Jordan - Policies and prospects for small and medium scale manufacturing industries

Report No. 6848-10 Jordan Policies and Prospects for Small and Medium Scale Manufacturing Industries January 1988 Europe, Middle East and North Africa Regional Office FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  JORDAN POLICIES AND PRvSPECTS FOR SMALL AND MEDIUM SCALE MANUFACTURING INDUSTRIES CURRENCY EQUIVALENTS End of Period U.S. Dollar ($) Per 1 Jordan Dinar (JD) 1980 3.2 1981 2.9 1982 2.i 1983 2.8 1984 2.5 1985 2.7 1986 2.8 GLOSSARY AND PRINCIPAL ACRONYMS SMIs - Small and Medium Scale Industries NRIs - Natural Resource Based Industries QRs - Quantitative Restrictions IBs - Import Bans F5PS - Food Processing Sector CPR - Chemicals, Pharmaceuticals and Rubber Sector EBM - Engineering and Building Materials Sector NFG - Non-Food consumer and Intermediate Goods Sector EI Law - Encouragement of Investment Law IDB - Industrial Bank of Jordan CBJ - Central Bank of Jordan SSIHF - Small Scale Industries and Handicraft Fund CVDB - Cities and Villages Development Bank JVA - Jordan Valley Authority SDR - Special Drawing Rights This report is based on the findings of a mission which visited Jordan during December 1986. The missicn consisted of Mr. Sudhir Chitale (Mission Chief, EMENA Country Programs), Mr. Gabriel Sciolli (EMENA Country Programs), Mr. Gianni Brizzi (EMENA IDF), Mr. Peter Glenshaw (EMENA IDF), Mr. Vladimir Konovolov (Industrial Strategy and Policy), Ms. Bita Hadjimichel (Industrial Strategy and Policy), Mr. Turgut Ogman (Consultant), Mr. Robin Theodore (Consultant), Mr. Vimal Atukorala (Consultant), Mr. Stephano Bologna (Consultant). In addition, at Headquarters, Ms. Jeanne Giddings provided analytical support for the preparation of the report and Ms. Mary Brady of the English Department helped with the organization and presentation of the subject matter. A draft of this report was sent to the Government in June 1987, and was discussed by Messrs Sudhir Chitale and John Wall at a seminar at the Jordanian Ministry of Planning, Amman, on September 20, 1987.  FOR OFFCIAL US ONLY JORDAN POLICIES AND PROSPECTS FOR SMALL AND MEDIUM SCALE MANUFACTURING INDUSTRIES Table of Contents Page Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . i-xv Chapter 1: MACROECONOMIC SETTING AND THE MANUFACTURING SECTOR . . . . . 1 A. Overview . ... . . . . . . . . . . . * * * . * * * . I B. Macroeconomic Developments . . . . . . .'. . . . . . . I C. Developments in Manufacturing . . . c . . . .. .. . 5 D. Conclusion . . . . . . . . . . . . . . . . . . . . . . 14 Chapter 2: POLICIES AND INSTITUTIONS AFFECTING MANUFACTURING . . . . . . 15 A. Overview . . . . . . ..... . . . . . . , . . . . . 15 B. Trade Pegime - Policies Affecting External Competition 15 C. Policies Affecting Internal Competition . . . . . . . . 25 D. Burden of Inefficient Industries . . . . . . . . . . . 29 E. Conclusion . * . * * . . . . . . . . * . . . . 33 Chapter 3: FINANCING SMALL AND MEDIUM INDUSTRIES (SMIs) . . . . . . . 35 A. Overview . . ... . . . . . . . . * * . 35 B. Sources of Funds for SMIs . . . . . . . . . . . . . . . 35 C. Government Policies in the Financial Sector . . . . . . 37 D. Problems with the Present Financial Institutions . . . 39 E. Conclusion . . . . . . . . . . . . . . . . . . . 42 Chapter 4: SUGGESTIONS FOR REFORM ... .* .. * * . 43 A. Overview.. . . . ... . . . . . 43 B. Measures to Alter the Incentive Stracture . . . . . . . 44 C. Measures to Improve Institutions . . . . . . . . . . . 49 Chapter S: PROSPECTS FOR SMIs . . . . . . . . . . . . . . . . . . . . . 54 A. Ov'-rview . . . . . . . . . . . * . . . . . . . . . . 54 B. Lontribution of SMIs to Overall Growth . . . . . . . . 54 C. Overall Growth Prospects for SMIs . . . . . . . . . . 55 D. Sources of Subsectoral Growth . . . . . . . . . . . . 57 E. Conclusion . . . . . .. . . . . . . . 61 Annexes A. Analytical Tables Supporting the Text . . . . . . . . . 62 B. Assumptions and Methodology for the Firm Level DRC/ERP Analysis . . . . . . . . . . . . . . . . . . . 97 C. Subsectoral Surveys . . . . . . . . . . .. ..120 D. Basic Data on Small and Medium Scale Industries . . . . 142 MAP This docutnnt has a e.tsdcotet dsmbuton and may be udsd by wcipionts only In tha Porfoiate of their of DcW duties. Its contents may not othorwiw be ditsed without World Nakc authodzation.  JORDAN POLICIES AND PROSPECTS FOR SMALL AND MEDIUM SCALE MANUFACTURING INDUSTRIES Text Tables Table Number Title Page Chapter 1 1.1 Macroeconomic Trends . . . . . . . . . . . . . . . . . 3 1.2 Structure of Jordan's Small and Medium Scale Industries (SMIs) . . . . . . . . . . . . . . . . .A 5 1.3 Trends in Real Value Added in SMIs by Subsector . . . 8 1.4 Trends in Average Investment . . . . . . . . . . . . . 9 1.5 Growth of Real Exports by Subsectors . . . . . . . . . 10 1.6 Contribution to Net Domestic Supply (NDS) . . . . . . 11 Chapter 2 2.1 Extent of Production in Manufacturing Affected by Quantitative Restrictions (QRs) . . . . . . . . . . . 18 2.2 Comparison of Jordan's Tariff Structure with Other Countries . . . . . . . . . . . .9 2.3 Structure of Trade Taxes . . . . . . . . . . . . . . . 19 2.4 Nominal and Effective Rates of Protection 1986 Tariff Rates and 1983 I/O 'table . . . . .. .f. . . . . 22 2.5 Part of Profits Exempt from Income Tax . . . . . . . . 24 2.6 Ex-factory and CIP Import Prices . . . . . . . . . . . 30 2.7 Implicit Annual Subsidies for Selected Product Lip's . 32 2.8 Efficiency of Manufacturing Enterprises . . . . . . . 33 2.9 Domestic Resources Used in Earning or Saving One JD of Foreign Exchange . . . . . . 34 Chapter 3 3.1 Growth of Credit Outstanding to Private Sector by Financial Institutions . . . . . . . . . . . . . . 38 Chapter 4 4.1 Jordan's Exchange Rate Vis-a-Vis Major Currencies . . 46 4.2 Jordan's Nominal Effective Exchange Rate, Relative Price, and Real Effective Exchange Rate . . . . . . . 47 Chapter 5 5.1 Impact of SMI Performance on Gross Borrowing Requirement . . . . . . . . . . . . . . . . . . . . . 55 5.2 A Comparison of Industrial Input Prices . . . . . . . 57 5.3 Status of Projects Identified by Dar El Handasah Study ........................58  JORDAN POLICIES AND PROSPECTS FOR SMALL AND MEDIUM SCALE MANUFACTURING INDUSTRIES Charts Chart Number Title Page 1.1 Current Account as Percent of GDP . . . . . . . . . . 5 1.2 Output as a Percent of Total Supply . . . . . . . . . 17 2.1 Tariff Rates by Sector and Distribution of Imports by Tariff Rates . . . . . . . . . . . . . . . . . . . 32 3.1 Structure of the Financial System . . . . . . . . . . 55  JORDAN POLICIES AND PROSPECTS FOR SMALL AND MEDIUM SCALE MANUFACTURING IhDUSTRIES EXECUTIVE SUMMARY 1. The objective of this report is to assist the Government of Jordan in asses3ing the prospects for small and medium scale industries (SMIs) sector and in defining the policies needed to achieve them. It is argued that while the immediate prospects for the SMI sector are not encouraging, over the medium term the SMI sector in Jordan has the potential to grow and to contribute to increased foreign exchange earnings and employment. In order to achieve this, however, a series of reforms have to be initiated, as soon as possible, to reduce costs and improve the efficiency of resource use in the sector. The most important of these are a reform of the trade regime and the investment licensing system. In addition, it would be necessary to carry out a number of "institutional" improvements which could expand the markets and increase industrial productivity. This executive summary, like the Chapters in the report is divided into five sections: Section A describes the recent trends in the economy and the industrial sector in particular, Section B describes the policies affecting the SMI sector, Section C analyzes the issues in financing the SMIs, Section D offers some suggestions for reform, and SecLion E discusses the prospects. A. Macroeconomic setting and the Manufacturing Sector (a) Macroeconomic Developments 2. Although Jordan is not an oil-producing country, it relies heavily on its oil-producing neighbors for foreign aid, workers' remittances, and export markets. Consequently, Jordan continues to suffer from the economic recession which began in 1983 with the weakening of oil prices and a slowdown in the neighboring economies. Real GDP grew only by 2 to 3 percent p.a. during 1983-86 compared to aboAt 10 percent p.a. during 1977-83. Given the continued growth of population at 4 percent p.a., there has thus been a fall in per capita income. Most of the growth in the piast three years was accounted for by agriculture, mining (largely due to coming on stream of new phosphate projects), and services. There was no growth in manufacturing, and construction, which had grown by above 10 percent p.a. up to 1983, has in fact sharply fallen since then. 3. The recession in the economy since 1983 was due to the sharp fall in external resources. Since 1983, workers' remittances (which amount to 1.3 times the export of goods and finance 40 percent of imports) have stagnated, and foreign aid has declined by 30 percent. The Government responded to these  - ii - adverse developments by sharply reducing public investment and by increasir.g the tax effort. 4hile this response averted major public finance and balance of payments problems, Jordan has paid the price of slow growth and rising unemployment. (b) Developments in Manufacturing 4. Structure. The small and medium scale manufacturing industries (SMIs), the focus of this study, amount to a small portion of the Jordanian economy. During 1981-85, industry (manufacturing and mining) averaged about 18 percent of GDP. Nearly 60 percent of this, however, consisted of the large natural resource based industries (NRIs) such as potash, phosphate, and petroleum refinery, leaving the share of the SMIs to 7.2 percent of GDP. The investments in industry have also been dominated by the NRIs. These accounted for 75 percent of the industrial investment program, which amounted to 23 percent of the overall investments during 1981-85. SMIs, however, feature more prominently in trade and employment. In 1985, products of SMIs, accounted for 24 percent of the value of domestic exports (most of them to the neighboring Arab countries), and as much as 40 percent of commodity imports. Mining and manufacturing employ 12 percent of the Jordanian labor iorce, and 85 percent of these workers are employed by the SMIs. 5. The labor market in Jordan is characterized by an open immigration policy, an absence of strong trade union activity, and no minimum wage legislation. There have not been any industrial disputes and wages, and productivity has generally increased. The labor force in manufacturing is clearly better paid than the labor force in the economy as a whole. On average, wages in manufacturing are higher than the average wages in the rest of the economy, especially those in agriculture and construction. 6. With the exception of the pharmaceutical industry, the SMI sector uses relatively low technology. A large part of the SMI sector is geared to serve the Jordan Valley, and the construction industry. The Jordan Valley is served by small enterprises which process output, making fruit juice and tomato paste, and manufacture inputs such as drip irrigation systems, rubber pipes and green houses. The construction sector is served by enterprises which produce paints, aluminum profiles, sanitaryware, doors and windows, and tiles. A third area where the Jordanian SMI sector has had some success is in makint simple consumer goods such as cosmetics, detergents, bottled soft drinks, beer and textiles. It is unfortunate, however, that the large NRI's have not been successful in developing local suppliers for spare parts and other items needed for periodic maintenance. 1/ The engineering subsector is fairly unsophisticated, and is largely geared to supplying the needs of the construction sector. 7. Government Policy and Performance of Manufacturing. To promote the growth of manufacturing, throughout the 1970s, the Government followed a three-track policy. First, manufacturing enterprises were offered protection by a combination of low tariffs on inputs and high tariffs on outputs. Second, substantial public expenditures were made to create and maintain infrastructure in the support of SMI, such as industrial estates, roads, power and the Port of Aqaba. Third, exports of SMIs were encouraged by promoting 1/ The reasons for this are discussed in detail in Sect on D.  - iii - bilateral agreements with neighboring countries which allowed Jordanian manufactured goods to enter them on a duty free basis. 8. In response to the policies followed by the Government, combined with the rapid growth in the dowt' ic and regional economies, the SMI sector grew by over 18 percent p.a. during 1975-82. Thus, judging purely from the growth of the SMI sector during the 1970s and early 1980s, the Government policy succeeded in meeting its goals. The pattern of growth, however, left the SMI sector with a number of structaral weaknesses. To begin with, the rapid growth of SMIs was based on a narrow range of markets and product lines. The policies followed by the Government had made it possible for a large number of firms to grow on the basis of import sub'titution within the small domestic market, while over 90 percent of exports remained concentrated in the Iraqi, Syrian and Saudi Arabian markets. Further, both the import substitution and export industry was excessively dependent on the construction activity. Thus, by 1983, Jordanian SMIs had very few linkages with the rest of the economy, weak technological capabilities, inflexible product lines 0.id undeveloped marketing skills. 9. The economic recession in 1983 exposed the major structural weaknesses in the SMI sector. The economic recession resulted in a slowdown in the regional economy and sharply reduced the domestic and regional construction activity which was the main market for a large part of the SMI sector. The Jordanian manufacturers, being handicapped by the structural weakness described aboved, were ill prepared to deal with this loss of markets. Consequently, the real value added in manufacturing grew only by 1.7 percent p.a. during 1982-84 compared to 17.1 percent p.a. achieved during 1979-82. The slowdown has become more pronounced since 1985. In 1985, in nine out of twelve sub-industry groups monitored by the Department of Statistics, the output has fallen in absolute terms. Our subsector analysis shows that, on average, the capacity utilization is running at barely 60 percent and most industries have difficulties in competing with imports and maintaining market shares in exports. 10. In order to help the SMI sector through this difficult period, beginning 1984, the Government policy was adjusted to offer increased protection and increased selectivity in allowing new investment. While these measures have helped a large number of firms survive the economic recession, they could not discriminate between efficient and inefficient firms in the process of offering protection. Thus the SMI sector in Jordan today onsists of a mix of efficient, well-managed firms and high cost inefficient firms. Consequently, consumers and downstream industries have been hurt, and there has been a net resource loss to the economy, as discussed in detail in paragraphs 25 and 26. B. Policies and Institutions Affecting Manufacturing (a) Policies Affecting External Competition - The Trade Regime 11. Up to the beginning of 1984, the trade regime had very few quantitative restrictions (QRs). The protection offered to the SMIs was mainly through a low level of tariffs on inputs coupled with a relatively high tariff on competing imports. This trade regime operated within the framework of a stable currency that was linked to the SDR. Over the past three years, however, there has been intense lobbying by the industry for increased  - iv - protection as it faced shrinking markets, and rising costs due to falling capacity utilization which eroded competitiveness in exports ani import substitution. There has also been very little movement in nominal exchange rate. Low inflation in Jordan, vis-a-vis its trading partners together with fairly stable inflow of workers' remittances, however, have preempted any overvaluation of the Jordanian Dinar. In response, since the beginning of 1984, there has been gradual increase in the protection offered to industry. Simultaneously, the Government has attempted to encourage exports by offering income tax exemptions, customs duty drawbacks, and below-market rate export finance. On balance, however, the trade regime continues to have an anti-export bias because it is more profitable to produce for import substitution than for exports. 12. Quantitative Restrictions (QRs). Until the middle of 1984, Jordan had very few Quantitative Restrictions (QRs) on its imports. Imports of some agricultural commodities like wheat, sugar, etc. were restricted to the Ministry of Supply to ensure their availability to the poor at reasonable prices. In addition there were market sharing arrangements in some products. For example, users of tubes and pipes were required to obtain 50 percent of their requirements from the local firm, and a market share of 30 percent was reserved for the local paper and cardboard firms. By and large, however, the number of these QRs was small, and they did not protect a significant part of the local industry. 13. Since the middle of 1984, however, in response to the regional and domestic recession, 32 manufactured goods 2/ have been protected by introducing QRs. A complete list of items under QRs together with the relevant import duty is presented in Annex Table A2.2. 14. While the QRs are not significant from a macroeconomic perspective, they protect a significant portion of manufacturing industry. Based on the pre-QR (the 1983) structure of imports, we estimate that the QRs would have applied to only about 4 percent of total value of imports (Annex A2.2). The macroeconomic impact of QRs is, therefore, small since the removal of QRs would increase imports by a small amount. However, QRs apply to products which account for over 40 percent of the total SMI value added in 1985, as discussed in detail in Chapter 2. Thus, the profitability and, hence, the chances of survival of nearly 40 percent of the SMI secFsr is determined by the QRs. 15. Tariffs. Together with the emergence of the QRs, the protection offered by tariffs has also increased. The average level of tariffs in 1986 was not different from that in 1983. The increase in protection is, therefore, the result of a selective increase in tariffs on final goods produced by the SMIs, coupled with a decrease in tariffs on intermediate inputs used by the SMIs. 16. The existing trade regime creates a wide variation in effective rates of protection (ERPs) across sectors not only due to the wide variation in tariffs but also due to an extensive system of tariff exemptions. All exporters are exempt from duty on imported inputs. In addition, 21 2/ Sheet glass, matches, washing machines and aluminum profiles are soiae of the items whose imports are banned.  institutions 3/ in Jordan are currently exempted from paying customs dut es on their imports. This exemption, however, does not apply to yet another list of seven items. 4/ 17. The main impact of the institutional tariff exemption is that it differentiates the price of a commodity subject to tariff to different consumers within Jordan, concomittantly affecting the pattern of consumption without any economic rationale. More importantly, however, it places the domestic manufacturer at a significant disadvantage vis-a-vis imports within a large portion of his market, in effect reducing the size of his market substantially. In all, the value of imports which came into Jordan in 1985 without paying any tariff was about half the total value of imports. Of these, roughly JD 125 million, amounting to nearly 25 percent of the gross output of the SMI sector, competed directly with domestically manufactured products. Thus in 1985, the institutional exemptions effectively reduced the available market for the SMI sector by as much as 25 percent. (b) Policies Affecting Internal Competition 18. Investment Licensing. In spite of efforts made by the Government to streamline procedures, the investment licensing process remains cumbersome. Investment licensing in Jordan is carried out by the Department of Ir.dustry, Ministry of Industry and Trade. A prospective investor is required to submit a 20-page report highlighting the results of a feasibility study for Lhe venture as a part of his license application. In parallel, the investor has to apply for registration with the Department of Companies, the Municipality and apply for benefits under the encouragement of investment law. 19. A recent amendment to the procedure which went into effect on December 10, 1986 has increased the uncertainty for investors even after obtaining licenses. As per this amendment, only a temporary license valid for six months will be issued to prospective investors. During these six months the investor has to produce documents which provide evidence of the implementation of the project in conformity with the license application. At the end of six months, the progress is to be reviewed by the Ministry and at that point the license could be cancelled, extended or made permanent. In partice however, the Government believes that this ammendment is necessary for separating serious investors from those who merely corner the licences. This amendment increases the complexity and uncertainty and, hence, the cost of investing in Jordan. 20. Encouragement of Investment (EI) Law. Using the benefits offered under the EI Law, the Government has attempted to increase the level of investment in economy as well as influence its pattern in the favor of manufacturing. The EI Law defines a set of criteria by which a project can be classified as an "Economic" or an "Approved Economic Project" based on the extent to which it conforms to the objectives of the national plan. All fixed assets imported for the implementation of an "Economic Project" (EP) are exempted from customs duties. An "Approved Economic Project" (AEP), in 3/ Central government, municipalities, the sports complex and public sector undertakings such as refinery and potash company belong to this list. 4/ Gas ovens, refrigerators and batteries are some of the items which belong to this list.  - vi - addition, en4oys the benefits of exemptions from profits tax for a stipulated period. 21. Ailthough the macroeconomic impact of the EI law is rather small, its impact on the SMI sector is significant. Investment by projects benefitting from the EI Law amounted to less than 3 percent of the total investment in the economy in 1985. An analysis of the EI law carried out by the Dar El Handasaah 5/ showed that the tax revenue forgone from both the profits tax exemption and the customs duty exemption was a small proportion of the total budgetary revenue. The benefits of the EI law, however, are important in determining the profitability of the few projects in the SMI sector. In 1985, the El Law benefitted only sixteen out of the 116 projects approved by the Ministry of Industry. These projects, however, accounted for nearly 45 percent of the total investments in the SMI sector. 22. The detailed discussion presented in Chapter 4 in the main text shows that there are three problems with the present design and implementation of the Encouragement of Investment Law. First, the Law is biased against small investors since the benefits accrue only to projects which employ more than 5,000 JD (the equivalent of US$ 13,000) of fixed assets. Second, the eligibility of a prospective project for benefits under the El Law is discretionary. Although the Government officials make every effort to be objective, a prospective investor has no way of being absolutely sure whether or not his project will be declared an EP or an AEP. Third, the implementation and extension of benefits is discretionary as well as administratively cumbersome. 23. Price Control for consumer goods was introduced in Jordan around the mid-seventies in response to the rise in the inflation as a result of the rise in the price of oil. A Ministry of Supply was created in 1974 with the objective of ensuring the supply of basic food items such as wheat, rice, sugar, red and white meats, at reasonable prices. 6/ 24. At the moment, the impact of the pricing system on the profitability of SMI sector or consumers is not significant. Price control is exercised only on eight items locally produced by the manufacturing sector and three manufactured imports which compete with domestic producers. It is hard to see what benefit this system confers on consumers; especially since the Government is committed to a "no subsidy" policy. For example, if the controlled price (of say school uniforms) is fixed below its market clearing price, the manufacturer will produce something else, and the supply would therefore be reduced. 7/ The consumer would then suffer due to the unavailability of school uniforms. It is even more difficult to set a price on manufactured imports because it is impossible for the Government to guess the premium that a consumer would be willing to pay for an imported item vis-a-vis a domestically-produced item. 5/ Dar El Handasah, "Industrial Programming Study", task 1.17, March 1982. 6/ In addition to the items whose prices are regulated by Ministry of Supply, prices of items protected by QRs or high tariffs is also regulated by the Ministry of Industry and Trade. A list of these items is not available. 7/ Unless the Government is prepared to subsidize him.  - vii - (c) The Burden of Inefficient Industries 25. The increase in protection resulting from restricting domestic and external competition over the past two years has clearly helped a number of firms within the industrial sector to survive. The sharp reduction in domestic and regional demand was unexpected; and without the measures enacted by the Government, many of these firms would have lost their markets and would have had to close down. However, these measures could not discriminate between efficient and inefficient firms in the process of offering protectiont. Consequently, the SMI sector in Jordan consists of a mix of efficient, well-managed firms coexisting with high cost inefficient firms. One consequence of the continued existence of these firms to the economy is that they increase the cost of manufacturers in the domestic market over the CIF import price. For example, the analysis presented in Table 2.6, Chapter 2 suggests that because of the existing system of tariffs on intermediate inputs and outputs and QRs, the prices of adult jeans and clear sheet glass charged by the domestic producers are respectively 14 and ?8 percent higher than the prices at which they could be imported. This increase in cost induced by the existing policies can, therefore, be thot,ht of as a tax paid by consumers (in the case of jeatXs) and downstream industries (the construction industry in the case of glass). Based on out sample survey, we estimate that 'n 1985 this tax burden indueed by the SMI sector as a twhole was nearly JD 126 million which was almost equal to half the total tax revenue of the Government. Of this burden, JD 62 million was imposed on downstream industries and JD 64 million was passed ou to the consumers. In short, in 1985 the rest of the economy paid JD 64 million of implicit subsidy to maintain the existing structure of industries within the SMI. 26. The tax burden (or implicit subsidy) described above represents a large transfer of resources from one societal group to another. In addition, our analysis of a small sample of firms shows that protected firms also tend to be poorly managed and tend to impose resource losses to the economy as a whole. We estimate that, in our sample of firms, JD 40 million of Jordanian resources in the form of capital and labor are used to produce value added worth JD 30 million. This implies a resource loss of nearly JD 10 mtllion for a group of industries accounting for 29.2 percent of the value added fz the SMI sector. If the present sample can be thought of as representative of the general structure of the SMI sector, Jordan is wasting roughly JD 34 million per year, amounting to almost 20 percent of the value added it, the SMI sector by maintaining the existing structure of industries. C. Financial Institutions and Instruments 8/ 27. The financial institutions and instruments in Jordan are by and large well developed and work efficiently. The financial sector in Jordan consists of 17 9/ commercial banks, 6 specialized credit institutions, 11 financial 8/ Central Bank of Jordan, "the Financial Structure of Jordan", 1986. Arthur Young and Company (USAID), "A Preliminary Assessment of the Financial System in Jordan" August 1986. 9/ Domestic and foreign.  - viii - companies and several non-bank financial institutions, such as the pension fund and the post office savings fund. In addition, there is also a small but active stock market. The principal financial institution designed exclusively to serve industry is the Industrial Development Bank (IDB). Other financial institutions are also active in lending to industry creating a potentially competitive environment. 28. The financial institutions which serve industry carry poor loan portfolios and suffer from a low profitability. The general recession in the ecoromy has adversely affected the performance of many firms. As a result, in 1986 as many as 30 percent of the loans carried on the books of the Industrial Development Bank (IDB) were in arrears for more than three months. The industrial loan portfolios of other financial institutions are also suffering, although to a lesser degree due to their more conservative lending policies. In addition, the financial sector is adversely affected by the current interest rate structure under which ceilings on both lending and deposits rates are fixed by the Government. Fierce competition for deposits within the sector and the absence of restrictions on capital transfers abroad, has pushed the effective deposit rates close to the ceilings. This has reduced the spread between borrowing and lending rates, and hence adversely affected the profitability of the financial institutions. 29. Poor portfolio and low spreads have made the financial institutions extremely conservative and risk averse. Banks rely excessively on collateral rather than detailed project appraisal for making loans to industry. Financial institutions thus far have not been an important instrument to promote growth of SMI sector. They have preferred to lend to large public sector firms which have a Government guarantee, to non-Jordanian companies for whom the interest rate ceiling is higher, and have purchased Government securities which have high yields due to their tax-free status. D. Suggestions for Reform 30. In order to enable the Jordanian SMI sector to realize its full potential, its overall competitiveness must be increased by a package of measures that restructure the incentives facing the sector as well as offer institutional support to overcome some of the long-standing structural weaknesses described in Chapters 1 and 2. The restructuring of incentives would involve first, a reduction in the level of protection to the SMI sector as a whole. This would increase competition from imports and transmit to the SMI sector the structural changes in the macroeconomic environment that have taken place since 1983. The most important of these is the recession and the concommittant reduction in demand for some of the products of the SMI sector. Second, the restructuring would involve measures such as an elimination of the tariff exemptions for institutions and a rationalization of the tariff structure to create a uniform non-discriminatory set of incentives across different subsectors (or product lines) within the SMI sector. Such a restructuring of incentives complemented by a reform of the investment licensing system would allow resources to flow to more efficient firms (or product lines) at the expense of less efficient firms thereby increasing the competitiveness of the SMI sector and reducing the resource losses estimated in para. 2.49. 31. To increase the competitiveness of the SMI sector, the restructuring of incentives must be buttressed by improvements in institutional support for  - ix - export promotion, for facilitating efficient import substitution, for improving quality ar1 standards, and for improving the availability of credit. In the short run, the package of measures would result in higher levels of capacity utilization in the efficient firms and could involve closures of some inefficient firms. In the medium/long-term, new firms could emerge, some of which could become competitive exporters. 32. The measures needed to restructure the SMIs could be grouped into two broad categories as listed below. The listing is not in the order of importance. Further, as indicated in para. 4.3 in the main text, this report does not discuss the time frame over which these reforms have to be implemented or fully assess the broadcr macroeconomic impact of the suggested SMI sector policies. (a) Measures to Alter the Incentive Structure 10/ (i) Remove Tariff Exemptions for Selected Institutions (ii) Replace QRs by Tariffs (iii) Reduce the Level and Variation in the Tariffs Supported by an Exchange Rate Change (iv) Reduce the Scope of the Investment Licensing System (v) Simplify the Encouragement of Investment (EI) Law (b) Measures to Improve Institutions (i) Improve Institutions for Export Promotions (ii) Improve the Institutional Arrangements to Promote Efficient Import Substitution (iii) Improve the Institutional Support for Improving Quality and Standards (iv) Improve the Working of the Financial Institutions (a) Measures to Alter the Incentive Structure i) Remove Tariff Exemptions fo Institutions .3. For any commodity bearing a tariff, exempting selected institutions from paying this tariff not only differentiates the price of this commodity to different consumers without any economic rationale, but also places the domestic producer at a disadvantage vis-a-vis imports for a large segment of the domestic (import substitution) market. 34. An example could best illustrate the above phenomenon. If overalls are imported by the refinery (for its workers), it does not pay the scheduled customs duty of 58 percent. On the other hand, a Jordanian manufacturer of overalls pays the scheduled customs duty of 28 percent on the cloth even if the final product is destined for the refinery. 11/ Given that almost half of the total imports come in without tariffs, the domestic manufacturer, 10/ The whole question of the time frame over which these reforms can be implemented has not been discussed in this report. Clearly some reforms such as removing tariff exemptions could be carried out quickly, whereas others such as reforming the tariff code could take two to three years. 11/ The argument, however, does not apply in the case of non-competing imports such as oil which are also exempted from tariffs.  is placed at a disadvantage vis-a-vis imports in a large segment of the domestic market. 35. At a more macro level, a detailed analysis of the institutional import exemptions indicates that roughly JD 125 million, out of a total exempted imports of JD 500 million, compete directly with domestic manufacturing. This amounted to nearly 25 percent of the gross output and 23 percent of the imports of SMIs in 1984. Thus, even on the basis of the macro magnitudes, the domestic manufacturer is placed at a disadvantage vis-a-vis imports in a large segment of the market. For specific firms, this policy could be even more important in determining the chances of marking a profit or a loss. 36. There is thus a strong case for doing away with tariff exemptions, for competitive imports. This would offer a more uniform structure of protection to domestic producers, expand the market for import substitution and increase budgetary revenue. (ii) Replace QRs with Tariffs 37. The QRs have a significant impact on protection, and there is a real danger that their use will increase as domestic industry faces shrinking markets. We recommend that the increase in QRs should be stopped and an attempt be made to replace existing QRs by tariffs. 38. There are three reasons why tariffs are preferable to QRs as an instrument of protection. First, unlike tariffs, which place a ceiling on the price of the domestically produced good, the maximum impact of QRs on prices cannot be predicted. The policy maker is therefore not sure of the maximum possible increase in the cost to the consumer. Second, QRs deny revenues to the Government and third, importers in Jordan cannot be responsive to changes in international price. There is thus a strong case for replacing existing QRs by tariffs. The Government should, however, retain the existing mechanisms to examine complaints of unfair trade practices and dumping where a system based on tariffs and import surcharges may be inadequate. (iii) Reduce the Level and Variation in Tariff Levels Supported by an Exchange Rate Change 39. Increasing tariff levels for selected products of the SMI sector during the past two years have placed a heavy burden on consumers as well as increased costs to the downstream industries. These increases have come about on an ad-hoc case-by-case basis rather than as a result of a well-formulated protection policy, and have added to the complexity of the tariff code. High tariffs have also accentuated the anti-export bias within the tradable sector by encouraging the production of import substitutes over exports. 40. High levels of protection are probably necessary in the case of an infant industry or a sharp recession such as the one faced by Jordan in 1983. However, in both cases the protection offered should be temporary and should be reduced after allowing the industry time to make the needed adjustments. Given that the economic recession and the protective tariff structure has been with the Jordanian industry for at least the past three years, we recommend that the ave.age level of tariff be reduced. The reduction in tariffs should be accompanied by making the tariff structure as uniform as  - xi - possible. This would equalize the effecti%e rates of protection across different activities within industry and thus allow resources allocation to be guided by efficiency considerations rather than an externally-imposed tariff structure. 41. A reduction in the level of tariffs would normally be accompanied by a compensating exchange rate change to preserve the profitability in the import competing sector, increase the profitability in the export sector, and thus avoid the adverse impact on the balance of payments. Conventional indicators show that the current exchange rate is not overvalued from the point of view of a static balance between the demand and supply of foreign exchange. Low inflation in Jordan vis-a-vis its trading partners has kept the real effective exchange rate from appreciating since 1979. The QRs remain small in relation to total imports. There are no restrictions on capital movements and although the debt service ratio is rising, it remains within manageable limits. In the case of Jordan, however, there appears to be a conflict between the exchange rate determined by the static equilibrium in the market for foreign exchange and that necessary to attain the structure of balance of payments targetted in the Plan. The latter aims at substantially reduced reliance on foreign aid and remittances to finance imports. If this target is to be achieved and the industry is to be provided incentives for efficient growth, an adjustment of the exchange rate coupled with a reduction in average level of tariffs will need to be carried out over the next two to three years. (iv) Reduce the Scope of the Investment Licensing System 42. There are four arguments advanced by Government officials in the favor of maintaining the licensing system in its present form. First, the licensing system was useful in advising the prospective investors about the general market conditions. Second, it was necessary for "statistical" purposes to keep track of developments in the SMI sector. Third, it could be used to stop projects that do not have a chance to succeed and be profitable. Finally, it is easier to stop investment in weak projects than to deny tariff protection and/or subsidy at a later date when the project was unprofitable. 43. The use of investment licensing system for advising prospective entrepreneurs about general market conditions and for statistical purposes is legitimate. In fact, this function of the Department of Industry should be strengthened considerably by making up-to-date reports on market conditions and on Government policies available to potent al investors. It is, however, hard to see the value of the licensing system as an instrument to regulate market entry on the basis of the likely profitability. It is impossible for the Government officials to have a better assessment of the business opportunities than the entrepreneur themselves, and even if they did possess the knowledge, the advantages of free market entry and the competitive pressures it generates on reducing costs would outweigh any dislocations caused by closing down of firms. (v) Simplify the Encouragement of Investment (EI) Law 44. A reform of the EI Law is desirable to do away with the discretionary aspects, reduce the administrative and information demands of its implementation, and remove the bias against small investors. We recommend that the existing complex system of awarding benefits be replaced by the  - xii - following two measures: (i) place a zero or a very low uniform tariff rate on all capital goods; and (ii) allow profit tax exemption to all projects in specific sectors for a fixed period from the time of issue of the license. 45. The two measures would do away with the complex administrative machinery set up to define and implement the Law in its present form in three ways. First, the whole process of defining a project as an EP or an AEP would be redundant. Second, a zero (or low uniform) duty on all capital equipment would do away with the need to administer the exemption of customs duties under the new Law. Third, it would relieve the Ministry of Industry and Trade of the burden of administrating the profit tax benefit, which could easily be done by the income tax department as part of its routine work. Finally, these measures would allow small firms which receive almost no assistance from the Government under the present Law to claim their share of benefits. (b) Measures to Improv' Institutions (i) Improve Institutions for .xport Promotion 46. At present, the efforts to expand export markets are almost entirely focussed on expanding the scope of the bilateral agreements with the neighboring Arab countries. While this will continue to be an impottant market segment, efforts need to be made to expand exports nutside the region. There are two areas in which prompt action could help exports. The first involves defining more precisely institutional responsibility. Currently, the institutional responsibility for export promotion 12/ is fragmented between the Ministry of Industry, trading houses and the Commercial Centres Corporation (CCC). The responsibility of CCC, which now basically monitors the .implementation of bilateral agreements, could be expanded to allow it to become the central institution in export promotion. Second, Jordanian exporters will need substantial marketing assistance if they are to expand beyond the regional markets. This could take the form of setting up a service to provide information and process inquiries. The Government should also consider offering incentives such as tax breaks to trading houses engaged in exports. 13/ Third, the creation of an export credit guarantee scheme (discussed fully in Chapter 4) to cover country risk would be useful in promoting exports. (ii) Improve the Institutional Arrangements to Promote Efficient Import Substitution 47. An analysis of the purchases of the major public sector undertakings revealed that there were a large number of imported products which could be produced domestically by the SMIs. Work clothing, nuts and bolts, V-belts, hydrazine, process hoses and simple gaskets are some of the imported items which could, in principle, be produced efficiently in Jordan. Through our discussions with the purchase managers, we identified the following reasons why the domestic industry has not been able to penetrate this market. First 12/ which includes dissemination of marketing information and administration of benefits, etc. 13/ Currently, only firms which produce for exports are exempt from income tax.  - xiii - and most important is the system of tariff exemptions for these undertakings which has been discussed before. Second, there appears to be an absence of an effective dialogue between the SMIs and the NRIs. There is, therefore, a need for public intervention to assist with the dissemination of marketing information. The Government could help create and operate a central facility for recording the purchasing requirements of NRIs for the benefit of potential suppliers in the SMIs. Similarly, the membership of the existing joint committee on spares of phosphate, potash and fertilizer industries could be expanded to include representatives of the small and medium engineering industries. Third, the large NRIs could be discouraged from expanding into ancillaries whenever they be more cheaply locAted within the SMI sector. For example, activities such as LPG cylinders (refinery), recycling of centrifugal phosphate filters (phosphate mines), which are currently located within the NRIs, could be spun off or sold, thereby expanding opportunities available to the SMI sector and improving efficiency of the industrial sector as a whole. (iii) Improve the Institutional Support for Improving Quality and Standards 48. Poor quality of Jordanian products is often suggested by Government officials as a key factor behind poor export performance. Quality control is carried out today by the Bureau of Standards at the Ministry of Industry and some testing can also be done at the Royal Scientific Society. These institutions need to be strengthened and should offer testing and a standardized certification assuring quality. It is important, however, that testing is not made mandatory. Both certified and non-certified products should be allowed to be sold in the market, and it should be left to the supplier and the customer to decide on premium paid on certification. (iv) Improve the Working of Financial Institutions 49. There are three areas in which the working of the financial institutions could be improved. The first is the banks' capacity to assess risk and carry out effective project financing, the second is the paucity of sources for venture capital, and the third is the existing arrangements for export finance. 50. We expect the IDB to continue to remain the ceAtral insitution in providing MLT loans to the SMIs. The following reforms could, however, help the IDB as well as other financial institutions to lend to projects on the basis of a proper assessment of risk rather than on the basis of collateral or Government guarantee: (i) The Government should consider allowing the financial institutions some flexibility in setting the lending rates. This could enable them to charge higher rates for riskier ventures aed lower rates for less risky ventures thereby improving the access to credit for small entrepreneurs without collateral. (ii) The Government should help create a guarantee scheme for SMI project loans. This will contribute to relaxing the present collateral requirements as well as reduce the pressure for higher spreads. (iii) The Central Bank of Jordar. (CBJ) would establish rediscounting facilities available to all financial instit'ttions qualified for SMI  - xiv - financing. The use of this facility, however, must meet strict eligibility criterion to discourage large investors who have recourse to other sources of financing and to select new projects for exports and import substitution. 51. To improve the availability of venture capital to SMIs, the Government could, as a matter of policy, direct the efforts of public sector financial institutions towards higher risk, non-corporate borrowers. The Pension Fund (PF) and the Social Security Corporation, for example, could be encouraged to set aside a part of their resources to provide venture capital. To achieve this objective however, the two institutions will have to strengthen their project appraisal and supervision capabilities. Similarly, the Government should clarify the relative responsibilities of the Small Scale Industry and Handicraft Fund, (SSIHF) at the IDB, and a parallel fund which is being set up at the City and Village Development Bank (CVDB). 52. The third area in which immediate action is required is that of improving the existing arrangements for export financing. To begin with, the Government should consider lowering the CBJ rediscounting rate, or increasing the ceiling on the commercial banks' lending rate, for pre- and post shipment finance by one or two percentage points. Our discussion with banking officials indicate that the current spread of 1.5 percent 14/ is not attractive for most commercial banks. Although an increase in the spread would raise the implicit gross subsidy to exports, the subsidy would still be small compared to the protection offered to import substituting activities by the existing system of tariffs. Further, the Government should consider establishing a national export credit guarantee agency, to insure against risky importers and importing countries. Currently, as discussed in Chapter 2, exporters to Iraq and Syria are covered by special arrangements at the CBJ while other exporters have to rely on a Kuwaiti agency. Finally, the Government should consider instituting the Domestic Letter of Credit (DLC) System. The DLC, 15/ assures the automatic availability of short term export finance, and other benefits available to direct exporters, to all indirect exporters. In Jordan, these are (i) firms which supply intermediate inputs to direct exporters, and (ii) firms which supply finished export products to trading companies, which export directly. E. Prospects 53. The future prospects for SMIs would depend upon the macroeconomic trends as well as the progress on the set of reforms described in Section D. On this basis, the immediate prospects for the SMIs are weak. In the short term, i.e., during the next two years, if the suggested reforms are implemented, the SMI sector will undergo a process of restructuring. This would increase output from the efficient firms primarily by increased capacity utilization and could result in the closing down of some inefficient firms. As a result, the output from the SMIs could only grow by 2 to 3 percent p.a. 14/ Even margins of 3.5 to 4.5 percent in the case of Tunisia, were considered inadequate by a Bank study carried out in 1985. 15/ For detailed discussion of the DLC System see, Yung Whee Rhee, "A Framework for Export Policy and Administration-Lessons from the East Asian Experience" World Bank, Industry and Finance Series - No. 10.  - xv - Beyond 1989, however, as the tariff reform is implemented and institutional improvements are carried out, the SMI sector would become increasingly responsive to changes in the macroeconomic environment. Simultaneously the Government could be expected to respond to the increasing balance of payments difficulties with an adjustment in the exchange rate, while the excess supply of labor, would result in a fall in real wages. This would improve the profitability of exports and efficient import substitution activities. A healthier SMI sector could then grow by between five and six percent p.a., as targeted in the plan. 54. It is impossible to prbdict the likelv structure of SMI after the restructuring. The product lines in which the SMI sector can be expected to grow are most likely to be those which use a higher level cf technology, exploit the transport cost advantage, the familiarity with the regional markets and are based on the best imported raw materials. On this basis, our subsector work shows that the maximum growth prospects are in the chemical, pharmaceutical and non-food consumer goods and engineering sectors. On the other hand, the growth prospects for the food processing sector are weak. The prospects for the building materials sector are also weak unless Government reorients the emphasis of the present land zoning regulations towards creating smaller serviced plots. This could be expected to stimulate the construction of low and medium-income housing for which the demand is likely to remain strong. 55. While it is interesting to speculate on the product lines with promising growth prospects, its use is somewhat limited. Given the right incentives, and infrastructural support, growth could come from the most unexpected areas. In fact, an ex-post analysis of a Dar El Handasah Study to identify promising product lines shows that many products which were considered "priority" were not taken up by investors, whereas many products with doubtful potential have been successfully implemented. The Government assistance in this area should, therefore, be centered around providing assistance to potential investors in the analysis of markets and preparation of feasibility reports.  JORDAN POLICIES AND PROSPECTS FOR SMALL AND MEDIUM SCALE MANUFACTURING INDUSTRIES I. MACROECONOMIC SETTING AND THE MANUFACTURING SECTOR A. Overview 1.1 After growing by more than ten percent per annum for more than a decade, the Jordanian economy has been suffering from a severe economic recession since 1983. Output growth has slowed to only 2 to 3 percent p.a., and consumption and investment are falling. The economic recession was triggered by the sharp reduction in external resource inflows in the form of foreign aid and remittances linked to the price of oil. While swift Government reaction in the form of a cutback in public expenditure, increased tax efforts, and a tight monetary policy have prevented major public finance and balance of payments problems, they have, nevertheless, accentuated the general recessionary trends. 1.2 The economic recession since 1983 has exposed the major structural weaknesses of the small and medium industries (SMIs) in Jordan. The rapid growth of SMIs during the late 1970s and early 1980s was based on the rapid growth in a narrow range of markets and product lines. A large part of this growth came from import substitution within the small domestic market while over 90 percent of exports remained concentrated in the Iraqi, Syrian and Saudi Arabian markets. Further, both the import substitution and export industries were excessively dependent upon the construction activity. Thus, by 1983, Jordanian manufacturers were handicapped by few lirkages with the rest of the economy, weak technological capabilities, infiexible product lines and undeveloped marketing skills. The economic recession since 1983 resulted in a slowdown in the regional economy and sharply reduced the domestic and regional construction activity. Consequently, after 1983, both output and export growth slowed dramatically; and there is now a widespread capacity under-utilization. B. Macroeconomic Developments (1977-86) 1.3 Conscious of the country's limited natural resources, its relatively narrow productive base and the sensitiveness of the economy to changes in its oil-rich regional environment, the Government pursued liberal, outward looking policies in trade, labor migration and foreign exchange transfers. Incentive policies were increasingly geared to promoting private enterprise while the Government provided the required support in the form of capital and other financial contributions, assistance in project identification and preparation and provision of infrastructure. These policies enabled Jordan to respond to the emerring opportunities in the neighboring countries during the late  - 2 - seventies. Sustained by remittances from a growing number of Jordanians working abroad, rising demand for its exports and increased grant aid, the economy grew by over 10 percent p.a. during 1977-83. Balance of payments and public finance performance remained strong. External indebtedness was contained and inflation remained low. These positive developments were used to secure significant progress in diversifying the productive base. 1.4 The rapid growth during the 1970s also resulted in significant improvements in the standards of living of the Jordanian people. From a level of only 50 years in 1965, life expectancy rose to 64 years; and infant mortality declined by more than half. Primary schooling is now universal with enrollment rates of about 90 percent at the lower secondary level and 70 percent at the senior secondary level. In addition, most of the population now has access to electricity and safe water through house connection. These achievements are even more impressive if we see them in the context of the very rapid rate of growth of Jordan's population which is now approaching 4 percent p.a. 1.5 Beginning 1983, however, Jordan's economy began to be adversely affected by the slowdown of economic activity in the neighboring countries caused by the rapid decline in the price of oil. There was a leveling off of workers' remittances, and of exports of goods and services, and a sharp fall in official grant aid. Meanwhile, international demand for primary commodities produced by Jordan such as phosphate and potash, weakened, and their prices declined. 1.6 In consequence, compared to a growth of about 10 percent p.a. during 1977-83, GDP grew by only 2 to 3 percent p.a. during 1983-86 as shown in Table 1.1. Further, most of the growth in the past three years was accounted for by agriculture, mining (largely due to coming on stream of new phosphate projects), and services. On the other hand, construction, which had grown by above 10 percent p.a. up to 1983, has sharply fallen since then and the output in manufacturing has stagnated - resulting in widespread capacity under-utilization. 1.7 The emergence of balance of payments difficulties preceded the current economic recession. Over 1980-83, real imports grew by 8.7 percent p.a., real export grew by only 5.3 percent p.a., and oil prices rose sharply. As a result, the current account went from a surplus of 11 percent of GDP in 1980 to a deficit of 10 percent of GDP in 1983 as shown in Chart 1.1. Since then, expenditure reduction policies followed by Government have cut back imports by over 4 percent p.a. and have reduced the current account deficit to about 2 percent of GDP by 1986. The measures taken for reducing the deficit, however, coincided with a 30 percent fall in grant aid that occurred as a result of the weakening of oil prices. This made it necessary tor Jordan to increase its reliance on commercial b rrowing, and draw down on reserves. Consequently, debt service obligations increased from less than 5 percent of exports of goods and services in 1980 to about 15 percent by 1985 and reserves are currently only one and a half months of imports (excluding claims on Iraq). While Jordan's indebtedness clearly remains within manageable limits, it has nevertheless been achieved by a sharp reduction in imports, which has contributed to the economic recession. 143 18  - 3 - Table 1.1: MACROECONOMIC TRENDS (1977-86) (Growth Rates in Percent Per Annum and Period Averages US$ Million) 1977-80 1980-83 1983-86 j/ National Accounts in constant 1980 prices GDP 2/ 12.0 5.0 3.1 Agriculture 3.7 9.8 4.3 Industry 13.5 3.8 5.2 (0/w SMI) (20.8) (5.7) (2.1) Construction 21.3 5.5 -1.3 Services 11.0 4.7 2.9 Consumption 8.3 9.0 -1.8 Investment 13.7 4.3 -3.6 Balance of Payments *Current Account Deficit/GDP (X) -0.74 -2.2 -6.8 Exports GNFS 17.0 5.3 -2.1 Imports GNFS 11.7 8.7 -4.1 *Remittances 5/ 602.0 1005.0 1151.0 *Foreign Grants (official) 809.0 1100.0 700.0 Public Finance (Period Averages) Domestic Tax Revenue 6//GDP 20.1 19.6 20.4 Current Expenditure/GDP 37.1 33.3 32.6 Capital Expenditure/GDP 23.0 18.3 13.7 Capital Expenditure 533.0 658.0 577.0 Budget Deficit 3//GDP -12.0 -7.0 -5.3 General Area Under Construction ./ 21.8 16.6 -16.9 *Index of Share Prices of AFM 4/ 119.0 150.0 106.0 Source: Statistical Annex and Central Bank Bullentin, November 1986 * Indicate averages over the period. 1/ 1986 is an estimate based on partial year's data. 2/ At factor cost, all others are at market prices. 3/ Excluding grants. 4/ For manufacturing and mining companies only (1978=100) 5/ All remittances, receipts only. 6/ Including indirect taxes. 7/ Based on permits issued. 14318  -4- CHART .1; CURRENT ACCOUNT AS % GDP a 2 0 -20 12" ig19 l9fl isms 1.8 Concerned with falling external grant aid (a large share of which has traditionally financed budget deficits), during 1983-86 the Government adopted a fiscal policy that was aimed at controlling the overall budget deficit through a combination of increased tax effort and expenditure control. Given the difficulty of raising tax revenue during a period of economic recession, the Government's resource mobilization effort was creditable. Excise tax rates on cigarettes, soft drinks, alcoholic drinks and cement were increased frequently pushing up the tax revenue from 19.6 percent of GDP during 1980-83 to 20.4 percent of GDP during 1983-86. The growth in current expenditure was held to only 6 percent p.a. during 1983-86 compared to 9 percent p.a. during 1980-83 by freezing public sector wages. The most significant budgetary measure was, however, a cutback on the capital expenditure. The brunt of this adjustment was borne by projects in agriculture, especially in the rainfed areas, by the Maqarin Dam, and by projects in the social sectors. As a result of these measures, the budgetary capital expenditure fell by about 2.1 percent p.a. during 1983-86 compared to a growth of 1.6 percent p.a. during 1980-83. 1.9 While the tax/expenditure measures combined to hold the overall budgetary deficit to around 5.3 percent of GDP during 1983-86, the sharp fall in the foreign grants resulted in an increase in the residual financing requirements. The Government strategy was to finance these by increased foreign borrowing, while domestic financing wias restricted to only 2 percent of GDP on an average. This policy, together with a decline in international inflation contributed to a continuous reduction in domestic inflation rate from a high of almost 8 percent p.a. in 1980-83 to about 3 percent in 1985 and even lower in 1986.  - 5 - 1.10 While the fiscal policy was designed to reduce expenditures, the monetary/credit policies were used to stimulate growth in the productive sectors. When the signs of slowdown began to emerge in 1983, credit policy was eased. In 1983, the Central Bank of Jordan (CBJ) lowered the interest rates applicable to its advances, rediscounts, and export credits. In 1984, this was followed by a reduction of 6 to 9 percent in the reserve requirements of commercial banks. These measures were, however, inadequate to compensate for the general decline in economic activity resulting from falling demand. As a result, the credit to the private sector grew only by 8 percent p.a. during 1983-86 compared to over 24 percent during 1980-83. C. Developments in Manufacturina 1/ Structure of Manufacturing - Size, Ownership and Location 1.11 Structure. The small and medium scale manufacturing industries (SMIs), the focus of this study, amount to a small portion of the Jordanian economy. During 1980-84, industry (manufacturing and mining) averaged about 18 percent of GDP as shown in Table 1.2. Nearly 60 percent of this, however, consists of the large natural resource based industries (NRIs) such as potash, phosphate, and petroleum refinery, leaving the share of the SMIs to only 7.2 percent of GDP. The investments in industry have also been dominated by the NRIs. These accounted for 75 percent of the indulstrial investment program, which amounted to 23 percent of the overall investments during 1980-84. Manufactures, however, feature relatively more prominently in trade and employment. In 1984, they accounted for 24 percent of the value of domestic exports (most of them to the neighboring Arab countries), and as much as 40 percent of commodity imports. Mining and manufacturing employ 12 percent of the Jordanian labor force, and 85 percent of these workers are employed by the SMIs. Table 1.2: STRUCTURE OF JORDAN'S SMALL AND MEDIUM SCALE MANUFACTURING INDUSTRY (SMI) Shares in Total (X average 1980-84) NRI 1/ SMI Total Industry 2/ Value Added 10.8 7.2 18.0 Investment 17.2 5.8 23.0 Exports 26.0 24.0 50.0 Imports 5.0 40.0 45.0 Employment 1.8 10.2 12.0 Source: Statistical Yearbook, Bank Staff Estimates 1/ Natural resource-based industries 21 Mining and manufacturing total. 1/ A detailed description of data is presented in Annex A, page 7. 14318  - 6 - 1.12 The Jordanian industry is characterized by a dualism in which the highly sophisticated and large NRIs coexist with the relatively simple SMIs. An exception to the latter is the highly successful pharmaceutical industry with revenues of about $60 million in 1985, two-thirds of which are from exports. The SMI sector is dominated by two relatively big industries, cigarettes and cement, which explain the high share of value added (of 18 and 27 percent) in the "tobacco" and "non-metallic mineral products" subsectors as shown in Annex A, page 3. The rest of the SMIs do not involve technologically- complex processes or much capital stock. Thus, rubber products is mainly tire-retreading and water hoses, basic metal products refers to goldsmiths and many small metal workshops producing window grills, and food manufacturing consists of small bakeries and simple fruit processing plants. 1.13 A large part of the SMI sector is geared to serve only a narrow range of markets. The most important of these are the Jordan Valley, and the domestic and regional construction industry. The Jordan Valley is served by small enterprises which process output, making fruit juice and tomato paste, and manufacture inputs such as drip irrigation systems, rubber pipes and green houses. The construction sector is served by enterprises which produce paints, aluminum profiles, sanitaryware, doors and windows, and tiles. A third area where the Jordanian SMI sector has had some success is in making simple consumer goods such as cosmetics, detergents, bottled soft drinks, beer and textiles. It is unfortunate, however, that the large NRI's have not been successful in developing local suppliers for spare parts and other items needed for periodic maintenance. 2/ The engineering subsector is fairly unsophisticated, and is largely geared to supplying the needs of the construction sector. 1.14 Size and Ownership. Although the SMI sector consists of a large number of small enterprises employing less than five people, their contribution to the output and employment is small. The 1984 census shows that about 80 percent of the enterprises in the SMI sector employ less than five people -- yet they contribute to only 5 percent of the value added and 26 percent of the employment. 1.15 Although most of the establishments in the SMI sector are privately owned and operated, there is a close interaction with Government. An analysis of 100 medium-sized enterprises done for the Bank's 1986-90 Plan Review report, reproduced in Annex A, page 4 brought out that 8 enterprises were 100 percent owned by the Government, 34 had some Government participation in the equity and the remaining 58 had participation in the equity from one or more of the four 3/ public financial institutions. Thus, one of the conclusions of this analysis was that there were very few "purely private" medium-sized industrial firms on the Jordanian industrial scene and that almost every firm could potentially be influenced by the Government in its management and day-to-day operations. On the other hand, such close relationship often compels the Government to bail out loss-making firms. For example, in the case of the Jordan Spinning and Weaving Company, the Taiwanese 2/ The reasons behind this and the possible remedies are discussed in detail in Chapter 4. 3/ These are: the Industrial Development Bank (IDB), Pension Fund (PF), Housing Bank (HB), Social Sc^urity and Postal Savings Bank. 1431is  -7- partner left the company in 1981 after the company had mounting losses. To save the asset, the Government of Jordan stepped in with equity participation and improved management. A similar increased Government participation in equity and management was carried out in the case of the Glass and Aluminum Profiles Manufacturers. 1.16 Location. In spite of efforts made by the Government during the past decade, the SMI's remain overwhelmingly concentrated in the Amman Governorate. The Government incentives for encouraging regional dispersal include: (i) creating industrial estates and/or free trade zones, (ii) providing tax incentives under the encouragement of investment law, (ii) providing electric power, and credit, at preferential rates, and (iv) locating public sector projects in secondary towns. The establishment of the second cement factory at Rashidiya, and the glass factory near Ma'an are examples of policy (iv). These measures have benefited the Kerak and Ma'an Governorates. As shown in Annex 4, page 5, the contribution of industries located in Kerak and Ma'an Governo . es to total value added increased from 1 to 20 percent between 1979 and 1984. Less progress is, however, visible in other parts of the country, and the Amman Governorate continues to account for nearly 63 percent of the total value added. Government Policy in Manufacturing 1.17 Increasing the share of the productive sectors -- agriculture and industry -- has been a recurrent theme of the successive Five Year Plans prepared by the Government. In line with this goal, throughout the 1970s, the Government followed a three-track policy in support of the SMI sector. First, manufacturing enterprises were offered protection by a combination of low tar,.ffs on inputs and high tariffs on outputs. Second, substantial public expenditures were made to create and maintain infrastructure in the support of SMI, such as industrial estates, export processing zones, roads, power and the Port of Aqaba. Third, exports of SMIs were encouraged by promoting bilateral agreements with neighboring countries which allowed Jordanian manufactured goods to enter them on a duty free basis. 1.18 In response to the policies followed by the Government, combined with the rapid growth in the domestic and regional economies, the SMI sector grew by over 18 percent p.a. during 1975-82. Thus, judging purely from the growth of the SMI sector during the 1970s and early 1980s, the Government policy succeeded in meeting its goals. The pattern of growth, however, left the SMI sector with a number of structural weaknesses. To begin with, the rapid growth of SMIs was based on a narrow range of markets and product lines. The policies followed by the Government had made it possible for a large number of firms to grow on the basis of import substitution within the small domestic market, while over 90 percent of exports remained concentrated in the Iraqi, Syrian and Saudi Arabian markets. Further, both the import substitution and export industry was excessively dependent on the construction activity. Thus, by 1983, Jordanian SMIs had very few linkages with the rest of the economy, weak technological capabilities, infexible product lines and undeveloped marketing skills. 1.19 The economic recession in 1983 exposed the major structural weakbesses in the SMI sector. The economic recession resulted in a slowdown in the regional economy and sharply reduced the domestic and regional coustruction activity which was the main market for a large part of the SMI 14315  - 8 - sector. The Jordanian manufacturers, being handicapped by the structural weakness described aboved, were ill prepared to deal with this loss of markets. In order to help the SMI sector through this difficult period, beginning 1983, the Government policy was adjusted to offer increased protection from imports and increased selectivity in allowing new investment. While these measures have helped a large number of firms survive the economic recession, in spite of the Govenment's best efforts, they could not discriminate between efficient and inefficient firms in the process of offering protection. Consequently the SMI sector in Jordan today consists of a mix of efficient, well-managed firms and high cost inefficient firms. Trends in Manufacturing 1.20 Production. Since the onset of the economic recession, the SMI sector has come under severe strain. The real valtue added grew by only 1.7 percent p.a. during 1982-84 4/ compared to 17.1 percent p.a. achieved during 1979-82 as shown in Table 1.3. Within the SMI, the food processing subsector is the only subsector that has performed relatively well by virtue of its strong backward linkages with the Jordan Valley. On the other hand, any subsector which depended upon the construction industry has performed poorly. Thus, output in the "chemical" subsector dominated by industries such as paints and varnishes and plastic-based construction materials like pipes, conduits and water storage tanks, has fallen by 10 percent p.a. during 1982-84. This slowdown has become more pronounced since 1985. In 1985, in nine out of twelve sub-industry groups monitored by the Department of Statistics, the output has fallen in absolute terms. Our subsector analysis shows that, on an average, the capacity utilization is running at barely 60 percent and most industries have difficulties in competing with imports and maintaining market shares in exports. 5/ Table 1.3: TRENDS IN REAL VALUE ADDED IN SMIS (1975-84) BY SUBSECTORS (Percent Per Annum) 1975-79 1979-82 1982-84 Food Processing 29.0 10.5 12.8 Chemicals 37.3 17.7 -10.3 Engineering 12.9 35.8 -0.7 Non-Food Intermediate Goods 13.2 6.0 0.2 Total SMI 20.9 17.1 1.7 Source: Industrial Survey and Census, Department of Statistics 4/ Last year for which detailed data on SMI is available. 5/ In this Chapter, we shall restrict our discussion on the major trends in the SMI sector since the mid-seventies. An excellent historical perspective on the development of industry in Jordan is available in: Michel P. Kazur, "Economic Growth and Development in Jordan", Westview Press, 1979. I2 148  -9- 1.21 Investment. Industry (mining and manufacturing) has attracted considerable investable resources over the past two Plans. Most of them, however, have gone to the large NRIs. The share of investment going to industry while still large, shows a decreasing trend, down from 30 percent of the total gross fixed capital formatiorf during the 1976-80 Plan to 23 percent during the 1981-85 Plan. Much of this decline is due to the decline in public investment in NRI where most of the profitable opportunities have so far been exploited. The low share of the investment in the SMI and its decline, however, shows the absence of macroeconomic incentives and competitiveness, Notwithstanding the incentives offered under the Encouragement of Investment Law, and below market credit through the Industrial Development Bank (IDB), as shown in Table 1.4, the share of investment 6/ in SMIs in total investment reduced from an average of 7.6 percent during 1976-80 to only 4.8 percent during 1981-85. The decline is especially pronounced since 1983. The value of licenses issued during 1985 is only one fourth of the value of licenses issued during 1983. Table 1.4: TRENDS IN AVERAGE INVESTMENT (Millions JD) 1976-80 1981-85 Vqalue of licenses issued for SMIs 1/ 19.0 25.0 (7.6) 2/ (4.8) Investment in industry and mining 3/ 75.4 120.0 (29.8) (22.7) Gross fixed capital Formation 253.4 527.0 1/ Source: Ministry of Industry and Trade 2/ Figures in bracket indicate percent of total 3/ Plan documents 1.22 Exports. Jordan's export performance has deteriorated sharply since 1982. Exports of SMIs fell by 1 percent p.a. in real terms over 1982-84 compared to a growth of above 25 percent over 1979-82. The recent trends in exports show the vulnerability of Jordanian exports to its small export base and narrow regional markets. 1.23 In spite of the impressive export performance during 1975-82, exports continue to be a marginal activity for the SMI sector. On an average, during 1982-84, exports accounted for only 13 percent of the gross output of the SMIs. The Jordanian export growth during the late 1970s and early 1980s was based on two main product lines. The first was construction materials such as paints, sanitaryware, scaffolding, furniture, fixtures and doors and windows. In fact, the exports of this sector (engineering and building materials) grew faster than any other sector during 1979-82 as shown in Table 1.5. The second area in which Jordan's exports grew was textiles and clothing, based on cotton imported from Syria. 6/ Using the value of licenses issued by the Ministry of Industry and Trade as proxy. There are no other published data on the investment in manufacturing. 143t8  - 10 - Table 1.5: GROWTH OF REAL EXPORTS BY SUBSECTORS (1975-82) (Percent per Annum) Sectors 1975-79 1979-82 1982-84 Food Processing 24.0 23.5 13.5 Chemicals 50.9 23.1 2.1 Engineering 49.5 28.2 -27.5 Non-Food Intermediate Goods 33.3 25.5 -6.8 Total SNI 39.3 24.3 -0.7 Source: Statistical Yearbook, Staff Estimates 1.24 The decline in SMI exports since 1982 is a result of an excessive dependence on regional markets. The most important of Jordan's export markets are the neighboring Arab countries especially Saudi Arabia, Iraq and Syria, which account for nearly 80 percent of Jordan's manufactured exports. Between 1977-82, exports to Syria, Iraq and Saudi Arabia grew rapidly by over 10 percent p.a. Given Jordan's locational advantage, this growth stimulated a spurt of investments designed to serve these markets. Between 1982-85, because of a combination of economic and other factors, exports to Syria fell by 80 percent, exports to Saudi Arabia stagnated, and Iraq was beginning to find it difficult to pay for its imports. The coming on stream of additional capacity in a large number of industrial firms (e.g., paints, aluminum profiles, glass) coincided with the collapse of these markets resulting in low profitability and w-lespread capacity under-utilization. 1.25 Imports. Although protection offered to the SMI sector vis-a-vis competitive imports has had a small macroeconomic impact, 7/ it has nevertheless been sufficient to allow Jordanian industrialists to steadily expand their share of domestic market since 1975. During 1975-77, on average, domestically produced manufactured goods accounted for about 26 percent of the net domestic supply as shown in Table 1.6 and Chart 1.2. By 1982-84, however, domestically-produced goods had captured 45 percent of the domestic market. Although all sectors participated in the import substitution process, the most prominent was the engineering and construction materials sector. Assisted by the rapid expansion in the local construction activity during 1979-82, its share of domestic market increased twice as fast as any other sector. 7/ The value of imports under QRs for example has only been about 4 percent of the total imports. 14318  - 11 - Table 1.6: CONTRIBUTION TO NET DOMESTIC SUPPLY (NDS) 1/ (Percent of Total) Source of Supply 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 Subsector Outputs as a % of NOS / Food Processing 52.7 48.0 63.6 60.8 63.4 72.3 63.7 69.0 73.5 77.9 Chenicals 30.1 26.0 25.7 47.1 46.1 47.1 53.4 60.7 58.9 66.9 Fngineering 14.1 16.2 13.2 9.6 21.8 25.1 25.1 27.5 29.1 34.6 Non-Food Intermediate 38.3 45.0 36.4 39.9 38.0 42.3 49.5 49.1 43.0 54.8 Goods Total SMI Imports as % of NOS 3J 75.9 75.9 79.6 77.7 71.3 67.9 70.3 66.4 61.9 55.2 Total SM! Exports as % of NOS 3.3 3.8 4.5 10.3 4.8 5.6 6.8 6.9 4.1 7.1 Total SMI Output as X of NOS 27.4 27.9 24.9 27.6 33.5 37.7 36.5 40.5 42.2 51.9 Hems Item Export as a share 12.1 13.7 18.1 19.1 14.4 14.8 18.8 17.2 9.7 13.7 of SMI output Source: Industrial Surveys, External Trade Statistics 1/ Oefined as (GROSS OUTPUT - EXPORTS + IMPORTS) in current prices I/ Of each subsector I/ Of total SMI 1.26 Employment. 8/ The labor market in Jordan is characterized by an open immigration policy, an absence of strong trade union activity, and no minimum wage legislation. There have not been any industrial disputes and wages, and productivity have generally increased. The labor force in manufacturing is clearly better paid than the labor force in the economy as a whole. On average, wages in manufacturing are higher than the average wages in the rest of the economy, especially those in agriculture and construction. 8/ The following three studies are important contributions to the analysis of labor market in Jordan: (i) Dr. M.A. Smadi and Others, "Socio-economic Impact of Guest Workers in Jordan",, in Two Volumes, Royal Scientific Society, March 1986 (ii) World Bank, "Issues of Employment and Labor Market Imbalances" in Two Volumes, May 1986. (iii) Dar El Handas2'- "Industrial Programming Study, Task No. 1.6", March 1982. 14318  - 12 - Chart 1.2: Output As % Total Supply 70- 30- 40 20 10 1975 1978 1981 1984 1.27 Employment, labor productivity, and real wages rose rapidly between 1975-82. Since then, however, the economic recession has hurt the employment prospects within the SMI. Nevertheless, employers in the SMI have been reluctant to lay off workers and have preferred to reduce the wages instead. Thus, during 1982-84, while the employment growth in SMI has fallen by five percentage points from its level of 15 percent p.a. during 1975-82, it remains respectable. Real wages, however, have fallen by 2.6 percent per annum during 1982-84. Judging from our interviews with selected firms, a further fall in both employment and real wages can be expected during 1985 and 1986. 1.28 In spite of the general unemployment in Jordan, the SMI sector continues to employ a large number of guest (foreign) workers. It will, however, be difficult to alleviate unemployment in Jordan any further by replacing these guest workers because they fill important middle l1vel technical positions for which it is not easy to find Jordanians to do the job. Based on the information contained in a study carried out recently at the Royal Scientific Society, 9/ we estimate that guest workers accounted for nearly 27 percent of the total workers employed in the SMI sector in 1984. This study also showed that the guest workers in manufacturing were relatively better-trained than in other sectors (agriculture) and the reasons 9/ The study indicates that 10 percent of the total 153.3 thousand guest workers are employed in "industry". The SMI sector as defined in this report employs 65.4 percent of "industrial" labor force. Assuming that the guest workers are distributed in proportion to the total employed in SMI and industry, 15.353 x .654 = 10.04 thousand guest workers are employed in SMI. These account for 10.04/36.5 = 27 percent of the total SMI labor force. 14318  - 13 - for employing guest workers were equally divided between lower wages and unwillingness of Jordanians to do such jobs. This finding was confirmed in our own sample survey of 12 firms carried out during the mission. Based on this survey, as shown in Annex A, page 6, we find that the prevalence of guest workers was significantly lower in 1986 than in 1984. Thus, it is likely that the Jordanian industrialists have adjusted to lower demand by reducing guest workers while retaining Jordanians. Our data, however, indicates that further replacement of guest workers will be difficult since those remaining were crucial to the production process. For example, the brewmaster in the Jordan brewery and 10 technicians in the glass factory were hired from abroad. Specific Subsectoral Problems 1.29 While in general, trends in the subsectors reflect the general trends discussed above, each subsector has its own typical problems. These are discussed in some detail in Annex C and are summarized below. 1.30 The Food Processing Subsector (FPS) is most heavily dependent upon the domestic market and least reliant on exports. Given this strong linkage with agriculture, this subsector has performed better than other subsectors during the 1982-84 period. The main problem faced by enterprises in this sector was that of high cost of inputs such as sugar and tomato paste compared to their competitors in Saudi Arabia. In addition, the quality and reliability of bulk inputs such as wheat flour are a problem because the imports of these are restricted to the Ministry of Supply. Over the long run, this sector must also contend with being based on the highly subsidized irrigated agriculture in the Jordan Valley. 1.31 Unlike the FPS sector, the Chemical Pharmaceutical and Rubber (CPR) Sector depends on exports to absorb a larger proportion of its production. The highly successful pharmaceutical industry is probably the forerunner of the type of skill-intensive and high value-added industry in which Jordan could specialize. The main problem facing this sector is the potential loss of regional markets in a number of products such as paints, chlorine, caustic soda, and hydrocloric acid, since Saudi Arabia, Syria, and other Gulf countries are setting up plants producing these products -- many of which are subsidized. This industry thus needs substantial assistance in marketing. Further technical assistance is also required to improve efficiency of plant operation and quality control. High energy costs in Jordan compared to other Gulf countries are also a problem in this industry which is very energy intensive. 1.32 The Engineering and Building Materials (EBM) Sector is a classic example of growth based on a narrow construction market. Reflecting the slump in construction activities, enterprises producing glass, bricks, and steel reinforcing bars are operating well below 30 percent of their rated capacity. The main problems confronting this sector are inflexibility in product lines and the absence cf aggressive marketing. In instances where these problems were solved, Jordanian firms have done quite well. For example, a ceramic tile producer branched out into producing decorative vases (using Chinese guest workers), a manufacturer of U-bolts for truck springs developed a niche in the Saudi Arabian market, and a limestone crusher designed and built in Jordan is selling very well in the neighboring markets. On the other hand, the glass factory at Ma'an continues to face technical problems of bubbles and high energy costs. The cement factory, on the other hand, faces the problem of extremely low (dumping) prices at which cement is available in the region. 14318  - 14 - 1.33 The EBM sector is also handicapped by its inability in supplying the spare parts and other items needed for periodic maintenance for large NRIs. First, communications between the two sectors is poor, and second, the NRIs can import these requirements duty free - whereas the domestic manufacturer has to pay duty on imported raw materials used to fabricate the spare parts. 10/ 1.34 The major problems facing the Non-Food Consumer and Intermediate Goods (NFG) Sector are again those of high cost of imported raw materials, poor quality, poor product design, and a small domestic market. All these factors combined make the garments industry uncompetitive vis-a-vis imports from Taiwan (which are 30 percent cheaper). Jordan Tannery faces the problem of low quality and reliability and shortage of hides and skins from the local slaughterhouse. The paper tissue manufacturer in Jordan, thus far successful, will face stiff competition from a similar facility in Jeddah which has been set up on the basis of an interest free loan on 50 percent of the investment. Given the consumer orientation of this sector, the slow development of the modern retailing sector has also been a problem for this sector. Finally, the duty free access to imports available to civil service and military consumer societies has proved to be a serious handicap to firms in this sector. D. Conclusion 1.35 The economic recession since 1983 has exposed the major structural weaknesses of the SMI sector - high cost of imported inputs, dependence on a narrow range of domestic and regional markets, and weak technological and marketing capabilities. Thus, macroeconomic policies such as a reform of the trade regime, changes in the exchange rate, and a reform of the investment licensing system which restructure incentives facing the SMI sector need to be complemented by institutional reforms such as providing assistance for marketing, improving quality, and improving export financing arrangements which improve the efficiency of resource use to lay the basis for future growth of the SMI. 10/ This problem is discussed in more detail in Chapters 2 and 4. TW31S  - 15 - II. POLICIES AND INSTITUTIONS AFFECTING MANUFACTURING A. Overview 2.1 During most of the 1970s and the early 1980s, the Government used protection from import competition, regulation of market entry through investment licensing, and series of fiscal and credit incentives to promote the growth of manufacturing in Jordan. While the impact of these measures on the SMI sector was significant, their macroeconomic impact was small, given the small size of the SMI sector. Thus while selected firms within the SMI sector could count on a high degree of protection, the average economy-wide level of tariff was low, and on the whole, Jordan could be thought of as following liberal market oriented policies both in domestic economy and international trade. 2.2 During the past two years, however, in response to the economic recession, there has been a trend towards increased protection and increased selectivity in allowing new investment. Often this has come about by responding to individual requests for protection and new investment on a case-by-case basis. While this policy has generally helped the industrial sector to continue to grow albeit at a lower rate, it has nevertheless fostered several high cost inefficient firms. Consequently, consumers and downstream industries have been hurt, and there has been a net resource loss to the economy. Section B and C below will discuss policies that have affected external and internal competition respectively and created an environment which encourages inefficiencies and Section D presents the results from a small firm level survey to illustrate the extent of this burden on the Jordanian economy. B. Trade Regime - Policies that Affect External Competition 2.3 Up to the beginning of 1984, the trade regime had very few quantitative restrictions (QRs). The protection to manufacturing was mainly through a low level of tariffs on inputs coupled with a high level of tariffs on competing imports. This trade regime operated within the framework of a stable currency that was linked to the SDR. 11/ Over the past two years, however, there has been intense lobbying by the industry for increased protection as it faced shrinking markets, rising costs due to falling capacity utilization, and eroding competitiveness in exports and import substitution. There has also been very little movement in the nominal exchange rate. Low inflation in Jordan, vis-a-vis its trading partners, together with fairly stable inflow of workers' remittances, however, preempted any overvaluation of the Jordanian Dinar. As a result, since the beginning of 1984, there has been gradual increase in the protection offered to industry. The number of QRs and tariffs on competing imports have been increased. Simultaneously, the Government has attempted to encourage exports by offering income tax exemptions, customs duty drawbacks, and below-market rate export finance. On balance, however, the trade regime continues to have an anti-export bias because it is more profitable to produce for import substitution than for exports. ll/ A further discussion of the exchange rate is presented in Chapter 4. 14318  - 16 - Import Policy (a) Government Policy and its Administration 2.4 While there is no single public document describing the overall trade policy, it is possible to identify the rules of import policy currently being followed by the Government based on internal documents at the Ministry of Industry and Trade and discussions with key officials. The rules of import policy (presented in detail in Annex A, page 7) outline the conditions under which competitive imports may be banned or be subject to high tariffs. The rules attempt to balance considerations of protection offered to the local industry with considerations of efficiercy. Balancing these considerations, however, is generally difficult and, therefore, leads to some anomalies. For example, the rule that the value added of an industry eligible for protection must be at least 40 percent of gross output (Rule a(v)), is quite clearly arbitrary. Among other rules, some are difficult to implement. Rule (C), for example, states that the civil and military consumer associations should be encouraged to buy their needs from local industries. Given that these associations pay no tariffs, 12/ it is clear that thic rule would be difficult to implement. One rule subjects all goods benefitting from tariff protection to Government control with regard to prices, quality, conformity with standards and specification, and suitability to the Jordanian market. Once again with this rule, the Government takes on responsibility which will be hard to carry out satisfactorily. Finally, it is very difficult to reconcile the provision made in "Rule e" of offering protection without passing on at least a part of the burden to consumers. 2.5 Requests for protection are assessed by a committee comprising the Ministers of Industry and Trade, Supply and Finance. Based on the recommendations of this committee, the ultimate decisions are made by the cabinet. This committee is served by officials from the Ministries who prepare submissions on each request. The assessment procedure is undertaken within the broad framework of the rules for import policy augmented by rules of thumb such as imposing QRs where basic needs are involved (food, building and clothing) and requests for tariff duties of much over 50 percent being more closely scrutinized than others. The criteria used in assessing requests for protection are based on questionnaires setting out the nature of business, scale of investment and employment and a fairly simple analysis of production costs and pricing. 2.6 During 1986, the requests for protection from industrialists and consequently the workload on the protection committee has increased. Although the main committee is expected to meet only once a year, it has in fact met twice during 1986. In the second half of 1986, this committee processed 52 cases and raised output tariffs in 10 cases, lowered input tariffs in 9 cases, and the remainder were denied any increase in protection. (b) Quantitative Restrictions 2.7 Until the middle of 1984, Jordan had very few Quantitative Restrictions (QRs) on its imports. These consisted mainly of restricting 12/ This aspect will be discussed in more detail in the Section on tariffs later in this Chapter.  - 17 - imports of major agricultural commodities like wheat, sugar, etc. to the Ministry of Supply to ensure their availability to the poor at reasonable prices. In addition there were market sharing arrangements in some products. For example, users of tubes and pipes were required to obtain 50 percent of their requirements from the local firm, and a market share of 30 percent was reserved for the local paper and cardboard firms. By and large, however, the number of these QRs was small, and they did not protect a significant part of the local industry. 2.8 Since the middle of 1984, however, in response to the regional and domestic recession, 32 manufactured goods have been protected by introducing QRs. A complete list of items under QRs together with the relevant import duty is presented in Annex A, page 9. 2.9 While the QRs are not significant from a macroeconomic perspective, they protect a significant portion of manufacturing industry. Based on the pre-QR (the 1983) structure of imports, we estimate that the QRs would have applied to only about 4 percent of total value of imports (Annex A, page 9). The macroeconomic impact of QRs is, therefore, small since the removal of QRs would increase imports by a small amount. However, QRs apply to products which account for over 40 percent of the total SMI value added in 1985, as shown in Table 2.1. 13/ Thus, the profitability and, hence, the chances of survival of nearly 40 percent of the SMI sector is determined by the QRs. (c) Tariffs 2.10 The Jordanian tariff structure is complex, creates a wide variation in the effective protection offered to different firms within the SMI sector and has been adjusted during the past two years to increase the effective protection offered to the SMI sector. 2.11 Complexity The complexity of Jordanian tariff structure is due to the presence of surcharges, license fees and other fees rather than the size of the tariff code itself. Jordan's custom tariff schedule has 2178 entries as shown in Table 2.2. Jordan's tariff code is thus a little more detailed than countries such as Costa Rica and Egypt and far simpler than that of Argentina, Morocco and Turkey. 13/ The analysis assumes, in some cases, that the output of a prohibited item equal to the output of a four digit ISIC category. For example, output of prohibited items such as Macaroni and Spaghetti are assumed to be equal to the output of ISIC Category 3117 -- bakery products. Given the limited diversity of products available in Jordan, and because some of the ISIC catagories such as glass and cement are single firms, this is not a bad assumption. A more detailed ISIC classification, if used, could bring this number down by a little without changing the main thrust of the argument.  - 18 - Table 2.1: EXTENT OF PRODUCTION IN MANUFACTURING AFFECTED BY QUANTITATIVE RESTRICTIONS (QRS) ISIC Domestic Value Added Category Product Under QRs 1984 ('000 JD) 3122 Manufacture of dairy products 2,386 (milk, cream, ice cream, etc.) 3115 Palm and Olive Oil 777 3117 Bakery Products (includes 3,959 macaroni and spaghetti) 3121 Other Food (includes yeast 329 and salt refining) 3122 Prepared Animal Feed 1,295 3133 Bcer 430 3124 Soft Drinks and Carbonated water 6,206 3140 Cigarettes and Tobacco 32,908 3521 Paints and Varnishes 1,722 3620 Glass (and glass fiber) 745 3692 Cement 35,235 3720 Non Ferrous Basic Industries 722 (aluminum bars and shapes) Subtotal 86,714 (44.52) TOTAL (ISIC 3112-3843) 194,822 (1002) Source: Mission estimates. 143 IS  - 19 - Table 2.2: COMPARISON OF JORDAN'S TARIFF STRUCTURES WITH OTHER COUNTRIES Number of Average Nominal Country Items Tariff Argentina 11,500 21.8 Costa Rica 1,726 31.5 Egypt 1,799 30.3 Kenya 2,860 37.2 Mexico 8,256 22.2 Morocco 8,050 26.6 Turkey 8,017 36.0 Jordan 2,178 30.9 Jor4an 1/ 2,178 26.5 Source: Staff estimates. 1/ Taking into account exemptions. 2.12 For the purpose of tariff collection, Jordanian rules make a distinction between zero tariff rates and exemptions. Products exempt from tariffs do not pay any tariffs or surcharges. Products subject to a zero rate of duty do not pay the import surcharge of 12 percent but pay all other surcharges as shown in Table 2.3. Half the revenue generated from the import surcharge goes to the budget and the other half used to finance activities of specific public sector institutions. Of the taxes described above, the license fee has to be paid to the Ministry of Industry while all other taxes have to be paid to Customs. Table 2.3: STRUCTURE OF TRADE TAXES Customs Import License Additional Service Duty Surcharge Fee Fee Fee Total greater than 0 12 5 1 0.2 Customs Duty + 18.2 0 - 5 2 0.2 7.2 Source: Customs 2.13 Two more departures from the basic system described above add to the complexity of the trade taxes in Jordan. First, in lieu of the additional fee of 2 or 1 percent, special rates are levied on luxury goods such as alcoholic beverages, tobacco, cigars, etc. Finally, imports from countries other than the country of origin are subject to a penalty of 5 percent of the value of the imports. 1431S  - 20 - 2.14 Structure of Protection. Judging purely from the average level of tariffs, the level of nominal protection is not high. The average level of tariffs in Jordan is not much different from many other countries at similar levels of development as shown in Table 2.2. An average tariff rate of 26 percent calculated after taking account of all exemptions is comparable to Morocco, Argentina and Mexico -- countries which have recently undergone substantial trade liberalization programs -- and is almost 30 percent lower than Egypt and Turkey, Jordan's neighbors. 2.15 The low average rate of tariffs, however, masks the wide variation in tariff rates which results in a wide variation in protection to different industries within the SMI sector as shown in Chart 2.1. Nearly 57 percent of the imports are subject to tariff rates of zero, and nearly 80 percent of the imports are subjected to a total tax of 20 percent or less (details given in Annex A, page 15). On the other hand, some imports are subjected to tariff ra:.es of well above 50 percent. 2.16 The protection to an induscry resulting from a given structure of tariffs is measured by the Effective Protection Rate (EPR). The EPR is defined as the percentage by which the value added in a particular industry could potentially be increased due to the presence of tariffs on imported inputs and on competing imports. The Nominal Protection Rate (NPR) on the other hand measures percentage by which the price of the output of a particular industry could potentially be increased due to the presence of tariffs on competing imports. The NPR is equal to the advalorem tariff rate where applicable. Table 2.4 shows the nominal and effective protection rates resulting from the structure of tariffs in 1986 based on the 1983 structure of production (I/O Table). 14/ 2.17 The analysis shows that in Jordan, the variation in EPRs is far more than the variation in tariff rates (NPRs). The structure of tariffs offers the lowest protection to the mining industry (EPR 3.5 percent) followed by agriculture (EPR 8.8 percent), whereas the protection offered to manufacturing (EPR 74.8 percent) is almost double the protection offered to the economy as a whole. Within the manufacturing sector itself, there are significant disparities in the level of protection offered to different industries ranging from -320 to 315 percent. Within this range, industries like basic metal industries and printing and publishing are accorded very little protection while industries such as bakery products and wearing apparel are highly protected with EPRs exceeding 50 percent. 14/ The formulae for calculation of the EPR based on the I/O table are 14 resented in Annex A, page 20.  - 21 - Chart 2.1; Tariff Rates by Sector for IIM 20- m 70 7a IL 40 20 10 a a 5 7 9 I I 13 15 17 19 21 23 25 27 SEC1OW NULEER Distribution of Imports by Tariff Rates iile~ ~~~ R KzTariffs an Slurakarges 46- $ w--' iWI b 411 C20 Ca c0 <c 09 cSb <1b cg 9b ctOO ciSO >156 gT Kl U 0 ~ ~ ~ ~ ~ ~ $t  - 22 - Table 2.4: NOMINAL AND EFFECTIVE RATES OF PROTECTION 1986 TARIFF RATES AND 1983 I/O SECTORS Nominal Effective Sector No. I/O Sector Protection 1/ Protection 1 Agriculture 10.3 8.9 2 Fertilizer Mineral Mining 6.0 -2.60 3 Other Mining, Crude Ol 28.6 27.85 4 Grain Mill Products 27.0 86.22 5 Bakery Products 59.5 -319.48 6 Confectionary 59.1 315.51 7 Other Food Products 10.5 7.07 8 Prepared Animal Foods 7.2 -9.61 9 Beverages 87.5 164.58 10 Tobacco 78.1 121.73 11 Textile Manufacture 41.3 53.89 12 Wearing Apparel 49.5 61.46 13 Leather & Footwear 30.7 32.95 14 Wood, Cork & Furniture 38.9 40.99 15 Paper & Paper Products 24.8 22.33 16 Printing & Publishing 11.6 3.20 17 industry & Other Chemicals 16.3 15.81 18 Petroleum Refinery 59.3 -489.19 19 Rubber & Plastic 33.8 43.67 20 Ceramic & Glass 37.7 37.94 21 Cement, Lime & Plaster 10.2 0.63 22 Other Non-Mtl. Mineral Products 33.5 47.75 23 Basic Metal Industries 17.5 0.48 24 Fabricated Mtl. Prod. 34.0 46.73 25 Machinery (Non-elec.) 14.5 12.83 26 Elec. & Transport Equipment 30.8 31.85 27 Misc. Manufacturing 40.7 44.33 Average Effective Protection Rates (Weighted by World Value Added) 1 Agriculture 8.89 2 Mining 3.46 3. Manufacturing 74.82 4 Overall 37.62 Source: Mission estimates. 1/ Average tariff rates. 1431S  - 23 - 2.18 Exemptions. The existing trade regime creates a wide variation in Effective Rates of Protection across sectors not only due to the wide variation in tariffs but also due to an extensive system of tariff exemptions. All exporters are exempt from d-ty on imported inputs. In addition, 27 institutions 15/ in Jordan are currently exempted from paying customs duties on their imports. This exemption, however, does not apply to yet another list of items 16/ Presented in Annex A, page 18. 2.19 The main impact of the inst-tutional tariff exemption is that it differentiates the price of a commodity subject to tariff to different consumers within Jordan, concomittantly affecting the pattern of consumption without any economic rationale. More importantly, however, it places the domestic manufacturer at a significant disadvantage vis-a-vis imports within a large portion of his market, in effect reducing the size of his market substantially. In all, the value of imports which came into Jordan in 1985 without paying any tariff was about half the total value of imports. Of these, roughly JD 125 million, amounting to nearly 25 percent of the gross output of the SMI sector, competed directly with domestically manufactured products. Thus in 1985, the institutional exemptions effectively reduced the available market for the SMI sector by as much as 25 percent. 2.20 Changes in Protection. Judging purely from the movements in average tariff rates, the level of nominal protection has not increased since 1983. In fact, the average level of customs duties plus surcharges was slightly lower in 1986 compared to 1983 as shown in Annex A. The unchanging mean, however, masks an increase in effective protection to firms within the SMI sector which has stemmed from an increase in tariffs on outputs coupled with a decrease in tariffs on intermediate inputs. This pattern is clearly visible in tariff charnges granted by the protection ccmmittee during the second half of 1986 as reported in para. 2.6, and the data on specific tariff rate changes reported in Annex A. The reductions in tariff rates have been on inputs for Jordanian manufacturing sector such as palm oil, aluminum paste for paint industries, synthetic fabric, handles of suitcases and bags, and parts for ovens. On the other hand, tariff rates on outputs of Jordanian manufacturing sector such as wire rods, steel tubes and pipes, corrugated boxes and sliding dcors have been increased, typically to a ceiling of between 50-80 percent. The net result has been a substantial increase in protection offered to Jordanian manufacturing. Export Policy 2.21 In addition to encouraging import substitution through changes in the system of tariffs/QRs, the Government has also made efforts to improve incentives to exporters. These have included tax exemptions and duty drawback schemes and more recently refunding 50 percent of the cost of fuel used in the manufacture of exported goods. These fiscal/price incentives have been buttressed by the provision of infrastructure. In spite of these incentives, 15/ Central government, municipalities, the sports complex and public sector undertakings such as refinery and potash company belong to this list. 16/ Gas ovens, refrigerators and batteries are some of the items which belong to this list. 14318  - 24 - there is an anti-export bias which means that it is still more profitable to produce for substituting imports rather than for exports. Further, the administration of export incentives is fragmented, and there is no central organization which can provide a one-stop facility outlining various incentives and how they work. 2.22 Taxation Exemptions. Beginning 1985, a portion of the taxable income earned from exporting was exempted from the corporate proflt tax. The fraction of profits exempted from tax was related to the proportion of output exported according to a sliding scale as shown in Table 2.5. This exemption does not apply to exports of: fertilizers, phosphate, and potassium. The exemption is administered by the Department of Income Taxation and returns for 1985 are only now being processed--consequently there is no data on coverage or revenue foregone. Table 2.5: PART OF PROFITS EXEMPT FROM INCOME TAX Percent Exempted Proportion of output exported 10 20 20 20 to 40 30 More than 40 Source: Ministry of Industry and Trade. 2.23 The tax exemption described above is aimed at reducing the anti-export bias in the Jordanian trade regime. The actual benefit to the exporters, however, is rather small. It is easy to estimate that the maximum increase in net profits resulting from this facility could be about 18 percent. 17/ This is fairly small compared to the EPRs of around 40 percent for activities which compete with imports. Thus, the tax exemptions only go a small way in redressing the anti-export bias in the trade regime. Moreover, in many cases, the benefit is redundant because the industries to which it is applicable are already covered by the provisions of Encouragement of Investment Law. 2.24 Duty Remission and Drawback. In Jordan large established export industries are exempt from paying import duties and these include the mining sector, cement and pharmaceuticals industries. Also import duties are waived on capital goods imported by firms approved under the Encouragement of Investment Law. In addition, duties on imported inputs used by industry have been selectively reduced over the past 18 months. Consequently the structure of protection has become less of a cost imposition on exporters. 17/ If an exporter earned profits of JD 100 and exported more than 40 percent of his output, on the basis of a maximum tax rate of 38 percent, his profits without the facility would be 100 (1 - 0.38) = JD 62 His profits with the facility would be 30 + 70 (1 - 0.38) JD 73.4 Maximum Increase in profit is 73.4/62 = 18.3 143 IS  - 25 - 2.25 In Jordan there are two schemes designed to allow exporters to source inputs at border prices -- temporary entry and duty drawback. Temporary entry allows producers to import inputs duty free used solely in export production -- it cannot be used for materials which are transformed into products sold on the domestic market. This scheme involves bankers guarantee used as security to cover the average amount of duties the exporter owes to the government. The scheme works effectively for large firms wi;. some track record in export markets. 2.26 The recently introduced drawback scheme, however, has not worked well in practice. The problem is that Customs officials do not have the necessary technical capability to quantify input-output relationships when imported inputs are used in production for both domestic and export markets. Moreover, the Customs is a revenue generating organization and as found in many countries there are delays in refunding duties. Officials have an incentive to be distrustful because they receive a proportion of any penalties levied on firms caught cheating. Consequently firms do not take the drawback into account in pricing but treat it as a windfall gain, which obviates the objective of the scheme. 2.27 There is a need for new customs procedures to ensure that the temporary entry/drawback schemes work more effectively by lessening administrative difficulties and expediting repayments of duties. In a successful scheme, it is desirable that exporters rely on individual drawbacks for major imported items for each export product. Fixed drawbacks should be applied only to miscellaneous imported items. Initially improvements could be made to the determination of the material content of exports (with appropriate allowances for wastages). The Government could publish every six months input/output coefficients in a duty drawback schedule. This would facilitate the checking procedure and ensure prompt repayment. Further, customs could consider guaranteeing a maximum number of days before duty would be refunded after receipt of the relevant documents. The incentives for customs officials should be to make the system work and not focus on penalties. If anything the system should err in favor of the exporter--after all one of the intentions of trade reform is to lessen the extent of the anti-export bias. C. Policies that Affect Internal Competition 2.28 There are three policies which affect competition within firms in the domestic market. These are investment licensing, laws of encouragement of investment, and the system of price control. In comparison to the policies which determine external competition (discussed in Section B), the impact of the regulation of investment and price control has been small. However, as the discussion below brings out, many of the regulations carried on the books today have the potential to significantly affect competition between firms and create inefficiencies. Investment Licensing 2.29 In spite of efforts made by the Government to streamline procedures, the investment licensing process remains cumbersome. A recent study 18/ 18/ Royal Scientific Society (RSS), "Steps and Ways and Means to Establish an Industry in Jordan", 1984. 1431S  - 26 - carried out by the Royal Scientific Society (RSS) found that there were a large number of steps involved in obtaining an industrial license. Iivestment licensing in Jordan is carried out by the Department of Industry, Ministry of Industry and Trade. A prospective investor is required to submit a 20-page report highlighting the results of a feasibility study for the venture as a part of his license application. In parallel, the investor has to apply for registration with the Department of Companies, the Municipality and apply for benefits under the encouragement of investment law. 2.30 A recent amendment to the procedure which went into effect on December 10, 1986 has increased the uncertainty for investors even after obtaining licenses. As per this amendment, only temporary licence valid for six months will be issued to prospective investors. During these six months the investor has to produce documents which provide evidence of the implementation of the project in conformity with the license application. At the end of six months, the progress is to be reviewed by the Ministry and at that point the license could be cancelled, extended or made permanent. The Government beleivies that this annandment is necessary for separating serious investors from those who merely corner the licences. In practice however, this amendment increases the complexity and uncertainty and, hence, the cost of investing in Jordan. 2.31 Based on the licensing data, officials at the Ministry of Indtstry and Trade suggest that at the moment, the licensing system is not a significant barrier to market entry. In 1985, 125 license applications were received out of which 113 (90 percent) were granted. Government officials also indicated that a prospective investor had a right to go to court if his application was turned down. 2.32 In reality, however, the difficulties associated with processing new investments are somewhat more than those strictly implied by the licensing data. Discussions with businessmen indicated that they generally make formal applications only after informal discussions with Government officials suggest that a license would be granted. Further, if a license is turned down, getting involved in a litigation, although possible, is not worth the expense. 19/ Finally, even if the present system was not a major constraint to investment, today, it must be viewed with concern because the regulations carried on the books have the potential to affect the ease of market entry. Encouragement of Investment Law (El Law) 2.33 The Encouragement of Investment Law which was first passed in 1972, has since been updated as temporary Law No. 6 of 1984 and most recently in December 1986 20/. 19/ In 1985, only one investor actually went to court when his application was turned down. The Governments' arguments for maintaining the licensing system in its present form are presented in para 4.17. 20/ A revised version of the El law was issued in Feb. 1987. The new version differs from the one analyzed here in some details. The basic structure of the new Law, as well as the approach to the Encouragement of investment (AP, EP, etc) however, remains unchanged. The following two studies contain assessments of past El Laws. Although the succesive new Laws take account of some of the suggestions made there, most of the major criticisms continue to remain valid. Economics Department (RSS) and IRDC, Canada, "The Effect of the Encouragement of Investment Law on the Jordanian Economy", August 1980. Industrial Programming Study, DAH, "Policies Affecting Industrial Investment - Task 1.17", Amman, 1982.  - 27 - The El Law is administered by an "Encouragement of Investment Committee" at the Ministry of Industry and Trade, with the Minister as its Chairman, eight representatives from various ministries, and three representatives from the private sector. The broad objectives of these laws have been to: (i) encourage investment in productive sectors, (ii) encourage a regional dispersal of investment, (iii) encourage expenditure on training, and (iv) encourage export-oriented projects. 2.34 The EI Law defines a set of criteria by which a project can be classified as an "Economic" or an "Approved Economic Project" based on the extent to which they conform to the objectives of the national plan. All fixed asse;s imported for the implementation of an "Economic Project" (EP) are exempted from customs duties. An "Approved Economic Project" (AEP), in addition enjoys the benefits of exemptions from profits tax for a stipulated period. 2.35 In both cases, expansion of an existing enterprise is also eligible for duty exemptions although the profit tax exemptions are allowed for a shorter period than in the case of a new project. Extensions of these benefits are awarded if the applicant is a publicly held corporation or if the project is located outside the Amman Governorate. The details of the criteria, and the benefits are presented in Annex A, page 12. 2.36 Although the macroeconomic impact of the EI law is rather small, its impact on the SMI sector is significant. Investment by projects benefitting from the EI Law amounted to less than 3 percent of the total investment in the economy in 1985. An analysis of the EI law carried out by the Dar El iandasaah 21/ showed that the tax revenue forgone from both the profits tax exemption and the customs duty exemption was a small proportion of the total budgetary revenue. The benefits of the EI law, however, are important in determining the profitability of the few projects it benefits in the SMI sector. In 1985, the EI Law benefitted only sixteen out of the 116 projects approved by the Ministry of Industry. These projects, however, accounted for nearly 45 percent of the total investments in the SMI sector. Price Control 2.37 Price control for consumer goods was introduced in Jordan around the mid-seventies in response to the rise in the inflation as a result of the rise in the price of oil. A Ministry of Supply was created in 1974 with the objective of ensuring the supply of basic food items such as wheat, rice, sugar, red and white meats, at reasonable prices. 22/ 21/ Dar El Handasah, "Industrial Programming Study", task 1.17, March 1982. 22/ In addition to the items whose prices are regulated by Ministry of Supply, prices of items protected by QRs or high tariffs is also regulated by the Ministry of Industry and Trade. A list of these items is not available. 143 18  - 28 - 2.38 Price control in Jordan is exercised in two ways. One, directly, by restricting the imports of about 13 basic items 23/ to the Ministry of Supply. The Ministry then sells these to the wholesalers at a predetermined price (which could involve a subsidy). Thus, by controlling supply, it could control the final price. 24/ Second, indirectly, by fixing the price (based on Co8ts and profit margins), and making it illegal for the retailers to charge more than the fixed price and then monitoriag them. 2.39 In December 1986, about 30 imported and domestically-manufactured items were under price control. For locally-produced goods, the price to the consumer is fixed on the basis of the manufacturers cost of production plus a profit margin whi-h ranges from as low as 17 percent in the case of toilet paper to as high as 75 percent in the case of locally-made toothpaste. For imported goods, the Ministry of Supply fixes the profit margin. The retail price is then determined by the CIF price plus the profit margin. A list of items under price control, together with the profit margins is providel in Annex A, page 14. 2.40 During the 1970s, after the price control system went into effect, the commodities which were imported and sold by the Ministry of Supply were subsidized in ordez to enable the lower income group to meet their needs of these essential and basic commodities. Since 1980, however, these subsidies were gradually withdrawn with the exception of only wheat for bread and other industrial products in which it is used as one of its principal ingredients. The subsidy on wheat has also declined since 1980 and is expected to be eliminated completely in 1987. 2.41 At the moment, the impact of the pricing system on the SMI sector or consumers Ls not significant. Price control is exercised only on eight items produced by the SMI sector and three manufactured imports, which compete with domesti; producers. It is also hard to see what benefit this system confers on consumers; especially since the Government is committed to a "no subsidy" policy. For example, if the controlled price (of say school uniforms) is fixed below its market clearing price, the manufacturer will produce something else, and the supply would therefore be reduced. 25/ The consumer would then suffer due to the unavailability of school uniforms. It is even more difficult to set a price on manufactured imports because it is impossible for the Government to guess the premium that a consumer would be wi1ling to pay for an imported item vis-a-vis a domestically-produced item. 23/ The imports of the following items are restricted to the Ministry of Supply: sugar, rice, frozen chicken, split red lentils, fresh meat from Eastern Europe, wheat, yellow maize, olive oil, barley, frozen fish, powdered milk, wheat bran and cigarettes. However, speciality items such as sugar cubes may be imported by traders while sugar can be imported only by the Ministry. 24/ Assuming there is competition between wholesalers. 25/ Unless the Government is prepared to subsidize him. 1431S  - 29 - D. The Burden of Inefficient Industries 2.42 The increase in protection over the past two years has clearly helped a number of firms within the industrial sector to survive. The sharp reduction in domestic and regional demand was unexpected; and without the measures enacted by the Government, many of these firms would have lost their markets and would have had to close down. However, these measures could not discriminate between efficient and inefficient firms in the process of offering protection. Consequently, the SMI sector in Jordan consists of a mix of efficient, well-managed firms and high cost inefficient firms. There are basically two consequences of the continued existence of these firms to the economy. First, they increase the cost of manufacturers in the domestic market. The resulting cost burden which we roughly estimate to be JD 126 million, is shared by consumers and downstream industries. This burden, represents a large transfer of resources from one societal group to another. In addition, an analysis of a small sample of firms shows that protected firms also tend to be poorly managed and tend to impose resource losses to the economy as a whole. We estimate that, in our sample of firms, JD 40 million of Jordanian resources are used to produce value added worth JD 30 million. This implies a resource loss of nearly JD 10 million for a group of industries accounting for 24.2 percent of the value added in the SMI sector. Cost to Consumers and Downstream Industries 26/ 2.43 A comparison of the domestic and C.I.F. import prices for a number of manufactured products indicates that manufacturers tend to be priced higher in the domestic markets than they would be if imported directly from abroad. Domestic manufacturers can charge higher prices for their products if the existing system of tariffs makes a comparable imported product expensive. Thus, if the C.I.F. price of an imported adults jean is JD 5.50 and it has a tariff of 58 percent, the domestic manufacturer can remain in business if he sells his jean up to JD 9.7 (5.5 x 1.58). 27/ The actual price he charges, however, must also take account of sensitivity of domestic demand to price as well as other Government price control policies. Taking into account all these factors, as shown in Table 2.6, out of the 21 items examined, domestic prices of 10 items exceed the C.I.F. import price by over 60 percent, prices of 8 items exceed by less than 20 percent, and prices of three items are less than the C.I.F. price. The table also shows that the prices of commodities like cement and glass, which are protected by QRs exceed the C.I.F. price by 75-90 percent. An exception to this is cigarettes whose ex-factory price is lower than C.I.F. price. Cigarettes, however, carry a high excise tax which pushes up the price to the consumer well above the C.I.F. import price. 26/ This section is based on a survey of twelve firms producing 21 product lines in 1985. The survey was carried out by the mission with the assistance of the officials of the Ministry of Planning. The sample accounted for 18.6 percent of the gross output of the SMI and 29.2 percent of the value added. 27/ If there is a ban on the import of a competing good, in principle, he can charge what the market will bear. 1431S  - 30 - Table 2.6: EX-FACTORY PRICES AND C.I.F. IMPORT PRICES Ex-factory c.i.f. Import Duty on 1/ Duty on Uniti Price Price Output IXI Hajar Input Maior Inout f%? Beer JD/N.L. 32.60 11.20 N.A. Halt 6.40 Cigarettes J0/1000 5.48 O 8.50 Q4/ Leaf Tobacco 87.00 cigarettes Adult jeans JD/trouser 6.25 5.50 58.00 Fabric 28.00 Childrens jeans JD/trouser 3.32 2.76 58.00 Fabric 28.00 Corrugated boxes JD/MT 384.00 236.40 58.00 Kraftliner 18.00 Paper , paperboard JO/MT 213.00 216.70 32.00 Chemicals 17.00 Quick lime JO/MT 3S.00 20.30 36.00 Local Materials 0.00 Hydrated lime JO/MT 30.30 26.00 34.00 Local Materials 0.00 Lime stone brick JO/HT 25.30 29.10 36.00 Local Materials 0.00 Clear sheet glass JD/MT 196.10 110.00 B. Soda Ash 4.50 Ord. portland cement J0/MT 27.10 14.30 S. Local Materials 0.00 Pozzolanic cement JD/MT 27.10 14.30 D. Local Materials 0.00 S.R. cowent JO/MT 28.10 14.70 8. Local Materials 0.00 Aluminum profiles JO/hT 1323.00 1261.00 B. Aluminum Billets 0.00 Galvanized pipe JO/MT 239.00 149.70 48.00 Zinc 7.50 Black pipe JD/KT 192.00 112.30 - Steel 20.00 Steel panel radiators JD/Th. Mtr. 5.9S 2.95 51.00 Semifinished Panels 38.00 Steel boilers JD/Boiler 225.00 197.00 51.00 Steel Sheets 24.00 Scaffolding JD/prop 4.50 2.76 N.A. Local Steel Tubes 0.00 Welded wire mesh JD/MT 195.00 177.30 51.00 Hot Rolled Coils 13.00 Concrete nails JO/MT 624.00 567.70 5.2/ High Carbon Steel 4.20 Sources: hanufaeturers of items described; private importer; Customs Evaluation Unit; Jordan External Trade Statistise. 1985; Hauritious Imort Statistics. 198S; and mission estimates. 1J/ Includes 18 percent surcharge J/ Import is banned 3/ Quotas N Ret of excise tax  - 31 - 2.44 The difference between the domestic and the C.I.F. import price induced by the existing trade regime is the equivalent of a tax paid by consumers and downstream industries. The present trade regime, therefore, reduces incomes of consumers of beer and jeans and increases costs in the construction industry through higher prices for glass and cement, and in the packaging industry through higher prices for corrugated boxes. Based on our sample survey, we estimate that this implicit tax on consumers and downstream users imposed by the SMI sector during 1985 amounted to nearly JD 126 million 28/ which was almost equal to half the total tax revenue of the Government in 1985 (Table 2.7). Implicit Subsidies to Manufacturing 2.45 Barriers to imports erected by the Government to protect manufacturing industries affect the domestic prices of both industrial outputs and inputs. Thus, manufacturers receive an implicit subsidy when the additional amount they can charge for their output on the domestic market (in comparison to C.I.F. import prices) exceeds the additional amount they have to pay for their inputs (compared to C.I.F. import prices). alternatively, if the additional cost of inputs is greater than the additional price received on the output, the industry is effectively taxed for producing the product. 2.46 The data presetnted in Table 2.7 suggests that the subsidy (paid by the rest of the economy) to the 12 industries amounted to JD 18.8 million. This suggests that the subsidy received by the entire SMI sector in Jordan was about JD 64 million in 1985 or roughly 38 percent of the manufacturing value added. In our sample, the largest recipients of these subsidies were beer, glass and cement. These accounted for 86 percent of the subsidy for the sample. Efficiency of Resource Use 2.47 Large implicit subsidies used to create and maintain the present structure of SMIs in Jordan, reduce the real incomes of consumers, and impose cost burden on downstream industries. These are large transfers from one societal group to another. In addition, the results from our firm level survey suggest that the protected firms also tend to be poorly managed, and hence also result in a net resource loss to the nation. 2.48 Table 2.8 presents data on efficiency of firms within the sample surveyed at different levels of capacity utilization. Since our sample survey was small, and some of the sub-sectors such as cement and glass consisted of single plants, the results should be thought of as illustrative rather than as representative of the entire SMI. 29/ Efficiency is measured as the valule of domestic resources (labor and capital) spent in earning (in the case of an exportable), or saving (in the case of an import substitute) one Jordanian dinar of foreign exchange. This measure is commonly known as Domestic Resource Costs (DRC). A production process is, therefore, inefficient or efficient depending on whether the DRC is greater or less than one. On this basis, there appears to be a great deal of inefficiency in Jordanian 28/ This is based on the assumption that the sample of firms is representative of the general structure of the SMIs. 29/ The limitations of our exercise are more fully discussed in Annex C. 143IS  - 32 - Table 2.7: IMPLICIT ANNUAL SUBSIDIES FOR SELECTED PRODUCT LINES (JD '000) Cost Burden on Value of Implicit Product Line Downstream Users 1/ Annual Subsidy Beer 810 234 Cigarettes 2659 -157 Cotton yarn 74 59 Adult jeans 60 48 Childrens jeans 87 71 Corrugated boxes 1934 1641 Paper & paperboard 394 377 Hydrated lime 8 8 Bricks -41 -41 Sheet glass 573 551 Cement (3 kinds) 15409 15426 Aluminum profiles 238 -203 Black pipes 163 100 Galvanized pipes 1120 702 Radiators 24 16 Scaffolding 20 15 Total for Sample 23532 18847 Source: Mission's survey of firms. 1/ Refers to the additional expenditures downstream users and consumers would have to incur for an industry's product over and above what they would have to pay if the product were imported duty free. It is estimated by multiplying the difference between domestic and C.I.F. import prices (net of taxes) by industry sales to downstream users and consumers. In contrast, the column for annual implicit subsidy is estimated as the difference between the additional amount charged on the output (compared to C.I.F. import prices) less the additional price paid for the inputs (compared to C.I.F. import prices), multiplied by total production. manufacturing. Seventeen out of the 21 products examined in our survey are produced inefficiently. Of these seventeen products, 30/ three are an absolute drain on the country's balance of payments. The import cost of current inputs exceeds the cost of importing the final product; in other words, these products have negative value added (NVA) at border prices. In addition, the domestic production of these items uses up valuable resources in the form of capital and labor. Of these products, NVA of the glass production can be explained by the extremely high energy costs amounting to 86 percent of the value of the output. On the other hand the NVA of SH resistant cement production results from an extremely low world market price of cement -- perhaps due to economies of scale in cement production elsewhere. 30/ These are sheet glass, scaffolding and SH resistant cement. TV31is  - 33 - Table 2.8: EFFICIENCY OF MANUFACTURING ENTERPRISES At Present Level of At 90 Percent Efficiency Index Capacity Utilization Capacity Utilization Number of Product Lines Showing: Negative Value Added 3 3 DRC greater than 1 14 11 DRC less than 1 4 7 Total 21 21 Source: Mission Firm Survey. 2.49 On the whole, the sample of firms examined in our survey uses up JD 40 million worth of resources in the form of capital and labor to produce only JD 30 million worth of value added (Table 2.9). If the present sample can be thought of as representative of the general structure of the SMI sector, Jordan is wasting roughly JD 34 million per year,, wounting tci almost 20 percent of the value added in the SMI sector by maintaining the existing structure of industries. 2.50 As listed in Table 2.9, the domestic resources used in earning or saving one JD of foreign exchange, varies considerably from product to product. Clearly the efficiency of an industry does not depend on whether the industry is export-oriented or import substituting. Pozzolanic portland cement production which is largely sold domestically, uses up JD 1.6 to save one JD of foreign exchange. By the same token, ordinary portland cement -- which is exported -- uses up JD 1.5 of foreign exchange. Table 2.9, which arranges products in increasing order of efficiency, also suggests that the higher the level of protection, the lower the efficiency of resource use. 2.51 The data in Table 2.9 also refutes the notion that the inefficiency of Jordanian manufacturing industry results from the current low levels of capacity utilization due to the general economic recession. If capacity utilization in all manufacturing could be improved to 90 percent, only two product lines, welded wire and bricks with capacity utilization rates of 38.5 and 15.3 percent respectively will become efficient. E. Conclusion 2.52 The combination of policies pursued by the Government to protect domestic manufacturing enterprises has enabled both efficient as well as inefficient industries to survive. The present industrial structure, therefore, implies a large subsidy from the rest of the economy to the SMI sector as well as results in a net loss of Jordanian resources. A restructuring of incentives and improved institutional support which allows efficient firms to expand output at the expense of inefficient firms is, therefore, necessary to lay the basis for the future rapid growth of the SMI sector. 14318  - 34 - Tabte 2.9: DOMESTIC RESOURCES USED IN SAVING OR EARNING ONE JD OF FOREIGN EXCHANGE ................................. ................................................................ -........................ ........................................ Value-Added Domestic Domestic Effective Actual DRC at Resources Used Resource Rate of Capacity at 90X International Labor and Costs Protection Utili- Ca city Prices Capital Cost DRC ERP zation Utilization 05-Jan-88 ----------(mill JD)----------- (JD) ........(X).---------- (JD) (a) (b) (cub/a) (d) (e) (f) --- .....................................---....... ....................... EXPORTABLES Adult Jeans 23.0 91.3 3.970 89.1 12.5 2.955 Portland Cement 1654.6 2450.8 1.481 0.0 93.7 1.526 Children Jeans 77.6 113.2 1.459 79.8 24.0 1.138 Cotton Yarm 1296.3 616.9 0.476 4.6 85.0 0.467 Corrugated Boxes 879.9 325.4 0.370 120.3 91.5 0.371 INPORTABLES Sheet Glass NVA 1/ 1783.6 50.0 Scaffolding NVA 41.2 36.7 S.H.Resistant NVA 9676.8 93.7 Black Pipes 2.9 64.2 22.138 3429.3 85.0 21.812 Galvanized Pipes 25.2 465.2 18.460 2782.6 85.0 18.126 Radiators 2.2 38.7 17.591 725.8 17.3 14.470 Boilers 4.6 15.3 3.326 3.5 20.0 3.056 Adult Jeans 30.6 91.0 2.974 89.1 12.5 2.211 Pozolanic Portland 11511.5 18865.8 1.639 120.8 93.4 1.684 Beer 207.7 379.6 1.828 112.7 34.0 1.234 Bricks 183.2 293.7 1.603 -22.6 15.3 0.936 Welded Wire 64.2 71.2 1.109 -17.3 38.5 0.803 Alum. Profiles 2192.4 839.0 0.383 -9.3 96.2 0.397 Paper & Paperboard 398.1 151.1 0.380 95.2 91.9 0.380 Corrugated Boxes 485.1 179.5 0.370 120.2 91.5 0.371 Cigarettes 10614.0 2371.1 0.223 -1.3 100.0 0.229 Total 3931.4 15099.2 3.841 63.6 10.329 ......................................................................................................... 1/ Negative domestic value-added at intermational prices. This indicates that the iqort costs of components is greater than the international price of the final product. Hence the contribution of the activity is negative to the balance of payments. Source: World Bank staff estimates.  - 35- III. FINANCING OF SMALL AND MEDIUM SCALE INDUSTRIES (S IS) A. Overview 3.1 The financial institutions and instruments in Jordan are by and large well developed and work efficiently. Government policy during the early 1980s was designed to use the well-developed financial sector to stimulate industry in a recessionary environment. In the pursuit of this policy, the Central Bank of Jordan (CBJ) introduced a number of measures basically designed to stimulate the flow of credit to industry such as rediscounting of syndicated loans at a low interest rate, statutory purchase of equity by banks and limits on funds that could be held abroad. These measures, however, mainly benefited large, government sponsored industries. Moreover, they could not compensate for the severe regional and domestic economic recession. falling demand led to widespread capacity under-utilization and financial difficulties in many clients of the financial institutions. The financial institutions by 1986, therefore, suffered fromi high liquidity, poor loan portfolios and low profitability. The value of shares of mining and manufacturing firms traded on the Amman Financial Market also fell by 40 percent between 1982 and 1986. 3.2 These difficulties have accentuated some of the undesirable characteristics of the financial sector from the perspective of the SMIs. Financial institutions have increasingly preferred to lend to established, large to medium-sized corporate borrowers. Financial institutions have also tended to rely on substantial collateral requirements and thus have not developed the strong project appraisal and loan supervision skills that are a hallmark of a modern investment banking sector. In short, small new entrepreneurs with no collateral to offer, who could constitute an important source of growth within the SMI, continue to face difficulties in obtaining credit on the merits of their investment proposals alone. Section B below describes the institutions in the financial sector, Section C presents Government policies and their impact on SMI financing, and Section D discusses some of the major problems with the existing institutions. B. Sources of Funds for the SMIs 3.3 The financial sector in Jordan consists of the following four main types of institutions as shown in Chart 3.1. These are: commercial banks, financial companies (merchant banks), specialized credit institutions (SCIs) &nd several non-bank financial institutions; the most prominent among which are the post office savings fund, the pension fund and the social security corporation. In addition to these institutions, there are several insurance companies, money changers, leasing companies and a small but active stock exchange. 3.4 Of the financial institutions described above, three (commercial banks, financial companies, and the SCIs) are mainly involved in the provision of loans, whereas the pension fund, social security corporation and the Amman financial market are mainly involved in providing equity. Commercial banks and the SCIs also finance exporters during the pre and post-export phase. The activities of these institutions are described in detail in Annex A, page 23 to 35. 3.5 The Industrial Development Bank (IDB), is the most important institution in Jordan responsible for industrial development and is likely to remain so in the near future. The IDB is the leader in providing medium and 143 1S  - 36- CHART 3.1 JORDM 4 STRUCTURE OF THE FINANCIAL SYSTEM' Monsuy Auwhdt Central Bank of Jordan Domestic banks (10)2 Coamw-- Banks Foreign banks (7) Total number of branches: 256 Agricultural Credit Corp. Industrial Development Bank . = a - Housing Bank3 Cities and Villages Development Bank Jordan Cooperative Organization Housing Corporation Financial Companies (11) 0d bw*bV It_ , Real Estate Institutions Post Office Savings Fund Pension Fund Non f - Social Security Corp. Insurance Companies Representative Offices of Foreign Banks and Financial Companies Money Ex%change Companies Amman Financial Market (Stock Exchange) Smrs Cmntr S.m pt Jwlt _d t. 'F9IPSS@ olitMd 1 tbW t4W* Sat as nutid a pwt @9 th ierdba~n st  - 37 - long-term loans to the SMI fpr working capital as well as investment. The IDB has also been extensively involved in assisting the very small industries through the Small Scale Industries and Handicraft Fund (SSIHF). Snce 1982, the SSIHF has financed an impressive 1138 projects while maintaining a sound loan repayment record with only a staff of five. The IDB also plays an important role in providing training to the private and public sector industries in accounting, finance, general management and marketing through the Jordan Management Institute (JMI). C. Government Policies in the Financial Sector 3.6 Beginning 1983, the Government's credit and monetary policies were aimed at stimulating the flow of credit to productive enterprises. This, the Government hoped, would to some extent mitigate the impact of the severe economic recession. The Government's credit policy was conducted in a framework of regulated interest rate in which ceilings/floors on lending and deposit rates by institutions are fixed by the Government. The Government policy had the following three important elements: (i) to encourage banks fo finance the private sector, the CBJ rediscounted all commercial bank syndicated loans, increased its advances available to financial institutions, and reduced the interest rate applicable to these funds; (ii) to encourage the domestic use of resources, in 1985 the maximum amount of balances that commercial banks could maintain abroad against contingent foreign liabilities (such as bankers acceptances and documentary credits) was reduced from 25 to 15 percent; and (iii) to encourage the flow of funds to the corporate sector, effective February 1984, commercial banks were required to use at least 4 percent (each) of their dinar deposits to purchase public entity bonds and corporate bonds. They were also instructed to purchase corporate equity to the equivalent of at least 15 percent of their paid up capital plus reserves provided that no bank held more than 10 percent of any company's capital and reserves. 3.7 The Government policies described above have not been adequate to compensate for the adverse impact of the economic recession on the profitability and hence the debt servicing capability of enterprises in the economy. Industrial lending by most financial institutions, is thus characterized by sluggish disbursement performance, poor loan portfolios and low profitability. The growth of total credit extended to the private sector slowed down from 25 percent p.a. during 1980-83 to only 10 percent p.a. during 1983-85 (as shown in Table 3.1). This slowdown was most visible in IDB's lending indicating the severity of the recession in industry. IDB's disbursements have fallen by 16 percent p.a. between 1982-85 compared to a growth of almost 26 percent p.a. between 1977-82. In fact, since 1984, the net resource transfer by IDB (disbursement-repayments) to industry has been negative. 1431S  - 38 - Table 3.1: GRpWTH OF CREDIT OUTSTANDING TO PRIVATE SECTOR BY FINANCIAL INSTITUTIONS (percent per annum) Share in Total 1985 1980-83 1983-85 (Percent) Central Bank 12.8 7.5 0.3 Commercial Banks 23.7 8.0 69.0 Financial Corporations 123.4 20.0 6.9 Specialized Credit Institutions 25.9 14.2 23.8 o/w IDB (26.1) ( 3.3) ( 2.6) TOTAL 25.0 10.1 100.0 Source: Central Bank of Jordan 3.8 The disappointing performance of industry in the economy is also reflected in the poor loan portfolios of the IDB. At the end of 1986, 30 percent of the loans carried on the books of the IDB were in arrears for more than six months. This represents a marked deterioration since 1983 when only 8 percent of the loans were in arrears for more than six months. Judging from the pipeline of projects at the IDB the present recession shows no sign of abating. The pipeline of projects at the end of 1986 consisted of 41 projects of which 28 were being appraised and the rest (13) were in an early state of preparation. The total estimated demand from the 28 projects under appraisal was JD 2.8 million. Thus unless major promotional efforts are carried out, IDB will have difficulty in maintaining the present level of disbursement of about JD 7 million per annum; and the net resource transfer is likely to continue to be negative. 3.9 The interest rate policy followed by the Government has seriously affected the spreads between borrowing and lending rates and hence the profitability of the financial sector. The financial sector operates under a fairly detailed interest rate structure under which ceilings on both lending and deposit rates by instruments and institutions are fixed by the Government. Competition for deposits within the sector between the numerous banks as well as very few restrictions of transfer of funds abroad has pushed the effective deposit rates close to the ceiling. This, combined with the ceilings on lending rates, has reduced the spread between the borrowing and lending rates; and hence adversely affected the profitability of the financial institutions. In 1985, the Jordan National Bank and the Bank of Jordan, two of Jordan's largest and oldest banks, registered pre-tax profits that were 18 and 4.5 percent below these in 1984. In 1985, the profits of IDB were also almost 20 percent lower than those in 1984 and are expected to be even lower in 1986 and 1987. 143IS  - 39 - 3.10 The policies followed by the Government, together with the low profitability of banks has had two negative implications for the Bank's lending policies. First, because of the low spread and interest rate ceilings the banks were not able to differentiate between customers by risk. They, therefore, preferred to invest in low risk loans to preferred customers. Indeed by 1985, 58 percent of the credit outstanding of the commercial banks to the industrial sector was in the form of syndicated loans. Similarly, investment in corporate bonds grew fom only 1.2 percent to nearly 4 percent of the claims of the financial system on the private sector. Second, financial institutions preferred to lend in the form of certain instruments over others. For example, since the interest rate charged on overdrafts and bills discounted was higher than on other forms of lending, banks relied extensively on these instruments. We estimate that on an average between 1982 to 1986 the annual net resource transfer to SMIs through overdrafts and bills discounted exceeded that by loans by 20 percent. 31/ A part of this, overdraft financing was being used as project financing at a higher cost and the risk of a sudden recall of the loan for investors , without the benefit of a detailed project appraisal. In short, the ceilings on interest rates and Government policies reduced the availability of funds to the non-corporate entrepreneur who could be a source of growth within the SMI sector. 3.11 Clearly, the Government's policy had not succeeded in stimulating an additional flow of financial resources to the SMIs, rather only brought about a shift in the pattern of deployment of available resources. Thus, commercial Banks increasingly invested in secure Government-guaranteed syndicated loans and corporate bonds. By 1985, these trends were clear and the Government reduced the recourse of commercial banks to the CBJ. Refinancing of syndicated loans was reduced from 25 percent to 15 percent as a means of discouraging banks from excessive dependence on syndicated loans and bonds for financing private sector needs. D. Problems with the Present Financial Institutions 3.12 From the perspective of the SMIs, there are four main problems with the existing arrangements in the financial sector. First, financial institutions have tended to specialize in specific lending activities and instruments which has limited the usefulness of the diversified financial sector to the SMIs. Second, the financial institutions have shown a bias towards large projects and corporate borrowers, thereby denying the small scale industry the benefits of institutional credit. Third, the financial institutions have been excessively risk averse and have not acted as an instrument to stimulate industrial growth. Fourth, there are shortcomings in the present system for export financing. These problems are discussed in some detail in the rest of this Chapter, and the proposed solutions are discussed together with the rest of the reform program in Chapter 4. Specialization 3.13 Although there are a number of financial institutions available to serve the needs of the SMIs, each institution tends to specialize in a limited number of instruments or types of financing, thereby limiting competition. 311 This number will be much larger if drawings of less than one year duration are made against an overdraft facility. 143S1  - 40 - Commercial bank financing of fixed assets and permanent working capital for industry usually takes the form of rolling over overdraft facilities and participating in syndicated loans. This is partly due to the lack of staff to appraise projects or to follow the current lengthy procedures to make medium and long term (MLT) loans; and partly due to the low spreads on MLT lending, which given their higher loan processing costs and higher risk, do not make it worthwhile for the commercial banks to make MLT loans. The financial support extended by financial companies to industry is also focused on lending to large scale enterprises. Moreover, the financial companies generally tend to use their limited financial resources for more profitable activities such as financial restructuring of existing enterprises. Long-term project lending to SMIs thus mainly rests on IDB's ability to mobilize resources, reach out to investors and meet their demand for borrowings, without compromising the soundness of its loan portfolio through excessive risk exposure and sectoral concentration of investments. 3.14 As a result of the above specialization of roles, project lending to industry capitalizes only marginally on the well developed and diversified structure of the Jordanian financial system. While the IDB will continue to remain the main institution providing MLT finance for SMIs, a greater role of commercial banks and financial corporations could ensure a more effective response to, and a wider coverage of the financial needs of the SMIs. The ways and means to achieve this are discussed in Chapter IV. Bias Towards Corporate Lending 3.15 Most financial institutions serving industry focus on projects promoted by large corporate borrowers. To some extent, Government policy has been responsible. Government assistance to the mobilization of financial resources by the banking system for industry has taken the form of providing guarantees for syndicated loans, requiring commercial banks to use at least 4 percent of their dinar deposits to purchase bonds issued by public entities and private corporations, and use at least 18 percent of their paid-up capital plus reserves to purchase corporate equity. These measures have mainly benefited large enterprises; such entities being natural candidates for being organized as public shareholdings and receiving Government loan guarantees. 3.16 By the same token, public corporations such as the Pension Fund and the Social Security Corporation have mainly oriented their investment activities to the purchase of equity and bonds issued by large Government sponsored zompanies. While the creation of the AFM represents a major nrogress toward the establishment of an organized capital market and has offered new investment opportunities to Jordanian savers, the enterprises which have been financed through the sale of stocks on the AFM have also been mainly large Government sponsored corporations which would have been funded anyhow through other Government-backed sources of financing. Redirecting the investment activity of the Pension Fund and the Social Security Corporation so that they will also provide venture capital for SMI development would not only enhance resource mobilization for industry but also activate the stock market. 3.17 An exception to this is the small scale industry division of IDB which consists of a staff of 5 and administers the Small Scale Industry and Handictaft Fund (SSIHF). This fund provides loans with a maximum maturity of 5 years and an interest rate of 6.5 percent for the development of enterprises employing less than 5 workers and entailing a total investment, including 143S  - 41 - working capital, of less than JD 20,000. Since 1982 the SSIHF has financed 1,138 projects for a total amount of JD 3.4 million. The resources used by the Fund come from the Central Bank, the Ministry of Planning and foreign donors. Demand for SSIHF financing has expanded considerably in 1985 to reach 430 applications or twice as many those processed in 1984. Loan repayment appears sound for the time being. IDB activity in the sector is however marginal and does not seem to follow any long term industrial development strategy. A revision of the scope and level of activity of the SSIHF in the context of the Government's effort to promote SMIs is most needed and outlined in Chapter IV. Risk Aversion and Collateral Requirements 3.18 Poor portfolio, low spreads, and the absence of a public or private institution to offer insurance against bad loans have made the financial institutions extremely conservative and risk averse. Banks tend to rely excessively on collateral and Government guarantees rather than detailed project appraisal for making loans to industry. As a result, with the exception of IDB, the banks have not developed expertise in project appraisal and have generally been reluctant to promote industrial ventures by new entrepreneurs and to experiment with more innovative types of financial assistance. 3.19 To a lesser extent, IDB is also characterized by a conservative lending policy. Every year IDB processes about 100 new loans. These operations are mainly the result of direct applications from customers with very little promotional activity carried out by the IDB's investment department. Promotion is generally limited to visits to entrepreneurs located in the Amman Industrial Estate and to former clients who have indicated their desire to expand to the follow-up department within IDB. Shortcomings in the Existing Arrangements for Export Financing 3.20 To promote the development of Jordanian manufacturing exports, commercial baniks and IDB provide loans to exporters during the pre-export phase (financing of raw materials, intermediary goods and production costs) and the post-export phase (bridge financing). The pre-export loans are made on the basis of export orders and the relevant letters of credit. They can cover up to 60 percent of the total value of the letter of credit. The post-export loans usually take the form of an overdraft facility for a maximum duration of 18 months covering a maximum of 80 percent of the amount indicated in the letter of acceptance of the exported merchandise. According to Government regulations the loans carry a maximum interest rate of 6.5 percent. The financial institutions concerned can rediscount these loans at 5 percent with the Central Bank. 3.21 There are basically two problems with the existing export credit system described above. First, although credit is available in principle to all exporters, most banks are, in fact, reluctant to provide it at the conditions defined above since the spread is too small and it is more profitable for them to finance their customers with conventional overdraft facilities at higher interest rates. Second, there is no agency in Jordan to provide export insurance to cover country risk. As a result, banks are reluctant to provide financing (pre- or post-shipment) for large export orders which are not covered by an appropriate insurance policy. Exporters needing 143 IS  - 42 - insurance have to rely on the services of a regional insurance agency located in Kuwait at great cost and time delays. E. Conclusion 3.22 While the financial institutions and instruments are diversified and well developed, the small entrepreneur with no collateral to offer continues to face difficulties in obtaining funds on the merits of his investment proposal alone. The low spreads which result from an administratively determined interest rate structure partly explain this reluctance of financial institutions to offer medium and long-term loans to SMI. In addition, a series of institutional innovations such as creating loan insurance scheme and upgrading the project appraisal capabilities would be needed to redress the shortcomings in the financial sector. 14318  - 43 - IV. SUGGESTIONS FOR REFORM A. Overview 4.1 In order to enable the Jordanian SMI sector to realize its full potential, its overall competitiveness must be increased by a package of measures that restructure the incentives facing the sector as well as offer institutional support to overcome some of the long-standing structural weaknesses described in Chapters 1 and 2. The restructuring of incentives would involve first, a reduction in the level of protection to the SMI sector as a whole. This would increase competition from imports and transmit to the SMI sector the structural changes in the macroeconomic environment that have taken place since 1983. The most important of these is the recession and the concommittant reduction in demand for some of the products of the SMI sector. Second, the restructuring would involve measures such as an elimination of the tariff exemptions for institutions and a rationalization of the tariff structure to create a uniform non-discriminatory set of incentives across different subsectors (or product lines) within the SMI sector. Such a restructuring of incentives complemented by a reform of the investment licensing system would allow resources to flow to more efficient firms (or product lines) at the expense of less efficient firms thereby i-creasing the competitiveness of the SMI sector and reducing the resource losses estimated in para. 2.49. 4.2 To increase the competitiveness of the SMI sector, the restructuring of incentives must be buttressed by improvements in institutional support for export promotion, for facilitating efficient import substitution, for improving quality and standards, and for improving the availability of credit. In the short run, the package of measures would result in higher levels of capacity utilization in the efficient firms and could involve closures of some inefficient firms. In the medium/long-term, new firms could emerge, some of whom could become competitive exporters. 4.3 There are two areas where further analysis would be helpful in guiding the implementation of the measures described below. First the whole question of the time frame over which these reforms could be implemented has not been discussed in this report. Clearly some reforms such as the removal of the tariff exemptions could be carried out quickly, whereas others such as the rationalization of the tariff code could take two to three years. Second, some of the measures described below have macroeconomic implications which go beyond the SMI sector. It has, for example not been possible in this report to examine the impact of an exchange rate change on workers' remittances or inflation. Similarly, we have not examined the broader budgetary impact of the tariff reform. Further work on these issues is therefore needed aefore launching the reform program discribed below. 4.4 The measures discussed below are not new. Indeed, many of them have been a part of the Government's own thinking for a long time and some are even in various stages of implementation. They have been discussed in the 1986-90 Plan and in various internal documents of the Ministry of Industry and Trade and the Ministry of Planning. In addition to the Government, these measures have also been studied by many eminent Jordanian economists, by the Royal Scientific Society, in the studies carried out over the years by Dar Al Handasah and by aid agencies such as UNDP and USAID. Thus, the set of measures described below is more in the spirit of compiling what is known and supporting them where possible by additional empirical analysis. The measures needed to restructure the SMIs could be grouped into two broad categories as follows: 143 1S  - 44 - Measures to Alter the Incentive Structure 32/ (a) Remove Tariff Exemptions for Selected Institutions (b) Replace Quantitative Restrictions (QRs) by Tariffs (c) Reduce the Level and Variation in the Tariffs Supported by an Exchange Rate Change (d) Reduce the Scope of the Investment Licensing System (e) Simplify the Encouragement of Investment Law Measures to Improve Institutions (a) Improve Institutions for Export Promotion (b) Improve the Institutional Arrangements to Promote Efficient Import Substitution (c) Improve the Institutional Support for Improving Quality and Standards (d' Improve the Working of Financial Institutions B. Measures to Alter the Incentive Structure Remove Tariff Exemptions for Selected Institutions 4.5 For any commodity bearing a tariff, exempting selected institutions from paying this tariff, not only differentiates the price of this commodity to different consumers without any economic rationale, but also places the domestic producer at a disadvantage vis-a-vis imports for a large segment of the domestic (import substitution) market. 4.6 An example could best illustrate this phenomenon. If overalls are imported by the refinery (for its workers), it does not pay the scheduled customs duty of 58 percent. On the other hand, a Jordanian manufacturer of overalls pays the scheduled customs duty of 28 percent on the cloth even if the final product is destined for the refinery. 33/ 4.7 At a more macro level, a detailed analysis of the institutional import exemptions indicates that roughly JD 125 million (out of a total exempted imports of 500 million JD) compete directly with domestic manufacturing. This amounted to nearly 25 percent of the gross output and 23 percent of the imports of SMIs in 1984. Thus, even on the basis of the macro magnitudes, the domestic manufacturer is placed at a disadvantage vis-a-vis imports in a large segment of the market. For specific firms, this policy could be even more important in determining the chances of marking a profit or a loss. 4.8 There is thus a strong case for doing away with tariff ext itions for competitive imports. This would offer a more uniform structure of p-tection to domestic producers, expand import substitution and increase budgetary revenue. The removal/reduction of tariff exemptions is also an important element of Government's own thinking in this area. The rules for import policy presented in Annex A, page 7 for example aim to encourage the civil service and military consumers' associations 34/ to buy from local industries and not to import except in cases where no similar local product is available (Rule (c)). The Government has also drawn up a list if items Annex A, page 18. 32/ The listing is not in the order of importance. 33/ The argument, however, does not apply in the case of non-competing imports such as oil which are also exempted from tariffs. 34/ Which are exempted from tariffs.  - 45 - on which tariffs have to be paid by the tariff exempt institutions. What is therefore needed is an accelerated and comprehensive implementation of what is clearly Government's own policy of doing away with tariff exemptions, especially for competitive imports. Replace Quantitative Restrictions (QRs) by Tariffs 4.9 The QRs have a significant impact on protection, and there is a real danger that their use will increase as domestic industry faces shrinking markets. We recommend that the increase in QRs should be stopped and an attempt be made to replace existing QRs by tariffs. 4.10 There are three reasons why tariffs are preferable to QRs as an instrument of protection. First, unlike tariffs, which place a ceiling on the price of the domestically produced good, the maximum impact of QRs on prices cannot be predicted. The policy maker is therefore not sure of the maximum possible increase in the cost to the consumer. Second, QRs deny revenues to the Government and third, importers in Jordan cannot be responsive to changes in international price. To some extent, the rules of Import Policy (discussed in Chapter 2) have been designed to address the problems with QRs described above. Being aware of the adverse impact of QRs on the price of a locally-manufactured good, the Government has attempted to administratively control prices. The success of this policy, however, has been limited to some intermediate goods where as for a vast majority of locally made consumer goods protected by QRs, the policy has not really worked. Further, there is the real danger that if QRs are allowed to proliferate, the administrative complexity and cost of price control will become prohibitive. There is thus a strong case for replacing existing QRs by tariffs. The Government. should, however, retain the existing mechanisms to examine complaints of unfair trade practices and dumping, where the use of tariffs and import surcharges may be inadequate. Reduce the Level and Variation in Tariffs Supported by an Exchange Rate Change 4.11 Increasing tariff levels for selected products of the SMI sector during the past two years have placed a heavy burden on consumers as well as increased costs to the downstream industries. These increases have come about on an ad hoc case-by-case basis rather than as a result of a well-formulated protection policy and have added to the complexity of the tariff code. High tariffs have also accentuated the anti-export bias within the tradable sector by encouraging the production of import substitutes over exports. 4.12 To begin with, there is an urgent need to simplify the tariff code. The present method of raising revenue through the general tariff and additional taxes (described in Chapter 2) should be replaced by a single uniform tariff. Any allocation of the tariff revenue to different institutions could be carried out as a budgetary exercise without affecting the way tariffs are collected. 4.13 High levels of protection are probably necessary in the case of an infant industry or a sharp recession such as the one faced by Jordan in 1983. However, in both cases the protection offered should be temporary and should be reduced after allowing the industry time to make the needed adjustments. Given that the economic recession and the protective tariff structure has been with the Jordanian industry for at least the past three years, we 14318  - 46 - recommend that the average level of tariff be reduced. The reduction in tariffs should be accompanied by making the tariff structure as uniform as possible. This would equalize the effective rates of protection across different activities within industry and thus allow resource allocation to be guided by efficiency considerations rather than an externally-imposed tariff structure. 4.14 A reduction in the level of tariffs would normally be accompanied by a compensating exchange rate change to preserve the profitability in the import competing sector and increase the profitability in the export sector, and thus avoid the adverie impact on the balance of payments. The Government has traditionally fiilowed a policy of maintaining a stable nominal exchange rate. This policy has been guided by the concern that frequent adjustments to the exchange rate could have an adverse impact on the transfer of remittances, which in Jordan have financed a third of its total imports. Thus, since 1975, as shown below in Table 4.1, the Jordanian Dinar has been pegged to the SDR at JD 1 = SDR 2.578 with margins of 2.25 percent on either side of the peg. This peg has resulted in small movements in the nominal exchange rate of the JD vis-a-vis major currencies. Over the period 1980-84, the JD depreciated against the US$ by about 22 percent, changed little against the Japanese Yen, and appreciated against other major currencies. Since then, however, the trend has reversed. Between 1984-86, it had appreciated by 13 percent against the US$ while depreciating against the other major currencies. Table 4.1: JORDAN EXCHANGE RATE VIS-A-VTS MAJOR CURRENCIES End of US$/JD DM/JD JY/JD L/JD FF/JD Period 1980 3.2 6.44 667.3 1.4 14.9 1981 2.9 6.77 660.1 1.6 17.8 1983 2.7 7.35 627.0 1.9 22.5 1982 2.8 6.76 668.6 1.8 19.1 1984 2.5 7.96 634.8 2.2 24.2 1985 2.7 6.97 568.0 2.0 21.4 1986 (lst Qtr) 2.8 6.80 527.2 2.0 20.9 Source: IMF 4.15 Conventional indicators show that the current exchange rate is not overvalued from the point of view of a static balance between the demand and supply of foreign exchange. First, as shown in Table 4.2, there has been no appreciation in the real effective exchange rate (REER) since 1980 due to the low inflation in Jordan vis-a-vis its major trading partners. The REER provides a measure of the overall price and cost competitiveness of the country's currency. Second, the quantitative restrictions remain small in relation to total imports and there are no restrictions on the movement of capital. Third, although the debt service ratio is rising and reserves are low, they remain within irnageable limits. Finally, the fact that one can freely exchange Jordanian Dinars for foreign currency at the official exchange rate and there is no parallel market for the currency indicates that the exchange rate is close to being market determined. 1431S  - 47 - Table 4.2: JORDAN NOMINAL EFFECTIVE EXCHANGE RATE. RELATIVE PRICE AND REAL EFmFCTIVE EXCHANGE RATE INDICES Nominal Real Effective Period Effective Exchange Relative Price Exchange Rate Average Rate Index 1/ 2/ Index 3/ Index 4/ 1980 100.0 100.0 100.0 1981 99.5 101.2 100.7 1982 103.6 100.0 103.9 1983 106.6 96.8 103.2 1984 108.1 95.2 102.9 1985 110.0 94.5 104.0 1986 (lst Qtr) 106.6 94.5 100.7 Source: IMF 1/ A rise in the index indicates a relative appreciation of the Jordan Dinar and vice versa. 2/ Exchange rate of Jordan Dinar relative to trade-weighted exchange rates of 28 major trading partners. 3/ Jordan's consumer price index relative to trade-weighted price indices of 28 major trading partners. 4.16 In the case of Jordan, however, there appears to be a conflict between the exchange rate determined by the static equilibrium in the market for foreign exchange and that necessary to attain the structure of balance of payments targeted in the Plan. The latter aims at substantially reduced reliance on foreign aid and remittances to finance imports. If this target is to be achieved and the industry is to be provided incentives for efficient growth, an adjustment of the exchange rate coupled with a reduction in average level of tariffs will need to be carried out over the next two to three years. Reduce the Scope of the Investment Licensing System 4.17 There are four arguments advanced by Government officials in the favor of maintaining the licensing system in its present form. First, the licensing system was useful in advising the prospective investors about the general market conditions which the ministry was in the best position to assess. Second, it was necessary for "statistical" purposes to keep track of developments in the SMI sector. Third, it could be used to stop projects that do not have a chance to succeed and be profitable. Finally, it is easier to stop investment in weak projects than to deny tariff protection and/or subsidy at a later date when the project was unprofitable. 4.18 The use of investment licensing system for advising prospective entrepreneurs about general market conditions and for statistical purposes is legitimate. In fact, this function of the Department of Industry should be strengthened c-onsiderably by making up-to-date reports on market conditions and on Govermment policies available to potential investors. It is, however, hard to see the value of the licensing system as an instrument to regulate sarket entry on the basis of the likely profitability. It is impossible for 14: .  - 48 - the Government officials to have a better assessment of the business opportunities than the entrepreneur themselves, and even if they did possess the knowledge, the advantages of free market entry and the competitive pressures it generates on reducing costs would outweigh any dislocations caused by closing down of firms. Simplify the Encouragement of Investment Law 4.19 There are three problems with the present design and implementation of the Encouragement of Investment Law. First, the Law is biased against small investors since the benefits accrue only to projects which employ more than 5,000 JD of fixed assets. Second, the eligibility of a prospective project for benefits under the EI Law is discretionary. Third, the implementation and extension of benefits is discretionary as well as administratively cumbersome. 4.20 The eligibility of a prospective project for benefits under the EI Law remains discretionary even though Government officials make every effort to apply fair and objective criterion. In classifying a project as an Economic Project (EP) or an Approved Economic Project (AEP), officials at the Ministry of Industry follow a points system. 35/ Increasing number of poiaits (out of a predetermined maximum) are awarded to a project if it satisfies the following: (i) employs Jordanians, (ii) utilizes domestic resources, (iii) generates foreign exchange, (iv) is related to existing project, (v) employs the minimum capital, (vi) utilizes modern technology, and (vii) saves energy. If the sum of these points is more than a predetermined amount, it is considerei an EP or an AEP. While the system described above is close to being objective, it is not transparent to the investor, and its relationship to the Law itself is unclear. 36/ More important, since the actual number of points awarded for a feature (out of the maximum) is largely up to the committee, a prospective investor has no way of being absolutely sure if his project will be accorded as an EP or an AEP status. 4.21 Even after the project is declared an EP or an AEP, there remains a considerable element of discretion in the administration of benefits and requires repeated contact with the officials at the Ministry of Industry. For example, it is up to the EI Committee to consider, (a) an extension of grace period for project implementation beyond three years stipulated in the law (Article 16.D), (b) additional exemptions from income and social service tax of 25 percent of net profits, beyond the period stipulated in the Law (Article 17.A), and (c) granting of production or operation test period of four months before tax exemptions begin (Article 16.E). 4.22 A reform of the EI Law is, therefore, desirable to do away with the discretionary aspects, reduce the administrative and information demands of its implementation, and remove the bias against small investors. We recommend that the complex system of benefits be replaced by the following two measures: (i) place a zero or a very low uniform tariff rate on all capital 35/ This system has been available to the public through regulation No. 30 of 1984, published in Official Gazette No. 3245 dated July 4, 1984. 36/ The fact that export oriented projects earn points is not stated in the Law. 14318  - 49 - goods; and (ii) allow profit tax exemption to all projects in specific sectors for a fixed period from the time of issue of the license. 4.23 The two measures would do away with the complex administrative machinery set up to define and implement the Law in its present form in three ways. First, the whole process of defining a project as an EP or an AEP would be redundant. Second, a zero (or low uniform) duty on all capital equipment would do away with the need to administer the exemption of customs duties under the new Law. Third, it would relieve the Ministry of Industry and Trade of the burden of administering the profit tax benefit, which could easily be done by the income tax department as a part of its routine work. Finally, these measures would allow small firms which receive almost no assistance from the Government under the present Lax-- to claim their share of benefits. B. Measures to Improve Institutions Improve Institutions for Export Promotion 4.24 At present, L.le efforts to expand export markets are almost entirely focussed on expanding the scope of the bilateral agreements with the neighboring Arab countries. While this will continue to be an important market segment, efforts need to be made to expand exports outside the region. There are three areas in which prompt action could help exports. The first involves fixing institutional responsibility. Currently, the institutional responsibility for export promotion 37/ is fragmented between the Ministry of Industry, trading houses and the Commercial Centres Corporation (CCC). It is clear from our discussions with Government officials that the Government's th .nking on this important issue is still being formulated. The discussions on this subject in the 1986-90 Plan 38/ indicates that the Government proposes to expand the role of the Ministry of Industry and Trade in export promotion, through trade agreements, international exhibitions, the establishment of research units, the compilation of data on world markets, and an assessment of demand for Jordanian commodities in order to determine the export potential. The Ministry is also expected to exercise quality control on Jordanian commodities to render them competitive in foreign markets. 4.25 It is clearly unrealistic to expect the Ministry to directly carry out the activities described above. First, it would distract key officials from their policy formulation functions and second, there would clearly be a duplication. For example, the CCC has had considerable experience in organizing trade fairs, having so far organized fairs in North Yemen, Bahrain, Tunisia and Syria. On the basis of contact and direct sales realized at these fairs, they have been quite successful. 4.26 In view of the existing institutions such as the CCC, the Government should seriously reconsider whether the creation of a "Higher Export Council" under the chairmanship of the Ministry of Industry, as proposed in the 1986-90 Plan is a cost-effective way of dealing with the existing export problems. It might be preferable to expand the responsibility of the CCC to allow it to become the central institution in export promotion. 37/ which includes dissemination of marketing information and administration of benefits, etc. 38/ Under export policies, p. 108 14318  - 50 - 4.27 Second, Jordanian exporters will need substantial marketing assistance if they are to expand beyond the regional markets. Our discussions with exporters indicated that the following support services are needed. (i) A single point, fast, efficient service to deal with incoming enquiries from potential buyers, putting them in touch with selected exporters is needed. (ii) There should be a comprehensive, single point local service to provide information about oversees markets, using a mix of published library material and computer based information sources. (iii) Jordan should develop a unified network of effective oversees offices, concentrating on direct sales prospecting. At present, the CCC has only two offices located in Cairo and Baghdad, respectively. These offices, however, have generally been useful assisting exporters in the context of bilateral trade agreements but have not performed an active role in promoting exports in general. The precise institutional framework within which to house the marketing services is still being formulated. The Government is developing several ideas with the assistance of the USAID. Of those under consideration, include a productivity center, an exporters association and the provision of technical assistance for analyzing the feasibility of new products. 4.28 The 1986-90 Plan also proposes the establishment of specialized export companies (trading houses), as a means of improving the marketing arrangements in the export sector. We suggest that the Government consider offering export incentives such as tax breaks to trading houses engaged in exports. Currently, only firms which produce for exports are exempt from income tax. 4.29 The third area in which reforms are needed is that of improving arrangements for export financing. This will be discussed comprehensively together with other measures in the financial sector in paragraphs 4.37 to 4.40. Improve the Institutional Arrangements to Promote Efficient Import Substitution 4.30 An analysis of the purchases of the major public sector undertaking revealed that there was a large untapped market for the efficient import substitution by the SMI. Work clothing, nuts and bolts, V-belts, hydrazine, process hoses and simple gaskets are some of the imported items which could, in principle, be produced efficiently in Jordan. Through our discussions with the purchase managers, we identified the following reasons why the domestic industry has not been able to penetrate this market. First and most important is the system of tariff exemptions for these undertakings which has been discussed before. Second, there appears to be an absence of an effective dialogue between the SMIs and the NRIs. There is, therefore, a need for public intervention to assist with the dissemination of marketing information. The Government could help create and operate a central facility for recording the purchasirg requirements of NRIs for the benefit of potential Iu4?liers in the SMIs. Similarly, the membership of the existing joint  - 51 - committee on spares of phosphate, potash and fertilizer industries could be expanded to include representatives of the small and medium engineering industries. Third, the large NRIs could be discouraged from expanding into ancillaries whenever they could be more cheaply located within the SMI sector. For example, activities such as LPG cylinders (refinery), recycling of centrifugal phosphate filters (phosphate mines), which are currently located within the NRIs, could be spun off or sold, thereby expanding opportunities available to the SMI sector and improving efficiency of the industrial sector as a whole. Improve the Institutional Support for Improving Quality and Standards 4.31 Poor quality of Jordanian products is often suggested by Government officials as a key factor behind poor export performance. Quality assurance is carried out today by the Bureau of Standards at the Ministry of Industry and some testing can also be done at the Royal Scientific Society. These institutions need to be strengthened and should offer testing and a standardized certification assuring quality. It is important, however, that testing is not made mandatory. Both certified and non-certified products should be allowed to be sold in the market, and it should be up to the supplier and the customer to decide on the premium to be paid on certification. Improve the Working of Financial Institutions 4.32 There are three areas in which the working of the financial institutions could be improved. The first is their capacity to assess risk and carry out effective project financing, the second is the paucity of sources for venture capital, and the third is the absence of satisfactory arrangements for export finance. (a) Improving Capacity to Assess Risk 4.33 We expect the IDB to continue to remain the central insitution in providing MLT loans to the SMIs. The following three reforms could, however, be carried out to enable the IDB as well as other financial institutions to lend to projects on the basis of a proper assessment of risk rather than on the basis of collateral or government guarantee: 4.34 First, the Government should consider allowing the financial institutions some flexibility in setting the lending rates. This could allow them to charge higher rates for riskier ventures and lower rates for less risky ventures thereby improve the access to credit for small entrepreneurs without collateral. 4.35 Second, the Government should consider creating a guarantee scheme for SMI project loans. This will contribute to relaxing the present collateral requirements as well as reduce the pressure for higher spreads. The experience of countries where such schemes have been developed suggest that an effective loan guarantee scheme should have the following features: It would have (i) to be government sponsored though not necessarily government administered, (ii) to minimize the risk of bad loans, the guarantees provided by the proposed agency should cover not more than 50 percent to 70 percent of the total amount of the loans. The risk on the remaining amount should be assumed directly by the financial institution concerned, (iii) the offered guarantees should be self-funded through either a special fee on loans or T4-31I8  - 52 - margins on interest rates, and (iv) to foster commitment by the financial institutions, participation in the scheme should be voluntary. 4.36 Third, the CBJ could establish rediscounting facilities that are available to all financial institutions qualified for SMI financing. The use of this facility, however, must meet strict eligibility criteria to discourage large investors who have recourse to other sources of financing and to select new projects for exports and import substitution. (b) Improving the Availability of Venture Capital 4.37 To improve the availability of venture capital to SMIs, the Government could, as a matter of policy, direct the efforts of public sector financial institutions towards higher risk, non-corporate borrowers. The Pension Fund (PF) and the Social Security Corporation, for example, could be encouraged to set aside a part of their resources to provide venture capital. To achieve this objective however, the two institutions will have to strengthen their project appraisal and supervision capabilities. Similarly, the Government should clarify the relative responsibilities of the Small Scale Industry and Handicraft Fund, (SSIHF) at the IDB, and a parallel fund to be established at the City and Village Development Bank (CVDB). It would be a good idea to narrowly focus the activities of the SSIHF at the IDB on financing small and medium industries only and leave the other areas to CVDB. The eligibility criteria of the projects handled by SSIHF will also have to be revised to include projects larger than those presently being financed. Presently, projects financed by SSIHF are restricted to a total investment (including working capital) of less than JD 20,000 and total employment of less than 6. An appropriate ceiling on investment could be JD 200,000 and would be preferable to avoid ceilings on employment to prevent possible discouragement of investment in labor-intensive sectors. Cc) Improving the Arrangements for Export Finance 4.38 The third area in which immediate action is required is that of improving the existing arrangements for export financing. This would require the following three reforms: 4.39 First, the Government should consider lowering the CBJ rediscounting rate, or increasing the ceiling on the commercial bank lending rate for pre- and post shipment finance by one or two percentage points. Our discussions with banking officials indicate that the current spread of 1.5 percent 39/ is not attractive for most commercial banks. Although, increase in the spread would increase the implicit gross subsidy to exports, it (the subsidy) would still be small compared to the protection offered to import substituting activities, by the existing system of tariffs. 4.40 Second, the Government should consider establishing a national export credit guarantee agency, to insure against risky importers and importing countries. Currently, as discussed in Chapter 2, Iraq and Syria are covered by special arrangements at the CBJ while other exporters have to rely on a 39/ Even margins of 3.5 to 4.5 percent in the case of Tunisia, were considered inadequate by a Bank study carried out in 1985. 143IS  - 53 - Kuwaiti agency. A central export credit guarantee agency will, therefore, be helpful to exporters. 4.41 Third, the Government should consider instituting the Domestic Letter of Credit (DLC) System. The DLC, assures the automatic availability of short term export finance, and other benefits available to direct exporters, to all indirect exporters. There are two types of indirect exports: (i) firms which supply intermediate inputs to direct exporters, and (ii) firms which supply finished export products to trading companies, which export directly. 40/ The DLC System helps to achieve efficient industrial development through, (i) the creation of more efficient backward linkages arising from export expansion, (ii) development of trading companies specializing in cverseas marketing, and (iii) the expansion of small and medium scale industries by bringing them into production activities. Korea's extensive and successful use of the DLC system has been notable in achieving the three objectives listed above. 40/ For detailed discussion of the DLC System see, Yung Whee Rhee, "A Framework for Export Policy and Administration--Lessons from the East Asian Experience" World Bank, Industry and Finance Series - No. 10. 14318 0  - 54 - V. PROSPECTS FOR SMIS A. Overview 5.1 The future prospects for SMIs would depend upon the macroeconomic trends as well as the progress on the set of reforms described in Chapter IV. On this basis, the immediate prospects for the SMIs are weak. In the short term, i.e., during the next two years, if the suggested reforms are implemented, the SMI sector will undergo a process of restructuring. This would increase output from the efficient firms primarily by increased capacity utilization and could result in the closing down of some inefficient firms. As a result, the output from the SMIs could only grow by 2 to 3 percent p.a. Beyond 1989, however, as the tariff reform is implemented and institutional improvements are carried out, the SMI sector will become increasingly responsive to changes in the macroeconomic environment. Simultaneously the Government would be expected to respond to the increasing balance of payments difficulties with a depreciation of the exchange rate and the excess supply of labor would result in a fall in real wages. This would improve the profitability of exports and efficient import substitution activities. A healthier SMI sector could then grow by between five and six percent p.a., as targeted in the plan. 5.2 It *s impossible to predict the likely structure of SMIs after the restructuring. However, our preliminary subsector work shows that the maximum growth prospects are in the chemical, pharmaceutical and non-food consumer goods sector. On the other hand, the growth prospects for food processing and building materials sector are weak. Section B below, will discuss the significance of SMIs to the overall growth. Section C will discuss the likely overall growth prospects and Section D will discuss the potential sources of growth based on subsector reviews. B. Contribution of SMIs to Overall Growth 5.3 Although the exports from the SMI sector finance only a small proportion of imports, the performance of the SMI sector will be increasingly critical to sustain a strong balance of payments and control the level of unemployment. Over the next decade, Jordan is likely to face a considerably harsher cxternal environment compared to the late 1970's and early 1980's. The continued weakness in the price of oil, will mean a continued stagnation in the neighboring economies. Thus, workers' remittances and grants which together financed two-thirds of Jordan's imports during 1983-86, will probably stagnate. Further Jordan's manufactured exports would have to expand beyond the traditional markets. On this basis, the performance of the manufacturing sector becomes especially important during the 1990s to reduce the gross borrowing requirements as indicated in Table 5.1. An acceleration of manufacturing exports from 4 to 6 percent p.a., together with a reduction in the import elasticity by 20 percent, resulting from efficient import substitution, could reduce the gross borrowing requirements over 1990-95 by about 12 percent per annum and reduce the debt service ratio by nearly 4 percentage points. 5.4 A similar assessment is also made in the Government's 1986-90 Plan. The plan projects the economy to grow by 5.1 percent p.a. Corresponding to this growth rate, the manufacturing industries are projected to grow by 6.9 ?ercent p.a. The exports of manufactured goods are projected to grow slightly  - 55 - slower by 4.8 percent p.a. Within manufacturing industries, cement and pharmaceutical industries are projected to grow in real terms by 7.7, and 13.2 percent p.a.; the exports of cigarettes are expected to stagnate, and the exports of "miscellaneous manufactures" are projected to grow by 4.2 percent p.a. Thus both, our projections and those presented in the 1986-90 plan, suggest that a growth in manufacturing production in the range of 6 to 7 percent p.a., and exports in the range of 4 to 6 percent p.a. would be needed to sustain a viable balance of payments over the next decade. While these growth rates, appear modest compared to the growth rates of above 10 percent p.a. realized during the late seventies and early eighties, they represent a substantial acceleration compared to the growth rates of only 3 to 4 percent observed in the past four years. Table 5.1: IMPACT OF SMI PERFORMANCE ON GROSS BORROWING REQUIREMENTS Average Annual Gross Borrowing Export Growth Import Requirements 1/ (range, in 2p.a.) Elasticity 2/ (US $ Millions) 1987-95 1987-90 1991-95 1987-90 1991-95 Worst Case 3 increasing to 6 0.8 0.6 494 1,379 Medium 4 increasing to 8 0.7 0.6 472 1,301 Best Case 6 increasing to 9 0.6 0.6 445 1,233 1/ Current account deficit, net of grants. The grants are assumed to decline from a level of $600 million in 1986 at the rate of $50 million p.a. through 1995. 2/ A lower import elrticity indicates a greater substitution effort. C. Overall Growth Prospects of SMIs 5.5 Our analysis shows that over the medium term, the SMI sector in Jordan, can respond to the changes in macroeconomic environment and grow at the rates described above. However, for thia to happen, the series of reforms described in Chapter 4 have to be initiated as soon as possible to make the SMI sector more responsive to the changes in macroenvironment, reduce costs, and improve the efficiency of resource use. 5.6 The immediate prospects for SMI are however weak. First, the nature of macroeconomic adjustment in Jordan, since 1982, has unfortunately not yet reduced costs and significantly improved the profitability within the SMI sector. Second, the present policy has offered protection to both inefficient and efficient firms, thereby reducing the competitiveness of the SMI sector as a whole. 5.7 Since the early 1980s, there has been very little movement in the three critical prices affecting industry - exchange rate, interest rate and real wage. While the stable nominal exchange rate policy followed by the Government has perhaps had a beneficial impact on the remittances from Jordanians working abroad, it has not been adequate for stimulating exports. 14318  - 56 - The likely impact on the remittances, which financed a third of Jordan's three billion US$ imports has understandably been a principle determinant of Jordanian policy rather than the impact on the exports which finance less than 6 percent of Jordanian imports. Similarly, while the maintenance of high positive real interest rates have been necessary to attract foreign savings, they have pushed up the cost of capital to industry in Jordan. Finally, even though the general unemployment is rising, there is still a shortage of middle level technically skilled labor. Thus, while the real wage in industry has fallen somewhat, it has not been sufficient to make Jordanian industry competitive. In addition to all this, the cost of utilities (electricity and telephone) in Jordan is high compared to other countries in the region. All this makes the profitability in Jordanian industry low. 5.8 In the short term, i.e. over the next two years, if the suggested reforms are implemented, the SMI sector will undergo a process of restructuring. Measures like, the removal of tariff exemptions for institutions combined with improved marketing assistance, and better export financing arrangements will expand the markets for import substitution and exports. At the same time, measures such as replacement of quotas by tariffs, removal of price controls, and a reform of investment licensing will increase profitability in efficient fiTms. As a result, the output in the SMI sector could grow by about 2 to 3 percent per annum, over the next two years, primarily by increased capacity utilization in efficient firms, and could result in closing down or substantial restructuring of other inefficient firms. 5.9 In the medium to long term, however, the sustained implementation of the tariff reform and other institutional improvements could result in a healthier SMI sector. Capable of responding to the changes in the cost structure that will take place, as a result of the changing macroeconomic environment. 5.10 Over the medium term, the important elements of the cost structure described in Table 5.2, can be expected to reduce, improving the profitab-lity of firms in the SMI sector. A continued strain on the balance of payments 41/ can be expected to be reflected in a depreciated exchange rate, 421 resulting in an increased profitability in the export and efficient import substitution activities. An increasing labor force, together with narrowing opportunities for replacing guest workers, should exert a downward pressure on the wage rate. In addition, the 1986-90 plan also includes measures to reduce some of the infrastructural costs. One is to reconsider handling charges at Aqaba with a view to favoring commodities intended for export. Likewise, tile Government intends to review air freight charges on Jordanian commodities in order to promote their marketing in Europe and other distant markets (this is more applicable to agricultural commodities rather than manufactures). Consequently, the SMI sector could grow by between 5 to 7 percent p.a. as indicated in the 1986-90 plan. 41/ As a result of falling aid and remittances. 42/ Chapter 4 presents arguments why it would be a good idea to carry out a faster depreciation of the exchange rate than is strictly implied by the static equilibrium in the foreign exchange markets. 1431I  - 57 - Table 5.2: A COMPARISON OF INDUSTRIAL INPUT PRICES - 1985 Saudi Jordan Turkey Arabia Italy U.K. Electricity .069 .057 .015 .074 .056 (US$/Kwh) Diesel Fuel 222 316 42 290 220 (US$/ton) Wage rate 445 112 932 N.A. 696 (US$/month) Interest Rate 6.25 52 - 14.1 11.6 D. Sources for SMI Orowth 5.11 The Jordanian manufacturing sector enjoys a number of advantages. First is the locational proximity to the large and prosperous market of the Middle East which provides the crucial transport cost advantage. Second, strong cultural ties benefit Jordanian producers in the Middle Eastern and Gulf markets. Third, the excellent physical infrastructure such as roads, reliable electricity and telephone services, and industrial estates add to the productivity of Jordanian firms. Fourth, the reasonably, well-developed financial institutions and instruments are available to channel financial resources to industries. Finally, Jordanian manufacturers face no constraint on the availability of foreign exchange which gives them an advantage over Egypt, Syria and Iraq by ensuring access to the best imported inputs. Against these, the SMI sector also faces a number of disadvantages. These include first, a small domestic market which necessitates a strong export performance to achieve economies of scale in production. Second, absence of domestically available raw materials on which the SMIs can be based. Third, high wages, interest rates and a strong currency which contribute to the low profitability in the Jordanian SMIs. 5.12 The product lines in which the SMI sector can be expected to grow are thus most Likely to be those which use a higher level of technology, exploit the transport cost advantage, familiarity with the regional market and are based on the best imported raw materials. Some idea as to the kinds of product lines that are likely to grow can be obtained from the detailed work done in the Industrial Programing Study conducted by the Dar Al Handasah (DAR) in 1980. This study identified 43 product lines as promising sources of growth in 1982. An overview of these projects carried out in March 1985 revealed that 27 projects have either been implemented or have been the subject of further study while 16 have had no action as shown in Table 5.3. The pattern of potentially promising product lines shown in Table 5.3 is more or less in line with our own subsectoral analysis as presented below. 14318  - 58 - Table 5.3: STATUS OF PROJECTS IDENTIFIED BY DAR AL HANDASAH STUDY Projects Under Projects Licenced Projects with Implementation Projects but not in no Further or in Production Being Studied Production Study (10) 1/ (13) (4) (16) Electrical Fittings Phosphoric Acid Nuts & Bolts Pre-stressed Concrete Cylinder Pipes Medical Textiles Die-casting and Hand Tools & Vehicle Trailers Non-ferrous It plements Foundry Structuial Steel & Compound NPK Locks & Keys Sodium Tri- Holoware polyphosphate Sodium Silicate Potassium Nitrate Wallpaper Furniture Complex & Chlorine Solar Panels Tableware Tools and Dies Vegetable Oils Pumps Welding Machines Foundry PVC Leather Cloth Saws Printing & Garment Making Hand Tools & Packaging Implements(Case A) Infant Foods Travel Goods Welding Electrodes Plastic Furniture Machine Tools Drill Bits PVC Tiles Soda Ash CMC Ammonia Feldspar Phosphogypsum Wire Cables Aspirin & Paracetamol Electric Motors & Transformers 1/ Number of projects under this category. Food Processing Subsector 5.13 The prospects for this subsector are not encouraging. This assessment is also reflected in the Dar Al Handasah report. Infant food is the only product which is considered to have a growth potential in the near future. The growth prospects for this subsector depend upon the growth prospects for agriculture in the Jordan Valley. The latter remain highly uncertain since they are based on the highly subsidized water rates. Farmers receive water at JD 3/1000 M3 which is a fifth of the operating and 14318  - 59 - maintenance costs of the water supply system. As a consequence of these policies, there is an overproduction of water-intensive crops such as Tomatoes, Cucumbers and Aubergines. A rationalization of the present system which appears inevitable given its increasing cost to the economy will certainly increase cost of inputs, reduce profitability and reduce the prospects for the FPS industries. Nevertheless, the following three areas show some potential: Animal feedstuff. The Government's 5-year Plan gives great importance to meat production. The Plan includes projects for development of rangeland, sheep and goat breeding, poultry, fish production and animal health services. With the expansion of meat production, there will be a growing demand for animal feedstuff. The fodder industry could, therefore, grow by increasing its capacity utilization and lowering its production costs. Dairy products. Medium-term prospects are strictly tied to fresh milk production which basically needs improved infrastructural support. In 1985, 60,575 tons of dairy products were produced, meeting only 33 percent of local demand. An increase in fresh milk production can easily substitute for imported powder milk as well as encourage production of cheese and other milk products. Vegetable and fruit preserves. Traditionally, preserves were prepared at home; but now tastes and habits are rapidly changing and local demand for factory produced jams, pickles, dressing, sauces, etc. is growing fast. This industry could easily grow by absorbing seasonal surplus of agricultural products and by replacing imports. For this to happen, however, the Government will need to establish quality standards and provide extensive marketing support. Chemical Pharmaceuticals and Rubber (CPR) Subsector 5.14 Unlike the FPS sector, the prospects for the CPR subsector are encouraging. Within this sector, most of the future growth, however, is likely to come from the downstream products (based on imported raw materials) rather than basic or intermediate chemicals. Industries which produce basic chemicals are generally technologically complex and can be justified only as large-scale operations -- which will be difficult given the small and fragmented domestic and regional markets. The DAH study had identified two basic chemicals -- Phosphoric Acid and Compound NPK as potential sources of growth. Both these are currently being studied, and no investor has come forward to implement these projects. The main growth prospects for this subsector appear to be in the following two areas: Consumer goods. The major product lines in this area are soaps, detergents and cosmetics. The unfulfilled projected demand for synthetic detergent in the region by the 1990s is expected to be more than ten times the existing capacity in Jordan. This, combined with the fact that existing manufacturers of these products have been successful in marketing these products in both the domestic as well as export markets suggest that detergents could be a likely growth area. Another important product line is assorted plastic and rubber consumer goods such as kitchen utensils, bags, containers, toys, and soles and heels of shoes. Plastic furniture has also been identified 1431I  - 60 - as a priority project by the DAH study. Since these products are for household use, the demand can be expected to grow with population. Similar to the consumption of detergents, plastic consumer goods will also be in short supply in the Middle Eastern markets. Pharmaceuticals. The highly successful pharmaceutical industry in Jordan is the forerunner of the type of export oriented, quality and skill-intensive industries exploiting a market niche which could form an important source of future growth. The 1985 installed capacity of four formulators in Jordan amounted to $40 million whearas the regional market was US$ 715 million 43/ almost all of which is supplied by imports. Thus substantial increases in exports are possible from the pharmaceutical industry by merely increasing its market share. In order to achieve this, the Government could provide marketing assistance. In the near term, potential markets are Kuwait, Bahrain and the Gulf Emirates (some of whose pharmaceuticals are purchased through SGH, an interstate supply organization, on tender). In the longer term, Jordan could investigate Sudan, Tunisia, Egypt and even Malaysia, Thailand and the United States. Engineering and Building Materials (EBM) Sector 5.15 The near term prospects for the EBM sector are not encouraging given the uncertain prospects for the revival of construction activity. Of the 13 firms interviewed during the mission, four were on the verge of closing down, six had mounting losses, and only three were profitable but face shrinking demand. The key to medium term growth in the building materials sector will be the successful implementation of measures to facilitate the low and middle-income housing construction. It is clear that the recent boom in upper income housing and commercial construction is over. The demand for low and middle income housing however can be expected to remain strong since it is largely determined by the natural population growth and urbanization - factors which can be projected to remain constant over the medium term. 5.16 An analysis carried out in the context of the World Bank's ongoing work in the urban sector indicates that an improvement in the functioning of the urban land market could provide a powerful stimulus to the low and middle income housing construction activity. An important measure in this regard is the reorientation of the Government's zoning and standards polic) In the past, a great deal of residential land was zoned for larger plots suitable for upper income housing in response to the high demand in this section of the market. Consequently there is now an oversupply of serviced land that is unaffordable to low or even middle income families. To redress this imbalance, Government zoning policies should be directed towards creating smaller serviced plots affordable to the poor. This measure, together with other measures identified in the shelter units' housing strategy study, some of which have been taken up in the Bank's urban development projects would expand the market for the building materials sector as well as meet the Governments equity objectives outlined in the 1986-90 Plan. 43/ Saudi ALabia - $350 million, Iraq - $150 million, Syria $135 million, Libya - $80 million (Bank Staff estimates). 1431S  - 61 - 5.17 The most promising area for future expansion of the engineering industries which is yet not exploited fully is that of manufacturing engineering components for the routine maintenance of the big NRIs, the JEA and the trucking companies. The expansion into this area would also support the Government's plans to expand the export of maintenance and contracting services in the region. The measures needed to exploit this market efficiently have been discussed in Chapter 4. On the basis of our interviews with the purchase managers of the large firms, we estimate that the potential market for manufactured goods is between US$ 400 to 600 million, which is roughly half the gross output of the SMI sector in 1984. Non-Food Consumer and Intermediate Goods Sector (NFG) 5.18 The growth prospects in this area are in expanding exports and import substitution of consumer goods. The only intermediate good which has growth prospects is tissue paper, provided the technical problems facing the manufacturer -- the Jordan Industrial Company -- can be solved. The main constraint to growth in domestic markets is the tariff-free status enjoyed by the civil service and military consumers organizations. An expension of exports on the other hand would need reduced price, improved quality and improved marketing. In textiles and clothing, there is considerable potential for fashion clothing, sports garments, denim and furniture fabrics, and work clothing. Another area which has considerable potential is that of paper products. Within these, packaging materials look promising and so do printing and publishing. Currently, Lebanon is the most competitive supplier of packaging and printing products due to the sizeable devaluation of the Lebanese pound. 5.19 While it is interesting to speculate on the product lines with promising growth prospects, its use is somewhat limited. Given the right incentives, and infrastructural support, growth could come from the most unexpected areas. In fact, an expost analysis of the DAH study shows that many products which were considered "priority" were not taken up by investors, whereas many products with doubtful potential have been implemented. The Government assistance in this area should, therefore, be non-discriminatory. It could be centered around providing assistance to all potential investors in the analysis of markets and preparation of feasibility reports rather than directing to specific product lines. E. Conclusion 5.20 The SMI sector in Jordan, therefore, has the potential to grow in response to the changes in the macroeconomic environment. For this to happen, however, the measures described in Chapter 4 have to be implemented and the macroeconomic developments have to be reflected in lower wage rates and adjustments in the exchange rate. On this basis, the main prospects are in the chemicals and non-food consumer goods subsectors. To realize this potential, however, the existing firms and potential investors would need substantial assistance in marketing and preparation of feasibility reports. 14318  - 62 - ANNEX A Page 1 of 35 DATA SOURCES AND THE CLASSIFICATION OF THE FOUR SUBSECTORS OF THE SMI The most detailed source of information on the industrial sector is the industrial census, which is carried out once in five years. The most recent census was carried out in 1984. In between the census years, major parameters of the sector such as output, value added, employment, etc. are estimated using a sample survey. These data are reported for the entire industry and for establishments employing less than five persons, at the le.'-l of 23 subgroups, each subgroup roughly corresponding to a 3-digit SITC code. The industrial survey for 1985 was not available when the mission visited Amman. For the purpose of analyzing the internal structure of the SMI sector, the 23 subgroups were aggregated into four categories as follows: A. Food: Food processing and related industries B. Non Food: Non-food consumer and intermediate goods-producing industries C. Chemical: Chemical and related industries D. Engineering: Engineering and construction materials industries. In order to relate the developments in output to developments in trade, we used the standard correspondence between the ISIC, SITC and BTN codes. The details of the correspondence are presented below: Industry ISIC Code 1/ BTN SITC A. Food processing and related industries Food manufacturing 311-312 09,16 02,014,06 Beverages 3131-3133 17,19,20 048,056 Soft drinks 31340 21,22,23 058,081 Tobacco and cigarettes 3141-31490 24 071,098,11,12 B. Non-food consumer and intermediate goods Textiles 32110-32190 41,42,44,47 61,64,65 Clothing 322 48,49,51 82,83,84,85 Leather goods 323 53,55,64 Footwear 324 94 Furniture and wood 332 Paper and paper products 341 Printing and publishing *1/ ISIC: International Standard Industrial Classification BTN: Brussels Tariff Number SITC: Standard International Tariff Classification  -63 - ANN A Page 2 of 35 Industry ISIC Code BTN SITC C. Chemical and rubber industries Chemical products (without fertilixers) 351-352 28,29,30 5 (less 561), Rubber products 355-356 33 to 36 621,629 38 to 40 D. Engineering and construction material industries Basic metal products 3710-381 68,69,70 66 to 69 Non-electrical machinery 382 13 to 81 (less 667 & Electrical machinery 383 84,86,87 681),7,812, Transport equipment 384 899 In addition to these data, we carried out a small survey of 12 industrial firms producing 28 product lines (both for export and for domestic sales) to estimate the Effective Protection Rates (EPRs) and Domestic Resource Costs (DRCs) at the firm level. Details of this survey are provided in Annex B.  ANNEX A - 64 - Page 3 of 35 AVERAGE SHARE IN TOTAL SMI SECTOR, 1982-84 (Percent) Output Value Added Employment FOOD PROCESSING 26.3 31.5 19.3 Food Manufacturing 13.4 8.8 14.6 Beverages 3.8 5.1 2.7 Soft Drinks 0.0 0.0 0.0 Tobacco 9.1 17.7 2.0 CHEMICALS 20.8 13.0 12.1 Chemicals & Products 1/ 17.1 9.5 7.9 Rubber & Products 0.1 0.1 0.1 Plastic & Products 3.6 3.5 4.1 NON-FOOD INTERMED. GOODS 16.9 16.2 31.5 Textiles 2.6 2.3 3.6 Clothing 2.3 2.6 7.6 Leather & products 0.4 0.4 0.7 Footwear 1.2 1.9 2.1 Furniture & Wood 4.4 4.0 9.8 P Paper & Products 3.8 2.6 3.4 Printing & Publishing 2.1 2.4 4.2 ENGINEERING & BUILDING 36.0 39.3 37.1 Non-metallic Mineral Products 20.4 27.0 18.8 Basic Metal Products 7.4 3.4 2.7 Non-electrical Machinery 7.5 8.2 14.4 Electrical Machinery 0.3 0.4 0.8 Transport Equipment 0.2 0.2 0.4 Miscellaneous 0.0 0.0 0.0 TOTAL SMI SECTOR 100.0 100.0 100.0 SMI as 2 TOTAL INDUSTRY 2/ 49.2 60.1 61.9 Source: Industrial Surveys 1/ less fertilizers 2/ Non-SMI Sectors are Mining and Quarrying, Fertilizers, Petroleus Refinery, Energy Electrical Products, and Industrial Services.  - 65 - ANNEX A Page 4 of 35 CLASSIFICATION OF ENTERPRISES BY THE EXTENT OF GOVERNMENT OWNERSHIP Number of Enterprises Nature and Extent of Government Holding Net Overlap 1/ 100 percent Government-owned public enterprises 8 Government sharehol ing public enterprises - Majority holding 5 - Minority holding 29 Subtotal 42 Financial Institutions: 58 Industrial Development Bank 26 Pension Fund 49 Housing Bank 35 Postal Savings Bank 36 Subtotal 146 Total 100 -4 -._ Source: 1986-90 Plan Review (IBRD) l/ Some of these public enterprises are jointly owned by several financial institutions at once.  -66 - ANNEX A Page 5 of 35 SHARE OF VALUE ADDED BY GOVERNORATE 1979 1984 Amman 82.6 62.8 Irbid 5.0 4.3 Zarqa 11.5 12.9 Karak 0.7 17.7 Ma'an 0.2 2.1 Total 100.0 100.0 Source: 1984 Industrial Census  -67- ANNEX A Page 6 of 35 PREVELENCE OF GUEST WORKERS No. of Guest Category Total Workers Workers Jordan Paper and Cardboard 3 Unskilled 240 Factories Co. Jordan Wire Manufacturing Co. 4 Unskilled 22 Arab Aluminium Co. 3 Unskilled 240 Jordan Glass Industries Co. 10 Polish Experts Jordan Brewery Co. 1 Brewmaster Jordan Pipes Manufacturing Co. 9 Unskilled 130 Jordan Metal Industries Co. 3 Unskilled 24 Jordan Ready To Wear 3 Unskilled 103 Manufacturing Co. Jordan Tobacco and 1 Unskilled 718 Cigarette Co. Jordan Lime and Silicate 11 Unskilled 124 Brick Industries Co. Source: World Bank Staff Survey 44 . . -  ANNEX A - 68 - Page 7 of 35 RULES OF IMPORT POLICY 1/ It is a Government policy to: (a) Ban or impose high customs duty on the import of luxury commodities and goods which are similar to or competitive with national goods; protect industries which produce primary and intermediate goods necessary for industry so that protected industries may have benefits enjoyed by competitive foreign goods such as low cos0., in order to be able to compete in foreign markets, when exported. The industries which enjoy this protection must meet the following requirements: (i) They must be economic industries which have prospects of success, can be absorbed by the market and meet the consumers demand. (ii) Their productive capacity must be adequate enough to meet the domestic market demand. (iii) They must conform with Jordanian or international standards and specifications. (iv) Their prices must be relatively competitive. (v) The percentage of value added must not be le3s than 401. (b) Exempt from or reduce customs duties on imported capital goods necessary for implementation and construction of productive projects. (c) Encourage the civil and military consumer associations to buy their needs from local industries and not to import except in cases where no local product is similar or substittnte to the imported products. (d) Expand the application of the Approved Industries Regulations and prohibiting official authorities which enjoy exemption from customs duties to import directly or through any tenders committee unless the local products do not conform with the required specification. The Ministry of Industry shall form a special technical committee to decide if the goods to be imported, have no locally produced substitutes. (e) Subject all goods enjoying tariff or other protection, to government control with regard to prices, quality, conformity with standards and specifications, and suitability to the Jordanian market, so that protection provided thereto is not on the consumer's account. 1/ Based on an internal Ministry directive.  - 69 - ANNEX A Page 8 of 35 (f) Observe the counter trade concept in import whenever possible. (g) Remove barriers to trade with Arab Common Market states, and Arab and foreign states which have agreements with the Kingdom that permit freedom of trade. (h) Any industry which violates the rules and principles of this protection, shall cease to be protected. i34  - 70- ANNEX A Page 9 of 35 LIST OF IMPORT PROHIBITTONS APPLIED TO MANUFACTURED GOODS Tariff Total Trade 1983 Imports Number Products Under QRs in 1986 Taxes (2) JD ('000) 04.02.C Milk and Cream 32.2 1,273.2 06.03 Cut Flowers and Buds 36.2 224.6 15.07.H.2 Palm Oil 38.2 825.4 19.03.A Macaroni and Spaghetti 29.2 19.2 20.02.A Tomato Paste 71.2 61.7 a/ 20.07.B Fruit Juices 48.2 1,640.2 21.06.A Natural yeast 32.2 55.0 21.07.A Non-alcoholic Preparations 48.2 420.5 21.07.B.4.B Ice Cream 58.2 831.2 b/ 22.01.1 Minereal Waters 41.2 107.3 22.02 Flavored Beverages 58.2 103.7 22.03.A Beer in containers of different size 171.9 67.3 23.07.A Prepared Forage 7.2 4,023.6 24.02.B Cigarettes and Tobacco 91.7 1,732.3 25.01.A Salt 46.2 141.0 25.23.A Cement 36.2 22,326.7 28.31.A Chlorites, Hylbochlorites, etc. 26.2 31.9 32.09.B Paint 33.2 527.4 34.02.B.2 Organic Surface Active Agents 43.2 439.6 34.05.A Polishes and Creams for footwear 43.2 302.3 36.06 Matches 19.0 e/ 0.0 39.02.D.1 Polystyrene 50.2 154.2 39.06.D.2.B Plastic Mats 32.2 17.2 c/ 48.15.A Toilet Tissue 53.2 95.6 48.18.B Note Books 46.2 531.8 70.06 Polished Glass 32.2 1,045.2 70.20.A Glass Fibre (Yarn and Wool) 19.9 416.3 73.31.B Nails of Iron and Steel 38.2 122.8 73.36.B Gas Cookers 53.2 950.8 73.38.C.2. Scouring Pads 32.2 11.5 76.02.B Aluminum Bars, Shapes, etc. 38.2 3,985.7 80.06.A Tin Containers 7.2 0.0 84.40.B Household Washing Machines 58.2 1,553.3 d/ 96.01.A Brooms, Brushes and Mops 40.2 744.6 Imports of proh'bited items 44,783.0 Total imports in 1986 1,075,795.4 Source: Ministry of Industry and Trade a/ May include fresh tomatoes. b/ May include other miscellaneous food products. c/ May include other plastic products. d/ May include other washing machines. e/ Estimated from specific rates of duty.  - 71 - ANNEX A Page 10 of 35 CHANGES IN TARIFF RATES SINCE 1980 (Percent) Tariff Rates Tariff Jan. Jan. Dec. Number Description of Commodity 1980 1985 1986 03.01 Ornamental Fish 1 35 03.03 Shrimp 18 35 04.05 Eggs 18 0 06.02 Decorative Plants 0 35 08.01 Annanas, Mangoes 18 35 12.01 Unshelled Peanuts (Fils/Kg) 20 15 15.07 Palm Oil 20 10 18.06 Chocolates 35 50 70 19.08 Bakery Products e.s Input for Baby Food 18 5 5 19.08 Bakery Product for Other Uses 35 50 70 22.05 Wine (Fils/littre) 420 800 25.06 Mica 8 1 29.02 Tetra Chloroethylene 14 5 32.09 Aluminum Paste for Paint Industry 32 5 42.01 Travel Goods 28 40 42.03 Leather Clothing and Accessories 33 40 48.01 Tissue Paper used in Manufacturing of Toilet Paper 10 40 48.17 Corrugated Boxes 15 20 56.07 Synthetic Fabrics 35 33 64.01 Footwear 35 50 66.00 Garden Umbrellas 28 40 67.02 Artificial Flowers 28 35 68.04 Mill Stones 8 8 30 68.14 Friction Materials 23 30 69.02 Refractory Bricks 18 14 73.10 Construction Rods and Bars 5 20 73.18 Steel Tubes and Pipes 15 30 50 73.21 Sliding Doors 28 40 73.36 Cookery 35 85 83.01 Locks for Suitcases 0 0 0 83.01 Other Locks 14 20 30 83.04 Filing Cabinets 24 45 60 85.03 Dry Cells 35 45 50 Source: Jordan's Custom Tariffs, 1980, 1985  - 72 - ANNEX A Page 11 of 35 EFFECTIVE PROTECTION TO MANUFACTURING INDUSTRIES Relatively Low Moderate High (less than 20 percent) (20 to 50 percent) (over 50 percent) Prepared Animal Food Grain mill products Bakery products Printing and Publishing Textiles Confectionary Basic Metal Industries Leather, cork and furniture Beverages Paper and paper products Tobacco Industrial and other chemicals Wearing apparel Petroleum refinery Elecrical and Rubber and plastics trans. equipment Ceramics and glass Cement, lime and plaster Other non-metal man. fabricated metal prod. Machinery (non-electrical) Misc. manuf. Source: Mission estimates  _ 73 - ANNEX A Page 12 of 35 SALIENT FEATURES OF THE ENCOURAGEMENT OF INVESTMENT LAW 1/ Economic Project Approved Economic Project CRITERION Industry Industry Must have fixed assets of: Must have fixed assets of: JD 30,000 in Zon..e A, or JD 100,000 in Zone A, or JD 20,000 in Zone B, or JD 50,000 in Zone B, or JD 10,000 in Zone C JD 25,000 in Zone C Agriculture Agriculture Must have fixed assets of: Must have fixed assets of: JD 25,000 in Zone A, or JD 35,000 in Zone A, or JD 15,000 in Zone B, or JD 25,000 in Zone B, or JD 5,000 in Zone C JD 10,000 in Zone C Tourism Tourism Must be located in Zone B or C Must be located in Zone B or C and be in 2-star category and be in 3-star category For touristic transport project, the value of buses should be at least 500,000 Marine Transport Its vessels must be utilized for transport of stock, passengers or borh Hospital Hopital Must have at least 15 beds Must have at least 30 beds in Zone B and 20 beds in Zone C Education Could be in any professional field BENEFITS Customs Duties Exemptions Customs Duties Exemptions Fixed assets exempted Fixed assets exempted from customs duty if from customs duty if imported within three imported with..n three years of approval years of approval Spare parts up to 102 Spare parts up to 102 of the value of imported of the value of imported fixed assets exempted fixed assets exempted from duties if imported from duties if imported within five years of within five year of approval approval 1/ Includes the most recent (December 1986) amendments to the Temporary Law No. 6 of 1984  - 74 - ANNEX A Page 13 of 35 SALIENT FEATURES OF THE ENCOURAGEMENT OF INVESTMENT LAW (Continued) Economic Pro ect Approved Economic Pro ect Exemptions of Tax of Net Profits Exemptions of Tax on Net Profits In Zone A: 100% exemptions In Zone A: 1002 exemptions for first 5 years and oO2 for first 5 years and 60% for next 2 years for next 2 years In Zone B: 1002 exemptions In Zoae B: 100% exemptions for first 5 years and 60% for first 5 yeLrs and 602 for next 2 years for next 2 years In Zone C: 100% tax In Zone C: 1002 tax exemptions for first 12 exemptions fr first 12 years years The above could be extended The above could be extended if the project is owned by if the project is owned by a public limited company a public limited company The tax benefits will be effective from the date of commencement of production provided the project implementation period does not exceed 3 years ADDITIONAL BENEFITS Repatriation Non-Jordanian staff may transfer 70% of their net salaries abroad. Arab or foreign capital brought in and investment can be repatrinated with the approval of the Minister and according to the regulations of the Jordan Central Bank.  - 75 - ANNEX A Page 14 of 35 ITEMS UNDER PRICE CONTROL (Fils/Unit) Allowed Cost of Price to Retailers Unit Production Consumer Margin 1. Eggs I egg 21.21 27.33 34 2. Imported Milk 1 kg 790 922 17 3. Dairy Products 500 g 88 110 25 4. Lebeneh 500 g 196 240 22 5. Tahench 940 g 537 620 15.5 6. Halawa 1 kg 522 575 10 7. Coffee 1 kg 1075.9 1600 48 8. Natural Juice 250 ml 60 80 33 9. Imported Natural Juice 43 ml 405 460 14 10. Areated Beverage 250 ml 573 50 36 11. School Uniforms (Elementary) 1 1503 2000 33 12. School Uniforms (Secondary) 1 1920 2500 30 13. Imported Toothpaste (CIF price)x 210 40 14. Imported Shaving Soap 100 (CIF price)x 220 38 15. Local Toothpaste (Signal) 67.5 g 85.42 150 75 16. Local Shaving Soap 67.5 g 125.6 200 60 17. Imported School Pads 180 80 18. LWcal School Pads 32 books 20.54 35.0 70 19. Macaroni and Sago 400 g 60.2 75.0 25 20. Mineral Water 1.5 1 95.48 130 36 21. Imported Areated Water (CIF price)x 190 190 22. Live Local Chickens 1 kg 452 600 33 23. Already cleaned chickens 1 kg 551 740 34 24. Detergents 3 kg 1084 1550 43 25. Beutex 3 kg 1108 1790 61 26. Confectionary Sugar - (CIF x 150) - 50 100 27. Vegetable Oils - (CIF x 120) - 70 100 28. Saman De Gazahal (vegetable shortening) 2.5 kg 1030 N.A. N.A. 29. Toilet Paper 165 g 162 190 17 1/ Over the CIF price.  - 76 - ANNEX A Page 15 of 35 DISTRIBUTION OF IMPORTS BY TARIFF RATES (S) Range By Tariffs Exempted b/ (Percent) By Tariffs a/ + Surcharges a/ Imports 0 56.84 0.00 71.7 1 - 10 10.21 56.83 5.8 11 - 20 12.78 2.95 15.2 21 - 30 6.64 7.27 2.9 31 - 40 5.85 12.79 2.6 41 - 50 4.00 6.62 - 51 - 60 1.91 5.85 1.0 61 - 70 0.50 4.00 - 78 - 80 0.33 1.91 - 81 - 90 0.43 0.50 0.1 91 - 100 0.26 0.33 0.2 101 - 150 0.21 0.87 0.3 greater than 150 0.04 0.07 0.2 TOTAL 100.00 100.00 100.0 Source: Mission estimates a/ Relates to 1985 imports. i/ Relates to 1983 imports.  ANNEX A - 77 - Page 16 of 35 STRUCTURE OF TARIFFS 1/ Average Tariff Rate Without Accounting Accounting Category of Goods for Exemptions for Exemptions Finished Goods (Including Motor Vehicles) 39.3 33.4 Intermediate Goods 21.8 19.6 Capital Goods 28.1 16.5 Overall Manufacturing 30.9 26.5 Source: Mission estimates 1/ Tariff schedule effective during 1986.  -78 - ANNEX A Page 17 of 35 CHANGES 'N TARIFF RATES, 1983-86 Customs Tariff Surcharges Total 1983 17.2 15.5 32.7 end 1986 1/ 14.9 16.0 30.9 Source: 1983 - Dar el Handasah 1986 - Bank Staff Estimates I1 Unadjusted for exemptions in order to be comparable with 1983 estimates.  79 - Annex A Page 18 of 35 LIST OF PRODUCTS AS OF JAN. 1, 1987, FOR WHICH EXEMPTED INSTITUTIONS HAVE TO PAY CUSTOMS DUTY 1/ Type of Product Quality and Description of Product 1. Batteries Batteries of various cars and Electrical Appliances 2. Paper and Cartons Manila and Cheap Board Paper 3. Ceramic Chinese marble for walls 15/15 cm - Marble on ceramic sanitary equipment 4. Materials Various military materials Wool & Carlian materials 5. Tomato paste 6. Washers (Children) Washers weighing 1-2 kg for 7. Synthetic and natural marble 8. Empty tin cans white and beige 9. Macaroni & egg noodles 10. Cartons Printed cartons for napkins and Medicine, laundry detergents and pastries 11. Wire For wiring 12. Chemical detergents Liquid & solid chemical detergents 13. Central Heating Radiators Central Heating Radiators 14. Carpeting Silk persian carpeting 15. Perfumes, Shampoo, beauty supplies, toothpaste shaving creams. 16. Plastic products - Commercial Household plastic products sponges 17. Lead tubes Lead tubes 1/2 to 2 1/2 inches 18. Special tubes for drops Various size tubes 19. Plastic 20. Yeast 21. Wood Products, Metal and Normal Closets and desks 22. Aluminum profiles 23. Plain Cookies 24. Vegetable Oils Margarine 25. Solar Heaters Heaters 26. Paint Oil & liquid paints 27. Chlorine & Baking Soda Chlorine 29. Doors Wooden doors 30. Soaps Perfumed & non-perfumed soap 31. Mineral Water Still under study 32. Shutters Plastic & wood shutters 33. Matches 34. Cigarettes and Tobacco 35. Cement 36. White Cement 37. Hygenic Papers and Napkins 38. Little Bottles - Pre-constructed Homes 38. Children Strollers 4 types 39. Aluminum Ladders 3-4 steps  - 80 - Annex A Page 19 of 35 40. Dishwashing utensils 41. Skin Care Products 42. Gas Ovens 43. Household Freezers 44. Pens 45. Dry Batteries 4 46. Wall to Wall Carpeting 47. Shaving Blades with two Edges 48. Plastic Bags 49. Lubricant Oil 50. Elevators 51. Electric Wires and Cables 52. Books, Tourism Pamphlets, Publications Glendars and Phone Books. Source: Ministry of Industry and Trade 1/ The Industries producing these products are termed as 'Scheduled Industries'  - 81 - ANNEX A Page 20 of 35 FORMULAE FOR TARIFF ANALYSIS A. Weighted and Unweighted Average Tariffs for a Set of Commodities Define: Tk as the ad-valorem tariff rate for the K'h BTN code K-1,...,N N=2178 in the case of Jordan, Mk, as the imports of the K'h BTN code. EXMPx, as the imports of K%h commodity that are exempted from tariffs. then N (1) average unweighted tariff rate without exemptions = k-i N (2) averge tariff with exemr'ions is = k- Mk k this is the weighted average of Tk with Mk-EX7 Pk as weights. lMKk k Tariff rates calculated according to formulas (1) and (2) for the whole economy are reported in Chapter 2. B. Effective Rates of Protection (ERP) 'rhe general formulae for calculating the ERPs using the input/output (I/O) table are as follows: (3) ERPj = VADp - VAWj YAW 3j s VADj -1 41 VAWj where, ERPj = effective rate of protecti-,n sector j VADj - value added at domestic prices in sector j VAWj = value added at world prices in sector j from (3), using the Corden method of estimation of effective rates of protection, the rates can be calculated as follows: 27 1- E aij (4) ERPj = i=l -1 27 1 1+Tj i-i 1+Tj  - 82- ANNEX A Page 21 of 35 where, aij = input-output coefficients o2 tradeable sectors (im input sector, j= output sector) T1, Tj u average nominal protection rate of output sector i and j Effective rates of protection for the 27 tradeable input-output sectors of Jordan were calculated in three steps: 1. The aij coefficients were obtained from Jordan's 1983 input-ouput table. 2. A correspondence between BTN (the form in which the data on tariffs and the trade statistics were available) and the tradeable input-output sectors was established. Two sets of nominal protection rates were estimated for each sector. One set of rates were calculated as simple unweighted import duty averages, and the other was calculated taking into account imports exempted from tariffs as in formulae (1) and (2) presented in the Section A. No adjustments were made for quantitative restrictions or price controls. 3. Effective rates of protection were calculated as in formula (4) using the aij coefficients and the nominal protection estimates.  - 83 - ANNEX A Page 22 of 35 SECIORAL DISTRIBUTION OF THE VALUE OF LICENCES ISSUED (Million JD) 1985 1984 1983 1982 1981 1. Food Products 2.54 3.73 6.09 4.4 6.13 2. Textiles 0.70 0.05 0.01 1.20 0.66 3. Construction Materials 0.75 1.12 1.26 3.94 2.72 4. Chemical Products 1.60 1.77 7.20 3.53 5.93 5. Plastic Products 2.34 1.54 1.24 3.53 5.93 6. Metal Products 2.42 17.97 23.77 7.53 8.27 7. Wood Products 1.43 0.06 0.35 1.42 0.65 8. Leather Products 0.04 0.25 0.10 1.42 0.65 9. Paper Products/Printing 0.23 0.58 0.12 1.42 0.65 10. Total Manufacturing 12.05 27.07 40.24 22.02 24.63 (116) 1/(i32) (102) (156) (175) Source: Ministry of Induitry and Trade / Figures in brackets indicate the number of licenses issued.  - 84 - ANNEX A Page 23 of 35 SOURCES OF FUNDS FOR SMI OPERATIONS AND DEVELOPMENT I. Loan Financing Commercial banks are by far the largest source of loan finance for the SMIs. All 17 commercial banks are privately owned. Of these, 10 are owned by Jordanians and seven by foreign banks. The Arab Bank, an international bank, is the largest commercial bank holding 35 percent of the domestic banking market. The Housing Bank is the second largest, holding approximately 25 percent of the deposits of the banking system. Commercial banks mobilize the majority of their funds through demand and time deposits. They provide both long and short term credit to almost all sectors of the economy. In 1985, they accounted for 70 percent of the credit outstanding to the private sector which in turn amounted to 43.3 vercent of the total assets of the Jordanian financial system. Table I sectoral Digtrihution of outstanding Commercial Bank's Credit (JO million) ;9al 1982 1 9Aa 19t4 W9AL Sentor Jonm it JD m X ToQ - inm Jo m %D Agriculture 19.4 2.7 24.6 2.8 25.6 2.5 25.6 2.2 26.3 2.1 Mining 6.8 1.0 14.1 1.6 20.5 2.0 27.4 2.3 2.31 2.5 Industry 82.4 11.4 98.5 11.1 118.4 11.S 142.4 12.0 157.2 12.3 Construction 201.0 27.9 216.7 24.4 271.3 26.3 324.1 27.4 331.6 26.0 Transportation 23.3 3.2 32.9 3.7 50.5 4.9 58.5 4.9 64.0 5.0 Tourism 15.9 2.2 20.5 2.3 25.7 2.S 23.7 2.0 29.8 2.4 Conuercea & Trade 225.8 31.3 284.9 32.1 276.6 26.8 296.1 25.0 308.5 24.2 Public Entities 45.0 6.2 64.5 7.3 65.4 6.3 85.1 7.2 117.2 9.2 Others 101.7 14.1 130.5 14.7 116.9 17.2 201.9 17.0 207.7 16.3 Total 721.3 100.0 887.2 100.0 1,030.9 100.0 1.184.8 100.0 1,274.4 100.0 Source: Central Bank of Jordan Overdraft facilities and short-term advances represent the largest part of the credit extended to industry, thus it could be said that commercial banks mainly provide resources for the day to day fina-.cial needs of industry and its short term working capital requirements. There is evidence however that the above credit facilities are also used to finance permanent working capital and fixed assets as commercial banks have been ready to rollover short-term credit to qualified industrial borrowers. Since 1978 commercial banks have also paid an increasingly important role in medium- and long-term industrial financing by participating in syndicated loans. In 1985 the outstanding balance of syndicated loans by commercial banks has reached JD 91.8 million or 72 of their total outstanding credit and 582 of their outstanding industrial credit. Financial companies are privately owned and extend both short and long term credit to finance development projects. Their charter, however, excludes them from extending overdraft facilities. Trade financing is carried  - 85 - ANNEX A Page 24 of 35 out only when guaranteed by foreign SCIs or export guarantee institutions. In addition to lending they provide capital market services as stock brokers in the Amman Financial Market (AFM) or underwriters of new equity and bond issues, leasing and factoring services and assistance for merger, acquisitions and equity and debt restructuring. Unlike the commercial banks, financial companies are not authorized to accept demand deposits. They raise their resources mainly from time and savings deposits from the private sector. Most financial corporations have also been active in raising funds for industry in the capital market and participating in Government-guaranteed syndicated loans. Two of the financial corporations, the Jordan Finance House and the Islamic Investment House operate under Islamic principles. The Industrial Development Bank (IDB) is the Specialized Credit Institution responsible for industrial development through the provision of medium and long-term (MLT) loans for working capital and investment requirements of the industry. It was established in 1965 by various private financial institutions in association with the Government, which contributed 14 percent of the capital requirements. IDB staff totaled in June 1986 about one hundred. Its organization includes five departments: administration, finance, investment, followup, technical. In addition four other divisions (small scale industriee, research, securities and internal audit) report directly to the deputy general manager. In 1985 IDB's operating expenditures totaled JD 3.15 million, its net profits amounted to JD 509,000 or approximately 8% of its capital and it had reserves of JD 8.6 million. Net profits have declined almost 20% from the level reached in 1984 and are expected to remain lower also in 1986 and 1987. IDB also controls the Jordan Management Institute (IMI), a special department created to provide training to private and public sector students in the areas of accounting and finance, general management, production, marketing and computer activities. JMI has an autonomous budget supported by training fees, membership fees and various contributions including contributions from IDB. JMI's operating expenditures in 1985 totaled JD 166,000. Prevented by existing regulations from accepting deposits, IDB's main sources of funding are borrowings from the Central Bank and international financial institutions. At the end of 1985, long term liabilities totaled JD 27.9 millio.i of which JD 13.5 million was advances from CBJ and the remaining JD 14.5 million loans from Kreditanstalt (JD 0.6 million), EIB (JD 3.7 million), the Kuwait Fund (JD 2 million), the Royal Scientific Society (JD 2.2 million), and IDA (JD 0.6 million). The average cost of resources, to IDB, including short term resources, was approximately 5Z. In 1985 the outstanding balance of IDB loans to industry totaled JD 32.7 million, its equity investment JD 3.9 million. The growth of IDB's lending to industry has registered a considerable slowdown during the last three years due to the economic slowdown both in Jordan and in the region which have created sluggish investment demand. IDB lending operations extend to the mining, manufacturing and tourism sectors. The maximum size of loans is generally set at 50% of the total cost of projects, including land and working capital. For projects located in underdeveloped areas the loan size could reach 652. Loan maturities vary from 5 to 8 years with grace periods ranging from 6 to 35 months. Interest rates for fixed assets vary from 71 to 9% according to the  - 86 - ANNEX A Page 25 of 35 type of industry, the sponsor of the project and the location of the project. In accordance with the development purpose of IDB and its semi-public nature, lower interest rates are granted to projects located in developing areas (71), and having export orientation (8.5X). Tr,.erest rates for working capital vary from 81 to 9.25X according to their ma.urity from 1 to 2.5 years. IDB also provides loans for export orders at an interest rate of 7.75% (see section (C)). In 1985 IDB's disbursements totaled JD 7.46 million down from JD 8.7 million in 1984. This reflects declining commitments during the last three years due to the economic slow down, as well as a more conservative approach to lending caused by a deterioration in the loan portfolio. Disbursements from 1986 to 1990 are expected to hover around JD 7.5 million p.a. The present gap to cover the relevant need of resources is about JD 10 million. IDB should be able to mobilize these resources easily through advances from CBJ and new loans at low interest rates from its customary foreign levlers. The present portfolio of IDB includes 475 active loans, 361 of which in the industrial sector and the other 114 almost equally distributed between the mining and tourism sectors. Loans to the chemical and plastic industry dominate both in terms of outstanding balance and number of operations. Important also is the number of loans made to the food, beverage and tobacco industry. Wood, paper and metal product industries follow closely. Every year IDB processes 30 to 40 new loans. These operations are manly the result of direct applications from customers with very little promotional activity carried out by IDB's investment department. Promotion is generally limited to visits to entrepreneurs located in the Amman Industrial Estate as well as to former clients who have indicated a desire to expand to the followup department. The investment department also receives regular information from the Ministry of Industry on applicants for new industrial licenses. The pipeline of projects at the end of 1986 included 41 projects of which 28 under appraisal and 13 were at the stage of early preparation. The total estimated credit demand for the 28 were projects under appraisal was JD 2.8 million. This pipeline appears weak. Unless major promotional efforts are carried out, IDB will have difficulties to meet the lending target of JD 7 to 7.5 million planned for 1987. The analysis of the loan portfolio at the end of 1986 indicates that 401 of the loans are in default (30% with over 6 months payment arrears). This represents a marked deterioration with respect to 1983 when loans in default were only 14% (81 with over 6 months arrears). To cope, IDB is planming to set up a problem project unit reporting directly to its general manager. This, however, will not be sufficient if IDB does not enhance its ability with industrial restructuring and to provide appropriate technical and financial assistance. A Technical Restructuring Assistance Fund was established in 1983 with funds deriving from margins on the onlending rate of KFW loans to support industries experiencing difficulties and needing expertise to solve their problems, but so far only 5 enterprises have benefitted and the Fund need over-hauling. The small scale industry division of IDB consists of a staff of 5. It adminitters the Small Scale Industry and Handicraft Fund (SSIHF) which provides loans with a maximum maturity of 5 years and an interest rate of 6.51 for the creation of new enterprises employing less than 5 workers and entailing a total investment, including working capital, of less than  - 87 - ANNEX A Page 26 of 35 JD 20,000. Since 1982 the SSIHF has financed 1,138 projects for a total amount of JD 3.4 million. The resources used by the Fund come from the Central Bank, the Ministry of Planning and foreign donors. Demand for SSIHF financing expanded considerably in 1985 to reach 430 applications or twice as many as in 1984. Loan repayment appears sound for the time being. II. Equity Financing Amman Financial Market. The AFr was established by the Government with IFC assistance in 1977 to mobilize domestic and foreign savings and direct them toward productive projects. Before the establishment of the AFM, the sale and purchase of stocks used to take pla .e through a few real estate agents and brokers without any listed prices, which made transactions costly and share prices contentious. According to its establishment law the objectives of the AFM are to (i) promote savings by encouraging investment in securities and direct such savings to serve the development of the national economy, (ii) regulate and control issues of securities to ensure the- soundness, ease and speed of such dea'Lings, to foster the financial interest of the country and to protect small savers, and (iii) gather and publish the information tnecessary to realize the above mentioned objectives. Table 2 AFM Activity from 1978 to 1985 Number of Co. Number of Value of Floating Shares Traded Shares ('000) Traded Shares (JD '000) new exist. total new exist. total new exist. total Year co. co. co. Co. co. Co. 1978 3 8 11 2,568 1,440 4,008 3,180 4,776 7,956 1979 4 7 11 1,146 3,406 4,552 3,239 9,637 12,876 1980 13 10 23 10,242 6,107 16,349 10,354 25,069 35,423 1981 14 4 18 24,194 2,162 26,356 24,194 2,947 27,141 1982 12 12 24 21,266 12,497 35,763 21,266 45,458 66,724 1983 13 4 17 27,787 3,500 31,287 27*787 4,810 32,597 1984 3 1 4 2,825 333 3,158 2,825 383 3,207 1985 1 3 4 1,486 2,737 4,223 1,486 6,675 8,161 Source: Amman Financial Market: Annual Report, 1985 The Table above provides an overall picture of thte AFM's actitities from 1978 to 1985. Data on companies end shares include service companies, manufacturing and mining enterprises, and financial and insurance institutions. The value of traded shares of the manufacturing and mining sectors during the period amounted to about 25S of the total value of trade. Volume and value of APM activities grew rapidly from 1978 to 1983 under the speculative pressures which dominated the stock market during the early 1980's and the active investment policies pursued by public corporations and financial institutions which in turn was driven by the demand of the economy for all sorts of goods and services. Since 1983 the activity of AEM has registered a substantial and generalized decline paralleled by a drop in the prices of shares which in the case of the manufacturing and mining companies have gone back to their original 1978 value.  - 88 - ANNEX A Page 27 of 35 Table 3 AFM Share Price Indices 1978 1979 1980 1981 1982 1983 1984 1985 General Index 100.0 117.9 149.2 184.4 207.8 169.0 133.7 127.0 Manufacturing & Mining Companies 100.0 100.6 145.6 165.0 165.4 125.6 106.9 100.8 While the creation of the AFM represents major progress toward the establishment of an organized capital market and has offered new investment opportunities to Jordanian savers, it has basically failed to mobilize resources for small and medium private industrial development. The enterprises which have been financed through the sale of stocks on the AFM are mainly very large government sponsored concerns which would have been funded anyhow through other government backed sources of financing. By law the AFM is also entrusted with the responsibility for listing all bonds issued by the Government or by private companies. The sale of bond; by private companies is hampered by their limited attractiveness. To compete with tax free government guaranteed bonds issued by the Treasury or by public corporations, these bonds would have to provide a return of 13-142 - a cost to the issuing companies considerably higher than the average prevailing cost of capital (9S). The Pension Fund was established in 1976 to make pension payments to civil servants and the military personnel. This original mandate was however changed immediately after and the Pension Fund was transformed to a public investment corporation. The capital of the Fund belongs entirely to the Government and totals JD 42 million plus JD 8 million reserves. It has a staff total 37 of which 20 are professionals. Table 4 Assets of Pension Fund (JD 1000) 1984 1985 2 change Value Value 2 1984-1985 Deposits with Banks 6,171 10.5 8,353 14.6 35.3 Shares and bonds 50,172 85.8 46,577 81.6 -7.2 Other Fixed assets 2,132 3.7 2,121 3.8 -0.5 Total 58,475 100.0 57,050 100.0 -2.44 Source: Pension Fund; 1985 Annual Report.  - 89 - ANNEX A Page 28 of 35 Table 5 Investment in Bonds and Shares of Public and Private Shareholdings by Sector (JD 1000) 1984 1985 S change Value 2 Value _ 1984-1985 manufacturing 27,864 55.29 24,049 50.37 -13.7 mining 7,500 14.89 7,500 15.71 0 public corporations 4,100 8.13 4,700 9.84 .14.6 real estate 3,989 7.92 3,989 8.36 0 tourism and hotels 2,500 4.96 2,500 5.24 0 services 1,385 2.75 1,510 3.16 +9.0 banks and finance 1,125 2.23 1,181 2.47 +5.0 agriculture 905 1.80 1,290 2.70 +42.5 other 1,025 2.03 1.025 2.15 0 TOTAL 50,393 100.00 47,744 100.00 -5.3 Source: Pension Fund; 1985 Annual Report. As shown in Table 4, total assets decreased by about 2.5S from 1984 to 1985 in parallel with an increase in liquidity. Due to difficulties caused by the Jordanian economy on the Fund's inveztment holdings and new investment activity. Investments in bonds and shares decreased by 5%. They are highly concentrated in the manufacturing sector and on large enterprises, according to directives provided by the Government. The portfolio of the Pension Fund comprises 49 private and public shareholdings. Some of the companies have been founded by the Fund, generally in aseociation with other public investors. The companies presenting balanced or positive results exceeds those carrying losses. However a few companies are in a very difficult situation and require either liquidation or major restructuring. Data on the net worth of the companies are confidential and would not be disclosed. The new manager of the Pension Fund, appointed at the end of 1986, is contemplating a major reorganization of the institution to cope with the difficulties of the present economic situation and the challenge of promoting new economic development. The activity of the Fund will be focused on restructuring non-performing enterprises and promoting the creation of medium and small scale enterprises in promising subsectors geared to both efficient import substitution and export. The Social Security Corporation (SSC) was established in 1978 to provide pension and disability payments to workers of the privatd sector. At the end of 1985 the total capital of SSC amounted to approximately JD 102 million against JD 4.7 million in 1980. Actuarial analysis show that the institution is going to build up considerable liquidities. The investment strategy of the SSC is to maintain the real value of its assets while contributing to the economic development of the nation and stimulating investment in the productive sector. As of the end of October 1986, the value of SSC's investment portfolio (paid up capital) totaled about JD 160 million  ANNEX i - 90 - Page 29 of 35 of which 11.3% or JD 18 million is in equity participations in industrial concerns and 2% or JD 3.2 million in bonds of public shareholding companies. Equity participations extended to 30 major companies operating in the industrial and service sectors. The activities of industrial companies include oil refining, production of cement, pharmaceuticals, glass, and timbar. Similarly to the Pension Fund, SSC investments have been mainly concentrated on large enterprises and, in particular, on government sponsGred projects. As for the future, SSC is ready to invest JD 5 to 6 million annually in shares of manufacturing industries and to raise the portion of its assets invested in this sector from 11.3% to 15%. The management of SSC doubts, however, that this objective can be achieved due to scantiness of investment opportunities. In the past three years investment in the manufactirng industry hovered at about JD 3 million annually. Strong cooperation with the Industrial Development Bank and tbe Petision Fund for the identification of investment opportunities as well as participation with these institutions in the promotion of new industrial artivities has been and is expected to continue to be a major feature of SSC investment policy.  - 91 - ANNEX A Page 30 of 35 M LtSOLIOATED FINANCIAL SYSTEM EVOLUTION OF PRIVATE SECTOR DEPOSITS AND BORROWINGS (JO million) 1981 1982 1983 U8 1985 JD m X JD m JO m X 3D m X JD m Deposits by private sector 750 100 968 129 1,118 157 1,258 168 1,389 185 - Demand deposits 302 100 333 110 365 121 359 119 320 109 - Savings and time dep. 441 100 635 141 852 168 899 200 1.05w 236 Claims on private sector 830 100 1,062 127 1,314 158 1,474 177 1,579 190 - loans and advances 755 100 927 122 1,124 149 1,248 165 1,132 150 - corporate bonds 9 100 30 333 50 555 54 600 58 644 - domestic market 66 100 105 159 140 212 172 260 189 286 Source: Central Bank of Jordan, 1981 base year a 100  ANNEX A - 92 - Page 31 of 35 TERM STRUCTURE OF DEPOSITS ANq LENDING RATIS oct. 1992 April 1983 Noy 1983 _IJne 28i4_ Nov 1986- Deposits min max X mUin max X mn X max X m mQl3ax X min X I... - Demand deposits - 4.0 - 4.0 4.0 4.0 4.0 Time deposits 1 to 3 months S.0 - 6.0 6.0 - 6.0 - 7.5 3 to 6 months 5.75 - - 6.5 6.5 6.5 - 7.5 6 months to 1 year 5.75 7.0 7.0 7.0 7.5 over 1 year 6.0 - ?.75 7.75 - 7.75 - 7.5 - Savings with comm. banks S.0 - - 6.0 6.0 6.5 5.5 with financ. corps - - 6.S - 6.5 7.0 6.0 Certificate of deposits 3 to 6 months - - 7.0 7.25 8.75 7.375 6 to 9 months - - - 7.75 8.00 8.75 - 7.V 9 months to 1 year - - 8.0 8.25 8.75 - 7.375 over 1 year - - - 8.25 8.5 8.75 7.375 JulY 1982 May 1983 Sept. 1983 April 198S, Nov 1986 Loans min X max X minX maxX min Z max I min X min X max - Central Bank's rediscounts 6.5 6.5 6.25 6.25 5.75 - Central Bank's advances to spec. credit insts. 3.0 6.0 3.0 6.0 3.0 5.5 3.0 5.0 3.0 S.0 to commercial banks 6.5 6.0 6.0 6.0 5.75 1/ to financial corps. 7.5 7.5 7.25 7.25 6.25 1/ - Commercial Banks to residents 8.0 9.0 8.0 8.75 8.0 8.75 8.0 8.75 7.25 8.0 V to non residents 10.0 12.0 10.0 12.0 10.0 12.0 10.0 12.0 10.0 12.0 1/ - Financial Corporations to residents 8.0 9.0 8.0 8.75 8.0 8.75 8.0 8.75 7.5 8.5 A/ to non residents 10.0 12.0 10.0 12.0 10.0 12.0 10.0 12.0 10.0 12.0 _/ - Specialized Credit Insts. IDB - ind. projects 8.0 9.0 8.0 9.0 7.75 8.25 7.5 8.0 7.5 8.0 - rural projects 7.0 7.5 6.75 6.0 6.0 Cooperative Organizations 6.5 8.0 6.5 8.0 6.5 8.0 6.5 8.0 6.5 8.0 Agric. Credit Corp. 7.0 7.0 7.0 7.' 6.0 8.5 CVDB - municipal projects 7.0 8.0 7.5 8.5 7.5 8.5 7.5 7.5 8.5 - village projects S.S 6.5 6.0 7.0 6.0 7.0 6.0 8.5 6.0 8.5 Housing Corporation 5.0 S.0 5.0 5.0 S.0 Housing Bank ind. loans 8.5 8.5 8.5 8.5 7.5 - comn. loans 9.0 8.75 8.75 8.75 8.5 1/ Si for export loans Z/ optional comnission fee of 1% (1.5% for real estate investments) l/ optional comnission fee of 2% (2.5% for real estate investments) 4/ optional comnission fee of 1.25% (1.75% for real estate investments) i/ optional comnission fee of 2% (2.5% for real estate investments) Source: Central Bank of Jordan  - 93 -MNEX A Page 32 of 35 INDUSTRIAL INFRASTRUCTURE l/ Over the years, the Governmert has created a substantial infrastructure to encourage and help the SMIs, which by and large works quite well. Manufacturers in Jordan have access to industrial estates, duty free zones and the commercial centers corporation. The Government is also active in drawing up bilateral agreements aimed at expanding trade. (i) Industrial Estates Corporation (IEC) The IEC was established in 1980 with the task of providing modern, fully serviced estates for new industrial investments throughout Jordan. Since its inception, the IEC has pursued chis task vigorously and has, to date, completed the first phase of a major estate at Sahab on the outskirts of Amman. IEC is an independent corporation with a governing board made up of appointees of the Council of Ministers, a member representing the Pension Fund, the IDB, the Housing Bank and the Amman Chamber of Industry. The stated objectives of the Corporation are to establish and manage all industrial estates in Jordan, to encourage new industry to locate on these estates and to encourage existing industry to relocate. In addition, to well serviced land for rent, but not for sale, companies located on an estate qualify for extra investment incentives. There is a two-year exemption from income and social services tax for both new and relocating firms. IEC has also been delegated authority by local, regional and municipal planning committees, within the confines of the estate, to minimize administrative delays during the establishing of a firm. The Corporation is also able to ensure that all access and service delivery procedures are facilitated for the main utilities. The Sahab estate occupies 253 hectares with the first phase of 80 hectares already complete. The second phase of 100 hectares is at the stage of contract-letting with an expected compietion date of 1986. In addition to serviced sites, IEC provides standard factory units of which 30 were constructed as part of the first phase rangiug in size from 109m2 to 1370m2. Additional estates are in various stages of planning, with a 41 hectare zone at Irbid being most advanced. Applications for the Sahab estate have been encouraging, with 56 investors agreeing to locate on vacant sites. This represents about half of the available plots and 10 of the advanced factory shells are already taken. The no sale policy represents a particular problem in attracting industry to the zone because many companies wish to have ownership for collateral equirements, as well as for corporate security reasons. So far, the Board has decided not to allow the sales of sites. Instead, it has opted for a compromise "subrogation" of tenancy rights. We consider that the arguments against a policy of selling plots, providing adequate safeguards or the nature of the development as a condition of sale, are not convincing and recommend that the Board of the Corporation change its policy. The management of the Corporation gave a good impression of energetic competence and were able to supply publicity material which was of a high 1/ This section draws considerably on the work done by Coopers and Lybrand for USAID.  - 94 - ANNEX A Page 33 of 35 standard and was aimed at international as well as domestic investors. Indeed, the management has plans to extend its investment promotion activities even further by the opening of overseas offices to attract investors. While we support the intention which is behind this proposal, we remain unconvinced that this is the appropriate agency to undertake such work. (ii) Free Zones Corporation The Free Zones Corporation (FZC) was established in 1976 under the sponsorship of the Ministry of Finance. It is an independent corporation which is empowered to establish free zones to promote international trade exchange, transit trade and export oriented industries. To date, it has emphasized its role as a provider of bonded warehouse and secure storage facilities rather than an attractor of export oriented industries. The primary zone of the Corporation has been established at Zarqa with a second zone at Aqaba and a third joint zone on the Syrian border. The Zarqa zone covers 20 hectares and applicants are able to rent plots within the zone for a 20 year period. The first phase was developed in 1983 and it comprises about one third developed for commercial storage, one third developed as a car sales center, and the remainder allocated for industrial use. The zone allocated for industrial use has largely been assigned, although manufacturing activity has not yet commenced. Plans for a second phase involve a similar commercial/car sales/industrial balance, and is soon to be ready for occupation. The zone on the Syrian border, designed for industry-use only, is 400 hectares in size and is near completion. All factory units are to be provided by the Corporation although as yet, no companies have come forward to take any of the units. The Aqaba zone is in two parts; one on the port and one to the north of the town. Both are devoted to commercial uses only as, for environmental reasons, no industry is allowed at those locations. After substantial infrastructure investment is completed on a new road, a manufacturing-based Free Zone is planned for approximately 200 hectares east of the city and the port. It will, however, be a number of years before this zone will be available for use. Activities located on the Free Zone are treated by customs as external to the country so there are significant tax benefits associated with the location. Ease of import and export should also De an important advantage of the location but because of the orientation of the present users - bonded warehouaing prior to entry in the domestic market - these are not yet evident. Customs checks and tight security controls are as much a part of industrial life on the zones as they are in the rest of Jordan. If the zones are to play a full part in the attraction of export-oriented industry, then these procedural problems will have to be eliminated. In spite of a number of benefits associated with locating an industry within the FZC, the number of industries willing to move in has sc far been limited. The FZC has responded by reducing ren*i by 20 to 25 percent at the Aqaba and Zarqa, and by extending the tax benefits to industrial enterprises once they are established. These incentives will have to be combined with active promotional activity to promote the free zones in Jordan as a desirable processing location.  _ 95 - ANNEX A Page 34 of 35 III. COMMERCIAL CENTRES CORPORATION Government promotion of manufacturing exports is centered on the establishment and implementation of bilateral trade agreement with neighboring friendly nations. The Ministry of Commerce and Industry (MCI) prepares and negotiates the agreements by defining the type and volume of commodities and goods that will be mutually exchanged and the specific licensing provisions and custom duties exemption to be applied to this effect. The Commercial Center Corporation (CCC) oversees to the implementation of the agreement. More specifically the CCC seeks from the trading partner nation import rights for the authorized commodities and goods that it transfers to the Jordanian exporters at a fee corresponding to 3.5 percent of the value of actual exports. Additional activities of the CCC include the organization of trade fairs abroad and assistance to exporters through field offices in selected foreign countries. The CCC was established in 1972 by the Ministry of Commerce and Industry, which also provided one third of its initial capital of JD 15,000. The remaining two third of the capital were provided in equal parts by the Jordanian Chamber of Commerce and the Jordanian Chamber of Industry. By Iaw, the Chairman of the CCC's Board of Directors is the Deputy Minister of Industry. The Board includes six other members, two each from the Chambers of Commerce and of Industry and one each from the Ministries of Industry and of Agriculture. The CCC is financially self supporting. Its income derives from the 3.5 percent fee on exports carried out under the bilateral trade agreements and reached JD 0.43 m. in 1985. Expenditures in the same year totaled JD 330,000 of which JD 0.26 m. for operating costs, iacluding field offices, and JD 60,000 for the organization of trade fairs. CCC's financial management is conservative. At the end of 1986, the institution had accumulated earnings of about JD 0.5 m. invested in bonds paying an average interest of 8 percent. A more detailed review of CCC's past and prospective activities is presented below: (i) Implementation of trade agreements. To date this has foc-used on Iraq, Syria, Egypt, and Saudi Arabia. Most of these markets are strained by the economic downturn of the region following the decline of oil prices and the regional instability. The MCI and CCC have started to make contacts to develop trade agreements with Romania, Yugoslavia, India and Indonesia. While these markets appear of interest for natural resource based industrial exports and a few other specialized products such as phari-aceutical and canned food, they do not present major potential for other manufacturing exports. (ii) Trade offices abroad. At present CCC has only two offices located in Cairo and Bagdad, respectively. A third office in Khartoum has been recently closed due to the sluggish economic situation of Sudan. CCC's offices have rendered useful services to exporters within the framework of the implementation of trade agreements but have not performed a very active role in promoting exports in general and developing Jordan's image of a country producing competitive manufacturing products. CCC ts planning to open additional offices in Damascus and Sana and to reactivate the Khartoum office.  - 96 - ANNEX A Page 35 of 35 (iii) Trade fairs. This is a recent activity started only in 1985. To date the CCC has organized fairs in North Yemen, Bahrain, Tunisia and Syria. In 1987 it is planning to organize fairs in Egypt, Tunisia, Saudi Arabia, Oman and, possibly, two other gulf countries. Overall the organization of past fairs has been successful and has provided a useful forum to exporters to contact markets as well as to promote contract a-d direct sales. Contract and direct sales amounted to 13 million in Yemen, 35 million in Syria and 4 million in Tunisia. The relatively low level of sales in Tunisia was pertly due to the fact that exporters were prevented from making direct sales, a limitation which is expected to be removed in future fairs. Considering the need for Jordan to foster export promotion, future government decisions concerning the CCC should respond to the following considerations: (M) Role and Functions. To date the CCC has focused its export promotion activities almost exclusively on the implementation of bilateral trade agreement with neighboring countries. Representative offices abroad and trade fairs were mainly conceived as support activities to this task. While realistic and cost effective, this approach is inadequate to support the development of Jordanian manufacturing exports. She Government has recently considered tiie possibility of establishing a new Export Promotion Agency. Rather than creating an additional agency, it will be preferable to restructure and strengthen the CCC and entrust it with a broader and more dynamic export promotion role. This will allow to capitalize on the financial resources and the experience of the institution and avoid wasteful duplications. (ii) Funding. So far the operating cost of the CCC, including the organization of trade fairs, have been entirely funded through fees on exports resulting from bilateral trade agreement. Supporting the cost of trade fairs was justified by the experimental character of these initiatives and the relative inexperience of the CCC in the field. There is no reason, however, that the practice Gf not charging for services be maintained in the fututre, in parw-icular if the CCC were to organize a larger number of trade fairs and expand the services that it provides. Charging for services will subject the CCC to the test of market forces, thus improving its effi-iency; generate new revenue, thus enhancing its ability to provide additional services; and eliminate the demand for services of marginal utility to their customers. (iii) Coordination with domestic trade agents. Jordan has several trade houses offering exporters a variety of services including brokerage shipping and marketing assistance. The CCC should plan a more dynamic role in enhancing their ability to support exporters in foreign market by collecting and sharing with them information on commercial, technical and legal aspects related to these markets. To achieve this objective the CCC should coordinate with the diplomatic delegations of the Jordanian government abroad and in particular their commercial attaches.  - 97 - ANNEX B Page 1 of 23 PROTECTION AND DOMESTIC RESOURCE COSTS IN JORDAN, 1985 Introduction 1. This Annex presents the data and methodology used to estimate the Nominal Protection Rates (NPR), Effective Protection Rates (EPR) and Domestic Resource Cosrs (DRC) for a sample of 12 firms (21 product lines) using 1985 data. The purpose of this exercise was to gain some insight into the competitiveness and efficiency of Jordan's small and medium scale manufacturing industries (SMI) sector. This Annex is organized as followz: Part I discusses the methodology used to gather data, along with a brief introduction to FPR/DRC concepts. Part II discusses the crucial parameters in these calculations as well as limitations and assumptions inherent in the study. Part III presents the results. I. Concepts and Methodology 2. The Concepts. EPR/DRC calculations are carried out to capture the distortions inttoduced at a firm level because of the divergence between domestic and international prices due to the presence of *ariffs and subsidies. Domestic prices are defined as the prices actually paid by the firm for a particular service or input such as labor costs, raw material costs, or electricity rates. Border prices are defined as the cost incurred by the country in obtaining this good or service. Consider, for example, cloth used in the production of jeans. The border price is the c.i.f. import price of cloth while its domestic price is its factory gate price paid by the Jean manufacturer. The difference between the factory gate and border price can be attributed to import duties, forwarding and port clearing charges, bank charges and internal transportation. 3. For an output or final product, we use an exfactory price, exclusive of any output/production tax as the domestic price and the c.i.f. import price of a comparable product as the border price if the commodity is an import substitute. Gathering data on the latter is generally the most difficult step in EPR/DRC work due to a number of reasons, the most important of which is that competing imports are banned, and if imported, they are of higher quality than the locally-produced item. The aim of the survey is to generate, at a firm level, for each productive activity, the value of outputs and inputs at domestic and border prices. This makes it possible to derive value-added at domestic prices and at border prices. The percentage difference between value-added at domestic and border prices is the EPR. It is expressed as follows: EPR 5 Value Added at Domestic Prices -1 x 100 (1) Value Added at Border Prices 5. The nominal protection rate is simply the ratio of the ex-factory price of output to the c.i.f. import price of a comparable import, expressed as a percent. In other words, NRI = Ex-factory Price of Output -1 x 100 (2) cif Import price of Similar Item  ANNEX B -98- Page 2 of 23 6. The NPR is a quantitative measure of the extent to which output is being protected. By contrast, the EPR shows us the extent to which the entire productive activity (i.e., value added) is being protected. In general, in Jordan, since output tariffs are higher than the imput tariffs, the EPRs are higher than NPRs. Second, it is possible to have product lines with negative value added at border prices, even though value-added is positive at domestic prices making the firm financially profitable. This suggests possible adverse impacts on the balance-of-payments resulting from that activity. Third, products with high NPR do not necessarily have high (or positive) EPRs. Low domestic value added relative to border prices may cause the EPR to be low or negative. 7. The DRC coefficient measures the quantum of domestic resources spent in creating a unit of value added in border prices. Domestic resources 1/ are factors of production (i.e., land, labor and capital) used in the activity. The DRC is expressed as a ratio of value added at border prices to the total cost of capital and labor. This is expressed as follows: DRC = rK + wL (3) VABP Where: K = Capital stock used in activity L = Labor force used in activity r =Rental price of capital stock, K w = Wages for labor force, L VABP = Value-added at border prices 8. The preceding coefficient is defined as the long-run DRC. The short-run DRC treats capital costs as a "sunk" or fixed cost and focuses on wages only. The short run DRC is defined as: DRC,*,r = WL (4) VABP 9. In its present form, the ratio can be viewed as a measure of efficiency in that activity. A DRC ratio greater than one implies that the domestic resource cost exceeds its opportunity cost or VABP, which suggests that the activity is inefficient. Conversely, a coefficient smaller than one suggests an efficient activity. By definition, long-run DRC must exceed its short-run value. One application of a short-run DRC might be to check efficiency in the short-run if the long-run coefficient exceeds one. The firm could continue to operate in the short-run under these circumstances. However, in a country like Jordan where retrenchment is highly unusual, management tends to treat labor as a fixed cost. Therefore, the short-run DRC is of dubious valtie. The focus should be on long-run DRC. 10. Methodology. When the study was conceived, we intended to visit about 22 firms with the expectation that this would yield about 19-20 useful firm-level results or about 30-35 activities in a wide range of products. The range of firms included highly protected industries such as beer and 1/ The cost of these resources plus profit should sum to value-added.  _ 99 _ ANNEX B Page 3 of 23 cigarettes as well as unprotected industries such as pharmaceuticals. Detailed questionnaires attached as Table 2 were prepared to be sent to 22 firms in advance of the mission's arrival. The questionnaires were sent from the Bank to the Ministry of Planning which in turn maile'. them to the survey participants. Unfortunately, due to time constraints, the sample size was reduced. Only fifteen firms were visited, from which we could get about 12 completed questionnaires for 23 product lines. The exact products (activities) are listed in Table 1, and the companies visited are listed below. 1. Jordan Cement Company 2. Jordan Lime and Slicate Brick Industries Company 3. Jordan Pipes Manufacturing Company, Ltd. 4. Jordan Wire Manufacturing Company 5. Jordan Metal Industries 6. Jordan Brewery Company, Ltd. 7. Jordan Spinning and Weaving Company, Ltd. 8. Jordan Wood Industries Company 9. Jordan Ready-to-Wear Manufacturing Company, Ltd. 10. Arab Aluminum Industries Company, Ltd. 11. Jordan Glass Industries Company, Ltd. 12. Jordan Tobacco and Cigarette Company. II. Assumptions In order to fill up the detailed form attached as Annex, we made the following assumptions regarding prices of input and outputs. Capital and Labor Costs. To obtain an annual capital charge, the first step was to obtain the value of the capital stock in use. Here again the idea is to obtain the replacement value of the stock; so we asked what it would take today to buy a new plant which does the same function as the present one rather than obtain the book value of the capital stock. The latter is simply an accounting artifact used for tax purposes. The value of the capital stock was then converted to an annual charge using an interest rate of 8.75 percent (which is the standard onlending rate of IDB for medium and long-term loans to industry) using a straight line 'epreciation method as follows: Annual Charge = A*(value of capital stock) where, A = r (I + r) (1 + W)1 where r = rate of interest and n = life of the machine Whenever different components of the capital stock (such as land, machinery, vehicles, etc.) could be obtained, the annual charge was calculated on each one of tbhse separately and added up to arrive at the annual charge of the capital stock as a whole. The capital costs as calculated above plus the total wages paid to the local workers make up the numerator of the DRC formula (3). Foreign laborers are, however, assumed to repatriate 50 percent of their earnings.  - 100 - ANNEX B Page 4 of 23 Therefore, 50 percent of the wages paid to the foreign laborers are considered variable costs and are treated as variable inputs in calculating the value added. Multiple Products. In our exercise, we tried to disaggregate as much as possible the costs and revenues associated with the number of products produced by the same firms (example - adult and children's jeans). We found that it was easy to do this for revenues and variable input costs. In instances such as electricity or capital stock, however, the costs were allocated to each product in proportion of the value of output. Border Prices for Outputs and Inputs. Where a product was import competing, the price of a comparable import was obtained either directly from the producer or from the 1985 trade statistics. If the import of a competing import was banned, the CIF price was obtained either by interviews 2/ with firms or from t:ade statistics of an importing country such as Mauritius. A transport cost of 10 percent of value of the product was added if the import was sourced from Europe or 15 percent if it was sourced from the Far East. If a product was both exported and sold in the domestic market, the export price was used as the border price. III. Results Table 1 presents the results for twelve firms and 21 product lines, some of which are mainly exportables and others mainly import substitutes. An example of how the calculations are carried out step by step is provided in Table 3. The explanations of steps involved in the computation given in Table 1 are presented below. Column 1, Domestic Output Value: For each product line this gives the value of output at exfactory prices excluding any excise tax such as that in the case of cigarettes, beer, cement, etc. Column 2, Domestic Input Value: Value of inputs consumed in producing the output given in Column 1. All inputs valued in domestic prices including taxes and internal transport cost. Column 3, Domestic Value Added: Gives the value added at domestic prices. (Column 1 - Column 2). Column 4, International Output Value: Value of output at international prices. For an import substitute, we used the price of a comparable product available in the world market prices based on discussions with Jordanian manufacturers, importers and in some cases looking at import data of a third country. Column 5, International Input Value: Value of inputs valued at world prices. For domestically-bought inputs, we used domestic prices. For imported inputs, we used the border price net of taxes and internal transportation costs. 2/ Firms generally know the price of a comparable product on the world market.  - 101 - ANNEX B Page 5 of 23 Column 6, International Value Added: Value added at international prices, i.e., Column 4 - Column 5. Column 7, Government Transfers: Presented mainly a memo item. These are mainly relevant in the exportable products. In these cases, the column includes both the dirty drawback on imported inputs and any subsidy over and above this. This Government subsidy, defined in this manner, is included in calculating the value of output in domestic prices and excluded while calculating the value of output at international prices. Column 8, Output NPR is the nominal protection given to the output, i.e., domestic output value divided by international output value minus 1, or (Column 1/Column 2) -1, the quantity if expressed as a percent increase. Column 9, Input NPR: Defined as Column 8 for imputs, i.e., (Column 3/Column 4) - 1 Column 10, Activity EPR is defined as (Column 1 - Column 2)/(Column 3 - Column 4)) - 1 i.e., value added at domestic prices divided by value added at international prices minus one expressed as a percentage. Column 13, Short-run DRC: Labor cost divided by value added at international prices minus one. Column 14, Long-run DRC: (Labor cost plus capital cost) divided by the value added at border prices, minus one.  innk it JtbJiLl Uq lit I-I LEVEL. SIEVE 22-Apr-07 I 2 3 4 5 6 7 8 a 10 It 11 11 23 i 2FIU PROWUC :3U.DUTPUT MN.I.413 NK.VU If- INT.MTPUT IUI.UMU IKT.VALI- SWIIUM,I SITUT tWh ACTIVITI IASOI CWITAi. S1(0t411 t~G-mU NAIKT 2VALKE VM.IE AMlE VAE VALE AmlE IUISFE W onM EMR COST COST OK IOC I 2WU11IES t/s I DER 1193.1 751.4 441.7 362.90 175.20 207.7 73. 211.6 326. 112.7 182.31 199. 0.673 1.626 2 ICIoTIE COIPS IS t OIUIIS I 16992.7 1505. 10471.2 146534 40414.4 10614.0 0.0 15. 60.9 -1.3 1652.& 519.5 0.174 0.223 * ~~~~~~EVPORt CIUAIETE 21 2440.3 937.9 1510.4 2133.? 53.1I 1530.1. 33.3 15.9 60.6 -t.3 266.9 74.9 0. I74 0.223 3 KIMMIEKUB I *33 EXPOR I CMTTO YARN 2755.4 1399.7 1355.7 2681.30 1365.00 1296.3 74.1 2.6 1.1 4.6 401.1 2315.8 0.309 0.476