The Moorish Wanderer

A 5-year Austerity Package The Government Wouldn’t Dare Think About

Posted in Dismal Economics, Flash News, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on August 14, 2012

It is plain clear now we are headed toward the end of an expansionary cycle that dates back to late 1990s. Government stimulus cannot do much about it, and we have to bite the bullet. Not only that, but the “if it ain’t broken don’t fix it” policy about Morocco’s structural problems has taken us down the dark path of debt. Austerity, as I have mentioned before several times, is necessary to pre-empt any draconian conditions if we ever fall short.

From BKAM annual report, 2011. The Compensation Fund has reached historical levels, and threatens more than just budget balances.

The austerity package, like all austerity packages -but unlike the present course of action down here- involves both sides of the balance sheet: revenue enhancement as well as expenditure. The single biggest budget problem, I would argue, has a lot to do with the subsidies: in the name of stabilising prices (and preventing social unrest) the Compensation Fund exploded in absolute and relative terms, to threatening levels to the budget and foreign trade.

Taxes: Close Loopholes, Simplify the Tax Code, Broaden the Tax Base

In effect, these principles call for a radical re-alignment of tax sources: the treasury relies too much in indirect taxes, stamp duties and other discretionary revenues, which either denotes of an institutional weakness to extract taxes where it needs to, or chooses to pick easy targets (read: the middle class) rather than confront powerful special interests. From a personal point of view, I can hardly find economic (and quantitative) argument behind allowing farmers and real-estate developers generous tax breaks, and even subsidies even as their profits are going sky-high.

This is an opportunity to assert an economic-oriented fiscal policy, instead of the daunting pile of bureaucratic regulations, with no economic justification whatsoever: why would we make individuals pays VAT on some of their subsidized consumption? And why would we keep the arcane progressive taxation system (designed some 150 years ago when Teddy Roosevelt was President) when we have much more sophisticated (and simpler) taxation systems? Not to mention the chaotic fiscal structure: the academic body of evidence is overwhelmingly in favour of keeping the overall fiscal pressure constant over time, and it clearly isn’t.

a little more than 40% of total major taxes come from consumption. Guess why the Government cannot commit to a serious subsidies reform?

Let us look like at the numbers: the total fiscal receipts for the 2012 Budget is expected to be 170.67Bn MAD: that’s the total amount of taxes expected to be collected from VAT, Corporate Tax, Income Tax, Customs and miscellaneous stamp duties. To give you an idea of how much that broad measure of fiscal pressure, think of it as the Government’s share in every good and service produced in this country, and that is GDP: 21.2% of it goes into the pockets of government – and that is not enough. They borrow money too, but that’s another question. Incidentally, you can find the best evidence explaining why the past governments and the current one cannot commit to a serious reform on the subsidies system: about 40% of the main taxes come from consumption, that is a third of total fiscal receipts. this mainly VAT-funded receipt has a perverse link to the subsidies: the higher consumers buy subsidized goods, the higher VAT receipts are going to be, and the better the treasury will feel about its primary balance. A defiant reform  of the Compensation Fund would mean the instant denial of a lucrative resource to the budget.

Obviously, there is nothing wrong with the existence of a government funding itself through taxation – for those interested in the theoretical argument behind it, there are some papers worth looking into (don’t get sidetracked by the Maths, the conclusions are rocking) but, the present structure is flawed: 14.35% of these fiscal receipts are coming from discretionary taxes. So the main course is the so-called distortionary taxes, i.e. those who affect the behaviour of all agents, consumers or businesses: VAT, Corporate and Income Taxes. The optimal fiscal policy is actually far simpler than the arcane tax code we currently have: we first look at the contributions of each aggregate component to GDP, then produce at a long-term rate the respective average rates for labour, taxes and consumption; We know for instance that Capital relative contribution to wealth creation (that is, GDP) ranges between 33.5% and 32.7%, while that of Labour captures the remaining to 67% to 66.5% (the odd discrepancies, around 0.16% is left to technological progress) – assuming a long-term average maximum fiscal pressure of 19.2%, total primary fiscal receipts should be around 151Bn dirhams (against the current 123Bn for the 2012 Budget) with Consumption and Income Tax accounting for 96Bn and Corporate/Capital tax for the remaining 54Bn. These are moderate tax increases considering the present levels, but then again, the effective tax rate on the capital stock is less than 2.6%, and total taxes on the labour force around 11% (consumption and production). Why so? First, these discrepancies belie the unequal distribution in both income and consumption, and second, Morocco is a developing country, so the effect of taxation on low capital stock per capita (181,759dhs) can hamper growth. Note that I referred to the capital stock, and not its distributed dividend. Taxes on labour and consumption are further split into respective 48Bn – an effective tax rate per household of 7% (recall the pure income tax from an earlier post) and 11% per household consumption (that new consumption rate I might post something about).

Based on a pessimistic 4.3% annual growth (average growth since 1999) all the way up to 2022, this should be the expected level of fiscal receipts from the proposed tax system.

All in all, without boring you with the details, this fiscal revamping should be a net tax cut of 12Bn, down from 171Bn to 159Bn(we make room for various discretionary taxes worth 1% of GDP) what is more, the broader definition of fiscal pressure is brought down below 20% of GDP, the closest I can get to the Hauser ceiling.

These computations are based on the aggregate number of households, including the agricultural sector – this reform effectively ends the subsidy where fewer than 15% wealthy farmers benefit from a tax break on potentially as much as 90Bn worth of agricultural products. In the process, fiscal equality rewards other sectors and agents by cutting their taxes and/or simplifying them. Finally, I would like to point out these figures are computed on the basis of a 4.3% annual GDP growth with historical volatility, which means the uncertainty factor has already been taken into account.

Expenditure: Freeze, Cuts and Postponements

This is always the least popular item in the austerity package (as if austerity wasn’t already a killjoy), especially when there are talks of cuts to public service pay-wage and related items. And if any serious fiscal consolidation were to take place, it will do something about the 94Bn expenditure on human resources, especially the higher echelon.

Though cutting expenditure is not on the table, it would be interesting to see how a freeze on half the civil service – and a 2% annual increase for the lower echelon. Let us not forget that for the last couple of years, the average annual salary was 192.000dhs per annum, i.e. 65% more than the average annual income per household, and about 3 times more than the median income per household. If anything, the average income where at least one breadwinner is working with the civil service could be earning more than 83% of all the households in Morocco. Fairness dictates some of these civil servants need to see their taxpayer-funded salaries trimmed a bit.

The other juggernaut is the Compensation Fund: never, since the early 1980s, has household consumption been so heavily subsidized, and yet the large gap in consumption and standard of living creeps in, stronger than ever. A complete overhaul of the fund will have an initial negative effect on household consumption, but then again, it should not last no less than 10 quarters (based on domestic exogenous shocks) or 15 quarters if exogenous effects from foreign trade are taken into account; this means any unpopular reform needs to be undertaken at the very first year, until the negative effects eventually die away before election season. My plan subsidizes about 20% of the median consumption basket to the benefit of 60% Moroccan households, costs in 2012 about 25Bn and is indexed to household consumption growth. The poorest 10% receive an annual cash relief between 7,200 and 9,500 dirhams. Incidentally, it cuts subsidies twice its current budget and insures strategy-proof allocation of subsidies to those who genuinely need it, and does not harm middle class standards of living.

The Debt, Rates and PSBR

This whole austerity problem is not out there to serve a sinister right-wing dogma: our fiscal house was quite in order for the past decade, and yet we did not bother to push for continuous reforms; instead, the past government chose an unnecessary large tax cut (from 4 to 7Bn in 2007-2008) to the wealthiest while nothing was done to close loopholes and tax breaks for the privileged few. Obviously, these tax cuts and preferential treatment were funded by increasing public service borrowings: it went from 51Bn in 2007, to 65.7Bn in 2012, and that number can be expected to increase even further.

What the government fails to understand -and so would Paleo-Keynesians in the process- is that public borrowings are crowding out small businesses and individuals; this is even more perverse as these small companies in business with public service procurements are punished twice: the budget pays at later terms, and takes away the existing liquidities from M3. Big business is secured in its day-to-day financing; it is the small guy who takes the fall for the growing public debt.

Accordingly, there is a need to introduce a ‘debt ceiling’ mechanism, where over-borrowing is subject to a floor vote in Parliament, and conditioned by commitment on behalf of ministerial departments to cut or freeze spending over the same period of time the newly issued debt matures; for instance, a 5-year treasury bond has to be matched with spending cuts/freezes whose effect is likely to last 5 years as well. In this particular example, The expected borrowings cannot go beyond 5% of M3, or 47Bn in 2012.

Bottom Line: What Will You Bring Us, Mr Moorish?

Blood, Toil, Tears and Sweat. Well, almost. Unfortunately, making the deficit disappear while fighting government debt is mission impossible; if anything, there will be a large deficit in 2012 (about 7% of GDP) but that gradually disappears, with the first surplus reached by 2020. If anything, the effects of this 5-year austerity plan show around 2018, too late for the 2016 general elections. On the other hand the size of government relative to GDP would have shrunk from the current 44% to 25% by 2021, with all public services and welfare mechanisms in place. The deficit for 2012, projected to be 55Bn, would gradually go down until it reaches 20Bn surplus – or 12Bn if 8Bn dividends are not taken into account. We would however left by then the danger debt zone, with projected overall public debt ratio of 50% by mid 2014 to 2015, not to mention a robust 3% growth in public investment.

“The path Of Prosperity” vs “The Light at the End of the Tunnel”

If anything, the Moroccan economy would look at lot healthier by 2018: lighter, better and fairer government touch, lower tax burdens, lower rates and sustainable deficits and public debt. As always, any of these reform proposals assumes incredible courage among our elected officials, and a sheer willingness to take on special interest, lobbies and established rents. And most of all, an unwavering sense of social justice, because fiscal consolidation, whatever its initial motive, tends to fall harder on the weak, and treat harshly the middle class.

Only a keen interest in keeping suffering at the lowest possible level can bring about the broadest consensus around austerity; for this like so many other policies, a sense of purpose is needed, and carried by committed responsible politicians.

Austerity Measures Ahead… But No One Cares

I’ve enjoyed a good laugh when I found this Bloomberg TV interview with Minister Salaheddine Mezouar.

I might have been saying some mean things about his politics, either as a minister or as a coalition leader, but to be actually invited to an interview with one of the biggest financial data providers and answer questions in French, s’il-vous-plaît, has been the killer: the next Head Of Government-to-be proves to be a shallow person. He was presented as a new kind of technocrat-politician, a corporate manager of sorts; he turned out to lack intellectual depth as well as wordiness.

But these are only a trifle when compared to the hidden truth about future austerity measures and budget adjustments recommended in IMF Article IV findings. To bring back deficit within the 3% GDP threshold is going to take some tough fiscal consolidation measures; not because Morocco’s economy is in a bad shape, but because the outgoing government, and the likely next government do not have what it takes in terms of political courage to venture into deep structural fiscal reforms, including the decision to put an end to a host of fiscal exonerations, breaks, preferential regimes and moratoriums.

The successive political parties in charge of treasury and finance departments always referred back to the King as the source of all executive last-resort decisions, but now the new constitution no longer provides them with this panacea of a cover; whether the King still holds these extra-constitutional powers or no longer does is only relevant to the point that partisan politicians cannot invoke it now: they have repeated, time and again, before and during the referendum campaign that the new constitution was scheduled a long time before Feb20 activists took to the streets, and that it was in His Majesty’s wish to relinquish as much power to the political personnel to manage this country and preside over its destiny.

It is understood therefore that those manifestos each party -or coalition of parties– is releasing, are what they are set on applying once they take office. I suggest citizens interested enough in the affairs of the State should rise up to the challenge and question those pledges; Starting with the Minister’s coalition.

The Alliance For Democracy commits to a lot of spending. Those programs they have priced and evaluated will load up the next couple of Budget Bills with an average of at least 50Bn additional spendings per annum. He has, in short, committed public finances to a net cumulative spending spree of 205Bn over the 6 years. Supposedly these programs are there to make Moroccans feel better, and there is nothing wrong with it. The trouble is, the same Finance Minister has received communication from IMF that he needs to bring back budget deficit to 3% GDP. The draft budget bill predicts a deficit of 22.5Bn, in line with the 3% threshold, but the bill has provisioned for 40Bn, too low a figure, considering the constant intervention to replenish the fund mid-year. And it is even more worrying that the fund starts off with 10Bn more than what was observed in the past couple of years; It means we should be expecting an actual cost of 65-70Bn for compensation, if no reforms (or cuts) are implemented in the mean-time.

But there is two things left out by the profligate M. Mezouar: where will he get the money, and how will he accommodate his spending commitments with the promise to IMF to bring down deficit to 3% GDP? He will have to cut between 20 and 30Bn in spendings to do so, and he is not telling the Moroccan public about it. But why cut spendings? Why not continue borrowing, or better still, let the deficit run beyond 3%? Somehow, that commitment to increase spending at least 50Bn on average over 6 years is in line with the Alliance’s own promised growth rate; there is a betting on a quasi-linear growth in fiscal receipts to match the expenditure increase, approximately 6%. But this recent Radio Interview with Minister Nizar Baraka shows that in the high circles, that 6% growth (let alon 7 and 8% promised by PJD and USFP manifestos) is a charade:

Le ministre istiqlalien chargé des affaires économiques et générales propose un taux de croissance annuel moyen de 5% ainsi que la création de 150 000 emplois par an. Des objectifs bien en-deçà des promesses de l’Istiqlal formulées à la veille des législatives de 2007.[…]

Radio Aswat: La CGEM souhaite un taux de croissance annuel moyen de 6,5 % de croissance, qu’en pensez-vous ?

Nizar Baraka : Cette étude n’est pas du tout réaliste. C’est un modèle économique qu’ils ont souhaité transposé au Maroc. En voulant savoir combien de taux de croissance nous faut-il réaliser pour résorber le chômage. Ce sont des mathématique et moi je suis mathématicien, mais il ne faut pas oublier le contexte international.

First off, Moroccan officials and policy-makers have prided themselves to follow IMF instructions to the letter ever since the Structural Adjustment Program of 1983. Back then, Debt to GDP ratio was 110%, the war down South was taking its toll, large economies were in recession, and the Moroccan households were reaping the rewards of a decade of budget mismanagement. Save for the nameless Sahara war, we are in the process of replicating the 1970s-1980s scenario not before long.The finance ministry and Bank Al Maghrib have been scrupulously deflating the debt, battling away inflation -to the price of a recession during the 1990s and relatively high unemployment- so as to fit orthodox financial targets. And it did: Morocco has halved its CPI inflation rate from 7% in the early 1990s, to 1% in 2010. It has done so much that at every occasion, IMF officials have always praised our officials for their commitment to stabilizing and balancing macro-economic indicators:

November 2011

Thanks to several years of sound macroeconomic policies and political reforms, Morocco was well equipped to address the 2008 international crisis and to respond to the social demands that have emerged during the Arab Spring.

March 1998

Executive Directors commended the Moroccan authorities for the progress made over the past two years in macroeconomic stabilization and in liberalizing the economy, despite the economic and social impact of the recurring droughts.

So there is little reason for the next government -who will almost certainly return with some of the incumbent government officials- to deviate from their policy; if IMF asks for a deficit contained within 3%, they will. So this means that either these pledges for infrastructure, scholarships for students, apprenticeships for labour market insertion and the like promised in Mezouar’s manifesto might not be funded and dropped altogether; or some or all of these policies will be implemented but at the cost of borrowing money on domestic and international markets. Let’s have some fun with it, shall we?

– Scenario 1: Borrow ’till the next election

We are now standing at more than 400Bn public debt stock. That’s almost 54% of GDP. It seems Moncef Belkhayat (bless him) has it in good confidence that as long as we don’t get anywhere near 60% GDP, we are doing just fine. Not so much, no. I suspect The Minister has been skipping economics classes at ISCAE business school (presumably to smoke a cigarette and sketch a business plan to make money out of it in the process)

While the government can borrow as many billions as it possibly can on domestic markets with no immediate danger on its solvency, it drains liquidity away from other economic actors. This means inflation will be pushing beyond the 2% limit observed by Bank Al Maghrib, perhaps even beyond IMF projections of 2.7%; and at the current state of things, a real increase in main interest rates will cripple the economy more than anything else. Not only will borrowing be more expensive for the government to fund its projects, but a host of households will see their mortgages go up and their consumer’s loans repayments turning more and more expensive. At this point, scenario 2 takes place, with the government slashing its spendings and putting a freeze on the compensation fund, civil service pay-wage and many other items.

– Scenario 2: Freeze and stop spending

Smarter officials and ministers will anticipate all of this and abide by BAM and IMF projections on growth, inflation and government debt. A 5% growth with a 2% inflation rate call for government spending freeze, a lull that can be used to reform the tax code, discuss the opportunity of re-introducing the Agricultural Tax and reform the Compensation Fund. But the evidence so far suggests none of this will happen, save for the spending freeze.A 10% cut means 30Bn will have to be saved somewhere, and all departmental hands are at the pump.

But then, these austerity measures do not find favours with electorate; in fact, they are likely to get irate demonstrators, unemployed, poor working class individuals to take to the streets and riot violently, as they have in 1984. This scenario recalls the context in which the late King Hassan II castigated violently the demonstrators.

(On the plus side, the austerity package will bring debt to GDP ration below 50%, it will bring budget deficit below 3%, and inflation (core inflation to be precise) will be in line with target rates).

I am expecting Istiqlal Party to release their own manifesto to make a final judgement on how the political personnel is handling the economic issues; but so far, they have been -PJD included- grossly optimistic about figures they know well will not fit their spending commitments.

Whatever it takes to get elected. Even if it means endangering public finances.

The Price Of Debt

The times of thrift and fiscal prudence are long gone. In its effort to defuse social discontentment, the government spent billions of Dirhams either by subsidizing further strategic commodities, or by increasing dramatically wages in the public sector.

The result of these unexpected expenses led to further borrowings, and the time might come very soon when the unfortunate government of the day will be compelled to implement austerity plan measures, to slash some -if not all- of these subsidies, or to privatize more assets to pay up for interest on this unexpected debt, all of which would have been the result of unsound economic policies no one will be ultimately responsible for. Parallel to these public spending cuts, the social cost in terms of purchasing power losses and unemployment will exacerbate further existing social tensions.

Morocco has come a long way: the IMF-led painful structural adjustments plan the country submitted to in 1983 because of its abysmal deficit and debt record left economic decision-makers from then on very adverse to any debt-financing scheme, or at least to be adverse to any foreign borrowings; There were even times when relatively high domestic public debt was a sound economic policy that prevented inflationary pressures from getting out of control, and thus preventing ‘hot money’ foreign currency flowing in, with all its subsequent disastrous implications witnessed during the Singapore ’97 crisis for instance. That explains a successful policy in bringing down the size of public debt, but at the expense of any real economic growth, as the World Bank itself recognized:

“Toward the end of the 1980s, the Bank was excessively bullish it its assessments of Morocco’s economic future. Progress in public enterprise and financial sector reforms was considered excellent. […] The Bank’s overoptimism continued through 1993, despite the fact that there had been hardly any economic growth since 1990. Growth slowed from almost 5 percent a year in the second half of the 1980s to 2 percent in the early 1990s”.

And though great efforts have been made in upgrading the Moroccan economic structure, a potential austerity plan applied to the economy is most likely to finish off these sectors that have not been entirely reformed, namely private investment, rural areas, health and education. Furthermore, the economic growth -our official panacea for all structural economic growth hardships- has been too low to sustain real wealth creation. The consensus around Morocco’s economic growth potential is estimated around 5-6%. The 2011 Budget estimate for nominal growth is 5% with a 2% inflation, that is about 3% real growth. A poor showing indeed, considering how other comparable emerging countries manage to score higher growth figures. An austerity plan will most likely bring us into depression, an economic outcome too gloomy to contemplate, and yet very likely if the government continues in their folly trying to buy off loyalties and peace of mind.

Is the austerity plan likely in Morocco? Haven’t we managed to borrow the whooping sum of € 1 Billion a year ago? Aren’t the financial markets confident in our sound economic policies? not quite.

In 2010, total public debt increased by 5%, topped by an 11% increase in foreign debt, while the latter was going down at an annual average of 10% over the last decade

Consider the level of public debt in Morocco: According to the Finance Ministry’s debt figures, total public debt represents 49.3% of GDP (late 2010) much less than the 80.5% level recorded two decades ago. The foreign-held public debt -our subject of interest- accounts for about half of it i.e. 22.4% of GDP, an 8% increase compared to the 2009 period, an increase in total contradiction with the decade-long average trend of a 9% annual decrease. Now, these figures are nothing like those recorded in the early 1980s (when foreign-held debt was 110.9% of GDP in 1983) and the potential danger is certainly not that of a debt crisis where the Moroccan government would be unable to honour its debt. The danger looms domestically, because of the constraint national foreign currency holdings represent, economic authorities will be obliged to halve many public spendings; and because much of the budget is about non-productive expenses, the axe will primarily fall on the subsidies.

One of the reasons why Morocco’s rating is not Investment-Grade across all rating agencies is due to its weakness on foreign currency. The latest Bank Al Maghrib figures on that matter testify on our economy’s inability to field enough foreign currency to sustain economic resilience. Foreign holdings as of June 2011 are about MAD 182.8 Bn, a 6% dent compared to the MAD 194 Bn reserves held on December 2010. Already the effect of these policies can be felt on these reserves; the pressure on the foreign reserves can be linked to the public debt: indeed, as the graph shows, Morocco resorts more and more often to foreign debt, and so since 2005: even though domestic debt remains the preferred debt vehicle for government spendings, foreign-held debt stock have increased 33% over the last 5 years, compared to the 12% for domestic stock over the same period.

This, of course, is due to the gluttonous borrowings the Finance Ministry has engaged in to pay for many expenses: the new military acquisitions, the various “Grand Design” workshops, the subsidies, etc. have taken the annual domestic public borrowings from MAD 42 Bn in 2005 to MAD 54.2 Bn in 2011 an average of 4.34% annual increase, a commensurate variation to nominal GDP growth’s, about 4.84%. On the other hand, the budget circa 2005 records an additional MAD 7 Bn of foreign borrowings, compared to the MAD 18.05 Bn in 2011, a far larger annual increase of 17.1% a year. This is evidence that government spending resorts more and more to foreign borrowing, thus building on an increasing stock of foreign debt.

Interest relative to principle jumped from 24% to 50% from 2007 to 2011

The debt is also getting more expensive to pay back: even though the ‘super-borrowing’ of June-September carried only a 4.57% coupon interest, the overall foreign debt paid since 2007 has steadily gone up with an increasing interest/principal ratio, while the economy does not grow fast enough to create enough exports and attract foreign investments, in order to match the required payments.

The debt problem has also another feature, perhaps more concerning: the short-term debt (exclusively domestic) increases at inflationary proportions. The same Finance Ministry figures attest to that: early 2007, overall short-term debt amounted to MAD 15.3 Bn. Projections for debt service mid 2011 are MAD 18.22 Bn. This is due to the fallacy of low interest paid on short-term debt: 3-months treasury bonds pay a coupon of 3.44% while 5 years bond yield 3.94%. Though it is cheaper for the government to pay for short money, it also compels it to continue to borrow short in order to meet its most urgent expenses, and these have been quite numerous these last days.

Debt on itself is not such a bad thing: it can help public authorities benefit from leverage effect when important investments such as infrastructure upgrade or education and research facilities spendings are involved; They can provide value by expanding potential growth. But when subsidies equate the amount spent on public investment (about MAD 53.85 Bn for investment, about MAD 45 Bn for subsidies) the only outcome is future austerity plan and economic depression. Of course, these can be avoided, provided a deep-range fiscal reform, including an end on amnesty over agricultural taxes (who benefit to those owning more than 10,000 ha) and the tax breaks that benefit annually up to MAD 7 Bn, exclusively to the 10-20% richest individuals and households in Morocco.