Like many countries in the Middle East, Jordan’s high levels of inflation pose a threat to its economic growth and the livelihood of its population, many of whom live uncomfortably close to the poverty line. But unlike its wealthy neighbour Saudi Arabia or fellow GCC states, this economic misfortune is not offset by rising oil revenues.

The end of heavily discounted oil from Iraq, brought about by the US-led invasion of the country in 2003, means Jordan is fully exposed to the cost of energy imports at a time when prices are hitting record highs.

“Jordan is a small, open economy and highly vulnerable to external shocks,” says Finance Minister Hamad Kasasbeh. “The increase in food and fuel prices had a direct impact on the livelihood of our citizens and our economy.”

Fast facts

• Rate of inflation (Jan-May 2008) - 12.7%

• Projected 2008 budget deficit - $1bn

• Amount by which external debt has fallen over the past 18 months - $2.4bn

In his speech introducing the 2008 budget, which came into force on 1 January, Kasasbeh said he expected inflation to be 8-9 per cent for the year. At the time, oil was selling at $90 a barrel and the budget was based on the assumption that it would remain at about $90-100.

In the intervening six months, oil prices have increased by 50 per cent. Over the same period, the cost of food - of which Jordan is a substantial importer - has risen by more than 15 per cent. As a result, in the first five months of 2008, the country experienced inflation of 12.7 per cent, compared with 6.7 per cent for the same period in 2007.

Growing deficit

The easiest way for the government to alleviate the burden of rising costs on its population is to subsidise the most commonly consumed goods. But the increased spending this would involve would put it further into debt, running contrary to the finance ministry’s macroeconomic targets. In the supplementary budget at the end of June, Amman conceded that the budget deficit for 2008 would most likely increase to 6.5 per cent of gross domestic product (GDP), compared with the 5.6 per cent it forecast at the start of the year, and up from 5.5 per cent in 2007.

Increased fiscal spending has a knock-on effect on the government’s current account position. In co-operation with the International Monetary Fund (IMF), Amman reduced its current account deficit throughout the 1990s, and by 2004 it had a surplus for the first time in years.

Unfortunately, this fiscal stability was achieved just when the country’s supply of cheap oil had dried up, and the economy has subsequently returned to deficit.

Having intended to reduce the deficit to 13 per cent of GDP in 2008 from 17 per cent the previous year, the finance ministry now admits that preventing it from growing further might be a more realistic target.

“The most important challenge we face is inflation,” says Kasasbeh. “The second is the current account deficit - and there is a relationship [between the two].”

The difficulty of protecting Jordan’s citizens from the impact of steeply rising prices while maintaining fiscal stability has already taken its toll. One finance minister, Ziad Fariz, a vocal opponent of subsidies, resigned in August 2007 when the government decided not to extend its policy of reducing fuel subsidies even further.

Domestic impact

“A large part of our consumption basket is imported goods,” says Kasasbeh. “The world inflation caused by the high increase in oil products had a direct impact on domestic prices, especially after the government’s decision to eliminate most oil subsidies to maintain fiscal stability.”

Rising international prices forced the government’s hand in reducing subsidies, says Kasasbeh. “With this humongous increase in prices, continuing the subsidy policy was suicidal for the budget. The decision to liberalise oil prices was crucial to maintaining fiscal and economic stability.”

Since the policy to stop subsidising fuel was adopted in 2005, most price support has been removed, but Amman’s plans for the complete removal of subsidies - originally tabled for the end of 2007 - have been put on hold pending a reassessment of the economic climate in 2009.

“There are just the subsidies for LPG [liquefied petroleum gas] left,” says Kasasbeh. “They are used for cooking and heating, so the price affects everybody, particularly the poor.”

An earlier reduction in subsidies has already raised the price of a cylinder of gas from JD4.25 to JD6.5, but the complete removal of subsidies would force the price up to JD10. “This would be difficult to implement,” says the minister.

The decision to delay the removal of fuel subsidies will cost the government an estimated JD90m by the end of 2008, and it is not the only domestic policy decision that has added to fiscal spending. The removal of sub-sidies was accompanied by the introduction
of a social safety net, providing direct subsi-dies in the form of increased salaries and aid to the poor.

A delay in liberalising cooking oil prices from 1 January 2008 to 8 February cost the government about JD160m, according to the finance minstry, and a further JD90m cost was incurred when parliament demanded the planned public sector pay increase of JD25-30 a month be increased to JD45-50.

Under such circumstances, the government has shown both resilience and flexibility. Based purely on the country’s exposure to rising prices, the finance ministry says its projected 2008 budget deficit of JD724m could in theory increase by a further JD500m, taking the deficit to 9.5 per cent of GDP.

However, a combination of Jordan’s sound economic management and increased fiscal revenues means the final figure is more likely to be close to the government’s revised projection of 6.5 per cent.

Delaying projects

The government expects to save about 15 per cent of its projected expenditure in 2008 through delayed realisation of projects by the various ministries. And the flip side of the inflationary burden is that tax revenues should also increase. “Domestic revenue could be higher than expected in the budget because taxes are dependent on prices, so price increases will increase revenues,” says Kasasbeh.

Amman is also cutting its expenditure by reducing its debt burden. In late 2006, it achieved targets set in 2001 that domestic and external debt combined would not exceed 80 per cent of GDP, and that individually they would be no more than 60 per cent. Early in 2008, it lowered the bar, setting a target to limit domestic debt to 40 per cent of GDP and external debt to 60 per cent by 2011. “To achieve these ceilings, we are targeting the reduction of the budget deficit to less than 4 per cent of GDP by 2010,” says Yasein.

Amman is already making progress towards these new goals. Early in 2008, Jordan’s Paris Club creditors discounted the total value of its debts by 11 per cent, which is projected to save the government $900m in interest over the 14 years of repayments. In March, Amman signed an agreement to pay off $2.14bn of Paris Club debts. Since the end of 2007, the government has reduced its external debt from $7.4bn to $5bn.

Jordan has been in a position to pay off its debts while running a fiscal deficit because of a combination of strong economic management, privatisation proceeds and overseas grants.

Privatisation proceeds from the sale of compa-nies including Jordan Telecommunications Com-pany, national airline Royal Jordanian, Arab Potash Company and Jordan Phosphate Mines Company have raised more than $2.5bn, and the country’s political stability and strong relationship with the West and the Arab world have ensured it is a major recipient of financial aid.

At the end of June, Amman announced it had received foreign aid worth more than $300m from Saudi Arabia and $59m from other countries. Negotiations are under way to secure additional funding from the US, expected to amount to JD250-300m, and in late June Minister of Planning & International Co-operation Suhair al-Ali solicited additional aid from the European Commission.

By the end of the year, Amman hopes to have raised a total of $600-700m in grants.

In the medium term, the challenges Jordan faces are likely to be less severe than in 2008. Although its nominal debt levels are likely to increase in the wake of the substantial repayments made this year, GDP growth should ensure it does not increase proportionally. The government’s bold move to remove the majority of its fuel subsidies over a short period of time should mean inflation levels will soften, relieving pressure on the country’s finances.