Morocco - Private sector assessment update : fulfilling the promise of private sector-led growth

Report No 19975-MOR Kingdom of Morocco Private Sector Assessment Update Fulfilling the Promise of Private Sector-Led Growth December 15, 1999 Provate and Financial Sector Development Department Middle East and North Africa Region Document of the Worfd Bank  CURRENCY AND EXCHANGE RATE (as of June 30, 1999) Currency Unit = Dirham (DH) US$1.00 = DH 9.98 FISCAL YEAR July 1 - June 30 ABBREVIATIONS AND ACRONYMS ANRT Agence Nationale de Reglementation du Secteur des T6lecommunications AMC Associations de Micro Credit AMITH Association Marocaine des Industries Textiles et de I 'Habillement BAJ Barnamaj al Aoulaouiyat al Ijtimaiya (social priority program) BAM Bank Al-Maghrib (Central Bank) BCP Ban que Commerciale Populaire BMCE Banque Marocaine du Commerce Exterieur BNDE Banque Nationale pour le Developpement Economique CDG Caisse de Depot et de Gestion CDM Charbonnage du Maroc CDVM Comite Deontologique des Valeurs Mobilieres CEN Caisse d 'Epargne Nationale CGEM ConfiM&ration Generale Economique Marocaine CIH Credit Immobilier et H6telier CIOR Cimenterie de l'Oriental CNCA Caisse Nationale de Credit Agricole CPI Consumer Price Index CRAPP Comite de Reflection, d 'Accelration du Processus de Privatisation CSDP Contractual Savings Development Program CTM-LN Compagnie de Transports au Maroc-Lignes Nationales DEPP Direction des Etablissements Publics et des Participations DH Moroccan Dirham EPICS Etablissements Publics a Caractere Industriel et Commercial EU European Union ESNITH Ecole Superieure Nationale de Textiles FDI Foreign Direct Investment FTA Free Trade Agreement GDP Gross Domestic Product GATT General Agreement on Tariffs and Trade GIAC Groupements Interprofessionnels d 'Aide au Conseil GPBM Groupement Professionel des Banques Marocaines IAM Itissalat al-Maghreb IBRD International Bank for Reconstruction and Development IMF International Monetary Fund  INEJ Institute for Judicial Studies IPO Initial Public Offering MENA Middle East and North Africa MSTQ Metrology, Standards, Testing, and Quality Management NGO Non-governmental Organization OCP Office Cherifien des Phosphates ODI Office de Developpement Industriel ODEP Office d 'Exploitation des Ports OECD Organization for Economic Cooperation and Development OFPPT Office de la Formation Professionelle et de la Promotion du Travail ONCF Office National des Chemins de Fer ONDA Office National des Aeroports ONE Office National de l 'Electricit6 ONEP Office National de l 'Eau Potable ONPT Office National des Postes et T6l6communications ONT Office National du Transport PE Public Enterprise PEP Plancher des Effets Publics PERG Programme d'Electrification Rural Groupe PAGER Programme d 'Approvisionnement Groupe en Eau Potable des Populations Rurales PHRD Policy and Human Resources Development PSA Private Sector Assessment PSD Private Sector Development PSDAL First Private Sector Development Adjustment Loan RAM Royal Air Maroc REER Real Effective Exchange Rate RME Ressortissants Marocains a 1 'Etranger SAL Structural Adjustment Loan SAMIR Societe Anonyme Marocaine de I 'Industrie du Raffinage SBVC Societe de la Bourse de Valeurs de Casablanca SEFERIF Societe d' Exploitation des Mines du Rif SONASID Societe Nationale de Siderurgie TA Temporary Admission TFP Total Factor Productivity UJNCTAD United Nations Conference on Trade and Development USAID United States Agency for International Development WTO World Trade Organization Vice President: Kemal Dervis Country Director: Christian Delvoie Sector Director: Wafik Grais Task Team Leaders: Michel Kerf, Clemencia Torres   KINGDOM OF MOROCCO PRIVATE SECTOR ASSESSMENT UPDATE: FULFILLING THE PROMISE OF PRIVATE SECTOR-LED GROWTH TABLE OF CONTENTS EXECUTIVE SUMMARY_ i CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT i 1. INTRODUCTION 1 2. RECENTECONOMICPERFORMANCE 1 3. ECONOMIC POLICIES IN THE 1990s 5 3.1. Foundation for private sector development 5 3.2. Institutional and Sector-specific Reforms 8 4. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT 15 4.1. Results of the 1998 Enterprise Surveys 15 4.2. Comparison with 1994 PSA results 18 S. ANAGENDA FOR PRIVATE SECTOR DEVELOPMENT 20 5.1. Strengthening the Foundation for Private Sector Development 20 5.2. Addressing First-tier Issues: Administration, Labor, and Finance Constraints 23 5.3. Addressing Second-tier Issues: Industrial Land and Infrastructure, Technology Support, and Market Information Constraints 27 ANNEX 1: PERFORMANCE AND STRUCTURE OF THE ECONOMY ANNEX 2: FOUNDATIONS FOR PRiVATE SECTOR DEVELOPMENT ANNEX 3: LEGAL AND ADMINISTRATiVE FRAMEWORK ANNEX 4: ACCESS TO HUMAN RESOURcES ANNEX 5: ACCESS TO FINANCE ANNEX 6: ACCESS TO TECHNOLOGY SUPPORT AND MARKET INFORMATION ANNEX 7: ACCESS TO INFRASTRUCTURE AND LAND  Principal contributors to this paper include: Hamid Alavi, Saad Belghazi, Ferid Belhaj, Judith Brandsma, Olivier Fremond, Luis Guillermo Hakim, Eric Haythorne, Michel Kerf (Co-Task Team Leader), Axel Peuker, Valerie Reppelin, Andrew Stone, Clemencia Torres (Co-Task Team Leader), and Luc de Wulf. Extensive comments were received from the report's peer reviewers: Hassane Benabderrazik, Andrew Ewing, Ahmed Galal, and Charles Humphreys. Support and comments were also received from Denis Chaput, Joumana Cobein, Fran,ois Corfmnat, Christian Delvoie, Karim El- Aynaoui, Mourad Ezzine, Youssef Fehry Fassy, Stephanie Gober, Pierre Guislain, John Page, Mauricio Saavedra, Manuel Schiffler, Nemat Shafik, Elisabeth Sherwood, Vera Songwe, Rene Vaurs, and Paolo Zacchia. Deborah Davis edited the paper and Nicole Wautiez De Blaye translated the document into French. Ebru Engin, Richard T. Carter, Maude Jean-Baptiste, Ernest Forkpah and Liliane Vert helped with production of the document.  EXECUTIVE SUMMARY This report is an update of the private sector assessment (PSA) for Morocco undertaken by the World Bank in 1994. During the last four years, the country has clearly demonstrated its choice in favor of economic liberalization and opening to the global economy, as evidenced, for example, by the signing of important international trade agreements. In the resulting environment, firms will need to become more efficient in order to enhance their competitiveness, and the Government has a crucial role to play in facilitating that transition. The recommendations laid out below are intended to contribute to the development of Government policies that will support a more competitive, private sector-led economy. This report draws on extensive consultations with the Moroccan Government and on the views of private entrepreneurs, as captured by two field surveys of 370 enterprises carried out in seven cities in March and April 1998. MOROCCO'S PRIVATE SECTOR TODAY: ACHIEVEMENTS AND LIMITATIONS The Government has done much to promote private sector development (PSD), and these reforms have paid off. A decade of successful macroeconomic stabilization, progressive economic liberalization and deregulation, and the launching of the privatization program have created a solid foundation for PSD. Sector- specific reforms - such as the development of a new legal and regulatory framework in the financial sector, the launching of on-the-job training programs, and the promotion of private participation in infrastructure (PPf) - have also improved the conditions for PSD. As a result, the private sector's contribution to GDP went from 64 in 1985 to 73 percent in 1997, and its share in total exports went from 60 to 75 percent between 1985 and 1995. Foreign direct investment (FDI) has also increased significantly over the same period. However, the performance of the private sector has fallen short of the high expectations generated by the achievements of the 1980s. The private sector's share in investment has remained below 60 percent over the past decade and private savings have not risen. In addition, recent estimates show that total factor productivity (TFP) growth has slowed considerably during the 1990s. Low private savings, investment, and productivity, along with droughts and shortcomings in the performance of the public sector, have negatively affected the economy in general and the private sector in particular in recent years: non-agricultural real GDP grew at an average annual rate of 2.7 percent over 1991-97, in contrast with an average 3.9 percent growth per year over 1986-90. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT The modest performance of the private sector suggests that the macroeconomic, trade, and privatization policy reforms designed to establish a solid basis for PSD have not gone far enough. Key policies favorable to PSD have been maintained in the 1990s, but public savings are low and the fiscal deficit has been financed through extensive borrowing from the rest of the economy. Two financing mechanisms, in particular, have been used by the public sector and have reduced the pool of resources available for private investment: government bonds, and accumulation of public arrears and late payments. In addition, fiscal prudence has been achieved mainly through reductions in public investment that would have been complementary to PSD. On another policy front, the appreciation of the real effective exchange rate (REER) in the 1990s has hindered Morocco's competitiveness. At the same time, while the Government has taken significant steps to open the economy, trade liberalization has not been rapid or uniform, and domestic competition has been limited by inappropriate regulations. Finally, the achievements of the privatization program have been relatively modest, leaving Morocco with a public sector larger than that of other countries at a similar stage of development. This modest private sector performance is also due to institutional and sector-specific constraints that affect the business environment. The findings of the two firm-level surveys indicate that in addition to slow economic growth, which has had a dampening effect on demand, and to other factors discussed above, entrepreneurs consider the following to be the most binding constraints to PSD: costly administrative procedures, scarcity of qualified and flexible human resources, and lack of access to and high cost of credit.  ii The administrative procedures about which entrepreneurs complain, in their answers to the surveys, concern both impediments to the creation of new enterprises and difficulties encountered by existing firms. While procedures for the establishment of new enterprises are less time consuming than they were in the 1980s, they are still cumbersome by international standards and do not promote FDI for small and medium enterprises. Concerning existing enterprises, difficulties relate mostly to tax administration and the judicial system. Procedures in these areas are considered inefficient, time consuming, and costly. Until recently, entrepreneurs also complained about customs procedures, but interviews in 1998 indicate that they are beginning to notice positive changes due to computerization, streamlining of procedures (e.g., reliance on sample controls, which reduce clearance time), and a progressive change of the culture of customs, with authorities taking the needs of users better into account. The lack of appropriate skills is also at the forefront of entrepreneurs' worries. An unemployment rate of 25 percent among young university graduates suggests that the main problem is a mismatch between the skills of graduates and the needs of firms. The Government, through l'Office de la formation professionelle et de la promotion du travail (OFPPT), has launched a series of actions to make vocational training more responsive to firms' requirements, but further efforts are needed in that direction, and a long-term solution will require going beyond vocational training to correct the shortcomings of the formal education system. The slowdown of Moroccan exports demonstrates that having lower wages than the OECD countries is not a sufficient condition to maintain competitiveness. High illiteracy rates and poor preparation of unskilled workers are becoming serious burdens for firms attempting to survive in a more competitive environment. Financial constraints appear to be less binding than in earlier years, reflecting the progress toward formal liberalization of the financial markets. These constraints do persist, however, and affect firms differently according to their size. For smaller firms, including microenterprises, the problem is, as it was in 1994, the lack of access to credit: these firms are frozen out of the formal financial system, and financial NGOs can cater only to the needs of a limited number of businesses (an issue that is being addressed, in part, through the recently approved law on micro-credit). For larger firms that have established formal relations with banks, the main problem is the paucity of medium and long-term financial instruments, and to a lesser extent the cost of credit. Banks still prefer to acquire widely available low-risk government bonds rather than to lend to the private sector; and even though capital markets are developing, they are not yet a real alternative to the banking system in supplying private sector financing. Finally, there is another set of constraints, less severe than the ones already discussed but likely to become more important as the economy grows and economic globalization progresses. These constraints include: the lack of well-equipped industrial land; the high price and poor quality of infrastructure services in general, as well as the lack of such services in rural areas; and the lack of technology and market information support services. The specific nature of these constraints and possible measures to alleviate them are not further discussed in this Executive Summary but are elaborated in the main text. AN AGENDA FOR PRIVATE SECTOR DEVELOPMENT To enable the private sector to become the main engine of growth in the Moroccan economy, there is need for further reforms on several fronts. Many of those have already been outlined in the Government's "Economic and Social Reform Program," which accompanied the World Bank's 1999 Policy Reform Support Loan (see Report No. 7287-MOR, May 5, 1999). FURTHER FISCAL, TRADE, AND PRIVATIZATION REFORMS ARE ESSENTIAL Implementing sound macroeconomic policies and removing barriers to competition and to private participation in economic activities currently in the public domain are essential to create the foundation for vigorous private sector development. This involves several measures:  iii Increase public savings and use public resources more efficiently to facilitate private investment. A lower deficit will reduce the public sector's need for credit from the rest of the economy and will free up resources for PSD. Contrary to past practice, however, the deficit reduction should not come at the expense of investment expenditure (see section 2); instead, it should be achieved through an improvement of public sector efficiency and a reduction of current expenditure, as the civil service wage bill now absorbs almost 45 percent of fiscal revenues, and the debt service absorbs 23 percent. (see section 3.1). In this context, the commitment of the current Government to achieve additional budgetary savings of 2.5 to 3 percentage points of GDP over the next 4-5 years is a cornerstone of a sound macroeconomic policy. In addition, improving public investment expenditure within a multi-year plan to complement rather than substitute private investment is also an important requirement. Improve the competitiveness and productivity of firms by accelerating and broadening trade liberalization, by preventing further appreciation of the dirham in the short term and moving toward a more flexible exchange regime in the medium term, and by strengthening laws and regulations to promote domestic competition. A more flexible management of the exchange rate would make Moroccan products more competitive and provide some degree of uniform protection to local producers during the phasing out of tariff protection under the Free Trade Agreement (FTA) with the EU. Advancing the FTA schedule of duty reductions, applying such rules to all trading partners, and extending the agreement's scope to include agriculture and services would yield further benefits. Finally, to promote domestic competition, the draft Competition Law should be enacted and price controls reduced. To be effective, however, the Competition Law will need to be complemented with other measures, such as creating a credible enforcement authority, reforming the judicial system, and restructuring monopolistic sectors. Accelerate the implementation of the privatization program to improve efficient use of productive resources and create a leaner, more efficient State. Parliament has approved new legislation that modifies and complements the current Privatization Law (No. 39-89), including a provision to replace the principle of a global "positive" list with an annual identification of firms to be privatized within a given fiscal year. The Government has also established ambitious targets for privatization and liquidations to be achieved during its tenure. It is now critical to accelerate the preparation of the privatization dossiers and advance the implementation of the program. INSTITUTIONAL AND SECTOR-SPECIFIC REFORMS ARE ALSO NEEDED A series of measures needs to be taken to remove the most binding institutional and sector-specific constraints affecting the business environment. Reduce the administrative burden on enterprises by streamlining tax administration, making the judicial system more efficient, minimizing late payments by the public sector, and simplifying procedures for starting new businesses. Tax administration procedures are still cumbersome. The simplification of the system, along with the publication of clear procedures, would go a long way toward reducing the scope for arbitrary decisions. Two sets of measures are needed to speed up judicial processes. First, the modernization of the overall legal framework needs to be completed by enacting the various draft laws: the Competition Law (currently before Parliament), the Labor Code, the Customs Code, the Mining Code, and the Insurance Code. Second, the court system needs to be strengthened and the quality of judicial decisions in commercial areas needs to be improved through proper staffing of the new commercial courts, updating of the commercial law curriculum in universities, timely publication of judicial decisions, and extension to judicial support staff of the incentives and skill-upgrading opportunities already available to judges.  iv To minimize the occurrence of late payments by the public sector, corporatization could be used to increase the financial accountability of public entities that perform commercial functions. As for the administation itself, there is no substitute for appropriate budgeting and for designing incentives to promote good financial perfornance. Finally, further streamlining of the relevant procedures and consolidation of investment promotion agencies with overlapping responsibilities are essential to facilitate the creation of new domestic enterprises and attract foreign direct investment, especially into small and medium enterprises. Promote the development of a well-qualified and flexible labor force by providing better education and training to a larger portion of the population, and enhance labor mobility by removing legal and regulatory rigidities. The Government should give priority to literacy programs and to improving basic education, with special attention to rural areas. In addition, the content of higher education and vocational training programs should be revised to better tailor the qualifications of skilled workers to the real needs of the economy. Private participation in these areas could yield substantial benefits but would require a revision of current legislation. Finally, to facilitate the transition toward a more competitive and dynamic environment, the Government and associations of private entrepreneurs could assist smaller firms in improving their managerial skills through training programs. At the same time, firms need to be well informed about the implications of current labor rules and regulations, and about any subsequent changes in these rules. Several legislative measures could also encourage firms to invest in a stable labor force. Adopting a modern Labor Code - with emphasis on facilitating flexible arrangements - would be a first step. In addition, strengthening the capacity and efficiency of courts and promoting effective out-of-court settlements would expedite the resolution of conflicts. The current system of severance pay should also be revised to improve labor mobility while providing a safety net during job search. One possible alternative would be to replace the firm's obligation to pay the worker at the time of dismissal with an obligation to make regular contributions to a fund owned by the worker, who could carry this fund across jobs and access the money at the time of his or her dismissal or retirement. Facilitate the access of small enterprises to financial resources, help larger firms obtain longer-term loans under more favorable conditions, and strengthen capital markets as an alternative source of long-term financing. Key measures to help small firms include: (i) increasing the lending capacity of financial NGOs, (ii) developing awareness and expertise among banks on how to make microfinance a profitable undertaking, and (iii) exempt from the current guidelines on taux d'usure and other prudential regulations those financial institutions that are seriously committed to micro and small firm finance. To increase the availability of longer-term credit from banks, it will be important to: (i) enhance competition among banks by completing the liberalization of interest rates, (ii) design better creditor protection, and (iii) promote the provision by firms, and the use by banks, of transparent financial information. Equally important will be to promote the development of capital markets, which could provide an alternative to bank credit. To this end, further deepening of the insurance sector and the development of sound pension funds, which under prudent regulations could invest in these markets, are two important initiatives that could broaden the range of institutional investors in the capital markets. This is a complex reform agenda. Morocco has shown its commitment to support private sector development and has already implemented a series of difficult reforms to improve the macroeconomic, fiscal, and trade foundations for private economic activities. It has also implemented other institutional and sector-specific reforms to improve the business environment. The challenge now is to build on these substantial achievements so the Government can provide the best possible support to the efforts of the private sector to become the engine of growth in an open and dynamic economy.  1. INTRODUCTION The private sector assessment published in 1994 (the 1994 PSA) provided a wide-ranging assessment of the private sector in Morocco and suggested actions to remove identified constraints to private sector development (PSD). Much has changed since that time. New policies have been adopted and the external economic environment has been rapidly evolving. Nevertheless, the performance of the economy in general, and of the private sector in particular, have not lived up to the expectations that developed over the previous decade. This report attempts to take stock of the economic changes, identify the key constraints to PSD, and propose a reform agenda to eliminate those constraints and enable the private sector to contribute more fully to the welfare of the Moroccan people. This report draws on inputs from numerous colleagues both within and outside the Bank and on consultations with Moroccan Government officials, private sector investors and operators, and academics. It also builds on two 1998 surveys of 370 private firms. The main volume presents a synthesis of the diagnostic and recommendations, which are further elaborated in a series of annexes. Following this introduction, section 2 concisely describes the economic performance of the economy during the 1990s. Section 3 describes the main achievements and shortcomings of the economic policies over the last decade and their impact on PSD. Section 4 complements this analysis by highlighting the key constraints to private sector activities as perceived by the entrepreneurs themselves. Finally, section 5 proposes key components of a short and medium-term reform agenda to facilitate private sector development. 2. RECENT ECONOMIC PERFORMANCE This section summarizes the performance of the economy in general and the private sector in particular during the 1990s. Key performance indicators show that, while the economy grew at a high rate in the 1980s owing to the development of exports, there has been an overall slowdown in the 1990s. These results suggest that, although the private sector is an important actor in Morocco, it has yet to become the country's engine of growth. GDP growth has been slower than expected and also more volatile. Over 1991-1997, real GDP growth averaged 2.2 percent, compared to an average growth of 4.5 percent during 1986-1990. Average annual per capita income growth was 2.3 percent during the earlier period but only 0.2 percent during the more recent one. Weak growth partly reflected the effects of the droughts on agricultural output, but non-agricultural production also slowed, from an average annual growth of 3.9 percent during 1986-90 to 2.7 percent during 1991-1997. With 49 percent of the population living in rural areas, bad agricultural years have a particularly damaging effect on the economy, not only because of the direct impact on GDP, but also indirectly because of the general reduction of demand due to lower disposable income in the countryside. Unemployment continues to be high in this slowly growing economy. After having reached 23 percent in 1995, urban unemployment has been declining, largely because rural migrants who came to the cities during the drought are now returning to the countryside. However, urban unemployment is still high at 18 percent, and current trends are disturbing, with the urban labor force growing consistently at about 5 percent. In contrast, employment in urban areas is growing at only 4 percent. While the data on unemployment may overstate the problem because many Moroccans work in the informal sector and in rural areas, the fact is that these jobs often are a form of underemployment due to their low productivity. Sustained economic growth of 7 to 8 percent would be required to bring urban unemployment below 10 percent by 2010 (World Bank, 1998a).  2 Slow growth reflects low investment and low savings. Morocco's current investment rate of about 20 percent of GDP is too low to fuel rapid economic growth (an estimated 27 percent or more is needed for a 3 percent increase in the rate of growth of GDP). The dominance of the public sector in productive activities has had a detrimental effect on investment, not only because public investment tends to be less productive than private investment, but also because of the drastic reduction of investment expenditures that came with the fiscal austerity program (see section 3.1). Investment growth is also hindered by the paucity of financing resources, with the low level of domestic savings (15 percent of GDP) due to low growth in recent years, the limited penetration of the banking sector, and the Government's large borrowing requirements. In addition, the high level of external debt (around 50 percent of GDP) severely constrains the country's capacity to borrow on international markets. Morocco has become more attractive to foreign investors. Foreign investors' perceptions of Morocco have certainly improved, and foreign direct investment (FDI) as a percentage of GDP has recovered from a temporary low in 1995, reaching 1.5 percent in 1997 (excluding privatization receipts; see Table 1). In addition, credit rating agencies have been upgrading their assessments of Morocco slowly, but constantly, since 1987. And although the ranking of Morocco by the Institutional Investor relative to other countries temporarily declined in the period 1993 to 1997, it has recovered to its previous level. Table 1: FDI in Morocco and Other Countries (percent of GDP) FDI as % of GDP 1992 1993 1994 1995 1996 1997 Czech Republic 3.59 1.82 2.16 5.03 2.53 2.50 Greece 1.16 1.06 0.99 0.92 0.86 1.25 Hungary 3.95 6.06 2.76 9.97 4.39 4.56 Israel 0.82 0.88 0.84 2.28 2.57 3.47 Jordan 0.80 -0.62 0.05 0.20 0.24 1.00 Morocco 1.49 1.84 1.82 0.88 0.85 1.49 Pakistan 0.69 0.67 0.80 1.17 1.19 1.30 Philippines 0.43 2.28 2.48 1.97 1.83 1.53 Portugal 1.98 1.83 1.44 0.65 0.65 1.69 Spain 2.30 1.70 1.94 1.11 1.11 1.05 Tunisia 3.38 3.15 2.76 1.47 1.29 1.90 Turkey 0.53 0.35 0.47 0.52 0.40 0.32 Sources: UNCTAD, FDI/TN database (1997 United Nations Investment Report), GDF and WDI Indicators, World Bank 1998. Productivity growth has been slow and falling. Weak GDP growth in recent years has been accompanied by lower productivity in the use of resources. Recent estimates of the change in total factor productivity (TFP), which indicates the percentage of growth that is not due to an increase in the use of capital or in workers hired, show that increased productivity accounted for 38 percent of overall growth in 1984-90, when significant progress was made toward structural adjustment, but has accounted for practically zero during the 1990s (Belghazi and Bouhia, 1997). External factors have also contributed to the economic slowdown. Periodic droughts and the economic slowdown in Morocco's main trading partners explain to some extent the poor performance of the private sector. In addition, while economic liberalization offers great potential benefits from the access to larger markets, it also has increasingly exposed the economy to outside events and is forcing Moroccan firms to confront a larger array of competitors. For example, as a result of the  3 GATT Uruguay Round, Morocco's preferential access benefits will be reduced. Furthermore, quotas under the Multifiber Agreement are to be phased out and Morocco will face increased competition in its traditional European Union textile markets. It is therefore not surprising that economic results in Morocco are being increasingly affected by the economic policies and outcomes of its principal trade partners. In particular, after 1991, the EU, a major market for Moroccan exports, experienced an economic slowdown that reduced its capacity to import and altered its expenditure patterns.' At the same time, the opening of Eastern Europe provided the West with new opportunities to invest in countries with cheap labor closer to the EU markets. Cheaper Asian textiles also began to compete with Moroccan exports. Finally, EU trade policies created a series of quotas for products that favored traditional competitors of Morocco, such as Spain and the Canary Islands. All these factors contributed to the slower growth of Moroccan exports. Private sector activity lacks diversification away from agriculture, despite strong potential in other areas such as tourism. The flexibility to channel economic resources toward more productive activities has been a characteristic of rapidly growing economies. Morocco's economic structure, however, has remained largely unchanged for 25 years, with not much increase in the non-agricultural sectors of the economy (see Table 2). The chronic susceptibility of agriculture to periodic droughts makes this lack of diversification even more of a burden as the country attempts to achieve sustainable long-term growth. Production pattems also have not changed in other sectors, such as manufacturing, since 1985. Table 2: Morocco - Composition of GDP (percent of GDP) 1980 1985 1990 1995 1996 1997 GDP at market prices 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 18.4 16.6 17.7 14.6 19.3 15.4 Industry 30.9 33.4 32.4 33.0 31.0 33.0 Manufacturing 16.8 18.6 18.4 18.4 17.1 17.7 Mining & quarrying 4.6 4.3 2.5 1.8 1.8 2.2 Construction 6.3 5.7 5.3 4.4 4.2 4.6 Gas, elect. & water 3.2 4.8 6.1 8.4 8.0 8.4 Services 50.7 50.1 49.9 52.4 49.7 51.6 of which Administrations 11.9 11.5 11.9 13.2 12.8 13.6 Source: Office des Changes, 1998. The lack of diversification is also apparent in the country's failure to develop activities Figure 1 Tourism Receipts activities ~~~(Percentage of GDP) that have strong economic potential. 6.0% Tourism is one case in point. The country 5.0% has exceptional tourism potential, still largely unexploited, with a wealth of 4.0% - attractions (cultural and wild nature sites, 3.0 - / resorts, golf courses, convention centers) 2.0% - appealing to various types of tourists. In 1.0% _ addition, its year-round tourist season sets Morocco apart from its closest competitors, Source: Office des Changes. Nevertheless, the fact remains that the reduction in Moroccan exports was larger than the reduction in the rate of growth of the EU economy, indicating that the loss of export revenues also reflected a loss in market share to more competitive exporters (Riordan, 1996).  4 Tunisia and Turkey, which have more seasonal variations. But even with these advantages, Morocco has failed to exploit its tourism potential. With receipts that represented 4.7 percent of GDP in 1998, tourism is the second most important source of foreign exchange, after transfers from Moroccans working abroad (see Figure 1). Yet this contribution to GDP is well below that of Greece at 15 percent, Turkey at 10.6, and 10 percent of GDP worldwide. Morocco also attracts far fewer intemational tourists than other similar countries: 1.7 million in 1997, compared to 4 million in Turkey and 3.7 million in Egypt. In addition, Morocco's share of the world tourism market has declined steadily, from 0.53 percent in 1985 to 0.36 percent in 1994. A recent study (Tomatis, 1998) identifies the following causes of this poor performance: the absence of a clear strategy to develop the sector, the inefficiency and multiplicity of institutions in charge of the sector, the lack of maintenance of tourism infrastructure (hotels built during the 1970s and until recently operated by the Government), and higher transportation costs to Morocco than to alternative destinations. Export growth, while slower than in the 1980s, continues to play a leading role in growth and employment. The export industry is key to generating growth and employment in Morocco: comprising only 25 percent of industrial enterprises, it employs 60 percent of manpower and produces more than 50 percent of industrial output. Overall, exports have contributed 27 percent to GDP during 1990-97. However, with an annual average increase of 5.3 percent in 1992-1996, which was below the world level of 6.8 percent over the same period, the overall growth of exports has not matched the expectations created by the increasing globalization of the Moroccan economy. However, efforts have not gone far enough to realize the full potential of export-led development. A significant share of exports remains concentrated in a few markets and products, although there have been some efforts toward greater diversification. Clearly, Moroccan firms are trying to adapt to the new international environment (Belghazi, 1998d). First, more than half of Moroccan exports belong to markets where Moroccans have been gaining market share, even though Moroccan firms have also lost shares in various markets to more efficient competitors (e.g., exports of shirts, where China has displaced Morocco in the French market). Second, not all exports have lost dynamism in the 1990s. Exports produced under the regime of "temporary admission without payments" (TA), where raw materials are temporarily imported and processed and final outputs re-exported, grew at an annual average of 21 percent between 1992 and 1996 (see Figure 2). Finally, while patterns of production in the economy as a whole have remained essentially unchanged, the composition of exports itself has experienced a significant evolution away from primary products toward manufactured items during the last two decades: in 1996, manufactures accounted for 38 percent of total exports, up from 16 percent in 1980. Nevertheless, much work remains to be done if Moroccan exports are to become again, as in the late FigLre: 2 Structure of Expot (DH million) 1980s, the key source of growth. The TA exports that sooo- are driving export growth today demonstrate the ability 40000- 35,000- of Moroccan entrepreneurs to respond strongly to 30000- favorable incentives. However, they tend to have low 25,0000 - domestic value-added, and, as tariff exemptions benefit 1:000W -L only the final output, generate only limited backward 50O T- links to other domestic industries. Moreover, it remains i9s 1ssa 1994 o19 .99s 1997 199 true that the process of export diversification needs to be Exports of Goods (FOB), excl. TA deepened. Exports remain concentrated in a few items Exportabons under temporary admissions (TA) and a few markets. For instance, in 1996 there were only OdesC  5 four main manufacturing exports: fertilizers, knit fabrics, clothing, and electronic products. For two of these products, a single country, France, accounted for the large majority of demand: 61 percent for clothing and 71 percent for electronics. 3. ECONOMIC POLICIES IN THE 1990S By the early 1990s, after a decade of successful macroeconomic stabilization, progressive economnic liberalization, and deregulation of the economy, a solid foundation for PSD had begun to be established. Since then, the Moroccan authorities have broadly maintained macroeconomic stability; they have launched a privatization program and implemented other microeconomic and institutional changes favorable to PSD. They have also pursued the integration of the country into the global economy by signing various international agreements. Nevertheless, the disappointing performance of the Moroccan private sector in recent years, even accounting for the influence of exogenous events, suggests that policy reforms have not gone far enough. An effective incentive framework has yet to be built to induce Moroccan firms to become more efficient and enable them to successfully perform in larger, more competitive markets. 3.1. Foundation for private sector development The 1980s witnessed successful macroeconomic stabilization and progressive liberalization and deregulation of the economy, which translated into strong growth. Morocco's impressive stabilization effort in the 1980s, supported by large debt relief and structural adjustment lending, led to a reduction of the fiscal deficit from an average of 11.6 percent of GDP in 1980- 1985 to 5.3 percent in 1986-1991. In addition, a 40 percent real depreciation in the early 1980s increased the attractiveness of Moroccan products. The gradual shift from an inward-looking, public sector-led economy toward a more outward-looking one, with an increasing role for private entrepreneurs, was also reflected in progressive liberalization and deregulation of the economy. By 1993, trade barriers had been reduced: quota coverage went from 66 to 15 percent of imports, the range of import levies was substantially decreased, and most export taxes were eliminated. Foreign exchange controls were relaxed, achieving full convertibility of the current account in early 1993. Price and margin controls were lifted for many goods, and, after a slow start, the privatization program took off in 1993. GDP grew at an annual average rate of 4.5 percent over the 1986-90 period (compared to 2.1 percent for the world and 0.3 percent for the Middle East and North Africa region). Exports grew at an impressive 9.3 percent during the same period. Foreign direct investment also grew exponentially, from about US$1 million in 1986 to US$317 million in 1991. Key policies favorable to PSD have been maintained in the 1990s, but low public savings have reduced the pool of financial resources available for private investment. In addition, efforts at fiscal prudence have come at a cost to PSD, as there has been a drastic reduction in public investment to achieve budget equilibrium. The fiscal burden has been progressively lightened, from 27 percent of non-agricultural GDP in 1993 to about 24 percent in 1997. A particularly impressive achievement has been the reduction of the effective corporate tax rate for domestic finms, from 50.3 percent (manufacturing) and 44.2 percent (services) in 1986 to 24.2 percent and 19.9 percent, respectively, in 1995 (Sewell et al, 1996). Fiscal prudence has been preserved with a relatively limited fiscal deficit, averaging about 3.7 percent of GDP in 1992-1997 (see Table 3).  6 Table 3: Morocco - Selected Economic Indicators (percent of GDP) 1991 1992 1993 1994 1995 1996 1997 1998 Gross Domestic Investment 22.6% 23.2% 22.5% 21.3% 20.7% 19.6% 20.70%. 22.6% Gross National Savings 21.6% 22.1% 20.9% 19.0% 17.3% 19.7% 20.4% 22.3% Budget deficit (1) -3.1% -2.2% -3.3% -3.9% -5.6% -4.4% -3.7% -4.7% (1) Excludes privatization receipts. Fiscal data are in calendar year and includes VAT transfer to local municipalities. Source: Statistics Office; Ministry of Finance. Reducing Morocco's fiscal deficit has been sound policy, but its positive impact on economic activity has been reduced by the way cut in spending were achieved. Rather than reducing current expenditures, Morocco has relied on drastic cuts in public investment, which was supporting the development of the economy and complemented private sector investment. Accordingly, this reduction contributed significantly to the slowdown in total investment (see section 2). Furthermore, the civil service wage bill now absorbs almost 45 percent of fiscal revenues, and the debt service absorbs 23 percent. The current structure of public expenditure (mostly wages and debt service) makes it difficult to absorb exogenous shocks, because reducing the debt service would require restructuring the stock of debt, and reducing the wage bill would require difficult negotiations among groups with conflicting interests. The current level of the budget deficit is still significant, however, and has a negative impact on the resources available to the private sector. The abundant supply of low-risk government bonds financing the deficit has meant that banks and other financial institutions feel less pressure to expand their base of private clients or to develop new financial products. Most importantly, the considerable public arrears and late payments of the public sector to both private and public enterprises amount, in fact, to a form of credit granted involuntarily by these firns, which takes away resources that could be put to more productive use. The importance of the problem is confirmed by the PSA surveys, in which entrepreneurs said that public and private payment delays are among their main binding constraints. The appreciation of the real effective exchange rate (REER) over the 1990s has hindered firms' competitiveness. The decrease in inflation, from 6 percent in 1992 to an estimated 1 percent in 1999, has been accompanied by a 18 percent real appreciation of the dirham in the 1990s (see Figure 3). This problem has been exacerbated by the fact that the real exchange rates 6f a number of Morocco's competitors have depreciated faster over the last few years. The appreciation of the REER reflects a combination of factors linked to the evolution of the nominal exchange rate and the slow growth in productivity of Moroccan producers. This deterioration in relative prices clearly contributed to the slower growth of Moroccan exports during the 1990s (see section 2). Sales to African countries that had been opening to Moroccan products in the 1980s have been particularly affected because these countries exhibit a greater sensitivity than the OECD markets to price changes. Finally, the appreciation of the dirham has also favored imports of capital equipment, increasing the capital-labor ratio to the detriment of labor. Figure 3. REAL EFFECTIVE EXCHANGE RATE AND EXPORTS 1 3 0 .0 -- --------------------- 120.0: 1100= 70.0 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1998 1997 + REER index -export volume index Sourxe: lMFflxtrx,na,ioxxt Finaxx/el Sta Ostixx end 04 o,cxxx authoflhixs.  7 Economic liberalization has continued in the 1990s, albeit at a slower pace. But competitive pressures remain insufficient, since trade liberalization has not been uniform. The Govemment has taken several measures during the 1990s to foster economic liberalization. To start with, the import-weighted tariffs declined from a peak of 20 percent in 19934 to 16 percent in 1996. In addition, Morocco adhered in 1993 to the GATT evaluation code, and signed the Free Trade Agreement with the EU in 1996. The Govemment further liberalized the foreign exchange regime by allowing full convertibility of non-resident investors' capital accounts for portfolio investments, profit remittance, and repatriation of capital. Nominal tariff protection is still relatively high, however, compared to some of Morocco's key competitors. More than 50 percent of agricultural goods are subject to a tariff of 25 percent or higher, and almost 30 percent of non-agricultural imports are subject to a tariff of 32.75 percent or higher. Such levels of protection are detrimental to the efficiency of domestic producers and to the development of a strong export-oriented economy. Morocco has also tended to offer the highest degree of protection to some of the weakest segments of its economy, thereby promoting an inefficient allocation of resources. In addition, the commitments to further decrease tariffs under international agreements will only take place over time. The FTA, for example, is to be implemented over a period of 12 years following the agreement's effectiveness. Further drawbacks include the fact that tariff reductions for items manufactured in Morocco will be phased out last, while tariffs on raw materials and capital equipment will be eliminated within the first year of the FTA's effectiveness, so that the effective level of protection for goods manufactured in Morocco will actually be higher for up to five years following effectiveness. Although the FTA with the EU is complemented by free trade agreements with members of the Arab League and with other countries, and other free trade agreements are envisaged, a number of important trade partners will, in all likelihood, not benefit from import liberalization. The FTA thus could entail trade diversion and might give rise to additional controls to verify declarations of origin. Moreover, the FTA does not cover services, and the schedule of tariff reduction on agricultural products will not be negotiated until 2000. Finally, while a new unified Investment Code was adopted in December 1995 with the aim of attracting foreign investment, and despite the growing confidence of intemational investors, the requirements to establish businesses in Morocco remain cumbersome. Competitive pressures in domestic markets are still limited. In view of the high level of concentration in the economy (see annexes I and 2, and Table 4 below) and the anecdotal evidence on collusive behaviors (see section 3.2), promoting competition beyond trade liberalization remains a key objective of policies in favor of private sector development. Since 1994, significant steps have already been taken. Price controls, which covered about 172 product categories in 1993, now apply to only 29 goods and services. A draft Price and Competition Law to supersede the 1971 legislation is currently awaiting approval by Parliament. The Government has issued new regulations to enhance transparency in procurement, but contracts are outdated and lack safeguards to ensure transparent and competitive procedures. It is now important to deepen these reforms. Table 4: Structure of Industry in 1997, by Firm Size (no. of employees) Enterprises Production Exports Investment Firmsize No. % M. DH % M. DH % M. DH % Small <50 4737 74.0% 25249 17.0% 4414 12.1% 1668 18.2% Mediurn >=50, <200 1195 18.7% 44004 29.6% 7849 21.5% 2543 27.7% Large >=200 467 7.3% 79456 53.4% 24242 66.4% 4969 54.1% Total 6399 100% 148709 100.0% 36505 100.0% 9180 100.0% Note:. Includes private and public enterprises. Source.- Ministere du Commerce, de lI'ndustrie et de l'Artisanat.  8 After a slow start, the privatization program began implementation in 1993. However, 577 enterprises are still in the public portfolio, including minority participations in commercial enterprises. A vigorous effort to further pursue the program is needed. The Privatization Law, adopted in 1989, laid the foundation for the privatization program with a list of 113 firms to be privatized by the end of 1998. After a slow start, the program began to be implemented in 1993, tallying DH 15.3 billion (of which DH 13.1 billion accrued to the government budget), with 52 EPICS (etablissements publics a caractere industriel et commercial) and 125 of their subsidiaries privatized by 1998. A number of large enterprises have thus been privatized, resulting in significant fiscal revenues. In addition, the Government is currently implementing the liquidation of Charbonnage du Maroc (CDM) and the Societe d'exploitation des mines du rif (SEFERIF). This is an important and courageous decision on the part of the Government, which has taken into account both the economic needs of the country and the social impact of the liquidation on the region. Divestitures of the remaining 61 firms from the first list, however, are still pending. Many of the candidates are in financial difficulty and need to be liquidated. The human and financial resources needed for liquidation are relatively modest and postponing liquidation only increases the waste of productive resources. These firns also have a negative impact on the financial performance of other private firms. Other important transactions currently in the pipeline are also waiting be completed, which requires that Parliament authorize the transfer (e.g., the Banque commercialepopulaire, BCP) or that the Government deregulate the sector (e.g., sugar mills). In spite of advances in the pnvatization program, the relative importance of the public sector in overall value added and investment has, in fact, changed little between 1990 and 1997 (see Table 5). As of end-1998, there were still 573 enterprises under direct or indirect public ownership (56 EPICs and 517 subsidiaries, all of which are incorporated in soci&es anonymes). The persistent direct participation of the public sector in the economy hinders growth for various reasons. While some public enterprises have improved their performance in recent years (see section 3.2 below), intemational experience suggests that public entities are often less efficient than private firms, and that their presence decreases the overall performance of the economy. Equally important in the case of Morocco, the dominant position of the public sector in the economy has magnified the negative impact of the drastic cuts in public investment on the rest of the economy (see above). Table 5: Share of Public Enterprises in the Moroccan Economy 1990 1997 Value added (% of GDP) 13.4 13.0 Salaries (% of GDP) 4.5 4.6 Investment (% of total investment) 24.3 22.2 Sources: Ministere des finances et des investissements ext&rieurs, Direction des etablissements publics et de participation, avril 1998. 3.2. Institutional and Sector-specific Reforms The legal framework for commercial activities has been partially modernized, but the administration of business regulations is still perceived as slow and cumbersome, increasing transaction costs for firms. A new Investment Code (1995) has replaced the old sector codes. It covers all commercial activities with the exception of agriculture, and generalizes key incentives, which, under the sector codes, were available only to selected enterprises and regions. The new Law on Joint Stock Companies (1996) provides, inter alia, for minority stakeholder protection and for more rigorous corporate govemance on the part of managers. The Code des societes (1997) provides businesses with a variety of instruments to choose from when constituting themselves as corporations. The Commercial Code (1997) makes it possible, for the first time, to address bankruptcies, liquidations, and reorganizations at an early stage. The Law Creating the Commercial Courts (1998) gives authority to the newly created courts in all matters related to business activities. Finally, the Competition Law has advanced to Parliament, and the Cabinet has approved a  9 revised Customs Code. However, other important texts - notably the Labor Code, the Mining Code, and the Insurance Code - have been in preparation for years, but are stalled pending legislative or executive action. In addition to these advances in the legal framework, tax rules have been modified to reduce the fiscal burden on business (see section 2). Finally, the Government authorities have initiated a comprehenisive reform to modernize customs administration in recent months, resulting in a reduction of clearance time for imports from several days to some 8 hours in average. This demonstrates the potential for efficiency gains under strong leadership with clear objectives. The new laws and the other reforms described above constitute real progress. Now attention needs to shift to the application and enforcement of the laws and the streamlining of administrative procedures. The administration of business regulations remains characterized by a lack of transparency, overemphasis on controlling business activity, and excessive scope for discretion. The issues that pose the most serious problems, as shown in the surveys discussed in the next section, relate principally to tax administration and the judicial system. Procedures in these two areas are considered inefficient, time consuming, and costly. Despite Government's efforts to modernize and rationalize the system, tax administration remains one of the main areas of complaint. The national tax administration has introduced a unique fiscal identification system and reduced the number of tax forms. There remain, however, more than 30 different tax-related forms at the national level. Entrepreneurs complain about the complexity of the system, the scope for arbitrary decisions, and the frequency of errors by the tax authorities (about 40 percent of those surveyed thought they had been charged too much on one or more occasions). The length and lack of transparency of judicial processes have emerged as the most important issue for the Moroccan legal system. It is expected that the ongoing reform of the judiciary system, including the establishment of commercial courts, will help to address this issue. For the time being, however, judicial processes remain slow and unpredictable, in part because judiciary staff do not have sufficient expertise in specific areas (labor law, for instance). In addition, laws are often complex and ill suited to the local context, new laws are sometimes not well publicized, and essential application decrees take years to be issued, all of which contributes to the lack of transparency. Finally, although establishing a new business in Morocco takes less time now than in the 1980s, procedures are still cumbersome by international standards and do not promote FDI for small and medium enterprises. Late payments by the public sector and corruption (which is the target of a concerted effort by the new Government) are additional burdens. The Government has continued to invest in public education and has developed vocational training programs. These are important steps, but they have not been sufficient to raise the quality and mobility of human resources to the standards required in a more competitive environment. Since independence, the Government has made a systematic effort to improve the absorptive capacity of the formal education system, and vocational training has been offered since 1974 by the Office de la formation professionnelle et de la promotion du travail (OFPPT). Nevertheless, industrial surveys by the Observatoire in 1994 and the 1994 PSA both identified the shortage of skilled workers as one of the main constraints for business in Morocco. To solve this problem, the Government has taken various steps in recent years to strengthen the public education system and make training programs more responsive to the demands of firms. The Social Priorities Program (BAJ)2 adopted by the Government includes the expansion of basic education as a 2Barnamaj al-Aoualaouiyat al-ljtimaya in Arabic.  10 main objective. On the vocational training front, OFPPT has started to develop programs to upgrade workers' skills within firms, and to retrain the unemployed. The Government has also supported, as part of an overall strategy to facilitate the mise a niveau of the firms, the creation of non-governmental inter- professional organizations, Groupements interprofessionnels d'aide au conseil (GIACs), to assist enterprises in defining their needs and to carry out training programs. This program is still at an initial stage, but GLACs could be an important interlocutor in the private-public dialogue to improve labor efficiency and the living standards of workers. Finally, the private sector has also started to be more involved in the design and implementation of programs to upgrade workers' skills. A case in point is the creation of ESNITH (Ecole superieure nationale de textiles) by AMITH (Association marocaine des industries textiles et de 1 'habillement) with the collaboration of OFPPT and the financial support of the EU. These measures are an important step to improve the quality and mobility of the labor force in Morocco. Nevertheless, they appear to be insufficient in view of the slow growth in labor productivity, the overall modest economic results, and the evidence revealed by the interviews with private entrepreneurs (see section 4). However, illiteracy remains high, and the mismatch between the profile of higher-education graduates and the needs of firms persists. This challenge arises, in part, from the development strategy adopted by the country, which creates more jobs but also imposes new demands on the labor force: economic globalization sets higher quality standards for products and requires better preparation even for unskilled jobs. The latter becomes particularly relevant since illiteracy rates in Morocco, especially in rural areas, are among the highest in the region, and rural emigrants constitute an important source of job-seekers in the cities during bad harvest years. Problems also arise, however, from the limitations of the Government's current strategy for formal education and vocational training. The Government has allocated considerable resources to education, but resources have not been used efficiently in either area and there has been a bias in favor of secondary education. Similarly, vocational training has always been considered an important tool to upgrade workers' skills, but the programs still reflect the priorities of absorbing unemployed youth rather than giving workers the skills needed by enterpnses, and focus more on the insertion of first-time job seekers than on the reinsertion of displaced workers. Finally, in spite of the shortcomings of the public-led strategy, the rules and regulations provide lukewarm support to the development of private alternatives, even though the existing private institutes enjoy considerable demand for their services. There is also a lack of efficient channels for firms to voice their specific needs despite the creation of GIACs. These institutions are still at the take-off stage, have very limited capacities, and seem to have adopted a wait-and-see attitude toward the Government. Finally, in spite of the tripartite composition of the board of directors, OFPPT as an institution has few incentives to become more responsive to its clients, since its survival does not depend on demand for its services, but on the earmarked proceeds of the vocational training tax (73 percent of its 1994 budget). In addition, although they are often overlooked, outdated labor laws, and lengthy judiciary processes increase the cost of managing human resources and discourage firms from hiring a stable work force and investing in human capitaL Labor transactions are ruled by 1921 legislation that puts strong emphasis on job security by making it very costly to fire pernanent workers. The legislation has, in fact, acted as a deterrent for employers to hire permanent employees. Relying on temporary workers has given considerable flexibility to the Moroccan labor market, but at the cost of stable jobs and investment in human capital. High social charges in the organized private sector (from 21.7 to 35 percent of gross salary) also increase the cost of hiring permanent workers and discourage firms in the informal sector from integrating into the mainstream economy. Finally, the absence of quick conflict resolution mechanisms and the judiciary's lack of expertise in labor issues increase the cost of managing human resources within legal boundaries.  11 Distorted incentives in the public sector, mostly delinked from economic considerations, also contribute to luring workers away from the private sector. Employment conditions, i.e., job security for all workers and inflated wages for unskilled workers, are still more attractive in the public sector, although the number of new jobs offered has been declining in line with the program of fiscal austerity and transfer of public enterprises to private ownership. This has resulted in a rising rate of unemployment among qualified workers, who are willing to endure longer waiting periods, and in a dichotomy between a protected minority of unskilled public servants, on the one hand, and a majority of marginalized workers with low wages and scant social protection in the informal sector, the rural areas, and the traditional export sectors, on the other. The legal framework for financial intermediation also has improved considerably, but the access to financial resources, and to a lesser degree the cost of these resources, remain important constraints that reduce the pool of financial resources available for PSD. Two new pieces of legislation (the Banking Law and the Securities Law) have contributed to updating and strengthening the legal framework for financial intermediation. The plancher des effets publics (PEP), under which banks had to hold a certain percentage of sight deposits in below market rate Treasury bonds, was eliminated in June 1998. Absolute maximum lending rates also have been abolished and replaced by a relative ceiling or taux d 'usure,3 while preferred time deposit rates have been removed, with the exception of passbook deposits, which still have to be remunerated at 6 percent minimum. Finally, while state ownership in the financial sector remains high, it has steadily decreased and is now about 30 percent of total assets and 24 percent of banking capital. Moroccan authorities have also recently begun to address the urgent need for restructuring of the main public banks, which are in serious difficulty. The Cabinet has approved legislation that transforms the rural credit institution, Caisse nationale de credit agricole (CNCA), into a joint stock company. The Cabinet has also approved a change to the statutes of BCP, to allow divestiture of state-owned shares to its regional network of banks (banques populaires). Finally, the authorities are fully aware of the need to conduct an intemal review of the Credit immobilier et h6telier (CIH), which has been severely affected by the lackluster perfonnance of the tourism industry, before a restructuring plan can be designed and implemented. In addition, the authorities are formalizing the status of financial NGOs, or Associations de micro credit (AMCs). These associations play a key role in providing financial resources to the tiniest microenterprises (self-employed entrepreneurs), although their institutional capacity is insufficient to satisfy the existing demand of these firms. The takeoff of the Casablanca Exchange Stock Market (Societe de la bourse de valeurs de Casablanca, SBVC) is another welcome development that should help increase the availability of long-term funds. As of December 1997, 49 firms were quoted on the SBVC and market capitalization had increased substantially, from 5 percent of GDP in 1993 (DH 1.3 billion) to 37 percent of GDP in 1997 (DH 117.9 billion, or US$12.3 billion). Despite the liberalization of banking regulations, the development of the SBVC, and the increased activity of financial NGOs, the access to and cost of financial resources are still constraints that limit private sector activities in Morocco, albeit not as much as reported in the 1994 PSA. The nature of the problems vary significantly, however, by the size of the firm. For smaller and microenterprise -firms, the main problem remains the mere access to financial resources, especially from the formal banking system, which does not 3 The taux d'usure limits to 1.7 times the weighted average of lending rates the maximum annual effective rate that can be charged by any financial institution licensed under the Banking Law.  12 see these firms as profitable lending opportunities. For larger firms with formal banking relationships, their main financial constraints are the paucity of medium and long-term financial instruments and the high cost of credit. The high cost of credit is due in part to insufficient competition in the financial sector. Until very recently, banks appeared to adhere to GPBM (Groupement professionel des banques marocaines) guidelines to set lending rates, and the evolution of rates as well as anecdotal evidence suggest that some collusion did keep rates at a certain level, although the general trend since 1997 has definitely been downward. In addition, competition is hampered by the fact that despite liberalization, various deposit rates remain regulated (sight deposits cannot be remunerated, while interest paid on carnets de dep6t cannot be lower than 6 percent). In April 1998, banks for the first time published their base lending rates individually rather than adhering to GPBM guidelines. This is certainly a positive development, but it is too early to say whether it marks the beginning of a more competitive era. Another reason bankers perceive lending to private investors as unprofitable is their lack of experience managing investment credits. Evaluating the net worth and risks of business projects requires specific skills that are different from dealing with investment in Treasury bonds. In addition, cumbersome judiciary processes (see Annex 5) increase the risk of lending to private entrepreneurs and explain why banks base their decisions more on tangible collateral than on a cash flow analysis of a project. Banks also lack the financial intermediation skills to make use of innovative techniques such as cash flow-based lending and information technology to reduce transaction costs. The insufficient availability of medium and long-term banking resources for the private sector is also explained by the fact that some medium-sized firms have great difficulty adhering to the transparency requirements of the new accounting plan introduced in 1994. This reinforces bankers' tendency to base their lending decisions on fixed asset collateral and to discard financial accounts and cash flow projections. These factors may help explaining why bank investments in Government bonds remain high despite the reduction in the reserve requirement and the elimination of the PEP in June 1998. Banks, in fact, decreased their holdings of T-bills only marginally, from 28 percent of assets in 1994 to 27 percent in 1997.4 It is not clear whether their preferences came from the crowding-out effect of a large supply of low-risk T-bills, which gives these institutions little incentive to compete aggressively for private sector clients, or from the scarcity of private investment projects worth lending to. Further research is needed to understand the roots of this problem. Capital markets in Morocco have yet to become a real alternative to the banking system, although they have been very active in recent years. Market capitalization on the SBVC has increased, but this has been accompanied by lower liquidity ratios (from 21.7 percent of market capitalization in 1993 to about 15 percent in 1997). One problem is the lack of transparency of the rules governing the stock market, combined with the lack of capacity of the supervisory body, the Comite d&ntologique des valeurs mobiliaires (CDVM), to enforce those rules. High transaction costs imposed by the SBVC on securities trading also deter investors from participating in the market and companies from seeking a listing. Bonds and commercial paper are also in short supply because, among other reasons, corporations lack an efficient benchmark against which to price their bonds in the absence of a market-determined yield curve. The provision of infrastructure services has increased considerably in the main urban centers. However, important problems still need to be solved: elimination of shortages of industrial land, resolution of cross-sectoral issues, and expansion to rural areas. Current funds deposited under the PEP have been transformed into I 0-year deposits, and will therefore be gradually released into the economy. Funds deposited after June 30, 1998 are not subject to the PEP rule.  13 An issue related to the provision of infrastructure is the shortage of well-equipped industrial land and associated services (trade facilitation, marketing, and technical and business services) to support PSD. This constitutes a critical constraint to private investment in Moroccan industry.5 Administrative bottlenecks have contributed to the shortage of well-equipped industrial land. For example, the conversion of agricultural and non-titled land into industrial land has proven very difficult. Also, various factors generate disincentives for the private development of industrial land. First, there is the risk of unfair competition by public agencies, which have traditionally received land free of charge or at nominal prices. Second, the right of the private sector to occupy and use land belonging to the state is precarious: only leaseholds for a maximum of twenty years are allowed, and such interests can be canceled by the state with a mere three months notice and without possibility of recourse. Third, when the Government first turned to private investors to develop and manage four industrial zones (Tangier, Nador, Nouaceur, and Jorf Lasfar), it could not attract foreign investors despite international bidding. This suggested that investment conditions were not sufficiently clear or favorable to attract private investors. Private Moroccan investors have, since then, indicated an interest in some of these projects, in particular Tangier and Jorf Lasfar. Water, electricity, and telecommunications services have clearly improved: a greater mobilization of water resources has increased the country's hydroelectricity capacity, electricity shortages have all but disappeared, and the quality of telecommunications services has greatly improved. The financial situation of some public service providers has improved as well, including stronger performance by Royal Air Maroc (RAM) and the Office national des chemins de fer (ONCF). Private operators have been involved in infrastructure activities since 1984 in the area of bus transportation, with the concession of urban bus routes. In 1993 the inter-city bus company, CTM-LN, was privatized, and the trend has since spread to other subsectors, notably electricity generation (in Jorf Lasfar) and water and electricity distribution (in Casablanca and Rabat). A modem and procompetitive legal and regulatory framework has been in place since 1998 in the telecommunications sector, and an active liberalization strategy is actively being pursued in that sector. Some liberalization measures have also been adopted in the road and air transport sectors. The country's most important infrastructure problems have to do with a series of issues common across several sectors (with the exception, for the most part, of telecommunications): lack of overall sector strategy; inadequate regulatory framework combined with complex and often unclear allocation of responsibilities, with the same officials generally in charge of both regulatory and operational tasks; insufficient competition; uneconomic tariffs; and lack of coordination and expertise to design and implement coherent infrastructure policies. These shortcomings have not prevented significant improvements in many infrastructure services in recent years, but they do cause infrastructure performance to remain below what it could be, even in sectors where progress has been most rapid, such as telecommunications. They also make it more difficult to expand services toward peri-urban and rural areas.6 The Government has also made special efforts to increase access to electricity and water in rural areas through the public PERG (Programme d'electrification rural groupe') and PAGER (Programme d 'approvisionnement groupe en eau potable des populations rurales) programs. Nevertheless, progress is still concentrated mainly in urban areas. Tariff perequation across regions - cross-subsidization that implies that tariffs in subsidized regions do not reflect the costs of providing service - combined with low prices for 5 Some numbers illustrate the problems very well: the price of industrial land in Casablanca is more than double that of Tunis, and in Tangier it is more than double that of Marseilles and Valencia (Price Waterhouse, 1994). In the metropolitan area of Casablanca, the supply of industrial land must increase by 1,300 hectares by the year 2000 to sustain the 235,000 jobs in the industrial sector. For an additional 80,000 new jobs to be created by that year, an extra 800 hectares would have to be developed. 6In some sectors, these problems have seriously constrained the activities of entrepreneurs. A case in point is their complaints, recorded in the surveys, about the poor quality of port services. Long delays to process goods through ports is the most common complaint, followed by the lack of accountability of ODEP (Office d'exploitation des ports) and the lack of security in the areas outside ODEP's warehouses. Entrepreneurs also express dissatisfaction with the price of electricity and with the delays and costs of obtaining connections to the water and electricity networks (about 25 percent of the firms surveyed reported connection-related problems during the last three years).  14 residential users have prevented the introduction of competition and have made it very expensive to extend infrastructure networks in rural areas. As of 1998, only 35 percent of rural households had access to electricity and 37 percent to a water distribution network, and there was only about one telephone line for every 185 rural inhabitants. With about half the population (13 million) living in rural areas, this situation has severe economic and social consequences. Limited availability of basic water and electricity infrastructure in rural and peri-urban areas constitutes a significant obstacle to providing basic health and education services. This is true for two reasons: first, because provision of such services is more difficult in the absence of basic infrastructure; and second, and more important, because the opportunity cost for families to send their children to school rather than having them help with domestic chores is very high in areas lacking modem water and electricity infrastructure. Various initiatives have been implemented to enhance the dialogue between Government and the private sector and to foster private-public partnerships in strengthening the productivity of firms. However, these initiatives are insufficient, given the large potential of the private sector to be an active partner in the efforts to increase Morocco's competitiveness. A tripartite consultative committee, Comite de suivi du projet de developpement du secteur prive, comprising an equal number of representatives from the public and private sectors, was established in 1994 to advise on the content and implementation of a reform program aimed at developing and enhancing the competitiveness of the private sector. In addition, an Observatoire de la competitivite internationale de 1'economie marocaine was set up to provide information to the consultative Comite de suivi on the impact of the reforms. Both the Comite de suivi and the Observatoire, however, focus almost exclusively on the formal sector. The Government is well aware of the challenges imposed on Moroccan firms by the transition from highly protected markets to a much more competitive environment. This adjustment can be expected to be especially difficult for the smaller firms, which comprise a large majority of the total enterprises in Morocco (see Table 4 above). To assist industry with the challenges of trade liberalization, the Government in November 1997 launched an industrial competitiveness (mise a niveau) program aimed at preparing industry for the challenges of trade liberalization. One component of the program aims at supplementing the efforts of individual firms with diagnostic studies by outside consultants, restructuring plans, and subsidized credit for implementation of those plans. The mise a niveau program is an important effort to help enterprises prepare for the fierce competition that will result from trade integration. However, to achieve sustainable results in the medium run, it is important to maintain the demand-driven character of the initiative, and to minimize the reliance on guarantees and subsidized loans that might erode the firms' financial discipline. The private sector has also been active in this public-private dialogue. The CGEM (Confederation generale economique marocaine) has evolved to become more representative of the private sector in its dialogue with the Government: it is now open to smaller firms and to federations of companies outside the manufacturing sector, and regional offices have been created to expand the scope of the association. 4. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT This section presents the results of two field surveys of 370 enterprises, carried out in seven cities and covering multiple sectors, in March and April 1998. The nature and ranking of the constraints on business activities that emerged from the interviews with entrepreneurs underlie much of the analysis developed in the previous sections, and confirm the need for further reforms to improve the business environment in Morocco and to facilitate firms' efforts to improve their efficiency and become more competitive. The survey samples cover firms of different sizes: Large (more than 100 workers), medium (50 to 100 workers), small (6 to 49 workers), and micro (5 workers or fewer). A key finding of the surveys is that  15 different constraints have different impacts depending on the size of the firm. These differences are most important between the group of firms with more than five employees (small, medium, and large firms in the formal sector) and the microenterprises (most firmns in the informal sector). But these differences are also significant among firms of varying sizes within the formal sector itself. Section 4.1 first presents the results for enterprises with more than five employees, followed by those for microenterprises. Section 4.2 discusses how these constraints have evolved since the 1994 PSA, which drew on various firm surveys to elaborate a ranking of the problems affecting the private sector at that time. 4.1. Results of the 1998 Enterprise Surveys Overall, entrepreneurs employing more than five employees find the following problems to be most constraining: administrative behavior, lack of qualified workers and good managers, late payments, and insufficient demand, as well as lack of access to and the high cost of finance. Entrepreneurs were asked to identify the three most severe problems they face in their daily activities. Figure 4 ranks their responses according to the number of times a given problem was reported. The behavior of the administration appears to be the most severe constraint now faced by entrepreneurs. This behavior includes tax administration, judicial processes, late payments by public entities, and corruption, which is especially problematic for small firms. Customs procedures are a severe problem for large and medium firms, while small firms complain more about problems related to company incorporation. The next most severe constraint is related to human resources. The lack of qualified workers is one of the problems most often mentioned, especially by large entrepreneurs, who rank it in first position. Small finns complain more about the high turnover of unskilled workers. The scarcity is not limited to the technical fields; there also appears to be a scarcity of managerial skills, with fnmns complaining about insufficient internal capacity to adapt to the changing external environment. To a large extent, poor managerial skills are rooted in an organizational structure with little staff mobility or versatility, which characterizes family-run enterprises as well as corporate establishments in Morocco. Many firms do not make plans to periodically assess their need for workers, capital, or other resources and do not invest in researching appropriate technology and market information (see below). Finally, although the legal environment is often overlooked, outdated labor laws - combined with lengthy judicial processes - have been shown in various studies to increase the cost of managing human resources in Morocco. Figure 4: Most Often Mentioned Problems for Firms with More than Five Employees (percentage of entrepreneurs who mentioned them) Behavior of the administration _ H um an resources , ______________-_...__:-.:-_______'___________________'_ Late payments by private clients Insufficient demand/Strong corn petition Access to/Cost of finance High level of taxes Infrastructure weaknesses 0 1 0 20 30 40 50 60 Source: E.quite sur les A touts et les Obstacles au Developpem ent du Secteur Privi au Maroc (1998). Late payments by both private clients and public agencies are also an important problem that can be attributed in part to the recent slowdown of economic activity. Many entrepreneurs have seen their client base stagnate or decrease, which has taken its toll on their ability to pay debts on time. In addition, despite  16 the progress achieved, many firms do not have easy access to financial resources: the survey confirms that many small businesses do not have a relationship with a bank, and often do not accept checks as a means of payment. As a result, during bad times, these firms, as well as many of their customers,7 do not have access to bank credit or to overdraft facilities. Smaller firms thus have difficulty maintaining sufficient liquidity to pay their own creditors promptly. The problem is less acute for larger firms, which have easier access to banking facilities. The high cost of finance and limited access to medium and longer-term resources are also mentioned by entrepreneurs as relatively important constraints. The recent decrease in lending rates suggests that competition among banks might be increasing and that entrepreneurs' complaints reflect past more than present experience. However, it is too early to determine whether the downward trend will last or whether collusive banldng practices will persist. High taxes are a less critical constraint than those mentioned above. Nonetheless, they are still a heavy burden for smaller firms, which tend to rank that constraint relatively higher than larger firms. Finally, infrastructure weaknesses (mainly access to land, but also the price of electricity, quality of port services, and delays in obtaining connections to infrastructure networks) are also perceived as constraints. The improvement of services in the main urban areas is evident, but entrepreneurs in other areas still complain about electricity shortages (mostly in Oujada and Tangier), sewerage problems (in FRs), and road quality (in industrial zones and some tourist areas). Scant competitive pressures among producers largely accounts for the lack of motivation to decrease prices or improve quality and attention to users. The review of sector policies in the previous section indicates that these problems, which are common to various sectors, could be best resolved by adopting a comprehensive cross-sectoral strategy rather than through isolated policy measures. The situation of microenterprises differs substantially from that of other firms. In order of importance, the main constraints for microenterprises have been the impact of a weak economy on demand and payments, high worker turnover, and lack of access to financial resources. As Figure 5 indicates, the problems of microentrepreneurs are very different from those of larger operators, with insufficient demand appearing to be a much more severe problem for microenterprises. This is consistent with the fact that large enterprises have had a less difficult time in recent years: only about 20 percent reported in the surveys that they had lost market shares, while 55 percent reported gaining market shares, as opposed to 50 and 40 percent for the smallest enterprises. Microfirms have less ability to diversify their markets and therefore strongly feel the impact of an econonic slowdown, both because there is less demand for their products and because supply increases as unemployed workers from the formal sector enlarge the number of microfirms fighting for the same market. In addition, because they have a harder time upgrading their technical and market skills (see below), the smallest firms are less able to compete to retain their customers. Late payments by clients rank second for firms overall, and this problem is much more acute for microenterprises than for larger firms. This is not surprising, since microenterprise customers often include the less well off and because these firms have less access to financial resources. 7 According to Lejournal (November 17-23, 1997), 84 percent of Moroccans over 20 years of age do not have a bank account.  17 Figure 5: Most Often Mentioned Problems for Microentrepreneurs ( percentage of entrepreneurs who mentioned them) Insufficient demand, strong competition I Payment delays by private clients Human resources HiQh taxes Access to finance Product quality