Since 1989, Jordan has implemented a series of IMF-supported economic adjustment programmes, the last of which was being completed in July 2004. The programmes addressed monetary, fiscal and structural reform issues. The main change in monetary management after the crisis is the adoption of indirect control instruments to influence monetary conditions, which increased both the ability and the autonomy of the CBJ to conduct monetary policy.
In response to the sharp depreciation, starting in late 1988 monetary policy was tightened by raising interest rates and reserve ratios. The ceiling on bank deposit rates was removed and the ceiling on lending rates charged by commercial banks was increased. As part of the initial stabilisation and reform phase, the interest rate structure was completely liberalised in February 1990 and as a result the lending rate reached 12% by September 1990. The CBJ also raised its discount rate from 5.75% to 7% in September 1988 and again to 8.5% in August 1989. To tighten monetary conditions further, the CBJ raised the required reserve ratios on time and savings deposits from 6 to 9% and the reserve ratio on demand deposits from 9 to 11% in late 1989. Monetary policy remained broadly unchanged until 1991 with further tightening from 1992 to 94 as reserve requirements were raised to 13% for commercial banks and 7% for investment banks in early1992 and again by an additional 2 percentage points in early 1993. In addition, the CBJ used moral suasion with commercial banks to restrain lending (IMF, 1995 pp. 44-46). Both credit to the government and overall domestic credit shrank in 1991and in 1992 money supply grew by only 3%. As a result of tightening monetary conditions and raising interest rates on local currency, the CBJ started to accumulate foreign reserves again and its stock of foreign exchange reserves almost doubled between 1990 and 1993.
The tight monetary policy continued into the late 1990s. Banking sector credit to the government continued to show negative rates of growth into the late 1990s with overall domestic credit growing by an average of 5% from 1990-1997 and money supply growing by 6% on average over the same period. Commercial banks’ lending rates were in the range of 12.5-14% and the CBJ discount rate was 9% in 1998 (CBJ).
In September 1993, the CBJ started using indirect instruments to control monetary conditions with the introduction of auctions of its own certificates of deposits (CDs). With the introduction of indirect-control monetary management, the CBJ was using M2 as its intermediate target to achieve its final objective of maintaining the exchange rate peg. To achieve its target, CBJ aimed at maintaining bank reserves at the required minimum level at all times (IMF, 1995). By mid-1995, the CBJ had expanded the use of CDs to the conduct of monetary policy and started using the CD auction rate as the operational target for achieving exchange rate stability. By targeting the CD rate, the CBJ tries to influence bank lending and deposit rates so as to induce changes in demand for the JD relative to the USD and maintain exchange rate stability. The CBJ changes CD interest rates by varying its offerings of CDs at auction, and this directly influences retail interest rates in the banking system (Poddar et. al, 2006). Thus after 1995, the intermediate target of monetary policy changed from M2 to banking system interest rates. The 3-month CD interest rate was maintained at between 9 and 9.55% from 1995 to 1998 to coincide with the tight monetary policy pursued by the CBJ as outlined above. The CBJ uses its CDs as the main instrument to control the money supply and absorb excess liquidity. A decade of tight monetary policy resulted in a reduction of inflation to very low levels: by 1999 inflation stood at 0.6% after averaging 4% between 1991 and 1999, while real GDP growth was 5% on average over the same period.
The change in the CBJ’s policy framework from targeting M2 to targeting interest rates coincided with the change in the nature of the exchange rate peg from pegging the JD to SDR within a narrow margin to fixing it completely to USD where the JD remained unchanged against the USD at the rate JD 0.71/USD until 2004. Kanakria (2002) confirms that the exchange rate of the JD was unofficially fixed against the USD since 1995. He noted that the monetary authorities are comfortable with maintaining this fixity without the need for any further devaluation or change to the parity. This view of the authorities may be justified, given that foreign reserves have been accumulating annually by an average of 13% from 1994 to 2004. Also
the weakening of the USD over the past few years constitutes a de facto devaluation
In 1998, the CBJ introduced another instrument to its indirect instruments kit: it launched an overnight deposit facility, which gives the CBJ a tool for managing liquidity on a daily basis and provides a floor for inter-bank rates. Since 2000, the CBJ has been adjusting the overnight rate in line with the changes in US Federal funds rate; however Poddar (2006) argued that the CBJ still has some independence in setting the interest rate spreads between the level of domestic interest rates and that in the US due to imperfect asset substitutability. Thus since 2000, the CBJ has moved away from solely targeting CD auction rates to a corridor system with the overnight window as the floor and the 7-day repo facility, which had been introduced in 1994, as the ceiling (Poddar et. al, 2006; p. 7).
The developments outlined above show that the Jordanian authorities have taken monetary framework reform seriously as it constitutes the cornerstone in establishing monetary stability and maintaining the credibility of the fixed exchange rate. At the same time, fiscal reform was also undertaken to address the structural weakness of government operations, which was a major factor behind the crisis of the late 1980s. As a result of these efforts, a measure of fiscal discipline can be seen during the 1990s. Domestic government revenues increased from 23% of GDP in 1988 to 30% by 1994, with tax revenue increasing by 5 percentage points. The government undertook tax reform, whereby revenue from taxes on domestic transactions increased from 3.5% of GDP in 1988 to 6.4% in 1994. The government also introduced a general sales tax in 1994, which is levied on all imports, all manufactured goods and some services. The aim was to widen the domestic tax base and increase the elasticity of the tax system. On the expenditure side, the average increase in government expenditure and net lending was limited to 5.7% and total expenditure as a percentage of GDP declined by 12 percentage points
from 1989 to 1994 (IMF, 1995).49 Throughout the decade, government expenditure
remained at the same level, while domestic revenues declined to 26% of GDP by 1999. Overall, the fiscal stance improved during the 1990s. CBJ data shows that in 1992, the fiscal balance registered a surplus of 5% of GDP including grants and a
49 The figures on expenditure improvement are different from those available from the CBJ and
calculated in the appendix. According to the CBJ data, expenditures as a percentage of GDP declined from 39% in 1989 to 30% in 1992. The discrepancy could be due to the changes that the authorities have introduces to the fiscal accounts in 2003 and applied retroactively to the government accounts starting in 1993.
surplus of 0.8% excluding grants. By 1999, the fiscal deficit was small at 2.4% of GDP including grants but was 9.4% without them, which represents a dramatic improvement from the pre-crisis averages of 15% and 28% respectively in the 1970s. Total government debt was halved from over 200% of GDP in 1989 to 100% of GDP by 1999, reflecting the cut in the share of foreign debt by the same magnitude.
Together the tightening of monetary policy and the efforts to control the fiscal deficit enabled Jordan to maintain the credibility and durability of the fixed exchange rate.
The increased sophistication in the monetary framework and in the design and implementation of monetary policy discussed earlier both impacts and reflects the improved status and independence of the CBJ. During fieldwork interviews, the staff of the CBJ stated that the prestige of the CBJ was enhanced after the crisis as it had been warning against the dangers of chronic fiscal deficits and excessive monetisation of the deficit. As the crisis erupted, the government felt that heeding the advice of the CBJ would have perhaps reduced the danger and/or cost of the crisis. Also, it was noted during interviews that the CBJ is completely autonomous in determining the volume and interest rate on CDs and that the ministry of finance has no role in this process, except through the influence of interest rates on TBs, which remain very small in volume. The ministry of finance also acknowledged that one of the main reasons behind the crisis was “borrowing from the Central
Bank” (Hammour, 2005, p.5)50.
As a result, the actual independence of the CBJ was enhanced after the crisis without much change in its legal independence. Although the law of the central bank did not reflect the increased actual independence of the CBJ, Article 25 of the central bank law was amended to stipulate that the central bank must be consulted when the Cabinet determines the par value of the currency, which had not been required in the previous laws.
Some insight into the degree of independence of the CBJ during the 1990s can be found in the Bank of England survey on monetary frameworks, published in 2000.
50 This was stated in the speech given by the Jordanian minister of finance at the eighth annual
On both instrument and target independence indicators the CBJ scored the full score of 100, reflecting a high degree of actual independence despite the low scores (50 out of 100) awarded with respect to the statutory objective of price stability and budget deficit finance. However, this particular aspect of budget deficit finance improved significantly in 2001 as will be detailed later. The CBJ’s overall independence score was 75 out of 100, which is above the developing countries’ average of 65.
In short, the monetary framework in Jordan evolved considerably during the 1990s in the post-crisis period. The actual independence of the CBJ increased and its ability to achieve monetary stability improved with the adoption of more sophisticated indirect control instruments. At the same time, the government acknowledged that excessive budget deficits and borrowing from the central bank had contributed to and exacerbated the crisis. This realisation along with the CBJ’s newly acquired skills and instruments to manage monetary policy enhanced its actual independence.
Over the period from 2000-2005, the main features of the monetary framework remained unchanged. Two main developments during this period are worth mentioning: the monetary stance of the CBJ became more expansionary for the first time since the end of the crisis in the late 1980s, and the government enacted a new public debt law to introduce new limits on debt, which limited government borrowing from the central bank and promoted its independence.
In 1999, the average CD rate was reduced to 6% from 9.5% in 1998 and it continued to fall until it reached 2.1% in 2003 and was only up to 2.8% in 2004. The discount rate followed the same pattern and stood at 3.8% in 2004, down from 9% in 1998. Similarly, banking sector interest rates showed a falling trend after 1999. Lending rates fell from 12.6% in 1999 to 11.6% the following year and continued on a falling trend until they reached 8.8% in 2004. Deposit rates followed a similar trend. At the same time, average money growth over the period 1999-2004 was 11% compared with 6% for 1990-98. The following graph shows that the central bank’s CD rate remained stable at 6% in 2000 and fell to 3.9 in 2001 despite the increase in the federal fund’s rate of 1.27 percentage points in 2002, which suggests that the CBJ may indeed enjoy a degree of independence in setting monetary policy despite the peg to the USD.
Chart 4.1: CBJ Interest Rate and Federal Fund Rate Central Bank CD Rate and Federal Fund Rate
0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 1996 1997 1998 1999 2000 2001 2002 2003 2004
Federal Fund Rate CD Rate
Source: IFS, CBJ data
Kanakria (2002) attributes the change in the stance of monetary policy to the unprecedented level of foreign reserves at the CBJ, reaching USD 2 billion or seven months of imports at the end of 1999. This signalled the confidence in the JD and allowed the CBJ to lower interest rates on CDs, which fed into banks’ interest rates. Fiscal policy also became more lax relative to that of the 1990s. According to the CBJ figures, the budget deficit excluding grants was on average 11% over the four years from 2000 to 2003, which represents a substantial increase over the previous decade, when the deficit was 7% on average.
Compared with the monetary framework, the area of public finance witnessed more significant changes since 1999, as the government started to use Treasury bills instead of direct borrowing from the CBJ and commercial banks to finance the budget deficit. The government started holding regular TB auctions in the fall of 1999 and the stock of government securities grew from JD 330 million in 1999 to JD 1500 million in 2004.
Generally, the stock of TBs is still very low as the government has relied on foreign debt and borrowing from the CB to finance its deficit. The government believed
that domestic borrowing through TBs was too costly compared to borrowing abroad at concessional rates. However, as the government borrowed abroad, the CBJ was forced to use CDs to sterilize the impact of government borrowing on domestic liquidity, with additional interest costs. It was noted during interviews that the total cost of borrowing, if one considers both the cost of borrowing abroad and the interest rate cost to the CBJ from issuing CDs, would be lowered if the government used TBs to borrow directly from the domestic banking system. However, the government was reluctant to do so because the cost of CDs does not appear directly in its balance sheets and is born entirely by the CBJ. In practice, however, this cost reduces CBJ profits, which are transferred to the government. At the same time, the government argued that the CBJ deposit rate was too high and that influences the interest rate on CDs and TBs, as commercial banks seem to simply add a ‘fixed’ premium to the CB deposit rate to purchase CDs.
In 2002, the IMF recommended a reduction in the stock of CDs on offer rather than a reduction in the interest rate in order to contain the cost of CDs borne by the CBJ, which had been making losses as a result of issuing CDs. However, the impact of this policy was to direct the excess liquidity still available in the banking system to the overnight deposit window of the CBJ almost at the same interest rate. This policy may also have been more costly to the CBJ, as the very liquid nature of overnight deposits allowed commercial banks to reduce the level of frictional balances that it would have kept otherwise.
An alternative recommendation was put forward by IMF staff during interviews that the CBJ could increase the volume of CDs and lower the overnight interest rate, which sets the floor for the CD rate determined by auction. This would channel excess liquidity back to CDs at a lower cost to the CBJ. This policy would also reduce the vulnerability of the peg to any change in sentiment regarding the currency, as it would minimise the volume of liquidity that could be dollarised so as to leave the Jordanian banking system rapidly. The longer maturity CDs (3 and 6 months) would buy the central bank more time to diffuse a currency crisis.
The IMF has been urging the government to replace foreign and CBJ borrowing by issues of TBs, which would 1) reduce the total cost of borrowing and 2) develop the Jordanian money market. Until 2001, the government was reluctant to make this
shift in policy, when it started gradually to move in this direction with the introduction of the new public debt law.
In 2001, the government enacted a new public debt law, which in itself enhanced the independence of the CBJ in several ways. The law established a Committee to Manage the Public Debt, which allows the CBJ a larger role in the management of the public debt. The committee is formed by three members, including the governor of the CBJ, the minister of planning and the minister of finance as chair. The law authorised the minister of finance to borrow on behalf of the government only after the approval of the Committee. Also, Article 11 of the new law states clearly that the minister of finance shall decide on the annual plan for issues of public debt and
determine the terms of issue upon consultation with the Governor. The new law
also prohibited the government from direct domestic borrowing from commercial banks or any other institutions and limited domestic borrowing to issues of securities. Article 25 deals with the outstanding debt to the CBJ by freezing it at the stock outstanding at the time the new law entered into force in April 2001. In addition Articles 21-23 limit the stock of both foreign and domestic debt at any point in time to 60% of GDP each and total outstanding public debt to 80% of GDP at current prices of the latest year for which data is available.
In practice, CBJ data show that the government debt to the central bank and commercial banks has been frozen at the 2001 levels while the stock of TBs has been increasing as noted earlier. However, the debt levels stipulated in the new law have not been enforced completely. While domestic debt was low at 24% of GDP in 2003, foreign debt was 76% of GDP and total public debt remained at 101%, which exceeds the 80% limit stated in the law.
In short, the few years since 2000 have witnessed positive developments in the monetary framework in Jordan in that the CBJ is now enjoying a higher degree of actual independence. Although the central bank law itself did not change, the legal independence of the CBJ has also improved since the new public debt law prohibits direct lending to the government; this represents a significant improvement over previous legislation.
D. Conclusion
The Jordanian monetary framework has evolved considerably since the balance of payments crisis left its exchange rate devalued by over 100% in 1988-89. In the aftermath of the crisis, the authorities embarked on a process of monetary and fiscal reform, which restored confidence in the currency and assisted in the maintenance