Combatting the effects of Jordanian inflation

How serious a threat does Jordan's inflation pose to the kingdom's economy?

Jordan's inflation rate has been catapulting at a phenomenal rate since the start of 2008, increasing from 5.4% in 2007 to 13.3% in the first half of this year.

In addition to eroding living standards, such inflationary levels can act as a deterrent to investment as investor confidence subsides.

The booming investment activity in Jordan has been one of the key drivers propelling economic growth in Jordan.

Should the prevailing inflation levels lead to a reduction in investment activity, this could result in a deceleration in the strong economic growth rates that have been registered over the past few years.

The higher inflation levels may also have a more direct effect on the market as rising costs may weigh down heavily on corporate profitability.

What steps is the government taking to help ease the impact of high inflation on Jordanians?

The government has taken a number of measures to contain inflationary pressures, including widening the interest rate differential between the dollar and the dinar.

Owing to the dollar peg, the Central Bank cannot fully break from the monetary policy being implement in the US, however, due to rising inflation, it has allowed the spread to widen; for the 325 points the FED has cut since September 2007, the CBJ cut rates by only 75 points.

To tighten lending ability by the banks, the Central Bank raised the margins banks must place with the CBJ from 8% of deposits to 9%.

Also, to ease some of the pressure on lower income households, the Jordanian government included in its 2008 budget a 'social safety net', estimated at JD301m annually.

The main features of the social safety net include linking the basic salary of employees in both the civil and military service, as well as in municipalities, with the inflation rate.

In addition, the budget provides for an extra allowance to improve employees' living conditions.

The safety net also increases pension salaries for civil and military pensioners equivalent to the inflation rate and increases the monthly cash assistance provided to needy citizens benefiting from the National Aid Fund by JD10.

Furthermore, given the fact that a significant portion of the inflation is tied to the global surge in food prices, the government has introduced initiatives to encourage local cultivation of barley and wheat.

For this purpose the government will designate land owned by the treasury in all governorates for growing wheat and barley, in addition to setting up a fund to finance the domestic agriculture.

This fund will be supported by a once-only amount of JD40m, disbursed equally in 2008 and 2009.

The CBJ has also put limits in place to ensure the avoidance of over-leveraged positions in stock and real estate markets by implementing strict lending limits.

Finally, the Central Bank has been building up foreign currency reserves as well as increasing diversification of reserve currencies. FX reserves reached JD4.87bn at the end of 2007, enough to over approximately six months of imports.

These dropped at the end of Q1 following the use of a part of the reserves to finance the debt buy-back agreement, that took place earlier this year. However, by the end of May 2008, the CBJ has built up reserves again to reach JD4.3 billion.

Should the government be doing more to curb inflation?

In a mature market, there are well understood transmission channels between monetary policy instruments and inflation so that interest rates can be adjusted to cushion again inflationary shocks. In a dollar pegged economy such as Jordan, this is not a viable option.

The dollar peg has served the Jordanian economy well since it was put in place in 1995, lending credibility to the Central Bank's commitment to maintaining the currency's external stability, enhancing investor confidence as well as controlling inflation.

This contributed to economic stability, and allowed for increased foreign investments and accordingly paved the way for economic growth.

In a report recently released by Jordinvest, we determined that there is no clear misalignment between the US dollar and the dinar given the currency composition of the kingdom's debt and its trade position.

We have therefore concluded that we are in favour of maintaining the status quo regarding the dollar peg; especially in light of institutional constraints and considering the lack of financial market depth to cover the higher exchange rate risk associated with a flexible exchange rate regime.

However, in our report we stated that we would endorse a slight appreciation of the dinar against the greenback. This would mean servicing Jordan's non-dollar denominated debt becomes cheaper as would our US dollar denominated imports.

The government has taken a number of measures, outlined below, to address what is now one of the prime challenges facing the economy.

While a one-off appreciation of the dinar against the dollar might contribute significantly to easing inflation as suggested above, the government may also resort to fiscal measures, such as cutting back on public spending, so as to break the inflationary spiral underway.

While this may have the effect of dampening economic growth, the negative impact on economic growth of rising inflation, via reducing both local and foreign investor confidence and accordingly investment levels, is greater.