The Moorish Wanderer

When Fiscal Conservatism can Actually Do Better

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on March 11, 2012

The level of prices in Morocco is perhaps the most important economic issue that can rally Moroccans around; Debt doesn’t seem to matter much, nor does the deficit. Even taxes do not seem to matter much. Since no particular (and reliable) polls are being carried out, I take it media coverage of these issues speaks for itself: public opinion does not seem to care about public debt and deficit, and public policy ensures level of prices are low, a good indicator of how priorities are ranked with a relatively popular government: stabilize prices at all costs.

By now, the major aspects of the new 2012 Budget have been made public: a big push in social sectors, education, health, housing and industrial relations, not to mention the appropriation for the Compensation Fund – around 40 Billion dirhams, and the deficit does not seem to be a priority, the trade-off in public debt and fiscal receipts has been pretty clear and favour immediate stabilization. It seems to me – but I might be mistaken- there is no Budget Policy for the next 5 years, only a year-to-year management of public finances. Sure, CST funds and Budget-allocated Public investment do contribute one way or the other to some long-term vision, but I doubt the government has fully endorsed, or even grasped the implications of, the spirit of past investment plans, like Plan Maroc Vert, Haleutis or the High-Speed train.

BKAM Core inflation doesn't take into account some elements that might be blamed for a rise in inflation

Though the government has pledged to spend its way to stabilize prices, it seems they have already overlooked the impact of their policies on future inflation as well as on the prospects of growth itself. Inflation is going to be a problem later on, perhaps sooner than what they might expect; so far, latest reports on inflation (core and total) state the following:

Selon le Haut commissariat au plan (HCP), l’Indice des prix à la consommation (IPC) a enregistré une hausse mensuelle de 0,2% en janvier 2012, après le recul de 0,5% observé en décembre dernier. Cette évolution reflète principalement l’accroissement des prix des produits alimentaires volatils de 0,9% après les baisses successives enregistrées durant les trois mois précédents. La progression des prix de cette catégorie tient à celle des prix des volailles et lapin et des légumes frais de 1,3% et 2,1% respectivement, qui a plus que compensé la baisse des prix des poissons et des fruits. Pour leur part, les prix des produits réglementés ont connu une légère hausse de 0,1%. Abstraction faite des prix des produits volatils et de ceux réglementés, l’inflation sous-jacente de Bank Al-Maghrib (BAM) ressort en hausse de 0,1% après 0,2% le mois précédent.

En glissement annuel, l’inflation s’est établie à 0,9% en janvier, inchangée par rapport à décembre 2011. Cette évolution résulte essentiellement de la poursuite de la baisse des prix des produits alimentaires volatils (-1,3% au lieu de -1,4%). Pour sa part, l’inflation sous-jacente est ressortie à 1,6%, après 1,7% en décembre.

The efforts put in stabilizing prices have brought overall inflation down, it is effectively a deflation of sorts: food prices are notoriously volatile, and the methodology makes sure they are not taken into account in core inflation computation. Bank Al Maghrib puts the 2012 trend for core inflation at 1.6%; yet HCP projects:

Concernant l’évolution de l’inflation, l’accélération attendue de la demande intérieure, associée à la persistance de la hausse des prix à l’importation, exercerait, en dépit du niveau élevé des dépenses de compensation, une légère pression sur les prix intérieurs.

L’inflation, mesurée par le prix implicite du PIB, passerait de 1,6% en 2011 à 2,5% en 2012.

that is to say, GDP deflator will rise moderately above BKAM’s core inflation 2%, which will amount to the same thing, since the last decade observed a 1.9% average GDP Deflator inflation rate, and BKAM policy rates haven’t change significantly on that period, and were much more responsive to GDP deflator fluctuations than they have been to regular ICV/IPC inflation rate. And so by postponing inflation shocks with subsidies, the budget only makes it harder to sustain future, compounded inflationary pressures that will come mainly from the crowding-out effect.

Bank Al Maghrib has only two alternatives: either support government policy and intervene a lot more on monetary markets to supplement flailing M3 and make up for the effect of government bond issues on available liquidities: as of late February 2012, the amount of liquidities BKAM serves amounted on average to 29.75 Bn dirhams, up to 238Bn since January 2012. up from 67Bn served last year at the same time by the Central Bank, an average intervention of a little less of 10Bn.

BKAM is more responsive to Deflator than the regular ICV rate. (1998 does not take into account a 50bps hike in policy rates from 5% to 5.5% then back to 5%)

My point is, government expenditure to stabilize prices will backfire, and I argue the price to pay for an inflation freeze on food prices is not worth it, since it also takes deviates liquidities from potential growth, and it pressures the Central Bank in going in with a hike in interest rates to sustain its other equally important target: sustain the Dirham’s value and manage foreign currency reserves.

Since I am getting more and more alarmist about this whole business, how come no major rating agency has produced a document about it so far? How come S&P didn’t change its outlook on Morocco? Last time they published any Moroccan-related news was July 2011, and the Outlook was Stable – and thus unlikely to change. So from a financial standpoint, the debt is manageable, not because Morocco’s economic prospects are going to improve, but because as far as its capabilities to mobilize foreign resources go, Morocco can count on generous creditors. And there goes the historic lesson: Morocco got into trouble in the early 1980s because it has borrowed too much from abroad. Foreign debt now stands at around 20% GDP; perhaps that level is considered to be sustainable; as long as the dices roll, take your chances, domestic debt doesn’t matter, does it?

Why fiscal conservatism, then?

Well, why not? It’s all a matter of trade-off, that is, a political decision that favours delaying deficit reduction and bringing debt under control because it values immediate price stability. I guess a 40Bn expenditure in compensation fund that benefits at least 75% to the top 20% affluent households. A subsidy that is likely to worsen trade deficit and weaken the level of foreign reserves accordingly. It looks as though as long as Morocco is assured of generous foreign financing -from the Gulf or the EU- its public finances aren’t much of a problem. On the other hand, if the assumption the business cycle has reached its peak holds, then it is dangerous to pursue the foreign debt path; it looks as though Real Estate is likely to be the main growth booster, and foreign, ‘hot money’ inflows do not mix well with tangible asset acquisition.

Budget rebalancing means the following: yes, overall inflation will rise moderately within the 2% BKAM target rate, and probably so would unemployment, but not above the 9% limit; but capping PSBR and spending would allow available liquidities to be channelled into private expenditure, thus boosting economic growth. Simultaneously, fiscal policy has to be rebalanced in favour of less indirect taxes and broader tax base; this means many of the existing loopholes, temporary and permanent exemptions and moratorium would be closed or ended, or at least directed in favour of actual contributors to growth: small and innovative businesses, agricultural cooperatives, higher education and research. What this government is doing is basically the worse of two worlds: social spending with no immediate repercussions on growth (domestic expenditure has a lower contribution to growth when heavily subsidized, and improving the livelihoods of 400,000 public servants out of a workforce of 11,8 Million people isn’t really going to make it happen) rolling up large deficits and mounting debt that crowd out liquidities.

S&P is Moody, Fitch is grading the rate

Theres little to be discussed seriously on the home front. Perhaps the Amar/Gazhaoui matter; No, too banal I am afraid, and we are in the process in making it so indeed.

There was something I wanted to discuss a couple of months ago but I lacked time but then again, and with the benefit of hindsight, the issue would be clearer and therefore easier to deal with.

For those of you with interest in economics and finance, you heard about the grading improvement on the Moroccan sovereign debt. In a nutshell, according to the grading agencies (like Standards and Poors, Moodys, or Fitch), Morocco is now safer to invest in (the assets bear less risk and are more liquid than before). Presumably, this is good news for the economy, especially with regard to the tightening global economic conditions. The business cycles likely trends are still on the downward slope (with little glimpses of recovery here and there, but not enough to reverse the tendency), so actual money is tight, therefore making credit opportunities rarer.

screen capture of the S&P announcement


Indeed, goods news because from now on, Morocco is Investment-Grade approved. Namely, bonds with grades ranging from AAA (the strongest and highest rate) to BBB. And we are now in a chance: since March 23th, 2010, the main grading agencies changed their ratings favourably on the various levels of debts the Moroccan government services to foreign holders.

The fact Moroccan sovereign debt went Investment-Grade allows for a new batch of investors to put their money in our economy. Indeed, the UCTIS III regulations provide for a particular kind of financial instruments all related to Money market. A new surge of money with which the government can put into practise the policies that would enable growth and wealth for the Moroccan economy. A fresh influx of money could also mean a renewal of our debt structure, a specific aspect that shouldnt be overlooked.

I believe this piece of good news is not really one. Yes indeed, the economic outlook seems stable, but on the other hand, Morocco is gasping for fresh foreign currency. It may seem a surprise, but the foreign exchange terms are absolutely not in our favour, as indeed the commercial balance deficit is worsening, and we desperately need, one way or the other, to finance it. Either by engaging the reserve currency or by calling up money on the international markets (the latter is now even more possible with the rating improvement)

The reserve currency has always been a nightmare for the Moroccan economists (and to the economic journalists as well); they were already alarmed in 2009 about it then, and have every reason to be alarmed now (as you may notice, the announcement effect takes time to be felt…)

Let us first list some facts and figures on our economic resilience in terms of currency holdings;

According to the quarterly statistics digest (N°123, March 2010), the Central Bank claims 187.392billion MAD on currency holdings. The holdings are mainly convertibles (96%), a liquid holding that enables BKAM to intervene whenever needed to in order to balance the books, i.e. hold he dirham value or finance indirectly imports.

Net Foreign currency holdings 2010 Q1

The 2008 Annual report rightly points out that this level enables for 7 months worth of imports, compared to 9 months the year before. It mainly goes back to the terms of trade; basically, our exports in terms of value do not match our imports. Though it is more of a structural nature, the exports did worse with respect to the past years. Without too much detail, the exports in the late 1990s used to match ¾ of the imports, but since 2005, only half of it was met (between 48 and 50% worth) which means a drain in reserve holdings. A current account deficit can be addressed in the course of the following actions:

* improve our exports monetary value is the most straightforward yet difficult policy

* choke the imports is virtually impossible (where one can get the oil and hardware from?)

* find the money to finance the deficit with foreign direct investment (FDI) which is now more possible with the ratings change.


Treasury Debt structure Domestic/Foreign

Like many countries that when through the painful process of structural adjustment in the 1980s, Morocco learned its lessons on foreign debt. In facts, it looks as though the top brass are trying to do anything but to borrow some money on international markets. Now the grading changed, they might go for it, which would not be a good idea now (yield curve 10+ indices).

The feat then-finance minister F. Oulalaou accomplishednamely, halving foreign debt by half in 7 yearscame to the price of local debt.

(Bloomberg, Finance Ministry)

As shown on the graph, Treasury rate of return outperformed stock exchange volume and cap (which has an effect on required return) It is quite unique in finance theory of course, but the Casablanca stock exchange is known for its over-capitalization, as well as the relative non-liquidity due to a high concentration of assets (the ONA-SNI theory holds firm even after the merger)

There was indeed a liquidity excess on the markets that enabled the government to issue T-bonds and T-bills at low premium (and thus, at low cost) and achieve a two-fold policy: keep inflation low (by taking away the liquidity instead of letting it flow through) as well as get their hands on cheap and harmless borrowings to carry out their policies.

Nonetheless, this state of grace ended with the flow of liquidities. The effect of structural balance deficit was emboldened by the decrease in expatriates (MRE) transfers. The Q1 2008 saw therefore a noticeable tightening in liquidity, which prompted the central bank to lower their main rates in order to get the show on the road.

On the other hand, public debt no longer was attractive (the stock exchange returns exceeded the public debt returns), and now that some of the middle and long-term arrived at maturity, a small yet distinguishable dip in the ratio domestic debt/GDP. This, combined with the worsening of commercial balance, put a heavy strain on the government to call up some fresh, foreign money.

They have to. Let us take a look at this simple but always true equation:

GDP = C+In+G+(X-Im)

Where GDP is the gross domestic product C consumption, In investment, X exports and Im imports.

On the other hand, Investment and total income are tied. In facts, the following equation depicts the relation between savings (the non-consumed income) and investment (earmarked to replace or expand means of productions):

CA = S-I

(Where CA is the current account, S savings and I the domestic investments)

The late equation can be computed into the first one, and thus:

GDP = C+G+(X-Im)+(S-CA)

Government spending is assumed to be exogenous to foreign trade. Consumption, on the other hand, can be function of imports (we do after all consume Turkish, US or Egyptian goods, dont we?) Furthermore, we can assume now the savings are indiscriminate between domestic or foreign;

GDP = C(Im)+G+(X-Im)+( S-CA)

(for anyone interesting in a more detailed and rigorous approach, this San Francisco Fed reserve working paper is a real bliss)

Now, (X-Im) and (TS-CA) need to be balanced: the first term needs to be financed by means of the second. It so happens that the commercial balance worsened the last few years, which means a negative value for (X-Im). In order to finance the deficit, we need to increase by the same proportions (or higher) the deficit itself, namely, by calling up foreign savings (i.e., FDI). Why foreign? Why cant we use the domestic savings? Two main reasons: either because we dont have much or it does not satisfy itself with the present returns.

For a fact, we know that R=C+S (where R is the total income) we also know that imports are a parameter in consumption behaviour, so R = C(Im)+S. However, we do know imports have risen quite substantially over the last 3 years, much more than the total income, indeed, R < C(Im), which makes Savings smaller in relative terms.

Bottom line is, sooner or later (and I believe it would be sooner rather than later) we will have to turn to the international markets.

Because of the present situation, the bonds issued are going to be expensive for Morocco (i.e with high premium rates, in order to attract investors) and thats were the danger lies.

Short or Long money do not cost the same, and its own use will affect its efficiency as well. Let us assume the brass goes for short money because its cheaper, short-term rates the US Fed, or the ECB or Bank Of England took up are at their historical lowest; Morocco needs to put the money into high-return short positions; They cannot sanely put the money into a long-term public investment, of course. In facts, its just a temporary patch-up plan with little help on the whole situation. Long-term borrowings are just too expensive, and the required rate of return is too high for the initial borrowing to be of interest. [Edit: they did, as my predictions turned wrong]

Whats to do then? The decision to borrow a larger amount of foreign money is inevitable, and in itself, is not that harmful.

The core question is two-fold: what kind of money do we need to borrow, and what sort of expenditure should we pay for? The first term is directly linked to the second. But because we have no idea what is the public policy on that matter, we can only speculate. And this is typical of an opaque governmental institution. When politicians are not pressed for electoral results, when they are not accountable to their constituents, and indeed, when the pursued policies are not in the interest of the many but to that of the few, the decisions usually lead to under-optima solutions.