Jordan - Industry and Trade Policy Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-5194-JO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$150 MILLION TO THE HASHEMITE KINGDOM OF JORDAN NOVEMBER 27, 1989 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  JOR DAN INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN CURRENCY EQUIVALENTS End of Period U.S.$ Per 1 Jordanian Dinar (JD) 1983 2.755 1984 2.604 1985 2.538 1986 2.858 1987 2.952 1988 2.690 1989 1.484 Glossary and Principal Acronyms CCC Gulf Co3peration Council BOP Balance of Payments CBJ Central Bank of Jordan EI Law Encouragement of Investment Law QRs Quantitative Restrictions PER Public Expenditure Review EDF Export Rediscounting Facility Government of the Hashemite Kingdom of Jordan Fiscal Year January I - December 31  FOR OFmFCIAL USE ONLY JORDAN INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN TABLE OF CONTENTS LOAN SUMMARY Chapter Page No. I. THE ECONOMY. . ........ 1 A. Economic Developments 1982-88 . . . . . . . . . . . . . . . 1 B. Government's Policy Response and Its Impact . . . . . . . . 5 II. A MEDIUM-TERM STRATEGY FOR SUSTAINABLE GROWTH . . . . . . . . . 9 A. Policies for Reducing Macroeconomic Imbalances . . . . . . 9 B. Policies for Growth and the Nature of the Supply Response. ll C. Policies for Protecting the Poor . . . . . . . . . . . . . 11 D. Macroeconomic Framework . . . . . . . . . . . . . . . . . 12 III. THE PR'OPOSED INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN . . . . . . . . . . . . . . . . . . . . 18 A. Background ... . . . 118 B. Description of the Proposed Operation . .18 C. Administrative Arrangements . . . . . . . . . . . . . . . 25 D. Loan Conditions ..27 E. Justification and Risks . . . . . . . . . . . . . . . . . 29 IV. COUNTRY ASSISTANCE STRATEGY AND BANK OPERATIONS . . . . . . . . A. The Context of Bank Assistance: The Government's Own Development Objectives . . . .30 B. Bank Strategy .30 C. Sectoral Composition of Bank Lending . . . . . . . . . . . 32 V. RECOMMENDATION .34 This document has a restricted distribution and may be used by recipients only in the performance of their offi-ial duties. Its contents may not otherwise be disclosed without World Bank authorization.  JORDAN INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN LOAN SUMMARY Borrower: The Hashemite Kingdom of Jordan Amount: US$150 million Terms: 17 years, including a five-year grace period, at the Bank's standard variable interest rate. Objectives and Description: The proposed loan would suppurt the Government's ongoing structural adjustment program designed to lay the basis for sustainable long-term growth, which is supported by an IMF Stand-By Arrangement and compensatory financing (of about US$100 million over an 18-month period). The proposed loan would include measures to ensure a competitive and stable macroeconomic environment; to improve the competitiveness and efficiency of industry and trade; to rationalize public expenditure; and initiate a program to protect the poor during the adjustment period. It aims to strengthen the most important sources of growth in the Jordanian economy, i.e., the expansion and diversification of industrial output and exports. The proposed loan would support policy reforms to create a more uniform, non-distortionary set of incentives across different sectors in the economy by (i) rationalizing the trade regime and replacing the current system of investment incentives by one that is simpler and more transparent; and (ii) strengthening the institutions that support industry and exports. Benefits and Risks: The reforms supported by the proposed loan are expected to reduce macroeconomic imbalances and create a more favorable environment for overall economic and sectoral growth at a time of resource constraints. In particular, reforms in the trade regime and reforms of institutions supporting export promotion,  -ii- industrial infrastructure and standards are expected to make the manufacturing sector a more efficient producer of export products and import substitutes. Risks relate to the length and difficulty of the adjustment process, possible social and political pressuies, unpredictable developments in the external environment, and uncertainties in the response of the private sector. These risks are mitigated by the Government's strong commitment to the objectives of the adjustment program, as shown by the significant reforms already taken. Fiaally, the proposed loan includes measures to support the Government's strategy for protecting the poor during the adjustment period. Estimated Disbursements: Of the proposed loan of US$150 million, US$148.5 million would be disbursed against general imports (subject to a negative list), US$0.5 million for the technical assistance program for industry and trade, and US$1.0 million towrards a program to assist the poor by reorienting and improving the efficiency of social services delivery organizations. The disbursement schedule is provided at Annex X. The proceeds of the proposed loan to be disbursed against general imports would be disbursed in two tranches: US$75 million following loan effectiveness and the balance of US$73.5 million subject to the satisfactory implementation of agreed policy measures. The remaining US$1.5 million would be disbursed against the technical assistance programs in industry and trade, and for assisting the poor. Release of the second tranche is expected eight months after effectiveness. Cofinancing of up to US$150 million equivalent is being sought from Japan and US$17 million equivalent from the Federal Republic of Germany. Staff Appraisal Report: This is a combined President's and Staff Appraisal Report. Map-, Number IBRD 12120R4.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN TO THE HASHEMITE KINGDOM OF JORDAN 1. I submit the following report and recommendation on a proposed loan for the equivalent of US$150 million to the Hashemite Kingdom of Jordan to support an industry and trade policy adjustment program. The proposed loan would have a term of 17 years, including a grace period of five years, at the Bank's standard variable interest rate. Cofinancing of up to US$150 million equivalent may be obtained from the Goverimnent of Japan and up to US$17 million equivalent from the Government of the Federal Republic of Germany. PART 1. TH- ECONOMY 2. "Jordan: Policies and Prospects for Small- and Medium-Scale Manufacturing Industries" (Report No. 6848-Jo) was circulated to the Executive Directors in January 1988. A mission to review major economic trends visited Jordan in November 1988. The findings of this mission, as well as those obtained at the time of appraisal of the proposed loan in May 1989, the subsequent mission in August 1989, and the IMF Article IV consultation/use of Fund resources mission in March 1989, are reflected in this section of the report and -in the country data in Annex I. A. Economic DeveloDments 1982-88 3. Economic trends in Jordan are an outcome of the country's proximity to an oil-rich region and its unique structural features. Jordan has a very large services sector, accounting for nearly 60% of GDP. By contrast, it has an extremely narrow productive base. Apart from its educated and hard-working people, its only natural resources are phosphate, potash and limestone. Less than 5% of its agricultural land is arable, virtually all of its oil has to be imported, and water is an increasingly scarce resource, with competing demands fro:a irrigation, urbanization and industrialization. 4. Conscious of the country's unique geographical situation and narrow productive base, the Government pursued liberal, outward-looking policies in Lrade, labor migration and foreign exchange transfers during the 1970s. Incentive policies were increasingly geared to promoting private enterprise. These policies enabled Jordan to respond to emerging opportunities .A neighboring countries during the late seventies. Stimulated by large remittances from Jordanians working abroad, the introduction of improved agricultural technology, Lne rise of mining exports, the rising demand for Jordanian manufactured products in neighboring countries, and increased grant aid, the economy operated at full employment and grew by about 10% p.a. from 1978 to 1982. Jordan's productive base expanded and became increasingiy diversified, and the standard of living improved. While both the current  -2- account balance of payments and the budget showed substantial deficits, these were largely covered by foreign grants. Foreign burrowing was not excessive and inflation remained low. 5. The rapid decline in the price of oil and the subsequent slowdown in regional economies, which began in 1982, adversely affected the Jordanian ecotlomy in three ways. First, there was a reduction in the demand for Jordanian goods and services in neighboring countries, resulting in a decline in the export of agricultural and manufactured goods which are sold almost exclusively in regional markets. Second, there was a slowdown in the out-migration of Jordanians; this caused a stagnation in remittances and created unemployment within Jordan. Third, between 1982 and 1988, there was a 30% reduction i1n grant aid. Grant aid has traditionally financed about 30% of Jordan's imports and amounted to about 80% of domeatic tax and non-tax revenue. This decline put a severe strain on the Government's budgetary operations, as well as on its balance of payments (Table 1). 6. The regional recession not only affected the external demand for Jordanian goods but domestic demand as well. Consequently, there has been a drastic slowdown in growth, which has become more pronounced since 1984: during 1984-88, real output growth slowed to about 2.5% p.a., and total investment fell by about 5% p.a. Given the continuing high population growth of about 3.8% p.a., Jordan experienced a sharp fall in per capita income and a decline in its standard of living. 7. Unemployment was another product of the recession. In 1986, the last year for which data are available, nearly 40% of the Jordanian work force was employed in the six Gulf Cooperation Council (GCC) states. Out-migration to the GCC, which had growr, by 2%-3% p.a. during 1975-82, has since fallen to zero. Thus, after experiencing almost full employment during 1975-82, nearly 10% of Jordanian workers were unemployed oy 1986. The unemployment situation is certain to have worsened since then, given demographic trends, the increasing participation of women in the labor force, and the continued presence of low-wage guest workers who constitute about 20% of Jordan's labor force. 8. Jordan's fiscal performance has also deteriorated since 1983, after steadily improving during the previous five years. The overall budget deficit (including grants) was brought down from over 17% of CDP in 1978 to under 5% of GDP in 1983. It has increased steadily since then and in 1988 stood at 14.7% of GDP. This worsening trend reflects: (i) the increase in public investments from 13% to 20% of GDP over 1983 to 1988; (ii) an increase in current expenditures from 33% to 37% of GDP; and (iii) a decline in budgetary grants from 14% to 8% of GDP. These three negative trends have more than offset the steady increase in revenue from 28% of GDP in 1983 to about 32% of GDP in 1988. 9. Historically, Jordan's balance of payments (BOP) has shown a large current account deficit (CAD), the result of a very high dependence on imports and an extremely narrow base for exports. In 1984-88, the CAD averaged about 20% of GDP. However, about 75% of this deficit had been financed by grants, thus limiting commercial financing to only about 5% of GDP.  -3- Table 1: MACROECOoNOIC TRENDS (1978-89) .............................. 1978?82 1982-84 1985 1986 1987 1988 1989 (period averages) Est. Proj. National Accounts Real Growth Rates 1/ (percent per ennum) ........................................ Gross Oome tic Product 8.0 3.9 3.5 5.4 3.2 -3.5 0.0 Agriculture 6.0 3.8 25.5 -3.5 14.3 3.6 1.0 Industry 11.3 3.9 -0.6 4.2 5.8 -12.3 3.2 (01/ SH.) 12.8 1.3 -1.3 *1.7 8.5 -4.1 3.0 Construction 22.6 -2.9 -11.2 0.4 -8.0 -30.9 3.0 Services 7.: 2.5 3.4 1.4 3.7 -1.. -1.3 Consumption 7.7 2.6 1.1 -6.7 3.1 -2.6 -7.2 Investment 19.8 -14.1 -0.9 1.9 -7.9 -13.3 -0.5 BaLance of Payments *----.-.------------ (as percentage of GOP at market prices) Current Account after Grants *2.5 -8.7 -6.3 -1.0 -7.0 -6.2 -2.7 (real growth rates, percent per an;nu) Exports of Goods 2/ 16.5 17.3 0.8 2.3 19.3 11.6 1.1 mports of Goods 9.5 -1.2 3.1 5.1 3.6 -0.8 -8.0 (millions of US Dollars) Remittances 3/ 807 1144 1023 118S 938 903 876 official Grants 999 837 740 633 599 566 483 Public Finance Total Revenue 4/ 25.4 27.8 27.4 31.4 31.5 31.8 29.6 Current Expenditure 35.5 32.7 33.7 35.0 35.9 38.8 38.4 Capital Expenditure 20.7 14.7 13.3 16.1 19.1 13.4 10.4 Budget Deficit 5/ -11.8 -7.6 -7.0 -9.3 -11.8 -14.7 -11.4 (millions of Jordanian Dinars) Capital Expenditure 615 566 214 265 322 349 408 Debt Indicators (as X of Exports of Goods, Services and Remittances) D............... Debt Service Ratio, civilian (ORS) 5.4 6.5 11.3 12.7 16.3 Debt Service Ratio, military & other 16.2 16.1 12.3 16.0 11.4 Debt Service Ratio Total 6/ 21.6 22.6 23.5 28.6 27.7 38.7 35.9 (as percentage of GNP at market Prices) DOD NLT (civilian onLy)/GNP 34.5 43.7 58.0 59.0 62.9 70.0 99.7 Total DOD/GNP na na na na na 143.6 246.1 7/ Source: ministry of Plannring and mission estimates. 1/ GmP is at market prices; sectoral data are at factor cost. 1/ COP is at market prices; sectoral data are at factor cost. 2/ Domestic goods only. 3/ Includes remittances of short-term migrants. 4/ Revenue excluding grants. 5/ Budget deficft inctuding grants. 6/ Total debt service payments before 1989 are estimated from the balance of payments. 7/ High ratio is in part due to a re-estimation of GNP at a depreciated exchange rate.  -4- 10. During the early 1980s, Jcrdan's BOP deteriorated as a result of the increase in the price of oil and the decline in grants. The CAD (including grants) increased from 2.5% of GDP during 1978-82 to 8.7% of GDP during 1982-84, resulting in a substantial increase in foreign borrowing and an accumulation of foreign debt. Since 1984, however, real imports have grown by less than half the rate of real exports. In addition, import prices have fallen by as much as 6% p.a., or, on average, two percentage points faster than export prices. As a result of these developments, the CAD (including grants) has fallen from 8.7% of GDP in 1982-84 to 5.2% of GDP in 1384-88. Despite this decline in CAD the overall balance of payments came under severe strain after 1984, due to the buildup of military debt (see para. 14 below). 11. In 1988, notwithstanding some improvement in the CAD, the overall BOP continued to deteriorate. There was a sharp increase in the debt service payments due on civil and military debt. The trade credits owed to Jordan by some of its neighbors (nearly US$450 million by the end of 1988) remained unpaid. There was also political uncertainty regarding the status of the Palestinians following King Hussein's announcement delinking Jordan from the West Bank; this resulted in capital flight not captured in official statistics. All of the above created speculative pressures on the JD and reduced the reserves at the Central Bank of Jordan (CBJ) to less than two weeks of imports towards the end of 1988. 12. External Indebtedness: Comprehensive statistics on Jordan's stock of external debt are only available for end-1988, which forms the basis for estimates of future debt service. For the past, data on civilian debt can be obtained from the Bank's Debtor Reporting System (DRS). The data on the remaining (largely military) debt are obtained from the Government. 13. On the whole, the increase in Jordan's indebtedness can be traced to the increase in the CAD after grants during 1982-84 and the rapid build up of military debt after 1984. Jordan's civilian medium- and long-term (MLT) debt outstanding and disbursed (DOD), about which there is detailed information in the Debtor Reporting System (DRS), rose from 32% of GNP in 1980 to almost 70% of GNP by 1988. However, nearly 50% of this debt is concessional. As a result, civilian debt service obligations, as a proportion of exports of goods and services, remained low, despite rising sharply from only 5.3% in 1980 to 18.9% in 1988. Since 1984, the rate at which new civilian debt has been contracted has slowed down drastically as a result of the reduction in the CAD after grants. Commitments have fallen from a high of US$593 million in 1984 to about US$188 million in 1988. 14. In addition to the civilian debt, Jordan has also contracted substantial military debt mainly during the period after 1984, almost doubling its civilian debt service ratios during 1980-87. In 1988, the payments on known military and civilian debt rose sharply. In addition, the estimates of total debt (outstanding and disbursed) were revised upwards by US$2.7 billion. As a result, in 1988, Jordan's debt/GNP ratio increased to about 144%, and the debt service ratio increased to 39%. By 1988 Jordan was a highly indebted country which was not in a position to fully service its debt. For the future, Jordan's solvency and creditworthiness depend upon the strength and credibility of its adjustment program, the external environment, and its success in obtaining concessional financing. These are discussed in detail in Part II.D.  - 5 - B. Government's Policy Response and Its Impact 15. Although fragmented, the response of the Jordanian Government during the early 1980s to the economic slowdown was designed to protect the existing productive enterprises. The response was perhaps based on the optimistic assumption that the difficulties being experienced by the oil surplus countries, and their consequences to the Jordanian economy, were temporary. In the agricultural sector, a system of production licensing and subsidies was introduced in 1985 to reduce the output of crops which faced marketing difficulties abroad. In addition, production was supported by highly subsidized inputs, and self-sufficiency in cereals was encouraged by offering high purchasing prices to farmers. In the industrial sector, in the early 1980s, high import tariffs and bans on competitive imports were introduced to protect domestic producers from falling demand. Although these bans protected a large number of producers, their macroeconomic impact was small. The banned imports amounted to only 3% of the total value of imports before the ban was imposed, and, by and large, Jordan's trade and payments system remained relatively open and free of non-tariff barriers. Finally, tax concessions and other incentives were- offered to private investors, and bilateral trade agreements were increasingly seen as an instrument for expanding trade with neighboring countries. 16. The first adverse consequence of the policy stance maintained by the Government in the early 1980s was a steady erosion in the internation-I competitiveness of goods and services produced within Jordan. In the face of falling grants and remittances,-Jordan's nominal exchange rate was maintained through expanded external borrowing and a drawdown of resources. Since 1984, most of the export growth can be accounted for by phosphate and potash. Exports of agricultural and manufactured products have fallen and remain overwhelmingly concentrated in the Middle Eastern markets. At the same time, falling wage rates in Saudi Arabia and Kuwait, combined with the strong Jordanian dinar, have considerably narrowed the wage differential between Jordan and the regional labor market. This has eroded the incentive to migrate, resulting in stagnating remittances. Finally, the high real wage in Jordan has stifled the growth of commercial services, such as computer software development, engineering consultancy, advertising and maintenance contracting. All of these could be important sources of growth given Jordan's skilled labor force and well-developed infrastructure. 17. The second consequence of the Government's policy stance during the early 1980s was growing macroeconomic imbalances which accentuated the structural problems with the budget and balance of payments. During the early 1980s, Jordan followed a budgetary policy of increasing the tax effort, cutting back on capital expenditures, and financing the deficit by borrowing from abroad. However, Jordan's tax base was narrow, i.e., excessively dependent upon import duties without a broad-based consumption tax. Jordan's expenditures, on the other hand, were ir.creasingly dominated by non-discretionary expenditures, such as debt service payments, pension and social security payments. Finally, the Government was overly dependent upon grants and borrowing from abroad to finance the deficit which quickly became constrained by the increased debt burden. 18. By late 1987, the Government realized -that the regional recession was not a temporary, cyclical phenomenon and that stronger and more permanent measures were needed. The Government initiated some reforms in early 1988 and accelerated the process towards the end of 1988 and earlv 1989 in  -6- response to the emerging balance of payments difficulties. The reform process culminated in the adoption of a coiiiprehensive medium-term adjustment program supported by an IMF Stand-By arrangement (approved by the IMF on July 12, 1989). The increase in prices associated with the Government's program touched off social disturbances in April 1989 and led to the fall of the Government in May 1989. The new Government has, nevertheless, indicated its firm commitment to the reform program and has maintained the pace of the reform set by the previous Government. The main elements of the reform program implemented so far include: a series of measures to reduce the budget deficit such as a hike in taxes and petroleum prices and more restraint in public expenditure; a freeze on new external borrowing; a large devaluation of the dinar; the deregulation of the financial sector, involving a freeing up of interest rates and an increase in the ceiling on funds held abroad by cimmercial banks; and a package of measures to stimulate industry and trade. Most of these actions were recommended in the Bank's economic and sector work and formed the core of the policy dialogue w,'ith the Government. The measures that have alr2ady been implemented are listed below and summarized in the policy matrix attached as Auinex IV. (i) Exchange Rate: 19. In October 1988, the CBJ withdrew its commitment to buy and sell Jordanian dinars (JD) at the official exchange rate, thereby, effectively floating the JD. This led to an immediate deoreciation of the dinar from 0.33 JD per US dollar to about 0.50 JD per US dollar. This depreciation was accompanied by the emergence of different, and highly fluctuating, exchange rates for transactions carried out by the CBJ, commercial banks, and money changers. To deal with the resulting volatility and speculation in the foreign exchange market, the CBJ and the commercial bank rates were unified at 0.54 JD/US$ on February 8, 1989. All transactions were to be carried out at this new rate, and the CBJ was to intervenc in the market to maintain stability and to ensure balance between the demand and supply of foreign exchange. At the same time, the money changers were closed down because the Government believed that they were indulging in speculative and illegal activities. 20. The economy's underlying financial difficulties, however, continued to create an excess demand for foreign exchange and exert a downward pressure on the Jordanian dinar. Beginning in April/May 1989, the commercial banks began to charge commissions on top of the official exchange rate set by the CBJ, depreciating the JD by as much as 15% to 20% in commercial transactions vis-a-vis the official CBJ rate. Recognizing that the CBJ was not in a position to support the JD at the official rate, on July 31, 1989, the Government announced that the exchange rate to be used for commercial transactions (accounting for about 80% of the import of goods and services) would be floated. The exchange rate used for the import of fifteen essential commodities, and to pay for the expenses of students studying abroad, would be the official CBJ rate. These rates are to be unified, at the latest, by March 1990 in line with the IMF agreement. As soon as this policy was adopted in August 1989, the official rate was set at JD 0.57/US$, and the market rate dropped to JD 0.83/US$. As of November 1989, these rates had moved closer to each other and were JD 0.63/US$ and JD 0.69/US$, respectively, indicating a substantial depreciation of the JD vis-a-vis the exchange rate of 0.33 JD/US$ in early 1988. 1/ 1/ The nominal exchange rate of 0.54 JD/US$ prevailing in April 1989 amounted to a real effective depreciation of 23% from its value in April 1988. Since then a further real depreciation could be expected due to the nominal depreciation in August 1989.  -7- (u) Interesit Rates: 21. During most of the 1980s, Jordan's financial system operated under a fixed interest rate structure set by the CBJ. Inflation in Jordan, however, has been very low (less than 5% p.a. between 1982 and 1987), resulting in positive real interest rates. In late September 1988, the CBJ decontrolled interest rates on consumer credit balances, call deposits and all types of time deposits. The base lending rates on direct credit facilities for resident customers in JD are fixed at 9% and for non-residents at 12%. Lending rates, however, were actually deregulaLed, as banks were free to charge commissions over and above these interest rates. In keeping with the IMF's Stand-By Arrangement, the Government is in the process of completing the necessary legislative and administrative procedures to free the base lending rate, which will be freely determined by market forces. D) Budgetary Policies: 22. The 1989 budget emphasized austerity. On the revenue side, average income taxes were raised; rental income deductions were reduced; interest on deposits outside Jordan was made taxable; tax exemptions for education expenditures were restricted; a 10% surcharge was placed on hotel bills; the airport tax was increased from 10 to 25 JD; and a 3% surcharge was placed on airline tickets. On the expenditure side, all purchases of furniture and vehicles were halted, regardless of the source of financing. For any purchase above JD 50,000, approval from the Council of Ministers was required. All expenditures on new infrastructure and service projects were halted, and military expenditures were maintained at the 1988 level, in nominal terms. By April 1989, however, it was evident that the favorable impact of the above measures was largely offset by other factors. Budgetary subsidies on wheat, barley, sugar, rice and powdered milk were projected to reach JD 60 million (3% of GDP) by year-end, due to the Government's decision not to raise their prices following the devaluation of the JD. Similarly, in the absence of a price pass-through of devaluation, the profits from the sale of petroleum products were projected to decline to JD 20 million, compared with JD 68 million in 1988, and the banning of luxury imports reduced custom receipts by about JD 23 million. In addition, interest payments on external loans rose sharply due to large payments falling due and the depreciation of the exchange rate; transfers to pensions were also higher due to the early retirement of Jordanian teachers in the West Bank. 23. Recognizing that its target of medium-term budgetary viability would be jeopardized, the Government implemented additional measures in mid-1989. These measures, which involved ad hoc increases in taxes on a number of goods, should be thought of as emergency, interim, actions which will be reviewed in the context of the overall rationalization of the tax system currently underway. Together, these measures will have a projected budgetary impact equivalent to 4.5% of GDP on an annual basis. They included: (i) increases in domestic petroleum product prices ranging from 11% to 33%; (ii) an average increase of 25% in the tax rate on local and imported cigarettes; (iii) a 40%-50% tax increase on alcoholic drinks and an 18% tax on soft drinks and mineral water; (iv) a 25% tax increase on detergents; (v) a 67% increase in taxes on steel bars; (vi) new telephone charges; (vii) the doubling of water charges in the Jordan Valley; (viii) increases in fees on car registrations and licenses; and (ix) new royalty taxes on phosphate and  -8- potash production. These measures were complemented by: a reduction in subsidies on barley, bran, olive oil, and powdered milk made possible by raising domestic retail prices; a reduction in, or the elimination of, subsidies for production and exports; and a reduction in capital expenditures. The likely budgetary impact of the most recent (August 1989) changes in the exchange rate (para. 20) is still unclear. Given that the rate has not changed for food imports, subsidies would be unaffected. The burden of debt service would increase, but this is expected to be more than compensated for by the likely increase in revenue from customs. The Government is observing the situation closely and stands ready to take quick corrective fiscal action if needed. (iv) Idustry: 24. In August 1988, the Government announced a number of measures to improve the operating environment for industry. These included the abolition of investment licensing, the elimination of import bans, and the strengthening of institutional support for production and exports (details at para. 55). 25. The measures described above were designed to achieve financial stabilization, as well as to shift incentives to exports and efficient import-substituting activities. Since these policies have been in place for only a short time, the response of the economy has been limited. While there has been no across-the-board expansion in output, there is evidence that markets are responding to the depreciation of the exchange rate. For instance, since late 1988, Jordanian manufacturers have signed large contracts to supply garmenFJ to the USA and Canada. Abolishing the old licensing system has resulted in over 1200 applications for new industries; so far, however, only a few of these have resulted in actual investments. Since August 1988, the Sahab Industrial Estate has signed on almost 60 new tenants, compared to an ainual average since 1981 of only 15. Finally, the Industrial Development Bank has seen a sharp increase in the demand for credit for new projects in the first quarter of 1989. 26. In sum, the adjustment problems facing Jordan are considerable. The productive base is small, and reliance on grants and remittances cannot be sustained in the changing, resource-constrained environmen:. Jordan's budgetary and balance of payments situation is fragile, containing a number of structural problems, and its external debt burden is high. On the positive side, Jordan's trade and payments system, and its capital markets, are relatively free and open. Also, Jordan has a well-functioning infrastructure and has avoided the expansion of the public sector into manufacturing, agricultural production, and agro-processing. 27. The Government has been quite responsive and courageous in taking measures to correct the rapidly deteriorating economic situation, and the pace of reform is being maintained in the face of severe social discontent. The measures implemented so far--aimed at reducing the budget deficit, curtailing public and private consumption, and shifting resources to exports and efficient import-substitution activities--have been in the right direction. However, given the magnitude of adjustment needed, the Government needs to accelerate the pace of reform and broaden its scope to restore sustainable growth.  -9- Part II. A MEDIUM-TERM STRATEGY FOR SUSTAINABLE GROWTH 28. The Government's main objective is to accelerate growth while maintaining financial stability and protecting the economically disadvantaged. Acceleration of growth in the Jordanian economy is critical, not only to stem the recent decline in per capita income, but also to provide employment for the country's growing labor force. A medium-term reform program designed to achieve the Government's objectives would involve: (i) reducing macroeconomic imbalances; (ii) generating growth by expanding and diversifying exports; and (iii) protecting the poor during the adjustment period. The main features of these reforms are discussed below and will be summarized in the Letter of Development Policy (Annex III). A. Policies for Reducing Macroeconomic Imbalances 29. A precondition for sustainable growth in Jordan is a reduction in the present imbalance between the supply and demand of domestic, as well as external, resources. Restoring balance would require policies that further reduce the budget deficit and improve the management of external resources. The Government has initiated a stabilization program, which has been supported by an IMF Stand-By Arrangement over an eighteen-month period, to implement these policies. The measures included in the program, some of which have already been implemented, are indicated below. 30. (i) Reducing the Budget Deficit: Growing budget deficits have been at the heart of the financial imbalances facing the economy. Continuing Jordan's fiscal deficit (including grants) at the 1988 level of about 14.7% of GDP is clearly incompatible with available resources, This deficit should not be financed with external borrowing, given Jordan's increased external indebtedness. At the same time, financing the deficit by domestic borrowing would "crowd out" private sector investment, as well as increase the burden of debt service on future budgets. The medium-term framework adopted by the Government (Table 2) calls for the deficit (including grants) to be reduced from 14.7% in 1988 to 6% of GDP by 1993. 1/ 31. The Government has already implemented a set of measures (see para. 23) which will reduce the budget deficit to 11.4% of GDP by end-1989, thereby making substantial progress towards achieving the medium-term target. A further reduction in the deficit, however, will require structural changes to Jordan's revenue base and to the pattern of expenditures. Jordan's revenue base is excessively dependent on import duties and on non-tax revenues such as transfers from the public sector telephone company and refinery. On average, during 1984-87, import duties amounted to 50% of tax revenues, and non-tax revenue amounted to nearly 50% of total domestic revenue. Jordan has no broad-based consumption or sales 1/ These targets were developed in May 1989 and were estimated at the prevailing exchange rate of 0.54 JD/US$. Hence, they do not take into account the exchange rate changes of August 1989 (para. 20). The deficits were estimated assuming a full repayment of the debt service due. The targets will be reviewed during the course of the IMF's mid-term review in November 1989.  - 10 - tax, and its income tax system is replete with exemptions which vitiate its efficiency and equity. Over the short term, the measures formulated by the Government to redress these problems include (i) a continuous adjustment of the customs evaluation rate to reflect the official exchange rate; (ii) an increase in excise duties and a change in tariff rates from specific to ad valorem; and (iii) the elimination of exemptions and tax loopholes. Over the medium term, the Government recognizes that the main source of additional tax revenues would have to be a general sales tax with a value-added format. Preliminary work has already been done in this area by the Government, with the assistance of the EEC and the USAID. In August 1989, an IMF mission from the Fiscal Affairs Department (FAD) completed a review of Jordan's revenue system and identified further revenue entiancing measures to be implemented over the medium term. 32. The scope for reducing current expenditures is becoming increasingly limited given the increasing share of debt service, pension and social security payments, and the transfers to decentralized agencies with no independent revenue sources in total expenditures. Further, while public sector employment has grown by about 5% p.a. during 1983-87, the real wage stagnated till 1987 and has since fallen sharply. Nevertheless, the Government recognizes that it must continue to limit wages and public sector employment, avoid subsidies, keep the rate of growth of expenditure on goods and services below the rate of inflation, and control extra-budgetary expenditures. In addition, savings can be generated from the elimination of budgetary transfers, excluding pensions, social security anid emergency relief operations. In spite of the decline in capital expenditures (in real terms) during the past five years, the-projects included in the public investment program need to be reassessed in terms of their contribution to growth and diversification of trade. 33. (ii) Improving the Management of External Resources: Emerging imbalances in the external sector show that, even if Jordan were to achieve modest gro%.th targets, its financing requirements would be substantial, amounting to almost US$4.3 billion, or US$1.4 billion, p.a. over the next three years (discussed in detail in para. 46). Managing Jordan's external resources thus involves actions to expand exports and reduce imports, complemented by efforts to raise concessional resources while keeping rescheduling to a minimum. A key policy in improving the trade account is the exchange rate. In the context of the Stand-By Arrangement with the IMF, the Government is committed to following a flexible exchange rate policy and to a unification of rates by March 1990, as has been discussed in para. 20. 34. Given these substantial financing requirements, a viable reform program should also include a cautious borrowing and debt-management strategy. In view of Jordan's high debt service burden, the Government has set fairly stringent limits on commercial borrowing. '1oreover, the Government has concluded a successful rescheduling of external debt owed the Paris and the London Clubs. The Government has also asked the Bank to examine the usefulness of organizing a donors' conference to raise the financing needed for the adjustment program. The details of a financing strategy are presented in paras. 44-50.  - 11 - B. Policies for Growth and the Nature of the Supply Response 35. Jordan's future pattern of growth is likely to be very different from that in the past and will call for a restructuring of the economy. While past growth in consumption and investment relied upon the growing availability of external resources in the form of grants and remittances, future growth will have to rely upon expanding the productive base. While past growth was based on expanding regional export markets, future growth will have to cope with sluggish regional markets and will require penetrating new markets. Unlike in the past, prospects for expanding the production of Jordan's natural resource-based industries such as potash and phosphate are limited. Currently planned investments in this sector are mainly designed to increase value-added by the downstream processing of minerals. Thus, future growth will have to originate in small- and medium-scale industries, in agriculture, and in commercial services and be based on exports to non-regional markets. This is possible only if the international competitiveness of these sectors is increased substantially. 36. The most important policy to increase the international competitiveness of Jordanian goods and services has been the substantial real depreciation of the exchange rate, which the Government has done since late 1988. As indicated above, there is already evidence of a positive supply response from both exports ar.d efficient import substitution industries. This policy needs to be followed up by a further rationalization of Jordan's trade regime, which involves reducing the range of variation in tariff rates, simplifying customs procedures and substituting tariffs for quantitative restrictions (QRs) on luxury goods. Investment incentives also need to be more sharply focussed on exports and become less discretionary. These policies would restructure incentives, making the economy responsive to changes in the external environment and allowing resources to flow to sectors in line with their comparative advantage--thereby laying the basis for growth. 37. A restructuring of incentives, in order to be effective, needs to be complemented by a strengthening of the institutions which support exports and industrial production. As explained in detail in Part III, the thrust of institutioial reform would be to reduce overlapping responsibilities and strengthen the focus of existing arrangements, rather than create new institutions. Towards this end: (i) the institutional responsibility for export promotion needs to be clarified; (ii) the present system of providing export finance needs to be improved; (iii) the administration of industrial standards, currently done by twelve organizations, needs to be simplified and improved; and (iv) the new institution resulting from the merger of the Industrial Estates Corporation and the Free Zones Corporation needs to be strengthened to improve the provision of services to entrepreneurs, as well as to provide a focal point for export promotion. C. Policies for Protecting the Poor 38. The nature of poverty in Jordan is very different from that in Asian or African countries. A long period of high growth, full employment, and substantial public expenditures on social services during the 1970s helped Jordan significantly reduce absolute levels of poverty, as well as improve the country's distribution of income. Jordan enjoys universal primary education; 902 of the population has access to electricity and safe  - 12 - water in their homes; and there is very little evidence of widespread malnutrition. Since 1982, however, the incidence of poverty has increased, as a result of sluggish growth, narrowing opportunities for employment at home and abroad and the high cost of migrating away from established family structures. The poor in Jordan are thus disproportionately concentrated in rural areas such as Maan and Karak in the south rather than in Amman. Poor households also tend to have large families and have low productivity/low income occupations. 39. Over the medium term, the proposed reform program can be expected tc have a positive impact on the poor in Jordan. Reforms would restructure the economy and expand the productive base, which in turn would increase domestic employment. In addition, maintaining a competitive exchange rate would help Jordanians expand their share of the regional labor market in teachers, health workers, and public administration professionals. In the short run, however, the adjustment program could adversely affect the poor. The restructuring of production set in motion by the adjustment policies could result in an increase in unemployment, unless retraining programs are instituted in parallel. The growth in public sector employment will be curtailed as a result of a compression in government spending, and expenditures on critical social services could be jeopardized as a result of cutbacks in public expenditures. 40. The Government has adopted a comprehensive program to protect the poor during the adjustment period. The first, and in some ways most significant, element of the government program consists of reorienting and improving the efficiency of existing government and non-government organizations already engaged in helping the poor (discussed in detail in Part III). The Bank would (i) assist in creating an apex agency to coordinate and improve the efficiency of the existing network of organizations; (ii) help the Government formulate a medium-term strategy for helping the poor; and (iii) provide seed money to raise additional bilateral resources. Second, the Public Expenditure Review, to be carried out with the assistance of the Bank, would be designed to protect expenditures on basic social services such as health, education and low income housing in addition to rationalizing recurrent expenditures and improving the efficiency of public investment. Third, the Government would strengthen the job search and placement capacity of the Ministry of Labor and devise schemes for on-the-job training to improve the employment prospects of Jordanians. The Government is currently working with the Bank on a Human Resources Developmer,t Project, recently approved by the Board, to enhance the quality, flexibility and, hence, the employability of Jordan's workforce, as well as with the ILO and the UNDP to create a labor market information system and to improve the effectiveness of vocational training facilities. D. Macroeconomic Framework 41. Even with the successful implementation of the program described above, Jordan's growth prospects are expected to be modest, as indicated in Table 2. The real GDP growth rate would accelerate to about 4.0% p.a. by 1992, while the rate of domestic inflation is projected to decline roughly to the same level as international inflation (6.5% p.a. by 1993). Manufacturing is expected to be the lead sector, growing by nearly 5.5% p.a. by 1993; agriculture would grow more slowly at 3.5% p.a.; and services would grow more or less in line with the increase in population.  - 13 - 42. Projections for the balance of payments are consistent with the projections of the GDP. Exports are projected to grow by 4.5% p.a. ove- 1988-93, higher than the growth of GDP. The main sources of this growth, fruits and vegetables and manufactured products, are expected to grow by 5% and 7%, respectively. This pattern of growth reflects gains in competitiveness and the outward orientation of the economy as a result of the real depreciation of the exchange rate since late 1988. Imports are projected to grow slowly during 1990-91. After this, growth accelerates to about 3.6% p.a. During the initial period, the slow growth of imports can be attributed to the substitution of imports by domestically produced goods in consumption and production and the existence of excess capacity following a period of negative or low output growth. The import intensity of production during this period can generally be expected to be lower than during a period in which capacity expansion is necessary to increase output. Beyond 1991, the import elasticity with respect to GDP stabilizes at around 0.9, which is lower than the 1.5 observed during 1984-88 and reflects the expected gains in efficiency from the ieform program over the medium term. Workers' remittances are linked to the Bank's projections for oil prices, and grants are projected to grow by 3.1% p.a. in nominal terms. With these assumptions, the projections indicate that the current account deficit (excluding grants) could be gradually reduced from a very high initial level of 19.4% of GDP in 1989 to less than half this value by 1993, and reduced further still to 2.8% of GDP by 1998 (Annex II). 43. In spite of the steady decline in the current account deficit, Jordan's financing requirements will be substantial and will have to be met, as much as possible, on concessional terms. The gross financing required to finance the current account deficit before grants, the debt service payments on old and new debt, and a modest build up of external reserves to one and a half months of imports is estimated to decline from about US$1.6 billion in 1989 to about US$1.1 billion by 1998 (Table 3). Of this amount, disbursements on regular borrowing I/ could be expected to contribute about US$460 million in 1989 increasing to about US$570 million in 1998, and concessionary resources, including grants, could be expected to contribute about US$600 million p.a. This would leave about US$1.3 billion to be mobilized during 1989-92 as exceptional financing consisting of debt rescheduling and resources from the Bank and the IMF. The interest and amortization on all exceptional financing is included in the calculation of the projected debt service payments. Creditworthiness and a detailed three-year financing plan are discussed below. 44. External Debt and Creditworthiness: Despite the large debt burden in 1988, the projections indicate that Jordan would be able to service its debt and achieve a sustainable balance of payments. This would basically be the result of a strong structural adjustment program which would lead to a rapid correction of the present macroeconomic imbalances and, over the medium term, result in an expansion of the production of exportables and import substitutes. 1/ Includes disbursements from outstanding balances of existing loans plus disbursements from regularly expected commitments based on a historical trend.  - 14 - 45. Although some of Jordan's current creditworthiness indicators appear alarmingly high when compared to those of other highly indebted countries, these indicators need to be interpreted in light of Jordan's special circumstances. To begin with, Jordan's current high indebtedness should be viewed in light of the rapid depreciation of the exchange rate that has taken place during 1988/89. In 1988 Jordan's debt/GNP and the interest/GNP ratios were 1442 and 7%, respectively (Table 4). By 1989 these are projected to increase to 2462 and 12.5%. Almost all the increase in these ratios can, however, be attributed to the downward adjustment of the GNP in US dollar terms due to the change in the exchange rate (Annex II). Such high ratios translate into unsustainably large debt servicing burdens in other highly indebted countries. In Jordan, exports of goods and services (including workers' remittances) are an unusually high proportion of GNP compared to other countries. They amounted to 70% of GNP in 1988 and are projected to be 120% of GNP in 1990, compared to 23% of GNP for Turkey, 30% for Morocco and 10% for Brazil. Such a high exports/GNP ratio, combined with the fact that a large proportion of Jordan's debt is contracted at concessional terms, means that the debt service to exports ratios could quickly return to a sustainable level in response to a strong adjustment effort. As indicated in Table 4, the financing strategy involves limiting the stock of debt to around US$8 billion which implies a reduction of debt/GNP ratio from a maximum of about 260% in 1'90 to 98% by 1998. Jordan's scheduled debt service ratios in 1989 and 1990 are unsustainably high necessitating debt rescheduling. This situation, however, improves rapidly; after only a short period of modest rescheduling, the debt service ratio falls below 30X by 1993 and 20% by 1998, i.e., well below the levels which triggered the accumulation of debt service arrears (Table 4). 46. Three-Year Financing Plan: The Government is currently putting together a three-year (1989-91) financing plan to mobilize an estimated US$4.3 billion. Of this amount, regular borrowing could be expected to contribute about US$1.4 billion, leaving about US$2.9 billion to be financed by a mix of concessional resources including grants, rescheduling of external debt and multilateral sources of finance. 1/ 47. Rescheduling: The Government has already concluded an agreement to resche'.ule the external debt owed to the members of the Paris Club and reached a tentative agreement with the members of the London Club. At the Paris Club, 100% of the principal falling due from July 1, 1989 through December 31, 1990 and 50X of the interest falling due from July 1, 1989 through December 31, 1989 on MLT debts contracted before January 1, 1989 were rescheduled. Also rescheduled were 1002 of the principal and interest arrears, as of June 30, 1989, on the same obligations. The above amounts were rescheduled on standard Paris Club terms: viz., 10-year maturity, including 5 years of grace, at market interest rates. 2/ At the London Club, 1/ While the underlying projections are the same, a slightly different presentation is found in the Letter of Development Policy, attached as Annex III. The gross resources required are estimated at about US$4.3 billion (or US$1.43 billion p.a. over the three years 1989-91). Of this amount, US$1.4 billion could be obtained from regular borrowing and about US$1.0 billion from regular grants, which would leave a gap of about US$1.9 billion that the Government proposes to raise from debt rescheduling, multilateral institutions, and concessional resources from traditional bilateral donors. 2/ Concessional loans are projected to be rescheduled at their original interest rates.  - 15 - Table 2. SUMNARY OF MACROECONOMIC FRAMEWORK ......... ................. .. .. Actuals 1/ Est. Projected 1984-88 1989 1990 1991 1992 1993 Mational Accounts ......................... ................................ . (Growth Rates) GOP 2.5 0.0 3.4 3.9 4.0 4.0 Agriculture 2/ 11.1 1.0 3.0 3.0 3.5 3.5 Manufacturing 0.1 3.0 5.0 5.5 5.5 5.5 Services 3.2 -1.3 2.5 3.3 3.4 3.4 Consumption 0.7 -7.2 1.5 2.5 3.7 3.6 Investment -7.7 -0.5 3.4 3.9 4.0 4.0 Salance of PaVments .................... .............................. ..... Exports of Domestic Goods 9.3 1.1 4.6 5.1 5.1 5.5 Commodities -7.0 3.0 6.0 5.0 5.0 5.0 Manufactured 0.7 3.0 8.5 8.5 8.5 7.0 Mining Goods 16.4 0.0 2.0 3.1 2.9 4.7 Imports of Goods 3.8 -8.0 0.4 1.9 3.6 3.5 3/ 3/ Import elasticity wrt GDP 1.5 .. 0.1 0.5 0.9 0.9 * Current Account Deficit Including Grants /GDP -5.2 -2.7 -4.2 *2.2 -1.2 0.3 Exctuding Grants /GOP -19.9 -19.4 -16.3 -13.0 -10.9 -9.1 * Exceptional Financing Requirement (GAP) (USSmitI) 0.0 555 415 220 160 0 * Debt Service Ratio 4/ 30.2 35.9 35.0 30.7 27.2 26.2 Money and Credit .................. ........................................... Oomestic Inflation Rate 1.6 14.0 11.8 9.5 7.8 6.5 Sustainable * Money Supply (% p.a.) 10.6 18.0 14.0 12.0 10.0 10.0 * Budget Deficit (% of GDP) 5/ 10.5 11.4 9.9 7.0 6.0 6.0 1/ Compound growth rates with a 1984 base, or average values 1984-88. Asterisk (*) indicates period average for 1984-88. 2/ Exceptionally good weather in 1986 and 1987, preceded by a long period of drought, gave rise to this high growth rate. 3/ Low/negative import elasticities due to capacity underutilization following a period of contraction in output. 4/ Scheduled payments (i.e., excluding rescheduling). 5/ Including grants.  - 16 - Table 3: PROPOSE) FINANCING STRATEGY Total 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1989-91 Current Account Before Grants -560 -457 -416 -390 -360 -319 -269 -225 -196 -172 *1433 Buildup of Reserves -111 -84 -77 -90 -100 -45 -41 -34 -47 -57 -272 Amortization on MLT 1/ -843 -892 -788 -729 -811 -891 -968 -948 -927 -915 -2523 Net Other 2/ -87 4 4 4 4 5 5 5 5 5 -79 Total Financing Requirement -1601 -1428 -1277 -1205 -1266 -1249 -1272 -1202 -1166 -1140 -4306 Financed by: 1601 1428 1277 1205 1266 1249 1272 1202 1166 1140 4306 Disbursement on Regular Borrowing 3/ 461 435 497 500 652 642 671 588 577 566 1393 Concessional Resources 4/ 585 578 561 544 615 608 601 615 588 574 1724 Exceptional Financing 555 415 220 160 0 0 0 0 0 0 1190 Debt Rescheduling 450 300 100 100 . .. .. . . .. 850 Multilateral (IBRD/IMF) 105 115 120 60 .. .. .. .. .. .. 340 1/ Includes debt service on exceptional financing. 2/ Includes net direct foreign investment and private short-term investment. 3/ Includes disbursements from outstanding balances of existing loans plus disbursements from regularly expected commitments based on a historical trend. 4/ Grants of S560 and $340 million in 1989 and 1990 have already been identified. The Government must raise additional aid of $25 and $238 million, respectively, in those years, or resort to additional, more expensive, debt rescheduling. Table 4: EXTERNAL CAPITAL FLOWS AND DEBT Key Ratios (percentages) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Interest Payments/XGS 1/ 10.3 11.7 12.6 12.9 12.1 11.0 10.0 8.9 7.9 7.1 6.3 Debt Service (scheduled)/XGS 38.7 35.9 35.0 30.7 27.2 26.2 23.8 22.0 19.6 17.5 15.9 Debt Service (after rescheduling)/XGS 38.7 23.0 28.2 29.9 26.6 27.9 27.0 25.9 23.2 20.9 18.9 Debt Outstanding & Disbursed 2/ /GNP 143.6 246.1 259.1 232.1 207.8 186.9 167.4 148.5 130.0 113.2 97.9 Interest/GNP 7.0 12.5 15.2 14.6 13.0 11.7 10.5 9.2 8.0 7.0 6.1 IBRD DOD/ Totai D0D 8.1 7.0 8.3 9.3 9.7 9.8 10.0 10.1 10.4 10.9 11.4 IBRD Debt Service/ Total Debt Service 6.6 11.7 10.0 9.6 10.8 10.7 10.8 10.7 11.4 11.6 12.2 Memo Items: (in Millions of US S) Debt Service 1314 1251 1414 1376 1330 1419 1583 1696 1663 1634 1587 o/W Amortization 963 843 934 854 803 893 1061 1188 1174 1159 1131 Interest 351 408 481 522 527 526 522 508 489 475 457 o/w Interest on Rescheduled Debt 0 0 42 66 74 82 80 70 57 41 25 Debt Outstanding and Disbursed 7209 8026 8201 8310 8399 8439 8354 8183 7931 7638 7303 1/ XGS includes workers' remittances. 2/ After rescheduling.  - 17 - only the principal payments falling due between January 1, 1989 and June 30, 1991 were rescheduled at 11.5 years maturity, including 5 years of grace. 48. If Jordan makes a maximum utilization of its debt rescheduling possibilities, its repayments would be reduced by about US$600 million p.a. 1/ in 1989 and 1990, respectively, which, together with disbursements on regular borrowing, and resources from the World Bank and the IMF, would be sufficient to meet projected gross financing requirements in 1989 and 1990. However, a decision to rely predominantly on debt rescheduling to finance the balance of payments during the initial years would place a heavier burden of debt service payments on Jordan's future balance of payments. As an illustration: if full utilization of debt rescheduling on current terms amounting to roughly US$600 million p.a. is made during the first four years (1989-92) to finance the gaps, 2/ the debt service ratio would increase on average between 2 to 3 percentage points every year beyond 1994 and would result in a substantial weakening of the balance of payments. It would thus be in the interest of Jordan's future growth prospects to minimize recourse to rescheduling as much as possible and to rely increasingly on multilateral and concessional sources of finance. The f.nancing strategy presented in Table 3 assumes that only US$850 million (instead of about US$2 billion that is possible over 1989-91), i.e, about 20% of Jordan's financing requirements of US$4.3 billion over 1989-91, would be met by rescheduling its external debt and the remainder by a mix of multilateral and concessional sources of finance (see para. 50). 49. Multilateral Sources: First, Jordan has concluded a Stand-By Arrangement with the IMF which,-together with the compensatory financing facility, could amount to about US$100 million over a one and a half year period. Second, the Bank's proposed adjustment loan (AL) would contribute US$150 million (see para. 95 for the relationship of this loan to overall Bank strategy). Given the magnitude of financing required and the potential availability of assistance from other donors, a second Bank policy-based quick-disbursing operation (of US$50 million) is envisaged. Assuming this second Bank quick-disbursing loan and a repetition of the IMF Stand-By Arrangement in the third year, the resources made available to Jordan by the Bank (other than for project lending) and the IMF would amount to about US$340 million over the next three years. 50. Concessional Resources: As discussed in para. 48, if the Government were to fully utilize its debt rescheduling possibilities, together with the World Bank and the IMF, the projected balance of payment gaps in 1989-91 would be fully financed. However, in case the Government were to adopt for 1989-91 the financing strategy outlined in Table 3, i.e., reschedule US$850 million, obtain US$1.4 billion as regular borrowing and US$340 million from the Bank and IMF, it would need to raise about US$1.7 billion, or about US$570 million p.a. over the next three years at concessional terms. This, while challenging, is a feasible assumption for the following reasons. First, the Government has already succeeded in obtaining firm commitments for grants amounting to about US$560 million in 1989 and has so far identified US$340 million in 1990. Second, there are strong possibilities of cofinancing for the proposed AL from the Governments of Japan (US$150 million equivalent) and the Federal Republic of Germany (US$17 million equivalent). 1/ In accordance with the agreements with the Paris and London Club for 1989 and 1990 only. 2/ With a concomitant reduction in concessional resources.  - 18 - PART III. THE PROPOSED INDUSTRY AND TRADE POLICY ADJUSTMENT LOAN (AL) A. Backround 51. During the President's visit to Jordan in November 1988, the Government requested Bank support for an adjustment program designed to reverse the rapidly deteriorating economy. An exploratory mission in December confirmed the Government's commitment to the program. A preparation mission, which included two staff members from the IMF, visited Jordan in February 1989. The mission assessed the macroeconomic situation and helped the Government put various ongoing initiatives into a comprehensive reform program. A Stand-By Arrangement was approved by the Fund's Board in July 1989 for an amount of SDR 60 million over an eighteen-month period, equivalent to 55% of Jordan's quota on an annual basis. In addition, drawings under the Compensatory and Contingency Financing Facility of about SDR 40 million were also approved. The proposed operation was appraised by the Bank in June 1989, and negotiations were held between October 28 and November 2, 1989. B. Description of the Proposed Operation 52. The proposed loan is designed to support the Government's medium-term adjustment program described in Part II; a number of elements of the program have already been, or are being, implemented. The proposed loan would help restructure public expenditures, improve the incentive framework for exports and efficient import substitution, and strengthen institutions in support of industry and trade (see the letter of Development Policy and Policy Matrix in Annexes III and IV). The proposed loan also initiates an immediate, as well as long-range, program of actions to protect the poor from the adverse impact of adjustment policies. Moreover, as discussed in Part II, the Bank's financial contribution is a critical component of the Government's financing plan for 1989 and 1990. Finally, the Bank would, if necessary, organize a consultative group to alert the participants to Jordan's need for concessional resources to substitute for expensive debt reschedulings. In sum, the measures included under the AL could be classified as policies to: ensure a competitive and stable macroeconomic environment; improve the competitiveness and efficiency of industry and trade; and protect the poor during the adjustment period. (i) Macroeconomic Policies 53. Maintaining a competitive and stable macroeconomic environment over the medium term is critical to the success of the reform program. The IMF Stand-By Arrangement is designed to establish a balance of payments and fiscal framework necessary for improved macroeconomic performance. The program supported by the Bank includes actions to complement the measures taken under the IMF Stand-By Arrangement. 54. An important element of the Bank's dialogue on macroeconomic issues is a Public Expenditure Review (PER), to be carried out before the release of the second tranche. This review will analyze trends in the economy's overall  - 19 - resource balance, in addition to making a detailed analysis of different components of public expenditures. As discussed in para. 30, a reduction in the budget deficit is at the core of Jordan's adjustment efforts. While the proposed macroeconomic framework included in the AL indicates the overall budget reduction targets, further detailed analysis is needed to determine how the burden of adjustment will be shared between revenues and expenditures. The program agreed with the IMF includes an analysis of Jordan's tax system to be carried out by the IMF's Fiscal Affairs Department (FAD). The Bank will complement this review by carrying out a detailed analysis of public expenditures. To provide a framework for this exercise the Government has outlined the key elements of its expenditure reduction strategy. These include (i) reduction of the wage bill, subsidies and defense expenditures as a proportion of GDP; (ii) rationalization of the public investment program by including only projects which meet well defined criteria; and (iii) protection of critical expenditures on health, education and social services. During the course of the PER, the strategy outlined above will be developed further and agreed upon with the Government as a condition of the second tranche release. (u) Policy Reforms in Industry and Trade 55. The policy reforms in industry and trade included in the AL can be seen as a continuation of a process that has been underway for the past year and a half. The Bank has been an active participant in this process through many years of economic and sector work, culminating in a recent report on manufacturing industry (para. 2). The Government has already implemented a number of measures, many of which are in keeping with the recommendations in this report. In sum, it has: abolished the investment licensing system;