The Moorish Wanderer

The Dirham’s Secret Value

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on July 29, 2012

A short post on Morocco’s most coveted economic secret: what is the currency board breakdown used by Bank Al Maghrib to determine our Dirham currency value?

Over the last 13 years or so, Euro-based commercial partners have accounted for a little less than 70% of physical goods. (Dollar in light blue and other currencies in Red)

Speculations place the Euro well ahead between 60% and 80%. And that has a lot to do with the flow of goods and capital circulating between us and the other side of the Gibraltar detroit. Dollar should follow closely as well, with our main exports (Phosphate) and strategic imports (Oil and derivatives) labelled in Dollar.

And yet we should have a close idea of how the Dirham value is determined; it is after all a matter of transparency as well as credibility: the Dirham value tends to condition -up to a point- a significant part of the overall monetary policy, and many businesses are interacting daily with the decisions of Bank Al Maghrib.

The assumption behind this is simple and a bit restrictive: I assume the only determinant (or indeed the most significant) for the Dirham value is the amount of traded goods in  a year, which is an overly simplistic assumption, but one that makes sense, because discrepancies can be then established on the basis of capital flows, and only then residual differences can be attributed to policy arrangements (the so-called activist policy) furthermore, the initial assumption only establishes itself because the price of a currency is mainly function of the relative price of goods traded between one country and many others. This is all very classical (or neo-classical) but for a small, outward-oriented country that is Morocco, the theory applies, since the trade integration index went up from .38 in 1993, to .58 in 2010: (Exports + Imports)/GDP.

Even without a perfect hindsight of the currency portfolio behind it, the Dirham is firmly pegged against the Euro: the correlation in its exchange rate with the Dollar, and that between the latter and the Euro reaches staggering high levels (.97) either points to a fixed currency board -meaning, with no substantial changes in portfolio weightings, or with a semi-constant weighting for the Euro, and a random process determining the pegging against the Dollar and other major currencies to fill in the remaining slots. If such theory were to be vindicated, then any random generating process for, say the remaining 20% will not change that much the trend observed in the second graph.

Firmly pegged to the Euro. the Dirham mimics very closely the Euro/USD rate at its own level.

Suppose now that the Dirham value is computed as the weighted sum of monthly variation in respective Euro and Dollar exchange rates, and consider these weightings do not change during the year (an unnecessary assumption since monthly breakdown per commercial partner are available, this is a convenient way to spare myself additional computations) if indeed the initial assumption holds, then we should not observe large discrepancies between the policy rate, and the pure currency board-based result.

These computations yield mixed results: overall, a synthetic Dirham based on monthly data from 2000 to 2012, solely based on yearly weightings draws about the same trend, but misses out mainly in terms of historical volatility, about three times as volatile as the empirical Euro/MAD exchange rate, an oddity observed during the first months of 2011.

So the currency board, in the narrow definition provided earlier on, does relatively well in describing the trend; if anything, I would say Euro makes up about 62% to 68%, Dollar 10.8% and 11.2%, and the remaining currencies at most 26%. But there are obviously other elements the simple setting fails to account for, chiefly the capital flows and the level of foreign reserves. Bank Al Maghrib tends to intervene on the Exchange Markets to sustain the currency value of Dirham by buying or selling it so as to remaining within a pre-determined Euro-peg. Since 2000, they have tried to keep these variations within a target of .11% a month. These restrictions are looser when it comes to the Dollar, however.

It may come as a surprise, but the managing policy tends to have a soothing effect on the sudden changes in times of market uncertainty, in that sense, it is safe to say if there ever was an activist policy, its aim was to manage volatility and bring it to an acceptable level. But, as P. Krugman has pointed out, fixed exchange rate cannot be maintained indefinitely. Morocco’s policy has been successfully tested during last year, but that resilience does not mean it can go on indefinitely should a global crisis arise from a possible Euro breakup.

2011 was a rough year on the currency board.

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