The Moorish Wanderer

A Dangerous Game: 5% Deficit and Mounting Public Debt

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard, The Wanderer by Zouhair ABH on March 2, 2012

I most certainly will devote a post underlying the inherent dangers of a large public debt on the Moroccan economy, especially when one considers it lives the closing moments of its expansionary cycle. But for now, I can only make the argument that a well-meaning government balks at serious fiscal policy schemes, and subsequently is running this country into uncharted and dangerous territories.

The various disclosed figures every now and then for the past week all point to a relatively high public borrowing requirements to match the unchanged total fiscal pressure – that stands at around 17.5% GDP and pay for the rather large increases in public spendings, in education, health and housing.

Will they make it safely to 2016?

While the government has pursued a commendable agenda in boosting spending in these departments, I fear the hikes in public debt, and the high levels of deficit will soon put a stop to the committed level of spendings.

Le Matin Newspaper reported on the press briefing during which some of the most important Budget figures were unveiled, and one can read:

Le deuxième volet a trait aux politiques sociales. L’enseignement sera doté de 51 milliards de dirhams, la santé de 12 milliards de dirhams, la politique de l’Habitat de 3 milliards de dirhams. […] Côté fiscalité, on n’enregistre aucun changement au niveau des taux déjà appliqués que ce soit au niveau de l’IS ou de la TVA.

That explains how the deficit first went from an initial projected 22 Billion deficit (around 3.2% GDP) to the 5% projected for 2012, that is 41 Billion – or almost 20 Bn of net additional spending. The previous Budget Bill projected 144Bn in fiscal receipts. The new deficit compounds the following:

* +4 Billion in education

* +2 Billion for Health

* +3 Billion for Housing

* +13 Billion for collective bargaining

I have some doubts about the last two items, given the high spending commitments relative to the budget allocated to departments in charge, and these might as well be part of the bombastic 188 Billion public investment target (most likely 64 Billion of Investment Budget) as for the other spending pledges, the 1Bn support scheme for private employment already exists -the net increase is a modest 360 Million dirham, up from the initial 640 Million. Moreover, the budget bill seems to provide for an additional 470 new public service jobs (up from the initial 25,734) the only new alternative -but not exclusive- policy to the Compensation Fund quagmire is a meagre 1Bn for the so-called solidarity fund – 50% less from what was talked about before the Election.

Overall, that means, ceteris paribus, the total Public Borrowings Requirements for 2012 will go up to *drum rolls* 66 Billion dirhams. For 2012, the government has to borrow that amount of money, which equates 1.6 receipts from the corporate tax, 2.3 receipts from the income tax, and most worryingly, one-fourth of total receipts for the Budget.

Wandering Thoughts, Vol.16

Posted in Dismal Economics, Flash News, Morocco, Read & Heard, The Wanderer, Wandering Thoughts by Zouhair ABH on January 29, 2012

Gary Oldman as George Smiley (Salon.com)

Two movies I have been watching and re-watching these last couple of days: ‘Funeral In Berlin‘ and the brand new ‘Tinker, Taylor, Soldier Spy’ movie adaptation of John LeCarré most famous novel. in fact, both are film adaptation of serial best-selling novels: George Smiley and Harry Palmer are two anti-hero spies, but with different characters, to say the least.

Palmer and Stok meeting in West Berlin

Harry Palmer (Michael Caine) and Colonel Stok (Oskar Homolka)

Tinker Taylor circa 2011 is much darker than the 1970s TV Movie with Alec Guiness; but then again I guess it has to be so – although I suspect Gary Oldman‘s performance was closely following that of Guiness’, going by the book, so to speak: George Smiley is a withdrawn, taciturn old man who doesn’t really fit in with the James Bond common type of spy. John LeCarr’sé best book so far (although I would say the final opus of that Karla-Smiley struggle did top it up) draws apparently a lot from his experience as an intelligence officer with MI5 in Austria.

Karla, the cunning Soviet master spy was found to be inspired by the head of East German intelligence Markus Wolf – Radio France Inter’s broadcast show “Rendez-Vous avec X” mentioned him in two interesting episodes about East German spy rings in France – the infamous Hauptverwaltung Aufklärung (HvA) was perhaps the best intelligence apparatus East of the Iron Curtain, on par with KGB’s operations –

Harry Palmer, on the other hand, is a different kind of spy: a former Corporal with the British Army, coerced into joining the Intelligence Corps after he was convicted of petty crime when stationed in Berlin. His supervisors made use of his “criminal tendencies” (as cited in “The ICPRESS File” novel) to carry on the covert side of East/West confrontation, this time in Berlin, a flashpoint of the Cold War; Berlin again, where the Karla-Smiley confrontation finds its dénouement, with Karla surrendering to the British in “Smiley’s People” (Karla’s identity is hidden in the 2011 adaptation (Mike Sarne apparently played the part) but revealed quite openly in the 1970s TV movies, portrayed by Patrick Stewart – in a manner that mirrors Smiley’s placid character.

LeCarré's cameo appearance as a Circus official

David John Moore Cornwell singing the Soviet Anthem (Picture from the film)

Oh, and LeCarré himself made a cameo appearance in the film, (humorously) singing the Soviet Anthem during a Circus’ Christmas party. The move has been very faithful to the novel’s narrative, very much so.

I don’t know why I compared these two films/novels, but they do share a lot in common: they both depict the Cold War as it really was, much more nuanced and dark than blockbusters suggest.

Back on the news front: twice nominated, never got to actually lay my hands on the much prized award. I guess Moroccan web-users have made up their minds about what they want to read and what blogs they enjoy.

So congratulations for Lcassetta Blog, voted best 2012 Blog, and for winners from other categories. The honour of being twice nominated is quite sufficient for me, I guess.

I have enjoyed a very refreshing, populist, funny, witty and spirited address delivered by our new Head Of Government, Abdelilah Benkirane.

An hour-long address during which he wandered off-topic quite a lot; perhaps it is part of his personality to be as spontaneous as he can be, and I can understand it carries some charm -and electoral appeal- to his party. But showmanship could hurt him personally as a government leader and politician. His address was his opportunity to set the record in his favour. The great thing about the unusually intense media coverage (on social media at least) is that it might well prompt a new level of civic scrutiny of government work. In essence, PJD-led coalition government has to do with opposition within and outside parliament, as well as, I hope civic awareness to their policies. 2011 showed a substantial part of the real electorate can choose wisely, 2016 is proving to be an even more exciting election, and I am looking forward to it ;the run-off to the next parliamentary elections, regional and local, will prove this optimism right or wrong.

Other than that, I have been working on a rather ambitious project – a Shadow Budget proposal of sorts, with detailed proposals on something I am increasingly considering as a sound fiscal policy: introducing a pre-computed Debt-Ceiling for the next budget year. It’s fiscal discipline and it shows a government is determined not to let the deficit go crazy – unless it warrants it. And so far, running a structural deficit because of the 2008 unsound tax cuts made the couple of last budget laws rely more and more on public debt; as long as business cycles are on the upswing, it doesn’t really matter. But with a weak stock exchange performance and an expected contraction in foreign demand for Moroccan exports, it would be sound to switch as early as possible revenues back to taxation; a deterrent on debt-financed deficit would be simply to cap it, then make it difficult to raise that ceiling mid-year.

Annual borrowing requirements almost double since mid 2007. Not the stuff to make headlines

But who cares really? The sad reality is, no one, media or politicians alike, dares to muddy their shirts and go down the numbers; taxations, fiscal exemptions, fiscal deficit and public debt surely can get technical at times, but still, the debate must start at one point. Or perhaps there is some kind of unspoken consensus running across party lines, including the pro-democracy platform, no to discuss matters that may well be more important than anything else: the livelihood of future generations.

Liquidity Drain, Public Debt and Stock Exchange Annus Horribilis

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on January 12, 2012

– 13%: almost MAD 60Bn value wiped off the books over 2011 in the Casablanca Stock Exchange. In the same time, Bank Al Maghrib had to deliver liquidities up to 130Bn over the same period of time, when the finance ministry looked for liquidity up to 73Bn. (but I am told the glamour of public finances has been overtaken by the recent news of freed Rapper Moad L7a9ed. It takes all sorts, I suppose)

significant correlation between BKAMs's Open Market (at 7-days) and MASI's daily changes: -.88

I argue that the distended domestic debt has already harmed the economy, first by distorting liquidity needs, and second by affecting the stock exchange in a negative way. To be sure, the levels of liquidity captured by the domestic debt are not overwhelming resources on liquidity markets (we are talking about almost 870Bn in M3 aggregate, 12 times the total annual borrowings) but they do exercise a negative effect on available liquidity, and thus on induced growth.

From then on, there is recursive effect: fewer liquidity resources drive stock exchange markets down, their yield go down accordingly, but since public domestic debt delivers a fixed interest on its bills, investors gradually shift their liquidity allocation, pushing yields on the stock exchange further down.An effect similar to what economists call a crowding out effect; it seems the level of domestic public debt, that is, the amount of liquidities captured by the treasury to finance expenses and the deficit are such that they have contributed significantly to MASI’s bad performance.

Assuming MASI’s represents a significant private sector valuation, it only right to ask: was domestic public debt important enough to afford a -13% nose-dive in the stock exchange?

First off, let us consider how much the treasury managed to levy last year. This is important because the main indicator of investors’ preferences, the required yield on treasury bills and short-term bonds, has changed to some extent over the year: comparing 2010 to 2011. Why is it important? Because once the weighted-average interest rate on public debt reaches a certain level, Bank Al Maghrib is bound to intervene by ‘punishing’ the treasury with higher policy interest rates: to be sure, liquidity will shrink even more -perhaps with a mini-depression in interest rates-sensitive sectors- but that would also push debt yields higher, and thus compelling the budget to deleverage.

This is only a pre-emptive threat: Bank Al Maghrib nor the Finance Ministry would go to such lengths, and that is why some (credible) reduction in domestic public debt is needed to inject back liquidities in private markets.

This is how the story goes: The budget needs to be financed, and tax revenues can sometimes fall short, either because businesses and private individuals did not pay them in time, enjoyed exemptions or decided to go before the court. But government payroll needs to be maintained, bills have to be paid, and to do so implies money needs to be borrowed. And that’s what the treasury does: last year, there was a weekly auction for T-bills of different maturities (usually less than 2 years) at an average amount of 1.8Bn, a total of 73.6Bn. It is worth to point out that the 2011 budget provided for only 33.6Bn, and that means some 40Bn have been over-borrowed. It even tops projected borrowings for the shadow 2012 Budget bill by 12Bn What does it tell about how the budget was managed last year? If it was regular working individuals, that would have meant an additional MAD 3.390 borrowing per worker, or 6.500 per household. I doubt commercial banks can allow so easily for such an overdraft, especially when the average interest rate is around 3.5%.

This is a free ride behaviour no particular expenses can justify: the money was primarily used to pay the exponential increase in Compensation Fund resources, a White Elephant that profits mainly to the wealthiest households, by the ministry’s own admission:

[…] Ceci dit, le système de compensation en vigueur fournit un soutien uniforme pour le maintien des prix abstraction faite du revenu des consommateurs. Il en résulte que les subventions versées bénéficient davantage aux riches qu’aux pauvres. (Presentation Note, 2012 Budget Bill, page.62)

The steady increase in public debt is matched very closely by CSE market capitalization

The excessive borrowings on domestic debt markets have had their effect on available liquidities: in 2011, available M3 aggregate broke a decade-long trend: a contraction of 250Bn. The reason behind the decrease is multifarious, but the magnitude of such a contraction compels to ask to what extent does the 40Bn excess borrowings account for it?

But let us now look at the maturities; surely a good point can be made about these borrowings, as a convenient way to finance investment and other expenses that have a good -if not immediate- impact on the economy. It seems that most of the maturities range from 3 weeks to one year, hardly a suitable maturity for investment for growth.

One last point perhaps, one that would conclude the various points raised early, and could be a matter of concern: projected paybacks for 2011 reached about the same amount of borrowings, i.e. 73Bn. But among those are 3 Billion of interest; the composite interest paid on the domestic debt for 2011 was about 4.1%. It is almost one basis point above the nominal yield for all short-term bills issued last year. The crowding-out effect has already taken place, and Bank Al Maghrib might not have to push interest rates higher: the cost of borrowing alone will compel the government to slow down, then reverse its borrowings policy.

Debt And Default : The International Markets On Moroccan Foreign Debt

Do you remember that €1Bn eurobond borrowing the outgoing Finances Minister S. Mezouar had managed to land early September 2010? well, the yield has increased some 33% in just a little more than a year, thus placing the lower bracket to the effective future rate of borrowing abroad to a little less than 6%. and the pricing value is going down with little prospects for recovery. For a budget set on borrowing a lot more abroad to sustain its expenditure, this is a bit of a bad news: 6% is not daunting as a yield for the treasury to pay back, but it will certainly put a strain on public finances and mortgage the future.

A 10% decrease over the depicted period, including regular 15% drop when coupons are paid off

Regarding the bond itself, the yield is not going to change: 4.5% to be paid every October 5th all the way to 2020 and then set to pay back in fine the €1Bn initial borrowing. However, if the government needs to go back to Debt Capital Markets to issue additional bonds, they will certainly not get to issue them at 4.5%. And so far, these bonds need to yield a lot more to keep up: the 4.5% have been issued on a par value of 1000 for a €45 coupon; but because they have been issued at a discount – meaning, an investor need not pay the nominal value, but a little less, so as to make the bond more attractive- their yield to maturity should decrease as each day gets the bond issue closer to a payment date or its maturity. Sadly enough, this is not the case: the steep decrease in bond price up to the early 2011 was DCM beliefs that Morocco’s foreign debt sustainability was not strong enough to earn the 4.5% coupon rate.

Supposing the next government decides at this very moment to issue another bond on international Debt Markets (DCM) they will have to provide investors with at least 6% yield- a penalty to be paid for  because the present debt stock -foreign and domestic- is to high and most of bugdet expenditure goes into subsidies and pay-wage.

Who’s fault is it? The context for foreign debt issuance needs to be recounted beforehand: the last time Morocco went on DCM was June 2007, where it has levied 500 Mln and is in the process of being paid, and in excellent terms for investors; meaning, the last time Morocco borrowed abroad, it has done so with a reasonable coupon, and the required yield remained in line with it. In other terms, the previous bond issue has been a success, so why not the next one?

I do not believe the increase in required yield to maturity is the sole result of global economic downturn, or related to sovereign debt crisis. The yield to maturity on the Morocco “Eurobond 2017” issue has picked up very quickly and recovered from 2009, and from then on sustained a robust premium price above the nominal value. The fact that the Eurobond 2020 cannot replicate these performances and dropped its value in the early days of its issue is tale-telling: investors doubt the Moroccan government will put the money to good use, both to Morocco and to themselves. In that sense, those high officials at the Ministry of Finance (as well as outgoing minister Salaheddine Mezouar) have failed in providing value for money.

I’d suggest this money has been squandered and could endanger not only Morocco’s freshly earned Investment Grade statuts, but the sustainability of its public finances. The coupon in itself certainly puts a strain: during the last couple of years, the treasury serviced MAD 2.1Bn in foreign debt and ceteris paribus, the 2020 Eurobond represents 74% of the average MAD 680Mln in paid interest since 2009. Though it is only 11.3% of all paid interest (foreign and domestic) the coupon drains a lot out of the country’s unstable foreign reserves, at times when they will be needed to sustain imports and the Dirham exchange rate.

From 4.5% to 6%... in less than 1 year. Discounted Bonds are supposed to have a decreasing yield to maturity, not the opposite.

Government responsibility weights in heavily when it comes to the guarantees it was supposed to provide so as to insure value for money: what do we know of the expenditure the €1Bn was supposed to fund? Is it invested or just used to pay for compensation, pay-wage and other non-productive expenditure? Shouldn’t the Caisse de Dépôt et Gestion (CDG) sovereign fund be involved in managing the receipts? Will the next government find the money intact and invest it wisely? These are questions that will most certainly be left unanswered thanks to the institutional swamps of political irresponsibility and governmental weaknesses.

In order to address these issues, the next government needs to assure investors they can deliver. The most straightforward policy to do so is to raise taxes. Relative to GDP, direct fiscal pressure for 2010 was only 8.73% and total fiscal pressure 19%. There will be a need for a more balanced approach to the fiscal distribution. Alternatively, but not exclusively so, the same policy will be needed to reduce expenditure. Given that the budget appropriation for the compensation fund has inflated over the last year, the much promised -but never implemented- reform of CdC will have to be carried on; the boil has to be lanced, either with unpopular measures to the average/median household, or with a vicious fighting with the establishment; a ‘caring’ government with a popular mandate is supposed to choose the latter.

I am being only too pessimistic about it. Then again, I don’t have access to a Bloomberg or Reuters terminal to get all the facts. But from what I can see (and get) surely there is a lot of goodwill to prove on behalf of the Moroccan authorities to reassure investors about how serious they are in providing all resources and pay back the debt, because the best we can hope for -and afford- next time the Finances Ministry decides to borrow abroad is going to be 6%, and that is generous.

Note: a couple of things to go over for the layman to find their way with the different concepts invoked earlier on, I used Robert W. Kolb ‘Investments’ (ISBN  0-673-38364-4) as a reference:

Discounted Bonds: a bond with a nominal value of 100 issued at 99.64 is a discounted bond. The idea is to attract investors, who will then pay a lower price for the nominal value, and cash-in the coupons as well. Premium and Par Bonds pay respectively higher or exact nominal price

Bond Prices vary inversely with interest rates: the standard bond pricing formula goes as follows:

the coupon is fixed with the issuance date. Prices and yields vary with respect to an array of variables, among others time and perceived risk; a higher perceived risk of default will lead investors to required a lower price -meaning, a lot less than the nominal 100 per bond, and thus increase the yield to maturity.

The Price of a Discounted Bond should increase over time: because it has been issued with a discount to investors, the bond price should theoretically converge to its par value; the 2020 Eurobond clearly does not converge to 100 – but rather to its Market-perceived true value, 90. The textbook explanation is that since the discount is only there to encourage investors to buy the issue, its true (nominal) value needs to be discovered along the time-line and after the first couple of coupons have been paid for.

 

The Case For Progressive Deficit Reduction

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on November 14, 2011

To put the question simply: “are deficit hawks bad for Morocco?” Obviously, we are heading towards fiscal consolidation, and whatever government formed after elections will have to ditch part (or all) of its electoral manifesto. In normal times, and that applies fully to Moroccan politics, a government does not carry out its electoral promises. But it is now more obvious that spending commitment will be cut, that even existing spending will be cut as well; furthermore, we can trust the next Finance Minister and their team will trigger social resentment with their target spending freeze.

Still and all, being a deficit hawk -a structural deficit hawk- could well be the most progressive stance one might take when it comes to the current state of public finances, the proposed remedy to make their way out of it, and more generally in the whole fiscal and budget policy a government can have. This brings about the question of the government’s own policy: do they have models and procedures to estimate precisely how much they can borrow? Let me ask rephrase the question: does the Finance ministry have an econometrics model as a benchmark for its policy? If so, why isn’t it made public? Surely the model is of no national security interest, and it would actually help the public debate if ministry officials were to release it into the public domain. Perhaps the next government will be kind enough to be more open about it…

Budget Bill 2012 - remember, you have read about it here first

The 2012 budget bill provides for a 61Bn borrowing to pay for expenditure -and narrow the deficit gap a bit. In terms of central budget it represents 20% of all receipts (excluding SEGMA autonomous departments) and 18% ex-SEGMA expenditure. So far, official reports have been confident in the budget and its sustainability, because (at least on paper) ordinary receipts still match equivalent expenditure: levied taxes still can cover pay-wage, stationery requisitions and investments; the orthodox balance is thus still observed: 170Bn in tax receipts vs 172Bn current expenditure. But then again, the balance is observed on paper; because there is already a 2Bn ordinary deficit, and the negligible amount of any possible primary surplus seriously impairs public finances sustainability. It is a bit worrying to notice that the 2012 Budget bill relies on dividends, rent and miscellaneous receipts to inflate artificially the primary deficit to 17Bn.

But a good point can be made about these figures: the government has engaged in what it has considered to be vital to the national interest (and I am not making this up, you will find below a reference to this flimsy argument) to subsidize goods and hire unemployed graduates to keep things stable. The 2012 deficit can easily be dealt with once growth picks up pace beyond the 4.5%-5% GDP forecast. In effect, the government made provisions for extra expenditure – as reported in BO n°5978 page.2122 (p.52 on pdf) such:

Vu l’Article 14 du décret n°2-98-401 […] relatif à l’élaboration et à l’exécution des lois de finances;

     Considérant la nécessité impérieuse d’intérêt national,

     Sur proposition du ministre de l’Economie et des Finances

[…] Décrète: […]

Article Premier – Des crédits supplémentaires d’un montant de 18 Milliards […] sont ouverts au titre des dépenses de fonctionnement du budget général de l’année budgétaire 2011.

“Imperious necessity of National Interest nature”: the money needed to subsidize further strategic goods was considered then a national security issue, supposedly. The decree also shows how much power the Moroccan executive wields, and how much money it can levy whenever it suits them. But the truth is, the public finances have been endangered with no serious case that the levied 18Bn were indeed required, and whether swiftly reforming the compensation fund wasn’t a considered move. The decree, it seems, embodies the utter failure of any political power in Morocco to take reasoned decisions, and betrays a lack of hindsight on behalf of the ruling class. The technocrats, the Grandes Ecoles graduates, the well-educated bunch took fright from stepping up and ultimately got it wrong.

There is another reason piling on debt or deficit is endangering Morocco’s future; by HCP own projections’ account, there are 10.6Mln young Moroccans aged less than 17. This generation makes up for 33% of total population, and they are in the process of being loaded with a mortgage even before they get out of school and go into active life. The national public debt should now stand at around 416Bn, that means MAD 13,000 per Moroccan inhabitant. But to the younger generation, the burden is heavier: MAD 17,000 per young Moroccan, almost 40% in excess of the debt per capita among the 30-60 age bandwidth; And a substantial amount of this debt (90%) is domestic; paradoxically, a domestic debt is more dangerous to the future generations: while foreign-held debt is more related to sovereign risk, domestic debt impairs future performances and growth perspective; a high public debt could well trigger a rise in interest rates, and new entrants on labour market will have to cope with it.

In that respect, the next government will have not only to cut the deficit and halve the debt. It means reducing discretionary and unnecessary spending, and above all, a deep and far-reaching structural reforms in fiscal policy. The difference between a liberal deficit-hawk and a conservative one is how they will deal with fiscal policy; It did show that Minister Mezouar and Head of Government El Fassi were very modest when they set on creating a modest 2Bn “solidarity fund” in the scrapped version of the bill. Incidentally, 2Bn is more or less the amount of unexpected expenses, or tax receipts in cars. The Finance minister assured the public on numerous occasions that he had secured the funding, another argument that strengthens the point made: conservatives will not raise taxes and reform tax regulations.

The income effective national tax rate is less than 4%; when compared to the tax brackets (from 10% to 38%) one can easily notice how many loopholes have been set up for taxpayers to deduct or escape taxation, and there is nothing wrong with it. But the trouble is, these loopholes are not evenly distributed; in fact, they are hardly there for any social equality purposes, and their distribution is anything but fair; The ab absurdo argument can be made that even a fiscally conservative policy of uniform effective income tax rate can out-take the present performance. A uniform 6% EIT (Effective Income Tax) can yield 45.6Bn instead of the existing 28.5Bn. For sure, the top 10% still gets away with less taxes relative to their income, but at least everyone will be on equal footing with the uniform 6% income tax.

Agriculture has benefited long enough from a generous fiscal amnesty; the Budget bill allows the minister to revoke the amnesty well before December 2013 and institute a flat tax on large farms. These are less subject to fluctuations, and they are already subsidized for their export-oriented goods. In effect, there are some 107Bn no tax is imposed on, and whatever effective receipts are more than welcomed.

The narrative in the next months is going to be about excessive expenditure in the Moroccan government. It would be wrong for anyone to buy into it just because it is half-true. It is wrong because on the other side of the balance sheet, there are only too much loopholes and exemptions around for the government to close and end; the deficit is a problem, but cutting expenditure alone is not going to solve it.