Morocco - First and Second Industrial and Trade Policy Adjustment Loan Projects

Document of The World Bank FOR OFFICIAL USE ONLY Repo...o. 7938 PROGRAM PERFORMANCE AUDIT REPORT MOROCCO INDUSTRIAL TRADE AND POLICY ADJUSTMENT LOANS I AND II (LOANS 2377 AND 2604-MOR) JUNE 30, 1989 Opevations Evaluation Department This document has a restricted distribution and ma) be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. ACRONYMS CG - Consultative Group EDI - Economic Development Institute EFF - Extended Fund Facility ESW - Economic and Sector Work ICOR - Incremental Capital-Outpuo Ratio ITPA - Industrial and Trade Policy Adjustment Loan OCE - Office of Marketing and Exports OED - Operatiois Evaluation Department PCR - Program Comp:etion Report PE - Public Enterprise PERL - Public Enterprise Rationalization Loan PFI Pr6lbvement Fiscal A l'Importation (Uniform Import Tax) PPAR - Project Performance Audit Report QR - Quantitative Restriction RPO - Research Project SAL - Structural Adjustment Loan SIT - Special Import Tax TA - Temporary Admission TFP - Total Factor Productivity VAT - Value Added Tax CURRENCY EQUIVALENTS Currency Unit: Dirham (DH) Official Exchange Rate: Dirham (DH) per US Dollar 1978: 4.167 1979: 3.899 1980: 3.937 1981: 5.172 1982: 6.023 1983: 7.111 1984: 8.811 1985: 10.062 1986: 9.104 1987: 8.359 1988: 8.209 FISCAL YEAR January 1 - December 31 FOR OFFAL USE ONLY THE WORLD SANK Washingion. DC 20433 USA Ofte n# Ov.c.WhI Opiemtn lVakaw June 30, 1989 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Program Performance Audit Report on Morocco Industrial and Trade Policy Adjustment Loans I and II (Loans 2377 and 2604-MOR) Attached, for infor .)n, is a copy of a report entitled "Program Performance Audit Report on Morocco - Industrial and Trade Policy Adjust- ment Loans I and II (Loans 2377 and 2604-MOR)" prepared by the Operations Evaluation Department. Y%es Rovani Attachment This document has a restricted distribution and may be used by recipients only in the performance of their oficial duties. Its contents may not otherwise be disclosed without World Bank authorization. FOR OFFICIAL USE ONLY PROGRAM PERFORMANCE AUDIT REPORT MOROCCO INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOANS I AND I! (LOANS 2377 AND 2604-MOR) TABLE OF CONTENTS Page No. PREFACE .................................................................. . BASIC DATA SHEET ..................................................... iii EVALUATION .JMARY ................................................... vii PROGRAM PERFORMANCE AUDIT MEMORANDUM I. BACKGROUND .....1.................................... 1 Introduction ....... ......................................1.... . I Brief History . ..... .........................2.... Response to the 1983 Crisis ................................... 3 II. THE ITPA LOANS AND POLICY DIALOGUE ....................... 4 Technical Aspects of the Loans ......................... 4 The Policy Dialogue .............................5...... 5 (1) Morocco's Support for the ITPAs ................... 5 (2) Bank/Fund Coordination ........................... 6 III. IMPLEMENTATION EXPERIENCE AND OUTCOME .....7........... 7 The Macroeconomic Framework ... 7 (1) Adjusting to Balance of Payments Shocks: The Basic Mechanisms .............................. 7 (2) Macroeconomic Adjustment in Morocco ................ 8 Restoring Market Incentives ............................ 11 (1) The Situation at the Outset of the ITPAs ........... 11 (2) The Measures Taken ............................... 12 (a) Removing the Bias Against Export ............... 12 (b) Bank and Financial Sector Reform ............... 16 (c) Removing the Bias Against Labor ................ 18 (d) Stability and Transparency of Incentives ....... 18 The Conflict Between Restructuring of Incentives and Budgetary Balance ................................ 19 IV. SUSTAINABILITY ........................................ 21 Conclusion and Sustainability of the Reforms ............. 21 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. TABLE OF CONTENTS (cont*d) Page No. List of Tables in the Text 1. Selected Data on Eight Highly Indebted Countries ............. 2 2. Investment in Modern Manufacturing, 1981-88 .................. 10 3. Shares of Export-Oriented Subsectors of Total Manufacturing, 1981-87 ..................................... 15 ATTACHMENTS 1. Morocco: Investment and Employment in Manufacturing Industry, 1983-87 .......................................... 23 2. Morocco: Production and Exports of Manufacturing Industry, 1981-86 .......................................... 24 PROGRAM COMPLETION REPORT I. FOREWORD ................................................. 27 II. BACKGROUND ............................................... 27 III. THE ADJUSTMENT PROGRAM: RESPONSE TO CRISIS .............. 32 IV. ITPA MEASURES AND THEIR IMPLEMENTATION ................... 35 V. THE IMPACT OF THE ITPA PROCVAM ON THE MOROCCAN ECONOMY ... 44 VI. THE ROLE OF THE BANK ..................................... 46 VII. EVALUATION AND CONCLUSION .............................. 49 ANNEXES I-A: Government Adjustment Program for ITPA I and II ............ 55 I-B: Morocco: Summary of Measures and Status of Implementation of the ITPA Program and List of Possible Measures for Implementation in a Second Phase :f Reform ............... 56 I-C: Morocco: Sunnary of Measures and Implementation Schedule of ITPA II .............................................. 66 II-A: Statement of Development Policy, ITPA I (Dec. 29, 1983) .... 71 II-B: Statement of Development Policy, ITPA II (May 14, 1985) .... 85 APPENDIX Comments Received from tb? Borrower ........................ 101 PROGRAM PERFORMANCE AUDIT REPORT MOROCCO INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOANS I AND II (LOANS 2377 AND 2604-MOR, PREFACE 1. This is a Program Performance Audit Report (PPAR) on the first and second Industrial and Trade Policy Adjustment (ITPA) Loans to Morocco. The principal objective of the loans was the introduction of structural changes in the system of incentives so as to promote more rapid industrial and export growth. Loan 2377 for US$150.4 million was approved in January 1984 and was closed in June 1985; Loan 2604 for US$200 million was approved in July 1985 and was closed in November 1986. Both loans were fully disbursed. 2. The PPAR covers both ITPA I and II, and consists of the Program Performance Audit Memorandum (PPAM) prepared by the Operations Evaluation Department (OED) and the Program Completion Report (PCR) prepared by the EMENA Regional Office of the Bank. The PPAM is based on the attached PCR, the President's Reports, sector and economic reports, loan documents, a study of the project files and discussions with Bank staff. An OED mission visited Morocco in October 1988 and discussed the effectiveness of the Bank's assistance with Government officials and leaders of the business community. Their kind cooperation and valuable assistance in the preparation of this report is gratefully acknowledged. 3. The PCR provides a complete account and assessment of the program experience, and discusses the performances of the Bank and the Government. The PPAM elaborates on particular aspects such as the preparatory work towards the design of the program and its sustainability. 4. Following standard OED procedures, copies of the draft PPAR were sent to the Government f3r comments. Comments were submitted by the Bank Al-Maghrib and are reproluced as an Appendix to the PPAR. - iii - PROGRAM PERFORMANCE AUDIT REPORT MOROCCO INDUSTRIAL AND TRADE FOLICY ADUSTMENT LOANS I AND II (LOANS 2377 AND 2604-MOR) BASIC DATA SHEET LOAN POSITION (Amounts in US$ Million) As of April 30, 1989 Original Disbursed Cancelled Repaid Outstanding Loan 2377 150.4 150.4 - 11.6 138.8 Loan 2604 200.0 200.0 - - 200.0 CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS (Amounts in US$ million) (Loan 2377) FY84 FY85 Appraisal Estimate 75.4 150.4 Actual 75.4 150.4 Actual as 2 of Appraisal (2) 1002 100 Date of Final Disbursement: June 30, 1985 (Loan 2604) FY85 FY86 FY87 Appraisal Estimate 120.0 200.0 - Actual - 120.0 200.0 Actual as Z of Appraisal (Z) - 60Z - Date of Final Disbursement: May 1, 1987 - iv PROJECT DATES Loan 2377 Original Revised/Actual Initiating Memorandum 07/06/83 Appraisal 07/31/83 07/31/83 Negotiations 10/31/83 12/01/83 Board Approval 12/31/83 01/31/84 Loan Agreement - 03/19/84 Effectivenesj 06/19/84 05/25/84 Loan Closing 06/30/85 06/30/85 Loan 2604 Original Revised/Actual Initiating Memorandum 01/28/85 02/05/85 Appraisal 02/28/85 02/28/85 Negotiations 04/15/85 04/22/85 Board Approval 06/04/85 07/16/85 Loan Agreement 07/19/85 07/29/85 Effectiveness 06/25/85 10/21/85 Loan Closing 05/01/87 11/20/86 STAFF INPUTS (staff weeks) (Loan 2377) FY84 FY85 FY86 FY87 FY88 Total Preappraisal - - - - - - Appraisal 2.7 - - - - 2.7 Negotiations 7.2 - - - - 7.2 Supervision 2.7 27.5 0.4 3.3.7 - 44.3 Other 0.3 - - - 0.6 1.0 Total 12.9 27.5 0.4 13.7 0.6 55.2 (Loan 2604) FY85 FY86 FY87 FY88 Total Preappraisal 53.2 - - - 53.2 Appraisal 47.2 - - - 47.2 Negotiations 10.6 1.5 - - 12.1 Supervision - 21.8 17.2 9.4 48.4 Other - - - - - Total 111.0 23.3 17.2 9.4 160.9 MISSION DATA (Loan 2377) No. of No. of Staff Date of Month/Year Weeks Persons Weeks Report Preappraisal ) 04/83 3 3 9 05/10/83 Preappraisal } 06/83* - Appraisal 07/83 3.5 5 17.5 08/30/83 Appraisal 09/83 3.5 3 10.5 09/26/83 Tranche Review 07/84 2 4 8 09/13/84 (Loan 2604) No. rf No. of Staff Date n: Month/Year Weeks Persons Weeks Report Preappraisal 07/84 2 4 8 - Preapprelsal 10/84 2 6 12 11/16/84 Appraisal 02/85 4 7 28 03/19/85 Tranche Review 06/86 1.5 5 7.5 07/11/86 OTHER PROJECT DATA Borrower: The Kingdom of Morocco Follow-on Projects: None *Mission to discuss Industrial Incentives and Export Promotion Study followed by further preparation undertaken in context of IMF mission. - vii - PROGRAM PERFORMANCE AUDIT REPORT MOROCCO INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOANS I AND II (LOANS 2377 AND 2604-MOR) EVALUATION SUMMARY i. During the second half of 1983 the Moroccan Government initiated a difficult adjustment process to be phased over a number of years and designed to: (a) stabilize the economy by reducing aggregate demand and the size of the budget deficit; (b) transform the economy into rn efficient export-oriented producer by reforming the structure of incentives; -nd (c) increase private sector savings and improve the allocation of invest- ment through financial sector reform. The Industrial Trade and Policy Adjustment (ITPA) program, backed by two Bank ITPA loans disbursed during 1984-86, constituted the Bank's 4nitial support for the adjustment process. (IMF-supported stabilization measures accompanied the ITPA r.ogram, while Morocco's adjustment process was subsequently iurther supported by the World Bank through four more !ectoral adjustment operations and a structural adjustment loan.) On almost all accounts the ITPA program has been highly successful: the policy measures were well designed, and, with cne important exception -- the Special Import Tax (SIT) -- they were implemented on schedule; as a result, there was a significant rationalization of the structure of industrial incentives; and the supply side response of the industrial sector and of manufactured exports has been impressive. In part because of chis success, the negative social impact of the contractionary policies of the reforms has been limited and manageable. ii. The keys to the success of the program were the determination on the part of the Moroccan Government to carry out the reforms and the excellent preparation on the part of the Bank. At a time when the economy was still heavily inward-oriented, i.e. during the late 1970s, an ongoing debate among senior officials in Morocco about the need to increase the economy's efficiency and the desirability of giving greater emphasis to exports, led to a request for research assistance from the Bank. The Bank responded with a three-year research progrcm on industrial incentives. The research was carried out in the Moroccan Ministry of Commerce and Industry jointly by Government staff and one World Bank consultant at a minimal cost to the Bsnk. The research involved daily contacts between the research team, government policymak,rs, and industrialists. The research was clearly conducted by the Moroccan Government itself with involvement of the industrial sector and support from the Bank: as a result, by the 1983 crisis year, there was a consensus among all parties on the maasures that were needed to turn the economy around. Although, as could be expected, important opposition to the reforms was encountered in some Government circles, the excellent quality of the ITPA program with strong Bank support made it possible to push the program forward. - vii' - iii. The one area where implementation fell short of objectives was the SIT, because of the inherent conflict between liberalization -- as reflected in import tariff cuts and the related decline in revenue -- and budgetary targets. Budgetary revenues have remained cr tically short of what was needed to meet necessary expenditures. Yet, at the same time, import duties in Morocco, though much reduced, are still high and will have to be lowered further to achieve a genuine open and competitive economy. Progress towards this objective was interrupted when the goal of totally abolishing the SIT was suspended mid-way through the process because the tax reform being implemeated failed, initially, to generate the additional revenues needed to compensate for the SIT. More recently, in January 1988, the SIT was combined with another import tax, the Stamp Duty, but the sum total of the two taxes was raised by about 2 percentage points, again as a result of budgetary pressures. While the new tax ic across-the-board and uniform and while it could be debated whether this increase constitutes slippage or a mere slowdown in the pace of policy reform, it is still an increase, at a time when total import duties and the anti-export bias remain very high. Those forces in Morocco, which were gradually sold on and consequently have pushed successfully for the ITPA pLogram, were taken aback when the Bank, in the context of the 1988 structural adjustment loan, accepted this increase. hile one could have argued that this had been a trade-off, such argument has not been made, and perhaps could not be made, ae revenue from other sources could probably have been raised further without affecting the ongoing tariff reduction process. In any case, the percep*ions of local authorities were clearly changed, and both the Bank and the advoca as of liberalization in the Moroccan Government appear to have lost some credibility in the process. iv. There are at least three general lessons which can be derived from the Moroccan ITPAs' experience, concerning respectively the design, imple- mentation and sustainability of a policy adjustment program. First, for a policy adjustment program to be well-designed, it has to be preceded by good economic and sector work and understanding of the economy's structure or dynamics or, as in the case of the Moroccan ITPAs, thorough research of the sectoral scene. This condition was clearly met in this instance. Second, the smooth implementation of a policy adjustment program requires a well-orchestrated campaign of information and discussion with the principal economic actors likely to be affected by the process. This condition was also met in this case. Third, the sustainability of a policy adjustment program depend3 on whether a well-conceived balance was reached between the macroeconomic and micro (sectoral) policies. In this particular instance, mainly because fiscal policies were not appropriately strengthened, the adjustment of trade policies, while substantial, fell short of expectations. PROGRAM PERFORMANCE AUDIT MEMORANDUM MOROCCO INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOANS I AND II (LOANS 2377 AND 2604-MOR) I. BACKGROUND Introduction 1. With a per capita GNP of $620 in 1987, Morocco is still a relatively poor country falling at t"e lower end of the group of lower middle income countries. The birthrate has been falling steadily, but the population of 23 million is still growing at 2.52 per annum, with less than half of it urbanized. The growth of the population of working age is even more rapid. The country is relatively well endowed with natural resources, including large areas of arable land, a long coastline, and three quarters of the world's easily accessible phosphate reserves. Phosphate rock and phosphoric acid still made up 30Z of merchandise exports earnings in 1986/87 although this is down from about 40Z during the early 1980s largely on account of a rapid expansion of manufactures exports. Some 461 of the labor force is engaged in agricultute which generates about 20Z of GDP; industry, with 25Z of the labor force, accounts for about 30Z of GDP. 2. Like so many developing economies, Morocco has been experiencing an external debt crisis since the early 1980s and has been applying stabil- ization and structural adjustment policies since. At present, the country belongs to the group of most heavily indebted countries and is, in fact, one of eight countries, all lower middle income, where the external debt outstanding and disbursed exceeds GNP (Table 1). Morocco's adjustment efforts to date have been quite successful. Although GDP growth during the 1980s has been low, per capita income and per capita consumption growth have both been slightly positive -- a remarkable achievement amongst the group of heavily indebted countries -- made possible, among o0ners, by the successful shift towards outward oriented policies. On the negative side, investment demand during the 1980s has lagged behind the requirements for sustainable development in the future, although this can be explained partly by the need to service the large external debt. - 2 - Table 1: SELECT DATA ON EIGHT HIGHLY INDEBTED COIWTRIES Per Capita Total Debt D L Average Annual Real Growth Rates ()N 1902-88 GNP US)- WIS bl1I.) ;W P*r Capita 1907 1980 1907 GP Exports Imports Investment Consumption Jamaica 9060 4.5 175.9 0.7 10.8 8.8 -2.2 -0.3 CSte d'vere 750 14.2 148.6 1.8 -1.0 -4.8 -9.0 -2.1 Bolivia 570 5.7 183.7 -1.4 -1.8 5.6 -16.7 -1.6 Morocco 620 22.0 132.4 3.6 5.4 0.5 -0.7 0.9 Chile 1,310 20.8 124.1 4.3 7.1 3.6 15.1 -0.8 Nigeria 370 30.5 122.6 -0.3 2.1 -20.6 -10.1 -4.5 Costa Rica 1,590 4.6 116.7 3.6 1.4 8.3 9.3 2.6 Ecuador 1,040 11.0 107.4 1.5 5.6 -2.3 -2.1 -2.4 /a Debt outstanding and disbursed. Source: World Bank. Brief History 3. For nearly two decades after Independence in 1956, Morocco followed conservative economic policies, with GDP increasing at about 4Z per year. A relatively weak savings effort and conservative foreign borrowing policies permitted only a slow rise in investment. The country thus entered the 1970s with no major financial imbalances but a limited growth capacity. 4. By the mid-1970s economic policy became more ambitious. With the sudden large jump in phosphate prices in 1974, the Government launched a massive public investment program which brought about a sharp acceleration in growth: GDP grew at 7.5? per year in 1973-77. Concurrently, a major defense build-up was taking place in connection with the conflict in the Western Sahara. 5. The phosphave boom, however, was short-lived with prices declining rapidly during the second half of the 1970s. In spite of this decline and of the second oil shock, the higher rate of public spending was maintained -- a brief attempt at stabilization around 1978 was followLd by a relapse into overambitious planning -- and was made possible by increased reliance on external borrowing which was abundantly available on attractive terms. (A proposed Bank structural adjustment loan (SAL) in 1980 was abandoned primarily because the Government saw no nee to accept the multitude of conditions when other external finance was still readily available.) Morocco's total external debt outstanding and disbursed grew from $1.7 billion at the end of 1975 to $12.4 billion by the end of 1983, or from the equivalent of about 20Z to 100? of GDP. Meanwhile, the share of the public debt on concessional terms had decreased from about 50Z to 40Z. - 3 - 6. By mid-1983 the financial situation had become untenable. The rise in international interest rates in the early 1980s, compounded by a prolonged drought during 1980-84, contributed to the virtual depletion of foreign exchange reserves, thereby forcing the country to debt reached- ulings, emergency import restrictions, and a massive curtailment of public spending. 7. The high level of government expenditure during 1975-83 did not yield the expected benefits, an* after the short-lived 1973-77 boom, GDP growth barely kept up with population growth. Public investment programs often emphasized capital-intensive import substitution, which had limited * returns, and costly infrastructure projects ahead of the country's needs. A key element of Morocco's policy response to the balance of payments con- straint was increased trade protection (quantitative restrictions, licensing, high tariffs) which hampered the efficient use of resources by the private sector and discouraged exports. Investment was very large, but the productivity of capital was low and employment creation limited. The one redeeming feature was the prudence displayed by Morocco in the monetary field, which has set the country apart from many developing countries that undertook a similar unsuccessful dash for growth: a price explosion was avoided. Response to the 1983 Crisis 8. The short-lived stabilization effort in 1978-80 had been quite inadequate to address Morocco's problems. A much broader program combining stabilization, debt rescheduling, and structural adjustment measures was called for. The primary problem areas were diagnosed as the poor export performance resulting from the anti-export bias of exchange and trade policies, the negative public savings, and the low levels of private domes- tic savings. With the assistance of both the IMF and the World Bank, the Government initiated during the second half of 1983 a far-reaching adjust- ment program to be phased over a number of years. The primary objectives were to: (1) stabilize the economy by reducing aggregate demand mainly through a reduction in the size of the budget deficit; (2) transform the economy into an efficient producer by reforming the structure of incentives through policy changes in agricul- ture and industry; and (3) increase private sector savings and improve the allocation of investment through financial sector reform. During 1983-86 the IMF provided support to the Government's progiam in the form of three standby arrangements while the Bank supported structural reforms through two consecutive Industrial Trade and Policy Adjustment loans (ITPA I and II) which were fully disbursed before the end of 1986. Additional and continued support for the Government's adjustment programs provided by the Bank has consisted of a first Agricultural Sector Adjust- ment Loan (ASAL I, approved in June 1985), an Education Sector Reform Loan (March 1986), a Public Enterprise Rationalization Loan (PERL, May 1987), ASAL II (November 1987), and a SAL (bovember 1988). 9. It is clearly much too early to draw definitive conclusions about the success of Morocco's stabilization-cum-adjustment program, both because the program is still ongoing, and because the effects of many of the policies already implemented will take time to work themselves out. Never- theless, developments in some major economic indicators would suggest that the new policies introduced during 1983-86 have led to some impressive results, at least thus far. Real GDP growth, at about 3.5% per annum during 1983-87, while sluggish did nevertheless represent a small increase in per capita income. Preliminary estimates suggest that real GDP grew at more than 8Z during 1988. Largely because of restraints in both current and capital spending, the overall deficit of the Central Government (on a cash basis) declined from the equivalent of 10.9Z of GDP in 1983 to 5.5Z in 1987. In fact, by 1987 the Central Government current budget balance had become positive for the first time in years. There was also a dramatic turnaround in the current account of the balance of payments, which moved from a deficit equivalent to 6.6Z of GDP in 1983 into a surplus equivalent to 1Z of GDP by 1987. after debt rescheduling, or an improvement of more than $1 billion during those years. II. THE ITPA LOANS AND POLICY DIALOGUE Technical Aspects of the Loans 10. Both ITPA loans were in support of the same ongoing program and were similar in most respects, including disbursement and procurement pro- cedures. The loans reimbursed 100Z of the foreign exchange cost of all imports, except for a negative list. Excluded categories involved goods financed from other sources, goods intended for military or para-military use, and goods for luxuiy consumption. Both private and public sector imports were eligible. Generally (commonly traded commodities and pet- roleum are exceptions) purchases under contracts of $5 million or more each were to be procured through international competitive bidding (ICB) in accordance with Bank guidelines. One difference between the two loans was that up to $20 million of retroactive financing was permitted under ITPA II in order to ensure a smooth transition of the program between the two loans. 11. Bank disbursements took place against statements of expenditure. Other supporting documents (bills of lading, customs and shipping docu- ments) were kept in Morocco (Central Bank and commercial banks) for super- vision missions to examine if they desired. 12. No procurement issues are reported in supervision reports. There is no evidence that there was procurement by ICB, and the Government does not seem to verify that importers are paying reasonable prices and, in fact, does not believe this to be necessary. Both loans were disbursed in two tranches, in large portions, and quickly. ITPA I ($150.4 million) was signed March 1. 1984, and became affectivq on May 25, 1984. The first tranche ($75 million) was disbursed fully in one payment on June 15, 1984. The second tranche ($75 million) vae released on September 19, 1984, and $71.9 million was disbursed within two days. ITPA II ($200 million) was - 5 - signed July 29, 1985, and became effective on October 21, 1985. The first tranche ($120 million, including the $20 million retroactive) was totally disbursed by November 8, 1985. Release of the second tranche ($80 million) was delayed until October 30, 1986 (a delay of 10 months) because of dis- agreements amongst the Government/IMF/Bank on further reductions in the Special Import Tax (SIT). an across-the-board, uniiorm surtax, which was originally scheduled to be abolished; once released, $70 million was dis- bursed in one payment on November 3, 1986, and another $9 million three days later. The Policy Dialogue (1) Morocco's Support for the ITPAs 13. The policy dialogue surrounding the ITPA loans has been excep- tionally fruitful, and the eventual shift to outward oriented policies was very much a Moroccan decision. Even at the time when the policy of forced growth seemed triumphant, there had been some debate among senior officials about the desirability of giving greater emphasis to exports. A report was, for example, commissioned as early as 1977 from a firm of consultants about such a strategy. As evidence was beginning to accumulate that pre- vailing policies were yielding little benefits, Moroccan advocates of a more open trade regime realized that the Bank's expertise could help them map out the practical details of a policy switch. In 1979, a major research project was initiated jointly by the World Bank and the Ministry of Commerce and Industry, based in the Ministry, in order to analyze issues of industrial incentives and export promotion. 14. The research project took three years to complete, during which time Morocco continued the overambitious, unrealistic policies of forced growth which it had been implementing since 1973. The formal dialogue between the Bank and the Government was at an ebb, as evidenced by the failure to agree on the terms of a SAL. Meanwhile, the lone Bank-supported researc'"r who was in charge of the work was finding himself thrust into the unique situation of reporting regularly on his findings to very senior officials. A team of between five and seven civil servants had been assigned to support his research: follcwing the completion of the three- year project, he was asked by the Moroccan authorities to stay, at their expense, for an additional year to help in the preparation of the reforms. The researcher was finding a warm welcome in private firms, which were increasingly irked by Morocco's byzantine system of controls and were happy to shlint their complaints through him to high officials in the Ministry of Industry and in the Customs Administration. Not only did th? Bank, through this process, acquire a thorough understanding of the workings of the industrial sector in the Moroccan economy, the involvement of the indus- trialists also meant that they came to appreciate the potential benefits of a number of reforms, and the almost daily interaction over a long period of time between the research team, government officials and industrialists became the key factor in the process of creating consensus on policy reform. 15. The ITPAs are thus a noteworthy example of the catalytic role that World Bank research can play in furthering policy innovation in developing countries, and of the crucial importance to successful adjustment lending of what has been called "borrower ownership' of the programs.1 Quite soon, the 1983 crisis vindicated the views of the Moroccan officials who had advocated an open trade policy. When the decision was made to go for adjustment there was, thanks to a Research froject that had cost the Bank a mere $161,000 in research and staff support costs, a detailed inventory of the measures that might set things right. This inventory, moreover, was not a document that was brought from Washington in a Bank Staff member's briefcase. Nor did it merely express the ideas of the World Bank researcher and of his supervisors. The reform program was also the result of the hard work and insights of the Moroccan economists who had been assigned to the project, as well as the thinking, experience, and authority of the senior overnment officials and business leaders who had followed it frcm close by. (2) Bank/Fund Coordination 16. The division of labor between the Bank and the Fund followed the generally standard pattern.3 Cooperation was, in pineral, excellent, with the Fund bearing responsibility for macroeconomic policies and budget reform, while the Bank advised on structural policies. The Fund found a ready partner in the powerful Moroccan central bank, proud of its record in curbing credit expansion so effectively that in spite of grossly overambitious policies, inflation had been milder in Morocco than in several countries of Europe. The central bank continues even today to enforce a monetary stringency, which limits public as well as private credit. Because the endemic causes of the Government's fiscal problem -- namely excess expenditures relative to available finance -- had not yet been eradicated, the Government was unable to pay its bills in full. There was as a result a rapid build up of arrears, which have not yet been fully eliminated. Domestically, this caused a troublesome situation -- but inflation was kept under control. 17. Budgetary problems were thus acute, and it is in this area that the dialogue proved most difficult. The reform of incentives clearly had budgetary costs. The Bank's view was that this should not prevent reform. Bank staff were well aware of the problem but felt that trade liberaliza- tion and fiscal reform could proceed in parallel. After all, money is fungible, and reductions in some taxes and increases in some expenditures can be offset by adjusting other budget items. In retrospect, it would 1/ See the remarks on the factors that account for the success of adjustment loans, Report on Adjustment Lending, R88-199, August 1988, pp. 93-95. 2/ The research results became a major input in a survey by a Bank mission of Morocco's system of incentives: World Bank, Morocco: Industrial Incentives and Export Promotion, Report No. 4893-MOR, January 11, 1984. 31 Responsibilities between the two institutions are defined in the December 1966 "Memorandum on Bank-Fund Relations," broadly reaffirmed in 1970 and again in 1980. - 7 - appear that the political difficulties involved in juggling public income and transfers were more severe than anticipated. The disagreement between the Bank and the Fund about the elimination of the Special Import Tax came to play a symbolic role in this debate, 18. The initiating memorandum for ITPA I, dated July 6, 1983, included a number of proposed fiscal measures specifically related to industrial and trade adjustments which would supplement a wider tax reform being pursued by the Government and supported by the Bank and the IMF. Bank management felt, however, that the fiscal area was the domain of the IMF and that the detailed design and monitoring of these measures should be left to the . Moroccan Government and the IMF. 19. Three topics stand out in an examination of policy changes and of the policy dialogue between the Bank, the Fund, and the Moroccan authori- ties. The first is the macroeconomic framework of the program. This has been the Fund's and not the Bank's primary responsibility. Macroeconomic balance is, however, so essential to the restoration of market incentives that a section of this report is devoted to how Morocco adjusted to the balance of payments and budget crisis. The secund and most important topic is, of course, the design and implementation of the ITPAs. The report discusses how they have sought to reduce the biases that had impeded the country's exports and limited its ability to provide jobs and to what entent they have contributed to strengthening Morocco's financial sector. The third topic is the conflict between reforming of incentives and restoring budgetary balance. III. IMPLEMENTATION EXPERIENCE AND OUTCOME The Macroeconomic Framework (1) Adjusting to Balance of Payments Shocks: The Basic Mechanisms 20. Morocco's payments' crisis had been in the making since the mid- 1970s. Between 1978 and 1982 the resource balance averaged -13.5Z of GDP and the external debt grew by leaps and bounds. When the country's access to foreign loans suddenly dried up, large foreign payments arrears had accumulated, a very costly form of "borrowing" because it makes it difficult for importers to obtain prices equally attractive as those offered to more reliable clients. The drop in foreign capital inflows since 1983 sharply reduced the supply of goods to the Moroccan economy: the resourte gap declined from -14.9Z of GDP in 1982 to -5.4Z in 1987.4 This swing in the resource gap is the visible part of the adjustment process. Two indirect losses have to be monitored and minimized to the extent possible. 4/ Report on Adjustment Lending, R88-199, August 1988, p. 136. - 8 - 21. The first *multiplier" reflects the short run lack of flexibility of world demand. To attract new clients, a country must cfer low export prices, and devalue for this purpose. This worsens its terms of trade. Furthermore, in Morocco's case, part of the adjustment was a widespread liberalization of imports: in this instance, the devaluation is necessary to enable domestic producers to adapt successfully to foreign competition. The loss is a short-term one only. Except for phosphates, the country's exports are so small that international markets can easily accommodate larger quantities of Moroccan products.5 How much this mechanism added to the cost of Morocco's adjustment cannot easily be read from the data, as the country's terms of trade are primarily influenced by exogenous events on world markets, such as changes in demand for phosphate rock and fluctuations in the price of oil. However, the fact that a price had to be paid in lowered terms of trade had to be kept in mind. Some of the strongest opponents of policy reform in the country argued vigorously that foreign trade elasticities were so low that devaluation would cause disas- trous terms of trade losses, while providing little benefit to the current account of the balance of payments. In retrospect, this pessimism proved entirely unwarranted. 22. The other "multiplier" reflects the lack of flexibility of supply. As adjustment policies curb expenditures, domestic demand for both traded and non-traded goods falls. Producers of traded goods can benefit from a devaluation through increased production for exports and import substitu- tion. In the non-traded goods industries, however, such as construction, retail trade, and other personal services, producers bear the full brunt of demand retrenchment. This, of course, is not a permanent loss from the country's point of view: in the long run, resources are mobile. In the short and medium run, however, this mechanism may cause a substantial amount of unemployment and excess capacity in those industries. It is this "multiplier" wb4ch accounts for the sluggish performance of countries for several years arter a balance of payments crisis. (2) Macroeconomic Adjustment in Morocco 23. Morocco's difficulties have been cushioned by a substantial amount of adjustment aid. There has been no "debt fcrgiveness," but the ODA loans which the country has received after the crisis did result in a significant increase in the grant element of the debt, from 5Z in 1982 to 28Z in 1987.6 A succession of six debt rescheduling agreements in the London and Paris Clubs have resulted in the rescheduling of $6.5 billion worth of payments during 1983-87. Of this amtount, $1.1 billion were interest reschedulings, where interest payments are converted into additional debt.7 5/ This is true even for the narrow range of textile products in which Morocco has specialized up to now. Morocco's exports of these products are sizeable to France only. Sales to other EC countries are very small; they are almost non-existent to the United States. 6/ World Bank, President's Report, Structural Adjustment Loan, No. P- 4867-MOR, November 8, 1988. 7/ Ibid. - 9 - 24. Pdjustment is, of course, also made easier if exogenous forces work in the country's favor. Here, Morocco was to some extent fortunate, as good harvests in 1985, 1986, and again in 1988, added to the supply of goods. Exogenous changes in the terms of trade were, on balance, also favorable. While phosphate prices have remained weak through 1987, this was much more than offset by the precipitous fall in oil import prices. World prices of grains -- another major import -- were weak until 1988, thanks to a small price war between the United States and the European Community. 25. Morocco, however, was also wise. The 252 real devaluation (para. 37) and the prudent handling of import liberalization permitted a significant opening up of the economy without causing the closure of any major firm. It takes courage to carry out an extensive program of deregu- lation at a time of balance of payments crisis, but the rewards have been handsome. Deregulation, and in particular the measures that improved the access of producers to high quality foreign inputs, led to a substantial supply response on the part of the private sector, to the extent that more jobs were created in labor-intensive export industries than were lost in the construction industry by the cuts in public investment. 26. Increasing output is of course not enough. When production grows, so does income and therefore spending. Measures have to be taken to con- tain expenditures in order to turn the balance of payments around. Public investment has taken the brunt of the demand retrenchment, declining from 10.5Z of GDP in 1982 to 3.32 on average in 1986 and 1987.8 The cuts were not entirely voluntary, with the Government having lost its easy access to foreign money, and because IMF conditionality, supi rted by the Central BanK's discipline, blocked access to the printing press. For a while (1983-84), expenditure on a commitment basis exceeded the state's ability to pay its bills oy a large margin, and arrears of 10.6 billion Dirhams (about 102 of GDP) arose in domestic payments (PCR, p. 20). The terms of the recent SAL, which include a Target Investment Program as part of the loan's conditionality, reflect the Bank's belief that the time has come for some catching up in public investment. 27. A parallel drop in private investment would have been very undesirable, but did not occur. In fact, investment in the manufacturing sector, one of the objectives of the ITPA program, was steady in the years immediately following the crisis but has risen rapidly during the past couple of years (Table 2). Moreover, investments in export-orieited indus- tries have grown at considerably higher rates than in the rest of the industrial sector; these industries also tend to be more labor-intenjive (see para. 43). 8/ Ibid., p. 39. - 10 - Table 2: INVESTMENT IN MODERN MANUFACTURING, 1901-86 (in million Dirhams and N of GOP) Investment GDP Investment/GDP 1981 1,498 76,737 2.0 1962 2,622 90,088 2.9 1908 2,137 94,635 ;.8 1964 2,621 104,307 2.4 1986 2,651 119,656 2.1 1906 3,264 134,334 2.4 1987 4,036 140,000 2.9 1988 5,382 155,735 3.5 Source: Data provided by Ministry of Commerce and Industry. 28. While the brunt of the adjustment fell on public investment, con- sumption also had to be constrained. This, however, occurred gradually thereby limiting the immediate social cost of the crisis. As shown in Table 1, Morocco is one of the few exceptions among highly indebted coun- tries in having succeeded in increasing per capita consumption during a period of severe adjustment. Consumption can be curtailed in a variety of ways. Cutting wages is fast, merciless, and usually necessary. Quanti- F tative information is limited. The available evidence suggests that real wages in the industrial sector have fallen steadily by some 15Z between 1979 and 1985, parallel to the fall in the real effective exchange rate.9 It is notable, however, that this reduction is substantially less than the losses suffered by workers in other countries that have undergone similar balance of payments crises. Government workers appear to have suffered the greatest loss, and there is now a consensus that some catching up is indis- pensable for this part of the labor force. Cuts in public consumption are usually some of the most difficult ones to achieve, but strict measures of economy have been enforced. Between 1982 and 1986 the share of general government consumption in GDP has been reduced from 21.4Z to 17.4Z.10 Nevertheless, there are irportant arels of spending, such as rural health and education, where penr up needs justify an expansion of government programs. To this, the Bank has responded with an Education Sector Reform Loan in 1986. 29. Raising ';exes is another way of curbing expenditures. However, in recent years, the share of taxes in GDP actially dropped, one aspect of Morocco's policies that has caused concern in both the IMF and the Bank. Possibly the best way to curb consumption is to encourage the population to ssve. Here the success of the new policy has been impressive. Gross 9/ C.f. World Bank, Morocco: The Impact of Liberalization on Trade and Industrial Adjustment, Report No. 6714-MOR, March 1988, Volume 2, p. 19. The table also illustrates strikingly the wage explosion that had taken place in the late 1970s. 10/ Report on Adjustment Lending, R88-199, August 1988, p. 136. - 11 - private saving increased from 14.72 of GDP in 1981-83 to 20.32 in 1986-8811 in response to the restoration of positive real interest rates, and the return of confidence in the soundness of economic management. This has improved Morocco's ability to achieve higher growth rates to a remarkable extent, in spite of the loss of its earli : access to foreign capital. 30. A Bank study12 provides an interesting perspective on the relative roles of stabilization versus structural adjustment policies and of exoge- . nous factors in generating the $1 billion improvement in the current account of the balance of payments during 1983-87 (para. 9). About 55? of the improvement is attributed to a reduction in domestic absorption, . largely associated with the decline in the budget deficit, devalvbtion, and a rise in interest rates. Some 30Z of the improvement is explained by exogenous factors, primarily the decline in international petLoleum prices and a return to favorable weather which helped a rebound in agricultural production. The final 15% of the improvement is attributed to the supply- side response of exports to the new policy envirorment: this is signifi- cant given the small starting base of manufactured exports and the lagged response to supply-side policies. 'oked at differently, exports of manu- factures (other than phosphoric acid and fertilizers) grew at 13.2? per year in volume during 1983-87 in response to the new industrial policies, thereby increasing their share of total merchandise exports from 20% in 1983 to 31? by 1987. Restoring Market Incentives (1) The Situation at the Outset of the ITPAs 31. When the balance of payments cris'is hit in 1983, the pattern of incentives in Morocco's economy was severely distorted. Tariffs ranged from zero to 400%. An extraordinarily detailed system of quotas and import restrictions commonly provided factory owners monopoly status in the domes- tic market. This was combined with cumbersome and pervasive price controls. The real rate of interest was strongly negative, and the resulting bias against labor reinforced by widespread exemptions from profit axes. Case studies done by the Bank-supported research team had revealed several instances where incentives were distorted to the point that activities were quite profitable e%en though, at world prices, the cost of inputs exceeded the value of outputs, so that they made a negative contribution to social welfare and to the balance of payments. 32. The programs supported by the ITPAs sought to improve market signals in four different ways. First and foremost, the bias against exports was to be reduced sharply. Imports had been heavily protected, while exporters were subjected to taxes, forced to use low quality domestic inputs, while some had been compelled to sell via government agencies that 11/ President's Report, SAL, p. 39. 12/ World Bank, Morocco: The Impact of Liberalization on Trade and Industrial Adjustment, Report No. 6714-MOR, March 15, 1988. - 12 - knew little about world markets. Effective protection calculations showed that at the outset of the ITPAs, the financial profitability of producing for the domestic market was more than 50Z greater than exporting.13 33. The second goal was to revitalize the country's fInancial system. As in other developing countries, most private investment in Morocco takes place via an informal capital market, where entrepreneurs secure funds through personal, mostly family connections. As a result, they are often unable to obtain adequate funding. To remedy this situation, the Moroccan Government had set up three public credit institutions, the Credit Immobilier et Hotelier (CIH), the Banque Nationale de Ddveloppement Economique (BNDE), and the Caisse Nationale de Credit Agricole (CNCA). However, because their functions did not overlap and because they were forced to lend at below market rates, there was no competition amongst these three. Commercial banks played a very limited role. Interest rates, private credit, and the portfolio allocations of banks were all tightly regulated so that commerc.A1 banks did little more than collect deposits and channel them to the State. 34. The bias against labor was the third area targeted. Interest rate distortions had kept down the price of capital, and profits were sheltered from taxes by generous exemptions. The bias against labor was particularly strong in public investment, partly because of the planners' emphasis on import substitution and 'modernization." 35. The fourth and last goal was that the new incentives system should he stable, transparent, and lobby proof The ten years of "forced" economic growth had been a period cf constant improvisation. Producers lobbied for funds, then sought and obtained the prohibition of competing imports. Almost immediately, they found that their prices were subjected to contrels. As inflation raised costs, their profits became totally dependent on ever renewed authorizations to raise prices and to obtain other favors from the administration. Business life was a never-ending battle with the administration, where profits stemmed from obscure bureau- cratic victories, not from success in improving productive efficiency. (2) The Measures Taken (a) Removing the Bias Against Export 36. The trade components of the two ITPAs are well documented in the PCR (paras. 21 through 24, and Annex I). The essence of the program may be summarized as follows. The focus was on measures in the trade and indus- trial sector designed to improve the allocative efficiency of resource use and reduce the anti-export bias of the incentives system. These measures were to be supported by a Government commitment under its agreements with the IMF to maintain an active exchange rate policy. 13/ World Bank, Morocco: Industrial Incentives and Export Promotion, Report No. 4893-MOR, January 11, 1984. - 13 - 37. On the exchange rate front, the real effective exchange rate on a trade-veighted basis deprr.ciated by about 252 during 1982-87, with most of the adjustment taking place between late 1983 and late 1985. The program of import policy changes, to be implemented over a number of years, con- sisted of the dismantling of quantitative restrictions, customs duty rates reform and the elimination of the SIT. The import licensing regime in place in 1983 consisted of three lists: goods on list A could be freely imported, those on list B required prior authorization, and list C con- tained prohibited imports. The 1TPAs sought to gradually transfer goods from lists B and C to list A. This went very much according to schedule and, in fact, by February 1986, list C was formally abolish-d so that list A accounted for almost 702 of the tariff positions and more than 851 of import value, compared with respectively about 50Z and 402 three years earlier. 38. Pricr to the onset of liberalization, the taxes applied solely to imports consisted of customs duti-R. the SIT and the Stamp Duty. While the latter remained unchanged during 1.PA, the other two were major elements of the reforms. In 1983, customs duty rates varied widely ranging from zero to 400Z. The SIT, on the other hand, was a uniform tax levied at 152 across-the-board (with few exceptions) and therefore relatively non-distor- tionary. As one of the ultimate objectives of the reforms was low and uniform import taxes, the SIT fulfilled that purpose and the reforms could have focussed instead on reducing customs duty rates only. At one point in time, such a course of artion was, in fact, considered, but rejected for the following reasons. F.rst, the translation of selective reductions in customs duty rates into an action program is a slow and long-term process, as firms must be given time to adjust, and therefore this could not have been done in the time framework of the reform program. Second, the primary objective of the SIT was to mobilize fiscal revenues and the rate had, in fact, been increased in successive stages from 2.5Z in 1972 to 15% by the early 1980s, and, as it had not been offset by increased export incentives, it gradually heightened the discrimination of the system of incentives against exports. Third, exchange rate depreciation was a vital part of the program, and when accompanied by a gradual elimination of the SIT, it would not only reduce the anti-export bias but, depending on exact rate changes, leave import prices roughly unchanged, making this a politically most acceptable course of action. 39. The approach decided therefore was to: (a) progressively but slowly reduce maximum nominal customs duty rates in order to reduce dis- persion and lower average protection, and (b) abolish the SIT within a period of two years. In fact, the maximum customs duty rate was reduced to 602 under ITPA I an! to 45Z under ITPA II, both according to schedule. On the other hand, serious implementation difficulties were encountered with the SIT The original program called for reduction from 152 to 10% in January 1984, to 5? in January 1985 and for its elimination by January 1986. Because of its impact on revenues, increases in other taxes were proposed to help offset the fiscal shortfall. - 14 - 40. The SIT was reduced to 10Z in January 1984, but the compensatory measures were not implemented as scheduled or their revenue impact fell below expectation, thereby aggravating the fiscal deficit. This conflict between liberalization and budgetary objectives has remained an issue, with the Bank giving ground when matters came to a show down. At first, during the preparation of ITPA II, the Bank agreed to slow down the rate of reduc- tion of the SIT by a year. The tax was reduced to 7.52 on January 1985; reduction to 52 became a second tranche condition. Then, the second trancht of ITPA II was held up for 10 months and the Bank eventually waived the condition, with what seemed to be a firm promise that further reduc- tions would take place tl-ough with another delay. The Government's fiscal difficulties did not ease, however. The SIT was reduced to 52 in January 1987 but customs duties were raised to compensate for this decline; finally, in January 1988 the SIT (together with the stamp duty) was replaced by a new uniform import tax, which in essence meant a slight increAse in trade taxes. Nevertheless, the end result of all changes in taxes on imports is that the average trade tax rate in 1988 is signifi- cantly lower than that in 1983, though much less so than originally intended. 41. In the area of export policies, the two ITPAs called for a large number of measures to help promote exports. All these policies were imple- mented without significant delays, vith one exception (PCR, para. 30) which turned out to be of secondary importance. Major accomplishments include: a considerable expansion and strengthening of the existing temporary admis- sions scheme, which allows for the duty-f:ee importation of all inputs by direct and indirect exporters; the gradual elimination of the monopolistic control over exports of agricultural and food products by the OCE (Office of Marketing and ExpLrts); the elimination of export licensing requirements for most products; the simplification of procedures; and a major informa- tion effort to promote exports. 42. The intensive information campaign in late 1983 and early 1984 was an important element in the success of the new economic policy. The objec- tives of this campaign were to explain to entrepreneurs the new direction of the Government's economic policy, with its emphasis on export promotion, and the benefits which could oe expected from it, as well as to indicate to them the Government's medium-term objectives in tariff and non-tariff pro- tection. All industrialists visited by the OED mission appeared to be fully aware of the different elements and objectives of the industrial and trade adjustment program. There was a general consensus in favor of the liberalization program, with most industrialists having adjusted fairly easily to the new incentives' structure and stressing the benefits felt thus far especially in terms of fewer administrative bottlenecks and delays and a greater incentive to export. The entrepreneurs themselves expressed amazement at the little time which had elapsed since 1983 to achieve such a dramatic turnaround and change in attitude towards trade policy on the part of the industrial community. 43. The reduction of the bias against exports was vindicated by a very strong supply-side response. As mentioned earlier, e.ports of manufac- tures, which had virtually stagnated during 1978-83, grew at more than 10? - 15 - per year in real terms during 1983-87. An analysis of the relative perfor- mance of industrial subsectors shows that export-oriented industries, fueled by strong export growth, have grown at considerab.y higher rates than the rest of the industrial sector. As mentioned above :para. 27), new investment in industry not only resumed its growth starting in 1986 but also has increasingly been concentrated in export- oriented, labor-inten- sive industries. . 44. Eummary data are presented in the table below. Five industrial subsectors exported, ot. average during 1981-86, more than 202 of their output: textiles (23.6Z), garments (74.3Z), leather and footwear (34.2Z), * basic metals (28.52), and chemicals (45.2Z); two more subsectort, food canning and wood materials/furniture, exported, respectively, 19.8Z and 18.42 of their output. Together these seven subsectors account for roughly half of industrial output and over 902 of industrial exports; their share of new investments in manufacturing rose from about 502 in 1983-84 to 632by 1987, while their share of newly created industrial jobs rose from 522 in 1983-84 to 782 by 1987. Tabl* 8: SHARES OF EXPORT-ORIENTED SUBSECTORS OF TOTAL MANUFACTURING, 1981-87 (in pC-cent) 1981 1982 1988 1984 1985 1986 1967 Share of 5 Subs* tore of: output 81 81 81 88 87 88 87 exports 71 71 78 76 78 71 73 new Investment 82 84 28 84 86 89 62 now employment 31 30 87 41 6 56 72 Share of 7 Subsector. of: output 47 47 48 54 54 54 n.e. exports 89 91 90 92 91 91 a. new Investment 47 41 58 48 59 60 68 new employment 43 47 51 58 66 69 78 Source: Attachments 1 and 2. 45. It is clear that the Moroccan economy has taken great strides towards reducing the bias ag.inst exports. This progress has paid off through better exploitation of the country's comparative advantages, not only in the form of increased exports of manufactures, such as clothing and leather goods, but also of fish products and tourism services. It must be kept in mind, however, that even though import protection has been reduced, its average level remains high; and, this is the only area where ITPA program implementation fell short of objectives. As a result, the bias against exports remains strong. Substantial additional reductions in pro- tection are necessary if the country is to achieve sustained growth of exports and income. - 16 - 46. The unweighted tariff average has been reduced from 58.4Z x' 1983 to 35.9Z by 1986; quantitative restrictions applied to 61? of trade in 1J83, compared with 142 in 1986. These figures, however, overstate some- what the reduction in protection to Moroccan producers. The largest tariff cuts and the greater proportion of the QR removals were for goods that are not produced in significant quantities in Morocco. Using domestic produc- tion weights in calculating averages. QR protection declined from 60 to 40?, tariffs from 66.42 to 38.7Z. World Bank calculations show that in effective protection terms, protection is even more restrictive. If the SIT had been reduced as originally intended, the average tariff rate would have been around 301 (a parallel change in the exchange rate would have been required). 47. The continually high protection of the textiles industry is a good example of ti.e danger of maintaining tariffs at current levels. This is an industry where developing countries, because of low wages, are highly competitive. Yet, in Morocco, for most items, the tariff rate is at the maximal level of 45Z, and much of the industry remains protected by QRs. The temporary admissions scheme, set up under ITPA, has helped circumvent the industry's lack of competitiveness and clothing exports have grown rapidly. The normal process, as countries liberalize, would be to extend their comparative advantages up the process chain, here from production of garments to that of cloth. This will not operate in Morocco, however, as long as heavy protection of the upstream industries shields them from the need to match the productivity and quality levels that prevail on world markets. This is but one example of a general phenomenon. Morocco's recent export successes have involved a very narrow range of goods; this range will need to become much broader which, in turn, will require sub- stantial further reductions from the current very high level of tariff and quota protection. (b) Bank and Financial Sector Reform 48. At the time of the shift in policies in 1983, Morocco was a typical example of what MacKinnon has called a financially repressed economy. There was (and still is) no stock market to speak of. Bank deposits were harnessed for the Government's purposes, thereby cancelling almost entirely the banking aystem's function of channeling savings to efficient investors. Moroccan banks cleared checks, handled deposits and withdrawals, while most funds collected were pre-empted by the state through placement obligations that forced banks to buy treasury securities and securities issued by the public investment banks; the little that was left for private lending was lent at negative real rates of interest, subject to rigid rationing. As the rate of inflation exceeded the rate of interest, the seignorage collected by the state was a large source of revenue. 49. It was unthinkable to deregulate the banking system all at cnce. Because the budget situation was tight, the state needed this seignorage. It did seem feasible, however, to try to revive what the ITPA documents call financial savings, represented at the time largely by time deposits. The placement obligations for these deposits were relaxed, which made them - 17 - more remunerative fnr banks and pavea the way to a substantial increase in interest rates. In addition, the Government decided to experiment with bond issues on the domestic market, at r4:tes thkt were competitive with the new rates for time deposits. The rebponse of *financial saving' was remarkably strong: both innovations were very successful. 50. The new policies also encouraged Moroccan bankers to begin competing. The wencadrement du credit' which rations credit granted to the private sector by each bank was changed to make the ceilings reflect perfo-mance in collecting deposits. There was also a relaxation of pruden- tial regulations wiich had made it difficult for commercial banks to offer medium-term tredits in competition with state credit institutions. 51. Much remains to be done, however, and these measures are but a beginning. The lencadrement du credit* is still in force. The leading rates of interest continue to be set by public regulators. Placement obligations continue to limit the freedom of action of commercial banks, which remaia severely limited in the types of operations which the, may carry out. The 15 existing banks are sheltered from foreign competition by exchange controls, and competition among the banks remains limited. While financial liberalization should proceed, it must be stressed, however, that its eventual success will depend on a prior further strengthening of the macro-economy, especially the control of the public sector deficit and the continued implementation of policies to sustain export growth. 52. Things could change quickly in response to new challenges. An immediate challenge is the integration of the banking sector into the world monetary system. For the moment, in view of the tight foreign exchange situation, capital movements remain controlled. While these controls may preveat sudden outflows of funds, the Moroccan authorities are aware that their impact is limited. For a number of reasons -- large numbers of migrant workers, substantial tourism income, the illegal transactions of fishermen as they by-pass EC import regulations -- capital in Morocco is de facto internationally mobile, and there will be little reason to maintain strict exchange regulations once the foreign exchange situation eases.14 53. Recently, some preliminary steps have been taken. Major Moroccan banks have been authorized to extend their representation abroad. The foreign exchange authorities have understood that exporters need to create a foothold in foreign markets in order to penetrate them or to consolidate hard-won market shares, and it has been easier to obtain funds to finance suck ,entures. The main problem area at present is foreign exchange risk coverage. Under current rigid regulations, it has not been possible for commercial banks to offer this service, and the drain on the Treasury has been significant. 14/ Some of the apparent increase in private saving, for example, undoubtedly reflects a return to Morocco of funds that had been held abroad. - 18 - (c) Removing the Sias Against Labor 54. The new economic policies have been quite successful in elimi- nating the bias against labor in the Moroccan economy. Interest rates remain strictly regulated, but at a level where the real rate of interest is around 8 or 92. Private credit remains rationed, but the evidence sug- gests that credit can be obtained readily at these rates, so that they are effective. The level of interest rates is appropriate, given the situation on world markets, and the high profitability of investment in the country. 55. While it took some time for the Moroccan authorities to bite the bullet of reducing tax exemptions for investment in export industries, steps were finally taken in 1988. The minimum tax was increased, and the period of exemption was shortened from ten to five years. (d) Stability and Transparency of Incentives 56. To be effective, incentives must not only be coherent, they must also be stable, transparent, and lobby proof. The achievements of the new economic strategy in this area have been outstanding. While protection remains quite high and the financial sector remains closely regulated, remaining distortions are far more transparent than before. 57. In the area of trade policy, there has been a broad shift from QRs to tariff protection, which is expected to continue in the future. Proce- dures for granting foreign exchange to importers have been made straight- forward. Import prohibitions have been abo'ished, and the dispersion of tariffs sharply reduced. The QRs are now stable. Morocco's accession to the GATT in 1987 led to the binding of 157 tariff positions (PCR, p. 31). 58. The Customs Office's effort to simplify and speed up customs pro- cedures is one aspect of the new economic strategy from which other developing countries might usefully draw lessons. The reforms were intro- duced following a detailed investigation of a host of practical diffi- culties, and involved close cooperation between the administration and the business community. The importance of speed and reliability of delivery as a crucial ingredient to export success is well known. 59. As in all countries, Morocco sets safeguards to protect domestic producers from imports at unreasonably low prices, in this case through setting minimum prices, rather than through anti-dumping codes. There is no inherent advantage to either system: the GATT anti-dumping and countervailing duties code is so vague that it is very easily abused. It is more important that the system is used sparingly. 60. From its contacts with businessmen and civil servants, the OED mission drew the impression that the strict controls that regulate private sector lending by the banking sector are applied fairly and transparently. Freeing comercial banks from the need to obtain a visa from the Banque Marocaine de Ddveloppement Economique on rediscounted medium- and long-term loans has clearly sped up procedures. Also, evidence suggests that exemp- tions from profits taxes are granted without undue red tape, on the basis of transparent criteria. - 19 - The Conflict Between Restructuring of Incentives and Budgetary Balance 61. The achievement of budgetary equilibrium has remained a major challenge for Morocco. For several years after the 1983 crisis, tax receipts actually dropped as a percent of GDP. The share of direct and indirect taxes in GDP fell from 192 in 1983 to 16.8% in 1986,15 in part because of transitional losses due to the switch over to a value added tax. This trend was compensated for by a special levy on oil, imposed in 1986, , which generated the equivalent of 2.7% of GDP during that year16 and through which the Government has captured the windfall brought about by the drop in the world price of oil. In spite of creditable progress in . containing current expenditures, the current budget, even today, is barely in balance. At the same time, the external public debt has grown as a share of GDP since 1983. Because the brunt of expenditure cuts associated with the adjustment has fallen on public investment, in what is otherwise still a very poor country with a great variety of urgent needs, this trend must now be reversed. It is clear that Morocco will need a steady budget surplus to sustain the public investment which development requires, while stopping the growth of the debt overhang. The Target Investment Program and related measures, contained in the SAL approved in November 1988, if adhered tc, will contribute positively to this objective. 62. It is unfortunate, though not entirely surprising, that these budgetary difficulties created an apparent conflict between the equally important goals of ameliorating production incentives for exports and the domestic market by lowering the SIT and customs duties on the one hand; and improving the budget balance on the other. The controversy over the SIT became a symbol of this dilemma which remains a source of continuing debate in the design of all trade policy adjustment programs. However, it is in reality a wrong dilemma. It became real in the Moroccan context because, contrary to expectations, the often delayed TPS/VAT tax reform, when finally adopted in April 1986, failed initially to broaden the tax base sufficiently and adjust rates upwards by enough to compensate for the reduction in the SIT. In addition, the need for fiscal resources was greater than expected because of the Government's continuing inability, at that juncture, to effectively contain expenditure and so arres' the accumulation of arrears. In retrospect, the debate about the SIT should already then have been put in the context of the overall budgetary and fiscal reforms. The trade-offs bNetween budgetary stabilization and the reforms of production incentives would have been easier to deal with. 63. As it turned out (see para. 39), by January 1985 the SIT stood at 7.5%, half of the 15% rate in 1983. A further reduction to 5% was a second tranche condition of ITPA II. Eventually, the Bank, with strong encourage- ment from the Fund, granted a waiver on this condition. The ultimate goal of abolishing the tax was abandoned. Later on, the SIT was reduced to 5Z but customs duties were raised to compensate for this reduction. Finally, 15/ President's Report, SAL, p. 9. 16/ Ibid., p. 3. - 20 - in January 1988, the SIT was combined with the stamp duty, but the sum total of the two taxes was raised by 2 percentage points. In other words, import taxes are now a full 9.5 percentage points above the original objec- tives. While the new tax is uniform and in that sense a desirable form of taxation, consistent with one of the ultimate objectives of the tariff reform, it did, nevertheless entail a 2 percentage points increase in the total of all import taxes at a time when these still remain very high. While it could be debated whether this increase constitutes slippage or a mere slowdown in the pace of policy reform, it was accepted by the Bank in the context of the 1988 SAL and may be regretted for one major reason: after several years of Bank efforts, a constituency for liberalization had been built up in Morocco -- a rare achievement indeed -- which then, with Bank support, helped push the liberalization programs through the rest of the bureaucracy. This constituency is now left wondering about the Bank's intention and may not be as willing or ready as in the past to insist and support further reform in the future. 64. The budgetary cost of the tariff reductions appears to have been surprisingly small. This can be explained partly by the relatively low share of heavily taxed items in the import basket and by the shift in the composition of imports away from duty-free items such as wheat and petroleum.17 Those who lost are the importers who had been deriving large quota rents by exploiting the loopholes and contradictions of the system. 65. Protection is but one of the areas of potential conflict between budgetary balance and improved incentives. Another is the impact on government income and expenditures of the real devaluation that was essen- tial to the success of the new economic strategy. Discussion of this topic in Morocco has tended to focus on a single, admittedly very large item, the dirham cost of servicing foreign debt, which accounts for a quarter of budget expenditures. This gives an exaggerated view of the seriousness of the conflict. On the debit side, one other item is the cost of the food subsidy programs. There are, however, significant credit items. Devalua- tion increases the profits of the Office Chdrifien des Phosphates (OCP), the State corporation which exploits the country's rich phosphate deposits. It generally improves the competitiveness of other public sector import substituting and exporting enterprises, and thus reduces the cost of sup- porti-g them. It raises tariff receipts by raising the dirham value of imports. Last but not least, the dorestic currency counterpart of the funds lent to Morocco by agencies such as the Bank increases. 66. A final area of friction in the new economic strategy has been the need to reduce food subsidies for budgetary reasons in spite of falling real wage rates. The Bank has persistently advocated reforms that would target these subsidies more effectively to the poor. At first, little progress was made with the Moroccan Government being justifiably apprehen- sive in view of past social unrest both in Morocco and other North African countries when such reforms were attempted. Nevertheless, recently, under 17/ Morocco: The Impact of Liberalization on Trade and Industrial Adjustment, paras. 2.23-2.27. - 21 - the Second Agricultural Sector Adjustment Loan, the Government has begun to develop and strengthen compensatory food subsidy programs targetted at the poorest income groups, to offset a gradual phasing out of generalized food subsidies with major savings to the budget. IV. SUSTAINABILITY Conclusion and Sustainability of the Reforms 67. The primary objective of the Moroccan adjustment program initiated in 1983 was to place the economy on a sustainable path of export-led growth. The ITPA program, accompanied by IMF-supported stabilization measures, was the beginning of this process which has since been further supported by the World Bank through four more sectoral adjustment opera- tions and a SAL. The progress made under the ITPA loans has demonstrated the validity of the strategy and has created a strong constituency in Morocco, among government officials and industrialists alike, for further reform. At this stage, Morocco would appear to be capable of resuming steady economic growth and be in a position, some years hence, to return to international creditworthiness: it could possibly be the first heavily indebted country to do so. The requirements for this are that policy directions initiated under the ITPAs are continued. The economic reform and liberalization process are far from completed, however. At around 40Z on average, protection is still very high and will have to be lowered considerably more to make the economy truly competitive. Also, given the paucity of external capital, the Government will have to maintain a surplus in its current budget if it is to finance needed public investments without crowding out the private sector. Debt rescheduling has now become almost routine, and if the structural adjustment efforts continue to progress and show results, a general debt renegotiation should eventually be possible. A return to access to world capital markets is important not so much because it would add to national savings but because of the gain in flexi- bility through integration of the domestic banking sector into the world monetary system. The Moroccan banking system should be subjected to the test of competition just as much as the manufacturers. This can only be realized through a return to creditworthiness which would reopen the credit markets of the world to private borrowers. 68. Given the size of Morocco's external debt, the challenge which lays ahead is far from easy. First, as mentioned earlier, exogenous factors, i.e. the decline in international petroleum prices and favorable weather, made an important contribution to Morocco's improved performance in recent years: any setback would make the policymakers' tasks that much more difficult. Second, further reductions in protection may encounter increasing opposition both from some industrial circles and from some of those policymakers primarily concerned with fiscal issues. The difficul- ties encountered in the process of lowering the SIT and, in fact, the recent increase in import taxes illustrates the latter. Also, following the significant depreciation of the real effective exchange rate between - 22 - late 1983 and late 1985. it has remained virtually unchanged during 1986 and appreciated slightly during 1987-88: this may be part of the reason for the slowdown in manufacturing export growth in 1988 to 2.6Z in real terms, in spite of good growth in Morocco's markets. Some of these latter developments are very worrisome. Any slowdown in the momentum towards the necessary further reductions in the anti-export bias of the incentives' system tends to discourage the forces behind liberalization in Morocco and may jeopardize the hoped-for development of manufactures exports on a sus- tained basis. &------------------------,-: Tユua加qつ’1コy -EZ- MMOCCO: Production and Exporta of Menufacturing Industry, IN1-68 (million* of Dirhams) Production Exports Exporte]Prod«tion Sub~tor INI 1992 1983 1994 1911116 19N 1981 1982 1983 1984 1966 19118 liffi 19112 lolIG affl 194 IM 10 4,710 6,8W 8,071 8.791 7,305 8.522 18 18 30 så 88 106 0.3 0.3 0.5 0.9 0.9 1.2 11 4,291 4,11M 8,119 7,192 9,042 10,932 el@ 969 1,048 1,= 1,900 2~ 19.1 19.9 17.1 19.9 19.9 21.9 12 2,895 2,910 3.828 2,945 3.148 3,722 42 22 103 48 49 49 1.6 0.9 9.1 1.8 1.6 1.9 la 3,721 3,894 9,941 5,761 8,691 8,779 849 947 990 1,320 1,814 1,907 17.4 22.9 22.6 22.9 24.1 29.2 14 ma 720 964 1,219 1,885 2.298 989 492 514 999 1,~ 1,us 44.2 66.9 U.9 74.1 N.O 112.* la 847 en M 1,169 1,417 1,846 164 219 2154 410 M 667 26.8 28.4 27.4 N.4 39.5 39.9 18 945 1,129 1,194 1,139 1,324 1,5m 94 179 223 246 258 314 11.1 15.9 19.7 21.8 19.1 20.111 17 1,475 1,818 1,9811 2,290 2,978 8,206 201 148 215 240 257 406 lik.III 9.0 10.9 10.5 8.6 åt3 in 2,758 2,932 9,697 9,801 4,102 4, SM 95 as 64 67 70 87 11.1 2.9 1.5 1.6 1.7 1.5 19 M 198 499 974 2.129 1,«8 8 - 290 253 230 974 1.1 - H.I 26.9 10.6 52.2 20 1. MO 2,490 2,511 2,872 9,108 10,452 a 60 ff 66 76 74 2.0 2.0 9.4 2.4 2.4 t.1 21 579 492 592 899 1,394 1,183 1 l 4 b 4 4 0.2 0.2 0.7 0.7 0.9 0.2 22 94 1,440 1,5% 913 2,206 2,333 73 64 90 127 142 lag 7.7 8.9 6.0 14.9 411.4 6.9 23 9117 Ull 1,871 1.298 1,922 2,099 51 73 122 143 240 294 5.2 7.4 9.9 11.1 19.2 18.6 24 90 72 89 71 et 92 1 a 4 4 8 7 8.8 4.2 5.4 5.6 7.2 7.6 25 4,529 8.061 8, 644 9,584 10,ON 11,292 2,240 2,863 3,423 4,871 4,637 4,299 49.5 89.9 52.8 60.9 44.9 H.I 26 943 1,092 1148 1,294 1,406 1,882 6 29 25 67 64 70 0.9 2.7 8.0 4.4 8.9 4.2 27 la 19 la 28 28 32 2 2 i 2 a 15.4 10.6 - 4.3 7.7 9.4 Total 32,098 37 49 42 b# 49,.487 59 31 88 08 4 852 6 522 7 362 10 197 11j326 13.807 16.1 14.9 17.5 20.8 18.9 20.3 Source: Minletry of Commerce and Industry. n IT 0 - 25 - PROGRAM COMPLETION REPORT MOROCCO INDUSTRIAL TRADE AND POLICY ADJUSTMENT LOANS I AND II (LOANS 2377 AND 2604-MOR' March 31, 1989 EMENA Regional Office - 27 - PROGRAM COMPLETION REPORT MOROCCO INDUSTRIAL TRADE AND POLICY ADJUSTMENT LOANS I AND II (LOANS 2377 AND 2604-HOR) I. FOREWORD 1. In 1984, with the approval of the First Industrial and Trade Policy Adjustment (ITPA I) loan to Morocco, the emphasis of Bank support to Morocco shifted markedly away from investment projects to policy-based lending (paras. 12, 13). As in most countries where this has occurred, the shift was in response to changing economic circumstances, which, in the-case of Morocco, arose as a result of the accumulated effects of changing internal and external factors and inap? ropriate policy response over a period of several years, as described below.- 2. The present report consolidates the economic background, describes the Government response to it, and evaluates the support provided by the Bank. Sections II - IV, VI and VII are based on extensive reviews of the loan documentation of the Industrial Trade, and Policy Adjustment loans (ITPA I and ITPA II), as well as on discussions with Bank staff involved in the preparation and supervision of these loans. Relevant related documentation, most notably a case study of the ITPA's prepared by a consultant for EDI (Economic Policy Analysis and Referm, A Case Study of Morocco - Draft: 10/14/1987), were relied on for information and for perspective. Section V of this report represents a brief summary of the impact of the ITPA policy measures on the Moroccan economy. A comprehensive analysis of the impact of the program was undertaken by a mission which visited Morocco in December, 1986, and updated its analysis in December, 1987. The results of the study undertaken by that mission are contained in Morocco: The Impact of Liberalization on Trade and Industrial Adjustment (Report No. 6714-MOR). II. BACKGROUND 3. Prologue: The 1970s. Traditionally conservative economic policies brought Morocco into the 197Cs with modest growth rates and no major financial imbalances. A relatively weak savings effort and conservative external borrowing policies had permitted only a slow rise in the share of resources allocated to investment (18%). Some industrialization had taken place; most of the labor force was employed in the traditional agriculture sector; and phosphates represented about 20-30% of the nation's total exports. ' By the mid-70s, however, economic policy became much more ambitious as export earnings from phosphates more than quadrupled in the commodity boom that followed in the wake of the 1973 oil price shock. Despite the quadrupling of petroleum prices at the same time, the increased phosphate earnings more than offset the country's higher import bill. Increased revenues to the Government encouraged a shift towards more expansionary economic policies. The Government's 1973-77 Economic Plan was revised upwards, and a massive public 1/ This subject is dealt with in great detail in project documents, as well as in the following reports: Medium-Term Adjustment Polic.--s and Prospects, World Bank Report 5785-MOR, August 1985; A Framework for Medium-Term Adjustment, World Bank Mimeo, March 1986; and Issues for a Medium-Term Structural Adjustment Program, World Bank Report 6608-MOR, January 1987. 2/ Morocco has 75% of world reserves. - 28 - investment program was launched. As a result, GDP grew at the rate of 7.5% p.a. during the Plan period, as compared to its earlier rate of 4% p.a.. Public consumption expenditure also increased during this period as the Government sought to offset the impact of international price increases on the domestic prices of certain commodities- _ through subsidies, and as defense spending increased following the repossession by Morocco of the former Spanish Sahara in 1975. An expanding civil service and growing social programs also placed increasing demands on the Government budget. 4. In mid-1975, the phosphate boom began to dissipate, - and the world recession started to adversely affect markets for other Moroccan exports, as well as receipts from tou-ism and workers* remittances. Agricultural production was also advers,ly affected by poor climatic conditions. These factors, combined with accelerated Government investment and consumption expenditures, led to a rapid deterioration of the macroeconomic equilibria. The current account balance went from a surplus position of 3.1% of JL? in 1974 to a deficit of 16.5% of GDP in 1977, and tne overall budget deficit increased from 3.9% of GDP to 15.8% over the same period. In the absence of adequate internal resources to finance these gaps, Morocco moved away from the earlier conservative external financing policies and borrowed heavily from the international capital markets: the result was that between 1975 and 1977 debt-service rose '-om :.6% of exports to 10.9%, and debt rose from US$1,668 million to US$4,094 million. 5. Stabilization Program: 1978-80. In 1978, as the debt-service ratio climbed even higher (18.8%), a three-year interim stabilization program was adopted with IMF assistance (Trust Fund) to reduce the economy's internal and external deficits to sustainable levels. Th2 program comprised demand management policies which focused primarily on reducing investment and increasing import protection and restrictions. The program also called for an exchange rate devaluation which took place in 1980, and for the curtailment of increases in current expenditure. These measures were only partially successful, however, as the initial momentum of the program could not be maintained. In 1979, civil service salaries, which were to have been frozen under the program, were increased by 10%, the minimum wage was raised, and budgetary outlays on consumption subsidies rose dramatically on account of higher import prices for subsidized goods, all leading to a climb in the share of government current expenditures in GDP to a level which could not be sustained by the margit,ally higher revenues being generated by increased trade taxes. By 1980, debt service had reached US$ 1.3 billion.- The debt service ratio was 30.1%. Although the overall treas .ry deficit (commitment basis) had been reduced to 10.3% of GDP and the current account deficit had been more than halved to 8% of GDP, equilibrium could not be restored. The Government requested medium-term support from the IMF in the fo:m of a 3-year Extended Fund Facility program (1980-83) and from the World Bank in the form of a Structural Adjustment Loan (SAL). 1/ Petroleum, sugar, edible oil, flour. 2/ By 1976, phosphate prices had declined back to their 1973 level in real terms. 3/ Includes debt service on MLT debt and IMF charges; excludes debt service on military debt and short-term credit. - 29 - 6. Growing Disequilibria: 1980-1982. Traditionally, the Moroccan economy's main source of growth had come from expanding Government expenditures.-/ The stabilization effurt.s of the early 1980s sought to restrain the high levels of expenditure. However, the economic recession produced mounting pressures for the Government to restimulate growth. As a result, the 1981-85 Development Plan aimed at an ambitious 6.5% p.a. GDP growth rate, to be obtained primarily through increasing public investment by 100% despite domestic resource constraints. The plan also emphasized rural development and recognized the need to ?rovide more effective social programs while containing their budgetary costs.- However, during 1980-82, overall real GDP growth actually slowed relative to its rate during 1977-80.-! Disequilibria increased, and the Government's renewed efforts to stabilize the economy were once more severely hampered by intensified internal political pressures and by a further series of external and internal shocks. The Fund's EFF program was declared inoperative in 1981 when its fiscal targets and credit ceilings were exceeded, ana negotiations of the Bank's SAL were suspended when agreement could not be reached on public expenditure issues.!/ 7. In response to social unrest in mid-1981 resulting from efforts to increase prices of subsidized commodities and from the continuation of the Sahara conflict, the Government's current expenditures on social services, consumer subsidies, and defense continued to rise. Public investment expenditure also rose 46% during 1980-82 as the ambitious investment program of the 1981-85 plan was being implemented. In addition, external factors contributed to attenuating the stabilization efforts including: (i) the 1979 oil price shock, which aggravated an already substantial oil import bill;j/ (ii) the onset of a severe drought in 1981, which reduced agricultural output by one-fifth and led to significant imports of cereals; (iii) the rise in international interest rates, which contributed to a steep increase in debt 1/ Government direct and indirect participation in the economy has been widespread in Morocco. Public Enterprises account for 20% of value added and Government transfers to P"s reached DM 3 billion in 1985, accounting for nearly 25% of the overall Treasury deficit. A comprehensive analysis of this sector is provided in Morocco Public Enterprise Sector Study (8/20/86), and a reform program for it is being undertaken by the GOM, with Bank assistance (PERL, Ln. 2820-MOR). 2/ Since the mid-70s, social activities had accounted for more than half of current budgetary outlays, yet social indicators remained low, especially in rural areas. 3/ Down from 3.6% p.a. in 1977-80, to 2.7% p.a. in real terms in 1980-82. 4/ The EFF was replaced in 1982 by a 1-year Standby program augmented by the Compensatory Financing Facility arrangement. Subsequent IMF and Bank assistance is described in paras. 15-19, and Section VI, respectively. 5/ The 1979 oil shock was also accompanied by a rise in phosphate prices: however, this was much smaller than had been the case in 1973 and was not sustained. Foreign exchange earnings were therefore not enough to support the growth in imports which had occurred in the interim, and foreign exchange reserves were run down faster than desired. - 30 - service; and (iv) the international economic recession, which contributed to a 30% decline in the dollar price of rock phosphates and to declining workers' remittances, Morocco's principal sources of foreign exchange. 8. The Crisis: 1983. The com,ined effects of these factors proved to be more than Morocco's economy could handle. By end-1982, the overall budget deficit (commitment basis) rose to 12.5% of GDP, and the current account deficit rose to 12.7% of GDP. Once again, to finance the current account deficit, the investment budget, and rising debt amortization payments, Morocco increased its external borrowings considerably. Loans were on less concessional terms, and debt-service reached 10.1% of GDP by 1982. In 1983, the economic situation became unsustainable with the foreign exchange shortages becoming so acute in March that the Government imposed emergency import restrictions and massively curtailed public expenditures. Morocco requested formal rescheduling of Paris and London Club debts. In the face of this crisis, it became clear that the sporadic, short-term stabilization efforts of the past alone were inadequate to address Morocco's problems: instead, a more c?mprehensive, medium-term program, combining stabilization and structural adjustment measures, supported by debt-rescheduling, was needed in order to correct basic weaknesses in the economy and to restore it to a pattern of viable long-te:m growth. 9. Structural Problems. The basic weakness which had plagued the Moroccan economy was evidenced by: (i) poor trade performance; (ii) negative levels of public savings, and low levels of private lomestic saviigs; and (iii) poor growth performance, combined with sectorpl imbalances- and high ICOR's, especially in industry. While disequilibria in these areas had been evident for several years, it was after the exhaustion of the Government's growth-oriented, expansionary policies during the latter hcl.f of the seventies that it became clear that the tax and incentive systems which had evolved in the area of trade, finance, and industry contained distortions and biases which led to growing structural current account deficits. 10. Trade. Poor export performance had constituted one of the key constraints to growth in Morocco since 1973. Aside from the decline in phosphate prices and other unfave-able world demand trends, the stagnation of Morocco's export performance during the mid-1970s was also attributable to a lack of diversification and loss of competitiveness of its exports, due to the anti-export biases inherent in the prevailing trade and exchange policies of the time. An overvalued exchange rate relative to the currencies of Morocco's major trading partners, coupled with a highly restrictive trade regime, rendered Moroccan exports less attractive in world markets and export production less profitable to Moroccan manufacturers compared to production for the domestic market. The exchange policies also had a negative impact on tourism receipts and workers' remittances. Meanwhile, imports continued to grow due to the poor performance of the agricultural sector, an investment program heavy in imported capital goods, and an industrial sector dependent on imported intermediate goods. As a result, Morocco has faced a chronic shortage of foreign exchange. 1/ Inefficient allocation of resources across sectors; i.e. high cost social programs. 2/ Including extensive use of import and export licensing and high tariff levels. - 31 - 11. Savings. Morocco's increasing recourse to external borrowings beginning in 1977 was a reflection of the fact that its expanding public expenditures could not be financed entirely by budgetary revenue and private financial savings. The Government's ability to generate savings from current revenues declined rapidly during the mid-70s following the phosphate boom, and by 1980 the current balance turned negative. During 1978-83, actions taken to redress the budgetary deficits concentrated mainly on the containment of expenditure growth, primarily through the politically and socially less sensitive capital account. Revenues as a share of GDP were relatively high compared to other lower middle income countries, so that revenue adjustment had a relatively minor effect on stabilizing the budget. Tax rates were successively increased and new taxes were introduccd. however, collection faltered, and increased revenues werc derived primarily from indirect taxes (especially taxes and duties on imports), which were considered easy to collect. Substantial sources of income" were exempted from direct taxes by the panoply of fiscal incentive codes which comprised industrial policy. In addition, the adequacy of the structure, level, and administration of income taxes remained weak relative to comparable middle-income countries. As a result, the overall tax structure was unbalanced, with biases across sectors and firms accentuating distortions in resource allocation and encouraging uneconomic investments. This resulted in a shortfall in government revenues over the years.-' Private financial savings were also weak during this period due to inappropriate banking policies and negative real creditor interest rates during the seventies. Moreover, commercial banks were required to lend a large share of their deposits to the Treasury at below market interest rates. With the increased d.mand of the Treasury on the banks for resources to support higher expenditure levels, availability of credit to private fitms was narrowed considerably. 12. Despite the high investment ratio achieved in the 1970s, GDP growth declined below its rate in the 1960s. During this period, productivity of capital declined sharply,-' reflecting a deterioration in the efticiency of investment and poor project selection. In industry, this resulted from a poorly conceived import-substitution strategy which involved high-cost, capital intensive projects and which relied on a continuing increase in protectionism: a system of generous investment incentives and an artificially 1/ Following the disappearance of windfall profits from high phosphate prices, tax and dividend payments by OCP, the state mining company, declined sharply after 1975, and profits from its growing phosphate fertilizer industry were declared tax exempt under the existing fiscal incentive system. 2/ For detailed analysis of the fiscal incentive system, see Morocco: Industrial Incentive System in Morocco (RPO No. 671-85); Industrial Policies and Export Promotion, World Bank Report 4893-MOR, January 1984; and the IMF report Maroc, Examen de la Reforme Fiscale, September 24, 1987. An historical summary of fiscal incentives in industrial policy is provided in Morocco: The Impact of Liberalization on Trade and Industrial Adjustment, World Bank Report 6714-MOR, March 1988. 3/ Morocco's incremental capital output ratio (ICOR) rose from 2.6 to 8.1 between 1973 and 1984. - 32 - low cost of capital. In the public sector, the low efficiency of investment in both social and productive sectors was due to poor project selection, wherein capacity was often prematur2ly extended, and other than least-cost options were employed. Aside from declining productivity, the generalized capital-intensive nature of public and private investments had led to less employment creation than could have been expected during a period of industrial expansion. in. THE ADJUSTMENT PROGRAM: RESPONSE TO CRISIS 13. In the wake of the March 1983 economic crisis, the Government sought the assistance of both the IMF and the World Bank to design a comprehensive adjustment program with dual objectives: (i) to stabilize the economy in the short-term by reducing aggregate demand and the size of the budget deficit; and (ii) to transform the economy into an efficient producer of goods and services in the medium-term by reforming the underlying structure of key economic and social sectors. The program envisaged spanned several years and was to be implemented in phases. It constituted a major departure from past approaches to resolving economic disequiliiria: stabilization policies were to be accompanied by structural reform in order to restore sustainable growth to the economy. Specifically, the Government's program sought to: (i) reduce the deficit of the balance of payments over the short- and medium-term through policy changes in agriculture and industry that would promot exports and efficient import-substitution while raising output in these sectors; (ii) improve the allocation of capital and the efficiency of investment, both in the public sector (through appropriate revisions of the investment program) and in the private sector (through reform of the investment codes and of interest rate policies); (iii) increase the level of public sector savings through reductions in the Treasury deficit and improvements in the efficiency of public enterprises; (iv) improve the mobilization of private savings through a reform of the financial sector involving interest rate increases, diversification of financial instruments, and greater competition in the banking sector; and (v) 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. 14. The first phase of the adjustment program started in mid-1983 and focused on: (i) stabilizing the economy through restrictive budgetary policies; (ii) implementing a comprehensive program of adjustment in the system of protection (including the reduction of tariffs and quantitative restrictions), export promotion and incentives; and (iii) initiating a reform of the fiscal and financial system. Implementation of the second phase of the adjustment program began in 1985 and continued the industrial and trade policy reforms initiated in 1984, while expanding the reform program to the financial sector, as well as extending it to the education and agriculture sectors.- In the area of trade policy, this program included further across-the-board reductions in the level of tariff rates and a second round of reductions in 1/ Reforms of the educational and agricultural sectors are not dealt with in detail in this document, although they derived from and form part of the Government's overall adjustment program. These efforts have been directly supported by Bank sector loans (para. 50) still underway and will be reported on in separate PCRs. - 33 - quantitative restrictions, with the objective of reducing the excessive levels of effective protection granted to some sectors, as well as the variation of protection rates within sectors. In support of the Government's program, the IMF approved a series of 3 standby arrangements during 1983-86 to support the stabilization measures. The Bank's program (paras. 20, 21 and 50 below) supported complementary structural reforms. 15. Stabilization. The first IMF program covered a period of about 18 months and initially sought to reduce the BOP deficit by a total of about * 50% (to 6.6% of GDP before debt-rescheduling) by end-1984. This objective was pursued through limits on monetary expansion, reduction in the Treasury deficit, and continued use of the flexible exchange rate policy first - initiated in 1980. The standby was prepared in close cooperation with the Bank to ensure the complementarity of its measures with the contents of the first phase of the Government's structural adjustment program, concomitantly being formulated with Bank assistance (para. 20). The standby was approved by the IMF Board in September, 1983, and provided the Government with SDR 300 million for BOP support. All of its measures were satisfactorily implemented, with the exception of a final adjustment of food prices (1984) following social disturbances, on which the Fund granted a waiver. 16. Although the overall ;.mpact of the stabilization program was expected to reduce the current account deficit, debt-service projections indicated that in the absence of rescheduling, debt-ser.ice payments would continue to create severe difficulties for the capital account of the balance of payments. Consequently, a process of debt rescheduling was initiated in order to ease Morocco's debt profile and restructure during stabilization efforts in keeping with resources availLble. With a rational, medium-term framework in place, supported by both the IMF and the World Bank, Morocco's creditors agreed to an estimated US$8.0 billion in debt relief between 1983-1988. Witnout this rescheduling, debt-service would have averaged US$2.7 billion per yeat during the same period. 17. The second cf this series of IMF standby agreements coverea the period April 1985-February 1987 and consisted of financial support, amounting to SDR 225 million, as well as compensatory financing (SDR 85 million) for shortfalls in phosphate earnings and increased cereal imports due to poor harvest. The principal objective of the standby was to a,tain sustainable internal and external balance by no later than 1988 through a continuation of the policy measures implemented under the 1983-85 Standby, as well as through the application of innovative measures aimed at reducing the build-up of arrears.- Specific measures contained in the 1985-87 Standby were also formulated in close cooperation with the Bank, as these were to complement actions undertaken in the context of the second phase of the Government's adjustment program, supported by the Bank's Second Indust-ial and Trade Policy Adjustment Loan (para. 21). 18. The 1985-87 IMF targets proved untenable, despite their upwards revision during the 1985 mid-year review. Lower than expected transfers from the phosphate company's earnings to the Treasury, combined with higher than 1/ The budgetary constraints which Morocco had experienced since the mid-seventies, combined with a commitment-based budgeting system, had given rise to a build-up of arrears in payments by the Government to its private contractors and public enterprises (paras. 19 & 28 below). targeted public expenditure and lower than expected disbursements from foreign loans undermined the attainment of the program's targets. Despite some positive developments (i.e. increased exports of non-phosphate manufactures), the standby was declared inoperative in December, 1985, with only SDR 10 million used. Following its cancellation, however, the Government continued to act as if the standby was still in force: as a result, a target deficit for 1986 of 6.6% of GDP (cash and commitments) was set--and obtained--aided to some extent by an exceptional windfall gain accruing from declining petroleum prices during the year. 19. In light of this progress, a third IMF standby (SDR 230 million) was approved in December, 1986, for a fifteen-month period. The primary objectives of the third standby were: the attainment of an overall budget deficit, on a cash basis before debt relief, of 5.3% of GDP (8.0 billion DH) in 1987 (including a net reduction of government arrears of 1.5 billion DH); approximate equilibrium on the current account balance; the elimination of all external arrears (SDR 345 at the end of December 1986); and increasing gross Bank of Morocco external reserves to SDR 210 million (about one month of imports). In the longer run, the hope was to reduce the debt service ratio, before relief, from 70% to a more reasonable 30% by 1993. The main elements of the stabilization effort continued to be severe restraint in Government investment and consumption, price increases to reduce consumer subsidies, limits on civil service growth and salaries, reductions in Government arrears, ceilings on credit to the economy and ceilings on non-concessional external borrowing. ProgreEs under this program has been halting, but thE standby was being successfully completed in April 19PS, albeit with waivers on the budget deficit, external arrears, and reserve build-up. 20. Adjustment. In support of the first phase of th,. Government's adjustment program, the First Industrial and Trade Policy Adjustment loan (ITPA I, US$150 million) was approved by the Bank in January 1984. The ITPA I program aimed at: (i) improving the system of industrial incentives so as to address the fundamental issue of inefficient resource utilization in the industrial sector; ii) improving the balance of payments by encouraging exports and a more efficient import-substitution policy; and (iii) promoting greater domestic resource mobilization and increased availability of long-term finance for industry. The strategy underlying this program consisted of modifying industrial and trade policy to encourage an outward-oriented approach, reducing administrative controls, and increasing reliance on market forces. To achieve its objectives, the loan supported the implementation of a program of reforms concerning export incentives and trade policy, and measures to improve the fiscal system, alleviate price controls, and rationalize the financial sector. 21. The second phase of the Government's adjustment program was supported by the Second Industrial and Trade Policy Adjustment loan (ITPA II, US$200 million), which was approved by the Bank in July 1985. The overall objectives of ITPA II remained essentially the same as those of ITPA I; however, the scope of its reform program was broader, to take into account more recent economic developments, notably with respect to public finance, and to deepen the structural reforms of ITPA I, particularly with respect to the financial sector. ITPA II therefore included measures concerning the public investment program and the rationalization of public enterprises, in addition - 35 - to the extension of the measures concerning export incentives, import liberalization, and financial sector reform, first initiated under ITPA I. The objective of the public investment measures was to reform the budgeting system such that the recurrence of arrears in the public investment budget would be prevented. With respect to public enterprises, the ITPA II measures sought to improve the overall structural and financial situations of these enterprises, with a particular emphasis on reducing their dependence on the Treasury and avoiding any further accumulation of arrears. Overall the major arean of reform covered by both ITPA I and ITPA II can be summarized as having been concerned with: - export promotion and import liberalization - fiscal reform - financial sector reform - public investment and public enterprise reform Specific actions required in each of these areas are detailed in Annex I, and are outlined below. IV, ITPA MEASURES AND THEIR IMPLEMENTATION 22. Export Promotion and Import Liberalization. The ITPA trade reforms emphasized reducing anti-export biases through reformed export incentives and a lower level of import protection. Central to this process was the Government's confirmation in the context of the ITPAs of its intent to adhere to its agreement with the IMF and to maintain a flexible exchange rate policy 'with the objective of maintaining and enhancing the competitiveness of Moroccan exports and supporting the program of import liberalization".1/ 23. Exports. To improve the system of export incentives, the ITPAs called for the gradual elimination of anti-export biases inherent in the: (i) system of control of agricultural and food product exports; (ii) administrative procedures for exports; and (iii) special customs regimes. The monopolistic control over exports of agricultural and food products exercised by the OCE (Office of Marketing and Exports) had constituted a strong deterrent to the export of these products: reforms therefore, aimed at the gradual elimination of OCE control over these exports. First, OCE control over processed food exports was to be eliminated, tollowed by the elimination of its control over exports of fresh fruits and vegetables. Also to increase exports of agricultural products, the program called for the abolition of export licensing requirements for all agricultural products subjected to them, except for subsidized basic food products. 24. More generally, to reduce direct control by the Government on exports and reduce anti-export biases, administrative reforms included inter alia the elimination of export licensing requirements for cement, tires, other industrial products, and nearly all mining products. A global approach to 1/ See Government's Letter of Development Policy (5/14/85). In order to reduce the bias against exports of the system of incentives and to compensate for the import Liberalization and duty reductions, Morocco devalued its exchange rate by 10% in Aug., 1983 under the IMF Standby arrangement in place, and by another 15% in mid-1985. - 36 - simplify and modernize foreign trade procedures was to be introduced through the establishment of a Committae for the Simplification of Trade Procedures, in which all agencies concerned with trade were to participate. In addition to reducing existing anti-export biases in administrative procedures, the ITPA's also called for the promotion of exports by the provision of specific information campaigns for entrepreneurs and assistance to exporters. The liberalization of foreign exchange allocations to exporters was also required, as was the elimination of the statistical export tax. A host of measures was required to improve the special customs regimes applicable to exporters. Duty-free access to imported inputs by direct and indirect exporters was to be improved by the gradual extension of the temporary admission system to all industrial inputs, except for those included in a limited negat. a list. Measures were also formulated to improve customs administration and international trade procedures. Finally, ITPA called for the przparation of an Export Code which rationalized fiscal and other incentives granted to exporters. 25. Imports. The Industrial Incentives research project (RPO No. 671-85; para. 51) had identified the negative effects of the existing system of protection on industrial activity in general, and on Moroccan exports in particular. As a result, import-related policy measures prescribed by the ITPAs focused on reforming tariff and non-tariff protection to improve industrial efficiency, and to further decrease anti-export biases. In this context, the ITPAs sought to: (a) reduce the overall level of protection to 25%; (b) decrease the maximum customs duties rates; and (c) even out tariff rates within and between sectors. The primary measures formulated to achieve these objectives included: - the phased abolition of all import licensing requirements--; - the phased elimination of the Special Import Tax (SIT); - the reduction to 45% (by 1/86) and rationalization of customs duties rates, including the elimination of the stamp duty or its incorporation into customs duties; and, - the preparation and adaptation of a new (harmonized) customs nomenclature. Similarly, in recognition of the importance of competition to economic dynamism and productivity, price controls on all but a few subsidized food products- were to be gradually eliminated, along with the elimination of import restrictions. 26. Fiscal Reform. ITPA I was prepared on The understanding that a comprehensive tax reform formulated with IMF assistance would be submitted to Parliament in 1984. The overall program included the introduction of a unified personal income tax and a value added tax (instead of the existing 1/ The import licensing system in place since 1967 included three regimes: list A comprised products free of licensing; list B comprised imports requiring prior authorization; and list C comprised prohibited imports. 2/ Pricing issues related to public utilities and to agricultural products were addressed under subsequent Bank operations, notably the PERL, and the ASAL I and II, respectively. - 37 - sales tax). Given the IMF's involvement in the overall reforms, ITPA measures in this area focussed only on economic development and export promotion aspects identified by the Industrial Incentives research project. These measures aimed at harmonizing fiscal pressure on enterprises while minimizing revenue losses; modifying aspects of industrial taxation disadvantageous to exporters; and restoring fiscal neutrality between local and imported products. Detailed proposals for the reform of direct profit taxes were to be prepared and submitted to Parliament before June, 1984 for implementation in 1985: reform of indirect taxes comprised primarily the phased reduction of the . SIT, and modification of the levels and treatment of sales tax from profit taxes, especially with regard to exporters. Pending the transformation of the sales tax into the VAT under the IMF's program, revenue losses resulting from . the reduction of the SIT were to be compensated for through a 2% increase in the sales tax on manufactured products, and from increased revenue accruing from additional output generated by expected increased exports. In addition, the higher level of imports permitted by the program and loan proceeds generated additional tariff revenues. 27. Financial Sector Reform. In the financial sector, ITPA measures were based on analyses in the Financial Sector Study (Report No. 4957-MOR), and sought to address structural issues relevant to improving financial savings and their mobilization by financial intermedia-ies. To :his end, measures centering on interest rates policy were identified with the objective of ensuring flexible interest rate policy through reform of the structure and level of rates; and of ensuring that prevailing rates reflected actual and expected changes in relevant variables (i.e. inflation, liquidity, and exchange rates) through the establishment of the Permanent Committee for Interest Rates comprised of representatives of the MOF, tne Central Bank, and commercial banks. Financial measures directly in support of exports were also adduced. These aimed at improving the terms of pre- and post shipment short-term financing for exporters, as well as on reducing the risk-aversive tendencies of banks to export financing. To further improve resource mobilization (particularly of long-term deposits) and strengthen market forces in the financial sector, measures were formulated to reduce the high level of obligatory placements of commercial banks in low-yielding Treasury bills and the extent of Treasury financing at subsidized interest rates. 28. Public Investment and Public Enterprise Reform. The scope of the public investment-related measures contained in ITPA I was limited to ensuring that new investments would be subjected to careful analysis of their economic benefits and budgetary impact before being initiated and to restraining the extent of tariff protection afforded new public investments in manufacturing (according to agreed criteria established for the protection of new investments in general). In the course of preparing ITPA II, it became increasingly clear that broader reforms in the area of public investment were necessary. The combined effects of the continued shortfalls in resources and of the Government's stabilization efforts had constrained expenditures for the public investment budget well below the levels foreseen in the 1981-85 Development Plan. Authorizations exceeded funds available by a large margin, a situation which had contributed to a build-up of arrears in 1983 and 1984.- In 1984, over half of these arrears (DH 3.8 billion) was owed by 1/ DH 4.6 billion, and DH 6.0 billion, respectively. - 38 - the State to 80 public enterprises. The traditional budget system had been unable to adjust to the fiscal constraints, and major reductions in public investment were made outside the normal budget process with technical assistance from the Bank. In light of these events, the scope of the public investment measures set forth in ITPA II was broadened: the overriding considerations were to increase the efficiency of resource allocation in the public sector and to arrest the growth of Treasury and public sector arrears. Revised budgetary measures were to be introduced to improve expenditure control such that unused investment authorizations and commitments be cancelled at the end of the budgetary cycle. This involved the development of an annually modifiable Plan, with strict prior control by the Ministries of Finance and Plan, to ensure that only high priority projects were inscribed in the Plan and funded in the Budget, and that limitations imposed by global budget resources were observed. In addition, a computerized management and monitoring system was to be introduced (by June 30, 1986). Vis-a-vis public enterprises, a major reform program was envisaged,"" but within ITPA II, emphasis was placed on the reduction of state arrears to public enterprises and to the private sector; conditions, however, were only on Public Enterprises arrears, and on the reduction of public enterprises' financial dependence on the Government budget. Thc Government was to reduce its net arrears to public enterprises by DH 1 billion by December 31, 1985, and by a further DH 0.5 billion by June 30, 1986. With a view towards the eventual elimination of budgetary transfers to public enterprises, these were to be reduced initially to DH 2.0 billion (excluding operating subsidies) in 1985, with further reductions planned in 1986. 29. Loan Conditionality. Special loar conditionality attached to both ITPA loans related to: (i) satisfactory progress with respect to implementation of the Government's overall program of adjustment (as embodied in its Letters of Development Policy of December 29, 1983 and May 14, 1985, and related side letters); and (ii) the implementation of certain specific meas,ires which were viewed by the Bank as key to the success of the programs (Table I below). Both loans were to be disbursed in two tranches (para. 37). There were no special conditions for first tranche release. Performance on a number of conditions had been required for negotiations and/or Board, and these had been satisfactorily met (Annex I). Formalized special conditions were formulated as conditions of second tranche release (approximately 6 months after loan effectiveness). Government commitment to the overall adjustment program had been demonstrated to be very strong, and prior to release of the first tranche many of the actions required had either been undertaken, or were initiated- . Formal Bank review of overall progress under the loan and of Government compliance with conditionality was required and was undertaken prior to the release of the second tranches of each loan. In addition, extensive informal supervision was undertaken in the context of other Bank operational missions to Morocco and during visits by Moroccan delegations to Washington (i.e. in September 1986 to review ITPA II progress 1/ Following a Government review of the Public Enterprise sector (the 1980 Jouahri Report), and in the context of formulating the ITPA programs, the Bank undertook a study of this sector which subsequently provided the basis of the Public Enterprise Rationalization Loan (Ln. No. 2820-MOR). 2/ These comprised all actions contained in the policy matrixes (Annex I-B and I-C) indicated therein as necessary to have been undertaken "Before Board" anC earlier. - 39 - with the Bank, and Annual Meetings discussions). While there was no cross-conditionality between the Dank and the IMF programs, continued Bank support was predicated on the Government's continued satisfactory performance on the overall macroeconomic framework, such as would be indicated in its Letters of Development Policy to continue to adhere to IMF programs. Shortly before Board presentation of ITPA II, approval of the Fund's 1985-87 Standby was delayed. Board presentation of ITPA II was postponed to enable the Bank to ascertain the reasons for the delay and to ensure that the Government's macroeconomic framework was satisfactory to the implementation of the ITPA II program. Once this was ascertained, the project was presented to the Board. Bank and Fund review missions were closely coordinated and views were exchanged on a routine basis. - 40 - Table 1: ITPA I and II - Special Conditions ITPA I 1st Tranche: 2nd Tranche: $75.4 mln. $75.0 mln. i) satisfactory progress with respect to continued implementation of the program of industrial and trade policy adjustment; and ii) the Government's having taken the following measures: a) reduce the maximum :ate of customs duty on each imported good to 60%; b) liberalize imports, through the transfer of 12% of total imports (in value, on the basis of 1982 dates) to list A (imports free of licensing), so that the percentage of total imports in List A will reach at least 42 of their aggregated values at 12/31/82; and c) eliminate export licensing requirements for all products except mining and basic food products subsidized by the Stabilization Fund. ITPA II 1st Tranche: 2nd Tranche: $120.0 m1n. $80.0 m1n. i) satisfactory progress with respect to continued implementation of the adjustment program; and ii) the Government's having taken the following actions: a) elimination of export certificate requirements for mining Droducts and hides and skins; b) establishment of a Com :ee for Simplification of Fore . Trade Procedures; c) elimination of the Statistical Export Tax; d) reduction of the Special Import Tax to 5%; e) reduction of the maximum ratE of customs duty on each imported good to 45%; f) liberalization of imports through the transfer of specified products; g) payment by the Government of DH 1 billion of arrears to public enterprises. - 41 - 30. In total, there were iver 120-' actions required of the Government under ITPA I and ITPA II (Annex I-B and I-C). Of these, only 3 were specific tranche release conditions under ITPA I, and 7 under ITPA II, in addition to the condition of satisfactory overall progress under the programs (Table I above). Program implementation was undertaken with a great deal of determination and ommitment on the part of the Government. Most requirements of the program were either fully met (and in some cases exceeded), and satisfactory progress was achieved in others to ensure that movement was going in "the right direction." The main area of deviation concerned the reduction of the SIT (paras. 32, 57-63), with a less critical deviation occurring in the completion of the OCE vegetable study (paras. 31, 65). 31. Implementation. In the area of export promotion (paras. 23, 24), the Government maintained a flexible exchange rate policy,i/ simplified procedures governing external trade, eliminated all export licensing requirements as required!- as well as the statistical export tax, liberalized exports of all fresh agricultural products, prepared a new export code with incentives to indirect exporters, reformed the special customs regimes for exporters, and undertook a massive information ca 'paign to promote exports. The only action in this area that was significantly delayed was a study of export marketing of fresh vegetables which was finally completed in 1987 under the Bank's Vegetable Production and Marketing project (Ln. 1757-MOR). Prior to the completion of the study, however, the monopoly of OCE for fresh fruit and vegetable exports was removed, which fulfilled a primary objective of the study. 1/ Covering 19 areas in ITPA I and 28 in ITPA II, with numerous sub- requirements under each area of reform. 2/ The dirham depreciated by 22% in real terms since 1983, aided by good performance on controlling inflation, in part due to restrictive monetary policies. 3/ Including mining products. hides, skins, and lead, the latter of which had not been required. In addition, the original list of goods excepted from the requirement to eliminate export licenses was modified at the request of the Government, to include certain rare species of livestock, collectors items and antiques. - 42 - 32. The system of tariff and non-tariff protection against imports (para. 25) was rationalized and imports were considerably liberalized. Import license requirements were eliminated for more products than was required and the list of prohibited imports was officially abolished. Items free of quantitative restrictions now stand at 89% of total imports, as compared to 38% in 1983, and exceptional protection is no longer granted through QR's. Although the SIT was not eliminated as planned (para. 33), the level of tariff and import duty protection was reduced (to 62% by January 1986) through the reduction of the maximum customs duties from 400% in 1983 to 45% at present, and of the SIT, from 15% to 5% (January 1987). Customs administration and procedures were reformed, and Morocco acceded to the GATT on June 15, 1987. 33. '4ith the exception of the reduction of the SIT, fiscal reforms required oy the ITPA's affecting firms and exporters (para. 25) were largely implemented in conjunction with the comprehensive tax reform undertaken by the Government with IMF assistance. Though with some delay, L the Fund supported reform was implemented and incorporated the reform of the profit tax and the modification of anti-export aspects of the sales tax. The IMF program also included the introduction in 1986 of the long-awaited value-added tax. However, its introduction, in fact, complicated Government compliance with the ITPA requirement to eliminate the SIT because sufficient VAT revenue did not materialize as had been expected. 34. In the context of ITPA I, the Government had planned that consistent with the objectives of revising protection policy, the SIT would be reduced by 5 percentage points in January, 1984 (to 10%); 5 percentage points in January, 1985 (to 5%); and eliminated by January, 1986.-' This commitment was made on the expectation that the resultant loss of fiscal revenues would be offset by increased revenues arising from: (i) a temporary 2 percentage points increase in the sales tax on manufactured products (agreed under IMF Standby); (ii) the linkages between the expansion of exports under the ITPAs and domestic suppliers; and (iii) the introduction of the Government/IMF fiscal reform program (expected in 1985). In addition, higher revenues were expected to accrue from the agreed tariff structure due to the exchange rate devaluation contained in the IMF's program. The first reduction of the SIT to 10% took place, as planned in 1984, but was not accompanied by a further increase in the sales tax. In the course of preparing ITPA II, in light of delays in fiscal reform and Government/IMF concerns over the short-term budgetary impact of the SIT reduction, the Bank agreed to alter the reduction schedule. Rather than a further 5 percentage points reduction of the SIT in January, 1985, a 2.5 percentage points reduction was effected, and the Government planned that a further 2.5 percentage points reduction (to 5.0%) would take place prior to release of the second tranche of ITPA II (January, 1986). The SIT was then expected to be eliminated completely in January, 1987. 1/ The IMF supported VAT program was to have been approved by Parliament in 1984 and implemented in 1985. In fact, Parliamentary approval was obtained in December, 1985, and implementation began in April 1986. 2/ The original proposal was to reduce the SIT by 7.5% points in 1984, and 7.5% points in 1985. However, following discussions with the IMF the negotiated agreement reflected the phasing described above. - 43 - 35. The budgetary situation, however, remained precarious, and Government arrears were accumulating rapidly. Moreover, withholding tranche release further endangered the attainment of IMF performance targets. After extensive discussions between the Bank, the IMF, and the Government, the Bank decided to waive the second 2.5 percentage points reduction as a condition of tranche release, on the basis of confirmation from the Moroccan Minister of Finance that the SIT would be reduced to 5% in the 1987 Budget Law (which was to take effect January 1, 1987) and thet trade neutral compensatory sources of revenue would be provided for in that law. Thus, on October 29, 1986, ten months later than was planned, the second tranche was released. In January, 1987, the SIT was reduced to 5%, but the revenue loss was offset by a 2.5% point increase in customs duties. This action was more or less equivalent to keeping the SIT at 7.5%. Notwithstanding the substantial reduction in protection achieved by the ITPA operations, this particular action, as a strictly revenue raising measure, was inconsistent with the overall objectives of the ITPA program, as stated in the Government's Letter of Development Policy (para. 12 of attachment to IT?A II letter--Annex II-B). 36. In the financial sector (para. 26), the Government introduced significant reforms. Interest rates were transformed and maintained at positive levels in real terms, and institutional arrangements were made to monitor rates and ensure that they adequately reflect market forces. In support of exports, a reform of export credit insurance was carried out, and a medium-term export crcdit facility for capital goods was created. To improve resource mobilization and strengthen market forces in the financial sector, ibligatory placement and reserve requirements on savings and term deposits were eliminated. Credit ceilings for commercial banks were reformed according to performance in deposit mobilization. Finally, the scope of Treasury financing at subsidized rates was reduced as the Treasury increased the share of i.s borrowirg at mark, t rates threagh Treasury bills and bonds, and through tht banks. 37. The ITPA measures concerned with public investment and public enterprises (para. 27) were satisfactorily'- implemented, and have spawned additional, broader reforms on the part of the Government and the Bank. Vis-a-vis public investments, institutional arrangements were made to ensure that all such investments are subjected to financial and economic evaluation before inclusion in the budget,' and that tariff protection afforded new public investments would be granted only on the basis of specific criteria. Of more generalized impact, however, is the initiation by the Government in 1987 of revised budgetary rocedures which would ensure funding for only the highest priority projects, and which would avoid the further accumulation of budgetary arrears (para. 27). A study to computerize the new budget system was completed (in the Budget Department), and its computerization is currently underway.1 Finally, with respect to required payments to P.E.'s towards 1/ A study on the structure of electricity tariffs was postponed by mutual agreement to a subsequent Bank-financed loan to the power sector. 2/ Under the First Vocational Training Project (Ln. 2479-MOR), a training unit was established in the Ministry of Plan to train Government agency and ?.E. staff in prcject financial and economic evaluation. Further support in this area is being prepared in the context of a proposed Public Administration Loan (PAL). 3/ This activity is being funded by the Government. Other departments in the Ministry of Finance are currently preparing computerization programs, with expected PAL assistance. - 44 - Government arrears, cash payments were made to selected public enterprises, totalling DH 1 billion in 1985, and DH 500 million in 1986, as required by the Bank. Moreover, the broader issues of arrears and of P.E. dependence on the Government budget are currently being addressed rigorously by the Government in the context of the PERL (para. 27). 38. Disbursement and Report in g.- As indicated in Table I and noted earlier, both the ITPA I and ITPA II loans were disbursed in two tranches. Both were also expected to be fully disbursed within one year of loan effectiveness. In the case of ITPA I, this took place as planned. Full disbursement of ITPA II, however, occurred about ten months later than planned due to the delayed release of its second tranche (para. 34). Once the second tranche was released (October 29, 1986) it was fully disbursed within one month. Loan proceeds were disbursed against the foreign exchange cost of general imports, excluding goods financed from other sources, goods intended for military or paramilitary use, and goods for luxury consumption. A US$50 million limit was placed on disbursements against petroleum products and food stuffs, and goods procured under contracts of US25,000 or less were not eligible for financing. ITPA II permitted retroactive financing oi up to US$20.0 million of expenditures in order to ensure a smooth transition between the first and the second loan. 39. The MiTinistry of Finance and the Central Bank bore the main responsibility for loan administration. Overall loan administration was satisfactory. Audit reports of the loan accounts were provided as required (although with delay) and were acceptable. Of a total of four status reports required by the Bank (for both loans) on program implementation, only the last was submitted due to the Government's intensive attention to program implementation and to an initial unfamiliarity with implementation of Bank policy loans. The lack of compliance in this regard did not preclude effective monitoring by the Bank, as constant and continuous progress checks were undertaken both as formally required under the loans and through rout ine operational communication. In addition, the collaborative Bank/Fund dialogue on the Government's programs provided additional opportunities for monitoring. V. THE IMPACT OF THE ITPA PROGRAM ON THE MOROCCAN ECONOMY 40. The program of trade and industrial reform undertaken by the Moroccan Government has succeeded in rationalizing the structure of incentiv-js, improving the administration of foreign trade, and changing economic behavior. A comprehensive analysis of tho impact of the liberal:zation program at the macro, sectoral, and micro levels" attests to the positive response of the economy to the reforms supported under the two ITPA loans. This section summarizes those structural changes in the economy which can be traced to the ITPA program. 41. Following the generalized control of imports in March 1983, quantitative restrictions have been significantly reduced. The list of prohibited imports has been officially abolished and the list of imports requiring licenses greatly reduced. As a result, 89% of total import value is 1/ Procurement arrangements are not reported on here, as these were reviewed by OED and are discussed in the PPAR. In any event, this review found n- reference in the documentation to procurement issues under the ITPA loans. 2/ See Morocco: The Liberalization of Trade and Industrial Adjustment (Report No. 6714-MOR, March 15, 1988). - 45 - free of licensing compared to only 38% at end-1983. In addition, the substantial reduction of maximum customs duty rate and of the special import tax (para. 31) have lowered the unweighted average cumulative rate of trade taxes from 58.4% to 35.9%, and the maximum protective rate from 466% to 62% The dispersion of rates across the 8050 positions of the Moroccan tariff code was also significantly reduced. The standard deviation decreased from 40.5 to 15.4. 42. Morocco's accession to the GATT in 1987 reaffirmed its commitment to free trade. The binding of 157 tariff lines, corresponding to nearly 35% of total import value, consolidates the gains achieved thus far in liberalizing the trade regime. Membership in the GATT will confer greater stability on Moroccan trade policy, help the Government resist political pressures from special interest groups for higher protection, and enable policy makers to extract concessions from trading partners in exchange for further trade liberalization in Morocco. 43. Analysis of the change in the structure of incentives as a result cf liberalization-induced policy reforms reveals that a growing proportion of local industry is being subjected to increased competition from abroad. Tariff lines corresponding to nearly one-quarter of total industrial production have been completely liberalized. According to a production-weighted index of protection, the share of domestic manufacturing subject to QRs during the period 1983 to 1986 has declined from 60% to 40% as a function of tariff line and from 45% to 15% as a function of import value respectively. The proportion of license requests approved has increased steadily, reaching 84% in 1986, and the time necessary to process li-cnse appliations has declined significantly, indicating that the licensing regime is being managed more flexibly. 44. Reductions in trade tax rates have led to a fall in the import-weighted mean tariff, excluding wheat and o.1, from 29.4% to 20.7% and in the production-weighted mean tariff from 66.4% in 1983 to 38.7% in 1986. Although not calculated explicitly, effective protection has fallen inferentially by at least 11% across-the-board on products which are not subject to licensing (i.e. QRs). The compression of the tariff structure from above has limited the potential for effective protection. 45. Analysis of Moroccan trade and industrial performance since 1983 indicates that the economy is reacting positively to the more efficient incentive struccure. Export growth has sustained a relatively higher level of imports, leading to an increase in the ratio of external trade flows to GDP from 54.2% in 1983 to 56.3% in 1986-87. Econometric analysis shows that the deprecia-ion of the exchange rate (22.1% in real terms since May 1983) was a determinant factor underlying the 14% average annual export growth of finished manufactures during the period 1983-87. This trend led, in turn, to an increase iii market shares abroad. After stagnating at 1.5% during the period 1982-84, Moroccan manufacturing exports as a percentage of EEC imports rose to 1.9% in 1986. The strong export performance of Moroccan manufactures, moreover, stood the economy in better stead Lo absorb the sharp decline in external phosphate demand which occurred ;,1 1985-86, and so reduced the variance of export earnings. - 46 - 46. Judicious exchange rate management and appropriate macro policies initially served to contain import demand for the domestic market at sustainable levels following the dismantling of external trade barriers. Temporary admission (TA) imports increased their share in total imports from 9.1% in 1983 to 14.2% in 1986, reflecting the improved functioning of the TA regime and the growth in manufactured exports. Consumption imports, including TA inputs for exports, have risen by 17.4% in real terms since the beginning of the liberalization program. 47. The supply-side effects of the adjustment program are manifest at the micro level. Recent evidence reveals that outward-oriented industries grew at relatively higher rates than import-substituting firms, induced by the policy changes which have occurred since 1983. Whereas some of these industries have previously exported a relatively high share of production, others have undergone a significant shift in orientation towards external markets. Analysis of export performance at both the sectoral and firm level as a function of relative factor intensities of production techniques reveals that industries characterized by high export-output ratios are a'so the most labor-intensive. Typical of this category are goods ploduced through subcontracting arrangements, exports of which have risen by 82% in real terms from 1983 to 1985, as measured by a value added index, thus increasing their share in total merchandise export value from 3.4% to 6.9% between 1983 and 1985. The recent expansion of labor-intensive exports can be attributed, in part, to the narrowing of certain fiscal incentives and the adoption of a more realistic interest rate policy. This served to attenuate, if not eliminate, the previous bias against labor. The realignment of factor prices in line with the prevailing conditions of supply and demand has tended to reorient investment decisions away from the relatively capital-intensive technologies that were favored 'u the past. This has been a major factor in improving the efficiency of capital and reducing the ICOR. 48. The analysis of changes in total factor productivity (TFP) and sources of industrial growth provides some further support of the reform's positive impact. The results indicated that nearly all industrial subsectors exhibited higher capital and labor productivity growth following the onset of the adjustment program. These trends were confirmed by the findings of an industrial survey which revealed increasing cost-consciousness and concern with efficiency as a result of greater competition from abroad induced by liberalization. Ma-y firms sought to economize on labor costs by substituting seasonal for permanent employment, while others began to retool as a means of improving product quality. The realignment of the wage-rental ratio in keeping with market forces was an important factor underlying the labor and capital productivity gains which ha-e taken place ia Moroccan manufacturing to date. VI. THE ROLE OF THE BANK 49. Generai. The structural adjustment process that began in 1983 represented a turning point in the nature of Bank lending to Morocco. Prior to 1983, Bank lending to Morocco was comprised exclusively of investment projects and DFC-type operations. Since 1983, however, in response to the needs of the economy and to adjustment measures undertaken by the Government, policy-based lending has comprised an increasing share of the Bank's portfolio - 47 - in Morocco (56.2%). These programs have grown out of comprehensive economic and sector work and have complemented a parallel program of priority project lending. 50. Lending Program. The objectives of the Government's adjustment efforts have been to stabilize the economy in the short-term, while simultaneously transforming it into an efficient producer of goods and services through reform of the structure of key Economic and social sectors. To support this effort, the Industrial and Trade Policy Adjustment loans have promoted manufactured and agricultural exports and improved efficiency in import substituting activities. Under two successive Agricultural Sector Adjustment loans (Loan No. 2590-MOR, signed July 29, 1985; Loan No. 2885-MOR, signed December 4, 1987) input subsidies are being eliminated, private sector activities are being promoted, productivity raised, and pricing, marketing, and trade policies improved. An Education Sector Reform loan (Loan No. 2664-MOR, signed July 9, 1986) is aimed at expanding primary and lower secondary education, reforming the content of the education curriculum, and increasing the efficiency and equity of the educational system, and controlling total expenditures on education. The Public Enterprise Rationalization loan (Loan No. 2820-MOR, signed July 27, 1987) is contributing to resolving the arrears problem of the public sector, initiating actions which are expected to lead to an orderly privatization of some enterprises, restructuring public utilities, and improving pricing of public goods, among other objectives. These sectoral policy operations have been complemented by investment loans in telecommunications, water supply, irrigation, vocationai training, agricultural and industrial credits, and port improvement to provide the productive capacity to help the economy take advantage of the policy reforms. DFC-type operations have continued to provide foreign exchange and technical assistance to private sector firms in industry and agriculture, as well as to low cost housing in urban areas. Lending operations are being supplemented by regular reviews of the public investment program aimed at increasing the efficiency of investment while revising planning procedures. Bank-financed training programs are also being provided to ensure that all public investment proposals receive appropriate appraisal. 51. Sectoral policy operations have provided the Government with quick-disbursing balance-of-payments support at a time of severe resource constraints. In the post-1983 era, gross disbursements have been high, as a result primarily of $1,065.4 million of Bank resources having been committed in support of policy reform. In addition, higher disbursement rates introduced for 15 traditional project loans in the context of the Bank's Special Action Program sought to improve disbursement performance, and thus alleviate project implementation bottlenecks arising from the unavailability of counterpart funds. A necessary consequence of the rapid increases in Bank commitments since 1983, however, is that the amount of repayments in terms of interest and principal due to the Bank are also increasing rapidly (see Table 2). As of March 31, 1988, cumulative commitments to Morocco (less cancellations) was US$3,814.3 m1n, of which US$735.3 mln. have been repaid, US$1789 m1n. are disbursed and outstanding, and US$1290 mln. are undisbursed. Total cumulative repayments in FY87 were US$635.2 mln. against gross disbursements of US$2238.2 mln. - 48 - MOROCCO Table 2: BANK DISBURSEMENTS FOR PRE-ITPA AND POST-ITPA PERIODS (annual averages, US $ millions) Pre-ITPA During and Post-ITPA FY78-82 FY83-87 Gross Disbursements 97.29 273.37 Principal Repayments 25.92 82.38 Net Disbursements 71.37 190.99 Int. + Charges 40.93 91.06 Net Transfers 30.44 99.92 52. ESW. All of the Bank's policy operations in Morocco have drawn heavily on Bank ESW. As a result of the intensifying policy dialogue since 1983, the ESW program has expanded to areas where the Bank enjoys comparative advantage and where the Government favors Bank involvement. The genesis of the ITPA programs lay in the 3-year World Bank Research project (RPO No. 671-85) Industrial Incentives and Export Promotion (Report No. 4893-MOR), undertaken jointly by the Bank and the Ministry of Commerce and Industry. The study's initial focus was on analyzing the 1973 investment codes; however, its scope was eventually broadened to include wider questions related to production incentives, price controls, and economic policy vis-a-vis industry and trade. The ITPA's also drew heavily on Morocco: Financial Sector Study (Report No. 4957-MOR). Similar ESW studies were undertaken prior to the preparation of the Education Sector Reform Program ("Education and Training Sector Survey", Report No. 4105-MOR), the Agricultural Sector Adjustment loans ("Compensatory Programs for Reducing Food Subsidies", Report No. 6172-MOR), and the Public Enterprise Rationalization loan ("Morocco Public Enterprise Sector Study", August 20, 1986). Other sector studies have covered Energy, Transport and Municipal Finance. In addition to these, studies of moru sector-specific topics were often undertaken in the context of Bank-financed projects in Morocco, with frequent collaboration of other multi- and bilateral agencies (i.e. UNFPA Population Study, Health Sector Financing Study, financed under the Bank's Health Development Project). The annual ESW program now includes about 12 tasks annually (including sector memos and extensive strategy papers). The average number of staff years spent on ESW for Morocco between 1982-87 was 6.9. Rather than resist Bank involvement in studies of politically sensitive topics, the Government has often welcomed the Bank's assistance in this regard as Bank support could bolster its political position in undertaking necessary , but socially quite difficult policy refcrms. 53. Other. Bank support to the Government's adjustment program was also provided through the Bank's chairmanship of two Moroccan Consultative Groups, which, until 1985, had not occurred for ten years. The Bank has also participated in Paris and London Club rescheduling meetings as an observer, reporting on the progress of the Government's adjustment program. 54. The primary objective of the first CG meeting (January 9-11, 1985), was to report to Morocco's donors on the progress of the adjustment program, and to solicit from them more creative approaches to their provision of aid to - 49 - Morocco in order to facilitate the rapid completion of the Government's priority investment projects. To this end, non-project assistance and sector lending were encouraged, as were faster disbursement provisions, and increased local cost financing. The meeting was successful in that it sought and won the participation of Morocco's aid donors as partners in the country's adjustment program. 55. The second CG Meeting chaired by the Bank during this period was held in Paris, from March 10-12, 1987. The objective of this meeting was to obtain an additional SDR 100 million, on concessional terms from Morocco's aid donors, to support the Government's core investment program. The request resulted in immediate pledges by two delegations, FF 200 million in unconditional grants and credits from France, and an additional $25.0 million in food aid from the U.S. The Government, with Bank support, also met with commercial Banks after the CG to report on its progress with structural adjustment. This was one of several initiatives to help improve Moroccan relations with the banks and mobilize additional capital. VII. EVALUATION AND CONCLUSION 56. As summarized in Section V and detailed in the liberalizatio; impact study (Report No. 6714-MOR), Morocco's economy has responded very favorably to the structural reforms implemented through the ITPA program. This confirms the overall appropriateness of the programs' policy directions (paras. 20 and 21). In comparing the outcome of the adjustment program with its originally expected results, it must be borne in mind that effecting a structural transformation of an economy may require five to ten years. Thus, the positive results already evident mark the beginning of the benefits of the 1983-87 adjustment efforts, which themselves constitute initial steps of a longer-term effort. 57. Deviation from Program Design. The main area where implementation deviated from the original design was in the reduction of the Special Import Tax (SIT). This measure was identified as problematic and cited as a risk in the ITPA program right from the start, but its inclusion was deemed critical to the program. Reduction of the SIT was a key component in trade liberalization to gain support for QR reductions, but it reduced revenue to a budget facing large deficits (although the net reduction was much less than the gross loss often cited ty the Government). The ITPA I President's Report (Report No. 3707-MOR) stated "the need to reduce the Treasury deficit and the elimination of the SIT would mean that the Government will have to take difficult decisions to raise other tax revenues and cut Treasury expenditures." To address this risk, ITPA I had originally sought to ensure compensatory revenues for the reduction/elimination of the SIT by seeking a commitment from the Government, within ITPA, on specific alternative revenues. However, in the event, the Bank decided that its fiscal requirements should be limited to those areas directly affecting industrial incentives and exports. The design and monitoring of other fiscal aspects "should be left to the Moroccan Government and the IMF."''. 1/ Minutes of Loan Committee meeting of July 6, 1983 (LC/M83-17, August 12, 1983). Pressure to raise the SIT further in 1982 and 1983 had been resisted in favor of increases in the general sales tax, which was a preferable revenue measure, and further sales tax increases had been discussed. - 50 - 58. Thus, while the reduction of the SIT was included in the Bank program, the Bank did not have direct control over its necessary complementary measures. The risks associated with its implementation were therefore heightened. Nevertheless, it was hoped that maintaining the SIT requirement ir ITPA would increase the incentive for the Government to continue in addressing broader aspects of fiscal structural reform. During program implementation, despite intense and continuous collaboration between the Bank, the Fund, and the Government, agreement on and implementation of the compensatory fiscal measures for the reduction of the SIT was not forthcoming, and the timing of the reduction/elimination of the SIT was therefore slowed. 59. The SIT implementation experience is an example of conflicting requirements of trade liberalization vs reductions of balance of payments and budgetary deficits, or alternatively, of adjustment and growth vs stabilization-. Over the years, the SIT, as an administratively and politically convenient revenue source, had taken on an important revenue-raising role. Its elimination, combined with the introduction of a sufficiently high VAT, was viewed as politically and budgetarily risky, although the positive impact on trade and production was admitted and notwithstanding the fact that other measures were contained in the Government's program which would reduce Lhose risks in the short-term (i.e. the compensatory exchange rate devaluation). In addition, the $350 million transfer (equivalent to about DH3.5 billion) from the ITPA loans would have largely compensated for the net revenue shortfalls resulting from the SIT requirement during the ITPA period. One of the justifications of policy lending was to help offset the short-term costs of adjustment. 60. From the IMF's perspective, despite the absence of agreement on adequate fiscal revenue raising measures and the delayed implementation of the fiscal reform program, satisfactory adherence by the Government to the standby program's performance criteria on an annual basis was necessary for continued Fund support. The resource transfers from the ITPA's were embedded in the Fund's annual performance criteria without full allowance for the revenue decreasing impact of the ITPA program. In the face of a level of current expenditures which appeared to be incompressible in the short-term, a continued depressed world phosphate market, inadequate fiscal revenues, and the accumulation of forced savings in the form of Government arrears, short-term stabilization considerations received greater priority than medium-term adjustment objectives with respect to the SIT dialogue. In January, 1988, the SIT was combined with the Stamp Tax under the new name of Prelevement Fiscal A l'Importation (PFI) and raised to 12.5%, equivalent to a SIT of 10% after account is taken of the Stamp Tax. It should be noted however that despite the slower than expected reduction in the budget deficit, performance in reducing inflation (2.4% in 1987) and the current account deficit (1.2% of GDP in 1987) was quite good, and that the chosen trade-off between "stabilization" and "adjustment" was not that clear cut. The joint Bank-Fund study on fiscal reform had recommended several feasible alternatives for raising revenues as preferable to the SIT/PF1. The issue of fiscal reform remains and is currently being addressed in a SAL recently approved (signed December 2, 1988).' 1/ Structural Adjustment Lending: An Evaluation of Program Design (World Bank Staff Working Paper No 735). 2/ For a full account of the changes to the tax system introduced by the Fiscal Reform Law of 1988, see President's Report No. P-4867-MOR. - 51 - 61. The waiving by the Bank of the SIT condition of second tranche release could be interpreted as a compromise in the Government's overall commitment to undertake medium-term adjustment measures, and in light of this, some question may arise as to whether or not the Bank should have released the second tranche of ITPA II (para. 35). Furthermore, in view of the Bank's early awareness of the difficulties involved in its implementation, the appropriateness of having included the SIT in the Bank's ITPA programs to begin with, could also be questioned. 62. In responding to such questions, it must be stressed that of the over 120 measures aimed at structural adjustment contained in the ITPAs, the SIT reduction was one of 7 conditions of second tranche release of ITPA II (paras. 29, 30, Table 1, and Annex I). The Government had and was continuing to satisfactorily implement almost all other aspects of the program and had complied with the other applicable conditions of tranche release, which signified a serious and strong commitment to the overall adjustment process. Moreover, the Government's overall commitment was reaffirmed several times during the ITPA period by its undertaking other extensive adjustment programs (with Bank assistance) in the education, agriculture, and public enterprise sectors (para. 50). Witholding release of the second tranche of ITPA II could have jeopardized these efforts in a larger adjustment program, which was also generating benefits. In addition, the implications of witholding the resource transfer from the Bank on the Government's ability to comply with the IMF program and to have access to its resources and to debt rescheduling would have had serious ramifications for Morocco. These factors combined indicate that the attainment of ITPA's objectives would have been in greater jeopardy had the Bank not been flexible on the SIT issue, and that despite non-compliance in this area, release of the second tranche was appropriate. The potential difficulty in achieving the SIT target had been recognized and its risk accepted: many, if not all, of the benefits from its reduction were obtained. 63. In evaluating whether or not the SIT (or other fiscal measures), should have even been included in the ITPA's, several factors indicate that despite its problematic implementation experience, inclusion of the SIT neasure was strategically appropriate. The SIT was a reliable tax that did not increase distortion among importables, and it did tax some capital goods imports that were otherwise free from import duties under the various Investment Codes. On the other hand, its reduction/elimination was viewed as a key element in the overall ITPA program because it reduced anti-export bias, brought producer prices closer to border prices, reduced dependence on trade taxes, and with the devaluation, compensated for the increased price of imports while promoting exports, thus attenuating some of the social costs of adjustment. The SIT requirement also served to re-open a policy dialogue on budgetary issues which had broken down during negotiations of the 1980 attempted SAL (paras. 5, 6). While part of the ITPA program was aimed at reducing and rationalizing expenditures, the insufficiency of resources to meet necessary investment expenditures was, and remains, of great concern. Staff analysis had indicated that the structure of revenues also inhibited growth in the medium term, particularly the high level of taxes on trade. In the context of the overall fiscal reform supported by the IMF, it was expected that alternate, less distorting revenues would compensate for the reductions in trade taxes. Pressures to raise the SIT for revenue purposes in 1982 and 1983 - 52 - had been resisted in favor of raising domestic taxes, indicating the feasibility of further movement away from trade taxes. The inclusion of the SIT was also viewed as strategically important in terms of gaining support and acceptance in the industrial community for the QR reduction program. Without the reduction of the SIT, it is unlikely that as much progress could have been made on trade liberalization. Nevertheless, instead of aiming at complete elimination, it might have been desirable to accept a positive but lower target te from the beginning. In fact, the Bank had decided not to press for a rzduction below 5% after the release of ITPA II's second tranche. 64. The continued constraints on public expenditure and the Bank's involvement in these issues have led the Government to seek further assistance in critical structural reforms in fiscal and expenditure policy. To this end, the first SAL (FY89) to Morocco was recently approved (Ln. 3001-MOR). This program aims at achieving a sustainable increase in the rate of economic growth while enhancing Morocco's external creditworthiness and comprises reforms in the fiscal, budgetary, trade and debt areas. Lessons learned from the SIT experience in terms of the need for timely coordination between Bank and Fund programs and for a_priori understanding on alternative measures in critical areas prov"d valuable in the preparation of this program, and are expected to contribute positively to the smooth implementation of both the Bank and the Fund programs, currently in effect. 65. A much less serious ITFA design problem was evident in the delayed completion of the OCE vegetable marketing study (para. 30). The dismantling of OCE's monopoly over the export marketing of processed agricultural products was required under ITPA I by September 30, 1984. Since the elimination of this and of the monopoly on fresh fruit and vegetable exports %ere expected to raise complex issues, the Bank required that a study of the arrangements for export marketing of fresh fruits and vegetables be undertaken by the Government. also by September 30, 1984. The ITPA I President's Report states, "on the basis of this study, appropriate changes for export marketing of fresh vegetables could be implemented in 1985". This timing gave OCE no incentive to cooperate in the study. Instead, OCE saw the study as an unnecessary inconvenience and a means of justifying a prior decision to dismantle its export marketing function. The study was finally completed 3 years atter the target date, at the insistence of the Bank, by which time new arringements for export marketing of fruits and vegetables had already evolved. In this case, had the required date for the completion of the study preceded th dat of the dismantling of the OCE monopoly, OCE may have been more willing t coop-rate in its undertaking in the hopes of affecting its outcome and ot having a voice in its resultant recommendations and decisions. Also, it had betn d- ided that OCE would be left only with a quality control function following the dismantling of its monopolistic export marketing functions. In light .t this, the study could have proposed to review OCE's institutional needs to arrv out its new function effectively. This would have given OCE an added inctntive to complete the study by making the undertaking directly relevant and also useful to it. - 53 - 66. Conclusion. The magnitude of the adjustment effort undertaken by the Government and the Bank since 1983 has been great. That these efforts have continued and expanded is a tribute to the Government's seriousness about adjustment. Deviations from the program, other than delays, have been few and have been in areas identified ai risky. This attests to the Government's commitment and to the soundness of the design of the ITPA programs, as well as to a close and effective relationship between the Bank, the Government, and the IMF. The success of the program also demonstrates the importance of having sound precise analytic work, such as generated by the 3-year Bank research project (RPO 671-85) and subsequent ESW, both, to design appropriate policies and to establish a serious dialogue with senior officials on the . adjustment program. The progress on liberalizing external trade has highlighted the importance of simplifying procedures and of liberalizing domestic trade for subsequent steps in the adjustment process. - 55 - ANNEX I-A GOVERNMENT ADJUSTMENT PROGRAM FOR ITPA I AND ITPA II IP2.I 1TPA.I (1) 11: reduction to 10%. (1) il: reduction to 7.5%. (11) Initiation of a Government information (ii) -- campaign concerning new trade policy. (iE) Eart Incentives: 1st round of elimi- (iii) Exnart Incentives: elimination of nation of export certificates, various statistical export tax; elimina- improvements in special customs regimes; tion of more export certificates; increase in foreign exchange; improve- further improvements in special ment in export credits and insurances. customs regimes: preparation of new export code. (Iv) Imoort Liberalization: share of free list (iv) Import Liberalization: preparation imports to reach 42%; definition of action of next year's import liberali- plan to eliminate total input loans. zation. (v) Tariff Reform: preparation of tariff (v) Tariff Reform: preparation of pro- reform, pari passu with import visional tariff structure with liberalization. protection cap of :5%. (vi) Tax Reform: approval of e-ioling legis- (VI) Interest Rates: introduction of lation by Parliament and eiimination of more flexible interest rate oolicy; anti-export dispositions of TPS regime. creation of a Permanent SubC-mis- sion for interest rates; pri:--ration of .tudy for elimination of interest rate rebates in investment codes. (vii) Interest Rates: selected increase of (vii) Credit Ceilings & Placement Re- credit and deposit rates, including for quirements: elimination of obigatory foreign worker remittances. placemen' & reserve requirements on term deposits; credit ceilings to reflect term deposit mobiliztion efforts. (viii) Price Controls: relaxation for about (viii) Foreign Exchange Risk Coverace: 60 families of goods and services. creation of foreign exchange risk Fund in Treasury with participation of specialized lending institutions and review by Bank of progress. (ix) Interbank Competition: extension of 3rd signature rights to commercial banks for MT credits; preparation of action plan to allow specialized institutions to accept sight deposits. (x) Money Market: issue of Treasury bonds to public, and greater recourse by Treasury to money market for short-term financinl. (xi) Public Investment Proaram & Enterprises: introduction of new investment budgeting techniques to keep commitments in line with available resoures and updating of cross arrears matrix for public enterprises, preparation of arrears reduction program and reduction of net government arears by 1 billion OH. HDRQ"Q__,iSUMARY OF MEASURES AND STATUS OfA IMLE MNATIO14 Of IhIL 11PA_PIG AND LIST OF POSSIBLE MEASURES FOR IMPLEMENTATION IN A SECONDPHASE Of REFDAN I. EXPORT PROWTION First Year Status Of List of Possible measures for" Program implementation implementation under the 1985 FITPA program A GenrAl 15asur9s 1. Devaluation of the exchange rate ip line with Comnitment to a Done Flexible exchange rate the stand-by arrangement with the IMF flexible exchange (17% devaluation) policy under INF standbyz' rate policy 2. Export code (exemption from profit tax for a Implementation in 1985 (draft longer period, and extension to indirect exporters, text expected by September 1994)2' 4 to 5% subsidy on prefinancing export credit) 3. Statistical export tax (0.5) Elimination over the medium terma. B AgriculLuralad an a"Lrdut 1. Abolish the export monopoly of OCE for Implementation In progress processed food products before October 1984 2 Elimination of required export licensing for about Implementation before Done a Lept for 100 positions in the customs nomenclature July 1984 live animals 3. Implementation of study on export marketing Implementation In progress Implementation of study's of fresh vooetables before October 1984 recommndations " C. Spocial Customs Reanimes 1. The procedure of temporary admission would be Done Extension of temporary admission to extended to include all imported inputs except containers (metal, cardboard. PVC) for those Indicated on a list and to allow before January 1985-2 indirect exporters to take advantage of this procedure 2. Wastage allowance. The firm would indicate to Done the customs office wastages. and rates for wastage allowance. Those rates would be accepted by the customs office as final unless the customs office would decide otherwise within a period of six months I/ easures already agreed under the ITPA program for implementation in the medium-term. I/ Possible additional measures for implementation in second phase of reform (to be finalized). 01 0 I: EXPORT PAOMOTION First Year Stat 1"t %%ible measures for"' Program implen. ion eng* ation under the 1985 PA program 3. Drawbacks to be replaced by temporary admission D( system. for firms primarily engaged in exports 4. Where goods originally produced for the local Ot market are exported, manufacturers may import non-consumable inputs under the temporary admission system, to replace such inputs used in the exported goods 5. On-site customs clearance for imported inputs D. and exported products 6. Capital goods belonging to foreign firms and Implementation by D imported for use in exports production to be June 1984 exempt from import duties 7. Required bank guarantees for customs duties on Implen.tation of a D Stue feasibility I imported i..vuts system of mutual guarantees of ucing an insurance granted by one firm to another fac ,' 0. Administrati redureu 1. Reduction of the numiber of products requiring Elimination of export certificate Done. -pt f * n of export certificates an export licence (export certificate) for all products except mining live ils. 3 a products.2/ products and subsidized colle . ite basic food products and a les by June 30. 1984 2. Study of export procedures for mining products Completion of study Not c tion of (specific taxes, export certificates, visas of in 1984 Lionsz/ the Ministry of Industry and Commerce). 3. Clarification of procedures foe imports and Publication by Done exports; publication 3f a revised manual June 30. 1984 concerning customs regulations 4. Offices with expertise in special customs regimes Done for exporters in ports of Casablanca and Tangiers, and Casablanca airport S. Program to give special assistance in explaining DoI customs regulations to new exporters during an initiated initial six month period 1/ Measures already agreed under the ITPA program for implementation in the media-term. 2/ Possible additional measures for implementation in second phase of reform (to be finalized) I * fTIlmI First Year Status of List of Possible measures for" Program implementation Implementation under the 1985 FITPA program E. Markt Develomnt Increase of rate per diem and ceiling per trip and Rates increased by 33% Automatic forei n exchange per individual for foreign travel by exporters for (June 1984) allocation equal to 3 of market development and export promotion exports or a certain % of the value added in exports.2' F InternaUnLIransorot Study of problems of small exporters In marine Study initiated Done trinsport in 1983 with UNCTAD G. Iformation C.miaig Such a campaign. in late 0,83 and early 1984 Done To be pursued.2' will aim at informing entrepreneurs of new Government policy direction with emphasis on promoting exports; also seminars aimed at explaining policies to officials affected by changes or responsible for implementing them. Also, information campaign to explain to entrepreneurs the Government's medium-term objectives (1988) In tariff and non-tariff 10 protetion Don To e pusued ]/ Hasues lredy gred uder he TPAproramformplmenttio inthemedum erm 11EAR[LAiLMORilMAIff YAIMCION First Year Status of List of Possible measures for'-' Program implementation implementation under the 1985 FITPA program A. ariff _LeLitl 1. Special Import Tax on all imports of 155 Reduction by 5 Done further reduction percentage points to St by January (to 10%) 198S and elininatioi by Jasksary 190b. 1 2. Reduction of maximum customs duty rate Maximum rate to be Done Maximu rate tu be reduced to 60% by reduced tu 4SI And/ June 30. 1984 or general reduction of all taliffs~. 3. Implementation of the harmonized system (new customs nomenclaturet and preparation of the reform of tariff and nontariff a monection a) Rationalization of customs duties on the Draft text to be Not done (delays due basis of te new harmonized international ready by Deceer to the International customs nomenclature and integration of 1984 council on customs old customs nomenclatuie into the ime one nomenclature) b) Implementation of new nomenclature To be doie w J,ut 1. 1987 c) Preparation of the tariff reform with the Preparation of Done for a few sectors Preparation of tariff aim of harmonizing the effective protection tariff reform reform for tme medium rate term. 4. Protection Policy for New Investments a. Protection will generally be given Implementation of Done Continued implemntation only through tariffs, and not through principle of principle." quantitative restrictions; An the exceptional cases that quantitative restrictions are considered hecessary, these will be limited II tPreparationoof3taraff i ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~ rfr forure tlreae agred tudrteIP poumfriplmnaini temdu-em a. Protib e ctionwl eesfrallypbemenIpeetation iseodpaefrfrm(of Don Coninudlipzeentt)o 0 01 1li- IARILflANUilN-ITARI FF PFERIKN First Year Status of List of Possble measures for" Program implementation implementation under the 1985 FITPA program b. After the first 3 years following project Implementation of Done Continued implementation completion, tariffs would be set at a level principle of principle.' providing protection not in excess of 25% c. Protection along the lines of (a)and(b) will implementation of only be accorded to projects where viability principle is demonstrated after rigorous economic and financial analysis 5. Evaluation of new public and private investment Done To be pursued projects Economic evaluation critciia including the criteria of exchange savings will be applied to new public and private investments in manufacturing under the Industrial Investment Code. when these investments are subject to a convention with the Government (investment in excess of OH 50 million or below this amount in specili ed sectors). b. Organizational Aspects Done a. Establishment of planning unit in the Ministry of Comierce and Industry to be responsible, inter alia. for the analysis of requests for protection and of proposals for public investment in industry b. Preparation of manual for the evaluation of Done and applied Continued application of protection requests manual methodology.' B. IVor " t ri1Qion5 hl;Llvos: Progressive import liberalization in order to improve industrial efficiency through greater competition from abroad. During this process of liberalization, the Government intends to give priority to capital goods (including imports under the investment codes), and to intermediate products not manufactured in Morocco 1. Transfer of all raw materials and spare parts Done except for some spare in List B (import licensing) to list A (no parts for car engines, moped restrictions) engines, farm equipments, and electrical circuit breakers. 1/ Measures already agreed under the ITPA program for implemenlation in the medium I rm. %A4 01 oft tol 11jiARIfL AHIUlolJARRf PROT[CT105 First Year Status of List of Possible measures fiir" Program implI nentatOi implementation undee the 1985 FITPA program 2. No restrictions on imports of goods for use Principle recognized Done except for a few Fu-ther reform of the procedure in production for exports and in implementation products of iemporar admission for exporters. 3. Transfer of a further 12% of total imports To be effected by Done (in value, on the basis of 1982 figures) to July 1984 list A. so that the percentage of imports in list A will reach at least 42; this transfer will exclude wheat. sugar, green tea, crude oil and oil obtained from petroleum dnd bituminous materials. 4. Transfer of additional 6% of total imports. To be effected Done (July 1984) on the same basis. and with the same between Jul, aid 48% of import,, - exclusions as in (c) above December 1984 in List A (free imports) S. Progressive elimination of import restrictions First step done in To be continued in parallel with the prevalent in 1983 (with the exclusion of July 1984 revision of customs tariffs and the items injurious to public morality and implementation of programs of indus possibly certain luxury articles) trial restructuring. lhe process is to be completed by 1988 "I 6. Progressive elimination of import interdictions Specific content First step done in July Process to continue wth induNtries (List C) existing in 1983 of the action plan for 194i (products trans- long-established in 4oiocco and 198S in this area to ferred to list A or 8) to be completed by 1988-" be defined in 1984 7. Restructuring of specific sub-sectors Studies to be carried In progress, nearly all Studies to cover other sectors. out, in Loordination studies are completed as required.' with the preparation for the 1985 tariff of the tariff reform reduction program, to prepare specific sub-sector rectructuring plans 1/ measures already agreed under the ITPA program for implementation in the medium-term. 2/ Possible additional measures for implementation in second phase of reform (to be finalized). 00 01 0M% tol L EII ALRLE11 first Year Status of List of Possible measures for" Program implementation implementation under the 1985 FITPA program Oh.ietlR: To reform direct and indirect taxation so as to iater lia improve industrial incentives through i) harmonizing the fiscal pressure on enterprises while minimizing loss of .evenues; and ii) reducing significant distortions. A. lirct Taxation Measures to establish uniform profit tax rate. Detailed proposals for Reform to be presented il~tation of reforms simplify accounting rules for taxation of reform of direct to Parliament at the In January 1946. Also, small firms and provide for re-evaluation of taxation to be presented asitumn session (first over t1w medium-term. the balance sheets to Parliament before session of 1984) coefficients for the reev: mid-1984 luation of balance sheets will be revised." 8. IfdrESt Taxation The measures (1) and In progress Implementation Modification of aspects disadvantageous to (2) would be prepared of III and exporters through: and approved in Jan. 1965. - 1) Acceptance of deduction of sales taxes (TPS) will Reform to be be generalized, in particular, to cover wholesale presented to Parliament trading companies; at the autu session 2) Revising and harmonizing TPS tax rates (this would include abolition of differential rates for local products and Imports) 3) Abolition of "cut-off rule" according to which firms Not done This abolition cannot claim deductions of sale tax (TPS) in excess would be effected of the sale tax on outout in the medium-term with itelemoe tation of a value-added tax. " o 4) Study of wastage allowance rates toabe applied fo Study to be cotleted in eot done fiscal purporss when a product imported by an 19s4 by fiscal authorities exporter is sold locally and Ministry of Coomerce. Industry and Tourism I/ measures already agreed under the ITPA program for implementation in the medilm-term. 0 01 Reform toob IV_ FINANCIAL SECTR REFD First Year Status of List of Possible metsures for" Program taplementation ieplementatioe under the 198 FITPA program A. Mobilization of Financial Savinas 1. Interest rates to be flexible, and fixed at Agreement reached Interest rates on Continued agreement levels permitting the necessary equilibrium on principle; savings and term on principle. Further between national savings and investment deposits, medium and measures identified and and long-term credits are to be iaplemented under positive in real term. FITPA. 2. Increase in interest rate Rates on non-rediscountable Done credit increased by 1% in Aug. 1983: Rate on incremental deposits of Moraccan workers abroad increased to 8. B. Rgfo*m of Exoort Credits 1. Ceilings on export prefinancing Ceilings being applied more Done Agreement on a greater increase flexibly (up to 3 months of in prefinancing export credit annual exports) Study by Government of means to foster a greater use of export credits. 2' 2) Extension of mturities of short-term To be done in specific cases Done export credits to allow for transport time 3) Medium-term export facility for capital goods . Creation of facility Done . Effective ue by commercial Not done Study to be prepared by Ministry comercial banks will be of Finance by September I964 developed. Study of feasibility and implementatiens of recammn- of extending tbrm from S to dations in 19S to foster effective 7 years and extension to exports use of medium-ters export by construction and engineering facility.2' service firms 1/ Measures already agreed under the ITPA program for iaplementation in the medium-term. Z/ Possible additional measures for implementation in second phase of reform (to be finaliaed). 0! 01 00 F-A IM _1INANCIALSECILfali First Year Status of List of Possible measures for" Program implementation implementation under the 1985 FITPA program 4) Provision of bank guarantees for export Study of feasibility Not done Study of bank guarantees and other contractors in construction through a initiated and implemen- export constraints by the Ministry consortium of Moroccan banks tation of study's of Industry-2' conclusions C. Reform of Exoort Credit Insurance: a) Extension of insurance coverage to include To be studied by the Done manufacturing risk insurance Government in 1984 b) Elimination of globality rule. so as to permit Done exporters to insure only part of their exports c) Removal of minimum limits on premium and Done maximum limits on repayments d) Allocation of budgetary credits to insuring Done agency (OMCE) ]/ Measures already agreed under the ITPA program for implementation in the medium-term. Z/ Possible additional measures for implementation in second phaie of reform (to be finalized). 00 Ol EL RICL LIBERALIZATHOf First Year Status of List of Possible measures for" Program implementation implementation under the 1905 FITPA program QkJeLivth To make the Moroccan economy more responsive to market forces. so as to increse dynamism and productivity Piugiessive elimination of price controls, so that Prices of 19 products Removal of remining price such controls would only be retained for subsidized liberalized in 19B3 controls on about 12 basic commodities, public utilities, and commodities Liberalization of Done for 10 products manufactured products.' for which there is limited competition prices of 10 more manufactured products. according to agreed schedule I. fgR4_floduKt All powder milk To be done by (June 30, li84) September 1984 Soft drinks Done Imported butter. " (Dec. 31. 1984) Rice Done (in advance) [I. Pgt ugm frigUU Lubricants Done III. Industrial Products Color television sets Done except Refrigerators. (Dec.31. 1984), cars molasses kitchen stoves (diesel and gaeline (lowest category). Dec.31, 1904). ordinary tractors, trucks of soap (Dec.31. 1984). more than 5.5 tons, tires (self-revision. paper pulp, diesel June 30. 1984). explosives engines. (Dec. 31, 1984), matches detergents, .avelle (self-revision. Dec.31. 1984) water, batteries. molasses (June 30. 1984), scrap metal (June 30. 1984). Cattle-cakes Done (in advance) IV. Srvice Four star hotels Done Hotels three stars (June 30. 1984) and less." 0o J/ Measures already agreed under the ITPA program for implementation in the medium-term. OH IS16B-Disk 1069 0W 08/29/84 O- MATRIX ITPA II - PR dated May 6, 1985 Morocco: Summary of Ieasures and Implementation Schedule of ITPA II QMMQCCO: SECOND INDUSTRIAL AND TRADE POL ICY ADJUSTHENT LOANIT-1PA-II) StNMARLRl fLMASURES 1/ Condition of 2nd. tranche release Measures being executed/ Wring/ d1ready imulamented Before Neaotiations BfrS_ABr Presentation AftAt efoe June 30. 1986 I. FKA'RT PRft)S1ION ANlDPROTFTION REFDAMI 1. Exchange Rate Maintenance. in agreement with IMF. of a flexible exchange rate policy 2. L.port Certificates Elimination of export certi- ficates for hides and leather and mining products with the exception of barytine. lead minerals. unrefined lead and charcoal ". Food Products Preparation and beginning of implementation of action plan to improve export marketing of fresh vegetables 4 Customs Regimes a)Temporary admission pro- F) Elimination of glass for cedure: elimination of items packaging from negative list on negative list except g) Reduction of the average glass for packaging. agricul- period of customs processing tural and fisheries products by s%. b) Decentralization of administration of pre- exporting procedures c) Customs guarantees: introduction of global annual guarantees d) A-WLiLri settlement of customs litigation, without blockage of ongoing transactions el Updating of customs Code and tariff list S. Simplification of Foreign Trade Procedures a) Establishment of Commit- c) Iaplementation * tee for Simplificition of of ist phase of Go Foreign Trade Procedures I/ reform of b) Preparation of an Itine procedures rary of exports and imports 0 1 Measures being executed/ already imolamented Before Neantiations Before BoardiUSQL n Before 2nd T1ranche Rlcase k(l.v Ju1i . .129 6. Exchange allocation Automatic allocation of to- exporters exchange up to 3% of annual export value with right to accumulate allocations 7. Statistical export tax Suppression of the tax 1/ 8 E,port Code Preparation of Export Code 9- Special Import Tax Reduction of the tax from Reduction of the tax from lot to 7.5% 7 ,4 to 5% 1/ 10. Maximum rate of keduction of the maximum customs duties rate to 45% 1/ II. Rationalization of Understanding on Preparation of provisional tariff structure & calendar & work duty structure with tariffs customs nomenclature program for prepa- in conformity with rate of ratory work protection not exceeding 251 12. Non-tariff protection a) Transfer of a certain b) Preparation of a number of products from list of products to be list U to List A. and transferred in 1986 from List C to List 8 or A from List I to list A and from List C to List B or A c) Understanding that d)Transfer of specified supplementary protection products to List A (frAm for new investments will not Lists 8 or C) and to List N be through quantitative (from List C) 1 restrictions, except in duly justified and excep- tional cases after discus- sion with the Bank II. PUBLIC INVESTHENT PROGRAM & PUBLIC ENTERPRISES eitlostment Prourm 13. Rationalization of a) Determination of revised public investment ceilings for appropriations and budget comitments in the Investient budget for 9AS following cancellations in 1985 b) Ieview of investment program for 1986-88 14 Reform of budgeting a) Initiation of preparation b) Functional design of new cl Iplementation ,g and planning system of new budgeting system computerized system of new system 00 abl£Alterarists 15. Reduction of Gvt. Understanding on ceiling Discussion with the Bank of 0a transfers to public for transfers in 1985 measures in IS6 to reouce "t enterprises financial dependence of LA public entreprises on Gvt. Measures being executed/ already inlemented BRfor U"OLl&tiiM Before BoartFrestntio gn Raflttlas.imaclRtlas bdrt-jim e12 1"fi I6 Preparation of matrix a) Preparation of matrix b) Updating of matrix of public sector covering 60 public up to end 1984 & its arrears (Govt; public enterprises in different extension to 80 enterprises and local sectors enterprises collectivities) 17. Plan for settlement a) Preparation of sectoral b) Understanding on amounts c) Reduction of net arrears d) Reduction of of arrears plans for resolving to be paid by Govt. of the Govt. to public entre- net arrears of the arrears, settlement to public enterprises prises by ON I billion" Govt. to public of disputes. etc. to reduce arrears in entreprises by a 1985 & 1986 further sun of O 0.5 billion 18. Programs for restruct- a) Implementation of b) Initiation of study c) Initiation of uring public enter- specific piograms in some of energy & power preparation of comprehensive prises (price/tariff sectors covering price tariffs reform progrant (or public increases, reform of increases & action plans sector enterprises structure, finances. control and management of enterprises) III. FINANCIAL SECTOR REFO 19. Interest rate policy: a) Freeing of certain Increased flexibility of interest rates (partic- the system of establishing ularly deposits with interest rates. & mainten- maturity beyond 1 year) ance of deposit A lending b) Conve-sion of other rates at real positive interest rates into levels (except in the minima (for deposits) case of export credits/ and maxima (for lending loans & cereal rates) production) c) Reduction of number of rates set by monetary authorities d) Establishment of system of pivot rates with subsequent changes of these rates in agreement with the Bank and the IMF e) Creation of a Permanent f) Review & modification of Sub-Commission for Surveil- interest rates according to lance of Interest Rates analyses agreed g) Preparation of measures for freeing credit allocation and lending rates 9 review of propositions with Bank 20. Progressive elimination Study in collaboration with Preparation of of interest rate rebates the Bank to identify program of elimi- measures to reach objective nation of rebates of elimination of rebates (in 1986) 0 1 **k C) Measures being executed/ alreadv imolemented Before Netotiations Before Board Presentation Before 2.;1 Tranche Release kfore June 30. 1986 21. Coverage of foreign a) Creation of a Foreign c) Periodic consultation with exchange risk Exchange Risk Fund the World Bank to study the with: i) payment by performance of the foreign specialized financial exchange risk coverage system institutions tHDE, CIN. d) Initiation of a study CNCA) of the difference to examine iaplicit foreign between their lending rate exchange risk in dirham and the irterest rate transactions of camercial on foreign borrowings, banks less a margin to permit adequate profitability; ii) payment by the specialized institutions of an amount of it on disbursement of medium & long term loans. b) Assumption by the specialized financ,al institutions of 2Z of all foreign exchange losses or profits on foreign borrowings after June 1. 1985 22. Obligatory placement a) Elimination from base b) Elimination from base requirements on for calculating obligatory fcr calculating obligatory comercial banks, placements of deposits Placement requirements of 0% and reserve beyond 12 months all term deposits and r4pquirements certificates of deposits, and increase of rate on Sight deposits to 3S; elimination of term deposits from base for calculating reserve requirements 23. Allocation of credit Modification of system ceilings to coaercial of allocation of ceilings banks to reflect deposit mobilization effort of banks 24. Bank camissions C fnication to Bank of results of study to be co- gleted by SePt.10. l9b5. to select 2ank c nissions which would be transformed into maxim. ieplemen- tation of reform. 00 0I Measures being executed/ already simDiAented afsu- "Caatol Dfouji" eenlion kfore 2nd Tranche Release BeforeJJMMilf,JLlo 25. Encouragement of a) Extension to OME b) Commnicati to Sank of competition between of riint to grant results of legal consultation comercial banks & third signature on regarding permitting specialized specialized financial medium term credits financial institut:ons to receive institutions deposits from general public; if Positive. Iolementation of measures: If negative. commnication to Sank of next steps for amending law governing specialized financial institutions c) Implementatson of measures to Permit spccialized financial institutions to issue certificates of deposit dS toclementation following discussion with lank of results of study concerning permitting othrr banks to grant third signature for rediscounting 26. Reform of taxation a) Modification of tax ci Replacement of affecting financial laws on bank provisions tax on products sector so As to clarify conditions Service% (TPS) by in which risk Proaisions value added tax can be established (TVA). with intro bb Reduction of registration duction of fiscal fee on capital increases of reform cfnnpanies quoted on the d Posibility Stock Exchange granted to coanies to revalue asset% (with introduction of fiscal reform) 27 . ,-lopment of the a) Financing of Treasury c) Experimental issue of OW-..Y market bills through Increased Treasury bonds to general recourse to money market Public borrowing at non- d Mobilization of supple concessional rates identary funds on financial bd Increase of proportion of market through fresh refinancing of oanque du borrowing from public Maroc at flexible interest rates 16- Reform of the Caisse Initiation of study Implementation of 2.c Esxperimental ossu of Centiale de Garanti fdr rebiltation of CCsupplemmesue 2. EtabisInt o r.~.Attee for Simplification of Foreign Trade Procedures. 3. Suppression of Statistical Export Tax. 4. Reduction of the Special Import Tax to Rl m 0 S. Reduction of the maximmia rate of customs duty to 4on. pir &n 6. Transfer of specified products to List A (from Lists B or C) or to List 8 (from List C) as agreed with Bank. 7. Payment by Goverdment of specified amounts of arrears to public enterprises. - 71 - ANNEX II-A Page 1 of 4 TRANSLATION OF THE ORIGINAL IN FRENCH December 29, 1983 Dear Mr. Clausen, Statement of Development Policy Since Independence, Morocco has followid a pattern of growth that has emphasized development of national capabilities, and increased self-sufficiency through reduced dependence on imports. There has been major progress in creating the base of a modern and progressive economy. However, an unintended consequence of import sLZZLItution policies, of the structure of protection that has evolved in support of these policies, and of exchange rate management. has been a disincentive effect on exports in agriculture. manufacturing, and tourism receipts. A second major structural question that concerns the Government is that of the level of domestic savings. After increases in the late sixties and early seventies, domestic savings fell from 15 percent of GDP in 1972 to 11.5 percent in 1980. Meanwhile, the Government has faced the need to meet mounting demands on its financial position: it was considered essential to increase military expenditures in defence of the national territory, and the highest priority was attached co increasing the access to social services, and to meting the basic needs of the poorest sections of the population. Gross fixed investments rose sharply in the mid-seventies, reflecting the strategy of accelerating growth through higher Go-..rnment expenditure and public investment. This strategy was successful in raising the growth rate in real terms from 4 percent p.a. in the 1960's to 6.7 percent in 1572-77. However, imports of goods and non-factor services increased by over 17 percent p.a. in real terms in 1972-77, while exports lost their dynamism and grew by only 0.6 percent p.a. Because of the important commitments by the Government, there was a rapid increase i. Treasury current expenditures in excess of current revenues. The financing of current budgetary expenditures led to increasing fiscal pressure, and consequently some adverse effects on the allocation of resources and the growth of private financial savings. Because of the effort to mobilize resources in the face of constraints on domestic savings, there was an increase in foreign indebtedness (much of it on commercial terms). In 1978-80 the Government, realizing the gravity of overall imbalances in the economy (particularly in the balance of payments and budgetary position), undertook serious stabilization efforts, in collaboration with the IKF. The policies of this period centered or. demand-management, and included reductions in investment outlays, stricter import controls and a devaluation of the exchange rate (in 1980). Thete measures brought about a decline of the current account deficit from 16.5 percent of GDP in 1978 to 8 percent 1980. Since then, the Government's efforts to stabilize the economy have been severely hzmpered by external shocks. - 72 - ANNEX II-A Page 2 of 4 As you are aware, developments, both international and internal, have placed a great strain on the Moroccan economy over the past several years. The series of external shocks in recent years have included the 1979 rise in oil prices, the rise in international interebt rates, and a decline in the world price of phosphate, Morocco's principal export. A severe drought in 1980-61 reduced agricultural value-added and led to substantial imports of cereals. In addition there has been renewed financial pressure to meet defence needs, social priorities, and to implement the increased investments of the 1981-85 Development Plan, which aimed at raising the GDP growth rate to 6.5 percent p.a. As a consequence, the overall Treasury deficit rose to 14 percent of GDP in 1982, and there was a correspoading weakening of the balance of payments position. By 1982 also, the debt-service ratio had risen from 18.7 percet. of exports of goods and services in 1978 to 35.8 percent. The rate of growth of the Moroccan economy and the pattern of this growth are of great importance in any structural analysis. Despite the sharp increase in the investment ratio achieved in the seventies, the growth rate of the economy has fallen to a level of 3.2 percent p.a. in real terms in 1977-82. barely above the rate of growth of the population. The Government is determined to reverse this trend and is committed to improving the efficiency of investments and the process of project selection. The Government is equally committed to restoring balance to the pattern of growth. In this connection, recent trends in the productive sectors are disturbing. The agricultural sector, which grew by nearly 4 percent p.a. in the 1960's experienced large fluctuations in output in the 70's in response to poor climatic conditions, and the trend rate of growth in 1973-82 was only 0.8 percent p.a. At the same time, value-added by the industrial sector increased by only 4.3 percent p.a. in real terms in 1972-82. and in 1982, it stood below the level reached in 1979 (in part because of a severe decline in the construction sector). Fellowing discussions with the International Monetary Fund, in mid-1983, the Government decided that a renewed stabilisation effort was essential. In September, agreement was reached with the IMF on a stabilisation programme covering the period up to the end of 1984. In the context of this programme, the Government's objectives are (a) to reduce the current account deficit of the balance of payments Lo 9 percent of GDP in 1983 and 6.6 vercent in 1984; and (b) to reduce the Treasury deficit to 8.7 percent of GDP in 1983 and 6 percent of GDP in 1984. It is also the Government's objective to further reduce these deficits in o%h,*quent years. It is clear that the extent of the disequilibrium in the Moroccan economy requires that the renewed stabilisatiov effert adopted by the Government in mid-1983 be pursued over an extende% period of several years in order to return to a financially sustainable internal and external situation. The Government is determined to adopt the series of policy measures necessary - 73 - ANNEX II-A Page 3 of 4 for succesi of the stabilisation effort over the medium term. However, pursuit of the stabilisation effort alone will severely constrain the prospects for growth of the economy, with consequent implicutions for employment and the pursuit of the Government's objectives for scial policy. Accordingly, the Government is convinced that stabilisation policies must be accompanied by the implementation of a sustained program of policy reforms, aimed at addressing structural constraints, in order to restore dynamism in the economy. The Government wishes to secure the support of the World Bank in this effort. The Government is aware of the importance of pursuing structural reforms in various sectors of the economy. In order to ensure that reforms are based upon a sufficient depth of analysis, and to address the most pressing issues facing the economy, we believe it is essential to develop a series of reform programmes dealing with different sectors. As a first priority, the Government has already begun to implement a programme of structural reform in the area of industrial and trade policy; the objectives of this programme are to improve the balance of payments through the development of exports, generate more efficient import substitution, and establish the basis for increased employment and growth. This programme is described in detail in the attachment to this letter. Subsequent reform programmes, in addition to pursuing the medium-term effort in industrial and trade policy reform, could ade:ess issues of public enterprises, reform of the financial sector, incentives and resource allocation in agriculture, and reform of the system of education and training. The Government wishes the World Bank to give consideration to providing financial support for the implementation of these reforms. Substantial preparation work needs to be done in all these areas before comprehensive programmes can be formulated. As you know, we are discussing with Bank staff the detailed arrangements for the execution of the necessary analytical and preparation work for these programmes. I would like to emphasize that the programme of industrial and trade policy reforms outlined in the attachment represents a significant departure from past policies, and that we propose to bring about important changes in our economy in the medium term. This letter and its attachment summarizes the essence of the Government's new economic policy objectives, designed to bring about key changes in priority areas in order that Morocco's economy could grow on a sound and viable basis. The Government declares its cormitment to the objectives of the stabilizaton and industrial and trade policy programmes as described in this lettet and its attachment, and will carry out the actions and policies described in this attachment. In view of the measures being taken, we would - 74 - ANNEX II-A Page 4 of 4 appreciate your favorable consideration of the Government's request for an Industrial and Trade Policy Adjustment Loan. It is our hope that the World Unk vill also support our efforts through other sector lending, as appropriate, in the medium-term. He appreciate the continuing exchange of ideas with the Bank, and look forward to the opportunity to discuss from time to time the progress in iaplementing the reforms which are planned. Yours Sincerely, Abdellatif Jouahri Minister of Finance ANNEX II-A Attachment Page 1 of 9 THE PROGRAMME FOR INDUSTRIAL AND TRADE POLICY ADJUSTMENT 1. The basic strategy underlying the Industrial and Trade Policy Adjustment Programme (ITPA) consists of (a) shifting from an inward orientation to an outward-looking approach to industrial and trade policy; and (b) reducing administrative controls and increasing reliance on market forces. It is our belief that such a strategy will permit Morocco to improve the efficiency of the economy and to realize the substantial potential which exists for the development of exports, particularly of manufacturel products. It also offers the prospect of achieving a structural change in the industrial sector, encouraging the development of new industrial activities and creating substantial additional industrial employment. The promotion of exports is of particular importance, as a contribution to sustaining domestic economic activity, helping to meet the foreign exchange needs of the economy and helping to service external debt. 2. The policy measures contemplated fall .nder the following major headings: export incentives; protection reform; fiscal reform; fi..ancial reform; and price liberalization. The implemertation programme in each of these areas, including progress achieved so fa is summarized in the following paragraphs. Export Incenives 3. The Government's policy is that the maintenance of an appropriate exchange rate is crucial to stimulating exports, in addition to its role in complementing tariff policy in providing r-asonable protection to domestic industry. The Government's policy is also that exports should be free of taxation on imported inputs and that in principle this advantage should be extended to indirect exporters. The Government will expand its export promotion programme and expects to make rapid progress in this area. Measures already implemented or which will be implementated before the end of 19R4 are the following: 4. Exchange rate: The exchange rate was devalued by 101 in August 1983 with respect to a basket of currencies. A flexible exchange rate policy will continue Zo be applied in 1984, in line with our agreement with the IMF, and with the objectives of maintaining Morocco's competitiveness and supporting moves towards trade liberalization. 5. 7ood Products: In order to promote exports of tinned and other processed food products, the Office de Commercialisation et d'Exportation (OCE) has held a series of discussions with producers' associations in the relevant sectors, with the objectives of modifying current export procedures, adapting OCE's administrative systems, and particul.cly of resolving the issue - 76 - ANNEX II-A Attachment Page 2 of 9 of alternative utilization cf staff assigned to activities in these sectors. A new marieting system based on the freedom of individual enterprises to export, will be operational at the latest, by end-September 1984. OCE will continue to be responsible for quality control. A study on the export-marketing of fresh vegetables is plnned. This study vill be completed by Septemer 30, 1984, and recommendations aimed at increasing fresh vegetable exports, which could be implemented at the beginning of 1985, will be made. 6. Special Customs Regimes: The Government introduced several important reforms in iavor of exporteri in late 1983. First, the procedure of temporary admission, permitting exporters to imi. rt automatically, free of duties and taxes, was extended to cover: (i) all iaputs imported by direct exporters except chose explicitly specified by the Customs Office; (ii) indirect exporzers. Secondly the wastage allowance procedure has been revised, the principle being that firms would indicate wastages and wastage allowance rates to the Customs Office, and that these razes would be accepted as final, unless otherwise decided by the Customs Office within a period of six months. Thirdly, the regime of drawbacks has been reformed, so as to replace drabacks by the system of temporary admission, for firms primarily engaged in exports. Fourthly, in cases where manufacturers opt to export goods already produced and destined for the local market, they are permitted to import non-consumable inputs under the temporary admission system, to replace such inputs used for the manufacture of the exported items. Fifthly, the Customs authorities have instituted a new systcm which allows exporters to obtain customs clearance for both imported inputs and exported products at the production site, rather than at the port of entry or exit. To complement these measuros, capital goodr belonging to foreign firms, and imported for use in export production, will, with effect from June 1984, be exonerated from import duties. Consideration is also being given to the extension of new forms of guarantees, for customs duties potentially payable by exporters, in replacement of traditional bank guarantees. 7. Administrative Procedures. Administrative procedures and controls on exporcs have also been simplified. The number of produLts subject to export licensing requirements will be subsLantially reduced. Before the end of 1983 export licensing requirements for cement and tires will be abolished. By June 30, 1984, export licensing requirements will be abolished for all other products subject to export licensing at present, except for mining products and subsidized basic food products. In the case of mining products, export procedures and taxation will be the subject of a study in 1984. In order to ensure that exporters develop a full understanding of recent zustoms regulations, and in particular the stipulations concerning Lhem, a customs manual will be prepared for publication by June 1984. In addition, an office specialized in the customs regulations for saporters has been created in each - 77 - ANNEX II-A Attachment Page 3 of 9 of the ports of Casablanca and Tangiers, and the airport at Casablanca. A special section for dealing with the problem of exporters will be created at Customs headquarters before end 1984. The Customs authorities have initiated a programme to give special assistance in explaining customs regulatins to new exporters during an initial six-month period. 8. Market Develooment. In order to allow exporters to investigate markets and develop sales, the rate per dies and the ceiling per trip and per individual have been raised by 20 percent for foreign travel. These rates and ceilings w&. be revised at least once annually, to provide for inflation. 9. International Transport. In view of the importance for exports of international transport, the Government initiated in 1983 a study of the problems encountered by small exporters in the case of marine transport; this study is being carried out by the Ministry of Fisheries and the Merchanc Marine, with support from UNCTAD and its recomendations will be reviewed and appropriate follow-up action will be decided before the end of 1984. 10. Information Campaign. In order to inform entrepreneurs of the new direction of Government policy aimed at promoting exports, the Government will undertake an information campaign, during late 1983 and early 1984. Seinars will also be held to explain the Government's policy in this field to officials affected by the changes or concerned with the implementation of the new policies. 11. Tariff Protection. The objectives of the Governrwnt's tariff policy are to foster greater competitiveness and improve the efficiency of investment and labour use. The Government will achieve those oLjectives through a phased lowering and evening out of tariff rates so that the maximum rate of protection would not exceed 25% by the end of 1988. 12. Towards this goal and in order to promote exports, the Governmeat will reduce the special import tax from 15 to 10 percent, with efftct from January 1984. Subsequently, the Government intends to reduce this tax from 10 to 5 percent on January 1, 1985, and to eliminite it on January 1, 1986. No custom duty rates will be increased with a purely fiscal objective, to compensate for the reduction in the special import tax. 13. In 1984, the Government will further red- a the level of protection. To this end, the maximum rates of customs duty on each imported good will be reduced to 60 percent by June 30, 1984. - 78 - ANNEX II-A Attachment Page 4 of 9 14. In parallel with the phased reduction of the overall level of protection described in the preceding two paragraphs, the Government will prepa-e in 1983-84 a) a rationalization of the existing customs nomenclature, and b) a reform of customs duty rates. Preparation of the new customs nomenclature (international harmonized system) will be carried out in 1984, and would include an initial rationalization of customs duties to ensure that similar products are subject to similar rates. The draft text is expected to be ready by Decemoer 1984, subject to the Customs Cooperation Council completing by June 1984 the explanatory notes for application of the new customs nomenclature. Necessary measuris will be taken with a view to application of the international harmonize6 system (probably by January 1, 1987). 15. In parallel with the implementation of the new custors nomenclature, a major tariff reform will be implemented in phases diring the period 1985-88. It would primarily involve a shift from systematic import substitution to a policy of encouraging investment in areas with comparative advantage. This policy change is expected to improve efficiency in industrial investments by prcmoting the establishment of a competitive industry. To that effect, the Government will implement a general tariff reform aimed at reducing ind evening out customs duty rates so a, to reduce rates of protection to a level not exceeding 25%. The preparation of the reform of tariff protection will be carried out according to the planning and organization detailed to the World Bank. 16. Protection Policy Lor new Investmencs. In order to promote the establishment of internationally competitive industries, the Government will carefully examine requests for protection. The following principles will b. applied: (a) protection will generally be given only through tariffs and not through quantitarive restrictions; in the exceptional cases where quantitative restrictions are considered necessary, these will be limited to period of three years. (b) while a level of tariff protection corresponding to protection in excess of 25 percent may be accorded during the first three years after project completion, tariffs would be set at a level providing protection not in excess of 25 percent thereafter. (c) protection along the lines of (a) and (b) above will only be accorded to projects for the manufacture of new products, whose viability is demonstrated after rigorous economic and financial analysis. It is also understook that the anti-dumping provision, as defined by GATT, could be applied for these new products. 17. Public Investment Policy. In view of the multiple demands on the centry's Limited capital resources, initiation of public sector investment projects will be phased carefully. During 1983, the public investment - 79 - ANNEX II-A Attachment Page 5 of 9 programme has been substantially reduced, on the basis of a detailed analysis of investument priorities. In view of the continued scarcity of resources, new public investments will only be initiated after careful analysis of their economic benefits and budgetary impact. In the case of public investment in manufacturing, the criteria for granting of tariff protection outlined in the preceding paragraph will be applied. We also confirm that in the evaluation of applications for access to the advantages of the industrial Investment Code, of public and private sector projects in manufacturing, subject to a convention with the Government under the CodeJ', the criteria for economic evaluation as detailed to the Bank (in particular, as concerns set foreign exchange savings) will be applied. 18. Organizational Aspects. In 1983, the Goverr-aent established a planning unit in the Ministry of Commerce and Industry. This unit is responsible, in collaborption with concerned technical divisions, inter alia, for the analysis of requests for protection and of proposals for public investment in industry. In order to facilitate the work of the unit in thase fields, a ma...a. for ie evaluation of protection requests has been prepared. 19. Import Restrictions. An essential element of the Goverament's strategy to improve industrial efficiency is to expose Moroccan industries to greater competition from abroad. In 1982. 42 percent of imports (in value) were free of import licensing (List A). Although this percentage declined to below 10 percent in March 1983 when additional restrictions were introduced, the Government will pursue the policy of import liberalization initiated in 1980-82. 20. As a first step, the Government introduced an easing of import restrictions in May and August 1983, so that all raw materials and spare parts previously in List B (import licensing) were transferred to List A (no restrictious). Following this liberalisation, imports in List A represented about 30 percent of total value of imports (calculated on the basis of values for imports in effect as of December 31, 1982). Rowever, as regards exports, goods imported for use in production for exports have not been subject to restrictions. The Government will maintain this principle. 21. The Governmenc will take further measures in 1984, in pursuit of the policy of import liberalization. By June 30, 1984, 12 percent of total value of imports (on the basis of December 31, 1982 figures) will be transferred to List A, so that the percentage of total value of all imports in List A will reach at least 42; this transfer will exclude the following products: wheat, 1/ Explanatory note: Projects are -*kject to a convention with the Government under the Investment Code when the size of the investment exceeds DH 50 million, or the investment is in a specified sub-sector. - 80 - ANNEX II-A Attachment Page 6 Gf 9 green tea, sugar, and crude oil. Between July and December 1985, an additional 6 percent of total value of imports (on the basis of December 1982 data) will be transferred to List A (again excluding wheat, green tea, sugar and crude oil). During this process of liberalization, the Government will give priority to capital goods (including imports under the investment codes) and to intermediate products not manufactured in Morocco. 22. In subsequent years, the Gove&nment will relax restrictions affecting imports, open the economy further tc competition from abroad, and progressively eliminate the import restriction prevalent in 1983 (with the exclusion of items injurious to public morality and possibly certain luxury articles) by 1988. This reform will be implemented in parallel with the revision of customs tariffs arL the implementation of programmes of industrial re.tructuring. As regards the goods prohibited from import in 1983 (List C), the prohibitions will be prograssively eliminated by 1988, beginning with industries long-established in Morocco. The specific content of the action plan for 1985 in this area will be defined in 1984. The Government has initiated an information programme. It aims at explaining to industrialists concerned, in particular, through meetings to be held before March 1984, with relevant professional associations, the Government's medium-term (1988) objectives in tariff (see papagraph 15) and non-tariff protection. 23. We are aware that the effort ;o restructure protection and increase copetition within Morocco's industrial sector will have an adverse impact on certain industrial subsectors over the mediui-term. We have identified the subsectors of packaging, related products and screws as areas where the reform of tariff protection may njed to be accompanied by specific restructuring programmes. We will carry out, within the Ministry of Commerce and Industry, preliminary studies on these sectors to define mre clearly the restructuring measures wich may bo necessary. On this basis, specific studies will be carried out by the end of 1984 and in coordination with the preparation of the tariff reform programme in order to prepare specific subsector restructuring plans. Fiscal Reform 24. The Government has already made considerable progress in developing proposals for fiscal reform which aims, inter alia, at improving industrial incentives through (i) harmonizing the fiscal pressure on enterprises while minimizing loss of revenuets and (ii) reducing the significant distortions created by the present system. In 1982, the Government prepared the broad outline of a general tax reform (Loi Cadre) which was approved by Parliament in 1984. The Government will prepare detailed proposals for the reform of direct taxation before mid-1984, which will be presented to Parliament, with a view to application in January 1985. Proposals for reform of indirect taxation will be prepared in a second stage. - 81 - ANNEX II-A Attachment Page 7 of 9 25. Within the context of the reform of direct taxation, measures of particular importance for improving industrial incentives would include the establishment of a uniform profit tax rate, simplifying accounting rules for taxation of small firms, and providing for the re-evaluation of balance sheets. In the medium-term, the Government's objective is to effect a greater degree of harmonization of the incidence of profit taxation. 26. In the case of indirect taxation, the immediate objective of the Government as concerns industrial incentives and export promotion is to modify aspects which are particularly disadvantageous for exporters, pending the full implementation of a value-added tax. In 1984, two imporant measures will be prepared and submitted to Parliament for approval, with the objective of implementation in January 1985: (i) the acceptance of the deduction of sales taxes (TPS) will be generalized, in particular to cover wholesale trading companies; (ii) TPS tax rates will be revised and harmonized (including the abolition of differential rates for local products and imports). In the medium term, with implementation of the value-added tax, the "cut-off rule" which limits deductions in certain cases, will be virtually abolished. In addition, as concerns the wastage allowance rates to be applied for fiscal purposes when a product imported by an exporter is sold locally, a study of the rates to be applied will be completed in 1984 by the Tax Department of the Ministry of Finance and the Ministry of Commerce, Industry and Tourism. Financial S-tor Refotm 27. The Government is in the process of formulating proposa'% for the restructuring of the financial sector in the medium-term, to make it more flexible and responsive to the country's development needs, notably to growtS of domestic savings and of exports. These proposals are being prepared in collaboration with the World Bank, and when they are finalized and approved, it is the Government's wish that the Bank give consideration to supporting the implementation of the reforms. 28. Over the past several years, the Government's policy has been to increase the level of interest rates and to make them more flexible, so that they play an increasing role in the allocation of financial resources. Interest rates on savings and term deposits, on r:dium and long-term credits are now positive in real terms. The Government is committed to the policy thaL interest rates should be more flexible than in the past, and fixed at levels permitting the necessary equilibrium between national savingd and it.vestment. Consequently, in normal economic conditions, and with the exclusion of certain concessional rates, notably for export credits, interest rates wi.1 be maintained at levels that are positive in real terms. Consideration is also being given to the elimination of subsidies on medium and long-term inteeest rates. - 82 - ANNEX II-A Attachment Page 8 of 9 29. Recently, several measures have been taken in the field of interest rates. In August 1983, the rates on non-readiscountable credit were increased by 1 percent. The rate of interest on accounts held by Moroccan workers abroad has been increased to 8 percent on incremental deposits. 30. To complement the reform of export incentives, the system of export credits is in the process of being revised. The ceilings on export prefinancing are being applied more flexibly, with a maximum per exporter of the average value of 3 months of the exporter's annual exports, to ensure that a sufficient volume of such credit is available to exporting enterprises, subject oi course to the usual criteria of enterprise creditworthiness. 31. In the case of short-term export credits, maturities, are currently 45 days for credits aga-nst documents, and 120 days in the case of payment periods (usually 90 days). These maturities could be extended in specific cases to allow for transport time. 32. A medium-term export credit facility was created in 1983 for capital goods. Its effective use by comaercial banks will be developed in 1984. Its extension to exports by construction and engineering service firms as well as the feasibility of extending its term from five to seven years, will be studied during 1984. The possibility of providing bank guarantees for export contractors in construction through a consortium of Moroccan banks is also being studied; conclusions of the study will be available by 31 March 1984 and application would take effect before 1 January 1985. 33. The export credit insurance system was also revised in 1983. The globality rule was eliminated so that exporters may insure only part of their exports; minimum limits on premiums and maximum limits on repayments were removed an budgetary credits were allocated to the insuring agency (BMCE). In 1984, the Government will develop proposals which could be implemented before mid-1985 to extend insurance coverage to include manufacturing risk insurance. Price Liberalization 34. The Government's position is that competition is a vital element to increase dynamism and productivity, and it is committed L make the Moroccan economy more responsive to market forces. In 1983. price controls on manufactured goods were significantly reduced as the prices of about 19 products were liberalized. The Government will liberalize the prices of about 10 more manufactured products in 1984 (see Appendix 1 for list and detailed timing). Remaining price controls on about 12 manufactured products will be gradually removed in line with the elimination of import interdictions - 83 - ANNEX II-A Attachment Page 9 of 9 (or restrictions) on those industries and greater exposure to international competition. Price controls will be retained only for subsidized basic commodities, for public utilities, and for commodities for which there is limited competition. Monitoring and Progress Reportins 34. In order to monitor progress in the implementation of the programme described above, an interministerial committee has been created, under the chairmanship of the Prime Minister. This committee would meet regularly to review progress and to decide on appropriate actions necessary to ensure the timely implementation of the programme. Two progress reports, summarizing the status of implementaticn of the programme will be prepared and furnished to the World Bank, the first one finished in early July 1984 and the second in early January 1985. - 84 - ANM II-A Appendix Page 1 of 1 Price Liberalization: Products and Timing I. Foods Products All povdered milk (June 30, 1984) Soft drinks (December 31, 1984) II. Industrial Products Color television sets (Dec.31, 1984) Cars (diesel and gasoline Dec. 31, 1984) Ordinary soap (Dec. 31, 1984) Tires (self-revision. June 30, 1984) Explosives (Dec. 31. 1984) Matches (self-revision, Dec. 31, 1984) Molasses (June 30, 1984) Scrap metal (June 30, 1984). III. Services Four star hotels (June 30, 1984) - 85 - ANNEX II-B Page 1 of 4 TRANSLATION OF THE ORIGINAL DRAFT IN FRENCH May 14, 1985 Dear Mr. Clausen, Statement of Development Policy: Second Industrial and Trade Policy Adjustment Program (ITPA II) Introduction 1. In 1983-84, the Government of Morocco undertook a serious stabilization effort, in collaboration with the International Monetary Fund, and a program of policy adjustment iu the industrial and international trade sectors, which was supported by the World Bank through the Industrial and Trade Policy Adjustment loan (2377-MOR). The objectives of these joint efforts of stabilization and adjustment were to correct the global disequilibria of the economy, particularly of the balance of payments and the budget, and to implement a continuing reform program to address structural conrtraints, so as to restore dynamism to the Moroccan economy. It was rrialized that the nature and the complexity of the structural issues would make it necessary to continue the adjustment program over a prolonged period of several years. However, we are convinced that the adjustment process initiated in 1983-84 has already contributed significantly to a perceptible change in relation to past policies. 2. In a second phase, the Government is committed to continue the adjustment program developed in collaboration with the World Bank as well as the stabilization program agreed with the IMF. The measures and specific actions recommended would contribute to the intensification and broadening of adjustment, and reflect changes in the economic environment and the results of implemented actions. Toe World Bank contributes, through its fivancial support and its analyses, to this process. Recent Performance of the Moroccan Economy 3. In the context of a world economic situation which was not very encouraging, the Moroccan Government was able to respect the performance criteria of the stabilization program agreed with the [MF. Important progress vas registered in correcting the financial disequilibria of the ecoromy. From a level of 13.3% of GDP in 1982, the current account deficit of the balance of payments was reduced to 8% in 1983 (before debt rescheduling), that is, from an amount of about $2 billion in 1981 and 1982 to $1,060 million in 1983. The implementation of a flexible exchange rate policy and a series of export promotion measures contributed to this progress, as also a tightening of import restrictions in early 1983. The budget deficit was reduced by about 30% in 1983, from 12.31 of GDP in 1982 to 9.1% in 1983. This reduction was effected principally through tight control of the public investment budget. -86 - ANNEX 11-B Page 2 of 4 4. On the other hand, in 1984, even with the observance of the performance criteria of the IMF and the IMples1cation of the ITPA measures, the performance of the economy was not very satisfactory, as a result largely ef the unexpected continuation of the drought. The growth rate was only 2.4%, the budget deficit was at 7.81 of CDP and the deficit of the -rrent account of the balance of payments rose to $1.2 billion. In 1984 the budget deficit was controlled by a tight control of expenditures, in particular as regards the investment budget, in the case of which expenditures only grew by 6.7%. Expenditures on salaries, materials purchases and personnel recruitment were strictly controlled, and petroleum product subsidies were eliminated through periodic price adjustments. Investment expenditures were reduced in 1986 to an estimated amount of DR 7.4 billion, as against the planned figure of DE 8.5 billion. As regards the balance of payments, exports grew at 7.8% in volume terms. Phosphate exports grew at 5.8%, and phosphoric acid exports at 19.1%; agricultural exports continued to stagnate because of adverse climatic conditions; and exports of finished goods grew by 9.21, reflecting improved competitivity. The higher than anticipated balance of payments deficit is explained by increased imports of wheat and petroleum, and the tendency to restock raw materials. 5. The increased imports of cereals in 1984 and the appreciation of the dollar resulted in an increase in expenditures on subsidies of basic food products. The appreciation of the dollar also increased the payment of interest on the external debt. As regards financing of the budget, the most important developments were the debt rescheduling, and a more important recourse of the Treasury to the money market. The ITPA Proaran 6. The objectives of this important program of structural reform were to improve the system of industrial incentives in order to address the fundamental problem of inefficient resourne utilization in the industrial sector, improve the balance of payments situation through export promotion, effect more efficient import substitution, and create the necessary conditions for employment generation and higher growth. The strategy underlying this program consists of: (a) modification of industrial and trade policy, which was previously focussed on protection of the domestic market, in order to encourage ea outward-looking approach; and (b) reducing administrative controls and increasing reliance on market forces. The economic policy measures envisaged in the first phase (1983-84) concerned the following main areas: export incentives, protection reform, fiscal measures, improvements of the financ!al system, and price liberalization. The results of the adjustment policies which were implemented in 1983-84 have been clearly encouraging. 7. However, the disequilibria at end-1984 were more serious than expected at the beginning of implementation of the adjustment program. This consideration influences the design of policies in the second phase of adjustment (1985-86), in order to return to a viable balance of payments situation and a satisfactory rate of growth of 'he economy. - 87 - ANNEX II-B Page 3 of 4 8. The Government's objectives, made explicit at the Consultative Grutp * meeting in January 1985 are to pursue economic and financial restructuring, in order to achieve in the next four years a reduction in the balance of payments deficit sufficiently large to eliminate the need for debt rescheduling at the . end of this period. The growth rate during this period will be 31 per annum. These objectives wll be achieved through reinforced policies of export promotion, trade liberalization, promotion of domestic savings, improvement of the efficiency of resource allocation and utilization in the economy. In this context, it would be important to improve the planning and budgeting system, and to rationalize the public enterprise sector. The expected results of these policies will only be perceptible slowly, given the structural and fundamental nature of the changes. Consequently, during this perioA, it will be necessary to implement suitable complementary measures to control the level of aggregate demand and the part of this demand which translates into imports. Despite the difficulties which can be envisaged, the Government is committed to realizing the required structural changes, and hopes to continue to benefit from the increased support of multilateral development institutions, as well as customary and exceptional aid from bilateral donors, and recourse to international financing markets, in order to meet the difficulties associattd with the adjustment process. The Next Phase of Adjustment 9. In function of the medinm-term perspective summarized above and of its global strategy, the Government has prepared, with the IMF, a standby program covering the period up to February 1987. In the framework of this program, the Government's objectives are to reduce: (a) the current account deficit of the balance of payments to 6.51 of GDP in 1985 and 4.5% in 1986; and (b) the budget deficit to 6.5% of GDP in 1985 and 4.5% in 1986. Policies in the areas of taxation (including the implementation of fiscal reform and control of public expenditures), money and credit, exchange rate management, public investments and public enterprises, would reflect these objectives. As regards the exchange rate, the Government proposes to maintain a flexible policy in order to ensure the competitivity of Moroccan exports and support the program of import liberalization. 10. The Government has also prepared, in collaboration with the World Bank, a program for the period 1985-June 1986 (ITPA II) of implementation of appropriate structural reforms and adjvstments. The ITPA II program covers three main areas: (i) continued export promotion and import liberalization, consisting of an extension of reforms already initiated in the ITPA program in the industrial and trade sectors; (ii) the re-establishment of equilibrium in public finance through pulicies and actions concerning the public investment program and the rational estion of public enterprises (public enterprise reform vill be continued in the context of a more detailed program, for the support of which a subsequent World Bank loan is anticipated); and (iii) financial sector reform aiming at liberalization through the restructuring of the administrative framework, incentives to increased competition, the gradual elimination of subsidies, institutional reform measures, and the development of the money market. This program is described in greater detail in the anax attached to this letter; the attached table summarises the measures and their -88 - ANNEX II-B Page 4 of 4 expected schedule of implementation. The Government has already begn to implement a large number of these measures. 11. Other reform programe, which ala at achieving the stated objectives. and for which analytical and preparatory work has been completed or initiated in collaboration with the World Bank concern public enterprises, incentivz.e and resource utilization in the agriculturat sector, and the sector of education and vocational training. The Government desires World Bank financial support for the implementation of these reforms. I would like to emphasize that all these reform programs support the economic policy announced by the Government, which aims at bringing about key changes in priority sectors, so that the Moroccan economy can grow on a sound and durable basis. 12. The Government declares its commitment to implementing the actions and policies described in the attached annex in order to attain the objectives of the stabilization and reform programs concerning industrial and trade policy, the re-establishent of the equilibrium of public finance, and the financial sector. 13. In view of the measures decided by the Government, we would be grateful for a favoreble response to the Goverrnent'a request for a Second Industrial and Trade Policy Adjustment Loan (ITPA II). We hope the World Bank will also support our adjustmeaL efforts through other sectoral/structural adjustment loans in the medium-term. 14. W appreciate the continuous exchange of vie%s -.th the World Bank and hope to discuss at Legular intervals the progress achieved it. implementing the envisaged measures. Yours sincerely, The Minister of Finance ANNEX II-3 Attachment Page 1 ot 11 The Second Industrial and Trade Policy Adius.ment Proaram (ITPA II) 1. Th. economic policv measu-es of the ITPA II progr,= cover three main areas: continued export promotion and reform of protection, rationalization of the public investment program and public enterprises, and financial sector reform.. Ve are convinced that these measures will permit Morocco to improve the efficiency of resource allocation and ulilization in the economy, and realize the substantial existing potential . r the development of exports, as well as for the gr2wth of domestic savings, public and private. I. Export Promotion and Reform of Protection 2. Export promotion Is uf special importance for get.erating foreign exchange to meet the needs of the economy and to service international d'bt, developing new industrial activities, and creating a aignificant source of employetent. 3. Exchange Rate. We confirm that a flexible exchange rate policy will continue to be pursued in conformity vitb the agreement with the IMF, and with the objecti-es of maintaining and enhancing the competitivity of Moroccan exports and supporting the program of import liberalization. 4. Export Certificates. In order to simplify export procedures, export certificates will be eliminated before e-nd-1985 for hies and leather, and for mining products with the exception of barytine. unrefined lead, lead minerals and charcoal. S. Food Products. The st.dy cf exports of fresh vegetables is expected to be completed by September 1985. This study is expected to yield recommendations aiming at increasing fr It vegetable exports; the agreed measures will be implemented after discussions with the World Bank during the last quarter of 1985. 6. Customs Regimes. In 1985, the temporary admission procedure (which permits exporters to import inputs free of tax and duties, without prior authorization), will be expended through modifying the negative list which was retained under the ITPA I program. This will be effected through the elimination from this list, before June 1985, ot all products other than blass used for packaging and agricultural and fisheries products; the latter will be- eliminated from the list immediately on their transter from List B to List A. In addition, the Customs Directorate will decentralize the management of the procedure of "exportation prealable" (pre-exporting). As rogards guarantees for customs duties payable by exporters, the Customs Directorate will accept global annual guarautees (bank guarantees or mutual Xuarantees of industries). A procedure will also be established to permit settlement a posteriori of customs claims, without blockage of customs clearance of - 90 - ANNEX II-! Attachment Page 2 of 11 merchandise. In order to iaprove the access if industries to custcaS legislation, the Customs Code and the tariff list will be up-dated regularly. The average period between filing a customs declaration and the delivery of permission to lift the goods will be reduced in 1985 by 6 days from the time estimated at the beginning of the year of 12 days. 7. Global Approach to Simplification of Foreign Trade Procedures. After implementing a number of measures under the ITPA I program to siepliAy administrative procedures for foreiln trade, the Government incends to complete ind amplify these measures Lt has realized that the complexity of administrative procedures and the tiowness of movement of merchandise require a global and continuing approach over the medium-term to address the problem by successive stages of analysis and action. A Committee for Simplification of Foreign Trade Procedures will be established by end-1985, with respresentatives of different agencies concerned: the Customs Directorate, the agencies rLsponsible for foreign trade, echange control, and transport, the port authorities, the commercial banks, transit and maritime agents, importers and exporters, etc. This Committee will be responsible for the conception and follow-up of programs of analysis and folow-up of the implementation of specific measures resulting from these analyses concerning: (i) the rationalization of all international trade documentation; (ii) identification and elimination of delays due to procedures; and (iii) the preparation and publication of an annual compendium of foreign trade and exchange control rules. During 1985, cn itinerary of export andimport transactions will be prepared to provide a clear set of documentation on current foreign trade procedures. This would permit preparation of the first phase of their reform before June 1986. 8. Exhange Allocation to Exporters. From January 1985, an automatic allocation of foreign exchange is granted to exporters, up to a ceiling of 3Z cf annual export value, with the possibility of cunlating the allocation, in order to assist exporters to cover the expenses of export operations such as business trips and other incidental expenses. 9. Blimination of the Statistical Export Tax. The statistical export to is currently levied on all exports at the rate of 0.5Z of each transaction. In order to simplify the operating framework for exporters, this tax will be eliminated with effect ftom January 1986. 10. Export Code. So as to permit exporters to work in a clear and defined framework and confirm incentives for investment in export production, while recognizing the obligation of exporters to contribute to the Govermnt an appropriate portion of the income from their activities, the Government is preparing a new Export Code. 11. Tariff Protection Policy. As it has already stated, the Goveromens' objective is to encourage increased competitivity, improve the efficiency of investment and lobor productivity. This objective will be realised through a gradual reduction of the level and dispersion of customs tariffs, so as to ensure by end-1988 a maxim rate of protection no greater than 252. - 91 - ANNEX II-8 Attachment Page 3 of 11 12. Speciat Import Tax. To achieve the above-meotioned objective, the Government has reduced the Special Import Tax from 10 to 7.5Z in Janary 1985. Subsequently, the Government will reduce the Special loport Tax from 7.5 to 5% in January L986 and intends to eliminate it with effect trom January 1987. No c-stoms duty will be increased with a purely fiscal objective to compensate for the reduction of the special import tax and the alimination of the statistical export tax. 13. Maximum Rate of Customs Duty. The maxi:um rate of customs duty vill be reduced to 45% by .anuary 1986. 14. Rationalization of Tariff Structure and Custon Nomencl-ruce. The Customs Directorate and the Ministry of Comerce and IMdustry have carried out preparatory work of rationalization to ensure that: i) similar products are taxed at the asn rate; ii) the dispersion of customs duties is reduced; iii) the level of protection does not exceed 25% by end-1988; iv) the system is rendered simpler and clearer, including through the suppression of the stamp duty and/or its integration into customs duties. The new harmonized nomenclature will be introduced at the latest within a year after the definitive clarifications from the Customs Cooperation Council are receLved. This will be preceded by a restructuring, sector by sector, of the Moroccan customs nomenclature, with duty rates to permit a definitive ceiling on the rate of protection of 25%, the whole system to become operational at the latest by January 1, 1989. A provisional struccura of duty rates permitting a rate of protection not exceeding 25%, to be used in preparing the definitive structure, will be prepared in 1985, 86, and 87 according to a calendar ad framework explained to the World Bank. 15. Non-Tariff Protection. The Government will coatinue to pursue the pclicy of import liberalization in the future so as to open up the economy further to increased foreign competition. Already in 1984 a large number of products were transferred from List B (requiring import licenses) to List A (free list). This process has been continued in 1985, and will be pursued according to a timetable explaineO to the World Bank. In addition, most products previously in List C (banned from imports) have been transferred from this list, either to List B, as an interim stage before their transfer to List A, or directly to List A. These isport interdictions will be eliminated by stages by 1988. The timetable of th&s process has also been explained to the World Bank. 16. As regards protection policy for new investments, the Government has already explained in paragraph 16 of the letter of December 29, 1984 to the Bank in the context of the ITP4 I loan the principles of granting special protection in an initial period (=ximum of 3 years after completion of the project); the Government does not propose to grant such protection in the form of quantitative restrictions, except in exceptional, duly justified cases. - 92 - ANNEX II-B Attachment Page 4 of 11 It. Public Investment Program and Public Enterprises 17. The main objective of policies and actions in this area is the improvement of the efficiency .oi resource utilization in the public sector. In order to harmonize budget expenditures vich resource availability, the Government accords priority to the rationalisation of public investments, increasing the return on these investments, and addressing the issue of Goverment and public enterprise arrears. Public Investment Program 18. In the face of the continuing scarcity of financial resources, the public investment program was substantially reduced in 1983 and 1984 on the basis of a dtailed analysis of investment pricrities carried out in cooperation with the World Bank. Within the framework of the objectives of developing national resources and employment promotion, the criteria for project analysis have been: (i) the economic rate of return; (ii) the stage of physical exacutio- F the project; (iii) the project gestation period; (iv) the project's conti ton to export promotion and efficient import substitution; (v) the need for budgetary allocations. In function of this analysis and considerations of sectoral and inter-sectoral balance, public investment projects have been classified in three categories: (i) highest priority projects whose rapid completion would be desirable; (ii) projects whose implementation could be slowed down; (iii) projects to be postponed or catcelled. Following from this analysis, the Government cancelled DR 4.6 billion of credits in 1983 and DH 6 billion in 1984. 19. The rationalization of the public investment program is continuing in 1985. The global envelope of the investment budget was about DB 26.8 billion at the begining of this year. After detailed analysis, the Government intends to cancel DR 4 billion. The control of the budget implies a practically total avoidance of inscriptions of new projects except if they would benefit from concessional financing. The Government proposes to use a significant portion of exceptional bilateral grant aid to reduce payment arrears. The Government also proposes to review with the World Bank in October/November 1985 the investment program for 1986 and subsequent years, to as to continue rationalization of the ptigran vith the application of the criteria mentioned in the preceding paragraph. 20. In addition to specific actions and increased control, as regards public investments, the Government is in the process of effecting a fundamental reform of the budgeting and planning system. This new planning system will involve an annually modifiable plan, with strict prior control by the ministries of Finance and the Plan to ensure that eely high priority projects in keeping with realistic global budget resource envelopes would be inscribed. Measures will also be taken to computerize project data, including astimates of total annual expenditure, amounts of credits available, :ommitaents and payments, in order to improve follow-up of the financial implementation of projecLs and control of expenditures on the investment 3adget. The Government will request tech%ical assistance from the World dank to design and implemant the new system of budgeting and planning investments, - 93 - ANNEX 11-3 Attachment Page 5 of 11 according to a timetable discussed with the World Bank. The preparation of a program has already been initiated, and the functional design of the new system will be prepared during the secood half of 1985. The implementation of the new system is expected before June 30, 1986. Public Enterprises 21. The growing importance of public enterprises in the last decade has led the Governarnt to consider carcfully the financial and structural problems of this sector. After a major, in-depth study in 1979-80 which served as the basis for a series of actions and programs in this area, in 1984 the Government analysed in detail the payables and receivables of the Government vis-1-vis public enterprises, in order to ascertain the magnitude of arrears. A program of measures has been prepared sector by sector, to resolve the structural causes of these arrears. The matrix of arrears as of December 31, 1983 has been completed for some 60 enterprises. Detailed analyses and sectoral action plans have also been developed for most sectors: energy, transport, water-supply, trade, mines, sugar, and agriculture. A study of local collectivities is in progress. An action plan has been designed and is being implemented to improve the situation of the enterprises and halt growth of arrears. Several decisions and specifications have been taken in the context of the sectoral rehabilitation programs. An InterminLsterial Committee chaired by the Prime Minister has been created to define a strategy for the public enterprise sector. A Vigilance Committee has also been created to propose reform seasures, settle disputes, etc. and follow-up on their implementation. 22. The matrix of debts and receivables covering 80 enterprises ihows a net deficit of the State to public enterprises of about DR 3.8 billion as of December 31, 1984. The Government expects to allocate in 1985 and 1986 a substantial sun to reduce arrears in the shortest possible period. While respecting the performance criteria of the IMF, the Government expects to reduce its net arrears to public enterprises by DR I bill.on by the end of 1985, and by DE 0.5 billion by June 30, 1986 (the arrears defined according to the methodology already established). The Government will furnish to the Bank it, 1985 a detailed breakdown ad timetable of Settlement of the arrears. The Vitilance Committee will continue to be responsible for the implementation of th& measures adopted (including revision of prices). The Government will aw-de any fresh increase of these arrears in the future. 23. The Government also confirms its objective of reducing the overall amount of transfers to public enterprises. The amount of nredits to public enterprises in the Finance Law has been limited (excluding operating subsidies) tu DR 3.3 billion for investment subsidies and payments for services of public enterprises to the Government. The actual overall payments in these categories will be about DE 2.: billion in 1985. In 1986, the Government expects to intensify the efforts undertaken in 1984 and 1985 to improve the performance of public enterprises so as to reduce their financial dependence on the Government, and to discuss with the Bank the measures to take in this connection. - 94 - ANNEX 11-8 Attachment Page 6 of 11 24. The Government renews its request to the World Bank for assistance in introducing basic structural reforms in the sector of public enterprises, so as to improve the efficiency of these enterprises and achieve financial and structural rationalization of their relations with the State, collectivities, and the private sector. With this objective, the Government will prepare, in cooperation with the World Bank, a program. to carry out: (i) structural reform of price, subsidy, and financing rolicies of the enterprises; (ii) administrative reforms permitting a better control of the efficiency of enterprise operations and greater enterpise autonomy; and (III) financial or physical restructuring of a few key enterprises playing a vital role in the economy, which can serve as test-cases for the implementation of policy and administrative reform in the sector. The Government has named a liaison and coordination group for these activities. The Government is endeavouring to progressively increase the proportion of self-financing by public enterprises of their investments. 25. Given the great importance throughout the economy of energy and power tariffs, the Government and the Bank have agreed to initiate a study in this area which will assist the preparation of a proposed Bank public enterprise sector loan. III. Financial Sector Reform 26. The Government has prepared, in collaboration with the World Bank, a major reform of the financial sector, in order to promote domestic savings and improve the efficiency of resource allocation. This reform includes a series of measures aiming at simplifying and easing the regulatory framework, increased reliance on market mechanisms, encouragement of increased competition in the sector, progressive elimination of subsidies, reduction of fragmentation of the financial market and resulting distortions, strengtiening the institutional system, and deve!oping the money market. An important aspect of this reform, which supports the Government's overall adjustment policy, is increased recourse by the Treasury to the financial market. The most important measures of thins reform are summarized in the following paragraphr. 27. Interest Rate Policy. The Government is comitte4 to greater flexibility of interest rates than in the past. With the exception of certain preferential rates, notably for export credits and cereal production, the Government recognizes the objective of maintaining interest rates at levels which are positive in real term. Certain interest rates (notably, on deposits of maturity greater than it moths) will be freed with effect from April 1, 1985. The other rates have been transformed into minima (in the case of deposit rates) and maxim (in the case of leading rates), and the system has been simplified through a reduction in the number of rates set by the authorities. The changes in interest rates effective April 1, 1985 are detailed in the table below. - 95 - ANNEX 11-3 Attachment Page 7 of 11 Term Deposits Former Change NOW Minimal Ra'ate - Rax' 3 months 6.5 +2 8.5 min. 6 months 8.5 +2 10.5 Min. 12 months 10.0 +2 L2.0 min. Savins Deposits Calase d'Epargne pass book accounts 8.0 s1 9.0 Min. Other pass book accounts 7.0 +1 8.0 min. Leadint Rates Overdraft 13.0 +1 14.0 Max. Rediscountable overdraft 10.0 +2 12.0 Max. Discount Rate 7.0 +1.5 8.5 Max. Medium-Term Rediscountable Loans 12.0 +1 13.0 Max. Long-Term Redscountable Loans 14.0 +1 15.0 Max. a/ From April 1, 1985. 28. The Government has created a Permanent Committee for Interest Rates, consisting of representatives of the Ministry of Finance, the Bank of Morocco, and the Professional Association of Moroccan banks, to follow up the evolution of rates and to ensure that, overall, the rates iu force reflect the conclusions of an analysis of relevant factors, in particular, the current inflation rate, the liquidity situation. movements in exchange rates nd the balance of payments, international inflation, etc. Each semester "his Commission will prepare a report presenting its conclusions regarding this objective, and recommending, to the Minis.er of Finance, if need be, modification of the rates. 29. It is to be r.oted that the interest rates indicated in the table above, are considered net of taxes. In view of the proposed fiscal reform, and the introduction of a value added tax (see para. 38 below), leading rates will be increased by .,e amount of the value added tax deductible by borrowers. 30. In parallel with the freeing of deposit rates, we have examined the freeing of leading rates, which also constitutes an objective of th-a Government's policy. The need for regulating credit through ceilings in 1985 will not permit us to free before the end of the year leading rates beyond the ceilings mentioned above. He would like to emphasize our intention to gradually liberalize lending rates at the same time as credit regulation is eased. Measures for deregulating credit allocation and liberalizing leading rates will be reviewed with the World Bank and the IMF before end-1985. - 96 - ANNEX 11-B Attachment Page 8 of 11 31. Gradual Elimination of Interest Rate Rebates. The Government intends to eliminate over the medium-term interest rate rebates on medium- ind long-term credits in differeac sectors. As these rebates are granted under investment codes, their !liination will require passage of a law. The Government will study, in collaboration with the World Bank by end-1985 the measures to reach this objective, with a view to preparing in 1986, a program to apply the nominal rates to these different sectors benefiting from rebates. 12. Foreign Lxchanse Risk Coverage. Medium- and long-term loans of specialized financial institutions (BNDS, CNCA and CIE) are critical to ensure access to term resources for priority investments. A large part of these resources is ,jbilized abroad in foreign exchange, and the Government has assumed responsibility for coveriug the foreign exchange risks of these three institutions. The burden of this coverage weighs more and more heavily on the Treasury, and the Government has therefore decided to transfer a larger portion of the costs to ultimate borrrowers and the specialized institutions in order to lighten the burden on the Treasury. It would, however, be premature LO transfer the entire risk to the ultimate borrowers. In function of these conclusions, the Government has decided to strengthen from June 1, 1985, the system of coverage of foreign exchange risks for foreign currency loans contracted by the specialized financial institutions, as follows. (i) The specialized institutions will pay into a Foreign Exchange Risk Fund for credit of the Treasury at each of the institutions concerned, the difference between their lending rate, and the interest rate on new foreign borrowings, less a margin sufficient to assure them an adequate profitability; .i) The Foreign Exchange Risk Fund will receive funds from a commission of 1% on disbursements of new medium- and long-term credits of the specialized financial institutions, with the exception of loans for low-cost housing (HBM) and credits to small farmers (CLCA). (iii) The specialized financial institutions will assume 21 (instead of 1.51, till now) of all exchange losses on their foreign resources acquired after June 1, 1985. (In the case of exchange gains, the institutions will be credited with 21). These measures will be reviewed every six months, and may be modified by the Linistry of Finance. The Government will periodically consult with the World Bank to study the results of these measures, and propose, if need be, their improvement - the long-term objective being to reduce gradually, with a view to its eventual elimination, the charge to the Government of exchange-risk coverae. 97 - ANE 11-8 Attachment Page 9 of 11 33. The propositions mentioned above caly deal with the foreign exchange risk on leading operations of the specialized financial institutions. rhe distortions which would ari- from the implicit exchange risk on local currency loans of commercial banks to importers of equipment and investment goods have not been considered in the Gov, -emat's program, for lack of a complete analysis of the situation. However, the possible impact of this distortion on public finances remains to be examined. The Gover.ment has therefore decided to initiate a study, by the end of 1985, with Bank support, on the importance of the implicit exchange risk for public finances, in order to specify the measures and the possible recommendations to transfer all or a part of the risk to importers benefiting from such loans. 34. Obligatory P1, ement Requirements and Reserve Requirements for Commercial Banks. In order to increase the margins of commercial banks on ters-deposits, and hence encourage them to mobilize term-deposits with greater dynamism, the ratio for obligatory placements by the banks in Treasury bonds has been modified. The deposit base on which the rate of obligatory placement is applied was reduced in 1984 through the elimination, from the calculation of this base, of deposits with a term greater*than 12 months. From April 1, 1985, all term deposits and certificates of deposit have bmen eliminated from the base of calculation of the obligatory placement requirement; the obligatory placement rate on sight deposits has been increased from 30 to 351. In addition term deposits have also been excluded for purposes of calculation of the reserve requiTements of commercial banks. 35. Allocation of Credit Ceilings to Commercial Banks. With the objective of encouraging commercial banks to mobilize savings, the system of determining credit ceilings will be modified effective June 1, 1985, to take account of the effort by the banks to mobilize savings. 36. Bank Comissions. The monetary authorities have set themselves the objective of simplifying, clarifying and up-dating bank commissions which have been in effect since 1975. A detailed study of comnissions will be carried out, in collaboration with concerned institutions, by September 30, 1985, and communicated to the Bank for analysis and comments; this study would have as. an objective the selection of commissions which would be expressed as maxima; it will take into account, as much as possible, the cost of operations. The reform of bank commissions will be effected, at the latest, by January, 1986. 37. Specific Measures to Encourage Competition Between Specialised Financia& Institutions and the Commercial Uanks. In order to strengthen competition bezween the banks and the specialized financial institutions, it; would seem appropriate to permit the latter to receive deposits from the public. The Government's General Secretary has been requested to provide a legal opinion on whether it would be necessary to amend the laus to achieve- this objective. This opinion will be fvrnished by end-September 1985. If -CI and BNDE can be authorized to receive dwposits through administrative measures, the Government will take steps to effect this authorization, at - 98 - ALNX II-B Attachment Page 10 of 11 the latest b, January 1986. In any case, the monetary authorities will take all appropriate steps to permit the specialized financial institutions to receive funds fro the public through the issue of certific*-es of deposit. In case the lat governing specialized financial institutions needs to be modified, the Bank will be informed before end-1985 of the next steps which could be expected. Besides, in order to grant the banks a greater degree of responsibility and a more important role in maediue-term lending, the monetary authorities have already granted BNCE the right to affix the third signature on credits. The monetary authorities are also studying the possibility of permitting other banks to provide the third signature necessary for rediscounting medium.-term loans at the Bank of Morocco. This study will be reviewed with the World Bank with a view to its implementation effective January, 1986. 38. Reform of Taxation Affecting the Financial Sector. There has already een a clarification of the conditions under which provisions for risk can be established by commercial banks, and a reduction uf the registration fee on capital increnses of companies whose shares are traded on the stock cxchange. The fiscal reform, whose presentation to Parliament is expected by mid-1985, includes important measures concerning the financial sector: (I) the tar. on banking services Will be replaced by a value added tax, with, as a result, the possibility for a coamercial enterprise to deduct this tax from its expenses; (ii) enterprises will have the possibility of re-valuing their assets, whic4 "eald lighten their tax burden and increase their self-financing. 39. Development of the Money Market. Since 1983, a growing proportion of the Treasury's financing needs have been met through borrowing on the money market at market rates. Also, the proportion of refinancing by the Banque du Maroc at flexible interest rates has continued to increase. In the future, these trends will be strengthened, in order to develop the onaey market and increase the participation of the Treasury in this market. In addition, the Treasury is seeking to mobilize supplementing resources on the financial market through the issue of bonds to the general public. In this regard, an- issue in March 1985 for a sum of DN 100 millVon resulted in subscriptions of over D6 400 million, and the Trearury intends to repeat this experiment in 1985. 40. Reform of the Caisse Centrale de Carantie (CC). To strengthen the credit guarantee system, there is need to redefine the role of CCG, and for a fundamencal reform of its financial and organizational strL:ture, including the procedures and principles of risk coverage by this organization. The Government is committed to study these issues by end-1985. A consultant will be appointed by the Government to carry out this strdy by September 1, 1985, and the study will be completed and its recommendations implemented during 1986, after discussions with the World Bank. - 99 - Attachment Page 11 of 11 Noitorias and Proress Reporting 41. Progress to iMplementing the program described above wilt be monitored by the interministerial committee, established in the context of the ITIPA I program, which will wmet regularly to review progre%s and decide on appropriate actions to ensure timely implemestation of th program. Two progress reports, summariag the status of Implementation of the program will be prepared and furnished to the World Bank, the first in early January 1986 and the second in early June 1996. - 101 - APPENDIX (Translation from French) Comments Received from the Borr*wer FROMs Bank Al-MLhrib, Rabat TO: World Bank, Washington, DC DATE3 June 8, 1989 ATTN.: Mr. Alexander Novicki, Chief, Division II, OED (Policy-Based Lending, Industry, Public Utilities and Urban Sectors) Thank you very much for forwarding the Evaluation Report on ITPA Loans I and II for our comments, which are as follows: 1. The Report's conclusions regarding the very favorable response shown by the Moroccan economy to the structural reforms introduced under the ITPA program should be refined. This response was really the result of an overall program of sustained adjustment and of stabilization that was applied to most sectors of the economy, and in which a restrictive and select *e monetary policy played a major role. 2. As regards external trade, the main target of the reforms intro- duced under the ITPA loans, improvements have been very slow in coming. In fact, the trade balance was deteriorating until 1965, and the subsequent improvements are, to a considerable extent, the result of exogenous factors: favorable climatic c8nditions, lower oil prices, and the recent recovery in the market for phosphate products. For example, in CIF/FOB terms the 26.22 improvement in the trade deficit in 1986 was mainly due to the decline in oil prices, which reduced the energy bill by 50Z, and the sizable agricultural harvest, which permitted grain imports to be reduced by 402. 3. The Report appears to overstate considerably the role played by exchange rate policy in the remarkable recovery shown by exports of finished manufactured goods. Although such goods are comparatively more sensitive to changes in relative prices, it is also true that other incen- tive measures were no less significant in producing these results: the total removal of restrictions on export and investment credit at a time when a policy of credit tightening was being applied to the other sectors, the economic measures applied to customs, etc. Moreover, our Institute's flexible exchange rata policy was more moderate in scope than that recommended by the World Bank and the IMF, so that it was possible to limit its adverse impact 3n the government budget and on price levels. Respectfully yours, ' d'