As recognized in last year’s Article IV consultation report, Morocco is reaping dividends from sustained commitment to prudent macroeconomic policies and structural reform. This year’s report confirms that in recent years, the country has entered a new phase of economic performance, with higher growth trajectory, low inflation, strong fiscal and external positions, sound and vibrant financial system, combined with high job creation, further reduction in poverty, and improved confidence. Since 2001, real GDP growth has averaged 5.4 percent, resulting in gains in real GDP per capita of 4 percent annually, unemployment declined to less than 10 percent for the first time in decades, and poverty was reduced from 19 to 14 percent. Importantly, the economy’s resilience has been strengthened and its vulnerability to weather conditions, although still significant, has declined. While agricultural GDP declined in 2007 to its lowest level on record, following very unfavorable weather conditions, its effect on overall growth was mitigated by stronger performance in nonagricultural sectors. With the return of agricultural production to its long term average level, real GDP is expected to rebound to close to 7 percent in 2008. Reflecting these favorable developments and outlook, market confidence has improved, with declining interest rates, buoyant stock market, increasing FDI, which is more diversified and less dependent on privatization, and improved standing in the international markets as evinced by the recent award of investment grade by a major rating agency and the success and very favorable terms of the recent benchmark euro issue.

The authorities are encouraged by these achievements but are also aware of the remaining challenges, including the need for achieving higher and sustained growth and further reducing unemployment, in particular among the young and university graduates, as well as poverty and regional and gender disparities. They remain committed to maintain and accelerate the reform momentum and stay the course of prudent fiscal and monetary policies. They will continue to improve the business climate by further streamlining regulations, reducing red tape and combating corruption, improving public service delivery, and strengthening and deepening the financial system in order to unleash the potential for higher private sector investment and productivity gains, while remaining vigilant so as to preserve the hard-won gains in macroeconomic and financial sector stability. In this regard, the policy and institutional framework will be further modernized to make it consistent with the new phase of economic performance and flexible enough to adjust to evolving conditions and structural changes. Continued attention will also be given to upgrading human resources and to developing and modernizing infrastructure in order to tap new sources of growth and seize the new opportunities offered by the globalized economy and regional integration.

Consistent with progress in macroeconomic stability and the strengthened reform momentum, this year’s streamlined consultation has appropriately focused on further fiscal consolidation, strengthening of the financial sector, and greater integration into the world economy. The authorities broadly concur with the thrust of staff assessment in these important areas and welcome their recommendations. Moreover, staff and the authorities had a useful exchange of views on potential risks to inflation arising from recent credit expansion, following the ongoing recovery, as well as from increases in asset prices.

The operational independence recently gained by the central bank (BAM), the ongoing modernization of its monetary framework as well as development of its policy instruments and analytical and research capabilities, together with greater transparency, have significantly improved its credibility and effectiveness. This was demonstrated in 2006 when the monetary policy was tightened in response to the slight acceleration of inflationary pressures resulting from the pass through of international oil prices. With tight bank liquidity and average inflation during the first half of 2007 falling to 2.1 percent for headline inflation (1.6 percent for core inflation) over the same period of last year, BAM is confident that recent easing in inflationary pressures will be sustained. Continued vigilance and readiness to tighten the monetary stance if warranted, supported by recent capital account liberalization measures, should help keep inflation in check. BAM is aware of the potential risks that excessive credit growth and asset valuations could pose to inflation and, together with improved monitoring of the CPI, is carefully following credit and asset price developments and has called for greater banks’ vigilance. Preparations are underway for a possible move to an inflation targeting framework, and the High Level Regional Seminar on the topic organized last April with Fund support, for which the authorities are grateful to management and staff, was an excellent opportunity to review Morocco’s progress in light of other countries’ experience.

Fiscal consolidation is ahead of schedule. While staff and the authorities agreed, during last year’s consultation, that a medium-term deficit target of 3 percent of GDP, to be achieved in 2009, was consistent with fiscal sustainability, the fiscal deficit, excluding one-off factors, declined to 2.5 percent GDP in 2006, reflecting strong revenue performance and a decline in the wage bill as a result of the voluntary retirement program, and is expected to remain within this limit in 2007. After increasing in 2005 following the settlement of arrears to the government pension fund and the one-off cost of the voluntary retirement program, public debt-to-GDP ratio resumed its downward trend, falling to 58 percent of GDP in 2006. Progress in fiscal consolidation is all the more significant in an election year and attests to the authorities’ firm determination to put fiscal policy on a sound footing. It also strengthens their conviction that persistent pursuit of well-prepared structural fiscal reforms have large pay-offs in strengthening the fiscal position, even if these are difficult to evaluate ex-ante and are gained only gradually.

Progress toward fiscal sustainability is also timely since it provides room for monetary policy, under its strengthened framework, to take responsibility for the task of macroeconomic stabilization, allowing the Budget to focus on qualitative fiscal adjustment to create the fiscal space needed to attend to key infrastructure and social needs and to absorb potential shocks. Nevertheless, there is no room for complacency, and efforts will continue toward further reducing the public debt, strengthening the tax system, improving spending efficiency, and increasing budget flexibility. Ongoing efforts at broadening the tax base, including by improving tax and customs administration, enhancing transparency, and reducing exemptions, will continue. Building on the success of the voluntary retirement program, the authorities intend to continue with wage moderation and civil service reform to increase productivity and improve service delivery, including through continued no-new-net-hiring policy, reform and unification of the civil service statutes and paylines, linking compensation and promotion to productivity, and redeploying and retraining to meet urgent staffing needs in priority sectors and regions. Expenditure control system has been overhauled, focusing on improved execution through simplification of procedures and increased efficiency. Results-based budgeting has now been extended to 25 ministries accounting for 75 percent of the Budget. A medium-term expenditure framework has been developed and a pilot program is underway in 6 major ministries. The authorities attach high importance to reforming the subsidy system and adopting an appropriate and well targeted safety net. While unlikely to result in significant net budgetary savings, it would help rationalize consumption, enhance efficiency, and provide for effective allocation of budget support to the poor. The authorities are reviewing available options to address this issue, in close consultation with social partners, consistent with their social strategy priorities as embedded in the National Initiative for Human Development.

A vibrant, competitive, and resilient financial sector is essential for effective resource mobilization and allocation. The stakes are even higher at a time of increased demand for resources resulting from the ongoing recovery, and in the context of greater integration of Morocco into the globalized economy and financial system. The authorities’ efforts at strengthening financial sector stability, resilience, and efficiency, enhancing bank regulation and supervision, restructuring public financial institutions, and deepening the financial markets, in line with FSAP recommendations, are bearing fruit. Progress achieved over the last 18 months in particular has been impressive. The new banking law has strengthened BAM’s independence and powers in banking supervision, expanded its scope to new sectors, including micro-credit and off-shore banks, and provided for improved coordination with other financial sector supervisors, both domestically and internationally. BAM’s supervisory resources were strengthened, and special emphasis was put on improving banks’ transparency, governance and internal risk assessment as well as on crisis prevention and resolution. The creation of a credit bureau is a major step forward and should improve risk assessment, strengthen competition, and improve consumer protection. Bank profitability and capital adequacy has improved, and nonperforming loans were reduced to 10.9 percent in 2006, down from 19.4 percent in 2004, while provisioning increased from 59 percent to 71 percent. In response to BAM’s efforts, in coordination with the banking association and business representatives, aimed at increasing information disclosure, access to credit by SMEs, one of the main weaknesses hindering their development, as discussed during last year’s consultation, has improved significantly and its cost has declined, as confirmed by a recent survey conducted by the central bank. Attention will therefore be refocused on improving nonfinancial services to SMEs in terms of advice and assistance. Restructuring of the two troubled public financial institutions has been virtually completed, their balance sheets and profitability have improved, and the temporary exemption from some prudential regulations has elapsed in June 2007 as scheduled, with the institutions now broadly in compliance. An anti-money laundering law, consistent with best practices, has been adopted, and a Financial Intelligence Unit will soon become operational.

The central bank has adopted a pragmatic and gradual approach for implementing Basel II principles, with due consideration to Morocco’s financial sector structure and specific needs. A risk based reporting system is in place starting from June, in conformity with pillar I, and the second pillar will be implemented gradually, starting from June. Preparations are also well advanced for adoption of international accounting standards (IFRS/IAS) in 2008, in close consultation with the banking system, and the necessary regulations have already been adopted. Ongoing work on the establishment of a postal bank system, benefiting from the extensive network of postal offices, will significantly enhance access to banking services in the remote and underprivileged areas. The FSAP update, scheduled for November, will be a valuable opportunity to take stock of recent progress in strengthening the financial sector, including recommendations of the 2002 FSAP, and should help identify avenues for further financial sector reform.

The authorities are also preparing for greater integration into the world economy. BAM, in particular, is actively preparing for the possibility of moving to a more flexible exchange rate system, including by strengthening the monetary policy framework. Moreover, progress is being made toward deepening of the forex market; recent authorization of forex bureaus should contribute to the process. The central bank has also published the composition of the currency basket of the peg, which so far had been kept confidential, which should help improve transparency and exchange rate risk management. With nonresident transactions virtually free from restrictions, recent measures liberalizing capital outflows and other capital account transactions for residents are important additional steps toward capital account convertibility, which should encourage more efficient use of resources and risk diversification., while facilitating the task of liquidity management.

The authorities see bilateral and regional trade agreements as a complement, and not a substitute for multilateral trade liberalization to which they remain fully committed. The dismantling of tariffs with the EU and other partners is proceeding as scheduled and the MFN tariffs are also being reduced to avoid trade diversion. Economic integration within the Maghreb has been revived recently, thanks to the Managing Director’s laudable support and personal involvement and staff’s helpful contributions. High level conferences organized late 2005 and 2006, in cooperation with the IMF, have adopted important roadmaps for regional trade facilitation and financial sector integration, respectively, drawing on best international practices and experiences in the region, to be followed by a conference on private sector development this fall. The authorities are firmly committed to redouble their efforts aimed at advancing regional integration.

The authorities highly appreciate the excellent cooperation with the IMF. They reiterate their gratitude to staff for their hard work, candid discussions, and useful and well-focused analysis, and to management and Executive Directors for their invaluable advice and support.