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The World Bank

Report No. 14935-JO

STAFF APPRAISAL REPORT

THE HASHEMITE KINGDOM OF JORDAN

EXPORT DEVELOPMENT PROJECT

MARCH 7, 1996

Private Sector Development and Infrastructure DivisionMiddle East DepartmentMiddle East and North Africa Region

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CURRENCY

Currency Unit: Jordanian Dinar (JD)(As of December 1995)

JD 1.0 = 100 filsJD 1.0 = USSI.40US$1.0= JD 0.71

LIST OF ABBREVIATIONS AND ACRONYMS

ACC = Agricultural Credit CorporationAFM = Amman Financial MarketsCBJ = Central Bank of JordanERDL = Economic Reform and Development LoanEU = European UnionFDI = Foreign Direct InvestmentFIAS = Foreign Investment Advisory ServiceFRR = Financial Rate of ReturnFZC = Free Zone CorporationGTZ Deutsche Gesellschaft fur Technische ZusammenarbeitIDB = Industrial Development BankIMF = International Monetary FundiPC = Investment Promotion CorporationISO = International Standards OrganizationJIC = Jordan Investment CorporationLIBOR = London Interbank Offered RateMOP - Ministry of PlanningMSTQ = Metrology, Standards, Testing and QualityPB = Participating BankSSC = Social Security CorporationUSAID = US Agency for International DevelopmentWTO = World Trade Organization

FISCAL YEAR

January I - December 31




Table of Contents

Page No.

LOAN AND PROJECT SUMMARY ........... ............................ i

I. INTRODUCTION .1

II. CONSTRAINTS TO EXPORT COMPETITIVENESS AND GOVERNMENTSTRATEGY. . 1

A. Characteristics of the Export Sector.. 1B. The Government's Export Strategy.. 1C. Term Finance.. 4

Constraints in Access to Term Finance.. 4Investment Requirement.. 6Government Agenda to Deepen the Financial Sector .. 6

D. Rationale for Bank Involvement. . . 7

III. THE PROJECT. . . 8A. Project Objective.. 8B. Project Description.. 8

Principal Features of the Line of Credit .. 8Participating Banks.. 9

IV. PROJECT COST, FINANCING, AND IMPLEMENTATION ....... ........... 10A. Project Cost and Financing ........................................ 10B. Project Implementation and Supervision ................................ 10

Implementation . .............................................. 10Supervision . ................................................ 10

C. Procurement . ................................................ 11

This report is based on the findings of an appraisal mission which visited Jordan in June 1995. The mission comprisedMme./Messrs. Tufan Kolan, Principal Operations Officer/Mission Leader; Kalyan Banerji, Sr. Financial Officer; ArvindGupta, Private Sector Development Specialist; and Tribhuwan Narain, Operations Officer. The report was producedby Mmes. Eugenia Dennis and Clara Lobo. Peer reviewers were: Messrs. Elkyn Chaparro, Shyam Khemani, JamesHanna, and Tyler Biggs. The Regional Vice President is Mr. Kemal Dervis; the Department Director is Mr. Inder Sud;and the Division Chief is Mr. Alastair McKechnie.

ii

D. Disbursements . ........................................ 11Special Account ......................................... 11

E. Accounting, Auditing, and Reporting . ................................. 11Reporting ....................................... 12

F. Lessons Learned from Previous Bank Involvement ....... .................. 12G. Project Sustainability ........................................ 12H. Project Objective Category ........................................ 121. Environmental Impact ........................................ 12J. Participatory Approach ......................................... 13

V. BENEFITS AND RISKS ........................................ 13A. Project Benefits ......................................... 13B. Project Risks ..................... 13

VI. AGREEMENTS REACHED .13

ANNEXESAnnex 1 - Letter of Export Sector Development PolicyAnnex 2 - Constraints to Supply of Medium- to Long-Term FinanceAnnex 3 - Terms and Conditions of the Line of CreditAnnex 4 - Project Cost and Financing PlanAnnex 5 - Supervision PlanAnnex 6 - Procurement ArrangementsAnnex 7 - Disbursement Schedule




Loan and Project Summary

Borrower The Hashemite Kingdom of Jordan

Implementing Agency The Central Bank of Jordan

Beneficiaries Private-sector banks and enterprises

Loan Amount US$40 million

Terms 20 years, including a 5-year grace period, at the Bank's standard LIBOR-based interest rate for US dollar single currency loans

Commitment Fee 0.75 percent on undisbursed loan balances, beginning 60 days aftersigning, less any waiver

Onlending Terms The Government would, through the Central Bank of Jordan (CBJ),onlend proceeds of the loan to private banks in US dollars or Jordaniandinars (JD) at interest rates that reflect market conditions. Funds wouldbe onlent to participating banks (PBs) under subsidiary financingagreements with CBJ. The PBs would make subloans to privateborrowers in US dollars or JD at terms to be freely determined, andwould bear the credit risk on the amounts onlent and commitmentcharges. Subborrowers would need to have a total debt-equity ratio ofless than 2:1 and a minimum debt service ratio of 1:3. The maximumrepayment period for the subloans would be 7 years, including up to 3years of grace. The maximum size of subloans would be US$2 million.

Project Objectiveand Description The principal objective of the project is to support the Government's

Export Sector Development Program, which aims at enhancinginternational competitiveness of Jordanian exports and increasing exportrevenues. The immediate objective of the project is to help privatefirms expand their productive capacity through a credit line for termlending.

.i;

Subloans under the credit line would finance viable medium- and longer-term investments in plant and machinery in productive activities (realestate and housing are not eligible); permanent working capital,marketing and training associated with new investments; and investmentsin energy conservation and pollution control equipment. The PBs wouldrequire detailed appraisal of the proposed subprojects in accordance withthe agreed eligibility criteria and operating guidelines, as specified in thesubsidiary financing agreements.

Benefits and Risks The principal benefit of the project would be the expanded productivecapacity of Jordanian private firns. Approximately 80 firms wouldreceive subloans to make the investments necessary to develop capacityto exploit export opportunities. It is expected that these investmentswould generate about 1,000 additional jobs, thereby raising totalemployment. The participation of private banks in the project would alsoenhance financial sector competition and build project-financingcapabilities. The eligibility criteria for subprojects include a minimumfinancial rate of return of 15 percent, which is considered a good proxyfor the economic rate of return.

Deterioration of macroeconomic conditions as a result of various factors,including adverse capital movements, could delay disbursements.However, the risk is small given the commitment the Government hasdemonstrated to maintaining a stable macroeconomic environment,including flexible exchange and interest rate policies, under adjustmentprograms supported by the Bank and IMF. Additionally, Jordanian banksare relatively new to project appraisal and term-lending techniques. Thisrisk will be addressed through close World Bank supervision-includinga project launch seminar-clearly specified operating guidelines andeligibility criteria, and training of selected PB staff in project appraisalseminars.

Estimated Project Cost

Local Foreign Total

--------------------------- (US$ million)------------------------------

Credit Line 20.0 40.0 60.0

Total Base Cost 20.0 40.0 60.0

Physical Contingencies n.a. n. a. n. a.

Price Contingencies n.a. n.a. n.a.

Total Project Cost 20.0 40.0 60.0

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Financing Plan

Funding Sources Local Foreign Total % of Financing Plan

-. ---- (US$ million)----

IBRD 0 40.0 40.0 67

Private Sector 20.0 0 20.0 33

Total 20.0 40.0 60.0 100

Estimated Disbursements

IBRD Fiscal Year(US$ million)

1996 1997 1998 1999 2000

Annual 4.0 8.0 10.0 10.6 7.4

Cumulative 4.0 12.0 22.0 32.6 40.0

Note: Initial disbursement into the Special Account (US$4 million) will be recovered during the lastfour semesters.

Economic Rate of Return Not applicable. The minimum 15 percent financial rate of returnrequired as one of the eligibility criteria for subprojects is considered tobe a good proxy for the economic rate of return.

Poverty Category Not applicable.

Project Identification No. 35995



I. INTRODUCTION

1.1 Following strong economic growth over 1973-1984, Jordan's GDP contracted by an annualaverage of 1.2 percent during 1985-89 as a result of the oil crisis. This reflected declines in output,consumption, employment and investment. In response, the Government adopted a stabilization andadjustment program, backed by the IMF and the World Bank, to trim budget deficits, reduce foreignexchange controls, and implement other deregulatory measures. Concurrently, the Paris Club and theLondon Club rescheduled Jordan's external debt payments. As a result, real GDP growth climbed to 6percent by 1992, inflation fell below 5 percent, unemployment declined from 25 percent to 15 percent,and external debt as a percentage of GDP fell to 120 percent, after peaking at 190 percent in 1990.

1.2 While this progress has been significant, Jordan still faces major challenges in maintaining itspositive economic momentum. The primary sources that have supported its balance of payments andpublic investments-remittances, official grants, concessional assistance, and regional trade undernoncompetitive protocol trade arrangements-are untenable as a foundation for sustained growth. Thedomestic economy is small and regional markets offer limited employment opportunities. Jordan,therefore, needs to build its export competitiveness and integrate into the global economy to exploit thebenefits of rapidly expanding world trade. The regional peace process, potential partnership status in theEuropean Union and membership in WTO provide Jordan unprecedented opportunities to do so.

1I. CONSTRAINTS TO EXPORT COMPETITIVENESS AND GOVERNMENT STRATEGY

A. Characteristics of the Export Sector

2.1 In 1994 the value of Jordan's exports was about one-third that of imports despite 6 percent a yearreal export growth of over 1990-94. Jordan's exports are concentrated in natural resource industries,such as phosphate- and potash-based products, which represented 36 percent of all exports in 1994.More than half of manufacturing is concentrated in pharmaceuticals, food, beverages, clothing, wood,and furniture. Firms are small, with 98 percent employing fewer than 20 workers. High tariffs andtransaction costs, institutional and regulatory rigidities, weak enterprise support systems, and limited termfinance have hurt the competitive position of Jordanian firms and left them ill equipped to compete in theglobal marketplace. Firms have relied on intergovernmental barter trade (protocol) arrangements withneighboring countries, which has further shielded them from developing the know-how needed to producefor, or sell in, global markets. While nontraditional exports (those other than natural resource industries)rose significantly-from -2 percent per annum in real terms between 1985 to 1990 to 10 percent between1991 and 1994, Jordan needs to accelerate the momentum of its export growth and eliminate the policy,institutional, technological, and financial bottlenecks that restrain export-led growth.

B. The Government's Export Strategy

2.2 The centerpiece of the Government's strategy is private-sector led, outward-oriented growth. Thestrategy has three main thrusts: (i) policy reforms to create an enabling environment for the private sectorto develop; (ii) institutional and administrative reforms, coupled with support to private firms foracquisition of technical and marketing skills, to enhance international competitiveness; and (iii) reformsto deepen the financial sector and improve private-sector access to investment finance. These reformsare outlined in the Government's September 1995 Letter of Development Policy for the Economic Reformand Development Loan (ERDL, Loan 3947-JO). On the policy side, with support from ERDL, Jordanhas already reduced maximum tariffs for non-luxury goods from 70 to 50 percent; consolidated taxes and

2 Export Development Project

surcharges into tariffs; reduced tariff exemptions; lowered border taxes on almost 500 capital goodscategories; and effectively eliminated import licensing requirements. Parliament recently enacted a newInvestment Law, for which IBRD and FIAS provided advice (Figure 1), and amended the Income TaxLaw, reducing maximum corporate tax rates from 55 to 35 percent. The Government, with support fromthe proposed ERDL II, plans to carry out further trade reformns, accelerate privatization, and reduceregulatory and administrative constraints to private-sector growth.

2.3 The Government also recognizes that trade liberalization and other broad economic policy changeswill not, alone, deliver sustained growth, and that measures need to be put in place to generate a speedyand effective supply response. It has, thus, with Bank assistance, prepared an Export Sector DevelopmentProgram and presented it in a Letter of Export Sector Development Policy to the Bank on March 7, 1996(Annex 1). The letter confirms the Government's commitment to carrying out the Program.

2.4 The Program, which is to be financed by the Bank and donors, focuses on two key areas. Thefirst is -strengthening the legal framework and institutional and firrn-level capabilities to fostercompetitiveness of Jordanian goods in global markets. 'This includes streamlining import and exportprocedures and reducing related transaction costs; facilitating investments; and improving productstandards, quality and marketing. Figure 1 below summarizes the issues faced by existing and potentialexporters in these areas-Customs, free zone regime, investment mobilization, production for export-andthe corresponding actions the Government plans to take under the Program. These elements of theProgram have drawn strong support from donors, including GTZ, USAID, the European Union (EU),Canada, and the Arab Fund for Economic and Social Development.

2.5 The Program's second area of focus is improving private firm access to term finance forinvestments in productive capacity expansion. The project would address this element of the Programthrough a credit line of US$40 million for onlending to private firns. The background on constraintsto term finance and details of the Bank support under the project to address those constraints are discussedin the sections following Figure 1.

Figure 1: Jordan's Export Sector Development Program (ESDP)

Issues ESDP Actions

Customs Administration

Key issues with Customs are two-fold: (i) The Customs Law The Government is drafting a new Customs Law in lineis outdated in its approach as well as penalty structures; and with international standards and the requirements of(ii) the procedures are cumbersome, discretionary, and proposed EU partnership and WTO membership. The draftlengthy, leading to high transaction costs. There are no Law will be submitted to the Parliament in 1996. Customsstandard operating procedures. Tariff classification and operations are to be simplified; self declaration adopted;valuation of imports are major problems. Staff are not standard operating procedures prepared; clearance timesadequately trained: they set values at high levels to reduced; a reference-based price system established tocompensate for expected undervaluation by traders. Export reduce valuation disputes (pending adoption of the WTOfacilitation schemes such as duty drawback and temporary Valuation Code); and enforcement and penalty structuresentry are complex, non-transparent and administratively updated. Customs operations are to be automated, and staffcostly. Customs officers are rewarded with bonuses of 40 given intensive training. A merit-based incentive systempercent of the fines they levy, which encourages will replace the present bonus system. The GTZ isoverzealous behavior. providing grant financing to support the above reforms.

Export Development Project 3

Issues ESDP ActionsFree Zone Regime

The free trade zones in Jordan, which are in the public The Governrnent plans to amend the Free Zone Law insector, have been dominated by trading, rather than export 1996 to allow the private sector to set up export-orientedoriented manufacturing and service operations. They have free trade zones for manufacturing and services; remove thehad limited success in attracting private domestic and ambiguities in the law; and establish a Free Zoneforeign investment; the private sector is not allowed to own Regulatory Office to license and regulate public and privateland in the zones-or develop export processing zones; free zones. Further, the Free Zone Corporation (FZC),eligibility criteria for certificates of origin for goods which heretofore has had both regulatory and developmentmanufactured in the zones are ambiguous; and backward functions, would be recorporatized and its responsibilitiessupply linkages with the domestic industries are inhibited by limited to the development and management of the public-inadequate incentives and cumbersome procedures for local sector free zones. GTZ is providing grant funds for thepurchase and processing of inputs. technical assistance services related to these reforms.

Investment Promotion

Despite the world trend of increasing foreign direct In 1995 Jordan enacted a new Investment Law thatinvestment (FDI) to developing countries, FDI in Jordan has provides uniform treatment of Arab and non-Arab investors;been negative in three of the past six years. Jordan's substantially removes restrictions on foreign ownership;investment regime was biased against non-Arab investors: introduces transparency of incentives; replaces tax holidayswas discretionary in determining eligibility for incentives; with lower corporate taxes; and introduces internationalrestricted foreign equity participation; relied on tax holidays arbitration. The Law also created an autonomousthat were costly, ineffective and vulnerable to abuse; and Investment Promotion Corporation (IPC) to facilitate anddid not provide internationally recognized dispute resolution promote investments, especially FDI. With support frommechanisms. The Investment Promotion Department was USAID grant funds, the Government plans to develop IPCpoorly staffed and operated as a regulator rather than a to international standards and streamline investmentpromoter or facilitator. These factors, coupled with procedures.perceived instability in the region, impeded FDI flows toJordan.

Metrology, Standards, Testing, and Quality (MSTQ)

Poor product quality is a key factor behind Jordan's poor Jordan is taking steps to strengthen its MSTQ infrastructureexport performance in more demanding export markets. to raise product standards to the requirements ofThe MSTQ system and related services have been weak. international markets. These include upgrading theJordan has nearly 100 public and private testing technical and managerial capability and private-sectorlaboratories, but no internationally recognized accreditation orientation of the Jordan Institution for Standards; preparingor calibration system. The Jordan Standards Institution has several product testing laboratories for international ac-focused on writing and enforcing Jordanian standards, and creditation; establishing a calibration system; setting up anhas not developed technical capability or a market-oriented Enquiry Point, as required for WTO membership, as afocus. The Institution does not have a system for certifying repository of Jordanian and international standards; guidingcompanies to ISO 9000 series standards. There is no public qualified Jordanian firms in obtaining ISO 9000 certificationor private facility providing exporters information on services: and establishing an MSTQ Extension Service toforeign standards and certification requirements. help firms raise their product quality. GTZ is providing

grant financing to upgrade the Standards Institution. TheCanadian Government has expressed interest in financingthe MSTQ program also.


Issues ESDP ActionsExport Quality and Marketing

Most Jordanian manufacturers have not learned how to The Government intends to establish an exporter supportproduce for, or sell in, export markets. Jordan's weak program to address the technical and marketing know-howdomestic infrastructure for supplying specialized exporter of existing and potential exporters. The program wouldsupport services severely handicaps exporters. They face provide grant assistance on a cost-sharing basis (up to 50difficulties in obtaining export market information or percent) to private firms to employ consultants specializedsecuring specialized consulting services in packaging, in exporting to help them improve production quality,product adaptation and quality assurance. Developing diversify product lines, and penetrate new markets. Thetechnical know-how, producing to market requirements, and program would support overseas market research andmarket research and penetration requires investments that promotion, minor product adaptation, quality certificationmany small and medium firms are reluctant to undertake. and assurance programs, test marketing, and training. ItLimited financial resources also constrain them from would also help develop local export consulting capacity bybusiness promotion travel, product launch, advertising or providing assistance to service delivery organizations,utilizing-specialized export consulting services. including industry and trade associations. The EU is

providing a grant of ECU7 million for some elements ofthe program; and the Government has also requestedadditional fulancing from the Arab Fund.

C. Term Finance

2.6 Constraints in Access to Term Finance. Shortage of term finance is a major constraint to Jordan'sexport growth. Although Jordan has a well developed banking system, the financial sector on the wholeis not sufficiently deep. The banking sector caters mainly to financing trade and working capitalrequirements of the private sector. The bulk of bank deposits are short-term and the capability of banksto carry out term transformation is limited. The capital market is shallow and has been a marginal sourceof funds to private Jordanian companies. Therefore, most private investors have to rely on internallygenerated funds and borrowing from banks through overdrafts. This severely restricts investment inprojects that require long gestation periods. The very small size of the manufacturing sector, whichaccounted for only 12 percent of GDP in 1994, is evidence of this. (Annex 2 provides an overview offinancial markets in Jordan.)

2.7 A Bank survey l of constraints faced by exporters identified limited availability of term resourcesas a major bottleneck in competing with foreign firms and realizing their full export potential. Most ofthe respondents indicated that they were unable to leverage internally generated funds with long-termborrowing.2 A series of round-table discussions held with enterprises as part of project preparation also

1/ The project preparation mission conducted formal interviews with 28 current and potential exporters,using a standard questionnaire. The survey results are presented in "Export Constraints Faced byJordanian Enterprises - A Survey of Jordanian Firms", Rhee and Katterbach, World Bank, December1994. In addition, interviews were conducted with over 100 other small-and medium-size firms duringproject preparation.

2/ For example, five firms in the survey indicated that they had enough demand to justify new investmentsin plant and machinery of around JD300,000 each. However, since obtaining term finance was adifficult and prolonged process, they would have to postpone capacity expansion until they accumulatedsufficient amounts of internally generated funds.


confirmed the problem of limited access to term funds. Most enterprises indicated that financialinstitutions were reluctant to commit term funds to other than large clients.

2.8 Interviews with 15 private commercial and investment banks and analysis of their loan portfoliosalso confirmed that there is a constraint in the availability of term finance for capacity expansion. Thebanks acknowledged that they have not been able to satisfy the demand for term loans because theirdeposit base is mainly short term. Over 70 percent of the loans extended by the banking system carrymaturities of less than a year, with 35 percent of all outstanding loans consisting of overdraft facilities.In most instances, loans with repayment periods in excess of three years were restricted to largecompanies, arranged either through loan syndication or through rolling over short-term credit facilities.The transaction costs associated with loan syndication prevented most small and medium enterprises fromtaking this route. Banks also acknowledged that fear of maturity mismatches prevented them fromfrequently resorting to short-term credit rollovers, and that without an identified and reliable long-termfunding source, they would not expand their term-lending operations.

2.9 The government-owned Industrial Development Bank (IDB) is the main source of term credit forthe productive sector. IDB has traditionally relied on term funds exclusively from the Central Bank ofJordan (CBJ), the Government, and concessional financing from bilateral sources. However, recentmonetary and fiscal restraints have prevented an increase in supply of funds from CBJ and theGovernment, while concessional aid has become scarce. As a result, IDB's share of extended andoutstanding credit by the financial system is smaller than 8 percent. In addition, cumbersome approvalprocedures and high collateral requirements have prevented most small and medium firms from obtainingIDB term loans.

2.10 The capital market also has not been successful in providing firms with longer-term capital.While there has been an increase in new equity issues, the main beneficiaries have been large establishedcompanies. Small and medium enterprises have no access to equity or debt funds from the capitalmarket-the costs are too high, regulations onerous, and often it is not practical to finance modernizationor one-off equipment replacement needs through direct placements in the capital markets. Even largercompanies face constraints in accessing capital markets due to regulatory and transactional impedimentsto smooth functioning of the stock exchange. The corporate bond market is underdeveloped because theCompanies Law imposes rigid and stringent conditions for issue of corporate debt and because the bondmarket is accustomed to government guarantees on bond issues. As a result, even private investment andcommercial banks have not been able to use bond markets to fund their term-lending operations.

2.11 Private contractual savings institutions are small and mutual funds do not exist, aue importantreason being the absence of an appropriate and independent regulatory framework. As a result,institutional demand for either traded or privately placed corporate debt and equity is limited. Most ofthe long-term financial savings generated in the economy through pension and retirement schemes areheld in the government-managed Social Security Corporation (SSC). Despite significant annual inflowsof long-term savings, SSC has not been successful in channeling these into the private sector (SSC assetsamount to about US$800 million equivalent). As SSC has most of its investments-by mandate-in short-term bank deposits and in certificates of deposit (about 65 percent) or in housing loans, it has failed tocatalyze the growth of the equity and bond markets, and investment in corporate equity or debtinstruments is a very small percentage of its total assets. The insurance sector accounts for only around4 percent of the total assets of the financial system; competition is limited and public confidence in the


insurance industry is low, mainly because of a weak regulatory and supervisory framework. The leasingindustry is not developed because of deficiencies in leasing laws.

2.12 Investment Requirement. Deregulation of the real sectors such as telecommunications,agriculture, and power have increased opportunities for private investment and will require termresources. The impact of these developments is already being felt. In 1994, 123 projects with anaggregate investment of JD 257 million were approved, nearly double the amount approved in 1992.Annual imports of electrical and non-electrical machinery have increased from JD 150 million in 1990to more than JD 360 million in 1994. Progress in the regional peace process and prospects for closercooperation with the EU are enhancing Jordan's attractiveness as a location for export-oriented productionfacilities. Furthermore, tariff, investment, and tax reforms supported by ERDL will establish theframework for increased competition; improved access to international markets under the proposedexporter support program (Figure 1) will also create more demand for plant and machinery. Over theperiod 1995-2000 gross fixed investment is projected to grow at a rate of 27 percent. This would requirea total investment of JD8.6 billion (US$12 billion equivalent). Out of this amount, JD2.6 billion (US$3.6billion) would be required for machinery and equipment. It is unlikely that the Jordanian economy willbe able to finance such an investment from internal sources. As access to international capital marketswill expand only gradually, a major part of this financing requirement will need to be funded frommultilateral and bilateral sources. The project would finance a part of this requirement, albeit small, andenable Jordan's private sector to undertake investment projects that contribute to economic growth andgenerate jobs and foreign exchange.

2.13 Government Agenda to Deepen the Financial Sector. The Government has begun implementingpolicy reforms with a view to deepening financial markets and improving intermediation efficiency.Considerable progress has been made in strengthening the safety and soundness of the banking system;commercial and investment banks are now required to follow Basle norms relating to capital adequacyand, as reported by CBJ, most banks are already in compliance. Prudential lending guidelinesconforming to international practices have been put in place; and loan loss-provisioning has beenincreased, with bad and doubtful loans fully provided for. Tighter prudential lending guidelines, theenhanced powers of CBJ to intervene in cases of incipient financial distress, and improved on-site andoff-site supervision have together resulted in a significant decline in bad loans, which are currently lessthan 6 percent of outstanding loans. These measures aimed at improving the stability of the bankingsystem have been accompanied by changes in bank regulations aimed at enhancing competition andintermediation efficiency. All interest rates have been deregulated and direct credit controls are beingreplaced by indirect monetary control. Since 1993 CBJ has been issuing certificates of deposits as partof its monetary management. In 1994 CBJ repealed regulations that restricted credit expansion to nomore than ten times the size of each bank's capital; in 1995 it aiso eliminated the credit-deposit ratio.Recently, CBJ has also allowed banks to lend a portion of their foreign exchange deposits to domesticborrowers. However, the ability of the banks to do this is constrained by the fact that most foreigncurrency deposits are from non-residents and have short maturities.

2.14 In its Letter of Development Policy for ERDL, the Government identified additional actions tofurther improve competition and efficiency in the financial system and increase the mobilization and


intermediation of long-term savings by the capital markets, contractual savings institutions, and theinsurance industry. These actions include:

(a) To enhance competition within the banking system for both deposits and loans, theGovernment plans to remove reserve requirements on inter-bank deposits so as toenhance flow of resources between banks; adopt more transparent financial disclosurebased on internationally accepted accounting principles; and further strengthen CBJ's on-site and off-site supervision. Also, in a move towards universal banking, theGovernment intends to reduce the difference between reserve ratios applied to commercialand investment banks to a maximum of 5 percent in 1996.

(b) The specialized credit institutions will be reformed. Their special privileges will beeliminated and they will be subject to the same regulatory regime as private commercialand investment banks.

(c) Capital markets will also undergo reform. Their operational and supervisory functionswill be separated; a modern trading, settlement, clearing and depository system installed;transparency introduced to the regulation of brokers and underwriters; and fuller financialdisclosure guidelines based on internationally accepted accounting principles adopted.

(d) The Companies Law will be amended. Pricing of equity issues will be determined bythe market and not by the "Issuing Committee"; companies will be allowed to issueunsecured bonds, and the amount of such bonds will be permitted to exceed their paid-upcapital; and shareholders will be allowed 100 percent pre-emptive rights.

(e) Finally, contractual savings institutions will be strengthened. The Insurance Law will bemodified to allow new entry under a strengthened and independent regulatory body;private management of social security and pension schemes will be permitted; and theCompanies Law will be amended to permit establishment and supervision of privatemutual funds.

2.15 The long-term efforts discussed above, however, are not sufficient to deal with the immediateneed of firms for long-term funds, particularly in foreign exchange. With the resumption of economicgrowth, and a strong economic liberalization program in place, private investments in Jordan are expectedto improve significantly and will need to be supported by term resources. Implementation of theGovernment's medium-term economic development strategy would address constraints that now preventthe financial system from fully responding to the investment finance needs of the real sectors. However,the impact of the financial sector reforms will be felt only over the medium term. The line of credit willenable the private sector to undertake investments that will enable the economy to grow and create jobs.Increasing productive investment, especially for exports, is essential for the economy. The project (paras.3.1-3.7) would therefore serve as a useful vehicle to support the private sector while the financial sectorreforms are being implemented and consolidated.

D. Rationale for Bank Involvement

2.16 The project builds on the work done by the Bank on the industry and export sectors and policyreforms in Jordan and is fully consistent with the Bank Group Country Assistance Strategy (CAS)


discussed by the Board on October 24, 19953. The CAS reflects the Government's central theme:promoting private-sector led, rapid and sustainable outward-oriented growth as a vehicle for reducingpoverty and unemployment. The project supports this objective by helping firms expand their productivecapacity and export potential. The Bank was also closely involved with the Jordanian public and privatesectors in preparing the Government's Export Sector Development Program. The project is an integralpart of this Program. In addition, the Bank played a catalytic role in attracting grant financing fromdonors for the other components of the Program. The project will also support IFC's strategy ofdeveloping Jordan's capital markets through new financial institutions, instruments, and services,including investments in a credit rating agency, and possible support for establishing a leasing company.

III. THE PROJECT

A. Project Objective

3.1 The principal objective of the project is to support the Government's Export Sector DevelopmentProgram, which aims at enhancing international competitiveness of Jordanian exports and increasingexport revenues. The immediate objective of the project is to help private firms expand their productivecapacity through a credit line for term lending. The benefits of the project would be monitored througha set of indicators agreed on with the Government [paras. 4.2 and 6.1 (c)].

B. Project Description

3.2 Principal Features of the Line of Credit. The US$40 million credit line would provide privatebanks with access to term resources at market rates for financing medium- and long-term investments inplant and machinery for productive activities other than real estate and housing construction. The CBJwould serve as the fiscal agent of the Government: it would onlend funds from the credit line toparticipating banks (PBs) and monitor the performance of PBs. This arrangement would not impose anysignificant new burdens on CBJ, which already closely monitors and supervises banks. As noted earlier,in the last three to four years there has been considerable improvement in both on-site and off-sitesupervision and in the authority available to CBJ in supervising and regulating banks.

3.3 The CBJ would onlend, under subsidiary financing agreements, only to financially strong privatecommercial and investment banks that conform with all applicable banking laws and have at least asatisfactory rating from CBJ.4 Funds would be onlent to eligible banks on a first-come, first-serve basis.As part of the eligibility criteria, PBs would satisfy CBJ that they possess adequate skills in project

3/ Industry and Trade Policy Adjustment Loan (Ln. 3142-JO, 1989); 'Export Incentives andTechnological Capabilities' (Report No. 10228-JO, 1992); Economic Reform and Development Loan(Ln. 3947-JO, 1995); and "Private Sector Assessment" (Report No. 14405-JO, 1995).

4/ The CBJ has adopted the Basle guidelines relating to capital adequacy, and has also issued detailedguidelines relating to classification of loans that are in conformity with international practices. MostJordanian banks would meet these requirements.


financing; alternatively, they would agree to strengthen their project appraisal and monitoring skills undera plan acceptable to CBJ.

3.4 The Bank loan would be extended to the Government as a single currency loan in US dollars atthe Bank's standard LIBOR-based rate. The CBJ, on behalf of the Govermment, would onlend theproceeds of the Bank loan to PBs in US dollars or Jordanian dinars (JD). Jordan has a relatively opencapital account and recently accepted the IMF's Article VIII obligations. Under current marketconditions, the US dollar onlending rate would be LIBOR plus a spread of 100 basis points, and the JDonlending rate would be the Jordanian Treasury Bill rate plus 50 basis points (including 25 basis pointsto cover CBJ's administrative costs). The CBJ would review and adjust onlending rates every sixmonths, as required, and inform the Bank [para. 6. 1(b)].

3.5 Participatina Banks. To date, CBJ has prequalified six banks as potential borrowers; they haveconfirmed their intention to enter into subsidiary financing agreements with CBJ. Table 1 providesselected financial indicators on these banks. They account for 30 percent of the assets of private banks,35 percent of loans, and 36 percent of deposits; and are well capitalized and profitable. Returns onequity range from 5 to 23 percent. Given the number of banks, there will be adequate competition inthe use of the credit line.

l___________ - Table 1. Participating Banks: Financial Highlights (1994)

Thousands of Jordanian Dinars Percentages

Banks Total Total Total Shareholder Net Return Return CapitaUAssets Loans Deposits Equity Income on on Deposit

Assets Equity Ratio

Cairo Amman 426,333 186,361 367,095 18,116 4.132 1.0 22.8 4.9Bank

Jordan 220,088 95,985 183,824 18,547 865,116 0.4 4.7 10.1Kuwait Bank

Housing Bank 972,984 524,220 822,300 43,901 4,953 0.5 11.3 5.3

Jordan 177,042 67,838 151,955 11,327 1,999 1.1 17.6 7.4Investment &Finance Bank

Union Bank for 159,891 58,494 135,173 11,849 1,010 0.6 8.5 8.8Savings &Investment

Arab Banking 154,190 70,224 115,348 14,004 1,933 1.2 13.8 12.1Corporation

Source: Amman Financial Markets Report. 1995

3.6 The PBs would onlend these funds to private subborrowers in US dollars or Jordanian dinars, atterms to be freely determined, and would bear the credit risk on the subborrowers and commitmentcharges on the Bank loan. The maximum repayment period of any subloan would be 7 years, including


3 years grace. Eligibility criteria for subborrowers are designed to ensure that financing is extended forsound projects promoted by creditworthy private-sector borrowers. To ensure that procedures foronlending by PBs are kept simple, prior approval of CBJ would not be required except for the first twosubloans extended by each PB. The subborrowers would have to be majority privately owned and wouldneed to have a total debt-equity ratio of less than 2:1 and a minimum debt-service ratio of 1:3. Aminimum projected financial rate of return of 15 percent would be required for subprojects financed bythe subloans. The maximum size of individual subloans would be US$2 million. The subloans areexpected to finance about 80 subprojects, at an average subloan size of around US$500,000. Annex 3details the terms and conditions of the credit line.

3.7 During negotiations, agreement was reached with the Goverm-nent that CBJ will: (a) implementthe project in accordance with the eligibility criteria for PBs, subborrowers, subloans, and subprojects;and (b) review every six months and adjust US Dollar and JD onlending rates to reflect marketconditions. Signing of the subsidiary financing agreements between CBJ and at least two prequalifiedbanks to serve as PBs would be a condition of loan effectiveness [paras. 6.1(a), 3.4, 6.1(b) and 6.2,respectively].

IV. PROJECT COST, FINANCING, AND IMPLEMENTATION

A. Project Cost and Financing

4.1. Total project cost is estimated at US$60 million, of which the foreign exchange componentrepresents US$40 million (67 percent). The Bank loan-US$40 million-would finance 100 percent ofthe estimated foreign exchange cost. Borrowers of subloans would contribute an estimated US$20 million(33 percent) and would cover applicable taxes and duties from their own funds. Annex 4 shows theproject cost and financing plan.

B. Project Implementation and Supervision

4.2 Impiementation. The CBJ will be the implementing agency; it has established a two-person unit,supervised by the CBJ Executive Manager, External Debts and Agreements Department, to overseeimplementation of the project. The unit would monitor project performance, accounts, expenditures,costs, and compliance with Bank guidelines; it would forward all withdrawal applications, reports andother documentation to the Bank. Each PB would forward the first two subloan applications to CBJ andthe Bank for prior approval. Thereafter, the PBs would forward a subproject data sheet Xneach subloanextended to CBJ which would tabulate the information for presentation to the Bank in its regular reports.The format and coverage of the data sheets have been agreed with CBJ. In order to assess job creationimpact of the project, PBs would include information on projected new employment under the subloansfinanced on the data sheets. Moreover, the Bank would review macro indicators of export performanceto determine the extent to which the Government's Export Sector Development Program is meeting itsobjectives.

4.3 Supervision. The project would be supervised twice a year. The total number of Banksupervision staff-weeks is estimated at 48, for a cost of US$200,000, of which 31 weeks would be spentin the field at an estimated cost of US$124,000. The initial supervision mission would be a project


launch seminar to be held with the members of the CBJ implementation unit and PB representatives. Theseminar would discuss the Implementation Plan, including operating guidelines, disbursement, accountingand auditing arrangements, and reporting requirements. A Mid-Term Review would be held in January1998, in addition to Annual Reviews, to examine disbursement progress to date, subproject pipelines ofPBs, and availability of term finance and interest rates in general. The project supervision plan isprovided in Annex 5. During negotiations, agreement was reached with the Government that a Mid-TermReview will be carried out on or about January 1998 to assess progress and introduce any requiredmeasures to improve project execution [para. 6.1(d)].

C. Procurement

4.4 Procurement of goods, services and works under the subloans would be carried out in accordancewith normal commercial practices of enterprises. These are acceptable to the Bank. The PBs wouldmaintain- records of procurement procedures and methods used, summarizing offers and awards for ex-post review by the Bank on a periodic basis.

D. Disbursements

4.5 The project would be implemented over a four-year period, with a completion target date ofDecember 31, 1999. The commitment deadline for the credit line would be January 31, 1999. The loanclosing date would be June 30, 2000, six months following the project completion date. Thedisbursement period of 4 years or 16 quarters is shorter than the country disbursement profile of 6.5years or 26 quarters. This is deemed achievable because the credit line, which is a relatively smallamount compared to anticipated demand for term funds, is expected to be disbursed within a reasonablyshort time, as six banks have already confirmed their interest in and entering into subsidiary financingagreements with CBJ. The estimated schedule of disbursements from proceeds of the Bank loan bysemesters is provided in Annex 7.

4.6 Special Account. To facilitate disbursements, the Government will open and maintain, underterms and conditions acceptable to the Bank, a Special Account at CBJ with an authorized allocation ofUS$4 million, representing 10 percent of the credit line. The Special Account will be replenished ona monthly basis or when its balance is equal to 50 percent of the authorized allocation, whichever comesfirst. Withdrawal applications will be supported by appropriate documentation, including a copy of themonthly bank statements and their reconciliation with the Special Account transactions. Disbursementscan be made through direct payment or special commitments (subject to a minimum application size ofUS$800,000) from the Bank.

E. Accounting, Auditing, and Reporting

4.7 The Borrower is in compliance with IBRD audit reporting covenants. During negotiations, theGovernment gave assurances that: (a) project accounts, including the Special Account, will be maintainedin a format acceptable to the Bank and audited in accordance with Bank guidelines; and (b) the auditreports will be submitted to the Bank within six months of the end of each fiscal year, in such scope anddetail as the Bank may reasonably request, including a separate opinion by an independent auditoracceptable to the Bank, on disbursements against the Special Account [para. 6. l(e)].


4.8 Reporting. In addition to monthly status update forms, which would include information ondisbursements, CBJ would submit annual imnplementation progress reports in November of each year, tothe Bank. The update forms and reports would follow a standardized format that would be finalizedduring the project launch seminar. They would cover implementation status; deviations, if any, from theImplementation Plan and reasons; problems and constraints, and the corrective actions being taken; andupdated disbursement and commitment tables. CBJ would also prepare a detailed Mid-Term Report andsubmit it to the Bank by end November 1997 to serve as the basis for the Mid-Term Review, and anImplementation Completion Report to the Bank within six months of the Closing Date of the Bank loan.

F. Lessons Learned from Previous Bank Involvement

4.9 The Bank has not been involved in an industrial credit finance operation in Jordan since the late1970s; however, the lessons of Bank experience with such operations in other countries are reflected inthe design of the credit line. Specifically, funds would be onlent to eligible private banks at marketinterest rates on a first-come, first-serve basis, and the- participating banks would price the subloansfreely. In addition, the macroeconomic environment is stable, inflation is low, interest rates arederegulated, and the credit line would not be distortionary. Bank experience also shows that prospectsfor achieving sustainable export competitiveness are greatly enhanced through a comprehensive approachcovering relevant policy and institutional reforms, support mechanisms to improve technical andmarketing know-how at the firm level, and availability of investment financing. The parallelimplementation of this project with the rest of the Government's Export Sector Development Program,complemented by policy reforms supported by ERDL operations, provides such an approach.

G. Project Sustainability

4.10 The project would enhance the capacity of participating banks to provide term finance and tolend in foreign exchange. It would thereby create a base for increased longer-term lending under thefinancial sector reforms that will be deepened with support from ERDL II. To help ensure sustainability,the design of the credit line has been based on market conditions. Also, it is expected that the credit linewill serve as a catalyst to stimulate term finance by the banks. However, as the financial markets are notyet sufficiently deep and term transformation limited, further support through credit lines may be neededuntil the financial sector reforms take hold.

H. Project Objective Category

4.11 The project objective is classified under "Private Sector Development".

I. Environmental Impact

4.12 In view of the potential environmental impact of subprojects financed under the credit line, theproject is rated under Environmental Category "B." The PBs will ensure that each subproject applicationunder the credit line will comply with environmental standards satisfactory to the Bank and applicablelaws and regulations of the Government relating to health, safety and environmental protection. For thispurpose, the Bank has prepared an environmental manual for use by PBs to screen subloan applicationsfor environmental impact of proposed subprojects.


J. Participatory Approach

4.13 The project was prepared jointly with the Government, CBJ, and private sector firms and banks.Interviews and group meetings were held with 125 firms and 15 of the 21 banks. The eligibility criteriaand operating procedures were developed with CBJ, taking into account the results of the interviews, aswell as Bank experience with credit lines. As part of the Bank support to the Government in formulatingits Export Sector Development Program, workshops were held in December 1994 and January 1995 withpublic and private sector representatives on Jordan's export performance, elements of modern Customslegislation, and international competitiveness.

V. BENEFITS AND RISKS

A. Project Benefits

5.1 The project would give Jordanian firms a timely opportunity to enhance their competitiveness andproductive capacity to enable them to participate more effectively in the global economy-either directlyor through joint ventures with regional or extra-regional partners. Approximately 80 firms would receivesubloans to make the investments necessary to develop capacity to exploit export opportunities. Inaddition to increasing trade integration, it is expected that these investments would generate about 1,000additional jobs, thereby raising total employment. Another benefit of the project would be to improveaccess to term lending. The participation of private banks in the project would also improve financialintermediation, enhance financial sector competition and build project-financing capabilities. Theeligibility criteria for subprojects include a minimum financial rate of return of 15 percent, which isconsidered a good proxy for the economic rate of return of the project.

B. Project Risks

5.2 Deterioration of macroeconomic conditions as a result of various factors, including adversecapital movements, could delay disbursements. However, the risk is small given the commitment theGovernment has demonstrated to maintaining a stable macroeconomic environment, including flexibleexchange and interest rate policies, under adjustment programs supported by the Bank and IMF.Additionally, Jordanian banks are relatively new to project appraisal and term-lending techniques. Thisrisk will be addressed through close Bank supervision-including a project launch seminar-clearlyspecified operating guidelines and eligibility criteria, and training of selected PB staff in project appraisalseminars.

VI. AGREEMENTS REACHED

6.1 During negotiations, Government gave assurances that it will cause CBJ to:

(a) implement the project in accordance with the eligibility criteria for participating banks,subborrowers, subloans, and subprojects (para. 3.7);

(b) review, every six months, and adjust US dollar and JD onlending rates to reflect marketconditions (paras. 3.4 and 3.7);


(c) carry out the project in accordance with the Implementation Plan, including target datesof actions to be taken and monitoring indicators (paras. 3.1 and 4.2);

(d) carry out a Mid-Term Review on or about January 1998 to assess progress and introduceany required measures to improve project execution (para. 4.3); and

(e) ensure that (i) project accounts, including the Special Account, is maintained in a formatacceptable to the Bank and audited in accordance with Bank guidelines; and (ii) the auditreports are submitted to the Bank within six months of the end of each fiscal year, insuch scope and detail as the Bank may reasonably request, including a separate opinionby an independent auditor acceptable to the Bank on the Special Account (para. 4.7).

6.2 As a condition of loan effectiveness, subsidiary financing agreements shall have been signedbetween CBJ and at least two prequalified banks to serve as participating banks (para.3.7).

6.3 The proposed project constitutes a suitable basis 'for a Bank loan to the Hashemite Kingdom ofJordan in the amount of US$40 million at the Bank's standard LIBOR-based interest rate for US dollarsingle currency loans, with a maturity of 20 years, including a 5-year grace period.

Annex IPage 1 of 6


MINISTRY OF PLANNING 1 rAMMAN I

Ref. lo/L23J1 f_ _ _

Date A ...±..5lA

Mr. James D. Wolfen.sohnPresidentThe World BankWashington, DC.U. S.A-

Dear Wr. President:

Letter of Export Sector Development Policy

1. As an integral part of its ongoing structural adjustment effort, The Govei nent ofThe Hashemite Kingdom of Jordan is pursuing a specific action- oriented prceram toboost the efficiency, international competitiveness, and global market orientaticni of itscxport sector. This letter describes the programs Iordan is undertaking, and confirms theGovernment's comrmitment to carry out their implementation The Government alsoconfirms its intention to seek a loan of USS 40 million from the World Bank to supportpriority cornponents of its export development program.

2. The action prograrn is designed to raise the international competitiveness ofexporting firms, increase export revenues by reducing trade transaction costs, liberalize thefree-trade zone regime, facilitate and promote investments, adopt intemational qualitystandards, facilitate access of Jordanian firms to technical and marketing know-how, andimprove the access of firms to long-term financing.

L Background

3. Jordan's economy has shown consistent growth since 1992 when th: reformprogram was rejuvenated aftcr the Gulf crisis. Preliminary estimates of GDP for 1995show a growth of about 6.4 percent, led mainly by the increases in the output ofagriculture and mining sectors, which grew at 6 percent and 18 percent respectively.Inflation remained below 4 percent and the extermal current aCcouat deficit was fiurtherreduced in 1995 by 1.5 percentage points to less than 5 percent of GDP. The exportsector also showed improvement. Merchandise exports increased by 14 percent in 1994and 19.4 percent in 1995. The latter showed a strong performance of nontraditionalexports (which expanded by 24 percent). Tmport payments declined in nomina1 terms in1994, but showed a shift in favor of raw materials a.nd capital equipment, which allowed

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Annex IPage 2 of 6

for sustained econorric expansion. This shift conLinued in 1995, with imports going up by11 1 percent, but those of raw materials increasing by 34.6 percenc. While the trade dcficitremains high at about 31 percent of GDP, the government expects that the policies it ispursuing to boost exports will bring it down to manageable levels over the next three tofive years.

4. MIr. President, the Government of Jordan subriitted a medium-term economicframework to the World Bank in a development policy letter dated September 25, 1995.This programn is well into its implementation phase and includcs major policy andlegislative reforms. Actions already completed during 1995 include: removal ofcumbersome import licensing requirements; lowering and restucturing tariff; loweringincome taxes and streamlining tax procedures; equalizing domestic taxes on imports andlocally produced goods; and strengthening investment incentives to make tho businessenvironment more investment friendly.

5. We strongly believe that the legislative and procedural changes recently introducedwill increase traasparency in the trade and banking regulations, simplify proccdures, andreduce bureaucracy to enhance the private sector busincss environment. These measures,-along with our futura straLegy of futher dcepening economic liberalization and reform,are expected to contribute in a substantive way to our efforts to strengthen Jordan'sprivate sector, enhance its export potential, and bring about the developments nec.;-ary toprepare our econoiny for further integration with the world economy.

6. Sections II and 11 below describe the government's policy rationale for accordinghigh priority to the export sector and a program of action in the policy, regulatory, andprocedural areas to achieve the desired results.

IL Exports: A Priority Sector

7. Concurrently with progress being made in the overall economic reform pxograrn,the Government is focusing extraordinary attention to the development of its export sectoras a key element in sustaining a healthy economic growth over the mcdium-termL As wemake progress in negotiating trade agreements with the European Union and the WorldTrade Organization (WTO), the need to organize the export scetor has become moreimminent. The challenges and opportunities generated by the progress in the rcgionalpeace process exert further pressure to expedite this task. Expansion in intra-regionaltradc and new foreiga investments over the next two to three years is the most likelyexpectation in Jordan.

8 lJordan's privatc sector, though willing and aware of these opportunities, needsimprovement. The majority of Jordanian exports are concentrated in natural resourceindustries and primary products. Jordanian businesses remain small relative to their globalcompetitors, and their lack of intemational trade experience remains a serious handicap.

Annex 1Page 3 of 6

9. The overall development sLrategy for poverty reduction, employmnent generationand improving Jordan's export potential rests on the roUowing three main policy dccisionsto which the govcrnment remains firmly committed;

* A deliberate, private sector-led export oriented strategy will be followed todiversify markets, increase private sector investments and improve the nation'strade balance.

* Economic growth will be sustained through; (a) increased investments in highreturn expoLt-oriented industries; (b) eMicicncy and quality improvernents inthe productive sectors; and (c) development and enforcement of a regulatoryenvironment that is private sector-friendly.

* yThe Govemrnent will provide practical tecnical and financial assistance oa acost-sharing basis to private sector enterprises to jump-start their growth andenhance their competitiveness.

10. With these pnrnciples in mind, the Governmcnt has formulated a comprehensiveprogram of policies and procedural reforms to develop the export sector. The proposedExport Development Project would assist us in imnplementng some of the most criticalcomponents of the Government's Export Developrnent Program.

ImL The Program

Il. The Government's Export Development Program cornprises a set ofcomprehensive and action oriented steps to be implemented during the next two to, threeycan. The various components of this program have been designcd in close cooperationwith private business leaders and representatives of public sector agencies such as theMnistry of Finaance, the Central Bank of Jordan, the Miaistry of Trade & Industry, and theInvestment Promotion Corporation. The program will work in tandem with the overalleconomic reform activities. In specific, five broad areas relating to export promotion areaddressed:

(a) Customs reforms(b) Liberalization of free trade zone regulations(c) Mobilization and enhancemcnt of invcstmcnts(d) Improvement of product standards and quality assurance(e) Increased access to term finance.

Customs Rcforms

12. The present Customs Law does not provide clear guidelines regarding customsdeclaration, valuation of goods, and the regulations eiiforcing penalty structures. It alsodoes not meet the WTO requiremeats for customs valuation. The government is in theprocess of finalizing a new Customs Law that will be submitted to Parliament during 1996.The new law woruld introduce the principle of self declaratior!, introduce clarity tominimize the discretionary rreannent, update cnforcement mcasures, revise penaltystructures for violations, improve the definition of value to conform to GATTIWTO

Annex IPage 4 of 6

requirernents foLlowing a transition period of refcrence-price based valuation. Areference-based price system would be adopted for problem conunodities while carryingout preparatory work for introducing the GATT/WTO Valuation Code. The ncw lawwould also establish professional performance requirements for Customs personnel,brokers and agerts.

13. Reform of the customs rules and regulations is being undertaken with a view toexpediting and simplifying customs clearance for imports and expoits. The stream-linedregulations will include: (a) a self-declaration system with only a random post-clearancecheck of import declarations of up to 25 percent of all transactions; (b) setting of higherprocessing targets to reduce clearance tirns; (c) reduction of physical inspection ofimports and exports to a maximum of 15 percent and 10 percent of all consignmentsrespectively; (d) exreading duty drawback and temporary cntry schemes to covcrintelnediate producers; (e) replacing the cullelmany used incentive system of percenta-e offines for custorns officials with a more systematic merit-based reward program; and (i)introducing a mechanism to appeal customs rulings.,

14. The customs clearince procedures currently in force are not properly documented,and are also not easily available to the concerned public. This causes unintended :d-hocand dissimilar handling of similar instances and introduces an element of discrct onarytreatment. In order to rectify this situarion, the government will devclop a detailed -nanualof clearly designed operating procedures for customs operations that wil bc binding in allrascs, The manual win contain responsibilities of both customs clearance officers andexporters and their agents. la order to implement the new customs regulations, anintensive training program wil be carried out for customs ofEcials, broker-3 and agents.The existing Custorns Training Center would be upgraded with qualified trainers, and anInternal Affairs Deparument would be created within the customs organization to overseeand implement a strict and transparent code of conduct and ethics.

15. Finally, customs procedures would be automated in order to standardizeprocessing, facilitate enforcement and improve revenue collection.

Liberalizing the Free Trade Zone (FTZ) Regulations

16. The currcnt legal framework governing the Free Trade Zones combiner bothregulatory and management functions in the Free Zone Corporation (FZC). giving itconflicting objectives. To ease these conflicts, the government will reorganize andreincorporate the FZC into a purely management entity for public sector free zones, whiletransferring regulatory functions to a new entity under the Ministry of Finance. Thegovernment also undertakes to introduce into Parliament during 1996, legislation toamcnd the Free Zone law to allow private sector to establish and managc export orientedand other special purpose free zones as well as allow private sector ownership of land andfactory premises at public sector free zones. The amended legislation would also thusprovide for dispute settement mechanisi, remnc-. a undue constraints rel-.1 ing tocertificates of origin and minimurm export requirements.

Annex IPage 5 of 6

Mobilizing Investments

17. The government has recemtly establishcd an autonornous Investment PromotionCorporation (rPC) with a mandate to work on activities that would encouragc directforeign investments through joint ventures, partnerships and equity participation. It isexpected that the IPC will be responsible for market promotion activities and act as abridge to foreign companies interested in business collaborations. The government plaunsto strengthen the PC's technical capabilities through recruitment and retention of highlyskilled staff and provision of short-term expatriate experts in the area of intemationalmarketing, financial management and quality control. A training needs analysis of thecurrent IPC staff will be conducted and appropriate training modules will be dcsigned toupgrade their skills.

Instituting Quality and Standards Controls

18. . It is widely understood that one of the most serious constraints to incteasingJordan's exports is the weakness in product standards and quality control. Manufacturersrealize that exports, particularly to the European Cormunity and beyond, can onlyflourish if Jordanian products meet their stringent quality standards of the re(eivingmar'Kets. To address this issue, the government plans to substantially upgrade the t-pacityand technical eiciency of the Jordanian Institution for Standards and Metrology.

Jpgrading will involve institution restructuring, standards development, enforccment oflegal meLrology, establishing national systems for laboratory accreditation, andcertificatioa of products and quality systems. We intend to enter into a twinningarran-ement with an international merrology, standards testing and quality (MSTQ)institution to provide technical support and help train the technical and managerial staff ofthe institution.

19. The government recognizes that, in tandem with the upgrading of the Irnstitution, itneeds to accelerate accreditation of Jordanian laboratories by internationally recognizedbodies. Plans are underway to accredit over 10 laboratories that are heavily invoived intcsting for exports. we are also establishing a calibration system in Jordan w a jointoperation between the Royal Scientific Society and the Royal Jordanian Air Force. Underthe program, we will also carry out a program to assist enterprises in preparing forobtaining IS09000 certification. Moreover, in preparation for WTO mcmbership -we willestablish a WTO Fnquiry PoiLnt as a central repository of lordanian and inter-ationalstandards.

20. As a fiurther effort to help firms develop their ability to compcte in the internationalmarket, we wiU establish an MSTQ extension service to provide finns with diagnosticscrvices on product standards and quality issues. We will also institute an Export SupportProgsam (ESP), to be operated on a cost-sharing basis with new or existing exporterfirns. to provide direct assistance in strategic export planning, product design andcustomization, international marketing techniques and market intclligence, qualitycertifl:ation, and traiing. The ESP will also provide test market facilities and assist withother start-up costs, such as for initial promotion, overseas visits to negotiate nmarketingcontracts and technical advice.

Annex IPage 6 of 6

Enhancing the Availability of Term-Fiuance

21. The resumption of economic growth and Jordan's strong ecoeoriic liberalizationprogram are expectcd to increase private investments in Jordan significantly; these newinvesTnents will need to be supported by an adequate supply of term resources. Whilc thegovernmcnt's economic development strategy wilI address many of the constralins Llatnow inhibit the financial system from filly responding to the investment finance needs ofthe real sectors, the impact of financial sector reforms will be felt only over the mediumterm. Increasing the availability of medium to longer-term finance will enable the privatesector to undertake investments that will enable the economy to grow and create jobs.

22. Jordan's credit market has traditionally lacked medium-to long-term finance tosupport industry expansion. Such credit is only avalable for real estate and housingconstruction. An important component of the Export Developmeal Program is to initiatea scheme to make available medium- to long-term loans for plant and equipment,permitting working capital, and investments in energy conservation and polution controLThe World Bank loan will be used to set up a line of credit to be channeled fi2c;n theCentral Bank of Jordan to private commercial banks for on-lending to new or existingpiva±c firms wanting to develop or expand productive capacity. This facility wil also helpJordanian. commercial banks to stengthen their project appraisal and supervisioncapabilities and make a substantial contnbution in enhancing the availability of medium- tolonger- term-finance to potential exporters.

Conclusion

23. Mr. President, the Export Development Program outlincd above will complcmentIordan's Econiomic Reform Program which is being carried out wiLh &iUll cooperati.n andsupport of the World Bank and the Iaternational Monetary Fund. Jordan is sparng noeffort in getting organized and positioning itself to present one of the most invesmnent-and trade-friendly environments in the Middle Est. Tlhe task is, by rLo means, n easy.one. The transition towards a more private sector-lcd economy will require subsrantiveinitial public sector investment to cover start-up costs. The Export Development Programis also being supported by a number of other donors such as Germany, the EuropeanUnion, USAID and possibly the Government of Canada and the Arab Fund for Econornicand Social Development. The World Bank's conLlibution toward its implementation willbe a key intervention not only as a direct investment, but also as a catalyst for attractingother donors.

With my best personal regards.

Sincerely Yours,

Rima KhalafHunaidiMinister of Plauling

Annex 2Page I of 9



Constraints to Supply of Medium- to Long- Term Finance

Background

1. Jordan's success in stabilizing its economy has led to a resumption of growth. Coupled withderegulation of the real sectors, tariff reforms, reform of investment and tax regulations, and progressin the peace process, investments in Jordan are poised for rapid growth and demand for long-term credit.Increased demand for term resources has been confirmed through field interviews with private investmentbanks. All of them confirmed that private firms are considering investments to exploit emergingopportunities and they have received many requests for term credit to finance new investment. However,they indicated that they are unable to fully satisfy the demand for long-term finance as they do not havean adequate supply of long-term funds. For large firms with whom banks have a long-standing creditrelationship, banks indicated that they attempt to provide term finance by rolling over short term loansand through syndicated loans. For other firms, the banks indicated that they entertain requests formedium- to longer-term lending only when they have an identified source of term funds. For example,a few years ago, investment banks extended medium-term finance under a line of credit from the IslamicDevelopment Bank, which provided term funds through the Government of Jordan. If such sources arenot available, banks indicated that they either direct their clients to the Industrial Development Bank orlend only against credit guarantees from the Jordan Credit Guarantee Corporation or under refinancearrangements with the Central Bank of Jordan (CBJ). Some of the smaller banks also indicated thatgreater availability of term resources would enable them to offer a fuller range of financial products andassist them in competing with the bigger banks.

2. These findings were confirmed by a recent survey of constraints faced by exporters.' The surveyidentified limited availability of term resources as a major impediment to realizing full export potential.Some of the main findings of the survey relating to access to preshipment export finance and investmentfinance are:

* Inadequate access to finance prevents firms from exploiting export opportunities. For example, amanufacturer with a good export track record and export market prospects could not exploit thedemand because he did not have access to preshipment and medium-term finance.

* Many exporters are interested in securing foreign currency loans to finance export production.Banks, despite having large sums of short-term foreign currency deposits, were reluctant to satisfythis requirement because the need to obtain prior CBJ approval on a case-by-case basis makes suchlending cumbersome (only very recently CBJ has announced measures to facilitate bank lending inforeign currency).

The project preparation mission conducted formal interviews, using a standard questionnaire with 28current and potential exporters. The survey results are presented in "Export Constraints Faced byJordanian Enterprises--A Survey of Jordanian Firms, " Rhee and Katterbach, World Bank, December 1994.In addition, interviews were conducted with over 100 other small-and medium-size firms and 15 banksduring project preparation.

Annex 2Page 2 of 9

* Most firms have recently invested in new machinery. Only a small number financed them throughmedium- and longer-term loans, while most relied on self-financing. Five firms indicated that theyhad enough demand to justify fresh investments in plant and machinery of around JD 300,000 each.As they would not be able to access term finance, they would postpone these investments until theyaccumulated sufficient internally-generated funds.

* Most firms indicated that CBJ's refinance scheme for term loans was not easily accessible due tolimited information about the scheme, restrictive eligibility criteria, and slow processing ofapplications, as each request requires a detailed analysis by CBJ in addition to appraisal by theIndustrial Development Bank which implements the refinance scheme.

3. Thus, particularly small- and medium-firms undertake fresh investments only when they haveaccumulated enough internally generated funds. As a result, productive investments cannot occur quicklyand at the right time to exploit market opportunities. Financing the anticipated growth in investments inthe productive sectors of the economy will be a major challenge in the next few years. Systematic effortswill be required to improve the performance of the financial system in mobilizing and intermediatinglong-term savings. The Jordan Country Economic Memorandum (Report No. 12645-JO) provides acomprehensive review of financial sector constraints and their impact on financing longer-terminvestments in the productive sectors. The next sections summarize projections of investmentrequirements and the main issues in increasing the supply of term resources through the financial system.

Investment Requirement

4. Deregulation of the real sectors such as telecommunications, agriculture, and power haveincreased opportunities for private investments and will raise the demand for term resources. The impactof these developments is already being felt. In 1994, 123 projects with an aggregate investment of JD257 million were approved by the Investment Promotion Department of the Ministry of Industry andTrade. The amount was nearly double that approved in 1992. Annual imports of electrical and non-electrical machinery increased from JD 150 million in 1990 to more than JD 360 million in 1994.Progress in the regional peace process and prospects for closer cooperation with EU are enhancingJordan's attractiveness as a location for export-oriented production facilities. Furthermore, tariff,investment, and tax reforms supported by the Economic Reform and Development Loan (ERDL),approved in September 1995, will establish the framework for increased competition; improved accessto international markets under the proposed exporter support program (Figure 1 in the main text) will alsocreate more demand for plant and machinery.

5. Over the next five years (1995-2000), gross fixed investment is projected to grow at a rate of 27percent. This would require a total investment of JD8.6 billion (US$12 billion equivalent). Out of thisamount, JD2.6 billion (US$3.6 billion) would be required for machinery and equipment. It is unlikelythat Jordanian economy will be able to finance such an investment from internal sources. As the accessto international capital markets will expand only gradually, a major part of the financing requirement willneed to be funded from multilateral and bilateral sources. The project would finance a small part of thisrequirement and enable the Jordanian private sector to undertake investment projects which will contributeto economic growth of the country and generate much needed foreign exchange.

Constraints to Supply of Medium- to Long-Term Finance

6. A wide variety of institutions intermediate savings and lending in Jordan. The main financialinstitutions are the commercial and investment banks, specialized credit institutions, the Amman FinancialMarket (AFM), pensions funds, insurance companies, and an investment company. While the financialsystem has a variety of institutional players with a well developed banking system, ,t is not sufficientlyflexible and efficient to support a competitive trade and investment regime. Institutional, policy and

Annex 2Page 3 of 9

regulatory rigidities have caused segmentation, muted competition, and thwarted efficient intermediation,leading to a suboptimal pattern of savings mobilization and allocation. As a result, sources of long-termfinance are limited and are not effectively channeled to financing investments in the productive sectors.

7. The banking system--21 licensed commercial and investment banks--is the largest component ofthe financial system. In recent years considerable progress has been made in strengthening the bankingsystem. Commercial and investment banks are now required to follow the Basle norms for capitaladequacy and prudential lending guidelines conforming to international practices. According to CBJ,most banks are now in compliance with the capital adequacy guidelines. Loan loss-provisioning has alsobeen increased and bad and doubtful loans have been fully provided for. The adoption of prudentiallending guidelines and enhanced powers of CBJ to intervene in case of incipient financial distress inbanks, coupled with improved on-site and off-site supervision, has caused a significant decline in badloans to less than 6 percent of outstanding loans.

8. Even though the banking system is sound, mainly privately owned and effectively supervised, ithas had limited success in providing long-term credit to the economy. While loans to the private sectoraccount for nearly 90 percent of total outstanding bank credit, majority of the loans (approximately 70percent in 1994) are for maturities of less than one year, with overdraft facilities accounting for nearly35 percent of all loans. These loans are predominantly for short-term working capital purposes andmainly to an established client base. On the remaining loans, repayment periods generally do not exceedtwo years. Loans with maturities in excess of two years are generally extended on a syndicated basis andrestricted to large and we!l known companies. In some instances, longer-term loans have been providedby rolling overdraft facilities. However, this arrangement is only made available to borrowers with whichthe banks have long-standing credit relationships.

9. The main reason for the limited supply of term resources from the banking system is thepredominance of short-term deposit liabilities: deposits with maturities in excess of one year account fora very small fraction of total deposit liabilities. Thus, fear of asset-liability mismatches prevents banksfrom extending term loans. Privileges enjoyed by the specialized credit institutions and rigidities in thecapital markets have reduced incentives for commercial banks and investment banks to mobilize andallocate long-term savings. Since banks cannot compete with specialized institutions that have access tosubsidized credit, they do not aggressively seek long-term savings. Instead they focus on providing short-term working capital.

10. Since 1989 CBJ has allowed the banking system to accept deposits denominated in foreigncurrency. This has resulted in the healthy growth of banking system deposits denominated in foreigncurrency. Such deposits accounted for approximately two-thirds of the increase in deposits between 1988and 1993. Foreign currency deposits from both residents and non-residents now represent approximately38 percent of banking system deposit liabilities. Until very recently, banks could not use these depositsfor extending loans to domestic firms. While this restriction has now been lifted and should encouragebanks to expand the choice of borrowing currencies they offer borrowers, it is unlikely to translate intoa significant increase in availability of term loans, as most of these deposits are short term.

11. Until recently a number of other factors were also responsible for reducing the role of banks inmobilizing and allocating long-term savings. The CBJ in the past used bank-by-bank credit ceilings asan instrument of monetary control. While this prevented excessive credit expansion, it reduced incentivesfor banks to compete for deposits and loans. The emergence of a liquid interbank market was alsothwarted because of reserve requirements on interbank deposits. The stunted development of the inter-bank market in turn held back the growth of properly functioning money or bond markets, preventedcompetition for funds between banks, and inhibited the smooth flow of funds between financialinstitutions. Finally, in the past, CBJ involvement in individual bank credit decisions also reducedincentives for banks to undertake term lending.

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12. The CBJ has made a number of changes in rules and regulations aimed at improving incentivesand intermediation efficiency within the banking system without jeopardizing its integrity. All interestrates have been deregulated and direct credit controls are being replaced by indirect monetary control.Since 1993 the CBJ has been issuing certificates of deposit as part of its monetary management. In 1994CBJ repealed regulations that restricted credit expansion to ten times the size of each bank's capital, andin 1995 it eliminated credit/deposit ratios. These measures are expected to improve competition withinthe banking system and enable smaller commercial and investment banks to compete more aggressively.

13. Ideally, long-term investment funds should be provided from the capital markets. The AmmanFinancial Market (AFM) is one of the largest stock exchanges in the region. About 150 companies arequoted on the AFM with total market capitalization of JD2.267 million as at end 1992. The Arab Bankaccounts for nearly 40 percent of AFM's market capitalization and the five largest companies account fornearly two-thirds of market capitalization. In the primary market between 1978-94, AFM supplied aboutJD 1.5 billion of equity capital through primary market issues. However, its role as provider of capitalto the economy has been uneven. In 1981 new equity issues by new and existing companies represented5 percent of GDP. By 1992 these had declined to 1.2 percent of GDP. During 1993 with the resumptionof economic growth new equity issues in the AFM aggregated about JD 230 million-about 6 percent ofGDP. About 60 percent of the newly raised capital went to existing companies quoted on AFM.

14. While AFM has been at times an important source of long-term equity capital, its full potentialhas not been achieved because of deficiencies in laws and regulations. The major constraints to AFM'ssmooth functioning and its growth are: (i) requirements under the Companies Law that limit shareholdingsby each of the original promoters to less than 10 percent; (ii) determination of pricing of new equityissues by the Government-appointed "Issuing Committee" instead of the market determining price of newissues; (iii) cumbersome registration procedures including the small denomination of the face value ofshares; (iv) taxation of capitalized retained earnings; and (v) poor rules and regulations relating tofinancial disclosure of companies and the activities of brokerage firms. These constraints have tendedto undermine public confidence. They have also prevented the growth of the market makers,underwriters, and brokers necessary to bring a larger number of companies to the market on acompetitive basis. Most firms other than large companies find the cost of raising equity capital throughAFM prohibitive.

15. Bond markets in Jordan are underdeveloped and generally not accessible by the private sectorfor a number of reasons. First, benchmarks for pricing bonds do not exist. Second, information on bondmarkets is not easily available, making trading difficult. Third, the poor development of long-termcontractual savings institutions in Jordan has limited the demand for long-term debt instruments. Fourth,the bond market is used to having government guarantees on bond issues. As a result, between 1988 and1993, the private sector raised only JD 14 million through bond issues. In 1994 no private manufacturingfirm or investment bank managed to raise resources in the bond market.

16. While transparent regulations and low transaction costs are necessary to motivate firms to accesscapital markets, the existence of a strong supply side is equally important. In this context, contractualsavings institutions can play a catalytic role in developing vibrant capital markets. The institutional basisfor contractual savings is not fully developed in Jordan, primarily due to weak regulatory and institutionalframework that impedes the growth of private pension and mutual funds. As a result, individual savershave limited institutional choices and limited financial products for storing their long-term savings.

17. The growth of private contractual savings institutions has also been deterred by the existence ofthe government-managed Social Security Corporation (SSC). The SSC manages the mandatory socialsecurity contributions of employees and employers (15 percent of salaries have to be put towards socialsecurity, with the employer contributing 10 percent and the employee, 5 percent). Total assets of SSCare about US$800 million. Thle SSC has a substantial annual cash flow surplus and logically should be

Annex 2Page 5 of 9

the source of long-term funds. However, the bulk of SSC's investments - over 50 percent - are in short-term bank deposits. Loans account for another 23 percent of SSC's assets, with a significant portion ofthese loans being to the G;overnment. Very few loans have been extended to purely private companies.Equity investments are only about 13 percent of total assets and bond holdings are very small becausethe Government requires SSC to keep a substantial portion of its funds as deposits with the Housing Bankand give priority to purchase of short-term Government debt. As a result, SSC has been ineffective inusing its large annual flow of long-term funds to catalyze growth of equity and bond markets.

18. One source of equity capital is the Jordan Investment Corporation (JIC) which is an investmentarm of the Government. Established in 1991 as a successor to the State Pension Fund, it is wholly ownedby the Government. It is the main institutional investor in the Jordanian economy and is fundedexclusively from Government equity contributions. At the end of 1993 JIC had invested in 43 companieslisted on the stock exchange that accounted for 60 percent of AFM's capitalization and JIC's owninvestments accounted for 18 percent of AFM's capitalization. JIC is the majority shareholder in anumber of these companies. In addition, JIC has holdings in 28 companies not quoted on the stockexchange. The total value of JIC investments as at end 1993 was JD 174 million. JIC has been animportant source of equity finance for Jordanian companies and has considerable influence and controlover publicly quoted companies. However, it is dependent on government financing and thus not in aposition to exercise independent corporate governance. Exclusive reliance on government funds has alsomeant that it plays no active role in mobilizing and investing long-term savings from private individuals.Thus, its impact on the growth of capital markets has been limited. In most instances its investmentshave been in companies that are monopolies. Its role in promoting a competitive private sector has beenminimal. In addition to SSC and JIC there are private pension funds established by large companies andbanks. While not much is known about their investments their share in the financial system is very small.

19. The insurance sector can also be a potential source of long-term funds. There are 17 insurancecompanies in Jordan all of which are publicly quoted; however, the sector represents only 4 percent sharein the total assets of the financial system. The regulatory framework governing insurance companies isnot well defined and there are restrictions on entry of foreign insurance companies. As a result, theinsurance sector plays a very marginal role in the supply of long-term funds.

20. The leasing industry in Jordan has not developed (there is only one leasing company, which hashad IFC involvement) for two main reasons: (i) restrictions on capacity to leverage; and (ii) deficiencyin collateral laws. Leasing companies are treated as non-financial companies. Hence their ability to raisefunds in the capital markets through bond issues is limited since they have to comply with leveragerestrictions of 1:1 set for companies that wish to issue corporate bonds. Furthermore, the Civil Codedoes not provide adequate protection to leasing companies for using moveable property as the onlysecurity in a lease transaction. The procedures for registering a lease interest or repossessing leased assetsis cumbersome.

21. Another factor that has delayed the growth of long-term equity and debt markets is the privilegedposition enjoyed by the four main specialized long-term financial institutions. These institutions wereestablished with a view to providing long-term loans for investment purposes. The Agricultural CreditCorporation (ACC) finances the agricultural sector, the Cities and Villages Development Bank financesmunicipal projects, the Industrial Development Bank (IDB) finances the industrial sector and the Housingbank finances the real estate sector (it also has a commercial banking wing). As of the end of 1993, totalassets of the specialized financial institutions were JD 1,334 million, with loans and advances to theprivate sector accounting for about 38 percent of total assets. Their share of credit extended by thefinancial system was around 18 percent. During the past few years net new lending to the productivesector has not been high-during 1994 net loan disbursements to the private sector were only JD 48million.

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22. These banks have enjoyed special privileges, in the form of access to funds from CBJ, theGovernment, and from international financial institutions (concessional funds). In most instances theseresources were made available at subsidized interest rates, enabling these banks to lend at interest rateslower than what private financial institutions were willing to charge. For example, ACC's agriculturelending has been at interest rates much lower than the going interest rates on loans from private banks.In some cases, the cost of funds has been further subsidized through exemption from income taxes orfrom import duties. For example, IDB pays neither income taxes nor customs duties. These privilegesare being removed however. As stated below (para. 25) and in the Government's Medium-TermFramework Policy Matrix, during the calendar year 1996, the special privileges of IDB and the HousingBank are to be eliminated and they are to undergo CBJ supervision as other banks. Furthermore, theGovernment will dispose of its minority equity holding (20 percent) in the Housing Bank.

23. These special privileges have had a distortionary effect on the rest of the financial systemparticularly on the availability of long-term credit for small and medium firms. Typically such long-termcredit institutions raise resources through bond issues. Resources raised through bond offerings are thenonlent to borrowers who, on their own, cannot directly access capital markets--generally small andmedium firms. However, in Jordan because of access to subsidized funds, these institutions lack theincentives, skills or strong balance sheets to access capital markets. Of late, these institutions have alsofaced a resource crunch. Because of monetary reasons and the need to curtail government spending,access to funds from the CBJ and the Government has been reduced. Concessionary finance fromexternal sources is also becoming scarce. As a result, these institutions have been unable to fully servicethe long-term financing needs of Jordanian firms. At the same time, development of bond markets isdelayed since bond issues by such institutions can often form the basis for development of a vibrant bondmarket.

Govermnent's Strategy for Financial Deepening

24. The Government of Jordan recognizes the policy and institutional constraints in the financialsystem that have slowed financial deepening, and has included financial sector liberalization as a majorfocus of its medium-term economic development strategy. With support from the Bank, the Govermmentplans to implement financial sector policy and institutional reforms to facilitate the growth of competitiveand well-regulated financial markets. These reforms are outlined in the Government's Letter ofDevelopment Policy for ERDL, and the related policy matrix is provided at the end of this Anmex.

25. For the near future, the Government has set two main goals for deepening the financial sector:(i) improve competition and efficiency in the banking system; and (ii) increase the mobilization andintermediation of long-term savings by the capital markets, contractual savings institutions and theinsurance industry. The Government's specific policy objectives are:

* Further enhancement of competition in the banking system, for both deposits and loans, throughadditional reform measures consisting of: (a) unification of reserve requirements for all banks so thatthe trend towards universal banking can be strengthened (by end 1996, the difference between reserveratios applied to commercial banks and investment banks will be reduced to a maximum of 5percent); (b) removal of reserve requirements on inter-bank deposits so that flow of resourcesbetween banks is enhanced; (c) further strengthening of CBJ's off-site and on-site supervisioninfrastructure; and (d) more transparent financial disclosure based on internationally acceptedaccounting standards.

* Reform of specialized credit institutions through: (a) elimination of special privileges; (b) applicationof a regulatory regime identical to that for private commercial and investment banks; (c) privatizationof the Industrial Development Bank; and sale of Government shares in the Housing Bank; and (d)comprehensive restructuring of the Agriculture Credit Corporation.

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* Reform of capital markets through: (a) separation of operational and supervisory functions; (b)installation of a modem trading, settlement, clearing and depository system; (c) adoption of fullerfinancial disclosure guidelines based on internationally accepted accounting principles; and (d)transparent regulation of brokers and underwriters.

* Reform of the Companies Law so that (a) pricing of equity issues is determined by the market andnot by the "Issuing Committee"; (b) companies can issue unsecured bonds; (c) the amount of bondsissued by companies can exceed their paid-up capital; and (d) share-holders can have 100 percent pre-emptive rights.

* Strengthening of the contractual savings institutions through: (a) reform of the insurance registrationallow new entry under a strengthened and independent regulatory body; (b) policy and regulatoryreforms that allow for private management of social security and pension schemes; and (c) amendingthe Companies Law to permit establishment and supervision of private mutual funds.

26. The long-term efforts discussed above, however, are not sufficient to deal with the immediateneed of firms for long-term funds, particularly in foreign exchange. The proposed credit line wouldtherefore serve as a useful vehicle to support the private sector in Jordan while the financial sectorreforms are being implemented and consolidated.

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The Hashemite Kingdom of JordanMedium-Term Policy Framework Matrix

Financial Policy

Policy Arcs Policy Actions taken prior to Policy Actions for Phase II Policy Actions for Phase IIIOctober 1995 (1996) (1997-1998)

(Indicative)

1. Banking Sector: Objectives: to improve bank competition, and the efficiency of financial intermediation.

I.1 Reserve Requirement Removed the provision subjecting Reduce the difference between Continue progress towardsinterbank deposits to reserve reserve ratios applied to unification of the reserve ratiorequirement. commercial banks and consistent with the monetary

investment banks to a maximum policy objectives.of 5 percentage points.

1.2 Credit Control Removed the Credit to Capital Continue to adopt andRatio as a monetary instrument consolidate the indirectand continue to use it only as a monetary control instruments asprudential instrument. envisaged in the macro

economic adjustment program.Removed the Credit to DepositRatio.

1.3 Local and regional Banking Relax the constraints on Formulate a phased action planCompetition mergers. to eliminate any legal

discrimination for entryEncourage the establishment of between Jordanian and foreignownership linkages between commercial banks.Jordanian and foreign banks.

Complete the study on "BankingSector Competition".

1.4 CBJ's Rediscount/Advance Reduced interest rate subsidies to Reduce the interest rate subsidy Eliminate the interest rateFacility one percent except for ACC, for ACC, handicraft industry subsidy with the exception of

export credit and small handicraft and export credit to 2 ACC, export credits andindustry. percentage points. handicraft industry.

1.5 Foreign Exchange interbank Accepted provisions under themarket Article VIII of the IMF Articles

of Agreement.

Permitted banks, without priorapproval of the CBJ, to use up to50% of their foreign exchangedenominated deposits in:

(i) syndicated loans;

(ii) to lend to each other; and

(iii) to invest in AAA and AAsecurities in the intemationalmarket.

2.0 Specialized Credit Institutions: Objectives: to eliminate the financial distortions, and to improve the financial viability of theinstitutions.

2.1 The Housing Bank Eliminate special privileges of Develop an action plan tothe lHousing Bank, and make privatize the Govemment'sthe Bank subject to the same ownership in the HousingCentral Bank supervision as in Bank.the case of all other banks.

2.2 The Agriculture Credit Finalizing study for the Commercialize the operationsCorporation (ACC) restructuring of ACC to cover of ACC through full financial

training of staff, diversifying its and managerial autonomy.portfolio, and formulating a

.__________________________ ____________________________ plan for com mercializing.

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Policy Area Policy Actions taken prior to Policy Actions for Phase II Policy Actions for Phase IIIOctober 1995 (1996) (1997-1998)

(Indicative)

2.3 The Industrial Development Start to eliminate special Develop an action plan toBank (IDB) privileges of the IDB to convert privatize the Govemment's

it into a full bank subject to the ownership in the IDB whileCentral Bank supervision. maintaining its provision of

medium- and long-termfinancing to industry.

3.0 Long-term Financial Markets: Objectives: to encourage longer-termi savings, and promote the development of capital markets

3.1 The Amman Financial Conduct a study to determine Based on study results, developMarkets (stocks and bonds) optimum structure for AFM an action plan and start

including the feasibility of implementation.separating the operationalfunction from the supervisory Automate systems, createone. central settlements and

securities depository.Acquire and install a tradingclearing settlement and Adopt and announce thedepository system. principle of full and credible

financial disclosure.Implement new proceduresconcurrently on a stock by stock Adopt a uniform code ofbasis, starting with less active general accounting principles.stocks.

The Companies Law withfollowing provisions will bepresented to the Parliament:

(i) the removal of the provisionwhich requires that the issuingprice to be determined by theIssuing Committee, andreplacing it with a provisionthat the market (i.e. theunderwriting company)determine the price at issue.

(ii) the removal of theprovisions requiring that the fullvalue of corporate bonds mustbe guaranteed by a mortgage;

(iii) allowing 100% pre-emptiverights for share-holders; and

(iv) removal of the provisionrequiring that the value ofcorporate bonds must not exceedthe paid-up capital.

3.2. Contractual Savings Amended the Insurance Law to Adopt by law to set standards Adopt policy and regulatoryInstitutions open market for competition and for insurance sector. reforms in pension fund

allow new entry. management as needed.Conduct a study to review thesocial security and pension Continue to implement andfunds to allow private pension consolidate the regulatoryschemes. reforms in pension and

insurance industries.

3.3 Financial Diversification Companies Law be amended to Consolidate the regulatory andpermit the establishment of supervisory capacity for themutual funds and the necessary mutual fund industry andregulatory capacity. establish the necessary

supervisory institutionalI capacity.

Annex 3Page 1 of 5



Terns and Conditions of the Line of Credit

Objective: The objective of the credit line is to enable private firms invest in improving theirinternational competitiveness. The credit line would provide financially sound private commercial andinvestment banks with access to term resources for financing medium and long-term investments ofprivate Jordanian firms. It would finance viable projects in all sectors other than real estate and housingconstruction.

Borrower: The Government of Jordan

Loan Amount: US$ 40 million

Terms: The loan would consist of a single currency loan in US Dollars at the Bank's standard LIBOR-based interest rate repayable over 20 years, including a grace period of 5 years. The last date forcommitment under the line of credit would be January 31, 1999.

Implementing Agency: The Central Bank of Jordan (CBJ), acting as the fiscal agent for theGovernment of Jordan.

Beneficiaries: Private commercial and investment banks that meet the eligibility criteria established byCBJ. The eligibility criteria are described on pages 4 and 5 of this Annex. During negotiations,Government agreement was received on these criteria.

Onlending Terms to Participating Banks: Funds under the credit line would be onlent by CBJ toparticipating banks (PBs) in US dollars or in Jordanian dinars (JD) at interest rates that, at a minimum,cover the Government's cost of funds and reflect prevailing market conditions. Under current conditions,the on-lending rate for US dollar loans would be LIBOR, plus a minimum spread of 100 basis points,including 25 basis points for CBJ's administrative fee. For JD loans the on-lending rate would be theJordanian Treasury Bill' rate plus 50 basis points, of which 25 basis points would represent CBJ'sadministrative fee.

The US dollar and JD on-lending rates would be reviewed every six months and, if necessary, new ratesreflecting the market conditions would be established; and the World Bank informed. The commnitmentcharges paid by the Government to the World Bank would also be recovered from the PBs. Therepayment period for each loan extended to the PBs under the credit line would be the same as that onthe subloan extended by the PBs to private borrowers, subject to a maximum of seven years. Fundswould be onlent to PBs on a first-come first-served basis under subsidiary financing agreements executedbetween the PBs and CBJ. Signing of subsidiary financing agreements between CBJ and at least twoprequalified banks to serve as PBs is a condition of effectiveness for the World Bank loan.

The 3-month Jordanian treasury bills are auctioned monthly by CBJ on behalf of the Government.They have been issued since 1960s. The volumes issued in the last three years were JD1 billion eachin 1993 and 1994 and JD603 million in 1995. The large majority is purchased by private banks. InJanuary 1996, the interest rate on the treasury bills was 8.6%.

Annex 3Page 2 of 5

Purpose of Subloans: The PBs would use loans under the credit line to fund medium- and longer-termloans (hereinafter referred to as subloans), sanctioned and disbursed by them to private Jordanian firms(hereinafter referred to as subborrowers) for financing eligible activities (hereinafter referred to as sub-projects). The eligibility criteria for subborrowers, subloans and subprojects are described in Appendix2. At negotiations, agreement has been reached with the Government on the eligibility criteria. Theactivities to be financed would broadly aim at implementing well conceived strategies for enhancingcompetitiveness and, would include the following:

(a) plant improvements, construction of factory premises, and acquisition of new plant andmachinery; and purchase of technical know-how and quality assurance equipment;

(b) investments in energy conservation and pollution control equipment;

(c) incremental permanent working capital needs arising as part of investments in new plantand machinery; and

(d) one-time cost of establishing marketing arrangements and providing training associatedwith the new investments;

Onlending Terms for Subloans. The PBs would onlend funds to eligible enterprises in US dollars orin Jordanian dinars. There would be no ceiling on the final interest rate or on the spread to be chargedby the PBs on individual subloans. These would be freely determined by the PBs, based on their analysisof credit risk and on their relationships with prospective borrowers. However, the maximum repaymentperiod on any subloan would not exceed seven years, including a grace period of not more than threeyears. The maximum amount of an individual subloan would be US$2 million. The first two subloansextended by each PB under the line of credit would require prior approval of CBJ and the World Bank.Thereafter, the PBs would send details about eligible subloans to CBJ for purposes of authorizingdisbursements only.

Implementation Arrangements. The CBJ will implement the credit line. For this purpose, CBJ hasestablished a two-person unit, supervised by the Executive Manager, External Debts and AgreementsDepartment. The specific responsibilities of this unit are to:

(a) prequalify PBs and execute subsidiary financing agreements;

(b) ensure that PBs meet the eligibility criteria;

(c) approve the first two subloans extended by each PB, as well as obtain World Bank'sapproval;

(d) ensure on ex-post basis that each subloan (with the exception of the first two sub-loansextended by each PB) complies with the eligibility criteria relating to subborrowers andsubprojects;

(e) monitor and supervise utilization of the credit line, and keep the World Bank periodicallyinforrned;

(f) obtain periodic reports from the PBs on the subloans; and

Annex 3Page 3 of 5

(g) ensure that disbursements under the credit line are in accordance with agreements reachedbetween the Government and the Bank on procurement and environmental assessments.

Environmental Impact. The PBs will ensure that each subproject will comply with the environmentalstandards satisfactory to the Bank and with applicable laws and regulations of the Government relatingto health, safety and environmental pollution.

Procurement. Procurement of goods, services and works under the subloans would be carried out inaccordance with normal comnmercial practices of enterprises. These are acceptable to the Bank. The PBswould maintain records of procurement procedures and methods used, summarizing offers and awardsfor ex-post review by the Bank on a periodic basis.

Disbursements. Of the amounts disbursed by PBs under any subloan, subject to a maximum of US$2million, the Bank loan would finance 100 percent of foreign expenditures and 90 percent of localexpenditures for goods and works, and 100 percent for consultants' services. Disbursements by PBswould be against invoices. A Special Account would be opened by the Government of Jordan with CBJ,with an authorized allocation of US$4 million. The Special Account would be replenished on a monthlybasis or when the balance is equal to 50 percent of the authorized allocation, whichever comes first.Withdrawal applications would be supported by appropriate documentation, including a copy of themonthly bank statements and their reconciliation with the Special Account transactions. Disbursementscan be made through direct payment or special commitments (subject to a minimum application size ofUS$800,000) from the Bank.

Subloan Approvals and Free Linmits. It is expected that the average size of each subloan would beUS$500,000. As noted earlier, the first two subloans appraised by each PB under the line of credit wouldbe submitted to CBJ for prior approval. The CBJ would forward these to the World Bank for itsapproval also. The request for approval would be accompanied by complete information on the subloans,including a credit appraisal report prepared by the PB. Once CBJ and the World Bank have approvedthe first two subloans, corresponding funds would be committed under the credit line. For subsequentsubloans, funds under the credit line would be committed to PBs as soon as they approve subloans thatmeet the eligibility criteria. Details about subloans would be submitted by PBs to CBJ on a formatprescribed by CBJ. The CBJ would, in turn, keep the World Bank informed about the utilization of thecredit line on a monthly basis. Since the maximum amount of individual subloans is relatively small, noseparate free limits are being proposed.

Monitoring and Accounting. The CBJ would monitor implementation of the credit line. In January1997 and 1999, Annual Reviews, and in January 1998, a Mid-Term Review would be held. In additionto the monthly statements on the use of the credit line, CBJ would submit annual implementation progressreports in November of each year, to the World Bank. The reports would follow a standardized formatthat would be finalized during the project launch seminar. The reports would cover implementationstatus; deviations, if any, from the Implementation Plan and reasons; problems and constraints, and thecorrective actions being taken; and updated disbursement and commitment tables. The CBJ would alsoprepare a detailed mid-term report and submit it to the Bank by end November 1997 to serve as the basisfor the Mid-Term Review, and an Implementation Completion Report to the Bank within six months ofthe Closing Date of the Bank loan. Progress on implementation of the credit line would be reviewed byBank supervision missions. The CBJ would ensure that the Special Account is audited by an independentfirm of auditors acceptable to the Bank. The audited accounts would be submitted to the Bank not laterthan six months from the close of each fiscal year.

Annex 3Page 4 of 5

Eligibility Criteria for Participating Banks

In order for commercial and investment banks to be eligible for acceding funds under the project,they would be subject to the following criteria:

(a) privately-owned and managed;

(b) in compliance with all applicable banking laws and monetary regulations of the Central Bank ofJordan (CBJ), including the capital adequacy requirements;

(c) have the technical, financial, and administrative capacity to manage tern loans; and should haveprepared and adopted operating policies and procedures considered satisfactory by CBJ forappraising and monitoring loans under the credit component; and

(d) audited by independent external auditors and have an unqualified audit.

Eligibility Criteria for Subborrowers, Subprojects and Subloans

1 . Subborrowers. Each subborrower should meet the following criteria:

(a) privately owned, i.e., own at least 51 percent of the controlling interest;

(b) have a maximum total debt-to-equity ratio of 2:1 and a minimum debt service ratio of atleast 1:3; and

(c) have its accounts audited by independent external auditors.

2. Subprojects. Each subproject should meet the following criteria:

(a) eligible investments would include: (i) plant improvements, construction of factorypremises, acquisition of new plant and machinery, purchase of technical know-how andquality assurance equipment; (ii) investment in energy conservation and pollution controlequipment; (iii) incremental permanent working capital arising as part of investments innew plant and machinery; and (iv) incremental marketing and training expenses.(investments in the housing or real estate sectors are not eligible);

(b) investments in the housing or real estate sector are not eligible for subloans;

(c) individual subprojects should have a projected financial rate of return of at least 15percent; and

(d) individual subprojects should comply with the environmental standards satisfactory to theBank and with applicable laws and regulations of the Government relating to health,safety and environmental pollution.

3. Subloans: Each subloan should be backed by the following information:

(a) descripticn of the subproject, including a detailed project report, description of theproposed or existing enterprise including description of its products, past exports,manufacturing capacity, organizational and management structure, and latest auditedfinancial statements;

Annex 3Page 5 of 5

(b) a detailed analysis of target markets, including a detailed description of the proposedmarketing strategy and analysis of existing capability to service the target market;

(c) an appraisal report analyzing the commercial viability of the proposed investment andcovering, inter-alia: a detailed balance sheet and cash-flow analysis, analysis of marketdemand-- both local and foreign; analysis of impact of tariffs; analysis of price-qualitycompetitiveness in target markets; analysis of access to inputs both local and imported;and steps taken by the enterprise to improve competitiveness, establish marketingchannels, and enter into firm marketing arrangements; and

(d) a financial analysis of past three years performance, if applicable, and projected financialperformance during the period of the subloan.

Annex 4



Project Cost and Financing Plan

Project Cost Sunmmary

Local Foreign Total

-----------------------(US$ million)--

Credit Line 20.0 40.0 60.0

Total Base Cost 20.0 40.0 60.0

Physical Contingencies n.a. n.a. n.a.

Price Contingencies n.a. n.a. n.a.

Total Project Cost 20.0 40.0 60.0

Financing Plan

Funding Source Local Foreign Total % of Financing Plan

-------------(US$ million)---).

IBRD 0 40 40 67

Private Sector 20 0 20 33

Total 20 40 60 100

Annex 5



Supervision Plan

Estimated Total Supervision Staffweeks Resources Required: 48Estimated Field Supervision Staffweeks Required: 31

Approx. Supervision Activity Mission Composition InputDate (sw)

April 1996 Project launch: Review project implementation arrangements; Task manager, procurement and 4monitorable indicators; procurement, disbursement, disbursement specialists, andaccounting and reporting procedures; and participating financial sector specialist.bank agreements (with CBJ project unit and PBs).

June 1996 Supervision: Review status of line of credit implementation. Financial sector specialist 4

Sept. 1996 Supervision: Review progress and arrange for Annual Financial sector specialist 2Implementation Review.

Jan. 1997 Annual Implementation Review: Review progress over the previous Task manager and financial sector 3implementation period against monitorable performance and specialistdisbursement indicators; make adjustnents as necessary.

June 1997 Supervision: Review line of credit disbursements and pipelines. Financial sector specialist, 2

Jan. 1998 Mid-Term Review: Review progress over the previous implementation Task manager and financial sector 3period against monitorable performance and disbursement indicators; specialistmake adjustments as necessary.

June 1998 Supervision: Review line of credit disbursements and pipelines. Financial sector specialist 2

Jan. 1999 Annual Implementation Review: Review progress over the previous Task manager and financial sector 3implementation period against monitorable performance and specialistdisbursement indicators; make adjustments as necessary.

June 1999 Supervision: Review the line of credit operation. Initiate special Task manager and financial sector 2account recovery procedures and project completion specialistreporting.

Dec. 1999 Implementation Completion Report Mission Task manager, financial sector 6specialist, disbursement officer,

Annex 6



Procurement Arrangements

Procurement Methods

Procurement Category ICB NCB Other NBF Total------------------------(US$ million)-----

Goods, works and consultants' services 0 0 60.0 0 60.0financed by subloans under the credit line (40.0)' (40.0)

Total 0 0 60.0 0 60.0i ______ (40.0) (40.0)

1/ Procurement under subloans would be carried out in accordance with normal commercial practices inJordan. The subloans typically would finance investments by private firms for productive capacitydevelopment or expansion.

Annex 7



Disbursement Schedule

IBRD Fiscal Year and Semester Ending: US$ million US$ million(Cumulative)

FY 96 June 30, 1996 4.0' 4.0

FY 97 Dec 31, 1996 3.2 7.2June 30, 1997 4.8 12.0

FY 98 Dec 31, 1997 5.1 17.1June 30, 1998 4.9 22.0

FY 99 Dec 31, 1998 6.2 28.2June 30, 1999 4.4 32.6

FY 00 Dec 31, 1999 4.8 37.4June 30, 2000 2.6 40.0

1/ Initial disbursements into the Special Account (US$4.0 million) will be recovered during the last foursemesters.

IMAGING

Report No: 14935 JOType: SAR

world bank document · are relatively new to project appraisal and term-lending techniques. this...

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