Document of The World Bank FOR OMCIAL USE ONLY Reort No. P-4075-MOR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND INDUSTRIAL AND TRADE POLICY ADWUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$200.00 MILLION TO THE KINGDOM OF MOROCCO May 6, 1985 This docmnt bms a resricted disuitm ad may be used by reciieat ely in the perfornee of tlewr 1Wz dumLb costeE m am othu dben dllselosed vndwt Wwrld R. O KINGDOM OF MOROCCO CURRENCY EgUIVALENT Currency Unit - Dirham (DH) Calendar 1984 average February, 1985 average US$1.00 = DH 8.81 DH 9.92 DH 1.00 = US$0.11 US$0.10 FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS BNDE Banque Nationale pour le Developpement Economique (National Industrial Development Bank) CIH Credit Immobilier et Hotelier (Housing and Tourism Development Bank) CCG Caisse Centrale de Garantie (Credit Guarantee Organization) CNCA Caisse Nationale de Credit Agricole (Agricultural Credit Bank) DFC Development Finance Company ITPA Industrial and Trade Policy Adjustment OCE Office de Commercialisation et d'Exportation (Office of Exports and Marketing) OCP Office Chrifien des Phosphates (National Phosphate Agency) ONCF Office National des Chemins de Fer (National Railway Company) ONE Office National d'Electricite (National Power Utility) ONEP Office National d'Eau Potable (National Water Supply Utility) ONET Office National des Postes et Telecommunications (National Posts and Telecommunications Office) ORMVA Office Regional de Mise en Valeur Agricole (Regional Agricultural Development Agency) SIT Special Import Tax VAT Value Added Tax FOR OMCIAL USE ONLY KINGDOM OF MOROCCO SECOND INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOAN Table of Contents LOAN SUMMARY PART I: THE ECONOMY 1 A. Introduction 1 B. Economic Performance in the 1970s 2 C. Stabilization Program: 1978-80 2 D. Growing Disequilibria: 1981-82 3 PART II: THE ADJUSTMENT PROCESS, PHASE I: 1983-84 4 A. Structural Problems 4 B. Stabilization Policies: 1983-84 7 C. The Industrial and Trade Policy Adjustment (ITPA I) Program: 1983-84 8 D. Macro-economic Performance: 1983-84 8 E. Evaluation of Disequilibria at End-1984 11 PART III: THE SECOND PHASE OF ADJUSTMENT: 1985-86 - 13 A. Medium-term Objectives 13 B. Stabilization Policies in 1985-86 15 C. The Second Industrial and Trade Policy Adjustment (ITPA II) Program: 1985-86 16 - Export Promotion 16 - Reform of the System of Protection 19 - Reform of the Financial Sector 22 - Public Enterprise Reform 25 - Rationalization of the Public Investment Program and Reform of Planning and Budgeting 29 D. Expected Effects of the Second Phase of Adjustment 31 E. The Role of the Bank 37 F. IrF Activities in Morocco and Government/IMF/Bank Cooperation 38 PART IV: THE PROPOSED LOAN 39 A. Loan History 39 B. Disbursement and Procurement 40 C. Monitoring 41 D. Risks and Justification 41 PART V: OTHER BANK GROUP OPERATIONS IN MOROCCO 43 This docunent has a reseicted disibution and may be usd by recipiem only in the performnce of their ofiid dutieL Its contents may not othwie be dicosed witout Word DBank authorizat Table of Contents Page 2 of 2 PART VI: LEGAL INSTRUMENTS AND AUTHORITY 45 PART VII: RECOMMENDATIONS 46 ANNEXES: I. Country Data 47 II. Status of Bank Operations 53 III. Supplementary Loan Data Sheet 54 IV. Government's Statement of Development Policy 56 V. Fund Position during Period of Stand-by Arrangement,l985-87 76 VI. Historical Key Nominal Interest Rates - 1973-84 77 KINGDOM OF MOROCCO FOR A SECOND INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOAN LOAN SUMMARY Borrowetr: The Kingdom of Morocco Amount: US$200.0 million equivalent. Terms: 20 years, including 5 years of grace, at the standard variable interest rate. Loan Description: The proposed loan would support the second phase of implementation of the Government's economic adjustment program. The program comprises actions extending export promotion and reform of protection policies, rationalizing the public investment program and improving investment planning and budgeting, and introducing financial sector reform. The principal aims of the program are to improve the efficiency of resource allocation and utilization in the economy, achieve structural changes in the incentives system, and realize the potential for export development and promotion of public and private savings. The:program is described in the Government's Statement of Development Policy to the Bank. The foreign exchange provided by the loan would be used to finance imports. The main benefits of the program would be improved allocation and efficiency of investment, increased national production, growth of savings, and an improvement in the balance of payments through increased exports and a reduced current account deficit. The risks of the program relate to uncertainties in the external env- ronment and export prospects, the possibility of further deterioration of Morocco's financial situation which could affect the commitment to import liberalization. and the difficulty of balancing the length and rigor of the adjustment process against the political constraints faced by the Government. Estimated Disbursements: The loan would be disbursed in two tranches. The first tranche of US$120.0 million would be available for disbursement at the time of loan effectiveness. The second tranche of US$80.0 million would be released after implementation of specified actions and a progress review, approximately six month.s after effectiveness. Disbursements of the entire loan are expected to be completed within 12 months. Appraisal Report: This is a combined President's and Staff Appraisal Report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOWMENDATION OF THE -PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$200.0 MILLION TO THE KINGDOM OF MOROCCO FOR A SECOND INDUSTRIAL AND TRADE POLICY ADJUSTMENT LOAN 1. I submit the following report and recommendation on a proposed Loan to the Kingdom of Morocco, for the equivalent of US$200.O million, in support of its program of industrial and trade policy adjustment. The loan would have a term of 20 years, including 5 years of grace, at the standard variable interest rate. Cofinancing possibilities with commercial lending institutions in support of this program are being explored by the Government. PART I - THE ECONOMY 2. An economic report, entitled "Morocco: Priorities for Public Sector Investment (1981-85)" (No. 4156-MOR), was issued in June 1983. It was followed by an economic report entitled "'orocco: Industrial Incentives and Export Promotion" in January 1984 and a report on the Financial Sector (No. 4957-MOR) in December 1984. A Country Economic Memorandum is being prepared and should be ready during the first semester of 1985 11. Country data are given in Annex I. A. INTRODUCTION 3. During the first 15 years after Independence in 1956, a conservative approach to economic policy predominated in Morocco. GDP increased at an average rate of 4Z a year in the 1960s. A relatively weak savings effort and conservative external borrowing policies permitted only a slow rise in the share of resources allocated to investment. Morocco thus entered the 1970s with no major financial imbalances, but a relatively limited growth capacity. Although some industrialization had taken place, over half of the labor force was employed in the traditional agricultural sector at relatively low productivity. Primary products accounted for close to 90% of merchandise exports, with phosphates representing about a quarter of the total. 1/ This will be an expanded version of the report prepared by the Bank for the Consultative Group meeting in Paris, January 9-11, 1985. -2- B. ECONOMIC PERFORMANCE IN THE 1970s 4. During the mid-1970s, economic policy became more ambitious. In 1974, phosphate export earnings more than quadrupled with the sudden jump in phosphate prices. Although the petroleum import bill also quadrupled in 1974, the current account of the balance of payments remained in surplus. The Government launched a massive public investment program which brought about a sharp acceleration in the rate of growth of the economy, and GDP grew at the rate of 7.5Z annually in 1973-77. 5. The phosphate boom, however, was shortlived and phosphate exports started falling in both volume and value as early as mid-1975. Markets for other exports as well as earnings from tourism and labor migration were also negatively affected by the world recession. Agricultural production and exports entered a period of prolonged stagnation and Morocco turned from being a net exporter into a net importer of foodstuffs. As a result of all these factors, the growth of exports of goods and nonfactor services averaged only 0.6P a year in 1972-77 in constant prices, compared to more than 8Z a year in 1967-72. 6. Accelerated investment, and growing public expenditures, increased defense spending resulting from the situation in the Western Sahara, coupled with stagnant exports, increasing imports, and relatively sluggish revenue performance created strong pressures on both the balance of payments and the Government budget. In 1977 the overall Treasury deficit reached 15.8Z of GDP and the current account deficit rose to 16.51 of GDP. To help finance these gaps, Morocco borrowed heavily from the international capital market, which led to rapid increases in external debt and the debt service burden. The debt service ratio rose from 5.61 of exports of goods and services in 1975 to 10.71 in 1977. C. STABILIZATION PROGRAM: 1978-1980 7. In order to redress the rapidly deteriorating financial situation, the Moroccan Government in 1978 adopted a three-year stabilization program which aimed at reducing internal and external deficits to sustainable levels. The demand management policies of that period centered on reductions in investment outlays and stricter import controls and included an exchange rate devaluation in 1980. The reforms did not adequately address the fundamental structural weaknesses of the economy, with the result that the short-term adjustment of the economy was only moderately successful. By 1980, both fiscal and external imbalances were still substantial: the overall Treasury deficit remained at about 11% of GDP and the current account deficit at 81 of GDP. 8. Expenditures for social activities have been high since the mid-1970s, accounting for more than half of current budgetary outlays. However, social indicators still appear to be at a relatively low level in Morocco. The limited effectiveness of past social policies in reaching the lower income groups, especially in rural areas, is increasingly recognized as a major issue. The strategy of the 1981-85 Deve opment Plan emphasized the 3 importance of rural development in rainfed areas, where most of the poorest households in Morocco currently live, and the need to improve mechanisms for delivering services to meet basic needs at an affordable cost. An effort is also being made to increase the involvement of local communities in meeting basic needs, particularly for low cost housing, water supply, sewerage and electrification. Although rapid results cannot be expected in any of these areas, accentuated implementation of these policies would help meet the needs of low-income groups, while holding down the budgetary cost of social programs. D. GROWING DISEQUILIBRIA: 1981-82 9. The agricultural sector, which grew by nearly 4X in the 1960s, failed to grow in the next decade, partly as a result of poor climatic conditions. This trend continued in recent years with a sharp fall in output in 1981, only partly reversed in 1982. At the same time, and despite large public investment in manufacturing since the mid-seventies, value-added in manufacturing declined in 1980-82. Expanding Government activities were the main source of growth (12Z per annum in real terms during the period) which was linked to the rapid rise in Treasury expenditures. Overall, real GDP increased by only 2.7S per annum in real terms in 1980-82 compared with 4.2% per annum in 1976-80, and Morocco's real income per capita declined for the first time in many years. 10. The Government's effort to stabilize the Moroccan economy was severely hampered by a series of external shocks: (a) the 1979 increase in oil prices aggravated an already substantial oil import bill ($1.2 billion in 1982); (b) a severe drought in 1981 reduced agricultural output by about 202 and led to substantial imports of cereals; (c) the rise in international interest rates contributed to a steep increase in debt service to 34.77 in 1982; and (d) the international economic recession contributed to a 307 decline in the dollar price of rock phosphates and to a fall in workers' remittances, Morocco's principal sources of foreign exchange earnings. II. In addition to the external shocks, continued internal pressure to provide social services and consumer subsidies to a rapidly growing population as well as defense expenditures for the Sahara war resulted in rapid growth in Government current expenditures. At the same time, the 1981-85 Development Plan, which aimed at an ambitious 6.57 p.a. GDP growth rate, led to a sharp increase in public investment expenditures (467 rise from 1980 to 1982). Despite tax increases, the ratio of current revenue to GDP has remained mostly in the 23-24% range and the overall Treasury deficit rose again from 10.7. of GDP in 1980 to 14.5X in 1981 and 12.37 in 1982. 12. The combined effect of the external shocks and the highly expansionary fiscal deficit was an overall increase in the current account deficit from $1.4 billion in 1980 to $2.0 billion in 1982 (or from 87 to 13.3% of GDP). On the export side, positive factors such as the continued growth of manufactured exports, the emergence of new non-traditional expQrts, and renewed growth in the tourism sector after the 1980 devaluation were more than offset by the fall in phosphate earnings, agricultural exports, and workers' remittances. On the import side, continued growth was due mainly to petroleum, food, and capital goods imports. -4- 13. To finance the investment program and current account deficit and to meet its debt amortization payments, Morocco increased its external borrowings considerably. Total commitments on medium-and long-term credits averaged $1.8 billion annually over the period 1976-82, compared with $320 million per annum between 1970 and 1975. External public debt outstapding and disbursed grew by 26% a year between 1975 and 1982 in current dollars, and by 20% per annum in constant dollars. Total debt service rose rapidly from 5.6% of exports of goods and services in 1975 to 34.7% in 1982, when a total of $1334 million was owed in interest and principal repayments. Of this total, about 55% was owed to official creditors, and about 42% to bilateral lenders. Saudi Arabia and France were the largest bilateral creditors, with claims to 23% and 13% respectively of the total outstanding debt. Among multilateral lenders the World Bank had the largest share at about 8% of the total. Payments to private creditors accounted for about 70-80% of total debt service in 1978-82- PART II: THE ADJUSTMENT PROCESS, PHASE I: 1983-84 A. STRUCTURAL PROBLEMS 14. The structural problems facing the Moroccan economy have been (i) a chronic shortage of foreign exchange, which stems from an unbalanced external trade situation and a high level of debt service; (ii) current budgetary expenditure persistently higher than current revenues, which has resulted in negative public savings and high internal and external borrowing by the Treasury to finance investment programs; (iii) a relatively low level of private domestic savings; and (iv) a low GDP growth performance with sectoral imbalances and a low share of industry in total value added. These disequilibria were already nascent in the 1960s and were aggravated in the 1970s by the more ambitious growth oriented policies adopted. 15. Imports of goods and non-factor services increased rapidly (17% per ann in real terms in 1972-77) while exports lost their previous dynamism and grew very slowly. As a consequence, the external trade situation became increasingly unbalanced during this period. Although this trend was briefly reversed with the implementation of the 1978-80 stabilization plan, the trade deficit became gradually worse in 1980-82, with merchandise exports declining from 56% of cif import costs in 1980 to 47% in 1982. 16. Although the poor export performance of finished manufactured prcducts can be attributed in part to unfavorable world demand trends, equally important factors have been a loss of competitiveness of industry and strong incentives to produce for the protected internal market rather than for exports. Exchange rate and trade policies have had anti-export biases. The real effective exchange rate appreciated by 17.4% between 1970 and 1980 in relation to the currencies of Morocco's major trading partners. The trade protection system during that period was highly restrictive, with extensive use of import and export licensing and a high level of tariffs. In 1978 there was on average a 50% differential in the effective protection ratio in favor of -5- production for the domestic market versus exports. 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. Table 1 Exchange Rate and Trade Balances 1970 1973 1975 1977 1980 1982 1984 Nominal effective exchange rate 97.5 99.5 99.2 100.0 100.0 92.9 89.1 Real effective 85.2 95.1 96.3 95.9 100.0 93.4 91.9 exchange rate 1/ Merchandise -137 -124 -736 -1538 -1357 -1774 -1373 Trade Balance (fob) (US$ Million) 1/ Trade weighted, excluding oil payments, phosphate receipts and including tourism, base 1980=100, revaluation = increase in index. 17. Domestic savings have been abnormally low as incentives for savings have been weak. After increasing in the late 1960s and early seventies, domestic savings fell from 15.6X of GDP in 1973 to 8.4X in 1982. This was in large part due to negative savings by the Government. However, private financial savings also remained low as a result of inadequate financial and banking policies. Real interest rates were negative on deposits during the 1970s and the early 1980s (Table 2). In contrast, gross fixed investment _ose sharply in the mid 1970s and remained at a high share of GDP in the early 1980s (23.3% in 1982 compared with 16.9% in 1973). As a conseou'.-nce, high foreign borrowings were contracted by the public sector to compensate for the deficiency in domestic savings, which resulted in high levels of external debt (para- 13). -6- Table 2 Interest Rates, SavinRs and Investment 1973 1975 1977 1980 1982 1984 (percent) Nominal interest rate on 6 months deposits 2.8 4.5 4.5 7.5 8.5 8.5 Inflation (CPI) 5.1 8.0 12.5 9.4 10.5 11.1 Real interest rate -2.3 -3.5 -8.0 -1.9 -2.0 -2.6 Ratio of Domestic Savings over GDP 15.6 14.5 12.1 11.5 8.4 12.0 Ratio of Investment over GDP 16.9 25.4 32.5 22.6 23.3 22.9 18. The sharp increase in the investment rate achieved in the mid-1970s could not be sustained without large capital inflows. As these declined, GDP growth fell to an average of 3.2% per annum in real terms during 1977-82, which was close to the population growth rate. The incremental capital output ratio rose from a level of 3.0 in the early 1970s to 4.3 in the period 1975-80, reflecting a significant decline in the efficiency of investment. The industrial strategy of import substitution and capital intensive projects relied upon continuing increases in tariff levels and quotas, generous investment incentives, and an artifically low price of capital to sustain growth in manufacturing. It did not succeed. In the public sector, the low efficiency of investment was due to poor project selection and a continued preference for large scale projects, which usually had a high import content. 19. Unemployment (about 10%) and underemployment (estimated at between 30% and 40%) remained high. While unemployment was alleviated in the mid-1970s by rapid growth, employment creation was less than could have been expected due to the capital intensity of new investment. Although accurate data are not available, it is likely that unemployment worsened in the 1980s due to the economic recession. In addition, a growing percentage of the unemployed are relatively well educated young people, but their skills have not matched the demand for labor, creating a potential source of political and social tension. 20. An important constraint on growth is the high level of debt (para. 13), which resulted from the rapid increase in external borrowing in 1975-82, when Morocco relied heavily on the international financial market to fill the balance of payments and government budget gaps. During this period, the debt structure shifted, with an increased proportion being owed to private -7- lenders (over 501 of total debt in 1977-80, compared with about a third in 1975). Consequently, average loan terms hardened significantly, wrhen beginnirg in 1979 there was a simultaneous rise in interest rate. and shortening of maturities on non-official borrowing. By 1982, the grant element of new commitments extended to Morocco had dropped to 4.8X from about 181 in 1977-78. B. STABILIZATION POLICIES: 1983-84 21. Current account deficits in the range of 8-13S that obtained in the early 1980s could not be sustained: the accumulated debt and debt service burden were more than the economy could support or creditors would tolerate. In 1983, access to international financial markets was sharply reduced and expectations of further inflows of concessional assistance did not materialize. Morocco was abruptly faced with a large external payment gap. Some $500 million of exceptional aid was raised at a special Doners' Meeting chaired by the IMF in November 1983. Official debt falling due in 1983-84 was re-scheduled by donors acting through the Paris Club, following negotiations in October 1983. In May 1984, Morocco signed a debt rescheduling agreement with Saudi Arabia. The rescheduling of commercial bank debt for this period was effectively completed by early 1984, although technical issues delayed the final signing. The total amount of debt relief obtaiced by Morocco on its medium-and long-term debt through these arrangements is estimated at $508 million in 1983 and $1031 million in 1984. Wichout Lz r s^chcduling, debt service would have reached 54.51 of exports in 1984. 22. The significant decline of net foreign assets in early 1983 prompted the Government to impose emergency import restrictions and to prepare a revised, reduced budget. The level of new budgetary investment appropriations was cut back sharply and virtually all new projects in the 1981-85 Plan that had not yet started were deferred or cancelled. A new stabilization program was prepared and supported by an 18 month IMF stand-by arrangement providing $317 million (SDR300 million). The DMW program aimed initially at reducing the current account deficit of the balance of payments from 13.21 of GDP in 1982 to 8.91 in 1983 and 7.51 in 1984 (before debt relief). The balance of payments target was to be achieved through a sharp reduction of the Government budget deficit, relatively tight credit policy, and depreciation of the exchange rate. The budget deficit was to be cut from 12.31 of GDP in 1982 to 8.7% of GDP in 1983 and to 7.31 in 1984 (before debt relief on interest payments). The balance of payments and budgetary targets for 1984 were subsequently revised to 7.31 and 7.8% respectively. 23. In 1983, in order to achieve its fiscal targets, the Government raised the price of subsidized foodstuffs by amounts ranging from 17 to 601. Prices of fertilizers, electricity, water, and petroleum products were also increased. Net public service recruitment was reduced and capital outlays were cut by one third. In 1984, remaining consumer subsidies were eliminated, except those for wheac flour, granulat-d sugar, and edible oils. Strict limits continued to be imposed on public service recruitment, salary increases and investment expenditures. -8- C. THE INDUSTRIAL AND TRADE POLICY ADJUSTMENT (ITPA I) PROGRAM: 1983-1984 24. Along with the stabilization effort in 1983-84, Morocco also made a significant start on the structural reforms needed to restore a viable balance of payments position with a package of measures to restructure trade incentives and to promote the efficient use of resources. In January 1984, the Bank approved a $150 million Industrial and Trade Policy Adjustment (ITPA) loan to support the first phase of this program. This phase included actions to increase exports, reduce import protection, remove price controls, improve the financial system, and prepare fiscal reforml/. Its focus was an improving industrial efficiency, lowering manufacturing costs, and restoring dynamism to industrial growth through a significant reduction of the bias against export production. Many of the measures envisaged under this program were initiated in 1983, and all have now been implemented. The profitability of production for export was substantially increased as a result of a depreciation of the effective exchange rate. Temporary import procedures for export production were expanded. Imports were liberalized; the special import tax was reduced from 15 to 10%, the remaining prior import deposit requirements were eliminated, and the maximum rate of customs duty was reduced to 60% so as to decrease the excessively high incentives previously granted to some import-substituting industries. In addition, the emergency quantitative import restrictions that had been imposed in March 1983 were progressively removed, so that the share of freely imported goods rose from 21Z of the value of imports in 1983 to 75% in 1984 (on the basis of composition of 1982 trade data). This import liberalization process included the removal of import licensing on about 350 product categories and elimination of import prohibitions on 60 product categories. On the export side, special customs regimes for exporters were extended and improved and export procedures simplified; export licensing was removed for all but a few products; and the monopoly of the state marketing board (OCE) on exports of processed food products was abolished, so as to allow exporters to choose freely their commercial intermediaries. In parallel to these external trade measures, the Government also implemented in 1983 and 1984 a reform of the system of export credits and export credit insurance and a substantial increase in interest rates on remittances of overseas workers. Measures for tax reform were proposed during this period, some of which were designed to strengthen specifically the incentives for export production. In addition, a significant lib3ralization of manufacturing prices was carried out. D. MACROECONOMIC PERFORMANCE: 1983-84 25. Stabilization policies succeeded in reducing external and internal deficits in 1983. However, the same policies, together with a poor harvest, contributed to a lower GDP growth performance: 2.2% real growth in 1983 compared to 3.4Z during 1979-82. The lower investment budget and the restrictions on consumer goods imports had a depressing effect on total demand. The drought caused a decline in agriculture value added, which 2! Please see memorandum Sec M84-816 of September 19, 1984 on release of the second tranche of the ITPA loan. decreased by 4.6% in real terms and slowed growth in other related sectors. Inflation also slowed in 1983 with consumer prices growing at less than 6.5S. The money supply however grew at a rate of 132 p.a., much faster than GDP in nominal terms, which increased cash balances in the economy. These could eventually finance private and public enterprise imports purchases at a later stage, and did so in 1984. The control of inflation was thus short lived, and consumer prices grew at 11.11 during the year. 26. Morocco's economic growth remained slow in 1984, at an estimated 2.4%. The 1983-84 drought and then damaging rainfall just before the harvest continued to depress the agricultural sector. The prolonged drought also led to a decline in the production of hydroelectric power. Value added by the construction sector declined by about 21, as a result of continuous restrictions in Government investment expenditures. Manufacturing industries stagnated in spite of a significant growth of manufacturing exports at 9.21. 27. The ratio of the Government budget deficit to GDP was reduced from 12.31 in 1982 to 9.11 in 1983. This relative improvement of the budgetary position did not result from a better performance in Government savings, which remained negative. Budgetary capital expenditures decreased from DH 12.5 billion to DH 8.0 billion and were the principal factor in the reduction of the overall budget deficit. 28. Despite the adverse effects of the low level of economic activity on Government revenues, the overall Treasury deficit was further reduced to 8.11 of GDP in 1984. Budgetary receipts increased by about 31 less than expected as there was a shortfall in receipts from indirect taxes and income taxes. Moreover, the shift in the composition of imports towards food imports and capital goods, which are exempt from customs duties, and towards fuels, which have lower than average duties, resulted in slower growth of revenues from customs duties. Capital expenditures were again restrained below projected levels in order to offset the shortfall in budgetary receipts. They amounted to DH 7.4 billion in 1984, compared with an expected level of DH 8.5 billion and an actual level of DH 7.9 billion in 1983. 29. The results on the trade and current accounts, although less favorable than expected, indicate that the trade adjustment policies adopted since 1983 have had a positive impact. The current account deficit as a proportion of GDP was reduced from 13.3% in 1982 to 8% in 1983. This was achieved through a significant reduction in the level of imports of consumer goods other than cereals (-14.81 in 1980 prices), intermediate (-1.61), and capital goods (-26.21). The decrease in imports was primarily due to a decline in fixed capital investment expenditures. Conversely, exports of goods grew at a rate of 9.7%. 30. The balance of payments performance worsened in 1984. The current account deficit reached 10.7% of GDP compared to 7.51, the original estimate of the IMF stand-by program. Merchandise exports grew by 7.81 (in 1980 constant prices), while imports increased at a rate of 15.81. The excess of imports was partially offset by a lower than expected deficit on service account and higher workers remittances, which were attracted by higher interest rates on deposits and, to a lesser extent, the devaluation of the dirham between mid-1983 and mid-1984. - 10 - 31. Recent export performance is encouraging. High export growth was registered in 1982-84 as a result of a surge in phosphate derivative exports as newly installed production capacity became operational. Phosphoric acid exports grew at an average of 25.2% per annum in real terms in 1982-84, and fertilizer exports increased by 38.6Z p.a.. The other sources of export growth were processed agricultural products, which increased by 10.21 per annum in 1982-84 and finished products, with a growth of 6.61 in 1983 and 9.2X in 1984. The performance of the latter trade categories was aided by the export promotion measures implemented under the adjustment program supported by the ITPA loan. Table 3 Export Performance 1979-82 1983 1984 (Annual Z growth rates in constant Dirhams) Merchandise exports (fob) 3.3 9.7 7.8 of which: Agricultural products 2.4 7.4 7.1 Phosphates and minerals -7.0 1.8 8.2 Derivatives of phosphates 22.9 44.2 14.0 Finished manufactured goods 5.5 6.6 9.2 32. Imports of merchandise grew on average at 3.4% per annum in 1983-84, with a sharp contraction in 1983 and a surge to 15.8X at constant prices in 1984, which led to a large current balance deficit in the year. The major sources of import growth in 1984 were cereals, fuel, and machinery and equipment: Table 4 Import Performance 1979-82 1983 1984 (Annual Z growth rates in constant Dirhams) Merchandise imports (cif) 0.3 -7.8 15.8 of which: Cereals 9.5 -1.3 32.8 Fuel -1.4 0.7 10.4 Machinery and equipment 0.3 -26.2 23.6 Consumer goods -6.6 -14.8 0.0 Cereals and fuel were imported in much larger quantities to compensate for hydroelectric production shortages due to the drought (para. 26). The high growth of machinery and equipment imports resulted from the implementation of - 11 - public sector investment programs already approved in past years. Imports of capital goods benefiting from the tax exemptions under the Investment Codes increased from DR 1.2 billion in 1982 to DH 3 billion in 1984. Half of the 1984 purchases were made by the national phosphate agency (Office Ch6rifien des Phosphates, OCP), including equipment for a phosphoric acid unit, and most of the remainder were made by other public enterprises such as the telecommunications, power, and rail companies. 33. Although the balance of payments position worsened in 1984, the devaluation of the dirham in 1983 and early 1984 had positive effects on key components in the trade sector and compensated in part for the tariff reductions and liberalization. The real effective exchange rate index calculated on a trade weighted basis declined by 9Z between July 1983 and May 1984. The devaluation did not have much impact on food and fuel, or public capital goods imports which benefit from duty exemptions under the investment codes and have no price elasticity. However, it had an effect on other consumer goods imports, as they declined in 1983 and remained at that level in constant terms in 1984. On the export side, no substantial effects were expected on phosphate products which are sold mostly in US dollars, but finished manufactured product exports grew faster in 1984 (para. 31). Canned fish, beverages, textiles, capital equipment, and hardware products were among the fastest growing export items. E. EVALUATION OF DISEQUILIBRIA AT END-1984 34. The first phase of the adjustment program grew out of the acute financial and balance of payments crisis of 1983. In that year, the Moroccan Government recognized that the inward oriented development strategy based on large Government interventions and major capital public investment projects was not working and that another strategy would have to be adopted. The severity of the debt crisis required that this major strategy reorientation take place during a period of severe constraints and stabilization, making the process that much more difficult. On the basis of analysis already undertaken in Morocco and consultation with the Bank and IMF, the Government adopted a development strategy based on an increasingly outward orientation, reduced protection and trade controls, increased reliance on the market and competition, and a more restrained role of the Government. Implementing this strategy required major changes in policies and practices as well as a fundamental change in mentality and attitudes of officials and the private sector. The program undertaken with the support of ITPA I was aimed at undoing the severe distortions introduced as reactions to the growing economic crisis in the last decade and at beginning to change the strategy followed by the Government away from protection towards economic openness. These objectives were achieved. 35. The ITPA I loan resulted in significant changes; however, its impact on nacional production and efficiency can be fully realized and evaluated only in the medium-term, in view of the structural nature of these changes. Import liberalization measures implemented under the loan helped reverse the import controls imposed in March 1983. The number of items prohibited from import decreased by 30%, and products which could be imported freely (raw materials, spare-parts, some intermediate goods) rose from 0 to 43% of all import -12- categories. The reduction in the level of trade taxes resulted in a decrease in the weighted average of nominal import duties from 48.0% to 35.8Z and a fall in the level of dispersion, as indicated by the standard deviation coefficient, from 32.8 to 18.5. The decrease in variance of the structure of nominal tariffs implied a considerable decline in both the average effective rate of protection and the dispersion of effective rates. In addition, export promotion measures under the ITPA I loan contributed to some extent to the significant acceleration of exports of finished manufactured products in 1984 (para. 31). Substantial increases from tourism and workers remittances occured as a result of a more flexible exchange rate and an increase in the interest rate on workers remittances from 3 to 8% in September 1983. 36. Factors which slowed adjustment in 1984 were exchange rate management in the second half of the year, continuing public sector investments, monetary and interest rate policies. The dirham appreciated in the second half of 1984 against currencies of Morocco's major trading partners, other than the US dollar, by about 5Z in real terms, as a result of inadequate management of the real effective exchange rate. This appreciation diminished the relative profitability of exports to Europe, Morocco's major market for finished manufactures, and did not discourage imports as much as desired. Public enterprise expenditures for investments approved in earlier years remained a major cause of import growth, although there were drastic cuts in the: Government's investment budget. However, the investments of the OCP group, which represented a major part of imports for the public sector, were necessary to increase productive capacity for exports. Finally, expansionary monetary policies in 1983 raised the inflation level to 11 in 1984. Several major interest rates were negative in real terms, and, as a result, there were insufficient incentives to domestic resource mobilization and efficient credit allocation. The disequilibrium between savings and investment remained high, with investment at 22.9% of GDP and domestic savings at 12X of GDP in 1984. 37. The import liberalization and export promotion measures of ITPA I were fully implemented. Available evidence indicates their positive effects on trade movements and industrial efficiency. However, inadequate management of the exchange rate limited some of the positive impact of the trade policy reforms, and required correction. Other areas in which corrective action was indicated at end-1984 were the financial sector (to raise interest rates, and improve intermediation efficiency), the public investment program (through continued rationalization and strengthening of planning), and public enterprises (through structural measures to raise operating performance and resolve the issue of public enterprise arrears). 38. The second phase of the adjustment program, which will be supported by the proposed ITPA II loan, will address the deep, long-standing structural distortions that have characterized the economy for a long time. It will also confirm the Government's intention to follow its strategy of liberalization and increased competition. In support of this strategy, this phase will continue the reduction of incentive distortions by lowering tariff barriers, increasing import liberalization, and furthering export promotion. A wider range of structural issues must be addressed to achieve the desired results of increasing production and productivity over the medium term. The trade and - 13 - industrial policy measures would reduce distortions and improve efficiency in the markets for intermediate and final goods, and shift supply towards exports and import substitutes. But to effect lasting structural changes, biases and distortions must also be eliminated in the factor markets, particularly the capital market. The second phase addresses these issues through measures to increase public and private savings; to improve the allocation of the savings to investment through more efficient inteimediation in the private sector and more effective investment plahaning in the public sector; and to make better use of existing capital stock through restructuring and rationalization of existing enterprises (public and private), thereby helping them adjust to the changed environment. The medium-term structural measures, begun under ITPA I and continued and expanded with the aid of ITPA II, are supported and complemented by short-term macroeconomic stabilization measures in the IMF's stand-by programs. These programs have focussed on demand management and the related exchange rate issue to meet the immediate crisis until the medium-term structural reforms can have their effect. The exchange rate, of course, also has a major role to play in the medium-term adjustment program. PART III: THE SECOND PHASE OF ADJUSTMENT, 1985-86 A. MEDIUM-TERM OBJECTIVES 39. The Moroccan authorities have fully recognized that continuing the adjustment effort is imperative. On behalf of the Government, the Ministers of Finance and Plan presented a comprehensive medium-term adjustment strategy at the Consultative Group meeting in January 1985 I'. The objectives of this adjustment program are to restore the Government budget and current account balances to sustainable levels while carrying out fundamental adjustment of the economy aimed at increasing its efficiency and productive capacity, in order to achieve the country's longer-term growth and development goals. The Government's objective is to reach a sustainable growth path by 1988, when it is expected that no further rescheduling will be necessary, and the country's creditworthiness will be sufficiently restored, so that it can return to commercial credit markets on a normal basis. The program presented is comprehensive and includes actions affecting all sectors in the economy. 1/ The Moroccan delegation included senior representatives of a large number of major economic agents and ministries to emphasize the Government's commitment to the program. - 14 - The primary emphasis is to resolve the current debt and balance of payments crises and make the economy more competitive, through reducing price and incentive distortions and promoting exports and growth. The program is supported by measures to increase national savings, improve investment allocation and planning, increase competition, and reduce Government intervention in the economy. Many of these measures are supported by the proposed loan. In addition, the Government's program includes extensive reform in agriculture, which is supported by a sector loan to be presented to the Board shortly; rationalization and restructuring of the role and functioning of public enterprises; reorientation of priorities in health towards primary care, and in education towards reaching a larger portion of the population, while reducing the burden on the budget. Similar measures are being undertaken in other sectors to achieve a better balanced and more effective development effort scaled to a realistic view of the resources available. 40. The medium-term prospects remain difficult, despite the encouraging results of the adjustment and stabilization policies pursued in 1983-84. Some elements of the external environment will have a positive impact on the realization of the stabilization and adjustment objectives. A recovery in phosphate exports in 1986-87 should provide additional foreign exchange, as well as a higher contribution to central government revenues. Acceleration bf industrial activity in OECD countries should facilitate Moroccan export promotion. Relatively good cereal production in 1985 will reduce import requirements and improve overall domestic production prospects. More normal rainfall after years of drought will help restore much of the productivity in the agricultural sector and hydroelectric capacity. The expected stagnation of international oil prices will also tend to moderate the growth of the oil import bill. However, the high level of debt service and the size of the current account and budget deficits imply that the attainment of an overall balance of payments equilibrium will require continued determined stabilization efforts supported by a strong package of restructuring policies over the next several years. 41. Future sectoral developments will be sustained in the Government's program by new policies concerning the main production factors, labor and capital. The human and financial resources in the education sector will be reallocated towards basic education and vocational training. Overall growth of expenditures on education, which have been very high, will be reduced. Priorities will be adjusted to support increasing the coverage of basic education (years 1-6) to all the population and to increasing vocational training. Expansion of upper secondary and university education, which is expensive and produces more graduates that can be currently absorbed, is being curtailed. This reform will improve the relevance and impact of the education system while reducing its cost to the budget. Links between planning and budgeting will be improved to assure that projects undertaken are economically justified and fit with the level of resources available. New systems will monitor their implementation more closely. Priority will be given in the near term to completing investments which are directly supportive of increasing production. Financial sector reforms will reduce biases favoring the use of capital by raising the cost of capital toward its scarcity value through increasing interest rates, reducing subsidies to capital, and improving its allocation. - 15 - B. STABILIZATION POLICY IN 1985-86 43. In view of the continuing disequilibria at end-1984 and in the context of achieving its medium-term objectives of a viable balance of payments and budgetary situation, the Government has concluded negotiations on a stabilization program with the IMF covering the period April 1985 to February 1987. This program will be supported by a stand-by in an amount equivalent to SDR 225 million. Compensatory financing has also been discussed with the IMF, to cover higher costs of cereal imports in 1984 and a temporary shortfall in merchandise export revenues. In addition, the Government has requested official lenders and commercial banks to reschedule debts in 1985 and 86, in the amounts of SDR 1.2 billion and SDR 1.7 billion respectively. 44. The stabilization program provides the necessary macroeconomic framework for successful continuation of the ITPA II program. Under the program agreed with the IMF, the target for the balance of payments deficit is set at 6.5% of GDP in 1985, and 4.5X in 1986. The need to meet the balance of payments targets highlights the importance of measures to encourage export growth and of appropriate exchange rate policy. Quarterly performance criteria have been set in the agreement to monitor progress towards the goal of a budget deficit of 6.5% of GDP in 1985. Realization of this target will require significant actions both to increase budget revenues and to limit expenditures. In connection with revenues, a major reform of both direct and indirect taxation (including introduction of a value added tax) has been prepared by the Government in collaboration with the IMF. The Bank has given its view regarding aspects of the reform concerning industrial and export incentives and they have been taken into account. The fiscal reform laws have been presented to Parliament and are expected to be- implemented by end-1985. 45. Current revenues are expected to increase in 1985 by 16.0%, more rapidly than current expenditures at 13.4X. A major source of additional revenues will be increased transfers from the national phosphate agency (Office Cherifien des Phosphates, OCP). The introduction of the value added tax (VAT) will provide some additional revenues in 1986. As regards current expenditures, personnel expansion by the Government will be limited in 1985 to a net recruitment of 2000, and salary increases for the year to an incremental cost of 52 of salaries in 1984. Budgetary outlays on subsidies paid through the Caisse de Compensation on flour, sugar and edible oils are to be limited to DE 2.1 billion. This will require significant price increases for subsidized commodities. Subsidies have declined in the period 1981 to 1984, from about 14.3 to 9.2Z of current expenditures, or from 3.8Z to 2.01 of GDP and are expected on the basis of the 1985 budget, to decline further in this year to 7.5Z of current expenditures or 1.7Z of GDP. The Government plans to control investment expenditures strictly; they are programmed not to exceed DE 7.1 billion in 1985, excluding settlement of accumulated Government arrears on the investment budget from exceptional grant financing. This latter may permit a reduction of up to DH 3 billion of accumulated arrears. - 16 - 46. Budget discipline will be accompanied by stringent monetary policy measures. The growth of bank credit to the economy will be restricted in 1985 to lO.OZ. Quarterly performance criteria have been set for the growth of total bank credit and net bank credit to the Government. At the same time, to ensure appropriate signals through thq interest rate mechanism, deposit and lending rates have been raised, effective April 1, 1985, as part of the financial reform package agreed with the Bank (see para. 64 below). Inflation is projected at about 12% atnually in 1985, 10X in 1986, and 8S in 1987. Finally, ceilings have been established for new external debt ($500 million for non-concessional debt) and total short-term debt outstanding (not to exceed the end-1984 figure of $1 billion). 47. The relatively poor performance on the current account in 1984 and the unexpected appreciation by 5Z of the dirham in real effective terms in the last half of 1984 have been a cause of concern. After evaluation and discussion with the IMF, the Government has agreed on an appropriate exchange rate adjustment. Additional adjustments will be made, as necessary from the point of view of the balance of payments and trade policy, given in particular the Government's objectives of achieving rapid export growth at around 7-8X annually and restricting import growth to around 2% annually in the period 1985-90. C. THE SECOND INDUSTRIAL AND TRADE POLICY ADJUSTMENT (ITPA II) PROGRAM:1985-86 48. The adjustment program which would be supported by the proposed loan is described in the Government's Statement of Development Policy (Annex IV). The measures constituting this program and their implementation schedule are outlined below and summarized in the table in Annex IV. 49. Within the context and constraints implied by the stabilization program described above, the adjustment program covers measures aimed at structural reform in three main areas: i) continued export promotion and import liberalization, consisting of greater simplification of export procedures, tariff reduction, and further trade liberalization in conjunction with continued flexible exchange rate policy; ii) rationalization of the public investment program and of public enterprise finances; and iii) financial sector reform to raise interest rates, restructure the administrative framework, reduce direct Government intervention, increase competition among financial institutions, eliminate interest subsidies, and develop the money market. This set of measures has been designed with the objectives of improving the efficiency of resource allocation and utilization in the economy, realizing the potential for development of exports, and promoting growth of public and private savings. Export Promotion 50. Exchange Rate. The Government has committed itself to a flexible exchange rate policy as described in para. 47. In addition to its short-term - 17 - impact, this policy is vital to the structural adjustment to provide appropriate price incentives to exporters and to compensate for the trade liberalization and import duty reductions. 51. Customs Regimes. Several important reforms were introduced in 1983-84 to improve existing customs regimes and assist exporters. Further reforms will be introduced under the second phase of the adjustment program. The procedure of temporary admission has been extended to cover all inputs of direct and indirect exporters except a few (particularly packaging materials) specified on a "negative list" by the Customs Office. In 1985, the Government plans to complete this reform by removing all industrial products (except glass used for packaging, which will be removed in early 1986) froai this "negative list", thereby facilitating certain exports (eg. canned fish) for which the unrestricted import of packaging materials is particularly important. Other items on the list (agricultural and fisheries products) will be removed progressively in function of freeing of their imports in 1986-88 through import liberalization (see para. 59). Administration of the prior export scheme (exportation prealable) has been decentralized. Under this scheme, when goods originally intended for local sale are exported, the value of these duties on imported inputs can be credited against duties on future imports, even where the latter are for products to be sold locally. The system of guarantees required from industries to cover possible payment of duties and taxes on temporary imports has been simplified by allowing global, annual guarantees for firms, rather than the previous requirement of a bond for each transaction. Such guarantees could be either from commercial banks, or from other firms. To speed up and facilitate processing, the Customs Administration has issued instructions to permit release of imported merchandise rapidly, even where there are unresolved customs claims from other transactions by the same importer. These latter should be settled separately. The Customs Administration will also compile and revise periodically the Customs Code and tariff list. As a result of the concerted effort of the authorities, it is expected that average customs processing time will be reduced by 50 percent, in 1985, from the estimated 12 days at the beginning of the year (in some cases, delays were as long as twice this period). The Government has stated its commitment to this target. 52. Administrative Procedures. To complement these measures, the Government will undertake a series of reforms of administrative procedures. Export licensing requirements have already been removed under ITPA I for industrial and most agricultural products. In 1985, such requirements will also be removed for nearly all mining products (with the exception of barytine, lead, and charcoal, for which prior monitoring of exports is considered essential), hides and leather. The Government has become increasingly aware of the administrative complexity of external trade procedures and the significant transaction costs incurred by both importers and exporters as a result of clearance delays. A concerted approach to trade facilitation over the medium term to address the problems that arise at each stage of the international transaction is needed in order that export growth not be slowed by overly cumbersome administrative procedures and clearance delays. The Government has confirmed that it will establish by December 31, 1985 a Committee for Simplification of Foreign Trade Procedures with terms of reference acceptable to the Bank. The establishment of the Committee would be - 18 - a condition of disbursement of the second tranche of the proposed loan. The composition of this Committee will reflect the full range of participants in most international transactions, namely importers and exporters, the Customs Office, administrative agencies responsible for international trade, foreign exchange allocation, and transport, various port authorities including the Port of Casablanca, commercial banks, and road, rail, and air carriers. This Committee will be responsible for the identification and monitoring of applied studies which will provide the analytical foundation on which to base the reform of international trade procedures. Three areas will receive immediate attention: Ci) the facilitation of informational flows by simplifying and standardizing official documentation; (ii) the identification and elimination of bottlenecks in the chain of international trade transactions which lead to costly delays for traders; Ciii) the preparation, publication and regular updating of a document setting out rules and regulations which pertain to all foreign trade operations. In addition, a handbook for importers and exporters will be prepared, providing a clear account of administrative requirements for the clearance of goods by Customs. This will enable the first set of reforms to be implemented by June 1986. 53. Agricultural and Food Products. In order to improve export incentives in the processed food sector, the Government eliminated the export monopoly of OCE for processed food exports in September 1984. Their exports are no longer submitted to price controls or commissions. OCE is still responsible for quality control of processed food products and has a monopoly of exports of fresh vegetables and fruits. A study of export marketing of fresh vegetables was proposed under the ITPA I program_1. The results are now expected to be available by September 1985; so that its recommendations would be implemented beginning in early 1986, following discussions with the Bank by end-1985. 54. Other Export Incentives. To facilitate promotional foreign travel by exporters, the Government has granted, with effect from January 1985, automatic foreign exchange allocation to exporters, up to 3 percent of annual export value, with the right to carry over any unused portion of this amount indefinitely into the future. Exchange allocations to cover payments of commissions on export sales have also been liberalized and made automatic. The Government will eliminate, in 1985, the statistical export tax, levied at 0.5 percent of the value of each transaction. Elimination of this tax would be a condition of disbursement of the second tranche of the proposed loan. In order to reaffirm its policy of active export promotion, the Government plans to prepare in 1985 an Export Code, which will confirm the fiscal and other incentives granted to exporters. 1/ This study was originally scheduled for: completion in September 1984, but as a result of slow recruitment of consultants, it has been delayed. - 19 - Reform of the System of Protection 55. A key objective of the Government's adjustment program initiated in 1983-84 is to reduce progressively the distortions caused by the system of tariffs and import restrictions built up over the years. This system was identified as a major cause of inefficient capital-use and low labor absorption 1/. it frequently favored industrial activities in which Morocco did not have any comparative advantage and often resulted in a strong bias against exports and efficient activities. The variation in effective protection rates across sub-sectors was quite large; there was no clear relationship of protection to the economic profitability of the production process; and exemptions from duties were granted on various products without consideration of the overall impact. As a result, the overall impact of the tariff structure was extremely unequal and led to severe distortions. The system resulted in high costs of production, both for exports and the local market. 56. Tariff Policy. The reform of protection policy begun in 1984 is planned to continue over a five-year period. The medium-term objective in tariff policy is to reduce the overall level of protection to 25% through decreasing maximum customs duty rates and evening out Zhe spread in tariff rates within and between sectors. In the first phase in 1984, the Government reduced the Special Import Tax (SIT, levied at a uniform rate on the vast majority of imports) from 15 to 10%, and the maximum rate of customs duty to 60% (affecting 320 tariff positions). In the second phase, beginning in January, 1985, the Government has further reduced the SIT to 7.5% 2. The Government will reduce the SIT to 5X by January 1986, and intends to eliminate it by January 1987. The Government will also reduce the maximum rate of customs duty to 45Z by January 1986. The reduction of the SIT to 5% and of the maximum rate of custom duty to 45Z would be conditions of disbursement of the second tranche of the proposed loan. 57. In the case of new investments in manufacturing, the Government will continue to apply the protection criteria adopted under the ITFA I program. For products which, after rigorous economic and financial analysis, protection in excess of 25% (within the overall tariff ceilings set) is considered justified in the first three years after project completion, the Government intends to grant such protection only through tariffs and not through quantitative restrictions, except in exceptional and duly justified cases. 1/ See "Morocco: Industrial Incentives and Export Promotion", Bank Report No. 4893-MOR, of January 1984. 2/ The Government had originally planned to reduce the SIT to 5% in January 1985, and eliminate it by January, 1986. This schedule has been modified for budgetary considerations in the context of the stabilization program, following discussions among the Bank, the IMF, and the Government. - 20 - 58. Import Liberalization. An essential element of the Goverment's strategy to improve industrial efficiency is to expose Moroccan industries to greater competition from abroad. This is partly achieved through tariff reductions, but the more important element in this liberalization is the gradual eliminatioi of quantitative import restrictions (import licensing and interdictions). This process is expected to be completed over five years. The liberalization of the licensing regime in July 1984 went beyond reversing the sweeping controls imposed in March 1983 by freeing imports of a number of additional products. Subsequently, in February 1985, considerable further progress was made in reducing the number of goods banned from import I' (only 7 items remained on list C compared to 132 in July 1984) as well as increasing the categories of products which could be imported without licensing (items on List A rose from 314 in July 1985 to 419 in February 1985). The increase in product categories subject to import licensing (goods on List B numbered 352 in February 1985 compared to 287 in July 1984) can be explained wholly by the greater transfer of items from List C to B than from List B to A. There were no regressive transfers from a more liberal to a more restrictive regime. The extent of liberalization can be gauged not only by the number of categories transfered, but even more by the degree of deprotection incurred by these categories. For instance, nominal protection - and by inference, effective protection - was reduced by approximately 40% for certain chemical product groups, 33% for specific ceramic products, 25% for cardboard boxes, and 20% for resinated plastics. Table 5 Changes in Import Regimes, 1982-85 Date of Transfer List A List B+C List B List C 1982 (December) 273 517 328 189 1983 (March) 0 790 601 189 1984 (July) 314 419 287 132 1985 (February) 419 359 352 7 59. A calendar of sectoral studies to be completed during 1985-86 has been prepared in anticipation of transferring more product categories to List A, including cheese, margarine, glass, rubber products, minerals and mining products, batteries, tableware, cutting tools, heating equipment, ceramics, wood products, hand tools, steel tubing, light bulbs, optical instruments, automobile spare parts, and certain appliances. The underlying rationale of these studies is to determine those There are three categories of imports: List A comprises goods which may be freely imported; List B consists of items requiring prior authorization through licensing; List C comprises items prohibited from import. - 21 - tariff rates (within the overall ceilings established) which confer the appropriate level of protection to industries no longer benefiting from quantitative controls. The Government plans to transfer these products corresponding to some 75 categories to the free list in January 1986. The transfer of these products to the free list would be a condition of disbursement of the second tranche of the proposed loan. Industries which will be significantly affected by the elimination of quantitative restrictions include glassware, steel tubing, certain rubber products, and heating equipment. The reduction in the level of nominal protection for these products ranges between 15% for hollow glass to 50% for heating equipment. The reduction in the nominal tariff ceiling from 60% to 45% will lead to a further decrease in the level of protection, with both the weighted average and standard deviation of nominal import duties falling respectively from 35.8 to 30.1% and from 18.5 to 13.9. The reduction in protection resulting from a decline in the maximum nominal tariff rate will be considerable in the Moroccan context, insofar as it primarily affects those industries which previously enjoyed indeterminate levels of protection afforded by quantitative restrictions. 60. Customs Nomenclature and Rationalization of Tariff Structure. The Government has commenced preparation of a new customs nomenclature (international harmonized system) and a major tariff rationalization (to ensure that duties are not higher on inputs than on output). The introduction of the new nomenclature is planned to take effect within a year of the completion of the final nomenclature by the international body, the Customs Cooperation Council. Rationalizing the tariff structure will reduce dispersion among customs duties, ensure that similar products bear the same rate of duty, and prepare for the reduction of the overall rate of protection to 25%. As part of this rationalization, the stamp duty would be either eliminated or subsumed by the customs duty. Continuing preparatory work on tariff rationalization will be carried out in 1985 - 87 according to a work-program discussed with the Bank. The first step will be the adaptation to Moroccan requirements of those chapters of the harmonized code already agreed, and the preparation of a provisional tariff structure with duties consistent Bith the 25% protection objective. This would serve as the basis for further tariff reductions and liberalization. The new harmonized nomenclature and rationalized duty structure will enter into effect, at the latest by January 1, 1989. 61. Price Liberalization. Recognizing that competition is a vital element to increase dynamism and productivity, the Government removed price controls in 1983-85 on about 40 products and services. Price controls have essentially been eliminated, except on subsidized food products, public utilities, and products where competition is limited, either as a result of the existence of natural monopolies, or where imports are still restricted. With the gradual elimination of import restrictions, the Government plans at the same time to remove price controls for these latter products. The few remaining cases where removal of price controls poses complex issues are in the agricultural sector: imported butter, molasses, cattle-feed. These issues are being addressed as part of the sector adjustment program in agriculture. In addition, it is expected that the Government will remove price controls in 1985 for tractors and explosives, two cases in which price liberalization has been delayed for essentially administrative reasons. 22 - Reform of the Financial Sector 62. Structure of the Sector. Morocco's financial system includes the Bank of Morocco (the central bank, Banque du Maroc), 15 deposit banks, five specialized institutions controlled by the public sector, and two savings banks. There is also a stock market in Casablanca with a limited role, an active inter-bank market, instalment finance and leasing companies. The Credit Guarantee Organization (Caisse Centrale de Garantie, CCG) is a public agency which guarantees domestic and foreign loans to public and private enterprises and organizations with a developmental role. Interest rates are set by the Minister of Finance upon the recommendation of the Bank of Morocco. The degree of concentration is high in commercial banking, with the two largest banks (controlled by the public sector) accounting for 44% of total commercial bank assets at end-1982, and the largest seven for 87%. The banking network is well-developed, with 643 branches at end-1982, of which over half are on the Atlantic coast. Commercial banks in Morocco generally have a record of high profitability, explained by lack of competition. Sight deposits represent the major portion of commercial bank resources, and short-term loans account for over 90% of their lending. Two principal reasons for this feature are the fact that commercial banks derive a much higher spread (6-7Z) on short-term than on medium- and long-term credits (about 2 percent), and the conservatism of commercial banks with regard to the greater risks inherent in medium- and long-term lending. The banks do not compete for deposits, and have even, on occasion, -cfused certain time deposits as not profitable. This is a result of tne constraints imposed on the banks to invest a portion of term deposits in Treasury instruments, (bearing interest well below market rates), reserve requirements, and the regul:-tion of interest rates. The Treasury is also a major agent in the financial sector. It is the main borrower abroad, uses domestic resources from non-financial agents, makes loans and advances to certain sectors, and provides capital subsidies to public enteprises and interest rebates to certain private investments. Three of the specialized public financial institutions are responsible for the bulk of medium- and long- term lending. They are differentiated by sector of activity: agriculture and agri-business (CNCA), tourism and housing (CIH), and industry (BNDE). 63. Financial Sector Issues. The Financial Sector Study carried out by the Bank (Report No.4957-MOR) of December 12, 1984 draws attention to several issues in the sector which need to be addressed to achieve the overall objective of raising national savings. The absorption of total financial resources by the Treasury is too high (40% of total lending of Moroccan banks, and over 70Z of total outstanding credit, including foreign loans, at end-1982) and has constrained sector development. Treasury borrowing at artificially low rates has distorted intermediation spreads and structure and has introduced a strong bias against term deposits. Competition in the financial sector has been limited, leading to adverse effects on sector efficiency, low savings mobilization, and distortions in resource use. Limited competition is due to the high degree of concentration, the tight regulation of interest rates and credit ceilings, the specialized role of public financial institutions, and the high level of obligatory placement requirements imposed on banks. Credit allocation has been strongly influenced - 23 - by selective credit policy operating through a number of instruments such as exemptions from credit ceilings, rediscounting beyond ceilings or at special rates, interest rebates, and preferential credit allocations to specialized institutions or particular sectors. The relatively undeveloped state of the capital market has restricted the range of financial instruments available. Institutional deficiencies in the financial sector are apparent in the system of coverage of the exchange risks on the foreign borrowings of the specialized financial institutions which imposes a heavy burden on the Treasury, and in the credit guarantee system. The policy measures concerning the financial sector in the ITPA II program are designed to address these issues. 64. Interest Rate Policy. Changes in interest rate policy aim at increasing domestic resource mobilization and raising the cost of capital to reflect its scarcity value more closely. They are designed to promote competition among financial intermediaries. The structure of delosit and lending raLes in Morocco has been rigid. Interest rate changes have been infrequent and have been tightly controlled by the monetary authorities (see para.17 and Table 2 above). Fixed rates have been set for deposits, and lending rates have been fixed within a narrow range, except for preferential credits. The levels of deposit and lending rates have generally been negative in real terms (Annex VI). Preferential rates for certain types of crLdit (in agriculture, housing, and for exports) and interest rebates (on term-loans to industry, agriculture, fisheries, housing, hotels, and merchant shipping) have accentuated this feature. The Government has recognized the importance of making the interest-rate structure more flexible and of maintaining rates at levels which are positive in real terms. To achieve these objectives, it has, with effect from April 1, 1985: i) freed interest rates on deposits exceeding 12 months from administrative controls; ii) transformed the remaining deposit rates into minima and lending rates into maxima; iii) raised the minima on term deposits by 2Z, and on savings accounts by 1X; and iv) raised the maxima on loans by 1 to 22. The Government is committed to reducing the number of rates set by the monetary authorities, thereby allowing more scope for market forces to operate. The Government will discuss with the Bank during 1985 propositions for further liberalization of lending rates and of phasing out credit rationing. It is also the Government's objective to eliminate interest rate rebates in various sectors, which would be identified in a study to be completed and discussed with the Bank by end-1985, with a view to preparing in 1986 a program for the elimination of such rebates. With the application of this program, it is expected that interest rebates would continue to be granted on a selective basis only for some investments particularly connected with export activities. 65. To inisure greater flexibility in setting interest rates, the Government has created a Permanent Committee for Interest Rates with representatives of the Ministry of Finance, the Bank of Morocco and the association of commercial banks. This Committee is responsible for ensuring that a continuing review of interest rates takes place to reflect changes in relevant variables such as the rate of inflation, the liquidity situation, and exchanige rate movements. The Committee will prepare, on a semi-annual basis, a report on interest rates, and if necessary, recommend changes. - 24 - 66. Coverage of Foreign Exchange Risk. Until now, the Government has assisted the specialized financial institutions (BNDE, CNCA, CIH), by bearing the bulk (all but 1.5 rprcent) of the foreign exchange risk on their term-borrowing abroad -/. While such a policy has contributed to the financial viability of the DFCs, it has distorted the costs of foreign borrowing to the intermediaries and to the ultimate borrowers. Since 1982, it has also imposed a considerable burden on the Treasury's finances. Costs of exchange risk coverage were estimated at DH350 million for 1984, and DH500 million for 1985. The Government considers that passing on the entire exchange risk to the ultimate borrower would be too sudden a step at this stage. It could considerably discourage use of long-term credit for priority private-sector investments. The Government has therefore set up a Foreign Exchange Risk Fund which will be funded by contributions from the specialized financial institutions and the ultimate borrowers to cover risks on operations after June 1, 1985. The fund's performance would be reviewed periodically, and the rates of contribution would be revised if necessary. The Government will also initiate a study, by end-1985, of the implicit foreign exchange risk posed by imports of capital goods and equipment, financed from local currency loans of commercial banks. The Government would plan to transfer to ultimate borrowers, in the long-term, the full exchange risk. 67. Obligatory Placements and Reserve Requirements. A major factor distorting intermediation spreads and creating disincentives for mobilization of term deposits by commercial banks has been the high level (as a percentage of total deposits) of obligatory placements of commercial banks in low-yielding Treasury bills. The Government moved to improve this situation in 1984 by excluding deposits of maturity beyond 12 months from the calculation of this requirement. Effective April 1, 1985, all term-deposits and certificates of deposit will be excluded from both obligatory placement and reserve requirements. These measures are expected to have a strong incentive effect on mobilization of term deposits. 68. Other Measures. Fnrther specific measures have been designed to increase competition in banking. The credit ceilings of commercial banks will henceforth be decided in function of their savings mobilization performance 2'. The commission rates charged by the banks for different services have been fixed by the Bank of Morocco and not revised in the last 10 years. With a view to simplifying and up-dating the structure of bank commissions, the Bank of Morocco will carry out a study by September 30, 1985, in collaboration with the commercial banks. This study will focus on identifying commissions which would henceforth be expressed as maxima, with the Bank of Morocco only establishing these maxima. Within this framework the commercial banks could compete by establishing lower rates. The reform of bank commissions will be implemented at the latest by January 1986. 1/ Public and private enterprises bear all the risk cn their direct borrowing abroad. 2/ Overall credit ceilings are part of the IMF stabilization program. Several measures are proposed to increase competition between the specialized financial institutions and the commercial banks, both in deposit mobilization and lending. By January 1986, the specialized financial institutions will be authorized to issue certificates of deposit to the public. In addition, the Government will examine, before September 30, 1985, what changes in the legal framework are necessary to permit BNDE and CIH to collect term deposits (CNCA already does so). If these institutions can be authorized through simple administrative steps, such measures will also be implemented by January 1986; alternatively, the Government will inform the Bank of the next steps in modifying the laws governing the specialized financial institutions. Regarding measures to facilitate and promote term-lending by commercial banks, the Bank of Morocco has authorized the Banque Marocaine du Commerce Exterieur (BMCE) to review and certify the medium-term loans of other banks; so far, this privilege was restricted to BNDE. The Bank of Morocco is also examining the possibility of extending this authorization to other commercial banks with appraisal capability; the study now in progress would be reviewed with the Bank by end-1985, with a view to implementation of the recommendations from January 1986. 69. Specific aspects of the major fiscal reform proposed in 1985 (see para. 44 above) of importance in the financial sector, are the replacement of tihe tax on products and services (levied at 12% on interest payments) by a value added tax system, and the possibility granted firms of revaluing assets, which would help reduce the fiscal burden and strengthen cash generation. 70. Since 1983, the Treasury has financed an increasing part of its requirements through borrowing at non-concessional rates in the money market. Such financing has grown from a negligible amount in 1983 to an estimated 33Z of the portion of the deficit financed by commercial banks in 1985. The Government plans to continue this policy through ensuring that all future incremental borrowing is on a non-concessional basis. The development of the money market will also be assisted by the increased proportion of rediscounting by the Bank of Morocco at flexible interest rates and the sale of Treasury bonds to the general public in 1985. So far Treasury bills were only placed with institutions. 71. Outstanding guarantees of the Credit Guarantee Organization (CCG) exceeded DH 10 billion at end-1984. Such guarantees have been provided on loans from foreign and domestic financial institutions and suppliers' credits. CCG has experienced major organizational, financial, and policy problems as a result of inadequate funding and staffing and the poor definition of its responsibilities and evaluation criteria. The major portion of its funding has been from the Treasury budget, and coverage of risks has not been systematically monitored. As a result of delays and difficulties in making payments against guarantees when due, its credibility is low. To address these issues, the Government will initiate a study by September 1985 with the objective of formulating a coherent rebabilitation program. Specific reform measures proposed will be reviewed with the Bank by end-1985, with a view to implementation in 1986. Public Enterprise Reform 72. Sector Organization. Public enterprises in Morocco generated about 20Z of value added for the whole economy in 1982. They are active in a - 26 - multitude of roles and sectors: utilities, manufacturing, mining, transport, wholesale trade, and services (eg. hotels). Specialized agencies are responsible for a variety of tasks in agricultural development (the Offices Regionaux de Mise en Valeur Agricole, or ORMVAs), industrial promotion, and local collectivities (the Regies) for distribution of electricity and water, and sewerage. Among the utilities, the most important are those responsible for power (Office National d'Electricite, ONE)+ water supply (Office National de l'Eau Potable, ONEP), posts and telecommunications (Office National des Postes et Telecommunications, ONPT), and railways (Office National de Chemins de Fer, ONCF). The largest and most important of the manufacturing enterprises in the public sector are the Office Cherifien des Phosphates (OCP) group, responsible for phosphates and phosphate derivatives. Other significant public enterprises are engaged in sugar milling and cement production. Certain public enterprises operate as "Offices". This structure confers a certain autonomy, which is utilized to varying degrees depending on the relative strengths of the enterprise and the supervising ministry. Each Office falls within the purview of the ministry responsible for the sector of activity. In addition, the Department of Public Enterprises at the Ministry of Finance exercises an inspection role; it is, however, seriously understaffed. The systems of controls and monitoring of performance are, in general, highly ambiguous and unsatisfactory. 73. Degree of State Involvement. The State is full owner of about 200 public enterprises, has a majority interest in another 270, and directly or indirectly has a minority interest in the remaining 130. Public enterprises experienced considerable growth both in size and number in the 1970s. State financial participation is largely concentrated in a relatively few large public enterprises and takes the form of capital grants, subsidies for operations, and loans (generally re-lent bilateral aid). In recent years (1981-84) capital grants have averaged about DH 2.0 billion ($280 million) per year; operating subsidies averaged about DH 600 million ($84 million). About 301 of capital grants were for agriculture, 22X for railways, 181 for water supp-y; and about 10% each for power and petroleum. Of the operating subsidies, on average, 60X went to agriculture. Domestic bank credit and external credit are available in principle to public enterprises on the same conditions as offered to private firms. However, financing public enterprises through these sources has hardly been possible, given their generally unsatisfactory financial situation. Net flows between the State and the major enterprises for the period 1977 through 1981 are estimated to have been as follows: Table 6 Financial Flows between the State and Public Enterprises 1' (in million of dollars) CY 1979 1980 1981 1982 1983 1984 Flows from public enterprises to the State 296 282 361 231 176 188 Flows from the State to public enterprises 706 565 502 542 409 317 Net Flow -410 -283 -141 -311 -233 -129 '' Appraisal mission estimates for 1982, 1983 and 1984 - 27 - 74. Financial Situation The financial performance of public enterprises has been less than satisfactory. Public enterprises in general have had low earnings and often operational deficits which have had to be met from the State budget. Liquidity has been poor and capitalisation inadequate. Low earnings have been mainly due to pricing policies (which were often controlled by the Government in order to keep prices "reasonable", e.g. power tariffs), poor sector organisation, unsatisfactory management, inefficiency, over-capacity, and inappropriate or untimely investment policies. Higher fuel costs, and increased costs arising from three successive years of drought, higher interest rates, and the appreciation of the dollar have also had a negative impact on earnings. The result has been inadequate internal cash generation and therefore higher demands on the State budget for public enterprise investment. The problem of low earnings has been compounded by the overall lack of liquidity caused principally by the inability of the Government and its agencies to pay amounts due to public enterprises. The arrears owed by the Government have created major illiquidity in the public enterprises, with repercussions on the cash-flow of private enterprises, to which the public enterprises have, in turn, not made payment. This arrears question has been the focus of a recent Government study, which has attempted to ascertain the dimension of public arrears, diagnose the structural problems of which they are a symptom, and initiate measures both to eliminate the arrears gradually, and more importantly, to prevent their recurrence. 75. Recent Analyses and Reform Initiatives In 1978 the Government became concerned about the unprecedented expansion of the public enterprise sector and the pricing and investment policies of public enterprises. A study of their role in the economy and of needed reforms was carried out in 1978-81. The report addressed in detail the problems stemming from the relationship between the State and the public enterprises and provided the Government with the reasons for strengthening controls which had become too lax in the 1970s. The Government is now determined to improve the financial performance and operational efficiency of public enterprises through improved controls, pricing policy reform, and restructuring where necessary. Privatization or outright closure will be considered where appropriate. An Inter-Ministerial Commission under the direction of the Prime Minister has already carried out an intensive study of arrears and is implementing a plan of action designed to reverse the accumulation of arrears and aid their elimination. The Commission will assure systematic reviews of the financial and economic aspects of the public sector, identify problems of individual public enterprises, and specify the measures necessary for their solution. A special committee of the Commission has been set up to monitor and report on the implementation of the corrective measures decided on by the Commission and an the performance of individual public enterprises against the established targets. In six sectors reviewed, the Commission has called for action on 142 measures over a wide field including pricing, settlement of Government and public enterprise arrears, budget allocations, remuneration of capital, abolition of subsidies, consumption curbs, capital increases, liquidation, rehabilitation studies, and improved cost accounting. Many of the measures have been implemented or are in course of implementation. Since early 1984 rail fares have been increased on average by 6.5%, but on some routes by 15-20%; coal prices have been increased by 20%; fuel oil prices by 22%. Power tariffs were increased by 11% in 1984, and a further increase of 13% is proposed; a 25% increase in water supply tariffs has been requested. - 28 - 76. The Conmission prepared a matrix of arrears of 60 major public enterprises due from the Government, its agencies, and local collectivities, and also between the public enterprises themselves and from the private sector as of December 31, 1983. The matrix has since been updated to December 31, 1984 with coverage being extended to 20 pore public enterprises and shows a net debt of the Government to these 80 public enterprises of about DH 3.8 billion at this date (this figure is a provisional estimate and excludes about DH 0.7 billion of claims which have not beea confirmed). As the Government is the major net debtor, the settlement of arrears owed by the Government will have a major impact on improving the liquidity of public enterprises and reducing the arrears problem. The Government proposes to reduce arrears in 1985 by DH 1 billion from special aid grant received. This payment will be a condition of disbursement of the second tranche of the proposed loan. The Government also plans to reduce the arrears by a further sum of DH 0.5 billion by June 30, 1986. 77. The Government is committed to make public enterprises financially self-sufficient and to eliminating budgetary subsidies to public enterprises. These objectives are a vital element of the Government's overall adjustment plan and will be achieved by implementing structural reform of public enterprises. The Government has set a ceiling of DH 3.3 billion for transfers to public enterprises in 1985. This ceiling includes investment subsidies and transfer payments for services rendered to the State by public enterprises; it excludes operating subsidies to public enterprises, for which accurate estimates are not available; the accounting framework is being up-dated to permit such estimates in the context of the on-going preparation of a public enterprise reform program. From this budget allocation of DH 3.3 billion, it is expected that as a result of strict discipline only payments totaling about D_ 2.1 billion will be made in 1985. The complete elimination of budgetary transfers to public enterprises requires detailed studies of the de jure and de facto relationship of the enterprises to the Government, the structure of the enterprises, and the specific actions required to make individual enterprises profitable, or salable. These are now being undertaken, and the Government would discuss with the Bank the measures proposed to reduce the overall level of budgetary transfers to public enterprises in 1986. 78. Proposed Global Reform. The phased reduction of arrears of public sector enterprises and specific measures for reform of particular sectors which have been initiated are part of the more global program to address the problems of public enterprises. The Government has given high priority to improving their performance efficiency and to establishing clear and appropriate control and monitoring systems, while ensuring adequate enterprise autonomy. The key objectives are to eliminate the structural problems which have caused enterprise inefficiencies leading to arrears and dependence on budgetary transfers. To achieve these objectives, the Government is preparing, in collaboration with the Bank, a program of reform of public enterprises which is expected to cover key changes in the administrative and control framework, improvements in the State-enterprise relationship, improved policies and procedures for appraising and implementing public enterprise investments, and detailed packages to rehabilitate particularly critical enterprises through financial, technical, and organizational restructuring. The Government has noted that this exercise could involve a rethinking of the - 29 - rationale for State involvement in particular sectors or activities and progressive divestiture where feasible. A Bank mission has visited Morocco in May 1985 to carry out an analysis of these questions. Its report is expected in the second half of 1985. 79. Preparation of a rehabilitation program is at an advanced stage in agriculture. As part of the adjustment of the agricultural sector supported by the Bank, the multi-purpose agricultural development offices (ORMVAs) are being re-organized. Their roles are being redefined, clear monitoring and control systems developed, and an action-plan to halve Government payments for specified current operations by 1990 put into place. The ORMVAs have so far represented the largest portion of Government operating subsidies with DH 250 million ($29 millAon) in 1984. Rationalization of the Public Investment Program and Reform of Planning and Budgeting 80. The combination of the shortfall in resources and the stabilization programs undertaken by the Moroccan government has constrained expenditures for the public investment budget well below the levels foreseen in the 1981-85 Development Plan. Authorizations exceeded actual funds available for expenditure by a large margin. The traditional budget system was unable to adjust to these changes and major reductions were made outside the normal budget process with technical assistance from the Bank. The Government has recognized the limits of the existing system and is designing and implementing a modern, computer-based budgeting system that is linked closely with the planning process, which is also being modified to make it more responsive to changing circumstances-- 81. In the current system, the public investment program is defined in the Five Year Plan at the beginning of the period. Priorities are set, and the investment projects are agreed for each implementing ministry or agency for the whole plan period, even though those in the later years have not been Lhoroughly studied. The Five Year Plan becomes a law and forms the basis for subsequent annual budget laws containing authorizations. The amounts authorized by Parliament each year often exceed the amounts that actually may be spent that year by a substantial amount. Unused authorizations are carried over to the next year. However, operating ministries cannot begin actual procurement activities or sign binding contracts against their budget appropriation until they have received executive approval from the Ministry of Finance. Once the approval is received, the investment outlays can be initiated, and actual disbursement may take place in the year of approval or any later year depending on the speed of execution of the project and availability of financial resources. 82. Neither the inclusion of a project in the Plan nor the authorization in the annual budget law are effective control points to assure-careful project selection. Insufficient information is often available-at the time the Plan is prepared, and a number of political factors enter into the annual budget process. Effective control is exercised by the Ministry of Finance when the funds appropriated for a project are given executive approval and when appropriated funds are carried forward without having been firmly committed. At those points, the Ministry of Finance can intervene, review the project, and adjust the amount to be spent. Once funds have been - 30 - comuitted by the executing agency, the Ministry of Finance can delay expenditures if resources are tight, but can no longer prevent their eventual disbursement. In the past, a ratio of total authorizations to actual resources available for disbursements of about 2 to 1 in a given year seemed to work, given the slack in the system: less would result in lower actual disbursements than funds available. However such a system is very poorly suited to deal with fluctuations and reductions in resources available in relation to the expectations of the Plan. 83. The 1981-85 Plan initially inscribed investment levels of DH 70.6 billion for the the five year period, expecting the resources to be available, and DH 9.2 billion were added "hors Plan" L' After the Plan was introduced, it became clear that resource availability wouild fall short of planned expenditure. The Government was slow to react and did not cut authorizations, which were based on the Plan. Disbursements were delayed when funds were not available. This led to complaints from suppliers and delays in a number of projects. The Bank became increasingly concerned about this and conducted investment reviews in 1983 and 1984 to speed implementation of its own projects. In the course of these reviews, the fundamental problem became clear, and technical assistance was provided to revise the investment program by freezing some authorizations and delaying executive approval of others by the Ministry of Finance. 84. Priorities were set by the Moroccan authorities following discussions with the Bank, and the investment program was reviewed in detail for six major sectors. Projects were evaluated on the basis of the following criteria: i) economic rate of return; ii) the stage of physical implementation of the project; iii) the lead-time to realize project benefits; iv) the project's contribution to export promotion and to efficient import substitution; v) the need for budgetary contributions. On the basis of these priorities, a number of projects that had been authorized were frozen, and others where appropriations were made but not committed were postponed. Frozen authorizatiors amounted to DH 4.6 billion in 1983, and DH 6.0 billion in 1984. New budget appropriations in these years amounted to DH 13.6 billion, and DH 10.0 billion H'. However, resources available have fallen faster than appropriations could be curtailed, ar,d arrears built up, amounting to DH 4.6 billion in 1983 and DH 6.0 billion in 1984 on the basis of actual commitments to be paid. Since all these commitments are not generally submitted for payment in the same year, the arrears in a legal sense were less. 85. This year the Government has further tightened up the review procedure for approving expenditures and has carefully examined projects where appropriations have not been committec. with the objective of further reducing actual disbursements. A joint working group of the Ministries of Plan and 1/ The program "hors Plan" included one railway project and one irrigation project which would have been implemented only if specific external financing were available. 2/ These do not represent new projects, but appropriations for ongoing projects expected to be committed in future years. - 31 - Finance under the direction of the Prime Minister has reviewed all projects currently authorized in order to establish a full inventory of projects, their state of preparation or execution, and their calendar of completion. This review has been completed in May, 1985. All remaining projects of the 1981-85 Plan have,been scrutinized in relation to the criteria established, and further cuts and delays will be enforced, reducing total outstanding appropriations to DH 22.8 billion, against expected resource availability of DH 10 billion, including DH 2 billion of special supplementary grant funds. This will leave a carry-over plus arrears of DH 12.8 billion for 1986, the first year of the next plan. Further efforts to reduce authorizations are expected during the year as projects are reviewed for carry over into the new plan beginninv 1986. It is also expected that the 1986 Finance Law (Loi de Finances) wilA definitely cancel the projects that have been frozen. While ad hoc in nature, these interim procedures to limit the use of budget appropriations and postpone commitments have assured that available resources are directed to the priority projects. The Ministry of Finance recognizes that this is at best a stop-gap measure and that given the momentum of projects already begun, it will take another two to three years to work off the backlog of approved projects even thotgh few new projects have been started in the past two years. 86. The Ministries of Plan and Finance are now cooperating clobely to improve the planning and budgeting system. A new planning system will be instituted in 1986 whereby only those projects of high priority and within the limits of available resources will be included in the budget. Better analytic tools would be installed in the Plan to estimate resource availability and the impact of major investment projects. A new technical cell is expected to be created in the Ministry of Finance to review project proposals and assure their economic viability, consistency with the country's priorites, and availability of resources prior to including them in the budget. A computerized system of monitoring investment projects from their inception in the Plan, their inclusion in the Finance Law, and the granting of executive authority to commit funds, to their execution and completion, is now being designed. It is expected to be implemented by mid-1986. This would allow adequate control of the investment budget far enough upstream to prevent serious project delays due to budget stringency late in the project cycle. It would also assure that the rate of appropriation is consistent with resources available. The Bank is working with the Moroccan authorities to improve the analytic tools of the Plan and is providing technical assistance to the Ministry of Finance to help design and implement the computerized system to monitor the investment program and budget. An Investment Review will be conducted in October to review the composition of the new Plan and the 1986 investment budget. Our review of the 1984 investment expenditures indicate that they were very much in line with the priorities originally set. The '985 investment budget also conforms to those priorities. D. EXPECTED EFFECTS OF THE SECOND PHASE OF ADJUSIMENT 87. The goal of the ITPA I and II loans is to effect lasting structural changes in Morocco's productive capacity and make the economy more dynamic and flexible. The achievement of these goals is rendered more challenging by the impact of this particularly difficult period in the country's economic history. The policy of import-substituting industrialization followed since independence gave rise to a highly distorted structure of production with - 32 - discrimination against exports and a low level of competitiveness and efficiency in Moroccan industry. In addition, expansionary macroeconomic policies pursued over the past decade led to unsustainable rates of growth, a inefficient public sector, financial rigidities, and a dramatic rise in foreign borrowing. The ensuing balance of paynments crisis, which necessitated external debt rescheduling, was addressed by a series of stabilization measures, and the imposition of sweeping import controls. The measures implemented under the ITPA I Loan reversed these restrictions an the trade regime and successfully began reorienting the economy towards export growth and industrial competitiveness. Levels of trade openness prevailing before the balance of payments crisis were restored and steps towards long-term adjustment begun. 88. The ITPA II loan is designed to support the next stage in the process, which is a fundamental shift away from the inward-looking strategy pursued in the past to a strategy of outward-oriented, export-led growth. The adjustment program will take place, however, under the constraints of the stabilization measures, which reflect the impact of lower levels of external finarcing available for future current account deficits and the necessity to restore equilibria on the external and public sector accounts. In order to achieve a rapid decrease in the current account deficit, import demand, including investment goods, must be contained, which implies implementing the adjustment under conditions of lower rates of economic growth. To avoid a precipitous decline in the level of domestic production, considerable increases in exports and domestic savings are necessary, and in this way, the stabilization and adjustment programs are complementary. The policy measures envisaged under ITPA II, addressing the structural deficiencies in the Moroccan economy, would serve to increase exports. and domestic savings, so as to permit a higher level of imports, investment, and growth than would otherwise be possible. The increase in performance will be achieved by eliminating distortions in the present structure of production incentives, and channeling increased domestic savings to the most productive uses through reform of the financial sector, particularly regarding interest rates policy. The speed of adjustment and hence the rate of economic growth are, however, conditioned by the constraints of stabilization as well as the successful implementation of the ITPA II policy reforms. Macro-economic Projections 89. The ITPA II adjustment program is expected to have a salutary effect on the Moroccan economy as a whole. The program is based on a set of coherent, mutually supportive policy measures designed to have a positive impact on economic growth, subject to the limits imposed by external constraints and the IMF stabilization program. Although the effects of the adjustment program will be felt at the sectoral level, it is useful to focus rather on their overall impact. 90. Global Economic Trends. The medium-term adjustment scenario is based on the following assumptions concerning developments in the external environment. Economic growth in tne OECD countries is assumed to average 3.3% - 33 - per annum during the period 1985-1990. International inflation is anticipated to rise to 7.5Z per annum in 1986, and 8.0% in 1987-90. International interest rates are projected to decline from about 12X in 1985 to OZ in 1986-88, and to 9Z in 1989-90. Apart from percoleum, commodity prices are expected to recover slowly in the 1985-90 period increasing at about 2% per annum in real terms. Finally, phosphate prices have begun to recover following a steady decline through 1983 and are projected to increase by about 2.5Z per annum in real terms, stabilizing at an equilibrium price of $45 (in 1983 US dollars) in 1990. 91. Policy Related Assumptions. The macro-economic projections assume continued progress on structural reform and stabilization as described in the ITPA II and IMF programs. The growth of domestic absorption would be slowed through restrictions on fiscal and monetary policy required for stabilization. Export promotion and import liberalization would be supported through further trade policy reforms and appropriate exchange rate management. The reform of the financial system would encourage the mobilization of domestic savings. 92. In view of the constraints set by global exogenous factors, external debt, and the stabilization program, an analysis of the policy measures envisaged under ITPA II leads us to expect the following trends: The progressive reductioa of trade taxes (special import tax, customs duties) and quantitative restrictions should constitute an important step toward restructuring the present system of incentives in order to attenuate the existing bias against exports. These measures would be further supported by measures reducing or eliminating other disincentives to exports, which should have a significant impact on exporc growth. Exports of goods and non-factor services are thus expected to increase by 4.2% in 1985 and 7.9% per annum during 1985-1990. The growth of finished manufactured exports (excluding fertilizers) is expected to rise from 9.2% per annum registered in 1984 under TTPA I to an average of 14.5% per annum in constant terms during 1984-1990, as the supply capacity for such an expansion grows. Current excess capacity in the economy is not in export sectors, so a more rapid response to the policy measures is not likely. Creation of this capacity is a major element in the adjustment program and is supported by Bank project lending. Exports of phosphoric acid and fertilizers, whose growth declined in 1984 due to capacity constraints, are expected to rise once new processing facilities are brought onstream in 1985. As a result, total phosphate exports should increase by 8.9Z per annum in 1985-90, implying a significant increase in Morocco's share of the world phosphate trade. Agricultural exports, which include fish and processed food, will also benefit from the reduction in anti-export biases and are expected to grow at an average real rate of 4% per annum in 1985-90. Appropriate exchange rate policies coupled with global economic recovery should also lead to an improvemeat in the service account: tourism, in particular, is expected to grow at 8% per annum in real terms, while other nonfactor service exports should increase at the same rate as merchandise exports. - 34 - 93. Import demand, which was unexpectedly high in 1984, due, in part, to exogenous factors, is assumed to increase very slowly in the near future from the high 1984 base. Containment of import growth is contingent on: (i) the implementation of appropriate demand management policies in the short-term, including limits on public expenditures and monetary expansion, the adoption of appropriate price and wage policies and continued reduction of subsidies; (ii) flexible management of the exchange rate to offset reductions in the levels of protection; and (iii) improvement in the efficiency of import substitution industries leading to reduced reliance of the Moroccan economy on imported inputs. The growth rate of agricultural imports is projected to decline as a result of assumed normal climatic conditions and increased domestic production linked to policy measures on producer prices and the reduction of consumer subsidies- . Energy imports are assumed to grow at an average rate of 1.6% per annum during 1985-1990, reflecting both a slowdown of domestic demand as well as progress in the areas of conservation and the development of domestic energy resources. Intermediate goods imports other than sulfur should grow modestly at an average of 2.7% per annum over the 1985-1990 period, reflecting a rise in the efficient substitution of imported inputs as a result of trade policy reform. On the other hand, capital goods imports are expected to deeline by 1.3% over the 1985-1990 period as a result of the reduction in overall investment growth as well as the policy measures designed to correct fiscal and financial distortions which encourage the use of imported, capital-intensive processes. Imports of non-food consumption goods should increase at a rate of 2.4% as a result of complementary policies (e.g. exchange rate, VAT) pursued in conjunction with trade liberalization measures. These measures would forestall an increase in the imported content of consumption. Finally, on the basis jf commodity price forecasts and the estimated average annual rate of international inflation during 1985-88, Morocco should experience a slight improvement in its terms of trade over the next few years. 94. The proposed financial policy reform and the fiscal stabilization program are designed to increase the levels of domestic resource mobilization and channel these resources to their most productive uses through greater reliance on market forces and more efficient financial intermediation. By raising the opportunity ccst of capital, investors will be less inclined to undertake direct investment in projects offering lower financial rates of return. The effect of higher deposit rates and flexible exchange management on worker remittances from abroad will contribute to the increased mobilization of financial resources. Commercial bank margins will benefit from the proposed financial reform and increase on a gross basis from 5.9% to 6.3%. This is principally due to the measure which significantly reduces the 1/ Major policy changes are planned in agriculture and will be supported by lending to this sector from the Bank; the first agricultural sector luan is planned for FY85. - 35 - deposit base of obligatory placement requirements of commercial banks to the Treasury, thereby increasing the return on loanable funds. On this basis, it does not appear that the overall package of policy reforms will impose insuperable costs on the concerned economic agents and will offer scope for more competition ip the financial sector. 95. The increase in deposit rates and the liberalization of the financial sector together with the increasing public savings is expected, moreover, to raise the ratio of gross domestic savings to GDP from 12% in 1984 to 17% by 1990, implying a sharp rise i2 the marginal savings rate from the historical level of 10-11% to about 40% by 1990. Only through a sharp increase in domestic savings can the external deficit be reduced while maintaining investment at levels sufficient for adjustment. In view of the greater fiscal restraint required by the IMF stabilization program, the overall budget deficit is expected to decline from 7.8% of GDP in 1984 to 6.5% in 1985,equivalent to DH 8.0 billion. It will decline further to alout 2% of GDP by 1988. This implies Government savings will increase from '0.7% of GDP in 1984 to about 3% in 1988. 96. Results of the Macro-economic Projections. Compared with a growth of 2.4% in 1984, GDP is expected to increase at over 4% in 1985, as a result of a recovery in the agriculture sector. However, the associated stabilization ; measures will allow GDP to grow only 2.8% per annum on average through 1990. With population growth forecast at about 2.5% per annum, per capita GNP and consumption would not register much real increase before the end of the decade. Notwithstanding the positive effects of ITPA II, medium-term growth will continue to be constrained by stabilization efforts, external debt, and the depth of the structural change required in the productive structure. Most of the positive growth effects of the adjustment policy measures will be felt after 1988, although it is necessary to initiate action now to achieve the results in that time frame. The measures to increase product vity and allocate resources more efficiently are reflected in the decline of the five-year ICOR from 8.3 in 1980-85 (relatively high due to a lower base rate of growth) to 5.7 in 1985-90. 97. The narrowing of the resource gap implied by stabiliaation suggests that the increase in domestic savings to 17% of GDP in 1990 will uot be sufficient to maintain the share of investment at its present levels, particularly in view of the decline in external financing in the future. This will result in a reduction of the share of both consumption and investment in GDP, with investment growth declining until investment corresponds to domestic and foreign savings availabilities. The share of gross fixed investment is thus projected to fall throughout the 1985-1990 period in real terms, decreasing from approximately 22.9% of GDP during 1984 to 18.5% towards the end of the decade. This reduction in the share will be borne about equally by public enterprises, the Government, and the private sector. An increase in the surplus of private savings is critical to achieving the overall investment-savings equilibrium. It will serve to finance a portion of the savings shortfall of the public sector. Increased financial savings and higher economic returns on investment are dependent on the Government's ability to increase public savings and improve allocation of domestic resources through a policy of positive real interest rates, greater deregulation of lending rates, and a more flexible financial sector. - 36 - 98. A key result of the adjustment process in the medium-term is a reduction in the current account deficit from l0.7% of GDP in 1984, before debt rescheduling, to 1.5Z by 1990, with short-term targets of 6.5S of GDP in 1985 and 4.52 of GDP in 1986 as agreed with the IMF. Export growth will contribute to this. In addition, the share of imports of goods and non-factor services in GDP is projected to decliuae from 35.7Z in 1984 to 33.3% in 1990. This result is closely related to the maintenance of a flexible exchange rate policy and the judicious management of domestic demand over the next few years, including strict controls on public expenditure, appropriate pricing, wage, and subsidy policies. Table 7: National Accounts and External Debt 1970-78 1978-82 1982-85 1985-90 (average annual growth rates in constant dirhams) Gross domestic product 5.4 3.4 2.3 2.7 Exports GNFS 2.5 3.0 5.5 7.9 Imports GNFS 7.1 0.2 -2.5 2.0 Investment 8.0 -2.4 -3.6 -0.7 Gross domestic savings 1.4 -5.6 11.0 11.1 (millions of dollars; end of period) Debt outstanding and disbursed 4827 9053 11599 13515 (rates in percent; end of period) Debt service ratio 18.7 34.7 46.5k' 32.7 99. The medium-term adjustment scenario projects a $1 billion annsal increase in external debt outstanding and disbursed until 1987; thereafter, debt outstanding will stabilize through the end of the decade at a level just below $14 billion. Substantial amounts of medium and long-term capital will thus be required over the next few years to finance the continuing current account deficits and meet the formidable debt repayment schedule, including significant EMF repurchases. Total gross capital requirements would average $2.3 billion annually in 1985-87. Of this total, about $1.3 billion, on average, could take the form of additional debt relief, essentially along the lines of the debt reschedulings obtained by Morocco from its creditors in 1983-84. The remainder could be obtained through normal medium- and long-term capital inflows, which could amount to about $1 billion a year on a net disbursement basis (after rescheduling), provided that new loan commitments from Morocco's official lenders can be maintained at their current rate (about $1 billion a year in 1983-84), along with the Government-guaranteed bank loan programs already in place in connection with official assistance. According to the macro-economic projections, the ratio of debt outstanding and disbursed to exports of goods and services will decline from a peak of 258Z in 1984 to 139Z by 1990. Moreover, the debt service ratio (excluding IMF repurchases) LI Before debt rescheduling. - 37 - will decrease from 54.52 before debt rescheduling in 1984 to 32.72 in 1990. 'Net external factor receipts are projected to decline from 0.9% to 0.41 of (MP, primarily because of higher foreign debt payments. The portion of Morocco's total debt outstanding and disbursed owed to the Bank was 9.31 in 1984 and is projected to increase to 18.9X in 1990. 100. An important result of the Government's program of economic adjustment would be to enhance Morocco's creditworthiness in the medium-term. During the transition period, when adjustment and stabilization policies take hold, the economy's needs for longer term external resources would be covered by multilateral assistance (in large part from the IMF and the Bank), official aid, and mixed credits. Rescheduling of official and commercial debt is expected to continue till 1988. In function of the projected reduction of the disequilibrium in the balance of pawments and the restoration of the econmy to a sustainable and stable growth pattern, the expected effects of stabilization and structural adjustment, Morocco would gain renewed access to commercial funds from international capital markets. The improvements in export performance, productive efficiency, and domestic resource mobilization would reduce the debt service ratio (including payments on rescheduled debt) to an estimated level of 33% in 1990, from 46% in 1985. The increase in the Bank's share of the external debt during the transition period would support adjustment efforts, leading to an improvement in the structure of Morbcco's external liabilities, and hence a more appropriate debt structure. On the other hand, in the absence of adjustment as supported by the Bank, not only would there not be such improvement in creditworthiness and the debt structure, but Morocco's ability to meet its current external commitments would be impaired. 101. The implementation of stabilize! on policies and measures for structural adjustment would entail some Lransitional social costs. Tight control of the public investment budget and of growth of Government expenditure on personnel, increases in public enterprise tariffs, and prices of basic staples, as well as measures to improve industrial efficiency would be reflected to some extent in depressed domestic demand, increased unemployment, and some possible reductions of incomes and real wages of urban workers, especially of Government employees and employees of less competitive firms. However, erosion in real personal incomes will be mitigated with control of inflation, and over the medium-term, the restoration of economic dynamism and strengthening of growth prospects will help address the issue of unemployment. Increased private investment and exports are expected to result from the structural change envisaged; the maintenance of real, positive interest rates and encouragement of exports should reduce the bias in favor of highly capital-incentive investments and promote employment. In addition, consumer welfare would be increased through overall improvement in the efficiency of Moroccan industry. E. THE ROLE OF THE BANK 102. In the past, the Bank has supported Morocco's development efforts with investment projects in agriculture, rural development, infrastructure, housing, energy development, industrial finance, etc. These have contributed to development of these sectors and improvements in sector policy. The Bank has also carried on a general policy dialogue in the context of its economic and sector work and sponsored studies in a number of areas, including - 38 - industrial and trade policy. With the crisis of 1982-83, the Bank shifted the primary focus of its activity from projects to a greater concentration on the policy dialogue and lending to support structural change. The policy dialogue in industry and trade has been supported by the ITPA I loan, which is followed by this op3ration. The policy dialogue in agriculture is being supported by a sector loan to be presented shortly. Disc'issions concerning major policy reforms are being conducted on education a-id vocational training, health, transportation and public enterprises. Th- impact of the Bank on policy formulation is significant and positive. 103. The Bank's policy based lending a d application of special action program measures to Morocco have provided ital financial support during this difficult period. The Bank is assuming a .arger share of total and official financing during this period to support the structural changes necessary to restore Morocco's longer term financial stability and creditworthiness. This will also lead to a healthier mix of official and private debt in Morocco's portfolio while assuring that the necessary policy reforms are put in place. The Bank's program provides a vehicle for attracting co-financing from other official and eventually perhaps private sources that are increasingly willing to be associated with the Bank supported reforms. As this process continues, the Bank can redu;e its own involvement and stabilize its share. 104. The Bank is, as a function of its larger role in policy discussions and aid flows, playing a larger role in aid coordination and consultation. The Morocco Consultative Group has been revived under the Bank's chairmanship and provides a forum for the Government to present and discuss its new strategy with donors. The Consultative Group Meeting in January 1985 has already shown some positive impact in facilitating bilateral aid flows. The Bank plans to increase its role in aid coordination in cooperation with the Government. F. IMF ACTIVITIES IN MOROCCO AND GOVERNMENT/INF/BANK COOPERATION 105. In the last five years, the IMF has supported a series of stabilization programs in Morocco through: i) an Extended Fund Facility (EFF) for $1.2 billion (SDR 956 million), negotiated in 1980, but declared inoperative in late 1981 when the target on domestic credit could not be met; ii) a one-year stand-by and drawings under the Compensatory Financing Facility, totaling about $570 million (SDR 518 million), which replaced the EFF in April 1982; and iii) a stand-by covering the second half of 1983 and calendar 1984, for $317 million (SDR 300 million). The key objectives of these programs were to address budgetary and balance of payments disequilibria. The specific targets and measures under the 1983-84 stand-by are described in paragraphs 43-47 . Progress under the program was good in 1983. Initial targets were revised upwards. T_e performance criteria were met in 1984, but macro-economic adjustment was impeded by continued severe drought, slower growth than expected, and budgetary and external deficits which exceeded targets. The curtailment of payments on the investment budget led to further build-up of payment arrears, the Government was unable to implement the proposed price increases for subsidized commodities in January 1984, the implementation of major fiscal reform was delayed, and the dirham appreciated in the second half of 1984 in relation to currencies of major trading partners. These developments have led to an increased emphasis in the latest stand-by -n corrective budgetary, monetary, and balance of payments measures. The ma.n features of this new agreement are discussed in Part III. - 39 - 106. There has been full coordination of Fund and Bank positions on assistance to Morocco, with extensive consultation and exchange of information at the staff level between the two institutions. Two Bank staff members participated in the mid-June 1983 preparatory IMF mission and two Fund staff participated in the Bank economic updating mission in July 1984. Their participation was aimed in particular at ensuring consistency in economic and financial projections, and reviewing the revised Government investment budget. The preparation of the currently proposed loan was also coordinated closely with IMF staff, and the appraisal mission was in the field at the same time that the IMF mission was there negotiating the 1985-87 Stand-by. The missions stayed in close contact. 107. There have been detailed discussions with Fund staff on the program of measures under the proposed loan. There is full agreement on its overall objectives, on the specific measures, and on their timi g. The division of work has followed the comparative advantages of the cwc institutions, with the Fund handling short-term macro management, budgetary dnd exchange rate issues, and fiscal reform. The Bank has addressed issues concerning the content of the public investment program, the rationalization of public enterprises and long term improvements in planning, as well as structural adjustments of trade, industrial policy, and the financial sector. The Moroccan Government has welcomed the close cooperation between the Bank and the Fund, as it hits helped assure consistency between the programs supported by the two institutions. 108. The Bank has participated in discussions organized by the IMF to coordinate balance of payments assistance over the short-term (para. 21), presenting its view of Morocco's medium-term prospects, and it chaired the meeting of the Consultative Group in January 1985, in which the Fund was a major participant. PART IV: THE PROPOSED LOAN A. LOAN HISTORY 109. The ITPA loan, approved in January 1984 was conceived as the first in a series of sectoral adjustment loans to Morocco. Given the far-reaching nature of the changes in industry and trade, it was clear that they would need to be phased over a period of four to five years, and would probably require continued Bank assistance. The Bank carried out a comprehensive study of the financial sector in 1983-84, with a view to policy changes which could improve intermediation efficiency and savings mobilization. The Bank and the Government have also engaged in an increasingly close dialogue on ways to rationalize the public investment program, and reform of the public enterprise sector. The loan was appraised in February/March 1985; negotiations were held in Washington in April, 1985. The Moroccan delegation was led by Mr. Tazi, Director of the Treasury at the Ministry of Finance. Supplementary loan data are provided in Annex III. -140- B. DISBURSEMENT AND PROCUREMENT 110. The proposed loan would be disbursed in two tranches, and is expected to be fully disbursed within a year of loan effectiveness. The first tranche of $120.0 million would be available upon effectiveness, and the second tranche of $80.0 million would become available about six months later. Disbursement of the second tranche would be conditional on: i) satisfactory progress with respect to continued implementation of the program of adjustment set forth in the Government's Statement of Development Policy (Annex IV), and ii) on the Government's having taken the following actions (Loan Agreement, para. 3 of Schedule 1 and Schedule 4): a) elimination of export certificate requirements for specified mining products and hides and leather (para. 52 above and para. 4 of the annex to the Government's Statement of Development Policy); b) establishment of a Committee for Simplification of Foreign Trade Procedures (para. 52 above and para. 7 of the annex to the Statement); c) elimination of the Statistical Export Tax (para. 54 above, and para. 9 of the annex to the Statement); d) reduction of the Special Import Tax to 5% of the cif price of imports (para. 56 above and para. 12 of the annex to the Statement); e) reduction of the maximum rate of customs duty on each imported good to 451 (para. 56 abore and para. 13 of the annex to the Statement); f) elimination of import licensing requirements on specified products through their transfer to List A (free list, and elimination of prbhibitions against imports of specified products, through their transfer from List C (items banned from import) (para. 59 above and para. 15 of the annex to the Statement); and g) payment by the Government of DH 1 billion of arrears owed to public enterprises (para. 76 above and para. 22 of the annex to the Statement). 111. The satisfactory administrative disbursement and procurement arrangements made for ITPA I will be continued, with the Ministry of Finance and the Bank of Morocco bearing the main responsibility for administering the proposed loan. 112. The loan would reimburse 100l of the foreign exchange cost of eligible imports. Ineligible imports include goods financed from other sources, goods intended ror military or paramilitary use, and goods for luxury consumption. A list of ineligible imports is included in the Annex to Schedule 1 of the Loan Agreement. Expenditures for goods procured under contracts of $25,000 or less would not be eligible for financing. Disbursements against petroleum products and foodstuffs will be limited to a maximum of $50 million. (Loan Agreement, Schedule 1, para. 2 (d) and (g)). Retroactive financing would be permitted up to $20.0 million of expenditures made after March 8, 1985 (Loan Agreement, Schedule 1, para. 2 (c)). The retroactive financing is to ensure a smooth transition between the ITPA I and II loans, particularly in view of the important measures of the ITPA II program already implemented. 113. The Rank of Morocco will be responsible for maintaining loan accounts, and for the preparation and submissicn of withdrawal applications. Disbursements from the proposed loan would be made on the basis of a summary from the Bank of Morocco detailing individual transactions in a given period, in respect of eligible imports, together with a certification from the Bank of Morocco of payment of the amounts involved, and of their eligibility under the - 41 - loan. Documentation would be retained by the concerned commercial banks, and made available for review by Bank supervision missions. Applications for withdrawal will be consolidated and submitted in amounts not less than $1 million (Loan Agreement, Schedule 1, para. 1 (b)). 114. Both private and publ-ic sector imports would be eligible for financing. Commonly traded commodities may be purchased through price quotations available from organized international commodity markets. Contracts under $5 million each and contracts for petroleum purchases would be awarded on the basis of the normal procurement practices of the purchaser. PetroLeum is procured under bilateral agreements with oil-exporting countries; these agreements are based on prevailing market prices, and are generally for a maximum period of 12 months. Contracts for the procurement of goods by the private sector estimated to cost less than $5 million are awarded on the basis of normal procurement procedures. Public sector imports under contracts below $5 million are procured in accordance with standard Government practices, which require competitive bidding, and which are acceptable to the Bank. Contracts for all other goods, public and private, estimated to cost $5 million or more each, will be procured through international competitive bidding in accordance with Bank Guidelines (Loan Agreement, Schedule 3). C. MONITORING 115. The implementation of the adjustment program will be monitored by the inter-ministerial committee which was established to follow-up on the ITPA I program. This committee will meet regularly to review progress, and to decide on appropriate actions to ensure timely implementation. 116. The Bank will also monitor the prcgress of implementation of the program through regular supervision and exchange of views with the Government, covering, inter alia, actual performance towards the goals of policy change, particularly as regards exports. As part of this process, the Government will prepare and send the Bank two status reports, summarizing the status or implementation, the first by early January 1986, and the second by June 1986. The first status report would precede a mid-term review, which in turn would form the basis for the release of the second tranche of the loan (see para. 110 and Loan Agreement, Section 3.01). D. RISKS L-SD JUSTIFICATION 117. The risks of the adjustment program relate to the uncertainties in the external environment and export prospe:ts; the possibility of further deterioration of Morocco's financial situation or inability to follow the IMF program, which could affect the commitment to import liberalization; and the difficulty of assuring adequate rigor of the adjustment process over a sufficiently long period. The medium-term prospects outlined in this report are based on assumptions of continued export growth, active exchange rate policy, and fiscal and monetary discipline. The magnitude of the expected benefits of the program cannot be predicted with certainty. If the projected increase in exports does not materialize as a result of unexpected adverse developments in the trade environment or international economic conditions, or - 42 - if the rate of growth is reduced as a result of adverse climatic conditions or inadequate policy support, the Moroccan economy's performance may be lower than projected. The resulting lower output and increased unemiloyment may lead to pressure on the Government to ease stabilization efforts and reverse import liberalization. The need to reduce the Treasury deficit and the progressive change in the structure of the fiscal system as a result of reduced dependence on customs duties will require difficult decisions to raise other taxes and cut Government expenditures. Firms which are unable to effectively compete are also likely to mount pressure to revecse import liberalization. 118. There are, however, significant features which reduce the above risks. First, the Government has demonstrated a strong commitment to adjustment by implementating the ITPA I program and the stablization as agreed with the IMF in 1983-84, despite a difficult economic environment. This commitment has been clearly affirmed during the January 1985 Consultative Group meeting. The ITPA II program and stabilization program under the* standby arrangement for 1985-87 therefore represent key elements of a coherent strategy for changing macro-policy and restructuring the economy. The Government has weighed the risks of this strategy and come to the conclusion that there are no viable alternatives other than such adjustment for restoring the economy to a dynasbic pattern of growth and eliminating the need for rescheduling external debt beyond a reasonable period. During implementation of ITPA I, the Government clearly indicated to the public that this was only the first phase in a medium-term adjustment program; momentum has subsequently been maintained, and the program is receiving increasing support in the Government. Measures will be implemented to offset some of the adverse effects of the program. For example, a flexible exchange rate policy will cushion the budgetary effect of reductions in tariff rates and special taxes and will forstall increases in imports due to lower tariffs. Also, industrial restructuring programs will be implemented to help firms adjust to a more competitive environment. The implementation of the program in phases will help allow firms to adjust gradually. Estimates of the fiscal cost of the various measures in the program have been reviewed in detail with the Government. It is expected that during the critical period required for policies to take hold, the support of the IMF, the Bank, and bilateral donors will provide adequate access to resources. 119. The main justification for the proposed Bank loan is that it will support the Government in a particularly critical phase of the on-going medium-term program of policy change and economic restructuring. The expected impact of the program, as described in section III D above, is to effect a fundamental revitalization of the framework for export production, and improve efficiency globally in the mobilization, allocation, and utilization of resources. Some of the adjustment measures (such as reduction of import tariffs and increase of interest rates) would impose immediate costs on the Government, while the benefits would be perceptible in the longer-term. Tax revenues will decline by about $180 million annually as a result of the tariff reductions. The introduction of the tax reform will widen the tax base to eventually provide additional revenues, so as to make up for the shortfall in receipts. The IMF has adjusted its budget targets to take account of this revenue shortfall, as well as the financing from the proposed ITPA II loan. - 43 - The financial sector reforms will raise Government interest payments by about $25 million per annum until the Treasury reduces its domestic borrowing requirements. The higher rate of export growth will raise the economy-wide requirements for foreign exchange-denominated working capital to cover higher inventory levels of imported inputs. The value of imports entering through the temporary admission scheme rose from DH 2.4 billion to DR 3.2 billion between 1983 and 1984. If stocks were to rise by 25S as a result of export growth, working capita. requirements, and hence foreign exchange needs, would increase by $35 millic . Finally, the structural changes require new capital investment in equipmer.- and certain intermediate goods to achieve the desired increases in productici and productivity. These must be imported and the foreign exchange proce ds of the loan will permit a higher level of necessary imports to accelerate the structural change. 120. The proposed Bank loan would help mitigate the costs of adjustment and provide resources for imports during the adjustment period. It is an important element of the total package of financial support expected from the international community in 1985-so. Other elements of this package are the stand-by agreement with the IMF, and rescheduling of official and commercial debt. Such support is essential for the adjustment process to be carried out in a planned and systematic manner. At the same time, Bank assistance would contribute significantly to enhancing Morocco's creditworthiness in the medium-term, as the effects of adjustment become evident. In this context, cofinancing with commercial lenders is being explored by the Government in support of the ITPA II adjustment program. If such cofinancing were to materialize, it would be within the IMF ceiling for commercial borrowing (see para. 46), but would help improve the term structure of Morocco's external debt. PART V: OTHRn BANK GROUP OPERATIONS IN MOROCCO1' 121. Bank lending to Morocco has supported 63 projects, financing a total of $2,408.5 million (net of cancellaticns), of which $25 million f7om a Third window loan. IDA credits, totalling $45.2 million, have been made available for five projects. IFC investments have amounted to $99.1 million ($52.2 million after cancellations, terminations, repayments and sales). Annex II contains a summary statement of Bank loans and IDA credits, and of IFC investments, as of March 31, 1985. 122. Until recently, performance in project execution has been satisfactory overall, although in some cases management problems have caused delays in project implementation, and in others insufficient tariff adjustments have affected project entities' financial performance. However, during 1983 and 1984, as budgetary constraints became more severe, projects relying on the Government budget for a substantial part of financing have been seriously delayed because of inadequate budgetary allocations. The appreciation of the dollar vis-a-vis the dirham in recent years has reduced considerably reimbursable expenses in dollar terms, thus lowering disbursements vis-a-vis appraisal estimates. The ratio of disbursements to 11 Part V is essentially the same as Part II in the Jerada Coal Mine Modernization and Expansion Loan (Report No. P-3965-MOR of February 27,. 1985). -44- appraisal estimates averaged. 48% as of March 31, 1985, low in comparison to other countries in the region. 123. The objectives of Bank Group activities in Morocco are to support (a) investments and policy reforms aimed at structural adjustment and strengthening the balance-of-payments; (b) measures to reduce the Treasury deficit; and (c) efforts to redress poverty and :mprove income distribution, particularly through lowering the unit costs for the delivery of basic services, in order to increase access by lower-i .come groups. Important structural reforms must be undertaken in the com ng years, in order to return to a path of reasonable economic growth compatib e with a sustainable external payments position. A major objective of Bank ec nomic and sector work is to provide the analytical basis for the development of specific proposals for structural reform, which in several cases may later be supported by Bank lending. The Government has requested that, in addition to ongoing work on the public investment program, the Bank assist in developing reform proposals relating to public enterprises (for which a sector mission visited Morocco in May 1985), and the education and agricultural sectors. Because severe budgetary constraints are likely to persist over the medium-term, projects now under preparation are being designed to minimize their reliaiice on budgetary funds. 124. Agriculture continues to represent the most important sector in Bank lending for Morocco. Past Bank lending has primarily supported rural development or irrigation projects focusing on particular geographical regions, as well as a highly successful agricultural credit program. In the future, increased attention will be given to agricultural support services at the national level, which are essential for backstopping regional development projects and would be more appropriate vehicles for addressing sectoral policy issues. Projects are under preparation in agricultural inputs distribution, research and extension services, cereals storage and marketing and irrigation management. In view of limited budgetary resources, special attention would be paid to maximizing non-budgetary financing and improving cost recovery. Sector work on agricultural incentives - fiscal, financial, pricing and institutional policies - has been undertaken; and a program of agricultural sector policy lending is plan2ned to support measures of structural reform. 125. Energy and mining. The Government has given high priority to reducing the oil import bill, a major factor in the current account deficit, through development of domestic energy supplies. The Bank has supported this effort through loans for the exploration and appraisal of petroleum (primarily natural gas) and oil shale resources as well as for power generation and transmission. Future projects would assist in the development of domestic energy supplies, including gas, and hydropower. In FY85, a Bank loan has been approved for the Jerada Coal Mine Modernization and Expansion project. Through these projects as well as in our sectoral policy dialogue, efficiency in energy development and use would be promoted through attention to pricing, cost recovery and management issues. A pilot project to support small-scale, export-oriented mining activities in a remote, low-income region still be monitored with a view to its possible extension. 126. Bank lending for infrastructure and utilities has helped to build a number of technically competent agencies in the fields of road transportation, electricity, water supply, housing finance, and community infrastructure - 45 - finance, as well as to expand the provision of essential services. Future projects will place greater emphasis on improving the productivity and efficiency of existing infrastructure through improved financial and management performance. Mobilization of private and non-budgetary financing as well as improved cost recovery in these subsectors through tpriffs should help reduce the Treasury deficit. la addition to continuing support for the above-mentioned subsectors, projects are under preparation for ports, sewerage and telecommunications. 127. Industrial development in Morocco has been supported primarily through strengthening the financial and institutional resources of the Banque Nationale de Developpement Economique (BNDE), the major source of industrial medium-term credit. In addition, policy changes were introduced to widen access to credit by small-scale labor-intensive industries. Other projects focused on phosphate processing and cement production. The Bank's efforts are now focused on the development and implementation of medium-term policy reforms aimed at encouraging exports and improving incentives to domestic production. The first phase of such reforms was supported by the Industrial and Trade Policy Adjustment (ITPA) loan, and the second phase of the medium-term ITPA program adopted by the Government, as well as comprehensive financial sector reform continuing rationalization of the public investment program, and discrete phases of public enterprise reform are supported by the proposed ITPA II loan. At the same time, the Bank is contributing through project lending to building up productive capacity to support the Government's priorities in the sector, particularly export promotion. The Electrical and Mechanical Industries Project, approved in FY85, aims at deepening the industrial base, encouraging term-lending to industry by commercial banks, and strengthening industrial promotion. 128. Education, health and urban development projects will increasingly concentrate on lowering unit costs in order to widen the access by low-income groups. Policy dialogue in these sectors continues to encourage the shift away from capital-intensive investments benefitting limited clientele and the development of more cost-ei.ccLive delivery systems for basic services. While previous Bank-financed projects have supported technical education, rural primary eduication _...'a p.roved teacher training, these should be complemented by efforts to expaua h-4ic education and skill training, as well as restructuring of the formal education system, which has represented a major drain on the recurrent btiiegt. A first health development project would test new health care delivery systems in order to improve basic health services in rural areas. Finally, the experience of projects in urban upgrading will be continued and expanded, with increased efforts t- -obilize private financing in order to reduce budgetary costs. PART VI: LEGAL INSTRUMENTS AND AUTHORITY 129. The draft Loan Agreement between the Kingdom of Morocco and the Bank, and the Report of the Committee provided for in Article III, Section IV (iii) of the Art-cles of Agreement of the Bank are being distributed separately. Proposed special conditions for disbursements are described in Annex III. - 46 - PART VII: RECOMMEDNDATIONS 130. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. 131. I recommend that the Executives Directors approve the proposed loan. A. W. Clausen President Attachments May 6, 1985 Washington, D.C. 47' - ANNEX I T A * L TA PACE I 'm:cCO -W CXuL IICxATwm DAMU Slla lZEWcco ~~~~~~~muauMii spscuzlaup AVRAOSS la KmST 6O0T SELT urTS) U b REUIC HIXDDUS IREX WIDOD .nmaluLC W. AFI & L AST IA. AoCA &CA AM (IWOU&mD JQ. I) TOTAL 446.6 A 46.6 c 446.6 Is. ACRICULTURAL 192.2 7j 200.1 /f 201.9 Ac QW P CAPrU (056) 190.0 300.0 870.0 1149.6 2108.6 ce cwsmuF CF (KILOAMS OF OM CquIVAts) 118.0 174.0 284.0 62L1 995.5 W NULr AND 1NUL 5951S$CS POPULATION,MID-TEAR (TOUSANDS) 11626.0 14968.0 20269.0 URBAN POPtATInON (2 OF TOTAL) 29.3 34.6 41.9 48.2 66.5 POPULATON PROECTIONS PoPUIATIoS IX YUAR 2000 (KILL) 31.2 STATIONAY POPUIATION (MILL) 70.4 FOPUUTIOI KIGIEYM 1.9 POPUIATION DENSITY PER SQ. It. 26.0 33.5 44.2 36.3 35.7 MM SQ. M AGRI. LAE 60.3 74.8 94.5 461.7 92.4 POPULATION ACC STRUCTUREt (2) 0-34 YRS 44.8 47.6 45.4 43.6 39.9 15-64 YRS 52.6 48.3 51.4 53.1 56.0 5 AND ABOVE L6 4.2 3.1 3.3 4.1 POPULATION CROW!H RATE (I) TO.AL 2.6 2.5 2.5 2.4 URBAN 3.7 4.2 4.1 4.5 3.6 CRUDE DIRTM RATE (PER THWUS) 50.3 47.5 40.3 40.4 31.3 CRUDE DEATH tATE (PER TIODS) 21.2 16.9 14.6 11.5 8.1 GROSS EPRODUCTION RATE 3.5 3.5 3.0 2.8 2.0 FAMILY PLANNING ACCEPTORS. ANNUAL (TOMUS) ., 25.1 78.0 /d USERS (Z OF MARRIED WOEN) .. .. 19.0 22.2 40.3 FOOD ADURITO INEX OF FWD PROD. PER CAPrTA (1969-71-100) 99.0 98.0 84.0 97.3 114.3 In CAPITA SUPPLY OF CALERIES (Z OF REqURDENS) 101.0 104.0 115.0 110.8 110.6 PROTEINS (CRAMS PER DAY) 64.0 67.0 73.0 70.1 67.3 OF WHEI ANnUL AND ULSE 14.0 13.0 14.0 te 17.8 34.1 CHILD (ACES 1-4) DEATH RATE 36.8 26.0 22.0 16.6 5.7 BEMH LIFE EXPECT. AT BIRTH (TEARS) 46.7 50.6 51.9 57.5 64.7 INFAr NMORT. RAT (PER TfOUS) 160.5 134.0 125.0 101.5 60.6 ACCESS TO SAfE WATER (ZOP) TOTAL 30.6 51.0 55.0 Id 59.7 65.4 URBAN 58.7 92.0 10.o 7d 84.5 78.1 RURAL 19.0 28.0 25.0 /d 38.4 4.2 ACCESS TO EXCRETA DISPOSAL (S OF POPULATIO) TOTAL .. 29.0 .. .. S;L9 URBAN ., 75.0 ,. .. 67.0 RURA .. 4.0 ,. .. 24.5 POPULATION PER PHYSICIAN 9410.0 12790.0 10750.0 /f 4345.1 1917.7 POP. PER NURSLU PERSON .. 2740.0 1830.07 1831.1 815.8 POP. PER HOSPITAL BED TOTAL 630.0 660.0 750.0 Ie 632.9 367.2 URBAN ., 450.0 610.0 7e 545.5 411.5 RURAL ., 5810.0 3010.0 7r 2513.5 2636.3 ADINSSIONS PER HOSPITAL BED ., 15.5 17.9 fc 26.2 27.3 AVERAGE SIZE OF HOUSEHOLD TOTAL 4.8 5.5 URBAN 4.3 4.9 RURAL 5.! 5.8 AVERAGE NO. OF PERSONStROOI TOTAL 2.2 2.4 URBN 2.1 2.1 RURAL 2.3 2.6 ACCESS TO ELET. (Z OF DWELICS) TOTAL . .. .. U4.2 UR--N .. 68.4 65.0/. 77.7 RURAL ., ,, ,, 16.1 -48- ANNEX I T A BLE 3A PACER HOROCCO - SOCIAL INDICATORS DATA 58ET MOROCCO NRZFERENCE GROUPS (NEICHTED AVCRAQES) MOST (MOST URCENT ESTIMASC) /b RECENT MIDDLE INCOME MIDDLC TNCME 19601b 197n/b EsTIMATEtbk N. ARCAA A MID CST LAT. AIELICA & CAR mDCanou ADJUSTED ENROLLMENT RATIOS PRIMARY: TOTAL 47.0 52.0 78.0 88.3 105.4 MALE 67.0 67.0 97.0 102.5 106.3 FEMALE 27.0 36.0 60.0 73.6 104.5 SECONDARY: TOTAL 5.O 13.0 26.0 43.0 43.2 MALE 7.0 18.0 31.0 52.3 42.3 FEMALE 2.0 7.0 20.0 33.0 44.5 VOCATIONAL (1 OF SECONDARY) 30.2 2.3 1. 10.3 33.6 PUPI L-TEACNER RATIO PRIMARY 42.0 34.0 36.0 30.3 30.1 SECONDARY 6.0 20.0 20.0 23.1 16.6 ADULT LITERACY RATE (Z) 13.8 21.4 28.0 43.5 79.5 CONlSUIPlTIOR PASSENGER CARS/THOUSAND POP 10.7 14.9 21.5 jj 17.6 46.0 RADIO RECEIVERS/THOUSAND POP 45.8 62.5 155.9 138.8 225.6 TV RECEIVERSITHOUSAND POP 0.4 11.6 38.9 46.1 107.2 NEWSPAPER (-DAILY CENERAL INTEREST-) CIRCULATION PER THOUSAND POPULATION 22.1 16.2 12.3 /f 31.2 63.5 CINEMA ANNUAL ATTENDANCE/CAPITA 1 5 1.5 lb 2.07; 1.7 2.8 LANR FORCE TOTAL LABOR FORCE (tTDUS) 3389.0 3939.0 5361.0 FEMALE (PERCENT) 10.0 14.2 16.0 10.8 23.2 AGRICULTURE (PERCENT) 62.0 57.0 52.0 42.4 31.5 INDUSTRY (PERCENT) 14.0 17.0 21.0 27.9 23.9 PARTICIPATION RATE (PERCENT) OTAL 29.1 26.3 26.5 26.2 32.2 MALE 52.1 45.2 44.4 46.4 49.3 FEMALE 5.9 7.5 8.5 5.8 15.2 ECONOMIC DEPENDENCY RATIO 1.6 2.0 1.8 1.8 1.4 LNCOS DISIRIJTION PERCENT OF PRIVATE INCOMIE RECEIVED BY HIGHEST 5: OF HOUSEHOLDS 18.0 /I 20.0 II HIGHEST 20S OF HOUSEHOLDS 43.3 7? 49.0 7? LOWEST 20S OF HlOUSEHOLDS 7.0 71- 4.0 717 LOWEST 401 OF HOUSEIIOLDS 18.07I 12.0 71 POVERTY TARlET GLOUPS ESTIMATED ABSOLUTE POVERTY INCOME LEVEL (USS PER CAPITA) URRAN 107.0 157.0 389.0 If 274.8 288.2 RURAL 66.0 101.0 238.0 71 177.2 154.0 ESTIMATED RELATIVE POVERTY INCOME LEVEL (UISS PER CAPITA) LRhAS. 242.0 tf 402.6 522.8 RURAL 157.0 7 284.9 372.4 ESTLIATED POP. RELW ABSOLUTE POVFRkll INRlMF LEVEL Ct) URBAN 51.0 38.0 28.0 If RURAL 49.0 45.0 45.0 7f NOT AVAILABLE NOT APPLICARLE N O T E S Is The group averanes for each indicator are population-weighted arithmalc means. Coverage of countries among the 1ndrar-'rn depends 'n availability of data and Is not unlfoxe. /b Unles. othIer.Ic noted, -Data for 1960- refer to any year between 1959 end 1961; 'Data for 1970- between 1969 and 1971; and data for "Most Recent Estimte" between 1980 and 1982. /c Excludes the ex-Spanich Sahara; /d 1976; Ie 1977; /f 1979; |L1978; lh 1972: /| Conumption expenditure of households. JUNE, 1984 ANNEX I -49- bee.,c
Группа Всемирного банка · President's Report
Morocco - Second Industrial and Trade Policy Adjustment Loan Project
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Марокко
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Всемирный банк