Public Information Notice No. 05/125

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Morocco

September 15, 2005

On August 29, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Morocco.¹

Background

Morocco has achieved macroeconomic stability since the early 1990s. Inflation has remained low anchored by the exchange rate peg and thanks to a prudent monetary policy. The external current account has been in surplus since 2001 and external reserves increased to a comfortable level. However, fiscal deficits have remained large and the authorities have used part of the privatization receipts to finance increased expenditures.

Growth has been volatile and insufficient to significantly reduce poverty and unemployment. Growth averaged three percent over the last decade. It has been volatile because of the dependency of agriculture to rainfalls, and recurrent droughts contribute to increasing poverty in rural areas. The unemployment rate remains high, particularly in urban areas. Although the growth of the nonagricultural sector has become more resilient to agricultural output shocks, it is insufficient to significantly reduce unemployment.

Morocco continues to implement its broad based structural reform agenda. Large state-owned enterprises have been privatized and remaining public enterprises are being restructured or prepared for privatization. In the area of trade liberalization, the implementation of the association agreement with the European Union, Morocco's main trading partner, is proceeding as scheduled. Trade agreements were signed with the United States, Turkey, Tunisia, Jordan and Egypt to complement the association agreement with the European Union. Most Favored Nation tariffs were reduced to a maximum of 10 percent for goods freely traded with the European Union. The financial sector is being strengthened. The imminent promulgation of a new central bank and banking laws will further enhance the autonomy of the central bank and its supervisory power. A new labor code has been approved and is expected to improve labor relations and flexibility in the labor market. The government is pursuing its efforts to fight poverty, improve social conditions, and enhance the rights of the female population. The impact of these reforms on Morocco's growth rates should be observed in the medium term.

In 2004, macroeconomic and financial conditions remained stable. While the overall GDP growth slowed down to 4.2 percent on account of a decline in growth in the primary sector, nonagricultural GDP growth picked up because of a dynamic tertiary sector and a recovery in mining and energy. Inflation remained below 2 percent. The current account was in surplus, and external reserves increased further and covered about ten months imports of goods and services as well as the public and publicly guaranteed external debt.

The fiscal deficit (including Hassan II Fund and excluding privatization receipts) declined by 0.4 percentage points to 4.9 percent of GDP, reflecting good revenue performance. However, some budgetary policies did not support fiscal consolidation. Expenditures were higher than envisaged because of increases in: (i) investment following acceleration in project execution; (ii) the wage bill following new salary increases; and (iii) subsidies because the food subsidy reform was postponed and the petroleum price adjustment was not fully implemented. The authorities were able to prevent further expenditure increases related to the El-Hoceima earthquake and a locust invasion by reallocating budgetary appropriations. Public debt declined to 66 percent of GDP because privatization receipts helped finance the deficit.

The unfavorable agricultural campaign is expected to affect macroeconomic conditions in 2005. The overall GDP growth rate is projected at about 1 percent. The current account is likely to register a small deficit partly because of a high level of imports of food products and higher oil bill. Nonetheless, the overall balance of payments is expected to remain in surplus. The fiscal deficit (excluding privatization revenue but including spending by Hassan II Fund) is expected to increase to about 5.5 percent of GDP (but to decline to 4.5 percent of GDP, excluding one-off factors) despite continued favorable revenue performance. Expenditures will increase reflecting the repercussions on wage payments of the 2004 wage negotiations, the voluntary retirement program, the new universal health insurance program, the delay of the food subsidy reform, and the partial adjustment in May and August of domestic petroleum prices. Large privatization receipts will help contain the debt to GDP ratio at about 70 percent, despite the issuance of debt to cover old pension fund arrears (2.4 percent of GDP).

Executive Board Assessment

Executive Directors commended the Moroccan authorities for maintaining macroeconomic stability and for continuing to implement their structural reform agenda in 2004. Inflation remained low, nonagricultural output growth accelerated, and foreign exchange reserves increased further. Good revenue performance contributed to the narrowing of the fiscal deficit and the debt-to-GDP ratio declined. Considerable progress has been made in the implementation of structural reforms, most importantly, those related to trade liberalization, the financial sector, public enterprises, and the labor market.

Despite these achievements, Directors noted that growth continues to be volatile and insufficient to significantly reduce unemployment and poverty. To these ends, they agreed that Morocco needs to achieve sustained high rates of growth in non agricultural output. In the context of Morocco's increasing integration into the world economy, they considered accelerated structural reforms and fiscal consolidation essential elements of a high growth strategy. They, therefore, welcomed the authorities' resolve to move expeditiously with their remaining structural reform agenda in a context of continued macroeconomic stability and fiscal consolidation.

Although the current fiscal stance and debt level do not pose a risk to macroeconomic stability in the short term, Directors considered that current policies, if maintained, could reduce the authorities' ability to absorb unfavorable shocks, which could constrain growth. They, therefore, welcomed the authorities' targeted reduction of the fiscal deficit to 3 percent of GDP over the medium term. They agreed that the achievement of this objective and its compatibility with a high-growth strategy would require a reform of the tax system that would widen the tax base and allow a reduction in tax rates, a decline in the wage-bill-to-GDP ratio, an overhaul of the food subsidy program, and the implementation of the petroleum price adjustment mechanism.

Directors welcomed the authorities' plan to implement a medium term budget framework to enhance the efficiency of fiscal policies. They supported the authorities' efforts to initiate a tax reform, particularly of the Value Added Tax, and to present a tax expenditure report with the 2006 budget to raise awareness about the need to improve the efficiency of the tax system. They encouraged the authorities to move expeditiously on a broad-based tax policy and tax administration reform. Directors welcomed the authorities' decision to continue their no net new hiring policy, implement a modern human resource management and remuneration system and a voluntary retirement/departure program, and pointed to the importance of controlling salary adjustments and bonuses. Directors welcomed the increased emphasis on social development, including through improved access to education, healthcare, housing and basic infrastructure and rural development, to be financed within the medium-term budget objectives. They also greeted the recent recognition of old pension fund arrears, and supported the authorities' efforts at adopting and implementing a comprehensive plan to put the pension system on a sound footing.

Directors agreed that the Moroccan authorities have made commendable progress in liberalizing the economy. The recently signed free trade agreements with the United States, Turkey and regional partners will help attract foreign direct investment and boost Morocco's growth and export performances. However, to fully exploit the benefits of trade integration, Directors urged the authorities to simplify the tariff structure, further reduce tariffs, and eliminate variable tariff rates in parallel with the reform of the food subsidy system while providing targeted support to vulnerable groups. They noted that liberalization measures in the area of telecommunications contributed to the current dynamism of the sector and those related to air transportation have positively impacted tourism. They encouraged the authorities in their efforts to liberalize other sectors of the economy.

Directors urged the authorities to fully implement the new labor code, which should help clarify employer/employee relationships, and to accelerate judicial reforms, which should enhance investors' confidence. Directors encouraged the authorities to accelerate the implementation of the remaining measures needed to improve the business environment. In particular, they noted the need to improve governance and transparency. Directors called for caution in the provision of exemptions or special incentives in favor of specific sectors as a measure to foster investment.

Directors welcomed the authorities' continued efforts to strengthen the financial sector and implement the recommendations of the Financial Sector Assessment Program. The promulgation of the new central bank and banking laws will further enhance the autonomy and supervisory power of the central bank. Directors noted the progress made in the restructuring of the three weak state-owned banks. They urged the authorities to accelerate the implementation of the measures required to bring these banks to compliance with prudential regulations as soon as possible. Directors encouraged the authorities to continue addressing the remaining vulnerabilities in the financial system, including the high level of non performing loans, and to remove the structural constraints in order to enhance the availability and reduce the cost of credit to small-and-medium-size enterprises, which represent the core of Morocco's enterprise sector. They commended the adoption of a bill to combat the financing of terrorism, and looked forward to action on anti-money laundering legislation.

Directors noted that the current peg of the dirham has served the economy well and contributed to keeping inflation low, and that there are no signs of an exchange rate misalignment. Given the increasing integration of the Moroccan economy into the rest of the world, they noted that a gradual transition to a flexible exchange rate regime would be advisable. They welcomed the authorities' openness to consider the desirability of alternative exchange rate regimes taking into account the characteristics of the Moroccan economy.

Directors commended the authorities' efforts to improve the statistical database. In particular, they noted the progress made toward meeting the Special Data Dissemination Standards (SDDS), and encouraged the authorities to implement the agreed action plan to enable Morocco to subscribe to the SDDS in the coming months.