The Moorish Wanderer

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.

Of the One, by the One… for the 1%

Protests in the United States against the plutocracy (the “99% movement”) are truly an unprecedented thing to observe. #OccupyWallStreet, as Dailykos contributor @Unaspencer (whom I had the opportunity to meet during the Netroots Nation at Minneapolis) explained it has to do with more than just unfair taxation, and I assumed she was referring to a demand for fairer society with more social justice. Given the quasi-impunity many bankers enjoyed after the ’08 credit crunch, the swift downgrade of US debt credit rating could be seen as double standards -although the same document pointed out that the blame was to be laid on the Republicans congress for their stalwart refusal to “continue to resist any measure that would raise revenues”.

In Morocco, we do not have these problems; after all, stock markets do not contribute a lot to GDP, and banks remain a lot more regulated under domestic regulations; furthermore, it is a well-known fact Moroccan assets are over-valued, and so remain unattractive to foreign investors. And yet, we have a small minority of wealthy households, with an average income well above MAD 200,000 per annum (and I have restricted myself to the top 10% only).

+32% over the year. And a full recovery since the early 2009 dip.

Those incomes earned on Casablanca Stock Exchange are even heftier, and benefit to an handful of privileged few.

We consider the MASI (Moroccan All Shares Index) Gross and Net returns: as late as December 2010, the Market valuation for MASI dividends increased 32% over the year, and considering the MASI’s valuation at the same time (MAD 129,25 Bn) the dividend value for late 2010 was MAD 31Bn for all MASI shareholders. This figure is very close to the effective paid dividends for at the same period, thus vindicating the computation of a “MASI Dividend index” and the claim of a very favourable tax deductions system applied to financial assets.

31 Bn is not such a big deal, after all: that’s about 5.1% of total GNI. The figure in itself is ambiguous, in the sense that it translates the relatively weak penetration of financial assets in gross income formation, as well as the relatively stable requirement of required capital returns from an economy like Morocco’s. Alternatively, it is only too much to be shared by a small group of wealthy individuals who, basically, concentrate as much income as 20% of the population. The question remains: how many of these über-rich own it? Also, it is safe to assume the vast majority of shareholders are not small ones; by all means, as a matter of fact, two individuals and three companies alone own 83% of all shares listed on Casablanca Stock Exchange. That’s a lot.

Large companies in Morocco also have a certain habit to display concentrated shareholding (usually other companies and holdings, a bit like SNI, who controls between 44% and 57% of total market capitalization) which makes it both easier and more difficult to get a precise overview of how concentrated wealth is among the top 10%; it is easier because these companies are ultimately owned by a handful of individuals, and more difficult because one exhausts very quickly the information yielded in publicly available documents.

And so, even among the 10% wealthiest, concentration is insanely high; and that’s not even the “We are the 1%”, it actually goes down to a lot less than that, and they can get away with it, not least because of the generous fiscal regulations.

Fatcats: they make more than the Markets.

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.