Morocco’s Baraka: Evolution not revolution

Euromoney, May 2013

Morocco has had a distinct advantage over its North African peers over the last two years: it looks absolutely nothing like them. While Tunisia, Egypt and Libya have undergone the painful progress from revolution to rudderless uncertainty, and while Algeria has suffered militant attacks on its infrastructure, Morocco has sailed through the Arab Spring largely unchanged and unscathed. “We can say,” says Nizar Baraka, Minister of Economy and Finance, “that Morocco had an evolution, not a revolution.”

What saved Morocco from the popular but difficult uprisings elsewhere was the fact that it had been reforming for many years anyway, and that its political model – a powerful kingdom, but nevertheless a democracy with a vibrant parliament – was more open to popular debate than many of its neighbours. King Mohamed VI acceded to the throne in 1999 and his tenure had already been associated with modest reform well before the Arab Spring took hold; then, in June 2011, perhaps sensing the tide turning elsewhere in the region, he announced a referendum on constitutional reform to strengthen democratic institutions and protect individual rights, while leaving him with some key powers.  That referendum took place in July 2011, reform was enacted, and with it any lingering sense of mass dissent faded away.  “Thanks to that [evolution], we can maintain political and social stability, reinforce our democratic institutions, give more power to our government and more rights to our citizens,” Baraka tells Euromoney in his Ministry office in Rabat.

Those in business and finance in Morocco tend to take the same view. “Morocco has always been reforming,” says Walter Siouffi, managing director for Morocco for Citibank Maghreb. “It is not a country that is reforming in response to an Arab spring. It has been reforming over the decades, and will continue to do so for sure.” He speaks of change “at a calibrated pace.”

But Baraka does not claim the Arab Spring passed without any impact on his country. “First, in 2011, we noticed a reduction of FDI because the region was unstable,” he says. Second, tourist arrivals dropped, and third, so did remittances. Still, all of those indicators have started to turn: despite a 26% year on year drop in FDI in 2011 to Dh26.06 billion, the 2012 figure was up 15% at Dh29.84 billion, while 2013 has so far brought commitments from Bombardier, Kraft Food, Danone and several Gulf enterprises. Tourist arrivals have also rebounded.

The clearest signal that investors see a distinct difference between Morocco and the rest of the region came in its landmark sovereign dollar bonds in December, which were rewarded in Euromoney’s deals of the year edition. The Kingdom’s US$1.5 billion deal was distinctive for many reasons – a debut in dollars; a $7.9 billion order book from 475 accounts – but none more so than the fact that the deal included a 30-year tranche, heavily oversubscribed and eventually tightening to price inside the initial guidance for the larger 10-year tranche. One couldn’t ask for a greater display of investor confidence in the future than heavy investment in 30-year sovereign paper. “People understand that Morocco is different,” Baraka says. “The markets did an evaluation of our country, seeing what can happen in the future, and it’s a very important sign that there is confidence in our country.”

But for all that Morocco has escaped political upheaval, it does face a number of challenges. For a start, the rest of the region is not really the point when it comes to Morocco’s economy: far more important is Europe. In conversations with bankers and businessmen in Casablanca, the state of the Eurozone cropped up in conversation considerably more often than events in Egypt or Libya. “There have been security issues across the region; it keeps people on their guard,” says Siouffi. “But in terms of how it affects us, Morocco’s trade is predominantly with Europe, with FDI coming from Asia and the west. So what’s happening across North Africa doesn’t have a big impact here.”

The other major concern involves the state of several key indicators in Morocco’s own economy. On the roadshow for that highly successful bond, most questions from investors had absolutely nothing to do with the Arab Spring or constitutional reform; they were about the more pragmatic matters of current and fiscal deficits, subsidies, and external funding. And this is a big challenge.

Morocco’s deficit stood at 7% of GDP in 2012 – “a huge deficit,” Baraka admits – and the target is to reduce this deficit to 4.8% in 2013 and 3% in 2016. The 2013 target in particular seems a big ask.

“Why did we have this deficit in 2012? Three important things happened,” says Baraka. The first was that, despite savings efforts on expenditure, costs related to subsidies were badly affected by movements in exchange rates and commodity prices. “We reduced subsidies on products like diesel and gasoil, but the savings were taken by the rate of exchange with the dollar,” he says. “We made savings of Dh5.7 billion, but [came out with] savings of Dh1.2 billion, because the rate of change of the dirham took away Dh4 billion of what we did.” Secondly, post-2011, the government perceived a need to invest in order to bolster the economy. “It was very important after 2011 to have confidence in our public and private sector. We did about Dh4 billion more than we expected in public investments, and that had an impact on the deficit.”

And third, perhaps the most significant, is the sheer scale of subsidies: equivalent to around 6% of GDP. This is where reform is most urgently needed in order to bring the country’s finances back in shape, and Baraka knows it. “In 2013 we will reduce subsidies from 6% of GDP to about 4.2% of GDP: a huge reduction. And at the same time, we will take a lot of measures to make better governance of the budget, better managing the transfers of subsidies to public companies.” Subsidy reform, he says, will use a partial indexation model, meaning that if petrol costs increase dramatically, subsidies will move with them; but from now on there will be greater use of hedging, “to maintain the price we expect. For example, if we have a reduction in the price of sugar, we will use hedging to maintain the same price, and if there is another increase in prices, we will not be affected.”

And with all that, can Morocco meet its targets? “Yes. We have to.

Clearly investors in the dollar bonds took the view that Morocco knows its problems and is dealing with them. “We know what we have to do and we are doing it,” says Baraka. But there is still a sense that Morocco is at a pivotal point in its public finances, which could go either way.

It is illuminating, for example, that Morocco divides rating agency opinion quite starkly. One agency, Standard & Poor’s, rates the country investment grade, BBB-; the other, Moody’s, rates it sub-investment grade at Ba1 and put this rating outlook down to negative from stable in February. The decision, Moody’s said, was driven by “the deterioration in the government’s fiscal metrics, which has been mainly driven by the authorities’ decision to accommodate the sharp increase in oil and other commodity prices by maintaining widespread subsidies on oil and basic food commodities.” For Moody’s, the fact that the government knows what the problem is, is not enough. “While the government has acknowledged the need for substantive reform to the system, it has so far implemented only two minor steps to reduce its large subsidy bill,” a reference to a hike in administered fuel prices in June 2012 and a reduction in some agricultural subsidies in September. Acknowledging what the government has said about new targets on subsidies, Moody’s adds: “timely implementation of these measures will be needed if the country’s public finances are to get back on a sustainable path and avoid a further rise in the public debt ratio.”

The Moody’s announcement is a sore point in Morocco, and the Ministry refused to take questions on it beyond to say that the rating itself is unsolicited. But S&P, too, has recently downgraded the outlook for Morocco from stable to negative, although it has kept it at investment grade. This agency, like Moody’s, has called for further cuts in subsidies and warned of the consequences of any failure to do so. It said in October: “We could lower the ratings if the fiscal and current account deficits do not narrow significantly and sustainably, social pressures escalate to a degree that they jeopardize political stability or impede coherent reforms, or economic performance is materially harmed by a weakening external economic environment.”

The problem is, to be blunt, subsidies are popular, and removing them is highly unpopular. Can Morocco implement the financial reform it needs to without triggering unpopularity or even revolt? Can it do what it needs to do and keep an atmosphere of stability?

“I think that when you do a reform like that, you can do it, but it’s not simple,” Baraka says. “We have to explain. We have to prepare people. We have to take other measures to reduce the impact of subsidies on some sectors, and to help people. But Morocco has three important things: first, our political stability; second, the legitimacy of our elected governments; and third, the fact that we will do this gradually.

“We can’t do it in one shot,” he adds. “It’s very important to have discussion and to open debate with all of our partners – the political parties, majority and opposition; the parliament, the unions, civil society. I’m sure that, with all that, we can do it in the right way.”

Bankers tend to be sympathetic. “There are reforms in terms of spending, and in the subsidy program,” says Siouffi. “But you can’t address all these issues overnight. If commodity prices were more accommodating and went up a little slower it would have been easier, because every country has to go through these adjustments, but you had some sharp hikes that can’t be digested overnight.” In his view, the Moody’s concerns reflect things that aren’t entirely in Morocco’s control. “The budget deficit needs to be brought in and the government is aware of that, but you are vulnerable to external factors. If there is further recession in Europe it will affect remittances and tourism. Morocco is not living in its own isolated world.

“With the ratings, they’re looking at what’s happening in the world and what impact that could have on Morocco. It doesn’t signal that the government isn’t taking the necessary measures, because it is.”

Brahim Benjelloun-Touimi, economist and banker at BMCE Bank in Morocco, says the deficit is partly a consequence of a proactive approach to investment. “Relative to GDP, investments represented an average of 35% over the past six years, a figure encountered only in East Asian economies,” he says. “If this approach’s main objective is to stimulate private operators by providing a virtuous framework for action, it may, occasionally, stress public finances.” Despite this, he says the government has “important levers” to reduce the fiscal deficit, including replacing subsidies with direct aid, and encouraging the private sector to take over state roles in creation of jobs and value.

He believes fiscal reform can happen without provoking unrest, pointing out that 85% of the Compensation Fund (the mechanism for providing subsidies) is used to support oil prices in products that are “consumed mainly by the non-poor”. “Therefore, the redistribution of wealth [through subsidy reform and direct aid where necessary] makes sense.” He calls the Moody’s assessment “in some ways unfortunate. With a public debt to GDP ratio below 55%, compared to European economies, as well as the IMF’s optimistic forecasts for 2013, Morocco offers promising prospects for development.”

Perhaps the opinion that matters most is nothing to do with the rating agencies – though the drop of a single notch for S&P would be highly significant, pulling it from investment grade portfolios – but that of the IMF, whose $6.3 billion precautionary liquidity line, approved in August 2012, is a vital element of Morocco’s external funding. The first review under this economic program took place in February, and deputy managing director Nemat Shafik at the IMF struck a broadly positive but cautious tone.

“The authorities’ fiscal strategy, including the 2013 budget, is in line with their commitment to maintain fiscal sustainability and support external adjustment,” he said.  “As part of this strategy, it will be important to move ahead with the reforms of the general subsidy system and the pension system and to better target social protection. Fiscal space needs to be preserved to support higher and more inclusive growth.” The IMF also encouraged Morocco to prioritize measures to improve competitiveness and to respond to external shocks; to move to greater exchange rate flexibility; and to make growth more inclusive by boosting employment, particularly among youth.

On top of subsidies, Moody’s is also worried about external deficits and funding requirements. It estimates the current account deficit was close to 10% in 2012, that the country is extremely vulnerable since oil products account for around 23% of total imports, and that the problem is exacerbated by problems in Morocco’s key EU trading partners. In order to finance the deficit, foreign exchange reserves had fallen to US$15.8 billion by the end of 2012, equivalent to less than four months of import cover.  Since the current account was roughly balanced in 2007, this has been a swift decline, and leads to funding needs of around 10% of GDP.

In this respect, though, Morocco does have options. The IMF precautionary liquidity line would, if fully used, meet 60% of the funding needs; Arab states have been committing aid; and now there are the possibilities provided by the capital markets. “For Morocco, first of all it’s important to say we have signed an agreement with the Gulf countries and are beginning to have agreements on projects and public investments,” Baraka says. “We will have about $1 billion in grants for this year. Secondly, we decided to have a legal framework for sukuk. Then we can decide what kind of bond we will do: go back to the international markets, or we can do a sukuk.” Asked whether the sukuk framework is in place, he says: “Yes. It has been adopted by the parliament. We can prepare it [a sukuk].”

This could prove to be very useful. Last year Turkey, a similarly-rated sovereign, launched a debut sukuk and was able to raise funds inside its conventional curve. If Morocco can do the same, that can only help its external funding position. “There is a lot of demand for Morocco sukuk,” says Baraka. “We have a very good relationship with the Gulf and Arab countries, and they all ask us when we will do a sukuk.”

On top of that, Baraka points to “important links with the international organizations for financing our projects, and also bilateral financing”; he speaks of $1 billion a year available from the African Development Bank, and $700 million from the World Bank. “We have the opportunity to take money at good prices from these organizations.” Because of this availability, he declines to put a figure to likely full-year capital market fundraising, although he says: “Morocco is not a frequent issuer but is keen on maintaining a more regular presence in the international financial market.”

Any further revival in FDI will clearly help Morocco too. Baraka notes changing patterns here: in 2012, industry was the most important part of FDI rather than tourism or construction in previous years. This, he argues, is all a reflection of a clear strategy around FDI. “There is a new kind of interest in our country thanks to our strategy in industry,” he says, highlighting Renault as a particularly important investment last year, and noting the increase in investment from Korea and Japan. “Investment from Europe is being maintained, but we have new countries investing here now. It’s very important.” Clearly, too, the Gulf will be increasingly important for Morocco FDI.

Siouffi also notes the importance of strategic priorities in FDI. “The angle which is really going to create jobs and help support growth for the economy in Morocco is manufacturing FDI,” he says. “Investments around Morocco’s strategic areas of development: the automotive sector, IT, aerospace.”

For all its reform, much of Morocco’s economy remains in the hands of the state, if not explicitly the monarchy; further privatization might also ease financial burdens, though as Baraka says, “most of the list of privatizations we had, we already did.” Morocco has developed a legal framework for public-private partnerships, “and thanks to that we will be less present than before in lots of sectors, like energy.” He says the government has also implemented an agency to build greater competitiveness, and is trying to build up capital in major companies and develop a strategy for public auctions of state assets.

An early example of a PPP came in solar energy, in a World Bank-backed project called Ourzazate, a 500MW plant. This deal, involving $1.435 billion in loans from seven international lenders in 2011, captured considerable attention because of its green credentials – World Bank president Robert Zoellick called it “a multiple winner” – but its PPP structure could prove equally influential. “We are trying to do it for hospitals, for schools, universities, and of course on other kinds of infrastructure projects,” Baraka says.

Siouffi at Citi suggests Office Cherifen des Phosphates, the world-leading phosphate company, as an example of a company that has been corporatized, done well, and could be listed in due course. “But it’s not the right time now. They can realize much higher values at a later stage.”

Developments like this offer a positive case for Morocco, and even Standard & Poor’s sees much to praise even as it downgrades the country’s outlook. “The Moroccan authorities have established a positive track record of consistent, stability-oriented economic policies over the past decade,” it says. “Inflation has been low and stable for many years now and the authorities have long pursued policies to improve social indicators for the population at large.”

In aggregate, “the mood is neutral, I would say,” says Siouffi.  “There are positive moments, but Europe is in crisis and the Middle East is in turmoil. There is optimism, but it is cautious optimism.”