Bonds, Yield and Morocco’s Future
Morocco succeeded in levying some fresh money on the international capital markets at good conditions. So that’s € 1.Bn at 4.563% interest to be paid over 10 years at our disposal; Let us just hope it would be put to good use. It is, in all fairness, a good deal. the fixed income market is still quite volatile due to lagging credit crunch effects, especially on the long-term rates. It is a good deal, provided the money is wisely used to create stream of currency cash flows as well as wealth and output expansion at once. Otherwise, it will be difficult for Morocco to meet the payments ahead.
April 2010, the Moroccan finance ministry mandated three international banks -HSBC, Barclays Capital & Natixis- to prospect for funds on the international capital markets. The ministry targeted a $ 500Mn levy, but retracted forthwith two months later, arguing that the “present mood in the international markets does not allow for favourable terms for a loan”. (at that time, the Greek and Spanish crisis was banging hard, and eventually the required risk premium was too high) Late September 2010 however, and due to a high demand for low-risk investment grade emerging markets debt, Morocco secured a good deal, the total offer was twice more than the initial target levy, at a low premium discount. The bond is Euro-dominated, with about 57% European holding and 19% of Middle-east and North Africa origin. Now this should, in my opinion, be good news (time and again), in the sense that the Finance Ministry managed to secured large sums of money at low price. The question remains, how is it going to be spent? If, as La Vie Eco suggested late May 2010, the government plans to use the money and reimburse an outstanding total debt of MAD 36 Bn (Finance Ministry Figures, Q1 2010) then where would the money come from to pay the coupons, and ultimately, the principal in 10 years’ time? Over the last 3 years, the average annual foreign middle and long-term service debt was about MAD 2.621 Bn, that is 52% of the effective coupon Morocco has to service with the new borrowing. It would be foolish to contemplate such policy that reminds us of earlier times, when Morocco was desperately borrowing money to pay back previous contracted debts. It is foolish because of our reliance on foreign currencies. Let us suppose for the sake of argument that there will be benefits in halving our foreign deficit. It would mean that (a) Morocco can borrow some more for other purposes, and (b) the economy is prepared to divert an annual amount of MAD 513Mn in Foreign Currencies and pay back its debt in 10 years time, whatever the economic conjecture impact on Morocco (by means of comparison, the coupon represents about 10-15% of the average annual interest paid on medium and long term debt).
While the first assumption can be translated into seemingly sensible policy of substituting debt, the second one shades great doubts on its soundness, and ultimately exposes its main contradictions. Indeed, the terms upon which the bond emission was agreed are not likely the be met in the present course of time. You will notice the graph on the opposite side that volatility (and thus, required risk premium) has risen sharply since the end of September. If the Ministry goes out on the market in the next months, and bearing in mind the present trend, it will be difficult to reiterate the feat of levying such amount at such low price. The bottom line is, the Bond cannot be used to reduce the level of debt. I had the funny assumption that the government could use the money and invest it in turns in the market for a higher return and capture some profit in the process. I could develop some more later, but it just makes turn around and go back to square one. The last strategy we are left with is therefore to actually spend the money i.e. inject some liquidity in the economic circuit. The way the money is pumped up in the economy will certainly determine its course for the next decade. Let us start off with some figures to understand how a billion Euro is not only too large a sum of money to be trifled with, but it might be a blessing in disguise to renovate some of our public economic policies as well.
The recent upgrade in Morocco’s sovereign debt rating in March 2010 finally came into concrete result, in the sense that the present market pricing of our debt gives a quantitative aspect to the rating upgrade. It also means the international capital markets, on which Morocco did not issue debt since 2007, reacted favourably to a new investment-grade debt that is deemed to be yielding enough to attract high demand, but on the same time with low risk with respect to other top-tier “junk” bonds.
The starting point is of course the considerable effort the Finance Ministry consented in order to reduce public deficit and public debt. And indeed the efforts have been must successful. It must be pointed out however, outstanding and interest debt did not fall in the same fashion; In fact, paid interest are comparatively more volatile to the remaining debt, due to a heterogeneous debt structure (an aggregate of common yet distinct maturities as well as an undeniable currency effect) but the fact remains it is quite difficult to forecast how likely the service debt would impact the economy. Please bear in mind the graph did not take into account the present bond emission, which when accrued, drives the paid interest to a two-fold increase for Q4 2010 and onward.
The Ministry (and la Vie Eco as well it seems) keep on comparing the level of debt to the GDP. Though it provides a good idea of how indebted a country is, or how likely a country is able to pay back its debt, it is, in all fairness not accurate nor a good indicator of the actual capabilities in paying back the debt. We should instead look at how well our foreign trade is performing. The reason for such choice is clear: because Moroccan Dirham is not a worldwide currency, we cannot expect the whole economy to pay back a debt. The stream of currency cash flow it generates through trade would instead. Our terms of trades, as well as our present balance of payment are the essential key to understand how crucial the bond emission is, and how equally important it is that we do not mess up with the money. As pointed before, the terms of trades are steadily degrading; Our exports are losing value with respect to the imports’, and the currency reserve is subsequently (but also due to other factors as well) degrading. According to the Office Des Changes and Bank Al Maghrib Figures, not only the balance of good deficit is deepening, but the capital balance does not follow suit (in the opposite direction that is) in facts, while the trade deficit steadily gets worse, capital net inflows are comparatively volatile, a volatility that has a sizeable impact on the national currency holdings. One might ask the question: why should we bother about capital inflows? Does it have any relation with our growth? As a matter of fact, it does. The import structure is very capital intensive. Indeed, according to the Office des Changes statistical survey, 44.6% of the total imports between January and August 2010 were capital-intensive: agricultural and industrial equipment, but also consumption goods such as cars, electronic and household equipment. Oddly enough, Oil imports do not amount to such values (Oil represents less than 8% of total 2010 imports). To sum up, the imports, capital and high skill intensive are less and less met by equal export value, and that could give some idea on how the bond emission could be used.
So there we are: we need money because the terms of trade are less and less in our favour. The borrowed money could be invested in machinery, industrial plants and agricultural investment, or, equally, to please the growing crowd of would-be middle-class aspirations and allow for some rise in wages in order to secure cheap publicity. A blogger colleague offered to vote for the Finance Minister’s party in order to bind him with the debt and urge him to spend it wisely. M. Mezouar does not have to, and even if he wants, he couldn’t. He is just overseeing the spending modalities; As for the strategic thinking, the decisions are taken higher up. a Bloomberg analyst reported M. Mezouar stating that: “The government forecasts economic growth to reach 5 percent in 2011, increasing by 0.5 percent annually through 2013”. I don’t know about this forecast, but it does not say a thing about the economy’s ability to pay back each year MAD 513Mn. In facts, if growth is fuelled by domestic demand, that would be bad news indeed, for domestic demand consumes high amounts of capital-intensive (and ultimately, expensive) goods that are not produced in Morocco. If anything, M. Mezouar has the opportunity of an easy ride: There is an election in 2012, and he could easily tempted to back up substantial tax cuts (or wage increase) to win him some popularity. Now this is all politics, and it does not say much about how the money could expand the economy. As mentioned before, the money could be in turn invested in another sovereign debt as well. Which one then? the US Treasury Bonds? Well, the higher yield is 3.40% for a 20-years maturities; What about the French or German debts then? same level of return and it is riskier to invest the money in another emerging country. The only viable alternative (or as Thatcher used to say, TINA) is to boost the exports with the billion in hand. The targeted sectors would be the semi-manufactured goods, consumption and equipment goods (all of which make up for 68% of the total exports) That involves tax cuts and tax incentives the government cannot deliver; The inflow will actually be used by the treasury and the central bank, subsequently pumped up in the financial markets and would end up in the private banks’ hands. The problem lies in the way the banks will use the money; The most dynamic sector (and for the banks, quite lucrative one might say) is real estate, a sector that is notoriously unable to deliver currency cash flow. So how’s to trust?
The idea of employing the CDG fund remains therefore the least disagreeable solution. Mezouar loses every authority over the money, and the sovereign fund gets it all, which is all for the best to generate cash. As an institutional investor, the CDG will look for the best opportunities to offset the money. The core question remains: would this benefit to all Moroccans? or rather, would it benefit to those working in export industries? Wait and See I think, until the first coupon payment that is.