The Moorish Wanderer

Taxes, Interest Rates and Hauser’s Law

Posted in Dismal Economics, Flash News, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on February 28, 2012

I can’t wait three weeks for the Finance ministry to unveil their new budget! I only wish the opposition in Parliament will grill the Bill the same way PJD used to when they were opposition backbench:

Still, I would like to share some thoughts on the projected tax receipts and the mounting public debt; the Treasury released a new batch of figures for January 2012, and some of the projected figures give a certain flavour of Minister Nizar Baraka’s first Budget Bill.

Domestic Debt: 322 Billion

S’établissant à 322 MMDH à fin janvier 2012, l’encours de la dette intérieure est en augmentation de 2,4% par rapport à son niveau à fin décembre 2011. Ceci s’explique par le recours du Trésor au marché des adjudications pour un montant net de 7,5 MMDH.

First off, I might reconsider my earlier projection of 420 Billion in total public debt (foreign and domestic) by the end 2012 as too optimistic. Indeed, and based on projections from the latest Q3 2011 Foreign Debt survey (adjusted for the projected Debt Service) we are in for at least 500 Billion dirhams of total public Debt for 2012, that is 61.2% of total GDP. For reference, we are back to 2003 levels, minus the economic affluence back then and the downward trend in government debt observed ten years ago. What is more, the paid interest for 2012 on the 322 Billion debt is about 4.9%, which is a lot more than any term structure one can compute per all ten maturities served with Treasury Bills and Bonds (maturities yield between 3.44% and 4.45% nominal rates)

Such high levels of public debt, especially when one considers the closing moments of the decade-long expansionary cycle observed since 1999-2000, might drive the level of interest rates up, with the accrued effects of a worsening Balance of Payment deficit. Bank Al Maghrib has a set of targets to meet, and it cannot do so if its own foreign currency reserves are dwindling that quickly. I do not mean to be melodramatic, but we might well be very close to the moment where Bank Al Maghrib board would switch priorities (from domestic demand to foreign concerns) and increase interest rates from historically low 3.25% to sustain itself and fire-fight the foreign deficit. The 150 bps real spread will inevitably compound with the projected decrease in available liquidity as per HCP estimates; this means less available liquidity, higher required premium for debt, including public debt. I suspect Finance Ministry officials are hurrying up to the money shop before prices go up.

Fiscal Receipts: Morocco’s own Hauser Law

Three consecutive years broke the Hauser Law: 1974-1977 (exceptional years that do not factor in)

Long time-series on Moroccan economic data are often difficult to gather, but eventually perseverance wins the day. I bumped into Hauser’s insightful paper on the remarkably constant share of US Federal fiscal receipts relative to GDP. While I do not entirely buy into the “Government creates no wealth” argument, I do understand there are limits to what a public budget can extract in terms of taxes, and in Morocco’s case, that seems to be about 19.4% of GDP.

The argument is neat and can be turned to the Government’s advantage; there has been an ongoing trade-off that favours public debt to taxation, a policy that drove fiscal receipts as low as 17.5% of total GDP. There are several explanations available to that effect: first off, the actual fiscal pressure relative to GDP is relative higher, of 20.3%, because agricultural output is not taxed; a fair fiscal policy would be to spread taxation across all sectors with perhaps a cut in nominal rates to balance things up. Ever since 2000, 84 Billion dirhams (in real terms) worth of fiscal receipts have been missed, precisely because past governments have refrained from using the margin provided by the Hauser Law.For 2012, while the projected fiscal receipts are estimated to some MAD 144Bn, a tax increase within the 19.4% boundary can generate an additional MAD 18Bn, that is 72% of projected deficit for 2012 – or most likely 41% – which is still a good policy to have the deficit to the 3% limit.

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.