Morocco - Electrical and Mechanical Industries Project

Tocument of The World Bank FOR OMCIAL USE ONLY Rhport No. P-3918&MOR REPtOT AND RECOMHENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$25.1 MILLION TO THE KINGDOM OF MOROCCO FOR AN ELECTRICAL AND MECHANICAL INDUSTRIES PROJECT December 4, 1984 This _omeat h a turhd dinbutlos ad may be wed by recipins ody In the perfernace of their ofI dues Ift contets qm na aothdewi be _dosd withot Wrld Bla au___riagn.  KINGClK OF MOROCCO CURRENCY EQUIVALENT Currency Unit - Dirham (DE) US$l.OO DH8.5 DHl.OO US$0.118 Fiscal Year January 1 - December 31. GLOSSARY OF ABBREVIATIONS BNDE National Economic Development Bank (Banque Nationale pour le Ddveloppement Economigue) EIs Electrical and Mechanical Industries ERR Economic Rate of Return FRR Financial Rate of Return MCI Ministry of Commerce, Industry and Tourism ODI Office for Industrial Development (Office pour le Developpemeat Industriel) SNI National Investment Company (Societe Nationale d'Investissement) SSIs Small-Scale Industries  FOR FmCIL USE ONLY KINGDO) OF MOROCCO ELECTRICAL AND MEC CAL IDEUSTRIES PROJECT Loaa and Project Summary Borrower; The Kingdom of Morocco Amount: US$25.1 million equivalent, including the capitalized front-end fee. Terms: 17 years, including 4 years of grace. at the standard variable interest rate. The Government would bear the interest and foreign exchange risks on the Bank loan. On-lending i) 922 million of the Bank loan would be on-lent to Terms Moroccan commercial banks at the Bank interest rate prevailing at loan signature, and would be repayable according to a composite amortizatiom schedule, reflecting the amortization of sub-loans extended by the commercial banks. The interest rate on sub-loans to EHI borrowers would be the current minumwm effective rate on long-term industrial loans. The terms of sub-loans would reflect the economic life of sub-projects, with a maximum matuzity of twelve years, including a maximum grace period of up to three years. ii) $3 million of the Bank loan would be on-lent to the Office pour le Developpement Industriel (ODI), at the Bank interest iate prevailing at loan signature, with a maturity of 15 years, including 5 years of grace. Project The project's objectives are to support the development of Description electrical and mechanical industries (ENIs), encourage Moroccan commercial banks to be more active in term financing of industry, and strengthen ODI in its role of industrial promotion. To achieve these objectives, the project would consist of: i) a line of credit of $22 million on-lent by * participating commercial banks to finance about 40 eligible EMI sub-projects; and ii) a subsidiary loan to ODI of $3 million, comprising $2.8 million-for financing minority equity participations by ODI in eligible EMI enterprises, and $200,000 to improve ODI's market analysis capability in the EKI area through sub-sectoral studies. This document has a resrwted distribution and may be used by recipents only m the performance of Ithir ofrwcial dutes. Its contents may not otherwise be disclosed without World Bank authorzation.  (ii) EKI investments under the project will create about 1,500 jobs. The project would provide an opportunity for commercial banks to improve their capabilities for economic and market analysis, and contribute to increasing term financing by commercial banks. ODI's policy framework would be improwed under the project, and its capability in the MUI area would be strengthened. The main risks under the project concern the receptivity of the commercial banks to the financing scheme and on-lending conditions, their ability to appraise sub-projects and follov procurement and disbursement proced.rcs umder the loan. These risks are expected to rewuin uinimal. as the participating commercial banks have c'afirmed their interest, developed sub-project pipelines, demonstrated appraisal capability, and are familiar with Bank procedures for procurement and disbursemaents. uss '000 Estimated Disbursements IBRD FY FY85 FY86 FY87 FY88 FY89 FY90 FY91 Annual: 60 1,665 7,625 8,200 4 800 2,175 575 Cumulative; 60 1,725 9,350 17,550 22,350 24,525 25,100 Rate of Return; Not applicable Staff Appraisal Report; Report No.5225-MOR dated December 4, 1984  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECCMENDATION OF TEE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED WAN IN AN AMOUNT EQUIVALENT TO USS25.1 MILLION TO THE KINGDOM OF MOROCCO FOR AN ELECTRICAL AND MECHANICAL INDUSTRIES PROJECT 1. I submit the following report and recommendation on a proposed Loan to the Kingdom of Morocco, for the equivalent of US$25.1 million, including the capitalized front-end fee, to help finance an Electrical and Mechanical Industries Project. The loan would have a term of 17 years, including 4 years of grace, at the standard variable interest rate. PART I - THE ECONOMY_/ 2. An economic report, entitled "Morocco; Priorities for Public Sector Investment (1981-85)" (No. 4156-MOR), was issued on June 15, 1983. Another economic report entitled "Morocco: Industrial Incentives and Export Promotion" was distributed to the Board on January 11, 1984. An economic mission on financial intermediation was in Morocco in September 1983 and its report is expected to be issued shortly. The following section reflects the findings of an economic updating mission that was in Morocco in July 1984. Country data are given in Annex I. Iatroduction 3. Compared with many developing countries, Morocco is well endowed with natural resources. Morocco has the world's largest and most easily recoverable phosphate reserves, which makes the phosphate sector a key export sector. Other minerals such as iron ore, manganese, lead and zinc are also exported, but in much smaller amounts. Coal and hydropower plants satisfy only a small part of the country's energy requirements, but Morocco has some uranium and oil stiale resources which could become significant energy sources in the long term. There are moreover preliminary indications of natural gas reserves. Morocco also has a relatively good agricultural potential. In addition, Morocco's proximity to Europe has favored trade, tourism and labor migration with the EEC countries. 4. During the first 15 years after independence (1956), a conservative approach to economic policy predominated in Morocco, and GDP increased at an average rate of 4% a year in the 1960s. A relatively weak savings effort and conservative external borrowing policies permitted only a slow rise in the share of resources allocated to investment. Morocco thus entered the 1970s with no major financial imbalances, but a relatively limited growth capacity. 1/ Part I is substantially the same as Part I of President's Report No. P-3893-MOR of November 2, 1984 on a Vocational Training Project.  Economic Performance in the 1970s 5. During the mid-1970s, economic policy became more ambitious. In 1974) with the sudden jump in phosphate prices, phosphate export earnings more than quadrupled, and although the petroleum import bill also quadrupled, the current account of the balance-of-payments remained in surplus. The Government launched a massive public investment program which brought about a significant acceleration in the rate of growth to 6.72 per year between 1973-1977. There was also a major expansion of expenditure on social services, which have however until now been relatively inefficient in reaching the lower income groups, particularly in the rural areas. 6. The phosphate boom, however, was shortlived and phosphate exports started falling in both volume and value as early as mid-1975. Markets for other exports as well as for tourism and labor migration were also negatively affected by the world recession. Accelerated investment, rising social expenditures and increased defense spending in response to growing tensions in tne Western Sahara, soon created strong pressures on both the balance-of- payments and the Government budget. The Treasury deficit reached 17.6% of GDP, and the current account deficit of the balance-of-payments, 16.5% of GDP in 1977. To help finance the gap, Morocco borrowed heavily from the inzernational capital market, which led to rapid increases in external debt and the debt service burden. 7. In order to redress the rapidly deteriorating financial situation, the Moroccan Government in 1978 adopted a stabilization program, with the aim of reducing internal and external deficits to sustainable levels. The program centered on reductions in investment outlays and stricter import controls but was not sustained long enough and did not address the fundamental structural weaknesses of the economy. By 1980, both fiscal and external imbalances were again substantial: the Treasury deficit remained at about 11% of GDP and the current account deficit of the balance-of-payments at 8% of GDP. By then, the external debt had risen to $7 billion and the debt service ratio was 27% of exports of goods and services. Recent Economic Developments 8. GDP growth has slowed down since 1978 to 2.8% a year on average, barely enough to keep per capita income from falling. Agricultural value added, which rose rapidly in the sixties, has stagnated since the seventies. Despite substantial public investrnzet, value added in manufacturing also stagnated in recent years. Construction, which had experienced intense activity durirg the mid-seventies, sbtaced declining steadily with the slow down in public investment after 1977. Government services have been the main source of growth since 1978. 9. In 1980-82, renewed efforts were made to stabilize the Moroccan economy with the help of the IMF. In October 1980, the IMF approved a three-;ear Extended Fund Facility (EFF) in the amount of SDR 810 million. The EFF was suspended in 1981, however, and replaced in April 1982 by a one-year  - 3 - Stand-by, which was implemented as planned, but had relatively little impact on Morocco's financial performance. Throughout this period, Morocco's attempts at stabilization were severely hampered by a series of external shocks; a) the 1979 increase in oil prices which aggravated an already substantial petroleum import bill ($1.2 billion in 1982); b) a severe drought, which reduced agricultural output by about 202 in 1981 and led to substantial imports of cereals; c) the rise in international interest rates which contributed to a steep increase in debt service; and d) the international economic recession which contributed to a 30% decline in 1982-83 in the dollar price of rock phosphates, as well as to a fall in workers' remittances, Morocco's two principal sources of foreign exchange in the early 1980s. 10. At the same time, however, expansionary public spending policies continued to be a major source of both fiscal and external imbalance. Adoption of the 1981-85 Development Plan, which aimed at an ambitious GDP growth rate of 6.5% p.a., led to a sharp increase in public investment expenditures and the Treasury deficit rose from 10.7% of GDP in 1980 to 12.3Z in 1982. 11 11. The combined impact on the balance-of-payments of external shocks and expansionary fiscal policies was an overall I..&.iase in the current account deficit from $1.4 billion in 1980 to $1.9 billion in 1982 (or from 8% to 13% of GDP). While there were some positive factors on the export side, such as the continued growth of manufactured exports, the emergence of some non-traditional exports and renewed growth in the tourism sector after the adoption of a flexible exchange rate policy in late 1980, these were more than offset by the fall in phosphate earnings and workers' remittances and the continued growth of petroleum and capital goods imports. 12. To finance its current account deficit and meet its debt amortization payments, Morocco continued to rely heavily on external borrowing. By December 1983, total external debt, including military and short-term commercial debt but excluding IMF obligations, reached an estimated t12 billion. As a result of growing debt and the rise in international interest rates, Kwrocco's debt service (excluding IMF debt service) averaged $1.2 to 1.3 billion in 1980-82. The debt service ratio in 1982 rose to 35Z of exports of goods and services. Loan commitments in 1980-82 averaged $2 billion a year of which $0.9 billion from multilateral and bilateral sources (not including grants). The 1983 Adjustment Program 13. In early 1933, the financial situation deteriorated rapidly and net foreign assets declined sharply, prompting the Government to tighten import restrictions in March. With freely usable reserves virtually depleted, and the high level of external debt entailing an unsustainable debt service burden for the next few years, the Government became aware of the need to put together a package of policies, including stabilization and structural adjustment measures, which could warrant support from both the IMF and the Bank, and form the basis for a debt rescheduling operation. 1/ Excluding changes in floating debt to suppliers ("Fonds reserves").  - 4 - 14. A program prepared in mid-19d3 was supported by an IMF stand-by arrangement covering the second half of 1983 and calendar 1984 in an amount equivalent to SDR 300 million. Its principal objective war to reduce the current account balance-of-payments deficit from $1.9 billion in 1982 to $1.3 billion in 1983 and $1 billion in 1984 through limits on monetary expansion, reduction in the Treasury deficit and continued use of a flexible exchange rate policy. Subsidized food prices were increased by 17Z to 60X and increases were made in the prices of fertilizers, electricity, water and petroleum products, with the result that budgetary outlays on subsidies would be cut in half in 1983-84. Budgetary investment appropriations were also revised downward, substantially in line with the recommendations of the Bank report on Priorities for Public Sector Investment, so as to limit actual Treasury investment expenditures to DH 8 billion in 1983 (compared with DR 12.5 billion in 1982). The objective of the 1983 adjustment program was to reduce the overall Treasury deficit from DR 11.1 billion in 1982 to about DU 8.8 billion in 1983. 21 15. To reinforce the adjustment process, the flexible exchange rate policy initiated in 1980 was continued in 1983 with the dirham depreciated by 17Z in the 12 months since August 1983. In addition, a process of debt rescheduling was started in order to improve the debt profile and restructure it in the light of the estimated resources available for debt servicing. The Government asked for, and was granted by the Paris Club and the banks, a rescheduling of its ext3rnal public debt maturing in September 1983 - December 1984. In addition, at a meeting of donors in Paris in November 1983 additional balance-of-payments assistance of about $500 million was pledged for 1983-84 and it was a6reed that a Consultative Group for aid coordination would be convened a year hence. 16. Finally, along with its stabilization effort, Morocco is making a significant start on the structural reforms needed to restore a viable balance-of-payments position in the medium term, with a package of measures to restructure incentives in order tc eliminate the bias in favor of import substitution which has in recent years handicapped the growth of the export sector and hampered efficient use of resources. In January 1984, the Bank approved a $150 million Industrial and Trade Policy Adjustment Loan (ITPA) to support the first phase of this program, which included actions to reduce import protection and promote exports, in particular: a continuation of the exchange rate adjustment initiated under the IMF Stand-by, coupled with a reduction of the special import tax; reductions in import tariffs and an easing of quantitative import restrictions; broader access to dity-free inputs for exports and the rationalization of border-tax adjustmeate on external trade under the domestic sales tax; improved administrative procedures; the elimination of export licensing in agriculture and manufacturing; improvement of the export credit and export credit insurance systems; and a ii-nificant reduction in the scope of price controls on manufactured goods. Most of the 1I/ Excluding changes in floating debt to suppliers ("Fonds r4serv6s").  - 5 - measures under this program have now been implemented. The first tranche of the Bank loan (375 million) was drawn in June 1984, and the second tranche in October 1984. E. follow-up loan is under preparation. The second phase of the adjustment program, expected to be implemented in 1985, would continue the industrial and trade policy reforms initiated in 1984 and would extend the reform program to the financial sector. Future phases of the adjustment process could address further fiscal reform and initiate reforms in public enterprises, education and in agricultural policy. * 17. The information available for 1983 and early 1984 confirms that the Government's adjustment program has led to a considerable improvement in both the external and fiscal accounts. The current account deficit of the balance- of-payments was halved in 1983 to $872 million and the Treasury deficit was reduced by about one third, from DH 11 billion to DH 8 billion or 8.5Z of GDP!/. While the initial tightening of import restrictions and public investment cutbacks were the main factors behind the improvement in financial performance in 1983, the depreciation of the exchange rate and measures to encourage exports also appear to have had a positive impact on exports of both goods and services, and import restrictions have subsequently been substantially relaxed. Current estimates for 1984 anticipate strong growth of earnings from manufactured exports, tourism and workers' remittances, along with a good performance of agricultural exports and a recovery of phosphate exports. In the fiscal area, further progress is expected in reducing the deficit, to about 7% of GDP, mainly as a result of economy measures in the recurrent budget. Imports are also rebounding, as a result of the recent trade liberalization measures and the need to replenish stocks. However, their growth is expected to slow down in the latter part of the year, and the current account deficit for 1984 is expected to remain below 98O0 million, after allowing for the impact of the debt rescheduling on interest payments. As was to be expected, GDP growth slowed down to an estimated 2.2X in 1983, as a new drought hurt agriculture and the growth of the Government sector was constrained by lack of budgetary resources. Medium-Term Policies and Prospects 18. A Consultative Group meeting has been scheduled in Paris in January 1985. The Consultative Groul. will focus on Morocco's medium-term adjustment policies and prospects. A joint Bank-IMF economic updating mission visited Morocco in July to prepare a background paper which will present to the Group a unified assessment of Morocco's current adjustment program and medium-term outlook by the two institutions. The mission's preliminary conclusions are that medium-term prospects rema::n precarious. Both the current account deficit of the balance-of-payments and the fiscal deficit, at 6-7% of GDP, are still too large to be sustainable. A fundamental stabilization effort needs to be sustained over several years and combined with a strong program of structural adjustment. Such a program would have as its basic aims: 1/ Relief on interest payments on external debt is estimated at $230 million in 1983. The current account deficit of the balance of payments would have been $1,100 million without debt rescheduling and the Treasury deficit DH 8.6 billion or 9.1% of GDP.  (i) to reduce the deficit of the balance-of-payments over the short- and medium-term through continued trade policy reforms and appropriate development strategies in the productive sectors, particularly agriculture and industry, that would increase production and promote exports and efficient import substitution; (ii) to improve the allocation of capital and the efficiency of investment, both in the public sector (through appropriate changes in investment policies) and in the private sector (through reform of the protection system and of interest rate policies); (iii) to increase the level of public sector savings through reductions in the Treasury deficit and improvements in the efficiency of public enterprises; (iv) to improve the mobilization of private savings through a reform of the financial sector involving interest rate increases, diversifi- cation of financial instruments and greater competition in the banking sector; and 5v) to accelerate the rate of employment creation through better manpower planning and a revision of the protection and incentives system so as to encourage investment in labor intensive activities. 19. Medium-term projections for Morocco are currently being revised. Preliminary projections based on the policies outlined above bring out the dampening effect of stabilization on growth in the short-term and the importance of improving the efficiency of investment, domestic savings and export incentives for higher long-term growth. As efforts to promote exports and increase domestic savings can be expected to bear fruit only gradually in Morocco's circumstances, this will severely limit the level of investment that can be financed for the next several years, under the conditions of a constrained net amount of external financing available to Morocco, with a resulting deflationary impact on domestic demand. Implementation of the adjustment measures, including improved export incentives would, however, induce an expansion of exports and a gradual increase in output. 20. In the medium-term, structural improvements in the efficiency of resource use should induce an acceleration of economic growth, and GDP is projected to increase at 3.6% p.a. in 1985-90. This result would reflect a change in the sources of growth, with the manufacturing and phosphate sectors playing an important role in improving the balance-of-payments. As a result of improved export incentives and the revival of foreign markets, exports of manufactured products (including phosphate derivatives) would grow at 12% p.a. Exports of rock phosphates and phosphate derivatives would recover from their present low level and grow at about 9% p.a. in 1985-90. The overall growth rate of Morocco's exports of goods and nonfactor services in this scenario would accelerate to about 7% p.a. in constant prices in 1985-90. With respect to imports, the change in the structure of incentives in conjunction with the depreciation of the dirham would improve the efficiency  of import substitution and reduce the reliance on imported inputs. Overall, import growth of goods and nonfactor services in this scenario would be limited to 5X p.a. during 1985-90. 21. Given the strong constraints on the resources available, gross investment is projected to decline in the short-term from 23Z of GDP in 1980 to about 16% of GDP in 1986-90. It is assumed that the Government would start fewer large capital-intensive projects and restrict the allocation of investments to priority subsectors so as to improve the sectoral allocation and the efficiency of investment. Priority is to be given to projects that are export oriented, less capital intensive and which use a greater proportion of domestic resources. In addition, particular attention would have to be paid by the Government to manpower planning and to the employment effect of investments in order to prevent unemployment from rising to excessive levels. 22. An essential aim of the adjustment process would also be an increase in domestic savings. As a consequence of policies aiming at a reduction in the Treasury deficit and at an improvement in public enterprises efficiency, public savings are projected to increase significantly. In addition, improvements in the mobilization of private savings would also take place through interest rate increases and reform of the financial sector, so that the overall domestic savings rate in this scenario would rise from about 8% in 1981-82 to about 13% in 1990. 23. The acceleration of export growth relative to import growth in conjunction with an increase in the savings ratio relative to the investment ratio would be compatible with a stabilization of the current account deficit at a level of $700 to 800 million a year in 1985-90. In relation to GDP, the current account deficit in this scenario drops to about 3Z by 1990. This would be consistent, under the above assumptions, with a GDP growth accelerating from 2.6% in 1985 to 3.9Z in 1990. However, gross external borrowings in this scenario are projected to increase from t2.2 billion in 1985 to $2.8 billion in 1990 as repayments of debts rescheduled in 1983 or contracted in the early 1980's fall due. The debt service ratio in these projections would remain high (40-45%) in the next few years, starting to decline below 35% in 1990. PART II - OTHER BANK GROUP OPERATIONS IN MOROCCOY/ 24. Bank and IDA lending to Morocco has supported 65 projects, financing a total of $2,453 million (net of cancellations), of which $1,630 million has been lent since the beginning of FY78. IDA credits, totalling $51 million, have been made available for five projects and a Third Window loan for $25 millior has been made for an education project. IFC investments have amounted to $99.3 million ($54.6 million after cancellations, terminations, repayments and sales). Annex II contains a summary statement of Bank loans and IDA credits, and of IFC investments, as of June 30, 1984. 1/ Part II is essentially the same as Part IV in the Industrial and Trade Policy Adjustment Loan (Report No. P-3707-MOR of January 6, 1984).  25. Until recently, performance in project execution has been satisfactory overall, although in some cases management problems have caused delays in project implementation, and in others insufficient tariff adjustments have affected project entities' financial performance. However, during 1983, as budgetary constraints became more severe, projects relying on the Government budget for a substantial part of financing have been seriously 4 delayed because of inadequate budgetary allocations. The appreciation of the dollar via-h-vis the dirham in recent years has reduced considerably reimbursable expenses in dollar terms, thus lowering disbursements via-h-vis - appraisal estimates. The ratio of disbursements to appraisal estimates averaged 42Z over the year preceding March 31, 1984, low in comparison to other countries in the region. 26. The objectives of Bank Group activities in Morocco are to support (a) investments and policy reforms aimed at structural adjustment and strengthening the balance of payments; (b) measures to reduce the Treasury deficit; and (c) efforts to redress poverty and improve income distribution, particularly through lowering the unit costs for the delivery of basic services, in order to increase access by lower-income groups. Important structural reforms must be undertaken in the coming years, in order to return to a path of reasonable economic growth compatible with a sustainable external payments position. A major objective of Bank economic and sector work is to provide the analytical basis for the development of specific proposals for structural reform, which in several cases may later be supported by Bank lending. The Government has requested that, in addition to ongoing work on the public investment program, the Bank assist in developing reform proposals relating to the financial sector (for which a mission visited Morocco in September 1983), public enterprises (for whi-h a first economic mission was undertaken in spring 1984), and the education and agricultural sectors. Because severe budgetary constraints are likely to persist over the medium-term, projects now under preparation are being designed to minimize their reliance on budgetary funds. 27. Agriculture continues to represent the most important sector in Bank lending for Morocco. Past Bank lending has primarily supported rural development or irrigation projects focusing on particular geographical regions, as well as a highly successful agricultural credit program. In the future, increased attention will be given to agricultural support services at the national level, which are essential for backstopping regional development projects and would be more appropriate vehicles for addressing sectoral policy issues. Projects are under preparation in agricultural inputs distribution, research and extension services, cereals storage and marketing and irrigation management. In view of limited budgetary resources, special attention would be paid to maximizing non-budgetary financing and improving cost recovery. Sector work on agricultural incentives - fiscal, financial, pricing and institutional policies - is expected to provide recommendations on structural reforms which could lay the basis for an agriculture sector policy loan. 28. Energy and mining. The Government has given high priority to reducing the oil import bill, a major factor in the current account deficit, through development of domestic energy supplies. The Bank has supported this  - 9 - effort through loans for the exploration and appraisal of petroleum (primarily natural gas) and oil shale resources as vell as for power generation and traasmission. Future projects would assist in the development of domestic energy supplies, including gas, coal and hydropower. Through these projects as well as in our sectoral policy dialogue, efficiency in energy development and use would be prow ted through attention to pricing, cost recovery and management issues. A pilot project to support small-scale, export-oriented mining activities in a remote, low-income region vill be monitored with a view to its possible extension. 29. Bank lending for infrastructure and utilities has helped to build a number of technically competeat agencies in the fields of road transportation, electricity, water supply, housing finance, and commmuity infrastructure finance, as well as to expand the provision of essential services. Future projects will place greater emphasis on improving the productivity and efficiency of existing infrastructure through improved financial and management performance. Mobilization of private and non-budgetary financing as well as improved cost recovery in these subsectors through tariffs should help reduce the Treasury deficit. In addition to continuing support for the above-mentioned subsectors, projects are under preparation for ports, sewerage and telecommunications. 30. Industrial development in Morocco has been supported primarily through strengthening the financial and institutional resources of the Banque Nationale de Developpement Economique (BNDE), the major source of industrial medium-term credit. In addition, policy changes were introduced to widen access to credit by small-scale labor-intensive industries. Other projects focused on phosphate processing and cement production. The Bank's efforts are now fc-used on the development and implementation of medium-term policy reforms aimed at encouraging exports and improving incentives to domestic production_ The first phase of such reforms is supported by the recently approved Industrial and Trade Policy Adjustment (ITPA) loan. and further sectoral adjustment lending is likely in industry to support subsequent phases of the medium-term ITPA program adopted by the Government. 31. Education, health and urban development projects will increasingly concentrate on lowering unit costs in order to widen the access by low-income groups. Policy dialogue in these sectors continues to encourage the shift away from capital-intensive investments benefitting limited clientele and the development of more cost-effective delivery systems for basic services. While previous Bank-financed projects have supported technical education, rural primary education and improved teacher training, these should be complemented by efforts to expand basic education and skill training, as well as restructuring of the formal education system, which has represented a major drain on the recurrent budget. The proposed Vocational Training project represents the first step in this direction. A project to test new health care delivery systems in order to improve basic health services in rural areas is under preparation. Finally, the experience of projects in urban upgrading will be continued and expanded, with increased efforts to mobilize private financing in order to reduce budgetary costs.  - 10 - PART III - SECTORAL BACKGROUND The Manufacturing Sector 32. The share of manufacturing in GDP has remained at about 17 percent since 1975. The sector accounts for about 8 percent of total employment, with about half the jobs in the modern sector, and half in small-scale and artisanal industry- The growth of manufacturing slowed from 7 percent annually in real terms in the Third Plan (1973-77) to 1.6 percent per annum in 1978-82, as a result of increasing financial constraints on the economy and the limitations on dynamism of an industrial development strategy based on import substitution. Since 1983 the Government has implemented a program of industrial and trade policy adjustment focussing on restoring dynamism to industrial growth, reducing manufacturing costs, and promoting exports (see paragraph 35 below). Preliminary results for 1983 indicate the resumption of a more vigorous growth of manufacturing, of over 4 percent per annum in real terms. 33. Prior to the Government's recent shift in policy as demonstrated by the adjustment program, the manufacturing sector was oriented tovard the production of consumer goods for the domestic market; import substitution and large public investments in capital intensive projects were major features in Morocco's industrial development, and the incentive system provided little encourageaent for labor-intensive processes. Manufactured exports generally stagnated in the 1970s, when manufactured imports exceeded exports by a wide margin. However, manufactured exports have increased substantially in recent years (24 percent annually in volume from 1979 to 1982). This trend was maintained through 1983, and into the first half of 1984. The share of manufacturing in total exports increased from 25 percent in the mid-1970's to 45 percent in 1982. The principal and fastest growing exports have been phosphate based products, textiles, carpezs, and leather goods. 34. The current (1981-85) Plan emphasizes export promotion, employment creation through encouragement of small-scale industries, and promotion of efficient import-substitution industries for capital and intermediate goods. Howe7er, investment levels have been much lower than projected in the Plan, as a result of macro-economic constraints, both for industry (DR 2.1 billion or $344 million annually during 1981-83) and the economy as a whole. With a continuing decline in the magnitude of public investment in manufacturing, the private sector's share of approved industrial investments has increased steadily. Excluding small scale industries, approved investments in manufacturing are expected to average DR 1.7 billion (0200 million) annually in 1985-87, of which DR 320 million ($38.5 million) would be in electrical and mechanical engineering industries (EMIs).  - 11 - 35. Sector Constraints and Adjustment Program. The critical constraints to the growth of manufacturing, and particularly export production, have been in the areas of protection policy, industrial incentives, and administrative barriers. As a result of these deficiencies, a bias against export production evolved, and there was a tendency to establish uncompetitive and inefficient enterprises in industries producing consumer goods and durables for a limited and protected local market. Following a detailed Bank-supported study of effective protection and industrial incentives (see Report No. 4893-MDR,