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Is Jordan economy ready to cope with more interest rate hikes?

Aug 07,2017 - Last updated at Aug 07,2017

The Central Bank of Jordan (CBJ) has recently followed the US Federal Reserve (Fed) and raised the interest rate four times since December 2016 by 1.25 per cent.  The CBJ's policy for setting interest rate right now is to follow any raise actions taken by the Fed. But the CBJ should consider recent forecasts of policymakers in the US that the Fed is projecting one more quarter-point rate increase in 2017 and a further three in 2018. Thus, can Jordanian economy cope with more interest rate hikes? What are the short- and long-term effects of such raises if taken on Jordan economy?

For example, while the recent third consecutive rate hike by the Fed that took place in July 2017 has pushed the US base rate just to1.25 per cent in an attempt to control the inflation target, similar hikes implemented by the CBJ has sent the interest rate in Jordan from 2.5 per cent to 3.75 per cent aiming to ensure  the Jordanian dinar is competitive and attractive for domestic savings.

The CBJ clearly indicates that the main objective of interest rate hikes is to maintain the Jordanian dinar as an attractive tool for domestic savings. Thus, someone would expect the level of domestic savings to increase as a result. However, statistics provided by the CBJ show that the level of domestic savings in Jordanian dinar has dramatically declined over the last two years from JD25,968.2 million in December 2016 (the date of first interest rate hike by CBJ) to JD25,192.1 million in February 2017 (the date of second interest rate hike), then declined further in March 2017 to reach JD25,060.2 million (the date of third interest rate hike), its lowest level since April 2015.  

On other side, and in contrast with the expectations, the level of domestic savings in foreign currencies has witnessed a gradual increase by almost 16 per cent over the last three years to reach its highest level in May 2017 of JD7,219.4 million, as compared to JD6,247.9 million in December 2014. Unless assuming that CBJ’s recent interest rate hikes would really take time before work their way into the real economy, sceptics would say the above statistics suggest the CBJ‘s interest rate hike policy did not achieve what was expected, but goes on the opposite direction by increasing domestic saving in foreign currencies rather than in Jordanian dinar.

Other direct impact for increasing interest rate is increasing the cost of borrowing and mortgage interest payments, which overall lead to slowdown the economy. For instance, the demand on service and products in the markets will fall down since people will spend more on their mortgage interest payments and have less disposal income to spend on other area of consumption. Recent reports supported this view and pointed out that commercial banks in Jordan responded to the recent interest rate hikes by the CBJ and raised their interest rate on the current mortgage interest payments, without having their customers approval since this is legal according to the rules. 

In terms of the cost of borrowing, any increase will directly increase the cost of manufacturing products and providing services since any raise in the cost of capital (borrowed money) would result to a similar raise in the total cost and a reduction in the profit margin. This is in turn will make Jordan a less attractive investment destination. Unfortunately, during the last three years the Foreign Direct Investment (FDI) in Jordan has sharply declined by 40 per cent from JD1546.7 million in 2014 to just JD1092.6 9 million in 2016. So it is not all about the investment regulatory environment as recently pointed out, it seems major reasons for FDI reduction are due to the high operating costs in Jordan; which is partly attributed to high interest rate.    

Theoretically, it is expected that a higher interest rate would make it attractive for investors to save in Jordanian dinar since the return on deposits is high (pushing up the value of Jordan dinar), but this would make imports more attractive and reduce the costly exports. The CBJ statistics show for May 2017 that Jordan imports are JD1,248.4 million, three times higher than its exports (JD388.1 million). Do we really need to increase the trade deficits (the gap between imports and exports)?  

The trade deficit has a negative direct impact on the level of foreign currencies reserves; which actually causes a big concern for the CBJ since there is a little room to move.  Foreign currency reserves have significantly dropped by 20 per cent in the last three years to reach JD8,067.8 million in April 2017 as compared to JD9,683.3 million in April 2015. 

Overall, raising the interest rate would lead for sure to strong Jordanian dinar but at the expense of many other side effects.  Based on the above statistics, Jordan's economy incurs very high costs for raising the interest rate, in addition to many other political, economical and social factors beyond its control. Given that the Fed is planning for further four interest rate hikes in the coming 18 months, the CBJ should therefore compares costs/benefits of any future interest rate hikes to ensure Jordanian economy is strong enough to override the side effects.

 

 

The writer is assistant professor in financial accounting at Al al-Bayt University, a visiting research fellow with the Institute of Banking and Investment, University of Leeds, UK. He contributed this article to The Jordan Times.

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