US embassy cable - 05AMMAN5311

C O N F I D E N T I A L SECTION 01 OF 03 AMMAN 005311 
 
SIPDIS 
 
LONDON PLEASE PASS TO D 
NEA/ELA FOR WILLIAMS/BARON 
EB FOR GRIFFIN 
TREASURY FOR QUARLES/SHWARZMAN 
 
E.O. 12958: DECL: 07/02/2015 
TAGS: EAID, EFIN, PREL, KPRV, JO 
SUBJECT: IMF ADVANCE REPORT PRESENTS STARK FISCAL PICTURE, 
IN LINE WITH MOF PROJECTIONS 
 
REF: AMMAN 5228 
 
Classified By: Charge d'Affaires David Hale for reason 1.4 (b) and (d) 
 
1. (C) SUMMARY: According to advance reports, a quarterly IMF 
review of Jordan,s economic situation shows a dramatic 
deterioration in the fiscal position of the GOJ, broadly in 
line with figures that we have seen from the Ministry of 
Finance, that stems from the rise of world crude prices and 
the GOJ,s failure to obtain the expected level of GCC grant 
aid.  Working with the Ministry of Finance, the IMF appears 
to have convinced the Cabinet of the necessity of taking 
drastic measures to partially rectify its fiscal position, 
chief among them the acceleration of the elimination of fuel 
subsidies from the original target date of February 2008 to 
January 2007.  Nonetheless, the upcoming several years will 
see higher-than-recommended budget deficits, even if the GOJ 
is able to muster the political will to follow up the painful 
measures it is taking in 2005 with equally painful measures 
planned for 2006 and 2007.  END SUMMARY. 
 
2. (C) Emboffs have recently seen a copy of the Concluding 
Statement of the IMF Quarterly Post-Program Monitoring 
Mission (which concluded on June 15), provided to them by a 
GOJ official.  The IMF appears from the report (and our 
conversation with one team member confirms this to be the 
case) to have been surprised by Jordan,s failure to secure 
its expected level of grants from the GCC states and by the 
continued rise in crude oil prices.  The mission found the 
resulting budget deficit - which it estimated at 12% of GDP - 
to be alarming, noting in the report that without aggressive 
action, "the serious macroeconomic imbalances would not only 
reverse the progress made in the past few years in reducing 
the debt/GDP ratio, but could also threaten stability of the 
exchange rate." 
 
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ELIMINATING FUEL SUBSIDIES 
-------------------------- 
 
3. (C) Given this substantial shortfall in Jordan,s budget, 
the IMF considers that the only option for the GOJ is to move 
aggressively to end fuel subsidies.  The team member with 
whom we spoke noted that progress had already been made on 
this front with the GOJ.  In alliance with then-Finance 
Minister Bassem Awadallah, the IMF had gotten an agreement 
from a previously reticent Cabinet to end fuel subsidies by 
January 2007, rather than the February 2008 date that the GOJ 
had previously noted as the deadline for fuel subsidy 
elimination. 
 
4. (C) The IMF report elaborates further on this agreement: 
the first fuel price increases will come by early July, 
followed by at least two further rises by March 2006 and 
January 2007.  (Judging from comments by PM Adnan Badran on 
June 28, prices will increase by approximately 30%, providing 
approximately $165 million in additional revenue to the GOJ 
during the final six months of 2005.)  The accelerated 
schedule is intended to neutralize, at the earliest possible 
time, the impact of further potential world crude oil price 
increases.  The GOJ, which already makes a surplus on every 
gallon of gasoline sold, would see this informal revenue 
source codified in the form of an excise tax on gasoline and 
diesel. 
 
5. (C) A gap still persists, however, between the IMF 
recommendations on fuel subsidies and the steps that the GOJ 
is willing to take at this point.  One sticking point has 
been the different estimates of the global crude oil price on 
which to base fuel price increases - the GOJ is still making 
its calculations at an estimated average price per barrel of 
$45, while the IMF believes $53 per barrel is more realistic 
given recent market pricings and projected movement of the 
world market.  (COMMENT: Given that the break-even point for 
the GOJ at current Jordanian fuel prices would be at a global 
crude oil price of approximately $27.15 per barrel, according 
to MOF figures, the gap between the IMF and the GOJ on this 
issue is relatively small.  Nonetheless, if high prices 
continue as the IMF projects, it may take some additional 
time for Jordan to eliminate all fuel subsidies - and the 
difference will be apparent in the budget deficits for 2006 
and 2007. END COMMENT.)  Even $53 per barrel, however, may 
eventually prove to be too low an estimate.  The IMF has 
therefore recommended "the adoption of quarterly automatic 
price adjustments in place of annual discretionary 
increases," but the GOJ has not indicated any intention of 
signing on to this idea. 
 
-------------------------------------------- 
FISCAL PREPARATION FOR THE END OF GCC GRANTS 
-------------------------------------------- 
6. (C) Of greater immediate effect to the GOJ balance sheet 
than the unanticipated fuel price increases has been the loss 
of anticipated GCC grants. The IMF currently assumes that no 
further grants will come from GCC states in 2005, and that 
even the reduced Saudi cash grant will not continue past 
April 2006.  Given that the grants from the GCC for 2005 were 
expected to outweigh the fuel subsidies - even at increased 
prices - by at least $300 million, the budget would have 
needed to be cut substantially even had fuel prices remained 
at 2004 levels. 
 
7. (C) The GOJ has begun this process by making some hard 
choices, though further hard choices remain to be made.  A 
substantial cutback in capital expenditures for 2005 (by 2.4% 
of GDP according to the IMF report - equivalent to the $288 
million in the most recent position paper that we have 
received from the Ministry of Finance) still represents a 
climbdown from former Finance Minister Abu Hammour,s 
repeatedly stated vow that Jordan would do no spending that 
was not covered by revenue or grants.  (We do not have access 
to information on exactly what capital spending has been 
cut.)  However, the capital spending cut being planned by the 
GOJ meets the recommendations of the IMF, who have proposed 
substantially smaller capital spending reductions for the 
projected 2006 and 2007 budgets.  In any case, the reduction 
in capital spending will contribute more heavily to the 
stabilization of Jordan,s fiscal position in 2005 than the 
projected additional revenue from the increased fuel prices. 
 
8. (C) The IMF language on the medium-term steps that the GOJ 
has agreed to take to raise revenues and cut expenses is also 
generally positive.  The IMF has received a verbal agreement 
from the GOJ to remove all food subsidies in 2006, though the 
increased expenditure on a social safety net (providing the 
neediest 20% of Jordanians with assistance in procuring food 
and fuel) will counterbalance most of the savings from this 
measure; they have also recommended that the GOJ freeze all 
current expenditures except for pensions at 2005 levels - a 
step that would cut GOJ projected expenditures by an average 
of slightly less than $130 million per year during the 
projected period.  The IMF staff member with whom we met 
viewed the King,s regional decentralization proposal as a 
key threat to the freeze in current expenditures, as the 
potential addition of elected officials and staff for this 
purpose would not only add additional current expenditures 
itself, but also make it harder for the GOJ to hold the line 
against other requests.  (NOTE: He also repeated the 
often-heard rumor that the USG was behind this initiative.) 
 
9. (C) The IMF has had less success in receiving GOJ 
concurrence in the partial and total elimination of 
exceptions to the GST for certain products taxed at a lower 
rate than the 16% standard rate, only securing agreement from 
the government for elimination of partial exemptions on hotel 
rooms, alcohol, and cigarettes and a vague statement of 
intent to double GST rates levied on some exempted goods and 
services currently taxed at the lowest rate (from 4% to 8%) 
in 2006.  The potential revenue gain foregone by the GOJ by 
its more selective (and delayed) policy on increases, 
however, only totals around $85 million over the two-year 
period of 2005-6. 
 
10. (C) The IMF report also endorses GOJ,s restructuring of 
Jordan,s income tax code to flatten the tax rate and improve 
collection.  It notes, however, that positive effects on 
revenue are unlikely to appear before 2007, and the IMF makes 
no attempt to quantify the potential returns of such a tax. 
 
11. (C) Finally, the IMF report appears to regretfully accept 
that rather than reducing the GOJ,s stock of debt, the 
proceeds coming in from the GOJ,s accelerated privatization 
program over the next three years will likely be used to 
finance part of the GOJ deficit.  These anticipated revenues, 
though they are not cited in the IMF report, probably 
underlie the GOJ,s optimistic prediction of a budget deficit 
amounting to 5.1% of GDP (rather than the 12% deficit 
projected based on commitments in the original GOJ budget) in 
2005. 
 
------------------------- 
OTHER ECONOMIC CHALLENGES 
------------------------- 
 
12. (C) In addition to their effects on the fiscal deficit, 
the IMF report notes that the loss of GCC grants and the rise 
in oil prices would further widen Jordan,s current account 
deficit.  The IMF team views the recent large portfolio 
capital inflows to Jordan as a potential additional element 
of risk to currency stability and advocates a tighter 
monetary policy on the part of the Central Bank of Jordan 
(CBJ).  Ultimately, the IMF does not foresee a serious 
near-term risk to the exchange rate, though it noted that the 
CBJ would likely have to draw down its reserves to some 
degree over the upcoming year. 
 
13. (C) The IMF notes a final risk to Jordan,s economy 
stemming from the possibility of a dramatic reduction in the 
value of the currently inflated Amman Stock Exchange, draws 
attention to the exposure of Jordanian banks to the stock 
market, and calls on the relevant authorities to be vigilant. 
 It also notes the necessity of swift passage of an 
anti-money laundering law. 
 
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COMMENT 
------- 
 
14. (C) That the IMF now considers the attainment of a 5.1% 
(of GDP) deficit in the GOJ budget in 2005 and a 6.5% deficit 
in 2006 to be best case scenarios in the absence of further, 
unanticipated grant aid is a testimony to how drastically the 
fiscal position of the GOJ has been transformed by the 
continued rise in crude oil prices and the government,s 
failure to obtain 2004 levels of grant aid from the GCC 
states.  The IMF, in its summary, notes that if all of their 
recommendations are followed to the letter, Jordan might 
barely meet the requirement specified in its Public Debt Law 
that sovereign debt be reduced to 80% of GDP by the end of 
2006.  However, an economic downturn - or even a slowed rate 
of growth - driven by the effect of the substantial fuel 
price increases to the competitiveness of Jordanian 
industries and to Jordanian consumer spending may mean that 
the GOJ will be unable to meet this target.  This likely will 
mean an undiminished drive by the GOJ for further debt swaps 
and debt forgiveness.  If the latter is unsuccessful, there 
will likely be increasing pressure for an amendment to the 
Public Debt Law extending the deadline for achievement of the 
target. 
 
15. (C) The good news of this story, for the IMF, is the way 
in which the GOJ has reacted to its sudden reversal of 
fortune.  By force of necessity - and, it appears, aided by 
straight talk from the IMF on the severity of Jordan,s 
fiscal position - the GOJ is now making concerted steps to 
end its dependence on grants from its Arab neighbors that 
have always been uncertain.  Nonetheless, the painful 
budgetary adjustments that now appear to be a fait accompli 
for 2005 will have to be followed by equally painful 
adjustments in 2006 and 2007 in order for the GOJ to safely 
maneuver into its new budgetary equilibrium.  To maintain the 
requisite political will to endure this pain over an extended 
period, the GOJ will require the strong support of its 
friends and their constant reinforcement of the message that 
the IMF has delivered. 
HALE