The Moorish Wanderer

Bonds, Yield and Morocco’s Future

Posted in Dismal Economics, Moroccan Politics & Economics, Moroccanology, The Wanderer by Zouhair ABH on October 3, 2010

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).

 

The graph measures changes in investors risk appetite for FX emerging markets (Investment-Grade only) Source: Fixed-Income Strategy Monthly survey October 2010, Amundi Asset Management

 

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.

 

Foreign Debt. while the outstanding amount declined rapidly from 1998 to 2006, and steadily since then. Paid interest however is relatively volatile across time period

 

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.

Meanwhile, as another blogger stated: “Moroccans, keep in mind this ISIN code: XS0546649822. You will answer for it in 2020 “

S&P is Moody, Fitch is grading the rate

Theres little to be discussed seriously on the home front. Perhaps the Amar/Gazhaoui matter; No, too banal I am afraid, and we are in the process in making it so indeed.

There was something I wanted to discuss a couple of months ago but I lacked time but then again, and with the benefit of hindsight, the issue would be clearer and therefore easier to deal with.

For those of you with interest in economics and finance, you heard about the grading improvement on the Moroccan sovereign debt. In a nutshell, according to the grading agencies (like Standards and Poors, Moodys, or Fitch), Morocco is now safer to invest in (the assets bear less risk and are more liquid than before). Presumably, this is good news for the economy, especially with regard to the tightening global economic conditions. The business cycles likely trends are still on the downward slope (with little glimpses of recovery here and there, but not enough to reverse the tendency), so actual money is tight, therefore making credit opportunities rarer.

screen capture of the S&P announcement


Indeed, goods news because from now on, Morocco is Investment-Grade approved. Namely, bonds with grades ranging from AAA (the strongest and highest rate) to BBB. And we are now in a chance: since March 23th, 2010, the main grading agencies changed their ratings favourably on the various levels of debts the Moroccan government services to foreign holders.

The fact Moroccan sovereign debt went Investment-Grade allows for a new batch of investors to put their money in our economy. Indeed, the UCTIS III regulations provide for a particular kind of financial instruments all related to Money market. A new surge of money with which the government can put into practise the policies that would enable growth and wealth for the Moroccan economy. A fresh influx of money could also mean a renewal of our debt structure, a specific aspect that shouldnt be overlooked.

I believe this piece of good news is not really one. Yes indeed, the economic outlook seems stable, but on the other hand, Morocco is gasping for fresh foreign currency. It may seem a surprise, but the foreign exchange terms are absolutely not in our favour, as indeed the commercial balance deficit is worsening, and we desperately need, one way or the other, to finance it. Either by engaging the reserve currency or by calling up money on the international markets (the latter is now even more possible with the rating improvement)

The reserve currency has always been a nightmare for the Moroccan economists (and to the economic journalists as well); they were already alarmed in 2009 about it then, and have every reason to be alarmed now (as you may notice, the announcement effect takes time to be felt…)

Let us first list some facts and figures on our economic resilience in terms of currency holdings;

According to the quarterly statistics digest (N°123, March 2010), the Central Bank claims 187.392billion MAD on currency holdings. The holdings are mainly convertibles (96%), a liquid holding that enables BKAM to intervene whenever needed to in order to balance the books, i.e. hold he dirham value or finance indirectly imports.

Net Foreign currency holdings 2010 Q1

The 2008 Annual report rightly points out that this level enables for 7 months worth of imports, compared to 9 months the year before. It mainly goes back to the terms of trade; basically, our exports in terms of value do not match our imports. Though it is more of a structural nature, the exports did worse with respect to the past years. Without too much detail, the exports in the late 1990s used to match ¾ of the imports, but since 2005, only half of it was met (between 48 and 50% worth) which means a drain in reserve holdings. A current account deficit can be addressed in the course of the following actions:

* improve our exports monetary value is the most straightforward yet difficult policy

* choke the imports is virtually impossible (where one can get the oil and hardware from?)

* find the money to finance the deficit with foreign direct investment (FDI) which is now more possible with the ratings change.


Treasury Debt structure Domestic/Foreign

Like many countries that when through the painful process of structural adjustment in the 1980s, Morocco learned its lessons on foreign debt. In facts, it looks as though the top brass are trying to do anything but to borrow some money on international markets. Now the grading changed, they might go for it, which would not be a good idea now (yield curve 10+ indices).

The feat then-finance minister F. Oulalaou accomplishednamely, halving foreign debt by half in 7 yearscame to the price of local debt.

(Bloomberg, Finance Ministry)

As shown on the graph, Treasury rate of return outperformed stock exchange volume and cap (which has an effect on required return) It is quite unique in finance theory of course, but the Casablanca stock exchange is known for its over-capitalization, as well as the relative non-liquidity due to a high concentration of assets (the ONA-SNI theory holds firm even after the merger)

There was indeed a liquidity excess on the markets that enabled the government to issue T-bonds and T-bills at low premium (and thus, at low cost) and achieve a two-fold policy: keep inflation low (by taking away the liquidity instead of letting it flow through) as well as get their hands on cheap and harmless borrowings to carry out their policies.

Nonetheless, this state of grace ended with the flow of liquidities. The effect of structural balance deficit was emboldened by the decrease in expatriates (MRE) transfers. The Q1 2008 saw therefore a noticeable tightening in liquidity, which prompted the central bank to lower their main rates in order to get the show on the road.

On the other hand, public debt no longer was attractive (the stock exchange returns exceeded the public debt returns), and now that some of the middle and long-term arrived at maturity, a small yet distinguishable dip in the ratio domestic debt/GDP. This, combined with the worsening of commercial balance, put a heavy strain on the government to call up some fresh, foreign money.

They have to. Let us take a look at this simple but always true equation:

GDP = C+In+G+(X-Im)

Where GDP is the gross domestic product C consumption, In investment, X exports and Im imports.

On the other hand, Investment and total income are tied. In facts, the following equation depicts the relation between savings (the non-consumed income) and investment (earmarked to replace or expand means of productions):

CA = S-I

(Where CA is the current account, S savings and I the domestic investments)

The late equation can be computed into the first one, and thus:

GDP = C+G+(X-Im)+(S-CA)

Government spending is assumed to be exogenous to foreign trade. Consumption, on the other hand, can be function of imports (we do after all consume Turkish, US or Egyptian goods, dont we?) Furthermore, we can assume now the savings are indiscriminate between domestic or foreign;

GDP = C(Im)+G+(X-Im)+( S-CA)

(for anyone interesting in a more detailed and rigorous approach, this San Francisco Fed reserve working paper is a real bliss)

Now, (X-Im) and (TS-CA) need to be balanced: the first term needs to be financed by means of the second. It so happens that the commercial balance worsened the last few years, which means a negative value for (X-Im). In order to finance the deficit, we need to increase by the same proportions (or higher) the deficit itself, namely, by calling up foreign savings (i.e., FDI). Why foreign? Why cant we use the domestic savings? Two main reasons: either because we dont have much or it does not satisfy itself with the present returns.

For a fact, we know that R=C+S (where R is the total income) we also know that imports are a parameter in consumption behaviour, so R = C(Im)+S. However, we do know imports have risen quite substantially over the last 3 years, much more than the total income, indeed, R < C(Im), which makes Savings smaller in relative terms.

Bottom line is, sooner or later (and I believe it would be sooner rather than later) we will have to turn to the international markets.

Because of the present situation, the bonds issued are going to be expensive for Morocco (i.e with high premium rates, in order to attract investors) and thats were the danger lies.

Short or Long money do not cost the same, and its own use will affect its efficiency as well. Let us assume the brass goes for short money because its cheaper, short-term rates the US Fed, or the ECB or Bank Of England took up are at their historical lowest; Morocco needs to put the money into high-return short positions; They cannot sanely put the money into a long-term public investment, of course. In facts, its just a temporary patch-up plan with little help on the whole situation. Long-term borrowings are just too expensive, and the required rate of return is too high for the initial borrowing to be of interest. [Edit: they did, as my predictions turned wrong]

Whats to do then? The decision to borrow a larger amount of foreign money is inevitable, and in itself, is not that harmful.

The core question is two-fold: what kind of money do we need to borrow, and what sort of expenditure should we pay for? The first term is directly linked to the second. But because we have no idea what is the public policy on that matter, we can only speculate. And this is typical of an opaque governmental institution. When politicians are not pressed for electoral results, when they are not accountable to their constituents, and indeed, when the pursued policies are not in the interest of the many but to that of the few, the decisions usually lead to under-optima solutions.