Morocco - First and Second Structural Adjustment Loans Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14697 PERFORMANCE AUDIT REPORT KINGDOM OF MOROCCO STRUCTURAL ADJUSTMENT LOANS I AND II (LOANS 3001-MOR AND 3463-MOR) JUNE 27, 1995 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents (period average) Qficial Exchange Rate: Dirhams (DHs) per US$ 1990 8.242 1991 8.707 1992 8.538 1993 9.299 1994 9.203 Abbreviations and Acronyms EU European Union OED Operations Evaluation Department PAR Performance Audit Report PCR Program Completion Report PERL Public Enterprise Reform Loan PR President's Report REER Real Effective Exchange Rate SAL Structural Adjustment Loan TIP Target Investment Program Fiscal Year January 1 - December 31 FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 USA Office of the Direclor-General Operations Evaluation June 27. 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on Morocco - Structural Adjustment Loans I and II (Loans 3001-MOR and 3463-MOR) Attached is the Performance Audit Report (PAR) for the Morocco Structural Adjustment Loans (SALs) I and II (Loans 300 1-MOR and 3463-MOR, approved FY89 and FY92, respectively) prepared by the Operations Evaluation Department. These two SALs were an integral part of Morocco s comprehensive economic reform program, which was supported by nine Bank adjustment operations for a total of US$1.8 billion between 1984 and 1992. SAL I was the seventh operation of the nine and SAL II was the last. By the time the SAL I program was launched in 1988, reforms were well underway in several sectors and major macroeconomic disequilibria had already been corrected. Accordingly, the two SALs concentrated on continuity and supplementary adjustments to a program in progress. Their primary objectives v ere to increase growth and strengthen creditworthiness. In addition, private sector development and poverty alleviation were explicit objectives of SAL II. The action programs focused on fiscal reform, public investment efficiency and private sector development, trade liberalization, external debt management and the articulation of a poverty reduction strategy. Two themes stand out. First, the SALs contributed in important ways to furthering the generally successful reform efforts of the Moroccan Government. In particular, they helped achieve significant fiscal improvements, strengthened creditworthiness and brought about an increased awareness among government policymakers of the pressing nature of social issues. Second, cont. iry to expectations, the economy's growth and export performance during the SAL years was disappointing: per capita income stagnated and targeted increases in spending to enhance human resource development were not achieved. Morocco's structural reform process remains incomplete, and the Bank 1: helping pursue further reforms, particularly on private sector development issues, and in human resource development. On balance, the outcome of the tALs is rated as satisfactory The sustainability of the SALs and of Morocco's overall reform program is rated as uncertain, pending implementation of additional reforms to generate higher economic growth and improved welfare indicators The institutional development impact of the loans is rated as modest. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY Contents Preface....... ........................................................ 3 Basic Data Sheets...................................................... 5 Evaluation Summary.................................................. 9 1. Background ....................................................... 13 2. Objectives and Design of the SALs ................................. ..... 17 3. Implementation and Outcome ............................................... 21 A. Loan Compliance and Disbursements ........................ .......... 21 B. Outcome ................. . ...................... ....... 21 (1) The Fiscal Effort, Debt Management and Trade Reform........... ..... 22 (2) The Target Investment Program and Poverty Issues............ ......... 24 (3) Export Performance and GDP Growth ..................... ......... 27 (4) Performance Indicators ......................................... 29 C. Overall Evaluation ............................................... 29 4. Sustainability and Lessons of Experience ........................... ...... 31 Figures in the Text: 1.1 Morocco - Debt Outstanding to Private Creditors, IMF and IBRD, 1973-1993 ............. 14 3.1: Export of Manufactures/GDP and the REER............................... 28 Tables in the Text: 1.1: Selected Indicators (1982-83 and 1987-88).............................. 16 3.1: Selected Indicators (1987-88 and 1992-94). ...................... ........ 23 3.2: Government Investment Spending, Total and Target Investment Program, 1984-93 ......... 25 This report was prepared by Ren6 Vandendries (Task Manager). Geri Wise provided administrative support. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed wihout World Bank authorization.  3 Preface This is the Performance Audit Report (PAR) on Structural Adjustment Loans I and II for the Kingdom of Morocco. SAL I, involving Loan 3001-MOR (US$200 million equivalent), was approved on December 1, 1988, and closed on December 31, 1989. Cofinancing was provided by the Overseas Economic Cooperation Fund of Japan (13 billion Japanese Yen) and the African Development Bank (US$140 million). SAL II, involving Loan 3463-MOR (US$275 million equivalent), was approved on April 30, 1992, and closed on December 31, 1993. Cofinancing was provided by the African Development Bank (US$140 million) and by the European Union (100 million ECU). Both loans were fully disbursed and closed on schedule. The PAR is based on the Program Completion Report (PCR) prepared by the Middle East and North Africa Regional Office and issued in March 1995,1 the President's Reports, sector and economic reports, the loan documents, summaries of the Board discussions, study of the program files and discussions with Bank staff. An OED mission visited Morocco in March 1995. The PCR provided an adequate account of the preparation and implementation of the two SALs. The PAR focuses on the role and contribution of the SALs to Morocco's longer-term development efforts, in the context of a decade-long Bank adjustment lending program to Morocco. The draft PAR was sent to the Borrower and Cofinanciers for comments, but none were received. 1 PCR, Kingdom ofMorocco - Structural Adjustment Loans] and]! (Loans 300,!-MOR and 3463-MOR), Report No. 14221, March 31, 1995.  5 Basic Data Sheet STRUCTURAL ADJUSTMENT LOAN I (LOAN 3001-MOR) Loan Position (Amounts in US$ million) As ofMay 31, 1995 Loan Original Disbursed Cancelled Repaid Outstanding 3001-MOR 200.0 200.0 - 7.5 192.5 Cumulative Estimated and Actual Disbursements (USS million) FY89 FY90 Appraisal Estimate 100 200 Actual 100 200 Actual as of % of Estimate 100 100 Date of Final Disbursement: October 20, 1989 Project Timetable Date Planned Revised/Actual Date Negotiations 10/88 10/19/88 Letter of Development Policy 11/88 11/01/88 Board Approval 11/88 12/01/88 Loan Agreement 12/88 12/02/88 Loan Effectiveness 12/88 12/20/88 Loan Closing 12/31/89 12/31/89 6 Staff Inputs (staffweeks) Stage of Project Cycle TOTAL Preappraisal 163.8 Appraisal 57.0 Negotiation 18.0 Supervision 71.5 Other - Total 310.3 Missions Month/Year No. Of No. Of Date of Persons Weeks Report Appraisal 06/14/88-07/01/88 6 2 06/12/88 Supervision I 05//15/89-06/06/89 1 1 06/28/89 Supervision II 09/04/89-09/19/89 3 1 09/13/89 Supervision Ill 10/26/89-10/31/89 2 1 11/14/89 Supervision Ratings (Form 590) Form Prof. Development Implementation Legal Management Date Objective Progress Covenants Performance 06/30/90 1 1 1 1 Other Program Data (Borrower/Executing Agency: Kingdom of Morocco) Follow-on Operations Loan No. Amount (US$M) Board Date Financial Sector Development* 3365-3373 235.0 06/25/91 SAL II 3463 275.0 04/30/92 *One operation consisting of nine loans. .7 Basic Data Sheet STRUCTURAL ADJUSTMENT LOAN II (LOAN 3463-MOR) Loan Position (Amounts in US$ million) As ofMay 31, 1995 Loan Original Disbursed Cancelled Repaid Outstanding 3463-MOR 275.0 275.0 - - 275.0 Cumulative Estimated and Actual Disbursements (US$ million) FY92 FY93 FY94 Appraisal Estimate - 138 275 Actual 136.4 138 275 Actual as of % of Estimate - 100 100 Date of Final Disbursement: August 12, 1993 Project Timetable Date Planned Revised/Actual Date Negotiations 03/92 03/24/92 Letter of Development Policy 04/92 04/08/92 Board Approval 04/92 04/30/92 Loan Agreement 04/92 04/30/92 Loan Effectiveness 05/92 06/01/92 Loan Closing 12/31/93 12/31/93 8 Staff Inputs (staffweeks) Stage ofProject Cycle TOTAL Preappraisal 190.8 Appraisal 47.7 Negotiation 18.9 Supervision 63.8 Other 17.8 Total 339.0 Missions Month/Year No. Of No. Of Date of Persons Weeks Report Appraisal 07/01/91-07/14/91 11 2 07/31/91 Supervision I 07/14/92-07/23/92 1 2 08/05/92 Supervision H 10/19/92-11/05/92 3 2 11/30/92 Supervision 111 02/14/93-02/26/93 2 2 03/26/93 Supervision IV 05/93 5 1 - Supervision V 12/01/93-12/03/93 1 3 01/11/94 Supervision Ratings (Form 590) Form Proj. Development Implementation Legal Management Date Objective Progress Covenants Performance 09/03/92 1 1 1 1 03/25/93 1 1 2 1 09/24/93 1 1 1 1 09/30/94 HS HS 1 1 HS = Highly Satisfactory, Other Program Data (Borrower/Executing Agency: Kingdom of Morocco) Follow-on Operations Loan No. Amount (USSM) Board Date None 0 9 Evaluation Summary Background 1. Like many developing countries, Morocco began experiencing a financial and external debt crisis in the early 1980s, following a period of excessive public investments and foreign borrowing, aggravated by the effects of the oil price increase in 1979. By mid-1983 the financial situation had become untenable as the country found itself unable to meet its heavy debt service obligations. The crisis called for action in several areas, combining stabilization, debt rescheduling and structural adjustment. A reform program was initiated during the second half of 1983, to be phased over a number of years. World Bank support for it has been intense: nine adjustment operations during 1984-92 for a total of $1.8 billion. The first six of these operations have been audited by OED and the outcome of all of them, with one exception, was found to have been satisfactory. The operations evaluated in this report are SALs 1 (1988) and H (1992), respectively the seventh and the ninth operation in the series of nine. Thus, by the time of approval of the first SAL, Morocco had already been the recipient of six Bank sector adjustment loans, and the program had made remarkably good progress. The economy had substantially stabilized and the growth record had been good. Objectives 2. Because of the apparent success of the ongoing reforms, the focus of the two SALs was on continuity and on support for relatively small adjustments to a program in progress. In retrospect, this appears to have been justified at the time of SAL I, when recent experience with the reform program was almost universally positive. Yet, by April 1992, when SAL II was approved, some indications of renewed problems had appeared: stubbornly high unemployment, renewed exchange rate appreciation, and a slowdown in industrial growth and manufactured exports. These warning signals were partially hidden by the excellent agricultural results in 1991, while the slowdown in growth was, at least partly, attributable to the recession in Europe. In the end, the signals were not picked up in the design of SAL II (para. 2.2). Thus, both the scope of the SALs and the conditionality package were limited. The weaknesses to be addressed were apparent: stabilization had occurred at the expense of an excessive decline in public investment thereby jeopardizing growth, by 1988 the fiscal revenue effort had not improved, social progress continued to lag and debt indicators remained high. Given high levels of unemployment and the debt overhang, an acceleration in growth was clearly desirable. 3. The overriding objectives of both SALs were twofold: an increase in GDP growth and strengthened creditworthiness. Five main areas were targeted for policy action: tax policy, public investment, trade liberalization, external debt management and poverty (paras. 2.5-2.10). The financing provided by SAL I was clearly needed at the time. The need for additional financing at the time of SAL II, however, was less clear as reserves had increased to over 4.5 months of imports. The Government's objective of full convertibility for current account transactions in 1993 was the main reason used to justify additional quick-disbursing lending by the Bank. 10 Outcome 4. Loan agreement conditions were met without great difficulty and both loans were fully disbursed on schedule. The overall outcome of the SALs, however, presents a mixed picture. There was a substantial improvement in public revenues, which allowed not only small increases in spending but above all a further reduction in the Government's budget deficit to around 2.5 percent of GDP in 1994, down from more than 5 percent in 1987/88. Likewise, external debt management was strengthened considerably and a reliable analysis of debt issues is now possible. Also, independently of the SALs, substantial debt forgiveness by Saudi Arabia helped reduce the debt/GNP ratio from 100 percent by the end of 1989 to 80 percent by the end of 1991. In addition, the SALs successfully continued the process of trade liberalization, which had been initiated at the beginning of the reform program, in 1984 (para. 3.8). 5. In other areas, the record was much less promising. With regard to public investment, the essence of the objectives had been to reallocate government investment towards priority sectors- agriculture, infrastructure and social sectors-while ensuring that investment in those sectors would increase as a share of GDP. While the first goal was achieved, the second was not, in part as a result of the Government's primary preoccupation with stability and with further reductions in the budget deficit (paras. 3.9-3.12). In addition, the objective of achieving an increase in select current outlays for the social sectors was poorly designed and not achieved (paras. 3.20-3.22). On the positive side, three major studies in this area, as part of SAL II, were completed and provide excellent insights into the nature of the poverty problem, which-provided the political will can be summoned-should allow for a much improved design of programs to address the issue in the future. The studies also helped raise the awareness among Government policymakers of the pressing nature of social issues. In retrospect, these studies and the knowledge gained through them should have been completed before proceeding with SAL II. This would have permitted a more appropriate targetting of public expenditures and would have avoided the inadequacies in the design of social indicators. 6. More importantly, progress on the SALs' two primary objectives, i.e. increasing the rate of economic growth and restoring external creditworthiness, was limited. The latter was substantially achieved if judged by trends in fiscal and external debt indicators or in the level of international reserves, which is now equivalent to six months of imports. But creditworthiness also depends on prospects for sustained economic growth and, in this respect, the record has been disappointing. The evidence suggests that GDP growth is on a declining trend. Economic growth during the SAL period (1988-94) was only 2.3 percent, roughly the same as population growth, and below historic long-term trends for the Moroccan economy. A declining export performance appears to be the main reason. In retrospect, the structure of the Moroccan economy needs considerably more change. The SALs did not carry trade liberalization much beyond what had already been achieved in 1986 and protection remains excessive (para. 3.19). Moreover, the SALs did not address some other direct policy actions to promote export growth, particularly the exchange rate which shows an appreciation before and during SAL II. 11 Conclusion 7. As mentioned earlier, the conditionality packages were complied with for both SALs; in addition, important objectives were achieved, especially the improvements in government revenue performance largely as a result of SAL I, and the long-overdue change to greater focus on social sector issues following SAL II, in response to good economic and sector work. While the overall outcome of SAL I is rated as satisfactory, that of SAL II is rated as only marginally so. When designing SAL II, the Bank did not pay adequate attention to evolving economic trends (exchange rate appreciation, slow industrial and manufactured exports growth), while preparatory work in the social sector area had not yet been completed, which contributed to additional design problems (para. 3.22). The institutional development impact of both loans is rated as modest. 8. At the same time, during the SAL period, per capita incomes stagnated while they increased only marginally over the whole of the adjustment period 1983-94. In retrospect, it is clear that in these 10 years much more has been achieved in terms of stabilization than on the structural reform front. While the country has effectively stabilized, as reflected in basic macroeconomic indicators, not all the ingredients for sustained growth are yet present. 9. The program will be sustainable only if additional structural changes are pursued. The success of past adjustment policies owes much to the very large levels of exceptional external assistance (IMF purchases, World Bank adjustment loans, debt reschedulings and forgiveness) which were equivalent to around 8.4 percent of GDP per year; this compares with average yearly budget deficits of 6 percent of GDP during those same years. After having benefitted from a net flow of external resources not linked to projects for a decade, Morocco may now have to finance a net outflow on this account. A further reduction in the budget deficit and an increase in domestic savings are imperative. Private sector growth is required to enlarge the fiscal basis, increase domestic savings and create jobs. Increased growth depends, above all, on a concerted effort to promote the industrial and export sectors, which have tended to lag or stagnate in recent years. This requires a careful look at the competitiveness of the economy, its private sector development policies, and the role of the exchange rate. 10. An important lesson emerging from this evaluation is that the promotion of economic growth will require policies and a strategy which are much more directly focussed on the growth objective than has been the case during the SAL period. In addition, efforts to promote more equitable social development will have to be intensified, among others through more precise targetting of public spending. Increased complexity in loan design is, however, likely to go hand in hand with more slowly disbursing operations.  13 1. Background 1.1 Morocco's recent economic performance, combining successful stabilization efforts since about the mid-1980s with moderate growth of about 3.6 percent per annum during 1983-94, has been matched by few developing countries. Yet, with a per capita GNP of $1,030 in 1993, Morocco is still a relatively poor country situated towards the lower end of the group of lower middle-income countries. The birthrate has been falling gradually during the past three decades, but the most recent estimates suggest that the population of 27 million is currently still growing at about 2.1 percent per annum, with slightly less than half of it urbanized. The growth of population of working age is considerably more rapid. The country is relatively well endowed with natural resources, including large areas of arable land, a long coastline well suited to tourism and three- quarters of the world's easily accessible phosphate reserves, yet much of this wealth remains underexploited. Water scarcity, however, is a growing bottleneck which will require improved management practices. Phosphate rock, traditionally the leading export commodity, and its derivatives (phosphoric acid and fertilizers) still made up about 25 percent of merchandise export earnings in 1994. This is down from more than 40 percent during the early 1980s, largely on account of the expansion of manufactures exports, which now constitute about 40 percent of the total; agricultural products account for about 30 percent of exports. 1.2 Like so many developing countries, Morocco began experiencing a financial and external debt crisis in the early 1980s and has been applying stabilization and structural adjustment policies since. After years of conservative economic management ever since Independence in 1956, GDP was increasing at about 4 percent per year when the sudden large increase in phosphate prices in 1974 (which more than compensated for the first oil shock), prompted the Government to launch a massive public investment program which brought about a sharp acceleration in growth: GDP grew at 7 percent per year in 1973-77. The phosphate boom, however, was short-lived as prices declined rapidly during the second half of the 1970s. In spite of this decline and of the second oil shock in 1979, the higher rate of public spending was maintained, largely made possible by increased reliance on external borrowing which was abundantly available on attractive terms. In the process, Morocco's external debt skyrocketed from the equivalent of 20 percent of GNP at the end of 1975 to 100 percent by the end of 1983. 1.3 The growing budgetary and balance of payments difficulties during the period from 1976 to 1982 did prompt a number of stabilization programs which received IMF support. A proposed Bank structural adjustment loan (SAL) in 1980 was abandoned primarily because the Government saw no need to accept the multitude of conditions when other external finance was still readily available. The Government's stabilization efforts, however, were weak, derailed regularly, and failed to generate the hoped-for financial improvements. Still, by the end of 1982, IMF exposure had reached $1 billion (see Figure 1.1). 1.4 By mid-1983, the financial situation became untenable as Morocco found itself unable to meet its heavy debt service obligations. In addition, the large public investments of the past were proving to be of generally low productivity, while increased trade protection, a key element of the 14 country's early policy response to the balance of payments constraint, hampered the efficient use of resources by the private sector and discouraged exports. Fiture 1.1: Morocco - Debt Outstanding to Private Creditors, IMF and IBRD, 1973-1993 (S million) 5,000 - 4,500- 4 00 - --+-Private 3,500 - -- -IBRD 3,000 2,500 2,000 1,500 1,000- 500 0 V~) LnU C I- CO 0) 0 ' N M~ V ~ U)CDN r- r'- , r- t , O~ ~ D 00 00 CO D D CD 0' D a-)0CC)0) 0) 0)0M )0 0)0) 010)0)0) 0) 0)0C)a)0a)0) 0)0)0) 0)0M Source: World Bank data. 1.5 The crisis required action in several areas, combining stabilization, debt rescheduling and structural adjustment. With the assistance of both the IMF and the World Bank, the Government initiated during the second half of 1983 a far-reaching adjustment program to be phased over a number of years. The primary objectives were to (a) stabilize the economy by reducing aggregate demand mainly through a reduction in the size of the budget deficit; (b) transform the economy into an efficient producer by reforming the structure of incentives through policy changes in agriculture and industry; and (c) increase private sector savings and improve the allocation of investment through financial sector reform. Implementation of this program, supported by the IMF and the Bank, would furthermore facilitate necessary external debt rescheduling. 1.6 World Bank support for Morocco's structural reforms was intense, consisting of nine adjustment operations during 1984-92 for a total of $1.8 billion: two Industrial and Trade Policy Adjustment Loans (1984, 1985), two Agricultural Sector Adjustment Loans (1985, 1987), an 15 Education Sector Adjustment Loan (1986), a Public Enterprise Rationalization Loan (1987), two SALs (1988, 1992), and a Financial Sector Development Program (1991). The first six of these operations have been previously audited by OED; their outcomes were all rated as satisfactory with one exception: the Education Sector Adjustment Loan was rated as unsatisfactory because its major aims, including enhanced access and equity at the bottom of the education system, were not achieved. The two operations evaluated in this report are the two SALs, respectively the seventh and the ninth operation in the series of nine. 1.7 Thus, by the time of approval of the first SAL in December 1988, Morocco had already been the recipient of six Bank sector adjustment loans. The overall reform program had made remarkable progress: probably most impressive was its very quick progress in stabilization and trade reform. The two Industrial and Trade Policy Adjustment loans contributed to a significant rationalization of the structure of industrial incentives and helped generate a convincing supply response of the industrial sector and, more particularly, of exports of manufactures (see OED Report No. 7938).' At the same time, IMF-supported stabilization measures had taken firm root. 1.8 Some of these achievements can be read from Table 1.1. By 1987/88 the public deficit had been cut drastically and the current account in the balance of payments actually showed a small surplus. While the Government's revenue performance had remained essentially unchanged, stability had been achieved primarily through a reduction in government spending with the major burden of the adjustment falling on capital investment. The rate of inflation had dropped from around 8.5 percent per annum during 1982/83 to 2.5 percent by 1987/88. Also, by the end of 1988 close to $7 billion in official and commercial bank debt had been rescheduled, while gross international reserves had increased slightly from the equivalent of about I month of imports in 1982/83 to 1.5 months by 1987/88. There was a substantial improvement in the domestic savings performance and, perhaps most remarkably, between 1983 and 1988, GDP had grown at about 4.9 percent per annum. In support of these achievements, net financial assistance from the World Bank had skyrocketed (Figure 1.1). In sum, at the time of approval of the first SAL, the Moroccan economy had already substantially stabilized while having achieved good growth. ' Program Performance Audit Report, Morocco: Industrial Trade and Policy Adjustment Loans I and II (Loans 2377 and 2604-MOR), June 30, 1989. 16 Table 1.1: Selected Indicators (1982-83 and 1987-88) (Ratios to GDP) 1982 1983 1987 1988 National Accounts Domestic Savings 13.8 15.2 16.7 20.5 Fixed Investment 27.3 24.4 20.2 20.4 Government Accounts Total Revenues 22.1 21.3 21.1 22.5 Current Spending 22.9 23.7 20.6 20.7 Capital Spending 11.6 9.7 6.2 6.4 Deficit -12.4 -12.1 -5.7 -4.6 Balance of Payments Exports (Goods + NFS) 19.2 21.5 22.6 24.7 Imports (Goods + NFS) 33.7 30.3 27.0 25.1 Current Account Balance -12.3 -6.3 0.9 2.1 External Debta Total 84.9 100.6 115.7 99.4 IBRD 4.7 6.2 14.2 12.2 Memo Item: Annual GDP growth: 1983-88: 4.9% a. Ratios to GNP. Source: World Bank data. 17 2. Objectives and Design of the SALs 2.1 SAL I for US$200 million was approved by the Board in December 1988, and was fully disbursed and closed on schedule in December 1989. It was cofinanced by the Overseas Economic Cooperation Fund of Japan (13 billion Japanese Yen) and by the African Development Bank (US$140 million). SAL II for $275 million was approved more than two years after the closing of SAL I, in April 1992: it was also fully disbursed and closed on schedule in December 1993. SAL II was cofinanced by the African Development Bank (US$140 million) and by the European Union (100 million ECU). 2.2 Because Morocco's overall structural reform process was seen as proceeding well, the focus of both SALs was on providing continuity and supporting relatively small adjustments to an ongoing structural reform process. In retrospect, this appears to have been justified at the time of SAL I, in December 1988, when recent experience with the reform program was almost universally positive. Yet, by April 1992, when SAL 11 was approved, new indications of economic weakness had appeared-stubbornly high unemployment, a slowdown in 1991 in industrial growth and stagnation in manufactured exports, and an appreciating exchange rate, which were only partially hidden by the excellent agricultural results in 1991. In fact, the economic background provided in the PR for SAL II was cast almost totally in terms of the achievements of the decade of the 1980s, and did not include an in-depth analysis of developments in the period between the two SALs. Furthermore, overall satisfaction with the reform process at that time was such that it was judged to have almost fully succeeded: "our strategy for the 1990's is based on the following objectives: (a) finalize the adjustment lending (in parallel with the IMF program) through SAL II...." 2.3 In view of the above, both the scope of the two SALs and their conditionality package were limited and similar. Major weaknesses to be addressed were apparent. In the pursuit of financial stability, public investment had declined excessively and the SALs would seek to raise both its level and its efficiency, with an eye to promote growth. In addition, Morocco's social indicators continued to lag behind those of countries with similar per capita income levels. Also, over the years, the fiscal revenue performance had not improved, which contributed to recurring domestic payment arrears and to a lack of counterpart funds for projects. Finally, the external debt indicators had remained high with the debt to GNP ratio still hovering around 100 percent, which remained an obstacle to investor confidence. 2.4 The overriding objectives of both SALs I and II were twofold: (a) an increase in GDP growth in order to ensure employment opportunities and acceptable living standards for the growing population, and (b) a strengthening of the country's creditworthiness so as to restore access to voluntary international lending. In addition, the promotion of private sector development and poverty alleviation were explicit objectives of SAL II. Five main areas were targeted for policy action: tax policy and administration (mainly SAL I), public investment (both SALs), trade policy (both SALs), external debt management (SAL 1) and poverty (mainly SAL II). 2 SAL II President's Report, Report No. P-5637-MOR, para. 99. 18 2.5 Measures proposed to reform the tax structure were based on recommendations ofjoint Bank-IMF technical assistance missions. The overall goals were to increase the buoyancy of the fiscal system and improve its allocative efficiency, strengthen tax incentives for productive investments, enhance equity, and raise collection rates by strengthening existing institutions and rationalizing tax administration efforts. The action program included revisions (primarily reductions) in corporate tax rates, adjustments in the value added tax on selected commodities, the presentation of a more equitable personal income tax to Parliament and the modification of investment codes to rationalize investment incentives by limiting the duration and rate of existing fiscal exemptions and reducing intersectoral disparities in the tax code. In addition, measures to improve tax administration-standardization of corporate accounting practices, reorganization of the tax department-would accompany the structural reforms of the fiscal system- 2.6 Reform proposals in the area of public investment grew from concerns about the drastic nature of the cuts in government capital outlays during 1983-88. It was felt that public investment had fallen below the minimum necessary to meet the development needs of the private sector and the social needs of the population, especially the poorer segments. Accordingly, six ministries were targeted for a special investment effort during the SAL period. The six included agriculture, two in infrastructure (public works and transport) and three in the social sectors (education, health and housing). They were judged to be key sectors in facilitating the country's future socioeconomic development, amongst others by providing essential infrastructure and a more productive labor force for the private sector. It was agreed that the target investment program (TIP) for these six ministries would be monitored regularly. SAL II went further than SAL I by targeting also more specifically the health, education and rainfed agricultural sectors (see para. 2.9). In addition, in the context of SAL II efforts were to be initiated to explore the possibilities for the provision of basic infrastructure by the private sector. 2.7 The proposed actions in the area of trade reform were a continuation of the measures initiated under the 1984 and 1985 Industrial Trade and Policy Adjustment loans in order to further open up the trade regime to international competitive forces. The SAL measures included the gradual elimination of import licensing requirements, the reduction of the maximum import duty first to 40 percent and then to 35 percent, a strengthening of the export insurance scheme and the repeal of exchange restrictions for foreign investment. 2.8 An important part of the efforts to improve Morocco's international creditworthiness was improved external debt management. The most obvious need was a strong statistical base. In the context of SAL I the Government committed itself to establish a system of data collection, compilation and recording of all debt, including mechanisms to fully cover public enterprise, publicly guaranteed, private non-guaranteed and short-term debt. The management of the system was to be centralized in the Department of the Treasury while a formal coordination committee among all agencies involved in the foreign borrowing process would be established. 2.9 By a variety of indicators poverty-related problems are more severe in Morocco than in other countries with comparable income levels. The SALs, more particularly SAL II, were a vehicle to begin to address the poverty issue. This was done in three distinct ways. First, broad reallocations of public spending were pursued to increase the shares of the health, education and rainfed agriculture sectors. In health and education, targets were set for annual investment 19 growth-10 percent in primary education, 15 percent in health-and for annual growth in real non-salary recurrent spending-15 percent for the health sector, 15 percent per primary pupil in the education sector. In rainfed agriculture, the investment level was meant to be maintained at a constant percent of GDP. Second, an important goal was the provision of information and analysis on poverty. Specifically in the context of SAL II three studies were commissioned: (a) the effect of public agricultural services (including rural infrastructure) and pricing on the poor; (b) the effect of the provision of social services on social conditions, including the availability and use of primary education and health services, and (c) the effect of public transfer programs (including feeding programs and public works) designed to provide a safety net for the poor on the vulnerability of income to shocks. Third, the overriding objective of the Bank's involvement was to assist the Government in formulating a poverty reduction strategy for the future. 2.10 An innovative feature of both SALs, well received by the Board, was the inclusion of yearly performance indicators to monitor progress made during implementation of the program. While these indicators did not feature in the loan agreements, the objective was to keep track of developments so as to be able to make necessary adjustments in policy, if warranted. SAL I included four economic indicators (the investment to GDP ratio, the ratio of external debt to exports, the growth of manufactured exports, and the level of international reserves). SAL II included the same four plus the level of foreign direct investment, as well as three indicators of progress towards achieving the social objectives of the program (non-salary public recurrent expenditures per primary pupil, non-salary public recurrent expenditures on health services, and the proportion of births attended by health personnel). The inclusion of these indicators in the adjustment program prompted the Wapenhans' report to cite Morocco's SAL II as an example of 'best practice" As noted later, however (paras. 3.20-3.22) the indicators turned out to be less useful than expected because of design flaws and limitations in the data available.  21 3. Implementation and Outcome A. Loan Compliance and Disbursements 3.1 The implementation of both SALs proceeded very smoothly. There were roughly an equal number of pre-Board and second tranche release conditions. With two exceptions-the elimination of import licensing on at least 120 items, in SAL I, and the reduction of the maximum import duty to 35 percent in SAL II-the second tranche release conditions in both SALs either were or could not be quantified: compliance was judged by action "satisfactory to the Bank." In the event, all conditions were assessed to have been met. Accordingly, all funds were fully disbursed as scheduled. 3.2 In the case of SAL I, it is clear that Morocco needed both the policy reforms and the accompanying external assistance for the program to succeed. At the time of Board presentation of SAL 11, however, in April 1992, policy reforms were still needed but the urgency of additional financing was less clear because, by then, the country's financial situation appeared to be quite robust. The overall government deficit had continued to decline and stood at 3.1 percent of GDP in 1991. Also in 1991, Morocco's participation in the Gulf War prompted Saudi Arabia to forgive the country's entire debt obligation of about $2.7 billion, roughly 12 percent of the total debt: the debt/GNP ratio declined from 100 percent by the end of 1989 to 80 percent by the end of 1991. By then, the country's gross international reserves also had reached the equivalent of 4.5 months of imports of goods and non-factor services. In addition, in early 1992 final Paris Club reschedulings had been completed, and Morocco's debt to IBRD was already quite high. 3.3 The above achievements prompted the Government to aim for convertibility for current account transactions by 1993, which was judged to require a sizable further accumulation of reserves to allow for a smooth transition. The SAL II PR justified the need for additional Bank financial assistance on those grounds. By the end of 1993 gross international reserves did reach the equivalent of six months of imports. B. Outcome 3.4 The overall outcome of the SALs presents a mixed p,;ture which is reviewed below in order of degree of achievement. In some instances the outcome was fully satisfactory, in other areas it was marginally so, and in tvo cases the results were clearly less than satisfactory. First, there was a substantial improvement in public finances and in the management of the external debt. In addition, the trade reform program proceeded as planned (but the exchange rate appreciated starting in 1990-see Figure 3.1). 'econd, progress in reallocating public investment spending towards the six priority sectors (the TIP) and in addressing poverty issues was significant though less than expected. Third, the overriding objective of achieving an acceleration in the rate of economic growth was not achieved. Finally, the use of economic and social indicators to continually monitor progress and take remedial action proved less than satisfactory. 22 (1) The Fiscal Effort, Debt Management and Trade Reform 3.5 Following upon the recommendation of joint Bank-Fund technical assistance missions, a series of tax measures were taken in the context of SAL I to rationalize the tax system. Progress was made in the implementation of the value added tax which had been introduced in April 1986, by broadening the base; the investment code was revised by limiting the level and duration of existing fiscal exemptions; maximum corporate tax rates were reduced and direct taxation was made more equitable; the various tax schedules relating to different types of income were unified into a single personal income tax schedule; corporate accounting practices were standardized and penalties applicable to late payments and fraud were strengthened. 3.6 The net result was a fairly substantial increase in revenues equivalent to about 4.5 percent of GDP between 1987/88 and 1993/94 (Table 3.1). This permitted not only small increases in spending but above all a further reduction in the Government's budget deficit to around 2.5 percent of GDP in 1994. 3.7 The intended improvements in debt management were also achieved satisfactorily. In practice, all external debt is now registered and compiled, and therefore a more rigorous and reliable analysis of the debt is now possible. In addition, the rescheduling exercises not only helped lower debt payments but also were a learning experience to help organize information. Nevertheless, unlike the one-time debt forgiveness by Saudi Arabia, the numerous reschedulings, while giving medium-term reprieve, have meant that the debt/GNP ratio remains fairly high at about 70 percent of GNP in 1994, which will generate a large foreign exchange outflow for a number of years. Total public debt service payments, which averaged $2.1 billion per year during the past five years, will average $2.5 billion per year through the year 2000 on existing debt only. 23 Table 3.1: Selected Indicators (1987-88 and 1992-94) (Ratios to GDP) 1987 1988 1992 1993 1994 National Accounts Domestic Savings 16.7 20.5 16.2 17.1 16.5 Fixed Investment 20.2 20.4 22.8 22.4 21.3 Government Accounts Total Revenues 21.1 22.5 26.4 27.6 26.7 Current Spending 20.6 20.7 21.5 22.0 21.1 Capital Spending 6.2 6.4 7.1 7.9 8.1 Deficit -5.7 -4.6 -2.2 -2.3 -2.5 Balance of Payments Exports (Goods + NFS) 22.6 24.7 22.8 22.9 21.7 Imports (Goods + NFS) 27.0 25.1 29.3 28.8 27.2 Current Account Balance 0.9 2.1 -1.6 -2.0 -1.8 External Debta Total 115.7 99.4 78.9 81.7 72.0 IBRD 14.2 12.2 12.5 13.6 12.0b Memo Item: Annual GDP growth: 1988-94: 2.3% a. Ratios to GNP. b. Provisional. Source: World Bank data. 3.8 Trade reform has probably been the most successful element of Morocco's structural change to date. The SAL measures were the continuation in a series of reform measures initiated in 1984, following thorough preparatory work including the build-up of a solid constituency for reform.' By now, non-tariff barriers to imports (quotas, licenses, reference prices) have been largely eliminated with a few exceptions, the tariff nomenclature and customs and trade procedures 3 See OED Report No. 7938, op. cit., para. ii: "At a time when the economy was still heavily inward- oriented, i.e. during the late 1970s, an ongoing debate among senior officials in Morocco about the need to increase the economy's efficiency and the desirability of giving greater emphasis to exports, led to a request for research assistance from the Bank. The Bank responded with a three-year research program on industrial incentives. The research was carried out in the Moroccan Ministry of Commerce and Industry jointly by Government staff and one World Bank consultant at a minimal cost to the Bank. The research involved daily contacts between the research team, government policymakers, and industrialists. The research was clearly conducted by the Moroccan Government itself with involvement of the industrial sector and support from the Bank: as a result, by the 1983 crisis year, there was a consensus among all parties on the measures that were needed to turn the economy around." 24 have been simplified and the maximum import duty rate has been lowered to 35 percent. As discussed further below (para. 3.19), however, the import liberalization process is not yet complete and the recent appreciation of the exchange rate has been a factor in the falling rate of manufactured export growth. (2) The Target Investment Program and Poverty Issues 3.9 The SALs' objectives in the area of government investment were twofold: first, to raise overall public investment from the exceedingly low levels reached by 1988, following the stringent stabilization efforts, and second, to shift its composition towards predetermined sectors (the TIP) where additional investments were judged to be of the highest priority in the pursuit of the goal of increased economic growth: i.e. the agriculture, basic infrastructure and human resource development sectors. SAL II also featured sub-targets for investment in education, health and rainfed agriculture. 3.10 It is difficult to evaluate the extent to which these objectives, as specified in the SALs, were achieved. In the case of SAL I, the targets were reasonably precise in the text of the PR, although vague in the policy matrix and loan agreement. In the case of SAL II, however, the targets specified in the text of the PR did not fully correspond to those in the policy matrix while the loan agreement again was vague. A further complication arises because targets were often defined as credit allocations in the finance law which may differ from actual spending by a large margin. Nevertheless, on balance, it is clear that the essence of the objectives was as specified in the previous paragraph, even if the targets were not precise: both SALs aimed for a reallocation of public investment in favor of the TIP; SAL I sought to raise the TIP as a share of GDP while SAL II sought to keep the TIP's share in GDP constant. 3.11 Table 3.2 shows actual government investment spending data (payment orders), both totals and the TIP. The objective of reallocating investment spending towards the priority sectors was clearly achieved; as a share of total government investment the TIP rose from 39 percent in 1987/88 to 49 percent by 1992/93, which is similar to the 50 percent share obtained in 1984/85, in the early stages of Morocco's adjustment and stabilization program. The SALs may be credited for this turnaround. On the other hand, the objective of raising the TIP as a share of GDP was not achieved: the best judgment would be that, for all practical purposes, its share remained fairly constant. 25 Table 3.2: Government Investment Spending, Total and Target Investment Program, 1984-93 Target Investment Public Year Total Program Education Health Works Transport Agriculture Housing (in millions of Dirhams) 1984 7,332 3,973 806 Ill 1,525 340 1,041 149 1985 11,986 5,661 914 166 2,516 834 1,009 221 1986 13,422 6,139 1,187 113 2,599 686 1,330 223 1987 12,126 4,187 798 128 1,654 313 1,187 108 1988 10,569 4,680 991 169 2,009 330 1,097 84 1989 12,297 5,891 1,036 189 2,280 676 1,630 80 1990 12,268 6,027 1,119 221 2,555 557 1,445 130 1991 11,447 5,885 995 316 2,366 561 1,580 67 1992 11,416 6,061 1,038 325 2,424 325 1,707 241 1993 15,237 7,027 1,359 397 2,468 559 1,908 336 (as % of GDP) 1984 6.5 3.5 0.7 0.1 1.4 0.3 0.9 0.1 1985 9.3 4.4 0.7 0.1 1.9 0.7 0.8 0.2 1986 8.7 4.0 0.8 0.1 1.7 0.4 0.9 0.1 1987 7.7 2.7 0.5 0.1 1.1 0.2 0.7 0.1 1988 5.8 2.6 0.5 0.1 1.1 0.2 0.6 0.1 1989 6.3 3.0 0.5 0.1 1.2 0.3 0.8 0.1 1990 5.8 2.8 0.5 0.1 1.2 0.3 0.6 0.1 1991 4.7 2.4 0.4 0.1 1.0 0.2 0.7 0.0 1992 4.7 2.5 0.4 0.1 1.0 0.2 0.7 0.1 1993 6.2 2.8 0.5 0.2 1.0 0.2 0.8 0.1 Source: Data provided by Morocco, Ministry of Finance (Budget d'Investissement - Emissions). 3.12 The fact that the Government's overwhelming preoccupation was stability and further reductions in the fiscal deficit may help explain its hesitation to increase the investment effort, including in the areas identified as priority sectors. It is interesting to note, e.g., that in 1990, when budget cuts were called for, it was decided to cut government investment by 15 percent across the board, including the TIP. This would suggest that the concept of "priority sectors" had not taken firm root. Also, while the lack of cluity in the targets set in the SALs may reflect difficulties encountered during negotiations, it also may have contibuted to this lack of ownership of a policy to promote the chosen sectors. 3.13 It should be added that the very definition of what constitutes an appropriate TIP is far from clear. First, separating core from non-core investments is always difficult: some of the Bank's own projects did not fall within the program of the six ministries which made up the TIP, which placed the Bank in a somewhat awkward position. Second, the TIP was restricted to investments financed by the central administration, its share in the total of public investments has been on the decline, however, to the benefit of investments by public enterprises and local governments. Furthermore, apart from investments per se in priority sectors, it may be equally if 26 not more important to target increases in current spending in those sectors. In fact, this was done in SAL II, with little success, as discussed further below. Internal Bank memoranda during the early 1990s stressed the importance of improving upon the definition of a TIP; a 1992 Bank study prepared in cooperation with the Government, focussed on consolidating all public spending, including current and capital spending by the central administration, local governments and public enterprises. However, the practice has not yet become routine within the Government. 3.14 A comparison between the result of the 1984-85 household consumption survey and those of the Living Standards Measurement Survey suggests that the percentage of the population below the poverty line fell from 21 percent in 1985 to 13 percent in 1991. This coincided with fairly good economic growth between those two years, fueled by a short spurt in growth of manufactured exports. 3.15 Concrete actions in the SALs to redress poverty were fairly timid. SAL I relied on the impact of economic growth. SAL 11 was more ambitious. First, there were elements of the TIP and other spending objectives for education and health (see below para. 3.22). In the end, the achievements were limited. Second, and of much more importance, there were three studies to be completed as a complement to the results of the Living Standards Measurement Survey: the latter provided a good statistical basis to begin to analyze poverty issues. Upon completion, the studies provided excellent insights, suggesting that the approach to addressing issues of poverty in Morocco may need to be revised substantially.4 In fact, the consequences of targeting total spending in any given social sector may even be perverse. Thus, e.g., it turns out that the top income quintile of the population benefitted much more from public expenditures on health and education than did the bottom quintile; or, food subsidies were more beneficial to urban dwellers than to the rural poor: urban-consumed granulated sugar being subsidized while sugar products consumed in rural areas were not. In other words, spending targets must be much more closely linked to the objectives pursued than was done in the case of the Morocco SALs. As an example, in the health sector in Morocco, about a third of total public spending is absorbed by the two university hospitals in Rabat and Casablanca. These hospitals already own expensive equipment which is much underutilized. The targets, as SCL in the SALs, may have further contributed to raise spending of these hospitals, which runs counter to the intended objective of raising preventive health spending in rural areas. In retrospect, these studies and the knowledge gained through them should have been completed before proceeding with SAL II. This would have permitted a more appropriate targetting of public expenditures and would have avoided the inadequacies in the design of social indicators. 3.16 Based on the findings of these studies the Government has now prepared a strategy to address poverty issues. To date, liovever, no concrete action has been taken. Nevertheless, the SALs may be credited for having contributed to raise the awareness of and change attitudes towards one of Morocco's most pressing development challenges. 4 See also: Royaumc du Maroc - Depenscs Publiques: Problematique et Perspectives. Projet de rapport de la Banque Mondiale No 13413, Scptenibre 1994 27 (3) Export Performance and GDP Growth 3.17 Of the SALs' two primary objectives, i.e. increasing the rate of economic growth and restoring external creditworthiness, the latter was substantially achieved when judged by trends in fiscal and external debt indicators or in the level of international reserves.' Creditworthiness also depends on prospects for sustained economic grovth, however, and in this respect the record has been disappointing. Least squares estimates of GDP growth rates suggest a declining trend. Long- term growth rates for the Moroccan economy are estimated at or slightly above 4 percent per annum. During the years 1970-94, which included the phosphate price boom and subsequent period of heavy external borrowing, GDP grew at 4.4 percent per annum. More recently, between 1983, the starting point of the structural reform period, and 1994, the economy grew at 3.6 percent per annum: however, GDP grew at 4.9 percent per year during 1983-88 versus only 2.3 percent per year during the SAL period, 1988-94.' While subject to wide fluctuations because of rainfall variability, Morocco's agricultural sector has grown remarkably well during 1983-94, at some 4 percent per annum. In contrast, the industrial sector grew at only 2.8 percent per annum during the same period, and its growth slowed considerably during 1988-94. 3.18 The acceleration in growth during 1983-88 was largely a result of the excellent performance of manufactured exports during those years, in turn a response to the ongoing process of import liberalization and a rapidly depreciating real exchange rate, among others. To an extent, the recent slowdown in exports of manufactures results from the recession in the markets of the European Union., the main destination market. Sluggish demand in Western Europe, however, is only part of the explanation. Morocco's share in total manufactured imports of the EU increased from .17 percent in 1980 to .32 percent in 1990 and then stabilized through 1992, while other competing exporters (Malaysia, Thailand, Eastern European countries) strengthened their market share in the EU considerably, in spite of the fall in demand.' 3.19 The slowdown in manufactured exports also appears to be partly due to two policy factors; both of these also suggest that Morocco's structural reform efforts have slowed during the SAL period and that much remains to be done to change the structure of the economy if growth is to be accelerated. First, although great strides have been made on many fronts towards trade liberalization, it is worth noting, e.g., that the maximum customs tariff rate which was reduced from 400 percent to 45 percent between 1983 and 1986 (before the SALs) still stands at a relatively high 35 percent after SAL II. In addition, the one failure of the Industrial and Trade Policy Loans was their inability to eliminate one additional tax on imports (the Special Import Tax, s The improvement in external debt indicators itself is, of course, largely due to the debt forgiveness by Saudi Arabia, quite independent of the SALs. At $2.7 billion the debt to Saudi Arabia was equivalent to about 9 percent of today's GNP. 6 The 1988-94 time series runs from a peak to a peak agricultural year. A growth rate estimate from a trough to a peak agricultural year (1987-94) still yields only 2.9 percent per annum. 7 Kingdom ofMorocco - Republic of Tunisia, Export Growth: Determinants and Prospects, World Bank Report No. 12947, October 1994. 28 currently at 15 percent for most products).' This issue was not addressed in the SALs.9 In other words, total taxation on imports remains high. Second, the slowdowsn in manufactured exports starting in 1990, coincides with a gradual appreciation of the real effective exchange rate (REER), suggesting that Morocco's manufactured exports are highly price sensitive (Figure 3.1). Other obstacles for Morocco's manufactured exports compared to those from competing countries include its relative lack of infrastructure and human resource development.'0 Figure 3.1: Export of Manufactures/GDP and the REER 120-- 6 100 5.5 4.5 4 Uj REERc Exportsi 80- 4 3.5 60 13 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Note: An increase in the real exchange rate index indicates appreciation. Sources: World Bank data and IMF. 8 The tax is reduced to 10 percent for capital goods imported by enterprises benefitting from investment codes, and to 12.5 percent for pharmaceutical products. 9 The Special Import Tax was part of the proposed reform program in the early stages of preparation of SAL I. The inherent conflict between liberalization-as reflected in import tariff cuts and the related decline in revenue-and budgetary targets became a conflict between the Bank, the Fund, and different parts of the Moroccan Government. In the end, the issue was dropped. '0 See World Bank Report No. 12947, op. cit. 29 (4) Performance Indicators 3.20 The use of performance indicators in the Moroccan SALs, not as part of the loan agreement but as yardsticks against which to judge progress and take remedial action, if warranted, was generally praised within the Bank. In retrospect, their usefulness in principle was not carried over into practice. In the end, the indicators were not carefully monitored (or monitorable) by the Bank or by the borrower, and were not particularly relevant in the case of a fast-disbursing loan. 3.21 Deviations between targets and actual outcomes were fairly large for three of the five economic indicators. Both the level of net foreign reserves and of foreign direct investment were higher than the targets set. On the other hand, manufactured exports grew at a much lower rate than predicted in SAL II. However, no remedial action was taken in the latter case because the shortfall was simply attributed to the slowdown in demand in the EU. Clearly, the use of indicators for monitoring progress was an important innovation. However, it would have been preferable to select at least two different types of indicators: (a) policy actions over which the borrower has full control and thus can be monitored easily, and (b) outcomes. If the latter are not achieved yet the policy actions to produce the outcome have been taken, explanatory factors could be identified including the missing element(s) in the policy package. 3.22 The social indicators (in SAL II) were poorly designed and, in retrospect, not particularly useful. Two of the three indicators were not monitorable; the third turned out to be meaningless, given the objectives. In education, the target was non-salary public recurrent spending per primary pupil." However, in the budget, spending on primary education is not separated from spending on the first stages of secondary school. The first indicator in health, the proportion of births attended by health personnel, was not monitorable: a relatively accurate statistic in this case is obtained only every five years. The other health indicator, non-salary public recurrent expenditures on health, did not address the true problem. The major problem is the disparity between the shares of the health budget going to urban versus rural areas, with the urban areas currently receiving a disproportionate share. A more efficient and equitable use of scarce public funds would raise the percentage allocated to preventive health services in rural areas. This clearly could not be captured by the indicator. Given the slow nature of social change it may be very difficult to devise useful social indicators for a fast disbursing loan. In some cases, it may not even be possible for some ministries to absorb a fairly substantial increase in budget, e 3., within a span of one to two years. C. Overall Evaluation 3.23 As mentioned earlier, the conditionality packages were complied with for both SALs; in addition, important objectives were achieved, especially the improvements in government revenue performance largely as a result of SAL I, and the long-overdue change to greater focus on social sector issues following SAL II, in response to good economic and sector work. While the overall outcome of SAL I is rated as satisfactory, that of SAL 11 is rated as only marginally so. When designing SAL II, the Bank did not pay adequate attention to evolving economic trends (exchange rate appreciation, slow industrial and manufactured exports growth), while preparatory work in the social sector area had not yet been completed, which contributed to additional design problems 11 The indicator was erroneously phrased in "million dirhams" rather than "dirhams". 30 (para. 3.22). The institutional development impact of the loans is rated as modest. At the same time, during the SAL period, per capita incomes stagnated at best while they increased only marginally over the whole of the adjustment period 1983-94. 3.24 In retrospect, over the period 1983-94, much more has been achieved in terms of stabilization than on the structural reform front. While the country has effectively stabilized, as reflected in basic macroeconomic indicators, the ingredients for sustained growth are not yet present. Moreover, the high levels of Bank and Fund assistance are now generating very high repayment levels. Substantial Fund assistance to Morocco started in the late 1970s but the initial attempts at stabilization were not sustained until 1983. As a result, during the six years of the SALs (1988-93) net flows and net transfers (including charges) from the Fund were both negative, by about $130 million and $190 million per year. Similarly, Bank assistance, which accelerated starting in 1985, generated a yearly net flow of $175 million during 1988-93, but net transfers became substantially negative starting in 1991 (above $100 million per year). 31 4. Sustainability and Lessons of Experience 4.1 The sustainability of the Moroccan SALs is part and parcel of the sustainability of the overall structural reform program to date, of which SAL II was meant to be the final step. Many positive developments have occurred which suggest that the reform process is sustainable, if, and only if, additional structural changes as discussed further below are pursued. The deficits in the budget and in the current account of the balance of payments have both been reduced substantially to around 2 percent per year; inflation, at about 5 percent per annum during 1993-94, is under control and international reserves have risen to the equivalent of half a year of imports; there is no apparent or immediate need for more exceptional foreign financing and convertibility has been achieved for current account transactions; a privatization process has been initiated and direct foreign investment in 1993 exceeded the equivalent of 2 percent of GDP (compared to 0.4 percent in 1985 and 0.9 percent in 1990), suggesting much increased external confidence in the economy. 4.2 It must be kept in mind, however, that the reform process was much facilitated by very generous levels of exceptional external assistance. Purchases from the IMF amounted to about $1.1 billion during 1983-92 and World Bank adjustment lending totalled $1.8 billion during 1984-92; the total amount of foreign debt rescheduled during 1985-92 was $13.3 billion while $2.7 billion of the foreign debt was forgiven. In other words, exceptional external assistance during 1983-93, roughly amounted to $18.9 billion or the yearly equivalent of 8.4 percent of GDP. To put things in perspective, this compares with an average yearly budget deficit of 6.0 percent of GDP during those years, or an average yearly current account deficit in the balance of payments of 2.6 percent of GDP. 4.3 Assuming no further exceptional capital inflows, and given the recent decline in GDP growth together with urgent needs for social improvement, the task ahead may be more demanding than that during the past decade. After having benefitted from a net flow of external resources not linked to projects for more than 10 years, Morocco now will probably have to finance a net outflow on this account. The first challenge will be to finance the budget deficit from domestic resources without resort to inflationary finance and without crowding out the private sector. A further reduction in the budget deficit and an increase in domestic savings are imperative. Expenditure switching to enhance human resource development will also have to be pursued. While the ongoing privatization program can be expected to yield some temporary additional resources, its contribution is likely to be minor. 4.4 The basic elements of the challenge ahead are clear. Private sector growth is required to enlarge the fiscal basis, increase domestic savings and create jobs. Increased growth depends, above all, on a concerted effort to promote the industrial and export sectors. This requires attention to the competitiveness of the Moroccan economy, to private sector development policies, and to the role of the exchange rate. In the recent past, industrial growth has lagged behind even that of the agricultural sector, while urban unemployment has risen substantially. In addition, critical issues of poverty and illiteracy will have to be addressed partly, but not only, in order to raise the productivity of the labor force. The two recently completed Bank studies (footnotes 4 and 7 above) provide an excellent basis from which to develop a strategy. 32 4.5 The main lessons of experience gained from the implementation of the Morocco SALs can be summarized as follows. First, the promotion of economic growth will require policies and a strategy which are much more directly focussed on the growth objective than has been the case in the past. Second, efforts to promote more equitable social development will have to be intensified, among others through more precise targetting of public spending. Performance indicators should be used in future Bank programs or projects, but must be more carefully designed. Third, the Bank's economic and sector work as well as the studies included in the SALs were of good quality and highly valued by the Borrower. Their impact on institutional development and on the country's appreciation of development issues was significant. Finally, solid economic and sector work is an essential ingredient for a well-designed program. The inadequate preparation of SAL II, especially in the social sector area, stands in sharp contrast to the three-year preparatory work for the Bank's highly successful first adjustment operation in Morocco in 1984.    IMAGING Report. No: 148C97 Type: PPARP