The Moorish Wanderer

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.

 

Open Society Project. Part I: The Economy (Continued)

What sort of budget would we have in a Open Society-upholding government? First, as mentioned before, investment budget would be much higher than the current level of expenditure, i.e. less than MAD 54 Billion. The idea is to take investment up to MAD 100 Billion; with a target of MAD 200 Billion over 5 to 7 years, and, more importantly, keep up a long-term average 10-years incremental increase rate of at least 2.77% with an ideal target of 3.93%. The lower bracket corresponds to the average real GDP growth over the last 20 years (thus taking into account depression years of the 1980s) and target level is the average GDP growth over the last decade.

Parallel to this ambitious program, there will be a need to downsize civil service human resources and expenses. Figures show that civil servant are spread evenly with respect to the Moroccan population, but reports also show a great deal of central bureaucracy (cost centres) that do no provide essential services. Furthermore, positions of education, health and local government are relatively underpaid when compared to these very same bureaucratic services. As a matter of principle, government money is taxpayers’ money. The idea that public sector is a last-resort recruiter for misfits should be definitely dropped. Indeed, it is a constitutional right for any citizen to apply for a government job, on the essential condition that they meet requirements, usually determined by their entrance exam results (difficult exams of course) and required degrees; Ideally, government civil service is an aggregate of competent, full-dedicated and bright minds fuelled by their public service spirit. That rules out unemployed graduates that are desperate for a job and settle in -as well as the arrogant Grande Ecole graduate with no idea whatsoever on how to actually run a country (those without the proper training and education, that is).

Whatever political allegiances one might hold and its derived policies on the matter of public administration, our own history with public service (even before 1912) unfortunately compel us to assume its actions to be evil, though the lesser of civil service’s evils is public investments, hence the heavy spendings commitment. Let me elaborate on that: traditionally, and I suspect many radical left-wingers in Morocco still hold it to be a good policy, the Moroccan left trusted the State to be the most efficient tool to achieve their objectives (I direct the reader to have a look to a post I wrote on the various stands regarding civil service). This might be due to a Trade-union tropism – and the history of struggle against the monarchy to take control of what was very early on, perceived to be the most powerful institution in post-1956 Morocco, but nonetheless, efficiency doesn’t compute in their design. What they don’t realize is that it will take on more bureaucracy, more waste of the taxpayers’ money, and ultimately the defeat of their projects. And in that respect, liberal Big-Statists -whether on the Right or on the Left- fail to notice the danger they are running into: behaving just like the Makhzen does, i.e. considering Moroccan citizens as irresponsible, with the indefatigable state intervention to run their lives. A genuine democratization goes through empowerment of communities and individuals, with a light touch regulation and intervention from the state (hence my stand on federalism and downsized civil service human resources).

It is high time the civil service factored in the concept of ‘Taxpayers’ money rather than ‘State money‘ and the promotion of a ‘self-reliance’ culture. Does it sound Blairite and Right-wing? Perhaps. But that is the most straightforward approach to break down the Makhzen system, and free individuals from a culture of dependency. “فلوس الشعب فين مشات” should be the watchword on every government spending.

Now, 2011 Budget figures show the following balance:

Finances Ministry 2011 Budget

Overall, government budget should be increased, but not in a discretionary fashion. Ideally, and alongside the increase of public investment within the assigned target, other government expenditures should be constrained with yearly inflation levels.

One way of doing so is to propose a reduction of central government wages by 5%, a moderate cut in the teaching corps (due to its ageing demographics) so as to match a student/pupils ratio of 12:1 as well as a pay rise to a median wage of MAD 17,000. [similar computations are run and observed on the health service] The first step for this to work is to spend, in two years’ time, windfall taxes from the fiscal reform to pay back the debt and terminate in that amount of time all debt payment (which amount to about xx). This expenditure, besides the positive effects it can have on government budget balance, is a strong signal the Moroccan government is committed to build up a reputation as a thrifty and efficient (in reference to Nigel Lawson‘s “primitive language”, but caring instead). The 5% cut mainly targets the high expenses account, such as the MAD 20 Billion of high salaries and the Civil List’s MAD 2.433 Billion.

There are several loopholes than can be filled, as well as policies that can either boost receipts (policies on income and VAT for instance) as well as reduce expenses (a shake-up of pay wage, or the detail analysis of ‘Charges Communes’). Furthermore, debt expenses should be phased out as early in the government’s legislature as possible, as these expenses represent a double exaction on the nation finances: first, 12.47% of total expenses were channelled to pay for debt; Knowing that about MAD 2.4 Billion of it is foreign-held, that means a direct annual pressure on total reserves of 5.98% which needs to be phased out as quickly as possible.

We need a cross-breed Prime Minister between Abdellah Ibrahim and Margaret Thatcher: strong Liberal credentials and a ruthless leadership

The alternative budget (with 2011 figures and holding all assumptions on Oil price and projected growth constant, as well as retaining specific items) would subsume the following projections:

1/ Military spendings to be cut by MAD 17 Billions, mainly by selling off obsolete or non operational hardware, and a reorganizing the military establishment. That means mainly a reduction in number of servicemen, the phasing out of compulsory military service (and the subsequent closing down of a number of military bases) and a re-organization of military units for more small outfits and more mobile forces. My own proposal for a radical change in defence strategy tries to make the numbers fit in, with an overall target of 2% GDP in defence spendings.

2/ Common expenses phased out: There are some MAD 36 Billion usually earmarked by the Finance Ministry as a common, inter-departmental  expenses. The trouble with such expenses is mainly the opacity.

3/ Reconsider accounting standards for SEGMA departments, if not an outright off-balance sheet outsourcing: this would save the public taxpayer about MAD 2 Billion. Even though SEGMA departments’ books have to be balanced, the budget often makes provision for subsidies, which on the long term weigh on public finances. If anything, an outright privatization of these SEGMA (Secteurs Gérés d’une Manière Autonome) might yield good money instead. For instance:
Golf Dar Es-Salam (receipts for MAD 18 Million)
The National Press (Imprimerie Officielle: MAD 13 Million)
Habous Ministry’s own Pligrimage Agency (20 Million)
Dar Annakhil Press (MAD 2 Million)

Overall reduce expenses by 53 Million, but saves capital account of about MAD 590 Million every year. Though it is difficult to put a fair valuation on these entities, if properly re-structured before privatized, a net yield could be around the Billion at least.

4/ Introduction of flat fees to replace ‘Grima’ applications. According to the 2007 Cour des Comptes audit report, 1749 ‘grimas‘ were delivered in 2007, an estimate of 3000 by 2011  (many of whom where for transport and fishing permits). Assuming a conservative estimated median flat fee of about MAD 10.000 per permit, the new system yields for 2011 about MAD 30 Million. This remains a conservative estimate, since many applicants eventually give up out of frustration (actual figures are more around 9000 applications. A detailed application listing (which doesn’t appear on the report) could allow  finesse discrimination (for instance by charging more on fishing permits than on taxi licenses) could yield even more. This policy -under assumption it remains tax-neutral- can actually contribute efficiently in fighting corruption, and bringing down one of its main features.

Budget balances with larger debt payment. A few items were retained due to a lack of detailed set of data

The Open Society project has the capacity to fund itself for the grand projects that lay ahead. This budget can next be broken down by regions (in accordance with the federalist option). [I haven’t got time for it, unfortunately]. Next piece will deal with the new Social Fabric.