2013: Psychological factors will weigh on the economy

1. 2013: Psychological factors will weigh on the economy December 2012

2. 2013 LOCAL ECONOMIC THEMES More austerity in the horizon

3. Fiscal balances are on a more sustainable track • The budget balance has deteriorated over the first ten months of the year, as the fiscal deficit widened to JD 1.17 billion compared to a deficit of JD 457 million for the same period last year, as grants remain sluggish in comparison to last year. • However, the fiscal deficit (excluding grants) at JD 1.3 billion for the first ten months, is actually narrower compared to last year’s JD 1.5 billion for the same period. • The government re-estimated fiscal deficit in the 2012 budget to JD 1.5 billion by the end of this year, representing around 7% of GDP. • If we exclude grants, then the fiscal deficit would reach 10.7% of GDP by end of 2012. • Nevertheless, fiscal balances are on a more sustainable track following the latest price increases and the IMF coordinated economic adjustment program. • Forecasts for 2013, expect the budget balance to improve. At the very least, as part of its National Economic Reform Programme, the government is expected to reduce central government’s deficit through extra measures equivalent to 1% of GDP in 2013.

4. Fiscal balances are on a more sustainable track • Fiscal measures exceeding 3% of GDP have already been implemented, without which the deficit for 2012 would have reached 9.6% of GDP. • On the revenue side, the authorities raised taxes on a number of luxury goods, broadened the coverage of the tax base, phased out some tax exemptions, and increased certain nontax fees. • On the expenditure side, the authorities reduced subsidies on gasoline, diesel, kerosene and electricity; cut military spending and subsidies to independent public institutions; in addition to reducing capital spending on non-priority projects. • Moreover, the government's programme also includes comprehensive reforms in the electricity sector through further increases in electricity tariffs and diversification of energy sources.

5. Fiscal balances are on a more sustainable track • Reports indicate that the projected deficit in the government's 2013 budget, expected to be finalized soon, is around JD800 million after including foreign grants, while by excluding foreign assistance, the deficit is estimated to reach JD1.3 billion. • This is taking into account that austerity measures recommended by the IMF were implemented, which might be somewhat optimistic. • The drop is likely to come from an increase in revenues following implementations of the IMF programme. • The finance minister in his latest interview stressed that state budget of 2013 will focus on increasing domestic revenues to cover around 84% of current expenditures, up from 74% in 2011, adding that the spending bill will also see expansions in capital expenditures to stimulate the economy. The capital spending will be financed by the $2.5 billion GCC development fund. • Nevertheless, government balances are still exposed to oil shocks and downside risks of social unrest. • Also, the assumptions on which the budget was prepared tend to be optimistic, as the historically the closing fiscal deficit balance tends to overshoot preliminary projections.

6. Medium Term Strategy For The Electricity SectorEgyptian Gas Supplies Back to Normal Levels As of Dec 2012 Source: IMF staff estimates End of Nov 2012 • Financial losses of the state-owned National Electric Power Company (NEPCO) are estimated to exceed JD1.19 billion by the end of this year due to dependency on expensive imported heavy fuel as a result of frequent disruptions of natural gas supplies from Egypt. • If gas supplies remain at its maximum capacity as of today, NEPCO losses will go down from 5.30% in 2012 to 1.8% or JD 280 Million in 2013. • This decrease in NEPCO losses does not mean dropping the plan of increasing electricity tariffs, since this lower loss should be addressed and since NEPCO arrears should be covered. • It is likely that electricity average tariffs will increase by 10% at least in 2013. • In addition, the hike in tariffs should remain there in order to reduce the government’s exposure to gas and oil shocks.

7. Yet, public debt on the rise nearing psychological barriers • Despite these strong efforts, public debt is projected to increase from 70.7% of GDP in 2011 to 83.9% in 2014, by IMF Staff estimates. • According to data from the Ministry of Finance, public debt had climbed by 19% toward the end of 2012, crossing the JD16.5 billion mark, representing 75% of estimated GDP in 2012. • Of this total, roughly two-thirds had been raised on the domestic market, with the remaining owed to overseas lenders. • Public debt is expected to continue edging up in 2013 to around JD19 billion, reaching 79.6%, edging close to the 80% public debt law of 2011. • Nevertheless, if inflation was to rise above expectations, then this could stabilize debt to GDP. • As for financing needs, the expected rollovers of public debt will reach JD4.1 billion, implying that debt service is highly exposed to higher interest rates in the coming years.

8. Reliance remain substantial on grants and external borrowing • Under the assumption that budgetary grants will come in as projected (3% – 4% of GDP, around $1 billion), IMF estimates suggest that to maintain reserves at about four months of imports, Jordan’s additional external financing needs would reach $1.1 billion in 2013. • The aforementioned gaps is anticipated to be covered through donors and external financing. Receiving expected grants will leave the Jordanian economy with a minimal external foreign currency gaps. • If a eurobond was to be issued at $1.5bn, and grants come in as expected, then the government can cover its financing needs using external sources, which would relieve pressure on domestic debt and the need for large bond issuance. • Over the longer term, reliance on external grants is expected to be reduced through more frequent market financing.

9. 2013 LOCAL ECONOMIC THEMES Mobilizing additional external financing

10. Issuing New Eurobonds – Expected Size $ 1.50 Billion • This new issue aims at reducing the crowding out effect of the credit granted to the private sector. • Private sector credit went down as a percentage to GDP from 7% in the first five months 2011 to 5% over the same period in 2012. • This step will improve foreign reserves’ levels and boost excess liquidity levels in Dinar. • Expectations that the new issue will take place in Q1 2013. • IMF strongly recommends issuing the new bonds in 2013

11. Issuing New Eurobonds Expected Yield 5.50% for 5 years & 6.70% for 10 years The Issue will be supported by huge amount of liquidity in the market & the recent positive feedback from the IMF

12. Issuing New Eurobonds Expected Yield 5.50% for 5 years & 6.70% for 10 years Compared to Jordan’s credit peers, the abovementioned expected yields appear to be reasonable, especially when taking into account economic fundamentals CAB Estimation

13. 2013 LOCAL ECONOMIC THEMES Foreign currency sources under stress

14. FX Reserves under pressure • Concerns over regional and domestic instability have put pressure on Jordan's foreign reserves. • The more expensive fuel imports resulted in a decline in the Central Bank of Jordan’s (CBJ) reserves, which was exacerbated in May by an increase in deposit dollarization, reflecting depositor nervousness. CBJ reserves dropped to $6.5 billion at mid-July—a decline by almost 40% since end-2011. • Although the reserve loss has stabilized recently, foreign reserve holdings were down by 34% by end of October, bouncing up to $6.85bn. • FX reserves are expected to remain under pressure throughout 2013, fuelled by the continued geopolitical unrest in the region and its downside effect on tourism activity and foreign investments. • However, if Egypt resume pumping gas, eurobond issued successfully and committed grants received then the trend will be upwards ending two years of hemorrhage where reserves shed nearly 45% of their value. • FX reserves are anticipated to have an average of 4 months of imports in the coming 3 years.

15. FX Reserves under pressure, but the peg remains stable Depreciation Appreciation • A main factors in the drop of FX reserves are the high oil import bill and psychological factors. Investor concerns and fears resulted in a move away from the dinar, with some investors shifting into overseas currencies as a hedge against further unrest. • Dollarization rose, especially in the past couple of months, the ratio reached 26.9% in October, compared to 21.6% in 2011. • The Central Bank of Jordan countered these risk, by creating a new monetary tool––a weekly repo operation––and narrowing the interest rate corridor. The central bank also injected liquidity into the market by trading government papers on the secondary market. It also raised in December its overnight rate on dinar deposits to 4%, a 0.75% increase, with the aim of making investments in dinar-denominated assets more attractive. • This may encourage more capital to flow into the market, though further unrest or negative reports on the economy in 2013 could erode any gains made through the CBJ's intervention. • The pegged system is expected to remain stable throughout 2013, as long as FX Reserves cover more than 4 months of imports. As noted by IMF staff, the real effective exchange rate remains broadly in line with medium-term fundamentals.

16. Some positive prospects for foreign currency inflows • On the positive side, tourism income increased by 15.3% in the first eleven months of this year, and remittances started to recover while the oil price declined from its level in the first half of the year and is likely to be on a downward trajectory. • However, uncertain regional developments and a significant increase in oil prices remain important vulnerabilities. • Workers remittances increased throughout 2012, rebounding from their drop the previous year. Though the trend into 2013 will depend on how the global factors such as the eurozone crisis play out, and the effect it will have on the GCC economies, where the bulk of Jordan’s workers reside. • Foreign direct investment is expected to increase slightly in the next year, with expected official support for investment projects, in particular from the Gulf Cooperation Council (GCC).

17. Current account deficit could pose a serious threat • Widening current account deficit is posing a serious threat on Jordan’s credit ratings in addition to exacerbating pressures on the stability of the Jordanian Dinar. • The current account came under intense pressure during the first half of 2012, mostly reflecting imports of expensive fuel products for electricity generation. For the whole year, the current account deficit is projected at 14.1% of GDP, about 2% of GDP higher than in 2011. • The current account deficit is projected to undergo adjustment in 2013, reflecting lower food and fuel prices, a rebound in export growth—following a sharp deceleration in 2012 due to disruptions in transit trade through Syria and in potash and phosphate production (caused by long worker strikes)— and continued improvements in travel receipts, including from the GCC. • Nevertheless, a deteriorating regional and global environment could hurt tourism receipts and FDI.

18. 2013 LOCAL ECONOMIC THEMES Promoting growth

19. Positive growth albeit at sluggish pace • The year is closing much as it opened, with the government looking to reduce subsidies while having to deal with the burgeoning costs of supporting the tide of Syrian refugees fleeing the conflict across the border. According to a study by UNDP, the cost of hosting Syrian refuges is estimated to reach $300 million in 2012. • These two factors have played on the economy throughout 2012 and are expected to continue into next year. • Despite these concerns, Jordan's economy continued to expand, with growth expected to reach 3% by the end of 2012, according to the IMF. • The IMF predicts GDP will increase by 3.5% in 2013, mostly through a JD495 million projected increase in capital spending and expected structural reforms to enhance the business environment and competitiveness. • Jordan's recovery is expected to remain sluggish, since the kingdom's main trading partners are on sluggish trend and risk balance remain downward tilted. • Global economy is still on the slide as the IMF reduced global growth forecasts. • The ongoing Arab spring is hampering growth in the MENA region, and the GCC is at crossroads, as ballooning governmental spending is hampering sustainability.

20. Significant inflationary pressures in 2013 • Despite the expected moderation in international food prices, CPI inflation is expected to increase to 4.5% by the end of 2012, only slightly up from the 4.2% in the first three quarters of the year, due mainly to an increase in fuel pump prices. • However, inflationary pressures on the rise going into 2013, as the impact of higher fuel costs kick in, as well as the potential increase in electricity and water tariffs. These price hikes are likely to infiltrate to the core economy. • International agencies project inflation rate of 4.3% for 2013, though the preliminary assumptions likely have not taken into account the recent price hikes, which might push inflation towards 6%. • Also expectations are for international fuel and food prices to drop, if that was to change then inflation will likely rise.

21. 2013 LOCAL ECONOMIC THEMES Tight interbank liquidity

22. Excess Liquidity in Jordanian Dinar to Remain Under Pressure • JD excess liquidity in the banking sector dropped significantly due to deficit in balance of payments & dollarization. • Till end of December 31st 2012, excess liquidity went down to JD 1.9 billion from JD 3 billion at the beginning of the same year. • The JD1.1 billion drop came despite the new injected liquidity by CBJ by JD1.1 billion. • The new liquidity was injected through weekly and monthly repos (JD550 million) and purchasing government bonds (JD 600 million). • JD Excess liquidity would have reached a critical level of JD 800 Million, if no CBJ intervention was there.

23. Excess liquidity is expected to reach JD2.5bn in 2013Increases in Liquidity will be Partially Curbed by Reversing CBJ Easing Instruments Negative External Gap is anticipated to be over-covered by IMF loan & eurobondIssue The projected surplus in Balance of Payment is anticipated to fund the excess liquidity with JD 800 million The growth of JD deposits if Dollarization amounts for JD 700 million will fund excess liquidity with extra JD 800 million The CBJ is anticipated to withdraw repos and outrights by JD 1 billion 1900 + 800 +800 – 1000 = JD 2,500 million

24. 2013 LOCAL ECONOMIC THEMES Maintaining calm

25. Vulnerabilities and downside risks to the economy in 2013 Regional and global factors: • A deteriorating regional and global environment could hurt tourism receipts and FDI, and might also have fiscal and political implications. • The situation in Syria disrupts transit trade and introduces significant uncertainty into the government’s spending to accommodate refugees’ needs. • Moreover, activity in the regional oil exporters could slow as a result of an escalation of the eurozone crisis, and this could spill over to Jordan through lower tourism, exports, and remittances. • Domestic factors: • The government needs to stay committed to its National Economic Reform Programme, which includes politically sensitive measures. • A difficult domestic situation could jeopardize reform plans and adversely impact confidence. • The government will be hoping that general elections in late January will provide it with parliamentary support for its austerity programme. • However, many opposition groups have vowed to boycott the poll over the issue of subsidy cuts, which could lead to further unrest in 2013. • If this were to happen, investors and donors may delay in committing funds.

26. Psychological factors played a large role in the deterioration of 2012 • 70% of FX reserves drop was driven by dollarization as psychological factors in the form of investors concern regarding reports of the drought of grants as well as political uncertainty led to conversion to foreign currencies and an increase. in dollarization to in. Otherwise • This in turn led to an increase in domestic interest rates, as higher burden was then placed on individuals and businesses, who had to facer higher borrowing costs, which likely hampered economic growth. • Also led to an increase in the government’s debt service

27. Psychological factors will weigh on the economy throughout 2013 • Reserves rise with eurobond issue A large & prolonged increase in energy prices • Capital spending to boost growth Political unrest following elections Social unrest More stable political position Less natural gas from Egypt Deteriorating in global environment Psychological factors

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