed in response to the continued financial inflows and to the unfolding events in the Occupied Territories. CH. VI: ECONOMIC REFORMS (1171 Tebte 8.1: Jordan - Key Neacreeconeic Indicators Under the Enhanced-Grouth Scenarie (X of GDP, unless otherwise Indicated) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Actual Projectimns Key Performance Targets (X) GOP Growth Rate 11.3 6.0 5.S 5.8 9.0 8.5 8.0 7.5 7.0 7.0 5.5 5.5 GDP Deflateor (annual X change) 4.6 5.1 4.5 4.5 7.0 8.0 8.0 7.0 6.0 4.0 4.0 4.0 Current Account Balance /GDP I/ *15.6 -12.5 -9.7 *8.0 -7.0 -6.0 -5.0 -5.0 -4.0 -3.4 -2.2 -1.2 Growth of Exports of Good (USS) 7.8 -2.3 15.4 1S.8 19.3 17.7 16.9 14.8 13.8 12.7 10.6 9.1 Growth of Exports of NFS (USS) 6.9 8.8 9.0 12.0 12.0 12.0 8.3 10.7 10.2 10.1 8.5 8.6 Growth of lports of Goods (USS) 29.9 4.3 5.5 7.0 10.0 12.0 10.1 9.5 8.9 8.9 7.5 7.5 Investment.Savings and Consumption (X) Investment/G6P 31.6 30.1 28.6 27.4 27.0 27.0 2S.0 25.0 25.0 25.0 25.0 25.0 Private Investment/GDP 25.3 23.0 20.7 t9.4 20.0 21.0 20.0 20.0 20.0 20.0 20.0 20.0 Public Investment/GDP 6.3 7.1 7.9 8.0 7.0 6.0 5.0 5.0 5.0 5.0 5.0 5.0 Incremental Capital-Output Ratio 2.1 5.3 S.5 4.9 3.0 3.2 3.4 3.3 3.6 3.6 4.5 4.5 Resource Batance/GOP -35.7 -32.3 -28.6 -24.6 -22.6 *19.2 -17.3 -15.6 -14.0 -12.6 -11.4 -10.7 Domestic Savings/GDP -3.6 -2.2 0.0 2.8 5.0 7.8 7.7 9.4 11.0 12;4 13.6 14.3 Consurption/aOP 2/ 103.6 102.2 100.0 97.2 93.6 92.2 *92.3 90.6 89.0 87.6 86.4 85.7 Consumption per Cap. Growth 17.7 -0.7 0.0 0.1 1.7 3.9 4.9 2.4 2.1 2.3 1.1 1.6 Creditworthiness Indicators Debt/GDP (X) 166.0 160.0 149.7 140.3 125.5 111.7 99.9 89.3 80.7 72.4 66.0 60.0 Post-Resch Sorvice/EXPGIFS (X) 3/ 20.0 24.9 21.4 19.0 16.2 16.4 16.5 13.9 11.2 10.7 9.6 9.0 Pre-Resch Service/EXPGNFS CX) 32.5 30.7 32.3 31.9 29.5 25.1 20.7 18.0 14.3 12.9 10.0 8.5 Public Fitnae Budget Deficit (-)/GDP (X) 4/ -3.7 -6.4 -5.4 . -4.4 -3.7 -3.1 -2.5 -3.0 -2.9 -2.2 -2.5 -2.4 Goverment Revenue/GOP (X) 4/ 36.2 32.5 32.8 31.8 31.5 31.3 30.8 27.5 26.6 25.8 25.5 25.6 GOverrnent Expenditures/GOP (X) 39.9 38.9 37.4 36.2 35.2 34.4 33.3 30.0 29.5 -!.0 28.0 28.0 Uages & Salaries/GDP 6.4 6.5 6.5 6.5 6.0 5.5 5.0 5.0 5.0 5.0 5.0 5.0 Mon-Wages & Salaries/GOP 33.5 32.3 30.9 29.7 29.2 28.8 28.3 2S.0 24.5 23.0 23.0 23.0 ~~~~~ ._.... __._._._........................__._................_.__........__._....__... _ _.................. Notes s 1/ fncluding grants and debt reschedulfng. 2/ Consumption has been consolidated with the resource batlance in the SOP account. 3/ Exports of goods and nonfactor services. 4/ Excluding foreign grants. Source: Bank staff estimates. 8.7 Increasing savings would require inter-related actions on several fonts. Jordan has managed to reduce its fisca eendites by 6 percentage points of GDP and to increase Its revenue by 7 percentage points during 1989-93 (table 3.1). While some further deficit reductions are possible particularly via reducing government consumption, the extent of such reductions is limited by the need to protect essential social services . Furthermore, reductions of government consumption may result in decreases in prvate savings, so the net effects are not that clear. Private domestic savings would be stimulated by the improved financial itrmediation as envisaged in this report, and by shifting toward a consumption-based VAT tax. But the effects of thes instuments are indirect at best, and the prospect for increasing domestic private savings via these instuments Is limited, given that real per capita income and consumption has sharply declined in the past and need to grow moderately in the figure for social and political considerations. Private capital inflows in connection with the resettlement of returnees has given Jordan the most relief on the current accounts. But, they are also most uncertain and sensitive to the perception of the large debt overbang problem and the JORDAN: CEM 11181 large debt service burden on the fiscal and external accounts. This points to the case for further debt relief so that the debt service burden could be reduced to allow increases in public sector savings, and to reduce the unc ranty dbcouraging private capita inflows and investments. 8.8 Jordan's economic prospects can be enhanced if the regional Peace Process succeeds and its pottial benefits are sufficiently captured. A regional peace setement would remove the political conflict preventing trade and business opportmities in the region, and could give Jordan access to larger markets, as well as business opportunities for development and reconstruction in the Occupied Territories. Jordan would stand to gain substantially if it could offer competitive and efficient banking and other business services and if it could capitalize on the new opporunities through expanding its tourist and other service industries. The economic projection below (Table 8.1) reflects the upside of the unfolding Peace Process, as well as the expected results of implementing the policy changes summarized above and detailed in each chapter of the report (though not including the benefits of fuiher debt relief beyond of the current terms of Paris Club rescheduling). This high-case scenario may be compared with the base-case scenario shown in table 3.1 and the two scenarios differ most notably with respect to the outer years of 1996-2003. 8.9 Balance of Payments. With trade and tariff reforms accompanied by a compettive and flexible exchange rate policy stance, exports of goods and nonfactor services including tourism income would be higher than the base case scenario (see table 3.1, and para 8.14 for remittance income), and the bulk of these increases would come from non-mineral goods and services sectors. Imports of goods and nonfactor services would be higher from 1996 to 2003. Current account deficits would be grually reduced. 8.10 Investmentand GrowthGross domestic investment as a share of GDP would be higher thaD the base case from 1996 onward, mainly consisting of increased private and foreign direct investments. With the strctural reforms to improve the efficiency of trade, fmance and labor markets, investment quality would increase more than that envisaged in the base case scenario, and investment level-paricularly in the productive sectors-would be boosted by a surge in foreign direct investment from 1996 onward. Therefore, growth would rise to 9 percent in 1996 and be sustained at around that level through 1998 and decrease moderately during 2000-2003 reflecting a downward trend typically expected of a normal economic cycle. 8.11 Dome Savings and CgMThe level of domestic savings would be the same as that in the base case during 1993-1995. But, it would be boosted higher during 1996-2003 by the transition to a value added tax, by the increase in Government savings, by the increased financial intermediation, and more importantly, by the more rapid growth domestic income. The increases in domestic savings would gradually reduce the reliance on foreign savings, hence the exten uncertainties. Growth of real consumption per capita would Increase throughout the projection period but it would be most remarkable during the high growth period of 1996-2001. zi Enta imam paymets amed to 23 peced nd 1S peea of fal eedres in 1m nd 1993 reeoy, or 9 perwn ad 6 per of GDP, debt evi paymns exteda accounts are mum larger de to ervWie pay_mn fium th pfic eteMpfAs. CH. VIm: ECONOAIC REFORMS (1191 8.12 Fisca Acounts. Tariff and tax reforms would widen the tax base, increase tax efficiency, and allow for possible reductions of rates. Thus, as a share of GDP, tax revenue would decline steadily. On the expenditure side, the initial phase of civil service would entail retenchment costs thus, savings in wage expenditures would not be available probably until 1996, from then on the share of wage expenditure would decrease reflecting the fiscal savings in having a smaller civil service. Public investment as a share of GDP would be smanler compared with the base case scenario though it would be comparable in absolute amount. Overall, the fiscal balance would not differ much from the base case scenario during the medium term. Limited and occasional domestic borrowing to finance the deficit have been envisaged over the longer term. 8.13 Employment Expansion. Demand for labor would be boosted by the realignment of the incentive regime as envisaged in Chapter 3, and Chapter 4 of this report, by the projected GDP growth at over 7-8 percent per anmnm, and by expansion of the non-traditional industries, particularly manufacturing exports, transportation and tourist service industries. The structural changes in trade, finance and labor markets would entail a shift in investment patterns in favor of more labor-Intensive sectors. With freer trade with neighboring countries, forces attracting guest workers to Jordan and pushing Jordanians to work abroad would be reduced, as the prospects for employment of Jordanian at home would improve. Thus, it is likely that employment growth would at least keep pace with output growth, though the extent of reducing unemployment of Jordanian workers depends on their response to labor market signals and on market flexibility. 8.14 External Debt Oudook. The enhanced growth scenario would affect the external debt outlook in several ways. The rapid export-led growth would increase the country's debt servicing capacity as well as reduce the debt burden, thus reenforcing the growth prospect itself. The level of worker's remittances is projected to remain the same as in the base case scenario, but the degree of external uncertainty would be reduced. Generally, the prospects for Jordan growing out of debt would be enhanced. This Is not only because growth would be higher but also, (more Importly for the projection to bear relevance) growth would rely more on the efficiency gains, and would be finmced by increased domestic savings as well as boosted by increased trade opportmities and foreign direct investments. In addition, as indicated in Chapter m (page 35) the enhanced grom* scenario would ental no significant gaplhlflandng during 1997-2002. Notwihstanding these positive aspects, Jordan would still have a long way to go before it could reduce its debt burden by 2003 tD the level that Algeria, Tunisia and Turkey bear today (see table 3.8), and Jordan's level of domestic savings would not reach, until after 2001, beyond 15 percent of GDP, a level still well below what the Asian economies achieved during their periods of rapid economic growth.3 Thus, it is aU the more important for lordan and its major creditors to find ways toward more debt and debt service relief. I/ Dometc ags b Jp Ia dung 1955-70 was 23.4 poemnI of GDP, fot Malya. duin 1981-90 i was 29.4 puaVt, 1to singawpoe during 1974-90 k was 35 pament, for hailad duDg 198 it was 213 poe Ses Page, (1993).