Document of The World Bank FOR OFFICIAL USE ONLY Report No. 86203 – MA INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED LOAN IN THE AMOUNT OF EURO 217.6 MILLION (US$300 MILLION EQUIVALENT) TO THE KINGDOM OF MOROCCO FOR A FIRST CAPITAL MARKET DEVELOPMENT AND SMALL AND MEDIUM-SIZED ENTERPRISE FINANCE DEVELOPMENT POLICY LOAN April 1, 2014 Financial and Private Sector Development Maghreb Department Middle East and North Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.     KINGDOM OF MOROCCO—GOVERNMENT FISCAL YEAR January 1st–December 31st CURRENCY EQUIVALENTS (as of March 3, 2014)  US$1 = 8.1604 Moroccan Dirham (MAD) US$1 = 0.7287 Euro ABBREVIATIONS AND ACRONYMS ACAPS Autorité de Contrôle des Assurances et de la Prévoyance Sociale (Independent Insurance and Pension Fund Supervisor) AMMC Autorité Marocaine du Marché des Capitaux (Independent Capital Markets Supervisor) BAM Banque Al-Maghrib (Central Bank of Morocco) ABB Banque Al-Barid (Postal Bank) CC Conseil de la Concurrence (Competition Council) CCG Caisse Centrale de Garantie (Government Credit Guarantee Institution) CCP Central Clearing Counterparty CDG Caisse de Dépôt et de Gestion (Government Investment Bank and Fund Manager) CDVM Conseil Déontologique des Valeurs Mobilières (Capital Markets Supervisor – prior to AMMC) CFC Casablanca Finance City CG Conseil du Gouvernement (Council of Government) CIMR Caisse Interprofessionnelle Marocaine de Retraite (Pension Fund for Independents) CMR Caisse Marocaine de Retraite (Pension Fund for the Civil Service) CNSS Caisse Nationale de Sécurité Sociale (Pension Fund for Private Sector Salaried Workers) CPS Country Partnership Strategy CSE Crisis Simulation Exercise CSEx Casablanca Stock Exchange DAPS Direction des Assurances et de la Prévoyance Sociale (Insurance and Pension Fund Supervisor – before ACAPS) DMO Debt Management Office D-SIFI Domestic Systemically Important Financial Institution EBRD European Bank for Reconstruction and Development EU European Union EUR Euro Fondep Fondation Banque Populaire pour le Microcrédit (Micro-credit Association) FDI Foreign Direct Investment FIRST Financial Sector Reform and Strengthening Initiative FPD Finance and Private Sector Development FSAP Financial Sector Assessment Program FSB Financial Stability Board GCC Gulf Cooperation Council     GOM Government of the Kingdom of Morocco HCP Haut Commissariat au Plan (State Planning Commission) HDN Human Development Network IAIS International Association of Insurance Supervisors IBRD International Bank for Reconstruction and Development ICP Insurance Core Principles ICR Implementation Completion and Results Report IFC International Finance Corporation IFI International Financial Institution IMF International Monetary Fund IOPS International Organization of Pension Supervisors IOSCO International Organization of Securities Commissions MAD Moroccan Dirham MENA Middle East and North Africa MFB Morocco Financial Board MFI Microfinance Institution MEF Ministry of Economy and Finance MOU Memorandum of Understanding MSME Micro, Small and Medium Enterprises NPL Non-Performing Loan OPCC Organisme de Placement Collectif en Capital (Mutual Fund Investing in PE/VC) OPCVM Organisme de Placement Collectif en Valeurs Mobilières (Mutual Fund Investing in Tradable Securities) PAYG Pay-As-You-Go PE/VC Private Equity/Venture Capital PEFA Public Expenditure and Financial Accountability PFM Public Financial Management PFMI Principles for Financial Market Infrastructures PLL Precautionary and Liquidity Line PPP Purchasing Power Parity RCAR Régime Collectif d’Allocation des Retraites (Pension Fund for Non-central Government Public Sector Workers) REIT Real Estate Investment Trust ROSC Report on the Observance of Standards and Codes SGG Secrétariat Général du Gouvernement (Government General Secretariat) SOE State-Owned Enterprise TFP Total Factor Productivity WBG World Bank Group Vice President: Inger Andersen Country Director: Simon Gray Sector Director: Loic Chiquier Sector Manager: Simon C. Bell Task Team Leader: Gabriel Sensenbrenner         KINGDOM OF MOROCCO FIRST CAPITAL MARKET DEVELOPMENT AND SMALL AND MEDIUM-SIZED ENTERPRISE FINANCE DPL Table of Contents LOAN AND PROGRAM SUMMARY ................................................................................................................ 1 I. INTRODUCTION AND COUNTRY CONTEXT (INCLUDING POVERTY DEVELOPMENTS) 1 II. MACROECONOMIC POLICY FRAMEWORK ................................................................................. 5 A. RECENT ECONOMIC DEVELOPMENTS.......................................................................................... 5 B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ................................................. 7 C. RELATIONS WITH THE IMF ........................................................................................................... 11 III. THE GOVERNMENT PROGRAM ..................................................................................................... 11 IV. THE PROPOSED OPERATION .......................................................................................................... 14 A. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION ................................. 14 B. PRIOR ACTIONS AND RESULTS .................................................................................................... 15 C. CONSULTATIONS AND ANALYTICAL UNDERPINNINGS ....................................................... 28 D. LINK TO CPS AND OTHER BANK OPERATIONS ........................................................................ 30 E. COLLABORATION WITH OTHER DEVELOPMENT PARTNERS ............................................... 32 V. OTHER DESIGN AND APPRAISAL ISSUES ................................................................................... 32 VI. SUMMARY OF RISKS ......................................................................................................................... 35 ANNEX 1: POLICY AND RESULTS MATRIX .............................................................................................. 36 ANNEX 2: LETTER OF DEVELOPMENT POLICY .................................................................................... 39 ANNEX 3: FUND RELATIONS ........................................................................................................................ 46 ANNEX 4: MACROECONOMIC DEVELOPMENTS AND DEBT SUSTAINABILITY ........................... 49 ANNEX 5: STRUCTURAL RIGIDITIES IN ECONOMIC PERFORMANCE ........................................... 52 ANNEX 6: THE MOROCCAN FINANCIAL SYSTEM ................................................................................. 56 ANNEX 7: FINANCIAL INCLUSION.............................................................................................................. 62             LOAN AND PROGRAM SUMMARY FIRST CAPITAL MARKET DEVELOPMENT AND SMALL AND MEDIUM-SIZED ENTERPRISE FINANCE DPL Borrower Kingdom of Morocco Implementing Agency Ministry of Economy and Finance Financing Data IBRD loan: Euro 217.6 million (US$300 million equivalent). Variable Spread Loan, commitment-linked, with a maturity of 29 years, including 7.5 years of grace Operation type Programmatic. This operation is the first of two single-tranche operations Pillars of the Operation  A. Deepening capital markets by broadening the range of instruments and and Program investors Development Objectives  B. Reforming pension system to ensure continued institutional demand for capital market securities  C. Fostering solutions for the financing of small and young enterprises  D. Consolidating oversight to balance greater access with continued financial stability Result Indicators  AMMC has certified 50% of finance professionals required to register Pillar A under Law 42-13  Continuous prices posted on Bloomberg for panel of Treasury securities  Number of separately identified securities reduced to 60 (2016)  Securities lending contracts recorded in central depository  Derivative contracts cleared and settled through central clearing counterparty Pillar B  Actuarial calculation forecasts year of first CMR deficit after 2022 Pillar C  CCG co-investing increased to 400 million MAD (2016)  3,000 new small or young enterprises reached between June 2013 and June 2016  Number of new CCG outlets in the regions increased to 6 (2016)  Creation of centralized collateral registry  Credit scoring offered by credit bureaux Pillar D  Financial conglomerates report to supervisors their internal arrangements for the identification and management of risks per the new regulations  AMMC complies with IOSCO Principles 6 and 7 on the perimeter of regulation and maintaining financial stability Overall Risk Rating Moderate Project ID P147257       I. INTRODUCTION AND COUNTRY CONTEXT (INCLUDING POVERTY DEVELOPMENTS) 1. This program document proposes a First Capital Market Development and Small and Medium-Sized Finance Development Policy Loan in the amount of Euro 217.6 million (US$300 million equivalent), which would be the first of a programmatic series of two single-tranche DPLs. It supports policies of the Government of Morocco (GOM) to adapt the financial system to the evolving needs of the real economy, develop market-based finance to complement banking in providing financing solutions and services to Moroccan enterprises and projects, and achieve higher growth through a better allocation of capital. 2. Morocco has invested 30-35 percent of GDP per year for the past 15 years, significantly more than peer countries, but this has not yet translated into higher growth. Total factor productivity, the key metric of competitiveness, lags behind peers, possibly reflecting the fact that public investment has been directed at long-gestation projects—in hospitality, phosphate extraction, energy, and infrastructure (highways, ports, airports, dams, free trade zones, etc.). The financial system is already large by international standards, most importantly because of large long-term saving locked in pension and insurance. The banking system is also large, with already commendable penetration of small and medium enterprises (SMEs) and low-income households. The financial system has performed well in mobilizing resources for investment. In future, the contribution of finance to growth hinges on enhancing the way it allocates and monitors these resources. 3. Diversifying finance from banks toward capital markets would improve the transparency of investment decisions, increase the diversity of investors implying stronger probing of projects, and foster corporate governance. Capital markets would bring discipline to the selection and monitoring of investments, and supplement banks in developing solutions for financing small and young enterprises. As in other countries, small and young enterprises face challenges that do not apply to other enterprises. The GOM’s program intends that markets and institutions also develop with the need of such enterprises in mind, including a transparent public sector and enabling investment climate, a regulatory and institutional environment supporting a competitive and stable financial sector, where banks and investors seek such enterprises. 4. The GOM’s program recognizes the central role of finance for the economy's competitiveness and resilience. The Program aims at a better mixture of banking and capital markets to finance the real economy, while ensuring continued financial stability. The proposed First Capital Market Development and Small and Medium-Sized Enterprise Finance Development Policy Loan (DPL I) supports this Program through its focus on the legal and regulatory framework for capital markets, pension reform, SME finance and oversight of the financial system. Pension reform is needed to sustain local capital markets. Pension funds are large holders of government securities. As in advanced countries, without reform, Morocco’s pension funds would, to varying degrees, soon have to sell reserves to pay retirees and other beneficiaries. 5. The proposed DPL builds on a stream of engagements of the World Bank Group (WBG) with GOM and stakeholders over the past few years: MENA finance flagship report entitled 1      “Financial Access and Stability” (2011); secured transactions framework (IFC, 2011); credit reporting system (IFC, 2012); FIRST project on establishing a benchmark yield curve (2013); MENA Transition Fund Microfinance Development project (Report No. 75522-MA) (2013); IFC “N-50” Initiative (2013); FPD/HDN diagnostics on pension reform (2013). Nonetheless, execution risk will need careful management. In this regard, GOM with the support of the World Bank has already financed from the FIRST Trust Fund, a large technical assistance (TA) program, with further funding pending review and approval by FIRST. Combined TA funds to support implementation would exceed US$2.5 million. 6. The Country Partnership Strategy (CPS) for Morocco (2014-17) retains, under its “Inclusive and Competitive Growth” Pillar, a core focus on the financial sector. The proposed DPL I is also aligned with the MENA Framework for Engagement by facilitating opportunities for private sector initiative and job creation, and strengthening economic governance and regulators, and contributes to the WBG’s strategic goals of ending extreme poverty and promoting shared prosperity. Governments, since the 1990s, have overseen noteworthy economic and social transformations. Sound macro-financial management put the economy on a recovery path from the stagnation of the 1990s. Morocco liberalized transport, energy, and telecommunications. The financial sector was reformed to support the new dynamism of the private sector as businesses adapted to major free-trade agreements. 7. Morocco enjoys a stable political system. The country is a parliamentary constitutional monarchy, whereby executive power is exercised by a multi-party government led by a Head of Government and by the King who is the Head of State. Morocco experienced noteworthy economic and social transformation since the 1990s, but fell short of creating sufficient jobs, particularly for the educated youth. A new Constitution, adopted in July 2011, reposes on a revised governance framework and strengthens the powers of the Head of Government and Parliament, and the independence of the judiciary. After years in opposition, the Justice and Development Party won legislative elections, and Mr. Abdelilah Benkirane became Head of Government in January 2012. The Benkirane I Government faced a large legislative agenda against a background of social demands exacerbated by an adverse external economic environment. Following a rebalancing of the coalition in 2013, the Benkirane II Government has reiterated its engagement to pursue the reform program and legislative agenda. 8. Morocco’s growth rate of nearly 5 percent per annum in 2001-11 has greatly reduced poverty and boosted shared prosperity. The extreme poverty rate dropped from 2 to 0.3 percent over the period. The wellbeing of the bottom 40 percent of the population grew in both absolute and relative terms. However, Morocco’s Gini coefficient of 0.41 reflects still high level of inequality, with 13.3 percent of the population living just above the poverty line. Disparities remain between regions, but also within cities. Inequality hinders potential economic growth and the emergence of the middle class. 9. Steady reforms and macroeconomic stability have buttressed the banking and financial system. More recently, liquidity in the banking system has been constrained by wider current account deficits and financial deepening has shifted somewhat to capital markets. Some bank disintermediation also reflects the growing financial sophistication of large businesses. Access is quite advanced, though some segments (microenterprises, start-ups) naturally remain underserved. Risks typically arising during rapid catch-up in financial development have not 2      materialized except in microfinance, which is being cleaned up after initial excesses. In banking, low loan default rates reflect improvements in information and risk management systems, as well as an effective supervisor. Maintaining the balance between development and stability will require an adaptive macro-prudential framework, periodic testing of crisis preparedness, while promoting inclusion for SMEs. 10. The proposed DPL I complements: (i) the First Economic Competitiveness Support Program DPL (Report No. 68007-MA), approved by the WBG Board of Executive Directors on March 12, 2013, dealing with investment climate, trade facilitation, and competition policy; and (ii) the First Transparency and Accountability DPL (Report No. 72127-MA), approved by the Board on October 29, 2013, dealing with performance of state-owned enterprises, procurement policies, and public services to the business community. It is also expected to complement a Second Skills and Employment DPL currently under preparation, supporting policies to better match the supply of skills with demand by the private sector. 11. Taken together, these reforms aim to bolster productivity and growth across sectors (see flow chart below). Improving economic performance requires competition policies that facilitate the re-allocation of capital to more productive uses, as well as policies that adapt public sector services to the needs of private sector development. It also requires a financial system that: (i) enables capital formation and mobilizes saving; (ii) allocates capital to better performing companies across sectors; (iii) monitors financial resources and restructures distressed companies. At this stage of Morocco’s development, capital markets play a key role in allocating and absorbing the risks entailed in financing Morocco’s diversification and growth, as financial institutions and businesses expand into Africa.1                                                              1 As economies develop, too little market finance relative to banking is associated on average with lower levels of economic activity, see Demirguc-Kunt et al. (WPS 5805, 2011) for cross-country evidence. However, getting the mixture right between banking and markets requires effective regulation and supervision, both micro and macro-prudential, see Cecchetti et al., “Reassessing the Impact of Finance on Growth,” BIS Paper No. 381, 2013. 3      High saving and investment but disappointing growth outcomes  Country Context  Weak external competitiveness    Developed banking system and institutional investors  Growth rate: 5.5 percent; inflation rate: 2 percent, unemployment: 8 percent, budget deficit: 3 percent  GOM Program:   Strengthen competitiveness: investment climate, transparency in public procurement, public‐private partnerships   Enhance the performance of SOEs and public agencies providing business services  Selected Targets   Greater support to small and young enterprises  (2012‐2016)   Develop long‐term savings   Develop finance beyond banking to achieve better allocation and monitoring of capital  World Bank  Transversal DPLs – supporting private sector development across sectors  Capital Market Development and SME Finance  Accountability and Transparency  Economic Competitiveness Support   Deepening capital markets by broadening the   Improve competition and   Improve investment climate by  range of instruments and investors;  transparency in public  removing barriers to entry and   Reforming pension system to ensure  procurement and public‐private  simplifying the regulatory  continued institutional demand for capital  partnerships;  environment for doing business;   market securities;   Enhance oversight and governance   Further trade policy reform and  of SOEs and public agencies;  trade facilitation;   Fostering solutions for the financing of small   Strengthen accountability in the   Improve economic governance by  and young enterprises;  management of public resources;  strengthening the competition   Consolidating oversight to balance greater   Enhance fiscal transparency and  agency and accountability in  access with continued financial stability. access to information. granting investment incentives. 4      II. MACROECONOMIC POLICY FRAMEWORK   A. RECENT ECONOMIC DEVELOPMENTS 12. Agriculture is the largest employer in the economy, absorbing almost 40 percent of the labor force. Although on a declining trend, the share of agriculture and fisheries has averaged 14 percent of GDP at factor costs over the past decade. The decline in the sector’s share of GDP benefitted services, and notably relatively low value-added services. As a result, the standard deviation of growth dropped from 6 percent during 1989-2000 to 1.7 percent in 2001-11. 13. Morocco has shown difficulties in benefiting from globalization. Morocco’s share of global exports declined from 0.15 percent in 1999 to 0.12 percent in 2012, while most peer countries saw substantial increases. The price of the national export basket has been higher than that of peers and the gap has widened since 2008. High and rising export prices are symptomatic of persistent weaknesses in the competitiveness of Moroccan enterprises on the global market. Part of the private sector was severely hit by the global crisis with the slowdown in trade, tourist arrivals and FDI. Domestic-driven sectors such as real estate slowed down, as shown by the slower expansion in mortgage credit. Export-driven activities have also fared poorly, particularly in low added-value industries like textile and industrial assembly. However, these impacts were mitigated by new trends in the development of the private sector in Morocco, mostly with the stimulation of higher value industries (car manufacturing, aeronautics, etc.) and the expansion of conglomerates in the African market, transforming Morocco into a hub for regional investments. 14. While the 2008 financial crisis had a limited impact on Morocco’s economy, the food and fuel price crisis had an important effect. The effect was magnified by reduced demand from European markets. With the price of oil averaging US$110 per barrel in 2011-12, Morocco suffered a major deterioration of its terms of trade. This deterioration was compounded by a significant increase in its food import bill in 2012 as a result of a severe domestic drought at a time of soaring international food prices, especially wheat. Moreover, Morocco has been adversely affected by developments in the Eurozone, in particular sovereign debt crises in Spain and Italy, among other countries, and the subsequent slowdown in economic growth. The banking/sovereign crises in Europe and related recessionary tendencies reduced demand for Moroccan exports, tourism receipts and remittances. As a result, growth of non-agriculture GDP decelerated to an average of 3.5 percent since 2009 compared to 4.7 percent over 2000-08. Growth has mostly been driven by debt-creating domestic demand and fiscal spending. 15. Unemployment of 9 percent remains a central concern despite having declined by 4 percentage points between 2000 and 2011. Unemployment is relatively higher in cities (13.7 percent compared to 4 percent in rural areas), among women (at 10 percent compared to 9 percent for men, however, with a very low participation rate of 25 percent), youth (18 percent, and only 32 percent participate), and educated individuals. Despite remarkable gains in access to education, both education quality and outcomes lag behind those of peer countries. According to the 2008 Investment Climate Assessment (ICA), 35 percent of firms identified hiring a skilled worker as an important constraint, a figure that was only 20 percent in 2004. 5      16. The authorities put a great deal of emphasis on controlling inflation. Subsidies on food and fuel have helped cap inflation, notwithstanding higher import prices. Consumer price inflation has been subdued increasing slightly from 1.3 percent in 2012 to 1.9 percent in 2013, with food prices contributing the most. However, the fixed exchange rate combined with subsidies on imported food and fuel products have increased pressures on international reserves. An accommodative monetary stance has helped to mitigate private sector crowding out. However, poor fiscal fundamentals have begun to feed through to higher interest rates, with yields on the key 5-year bond gaining 100 basis points since mid-2012. 17. Increased spending on subsidies, wages and pensions helped counteract weak demand from Europe, but is jeopardizing fiscal sustainability. In 2012, for the first time, subsidies were higher than capital expenditures. The fiscal outcome for the year was worse than expected with the deficit widening to 7.3 percent of GDP, compared to 5.4 percent in the Budget Law, despite good tax collection and hikes in subsidized fuel prices (up 19.6 percent for gasoline, 14 percent for diesel, 13.4 percent for industrial fuel). Subsidies and the wage and pension bill (up 12.4 and 8.7 percent, respectively) exceeded half of total expenditures. 18. The Government initiated reforms of the subsidy system in 2013 to reverse the deteriorating fiscal trend. The deficit including grants narrowed to 5.4 percent of GDP in 2013 as a result of a new indexation mechanism that cut subsidies by almost 2.5 percentage points of GDP. The budget also benefitted from lower world fuel prices. The Government also decided to rein in recurrent expenditures and capital outlays. The rise of the wage and pension bill was contained to 2 percent in 2013, while capital outlays were cut by 6.2 percent. 19. Government debt increased significantly in 2012, by 5.9 percent of GDP (to reach 59.6 percent of GDP), but was contained to 62.5 percent of GDP in 2013. The deficit in 2013 was mostly financed domestically, though Morocco also tapped international markets (BBB- rating). The Treasury issued 4.2 percent of GDP in domestic bonds and raised US$750 million through international bonds in May 2013. Although less than a quarter of debt is denominated in foreign exchange, Morocco’s government debt increased by 15.4 percentage points of GDP in just five years (2009-2013), of which 5.9 points in 2012. 20. Fiscal expansion and weak exports and remittances fuelled the current account deficit in 2012 and to a lesser extent in 2013. After widening to 9.7 percent of GDP in 2012, the current account deficit is estimated to have improved to 8.3 percent of GDP in 2013 with both imports and exports declining by 2 percent and 0.8 percent, respectively. Europe has remained by far Morocco’s main trading partner (absorbing 60 percent of its exports and providing 80 percent of the remittances received) with a concentration in France and Spain (one third of exports and half of total remittances). On the financing side, net FDI inflows grew by an impressive 26 percent in 2013. Thanks to the issuance of Eurobonds, overall financial flows more than covered the current account deficit, leading to a consolidation of foreign reserves by US$1.3 billion to US$18.5 billion (4.3 months of imports) at end-2013. 21. Current account deficits have tightened banking system liquidity. The Central Bank (Banque Al-Maghrib (BAM)) compensated by relaxing its stance in a context of low inflation: cutting its policy rate from 3.25 to 3 percent in March 2012, lowering reserve requirement from 6 to 4 percent in September 2012, and increasing liquidity injections. Money supply thus still grew 6      by 4 percent in 2013, compared to 4.5 percent in 2012. Bank credit to the economy grew by 2.5 percent (4.6 percent in 2012), mostly driven by mortgage credit (5 percent) on the back of housing programs and credit for business equipment (2.4 percent). Consumption credit slowed down to 2.2 percent in 2013, while working capital loans declined by 2.3 percent. Non- performing loans have been increasing in 2013 and represented 5.8 percent of bank credit to the private sector in December 2013. With the loan-to-deposit ratio above 100 percent in domestic banks, deposit growth is insufficient to support loans growth to the private sector. Implementation of the Basel III accords starting 2014 is expected to put further pressure on credit extension, especially longer terms and to larger borrowers. B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 22. The medium-term macroeconomic policy framework is broadly appropriate, although both the global and regional contexts exacerbate downside risks (Table 1). Recessionary tendencies in Europe would continue to undermine the macroeconomic outlook through weak exports, tourism, remittances and possibly FDI. A further increase in fuel prices, deterioration in the regional context, or renewed global financial turmoil could even compound these challenges. Under these conditions, it would become increasingly difficult to sustain pre-crisis growth levels if internal demand remains the key driver of growth. Absent a significant reorientation of the economy toward the tradable sector and increased competitiveness, growth and private sector job creation risk remaining weak. 23. Stronger macroeconomic prospects are essentially linked to the country’s capacity to generate productivity gains. Morocco would therefore benefit from increased efforts to enhance competitiveness and start gaining market shares on global markets, including moving toward greater flexibility in exchange rate management. Along with the sector strategies already under implementation, these efforts would involve improving the quality of domestic investments and continuing to attract large flows of FDIs. This would call for more opportunities and economic freedom for all Moroccans to compete, produce and participate in the economy. Moreover, Morocco’s competitiveness also depends on maintaining a stable macroeconomic framework, which in turn requires strengthening governance, consolidating public finances, and pursuing a prudent monetary policy. While subsidy and pension reforms are most urgent, including establishing more effective and inclusive social protection programs, proceeding with structural reforms is needed in the medium term to boost enterprise productivity through better channeling resources to competitive industries. Embarking on the ambitious deep and comprehensive free trade agreement with the European Union (EU) would provide a long term anchor to implement far reaching reforms and accompany the structural transformation of Morocco. 24. In line with the new constitutional requirement, the Government is committed to fiscal stability and to progressively reduce the budget deficit to the medium term target of about 3 percent of GDP by 2017 through the implementation of a set of reforms (Table 2). The key measures include: (i) continuing the reform of the universal subsidy system; (ii) implementing civil service reform, notably by introducing a ceiling on wage expenditures and a new remuneration system; (iii) accelerating the fiscal and pension reform agenda; and (iv) enhancing the efficiency of public as well as private investments. In May 2013, the authorities reduced the quota and the per-unit subsidy on wheat harvesting. In July, they adopted a circular to make wage bill appropriations binding and limit the rollover of unspent investment appropriations. 7      They also started in September 2013 to implement the indexation of domestic prices of industrial fuel oil, gasoline, and diesel on world prices. In January 2014, the Government stopped supporting prices of gasoline and industrial fuel oil. These actions helped keep the 2013 subsidy bill closer to its budget target, while reducing the vulnerability of the budget to international commodity price movements. These steps constituted major milestones toward a comprehensive subsidy reform. 25. The 2014 Budget Law confirmed the Government’s strategy to continue reforming the subsidy system and launch the reforms of the pension and fiscal systems this year. The Government has adopted the draft Organic Budget Law to enhance central and local governments’ budget design and implementation for better public service delivery and efficiency. To improve further the investment climate, the Government planned to proceed with justice reform, improve access to financing, especially for the SMEs, address access to land constraints, develop logistics services, and reinforce technical training. The Central Bank also announced last year its objective to move towards a more flexible exchange rate mechanism over the next three years. Assuming these reforms take place, growth in the non-agriculture economy could pick up to around 5.5 percent over the medium term, with inflation kept below 2.5 percent and the budget deficit below 3 percent of GDP. 26. The external position is expected to remain sustainable over the medium term provided that key critical reforms under implementation continue to take hold. The current account deficit is projected to gradually decline to around 5.5 percent of GDP in 2017 benefiting from improved export potentials and a recovery of tourism activities and workers' remittances. The latter would benefit from the anticipated progressive recovery in Europe, the main source of remittances flow to Morocco. This scenario critically assumes that Morocco would benefit from its continued reform efforts supported by a number of Bank-financed DPLs. These reforms, along with sector strategies already under implementation, would translate into higher productive private investments, including FDIs, and progressive gains in competitiveness of its exports, including tourism. Exports should also benefit from some diversification toward the BRICS (Brazil, Russia, India, China, South Africa) and other major developing countries. 27. External debt is expected to peak at 38.8 percent of GDP in 2015 before declining thereafter (Table 3). Foreign reserves would remain close to four months of imports, assuming foreign investors retain confidence and Gulf Cooperation Council (GCC) financial support materializes.2 External financing requirements constitute a moderate concern in the medium term, given the still low external debt, financial support from the GCC, access to international markets, and still adequate foreign reserves. Current account deficits are projected to narrow steadily in the medium term, and financing them should not be a constraint. Any remaining financing gap could be filled by tapping international markets. The confirmed Precautionary and Liquidity Line (PLL) from the International Monetary Fund (IMF) will continue to provide a potential line of credit until August 3, 2014.                                                              2   The Government signed in February 2013 a grant for US$1.25 billion over a five-year period with the Kuwait Development Fund, which made a first installment of US$500 million in November 2013. In 2013, the Government also received US$675 million from the Saudi Development Fund under a US$ 1.25 billion grant agreement. Qatar pledged its share of US$1.25 billion in January 2014. All these grants are part of a cooperation agreement with GCC governments for US$5 billion. 8      Table 1: Key Macroeconomic Indicators Act. Est. WB Proj. 2010 2011 2012 2013 2014 2015 2016 2017 Real economy Annual percentage change, unless otherwise indicated GDP (nominal--local currency) 4.3 5.0 3.2 5.9 5.4 7.0 7.3 7.3 Real GDP 3.6 5.0 2.7 4.4 3.0 4.6 4.8 4.9 Per Capita GDP 2.5 3.8 1.6 3.3 1.9 3.5 3.8 3.9 Contributions: Consumption 1.1 5.0 3.6 3.1 1.7 3.0 3.1 2.9 Investment -0.8 1.4 -0.9 -0.3 1.0 1.2 1.4 1.6 Net exports 3.4 -1.5 0.0 1.6 0.2 0.4 0.3 0.4 Imports (current prices) 3.6 5.0 2.0 -0.4 4.1 4.0 4.6 4.7 Exports (current prices) 16.6 2.1 2.7 1.5 6.3 6.6 7.1 7.3 Unemployment rate (ILO definition) 9.1 8.9 9.0 9.2 … … … … GDP deflator 0.6 0.1 0.5 1.5 2.4 2.3 2.3 2.3 CPI (pa) 0.9 0.9 1.3 1.9 1.7 1.8 2.3 2.3 Fiscal Accounts Percent of GDP, unless otherwise indicated Expenditures 27.5 30.0 31.3 28.4 31.5 30.8 30.0 29.8 Revenues 22.8 24.0 24.3 23.0 26.6 26.7 26.7 26.7 Central Government Budget Balance -4.7 ‐6.0 ‐7.0 ‐5.4 -4.8 -4.1 -3.4 -3.1 Central Government Debt 50.3 53.7 59.6 62.5 62.9 61.8 60.1 58.2 Selected Monetary Accounts Base Money 4.2 6.4 4.5 2.8 … … … … Credit to non-government 11.0 10.4 5.1 3.1 … … … … Interest (key policy interest rate) 3.25 3.25 3.00 3.00 … … … … Balance of payments Current Account Balance -4.5 -8.0 -9.7 ‐8,0 -7.6 -6.5 -5.6 -4.8 Imports (FOB) 36,2 41,2 43,2 40,1 46.6 46.0 45.7 45.4 Exports (FOB) 19,6 21,8 22,3 20,7 33.8 34.6 35.2 35.9 Foreign Direct Investment, net 1.1 2.4 2.8 3.3 3.2 3.1 3.2 3.3 Gross OfficialUS$, bln (eop) 23.8 22,1 17,3 18,7 … … … … In months of next year’s imports 5.6 4.9 4.2 4.4 … … … … As % of short-term external debt 0.9 0.5 0.4 0.5 … … … … External Debt 29.0 29.3 34.4 36.5 38.6 38.8 38.7 38.4 Terms of Trade, change in % -3.4 4.1 ‐11,9 ‐2,8 0.7 1.7 0.1 0.1 Exchange rate (average) 8.42 8.09 8.63 8,41 … … … … Other memo items GDP, nominal MAD, bln 764.0 802.6 828.2 877.3 924.9 989.9 1,062.1 1,139.7 GDP, nominal US$, bln 90.8 99.2 96.0 103.4 … … … … Sources: Moroccan authorities and World Bank staff projections. 9      Table 2: Fiscal Indicators of the Central Government (in % of GDP) Act. Est. WB Proj. 2010 2011 2012 2013 2014 2015 2016 2017 Overall Balance -4.7 ‐6.0 ‐7.0 ‐5.4 -4.8 -4.1 -3.4 -3.1 Primary balance -2.4 ‐3.7 ‐4.5 ‐2.9 -2.2 -1.5 -0.8 -0.7 Total revenues 22.8 24 24.3 23 26.6 26.7 26.7 27.7 Tax revenues 20.2 20.4 21.3 19.5 23.9 23.9 23.9 23.9 Taxes on goods and services 11.3 11.6 11.8 11 11.5 11.5 11.5 11.5 Direct taxes 8.5 8.8 9.5 8.6 9.3 9.4 9.4 9.4 Taxes on international trade 1.6 1.3 1.1 0.9 1.0 1.0 1.0 1.0 Other taxes 1.3 1.3 1.6 1.5 1.9 1.9 1.9 1.9 Special accounts, balance 0.5 0.4 0.4 0.3 0.2 0.2 0.2 0.2 Non-tax revenues 2.1 3.1 2.7 3.2 2.6 2.6 2.6 2.6 Grants, current 0.2 0.2 0.0 0.7 0.1 0.1 0.1 1.1 Expenditures 27.5 30 31.3 28.4 31.5 30.8 30.0 29.8 Current expenditures 21.2 24.2 26 23.5 25.7 25.0 24.3 24.0 Wages and salaries 10.3 11.1 11.7 11.1 10.8 10.6 10.4 10.3 Goods and services 5.0 4.8 5.3 5.2 5.3 5.3 5.3 5.5 Interest payments 2.3 2.3 2.4 2.5 2.6 2.6 2.5 2.4 Subsidies 3.6 6.1 6.6 4.7 4.3 3.9 3.4 3.2 Current transfers to Local Gov. 2.6 2.7 2.7 2.5 2.7 2.7 2.7 2.7 Capital expenditures 6.2 6.2 6.2 5.4 5.8 5.8 5.8 5.8 Central Government financing 3.8 4.8 7.1 6.1 4.8 4.1 3.4 3.1 External (net) 2.1 0.9 1.8 1.7 3.3 3.0 2.3 2.1 of which grants, capital 0.0 0.2 0.1 0.8 0.8 0.8 0.7 0.7 Domestic (net) 1.7 3.9 5.3 4.4 1.6 1.1 1.1 1.0 of which privatization 0.0 0.7 0.4 0.0 0.2 0.2 0.2 0.2 Sources: Moroccan authorities and World Bank staff projections. Table 3: BOP Financing Requirements and Sources (in US$ million) Act. Est. WB Proj. 2010 2011 2012 2013 2014 2015 2016 2017 Financing Requirements 6,894 11,300 13,140 12,621 11,893 11,006 10,597 10,831 Current accounts deficit 4,078 7,986 9,347 8,890 8,237 7,372 6,815 6,204 Long-term debt amortization (exl. IMF) 2,428 2,438 2,429 2,373 2,421 2,528 2,760 3,697 Other short term capital outflows 388 876 1,365 1,358 1,236 1,106 1,022 931 Financing Sources 6,894 11,300 13,140 12,621 11,893 11,006 10,597 10,831 FDI and portfolio investments (net) 1,074 2,156 2,720 2,715 3,480 3,700 4,050 4,435 Capital grants 10 185 116 786 1,435 1,423 1,412 1,399 Long-term debt disbursements (exl. IMF) 4,992 4,464 6,415 7,063 6,304 5,226 5,224 6,305 Other short term capital inflows 2,024 1,863 422 1,721 1,136 1,006 922 831 Change in reserves (-=increase in reserves) -1,206 2,632 3,467 335 -461 -350 -1,011 -2,139 IMF credit (net) 0 0 0 0 0 0 0 0 Sources: Moroccan authorities and World Bank staff projections. 28. The public debt sustainability analysis indicates that the framework remains sustainable although it would weaken under a scenario of medium term downside risks (Figure 1). Indeed, when the debt sustainability analysis is based on the assumption of "no-policy-change", the debt stock increased steadily over the period 2013-18. All the six bound tests proved sustainable over the medium term, although three of them show debt-to-GDP ratios in the range of 62-64 percent. 10      Figure 1- Central Government External Debt Sustainability (in % of GDP) Alternative scenarios Bound tests3 69.0 75.0 64.0 70.0 59.0 65.0 60.0 54.0 55.0 49.0 50.0 44.0 2013 2014 2015 2016 2017 2018 2019 2013 2014 2015 2016 2017 2018 2019 Base Line Key Variables at their Historical Averages No Policy Change B1 B2 B3 B4 B5 B6 C. RELATIONS WITH THE IMF4 29. In August 2012, the IMF and the GOM agreed an SDR 4.12 billion (approximately US$6.2 billion) PLL to be provided by the IMF. The PLL has remained undrawn. The IMF Board found that Morocco performed strongly in three out of five conditions (financial sector and supervision, monetary policy, data adequacy) and underperformed in fiscal and external conditions. PLL conditionality includes semi-annual reviews. Morocco issued Eurobonds in November 2012 following PLL approval, and re-opened them shortly after the First Review under the PLL was concluded in February 2013. The Second Review was concluded in July 2013, and the Third Review in January 2014. All three reviews reaffirmed Morocco’s continued qualification. III. THE GOVERNMENT PROGRAM5 30. The 2012-16 Program proceeds from three principles: (i) better integration of policies across sectors; (ii) consultations with stakeholders; and (iii) stronger governance. In the economic sphere, the Program aims to strengthen enterprise competitiveness and diversify the economy to achieve greater sharing of prosperity, supported by the rule of law, and accountability of public sector entities in the use of resources and the delivery of                                                              3 See Annex 4, Table A4 for assumptions of bound tests.  4   See Annex 3 and “Morocco: Third Review Under the Two-Year Precautionary and Liquidity Line,” Country Report No. 14/66 March 6, 2014 at www.imf.org.  5 The Government Program is at: http://www.cg.gov.ma/fr/fichier.30.48.programme+gouvernemental.  11      services. The governance agenda includes increased powers for the Competition Council, improving the accountability of state-owned enterprises (SOEs) through a review of the role of the state as shareholder, and consolidating governance and independence of financial regulators. For 2012-16, the Program aims for a growth rate of 5.5 percent, inflation of 2 percent, reducing unemployment to 8 percent and a gradual drop in the budget deficit to 3 percent of GDP by 2016. 31. External shocks have exposed the weak aggregate competitiveness of Moroccan enterprises. Investment has been insufficiently productive (see Annex 5): (i) Morocco has consistently invested 5 to 10 percentage points of GDP more than peer countries; (ii) capital formation as a share of GDP has increased from 20 in the 1990s to 35 percent currently. Investment has merely boosted the productivity of labor (a gain of 3 percent per year since 1999), but has not yet triggered a growth take-off through higher Total Factor Productivity (TFP). Better growth outcomes might still materialize in that government capital expenditures (about 5 percent of GDP) focus on infrastructure (energy, highways, ports, airports), for which productivity gains take longer to materialize. Also in this category are some projects undertaken by SOEs, such as utilities. 32. Morocco has a fairly diversified financial system that grew rapidly over the past decade (Annex 6). Financial system assets as a percentage of GDP have reached levels comparable to some high income countries, reflecting a combination of sizeable banking system assets, pension fund assets and insurance industry assets. The fairly advanced development of financial intermediation contrasts with a somewhat lackluster performance of the real economy. 33. Morocco’s financial system has performed well in mobilizing saving for the formation of capital. However, the functions of finance pertaining to financing and monitoring capital could be strengthened. Financial intermediation through capital markets increases the diversity of investors, improves the transparency of capital decisions, and fosters corporate governance. Market-based finance would bring more discipline to the selection and monitoring of investments, and supplement banks in developing new solutions for financing small and young enterprises. Raising the proportion of equity capital in the financial structure of companies, in particular SMEs, via measures that facilitate access to external finance would enhance creditworthiness and mitigate the impact of pro-cyclical bank lending on real economic activity. Finally, the implementation of Basel III liquidity requirements will dampen the role of banks in the provision of term finance, particularly to enterprises and projects. 34. The Program recognizes the central role of finance for economic competitiveness. At this stage of Morocco’s development, capital markets play a greater role in allocating and absorbing the risks from financing Morocco’s enterprises as they diversify into Africa. The Program aims to get the mixture right between banking and capital markets and develop new solutions for the financing of enterprises, while ensuring continued financial stability. To this end, the Program is focused on capital market reforms, banking, insurance and pension fund oversight, and the promotion of Casablanca Finance City (Box 1). 35. Morocco’s regulatory architecture is changing as a result of new practices in Europe, cross-border expansion of financial institutions in Africa, and more rigorous international standards. The Constitution tasks the Ministry of Economy and Finance (MEF) with leading both 12      legislative and regulatory work streams, while supervision is devolved to three dedicated agencies: BAM for credit institutions (banking, leasing, microfinance); a capital market authority—the Autorité Marocaine du Marché des Capitaux (AMMC); an authority for insurance and pension—the Autorité de Contrôle des Assurances et de la Prévoyance Sociale (ACAPS). The law creating AMMC has been promulgated in 2013, and Parliament has adopted the law creating ACAPS in February 2014. BAM is independent since 1996 and often initiates legal and regulatory reforms for credit institutions. However, enactment requires MEF’s review and approval to ensure coherence of policies across the financial system. Over the years, several committees of MEF, supervisors, and (depending on topic) market entities (custodian, stock exchange, industry group) have coordinated the operation of the regulatory architecture. Box 1. Casablanca Finance City (CFC) CFC was launched by a 2010 law aiming to turn Casablanca into a regional hub. The Moroccan Financial Board (MFB), a public-private initiative, oversees the development, promotion and managment of CFC. Strategic partnerships were signed with The Singapore Corporation, CityUK, and Paris Europlace. CFC aims to attract three types of companies:  Financial institutions;  Regional headquarters of global firms;  Professional services providers (accounting, auditing, legal, compliance, custody, IT, etc.). CFC offers an incentives package:  One third of a greenfield office district is earmarked for CFC. With delivery starting in 2014, it will overcome office space constraints in central Casablanca and help generate cluster effects;  Moroccan laws apply; CFC is not an off-shore scheme with less intensive supervision;  Specialized judges ensure speed and predictability of court process;  Supportive tax and exchange control regimes. CFC status are granted by MFB based on pre-set criteria (e.g., minimum share of international activities). Moroccan regulatory and supervisory requirements fully apply to financial institutions. In particular (i) a license from the relevant authority is required, (ii) financial regulators will have same powers of access to CFC firms and (iii) AML/CFT requirements are those applicable to any Moroccan entity. In February 2014, the First Chamber of Parliament adopted amendments to the 2010 law to:  Extend CFC status to holding companies and providers of investment services (investment banks, brokers, rating services, etc); asset management companies and financial advisors; branches and rep offices.  Allow CFC-status commercial banks to collect term deposits from corporate clients. 36. Concerning capital market reforms, the GOM’s Program aims to upgrade the legal, regulatory and oversight eco-system for market-based finance, broaden the range of instruments to complete markets, and supplement traditional banking. The reforms also intend to foster long- term saving and investment, including equity finance. To this end, efforts are directed at upgrading the governance of the stock exchange by diversifying shareholding beyond current seat owners. This will enhance surveillance, ensure better disclosure and transparency of 13      companies with securities traded on the exchange, and attune the services provided by market intermediaries to the needs of enterprises and projects. 37. Pension reform will help ensure continued institutional demand for capital market securities, thereby anchoring long-term saving. Meanwhile, the GOM intends to complement broad-based capital market reform with specific policies aimed at facilitating financing of small and young enterprises, both bank loans and equity, through better information on these borrowers as well as public-private equity funds. The GOM’s program toward SMEs envisages simplifying the tax regime, encouraging new financing solutions, developing risk capital, and facilitating access to public contracts. 38. The GOM finally continues to pursue policies that ensure the stability of the financial system, particularly as regulated institutions begin to use new financial instruments. The Program includes measures to enhance the capacity of banks to manage risks, and to improve the oversight of insurance and pension funds, which are large investors in the capital market and potential investors in new products. The GOM believes that the success of the CFC project depends on the development of a reputable and diverse domestic marketplace, rigorously overseen by the financial sector authorities. IV. THE PROPOSED OPERATION A. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION 39. The proposed operation is the first in a programmatic series of two DPLs. The programmatic option reflects the medium term nature of the reforms. The duration of the series remains within the Government’s term in office, thus fostering accountability for implementation and outcomes. The programmatic option responds to MEF’s interest in a follow-up operation, potentially within the next 24 months, assuming the authorities meet substantially the indicative triggers for the second DPL. 40. Prior actions and triggers have been selected to help achieve the objectives of the Government’s Program in the economic sphere, namely to strengthen competitiveness and diversify the economy to achieve greater sharing of prosperity. To this end, the Government aims to adapt the functionalities of the financial system to the needs of the real economy as follows:  Deepening capital markets by broadening the range of instruments and investors;  Reforming pension system to ensure continued institutional demand for capital market securities;  Fostering solutions for the financing of small and young enterprises;  Consolidating oversight to balance greater access with continued financial stability. The Policy and Results Matrix (Annex 1) detail each pillar in terms of prior actions, indicative triggers, and results indicators. 14      41. The operation’s design reflects reforms built on extensive consultations between the authorities, stakeholders, and the World Bank Group. The design therefore includes:  A monitoring and evaluation framework that rewards priority elements in the reform sequence. GOM fully owns the monitoring framework and its outcomes are designed to be measurable;  Extensive support of reform implementation with advisory services by the WBG;  Shared ownership of the reforms by the financial industry, MEF, and financial sector supervisors. B. PRIOR ACTIONS AND RESULTS Pillar A: Deepening capital markets by broadening the range of instruments and investors Launching the new independent capital market authority 42. The Minister of Finance created in 2013, a strategic committee of stakeholders tasked with coordinating capital market policies to diversify financial intermediation beyond banks, revitalize the Casablanca Stock Exchange (CSEx), and promote the CFC. MEF deals with a variety of financial industry stakeholders advocating many initiatives, often prompted by global developments. The committee focused in a first phase on legal and regulatory aspects. The legal and regulatory pipeline aims to diversify the range of instruments and increase appeal to investors through greater market completeness. The MEF plans to tackle market development topics in a second phase, including broadening the shareholding structure of the stock exchange, strengthening market infrastructures, and streamlining incentives for long-term saving and investment. A multi-year FIRST project is being finalized to support this agenda. 43. Foreign and retail investors have little presence in the market. Local institutional investors are steady captive buyers as a result of exchange controls, and the weight of buy and hold investors naturally limits price discrimination across issuers. Investment decisions also appear concentrated in conglomerates and some major institutional investors. Lack of liquidity and low tradable float of major names has lessened the interest of foreign investors. New issuers have been discouraged, as better financial results relative to competitors did not always translate into higher valuations. Some retail investors have limited their participation after the steady decline in prices following the 2008 peak. 44. The new independent capital market supervisor (AMMC) will for the first time license and certify financial professionals, thereby strengthening investor protection. AMMC as successor of the CDVM (Conseil Déontologique des Valeurs Immobilières) has broader power, importantly introducing licensing and certification of professionals in compliance, advice, asset management, and trading. Certification will ensure business conduct more in line with fiduciary standards in advanced markets. AMMC will also need to enhance supervision over conflicts of interest in the asset management industry. Conflicts may arise in transactions between funds and other entities in the conglomerate: soft commissions, lending to affiliates, buying securities underwritten by affiliates, or window-dressing at reporting time. 15      45. AMMC will become operational once the GOM adopts the draft Organic Law governing appointments to the higher civil service. Once promulgated, the Law will enable the appointment of the Chairman of AMMC and all Board members. The Board will approve the authority’s rules and procedures in line with IOSCO’s Objectives and Principle for Securities Regulation. It is planned to assess Morocco’s observance of IOSCO Principles during the forthcoming Financial Sector Assessment Program (FSAP) Update. The Law creates also an independent College of Sanction, chaired by a specialized judge appointed by the judiciary branch. As a result, the Board will not anymore be in charge of enforcement. Finally, AMMC will report annually to the Head of Government on its activities and those of capital markets.  46. The GOM is reviewing its role as SOE shareholder, which could bring new names in equity and debt markets.6 Corporate debt has minimal impact on governance and implies less continuous disclosures. However, the GOM plans to enhance accountability and governance of SOEs supported by the First Transparency and Accountability DPL. The large projects being mooted with GCC sovereign funds are also potential new names. As large borrowers replace banking with more market finance, banks will be equipped to lend more to SMEs on account of measures to improve the informational and transactional infrastructure for mitigating the risks associated with such lending (see Pillar C). Results Chain: By adopting the draft law on the higher civil service (prior action), the GOM would be able to install the Board of AMMC. The Board would in turn take key operational decisions. Two decisions are singled out (indicative triggers): installing the new College of Sanction; adopting rules and procedures in line with international standards. The rules and procedures would enable AMMC to license and certify financial professionals performing key roles in capital markets and, with the independent sanction process, ensure business conduct and investor protection in line with standards in developed markets (results indicators). Prior Action 1 Indicative Trigger 1 Expected Results Per minutes (compte rendu) dated Board adopts rules and June 2016: AMMC has certified 50% of February 5, 2014, the Council of procedures of AMMC to finance professionals required to register Government (Conseil du implement Law 42-13 under Law 42-13 in trading, compliance, Gouvernement) has adopted the draft creating independent capital asset management, and financial Organic Law No. 12-14 on the higher market supervisor. analysis civil service, which Law is a prerequisite for the appointment of All members of College of Baseline June 2013: no certification the chairman of the Board of the new Sanction of AMMC have capital market authority (Autorité been appointed. Marocaine du Marché des Capitaux). Effecting government debt market reform 47. Morocco has achieved a fairly developed stage for its government debt market. However, the market needs a cleaner yield curve; the deteriorating fiscal situation has increased price volatility; and pension funds have reduced the duration of their Treasuries holdings—to match the falling duration of liabilities. Over the past two years, a Bank-funded TA project has enabled the MEF’s debt management office (DMO) to: (i) improve its benchmark policy, reducing the                                                              6  The phosphates company has started issuing MAD-denominated bonds to build an investor base.  16      fragmentation of the debt and enhancing liquidity of key bonds; (ii) revise the Primary Dealers' agreement, establishing price quoting obligations and increasing incentives to provide liquidity in the secondary market; (iii) launch an electronic trading platform, supporting price transparency and liquidity through an innovative architecture (one trading system with two segments: business-to-business; and business-to-consumer); (iv) launch a DMO securities lending facility. This package constitutes the core of debt market reform. 48. The 2012 Budget Law gave MEF authority to conduct securities lending with Primary Dealers. This facilitates active market-making, as Dealers can now call on DMO to obtain securities temporarily unavailable in the market. MEF has also entered into agreements with Primary Dealers to post continuous, tradable prices for selected securities on a new “click and trade” platform. Over time, the reform will help reduce the number of separately-identified securities. A proliferation of separately-identified securities hinders market deepening, as no security has large enough outstanding volume to support market liquidity. However, Morocco’s benchmark building has slowed, as investors prefer shorter maturities due to fiscal uncertainty and needs of pension funds to reduce duration (see Pillar B). Implementing the securities lending framework 49. Securities lending is a core building block for completing capital markets and ensuring more informative prices. Securities lending broadens the range of investors by allowing investors to sell securities that they borrow. Selling borrowed securities helps faster price corrections, thereby ensuring that prices fall more quickly in line with fundamentals. Otherwise, price corrections only occur when primary owners of securities sell, a concern in Morocco because of the weight of captive institutional investors. In the government debt market, securities lending allows Dealers to quote continuous prices in the secondary market. Primary Dealers borrow from the Treasury repo facility certain securities temporarily unavailable in the market. In this way, they replenish the inventory they need to ensure liquidity. Results Chain: By signing agreements with Primary Dealers (prior action), continuous prices for selected securities have become available to market participants subscribing to the data feed from the new trading platform. Continuous prices will facilitate the pricing of new corporate debt, and interest rate and foreign exchange swaps. Market deepening will also occur by reducing the number of securities (results indicators). Prior Action 2 Indicative Trigger 2 Expected Results The Ministry of Economy and June 2016: continuous prices posted on Finance has launched the reform of Bloomberg for the following securities: the government debt market by (i) less than 1 year residual maturity, less transmitting, on March 12, 2014, than 2 year residual maturity, more than draft agreements to the six primary 10 year residual maturity, 5 year dealers (intermédiaires en valeurs du benchmark, 10 year benchmark Trésor), that set forth their commitment to quote continuous, Baseline June 2013: no tradable prices tradable prices for a panel of Treasury securities; and (ii) Reduction in number of separately concluding one of said agreements identified securities from 77 in June 2013 on March 14, 2014. (baseline) to 60 in June 2016 17      50. Morocco lacked an effective securities lending framework until 2013. The GOM has adopted a new legal framework to encourage holders of securities to lend them in the certainty of getting them back. It will also provide a new source of revenue for large holders of securities. 51. The benefits of securities lending for capital market development come with new risks, and therefore new responsibilities for financial sector supervisors.7 Morocco will need to prepare implementing regulations that address the participation of potentially large non-resident investors relative to the size of the market, the scope for temporary limits on short-selling of financial firms in case of systemic distress, in addition to more standard disclosure rules on the frequency and details of short positions, rehypothecation rules, fails, etc. The WBG supports this work through FIRST-funded TA. Results Chain: MEF issues the master agreement governing securities lending (prior action). MEF adopts and publishes the regulations enabling securities lending transactions (indicative trigger). The central depository begins recording the lending and borrowing of securities (results indicator). Prior Action 3 Indicative Trigger 3 Expected Results By Order (Arrêté) No. 2840-13 dated MEF approves new June 2016: securities lending contracts December 26, 2013 published in the regulations for securities regulated and recorded in central National Gazette No 6236 dated lending to implement Law depository March 6, 2014, the Minister of 45-12 Baseline 2013: no regulated securities Economy and Finance has issued the lending, no recording in central depository master agreement (modèle type de convention cadre) for securities lending, as required by Law No. 45- 12 published in the National Gazette No. 6124 dated February 7, 2013. Building a central clearing counterparty to enable the derivatives market 52. The authorities are aware that the trading of the new capital market instruments requires rigorous standards of clearing and settlement finality. Existing market infrastructures lack a robust central clearing counterparty (CCP) to manage such risks. CSEx houses a CCP for the cash market; Maroclear settles gross the government securities, and settles net the non- government securities. The failure of a participant in the payment and delivery chain could disrupt the market and trigger a contagion cascade. The adequacy of CSEx margin rules and of its CCP fund should be stress tested on a regular basis using representative price volatilities and correlations. Moreover, risks arising from tiered participation are insufficiently recognized, as the same prudential rules apply both to clearing and trading brokers. 53. In addition to risks in clearing and settlement in the cash market, work is also needed to manage risks arising from the clearing and settlement of new instruments introduced by the law creating an organized, exchange-traded derivatives market. This law mandates a dedicated CCP                                                              7  See FSB Policy Framework for Addressing Financial Stability Risks in Securities Lending and Repos, 2013.  18      to identify, monitor and mitigate the risks in the settlement of derivatives trades.8 To this end, BAM is leading consultations with the industry on creating a new CCP. The World Bank supports the authorities’ reforms by conducting an assessment of the Principles for Financial Market Infrastructures (PFMIs) of CPSS-IOSCO during the forthcoming FSAP Update. 54. The supervisors (BAM and AMMC) have agreed with MEF and industry participants to merge at a later stage, the derivatives CCP with the existing cash CCP. This is needed to achieve stronger risk management, benefit from economies of scope, and ensure business continuity in case of default by members of these CCPs. These efforts strengthen the CFC project by creating trust of foreign investors in the integrity and resiliency of the Casablanca financial market place. Results Chain: By communicating to the industry the rules and procedures for operating the new CCP (prior action), MEF launches the implementation of the derivatives law. The assessment of the CCP against the PFMIs and other work will allow MEF to issue regulations for the trading, clearing and settlement of derivatives (indicative trigger). Market activity will be shown in the recording of trades in the new CCP (results indicator). Prior Action 4 Indicative Trigger 4 Expected Results By letters dated March 7, 2014, the MEF approves regulations June 2016: all derivatives traded on the Ministry of Economy and Finance for the trading and for the regulated market are cleared and settled has communicated to market clearing of derivatives to through central clearing counterparty institutions the rules and procedures implement Law 42-12. Baseline 2013: no regulated trading and (règlement général) for the central centralized clearing of derivatives clearing counterparty (chambre de compensation) created by Law No. 42-12 creating an organized derivatives market (marché à terme). Pillar B: Reforming pension system to ensure continued institutional demand for capital market securities Implementing the parametric reform of CMR 55. The pension system in Morocco is largely PAYG (defined benefit) with four distinct schemes: two mandatory for the public sector (Caisse Marocaine de Retraite (CMR) for civil service; Régime Collectif d’Allocation des Retraites (RCAR) for SOEs); and two for private sector—one mandatory (Caisse Nationale de Sécurité Sociale (CNSS)) for salaried employees, one (Caisse Interprofessionelle Marocaine de Retraite (CIMR)) for specific professions.9 However, Morocco needs to increase coverage (Figure 2), as 40 percent of the labor force works in agriculture. 56. The current pension promise in Morocco is large by international standards, reflected in both high accrual rates and high replacement rates (Figure 3). As a result, all schemes are unsustainable to varying degrees, especially those burdened by adverse demographics—rising                                                              8  Swaps among financial institutions and with large non-financial corporates are common but cleared bilaterally. Risks associated with bilateral contracts have been underscored during the global financial crisis, and a major aim of G-20 reforms is to control such risks through CCP clearing, with a strong focus on risk management of the CCP.  9  Some schemes include defined contribution elements through point-systems accruing notional rights.  19      dependency ratio of beneficiaries to contributors. This is most pressing for CMR, which will turn cash flow negative in 2014. Without reform, the supply of long-term saving arising out of mandatory pension schemes will lose its anchor:  Contributions to CMR will exceed its payments of benefits starting in 2014;  The continuation of deficits would force CMR to sell its reserves (8 percent of 2013 GDP) by 2022. At that point, payments would stop, or the budget would take over at a projected initial cost of 2-3 percent of 2013 GDP per year; 10  The fiscal burden would grow further as the ratio of retirees and survivors to contributors is projected to ratchet up from 40 percent in 2012 to above 100 percent by 2030. Figure 2: Coverage of Mandatory Pension Systems in MENA (% of labor force) ECA average Tunisia Turkey Jordan Iraq Iran Morocco Djibouti West Bank Gaza Yemen Lebanon 0% 20% 40% 60% 80%   Source: HDNSP database (note: data refers to different years between 2005 and 2012) Figure 3: Unaffordable pension promises, Morocco Schemes v. Selected OECD Accrual Rates Net Replacement Rates Pension accrued per year of contribution, %of earnings. After-tax pension, % of net earnings for aver. worker. Source: World Bank calculations on authorities’ data, and OECD.                                                              10 CMR numbers exclude the military scheme. Its reserves ran out in 2012, but the law mandates payment of pensions from the budget, currently resulting in budget expenditures of about 1 percent of GDP.  20      57. CMR imbalances would create dislocations in the capital markets. Without reform, CMR must sell its large reserves by 2022. It already shortened the duration of its assets, mainly Treasury securities, thereby undermining the development of longer-maturity benchmarks and the Treasury’s intention of reducing the number of outstanding lines of government securities. 58. The authorities have been keenly aware of pension imbalances since the late 1990s, and commissioned several studies that culminated in 2012. A National Technical Commission recommended to the Government a reform consisting of:  parametric reform of CMR to delay the onset of deficits by enough years to prepare a more comprehensive reform;11  creating a less generous public sector pole able to grandfather legacy pension rights of the reformed CMR, with a funded defined contribution pillar to diversify pension risk;  at a later stage, also merging the two private sector schemes and broadening coverage. This proposal was endorsed by the State Accountability Court (Cour des Comptes) and reflected in the policy paper that GOM sent to Parliament in October 2013 with the 2014 Budget Law. 59. The Bank has assessed the reform of CMR. The proposed parametric changes would increase retirement age, contribution rates, reduce accrual rates, with the expectation to reduce CMR implicit debt by 45 percentage points of 2013 GDP while maintaining existing pension rights. Although the reform would still leave CMR implicit debt of 22 percentage points of 2013 GDP, it would protect capital markets from a precipitous selling of reserves and lay the ground for comprehensive reform later. 60. After extensive consultations that began in 2003 in the National Technical Commission comprising all stakeholders, the outline of CMR reform has been made public in 2013. Legacy rights would be respected, meaning that the old parameters would be used to calculate pension rights for pre-reform years of service, while the new parameters will be used for the post-reform years of service. Subsequently, both CMR and RCAR would close to enrollment, and new employees would come under in a less generous pole with a defined contribution and a defined benefit pillars. Agreement on specifics still requires negotiations between the GOM (as employer) and stakeholders (as contributing employees and as retirees paying income tax on pension benefits). The GOM aims to finalize negotiations in time to prepare legislation for adoption in 2015, with the reform becoming effective no later than 2016. Because the timetable is ambitious, it also carries risks of delays if negotiations become contentious. 61. To support the second stage of the reform, the Bank has completed an assessment on merging CMR and RCAR. Preliminary findings are that the defined benefit pillar would imply a replacement rate of about 40 percent to ensure long-term viability, and possibly cover some of CMR’s implicit debt, with the budget paying the rest—the forthcoming negotiations will define these aspects. The 40 percent gross replacement rate would be achieved through an accrual rate in the low 1 percent, higher pensionable age, a contribution rate in the low teens, lifetime salary                                                              11 The GOM’s proposal is to increase retirement age and contribution rates, reduce the accrual rate and change the calculation of benefits from final year salary to an average of the last 8 to 10 years. 21      averaging, and some valorization and indexation appropriately adjusted for taxation of pension benefits. According to Bank estimates, the reformed public sector pole as outlined above would bring Morocco’s replacement rates in line with advanced countries, and close substantially the gap between the private and public sector. 62. The adoption of a legislative package creating a public pole from CMR and RCAR, including the introduction of a funded defined contribution pillar, would take place after the proposed DPL. After that, increasing coverage in the private sector is a challenge that cannot be addressed by contributory, employment-based regimes. Other approaches are needed to reach uncovered workers, particularly those in rural areas. These might comprise a basic, non- contributory scheme financed from the general budget and incentives to join a voluntary system through government contribution matching. 63. The authorities are keen on the Bank supporting their broader vision through another DPL dedicated to comprehensive pension reform. Naturally, the proposed programmatic DPL series targets the capital market angle of pension fund sustainability. However, the work that the Bank is delivering in support of the initial stages of pension reform could inform future Bank engagement, which would be designed around efficiency, security, inclusion and adequacy. Results Chain: The GOM makes public the outline of the reform of CMR (prior action) and starts negotiations with stakeholders. The GOM adopts legislation to implement the parameters of the reform (indicative trigger). The first deficit for CMR is postponed by at least eight years compared to the baseline (results indicator). Prior Action 5 Indicative Trigger 5 Expected Results The plan to reform the civil service The Council of June 2016: actuarial calculation forecasts pension fund (Caisse Marocaine de Government adopts the year of first CMR deficit after 2022 Retraite) has been made public through draft law specifying the the Government’s position paper (note parameters of CMR Baseline June 2013: actuarial calculation de présentation de la loi de finances) reform. projects 2014 as year of first deficit transmitting the draft 2014 Budget Law to Parliament, as published on the website of the Ministry of Economy and Finance. Pillar C: Fostering solutions for the financing of small and young enterprises 64. Economic competitiveness depends on SMEs having access to equity and debt finance. Banks are inclined to finance incumbents that have achieved a certain size and control tangible collateral. For their part, financial markets can be alternatives to banks for relatively transparent enterprises that seek to diversify their financing and reduce their financing costs through competition between markets and banks, or need financial services more typical of investment banking. The potential for creating sustainable jobs by competitive SMEs suggests a need to support this type of enterprises. Many OECD (Organization for Economic Co-operation and Development) countries have redoubled efforts to develop innovative financing for small and young enterprises since the global financial crisis. 12 Emulating countries that pursue policies to                                                              12  See OECD 2012, “Financing Policies to Promote Growth and Development of SMEs,” and OECD 2013, “Policies for Seed and Early Stage Finance.” For MENA, see “Entrepreneurship and SME Policy Regime in five MENA countries,” OECD 2013.  22      help sectors take off, Morocco is pushing activities where it enjoys competitive advantages (car assembly, aeronautics, agro-foods, renewables, and finance). 65. Morocco has made inroads in expanding access to finance for SMEs. They account for about a quarter of banks’ loans and two thirds of leasing assets. However, while Morocco leads in the region for several indicators of SME access, bank lending still focuses on larger companies with more readily pledgeable collateral.13 The GOM wants to supplement broad-based capital market reform with policies that encourage new solutions for financing small and young enterprises. Improving SME access by expanding the range of Government guarantees and co-investing 66. The GOM’s strategy to improve SME access is based on guarantees and co-investments put in place by MEF and managed by the Credit Guarantee Institution (CCG). CCG is the key vehicle of government policies toward small and young enterprises. CCG has adapted its traditional guarantee products to better leverage banks’ strategies towards SMEs. CCG provides generic guarantees to SME loans at all their stages of development (start-up, development, restructuring and working capital) and a specific product, named “Damane Express,” targeting small enterprises. Damane Express uses simplified eligibility criteria and banks as agents, and does not differentiate among types of loan. Guarantees are paid rapidly based on electronic feeds from banks. 67. The GOM tasked CCG under its strategic plan for 2013-16 to expand the menu of guarantees, such as on receivables for small exporters, guarantees that facilitate ownership changes and SME succession planning, and for leasing companies. The strategy also calls for regional outlets to familiarize the financial chain with its products. CCG has boosted its production particularly via its presence in the regions. The Bank supports GOM and CCG through a TA Program - funded by a joint World Bank-IFC MENA Region MSME Technical Assistance Facility - aimed at reviewing its institutional set-up, delivery model and risk management. 68. The strategy also authorizes co-investing with private funds in small and young enterprises. The public-private funds would combine public capital/grants with private capital and management, along the lines of existing funds targeting SMEs already in the expansion phase (Figure 4). Some start-up initiatives already exist (Technopark Casa, Centre Innovation, Maroc Entreprendre, Emergence Invest, etc.), but do not yet reach start-ups below the first stage. Under a new technical assistance activity the Bank will assist MEF in launching a public-private fund dedicated to such enterprises. 69. Modern secured transactions systems result in greater SME access to credit, lower NPLs (Djankov, McLiesh, Shleifer, 2005; Love, Peria, Singh, 2013), and a lower cost of credit (Lago, Lopez, Saurina, 2007). Modern systems allow ready pledging of movable assets such as equipment, inventory, receivables, cash flows, livestock, crops, etc., as collateral for loans. Secured transaction laws and electronic registries also underpin capital market instruments such                                                              13 See WPS 5607 “Bank Lending to SMEs in MENA: A Joint Survey by Union of Arab Banks and World Bank.”  23      as securitization. Morocco’s secured transactions system needs overhaul. The legal framework should govern the creation, priority, publicity and enforcement of interests through extra judicial repossession, and create a centralized electronic registry. The registry should: allow access to qualified users via internet; provide automated acceptance or rejection of notices in real time; produce automated search results; generate automated charging of fees and collection of payments; and be tamper-proof. The authorities have received Bank/IFC recommendations to this effect and cooperate with the European Bank for Reconstruction and Development (EBRD) to develop the framework. Results Chain: The CCG expands the scope of its support of small and young enterprises’ access to bank loans and equity, by adopting its 2013-16 strategy (prior action). Under the strategy, the CCG designs and implements a public-private fund for co-investing with private capital in start-ups (trigger). At the end of the chain, larger numbers of small and young enterprises gain access to various modalities of finance, and the CCG portfolio becomes more regionally diversified (expected results). Adopting a modern secured law (trigger) would authorize MEF to issue implementing regulations and establish a centralized e-registry for movable collateral (expected result). Prior Action 6 Indicative Trigger 6 Expected Results By Resolution of its board No. 7 The CCG launches a public- CCG co-investing: from 130 million dated July 3, 2013, the Borrower's private fund dedicated to MAD in June 2013 to 400 million MAD credit guarantee institution (Caisse start-ups. by June 2016 Centrale de Garantie) has adopted its 2013-16 strategic plan, which, inter Council of Government Number of new small or young alia, expanded bank guarantees and adopts the draft law on enterprises reached: 3,000 from June created new solutions for financing secured transactions. 2013 to June 2016; baseline: 1,572 from small and young enterprises. June 2010 to June 2013 Number of new CCG outlets in the regions: 6 by June 2016; baseline: 2 in June 2013 Creation of centralized collateral registry Modernizing the legal framework for private equity and venture capital investing 70. A vibrant private equity industry has become critical in modern economies to support the growth of companies in their expansion phase and prepare them for possible access to the capital market (Figure 4). The industry is no less critical to attract domestic and international investors in large infrastructure projects via private equity infrastructure funds. Morocco has had a legal framework for Private Equity/Venture Capital (PE/VC) investments since 2005. However, the 2005 law limited the allowed investments, did not foresee the possibility of funds with compartments, and generally overregulated the industry. As a result, the supply of “investment ready” SMEs under the current law fell well short of funds committed to PE/VC, and only the most patient investors could stay the course. 71. After extensive consultations, the GOM has adopted a new draft law on private equity. The new draft widens the scope of investments eligible for favorable taxation, permits funds with compartments, and generally aligns its regulatory framework on competing jurisdictions. It is expected that, after adoption by Parliament, the AMMC would rapidly register at least three new 24      funds. It would then take some five more years of investing and grooming the portfolio before companies or infrastructure projects could be floated on the capital market. Figure 4: Equity Finance Eco-System   Source: OECD, Committee on Financial Markets, October 2012. Results Chain: The GOM adopts the draft PE/VC law (prior action). After parliamentary approval and promulgation, AMMC will register at least three new funds (indicative trigger). Outcomes will not be observable until after closing of the proposed programmatic series. Prior Action 7 Indicative Trigger 7 Expected Results Per minutes (compte-rendu) dated AMMC registers at least three March 13, 2014, the Council of funds under the new Government has adopted the draft law framework for private equity No. 18-14 on capital investment and venture capital. mutual funds (organismes de placement collectif en capital), which will modernize the framework for private equity and venture capital which will invest, inter alia, in small and young enterprises. Introducing credit scoring for SMEs 72. Credit reporting systems help SMEs build track records and leverage this reputational collateral to access finance. Lenders use credit bureau data to enter new markets, and regulators can monitor systemic risk and calibrate macro-prudential tools. In Morocco, reporting to the private credit bureau has been mandatory for banks and finance companies. Since 2011, MFIs 25      also report, with plans to extend coverage to telecoms and other utilities. As of 2012, the bureau had 5.5 million contracts in its database covering 3.3 million individuals and 110,000 firms. 73. BAM will license a second private bureau to generate competition among bureaus around more advanced services. The existing system has sufficiently rich data to market credit scoring services by 2014. A task-force is making good progress to develop a uniform identifier system. This work assumes particular importance for the new securitization law of September 2013, in light of the high granularity, traceability and overall data intensity of securitization.14 Results Chain: By announcing the operator of the second credit bureau (prior action), the Central Bank will be in a position to review and approve a license that mandates credit scoring of SMEs in 2015 (trigger). By the end of the program, the credit bureau will produce credit scores for a material share of SME borrowers (expected result). Prior Action 8 Indicative Trigger 8 Expected Results By communication (attestation) dated The Central Bank issues a June 2016: credit scoring product March 13, 2014, the Central Bank license to the entity selected offered by credit bureaux has confirmed selection of the for establishing a second commercial entity that will be credit bureau with the June 2013: no credit scoring product licensed to operate a second credit requirement to provide a offered by credit bureau bureau. credit scoring service for SMEs. Pillar D: Consolidating oversight to balance greater access with continued financial stability 74. Morocco stands out as having in place tested coordination arrangements for crisis preparedness and management among financial sector agencies. Recognizing the growing linkages among regulated institutions, including a prevalence of conglomerates with important banking arms, the 2006 Banking Law created a committee of supervisors tasked with coordinating regulatory initiatives. In 2009, Morocco was first in MENA to conduct a Bank-led crisis simulation exercise (CSE), whereby BAM and MEF simulated a systemic crisis scenario. Lessons have been incorporated into a Memorandum of Understanding (MOU) covering information sharing and decision making in crisis situations.15 Finally, in March 2013, BAM has implemented a reorganization that formally embeds a macroprudential policy pillar in its structure, with regularly updated early warnings for six types of risks. 75. The 2009 CSE led to an ambitious new banking law to strengthen the stability framework (Box 2). The draft law has been adopted by the Government in February 2014 and is under discussion in Parliament. An oversight council on systemic risk will be responsible for monitoring systemic risks and proposing macroprudential mitigation measures. The draft law provides for modern deposit insurance, more assertive bank intervention and resolution, and a new regime for the supervision and resolution of financial conglomerates. The law also gives BAM licensing authority over microcredit (see Annex 7).                                                              14  Bank and MEF are preparing a review of local accounting standards to meet the data intensity of securitization.  15  The Government does not have a pre-announced policy for intervening distressed institutions, to guard against moral hazard. Interventions are last-resort measures according to an MOU signed by the Government, BAM and CDVM in June 2012.  26      76. The draft law provides a wide definition of financial conglomerates, thereby expanding the perimeter of supervision as a policy to ring-fence the financial part of a conglomerate.16 The draft law mandates BAM and the systemic risk council, to develop implementing regulations to ensure that supervisors have the information and powers to control risks within the conglomerates, verify that the solvency and liquidity buffers of the banking part of a conglomerate cannot be tunneled out, mandate specific disclosure rules, and be satisfied that living wills conform with the Key Attributes for the Resolution of Systemic Institutions. In this regard, the regulations will specify the ability (legal power and tactical processes) of supervisors to promptly “wall off” negative implications for the financial entities within a conglomerate from heightened risk presented by non-financial entities and to order financial or other material support from the parent holding to financial affiliates in the conglomerate. Box 2. Key amendments to the 2006 banking law (“loi établissements de crédit et organismes assimilés”) Broadening the regulatory scope:  Financial conglomerates: new regime potentially introducing top-up requirements on solvency, liquidity, large exposures, arm’s length transactions, with strengthened coordination among regulators.  Microcredit: BAM becomes the licensing authority and exercises sole supervisory responsibility;  New category of licenses created for entities solely providing payment services (e.g. prepaid cards, mobile payments, etc.). Strengthening prudential requirements:  BAM empowered to block any participation which may hinder effective supervision (i.e. not only when exceeds 15 percent stake);  Stronger bank governance: audit and risk management committees at board level, minimum number of independent directors, power to oppose directors with too many mandates. Creating a structured framework for financial stability:  New systemic risk council of financial regulators and MEF responsible for assessing systemic risks and proposing mitigation policies;  New governance for deposit insurance scheme (i.e., operational independence from BAM),  New bank resolution framework. Bank competitition:  Coordination with Competitition Council (“Conseil de la concurrence”) on bank mergers. 77. Observance of Basel Core Principles was assessed as very high in the 2008 FSAP Update. BAM continues to strengthen macro-financial surveillance to catch risks early on and take corrective action. BAM has recently focused on cross-border risks in light of expansion into Africa by the leading groups. In 2010, BAM fielded missions to assess risks arising from such operations. In 2011, BAM signed MOUs with local regulators to ensure information exchange and the ability to conduct inspections in those countries. BAM is also building capacity under Pillar 2 of Basel pertaining to the Supervisory Review and Evaluation Process of bank risk appetite. New early warning tools have been developed for the identification of risks (in banks and system). Scenarios run on these tools help calibrate risk-weights on specific exposures                                                              16  Moroccan financial conglomerates (FC) span finance, real estate, telecom, tourism. Although FCs control 53 percent of financial system assets, they are mainly involved in non-financial activities (70 percent of their balance sheet). BAM also supervises CDG, a state-owned FC created by a 1959 law. As of December 2012, CDG had 141 subsidiaries of which 93 in the consolidation perimeter.  27      and/or capital and liquidity buffers that are then submitted to bank managements in the context of Pillar 2 discussions, as well as fed into macroprudential policy making. 78. BAM intends to conduct a second CSE in 2014 and requested Bank support to benefit from best practices. A FIRST-funded CSE will test Morocco’s evolving informational, legal and governance arrangements, particularly as the risk council will comprise newly independent supervisors for insurance, pension and capital markets. Together the new CSE and the Joint Forum assessment will help BAM meet G20/FSB expectations as concerns key attributes for effective resolution of systemically important financial institutions, as well as risk management, aggregation and reporting for such institutions. 79. Besides BAM, the other members of the systemic risk council will need to build capacity to identify and mitigate risks through macroprudential means, particularly as regulated entities begin to use capital market products more actively and often within a conglomerate structure. Indeed, ACAPS has conducted a guided self-assessment of the Insurance Core Principles under a FIRST project to implement risk-based supervision of insurers. The assessment will help formulate a work plan to bring ACAPS up to international standards, and thereby allow it to contribute to the risk council. For its part, AMMC will conduct an assessment of the IOSCO Principles and Objectives of Securities Regulation under the planned 2014 FSAP Update. This standard has been upgraded following the global crisis, and now comprises two principles on the role of capital market authorities in monitoring and mitigating system-wide risks arising from destabilizing practices by regulated and less well regulated intermediaries. The assessment will help formulate an action plan for AMMC to comply with the two new principles, and thereby effectively contribute to the risk council. Results Chain: The GOM adopts the new banking law (prior action) thereby formally launching, among other things, the work program of the risk council. BAM, in coordination with the risk council, proposes to the MEF the regulations implementing the new regime for the supervision and resolution of financial conglomerates (FC) (indicative trigger). AMMC, as member of risk council, meanwhile completes assessment to IOSCO Principles (indicative trigger). At the end of the chain, the regulatory framework for FC becomes effective and AMMC complies with IOSCO Principles pertaining to system-wide risk (expected results). Prior Action 9 Indicative Trigger 9 Expected Results Per minutes (compte-rendu) dated MEF approves the regulations Financial conglomerates communicate January 16, 2014, the Council of implementing the regime for to supervisors their internal Government has adopted draft Law financial conglomerates. arrangements for the identification, No 103-12 on credit institutions, management and reporting of risks per AMMC completes assessment which will create the oversight the new regulations by June 2016. of IOSCO Objectives and regime for financial conglomerates Principles of Securities AMMC complies with IOSCO and will give the Central Bank Regulation. Principles 6 and 7 on the perimeter of licensing authority over microcredit regulation and maintaining financial institutions. stability by June 2016. C. CONSULTATIONS AND ANALYTICAL UNDERPINNINGS 80. The GOM has conducted extensive consultations with professionals, industry groups, associations and international partners on the reforms supported by this DPL. Draft laws adopted by the Council of Government benefitted from public comment periods that give citizens the 28      chance to express an opinion if they feel they have not been heard during the consultations that informed the drafting process. In the area of pension reform, the analytical work started in 2003, and the numerous subsequent consultations included contributors and beneficiaries represented by unions and associations. The following table provides details on consultations and analytical underpinnings. CONSULTATIONS BY THE AUTHORITIES SELECTED UNDERLYING STUDIES AND ANALYSES Pillar A—Program Development Objective A: Deepening capital markets by broadening the range of instruments and investors. 1. Establishment of independent capital market supervisor Law creating AMMC debated and adopted by Parliament. FSAP Update 2008 The draft law was subject to public comments before Assessment of CDVM against IOSCO Principles and adoption by the Council of Government and before Objectives transmittal to Parliament. 2. Reform of government debt market Consultations with Primary Dealers and institutional TA funded by FIRST in 2012-13 to establish investors in context of Bank-led TA project, including government yield curve joint selection of platform for price dissemination. 3. Framework for securities lending Law on securities lending debated and adopted by Studies by industry groups and securities lawyers to Parliament. Draft law was subject to public comments prepare master agreement adapted from international before adoption by Council of Government. Master practices. agreement developed in close consultations by users in the industry. 4. Rules and procedures for central clearing counterparty on derivatives Law on derivatives market debated and adopted by Working group led by Central Bank delivered a Parliament. The draft law was subject to public comments technical report on setting up a central clearing before adoption by the Council of Government for counterparty transmittal to Parliament. MEF/EBRD seminar in 2013 on trading and clearing of derivatives Pillar B—Program Development Objective B: Reforming pension system to ensure continued institutional demand for capital market securities 5. Reform of civil service pension fund Consultations since 2003 in context of the National ILO review of draft report of National Technical Technical Commission, comprising representatives of Commission beneficiaries, contributors and MEF. Conference on Final report on CMR reform transmitted to pension reform attended by Ministers in September 2012. Government, 2012 Outline of reform posted on Government’s website with Report of Cour des Comptes, 2013 the draft 2014 Budget Law. Pillar C—Program Development Objective C: Fostering solutions for the financing of small and young enterprises 6. New solutions for financing small and young enterprises 29      The Board of CCG comprising representatives from the Several joint working groups, public/private and banking industry, leasing, non-financial business users/providers contributed to the strategy, and associations, and MEF adopted the 2013-16 strategy. Law reported to the Board on secured transactions being prepared by MEF, in EBRD provides advice on the secured transactions collaboration with Ministry of Justice and Ministry of law Commerce, and with extensive inputs from industry IFC provides advice on the centralized collateral groupings registry 7. Law on private equity/venture capital Draft law has been subject to formal public comments, Industry conference held in March 2013 opened by after extensive comments from industry group on the Minister of Finance and co-organized by international MEF’s draft. PE/VC association 8. Establishment of second private credit bureau Two international private operators conducted market analyses and expressed interest in formal bidding process. Pillar D—Program Development Objective D: Consolidating oversight to balance greater access with continued financial stability. 9. New law on credit institutions The draft law was subject to public comments before FSAP Update, 2008. adoption by the Council of Government for transmittal to Crisis simulation exercise, 2009. Parliament. D. LINK TO CPS AND OTHER BANK OPERATIONS 81. The 2014-17 CPS for Morocco retains, under its proposed “Inclusive and Competitive Growth” Pillar, financial sector reforms as a cornerstone of the strategy of the WBG toward Morocco. The aim is to address outstanding issues preventing Morocco's financial system from fulfilling the catalytic role of capital markets in promoting competitiveness through stronger and better overseen investments, as well as extending access of small and young enterprises to finance. Governance has strong transversal emphasis throughout the CPS, including through governance assessments of financial sector regulators. 82. This operation builds on the positive experience of the Bank’s past engagement in the financial sector. The CPS Completion Report assesses that Morocco’s strong commitment to carrying out financial sector reform and the Bank Group’s support to the financial sector during the period of the last CPS was overall satisfactory. The Implementation Completion and Results Report (ICR) of the 2010 Sustainable Access to Finance DPL (Report No. ICR 2310) notes that the operation helped strengthen the legal and institutional environment for financial intermediation and risk management, and increase the private sector’s participation in the provision of financial services. All targets of the 2010 Sustainable Access to Finance DPL were met and the operation’s outcome and Government’s performance were rated satisfactory. 83. A comprehensive stream of TA projects has been designed and funded from FIRST to deliver the expected results under the proposed operation (Box 3). 30      Box 3. Supporting implementation: TA financed by FIRST Initiative New projects Technical assistance financed by the FIRST Initiative will support the proposed DPL though a project that implements legal and regulatory changes in the capital markets. With the MEF as a recipient, it will contribute to the strengthening, broadening and deepening of Morocco’s capital markets by helping the authorities implement an enabling legal and regulatory framework for new products and activities (securitizations, securities lending, and SME exchange) and to increasing the capacity of the insurance and pension regulators to meet international standards on supervisory expectations. The project was approved in January 2014 and is leading to a larger multi- year FIRST TA project on Capital Market Development and SME Finance that MEF and WBG staff are finalizing for effectiveness in the second quarter of 2014.   The forthcoming project would: (i) help complete the legal and regulatory requirements for Sukuk, Real Estate Investment Trusts and increased use of derivatives; deliver strategies and measures aimed at completing capital markets (e.g. promoting foreign investment in government bonds, corporate debt market development, and market infrastructure such as CCP and Euroclearability); (ii) capacity building of financial sector agencies in supervising the use of new products; and (iii) new financing solutions for small and young enterprises (e.g. aiming at increased SME listings on the exchange, enabling environment for increased private equity/venture capital, implementation of public-private early stage financing solutions for young enterprises, and incentives to encourage long-term saving and the supply of risk capital.  In January 2014, FIRST also approved a project for BAM to develop dedicated regulations and supervisory protocols for cross-border conglomerates that control domestically important financial institutions, to be followed by a CSE on a fictional conglomerate. The CSE will help test Morocco’s evolving informational, legal and governance arrangements, particularly as the soon-to-be created oversight board on systemic risk will comprise the newly independent supervisors for insurance, pension and capital markets.  Ongoing projects  Started in 2013, the project on ‘Strengthening Insurance Supervision in the MENA Region’ helps ACAPS conduct a guided self-assessment against new IAIS standards in order to identify gaps in insurance regulation and supervisory expectations, and develop effective and time-bound remedial plans.   A FIRST-financed project on ‘Oversight and Regulation of Non-Bank Payment Service Providers’ helps BAM implement the provisions of the new draft banking law that will allow non-bank entities to provide payment services. The project, which started in 2013, helps to develop the needed oversight framework and regulations, as well as roadmaps for the further expansion of e-payment (government payments and remittances). Selected previous projects  The FIRST Initiative has had a long standing relationship in supporting Bank-executed TA in Morocco.  FIRST has financed the ‘Financial Crisis Simulation Program,’ a CSE focused on a cross-border bank, as well as ‘Strengthening Crisis Preparedness Policies and Procedures,’ which supported the implementation of recommendations from the CSE.  Under ‘Strategy and Instruments to Establish Reliable Interest Rate Benchmarks,’ the Bank worked with MEF to: (i) build benchmarks in the government securities market by organizing maturities, concentrating demand in auctions, and improving issuance predictability; (ii) implement e-trading and protocols for the secondary market; (iii) update the primary dealer agreement to support benchmark building and market liquidity (including obligation to quote continuous tradable prices); and (iv) support market-making through repo and securities lending. Under this DPL, MEF will issue the necessary orders to enable these reforms. Under ‘Introduction of covered bonds,’ the MEF developed the legal and regulatory framework for the issuance of covered bonds. 31      84. Other Bank-funded operations complement this proposed DPL. The Board approved a loan to Morocco in June 2012 as part of an MSME facility for MENA countries (MSME Development Project, Report No. 68550-MA). This loan supports the provision of partial guarantees to banks, facilitating lending to collateral-poor MSMEs. Bank/IFC has also entered into a Reimbursable Advisory Services agreement for the Moroccan Investment Authority, a new government vehicle co-investing with GCC funds into strategic sectors. The magnitude of mooted projects holds promise for capital market development in terms of new listings in the context of exits, corporate bonds, supplier chain finance, and innovative structuring of infrastructure finance.17 E. COLLABORATION WITH OTHER DEVELOPMENT PARTNERS 85. IMF and Bank teams have regular exchanges on macro-financial issues with a common understanding on the division of labor and a shared assessment of the critical macroeconomic challenges facing the country. Discussions focus on the respective work programs and recent macro-financial developments and prospects. Bank-Fund collaboration reflects the growing importance of transversal DPLs in the Bank’s portfolio. Fund staff participates in Bank project reviews, while Bank staff is consulted in the preparation of IMF missions and contributes to the Fund’s Article IV consultation missions to Morocco. The ongoing analytical work being carried out by the Fund team focuses on: (i) the medium-term outlook for public finances; (ii) an analysis of the real exchange rate; and (iii) the macroeconomic implications for Morocco of the global financial crisis and its aftermath in Europe. 86. The Bank collaborates closely with the IFC. IFC has worked with banks on SME banking, and helped develop the country’s credit information infrastructure, including assisting BAM to license a credit bureau. IFC’s support to microfinance has reached over 500,000 clients. IFC issued a MAD-denominated bond—the first domestic bond offering by a multilateral institution in Africa and MENA. IFC also has several investments in leading Moroccan banks, in particular banks pursuing cross-border strategies. 87. The IFIs agreed on eight modules of activity to assist Arab Countries in Transition following the G-8 Finance Ministers' Meeting of September 2011. The EBRD leads the module on the development of local currency capital markets; the Bank/IFC covered the government debt and equity markets during an assessment mission in March 2013. The IFIs will implement follow-up TA in a coordinated manner according to their respective mandates and expertise. V. OTHER DESIGN AND APPRAISAL ISSUES A. POVERTY, SOCIAL AND GENDER IMPACT 88. Reforms are expected to generate benefits for lower income households mainly through pension reform, as well as job opportunities through economic growth and SME growth in particular. Consultations on Morocco’s reform program supported by the Bank were conducted                                                              17  The GCC committed US$5 billion, compared to worldwide FDI inflows to Morocco of US$2.8 billion in 2012. 32      with stakeholders (financial institutions, donors, government authorities, industry associations, etc.) throughout the preparation of the DPL I. The Government remains committed to monitoring the distributional impact of all key reforms and economic events. 89. The reform of CMR will help avoid pension-related budgetary spending from crowding out key social programs in health or education. The implementation in the coming years of a “two-pole” pension system and, later on, broadening coverage, is also expected to improve social outcomes. Potential poverty and social impact analysis (PSIA) and Social Protection Assessment of Results and Country Systems (SPARCS)18 to be carried out during preparation of the second DPL would help harmonize policies, programs and delivery instruments. The development of credit scoring products for SME and microfinance borrowers will facilitate access to finance of credit constrained enterprises, thereby increasing the potential for job creation in the private sector and better social outcomes. 90. The gender impact would be indirect and consist of: (i) new financing solutions for women-led SMEs under the strategy of the CCG, including through more branches in Morocco’s regions; (ii) pension reform. The pension reform will be beneficial for women, notably through the planned introduction of explicit indexation rules. With life expectancy longer than men, indexation will mean better preservation of the purchasing power of women pensions. The move away from final salary to average will also benefit women, as men still have steeper career paths. Finally, the reform will preserve very generous existing survivorship pension promises: beneficiaries of survivorship pensions represent around 41 percent of all beneficiaries in CMR, and women represent 99 percent of survivorship beneficiaries. B. ENVIRONMENTAL ASPECTS 91. This operation supports a broad program of policy and institutional reforms, for which the environmental requirements of OP/BP 8.60 apply. Increased access to finance for SMEs is not expected to have material environmental impacts. The five largest Moroccan banks have participated in a training program on environmental and social risks within the framework of the World Bank-funded Morocco MSME Development Project which provides partial credit guarantees for loans to SMEs. In addition, the IFC holds equity stakes in banks that account for the majority of SME lending. These banks therefore follow rigorous protocols to screen and mitigate environmental impacts of their clients' investments. Finally, Morocco has developed a well-articulated legal and institutional framework for environmental protection. Law No. 12-03 approved in 2003 defines the requirements for Environmental Impact Assessments (EIAs), including review and oversight for implementation, such as national and regional EIA committees, as well as procedures for public consultation and disclosure. The monitoring and control framework has also been recently strengthened through the creation of national and regional observatories for environmental protection, and the introduction of an environmental policy.                                                              18  Siteresources.worldbank.org/socialprotection/Resources/28055-8138289492561/SPARCS_Concept_Note.pdf.  33      C. MONITORING AND EVALUATION 92. Responsibility for implementing the program rests with MEF in collaboration with BAM. MEF will take the lead in monitoring implementation and progress towards expected results. Bank staff will maintain close dialogue with stakeholders and counterparts and conduct periodic reviews in coordination with other IFIs. Dialogue will focus on the outcomes of the program and eventual adjustments, stakeholder support, and options for realizing the intended development goals. D. FIDUCIARY, DISBURSEMENT AND AUDITING 93. The Bank completed a Public Expenditure and Financial Accountability (PEFA) assessment in 2009 with the European Commission. The PEFA found progress in Public Finance Management (PFM). The PFM framework supports the achievement of fiscal discipline, strategic allocation of resources and efficient delivery. The budget and extensive supporting reports are available on the MEF’s website in a timely manner. Remaining challenges relate to: (i) improvement in budget classification; (ii) timeliness of annual statements, (iii) limited legislative scrutiny of external audit reports; and (iv) frequency and scope of audits and follow- up of recommendations. The Government is addressing these challenges under the First Transparency and Accountability DPL, and hence the PFM framework is adequate to support this DPL. 94. The IMF’s safeguards assessment of BAM of February 2013 found a robust framework with strong controls. Since then, BAM has implemented recommendations from the assessment, including publication of audited financial statements. Existing governance practices and safeguards will be enshrined in the new central bank law currently awaiting adoption by the Council of Government. 95. The proposed loan will follow the Bank’s disbursement procedures for development policy lending. Once the loan becomes effective, proceeds will be disbursed in compliance with the stipulated release conditions as defined in the Loan Agreement and in a single installment. The flow of funds (including foreign currency exchange) is subject to standard public financial processes. Loan proceeds will be deposited in a government account at the Central Bank and the equivalent of the funds in local currency will be transferred to the Treasury’s current account. The MEF will furnish to the Bank a confirmation of this transfer, advising that the total sum of the loan has been received in an account that forms part of the country’s official foreign exchange reserves and credited to the Treasury’s account. 96. The Bank reserves the right to ask for a transaction audit. This audit would cover the accuracy of the transactions, i.e., receipts and payments from a dedicated account, including accuracy of exchange rate conversions; confirming that the dedicated account was used exclusively for the purposes of the operation. Also the auditor will have to obtain confirmation from corresponding bank(s) involved in the funds flow regarding the transaction. The time period for submission of the audit report to the Bank is four months from the date a request for such audit is issued. 34      VI. SUMMARY OF RISKS 97. The overall risk of the proposed operation is rated Moderate. There is a risk of delays in implementing the reform of the civil service pension fund. While most measures in the GOM’s agenda supported by this DPL are technical (more access while maintaining stability), pension reform could cost political capital as it follows subsidy reform. However, there is substantial agreement in society on the content of the pension reform, and grandfathering existing pension promises will help to some extent. 98. Morocco faces challenges from an unfavorable external environment and internal social pressures. External factors relate to weak recovery in Europe, with which Morocco has major trade, tourism, remittance and FDI ties, as well as continued high prices on cereal and fuel imports critical to the welfare of many households. External factors have exacerbated demands to share prosperity more widely and create jobs. In the past, the political system has on occasions dealt with these demands at the cost of deteriorating external and fiscal accounts. 99. The dispensation arising from the 2011 elections (coalition government) has been characterized by slow implementation of the massive legislative agenda triggered by the new Constitution. In turn, the constitutional agenda has delayed legislative work on economic reforms that help improve the people’s socio-economic conditions, notably job creation in the private sector. The Government mitigates these risks by continuing consensus-building within the financial/private sector, and the Bank provides extensive technical assistance to support implementation. 100. Capital market development may over time challenge the dominance of banks in financing the economy. Demonstrating early on the independence of the new regulators through higher profile enforcement may also challenge entrenched interests. However, there is robust agreement among stakeholders on the merits of the reforms. Residual risks are mitigated through careful phasing of reforms and supporting technical assistance. 101. From a procurement perspective, fostering solutions for the financing of small and young enterprises complements GOM measures to level the playing field for SME bidding on public contracts. A March 2013 Decree governing public procurement provides that public entities allocate 20 percent (in amount) of contracts to SMEs. However, contract tracking from procurement through execution and payment remains unreliable, and payment delays represent a critical risk for SMEs, including application of penalties for arrears. The Bank and IFC are developing with the GOM a set of indicators that go beyond the current limited tracking, and close the gap between mandated procurement rules and their effective application over the entire payment process. 35      ANNEX 1: POLICY AND RESULTS MATRIX Prior Actions and Triggers Prior Actions: DPL 1 Indicative Triggers: DPL 2 Expected Results Pillar A—Program Development Objective A: Deepening capital markets by broadening the range of instruments and investors 1. Per minutes (compte rendu) dated February 5, 2014, Board adopts rules and procedures of June 2016: AMMC has certified 50% of the Council of Government (Conseil du Gouvernement) AMMC to implement Law 42-13 creating finance professionals required to register has adopted the draft Organic Law No. 12-14 on the independent capital market supervisor. under Law 42-13 in trading, compliance, asset higher civil service, which Law is a prerequisite for the management, and financial analysis All members of College of Sanction of appointment of the chairman of the Board of the new AMMC have been appointed. Baseline June 2013: no certification capital market authority (Autorité Marocaine du Marché des Capitaux). 2. The Ministry of Economy and Finance has launched June 2016: continuous prices posted on the reform of the government debt market by (i) Bloomberg for the following securities: less transmitting, on March 12, 2014, draft agreements to the than 1 year residual maturity, less than 2 year six primary dealers (intermédiaires en valeurs du residual maturity, more than 10 year residual Trésor), that set forth their commitment to quote maturity, 5 year benchmark, 10 year continuous, tradable prices for a panel of Treasury benchmark securities; and (ii) concluding one of said agreements on Baseline June 2013: no tradable prices March 14, 2014. Reduction in number of separately identified securities from 77 in June 2013 (baseline) to 60 in June 2016 3. By Order (Arrêté) No. 2840-13 dated December 26, MEF approves new regulations for June 2016: securities lending contracts 2013 published in the National Gazette No 6236 dated securities lending to implement Law 45- regulated and recorded in central depository March 6, 2014, the Minister of Economy and Finance 12. Baseline 2013: no regulated securities has issued the master agreement (modèle type de lending, no recording in central depository convention cadre) for securities lending, as required by Law No. 45-12 published in the National Gazette No. 6124 dated February 7, 2013. 36      4. By letters dated March 7, 2014, the Ministry of MEF approves regulations for the trading June 2016: all derivatives traded on the Economy and Finance has communicated to market and for the clearing of derivatives to regulated market are cleared and settled institutions the rules and procedures (règlement général) implement Law 42-12. through central clearing counterparty for the central clearing counterparty (chambre de Baseline 2013: no regulated trading and compensation) created by Law No. 42-12 creating an centralized clearing of derivatives organized derivatives market (marché à terme). Pillar B—Program Development Objective B: Reforming pension system to ensure continued institutional demand for capital market securities 5. The plan to reform the civil service pension fund The Council of Government adopts the June 2016: actuarial calculation forecasts year (Caisse Marocaine de Retraite) has been made public draft law specifying the parameters of of first CMR deficit after 2022 through the Government’s position paper (note de CMR reform. Baseline June 2013: actuarial calculation présentation de la loi de finances) transmitting the draft projects 2014 as year of first deficit 2014 Budget Law to Parliament, as published on the website of the Ministry of Economy and Finance. Pillar C—Program Development Objective C: Fostering solutions for the financing of small and young enterprises 6. By Resolution of its board No. 7 dated July 3, 2013, The CCG launches a public-private fund CCG co-investing: from 130 million MAD in the Borrower's credit guarantee institution (Caisse dedicated to start-ups. June 2013 to 400 million MAD by June 2016 Centrale de Garantie) has adopted its 2013-16 strategic Number of new small or young enterprises plan, which, inter alia, expanded bank guarantees and reached: 3,000 from June 2013 to June 2016; created new solutions for financing small and young Council of Government adopts the draft baseline: 1,572 from June 2010 to June 2013 enterprises. law on secured transactions. Number of new CCG outlets in the regions: 6 by June 2016; baseline: 2 in June 2013 Creation of centralized collateral registry by June 2016 7. Per minutes (compte-rendu) dated March 13, 2014, AMMC registers at least three funds the Council of Government has adopted the draft law No. under the new framework for private 18-14 on capital investment mutual funds (organismes de equity and venture capital. placement collectif en capital), which will modernize the framework for private equity and venture capital which will invest, inter alia, in small and young enterprises. 37      8. By communication (attestation) dated March 13, The central bank issues a license to the June 2016: credit scoring product offered by 2014, the Central Bank has confirmed selection of the entity selected for establishing a second credit bureaux commercial entity that will be licensed to operate a credit bureau with the requirement to June 2013: no credit scoring product offered second credit bureau. provide a credit scoring service for SMEs. by credit bureau Pillar D—Program Development Objective D: Consolidating oversight to balance greater access with continued financial stability 9. Per minutes (compte-rendu) dated January 16, 2014, MEF approves the regulations Financial conglomerates report to supervisors the Council of Government has adopted draft Law No implementing the regime for financial their internal arrangements for the 103-12 on credit institutions, which will create the conglomerates. identification and management of risks per the oversight regime for financial conglomerates and will new regulations by June 2016 AMMC completes assessment of IOSCO give the Central Bank licensing authority over Objectives and Principles of Securities AMMC complies with IOSCO Principles 6 microcredit institutions. Regulation. and 7 on the perimeter of regulation and maintaining financial stability by June 2016 38      ANNEX 2: LETTER OF DEVELOPMENT POLICY ltl#t ~t ROYAUM E DU MAROC ...... __ ~='--- -----'A= itJWI 1 .. .:c.._.:;_ .~H i )l), _ _ . . ___:;....:.,:_ LE M INISTR £ .J-~..»1 Premier Pre t d'appuj a une p o litique d e d eveloppem ent visant l'appro fonru ssement du marche des capitaux et le financeme nt des petites et moyennes entreprises Lettre d e politique d e d eveloppement Monsieur le President, Le Royaume du Maroc s'est inscrit resolument durant les deux dem.ieres decennies dans un processus de modernisation de son secteur financier afin d'accompagner et de soutenir le developpement ecooomique et social du pays. Les resultatS ont ete pri.ncipalement )'amelioration de )'inclusion financiere et de l'acces au financemenr des Petites et Moyennes E ntreprises (PME), le renforcement du role du marche des capitaux dans le financement de l'economie et Ia consolidation du cadre de contr6le et de supervision du secteur financier en vue d'assurer sa soliclite, sa p6:ennite et sa stabilirc. Ces rcformes onr permis de batir un secrcur fmancier moderne dote des principaux instruments financiers et institutions du ma.rche et d'uoe base solide d'investisseurs institutionnels. Le Gouvememenr a Ia volonte de continuer les efforts de modernisation et de developpemenr du secteur financier et de franchir une nouvelle etape dans ce processus en capitalisant sur les acquis. Nous souhaitons que Ia Banque Mondialc nous accompagne a nouveau dans cene nouvelle phase de rCformcs comme cela a etc fait avec succes dans le cadre des precedents programmes de dcvcloppement du secteu.r financier. Le n ouveau programme gouvememental en matiere de modernisation du secteur financier est structure aurour des principaux objectifs suivanrs : Poursuite de l'approfondissement des marches de capitaux en elargissant Ia gamme des instruments et des investisseurs pour que le secteur financier joue pleinement son role en matiere de mobilisation de l'epargne er de son allocation optimale pour le financemem de l'invcsrissement et de !'economic. Le laocement de la reforme du systeme de retraite pour garantir l'equilibre financier du systeme et sa viabilite dan s uoe perspective a long terme. Le reoforcement des solution s de financemem en faveur des petites et jeunes entreprises qui constituent uoc source importance de developpement sociocconornique perenne et de creation de richesse et d'emplois ; Le developpemeot du cadre de supervision et de surveillance des risques systCmiques afin d'assurer l'equilibre entre !'exten sion de l'acces au financemeot et les objectifs de stabilite financiere. Ces objectifs ont ere traduits dans les quatre ~ ~ers suivants du programme de developpemcnt propose pour un appui de Ia Banque Moncliale~   39      Piller A : p ours uite d e l'approfonclissement d es march es d e capitaux en elargissant Ia gamme des ins truments et d es investisseurs La loi relative a I'Autoritt~ Marocaine du Mru:che des Capitaux (AMMC) a etc promulguee debut 2013. Cette loi vient consacrer l'independance de l'autorire chargee de Ia supervision du marche des capitaux et Ia doter de prerogatives larges afin de lui permettre d'accompl..ir les missions qui lui onr ere devalues. L'independance de l'AMMC est un element de de Ia reformc du marche des capitaux et se materialise principalcmeot par l'independancc du President et du College des Sanctions. La mise en reuvre de cette loi necessite Ia nomination du President de I'AMMC. Le projet de loi organique n°12-14 regissant Ia nomination aux fonctioos superieures adopte en Conseil du Gouvememeot le 5 fevrier 2014, eo application des dispositions des articles 49 et 92 de Ia constitution, inclut l'AMMC commc etablissemeot a caractere strategique dont le president est nomme en cooseil des Ministres. Ce meme projet de loi coocerne egalement Ia nomination du President de l'Autorite chargee du cootr6le du secteur des assurances et de Ia prevoyao ce sociale (ACAPS) nouvellement instituee. A cet egru:d, le Gouveroement s'eogage a mettre en place les conseils d'administratioo de l'AMMC et de l'ACAPS des que Ia loi organique susvisee est adoptee par le Parlement et publiee. Uoe fois rnis eo place, le Cooseil d'administratioo de l'AMMC adoptera le reglement general de cette autorite. Ce document fixera ootamment les modalites de fooctionoement de cette institution, le dispositif de sanction, les modalites et les conditions d'habilitatioo de certaines professions finaocieres ainsi que les regles deootologiques applicables au personnel de l'AMMC. Soucieux d'ameliorer le fooctioonement du marchc de Ia dette publique, le Gouvem ement emend egalemeo t lancer uoe importante reforme du marche de Ia dette publique. Cette reforme devra permettre de reoforcer la rransparence et l'efficience de ce marche en precisant norru:nmeot les conditions de cotation des boos du T resor ainsi que les engagements que doiveot observer les interveoaots sur ce mru:che. Ainsi, le Gouvemement a prepare uo projet de conventions acooclure avec les intermediaires en valeurs du Tresor pour uo e coration co ntinue et ferme d'uo panel de boos du Tresor ce qui permettra une meilleure definition de Ia courbe des taux qui sert de reference de raux sur le mru:che de Ia dette eo general ainsi qu'aux operations de couverture. L'approfoodissement du marche de la dette publique sera egalement assure grace a Ia reduction sensible du oombre de !ignes des boos du Tresor en circulation. A fin de reoforcer Ia liquidite du marche des capitaux, le Gouvernement a egalemenr procede a Ia mise en place d'un cadre legislatif regissant les operations de pret de titres. L'operatioonalisatioo de Ia loi necessite Ia mise en place d'une convention cadre qui specific les obligations des parties preoantes et precise les modalites techniques de ces operations. Cettc convention, preparec en concertation avec les acteurs du mru:che, a ere approuvee par un ru:rete et publiee au Bulletin Officiel. Toutes les operations de p ret de titres seroot cnregistrecs au niveau de La plateforme du depositaire central pcrmettanr le suivi de ces operations. E nfin, le Gouvemement a presente au Parlement uo projet de loi etablissant les foodements d 'un marche a terme reglemeote d'insrrumeots financiers permettant aux enrrepriscs mru:ocaines de mieux couvrir leurs risques. Ce projet de loi prevoit Ia mise co place d'une chambre de compensation, coorrepartie centrale afin de securiser ces o peratio ns. Dans ce cadre, un projet de regiement genera) fixant Jes regies de fonctionnement de CCtte chambre a ete prepare Ct transmis aux institutions du marche et aux superviseurs pour recueillir leurs o bservations. Ce projet de reglement sera approuve par arrete. La prochaine etape coosistera eo !'evaluation de ladite chambre au regard des normes intemationalcs en matiere de securite et de stabilite financiere. Piller B : Lancement de la reforme du s ystemc d e retraite Le Gouvernement emend lancer une rCforrne integree des regimes de rerraitc pour gru:an~ l, l'equilibre financier du systeme et sa viabilite dan; une perspective a lo ng terme. Dans ce cadre, 1 :;> t'J     40      Gouvernement a annoocc comme premiere crape Ia reforme parametrique de Ia Caisse Marocaine des Retraites (CMR). Cet engagement a etc refletc dans Ia note de presentatio n de Ia loi de finances pour l'exercice 2014 tran sm.ise au Parlement. La mise en reuvre de cettc reformc passe par ]'adoption par le Gouvernement d'uo projet d'amendement de la loi relative au regime des pensions civiles qui permettra de reduire sen siblemeor sa dette implicite. La perennite de ce secteur sera egalement assurce par le controle confie a Ia nouvelle autorite (ACAPS) qui a ete do tee de pouvoirs larges et d' une indcpeodance confirmee. Son conseil autorisera Ia supervision sur site et hors site de nos regimes de retraite. Pilier C : Renforeement des solutions de financem ent en favew des petites et je unes entreprises Le Gouvemement enteod prornouvoir de nouvelles solutions de financerneot dediees aux petites et jeunes entreprises. Dans ce cadre, et en application de Ia strategic gouvemementale, le conseil d'Administration de Ia Caisse Centrale de Garantie (CCG) a adopte le plan de developpernent 2013 -16 de cette institution. Cette strategic Clargit le champ d'interventio n de la CCG po ur un meilleur acces des petites et jeunes entreprises aux prets bancaires et en capitaux propres. De meme, le Gouvemernent concevra et mettra en reuvre un fonds public-prive pour favoriscr le co- investissemeot dans les start-ups. L'objectif est de permettre a un plus grand nom bee de petites et jeunes entreprises un acces facilite a une gamme plus large de modes de financement adaptes ouverts a une frange d'eotreprises mal desservies ou exclues du systeme de financement dassique. De plus, le nouveau projet de loi relatif aux o rganismes de placement collectif en capital vise a apporter des solutions en matiere de financemeot en foods propres et quasi-fond s propres des entreprises en general et des PME eo particulier. Les principaux apports de ce projet de loi soot l'elargissement du champ d'application de Ia loi pour couvrir route l'activite de capital investissernent; une plus grande securisation du dispositif et le renforcement de Ia protection des invcstisscurs, une amelioration des techniques fmancieres utilisees et Ia promotion de l'investissement etranger dans le capital investissement. D'un autre cote, Ia mise en place d'un premier « Credit bureau » dans notre pays a constirue une mesure essentielle pour completer les autres initiatives eogagees et reduire les contraintes de financement auxquelles certain s segments de Ia p opulatio n et des PME cootinuent a faire face. Le succes de cet instrument et Ia vo.lonte des Po uvoirs publics d'elargir les services des credit bureaux a Ia no tation tout en favorisan t la concurrence ont motive le lancement d'un 20mc credit bureau. A ce titre, Ia Banque centrale a annooce Ia selectio n de l'operateur qui sera agree pour gerer le second credit bureau. Pilier D : Renforcer Ia surveillance afin d'assurer l'equilibre entre meilleur acces et stabilite financiere dwable Dans l'objectif de renforcer Ia solidite et Ia srabilite du secteur financier, le Gouvernement a adopte le nouveau projet de loi bancaire. Les principaux apports de ce projet soot la mise eo place d'un cadre de surveillance macro-prudentielle et de gestion des crises systemiques, le reoforcernent de Ia reglementation prudentielle et l'encadremeot des conglomerats financiers. A ce titre, ce projet de loi prevoit notamment Ia mise en place du Com.ite de coordination et de surveillance des risques systemiques qui va renforcer le dispositif en matiere de stabilite financiere. La banque centrale et !edit Cornite mettront en place les reglements d'application du nouveau regime de surveillance des conglomerats financiers. L'Alv[MC, eo tant que membre de ce Comire effectuera quant a elle une evaluatio n de sa oonfomll<< >ux prindp" do l'OICV d>O' lo <>d pino mi" i jou< do l'>v>lu>cion y 3   41      secteur financier (FSAP) dans l'objectif de se conformer aux principes de l'OlCV en matiere de risques systemiques et de stabilite financiere. Le Gouvernement est convaiocu que le lancement de ce nouveau programme permettra d'atteindre des objectifs ambitieux grace au large programme d'assistance technique qui sera fourni par Ia Baoque et finance par le Trust Fund FIRST. Cette collaboration va renforcer davaotage le partenariat e..xernplaire et strategique entre le Maroc et le Groupe de Ia Banque mondiale et parriculierement eo ce qui conceme le secteur financier. Nous sommes convaiocus que notre panenariat donnera lieu a de nouvelles initiatives dans le developpement du marcbe de capitaux et Ia reforme de notre systeme de retraite. A cet egard, oous exprimons le vif interet que nous portons dans un prochain Programme d'appui budgetaire pour mener abien Ia grande reforme de retraite, qui s'appuierait sur les mesures du present programme. Tels sont, Monsieur le President, les grands axes de cette nouvelle etape dans le processus continu de reforme et de modernisation de notre secteur financier. E n vous reroerciaot de votre precieux appui pour La mise en reuvre de cet arobi~~Kx ~rograrnme, je vous prie d'agreer, Monsieur le President, !'expression de rna haute considerationJN 42      First Development Policy Loan in support of deepening capital markets and financing small and medium-sized enterprises Letter of Development Policy (unofficial translation) March 24, 2014 Mr. President: In the last two decades, the Kingdom of Morocco has resolutely undertaken a process of modernization of the financial sector to support and sustain the country economic and social development. The results have been mainly improving financial inclusion and access to finance for Small and Medium-Sized Enterprises (SMEs), strengthening the role of the capital market in financing the economy and consolidating the supervision of the financial sector to ensure its soundness, resilience and stability. These reforms have allowed building a modern financial sector equipped with key financial instruments and market institutions as well as a solid base of institutional investors. The Government wants to pursue the modernization and development efforts of the financial sector and to reach the next phase in this process by capitalizing on lessons learned. We hope the World Bank will again support us in this new phase of reforms as it has done successfully in the previous financial sector development programs. The new government program for financial sector modernization is structured around the following main objectives: - Further deepening of capital markets by broadening the range of instruments and investors for the financial sector to fully play its role in mobilizing savings and its optimal allocation for financing both investment and the economy. - Initiating the pension system reform to ensure the system's financial stability and its long-term viability. - Fostering financing solutions for small and young firms as a major source of sustainable socio- economic development, wealth creation and employment generation; - Developing the surveillance and monitoring of systemic risks to ensure a balance between expanding access to finance and the financial stability objectives. These objectives have been translated into the following four pillars for the development program submitted to the World Bank. Pillar A: further deepening of capital markets by broadening the range of instruments and investors The Law creating the independent Capital Market Authority (AMMC) was enacted in early 2013. This law affirms the independence of the Authority in charge of supervising the capital market and grants it broad powers to enable it to perform the tasks entrusted to it. AMMC's independence is a key element of our capital market reforms and is materialized mainly by the independence of its Chairman of the Board and of its College of Sanctions. The implementation of this Law requires the appointment of the Chairman of AMMC. Draft Organic Law No. 02-12 governing the appointment to senior civil service positions adopted by the Council of Government on February 5th, 2014, pursuant to Articles 49 and 92 of the Constitution, includes AMMC as a strategic institution whose Chairman is appointed in the Council of Ministers. This draft Law also provides for the appointment of the Chairman of the newly instituted Insurance and Pension Fund Supervisory Authority (ACAPS). In this regard, the Government is committed to install 43      the boards of both the AMMC and ACAPS as soon as the aforementioned Organic Law is adopted by Parliament and published. Once established, the AMMC's Board of Directors shall adopt the general regulations of this Authority. This document will notably set the institution's operating procedures, the sanctions system, process and conditions of accreditation of certain financial professionals as well as the ethical rules applicable to AMMC staff. With the goal of improving the functioning of the public debt market, the Government also intends to launch a major reform of the public debt market. This reform is expected to strengthen this market's transparency and efficiency notably by specifying the trading conditions for Treasury securities and the Primary Dealers’ commitments in this market. In this regard, the Government has entered agreements with Primary Dealers in Treasury securities for a continuous and firm quotation of a panel of Treasury securities that will allow a better definition of the yield curve, which serves as a pricing reference to the debt market in general as well as for hedging contracts. Deepening the public debt market will also be secured by substantially reducing the number of outstanding lines of Treasury securities. In order to strengthen the liquidity of the capital market, the Government also proceeded with the establishment of a legislative framework for securities lending transactions. Its implementation requires establishing a master agreement specifying the obligations of market participants as well as the technical conditions of these transactions. This agreement, prepared in consultation with market participants, was approved by an order published in the Official Gazette. All security-lending transactions are registered in the central depository platform for an easy monitoring of these operations. Finally, the Government presented to Parliament a draft law establishing the foundations of a regulated derivatives market enabling Moroccan firms to better hedge their risks. This law provides for the establishment of a central clearing counterparty (CCP) to secure these operations. In this context, a draft general regulation laying down the rules of operation of the CCP has been prepared and sent to market institutions and supervisors for comments. The regulation will be approved by Ministerial order. The next step will involve an assessment of the planned CCP with regards to international standards on security and financial stability. Pillar B: Initiating reform of the pension system The Government intends to launch an integrated reform of the pension system to ensure the financial stability of the system and its viability in the long term. In this context, the government announced as a first step a parametric reform of the civil service pension fund (CMR). This commitment was reflected in the Government’s position paper that transmitted the 2014 Budget Law to Parliament. The implementation of this reform requires the adoption by the Government of draft amendments to the Law on CMR that will significantly reduce its implicit debt. The sector's overall sustainability will also benefit from new broad supervisory powers granted to ACAPS, which has become an independent authority. Its board will adopt rules and procedures governing the on-site and off-site supervision for our pension plans. Pillar C: Fostering financing solutions for small and young firms The Government intends to foster new solutions for financing small and young enterprises. In this context, applying government policy, the Board of Directors of the Central Guarantee Institution (Caisse Centrale de Garantie - CCG) adopted the 2013-16 development plan of the institution. This plan broadens the CCG scope of intervention for a better access of small and young firms to bank 44      loans and equity finance. Similarly, the Government will develop and implement a public-private fund to promote co-investment in start-up companies. The goal is to provide a greater number of small and young firms with easier access to a wide range of appropriate financing solutions open to firms underserved or excluded from the conventional financing system. In addition, a new draft law on private equity/venture capital aims to provide more equity and quasi- equity financing solutions to enterprises in general and SMEs in particular. This draft’s main novelties are to expand the scope of the law to cover all capital investment activities; greater security of the regime and strengthening of investor protection, improved financial techniques and promoting foreign investment in private equity. Besides, the establishment of the first credit bureau in our country has been essential in supplementing other initiatives and in reducing financing constraints that certain segments of the population and SMEs continue to face. The success of this instrument and the willingness of public authorities to expand credit bureaus' activities to credit scoring services, while promoting competition, motivated the launch of a second credit bureau. In this regard, the Central Bank announced the selection of the operator that will be licensed to operate the second credit bureau. Pillar D: Consolidating oversight to balance greater access with continued financial stability With the aim to strengthen the soundness and stability of the financial sector, the Government adopted the draft of the new banking law. The key novelties of this draft are the establishment of a framework for macro-prudential supervision and management of systemic crises, strengthening prudential regulation and supervising financial conglomerates. As such, this bill provides for the establishment of the Committee of coordination and monitoring of systemic risks to strengthen the system with regards to financial stability. The central bank and this Committee will establish the regulations under the new regime for the oversight of financial conglomerates. The AMMC, as a member of this Committee, will conduct an assessment of its compliance with the IOSCO Principles in the context of the forthcoming Update under the Financial Sector Assessment Program (FSAP) with the goal of complying with IOSCO principles notably regarding systemic risk and financial stability. The Government believes the launch of this new program will help achieve ambitious objectives thanks to the comprehensive technical assistance that the Bank will provide under funding by the FIRST Trust Fund. This collaboration will further strengthen the exemplary and strategic partnership between Morocco and the World Bank Group, particularly in the financial sector. We are confident that our partnership will lead to new initiatives in developing capital markets and reforming our pension system. In this respect, we would like to express our strong interest in a future program to support our comprehensive pension reform, building on the measures included in this program. Mr. President, this is the thrust of our policies under this program to reform and modernize our financial sector. Thank you for your valuable support in the implementation of this ambitious program, very sincerely yours.   45      ANNEX 3: FUND RELATIONS IMF Executive Board Completes Third Review Under the PLL Arrangement with Morocco and Concludes 2013 Article IV Consultation Press Release No. 14/37, January 31, 2014 On January 31, 2014, the Executive Board of the International Monetary Fund (IMF) completed the third review of Morocco’s economic performance under a program supported by a 24-month Precautionary and Liquidity Line (PLL) arrangement and concluded the 2013 Article IV consultation with Morocco. The PLL arrangement was approved on August 3, 2012 in an amount equivalent to SDR 4.12 billion (about US$6.2 billion or 700 percent of Morocco’s quota). The Executive Board concluded the second review on July 31, 2013. The authorities are treating the arrangement as precautionary. The PLL arrangement continues to support the authorities’ home-grown reform agenda aimed at achieving higher and more inclusive economic growth by providing an insurance against external shocks. The PLL was introduced to meet more flexibly the liquidity needs of member countries with sound economic fundamentals and strong record of policy implementation but with some remaining vulnerabilities. Following the Board discussion of the review, Ms. Nemat Shafik, Deputy Managing Director, and Acting Chair made the following statement: “Notwithstanding the continued unfavorable external environment and challenging domestic conditions, Morocco’s macroeconomic performance improved in 2013, supported by strong policy commitment and implementation, as well as the insurance provided by the PLL. Important measures taken by the authorities helped reduce fiscal and external vulnerabilities and strengthen the economy’s resilience. Given significant downside risks and persistently high unemployment, the economic outlook will depend on the sustained delivery of policy and structural reforms designed to continue rebuilding policy buffers and promote higher and more inclusive growth. “The substantial reduction in energy subsidies achieved in 2013, along with increased social assistance to the most vulnerable, helped strengthen the fiscal accounts and reduce underlying fiscal vulnerabilities. Looking ahead, continued strengthening of public finances will require a reorientation of revenue and spending to better support growth and inclusiveness, along with the passage of a new organic budget law that incorporates best practices with respect to fiscal discipline, coverage and expenditure control. “Sustaining the recent gains in improving Morocco’s external position hinges on measures to support its external competitiveness. Structural reforms in this area are a priority. More flexibility in the exchange rate regime, in close coordination with other macroeconomic policies, would also help and would increase the economy’s resilience to external shocks. “Further reforms are needed to strengthen the business climate, transparency, and the judiciary system and to improve the functioning of the labor market in order to attract foreign direct investment and promote strong job growth. Broader financial inclusion including greater access to credit for small and medium-sized enterprises is also needed to foster higher growth and boost employment.” The Executive Board also concluded the 2013 Article IV consultation with Morocco. The Moroccan economy has weathered the recent unfavorable regional and global economic context relatively well. GDP growth is expected to have reached about 4.5 percent in 2013 on the back of an exceptional agricultural season. Growth in other sectors has been dragged down by the effects of the European crisis, but is expected to rebound in 2014 for an overall growth rate of around 4 percent. Inflation is well under control, while the financial sector remains sound. The 2013 current account deficit was reduced and international reserves have been stable above four months of imports for more than a year, thanks in part to sustained foreign investment and access to international bond markets at favorable terms. Lower international oil prices and policy actions helped reduce the fiscal deficit from 7.3 percent of GDP in 2012 to 5.4 percent in 2013. Executive Board Assessment. Executive Directors commended the economy’s resilience in the face of significant external shocks and challenging domestic conditions, and welcomed recent measures that successfully helped reduce fiscal and external vulnerabilities. Noting Morocco’s high unemployment rate and the downside risks to the outlook, Directors advised sustaining reforms to continue rebuilding policy buffers and promote higher and more inclusive growth. 46      Directors supported efforts to strengthen the public finances and support both fiscal and external sustainability. They welcomed the reduction of energy subsidies in 2013 while increasing social protection to the most vulnerable, and encouraged the authorities to sustain such efforts. They advised that revenue and spending should be reoriented to better support growth and inclusiveness in 2014 and beyond, through reforms aimed at broadening the tax base, reviewing tax incentives and exemptions, reforming the VAT system, moderating the public wage bill, and reforming the pension system. Directors welcomed the adoption by the Council of Ministers of the new Organic Budget Law as a step toward the establishment of a modern and improved fiscal framework. They called for strengthening the provisions of the draft law pertaining to fiscal discipline, coverage and expenditure control, in line with international best practice, and looked forward to the law’s timely approval ahead of the preparation of the 2015 finance law. Directors underscored that consolidation of Morocco’s external position hinges on improving its external competitiveness. They stressed the critical importance of structural reforms in this area. They noted that a move toward a more flexible exchange rate regime, in coordination with other macroeconomic policies, would also help and would increase the economy’s resilience to external shocks. In this regard, Directors welcomed the Fund’s provision of technical assistance to the Bank Al-Maghrib (BAM) to help prepare for a smooth transition to more exchange rate flexibility. They recommended further reforms to strengthen the business climate, transparency, and the judiciary system and to improve the functioning of the labor market in order to attract private investment and promote strong job growth. Directors supported BAM’s efforts to strengthen banking supervision and regulatory arrangements, including gradual adherence to the Basel III norms, as well as closer monitoring of the banking sector’s international expansion. They underscored the importance of financial deepening and increased access to credit for small and medium-sized enterprises for fostering sustained growth. Morocco: Selected Economic Indicators, 2012–17 PLL1/ Rev.2/ Proj. 2012 2013 2014 2015 2016 2017 (Annual percentage change) Output and Prices Real GDP 2.7 5.1 4.5 3.9 4.9 5.2 5.4 Real primary GDP -7.2 13.6 17.0 -1.0 4.5 4.5 5.0 Real non-primary GDP 4.6 3.7 2.4 4.8 5.0 5.3 5.5 Consumer prices (end of period) 2.6 2.3 0.4 2.5 2.5 2.5 2.5 Consumer prices (period average) 1.3 2.3 1.9 2.5 2.5 2.5 2.5 (In percent of GDP) Investment and Saving Gross capital formation 35.3 34.3 34.7 35.3 35.3 35.4 35.5 Of which: Nongovernment 29.7 30.0 29.5 30.7 29.9 29.9 30.1 Gross national savings 25.6 27.1 27.2 28.8 29.7 30.6 31.3 Of which: Nongovernment 25.9 26.8 25.9 27.6 26.8 26.9 27.0 (In percent of GDP) Public Finances Revenue 28.7 27.5 27.9 27.4 28.1 28.1 28.2 Expenditure 36.1 33.0 33.4 32.4 32.4 31.7 31.2 Budget balance -7.3 -5.5 -5.4 -4.9 -4.3 -3.6 -3.0 Primary balance (excluding grants) -5.0 -4.0 -3.6 -2.8 -2.7 -1.9 -1.4 Cyclically-adjusted primary balance -4.7 … -3.4 -3.3 -2.6 -1.9 -1.4 (excl. grants) 47      Total government debt 60.2 61.8 61.7 62.5 62.4 61.5 60.1 (Annual percentage change; unless otherwise indicated) Monetary Sector Credit to the private sector 3/ 4.8 6.1 3.6 5.6 6.2 6.9 6.9 Base money -0.5 11.5 9.8 4.6 5.5 6.5 6.0 Broad money 4.5 5.5 3.9 4.6 5.5 6.5 6.0 Velocity of broad money 0.8 0.8 0.9 0.9 0.9 0.9 0.9 Three-month treasury bill rate (period 3.2 ... ... ... ... ... ... average, in percent) (In percent of GDP; unless otherwise indicated) External Sector Exports of goods (in U.S. dollars, -0.8 3.3 1.8 9.1 7.3 7.0 6.3 percentage change) Imports of goods (in U.S. dollars, 1.6 0.7 0.7 6.8 5.2 5.1 5.2 percentage change) Merchandise trade balance -20.9 -18.7 -19.0 -18.1 -17.1 -16.2 -15.6 Current account excluding official -10.0 -8.2 -8.0 -7.5 -6.7 -5.7 -5.2 transfers Current account including official -9.7 -7.2 -7.4 -6.5 -5.7 -4.8 -4.2 transfers Foreign direct investment 2.4 3.2 2.9 2.9 3.0 3.1 3.1 Total external debt 29.8 31.3 30.9 31.5 31.6 30.6 29.2 Gross reserves (in billions of U.S. 17.5 18.7 19.3 20.0 21.1 22.4 23.7 dollars) In months of next year imports of 4.2 4.3 4.3 4.3 4.3 4.3 4.3 goods and services In percent of short-term external debt 1251.8 1332.0 1374.5 1427.1 1508.7 1601.2 1691.2 (on remaining maturity basis) Memorandum Items: Nominal GDP (in billions of U.S. dollars) 96.1 104.8 105.5 115.1 125.1 136.0 146.7 Unemployment rate (in percent) 9.0 8.9 8.9 ... ... ... ... Population (millions) 32.5 32.9 32.9 33.2 33.5 33.8 34.2 Net imports of energy products (in -12.4 -11.6 -12.2 -13.0 -12.9 -12.9 -12.9 billions of U.S. dollars) Local currency per U.S. dollar (period 8.6 ... 8.4 ... ... ... ... average) Real effective exchange rate (annual -1.0 ... 0.1 ... ... ... ... average, percentage change) Sources: Moroccan authorities; and IMF staff estimates. 1/ Refers to the macro framework for the 2nd review in EBS/13/96. 2/ Revised macro framework. 3/ Includes credit to public enterprises. 48      ANNEX 4: MACROECONOMIC DEVELOPMENTS AND DEBT SUSTAINABILITY 1. Morocco made significant economic headway during the last decade. Growth shifted upward, averaging 4.7 percent over 2001-2013, much higher than the average rate of the 1990s (2.8 percent). Inflation was subdued, recording less than 2 percent on average over the period. The growth and inflation performance allowed gross domestic product (GDP) per capita to almost double over the last decade, to reach the equivalent of US$3,100 in 2013. The unemployment rate declined from 12.3 percent in 2000 to 9.2 percent in 2013. Absolute poverty decreased from 15.3 percent to roughly 6.2 percent between 2001 and 2011. Based on these achievements, Morocco gained “investment grade” rating in 2007, which was confirmed over 2009-2013 despite ongoing world economic turmoil. 2. These achievements were in part the result of sound macroeconomic policies. The steady consolidation of public finance turned fiscal deficits into surpluses in 2007 and 2008 (averaging 0.3 percent of GDP). The fiscal deficits widened to 4.7 percent of GDP in 2010 but remained manageable, before deteriorating further to 6.9 percent of GDP in 2011 reflecting higher food and fuel subsidies. Recent reforms allowed the budget deficit to decline to around 6 percent of GDP in 2013. The Treasury total debt steadily declined from 68 percent of GDP in 2000 to 47.1 percent of GDP in 2009, but reversed its downward trend starting in 2010 to reach 62.3 percent of GDP in 2013. Monetary policy sought to keep inflation in check while managing both liquidity and the exchange rate in an effective manner. In addition to timely adjustments of its money policy rate and reserve requirement rate, the Central Bank (BAM) implemented an adequate mix of its other instruments. 3. Morocco’s economic improvement was also due to the implementation of ambitious structural reforms. Morocco liberalized a number of sectors, including transport, energy, and telecommunications. The financial sector was reformed to support the new dynamism of the nonagricultural economy. Also, sector-specific strategies were implemented to diversify employment opportunities. Gross investment, which had averaged around 25 percent of GDP in the 1990s, picked up in the 2000s to reach 38 percent of GDP in 2008 and stabilize around 35.5 percent of GDP thereafter. Morocco signed many free-trade agreements culminating with the “Advanced Status” awarded by the EU in 2008. FDI inflows rose to an average of 4.2 percent of GDP per year over 2001-13. Figure A. Rising investment, in percent of GDP 40.0 7.0 35.0 6.0 30.0 5.0 25.0 4.0 20.0 3.0 15.0 2.0 10.0 5.0 1.0 0.0 0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 Non‐financial firms, incl SOEs Financial institutions Public Administration Households Investment in 2011 Investment in 2012 FDI (right axis) Source: Moroccan Government and Staff estimates. 49      Figure B. Growth shifted to higher path and is less volatile Figure C. Unemployment declined, but remains high for and less dependent on agriculture (in percent) urban and educated youth (in percent) Croissance moyenne élevée, mais reste insuffisante Le chômage en baisse (en %) 40% 15.0 35% unemployment rates 30% 10.0 25% 4.5% 3.2% 20% 5.0 15% 0.0 10% 5% ‐5.0 0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ‐10.0 National Urban 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Urban youth Urban educated Figure D. External position improved in 2013 with Figure E. Public Finances have improved before the vulnerability in trade (in percent of GDP) global crisis but are now under pressure (in percent of GDP) 11 38 15% 35.0% 28 6 30.0% 10% 18 25.0% percent of GDP 1 8 5% 20.0% -2 15.0% -4 0% -12 10.0% -9 ‐5% -22 5.0% ‐10% 0.0% -14 -32 Est. 2013 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Current account balance Net reserves in months of GNFS Budget deficit Wages & salaries Foreign direct investments, Gross Trade Balance (right axis) Consumer subsidies Total revenues   Figure G. After a steady decline, government debt Figure F. Inflation remains subdued increased again, though remains sustainable in the MT cumulated year over year (in percent) (in percent of GDP) 80.0% 10.0 70.0% 8.0 60.0% 6.0 50.0% 4.0 40.0% 2.0 30.0% 0.0 20.0% ‐2.0 10.0% ‐4.0 0.0% Jul‐07 Oct‐07 Jul‐08 Oct‐08 Jul‐09 Oct‐09 Jul‐10 Oct‐10 Jul‐11 Oct‐11 Jul‐12 Oct‐12 Jul‐13 Oct‐13 Jan‐07 Apr‐07 Jan‐08 Apr‐08 Jan‐09 Apr‐09 Jan‐10 Apr‐10 Jan‐11 Apr‐11 Jan‐12 Apr‐12 Jan‐13 Apr‐13 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Series1 Series2 Series3 Foreign Domestic Total 50      Table A4: Public Sector Debt Sustainability Framework, 2008‐2018 (in percent of GDP, unless otherwise indicated)  2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 I. Baseline Projections Public sector debt 1/ 47.3 47.1 50.3 53.7 60.1 62.3 62.9 61.8 60.1 58.2 57.0 o/w foreign-currency denominated 9.9 10.7 12.1 12.4 14.1 15.0 16.7 17.8 18.1 18.4 18.7 Change in public sector debt -6.2 -0.2 3.2 3.4 6.4 2.2 0.6 -1.0 -1.7 -1.8 -1.3 Identified debt-creating flows (4+7+12) -5.6 -0.9 3.4 4.1 5.1 2.9 1.5 -0.1 -0.8 -1.0 -1.0 Primary deficit -3.1 -0.2 2.4 4.6 4.9 3.5 2.2 1.5 0.8 0.7 0.7 Revenue and grants 29.7 25.8 25.4 25.9 26.7 25.3 26.4 26.5 26.5 26.5 26.5 Primary (noninterest) expenditure 26.6 25.6 27.7 30.6 31.6 28.8 28.6 28.0 27.3 27.2 27.2 Automatic debt dynamics 2/ -2.5 -0.7 1.0 0.2 0.6 -0.6 -0.5 -1.4 -1.5 -1.5 -1.5 Contribution from interest rate/growth differential 3/ -3.0 -0.5 0.4 -0.1 0.8 -0.8 -0.6 -1.5 -1.7 -1.7 -1.7 Of which contribution from real interest rate -0.3 1.7 2.0 2.2 2.2 1.7 1.2 1.2 1.1 1.1 1.1 Of which contribution from real GDP growth -2.7 -2.1 -1.6 -2.4 -1.4 -2.5 -1.7 -2.7 -2.8 -2.8 -2.7 Contribution from exchange rate depreciation 4/ 0.5 -0.3 0.7 0.3 -0.2 0.2 0.1 0.2 0.2 0.2 0.1 Other identified debt-creating flows 0.0 0.0 0.0 -0.7 -0.4 0.0 -0.2 -0.2 -0.2 -0.2 -0.2 Privatization receipts (negative) 0.0 0.0 0.0 -0.7 -0.4 0.0 -0.2 -0.2 -0.2 -0.2 -0.2 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -0.6 0.8 -0.2 -0.8 1.3 -0.7 -0.9 -1.0 -0.9 -0.9 -0.3 Public sector debt-to-revenue ratio 1/ 159.2 182.5 198.6 207.0 225.5 246.2 238.3 233.4 226.8 219.9 215.1 Gross financing need 5/ 15.8 20.4 25.7 22.2 19.9 19.1 18.9 17.2 16.2 15.5 14.4 in billions of U.S. dollars 14.0 18.5 23.3 22.0 19.1 19.7 20.4 19.6 19.6 19.9 19.7 Key Macroeconomic and Fiscal Assumptions Real GDP growth (in percent) 5.6 4.8 3.6 5.0 2.7 4.4 3.0 4.6 4.8 4.9 5.0 Average nominal interest rate on public debt (in percent) 6/ 5.5 5.3 5.1 4.7 4.7 4.5 4.4 4.4 4.4 4.3 4.3 Average real interest rate (nominal rate minus change in GDP deflator, in percent) -0.3 3.8 4.4 4.7 4.2 3.1 2.0 2.1 2.0 2.1 2.1 Nominal appreciation (increase in US dollar value of local currency, in percent) -4.8 3.0 -5.9 -2.6 1.7 -1.5 -0.8 -1.2 -1.1 -1.0 -0.8 Inflation rate (GDP deflator, in percent) 5.9 1.5 0.6 0.1 0.5 1.5 2.4 2.3 2.3 2.3 2.3 Growth of real primary spending (deflated by GDP deflator, in percent) 16.7 0.8 12.2 15.7 6.1 -4.8 2.3 2.2 2.5 4.3 5.0 Primary deficit -3.1 -0.2 2.4 4.6 4.9 3.5 2.2 1.5 0.8 0.7 0.7 II. Stress Tests for Public Debt Ratio A. Alternative Scenarios A1. Key variables are at their historical averages in 2013-2022 7/ 62.3 61.4 60.6 59.9 59.3 59.2 A2. No policy change (constant primary balance) in 2013-2022 62.3 63.1 63.5 63.7 64.0 64.8 B. Bound Tests B1. Real interest rate is at baseline plus one standard deviations 62.3 63.4 62.8 61.6 60.2 59.3 B2. Real GDP growth is at baseline minus one-half standard deviation 62.3 63.6 63.5 62.8 62.3 62.4 B3. Primary balance is at baseline minus one-half standard deviation 62.3 64.3 64.6 64.2 63.7 63.7 B4. Combination of B1-B3 using one-quarter standard deviation shocks 62.3 64.1 64.2 63.6 62.9 62.7 B5. One time 30 percent real depreciation in 2014 9/ 62.3 69.8 68.6 66.7 64.7 63.3 B6. 10 percent of GDP increase in other debt-creating flows in 2014 62.3 62.9 61.8 60.1 58.2 57.0 Source: Government of Morocco and staff calculation and estimate 1/ Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used. 2/ Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar). 3/ The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g. 4/ The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r). 5/ Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period. 6/ Derived as nominal interest expenditure divided by previous period debt stock. 7/ The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP. 8/ The implied change in other key variables under this scenario is discussed in the text. 9/ Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator). 51      ANNEX 5: STRUCTURAL RIGIDITIES IN ECONOMIC PERFORMANCE 1. Post-global financial crisis shocks have exposed weaknesses in the competitiveness of Moroccan enterprises. Morocco has had virtually no productivity gains over the past two decades despite high levels of investment (Figure A5.1): (i) Morocco has consistently invested 5 to 10 percentage points of GDP more than peer countries (Figure A5.2); (ii) investment as a share of GDP has increased from 20 in the 1990s to 35 percent currently. Investment has been insufficiently productive, even though its high level has helped dampen the volatility of growth. Figure A5.1: High investment compared to peers … Figure A5.2:… with little growth to show for. Source: HCP; and staff calculations. 2. It appears that investment has merely boosted the productivity of labor, but has not yet triggered a growth take-off through higher TFP (Figure A5.3). Some impact might still occur in that government capital expenditures (about 5 percent of GDP) focus on infrastructure (energy, highways, ports, airports), for which TFP gains take longer to materialize. Also in this category are some projects financed by CDG Capital and other government-controlled vehicles. Figure A5.3: Longstanding Weaknesses in the Productivity Performance of the Economy   Sources: The Conference Board/University of Groningen Total Economy Database; World Economic Forum 2010.   52    3. The calculation of productivity growth is sensitive to modeling assumptions. Preliminary calculations of the IMF indicate a higher productivity growth than the Conference Board (TCB). The main differences in assumptions are:  The assumed weight of labor in the production function (0.6 for the IMF; 0.5 for TCB). Under perfect competition, the weight of labor is the share of labor compensation in value added. A share of 0.7 is typically used for advanced economies. In emerging economies, labor is cheaper than capital and therefore its share in gross income is lower than 0.7. TCB calculations apply 0.5 consistently across countries; IMF calculations apply 0.6 only to Morocco, and therefore cannot be compared across countries.  IMF assumes just two factors of production: labor and capital. TCB assumptions are much more granular, comprising eight distinct factors across countries. Labor consists of two factors: quantity and quality (skills) of labor. Capital consists of two major factors, each with three distinct types of capital: non-ICT capital, including non-residential construction, transport equipment and machinery; and ICT capital, including IT hardware, telecom equipment and software. Accordingly, TCB constructs six capital stock series and two labor series. 4. High and rising export prices are another facet of persistent weaknesses in the competitiveness of Moroccan enterprises on the global market. The price of the national export basket has generally been higher than key competitors and the gap has widened since the global financial crisis (Figure A5.4). As a result, Morocco’s share of global exports has declined from 0.15 percent in 1999 to 0.10 percent in 2012 while most competitors saw substantial increases in their shares. Figure A5.4: Morocco and Competitors: Export Prices and Shares of Global Exports Source: Natixis   53    5. The aggregate picture is confirmed when looking at export performance data in the highly disaggregated product space (Figure A5.5). Traditional lower productivity products such as garments and textiles and food still account for a large share of Morocco’s revealed comparative advantage (RCA). Morocco has maintained its RCA in garments, phosphate and derivatives, and food products, while the textile cluster (e.g., cotton fabrics, bed linens) disappeared over the past 20 years. Morocco also lost a number of products close to the densely connected core of manufacturing. For instance, instruments and apparatus for measuring the dynamics of liquids or gases, metal forgings/stampings, (6793), tires and tubes (6259); articles of ceramics. In general, the domestic manufacturing sector has not diversified into exports with higher productivity content. However, more recently, foreign firms operating in free trade zones have added exports in electrical/electronic related products, as well as automotive and aerospace. Figure A5.5: Productivity Content of Exports Technological Sophistication of Exports      Source: “Mapping MENA’s Manufacturing: The Export Performance and Prospects of MENA Countries Since the First Structural Reforms.” Sahnoun et al. (2013), World Bank, mimeo. 6. A tightly managed exchange rate over the past twenty years distinguishes Morocco from countries at similar levels of development. Cross-country studies have generally concluded that exchange rate undervaluation helps sustain rapid growth in the export of goods. These surges in turn allow exporters of manufactures to grow clusters of competitiveness and progressively move up the value chain into higher productivity exports. More recent research suggests that the real exchange rate may have an even stronger effect on the export of services, particularly high value services.19                                                              19  Eichengreen et al. (2013), WPS 6629, World Bank.    54    Box A5. Liberalizing the exchange rate regime and opening the capital account The Office des Changes, under the Ministry of Finance, regulates and supervises foreign exchange transactions. Since 1992, Morocco has liberalized the transfer of capital and the transfer of income from foreign investments (direct investment, portfolios, treasury bonds), subject to the fulfillment of certain conditions. In November 1993, exporters of goods and services and Moroccan residents abroad were authorized to open foreign currency accounts with Moroccan banks. Since May 2002, banks are authorized to place deposits in foreign currency with banks abroad and to acquire foreign securities. In 2007, the Government adopted a package of measures to open gradually the capital account. Insurance and reinsurance companies and pension funds can invest abroad up to 5% of their assets and 5% of their reserves, and mutual funds up to 10% of their portfolios without prior authorization. Banks were authorized to grant MAD loans to non-residents for purposes of financing real estate investments in Morocco. Since 2010, Moroccan companies in existence for three years can invest up to MAD 100 million in Africa and up to MAD 50 million elsewhere without prior authorization, and to use a broadened range of FX hedging contracts. The maximum maturity of banks’ investments abroad has been increased from two to five years and export accounts may be credited up to 70% in repatriated currency from 20% before. The Government encourages foreign investment through 63 agreements for the protection of foreign investment and 53 agreements for the avoidance of double taxation. The Government is in the process of preparing a new investment charter structured around four regimes: (i) common investments; (ii) conventional investments; (iii) specific investments; and (iv) major investment schemes. Morocco’s exchange rate has been tightly managed around a basket of currencies. Since 2001, the basket has been 80 percent EUR, 20 percent USD, after the authorities increased the EUR weighting against which BAM sets daily the exchange rates of the Dirham. The 2001 readjustment depreciated the MAD/USD rate by 5 percent on impact and aimed at ensuring that the Dirham becomes less sensitive to the fluctuations of EUR/USD. Since 1996, BAM announces a daily central rate for the Dirham against the basket, with banks quoting buy-and-sell rates limited to plus or minus 0.3% of the central rate. Banks are subject to net foreign exchange position limits of 20% of capital for all currencies and 10% of capital in a single currency. Banks are permitted to take open positions for operations linked to trade finance (up to 90 days, extended to one year in 2002) or bona fide external finance (not exceeding one year, extended to five years in 2007). The IMF’s exchange rate assessment in the 2012 Article IV found evidence of MAD overvaluation. A recent Bank analysis found that the MAD exchange rate had been systemically overvalued in each of the 8 five-year periods since 1970. The average overvaluation over the 8 periods was also being the highest among MENA oil importers.         55    ANNEX 6: THE MOROCCAN FINANCIAL SYSTEM 1. Morocco has a fairly diversified financial system that grew rapidly over the past decade. Financial system assets as a percentage of GDP have reached levels comparable to high income countries. The fairly advanced development of financial intermediation contrasts with a real economy that still delivers poor productivity outcomes despite sustained high levels of capital formation (Annex 5). Sources: Finstat. Moroccan authorities. 2. Morocco’s banking system is one of the largest in the region, with assets in privately- owned banks reaching 130 percent of GDP. Concentration in banking has grown continuously over the past decade in contrast to many countries at similar levels of development. The top three banking groups are pursuing expansion strategies in North, West and Central Africa, and some banks belong to broader financial groups. Morocco also hosts a government financial conglomerate, the Caisse de depot et de gestion (CDG). CDG’s on- and off-balance sheet assets of 25 percent of GDP include investment banking and asset management on behalf of (mainly) pension funds and the postal bank. 3. Bank credit to the private sector has recently plateaued, and large borrowers have turned to the local debt market to replace traditional bank finance. Moroccan banks face tighter liquidity conditions (higher loan/deposit ratio), reflecting elevated current account deficits (Annex 4). For a while, BAM refinancing and lower reserve requirements have allowed banks to continue expanding credit without commensurate deposit growth. Indeed, the credit/GDP ratio gained 15 percentage points between 2008 and 2012. However, with the recovery in external accounts still elusive, this policy is reaching its limits, with credit growth also being pressured since 2010 by larger exposures to Government as a result of fiscal deficits. Banks have issued bonds to lengthen the maturity of their funding as they prepare for more rigorous mismatch requirements under Basel III. The tighter external accounts have prompted competition among issuers (banks,   56    large non-financials, Treasury). Top banks and corporates are therefore also tapping the international capital market, encouraged by the terms at which the sovereign issued in 2012-13 thanks in part to the comfort provided by the IMF’s PLL. . . Sources: Finstat, IFS/IMF, and staff calculations. 4. The recent increase in the issuance of private debt securities was accounted by negotiable certificates of deposits (CD) as banks sought to secure more term funding, followed by bonds, commercial paper (CP), and notes issued by finance companies (BF). Higher budget deficits leading to higher long-term yields on government securities have dampened bond issuance since 2010.   57    5. Increases issuance of private debt securities has meant that the share of bank loans in the annual net supply of new finance to the economy has been steadily shrinking, marking the beginning of a process of diversification away from banking. By 2011, securities represented more than half of the increase in finance. However, the supply of equity finance remains marginal and has even stopped after 2008. Equity issuance  Issuance of private debt securities  New bank loans  Sources: Maroclear, BAM, CDG Capital. 6. The demand of derivative instruments has grown significantly over the past decade. However, this concerns FX swaps and options, not yet interest rate products, and exclusively over-the-counter. Increase in notional FX derivatives Increase in number of client derivatives accounts Source: large domestic bank. 7. An uptick in NPLs recently and associated provisioning requirements has prevented banks from building solvency buffers much above regulatory requirements (12 percent minimum Capital Adequacy Ratio as of 2012). Compared to other banking systems in the region, Moroccan banks have always operated close to the regulatory solvency ratio, although they face broadly similar risks and macroeconomic volatility. Offsetting factors include a reputable and intrusive supervisor, more risk diversification on account of growing cross-border exposures in Africa, and a quality of capital strongly tilted toward Common Equity Tier 1.   58    . Sources: Finstat, Moroccan authorities, and staff calculations. 8. Banking is well-prepared for Basel III, thanks to a pro-active supervisor. The minimum capital adequacy ratio became 12 percent in 2012 and 9 percent core tier 1, with effect in June 2013. Banks are already required to hold qualifying liquid assets to cover 100 percent of short- term liabilities and the large exposure ratio has been lowered to 20 percent of equity since 2000. 9. Pension and mutual funds are quite advanced for Morocco’s level of development. The four pension funds are PAYG-types that have accumulated large assets as a result of favorable demographics. With the accumulation phase ending, the size of the funds means that any decline in holdings could create potentially destabilizing flows in capital markets. Pension reform is needed to reduce contingent fiscal liabilities, but also to secure reliable demand for issuers of capital market instruments by anchoring long-term savings. 10. Mutual funds cater mainly to institutional investors; competition with the insurance industry for retail accounts is limited. This reflects distortions from diverging practices in marking to market, and the tax treatment of capital gains. The mutual fund industry comprises 16 asset management companies, eight being owned by large financial institutions. Close to 40 percent of Assets Under Management are funds dedicated to a sole investor (pension fund, insurance company). Mutual funds lack tax advantages, therefore only 20,000 retail accounts invest in funds, while more than one million own life insurance contracts. Banks also do not distribute in-house mutual funds to individual investors, except high-net-worth individuals.     Source: Finstat.   11. There is a striking disconnect between the advanced stage of development of the financial system and the equity market. Morocco has been downgraded in June 2013 from emerging to   59    frontier market, based on poor liquidity, shallow float, and the virtual absence of new listings since the market peak of 2008. The number of listings is low in comparison to peers, and concentrated in finance and real estate. Morocco’s world leading phosphate cluster, consumer goods or distribution are not represented.     Source: Finstat. 12. A central theme of CSEx development deficits is the lack of new issuers, particularly flagship issuers. Most SOEs obtain their funding from the budget, CDG and banks. Family conglomerates seem content to grow in line with earnings and are naturally reluctant to embrace the continuous disclosure regime of an equity listing. Mid-sized companies that could grow faster are loath to share control. Although CSEx market cap is the second highest in Africa (Table A6.1), the market is rarely used to raise capital, but rather for shareholders to cash out during periods of inflated valuations. With bank assets at 130 percent of GDP in 2012, banks remain key supplier of finance to the corporate sector (an estimated 9/10th). Much work also needs to be done to detect and nurture potential future issuers, including incubator schemes, or legal, fiscal, compliance and accounting services that facilitate investor due diligence. Table A6.1: Key Metrics for Selected Exchanges in MENA and Africa Market Market Turnover Listed Domestic capitalization (% of capitalization Ratio Companies GDP) (US$ bn) South Africa 210% 855.7 355 40% Morocco 68% 60.1 78 10% Egypt 21% 48.7 231 34% Nigeria 16% 39.3 196 9% Jordan 94% 27.2 247 14% Oman 27% 19.7 136 13% Lebanon 25% 10.2 10 4% Tunisia 21% 9.7 57 11% Source: World Federation of Exchanges, 2011 for Morocco. 13. Institutional investors have provided a steady, captive demand partly as a result of exchange controls, and have consequently driven market development. However, investment decisions appear concentrated in financial conglomerates, often comprising banks, fund management, brokerage and insurance entities. The mandates for pension, insurance and mutual funds are concentrated among a few asset managers. Tax incentives favoring life insurance have   60    hampered retail flows into mutual funds. Slow correction and related persistent overvaluations reflect low float and lack of new supply. These factors have also deterred foreign investors: only three stocks qualified for the MSCI EM benchmark (Morocco weight: 0.1 percent). The downgrade to MSCI frontier market (7 percent weight) could trigger fresh flows from a new investor base.       61    ANNEX 7: FINANCIAL INCLUSION 1. Morocco has appreciably expanded financial inclusion. BAM estimates that 54 percent of Moroccans had a bank account in 2013 (37 percent in 2006), thanks to Low Income Banking (LIB) services by large banks and the 2010 launch of Al Barid (postal bank). The Global Finscope Survey (2011) confirms the overall positive picture, although a breakdown by segments reveals that women and youth remain underserved in rural areas (Figure A7.1). Figure A7.1: Access to Formal Financial Services Account at a formal financial  Account at a formal financial  institution, male (% age 15+) institution, female (% age 15+) 100 100 80 80 60 60 40 40 20 20 0 0 Morocco Lower middle High income: Morocco Lower middle High income: income OECD income OECD Account at a formal financial inst.,  Account at a formal fin. inst., young  older adults (% age 25+) adults (% ages 15‐24) 100 100 80 80 60 60 40 40 20 20 0 0 Morocco Lower middle High income: Morocco Lower middle High income: income OECD income OECD Source: FinScope Database (2011). 2. Following a 1999 law, the microcredit sector saw explosive growth followed by a crisis in 2007. The authorities uncovered gaps in governance, controls (i.e., poor monitoring, fraud) and information systems (absence of MFI data in credit reporting system). BAM organized the absorption of the largest independent MFI by a bank-affiliated MFI, and encouraged banks and donors to maintain funding. Since then, BAM has overseen an orderly deleveraging plan Morocco shows that systemic risk exists even in the case of credit-only institutions, which become interconnected when light regulation and competition for market share breed multiple lending.20                                                              20  See CGAP (2013): Brief-Lessons-Learned-from-the-Moroccan-Crisis-July-2013_0.pdf    62    3. The crisis led to a six-year decline that is coming to an end. The industry has issued a white paper in 2012 with the goal of reaching 3.2 million borrowers by 2020, a four-fold increase.21 In addition to expanding the client base, many MFIs aim to provide more differentiated products and services. These ambitions require a legal and regulatory environment that allows the larger MFIs to transform from their current associative status into corporate entities able to tap a more diverse pool of funding. A new microcredit law provides such a framework, while the draft banking law makes BAM sole licensing and supervisory authority. 4. The authorities are keen for microfinance to play a larger role for inclusion. To this effect, Parliament amended the 1999 MFI law in 2012 to: i) institutionalize a framework for the resolution of weak associations through take-overs or mergers; ii) allow MFIs to transform into finance companies. “Transformation” would secure more stable bank funding on better terms, as well as attract equity capital beyond the original associates. Through “transformation” and other measures, the aim is to multiply by five the volume of credit (to 2 percent of GDP). Close to half of the population would potentially be reached, assuming 4-5 beneficiaries per account. However, the large MFIs have indicated that attracting fresh capital hinges on keeping not-for- profit status. Table A7.1: Microfinance Institutions in Morocco Loans (USD) Borrowers Al Amana 237,182,257 314,878 Attawfiq Microfinance 199,026,891 223,551 FONDEP 81,599,046 128,620 ARDI 25,461,490 105,708 AMSSF/MC 5,364,470 13,508 Al Karama 4,050,300 15,845 INMAA 2,385,030 5,793 AMOS 709,029 2,779 ATIL 653,485 1,376 AIMC 374,177 1,329 Total 556,806,175 813,387 Source: Mixmarket (2013) 5. Parliament directed MEF to regulate MFI lending rates, in parallel with legal provisions applying to other institutions extending credit.22 The amendment came about during parliamentary review of the MFI law, which grants BAM regulatory authority over MFIs. A number of principles apply in such circumstances and the authorities’ consultative approach with the industry incorporates them (Box A7). The current proposal envisages an all-in lending rate comprising staff and operational expenses, funding costs, cost of risk (reflecting recent credit losses), plus a four percent profit margin.                                                              21  http://www.cm6-microfinance.ma/uploads/file/Livre_blanc_du_Microcredit_au_Maroc.pdf  22  The banking law directs BAM to calculate the usury rate as the weighted average rate on consumer loans issued by regulated credit institutions in the preceding year, plus 200 basis points. The rate is reset April 1st.    63    6. As member of the Alliance for Financial Inclusion,23 BAM has developed an inclusion action plan comprising: a foundation for financial education; a center for financial mediation; licensing intermediary agents that offer access to bank payment services for unbanked individuals (tiered access); new bank reporting on financial inclusion; and promoting consumer choice (no-fee account portability). BAM also asked banks to develop products for low-income clients, and since 2012, requires banks to offer 16 different free services, including zero-cost saving accounts. BAM targets 2/3rd of households having bank accounts by 2014 (Figure A7.2).24 Finally, the draft banking law creates a framework for Islamic banking that could also help inclusion. Box A7: Interest Rate Caps for Microlending The rise of microfinance as a key financing source to the poorest segments has raised the question on how the beneficiaries can be protected from abusive lending practices. In many countries, policymakers, regulators and the wider public find it difficult to accept that microloans to poor borrowers bear significantly higher interest rates than conventional bank loans to wealthier clients as a result of higher transaction costs. In addition to consumer protection considerations, many governments feel political, cultural or religious pressures to keep interest rates low, leading them to impose interest rate ceilings on the microfinance sector. Despite good intentions, interest rate ceilings generally hurt the poor by making it hard for new microfinance institutions (MFIs) to emerge and existing ones to stay in business. In countries with rate caps, MFIs often withdraw from the market, grow more slowly, become less transparent about total loan costs, and/or reduce their work in markets which are more costly to serve. By pushing pro-poor financial institutions out of business, rate caps often drive borrowers back to the informal market where they have no protection. Borrowers are therefore better served through effective consumer protection frameworks and recourse mechanisms, disclosure requirements and the promotion of a more diversified microfinance market, all of which contribute to better financial services provided at a lower cost. However, in some circumstances, the political environment may leave policymakers with no choice but to limit interest rates of the microfinance sector. There are a number of countries which have introduced interest rate caps in recent years, including some hosting a large microcredit sector like Bangladesh25 or India26. If an interest rate cap becomes inevitable, policymakers should consider a number of factors. The interest rate cap should be set at a level that allows MFIs to fully recover their costs and a reasonable profit margin. The interest rate should not be defined in the law, but in implementing regulations to allow for adjustments due to a changing macroeconomic and/or financial environment. Finally, any interest rate cap should be embedded in a sound disclosure/transparency framework for MFIs to ensure that the interest rates are not re-labeled as commissions or fees to the clients. Source: CGAP/World Bank 7. BAM’s inclusion strategy has benefitted from the licensing of Al-Barid Bank (ABB) in 2010. The bank houses financial services formerly offered by the postal network, and reaches about five million customers in areas largely untapped by banks (informal workers, small traders,                                                              23  Bangkok-based network of 95 institutions in 81 countries; administered by GIZ; funded by Gates Foundation.  24  Banks have opened 3.5 million accounts in recent years through telecoms, remittance operators, etc.  25  http://www.ft.com/cms/s/0/fd16a1f0-ecea-11df-9912-00144feab49a.html#axzz2cWXiDdxB  26  http://in.reuters.com/article/2011/05/03/idINIndia-56735520110503    64    etc.).27 Initially focused on savings, ABB introduced overdraft products in 2011 and some mortgage lending in 2012, with a mandate to serve low-income borrowers. By law, ABB’s excess cash is managed by CDG. Figure A7.2: Banking Penetration (% of adults)Number of Accounts (in mln) by Segment Source: BAM and staff calculations. 8. ABB plans to expand its reach through mobile banking. While the new service represents merely another delivery channel for existing clients, new clients will have access to basic services such as money transfer and pre-paid accounts (“comptes de paiement”) up to MAD 20,000. ABB’s “mobile account” is opened with only a valid ID. Additional inclusion gains will come from a partnership signed in 2013 with Fondep, a large MFI, giving its clients access to ABB services including payment cards and mobile banking to service Fondep loans. ABB aims to enter similar partnerships with other MFIs. 9. The industry and authorities work on other inclusion initiatives at various stages of maturation. Progress is hampered by weakly integrated information systems for analysis and policy formulation, although much data is collected and with suitable granularity. Building up knowledge management and institutional capacity are objectives of a Bank-supported project financed by the MENA Transition Fund. This project includes the formulation of an integrated national inclusion strategy and stronger coordination among stakeholders.                                                              27  See El-Zoghbi, Mayada, and Martinez. 2012. “Can Postal Networks Advance Financial Inclusion in the Arab World?” Washington, D.C., CGAP.    65