Morocco - Structural Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY AA/ 3oc'd- ,szoZ Report No. P-4867-MOR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$200 MILLION TO THE KINGDOM OF MOROCCO November 8, 1988 This document bas a resticted ditibution and may be used by recipients only in the perfonnance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Average Calendar 1987 July 1988 Currency Unit = Dirham (DH) 1 Dirham (DH) - US$0.1196 0.1186 1 US Dollar (US$) = DH 8.359 8.432 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AfDB: African Development Bank ASAL: Agricultural Sector Loan Bank al-Maghrib: The Central Bank CMPE: Centre Marocain pour la Promotion des Exportations (Center for the Promotion of Moroccan Exports) GFCF: Gross Fixed Capital Formation ICB: International Competitive Bidding IGR: Personal Income Tax IHS: International Harmonized System ITPA: Industrial and Trade Policy Adjustment Loan MLT: Medium and Long Term OCP: Office Cherifien des Phosphates OECF: Overseas Cooperation Fund (Governmenc of Japan) PAL: Public Administration Loan PGI: General Import Program PSN: National Solidarity Tax QR: Quantitative Restriction SMAEX: Societe Marocaine d'Assurance a 1'Exportation (Export Insurance Agency) SOE: Statement of Expenses TIP: Target Investment Program TPS: Domestic Sales Tax VAT: Value Added Tax  FOR oFCAL US ONL! MOROCCO SrRUCITURAL ADJUSTMENT LOAN Loan and Pro Sam Borrower: The Kingdom of Morocco. Amount: US$2C0 million equivalent. Terms: 20 years, including 5 years of grace at the standard variable interest rate. Description: Morocco's Structural Adjustment Program aims to achieve a sustainable increase in the rate of economic growth in order to ensure employment opportunities and acceptable living standards for its growing population, while -- enhancing external creditworthiness. The proposed SAL would support the first phase of a program of action covering: an increase in the level of public revenues and savings to finance essential infrastructure and social investment, while reducing the need for public sector borrowing; further rationalization of trade and industrial policy; and the elaboration of an external liability management action plan. Specific policy measures would help raise the overall efficiency of the economy in line with program. goals. Bentfits The principal benefits of the adjustment program resulting and Risks: from the acceleration of economic growth through increased factor productivity would be: a rise in employment opportunities and living standards for the growing population; the development of an outward-oriented private sector; and continued improvement in external creditworthiness with a view to restoring voluntary access to commercial borrowing. Program risks concern the timely implementation of a comprehensive set of structural reforms, which will require a cohesive and concerted approach from those governmental institutions involved in policy implementation. Underscoring the Government's commitment to the adjustment program are strong policy dialogue as reflected in a jointly-evolved, medium-term macroeconomic framework, the implementation of several broad reforms in the fiscal area, and the buoyant response of the economy to the structural measures in place. These, bolstered by a multifaceted program of training and technical assistance, all serve to mitigate the risks. This document has a stricd distrbution and may ' t:u<d by ecipients only in the peformane of their official duties. Its contents may not otherwi -e be dis m-ed without World Bank authorition.  - ii - Estimated The proceeds of the proposed loan would be disbursed in two Disbursements: tranches: US$100 million upon loan effectiveness, bhich is expected to take place by December 1988, and the remaining US$100 million after the completion of a number of key actions upon which success of the program depends. Release of the second tranche iP planned for mid-1989. Appraisal Report: None Map: IBRD No. 20864  KINGDOM OF MOROCCO STRUCTURAL ADJUSTlM LOAN Table of Contents Page INTRODUCTION I PART I: THE ECONOMY 1 Background 1 Macroeconomic Developments since the Firancial Crisis of 1983 2 Outstanding Development Issues 5 Rationale for Continuing Bank Adjustment Lending 6 PART II: THE STRUCTURAL ADJUSTMENT PROGRAM 7 Program Objectives and Policy Tools 7 The Policy Framework of the First Structural Adjustment Loan 9 Tax Policy and Administration 9 The Public Investment Budget 12 Trade and Industrial Policy 16 External Liability Management 20 Program Benefits, External Financing Requirements and Social Impact 23 fsacroeconomic Outcome of the SAL 23 Assessment of Macroeconomic Perfozmance 26 Medium-Term External Financing Requirements 27 Social Impact of Adjustment 29 PART III: LOAN ADMINISTRATION 30 Procurement and Disbursement 30 Accounts and Audits 31 Coordination with Other Agencies 31 The OECF 31 The AMDB 31 Implementation Risks and Justification 31 PART IV: OTHER BANK OPERATIONS 33 Experience with Past Adjustment Lending 33 Project Lending 34 PART V: RECOMMENDATION 35 ANNEXES: I Key Economic Indicators 38 II Letter of Development Policy and Associated Policy Matrices 44 III Supplementary Program Data Sheet 62 IV Status of Bank Operations in Morocco 65 V Institutional Support, Technical Assistance & Training 68 VI Progress under Existing Adjustment Operations 70 MAP: IBRD No. 20864  REPORT AND REON OF THE PR OF THE ITERNAIONAL BANK FOR RECONSTRUCTON AND DEVELOPMENT TO THE EXECUTIVE DRECTORS ON A PROPOSED STRUCTURAL ADJSIENT LOWAN IN AN AMOUNT EQUIVALENT TO US$200 MILLON TO THE KINGDOM OF MOROCCO INTRODUCTION 1. I submit the following report and recommendation on a proposed loan for the equivalent of US$200 million to the Kingdom of Morocco. The loan would support the first phase of a structural adjustment program aimed at an acceleration of growth and a strengthening of social services. The program would be implemented in the context of a macroeconomic framework which ensures internal and external equilibria. The loan would have a term of 20 years, including 5 years of grace, at the standard variable interest rate. Cofinancing arrangements with other bilateral and multilateral agencies are being actively pursued. PART I - THE ECONOMY 2. Morocco has a relative abundance of natural resources, including the world's largest and most easily accessible phosphate reserves, vast areas of arable land, and an extensive coastline. Its geographical proximity to major industrialized markets favors the development of international trade. This potential has been exploited in terms of strong manufactured export growth, a booming tourism sector, and the substantial outflow of workers abroad whose remittances figure prominently in Morocco's balance of payments. 3. Social indicators have improved over time, although differentially according to income level. The urban-based growth of the 1960s and 1970s, for example, increased the share of income accruing to the upper 20% of the population, while the poorest levels vitnessed a reduction in their share from 181 to 12X. Overall growth was nonetheless sufficiently rapid to diminish the incidence of absolute poverty from almost 50% in 1960 to 372 in 1979. Other aspects of socioeconomic development have improved since the mid-1960s with life expectancy at birth rising from 49 to 59 years, infant mortality declining from 145 to 90 per thousand, caloric intake per capita increasing from 952 to 119S of the minimum daily standard requirement, and primary school enrollment rates growing from 572 to 81S, principally the result of higher female participation rates. Although the urban growth rate is twice that of the rural sector at present, a significant share of the population continues to reside in the countryside and is employed in agriculture. In 1986, the population, which is increasing at about 2.61 per annum, reached 22 million with a GNP per capita of US$580.  -2 - 4. For nearly two decades after Independence in 1956, Morocco followed a re-atively conservative approach to economic management. A slow rise in investment was financed by periodic recourse to external borrowings, which supplemented the limited pool of domestic savings. During this period, the economy grew at a rate of 4S per anmum. Primary products, principally phosphates, accounted for 90S of merchandise exports. 5. A boom in phosphate prices during the years 1975-77 injected renewed vigor into the economy and coincided with rising defense expenditures and an unprecedented expansion of the public investment program, signaling the end of the circumspect fiscal policies of the past. The sudden reversal in the terms of trade in the late 1970s, as a result of the plunge in phosphate prices and the second oil shock, prompted Morocco to resort increasingly to external capital markets in order to maintain the higher rate of public investment. The viability and expediency of this development strategy were conditioned by the abundance of foreign financing opportunities on highly attractive terms (interest rates were negative in real terms). 6. During this period, Morocco's external debt grew exponentially from US$1.8 billion in 1975 to US$13.9 billion in 1983, at which point it represented nearly 1201 of GDP and 3551 of foreign exchange earnings. The structure of Moroccan debt changed over this period with 401 of outstanding liabilities owed to conmercial banks compared to nil a decade earlier; more than 601 of the debt was at non-concessional rates. The unanticipated rise in international interest rates in the early 1980s, compounded by the declining productivity of public investment and a severe and prolonged drought in 1980-84, proved more than Morocco's balance of payments could endure. Bereft of foreign exchange reserves and access to external funds, Morocco was unable to shoulder its debt service burden-the debt service ratio reached 531 in 1983, with interest payments alone accounting for 201 of exports. 7. By that time, it ha'd become clear that the solution to Morocco's financial distress lay in a comprehensive program of economic reform. A set of extensive stalb'lisation and adjustment policies was evolved by the Government and supported by a series of IMF standby arrangements and World Bank sectoral adjustment loans. Restrictive fiscal and monetary policies were employed tu contain aggregate domestic demand, while structural reforms in trade and industry, agriculture, education, and the public enterprise sector were initiated to augment the supply response of the economy. Debt service payments to official and comnercial creditors were rescheduled, initiating a process that has already spanned five years and is expected to continue well into the future. M b Deveow_ents since the Financial Crss of 1983 8. The challenge of adjustment facing Moroccan policy makers was indeed formidable given the forbidding debt burden, the large financial imbalances which beset the economy, and the relatively limited base of non-traditional manufactures. Despite difficult circumstances, Morocco has made much progress in alleviating both internal and external disequilibria since 1983. Stabilization of public finances was achieved through a package of expenditure-reducing measures to decrease government absorption. As a result, the overall fiscal deficit as a share of GDP fell from 11.71 in 1983 to 6.11  _3- in 1987 on a commitment basis. This performa.'ce was all the more remarkable in view of the budgetary claims of national priorItios in the Western Sahara and the sizable interest payments on the public debt, the latter representing nearly one-quarter of total budgetary expenditures. The improvement it the balance of payments has been even more impressive, as evidenced by the decline in the current account deficit from 12.71 of GDP in 1982 to about 1S (before debt rescheduling) in 1987. 9. The substantial reduction in macroeconomic imbalances can be attributed to a combination of favorable external dtvelopments and the pursuit of rigorous policy reforms. The decline in international petroleum prices served to strengthen not only the trade balance but the fiscal situation as well, with the introduction of an oil levy equivalent to 2.7S of GDP (para. 32). Following a period of protracted drought, agricultural productien responded decidedly to the more auspicious weather conditions, leading to a decline in food prices ana imports. These factors contributed to an improvement in the overall terms of trade when the decrease in import prices more than offset the fall in export-prices (para. 10) in 1986, restoring much of the deterioration that occurred since 1980. 10. Structural policy measures intended to augment the productive capacity of the economy, however. underlie much of the adjustment that has taken place sinc6 1983. The sweeping reform of the trade and industrial regime has given rise to productivity gains in labor and capital, averaging over 51 per year, as well as a shift in the structure of external trade flows-V. Measures introduced to eliminate export barriers, reduce existing disparitiks between exporting and import-substituting activities, and simplify administrative procedures in the area of external trade have led to buoyant export growth of manufactured goods (para. 60). Increasing at an average annual rate of 15.5S since 1983, nonphosphate-based manufactures have compensated both the decline in the price of phosphoric acid and the stagnati=n of world phosphate demand. Nont-aditional manufactured goods now account for over 301 of total merchandise exports, compared to approximately 201 in 1983, ~esulting in a more diversified export base and a reduced dependency on natural resource-based manufactures. 11. Appropriate exchange rate management, an important factor underlying this impressive performance, served to boost tourism proceeds and worker remittances as well, while containing import demand at sustainable levels following the reduction of external trade barriers. Despite a 251 nominal depreciation of the Dirbam since 1983, judicious monetary policies helped staunch inflationary pressures, resulting in a 231 decline in the real exchange rate. In line with the objectives of a Bank-supported financial sector reform, the structure of deficit financing changed significantly during this period, as the Treasury resorted increasingly to the nonbank private sector to compensate for reduced borrowing opportunities abroad and limited access to Central Bank funds. This enabled the monetary authorities to eschew inflationary financing and lower the rate of change in prices from 12.5% in 1983 to 2.41 in 1987. 1/ The impact of liberalization on trade and industrial adjustment has been thoroughly documented in report 6714-MOR.  4- 12. The extent of Morocco's adjustment efforts is apparent in the evolution of the non-interest current account balance, which represents the magnitude of the resource transfer between the home country and the rest of the world. Before the adjustment program was launched in 1983, Morocco was receiving a not resource transfer in excess oL 52 of its GDP. This trend was reversed after 1985 with Morocco transferring nearly 3% of its GDP abroad in 1987, net of debt rescheduling, in line with the narrowing of the current account deficit (para. 8). During this period, the stock of external debt nonetheless continued to rise owing to continuing, albeit decreasing, current account deficits, and increases in the valuation of external liabilities linked to real exchange rate movements between the Dirham and international currencies and amongst the international currencies themselves. By 1987, total debt outstanding and disbursed still represented about 115 of GDP and 353X of all foreign exchange earnings. 13. The Bank has given its support to Morocco's adjustment program in terms of policy advice, technical assistance, and financing (paras. 109-110). In certain areas, however, progress was not as rapid as expected. For example, objectives aiming at the complete repeal of quantitative restrictions on imports by 1989 and the elimination of a stable source of fiscal receipts in the form of the special import tax (para. 61), as reflected in the ITPA program, were not achievable within the given timeframe in light of the looming threat of world protectionism. the growing opposition of certain domestic interest groups to further trade liberalization, and the pressing need to narrow the budget deficit in the face of structural revenue constraints. In the context of the overall implementation of trade policy reform (paras. 57-61), however, Morocco has arguably become one of the more liberal trade regimes within the developing world. 14. On balance, the extensive reforms implemented since 1983 have initiated a significant transformation of Morocco's underlying economic structure without unmanageable stress to the social fabric. The moderately-paced implementation of stabilization measures, the exploitation of available financial capital and restructuring techniques in the form of debt rescheduling, and the adoption of supply-oriented policy reforms have all served to mitigate the contractionary impact of adjustment. The fall in purchasing power of salaried employees tollowing the devaluation of the Dirbam was to some extent limited by the fact that consumer prices increased at a slower rate than producer prices. The social costs of lower real wages, however, were partly compensated by a postive employment effect in the manufacturing sector (7.5% growth per annum since 1983), as the bias toward capital use was reduced and production shifted to more labor-intensive exporting activities. In general, the rationalization of the structure of incentives led to a growing outward-orientation and an increased competitiveness of Moroccan industry which, in turn, enabled firms to exploit existing productive capacity and avert recessionary pressures. Prescient policy-making was evident in the design of a detailed plan, developed in conjunction with the Bank, to target subsidized foodstuffs to the poor to permit a substantial narrowing of generalized consumption subsidies.  -5 - 15. The progress achieved in remedying macroeconomic imbalances since the onset of the adjustment program nevertheless belies certain structural weaknesses. Although the impact of stabilization policies on economic growth was relatively restrained, with GDP increasing at an average annual rate of 3.3S, per capita consumption stagnated. Moreover, the narrowing of the fiscal deficit has been achieved, in large part, at the expense of public investment. To this effect, the share of central government gross fixed capital formation in GDP has fallen by more than half since the early 1980s, representing a modest 2.81 in 1987. While a good deal of budgetary resources had previously been channeled to finance premature investments or projects of questioneble economic priority, the recent curtailment of development expenditures has been so severe that it has led to the suspension or cancellation of many essential investments in key economic and social sectors, with potentially deleterious effects on future growth and the development of human capital, as well as on income distribution. 16. A less than buoyant fiscal system and the inability to effect the requisite cuts in current expenditures are manifest in the weak public savings effort, reflected in a 4.51 current budget deficit on average since 1983. kUe discrepancies between budgetary commitments and cash payments have led to a s,ubstantial buildup of domestic payment arrears, which represented 7.31 of GDp at end-1987. In addition, the virtual depletion of foreign exchange reserves, amounting at times to only several days worth of imports, has given rise per4!-dically to external payment arrears and protracted delays in obtaining foreign exchange. This has resulted in foregone opportunities or higher financial charges for those economic agents operating in the foreign trade sector. 17. T..re are indications that the tendency of the Government to consume beyond its means may adversely affect private investment demand. For example, real interest rates have risen by approximately 19.5 percentage points since the mid-1970. in order to mobilize the private resources necessary to compensate for the comparative lack of foreign and public savings. The significant rise in the cost of capital and the liquidity problem faced by some firms as a result of the proliferation of domestic payment arrears, point to the continuing danger of crowding-out. 18. Finally, Morocco's balance-of-payments' position remains precarious despite the dramatic improvement in the current account previously noted (pars. 8). At present, debt indicators remain high (para. 74) and constitute a major impediment to mobilizing adequate levels of external financing. Furthermore, the future performance of the current account is predicated, in part, on the favorable evolution of the external environment. Unless constraints on the capital account are eased, Morocco would have to transfer even higher levels of net resources abroad, thereby compromising future economic growth, adjustment efforts, and, ultimately, prospects for improved creditworthiness.  - 6 - FRdl#2fti for g9