My authorities asked me to convey their appreciation and gratitude to staff for the high-quality papers and the useful policy dialogue in the context of the Article IV discussions and the FSAP Update, and to the Board and Management for their valuable support and advice.
Supported by prudent macroeconomic policies and broad structural reforms as well as strong investor confidence, underpinned by an open political and social system, Morocco has continued to make progress in improving growth performance and the standards of living of the population despite a challenging economic environment. The economy has reached a higher growth trajectory, with real GDP growth increasing by close to 6 percent on average since 2002, driven mainly by private consumption and investment, and unemployment declining from 11.6 percent to less than 10 percent. While the economy suffered from a very severe drought and the sharp increase in international fuel and food prices in 2007, it remained remarkably resilient, reflecting significant progress in diversification, and exhibited a very satisfactory overall performance. Real GDP increased by 2.7 percent in 2007, with nonagricultural sectors growing by 6 percent, and inflation was brought down to 2 percent from 3.3 percent in 2006. A surge in tax revenue led to a significant fiscal overperformance, with the overall fiscal position close to balance as against a budget deficit target of 3 percent and the debt-to-GDP ratio declining further. The external current account remained broadly in equilibrium, although fuel and food imports increased by 2.3 percent of GDP, reflecting Morocco’s high dependence on energy and cereals imports. Reserves increased further, including from strong FDI, and external debt indicators continued to improve. Strong incomes growth and increased social spending, mainly on health, education, and rural development, including under the priority Human Development National Initiative (INDH) program, led to a substantial decline in poverty from 19% in 1998-99 to 9% in 2007. With cereal production in 2008 recovering close to its long-term average and continued buoyant nonagricultural sector, growth is projected to recover to 6 ½ -7 percent. While the impact of the global financial turbulence on the economy has been limited, spillover effects from the weakening of growth in major trading partners should not be ruled out.
Outstanding tax revenue performance,
Recent progress made in reforming the tax system, reducing exemptions, and strengthening tax administration, as well as strong contribution from high growth sectors and higher tax compliance, has significantly improved tax buoyancy, leading to a sharp increase in revenue, notwithstanding further reductions in import duties under FTAs with the EU and other partners. The tax revenue-to-GDP ratio, which increased by 2.1 percentage points during the two previous years, gained an additional 3.1 percentage points in 2007. This performance is likely to be sustained, as evinced by strong revenue continuing through June 2008.
… along with expenditure control and rationalization, have created fiscal space to absorb the exogenous shocks,
The authorities attach high priority to rationalizing expenditure and reducing budget rigidities. The escalating trend in the wage bill through 2005 was reversed in 2006 following the success of the voluntary retirement program. The net gain from the program, combined with continued restrictive recruitment policy, contributed to a decline in the wage bill as a share of GDP of 1.2 percentage points. Revenue performance and prudent spending have created crucial fiscal space, which is being used temporarily to absorb the impact of the increase in fuel and food prices, pending completion of the ongoing work on the reform of the subsidy system. The authorities’ immediate concern was to prevent the kind of social unrest that has affected many countries in the Middle East and Africa recently. They responded in 2007 by reducing tariffs on cereals and milk imports and keeping the prices of subsidized food and fuel prices unchanged. While cognizant of the inefficiencies of the subsidy system, they were also concerned by the effect of rising fuel prices on consumption and economic activity.
… further reduce the fiscal deficit and the debt-to-GDP ratio,
The overall deficit declined by 5% of GDP since 2005. This improvement reflects not only the impact of revenue performance, but also a decline in expenditure to GDP ratio, notwithstanding the higher capital expenditure and food and fuel subsidies. As a result, the debt–to-GDP ratio, which declined by 5 percentage points in 2006, was reduced further by 4.5 percentage points in 2007.
… and start a program of tax rate reduction.
Strong tax revenue performance also provides a window of opportunity for reducing tax rates, consistent with recent trend in emerging market countries and to enhance incentives for investment, job creation, and productivity. The marginal income tax rate was reduced by 2 percentage points in each of 2007 and 2008, together with an increase in the taxation threshold, and the corporate tax rate was reduced from 35% to 30% in 2008. Further reductions are contemplated, contingent on progress in broadening the tax base.
The authorities are fully committed to their fiscal consolidation targets,
The authorities are committed to maintaining the overall deficit in 2008 at 3 percent of GDP, in line with their original budget target and their medium-term objective, despite the increase in the subsidy cost. The moderate increase in public sector wages, mainly benefiting the lowest salary grades, should not derail the wage bill from its declining trend as a ratio to GDP. The extension of social negotiations to include not only wages but also income tax reductions helped moderate the wage increase. Moreover, effective July 1, the authorities increased fuel prices of products that are not highly economically or socially sensitive by between 11% and 17%, with a full year impact of 0.3 percent of GDP. They have also decided to increase contribution from highly profitable public enterprises (0.15 %) and to cut nonessential spending (0.1%). A decree providing the additional budget appropriations to finance the increase in subsidies will be adopted shortly.
The authorities consider that achieving their medium-term fiscal consolidation target is crucial to preserve fiscal sustainability and create the conditions for faster and more sustainable growth and greater integration into the world economy. In this regard, they attach high priority to replacing current universal subsidies with a well-targeted system. Work is underway to identify available options and mechanisms, drawing on successful experiences with World Bank support. However, the challenge of establishing an efficient and credible targeting system should not be underestimated and the authorities recognize the importance of ensuring the necessary conditions for its successful implementation. They also intend to keep the wage bill firmly under control, including through a prudent wage and recruitment policy and a comprehensive reform of the civil service carried out with World Bank support.
The authorities appreciate the useful exchange of views with the mission and the interesting Selected Issues paper on the medium-term budget. Although the accelerated adjustment scenario is attractive, they consider the baseline scenario as more realistic and balanced, given the overarching social objectives. They believe, however, that the projected decline in the tax-to-GDP ratio under the baseline scenario is too pessimistic in view of the improved tax buoyancy. Moreover, in Morocco’s circumstances, the impact of the growth shock on the fiscal position in the sustainability analysis should be assessed in relation to nonagricultural GDP, in view of the large volatility of agricultural production and the fact that tax revenue from this sector is marginal. This being said, they remain open to exploring the possibility of a faster fiscal consolidation path and adopting a fiscal rule to better anchor fiscal policy.
Strengthened monetary policy framework has enhanced its effectiveness,
The governance structure of Bank Al-Maghrib (BAM) has been modernized, following the adoption of a new central bank charter that established its independence, and the monetary policy framework has been strengthened, with transparency of monetary policy brought in line with best international practices. BAM strengthened its research and analytical capacity in monitoring economic activity, analyzing price developments, and forecasting inflation, thereby improving effectiveness of monetary policy. These enhancements place the central bank in a favorable position to adopt an inflation targeting framework.
In view of its assessment of economic trends and its inflation forecasts, on the one hand, and the risks from lower domestic food supply, higher international energy prices, and high credit growth, on the other, the central bank’s Board decided during its regular meetings in 2007 to maintain the policy rate unchanged at 3.25 percent, while calling for vigilance. In an overall tight liquidity environment, following a period of 6 years of excess liquidity, BAM’s interventions aimed at ensuring that the interbank rate remained within close range of the policy rate. In view of the structural nature of the tight bank liquidity situation, the reserve requirement was lowered by 1½ percent at the end of the year.
BAM is closely monitoring the pick-up in inflation since the beginning of 2008, much of it stemming mainly from imported food prices. During its March meeting, the central bank’s Board kept the policy rate unchanged, with its central inflation forecast for 2008 at 2.2%, and called for high vigilance in view of the persistence of upside risk factors. In its June 2008 meeting, the central bank’s Board raised its central inflation forecast through March 2009 to 2.7 percent and decided to keep its policy rate unchanged, while emphasizing the need for greater vigilance in view of the upside risks from further increases in international commodity prices and uncertainties regarding domestic price adjustments, as well as from credit growth and recent wage increases. The central bank will continue to monitor closely any signs of second round effects and of transmission of tradable goods prices to nontradables and will remain vigilant to preserve the credibility of monetary policy.
… with BAM closely monitoring credit developments.
The authorities view the recent surge in credit growth as reflecting the strong growth performance, as well as successful efforts to promote competition among banks and improve SMEs’ access to credit. Credit to real estate and consumption is increasing at a high rate, but from a relatively low level. Real estate credit is driven mainly by the acute shortage in low-income housing and government incentives, including greater availability of land for housing projects. BAM is closely monitoring credit developments and bank risks, including through regular surveys, and has called for banks’ increased vigilance and development of a code of ethics in real estate financing. The implementation of Basel II (standardized approach) in June 2007 and IFRS in January 2008 have significantly enhanced the regulatory framework.
While the FSAP Update has confirmed the soundness of the financial sector,
Considerable progress has been made in improving the soundness of the financial sector and in financial deepening, including in implementing the 2002 FSAP recommendations. The authorities share the mission’s view that the banking sector is “stable, adequately capitalized, profitable, and resilient to shocks.” Following completion of their restructuring, the public financial institutions are now broadly compliant with prudential regulations. NPLs have declined significantly and their provisioning has increased. Strengthening of BAM’s regulatory powers, as provided for in the new banking law, and of its risk assessment and human resources, and close coordination among financial sector supervisors have also improved the regulatory framework. The stock market performance has remained strong, reflecting the economy’s sound fundamentals and highly successful new listings. As indicated in the FSSA, banks’ direct exposure to the stock market is limited.
… the authorities are committed to continue improving its soundness and resilience.
Although the solvency of the banking sector is broadly adequate, BAM has increased the capital adequacy ratio from 8 percent to 10 percent at end-2008 and has announced its intention to increase it further on a selective basis to 12 percent at end-2009, depending on banks’ risk profile. A directive containing new rules on country and transfer risk was adopted on July 8, in line with the FSAP Update recommendations, and will be published shortly. A new credit bureau is slated to start its operations soon. Also in line with the FSAP Update recommendations, the authorities announced on July 15, that the supervisors of the capital market and the insurance sector would be granted full independence and that the public financial institutions will be open further to private capital. The financial intelligence unit will be operational soon, following the recent adoption of the appropriate regulation, thereby completing the new AML/CFT framework. These reforms will help prepare the financial sector for greater competition in a globalized environment and for transforming Casablanca into a regional financial center.
Exchange rate policy is appropriate and external developments are favorable,
The authorities share staff conclusions that the exchange rate peg has served as a useful anchor to macroeconomic stability and that the exchange rate level is broadly in line with economic fundamentals. The increase in food and oil prices and a possible slowdown in tourism and workers remittances in 2008, following lower growth in Europe, are expected to be largely offset by higher exports of phosphates and derivatives, supported by higher world prices. While the current account deficit is expected to increase marginally to 0.7 percent of GDP, it will be more than offset by continued high FDI, leading to a further reserves buildup. The medium-term outlook is also favorable, with continued strong external position, supported by growth in traditional and nontraditional exports of goods and rising exports of services as well as FDI inflows.
Following the additional liberalization measures enacted in 2007, which signaled their commitment in this area, the authorities intend to move gradually to full capital account liberalization. Work is underway to meet all the prerequisites to a successful transition, including continued progress in strengthening the fiscal position and the financial sector and in modernizing the monetary framework. Preparations are well advanced for the adoption of inflation targeting and greater exchange rate flexibility, including through appropriate communication of the authorities’ intentions and enhancing preparedness of economic agents to the transition. In the meantime, consideration is given to measures to deepen the foreign exchange market, including a widening of the band.
… with continued structural reforms to enhance competitiveness and growth potential.
Significant advances have been made in improving the business climate, further liberalizing the economy, and alleviating impediments to private sector development. In close coordination with the business community, the authorities have developed a number of strategies to increase investment and productivity in sectors of the economy with high growth potential, including textiles, tourism, offshoring, agriculture. A strategy for the energy sector, for which donor support has been earmarked, has been announced recently. Major port facilities and infrastructure projects, with private sector contribution, and development of new high value-added activities, including IT and related services, automobiles, and aircraft components, are reflecting increased attractiveness of the economy to investors and reshaping the economic landscape. Greater attention is given to improving the education system and accelerating training programs to meet the growing demand for qualified work force.
The authorities are committed to regional and multilateral trade liberalization, including in services. While they view Morocco’s membership in a number of bilateral and regional FTAs as opportunities to strengthen growth and export performance, they will continue to reduce MFN tariffs to avoid trade diversion. They attach the utmost importance to Maghreb integration and will continue to work closely with their partners to foster cooperation and intraregional trade and investment.