Initial Opinion

6 September 2011

Jordan in the GCC

Our Initial Thoughts

The Invitation
The Gulf Cooperation Councils (GCC) announcement during the Heads of State summit held last May in Riyadh to formally welcome the idea of Jordan as a member of the council represents a break from the past. While this announcement came as a surprise to almost everyone, the GCC's outreach could have significant economic and political consequences for both Jordan and the GCC. This paper will attempt to analyze the economic implications of joining such a wealthy regional block for a resource-scarce country like Jordan. We will start with a brief introduction to the GCC in addition to its accomplishments in terms of economic integration. This will be followed by a closer look at the possible implications for Jordan under different frameworks of integration.

The Gulf Cooperation Council: A Brief History

On May 25th, 1981, the GCC was formed with six member states: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE as a multipurpose organization seeking integration and interconnection between member states in all fields. On the economic side, GCC members drew-up a unified economic agreement covering freedom of movement of people and capital, the abolition of custom duties, harmonization of banking regulations, technical cooperation, and monetary coordination. Today, the GCC is a thriving region with a population of 39 million across an area of 2.7 million km2 and a nominal GDP of USD 1,085 million. Per capita GDP has increased by around 45% over the last decade to reach USD 23,260 by the end of 2010, and is expected to reach USD 38,000 by 2015. More important, the GCC controls almost 40% of the worlds proven oil reserves and around 20% of Gas reserves, making it an important economic bloc on the world stage.

Economic Research Jordan

Stages of Economic Integration

Whether it is shallow or deep integration, the progression of economic integration usually follows four sequential initiatives: Free Trade Areas (FTAs), customs unions, common markets and monetary unions. The various stages increase the depth of economic integration between the countries involved. Each stage requires greater commitment from the participants and further harmonization and standardization. In order to appreciate this progression, a description of each stage is useful: 1. Free Trade Areas (FTAs) Within an FTA, barriers to goods movement are reduced. However, members maintain their individual tariff schedules against goods imported from third parties. FTA effective operation requires certificates of origin to verify the source of imports. These documents differentiate between goods produced within or outside the area. 2. Customs Unions In customs unions all tariffs are abolished and no restriction to trade exists as with FTAs. Unlike FTAs, however, customs unions members levy an identical tariff rate to all third party imports. A unified tariff schedule is agreed upon between all members.
Research Team:
Tarek Yaghmour Head of Research Tel: +962 6 5200330 Ext. 327 Tarek.Yaghmour@Capitalinv.jo Nawaf Masri Research Analyst Tel: +962 6 5200330 Ext. 478 Nawaf.Masri@Capitalinv.jo

Sales & Trading contact:

Wissam Al-Hourani Head of Local Markets Brokerage Department Tel: (962 6) 5200330 Ext. 262 Wissam.Hourani@Capitalinv.jo

Jordan in the GCC | August 2011

3. Common Market Common markets are a progression from customs unions where not only goods are allowed to move freely but factors of production too. Free movement of labor and capital across borders is facilitated, ensuring that national treatment of factors of production apply across borders. 4. Monetary Union A monetary union is the culmination of the economic integration process. Once goods and factors of production can move freely, members of a union seek to unify their national currencies. Consequently, members forfeit their national currency and a common currency is used across political borders as legal tender. This stage requires national governments to relinquish their sovereignty over monetary policy to a super-national central bank.

The GCCs Road to Integration

The progression of the GCCs economic integration has followed the four stages discussed in the previous section. In 1983 the GCC launched its FTA that helped reduce trade restrictions between member countries. The GCC however did not progress to the next step until 2003, when it initiated a customs union whereby all remaining restrictions between member countries on the movement of goods and services were removed. The GCC also unified its external tariff against non-members in the same year. Nevertheless, GCC members have yet to agree on a number of pending issues including custom duties sharing and the protection of local industries with plans underway to resolve all outstanding matters by 2015. In 2008 the GCC launched its common market allowing for greater mobility of capital and labor within the region. Finally, the planned establishment of the GCC single currency in 2010 has been postponed pending further studies and harmonization measures. This delay followed the decision of two members (Oman and the UAE) to opt out, and, more recently, concerns about other members readiness in the wake of the financial crisis in Europe and mounting pressures on the euro.

Jordan will Benefit First

Although it is still too early, and largely speculative, to assess the implications of Jordans accession to the GCC, we believe that Jordan could be the first to reap the benefits of any possible GCC expansion as the financial advantages, in the form of either grants or cheaper oil, would immediately act as an effective instrument to lower Jordans mounting deficit following the governments decision to expand its subsidy program earlier this year pushing the budget deficit to as high as 7% of GDP by year end. In fact, Jordan has received USD 1.4 billion in financial aid from Saudi Arabia during the past few months which resulted in a budget surplus of JD 313.2 million at the end of July 2011. Joining the GCC will also help Jordan maintain inflation rates at acceptable levels, especially after the government exhausted most of its options to expand its subsidy program in the face of rising international commodity prices.

Budget Deficit as % of GDP

40% 10% 8% 6% 4% 2% 0% 2001 2002 2003 2004 2005 2006 2007
3.5% 3.2% 4.2% 2.7% 2.7% 2.2% 5.3% 5.1% 5.6% 8.9%

Consumer Price Basket YoY % chg

30% 20% 10% 0% -10% -20% -30% Jul-08 Jul-09 Jan-08 Jan-09 Jan-10 Oct-08 Oct-09 Apr-08 Apr-09 Apr-10
Food Items Housing Transportation

Jul-10

Oct-10

Jan-11

Source: CBJ

Source: DOS

Economic Research | Initial Opinion

Apr-11

2008

2009

2010

Jordan in the GCC | August 2011

But Lets Not Get Carried Away

Despite all the short-term benefits, one should focus on the medium to long-term implications when studying Jordans possible accession to the GCC, not just the immediate benefits on public finances and price levels, but also the long term implications on the different economic sectors in the kingdom in terms of competitiveness, labor, growth outlook, regulations, etc.

Customs Union or Common Market

It is well understood that the future of this agreement will depend solely on the GCCs decision regarding Jordans request, but for the sake of this analysis, we will assume that Jordan will be granted a full membership under one of the two most probable frameworks, the customs union and the common market.

Scenario 1: A Full Membership within the Customs Union

Based on the scenario where Jordan will be granted full membership within the customs union framework, here are our initial thoughts on the possible implications for the Jordanian economy. Minimal impact on exports As Jordan and GCC countries are already members of the Greater Arab Free Trade agreement (GAFTA), formed in 1997 and implemented in 2005, to liberate trade between 17 Arab countries and emphasize the complete removal of tariffs on trade between members, we dont expect any significant impact on Jordanian exports from joining the GCC. However, cheaper oil from the GCC countries could lower Jordans imports and trade deficit especially when taking into consideration that the kingdoms energy bill reached JD1.8 billion by the end of June 2011, equivalent to around 28% of total imports during the period.
Exports vs Imports
12,000 9,000 JD Million 6,000 3,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -3,000 -6,000
Source: DOS

Oil & Oil Derivatives Imports as % of Total Imports

30% 23.6% 21.1% 17.9% 10%

21.7%

22.3%

20%

0% 2006 2007 2008 2009 2010

Exports

Imports

Trade Deficit Source: DOS

Lower custom duties from tariff cuts On a different note, the customs union assumes common external tariffs for members on their trade with other countries outside the union at a low rate of 5%, which will require Jordan to significantly decrease its existing tariffs relative to other members in the GCC and will lead to increased competition and less protection to local producers, considering that GCC manufacturers enjoy more government subsidies, cheaper energy and lower taxes. It is also worth noting that the kingdoms custom duties and fees on international trade averaged 6.5% of total government revenues during the period 2008-2010. Consequently, the repercussions of the customs union will jeopardize one of Jordans main sources of revenue.

Economic Research | Initial Opinion

Jordan in the GCC | August 2011

Custom Duties Fees

400 15%

Custom Duties as % of Gov. Revenues

JD Million

315.6 300

312.1 284.4 270.3 275.3

10%

10.0%

8.6% 6.5% 6.5% 6.5%

5%

200 2006
Source: CBJ, MOF

0% 2007 2008 2009 2010 2006

Source: CBJ, MOF

2007

2008

2009

2010

Factors of production wont be affected The membership agreement within the customs union framework is not expected to have an impact on the factors of production, such as labor and capital, as these are not included in such an agreement. Therefore, foreign direct investments, remittances and unemployment will not be affected under this scenario.

As a result ... Under the customs union scenario, the agreement will not prove to be successful for Jordans economy in the medium to long term as, aside from the limited benefits mentioned earlier; Jordan will have to undergo costly structural changes to conform to GCC economies in terms of tax systems, fiscal policies, and custom tariffs.

Scenario 2: A Full Membership Within the Common Market

Based on the aforementioned and in order for Jordan to reap the benefits of joining this wealthy economic bloc, the membership must fall under the third stage of integration, the common market. Despite the fact that this framework requires time and effort for Jordan to adapt with the existing structure of GCC economies, we will try to examine the possible outcomes under this scenario. Remittances will rise and unemployment will fall An estimated 600,000 Jordanians are already working in the GCC, and their remittances, which amounted to JD2.25 billion or 12% of GDP in 2010, boost the countrys balance of payments and the living standards of many Jordanians.

Remittances to Jordan
14.7%

Unemployment in Jordan
15.3% 14.0%

2,500 2,000 JD Million 1,500 1,000 500 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

25% 20% 15% 10% 5% 0% -5%

16% 15% 14% 13% 12% 11%

13.7%

14.5%

14.7%

14.8%

13.1%

12.7%

12.9%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Remittances
Source: CBJ

Growth

Source: DOS

Economic Research | Initial Opinion

2010

Q1

10%

12.5%

13.1%

Jordan in the GCC | August 2011

As of the first half of 2011, remittances have decreased by 3.1% to stand at JD1.2 billion compared to the same period last year and have decreased by 9.6% during June alone when compared to the same month last year, this in turn has added further pressure on Jordans foreign currency reserve which declined 12.6% or JD1.09 billion to stand at JD7.5 billion at end of the first half of 2011 compared to the balance at the end of 2010. Moreover, the membership will provide easier access to the GCC for skilled Jordanian workers and eventually help contain Jordans rising unemployment which reached 13% by the end of Q1 2011, up from 12% in the previous year and ultimately increase workers remittances. Tourism might flourish According to the latest figures released by the Ministry of Tourism, the number of visitors from the six GCC states grew by 11.6% in 2010 to reach 1.65 million or 20% of total visitors while tourism receipts from GCC nationals amounted to around JD450 million or 18.5% of total receipts during the same year. Although we do not expect to see a notable increase in inbound leisure tourists from the GCC as all GCC nationals already enter Jordan without any Visas, the same is not true for medical and educational tourism which could see a boost if Jordan was able to position itself as a more costeffective destination for these two subsectors.

Number of Tourists in Jordan

10 8 Million 6 4 2 2005
GCC

Tourism Receipts in Jordan

23% 22% JD Million 21% 20% 19% 18% 3,000 2,500 2,000 1,500 1,000 500 0 2005
GCC Source: Ministry of Tourism

20%

19%

18% 2006
Others

2006

2007

2008

2009

2010

2007

2008
GCC as % of Total

Others

GCC as % of Total

Source: Ministry of Tourism

More FDI Foreign direct investment in Jordan, especially from the six GCC nations, witnessed substantial growth in the last decade reaching a record level of USD3.5 billion or 23% of GDP in 2006 before gradually dropping to USD 1.7 billion or 6% of GDP by the end of 2010. The GCC accounted for 29% and 15.5% of total FDI in Jordan during 2009 and 2010 respectively while Saudi Arabia alone accounted for 10% and 13.5% of FDI in the kingdom during the same period.

FDI in Jordan
4,000 3,000 USD Million 2,000 1,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 25% 20% 15% 10% 5% 0% 35% 30% 25% 20% 15% 10% 5% 0%

GCC Share of FDI in Jordan

29%

16% 11%

2008

2009

2010

FDI Source: CBJ, Dhaman Source: CBJ, Dhaman

FDI as % of GDP Source: CBJ, Dhaman

Unrestricted flow of capital from the GCC would facilitate more FDI in coming years which will boost economic growth and help solve some of the countrys structural problems such as rising

Economic Research | Initial Opinion

Jordan in the GCC | August 2011

unemployment. This could also positively impact the real estate sector and the Jordanian Stock Market, which have recently experienced falling prices and subdued activity. It is also worth mentioning that Jordan could experience some capital outflows towards the GCC searching for more competitive business environments with cheaper energy and lower tax rates.

It will also ease the Kingdoms debt burden Following several years of expanding budget deficit and declining GDP growth, Jordans public debt has been rising steadily in both relative and absolute terms. Net public debt increased by 5.8% during the first 4 months of 2011 to reach JD12.1 billion, or 57.7% of GDP. As mentioned earlier, higher economic growth and lower deficit in coming years will reduce the countrys reliance on debt markets and alleviate its debt burden.

14,000 12,000 JD Million 10,000 8,000 6,000 4,000 2,000 0

Government Debt in Jordan (JD Million)

Total Government Debt as % of GDP

70% 60% 50% 40% 30% 66.3% 58.7% 65.1% 53.1% 54.2% 57.7%

2006

2007

2008

2009

2010

Apr-11

2006

2007

2008

2009

2010

Apr-11

Domestic Debt
Source: CBJ

Foreign Debt

Source: CBJ, DOS Source: CBJ, DOS

Economic growth should strengthen After growing at an average rate of 7.2% between 2006 and 2009, real GDP growth dropped to 2.3% in 2010 as a result of the global financial crisis. Moreover, and following the political unrest in the region, which affected most sectors in the kingdom, the IMF has recently lowered its 2011 growth forecast for Jordan to 3.3%, down from its October 2010 estimate of 4.2%.

Real GDP Growth in Jordan

8.6% 8.1% 8.1% 8.2%

GDP Per Capita in Jordan

3,500 27% 22% 17% 12% 7% 2% -3% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 6

12% 10%
5.8% 5.3% 4.2%

7.2%

3,000
5.5%

8% 6% 4% 2% 0%

2,500 2,000
2.3% 2.4% 2.3%

1,500 1,000 500 0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Q1 10

Q1 11

GDP per Capita (JD) Source: DOS Source: DOS

Growth (%)

In fact, Jordans nominal GDP, which was estimated at JD18.76 billion, or USD 26.50 billion, in 2010, is the second smallest in the region while the kingdoms GDP per capita amounted to USD 4,328 in 2010 and ranked 10th in the Arab world, ahead of Tunisia, Morocco, Syria, Egypt, Iraq, and Yemen.

Economic Research | Initial Opinion

Jordan in the GCC | August 2011

Should plans for the GCC expansion come through, more FDI and remittances coupled with lower inflation and oil prices would boost real GDP growth in Jordan as the economy benefits from a much lower base compared to many other wealthier countries in the MENA region.

MENA-Nominal GDP
450 USD Billion 375 300 225 150 75 0 KSA UAE Egypt Algeria Kuwait Qatar Morocco Iraq Libya Syria Oman Tunisia Lebanon Yemen Jordan Bahrain USD 75,000 60,000 45,000 30,000 15,000 -

MENA- GDP per Capita

Source: IMF

Source: IMF

As a result The common market framework looks like a more promising scenario, although one that requires time and effort to resolve difficulties pertaining to the free flow of capital and unrestricted movement of citizens between member states. The implications under such framework are far more significant than the customs union and will place Jordan in a favorable position in the future.

Next Steps
Jordan will open formal accession talks with the GCC on the 11th of September 2011, in a move that is expected to deepen economic relationships between the kingdom and the six-nation coalition. It is still difficult to say how long the accession negotiations would take, but Jordanian officials hope to reach an agreement as soon as possible. As this is just the beginning of a lengthy process, we will revisit this topic with a more detailed and comprehensive analysis in the near term after further negotiations take place between both sides and more information is released.

Economic Research | Initial Opinion

Qatar UAE Kuwait Bahrain Oman KSA Libya Lebanon Algeria Jordan Tunisia Morocco Syria Egypt Iraq Yemen 7

Jordan in the GCC | August 2011

Capital Investments

Research Contacts:
Tarek Yaghmour Head of Research
Tel: +962 6 5200330 Ext. 327 Tarek.Yaghmour@Capitalinv.jo

Trading contacts:
Wissam Al-Hourani Head of Local Markets Brokerage Department
Tel: +962 6 5200330 Ext. 262 Wissam.Hourani@Capitalinv.jo

Customer Service:
Sawsan Saleh Head of Customer Service
Tel: +962 6 5200330 Ext. 349 Sawsan.Saleh@Capitalinv.jo

Nawaf Masri Research Analyst

Tel: +962 6 5200330 Ext. 478 Nawaf.Masri@Capitalinv.jo

Khaldon Al-Zoubi Assistant Vice President Local Markets, Brokerage Department

Tel: +962 6 5200330 Ext. 351 Khaldon.Zoubi@Capitalinv.jo

Disclaimer
The information and opinions contained in this document have been compiled in good faith from sources believed to be reliable. Capital Investments makes no warranty as to the accuracy and completeness of the information contained herein. All opinions and estimates included in this report constitute and reflect our independent judgment as of the date published on the report and are subject to change without notice. Capital Investments accepts no liability whatsoever for any loss of any kind arisin g out of the use of all or any part of this report. Capital Investments and its related companies may have performed or seek to perform any financial or advisory services for the companies mentioned in this report. Capital Investments, its funds, or its employees may from time to time take positions or effect transactions in the securities issued by the companies mentioned in this report .This document may not be reproduced in any form without the expressed written permission of Capital Investments.

Economic Research | Initial Opinion