Morocco cut on fiscal pressures

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Morocco’s long- and short-term local and foreign currency ratings have been dropped from BBB-/A-3 to BB+/B by S&P Global Ratings, on fiscal woes.

The rating agency has however kept Morocco’s outlook at stable. This is on the expectation that an economic recovery, alongside further structural economic and budgetary reforms, will help counterbalance fiscal pressures.

Morocco’s economy contracted sharply by 6.7% in 2020 and its general government deficit rose to 7.7% of gross domestic product (GDP).

The country’s budgetary consolidation over 2021 to 2024 is likely to be slow, with net general government debt rising to about 72% of GDP in 2024.

S&P believes the increase in state guarantees has spurred a significant rise in contingent liabilities, which if materialised could also further exacerbate budgetary pressure.

Morocco has embarked on a comprehensive overhaul of the social security system to extend the coverage of health care and social transfers, while broadening the tax and social contribution base.

In 2020, authorities launched the second phase of the gradual currency liberalisation reform by widening the fluctuation band for the dirham to 5% from 2.5%.

The central government’s budget deficit widened to 7.7% of GDP in 2020 from 4.1% in 2019 because of coronavirus disease 2019 (COVID-19) crisis-related impacts on revenues.

Revenue declined 9.4%, and current spending and public investment increased by 3.4% and 18.8%, respectively.

For 2021 to 2024, the government targets gradual budgetary consolidation, based on higher revenue intake by about 1% of GDP.

The government also targets a reduction in the public wage bill, including social security contributions from 12.2% of GDP in 2020 to 10.8% in 2024.

S&P expects the general government deficit to decline from 7.7% of GDP in 2020 to 4.6% of GDP in 2024.

The rating agency forecasts the net general government debt-to-GDP ratio will climb from 66.3% of GDP in 2020 to 71.9% of GDP in 2024.

Included in this is the government’s expected privatisation proceeds worth in total about 1.5% of GDP during 2021 to 2024.

Exposure to interest rate, refinancing, and foreign exchange risks is limited.

The average maturity of the central government debt outstanding stood at more than 7.5 years at end-2020, with the average interest rate estimated at 3.6%.

More than three-fourths of government debt is denominated in dirhams. The existing stock of state guarantees dominates Morocco’s contingent liabilities, creating risks that could burden the government’s balance sheet.

S&P estimates the total stock of guarantees in 2021 to stand at about 19% of GDP, of which 11% is related to state guaranteed external debt of very large state-owned enterprises (SOEs).

The Moroccan dirham is pegged to a currency basket of 60% euros and 40% US dollars. The foreign exchange peg limits monetary policy flexibility in S&P’s view.

However, this is gradually changing, last year authorities launched the second phase of its gradual currency liberalisation reform by widening the fluctuation band for dirham to plus or minus 5.0% from plus or minus 2.5% previously.

At the time of the launch, the reserve coverage was slightly above five months of current account payments.

Bank Al-Maghrib (BAM), the central bank of Morocco, in June 2020 decided to reduce the key policy rate further to 1.5%.

In addition, to alleviate liquidity constraints, BAM is providing extensive support to the banking system through widening eligible collateral and extending maturities for central bank repo facilities.

BAM’s important policy easing measures include reductions in reserve requirements from 2% to zero and capital conservation buffer by 50 basis points (bps) for one year.

Although nonperforming loans constitute a relatively high proportion of the total, at about 8.3% at end-2020, they appear adequately provisioned.

The banking sector remains vulnerable to credit concentration risks. The banks’ expansion into sub-Saharan Africa has so far been highly profitable, but it opens new channels of risk transmission to the country’s banking system.

Morocco’s current account deficit shrank substantially to about 1.8% of GDP despite the sudden, large drop in external demand for its products and services. This is besides a sharp decline in imports, about 14.1% and a relatively smaller decline in exports – 7.5%.

Strong performance of remittances from abroad 5% and increase in grants helped to contain the loss of foreign tourism receipts.

Net foreign direct investment (FDI) inflows are expected to rise again this year. A narrow net external debt as a proportion of current account receipts (CARs) is expected to remain moderate at about 30%.

On the upside, the rating agency expects Morocco’s economy to grow by 5% this year and recover to its 2019 size in 2022.

Economic expansion will be supported by the government’s budgetary support measures, with an economic recovery package valued at 11% of GDP.

S&P expects Morocco and the International Monetary Fund (IMF) will update their arrangement. This is following the finalisation of the precautionary and liquidity line (PLL), from which Morocco drew $3 billion in 2020.

The Moroccan economy was hit by a fall in almost all components of aggregate demand given the simultaneous effects of the COVID-19 crisis on external and domestic demand.

International travel and tourism suffered major disruptions, translating to a drop in current account travel receipts of about 54% in 2020.

To counter the pandemic’s economic repercussions, the government and monetary authorities adopted a series of countercyclical support measures.

These were financed by a special fund, with endowment of about 3.2% of GDP with tax-deductible contributions from the public 0.9% and private sectors 2.3%.

Furthermore, in 2020, the Moroccan government drew on available funds under the PLL arrangement with the IMF.

This enabled the government to contain the COVID-19 economic fallout and strengthen the economy’s buffers against the potential balance of payment pressure.

The amount, $3 billion, was equivalent to about 3% of GDP in 2020, and a third of that was repaid in January 2021.

S&P expects a real economic rebound of about 5%, and real GDP to average 4% in 2021 to 2024. This will hinge, however, on when the effects of the COVID-19 crisis in Morocco and its key trading partners subside.

Europe’s recovery is particularly key since the region represents 70% of Morocco’s total exports.

Restoration of economic growth will likely stem from domestic demand on the back of private consumption, business investment activity, goods exports, according to S&P.

The agricultural sector in 2021 will likely benefit from a more supportive climate compared with the dry weather conditions since early 2019.

Economic growth in 2021 to 2024 will also be supported by the government’s strategic focus on accelerating economic recovery.

In 2020, Morocco launched an economic recovery plan valued at approximately $13 billion (MAD120 billion) 11% of GDP.

This mainly constituted credit guarantees to firms, 7% of GDP and funding for a newly created Fund for Strategic Investment, 4% of GDP, with the state providing one-third of the funds.

Beyond the crisis, in the medium term, the government will maintain its strategy on reducing the economy’s vulnerability to climate-related shocks by diversifying the economy.

Non-agricultural output will continue to expand in line with pre-crisis trends and reflect continual growth in foreign direct investment.

In structural terms, Morocco has been building industrial clusters that will likely drive the economy throughout this decade.

For instance, the number of vehicles produced in Morocco has increased more than 2.5x since 2014, overtaking value exports related to phosphates and their derivatives a few years ago.

Knock-on effects of the crisis have included a rise in unemployment and wider income disparities between more and less developed areas.

The unemployment rate rose to 11.9% in 2020 from 9.2% in 2019, and it was particularly prevalent among youth and women, and within city centres.

S&P expects social needs will persist, delaying a faster improvement in the budget deficit. Morocco’s efforts to improve education and labour market outcomes could bolster the country’s growth potential in the medium to long term.

The rating agency believes higher women’s labour participation at 17.8% in third-quarter 2020 could also help increase the country’s economic growth potential.

Morocco has largely demonstrated political and social stability, especially following the Arab Spring.

The rating agency would downgrade Morocco if the fiscal results materially underperform expectations.

S&P would consider uplifting rating if budgetary consolidation is markedly faster than expected, or the ongoing transition toward a more flexible exchange rate bolsters Morocco’s external competitiveness.

The rating agency may also upgrade the rating if the country’s continuing economic diversification strategy yields less volatile and higher rates of economic growth.

Meanwhile, S&P has also lowered Morocco’s transfer and convertibility assessment from BBB+ to BBB.

This comes after Moody’s dropped Morocco’s outlook from stable to negative, earlier in 2021, due to its weakening fiscal strength on the back of the COVID-19 crisis.

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