Explanatory Memorandum to COM(2019)411 - Further macro-financial assistance to Jordan - EU monitor

EU monitor
Wednesday, October 28, 2020
calendar

Explanatory Memorandum to COM(2019)411 - Further macro-financial assistance to Jordan

Please note

This page contains a limited version of this dossier in the EU Monitor.

dossier COM(2019)411 - Further macro-financial assistance to Jordan.
source COM(2019)411 EN
date 06-09-2019


1. CONTEXT OF THE PROPOSAL

Reasons for and objectives of the proposal

In recent years, the Jordanian economy has been significantly affected by regional unrest, notably in neighbouring Iraq and Syria. This regional unrest has taken a heavy toll on external receipts and has strained public finances. Lower tourism and foreign direct investment (FDI) inflows, blocked trade routes for 8 years, and repeated disruptions to the flow of natural gas from Egypt, which forced Jordan to replace gas imports from Egypt with more expensive fuels for electricity generation, have put a drag on growth and weighed on Jordan’s external and fiscal position.

The Syrian conflict has impacted Jordan not only by disrupting trade with and through Syria but also by causing an inflow of around 1.3 million of Syrians refugees (according to estimates from the Jordanian authorities) of which 660,330 are registered with the office of the United Nations High Commissioner for Refugees – UNHCR (data as of 4 august 2019). This large inflow of Syrian refugees into Jordan has increased pressure on Jordan’s fiscal position, public services and infrastructure.

A broadly appropriate policy response and large-scale international support helped the country to preserve macroeconomic stability and prevented an economic contraction. However, Jordan’s economy remains vulnerable to external shocks. Real growth receded to 1.9% in 2018, the lowest rate since 1996. Unemployment jumped to 19% in early 2019 while FDI plummeted. Despite efforts, fiscal consolidation was not sustained at the initially programmed pace, as a result of lower than expected growth, which weakened tax revenues, and the generation of losses by the electricity company in the absence of cost-reflective tariffs. Public debt has barely decreased and Jordan remains dependent on foreign aid. Indeed, Jordan continues to face considerable external financing needs including payment obligations on Eurobonds and other external market borrowing which comes due in 2020-22. In this context, continued support from Jordan’s international partners remains essential.

In August 2016, Jordan and the International Monetary Fund (IMF) agreed on a three-year USD 723 million (150% of quota) Extended Fund Facility (EFF) which has recently been extended to March 2020. This programme followed a three-year Stand-By Arrangement (SBA) in the amount of USD 2 billion (800% of quota) which was agreed in August 2012 and completed in August 2015. The IMF programmes were complemented by two Macro-Financial Assistance (MFA) programmes: the MFA-I, for an amount of EUR 180 million in loans, which was adopted by the co-legislators in December 2013 and completed in October 2015; and the MFA-II, for an amount of EUR 200 million in loans, which was adopted by the co-legislators in December 2016, and completed in July 2019.

The MFA programmes were part of a wider effort by the EU and other international donors, agreed at the London conference “Supporting Syria and the region” in February 2016, to help Jordan and other countries in the region mitigate the economic and social impact stemming from the regional conflicts and the presence of a large number of Syrian refugees. The international commitment towards Jordan was confirmed on several subsequent occasions, notably during the Brussels Conference on “Supporting the Future of Syria” in April 2017, the EU-Jordan Association Council in July 2017 and the Brussels-II Conference on “Supporting the Future of Syria” in April 2018. At the “London Initiative” conference, which took place in February 2019, and at the Brussels-III Conference held in March 2019, the international and regional donor community, including the EU, re-confirmed its intentions to support Jordan’s efforts to preserve macroeconomic stability and enhance growth prospects.

On 11 July 2019, Jordan addressed an official request to the European Commission for additional macro-financial assistance from the EU in the amount of EUR 500 million in three instalments, as anticipated during the EU-Jordan Association Council held in Luxembourg on 26 June 2019. This assistance would contribute to covering the country’s external financing needs and support reform implementation.

In light of this request and of the economic situation in Jordan, in particular the emergence of additional external financing needs, the European Commission is submitting to the European Parliament and the Council a proposal to provide further macro-financial assistance (MFA) to Jordan, based on Article 212 of the TFEU, for an amount of up to EUR 500 million, to be provided in the form of medium- to long-term loans in three instalments.

The objective of the proposed MFA is to help Jordan cover part of its additional external financing needs in 2020-2021, reducing the economy’s short-term balance-of-payment and fiscal vulnerabilities as well as contributing to the debt sustainability. In addition, the EU assistance would provide incentives to step up Jordan’s reform efforts through a Memorandum of Understanding, to be agreed with the Jordanian authorities, setting out an appropriate package of measures supporting economic adjustment and structural reforms. These policy conditions would be in line with the reform commitments taken by Jordan in the context of the EU-Jordan Partnership Priorities and other EU support instruments, as well as the adjustment programmes agreed with the IMF and the World Bank, and the Five-Year Reform and Growth Matrix presented at the “London Initiative” conference in February 2019.

As further elaborated in the Commission Staff Working Document accompanying this proposal, and based, among others, on the assessment of the political situation made jointly by the Commission and the European External Action Service (EEAS), the Commission considers that the existence of an external financing gap in Jordan, combined with the country’s cooperation with the IMF under a disbursing programme, warrants an MFA operation from an economic point of view, and that the political pre-conditions for the proposed MFA operation are satisfied.

1.

General context


The Jordanian economy has been particularly affected by the conflict in Syria, which broke out in 2011. Following a period of robust growth averaging 6.2% during 2001-2010, Jordan’s GDP growth has decelerated to an average of 2.4% in 2011-2018. While reflecting Jordan’s long-standing macroeconomic and structural weaknesses the economic slowdown was largely driven by a series of external shocks including the disruption of critical export routes and markets from protracted regional conflicts, the sharp decline in FDI, the hosting of large numbers of Syrian refugees (1.3 million according to estimates of the Jordanian authorities out of which 660,330 are registered with the UNHCR) and rising oil prices and borrowing costs reflecting the rise of Fed’s rates.

The weakening of economic activity continued in 2018, as real GDP growth slowed to 1.9% in 2018 (from 2.1% in 2017) marking the lowest rate of expansion since 1996. Positively, tourist inflows and exports recovered somewhat and two border crossings with Iraq and Syria were reopened in 2018. In the fourth quarter of 2018, low-cost gas imports from Egypt also resumed. However, these developments have yet to manifest themselves in growth figures: in the first quarter of 2019, real GDP increased by 2%, essentially unchanged when compared with the pace of recent years.

Against this background, unemployment rose to 19% in Q1 2019 from 18.4% a year earlier, marking a significant upward trend since 2014, when it stood at 12.9%. Unemployment for youth (38.5%) and women (28.9%) remains high compared to unemployment for men (16.4%).

Inflation rose to 4.5% in 2018 (from 3.3% at the end of 2017) reflecting the increase in oil prices during much of 2018 and the rise of the General Sales Tax in various basic products that was enacted in January. However, in the first four months of 2019 inflation moderated to 0.6% as the effect of the tax increases faded away. The Central Bank of Jordan increased the re-discount rate in seven steps from 3.75% to 5.75% between February 2017 and December 2018. This broadly mirrors the Fed’s rate rises, given the peg of the Jordanian Dinar to the US dollar. The tightening cycle coincided with a gradual yet moderate increase in inflation, as mentioned earlier. In June 2019, the re-discount rate remained unchanged (at 5.75%) as inflation declined and foreign exchange pressures, which had persisted in 2018, eased. Nevertheless, in the context of the second review of the IMF programme, the authorities expressed their readiness to tighten monetary policy, if needed, to ensure reserve targets are met.

Jordan made significant progress in consolidating its public finances in the past years, but on the back of the weak growth profile and lack of progress in addressing the losses of the public electricity and water supply providers, this progress could not be sustained in 2018. The overall fiscal deficit (including grants) widened to 3.3% of GDP in 2018 from 2.2% of GDP in 2017. The combined public sector deficit – a fiscal metric that takes into account the balance of NEPCO (the public electricity provider) and WAJ (the Water Authority of Jordan) jumped to 4.3% of GDP in 2018 from 2.9% of GDP in 2017, reflecting increased cost of oil combined with the absence of cost-reflective tariffs in the electricity and water sectors, which encourages over-consumption. For 2019, the IMF programme foresees the reduction of the fiscal and of the combined public sector deficit to 2.3% and 2.6% respectively. In the first four months of 2019 the fiscal deficit narrowed to 3% of GDP from 3.8% of GDP year-on-year. However, tax revenues declined by 1.4% year-on-year raising concerns about the budget execution until the end of 2019.

At the end of March 2019, total gross public debt stood at 94.4% of GDP, practically unchanged from end-2018. External public debt amounted to 39.4% of GDP, out of which 72% was denominated in USD, to which the Jordanian Dinar is pegged. While the elevated level of public debt is a source of vulnerability, the IMF judges it to be sustainable provided that the country continues to deliver on fiscal adjustment and growth enhancing reforms and that the international and regional donor community continues to provide significant support to Jordan, notably in the form of grants and concessional funding.

With respect to the external sector, Jordan’s current account deficit narrowed in 2018 to USD 2.9 billion or 7% of GDP (10.3% excluding grants) from 10.5% of GDP in the same period in 2017. This reflected a moderate increase in goods exports (which increased by 3.4% in value terms), while goods imports decreased (by 1.3% in value terms). In the first quarter of 2019, goods exports performed even more strongly, recording a 9.3% increase in value terms, while goods imports decreased by 3.2% in value terms. In the same period, income from tourism increased by 6.1% year-on-year while remittances increased only marginally.

Foreign direct investments (FDI) plummeted to USD 959 million in 2018 (2.2% of GDP), down by 52% in US dollar terms compared to 2017. This marked the lowest net FDI inflow since 2003. This downward trend is consistent with the long-term weakening of FDI (as a share of GDP) since the Syrian conflict: from an average of 12.7% in 2005-2010 to 4.5% in 2011-2018. The regional conflict, which blocked trade routes for 8 years, the economic slowdown in Gulf countries, which were Jordan’s major investors, but also the country’s structural weaknesses, such as rigid labour markets, constraints to foreign investors and high business costs, contributed to the decline of FDI inflows.

The decline in FDI created further pressures on the capital and financial account, as did a decline in public borrowing from around USD 1 billion in 2017 to less than USD 500 million in 2018. These pressures contributed to a sizeable decrease of the commercial banks’ net foreign assets (by around USD 900 million) in 2018, partially caused by tighter monetary policy in neighbouring countries and the political instability in Jordan in mid-2018 (when former Prime Minister Mulki resigned in response to public discontent notably over tax reform plans). Conversely, a small net inflow of USD 41 million in private portfolio investments in 2018 (compared to a large net outflow in 2017), as well as a considerable increase by around USD 600 million in other investments supported the capital and financial account in 2018.

The current level of reserves – standing at USD 13.2 billion (or 7.1 months of imports) at the end of April 2019 – should be increased to make the country more resilient to the above factors. This is particularly important given the vulnerability of the external position, the elevated risks from regional conflicts or geo-political tensions, the exchange rate peg and exposure to oil price shocks.

Despite the favourable developments in exports and tourism, a number of macroeconomic vulnerabilities remain. The country continues to operate under a difficult economic environment impacted by the protracted regional conflict, the hosting of Syrian refugees, the disruption or slow recovery of critical export markets and the marked fall of FDI. As a result, economic growth has remained at very low levels, insufficient to reduce high unemployment. As happened in 2018, the pace of future fiscal adjustment could be lower than envisaged if growth weakens further and Jordan fails to mobilise tax revenues through combating tax evasion and increasing the capacity of tax administration. The same could happen if Jordan does not achieve to restructure effectively the loss-making state-owned (electricity and water) companies, which add to the general government’s deficit. In addition to the above risks, borrowing costs of Eurobonds are higher compared with the cost of Jordan’s Eurobonds that will mature in the coming years (many of which were US-guaranteed), rendering costly the roll-over of the bonds. For the above reasons, the current projection for the decline of public debt to 83.7% by 2024 remains fragile and depends on the success of fiscal adjustment and growth-enhancing reforms that the authorities have committed to do, as well as on the their ability to continue attracting sizeable donor and market financing. Reserves remain below IMF adequacy standards and could come under renewed pressure in 2020-2021, when the country is expected to make around USD 3.1 billion of payments (interest and principal) on sovereign and Eurobonds external debt. In this context, the further replenishment of Jordan’s international reserves seems necessary, and the EU’s additional MFA could usefully support this effort, both directly (through its disbursements) and indirectly (as a catalyst for private capital inflows and instilling confidence in the local currency).

In conclusion, Jordan’s economy remains fragile with substantial external financing needs and exposed to a number of vulnerabilities. In this context, continued support from the IMF and Jordan’s international partners, including the EU, remains essential.

Consistency with existing policy provisions in the policy area

2.

MFA has been provided to Jordan under two separate decisions:


–Decision No 1351/2013/EU of the European Parliament and of the Council of 11 December 2013 providing macro-financial assistance to the Hashemite Kingdom of Jordan 1

–Decision No 2371/2016/EU of the European Parliament and of the Council of 14 December 2016 providing further macro-financial assistance to the Hashemite Kingdom of Jordan 2

As both these operations have been fully disbursed, a new Decision is required before EU MFA support to Jordan can continue.

Consistency with other Union policies

The proposed MFA is consistent with the EU’s commitment to support Jordan’s economic and political situation. It is consistent with the principles governing the use of the instrument of MFA, including its exceptional character, political preconditions, complementarity, conditionality and financial discipline.

The proposed MFA is in line with the objectives of the European Neighbourhood Policy (ENP). It contributes to support the European Union’s objectives of economic stability and development in Jordan and, more broadly, resilience in the South European neighbourhood. By supporting the authorities’ efforts to establish a stable macroeconomic framework and implement ambitious structural reforms, the proposed operation enhances the added value of the overall EU involvement in Jordan. It also improves the effectiveness of other forms of EU financial assistance to the country – including budget support operations and grants available through external financial instruments under the current multiannual financial framework for 2014-2020. The proposed MFA will also be an integral part of overall international support for Jordan, including in response to the Syrian crisis, and will continue to complement the assistance provided by other multilateral and bilateral donors.

Jordan is a key partner for the EU due to its important role in promoting stability and inter-faith tolerance in the Middle East but also due to the hospitality that continues to provide to 1.3 million of Syrians (out of which 660,330 are registered with the UNHCR). The EU and Jordan have a strong partnership across many sectors and have been linked through an Association Agreement which entered into force in May 2002. In line with the revised European Neighbourhood Policy, the EU and Jordan adopted in 2016 the EU-Jordan Partnership Priorities (which included at that time the EU-Jordan Compact). In December 2018, the EU-Jordan Partnership Priorities were extended by two more years to cover 2016-2020.

Cooperation under the Partnership Priorities is structured around three mutually reinforcing objectives: i) macroeconomic stability and sustainable and knowledge-based growth; ii) strengthening democratic governance, the rule of law and human rights; and iii) regional stability and security, including counter-terrorism. Cooperation is also being pursued on cross-cutting issues such as migration and mobility as well as economic, social and political inclusion of vulnerable groups, including youth and women.

Trade relations between the EU and Jordan are governed by the Association Agreement. This agreement established a Free Trade Area opening up two-way trade in goods between the EU and Jordan. In July 2016, the EU and Jordan agreed to make more flexible the rules or origin that Jordanian exporters use in their trade with the EU. Both sides reviewed and improved this initiative in December 2018. The EU is Jordan’s first trading partner, accounting for 17.1% (in value terms) of Jordan’s total trade in 2018. Jordanian exports to the EU amounted to EUR 300 million in 2018 while imports from the EU amounted to EUR 3.6 billion (in value terms).

2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY

Legal basis

The legal basis for this proposal is Article 212 of the TFEU.

Subsidiarity (for non-exclusive competence)

The subsidiarity principle is respected as the objectives of restoring short-term macroeconomic stability in Jordan cannot be sufficiently achieved by the Member States alone and can therefore be better achieved by the European Union. The main reasons are the budgetary constraints faced at the national level and the need for strong donor coordination in order to maximise the scale and effectiveness of the assistance.

Proportionality

The proposal complies with the proportionality principle: it confines itself to the minimum required in order to achieve the objectives of short-term macroeconomic stability and does not go beyond what is necessary for that purpose.

As identified by the Commission based on the estimates of the IMF in the context of the Extended Fund Facility, the amount of the assistance corresponds to around 9.7% of the estimated residual financing gap for the period 2020-2021. This significant commitment is justified by: the political importance of Jordan for the stability in the European Neighbourhood; the political association and economic integration of the country with the EU as reflected by the Association Agreement between the two sides that entered into force on 1 May 2002; as well as the challenging economic situation that Jordan continues to face, notably as a result of the conflicts in Syria and Iraq and the presence of large numbers of Syrians in the country.

Choice of the instrument

Project finance or technical assistance would not be suitable to address macroeconomic objectives. The key value added of the MFA in comparison to other EU instruments would be to alleviate the external financial constraint in a swift manner and to help create a stable macroeconomic framework, including by promoting a sustainable balance of payments and budgetary situation, and an appropriate framework for structural reforms. By helping to put in place an appropriate framework for macroeconomic and structural policies, MFA can increase the effectiveness of the actions financed in Jordan under other, more narrowly focused EU financial instruments.

3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS

Ex-post evaluations/fitness checks of existing legislation

The Commission’s MFA proposal builds on lessons learned from ex-post evaluations carried out on past operations in the EU’s neighbourhood, particularly on the ex-post evaluation of the MFA-I operation provided to Jordan in 2015 that was governed by Decision 1351/2013/EU of the European Parliament and of the Council of 11 December 2013. 3

This ex-post evaluation 4 concluded that the MFA-I programme met its objectives. Its design was relevant with Jordan’s economic challenges, while it contributed substantially to the effective stabilisation of Jordan’s external and fiscal financial position. The programme had considerable added-value for the EU as it supported macroeconomic stability in a neighbouring partner country and mitigated the impact of the refugee crisis. It was designed and implemented in a coherent way to other EU policies or instruments. The programme also had a positive social impact while it made an impactful contribution with regard to public debt sustainability by offering extremely favourable financing conditions.

Stakeholder consultations

In the preparation of this proposal for MFA, the Commission services have been in regular contact with the Jordanian authorities, in order to foster Jordan’s ownership of the programme. Besides, as MFA is provided as an integral part of the international support for the economic stabilisation of Jordan, the Commission has also consulted with international partners of Jordan such as the International Monetary Fund and the World Bank, which are supporting the country through sizeable financing programmes.

Collection and use of expertise

An Operational Assessment verifying the quality and reliability of Jordan’s public financial circuits and administrative procedures was carried out by the Commission with the assistance of external experts, with the final report prepared in September 2016. A new Operational Assessment is foreseen to be conducted in the first quarter of 2020 in order to reflect recent developments.

Impact assessment

The EU’s macro-financial assistance is an exceptional emergency instrument aimed at addressing severe balance-of-payment difficulties in third countries. Therefore, this MFA proposal is exempted from the requirement to carry out an Impact Assessment in accordance with the Commission’s Better Regulation Guidelines (SWD(2015) 111 final) as there is a political imperative to move ahead quickly in this emergency situation requiring a rapid response.

The MFA will help alleviate Jordan’s short-term financing needs. The economic adjustment and reform programme attached, building on the Jordan government 5 year growth and reform matrix, will contribute to create a stable macroeconomic framework and to implement ambitious structural reforms that will enhance growth and job creation prospects. MFA financing will also help the beneficiary country make the necessary economic adjustment less harsh and abrupt, compared with an alternative scenario without external financial assistance. In this way, it helps cushion the social impact of the adjustment and avert the adverse effects of the crisis that the country is undergoing. By providing long-term financing on highly concessional terms and supporting reforms, the MFA programme will contribute to pursue fiscal adjustment, enhance Jordan’s debt sustainability and to create the fiscal space necessary to preserve necessary social spending amid the persistent economic and social pressures arising from the challenging regional context, including the presence of around 1.3 million of Syrians according to estimates of the Jordanian authorities (out of which 660,330 were registered with the UNHCR in August 2019). Moreover, through targeted policy conditionality, MFA helps to set the conditions for more balanced, sustainable and inclusive growth with adequate social protection.

4. BUDGETARY IMPLICATIONS

The planned assistance would be provided in the form of loans and should be financed through borrowing operations that the Commission will conduct on behalf of the EU. The budgetary costs of the assistance will correspond to the provisioning, at a rate of 9%, of the amounts disbursed into the Guarantee fund for external actions of the EU, from budget line 01 03 06 (“Provisioning of the Guarantee Fund”) 5 .

Assuming that the first two loan disbursements will be made in 2020 for a total amount of EUR 300 million and the third loan disbursement in 2021 for the amount of EUR 200 million, and according to the rules governing the guarantee fund mechanism, the corresponding provisioning amounts will be entered in the budgets for 2022 (EUR 27 million) and 2023 (EUR 18 million).

The Commission assesses that the budgetary impact of the proposed MFA operation for Jordan can be accommodated within the Commission’s proposal for the next MFF.

5. OTHER ELEMENTS

Implementation plans and monitoring, evaluation and reporting arrangements

The European Union shall make MFA available to Jordan for a total amount of up to EUR 500 million, provided in the form of medium- to long-term loans, which will contribute to cover Jordan’s residual external financing needs in 2020-21. The assistance is planned to be disbursed in three loan instalments. The disbursement of the first instalment is expected to take place towards June 2020. The second and third instalment could be disbursed in the fourth quarter of 2020 and in the second quarter of 2021 provided that the policy measures attached to each instalment have been implemented in a timely manner.

The assistance will be managed by the Commission. Specific provisions on the prevention of fraud and other irregularities, consistent with the Financial Regulation, are applicable.

The Commission and the Jordanian authorities would agree on a Memorandum of Understanding setting out the structural reform measures associated with the proposed MFA operation, including aspects of timing and sequencing. Moreover, as is normally the case with MFA, the disbursements would inter alia be conditional on satisfactory reviews under the IMF programme and the continued drawing by Jordan on IMF funds.

The proposal includes a sunset clause. The proposed MFA would be made available for two and a half years, starting from the first day after the entry into force of the Memorandum of Understanding.

The Commission will report yearly to the European Parliament and to the Council on the implementation of this Decision in the preceding year. Furthermore, the fulfilment of the objectives of the assistance will be assessed by the Commission, including in the context of an ex-post evaluation that the Commission shall submit to the European Parliament and to the Council not later than two years after the expiry of the availability period of the assistance.

The text of this proposal is consistent with the text of previous MFA Decisions as approved by the European Parliament and the Council in recent years.