Jordan faces post-Saddam challenges

Jordan continues to be caught between improving economic prospects and a deteriorating regional security situation. Trend growth could be as high as 7% per annum. But the economy has been prevented from achieving this by a series of external shocks.

The war in Iraq is the latest, but the ongoing Palestinian Intifada has had an equally large impact. If uncertainty continues about regional security the economy may struggle to grow at all this year.

However this backdrop makes Jordan's recent economic performance doubly impressive. In particular the continuing success of the Qualified Industrial Zones in delivering 20% plus y/y growth in exports.

Policy continues to move in the right direction and provided stability returns to the region Jordan's medium term prospects look bright. The recent focus on Iraq puts Jordan in a precarious position. The US has become a key political ally and Jordan's biggest export market.

But the Kingdom's also has strong ties with its larger neighbour Iraq. Finance Minister Michel Marto has estimated that the cost of the war in Iraq to the Jordanian economy would be $1.5 billion.

Importantly all of Jordan's oil was imported from Iraq under a set formula that currently implies a de facto subsidy of $300 million. Thus the loss of Iraqi oil supplies on its own has dealt a heavy blow to the economy.

There are some mitigating factors. Jordan has been stockpiling oil in case of such an event, and Saudi Arabia has provided Jordan with oil in lieu of Iraqi supplies.

However Jordan's economy is more robust now compared with the time of the first Gulf War in 1991. It has diversified away from the Middle East export markets and its previous dependence on tourist receipts. Aid and remittances will not collapse as in 1991. Foreign reserves are at a record level of $3.5bn, or nine months of imports.

Furthermore Jordan is likely to receive considerable aid money from the US to offset any potential economic losses. Structurally the economy is also stronger. Ahead of Operation Desert Storm in 1991 Jordan's debt to GDP was 140%, the fiscal deficit was 24% of GDP and inflation was close to 25%.

The biggest economic risk is that the crisis derails Jordan's reform efforts. The economy still has significant vulnerabilities. Fiscal retrenchment has slowed. The government is forecasting a deficit of 4.3% in 2003. Below last year's 4.4% but up from 3% in 2001 and well above the 2.8% target originally set by the IMF.

This would not be troubling except that the government currently receives multilateral grants of 3% of GDP. The underlying budget deficit this year therefore will be closer to 8%.

Jordan has rightly received many plaudits for its recent export performance, but it still runs a recurrent trade deficit. In 2001 it was $1.85 billion. Further the advantage of the QIZ's is diminishing as the US signs more free trade deals. Jordan will need to move up the value chain in order to maintain export growth in the medium term.

While the external side of the economy has been transformed more needs to be done to raise living standards and the success of the government's Plan for Social and Economic Transformation will be critical for maintaining public confidence in economic reforms.

The economic impact of the US led attack on Iraq should be less than the effects felt in 1991, but the political fallout could be greater. Last year's speculation, since squashed, about King Abdullah's uncle, and former Jordanian crown prince, pressing a claim to the Iraqi throne highlights the close political links between the two countries.

The exact makeup of post Saddam Iraq could have a profound impact on Jordan. A substantial minority of the population continues to have strong pro-Iraqi and pan-Arab sentiments. It is no coincidence that King Abdullah has launched a new political campaign under the title 'Jordan First' which stresses the need to put national interests above all else.