The Moorish Wanderer

Stability First: Foreign Exchange Terms

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, The Wanderer by Zouhair ABH on December 26, 2010

Last issue of Bank Al Maghrib was of great interest especially the foreign exchange bit. Apart from its comparatively low productivity per exported output, one of the curses of Moroccan economy is its inability to field enough foreign reserves to hold a long-term shadow exchange rate, or just to attract confidence and therefore more diversified foreign investment.

downward trend in terms of trade and a high volatility in capital cashflows. The relationship is cardinal: Morocco is not a financial center, so most of its currency flows must be secured from goods exports, as FDIs are growing more and more volatile (Source: Finance Ministry)

Following the November issue of the “Revue Mensuelle de la Conjoncture Economique, Monétaire et Financière“, the Foreign Trade balance is definitely worsening. Indeed, the Goods and Services balance is in a MAD 114.5 Bn deficit, which means that it aggravated by 5.1% compared to last year. This is mostly due to the fact that imports increased by 13%. However, cover rate (i.e. Exports/Imports ratio) climbed back to the average of the past decade to 48% (from an average f 46% in the last 3 years); and so one of our structural weaknesses is that of exports’ inability to match the imports. In value of course, especially -but not only- when it comes to energy imports. Indeed, the digest does underline the fact the deterioration of the present goods and services balance deficit was due to the increase of 34.8% of energy-based imports. “L’expansion des achats de produits pétroliers est due à l’accroissement du prix moyen de la tonne importée de pétrole brut et du volume, respectivement de 40,6% et de 19,3%. Le prix moyen de la tonne importée s’est en effet établi à 4.689 de dirhams, au lieu de 3.334 dirhams pendant la même période de 2009. Quant aux importations de demi-produits, chiffrées à 45,5 milliards de dirhams, elles ont enregistré une croissance de 18,3%, attribuable pour l’essentiel à la hausse des achats de produits chimiques, de fer et acier et de matières plastiques, respectivement de 23,4%, de 17,9% et de 15,8%.” This is one way of explaining why our imports do not cover exports fully: the cost per exchanged good is in favour of imports, which means that value -in terms of capitalistic or skilled labour intensity- is lower in the exports when compared to exports, excluding energy goods (whose prices are market future, thus encompassing the expectations rather than any cost of production or indeed any efficient factors’ combination). The total average cost of imported ton was for the first semester 2010, MAD 7.663 per ton, while the total average cost per export ton was, for the same time period, MAD 6.41 per ton. (Office des Changes Figures) Oil and energy-based goods do not represent the most expensive imports (Their weighted average was MAD 4.05 per ton, but the strain they put on the balance deficit is due to their intrinsic volatility. On the other hand, some imported quantities can be substituted away due to the fact electricity is mainly produced by means of conventional fossil fuel. Seeking new sources of energy would result in an expanding GDP, a net creation in jobs and partial resorption of the deficit in goods and services balance. Furthermore, more efficient energy sources would enhance production, and thus increase exports productivity (again, reducing the balance of commerce deficit) cutting by half the MAD 114.52 Bn deficit is possible if import of MAD 52 Bn in energy-based goods can be halved one way or the other. In facts, there are other ways around to cut the deficit, especially any re-exports. However, this is not my subject. I wanted to discuss the effects on foreign reserves and perhaps some ways to finesse it.

The structural commerce balance deficit compels the Moroccan economy to finance it by getting real money (service like tourism, or FDIs) into the domestic market, foreign currency money. The Moroccan economy has to face two broad challenges in managing the foreign currency reserves: it has to sustain the announced peg, and to pay for any outflows of these hard currencies as well (whether in terms of exports, or for FDIs when the investors want to cash out their dividends). The first decision is basically a matter of policy-making: there was an official decision that the local currency -the Moroccan Dirham- needs to sustain a certain level of exchange rate with dominant currencies, either large commercial partner (Euro for France or Spain) or because strategic goods are labelled in Dollar (Phosphate, Oil and Gas).

Crawling pegs: Euro fixing is tighter compared to USD -mainly because significant commercial partners trade in Euro (Bank Al Maghrib Data)

This crawling peg though, is not credible for the forex markets: either because of interest rates and/or inflation rate differential with the significant currencies, or because the foreign reserves Bank Al Maghrib holds are not deemed sufficient to sustain it. The peg is an artificial exchange rate, to be sure. And speculators can from time to time arbitrage the Dirham (it is true the currency is not that important in terms of foreign trade, but if the differential is above market levels, then arbitrage is possible, even over small amounts, dozens of millions are gained usually) and thus increase the exchange rate with say the Euro. BAM will indeed from time to time buy up some Dirhams on these markets to sustain the desired level and needs to pay it up from the foreign reserves it holds. This can be observed on the exchange rate Bank Al Maghrib sustains with the Dollar, and more specifically the Euro. Basically, an idea can be tossed around about the variables that could have an effect on our foreign reserves , are mainly due to differentials between our own business cycle, and those of significant partners. Because our currency has tied itself to, say the Euro, differentials in inflation rate, in interest rate, in output gap and in an array of less , significant but non negligible other micro-variables, all of which make the official exchange rate more or less artificial, and so, more or less easy to manage. Ideally, the central bank would seek ‘smoothing’ the exchange rate by synchronising our business cycles with those of our partners. The trouble is, we do not have the same structures, the same weaknesses or strengths countries like France or Spain’s. The ensuing peg can therefore differ from the real exchange rate Morocco sustains with the Euro. This differential results in speculation attacks on the Dirham’s value, thus a pretty useless waste of precious foreign reserves. The problem can be solved either by abandoning fixed or pegged exchange rate -with its drawbacks and benefits- or do the courageous thing, that is, to look for commercial partners with congenial business cycles, or the least thing to do is to diversify a bit (and I got an interesting theory about that. Not mine, but something about diversifying risk) so as not to be fettered with an expensive exchange rate. This money can be used for other things: investment in infrastructures, paying back foreign debt, alleviating pressure on the domestic debt market, or even to pour it so that our exports can create value instead of destroying it.

Real Exchange rates. Starting from the 80's (financial liberalization in France and ECC entry for Spain) each country took a separate path but both countries remain significant markets for the exporters.

The depletion of our foreign reserves can, with reasonable assumptions and extrapolations, be delineated as the effect of constant desynchronizing of our economy, and that of the Euro-zone, France in particular. Let us walk through the figures here. Consider the real exchange rates of France and Spain compared to that of Morocco. Prima facie evidence shows a seemingly good correlation between our exchange rate and their over a long period of time (and 50 years is a long time series as far as Moroccan economics is concerned). However, statistical computations would show that starting from the 1980’s, figures wildly diverge, which means that in real terms, the relative prices of goods produced in Morocco, in Spain and in France are getting more and more different from each others. The assumption that our business cycles are desynchronizing is not inherently extravagant, and the observations on real exchange rate just shows it. The question is now how to move away from this unhealthy relationship to a state in which not only our reserves would stand a larger chance than a snow ball in hell, but also, how to actually make foreign exchange in goods and services worthwhile.

Real Exchange rates of some Scandiniavian countries are similar to those of Morocco

First, we need a benchmark of similar countries in terms of exchange rate -we while then move to another, more detailed argument. Computations on the U-Penn world table allowed for 4 countries to compare to Morocco as follows (graph on the side). The group countries is unlikely, to be sure. But the fluctuations since the 1980’s do prove that there is a certain convergence, if not a good synchronization of Morocco’s and the Scandinavian countries’ cycles. The fact that some are Euro-dominated currencies is not important, as the currency is not an aggregate  of Euro economies. Let us now examine their structural imports to see if there’s some opportunities Moroccan business can leap on and get us some honours (this does not exculpate them from looking into other sectors to invest in).

Beforehand, I wanted to discuss the differences between imports and exports values (for Morocco), more specifically, the clothing industry. For the 2009 figures, the Office des Changes reports an average price MAD 15,855  per ton for the synthetic textile fibre used for clothing. The average price for exported clothing was, for the same time period, %AD 4151,5. Synthetic fibre is a key component in textile products, thus actually destroying value for imports. When it comes to overall clothing however, figures are trickier: the nominal value for exported clothing items is MAD 23,180 which could lead to think that value is created out of fibre input; However, the nomenclature subsumes other items that do not require the synthetic fibres for their industrial process: the complete name for clothing rubric is ‘ARTICLES D’HABILLEMENT ET FOURRURES‘ which includes Fur as well. The breakdown shows that Fur items have actually a value of MAD 19533, which is part of the overall clothing exports nomenclature- fur does not need synthetic input, the wildlife supplies it.

It is, without a doubt, a sad indictment of how competitive one of our leading export. Not only do they specialize in poor capitalistic and skilled labour-intensive goods, but they actually are gradually destroying value, rather than creating it. This explains partially why Morocco is running a balance deficit. What applies to clothing and textile could apply to other industries as well, but because clothing exports make up for 20%, along Chemical products (15%) and Food industry (14,1%), I rest my case.

Now, what sort of imports Scandinavian countries like Sweden, Norway and Denmark? Sweden imports more than $ 16 Bn. worth of manufactured goods and continues in doing so, chiefly clothing and textile (surprise, surprise !). Denmark imports similar pieces of goods and amounts in Dollar. It is true Morocco suffers from juggernaut Chines competition, but that is due to the fact that our clothing industry competes on the same sectors, and quite often on the same markets. If textile business were to put their heads together into increasing productivity, or indeed increasing the level of capitalistic and skilled labour contribution in output, that would insure far better quality, and the little extra in production cost can be passed on to consumers like Scandinavian without much losses in terms of competitiveness, as long as Moroccan textile can differentiate itself as a “good quality” product.

That’s were challenges lie: how to increase the average cost of exported ton, so as to create value, and subsequently cut down the trade deficit. In order to provide resources for these policies, our exports need to look somewhere else, get rid of the small and shrinking niches they got so comfortable in, and start looking for new markets. The positive externalities would have far-reaching consequences: a more diversified pool of export markets would render us less dependent on our traditional partners’ business cycles, with all the benefits on our foreign reserves and the Dirham value.

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 “