Report No. 6714MOR Morocco: The Impact of Liberalization on Trade and Industrial Adjustment (In Three Volumes) Volume Il: Main Report March 15, 1988 Europe, Middle East & North Africa Country Department l! Country Operatiions Division FOR OFFICIAL USE ONLY .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Dmvamd of the %*rld Unk0- 4, ,~~~~~~~~~~~~~~~~4 O ..~ ~ ~~~~~~~~~~. .})~~~~~~~~~~~~~a '0 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. 0 * 4 )- 0 TNs repot hasa rstricte ditrbtio anea eueyrcpet .~~~~~~~~~ , Do~ien oo th Wol BnO only in the performance of their official duties. Its con'tents may not otherwise' be disclosed without World sahk cluthorization. 4,~~~~~~~~~~~~~~~~ 0 O~~~~~~~~~~~~~~~~~~~ 1 KINGDOM OF MOROCCO CURRENCY EQUIVALENT Currency Unit: Dirham (DH) Official Exchange Rate: Dfrham (DH) per US Dollar 1975 4.053 1981 5.172 1976 4.419 1982 6.023 1977 4.503 1983 7.111 1978 4.167 1984 8.811 1979 3.899 1985 10.062 1980 3.937 1986 9.104 1987 8.359 FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS BNDE = Banque Nationale pour le D6veloppement Economique (National Bank for Economic Development) BTN 2 Brussels Tariff Nomenclature CAP 2 Common Agricultural Policy CCCN Customs Cooperation Council Nomenclature CGE Computable General Equilibrium Model CIH = Cr6dit Industriel et H6telier (Housing Finance) DRC = Domestic Resource Cost GATT = General Agreement on Tariffs and Trade IBP = Corporate Income Tax IHS = International Harmonized System ITPA = Industrial and Trade Policy Adjustment Loan MC = Domestic Market Regime MCIT Ministere du Commerce, de l'Industrie et du Tourisme (Ministry of Commerce, Industry and Trade) MFA = Multifiber Arrangement MFN = Most-Favored Nation NTB = Non-Tariff Barrier ONT = Office National du Transport PERL 2 Public Enterprise Rationalization Loan PMIs Petites et Moyennes Entreprises (Small- and Medium-Scale Firms) QR Quantitative Restriction SAL 2 Structural Adjustment Loan SIT Special Import Tax TA = Temporary Admission Regime TFP - Total Factor Productivity TPS = Taxe sur les Produits et les Services (Turnover Tax) VAT = Value-Added Tax VER = Voluntary Export Restraint FOR OMCLIL USE ONLY TABLE OF CONTENTS Page No. L DNl1ODUCTION ....................................... I IL STABILIZATION, ADJUSTMENT, AND THE MACRO-ECONOMY 4 A. Macro-economic Developments since the Financial Crisis of 1983 .............................. 4 B. The Interaction of Stabilization and Adjustmeiit ........ 8 Budgetary Impact on Savings and Investment Behavior .. 9 Internal Consistency of Macro Policies ... ........... 12 Budgetary Effects of Structural Measures ............ 15 C. The Social Impact of Adjustment ......, ................ 18 IlL THE EVOLUTION OF TRADE POUCY REFORM IN MOROCCO . 21 A. The Political Economy of Trade Reform in Morocco ...... 21 B. Changes in the Instruments of Trade Poliny ............ 22 Import Policies ..... ......... ....................... 23 Export Policies ..................................... 25 Accession to the GATT ....... ........................ 26 C. The Impact of Trade Policy Reform on the Structure of Incentives ............................. 28 IV. THE IMPACT OF LBERALIZATION ON EXTERNAL TRADE PERFORMIANCE ......................... 36 A. Export Performance Under Liberalization ............... 37 Export Diversification ......... ................... . 37 Exchange Rate Policy and Export Response ............ 39 Market Penetration of Moroccan Exports .............. 39 B. Import Performance Under Liberalization ............... 41 Global Import Trends ........ ....... ................. 41 Policy Change and Import Behavior ................... 43 Import Performance by Economic Regime ............0... 45 C. Direction of Trade .................................... 45 The Structure of Morocco's External Markets ......... 45 Effects of Foreign Trade Practices on Moroccan Market Access ..... .................... .... 46 Market Diversification: A Strategic Issue for the Future ................................. 48 This document has a resticted distdbution and may be used by recipients only in the prfomo of thir official duties. Its contents may not otherwise be discled without World Bank auhodzation. - ii - Page No. V. THE DIPACT OF INDUSTRIAL AND TRADE POLICIES ON THE STRUCTEURE AND PERFORMANCE OF INDUSTRY ............. 50 A. Structural Characteristics of the Industrial Sector ... 51 The Evolution of Moroccan Manufacturing ............. 51 Outward-Orientation and Patterns of Sectoral Growth . 51 Industrial Concentration ............................ 55 B. Industrial Promotion Policies and Sectoral Constraints 57 The Structure of Fiscal and Financial Incentives .... 57 The Regulatory Environment ....... ................... 58 Labor Mobility ...................................... 60 e,onstraints to Industrial Performance . ..a....................... 60 C. Productivity and Sources of Industrial Growth: The Micro-economic Effects of Adjustment .............. 62 International Comparisons of Productivity Growth .... 62 Components of Productivity Growth ................... 64 The Impact of Stabilization on Industrial Productivity 68 International Competitiveness in a Dynamic Context .. 69 VIL A FRAMEWORK FOR FURTHERING TRADE AND IIND)USTrUIAL POIICY REFORMf .............................. 73 A. Conclusions ..... . .......... ................. . ........ 73 B. Issues for Future Policy Reform ....................... 75 C. Recommendations ....... ................... ............. 77 D. Policy Simulations ...... .............................. 79 - 1 - L INTRODUCTION 1.01 The events leading up to the balance-of-payments crisis of 1983 have been well documented in a number of World Bank reportsX' and will be only sunu_rized by way of introduction. In the early 1970s, Morocco's terms of trade benefited from a sharp increase in the price of phosphates, the country's primary export, which more than compensated for the first oil shock. At this time, the Government adopted a strategy of accelerated growth through high levels of public investment spending in a protected domestic market. The phosphate boom was short-lived, however, and the Government sought to supplement dwindling foreign exchange earnings through increased recourse to external borrowings on highly attractive terms-'. Despite a 7.6X average rate of GDP growth p.a. in 1974-79, the inability to control public expenditure (partly a result of the increasing defense efforts in the Western Sahara) and diversify exports left the economy highly vulnerable to the second oil shock in 1979-80. 1.02 Sporadic attempts to stabilize the economy beginning in 1978 met with limited success, and the Government embarked upon a second round of expansionary public investment in 1981. Rather than adjust to the changing external environment, the abundance of foreign financing opportunities with little loan conditionality prompted Morocco to borrow more, thereby aggravating the country's indebtedness. At the same time, Morocco's ability to service its massive debt was becoming increasingly impaired. International interest rates began their unanticipated rise, while a combination of inexpedient public investments and unfavorable external factors, viz. a severe drought in 1980-84 which reduced agricultural and hydroelectric production, led to a marked deterioration in the productivity of investment. The ICOR increased from 3.9 in 1975 to 7.4 in 1983. 1.03 By 1982, the budget deficit had grown to 12.3% of GDP and the current account deficit had reached 13.32 of GDP. The stock of total foreign debt outstanding had risen from US$1.8 billion in 1975 (09.6% of GDP) to US$11.2 billion in 1983 (84.22 of GDP and 2902 of exports). The structure of Moroccan debt had changed, moreover, with 40S of outstanding liabilities owed to commercial banks compared to nil a decade earlier and over 60% at non-concessional rates. In mid-1983, the economic situation had become unsustainable. Foreign exchange reserves virtually disappeared prompting the Government to impose emergency import restrictions and to effect draconian cutbacks in public expenditures. Official and commercial creditors acceded to the request by Morocco for debt rescheduling. Concomitantly, a new Government, appointed to confront the economic crisis, sought the assistancei of the IMF and World Bank to design a program with dual objectives: (i) to stabilize the economy in the short-term by reducing aggregate demand and the size of the Government budget deficit; and (ii) to transform the economy into V/ See Morocco: Medium-Term Adjustment Policies and Prospects, World Bank Report 5785-MOR, August 1985 Morocco: A Framework for Medium-Term Adjustment, World Bank Mimeo, March 1986 Morocco: Issues for a Medium-Term Structural Adjustment Program, World Bank report 6608-MOR, January 1987. 2/ Interest rates on Moroccan debt were negative in real terms, averaging -13.31 during the period 1973-80. -2- an efficient producer of goods and services in the medium-term by reforming the underlying structure of key economic and social sectors. 1.04 In order to attain these objectives, the Government launched a program of stabilization and structural adjustment supported by a series of standby arrangements and sectoral adjustment loans. Restrictive fiscal and monetary policies were employed to provide for an orderly elimination of the imbalance between aggregate domestic demand and resource availability. At the same time, structural reforms were initiated in the trade and industrial sector to promote increases in productivity and export potential by improving the allocative efficiency of resource use and attenuating the existing bias against exports. The Bank supported these objectives with two consecutive Industrial and Trade Policy Adjustment (ITPA) loans, which included measures to reduce barriers to external and internal trade, liberalize the financial sector, and. streamline administrative procedures. It was recognised from the outset that the appropriate mix of stabilization and adjustment policy instruments was critical to enable the country to service its massive debt while maintaining a socially acceptable rate of economic growth. 1.05 Following the release of the second and final tranche of ITPA II, a Bank economic mission visited Morocco in December 1986 to study the impact of the liberalization program on trade and industrial development and to update the stock of knowledge-' in order to confirm preliminary results and to Justify further efforts in this area. The mission attempted to evaluate the extent of liberalization which has taken place to date and assess the capacity for future industrial adjustment. In this vein, an industrial survey of forty firms was carried out to elicit the reactions of industrialists to the program and provide a framework in which to interpret analytical findings. The interaction between stabilization and adjustment was evaluated, as was the compatibility of expected macro-economic developments with further liberalization efforts. The effects of changes in trade and industrial policy instruments on the structure of incentives were analyzed. The reaction of the economy to a more efficient trade and industrial regime as manifest in the behavior of the external sector and changes in the international competitiveness of Moroccan industry was examined. Finally, in preparation of a proposed structural adjustment loan (SAL), a set of policy measures for future reform was evolved and its impact on the economy assessed. 1.06 The report is organized as follows. Chapter II analyzes the effects of stabilization and adjustment on the evolution of the macro-economy. The discussion focuses on the budget deficit and associated strategies of financing. It is demonstrated that the increased recourse of the Treasury to domestic savings in order to finance unsustainably large budget deficits has led to rising real interest rates; this has served, in turn, to discourage domestic investment and dampen industrial adjustment at the sertoral level. 1.07 Chapter III reviews progress achieved in implementing trade policy reforms and evaluates the resultant structure of incentives. It is argued that although the economy has been increasingly exposed to international 1/ The last industrial sector report is based on information collected from 1978 to 1982. -3- market forces, further efforts in this direction are necessary. Political economy aspects of trade liberalizati'a are first developed, followed by an analysis of import and export policies. The chapter concludes by assessing the implications of Morocco's accession to the GATT on future trade relations. 1.08 Chapter IV examines the impact of liberalization on external trade performance. The response of exports and imports to variations in trade policy, the exchange rate, and external factors is analyzed at both a general and disaggregate level. It is shown that exports have reacted positively to relative price movements and changes in the structure of incentives. This has led to a significant shift in the composition of exports toward non-traditional products. Morocco has maintained its share in traditional markets principally because of an active exchange rate policy and bilateral agreements with the EEC which secure market access. It is concluded that the preferential arrangements from which Moroccan exports benefit may be eroded in the future as a result of quota limits and the upcoming Uruguay round of multilateral trade negotiations. Consequently, Moroccan efforts to diversify products and markets should be encouraged through further trade policy reform. 1.09 Chapter V traces the evolution of the industrial structure and assesses the potential for structural adjustment. Recent changes in industrial policies were shown to affect relative factor use in line with Morocco's natural comparative advantage. Certain features of the regulatory environment were identified as potential obstacles hindering industrial adjustment. Detailed analysis at the subsector level indicates improvements in the productivity of capital and labor; however, the effects of macro-economic imbalances which are presently being felt at the firm level have attenuated the degree of efficiency gains. From an international comparative framework, it is concluded that further adjustment of industry is necessary. The scope of adjustment, however, will be conditioned by the extent and pace of stabilization. 1.10 Chapter VI presents the general conclusions of the report. The outstanding issues for continued liberalization of the trade and industrial sectors are identified and recommendations for future policy reform adduced. The chapter concludes with a simulation of the effects of policy measures on the budget and 4alance of payments. The link between liberalization and macro-economic policy is established analytically, leading to the judgment that a strengthening of stabilization efforts is a sine qua non of further adjustment in the areas of trade and industrial policy. -4- IL STABILIZATION. ADJUSTMENT. AND THE MACRO-ECONOMY 2.01 The purpose of this chapter is to analyze macro-economic developments which have taken place since 1983 as they relate to stabilization and liberalization objectives. In particular, the impact of the budget deficit and the associated financing strategy on broad macro-economic aggregates such as savings and investment will be assessed, as will the effect of trade policy measures on the budget. In this context, an attempt will be made to reconcile the sustainability of the budget deficit with the structural transformation of the economy. The chapter concludes with an evaluation of the costs of adjustment in terms of employment and income. A. Macro-eeonomic Developments since the Financha Criss of 1983 2.02 Stabilization in Morocco during the period 1983-87 took the form of a package of expenditure-reducing measures to decrease Government absorption. On the other hand, adjustment was induced through expenditure-switching policies which sought to promote the tradables sector. The macro-economic program concluded with the IMF emphasized contractionary fiscal and monetary measures, rather than the restrictive trade policies of the past as the means to alleviate the acute foreign exchange shortages which beset Morocco at the time. This approach implicitly recognized the importance of an appropriate macro-economic environment in which liberalization could take place. As the experience of the Southern cone countries demonstrates1', inconsistent macro-policies could serve to undermine the liberalization program, provoke a financial crisis, and erode credibility for future reforms. 2.03 With the onset of stabilization, the overall budget deficit fell from 12.22 in 1983 to 6.02 in 1987 on a commitment (accruals) basis. The favorable trend which has characterized the evolution of the budget deficit since 1983 nevertheless belies a number of structural weaknesses. Tax pressure from traditional sources of revenue has declined nearly two percentage points from 19.1S of GDP in 1983 to 17.42 of GDP in 1987. The increase in total revenues in 1986/87 was principally due to the excise tax levied on petroleum, which kept the price facing domestic consumers at US$28/bbl equivalent. Proceeds from this source alone represented nearly 152 of total fiscal receipts. Notwithstanding a fall in international interest rates and a reduction in outlays on consumption subsidies which served to contain the growth of current expenditures, most of the fiscal adjustment was due to a substantial decline in the public investment budget from DR 9.3 billion in 1983 to DH 5.6 billion in 1986. This resulted from a notable lack of progress in mobilizing public savings: the current budget deficit on a commitment basis fell only from 2.42 to 2.1% of GDP from 1983 to 1986'*. During this period, there have also been wide discrepancies between budgetary commitments and cash payments 1/ See especially "Liberalization with Stabilization in the Southern Cone of Latin America", World Development, August 1985. 2/ This trend has been reversed somewhat in 1987 with public investment expenditures rising by DR 9.6 billion and the current budget registering an estimated 0.71 surplus with respect to GDP. leading to a substantial buildup of domestic payment arrears. At end-1987, the outstanding stock of arrears owed by the Treasury totaled DR 10.5 billion or 7.71 of GDP, indicating that the Government has continued to consume beyond its means over the period in question. 2.04 The exchange rate was a major policy instrument used to forestall a deterioration of the balance-of-payments position with the onset of liberalization. By dismantling quantitative restrictions on imports and reducing tariff barriers to external trade, Moroccan policy makers sought to attenuate the bias against exports inherent in the existing system of incentives and induce structural adjustment at the sectoral level. In order that liberalization of the external regime not stoke balance-of-payments pressures, a depreciation of the real exchange rate was critical. In Morocco, bilateral real exchange rates have fluctuated significantly despite the relatively frequent adjustments of nominal rates. In addition, the real exchange rate has tended to appreciate in periods of relatively high protection as was the case in the late 1970a (Table A.II.1). Since September 1983, however, the Moroccan government has pursued an active exchange rate policy which has served both to restrain domestic demand and support trade liberalization measures (Table 2.1). The real effective exchange rate on a trade-weighted basis has depreciated by 26.01 since end-1982. This reflects a downward crawl vis-a-vis a basket of international currencies attendant on a number of discrete devaluations which has more than offset inflation Table 2.1: REAL EXCHANGE RATE INDICES A& (1980 = 100) OF THE DIRHAM AGAINST THE CURRENCIES OF MOROCCO'S MAJOR TRADING PARTNERS, 1980-1986 Nominal French Saudi Spanish German Italian U.S. Real Year Effective Franc Riyad Peseta Mark Lira Dollar Effective Rate Rate Rate k 1980 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1981 93.7 97.1 112.9 100.3 96.9 98.2 122.0 92.3 1982 92.5 92.9 115.1 98.3 99.3 97.6 129.3 90.3 1983 89.6 95.8 124.9 94.6 105.3 105.0 144.0 84.3 1984 82.8 99.2 131.9 103.3 106.0 109.1 160.7 79.5 1985 78.4 105.5 129.3 109.9 109.2 112.4 166.7 74.2 1986 72.6 70.9 1987 72.7 69.2 a/ A decrease indicates a depreciation for effective exchange rates whereas an increase indicates a depreciation for bilateral exchange rates. b/ Basket with multilateral trade weights based on the geographical pattern of trade including third market effects. Source: Mission estimates based on IMF statistics -6- differentials between Morocco and its principal trading partners. To the extent that exchange rate depreciation has been used to offset reductions in quantitative restrictions and tariffs, and in particular, the special import tax (Annex IV), inflationary pressures linked to devaluation have been kept to a minimmv' 2.05 The sustained real depreciation of the exchange rate and contractionary macro policies resulted in a gradual improvement of the trade balance (Fig. 2.1). Certain categories of price-elastic exportables registered strong growth1', which served to offset the decline in demand for phosphate rock and derivatives, Morocco's principal export. Import demand was contained during this period by four factors. First, the depreciation of the exchange rate limited imports of consumption goods recently subject to liberalization to sustainable levels. Second, the higher cost of capital which resulted from reforms undertaken as part of the liberalization program (para. 5.14) served to dampen investment demand. Third, increased domestic agricultural production led to a major decline in the volume of grain imports. Fourth, the sharp decline in international petroleum prices reduced the value of oil imports by 452 in 1986. Abetted by a favorable external environment, the program of stabilization with adjustment thus led to a narrowing of the resource gap by increasing the share of external trade in overall economic activity rather than by solely compressing imports. 2.06 The downward movement of the exchange rate had salutary effects on the balance of services as well. Net tourism proceeds, in particular, reacted strongly, increasing by 322 p.a. in dollar terms since 1984. Continued growth of worker remittances and the decline in net investment income payments abroad, in line with the easing of international interest rates, contributed further to this trend. As a result, the evolution of the current account deficit was even more favorable than that of the trade balance and fell from US$2.0 billion (13.3Z of GDP) in 1982 to an estimated US$222 million (1.62 of GDP) in 1987 before debt relief. 2.07 Despite this impressive progress, the current account deficit has not been narrowed as rapidly as would have been required by the evolution of the capital account. Structural weaknesses of the capital account linked to low autonomous loan disbursements and high amortization payments (before debt relief) have given rise to financing gaps over the past few years. These gaps have been financed, in turn, by the virtual depletion of foreign exchange reserves and the buildup of external trade arrears. At various times in the past, the level of reserves was equivalent to only two days worth of imports and the outstanding stock of external arrears reached US$540 million. In consequence, Morocco is presently experiencing an acute shortage of foreign exchange which has had serious repercussions on the adjustment process. For example, importers have experienced delays of up to 120 days in obtaining foreign exchange, which has raised intermediation costs, increased the level of uncertainty in the tradables sector, and made foreign suppliers more reluctant to extend trade credits to Morocco- . The disequilibrium in the 1/ The rate of inflation as measured by the consumer price index declined from 12.5Z in 1983 to 2.42 in 1987. 2/ The magnitude of these relative price effects are analyzed in Chapter IV. 3/ The impact of this liquidity constraint on industrial activity is analyzed in greater detail in Chapter V. EXTERNAL ACCOUNTS AND EXCHANGE RATE MOVEMENTS 1 0.8 A 0.6 0.4 iF 0.2 00 -0.2 -0.4 -0.6 ID ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~CD 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~t -1.44w -1.6 -1 .8 -2--- 1980 1981 1982 1983 1984 1985 1986 1987 O Trade 8al + Cur Acet O Real Exch Rate -8- foreign exchange market could well reflect the failure to adjust the exchange rate in order to compensate for the reduction in import barriers which occurred in early 1986^'. B. The Interaction of Stabilzation and Ad3ustment 2.08 It is useful at this juncture to segregate the relative macro-economic effects of the stabilization-cum-liberalization policies which have been pursued since 1983. While reductions in the Government budget deficit are unambigously contractionary, exchange rate devaluation, in theory, can induce either economic expansion or recession depending on a number of factors (e.g. levels of capacity utilization, elasticities of tradables, rigidities in factor mobility). The use of a computable general equilibrium (CGE) model to simulate alternative policy scenarios can provide insight in this area. 2.09 In the case of Morocco, devaluation alone can be shown to improve the balance of payments and raise GDP growth as well1'. On the other hand, a reduction in public expenditures and/or an increase in taxation inevitably results in a significant slowdown in economic activity1'. In effect, the deflationary impact of demand management policies pursued since 1983 appears to have been cushioned by the downward movement of the exchange rate. By attracting resources to the tradables sector, devaluation has stimulated both efficient import substitution and export growth, and has thereby contributed to the favorable evolution of the balance of payments. This, in turn, has mitigated the fall in aggregate demand and income that would have ordinarily obtained from traditional stabilization policies alone4'. 2.10 The results of two alternative policy simulations support these conclusions. In the case of a pure stabilization package comprised of a 101 increase in import taxes, a 52 reduction in Government consumption, and a 202 cut in public investment, GDP decreases by 1.52 with imports and exports falling by 4.52 and 0.32 respectively. The budget and balance of payments improve by DE 2.2 billion and DH 1.7 billion respectively with employment falling by 3.6% in the formal sector. The impact of an outward-oriented, stabilization-cum-adjustment policy package was subsequently evaluated. As a result of a 51 reduction in Government consumption, a 10% cut in public investment, and a 10% devaluation, GDP decreases only by 1.2% and employment by 2.41. Imports are reduced by less than in the absence of devaluation, 1/ The modest decline in the real effective exchange rate in 1986/87 was insufficient to offset the implicit appreciation resulting from the reduction of the maximum nominal tariff rate from 60% to 451 and the elimination of quantitative restrictions on certain consumption goods with a relatively high level of notional demand. 2/ A 10% devaluation without any nominal wage adjustment reduces the current account deficit by about US$200 million or 221 of the 1985 level and raises GDP by 1.31. 3/ A reduction in Government expenditure of 101 leads to a fall in GD? of 4.11, whereas an increase in commodity taxation of 101 results in a 2.31 decline in GDP. 4/ The economy has grown at an average annual rate of 4.1% since 1983. - 9 - whereas exports grow at 5S compared to a 0.3% decline in the previous scenario. As a result, the DR 2.5 billion improvement in the balance of payments is substantially greater, as is the DR 2.9 billion reduction in the budget deficit. 2.11 In order to isolate the relative effects of stabilization and structural adjustment policies on the performance of the Moroccan economy since 1983, a macro-econometric model was employed. The simulations show that most of the improvement on the current account over the past three years can be attributed primarily to a reduction in domestic absorption and to a number of favorable exogenous factors. Of the US$1.1 billion decline in the current account deficit, US$630 million derives from the reduction in domestic absorption, linked in large part to the narrowing of the Government budget deficit, devaluation, and the increase in interest rates; US$310 million results from a combination of the positive shock to agricultural production (para. 2.05) and the improvement in the terms of trade, the drop in oil prices more than compensating for the decline in phosphate demand; and US$160 million can be attributed to the supply-side response of the economy to the more rational structure of incentives. The limited effect of the liberalization program on the balance-of-payment adjustment is not surprising in view of the relatively limited share of non-traditional manufactures in total exports which prevailed at the onset of the program, as well as the lags associated with supply-oriented reforms. In the medium-term, it is expected that the relative impact of structural policies on the current account would increase, thereby reducing the degree of required disabsorption. 2.12 Budsetary impact on Savings and Investment Behavior. The medium-term development strategy of Morocco is predicated on the appropriate use of trade and industrial policy to enhance international competitiveness and expand the production of tradable goods. An increase in aggregate domestic supply is likely to entail an initial rise in the level of domestic investment as well as major shifts in resource allocation. An important cnponent of structural adjustment in Morocco is the substitution of the dynamic private sector for the State in commercially-oriented economic activity. An analysis of the relationship of the budget deficit to savings and investment behavior indicates that slippages on the stabilization front are beginning to constrain the potential for future adjustment. 2.13 The macro-economic environment in Morocco has been characterized in general by an expansionary fiscal policy combined with relatively contractionary monetary policy. Prior to 1983, foreign borrowings financed nearly 60% of the Treasury deficit. When Morocco's access to external funding was abruptly reduced in 1983, Central Bank borrowings rose on an exceptional basis as shown in Table 2.2. Insofar as the monetary authorities have been firmly committed to eschew sustained inflationary financing, there has been a concerted effort to mobilize additional domestic savings for the Treasury. As part of a broader financial sector reform supported by the second ITPA loan, measures have been taken to deepen the money and capital markets/'. 1/ See Morocco: Second Industrial and Trade Policy Adjustment Loan, World Bank, Report P-4075-MOR, May 6, 1985. - 10 - Table 2.2: SOURCES OF TREASURY FINANCING (In Millions of Dirhams) 1981 1982 1983 1984 1985 1986 1987s' Treasury Deficit1' 11148 11322 10643 10623 11346 6819 6198 Source of Funds Foreign Borrowingko 6761 6503 4466 5071 3772 -225 155 Borrowing from Central Bank 1332 1182 3382 1325 917 952 n.a. Borrowing from Domestic Banks 2510 839 2962 841 3573 3683 22251' Other Domestic Sources&' 176 37 -539 -28 1731 2953 5001 Net Flow of Arrears 369 2761 372 3414 1353 -544 -1183 a/ Commitment basis after debt relief. b/ Net of debt relief on interest payments. c/ The figures for 1985-86 reflect the recent issue of Treasury bonds to the uon-financial private sector (para. 2.14). d/ Provisional. e/ Including borrowings from Central Bank. Source: Ministry of Finance and Mission Estimates. 2.14 This strategy has yielded some short-term benefits. The steady increase in both nominal and real deposit rates (Table 2.3) has been associated with a major shift in portfolio composition away from currency holdings toward bank deposits and especially time deposits, as witnessed by the stronger growth of Mz (541) relative to Mi (33S) since 1984. The ceiling on credit to the economy has ensured that a significant proportion of the increased financial resources of commercial banks would be channeled to the Treasury. The recent issues of high interest-bearing, tax-exempt Treasury bonds to the non-financial private sector have further contributed to financing the deficit. These factors have thus contributed to the reduction in the share of Central Bank finincing from 31.8X in 1983 to an average of around 101 in 1985-86, as well as the decline in the rate of inflation from 12.51 in 1983 to 2.41 in 1987. Table 2.3: THE EVOLUTION OF INTEREST RATES IN MOROCCO (percentages) Nominal Rates Inflation Rate1' Real Rates Year Borrowing&' Lending'' Borrowingi Lending' 1974 3.0 6.5 14.4 -11.4 -7.9 1976 3.5 8.0 13.4 -9.9 -5.4 1981 6.0 10.0 13.2 -7.2 -3.2 1983 6.5 12.0 12.5 -6.0 0.5 1985 10.5 14.0 10.0 0.5 4.0 1986 10.5 14.0 4.4 6.1 9.6 1987 10.5 14.0 2.4 8.1 11.6 a/ Rate paid on six-month time deposits at year end. b/ Rate paid on medium-term rediscountable loans at year end. c/ Annual percent changes in the consumer price index from December to December. Source: Bank of Morocco and Mission Estimates. - 11 - 2.15 Despite the positive results achieved to date, further analysis reveals that the present financing strategy entails significant medium-term costs which run counter to the objectives of structural change and may be unsustainable in the future. Despite considerable success in mobilizing additional savings, borrowings from traditional domestic sources were still insufficient to finance the budget deficit. As a result, the Treasury resorted to forced savings from domestic private suppliers and public enterprises in the form of payment arrears, which have financed up to 322 of the budget deficit since 1983. There is also an increasing danger of crowding-out, as shown by the recent evolution of monetary indicators. Between 1980 and 1985, total domestic credit to the Government from the consolidated banking sector increased at an average annual rate of 14.82, whereas M2 grew only by a yearly rate of 8.91 over the same period. As a result, the share of total domestic bank credit to the Government in the money supply rose from 62.61 in 1980 to 81.8% in 1985. Interest rates1' have risen by approximately 19.5 percentage points since the mid-1970's in order to mobilize the private resources necessary to compensate for the comparative lack of foreign and public savings-'. 2.16 The rise in interest rates attendant on the elimination of accelerated depreciation allowances for fiscal purposes in the context of the 1983 investment code (para. 5.14) resulted in a significant increase in the cost of capital-' as shown in Table 2.4. In relation to both the industrial wage and manufacturing value-added, the co8t of capital has exhibited a clear upward trend. This suggests that investment demand was negatively affected by the increase in the cost of capital as a result of both the substitution effect (by making capital more costly with respect to labor) and the output effect (by raising the real cost of capital). An analysis of gross fixed capital formation in the industrial sector shows that after reaching a peak in 1982, real investment expenditure in manufacturing has subsequently declined (Table 2.4). To this effect, medium-term rediscountable and BNDE1' loans, the two main lending instruments for industrial investment, registered a decline in their share of total credit from 37.4% in 1982 to 35.5% in 1985 (Table A.II.3). 1/ Although not excessively high (101 in real terms) compared to some other developing countries, real interest rates, if they continue to rise, could lead to a situation whereby the successive rise in rates, interest payments, and the outstanding stock of public debt eventually culminates in an explosion of the budget deficit. In 1986, for example, the ratio of interest payments on outstanding Government debt to the overall budget deficit was 1.07 before debt relief. 2/ Although the average saving propensity of the Moroccan private sector has increased in line with real interest rates (Table A.II.2), no causal link could be established econometrically. In the Moroccan context, the rise in real interest rates is likely to have affected investment. 3/ The methodology used to calculate the cost of capital in Morocco is presented in Annex I. 4/ Banque Nationale pour le D6veloppement Economique, the national development bank. - 12 - Table 2.4: MANUFACTURING INVESThENTS AND RILATMVE COST OF CAPITAL FOR MOROCCAN INDUSTRY (In thousands, at 1980 constant DR prices) I n v e s t m e n t Relative Cost of Capital tot Year Agro- Textile & Chemical Electrical & Manufacturing _ industry Leather Mechanical Labor Value-Added (In thousands at 1980 constant DR prices) (1980.100) 1979 107.0 75.1 151.9 79.9 78.91/ 76.7k' 1980 160.2 155.5 227.7 100.2 n.a. n.a. 1981 89.6 123.6 144.8 92.2 110.3 108.8 1982 221.2 113.8 360.8 87.2 n.a. n.a. 1983 208.0 85.2 142.4 80.8 157.5 173.3 1984 112.3 145.7 135.5 118.5 170.8 191.8 1985 120.4 140.4 126.6 71.0 173.3 203.0 a/ For the year 1977. Source: Ministry of Industry and mission calculations. 2.17 The evolution of the relative cost of capital is determinant in explaining investment behavior in Morocco. It shows also how the policy reforms implemented to date have succeeded in substantially reducing, if not eliminating, the previous bias against labor. In the second half of the 1970's, increasing real wages and low capital costs, due mostly to the biased structure of trade and industrial incentives, oriented both sectoral and technical choices towards a relatively high level of capital intensity. The recent decline in investment must therefore be viewed in the context of shifting relative factor prices which act to correct previously existing distortions. More importantly, growing investment in the relatively labor-intensive, export-oriented sectors indicates that the economy is moving steadily toward a sectoral pattern of production more in line with its natural comparative advantage. 2.18 A detailed analysis of the sub-sectoral distribution of investment within manufacturing reveals that industries which have succeeded in maintaining a steady level of capital accumulation are those which have derived maximum benefit from the increasing export orientation of the economy. This is reflected, moreover, in the evolution of the relative demand for credit in manufacturing. Whereas the share of manufacturing in total credit barely changed during the 1982-85 period, the relative share of export credits increased, reflecting the more dynamic performance of exports and the exemption of export lending from credit ceilings. 2.19 Internal Consistency of Macro Policies. The past financing strategy which succeeded in lowering inflation by depleting net foreign assets and building up arrears appears to be unsustainable, as witnessed by the recent foreign exchange shortages and intermittent work stoppages in publicly financed projects. An analysis of the structural budget deficit1' (i.e. the 1/ The derivation of the structural deficit is presented in Annex II. - 13 - public deficit corrected for the effects of inflation, cyclical variations in revenues and expenditures, and Government net worth) reveals, moreover, a fundamental inconsistency with inflation targets in the medium-term. This is shown using an analytical framework developed by Sargent and Wallacel'. It is based on a simple accounting identity which relates the budget deficit to possible sources of financing] '. The relationship between the change in the monetary base and the primary deficit is directly linked by constraining certain variables. In the case of Morocco, financing the budget deficit through increased borrowings or further depletion of foreign exchange reserves must be ruled out at this time in view of the unsustainably high debt burden and present liquidity crisis-'. Its small country status renders world interest rates and proportional changes in the terms of trade exogenous. The domestic interest rate in Morocco is closely linked to the world interest rate adjusted for inflation differentials and expectations with regard to future developments in exchange rates. As such, the ability of the monetary authorities to adjust domestic interest rates in real terms to accomodate 1/ See Sargent, T. and Wallace, N. (1982), "Some Unpleasant Monetarist Arithmetic", Federal Reserve Bank of Minneapolis Quarterly Review. 2/ The excess of Government expenditures over revenues can be financed by domestic borrowings, foreign capital inflows, money creation, or running down the stock of foreign exchange reserves, yielding the public sector budget identity: G + i D + ei* D* - T - M + D + e D* - e R p p _ _ _ _ where G is the level of total Government expenditures, T is real taxes net of subsidies, i and i* are the nominal domestic and international interest rates respectively, D and D* are the outstanding stock of domestic and foreign public debt respectively, R is the level of official foreign reserves, e is the exchange rate, M is the nominal stock of high-powered money, and P is the domestic price level. 3/ Setting the present debt to GDP ratios at maxima for both domestic (d) and foreign (d*) borrowings and setting the official reserves to GDP ratio at a minimum, the following relation between inflationary financing and the real budget deficit as a proportion of GDP obtains: S= - - 6 + ( r - gy) d + (r* + g. - gy) d* Py where S is the real seignorage the Government has to extract by printing money, 6 is the real primary deficit (i.e. the overall budget deficit less interest payments), r and r* are the real domestic and international interest rates respectively, gy is the rate of growth of real GDP, and gc is the rate of deterioration in the terms of trade. The omission of a term corresponding to the change in official reserves is predicated on the assumption that the level of reserves with respect to GDP is at a minimum and the cost of accumulating additional reserves in the near future is deemed too high. - 14 - Treasury borrowing requirements is limited-". Apart from an increase in the rate of growth of GDP which improves the debt servicing capacity of the economy and relaxes the Treasury's borrowing constraint1', a reduction in the primary deficit by some combination of tax increases and/or expenditure cuts is the only way in which the Government can limit its recourse to seignorage. 2.20 The internal consistency between budget deficit and inflation targets was evaluated for Morocco on the basis of projected revenue and expenditure levels, domestic and external interest rates, GDP growth rates, and domestic and international inflation rates. The primary structural deficit was estimated to be approximately 1.71 of GDP in 1986. In view of the underlying assumptions on borrowing constraints and exogenous developments, a seignorage level of 3.41 of GDP is required to finance the budget deficits'. This would generate, in turn, a rate of inflation on the order of 202, significantly higher than the rates recorded in the past4'. The Government's increasing reluctance to devalue even nominally would induce an appreciation of the real exchange rate, placing the liberalization program in jeopardy and fueling speculative capital flight. 2.21 Developing countries resort more often to seignorage as a source of deficit financing than do industrialized countries1'. The former typically exhibit a lower velocity of circulation of high-powered money which serves to broaden the inflation tax base, allowing more revenue to be captured for a given inflation tax rate. The relative dependence on seignorage as a source of Government revenue in selected developing and developed countries over time is depicted in Table 2.5. As expected, the level of seignorage in relation to GDP is much higher in the developing countries. I/ Artificially lowering rates on Treasury borrowings or forcing banks to absorb more Government assets than they would ordinarily choose to hold at a given lending rate effectively constitutes a tax on bank holdings and can be considered as another form of seignorage. 2/ For a more thorough treatment of the relationship between debt, economic structure, adjustment, and growth see M. Selowsky and R. van der Tak, "The Debt Problem and Growth", World Bank, mimeo, 1986. 3/ The algebraic derivation of this relationship is presented in Annex II. 4/ Seignorage as a proportion of GDP is equal to the rate of change of high-powered money times the inverse its velocity of circulation, or S dM/M x 1/V. The rate of change of the monetary base is thus equal to the level of seignorage with respect to GDP times the income velocity of circulation of the monetary base, estimated at between six and seven in Morocco. The quantity equation of money, MV a Py, demonstrates that with a level of seignorage equal to 3.41 of GDP with V and y held constant, the rate of change in the price level will surpass 201. Clearly, the budget deficit must be reduced, or alternatively, a higher rate of economic growth achieved if inflation is not to accelerate in the future. 5/ This results from a relatively lower degree of financial intermediation and a limited array of financial instruments in the case of the former. - 15 - Table 2.5: SEIGNORAGE AS A PERCENTAGE OF GDP IN SELECTED COUNTRIES Year Germapy France Japan USA Morocco Philippines EAypt Tunisia Korea 1975 0.292 -2.272 0.39% 0.462 1.892 0.74% 3.601 1.602 2.95% 1978 1.312 0.901 1.282 0.711 2.022 1.35% 5.85% 1.611 3.042 1980 -0.381 0.90% 0.572 0.342 0.741 0.712 14.28% 1.051 -0.59% 1981 -0.161 0.292 0.24% 0.182 1.851 0.561 8.432 2.11S -0.941 1982 0.481 1.042 0.54% 0.342 0.921 0.31% 10.971 2.071 1.931 1983 0.511 0.301 0.481 0.33% 1.791 2.44% i0.28% 1.681 0.441 1984 0.352 0.631 0.752 0.332 1.581 1.08% 5.561 1.011 0.221 1985 0.301 0.351 n.a. 0.511 1.01% 0.811 6.45% 0.87% 0.091 Source: International Financial Statistics. 2.22 It is noteworthy in the case of Morocco that the level of seignorage required to finance a primary deficit of 1.71 of GDP would be significantly above the historical trend. With the onset of financial sector reforms and the elimination of artificial barriers to private financial intermediation, the demand for money at a given level of income tends to fall. This increases the income velocity of circulation as individuals seek to rid themselves of excess cash balances which reduces, in turn, the inflation tax base. If the same level of seignorage is to be maintained, the inflation tax rate, that is the rate of growth of the monetary base, must increase and with it the rate of inflation. If the inflation target is to be respected in a country undergoing a major financial sector reform, then the budget deficit must be correspondingly lower. This conclusion is particularly relevant to the case of Morocco which, under the ITPA program, has adopted a series of significant measures to promote financial deepening. The link between stabilization policies and the successful implementation of structural reforms is thereby reinforced. 2.23 Budgetary Effects of Structural Measures. The trade liberalization program was expected to have both a negative direct effect on budgetary revenues in the short run, which was to be offset by specific compensatory measures, and a positive indirect effect over the medium-term. Rationalizing the structure of protection and reducing the bias against exports by lowering the rate of international trade taxes, were expected to lead to shortfalls in budget receipts. On the other hand, a number of compensatory measures, such as an across-the-boardr increase in the rates of indirect taxes which do not discriminate against eiKternal trade1' and an active exchange rate policy serving to broaden the taxable base, were identified to neutralize the decline in revenues. Finally, the increase in general economic activity, particularly in the industrial and exporting sectors, resulting from a more efficient allocation of resources in line with Morocco's comparative advantage, was expected to increase tax revenues in the medium-term. 1/ The introduction of a value-added tax in Morocco in April, 1986 precluded this option. The authorities first wanted to be sure that the VAT was functioning properly before proceeding to a modification of rates. - 16 - 2.24 Table 2.6 shows the evolution of trade tax receipts in absolute terms and as a share of total import value. Global proceeds from trade taxes in current prices excluding the turnover tax have steadily increased up to 1982 and fallen slightly thereafter. In accordance with the liberalization prosram", the special import tax (SIT) rate (para. 3.04) was reduced from 151 in 1983 to 52 in 1987, accounting for a significant loss in revenues. The SIT in overall import tax revenues fell from 34.81 in 1982 to an estimated 14.01 in 1987. This trend was cushioned to some extent by an increase in receipts from customs duties, which continued to grow despite a series of reductions in the maximum nominal tariff rate in 1984-86. This finding can be explained by the relatively low share of heavily taxed items in the overall import basket, the majority of which remain subject to quantitative restrictions (para. 3.26); and by the shift in the composition of imports away from zero-duty goods in 1985-87'. This explains the increase in import tax revenues as a proportion of total import value in 1986, despite a continual decline in the share of trade taxes in total tax revenues since 1984. Table 2.6: EVOLUTION OF TRADE TAX REVENUES (In Millions of Dirhams) 1982 1983 1984 1985 1986 1987 Total Trade Tax Revenues Excluding turnover tax 5792 5262 5627 5771 5600 5640 S of total tax revenues 37.82 29.01 29.51 27.31 23.32 21.5% Including turnover tax 8611 8138 9251 9866 9926 10039 1 of total tax revenues 56.2% 44.91 48.51 46.61 42.51 38.21 Import Tax Revenues Customs Duties 1703 1598 1885 2245 2373 3059 Special Import Tax 2994 2631 2533 2221 2033 1402 Stamp Tax 849 810 913 972 970 996 Total 5546 5039 5331 5438 5376 5457 Percentage of Imports 21.31 19.71 15.51 14.12 15.51 15.6S Source: Annex Table A.II.4. 1/ For a discussion of the panoply of trade taxes in Morocco and the way in which they have been affected by the liberalization of the trade regime, see Annex IV and Chapter III (paras. 3.09 to 3.10). 2/ The relative share of wheat and petroleum imports, both of which are imported duty-free, declined dramatically in 1985-87 as a result of high domestic agricultural production and the fall in world oil prices; this, in turn, freed up import capacity for dutiable items. - 17 - 2.25 Export taxes have been virtually abolished in keeping with the liberalization program (para. 3.11), except for a levy on mineral exports. The latter does not constitute a bias against exports insofar as it applies in general to phosphate rock where Morocco enjoys considerable market power and is tantamount therefore to an optimum tariffl *. The 1987 level of trade taxes (excluding VAT proceeds from imports) is estimated at 21.51 of total tax revenues, reflecting both structural measures (i.e. the elimination of the statistical tax on exports and the reduction in the maximum tariff rate) and cyclical ones, notably a fall in tax revenue from phosphate exports link'd to the recent decline in world demand for phosphate rock and derivatives. 2.26 Tax expenditures which result from the various incentives embodied in the investment and export codes (paras. 5.13-5.15, 3.15-3.17) have contributed to budgetary strain. Whereas much progress has been realized in limiting the scope of investment incentives, Treasury revenue foregone under the export code remains considerable (Table 2.7). This fiscal loss amounted to an estimated DE 600 million in 1986 or nearly 10 of total direct tax revenues. Table 2.7: REVENUE FOREGONE DUE TO GRANTING OF FISCAL INCENTIVES (Value in Millions of DR) 1976 - 1985 1976 1979 1983 1984 1985 Export Code 16.3 25.9 66.4 131.6 447.0 Investment Code 113.0 139.2 20.8 54.0 69.4 Total Revenue Foregone 129.3 165.1 87.2 185.6 516.4 Memo Items Central Government Tax Revenue 8,322 13,802 18,943 20,971 23,161 % Tax Revenue Foregone 1.5 1.2 0.5 0.9 2.2 Source: Ministry of Industry and Mission Estimates 2.27 This analysis has shown that the effect of tariff reductions on budgetary revenues was not a major cause of macro-economic disequilibrium. These measures were necessary, moreover, to reduce distortions in the structure of incentives and promote a more efficient allocation of resources. In contrast, the fiscal incentives provided under the export code may prove increasingly costly as trade liberalization proceeds and resources are increasingly allocated to export-oriented activities. With exporters exempt 1/ For a discussion of how a large exporting country can pass on the costs of an export tax to the importing country, see H. Johnson, "The Gains from Exploiting Monopoly or Monopsony Power in International Trade", Economica, May 1968. - 18 - from virtually all forms of taxation-', the expansion of exports will be accompanied by declining tax receipts, that is, the income elasticity of fiscal revenues will decline with the structural transformation of the economy. This could result in a worsening of the already precarious budgetary situation, casting considerable doubt on the future of trade liberalization in Morocco. If the progress achieved under the liberalization program is not to be undermined, the sectoral reforms must be complemented and strengthened by an array of macro-policies that raises the rate of investment and reduces the ratio of debt service to total savings, while containing aggregate demand and inflation. C. Ibe Sooa ImIact of Adjustment 2.28 After rising steadily until 1979, real wages have declined significantly. This behavior parallels that of the real exchange rate which, as noted earlier (para. 2.04), had been appreciating until the end of the 1970. and depreciating thereafter. It is probable that the devaluation of the nominal exchange rate would have led to much less of a real depreciation, had it not been for the decrease in real wages3'. 2.29 The negative impact of the real depreciation of the dirham on the purchasing power of wage earners was to some extent limited by the fact that consumer prices increased at a slower rate than producer prices. As a result, the product wage decreased more than the real wage in consumption goods. The disparities in the movements of the CPI relative to the producer price index indicate, moreover, that the "internal" real exchange rate (i.e. the relative price of domestic tradables to non-tradables) also tended to depreciate. 2.30 The behavior of employment has been significantly affected by the evolution of real wages. In view of the general scarcity of labor statistics in Morocco, the analysis of the effects of the adjustment program on employment was confined to the manufacturing sector1'. Table 2.8 traces the evolution of permanent and total employment in the manufacturing sector since 1976. Employment stagnated until 1979, while real wages increased at an average annual rate of 7.71 over the same period. With the subsequent decline in real wages, the employment response was swift, rising from 197,300 workers in 1979 to 296,953 in 1986. Unlike investment, employment exhibited a common upward trend across sub-sectors, with no one industry significantly outperforming the others (Table A.II.5). 1/ Exporting firms are required to pay the National Solidarity Tax (PSN), introduced in 1980 to finance the defense effort in the Western Sahara. The PSN rate of 10% is applied to the marginal rate of profits tax (481) yielding an effective tax rate on export profits of 4.82 Results from the industrial survey, however, indicate a significant compression of profit margins which served to reinforce the impact of the devaluation. 3/ In view of the linkages between industry and other sectors of the economy, formally respresented by intersectoral employment multipliers, the global employment effect is presumably greater. - 19 - Table 2.8: INDUSTRIAL EMPLOYMENT (Number of employees, in thousands) Total Seasonal Real Wage Employment Employment (1980u100) 1976 190.0 29.4 89.0 1977 194.0 22.1 99.1 1978 176.9 14.7 108.9 1979 197.3 21.3 111.2 1980 222.1 27.9 100.0 1981 223.0 26.3 98.7 1982 NA NA NA 1983 239.3 29.5 97.3 1984 255.6 31.1 94.3 1985 271.3 42.7 94.2 1986 297.0 55.2 Source: Ministry of Industry, Les industries de transformation. 2.31 The employment effect was greatest in the food processing sector, where labor demand surged at an average annual rate of 5.5%, most likely in response to a marked decline in real wages in that sector (more than 20X since 1980). Employment growth in textiles, however, was less impressive (3.61 per annum) as a result of the rise, however modest, in real wages (0.61 per annum). Wages in the textile sector remained only 75.8% of the average industrial wage in 1985. This result is not surprising insofar as textiles is a relatively unskilled labor-intensive sector. 2.32 The social costs of lower real wages, and hence reduced purchasing power, was partly compensated by a positive employment effect, as production shifted to more labor-intensive exporting activities. At the same time, however, the composition of employment has changed somewhat, with part of the increase coming from seasonal workers (Table 2.8). It is clear from Table 2.9 that the social costs of adjustment in Morocco have been moderate in relation to other comparator countries. On the other hand, ther. are signs that the labor market is still going through a difficult phase of readjustment. According to Government estimates /, urban unemployment has steadily increased in the last few years from 11.9% in 1981 to 18.4% in 1984, declining to 14.51 in 1985. 1/ Report prepared by the Government of Morocco for presentation at the Consultative Group in March 1987. - 20 - Table 2.9: COMPARATIVE SOCIAL INDICATORS 1982-1985 (average anDual percentage change) GDP Employment in Manufacturing per capita Manufacturina Real Wase Argentina -1.22 2.3% 12.6% Brazil 1.0% -0.22 -2.42 Chile 1.0% 5.72 -5.1S Mexico -2.31 -2.8% -12.1% Morocco 1.21 A" 5.52 -1.41 Peru -4.61 -4.22 -15.9% Turkey 2.51 3.52 -5.01 aJ 1982-1986. 2.33 In Morocco, employment is a politically more sensitive issue than wage levels given the high rates of unemployment and underemployment. The rapid growth of the civil service despite the relatively depressed level of public sector salaries is but one manifestation of this. The positive employment effect in the manufacturing sector is an encouraging development which may render the continuation of the adjustment program more palatable politically. - 21 - TIL THE EVOLUTION OF TRADE POUCY REFORM IN MOROCCO A. The Poltical Eeonomy of Trade Reform In Morocco 3.01 Two primary considerations have been instrumental in shaping Moroccan trade policy in the past. The first was the desire to protect the nascent industrial tissue by shielding domestic import-substituting activities from international competition. The second was the desire to resort to trade restrictions as a means of addressing external disequilibria and shortfalls in fiscal receipts. Exchange rate policy was formulated independently to control inflation. The tendency of the exchange rate towards overvaluation, however, aggravated the balance of payments which stoked pressures to restrict the trade regime. 3.02 The barriers to external trade and the regulatory apparatus governing international transactions generated a strong anti-export bias. The combination of relatively high tariffs and binding quantitative controls resulted in a gradual shift in import demand away from finished goods and towards intermediate products and capital equipment. Pressure from industrial groups to reduce tariff rates on the latter categories led the Government to introduce an extensive array of tax exemptions embodied in the various Investment codes (paras. 5.13-5.15). This artificially depressed the cost of capital and discriminated against labor-intensive activities, an area in which Morocco enjoys a natural comparative advantage. As customs revenues deteriorated, the reaction of policy makers was to introduce new layers of trade taxes. This, in turn, led to higher levels of dispersion in tax rates which further aggravated the distortions in the system of protection. Scarce resources were misallocated to highly protected and/or inefficient sectors with the result that the international competitiveness of Moroccan industry deteriorated. 3.03 Ackaowledging the importance of a more neutral incentives regime, Morocco embarked on an extensive program of structural reform required to restore a viable balance-of-payments position and a sustainable growth path in the medium-term. The objectives of the program were defined and internalized by the Ministry of Trade and Industry in the context of a joint research project with the World Bank on the structure of industrial incentives. The results of this studyV 'were used both to establish a substantive policy dialogue between the Bank and the Government and to gain the necessary support for reform from Moroccan industrialists. This involved prolonged discussions with firm owners to explain the objectives, timing, and sequencing of liberalization measures. Studies were carried out on the impact of specific measures on individual sub-sectors. This reassured industrialists that the Government was sensitive to their concerns and marshaled support for the program. 1/ Morocco: Industrial Policies and Export Promotion, World Bank Report 4893-MOR, January 1984 - 22 - 3.04 The liberalization strategy adopted was predicated on the graduated and simulataneous reduction of both non-tariff and tariff barriers, the flexible management of the exchange rate, and continued progress in stabilizing the economy. The notion of the "compensated" devaluation was considered vital to provide appropriate price incentives to exporters and to offset the economic and financial effects linked to trade liberalization measures. Quantitative restrictions were to be reduced on a yearly basis and eliminated by 1989. Protection afforded by the tariff structure was to be rationalized by the so-called concertina approach, consisting of progressive reductions in the maximum nominal tariff rate such that no tariff would exceed 251 by 1989. The special import tax (SIT), an across-the-board, uniform surtax, was to be abolished by 1986. The underlying rationale for targeting the relatively non-distortionary SIT was that its elimination would reduce effective protection equally across sectors. The putative advantage of this approach was the equitable distribution of burden-sharing, which enhanced its political acceptability. The budgetary impact of the program was meticulously analyzed and measures were proposed to offset the fiscal shortfall. The need to lower the overall budget deficit was recognized as an independent but complementary objective to liberalization!". The program was launched in 1984 in response to the March 1983 balance-of-payments crisis, which required that generalized quantitative import restrictions be applied to contain imports and defuse the foreign exchange crisis. As the subsequent analysis shows, much has been accomplished to date. 3.05 The determinant factor conditioning the success of the liberalization program, however, has been the sustained commitment of the Government to trade policy reform and the astute management of the bargaining process with industrialists. The six years which have elaspsed between the onset of the joint research project and the implementation of the liberalization program, although seemingly lengthy, were necessary to induce the requisite attitudinal changes throughout the economy. According to the results of an industrial survey of forty firms, carried out by a World Bank mission in December 1986a', all industrialists interviewed at the time were fully aware of the program's objectives. The commitment of the Government to eliminate quantitative restrictions by 1989 and reduce levels of protection to a maximum of 251 was frequently cited by firm managers in the course of the discussions. The annual liberalization program for 1987 had already been discussed with the relevant industries, which underscores the Government's intention to proceed with liberalization even in the absence of a specific Bank policy loanz-L. I. CbanRes in the Instunts of Tade Policy 3.06 The liberalization of the external trade regime is reflected by reforms of both import and export policies. A description of the different features characterizing the import and export regimes in Morocco is presented 1/ Morocco: Industrial Policies and Export Promotion, op.cit. 2/ A full description of the survey methodology, including criteria for sample selection, is given in Annex III. 3/ All loan conditions having been satisfied, the second tranche of ITPA II was released in November 1986. - 23 - in Annex IV. This section will therefore focus on documenting the major changes in trade policy that have occurred since 1983. 3.07 Import Policies. Progress achieved in dismantling quantitative restrictions can be observed in Table 3.1. Following the generalized control of imports in March 1983, products have been steadily transferred from lists B and C to list AL'. As of February 1986, list C was formally abolished with the result that list A accounted for 671 of all tariff positions and 86S of total import value. With the transfer of 332 products in the context of the 1987 General Import Program, List A now accounts for over 701 of all tariff positions. Table 3.1: CHANGES IN IMPORT REGIME 1983-1986 (percentages) Tariff Position"' Import Value 1983k' 1984 1985 1986 1983 1984 1985 1986 List A 49.9 52.5 58.5 66.7 38.5 84.7 86.7 86.3 List B 32.1 37.7 41.2 33.3 61.3 15.2 13.3 13.7 List C 18.0 9.8 0.4 - 0.2 0.1 - - 100 100 100 100 100 100 100 100 al Six digit CCCN tariff codes. b/ February of each year. Does not reflect the closure of the economy in March, 1983 where all goods in list A were temporarily shifted to list B. Source: SINTIA Customs Files and Ministere du Commerce et de Ilndustrie 3.08 Recourse to the system of floor prices has been effectively abolished for all industrial goods. The reference price, a more transparent albeit imperfect instrument, has been intermittently invoked as a safeguard measure against what is perceived as unfair trading practices by foreign producers. The use of reference prices has been limited primarily to ceramic tiles, end-of-series and second-hand clothing, and used auto-parts. In these instances, reference prices are reportedly being used to counteract dumping from abroad and are generally based on international price comparisons. Moroccan authorities justify the use of reference prices to counter unfair trade practices in that they are less visible and hence, less likely to invite retaliation from abroad. 3.09 Measures have been taken to compress the range of trade taxes and reduce dispersion in the tariff structure. Prior to the onset of liberalization, customs duties were subject to wide variations both between 1/ Goods on list A can be freely imported without prior authorization, those on list B require that a license be obtained, and imports of products on list C are prohibited except in special circumstances. - 24 - and within sectors with rates ranging from 0% to 400S. Similar products often received different rates of nominal protection. An analysis of the 1982 composition of imports by tariff levels indicates the extent of these distortions. For example, twelve out of 20 sectors had tariffs ranging from 01 to over 751. Once those items benefiting from tariff exemptions (i.e. temporary admission, investment codes, products taxed at a zero duty rate) are excluded, the mean unweighted tariff"' varied from 8.41 to 150% depending on the sector. This analysis does not take into account the effect of quantitative reatrictions which serves to increase the implicit nominal rate of protection for many goods. At end-1983, total duty and tax rates for 70% of all products averaged over 301. 3.10 In January 1984, the special import tax (SIT) was lowered from 151 to 101 and the maximum customs duty rate was reduced to 601 in July 1984 with a view to decreasing tariff redundancy, import smuggling, and the high costs of protection. Sectors affected by this measure included plastics (mean tariff 681), glassware (mean tariff 881), beverages (mean tariff 125X), and footwear (mean tariff 1422). Rationalization of the tariff structure progressed further with the SIT being reduced to 7.5X in January 1985 and the maximum customs duty falling to 451 in early 1986A'. This combination of measures brought the unweighted average cumulative rate of trade taxes to 35.9% down from 58.4% and the maximum protective rate to 62.3% down from 466.31 (Table 3.2). The dispersion of rates across the 8050 positions of the Moroccan tariff code was also significantly reduced. The standard deviation of customs duty rates decreased from 40.5 to 15.4. Table 3.2: TARIFF STATISTICS (percentages) Rate of Cumulative Customs Duty Trade Tax Rate A/ 1983: Minimum 0.0 0.0 400.0 466.3 Average 36.1 58.4 St. Deviation 40.5 46.0 Coeff. of Variation 112.2 78.9 1986: Minimum 0.0 0.0 maximum 45.0 62.3 Average 23.4 35.9 St. Deviation 15.4 17.7 Coeff. of Variation 65.8 49.3 a/ Including special import tax and stamp duty; excluding the value-added tax. Source: SINTIA Customs Files and Ministere du Commerce et de l'Industrie 1/ All references to mean tariffs in this section include only the customs duty rate. The SIT was reduced to 51 in January 1987. - 2.5 - 3.11 Export Policies. The active promotion and diversification of Moroccan exports have been key components in the liberalization program. Since 1983, several important reforms were introduced to eliminate barriers to exports, reduce existing disparities between exporting and import-substituting activities, and simplify administrative procedures in the area of external trade. Export licensing requirements, which proliferated during the early 1980s to secure supply for the domestic market, have been abolished on virtually all industrial, agricultural, and mining productsL'. The sole remaining levy on exports, the statistical tax which was applied at a rate of 0.5S, has been repealed. 3.12 The centerpiece of Morocco's export promotion policy has been the temporary admission scheme which functioned even during the financial crisis of 1983. This is clear evidence of the Government's continued commitment to the promotion of exports. The benefits of this regime have since been expanded and made more attractive in the context of the liberalization program. For example, both direct and indirect exporters (i.e. local suppliers to exporters) are now able to import all inputs duty-free, without having to obtain a license for those products on lists B or C. The only major exception was packaging materials where domestic suppliers were given priority. As a condition of the ITPA loans, these products were liberalixed and the "negative" list for industrial products abolished. 3.13 Other measures taken since 1983 to improve the temporary admission scheme include an allowance for wastage; on-site customs clearance for imported inputs and exported products; the introduction of global, annual guarantees to cover possible payment of duties on temporary admission imports in the case where goods are not re-exported; and the decentralization of the prior export scheme ("exportation pr6alable"). Under this procedure, when goods originally produced for the local market are exported, manufacturers may import duty-free those inputs which were not imported under the temporary admission regime (and hence required payment of import duties) but which were subsequently exported. Progress was also achieved in reducing the average processing time for customs clearance by 50X from 12 to 6 days. In order to improve the flow of information and eliminate institutional constraints pertaining to international trade transactions, the Moroccan Government established a Committee for the Simplification of Foreign Trade Procedures under the auspices of the Prime Minister. 3.14 Preferential financing arrangements for exporting activities have been broadened and made more attractive. Ceilings on pre-shipment export credits have been raised and the maturities of post-shipment financing have been extended. A medium-term credit facility to finance the export of capital goods has been established. The preferential terms on credit extended to exporters for working capital have been increased. Exporters receive rates of 91, compared to short-term rates of 14% on regular commercial credit. Only a fraction of the value of exports, however, is being financed on preferential 1/ Remaining exceptions include barytine, charcoal, hides, and leather. - 26 - terms. For the manufacturing sector as a whole, it has been estimated that the amount of loans outstanding as a proportion of exports is 6.62 and 11% respectively for pre-shipment and post-shipment credits. Therefore, a crude approximation of the interest rate rebate as a proportion of f.o.b. export value is 1S (i.e. 52 times 17.61), or more than twice the level which prevailed in 1983. 3.15 Significant fiscal and financial incentives granted to exporters are embodied in the Export Code, which extends and qualifies many of the advantages governed by the Industrial Investment Code (para. 5.14). Promulgated in 1973, the existing export code exempts profits of industrial and artisanal exporting activities from the corporate income tax (IBP) for ten years in the case of new firms and until 1983 for firms existing prior to 1973. Parliament has been renewing this incentive yearly for existing firms since 1983. The benefits of the temporary admission scheme, moreover, are formally grarled to exporters in the context of this code. 3.16 A revised export code has recently been submitted to Parliament. The main features of this code include an extension of benefits to exporters for fifteen years, followed by an additional ten years if profits are reinvested, and the establishment of parity of incentives between direct and indirect exporters. The scope of the code will also be broadened to include agricultural, fishing, and mining exports as well as the export of construction services and public works. Finally, the turnover threshold of trading companies for inclusion under the code has been reduced from DH 10 billion to DH 2 billion. 3.17 The export code exhibits several weaknesses which serve to exacerbate existing distortions in the economy. For example, certain fiscal incentives discriminate against labor in favor of capital. This encourages the adoption of relatively capital-intensive technologies in which Morocco may not enjoy a clear comparative advantage. The set of fiscal and financial incentives may invite retaliatory action by industrial countries in the form of countervailing and anti-dumping duties. In addition, these incentives might have potentially serious consequences from a macro-economic perspective (para. 2.27). In view of the remaining net anti-export bias in the structure of incentives (para. 3.29), and the increasing reluctance of policy makers to use the exchange rate,as an instrument of export promotion, continued reliance on fiscal and financial incentives, although to a lesser degree, appears justified. 3.18 Accession to the GATT. Morocco became an official contracting party to the GATT on June 1, 1987. In acceding to the GATT, Morocco reaffirms its commitment to the principles of free trade. The binding1' of 157 tariff lines consolidates the gains achieved thus far in liberalizing the trade regimes'. An examination of the relevant characteristics of these bindings 1/ In binding a tariff line, the contracting party is prohibited from raising the corresponding customs duty rate unless concessions are made to the relevant trading partner. 2/ The analysis of tariff bindings is .based on preliminary information provided by the Ministry of Commerce and Industry. Except for minor changes, the analysis presented does not deviate significantly from the agreements which enmpt se Moroceo's protocol with the GATT. - 27 - by BTN section4' shows that out of the 157 bound tariff rates, 99 (or 63X) were granted in four sections of the BTN (Table A.III.1). Of these, 42 were in electrical machinery and equipment (Section XVI), 21 in textiles (Section XI), 18 in chemical and allied products (Section VI), and 18 in paper and paperboard (Section X). 3.19 Tariff bindings are more meaningful when they apply to products not subject to quantitative controls. In these cases, the tariff is the sole instruments of protection and may not be increased without reducing protection elsewhere. The majority of the items bound in terms of both tariff lines and import value (62X) figures on list A, including certain sensitive products such as textiles (Section XI), machinery, mechanical appliances and electrical equipment (Section XVI), and chemical products (Section VI). The average rate at which these products are bound ranges from 28% to 37.5S, significantly below the maximum nominal rate of the present tariff structure. It is noteworthy that the tariffs of certain sensitive import-substitutes in list B have also been bound. Two sections - machinery, mechanical appliances, electrical equipment (Section XVI) and vehicles and transport equipment (Section XVII) - account for around 601 of the total value of tariff-bound imports in list B. With the anticipated elimination of quantitative restrictions, the potential for protection will be limited by the tariff bindings. Finally, the import value of tariff-bound items was US$1,160 million in 1985, or around one third of total imports. The extent of tte tariff bindings is significant and can be taken as evidence of Morocco's firm commitment to trade liberalization. 3.20 An analysis of tariff bindings by country reveals that tariff concessions were granted solely to industrialixed countries (Table A.III.2). This is not suprising given the relatively low participation rate of developing countries in past trade negotiations. For example, the US received the majority of tariff bindings both overall (531) and in virtually every section. The second country that benefited from Morocco's bindings oddly enough was Switzerland, where most were concentrated in textiles (Section XI) and machinery and mechanical appliances (Section XVI). 3.21 Morocco stands to gain from its accession to the GATT in several ways. First, agreements negotiated within the GATT will confer greater stability on Moroccan trade policy. This results from the fact that previously agreed import barriers cannot be increased without compensating trading partners if the latter's exports have been hurt. Second, Morocco can invoke international trade agreements as part of the GATT to resist political pressures from special interest groups for higher protectionA". Last, any further liberalization of the trade regime can be used by Moroccan policy makers to extract concessions in the form of increased access to other countries' markets. This feature takes on particular significance in view of the upcoming Uruguay round of multilateral trade negotiations. 1/ The available information on tariff bindings is presented at the BTN 4 digit level in Table A.III.1 In some cases, only a subset of the tariff lines at the BTN 4 digit-level was bound. This difference is not reflected, however, in the second column. 2/ This was a major factor in Mexico's decision to join the GATT. - 28 - C. The.hdofTadePoHlyRformomthe Struo of e-vs 3.22 A major objective of the liberalization program was to effect a generalized reduction in effective protection through the elimination of quantitative restrictions and the lowering of tariff rates. During the initial phase, the substitution of tariff barriers for quantitative controls in selected subsectors constituted a parallel aim. Finally, the program sought to convince entrepreneurs of the Government's comuitment to liberalization, as a prerequisite to inducing structural reform in industry. This section assesses the progress achieved in attaining these objectives. 3.23 Reductions in the coverage of quantitative restrictions by tariff item and import value have been sipificant (para. 3.07). A low share of imports under QRs, although indicative of protection, does not by itself indicate the openness of the trade regimeL'. A more accurate measure of the extent of deprotection which has taken place to date is the share of domestic production which remains subject to non-tariff barriers. Table 3.3 depicts the changes in the sectoral coverage of quantitative restrictions by tariff line and import value since 1983 as a function of domestic production. In addition, the average customs duty rate (unweighted) for the subset of tariff positions under QRs is shown. According to a more detailed sub-sectoral analysis (Table A.III.3), a growing proportion of local industry is being Iable 3-.: QUANTITATIVE RESTRICTIONS (1983-86) Subsectoral Coverage of B/C Lists Share of Sector Position a/ Average Customs Duty Share of Sector IUorts VI in 8/C Lists Unweighted in 5/C Lists Sector (ISIC) (X) (%) (X) 1932 19*4 1933 1931i 1951 1954 1983 1956 12931 19*4 1933 tam6 Agriculture 67.0 61.5 57.6
Groupe de la Banque mondiale · Pre-2003 Economic or Sector Report
Morocco - Impact of liberalization on trade and industrial adjustment (Vol. 2 of 3) : Main report
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Groupe de la Banque mondiale
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Pre-2003 Economic or Sector Report
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Maroc
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Banque mondiale