The Moorish Wanderer

Subsidized Pass the parcel: Compensation Fund

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco by Zouhair ABH on February 12, 2012

As per the latest Treasury survey figures, the Compensation Fund stands at about 41Bn – although the initial 2012 Budget bill provides for 45Bn; that represents 5.7% of GDP, 14% of total budget. It also represents 80% of total public investments for 2012. And finally, it seems all public subsidies equate total expenditure en education. And yet every annual budget statement pushes for a Compensation Fund reform:

L’accent sera mis, notamment, sur des questions liées à la réforme fiscale, à la masse salariale, à la réforme de la compensation… pour s’assurer de la soutenabilité des finances publiques à la lumière des exigences de développement économique et social auquel le Maroc est en droit d’aspirer.

But is the compensation fund worth the money? After all, the total resources allocated to the most important expense – or shall we say the most politically sensitive- remains wheat and sugar; According to the addendum on special funds to the Budget bill (Comptes Spéciaux du Trésor) the designated “Fonds de Soutien des Prix de certains Produits Alimentaires” is allocated with some 880 Million dirhams – and even that amount of money can be halved; either by targeting those subsidies (which hasn’t really been the case ever since subsidies were enforced) or by by setting up a task force within the Exchange Office or the Finance Ministry to trade in those commodities the Moroccan authorities consider to be valuable.

I’m looking at some of the ministry’s own figures regarding the observed average traded prices of sugar on international markets,  and they list traded average prices:

Les cours moyen du sucre brut et du blé tendre au titre du premier semestre 2011 s’élèvent respectivement à près de 652 $/t et 352 $/t contre respectivement 444 $/t et 172 $/t au titre de la même période de l’année 2010.

It is a bit strange the Sugar Index prices do not match MINEFI figures. Or perhaps looking for the cheaper alternative isn't a priority down there. (Bloomberg)

But it seems to me this is not true; not for sugar anyway. I have looked up two indexes for sugar, and the maximal value did not top up $ 360/ton – March 2011, if our government was wise enough to cover imports with futures. As for wheat, it seems the market price did not go beyond $350/ton since 2008; that  $ 20 doesn’t make a difference, and for the specific category of wheat, total cost to import was about MAD 6 Bn for 2010; that means each household had to shoulder 896 dirhams of direct expenses incurred from wheat imports. Total cost for imported sugar (of all kinds) would have been 3.3Bn, that is 511 dirhams per household

896 dirhams of basic cost computed from raw imported wheat; assuming negligible additional costs, and based on the regulated price of one loaf of bread, that means one household would have consumed an annual set of 690 loafs of bread; same computations for sugar based on an average price of 6 dirhams/kg would yield a theoretical consumption of 85kg per household. Gee-whiz statistics perhaps, but it paints a picture; international prices have only limited impact on purchasing power; as far as I can tell, domestic interactions account for a lot more, perhaps because of the strait-jacketing of specific prices and oligopolistic markets for goods such as wheat storage, sugar and distribution.

Now 2010 yielded an average annual income per household of about MAD 106,751, and based on HCP 2006/2007 household consumption survey, consume 41.3%, thus spending MAD 1812 in sugar and MAD 7847 in wheat (bread and otherwise) That’s a lot more than the raw cost for these imported goods.

This comparison suffers from major flaws however: it does not take into account other costs factored in the final product, and second, computing expenditure in average term tends to produce bias; indeed, compensation subsidies are not mean-tested; furthermore, figures are not that reassuring when one looks into the median expenditure, let alone the fact that average household does not take into account its intrinsic size. Median annual income has been MAD 77,000 and thus consume MAD 5288 in wheat and MAD 1244 in sugar per annum.

But the argument is basically sound: raw cost per household is too low to justify what might come to be a MAD 7,800 subsidy per household. Actually, that argument is strengthened by the disparities in consumption distribution; in fact, because the top 10% households (that’s 2 Million individuals, give or take) capture a third of total household consumption, they get more than their theoretical 10% share in subsidies -since those are indiscriminate- in fact they get three times more than average, and they get to benefit from 3/4 of total subsidies – this is derived from the fact that subsidies are distributed uniformly across population deciles.

I would argue it is too high a price to pay for an arcane system that may have been working when income dispersion was not that high: with a widening income, wealth and consumption gaps within the economy, an indiscriminate subsidy on food and other essential goods tends to favour those who capture the largest proportion of household consumption, i.e. the top 10%, or as one would like to label them, those who do not need the subsidy.

Furthermore, the compensation also encompasses the following:

à la compensation des produits de base, en l’occurrence le sucre et la farine. Le montant réglé dans ce cadre par prélèvement sur le compte intitulé “Fonds de soutien des prix de certains produits alimentaires” se monte à 880 MDH, auquel s’ajoutent des dépenses de 14.987 MDH prises en charge par le budget général (Chapitre des Charges Communes), dont 2.357 MDH au titre de la compensation des denrées alimentaires de base et 12.630 MDH destinés à couvrir la charge de compensation des produits pétroliers.

So as far as identified compensation-related items go, the industrial subsidy is 4 times larger than the more important matter of subsidizing food and edible goods. A call has been made by government officials to maintain an industrial status-quo that might not, after all, benefit the domestic economy; what if the cost of subsidizing oil-intensive industries was actually much higher than any transitional loss to alternative industries? And how come oil-related imports benefit from a 12.6Bn subsidy when the immediate household consumption of Butane is only 15%? Unless Butane is sold for a symbolic price (which is not the case as long as I can recall the commercial price of one butane cylinders) that subsidy goes primarily into business oil consumption;

So total expenses for subsidizing food is at most 3.2Bn, that’s less than 1% of total budget and 13% of projected deficit – which is so far quite a sustainable subsidy and an expenses ceiling for future mean-tested programs for targeted subsidies. As for oil-related subsidies, the same observations can be made regarding income/consumption gaps: on households’ sides, who owns/drives cars? on business’ side, which industries are hungry for oil? A valid counter-argument can be made for the poorer household deciles; how will they cook and keep their family warm? Well, given the fact that these account for 10%, and since HCP reports the following:

En 2007, 54,6% des ménages marocains disposaient d’une cuisinière à gaz. Selon le milieu de résidence, ce taux passe de 42,9% dans les campagnes à 61,6% dans les villes. Selon la classe de dépense, ce taux passe de 67,4% pour les ménages les plus favorisés à 37,1% pour les moins nantis.

[…] Au niveau national, 20% des ménages disposent d’un chauffe-eau à gaz. Ce taux varie de 1,2% pour les 20% les moins aisés à 45,9% pour les 20% les plus riches. En milieu urbain, le taux d’équipement est 10 fois supérieur à celui enregistré en milieu rural (30,3% contre 3,0%).

Furthermore, the bottom 20% households are twice less likely than the top 20% to own a gaz-based stove, and only 1.2% of those households own a gaz-based heaters.

This is to say that an inflated compensation fund, in all its individual components, is not due to the international hike in prices – only 4Bn out of the 45 have a direct impact on the livelihoods of Moroccan households;A willing (and strong-willed) finance minister can gradually start reforming the fund by first setting up a team to supervise pricing on international markets -by using commodity futures, since Morocco’s own demand is unlikely to tip futures’ valuation one way or the other- and get prices down by as much as 6% per annum for wheat for instance. Second, there must be a way to mobilize the services of the Inland Revenues (Direction des Impôts) HCP and the whole Finances ministry to design mean-tested tax deductions and breaks, as well as cash relief schemes to support as many as 661,000 households, about 5.3Mln individuals who do not have the means to sustain themselves; so far, a 7,000 annual relief (that’s a 23% boost on average income of the bottom decile) would cost about 4.7Bn and still be a relatively low burden on the budget, plus subsidy would go to those it can actually help. Third, subsidies to businesses cannot go on indefinitely; first because it skews Morocco’s industrial structure, and would give an unfair advantage to what might be obsolete and rent-seeking industries; subsidized fuel only boost the value of a taxi license, when the money can be used to improve public transportation.

The thing is, there is a way to halve subsidies gradually, though it means taking on many powerful lobbies. The only essential condition for such a scheme to succeed is political courage. I doubt Mr Baraka or his sidekick Mr Azami Idrissi, or even Mr Benkirane have what it takes to take the fight where it is necessary: suppressing rent, promoting innovation to boost growth.

Towards a New “Corporate Morocco”

The thing one needs to know about Corporate Morocco is that there are good companies and bad companies; at first sight, there is little difference between them: all of them create output and wealth, most of them create jobs -or at least provide facilities for jobs- but ultimately, the “moral” judgement -or in a agnostic setting, “social judgement”- lies in the distribution of profit (or in accountancy terms, EBITA) the post is not going to be about the evils of crony monopolies, but rather a general description of what companies in Morocco are up to, if they can indeed perform in similar proportions in a strict environment of rule of law and impartial regulatory bodies (in contrast with the very predatory, very concentrated and quite corrupt present state of affairs)

I suspect many left-leaning people in Morocco still view corporations as the source of all evil. In fairness, the prejudice held against corporations is not entirely unjustified – history taught us that much; But then again comes back the paradox many liberals and radicals in Morocco are wading through when it comes to the whole paradigm of government action vs individual/collective rights. It seems even the most vanguard thinker does not imagine improving the lives of fellow Moroccan citizens without the constant nudge of governmental intervention, even though the record on state intervention’s part is not that glorious (and USFP people sure illustrated the case in 1997).

What, Makhzen is going to disappear when progressive people are going to be in charge? Empowering individuals and communities surely contributes to bring it down; A heavily activist state, even when pushing for left-leaning project, could be just as bad as the old one. But coming back to corporate issues: though regulations are not precisely anti-business, it is the general framework within which laws are enacted, plus large businesses have always enjoyed close relationship with the equally high circles of power. In most countries, this is true indeed; But in democratic countries with a genuinely independent judiciary and impartial executive bodies, it is inconceivable that such an incredible leverage would be at the disposal of both a financial and executive power.Breaking down the Makhzen is equally a matter of weakening central government as well as big business. My claim here is that promoting small business and growth-potential companies is actually the smart thing to move, and that our pale imitation of Korea and its Cheabol model is, so far, a failure, and benefits only a few nucleus of influential people.

Also, it is high time the fight against big business was clarified so as not to give the impression liberals and radicals are anti-business, and that the way to expand the economy, create jobs and improve standards of living is though smaller, more innovative and more engaged in involving its employees in the productive activity and creating output.

The graph compares some indexes on Moroccan businesses. Since 2008, the national economy took a hit following the shock wave of the credit crunch. Though the broad macroeconomic variables held forth, the economic resilience, as it turned out, was not that strong in face of negative shocks. The pick up trend recorded early 2009 does not make up for the losses, and it has proven to be very volatile for most large-cap indexes. By contrast, the small-cap index did better and made up 92% of an all-times high in 5 years. A shrewd investor entering early 2009 would have made, so far, a gross 37.5% profit over small cap Moroccan companies (or a net profit of at least 35%).

They would have broken even at best (or make an average loss of 14%) with other indexes encompassing larger companies (supposedly with stronger fundamentals) The index analysis provides plenty of insights on the limitations of Moroccan capitalism: here are large companies whose share value is going down for the last three years, and yet manage to squeeze out enough cash and distribute it to its wealthy shareholders. The policy of accumulating earnings and invest them in tangible assets to expand companies’ capacities so as to accelerate recovery, it seems, is not the order of business of (big) Corporate Morocco.

In addition to the  small caps out-performing the larger ones, it is worth mentioning the robust growth they have been enjoying, especially when compared to the bumpy ups-and-downs of other indexes; But let us start off with an overview of what goes up and what goes down;

Even though dividends recorded a daily average of 8.9% decrease, the 3-years net period yielded a robust 5% (BVC)

The standard indexes to gauge how well companies are doing in the Moroccan economy are those used for the Casablanca Stock Exchange BVC. The MASI (Moroccan All Shares Index) and MADEX (Moroccan Most Active Shares Index) provide a usually comprehensive picture of the whole thing. Since early September 2008, the MASI has been losing so far 18% of its value, a daily average decrease of 2%, as of late August 2011. The volatility did not help, too: a 7% relative dispersion over the last 3 years only complicates further BVC’s poor showing and compromises hopes of recovery. These observations equally apply to the MADEX as well.

And yet, distributed dividends perform extraordinarily well; When considering the MASI Gross and Net returns differential, the distributed dividends on the considered period increased 5%. 2008 was a grim year for both BVC and the distributed dividends index-although MASI did worse- but dividends recovered next year with a respectable 8.65% per annum increase, and then 33.82% in 2010 (which resulted in a total of effective distributed dividend of approximately MAD 20.63Bn from potential MAD 30Bn reserves)

Big companies prefer, even under stringent economic conjecture, distribute their dividends, even when the price of their shares are down and have difficulty picking up. The dividend strategy could very well be a gesture of appeasement towards its shareholders, but it does not, on the longer term, benefit them, nor does it benefit the domestic economy.

Other indexes tell the same story: the FTSE Morocco index, considered a more comprehensive an index (compared to MASI/MADEX) provides very similar results on how well corporations are doing;  As a matter of fact, the FTSE index is even more pessimistic starting from July 2009, as it lost a third of its value over the period September 2008 – August 2011. That discrepancy between MASI and FTSE can be explained by the more stringent set of criterion applied by the company.

FTSE Morocco lost 31.44% of its value over three years, MASI 18% (Bloomberg)

To be included in the Index, a stock must pass free float and liquidity criteria.
5.1 Free Float
        a) A security that has a free float of less than or equal to 5% will be ineligible for the Index.
        b) A security that has a free float greater than 5% but less than or equal to 15% will be eligible for the Index providing the security’s full market capitalisation (before the application of any investability weight) is greater than or equal to 1% of the full market capitalisation of universe at periodic review.
The actual free float will be rounded up to the next highest whole percentage number.” (page 7)

And this reflect the ‘desirability’ of company shares. As a matter of fact, it now safe to argue that the dividend policy is subject to no other objective but to distribute the highest possible levels of dividends, a complete contradiction with the so-called “national champions’ strategy.

What if an alternative strategy was considered instead? There is no systematic evidence large companies provide an emerging economy with the leverage needed to promote exports or bring hard currency to the domestic economic circuit; Couldn’t smaller companies do Morocco’s bidding just as well? When compared to regular indexes, the small cap index not only beats them on recovery and returns over the last three years, but it has a robust growth compared to large and mid-capitalizations: over the last three years, gross returns recorded levels varying between 22% and 29% and starting from April 2010, growth as been consistent, in contrast with the large-cap indexes.

Growth-Small caps index systematically beat down mainstream,large cap-focused indexes over short and medium term. (Bloomberg)

The point is, and contrary to the theory that smaller companies cannot stand global competition, growth industry in Morocco provided good returns, further emboldened by the flexible structure of its capital. It could be indeed just a phase, and it could well be expected that these companies would eventually slow down their growth; but over a longer period of time (the longest available being 5 years) the small caps index still beats down with a 12.25% 5-years return, while MASI performs a -4.3% returns.

A reasonable case can be raised on whether the index analogy holds: after all, the index composition tends to fluctuate, and it has its shortcomings. After all, MASI and other indexes do not represent the overall showing of the domestic economy; But this goes beyond it, or rather, goes into the specifics of private sector contribution to growth. With no excessive generalization, the ingredient of good and stable growth for Morocco are investment (both public and private) and now as it turn out large corporations actually harm growth, smaller, more innovative and high growth-led industries.The political implications for shifting away from big corporation is that the financial war chest of Makhzen will dry up, and with it, its power and hold over all aspects of political, economic and social life will fade away in favour of a more open, democratic and equitable society.

If these can be cooperatives as well, My crypto-communism would be achieved. In the mean-time, let’s buy us some MSCI Morocco Small Caps, it earns good money.