Amman has long made capital out of its position as a relative haven of stability in a turbulent region. Jordan’s policy makers are now daring to hope that the country’s economy will be in a similar position with regard to the global financial downturn, as they struggle to combat an increase in inflation and a widening current account deficit.

The threats emerged this year as the biggest policy challenges to the Jordanian economy, with the country reeling from an inflationary spike that saw the Consumer Prices Index rise to 19.9 per cent in September.

Ordinary Jordanians are hurting. A recent Moody’s Investors Service report on Jordan’s economy states that if inflation remains at current levels it could prove socially destabilising. A sustained high level of inflation could undermine growth by damaging consumption and investment. And, as Moody’s warns, inflation has already prompted an expansion of fiscal expenditure that could be difficult to reverse.

Account deficit

The same factors that underpinned the inflationary price increases have also cranked up the current account deficit, which at nearly 18 per cent of gross domestic product (GDP) is one of the world’s largest. The mix of higher import costs, slower exports and weaker external grants have hit the balance of payments.

This is a concern as it raises the risk that foreign investors, notably supportive of Jordan’s economy in recent years, are alarmed by the adverse turn of economic events.

Jordan’s reliance on oil imports to meet its energy requirements, is the main contributing factor to the deterioration in the current account in the past five years. From being in balance in 2004, the current account deficit is forecast to reach $3.13bn in 2008.

There may, however, be an upside for Amman. The global financial turmoil and the subsequent squeeze on oil prices may bring relief from inflation.

“Most of our inflation is related to imported inflation – increased oil prices and basic commodities. But since August 2008, oil price prices have declined sharply,” says Essa Saleh, assistant secretary-general at the Finance Ministry. “Since August, we estimate that domestic oil prices have come down by around 35 per cent and we expect inflation to decrease in the fourth quarter of this year, to below 15 per cent.”

This optimism reflects the government’s underlying belief that inflation is a temporary phenomenon, rather than an endemic structural affliction.

There are fiscal benefits in the offing too. Every dollar increase in the price of a barrel of oil costs the government more than $28m at current subsidy levels. No surprise then that the recent downturn in global oil prices is primed to deliver a timely fiscal boost.

The recent commodity market trends have given Amman high expectations of keeping a lid on domestic price rises. The government expects inflation to drop next year to below 7 per cent, supported by measures to tackle inflation, including instructing ministries to defer 15 per cent of project spending until 2009.

The government takes an upbeat view of the country’s balance of payments prospects. “The import bill represents 15-20 per cent of Jordan’s total GDP,” says Saleh. “Therefore, any decline in prices will affect the trade balance and will definitely reflect positively in the current account.”

This view is shared by some of the ratings agencies. Moody’s analyst Tristan Cooper says that although Jordan is highly reliant on inflows of private capital to finance its current account, with oil prices falling and growth slowing, the current account deficit is likely to narrow significantly.

“Unlike many other emerging markets, Jordan is not reliant on portfolio flows to finance its current account deficit” says Cooper. “Rather, the bulk of financing comes from the Gulf in the form of foreign direct investment (FDI), which is well distributed in terms of sectors.”

While Jordan, as a small, open economy, is vulnerable to external shocks, its ability to finance the current account by FDI, rather than dipping into its foreign exchange reserves, is a confidence-booster.

Even if it did have to tap its estimated $8bn in foreign currency reserves held at the central bank, this stock of reserves stands as a buffer. “There are enough reserves to cover six months of imports,” says Saleh. “This indicates that we don’t face any problems on the balance of payments.”

The government reported that FDI in the first half of 2008 was up by nearly 50 per cent on the previous year, but other indicators suggest that the inflow of investment is at risk as the global downturn affects investment decisions. Investments registered at the Comptroller’s Department in the first 10 months of this year dropped by 17.7 per cent to JD674m, compared with JD820m the same period in 2007.

The Jordanian authorities note that the strong reserve position mitigates concerns about a tail-off in FDI eroding the current account. In March this year, the government paid off a $2.1bn tranche of its buy-back agreement with the Paris Club of creditor nations, forcing a decline in reserves to $4.5bn. Yet, foreign currency reserves have subsequently swelled to $8bn.

According to Moody’s, the government’s recent debt buy-back contributed to the improving trend in government debt metrics, such as the ratio of government debt to GDP and external debt to current account receipts. The government’s gross direct and guaranteed debt fell to less than 80 per cent of GDP in 2007, from more than 100 per cent of GDP in 2002 . The March external debt buy-back has led to a further large drop in gross debt, to around 65 per cent of projected 2008 GDP by the end of June.

Under pressure

The combination of a general government surplus, rising inflation, and high real growth rates have all contributed to the attrition of Jordan’s public debt. But public finances are still under pressure.

The budget deficit for the first nine months of this year reached JD720m ($1,015m) due mainly to an increase in public expenditure, according to the Finance Ministry. This deterioration came despite an improvement in domestic revenues by 14 per cent to JD2.78bn during January to August, helped by burgeoning tax revenues, which account for 70 per cent of state income.

Public expenditure surged by 33 per cent over the first seven months in 2008 compared with the same period in 2007, to stand at JD2.86bn. The spending hikes follow salary and pension rises intended to ease the pain of the removal of the fuel subsidy, as well as increased military outlays.

The government anticipates a budget deficit for 2008 of 5.2 per cent of GDP, which it says it is on course to meet. “We had to spend about $500m to $700m on social issues,” says Saleh. “In spite of the extra spend, the deficit will be the same level as targeted in the original budget.”

In the 2009 budget presented to parliament at the end of October, the government forecasts a JD689m deficit, equivalent to 4.6 per cent of GDP. Finance Minister Hamad Kasasbeh expects capital expenditure to surpass the JD1.4bn mark next year. The draft budget forecasts only a slight 3.3 per cent increase in current expenditure to JD4.79bn.

The latest fiscal data shows that Jordan’s general government is in surplus, says Cooper, so there is room for manoeuvre on the fiscal side to cushion a downturn in the private sector.

“Jordan’s public debt levels, while falling, remain high,” says Cooper. “But the structure of this debt is good, with the external part mostly payable in long maturities at low interest rates to official creditors.”

Critics warn that rapid credit growth in recent years could yet affect the financial strength of commercial banks, especially in the event of a real estate price correction. However, Jordanian banks have little significant direct exposure to toxic sub-prime assets or failed Western financial institutions.

Economic growth

The real economy is holding up well, and unemployment, at 12 per cent, is at its lowest level since 1999. The government has over seen an impressive diversification of the Jordanian economy over recent years, which has helped to reduce volatility. Jordan’s GDP per capita continues to rise amid the robust real growth rates that are being achieved, says Moody’s. Real GDP grew by 6 per cent during the first half of 2008. GDP growth has averaged 6 per cent annually since the beginning of the decade, resulting in an increase in per capita GDP of more than 60 per cent.

Recent indicators reveal a mixed picture. Industrial exports from the Zarqa and Mafraq governorates grew by 16.5 per cent in the first 10 months of 2008 to $368m.

Yet there are concerns about the performance of key commodities producers such as the Jordan Phosphate Mines Company, the Arab Potash Company and the Jordan Cement Factories Company.

“Clearly, the growth outlook has deteriorated and we are expecting growth to slow in 2008, as the harsher global environment takes its toll on exports, investment, and consumer confidence,” says Cooper.

The IMF expects only a slight decrease in GDP growth to 5.5 per cent this year, before recovering to close to 6 per cent in 2009-10. The fund anticipates strong investment flows from the Gulf and continued robust activity in tourism and construction.

Such indicators could help the kingdom survive the international crisis that has granted it some relief from the inflationary cycle earlier this year. But sustaining the improvement amid a global downturn may still be asking a lot as the country remains vulnerable to external shocks, even though it looks as if it has got off relatively lightly this time.