The World Bank. Public Disclosure Authorized Document of USE ONLY FOR OFICIAL. Report No. P-6633-MOR. Public Disclosure Authorized

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1 Public Disclosure Authorized Document of The World Bank FOR OFICIAL USE ONLY Report No. P-6633-MOR Public Disclosure Authorized REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS Public Disclosure Authorized ON A PROPOSED SINGLE CURRENCY LOAN WITH A US DOLLAR TRANCHE IN AN AMOUNT EQUAL TO US$125 MILLION AND A FRENCH FRANC TRANCHE IN AN AMOUNT EQUAL TO FRF600 MILLION Public Disclosure Authorized TO THE KINGDOM OF MOROCCO FOR A FINANCIAL MARKETS DEVELOPMENT LOAN JUNE 29, 1995 This document has a restricted distribution and may be used by recipients only in the performance of their ofricial duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EOUIVALENTS Currency Unit: Dirham (DH) April DH per US$ End of Period DH per US$ Period Average I I_I_ i FISCAL YEAR January I - December 31 WEIGHTS AND MEASURES Metric System ACRONOYMS AND ABBREVIATIONS BAM BCP BMCE BNDE BOT CCG CDG CG CIIH CDVM CNCA CNSS CSE EU FMDL FRF IPO ICB LCB PE PEP PSA PSD SFI SNI SOEs USD VLR Bank Al-Maghrib Banque Centrale Populaire Banque Marocaine du Commerce Exterieur Banque Nationale pour le Developpement Economique Build-operate-transfer Caisse Centrale de Garantie Caisse de Depots et Gestion Central Government Credit Immobilier et H6telier Comite Deontologique des Valeurs Mobilibres Caisse Nationale de Cr6dit Agricole Caisse Nationale de Securit6 Sociale Casablanca Stock Exchange European Union Financial Markets Development Loan French francs Initial Public Offering International Competitive Bidding Local Competitive Bidding Public Enterprise Plancher d'effets Publics Private Sector Assessment Private Sector Development Specialized Financial Institution Societe Nationale d'lnvestissement Statement of Expenditures US dollars Variable Lending Rate Bank staff contributing to the project include: Messrs./Mmes. Forestier (Task Manager), Batchoun (Foreign Exchange Market). Brun (Monetary Policy), De Wulf and Soman (Macroeconomic Framework), Dupuy,(Legal Aspects), Gress (Procurement), Savorelli (Capital Markets), Yourougou (Bank Lending Products). Mr. Al-Khafaji and Mr. Daniel Ritchie are, respectively, the managing Division Chief and Department Director for the operation. Ms. Liliane Vert provided excellent support services.

3 FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF TBE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIIVE DIRECTORS ON A PROPOSED FINANCIAL MARKETS DEVELOPMENT LOAN TO THE KINGDOM OF MOROCCO TABLE OF CONTENTS LOAN AND PROGRAM SUMMARY... i I. INTRODUCTION.1 II. RECENT ECONOMIC DEVELOPMENT AND PROSPECTS.. A. Stabilization and Structural Adjustment Policies.1 B. Recent Economic Performance. 2 C. Prospects... 4 III. PRIVATE SECTOR DEVELOPMENT... 5 A. Public Enterprises and Privatization... 5 B. The Financial Sector... 8 C. Government Strategy IV. PROGRAM OF FINANCIAL SECTOR REFORMS A. Reform of Treasury Financing B. Indirect Monetary Control C. Development of Capital Market D. Banking System E. Capacity Building F. Fiscal Impact of Reforms V. PROPOSED LOAN A. Loan Amount and Borrower B. Rationale for Bank Involvement C. Project Description D.. Implementation Arrangements VI. RISKS VII. OTHER BANK GROUP OPERATIONS.22 VIII. AGREEMENTS REACHED.22 IX. RECOMMENDATION.22 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.

4 ANNEXES Annex 1: Letter of Development Policy Attachment 1: Macroeconomic Framework - Selected Indicators Attachment 2: Matrix of Policy Measures Annex 2: Macroeconomic Indicators Annex 3: Cost of Reforms Annex 4: Privatization Indicators Annex 5: Securities Market Annex 6: Situation and Role of Institutional Investors Annex 7: Capacity Building Program Annex 8: Distribution of Financial Assets Annex 9: Consolidated Balance Sheet of Deposit Banks and Monetary Survey Annex 10: Social Indicators Annex 11: Status of Bank and IFC operations Annex 12: Key Processing Events MAP: IBRD No

5 i LOAN AND PROGRAM SUMIARY Borrower: Amount: Terms: Kingdom of Morocco US$250 million equivalent comprising: (a) a US$125 million US dollar Tranche, and (b) a FRF 600 million French franc Tranche Fixed rate single currency loan for up to 15 years. For each loan currency Tranche, each semester's aggregate disbursements (Disbursed Amount) will have a grace period of 3 years and a final maturity of 12 years; both beginning from the rate fixing date for such Disbursed Amount. Interest Payment dates November 15 and May 15 and Rate Fixng Dates: Loan Description: Benefits: The Financial Markets Development Loan (FMDL) is the first of a US$ million equivalent multi-year private sector development (PSD) lending program currently under preparation and scheduled for FY The FMDL would support a program of reforms in the financial sector and finance the temporary cost to the Moroccan Treasury of implementing this program. Beyond a transitional period of three years, the budgetary impact will remain limited to about 0.17 percent of GDP per year and, therefore, consistent with macrostabilization objectives. The specific policy measures concern: (a) the reform of Treasury financing including the removal of mandatory placement ratios for banks in Treasury bonds at below market rates; (b) indirect monetary control including the liberalization of lending rates; (c) the development of capital markets; and (d) the banking system, in particular the privatization of the remaining state-owned banks and the establishment of an interbank foreign exchange market together with related prudential measures. A policy matrix details the specific actions to be supported by the FMDL and shows how they complement those already implemented. The main benefits of the loan will be: (a) establishment of a market-based financial system, essentially free of any significant distortion in the allocation of credit and the pricing of financial assets; and (b) the deepening of domestic financial markets which will increase the supply of long-term capital for private investment and contribute to achieving a sustained improvement in domestic savings.

6 ii Risks: Financial Benefits and Risks: Estimated Disbursements: Two main risks are associated with the proposed loan. The first relates to the fiscal sustainability of the reform program. The recent resurgence of macroeconomic imbalances, in particular on the fiscal front, could put pressure on interest rates, increase the cost of public sector borrowing and prompt the authorities to revert to administrative controls of interest rates and credit allocation. Corrective measures aimed at increasing public savings, notably through tightening of recurrent expenditures and acceleration of the privatization program, are being prepared by the Government. The impact of these measures is reflected in the macroeconomic indicators, attached to the Letter of Development Policy, which will be used to monitor continued satisfactory macroeconomic performance which is essential for the successful implementation of the financial reform program. The second risk is a deterioration of banks' loan portfolios following the implementation of liberalization measures and increased competitive pressure as financial markets develop. Moroccan banks are generally healthy and have demonstrated their capacity to sustain an adequate profitability following the first liberalization measures in the early nineties. Furthermore, a sound prudential and regulatory framework is already in place. This risk will be reduced by further strengthening of bank supervision. The Borrower has selected a fixed rate single currency loan with currency Tranches in US dollars and French francs in order to improve the management of its external liabilities. The choice of currencies reflects the weight of French francs and US dollars in Morocco's foreign exchange receipts, of which about 35 percent is denominated in each of those two currencies. The choice of a fixed interest rate reflects the Borrower's preference to reduce the risk of interest rate volatility in view of its current exposure in floating rate loans which account for about 45 percent of its total external debt. In addition, the Borrower considers that the budgeting and management of its external debt service obligations would be simpler for single currency loans than for currency pool loans. The loan would be disbursed in two aggregate tranches of US$150 equivalent and US$100 million equivalent against import documentation. The release of the second tranche will be conditioned on satisfactory macroeconomic performance and satisfactory progress in the implementation of the reform program in the financial sector, including the achievement of a limited number of specific measures. FY96 FY97 (US$ million equivalent) IBRD Parallel Financing: Project Identification No. Parallel financing may be provided by the African Development Bank and the European Union MA-PA-5522

7 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED FINANCIAL MARKETS DEVELOPMENT LOAN TO THE KINGDOM OF MOROCCO I. INTRODUCTION 1. I submit for your approval the following report and a recommendation on a proposed Financial Markets Development Loan (FMDL) to the Kingdom of Morocco in an amount equivalent to US$250 million in support of a program of financial sector reforms. The fixed rate single currency loan package would comprise a US$125 million US dollar Tranche and a FRF 600 million French franc Tranche, for up to 15 years. For each loan currency Tranche, each semester's aggregate disbursements (Disbursed Amount) will have a grace period of 3 years and a final maturity of 12 years, both beginning from the rate fixing date for such Disbursed Amount. Parallel financing may be forthcoming from the African Development Bank and the European Union (EU). 2. The FMDL is the first loan of a FY96-98 US$ million equivalent multi-year PSD lending program. In line with the CAS discussed by the Board on November 23, 1993, and the 1994 Private Sector Assessment (PSA)', the core objective of the Bank PSD program is to achieve higher private investment and private sector growth which are necessary to accelerate the rate of overall economic growth, above the average 3 percent real rate of the period. Some five other projects, currently under preparation, are scheduled for FY They will focus on: (a) private provision of infrastructure; (b) vocational training; and (c) enterprise competitiveness. 3. The main objectives of the FMDL are to deepen Morocco's financial markets and to establish a market-based financial system. The financial sector remains a bank-based system where domestic capital markets play a very modest role in supplying long-term capital to the private sector. The Government channels a large share of banks' deposits and medium- and long-term institutional savings to secure the Treasury borrowing requirements at administered, below-market interest rates. Morocco's domestic savings rate of about 16 percent remains significantly below countries that have achieved high rates of investment and growth. To sustain the necessary increase in the overall rate of domestic savings and private investment, further reforms are necessary to develop domestic financial markets along with other macroeconomic measures aimed at raising public savings, in particular, fiscal stabilization and an acceleration of the privatization program. The policy measures supported by the FMDL represent a continuation of the financial sector reform that Morocco launched in the late eighties, and that the Bank has supported through the 1991 Financial Sector Development Project 2. II. RECENT ECONOMIC DEVELOPMENT AND PROSPECTS A. Stabilization and Structural Adjustment Policies 4. The internal and external imbalances that characterized the Moroccan economy in the early 1980's led to the adoption of vigorous stabilization-cum-adjustment policies. These efforts were supported by bilateral and multilateral sources and debt relief under the auspices of the Paris and London Clubs. In the first phase, up to 1986, the emphasis was on economic stabilization. Supported by lower budget deficits, prudent monetary policies favored greater price stability, while an active exchange rate 1/ Preparing for the 21st Century - Strengthening the Private Sector in Morocco - Report No MOR; June 30, / Report No. P-5553-MOR; June

8 2 policy restored external competitiveness. In the second phase, policies focused on structural reforms, while maintaining internal and external balances. The adjustment process moved generally in the right direction and brought tangible progress. 5. Main elements of the structural adjustment measures implemented since the mid-1980's are: (a) liberalization of foreign trade; (b) progress towards balance of payments sustainability; (c) partial reform of the financial sector; and (d) reform of the public enterprises and privatization. 6. Trade liberalization, begun in 1984, was pursued, and from a situation of wide scale import and export restrictions, Morocco became a country where only ten products remain subject to quantitative trade restrictions. Tariff protection has also been lowered (maximum rates fell from 45 percent in 1988 to 35 percent in 1994, but a fiscal duty of 12.5 percent still applies), with the exception that the 45 percent tariff still applies to selected agricultural commodities. The 1995 Finance Law reduced tariffs to 5 percent on a large number of imports that do not compete with domestic products, and abolished the fiscal duty on imports of a wide range of investment goods. The scope of reference prices was also narrowed considerably, and by 1994 applied to only 10 percent of industrial imports. Within the context of an eventual association agreement with the European Community (EU), discussions are ongoing to phase out duties on imports from the EU. 7. Current account convertibility has been achieved with Morocco accepting obligations under Article VIII of the Articles of Agreement of the IMF in January Virtual full capital account convertibility is achieved for foreign investors. The relaxation of surrender requirements and restrictions on foreign borrowing, as well as authorization of outbound investment by certain export firms and banks, represent the first moves towards capital mobility for residents. 8. Recent public enterprise (PEs) and financial sector reforms are detailed in Chapter III. They are consistent with the growing conviction that the private sector is to become the engine of future growth in Morocco, that the public sector should withdraw from direct production activities, and that a market-driven financial sector should gradually replace a system largely based on administrative controls of the price and allocation of financial resources. B. Recent Economic Performance 9. The growth performance of the Moroccan economy varies greatly from year to year, largely because of its structural vulnerability to climatic conditions (Table 1). During , annual GDP growth averaged 3.6 percent. In 1993, a drought caused the growth rate to decline. With good rainfall in 1994, the economy picked up strongly and GDP rose by 11.8 percent. For 1995, negative growth is projected as a result of another severe drought. Inflation has been successfully contained at around 5 percent a year, as a result of prudent fiscal and monetary policies. The budget deficit fell to 3-4 percent in recent years as compared to 11 percent in External balances were also substantially strengthened. The deficit of the current account, on average 8 percent of GDP during the first half of the 1980's, has been successfully contained below 3 percent of GDP since External reserves rose steadily due to increasing flows of direct foreign investment and improving current account deficits, including continued inflows of worker remittances. They amounted to the equivalent of six months' worth of imports at the end of 1994, compared to about one month in the mid-1980s. At one-third of exports, the burden of servicing the external debt remained heavy in However, the stock of external debt stood at 67 percent of GDP in 1994, down from an average 90 percent in , and the debt service ratio is declining (Table 1).

9 3 Table 1: Selected Macroeconomic Indicators Actual Prelim Estim. Proiected ( in Percent) Real GDP Growth Agriculture Non-agriculture (In percent of GDP) Gross Investment Central Govt Private Sector " Domestic Savings Government Private Budget Deficit Privatization receipts Current Account Deficit Exports Manufact. Exports/GDP Foreign Debt Outstanding (In Percent of Exports) Foreign Debt Service (In Month of Imports) Foreign Reserves / Includes Public Enterprises Source: Annex Since 1992, however, macroeconomic developments, especially in the area of public finance, indicate an emergence of modest but growing imbalances. Over the period, the fiscal deficit increased from 2.2 percent to 3.8 percent of GDP. There are also signs of potential tension on the external situation despite a relatively comfortable level of foreign reserves at the end of Total exports have stagnated as a percentage of GDP and manufactured exports have declined in line with an appreciation of the real effective exchange rate of 6 percent since The end of external debt relief since 1992 has translated into an increase in the debt service ratio over the period. Finally, both investment and savings have stagnated as a share of GDP and remain significantly below the rates achieved by other fast-growing middle-income economies. For 1995, the budget deficit is expected to widen further to 4.7 percent of GDP. This deterioration is explained in part by excessively optimistic projections of budgetary revenues which led to high expenditure authorizations. During the first quarter of 1995, the trade deficit widened by 3 percent compared to the corresponding period of 1994, while foreign exchange receipts from tourism shrank by 21 percent. In addition, the drought will cause the GDP to decline which will undermine Government revenue performance and necessitate exceptional drought-relief expenditures. Hence, macroeconomic stability needs to be reasserted more firmly than in recent years.

10 4 C. Prospects 12. Assuming basic internal and external stability are maintained and the structural reforms continue at the modest pace of recent years, Morocco can expect to continue to grow at the average level of about 3 percent p.a. However, this rate would lead to a further increase in the unemployment rate. Only higher economic growth built on labor intensive investment will permit an increase in the number of jobs that exceeds the number of people coming into the urban labor market. 13. Maintaining a sustainable macroeconomic framework is a pre-requisite for achieving higher savings and growth and also for liberalizing the financial sector, a major objective of the proposed loan. A package of policy measures, mainly on the fiscal front, is being prepared by the Government in close cooperation with the IMF and the Bank to bring the recent deterioration under control. They include: (a) reforming the tax system, in particular through the adoption of a unified investment code and the redefinition of the personal income tax to simplify its administration and achieve a more equitable pattern; (b) increasing the cost recovery of services delivered by the State, in particular by raising water charges; and (c) rationalizing public expenditures through a limitation in the increase in recurrent expenditures, an acceleration of the privatization program (Chapter III), an increase in resources allocated to human capital formation (basic education and health) and the preparation of three-year rolling public investment plans. Prudent monetary policy will complement these fiscal measures and aim at providing the private sector with adequate credit to support economic growth while ensuring that monetary expansion is consistent with maintaining a low level of inflation and international reserves at about 5 months of imports. Macroeconomic variables consistent with these measures and with the gradual achievement of a higher growth scenario are provided in Table 1 and detailed in Annex By the year 2000, the accumulated impact of structural changes is expected to result in sustainable growth of around 5 percent p.a. and the budget deficit is projected to approach balance. Fiscal revenues, currently at 24 percent of GDP and relatively high compared with those of fast growing economies, are to drop slightly, while recurrent expenditure growth is contained. Based on the existing stock of debt and a modest net foreign borrowing, the ratio of foreign debt to GDP would fall from about 70 percent of GDP in 1994 to 56 percent in 1998 and 49 percent in the year The debt service to exports ratio would fall from 32 percent in 1994 to a more sustainable level of 23 percent. Investment, as a share of GDP, would increase by 4 percentage points between 1994 and the year 2000, and would be financed by a substantial increase in domestic savings. The increase is expected to result from the deepening of domestic financial markets and higher public sector savings. The reduction in the overall budget deficit will reduce the pressure on domestic financial resources. Reforms, restoring and then maintaining external competitiveness through flexible exchange rate management, would further improve the medium-term macroeconomic outlook, especially the growth and balance of payments indicators. 15. At about 30 percent of GDP, total Government expenditures are high compared to other rapidly growing economies. The brunt of the budgetary adjustment will need to come from lower recurrent expenditures which currently amount to about 70 percent of total expenditures. They are projected to come down by 4-5 percentage points of GDP by the end of the decade. The share of civil service wages in GDP, in particular, would drop from its current level of 10 percent of GDP to 8 percent in the year 2000, by limiting the increase in the wage bill to the rate of inflation. 16. Morocco's balance of payments remains vulnerable to the external environment, as well as to the climatic conditions (three droughts over the past four years). The current account deficit is projected to deteriorate to 3.5 percent in 1995 due to increased import demand for foodstuffs and investment goods. The high concentration of over 60 percent of the country's merchandise trade with the European Union makes Morocco's exports sensitive to economic growth trends in the EU. As a result of the Uruguay Round of the GATT and the impending Free Trade Agreement with the EU, Morocco will face increased competition for its main exports: textiles and clothing, and agricultural

11 5 products. All these developments could put a strain on the economy's ability to generate additional foreign exchange and sustain the current level of external reserves. A decline in external reserves would adversely affect the internal and external credibility of the Government's program. Consolidating the level of reserves at its current level of about 5 months of imports is, therefore., part of the medium-term economic framework agreed between the Moroccan authorities, the Bank and the IMF. III. PRIVATE SECTOR DEVELOPMENT 17. The private sector accounts for an increasingly significant share of economic activity in Morocco, about 70 percent of value added, 90 percent of employment, and 75 percent of investment. It contributes virtually all of the value added in agriculture, commercial construction and trade, 75 percent of industry, and 70 percent of banking and financial institutions. However, the public enterprise (PE) sector remains economically important. It accounts for about 20 percent of GDP, with more than half of value added in mining, energy, water supply, and roughly half of transport and communications. Since 1990, most restrictions on foreign ownership have been lifted and direct foreign investment rose from about 0.9 percent of GDP to an annual average of 1.7 percent in Recent Bank economic and sector work, in particular the 1994 PSA, has shown that achieving a higher rate of private investment and private sector growth will be predicated upon further progress primarily in three areas. First, deepened macroeconomic adjustment, in particular lower fiscal deficits, is necessary to raise public savings and overall domestic savings to finance investment (Chapter II). Second, the PE sector needs downsizing primarily through faster and bolder privatization. This will raise the level of efficiency of private investment and open key infrastructure services such as water, electricity and communications to private financing. Investment needs in these sectors are estimated to grow at an annual average rate of 7 to 12 percent depending on the sector, and their public financing is no longer compatible with macroeconomic stability objectives. Privatization will, in addition, raise revenues for the Government and contribute to the development of capital markets. Third, further reforms in the financial sector are essential to alleviate the shortage of term resources to finance private investment. This shortage is largely due to the low development of domestic financial markets, the Government's preferential access to bank credit at non-market terms which taxes and crowds-out private investment, and Morocco's limited access to international capital markets. A. Public Enterprises and Privatization 19. The Public Enterprise Sector. As detailed in Table 2, Morocco has a large PE sector. There are about 330 firms in which the State has a majority holding. The fourteen largest PEs, mainly operating in power, water, transport, and mining and phosphate processing, account for the bulk of the sector. Table 2: The Public Enterprise Sector GDP Gross Domestic Wages and Domestic Credit Investment Salaries (1994) In Percent of Total PE PE PE transfers from Stock of Arrears Investment Losses CG (1994) Gross Net From From In Percent of GDP PE to CG CG to PE Source: Ministry of Finance and Bank estimates. CG = Central Government; annual average of various years, mainly

12 6 20. Performance. Despite the divestiture program initiated in the late eighties, the efficiency and the financial health of the large PE sector remains a concern. In the period , the fourteen largest PEs had an annual average deficit of 1.7 percent of GDP. Despite recent improvements, Government-PE cross arrears remain substantial. Central Government (CG) arrears to PEs totalled 1.3 percent of GDP at end-1994 and were mainly related to lack of payment to utilities caused by a lack of budgetary discipline. Arrears from PEs to CG of 3.2 percent of GDP at end-1994 are mostly related to tax payments and service of guaranteed external debt. The PE sector, as a whole, is a slight drain on the government budget: net CG transfers to the PEs averaged 0.3 percent of GDP p.a. during Investment and Financing. The bulk of the investment by the PE sector is accounted for by the fourteen largest PEs and averaged DH 13.5 billion p.a. (5.8 percent of GDP) during About 40 percent is self-financed, 20 percent is financed through CG capital transfers and 40 percent through domestic (10 percent) and external borrowing (30 percent). The importance of foreign borrowing explains why the largest PEs only account for less than 10 percent of domestic credit to the economy and, therefore, does not represent a significant risk for the financial system. During the eighties, the PE sector enjoyed special privileges to finance its borrowing requirements, such as various government guarantee schemes and mandatory placements of a fixed portion of banks' deposits in bonds issued by state-owned specialized financial institutions'. PEs' preferential access to credit combined with their poor financial performance led to an increase in non-performing loans, mainly in state-owned banks, and in the case of some PEs, forced the CG to service their guaranteed external debt. In 1992, the Government started to reduce these privileges: (a) directed credit policies benefitting SFIs were eliminated; (b) the Ministry of Finance discontinued granting credit risk guarantees on domestic and external loans and is phasing out its policy of covering the foreign exchange risk'; and (c) prudential ratios were introduced in the banking system to prevent excessive risk concentration 5. Combined with the forthcoming reforms which will eliminate Government guarantees of PEs bond issues, these measures will essentially create a level playing field between PEs and the private sector in raising funds. Subsidies resulting from PEs' preferential access to domestic and foreign resources will be eliminated and the risk of contamination of banks' portfolios by PEs' losses will be reduced. In parallel, the Government plans to complete the first phase of its privatization program and subsequently expand it to a second phase. 22. First Phase of Privatization. Recognizing the unsatisfactory performance of the PEs, a Privatization Law was passed in 1989 mandating the sale of 112 companies and hotels. As of end-april 1995, after a relatively slow start, some thirty companies have been sold generating revenues of 7.2 billion DH (US$785 million). Individual share-holding is expanding rapidly and testifies to the existence of savings available for long-term investment: nearly 150,000 individuals had subscribed to privatization offers on the Casablanca Stock Exchange, while less than 10,000 individuals participated in the stock market before the onset of the privatization program. The Stock Exchange itself is due to be privatized in About 35 percent of the proceeds generated have come from foreign investors. In early 1995, the Government extended the sales deadline for the first phase by one year to December 1996 and added the two oil refineries to the list of privatizables. However, with the notable exception of the financial sector, the privatization program has not yet seriously reduced the economic weight of the public enterprise sector, in particular in transport and utilities. This conclusion is consistent with the 3/ Banks were required to place 5.5 percent and 6 percent of their deposits in BNDE and CIH notes, respectively. 4/ Several large borrowers, such as ONE, the electricity utility, already bear the foreign exchange risk on new borrowings. 5S Loans to a single beneficiary and to a single corporate group are limited to 7% and 15% of the bank's net equity, respectively.

13 7 regional pattern: privatization in Middle East and North African countries is lagging behind other regions, in particular Latin America, both in terms of number of transactions and receipts (Annex 4). 23. Privatization in the Financial Sector. Ten financial institutions (banks, insurance companies and a large financial holding) which contribute about 30 percent of total value added of the sector, are to be privatized before end The first two large and complex privatizations were successfully completed in 1994 and The State's shares in Societe Nationale d'investissement (SNI), a financial holding with shares in 41 varied concerns, were sold in two phases for a total of DH 2.0 billion (US$225 million) at the end of An initial public offering (IPO) of 18 percent of SNI's share was oversubscribed six times on the Casablanca Stock Exchange (CSE), while 51 percent were sold through tender to a consortium of Moroccan private financial institutions. SNI management was restructured shortly after privatization. In 1995, Banque Marocaine du Commerce Ext6rieur (BMCE), Morocco's second largest commercial bank with assets representing 18 percent of total assets of the banking system was privatized in three tranches for a total of DH 1.8 billion (US$214 million): (a) an IPO of 14 percent of BMCE's shares sold on the stock exchange; (b) 3 percent sold directly to BMCE's employees; and (c) 26 percent of BMCE's shares sold through tender to a group of foreign and Moroccan financial institutions. Finally, a consumer credit institution was also privatized in 1994, through a combination of tender, IPO and direct sales to workers. The State's shares were sold for a total of DH 130 million (US$14 million). 24. Lessons of First Phase. Morocco has so far privatized a few PEs. What has been privatized, has been privatized very well. One should not discount the substantial benefits of having at first proceeded slowly and cautiously, with much discussion along the way, and with considerable attention to transparency mechanisms. In privatization programs, building a public consensus is as important as the technical quality of transactions. The first set of privatizations has demonstrated that sales of PEs can be conducted that are fair, open and mutually beneficial to seller and buyer, and that do not impose undue pain on workers and consumers. Thus, Morocco now can and should go farther and faster along the path of increasing private participation in, and ownership of, the remaining public enterprise sector to reduce the size and the losses of the sector, and to raise the overall efficiency of investment. 25. Second Phase. In October 1994, the Minister of Privatization launched the second phase of the privatization program by requesting all Ministries to submit to him: (a) a list of PEs in their portfolios that they consider suitable for privatization; and (b) data on the performance of every enterprise under their control to compile a data base for the Ministry's supervision activities and examine whether likely divestiture candidates were being held back. The second phase will be extended to previously untouched areas, primarily transport and the largest utilities'. In April 1995, the Government confirmed this orientation and stated that it "cannot continue to apply conventional public financing methods in order to raise the whole of the financing needed to satisfy the real basic infrastructure needs generated by Morocco's economic expansion and population growth"'. The Government's strategy consists of: (a) withdrawing from industrial and commercial activities and promoting new formulas of partnership between the public and private sectors, such as concessions and limited recourse project financing; and (b) diversifying sources of infrastructure financing notably through reforms of the domestic financial market. Several ground-breaking activities are already underway. The electricity enterprise ONE 6/ The first list of privatizable companies excluded: (i) firms fulfilling a public service role, and (ii) firms not operating in competitive markets. 7/ "Infrastructure Financing in a Post-Adjustment Economy" paper by the Government of Morocco, presented to the April 1995 meeting of the Development Committee.

14 8 awarded in early 1995 a leaseback and a build-operate-transfer (BOT) contract for a total of US$1.7 billion to a private group for the operation of two existing units and for the construction and operation of two additional thermal generating units. Discussions are advanced for concession arrangements in electricity, water distribution and sanitation services, in a number of municipalities. A concession has also been awarded to build and operate a toll road system, the Rabat-Laracha 150 km highway. Finally, a new telecommunications law has been drafted which calls for the creation of an independent telecommunications company operating on commercial principles, which paves the way for competition and, ultimately, privatization in the sector. B. The Financial Sector 26. Institutions and markets. The public institutions currently operating in the financial system include: the Central Bank, Bank Al-Maghrib (BAM); the Treasury; the postal checking system and the National Savings Bank which collects small savings from the public; and the Caisse Centrale de Garantie (CCG) - providing guarantees on loans to private and public firms. There are also five state-owned specializedfinancial institutions (SFIs) 5. Finally, the Casablanca Stock Exchange (CSE) was created in 1929, and became a formally organized market in Private financial intermediaries include 13 commercial banks, a financial holding company recently privatized (SNI), 6 leasing companies, 22 insurance companies, and a few recently created brokerage houses operating on the stock exchange. Institutional savings still play a modest role in the Moroccan financial system. In 1993, total assets managed by institutional investors amounted to about 20 percent of GDP compared with, for instance, about 150 percent in the US, 50 percent in Malaysia and 30 percent in Chile. Pension funds and social security collect long term savings from households and place most of them in Treasury bonds, deposits at CDG, and other public securities. The insurance industry is growing rapidly but remains financially weak and underdeveloped. Insurance premiums amounted to 2.5 percent of GDP in 1993, which situates Morocco in the low range of middle-income countries (Annex 6). Table 3: Moroccan Financial Institutions end-1993 (million DH) Deposit Banks SFIs" Institutional Savers Total Assets 135,557 54,563 Insurance companies Net Worth 12,973 7,399 Reserves 20,288 Number 15 6 Number of 2/22 public/private of which private: Social Security % of Total Assets Reserves 7,624 % of Net Worth Pension Funds Number 13 0 Reserves 11,749 1/ Specialized financial institutions (including SNI) Source: Bank Al-Maghrib, and Casablanca Stock Exchange. Number of 6/2 public/private 8/ Banque Nationale pour le Developpement Economique (BNDE), which lends to industry; Caisse Nationale de Credit Agricole (CNCA), which lends to agriculture; Caisse de Dep6t et de Gestion (CDG), which mobilizes public sector savings; Crddit Immobilier et Hotelier (CIH), which lends to the housing and tourism sectors; and Caisse Marocaine des Marches (CMM), which lends to private companies involved in public works.

15 9 28. Credit. Morocco still has a bank-based financial system, where direct instruments of financing (bonds, stocks) are rarely used by the private sector. As detailed in Table 4, the Treasury absorbs 35 percent of domestic credit, of which 23 percent consists of forced placements of bank deposits in Treasury bills at below market rates and 12 percent of statutory advances from the Central Bank and auctioned securities placed with CDG and banks. The Treasury thus absorbs a substantial portion of investable resources in the economy, some of them through mechanisms that distort the efficient allocation of funds. SFIs continue to provide most medium and long term credit to the economy (about 66 percent of the total), but other commercial banks have become increasingly active in this respect. Public enterprises account for a relatively small portion of total domestic credit to the economy (para. 21). DEMAND Table 4: Morocco - Distribution of Domestic Credit (end 1993) SUPPLY TOTAL Central Bank Deposits Banks Specialized Institutions billion % billion % billion % billion % DH DH DH DH Treasury / Economy: Short term (64.2) (37.9) (8.8) (5.2) (50.1) (29.6) (5.3) (3.1) Medium-long term (45.9) (27.1) - (15.7) (9.2) (30.2) (17.8) Total Private Sector Public enterprises Public Sector = Treasury + PEs / Credit outstanding. 2/ Of which 31 percent consists of forced placements of bank deposits in Treasury bills at below market rates (4.25 percent). Source: Bank Al-Maghrib. 29. The money and interbank markets show little transaction activity. For its advances, the central bank de facto sets the rediscount rate by fiat and this rate bears little relationship to the interbank market for short-term funds. The Treasury holds weekly auctions, but few bids take place in any one auction. The money market still plays a limited role and, as such, has not provided an efficient mechanism to price financial assets (there is no risk-free benchmark like the yield curve on US Treasury bills), and does not allow indirect monetary control. 30. Capital markets. There has been recently some important progress, especially in the legal and regulatory framework. Primary Treasury bonds issues increased by 31 percent in 1993, and provide the basis for a secondary market, which has so far remained thin. The main underwriters of these bonds are CDG banks and contractual savings institutions (Table 5). Private fixed income securities are neither issued nor traded, because of the cumbersome administrative procedures prevailing until 1993, the fiscal advantages granted to Treasury bonds, and the government guarantee attached to bonds issued by public enterprises.

16 10 Table 5: Primary Bond Market: Borrowers and Underwriters DH million Percent DH million Percent BORROWERS/ISSUERS 5, , Treasury: 1, , Auctions (688) (13.1) (1,713) (25.0) National Issues (932) (17.8) (1,861) (27.1) SFIs and other PEs 3, , UNDERWRITERS: CDG 2, , Insurance C , Other 1, , As detailed in Annex 5, and summarized in Table 6 below, the stock market has grown remarkably fast since Market capitalization as a percentage of GDP has tripled. The trading volume has increased dramatically and the liquidity ratios have improved. Privatization has been a major factor behind this surge of the stock market. The volume of trading related to privatization accounted for 27 percent of the total in 1994 and rose to more than 50 percent in early The Casablanca stock exchange presents many features of a nascent capital market: (a) high concentration (94 percent of total transactions were concentrated in 10 stocks in 1993); (b) high P/E ratio and low liquidity (trading volume represents 3.5 percent of GDP as compared with 10 percent in Pakistan and more than 40 percent in Hong Kong, Japan or the UK, for instance); and (c) an excessive share of off-floor trades. Moreover, while privatization has given a boost to the market, its sustainability will depend on public offerings from private enterprises which have been scarce. Compared with other emerging markets, in 1993, market capitalization of the CSE was close to that of Egypt, exceeded Iran, Tunisia and Nigeria, but was lower than most other comparable middle income developing countries (Annex 5). Table 6: Stock Market-Key Indicators Market Size -Market Capitalization/GDP % " Number of listed companies Average daily trading volume by market session (million DH) 2. Liquidity -Turnover Ratio % Trading volume/gdp % Concentration -Share of 10 most traded stocks in 80.0 NA 94.0 NA total transactions % 4. Asset Pricing -Official Call Market % Price/Earnings ratio (P/E) Privatization Impact -Average daily trading related to privatization as % of total trading 1/ Associated with the number of shares submitted for listing for each listed company's share capital. 2/ Trading volume as a percentage of market capitalization. Source: Bourse des Valeurs de Casablanca.

17 I1 33. In conclusion, the Moroccan financial system remains a bank-based system where a large portion of domestic credit goes to the Treasury through forced placements and where private enterprises must rely on bank credit or self-financing. Banks are generally healthy due to their limited latitude for lending, to their prudence (about half of commercial banks' assets are invested in risk-free government securities), a modern prudential and regulatory framework and to a long-time association with foreign banks. However, partly because of the administratively set ceiling on lending rates, they tend to lend only to best clients, mainly large enterprises. Capital markets still play a limited role in the intermediation of investable resources, but spurred by the privatization program, they have recently demonstrated their potential to become a major source of long-term resources for private investment. 34. The First Phase of Financial Sector Reform. Morocco has been engaged in financial sector reform since the mid-eighties with the establishment of positive real interest rates, the introduction of an auction market for T-bonds, and the elimination of special advantages granted to SFIs. In 1991, the Government developed a program of financial sector reforms supported by the Financial Sector Development Project. The main objective of this program was the reform of the banking system. Key measures (detailed in Annex 1) included the liberalization of interest rates on deposits, elimination of quantitative credit rationing, obligatory lending by commercial banks to selected sectors, and strengthening of the prudential regulatory and supervisory framework of banks. This program has been implemented, and the two tranches of the Bank's loan were released as scheduled. C. Government Stratey 35. In June 1994, the Government set up an Advisory Committee comprised of policymakers and private sector leaders, with a mandate to prepare a charter for private sector development. At the Government's request, the Bank is a member of this Committee in which it actively participates. The Committee has been meeting every month since its inception. A joint private sector/government strategy for PSD has been defined and is detailed in the charter which will be discussed with the Government. The central objective of this strategy, supported by the Bank, is to create an environment to stimulate greater private investment and higher growth. The charter recommends specific actions to: (a) establish a market-based financial system and develop capital markets; (b) promote private sector participation in the development of basic infrastructure and services; (c) improve skilled labor and remove restrictions on the labor market including minimizing government interference in business-labor relations; and (d) enhance the competitiveness of the private sector in anticipation of a free trade agreement with the EU. 36. The Bank's FY96-98 PSD program aims at delivering lending and non-lending services in support of the above strategy. Six projects, including the proposed FMDL, are at various stages of preparation, for a total lending volume of US$ million equivalent. Non-lending services include continued participation in the Advisory Committee, sector work on private participation in infrastructure, and technical assistance for enhancing industrial competitiveness. (a) Financial sector. The proposed FMDL comes at the forefront of the Bank's multi-year PSD program because further reforms of the financial sector are required to achieve the medium-term objective of a higher rate of economic growth and higher private investment. Forced placements tax the banking system and distort the allocation of its resources. In the absence of market-determined lending rates, there is limited competition within the banking system. The low development of domestic financial markets represents a barrier to the necessary increase of domestic savings and contributes to the shortage of long-term capital for private entrepreneurs. The Treasury relies on its tight grip on the banking system and institutional savers to finance its deficit: a loss of control on the fiscal deficit in such a rigid context would imply either hidden money creation, and thus a potential inflationary pressure, or substantial crowding out of private

18 12 investable resources. Freeing lending rates and eliminating forced placements of credit, thereby enabling both the Treasury and the private sector to tap deep, active domestic financial markets capable of mobilizing large amounts of resources, are therefore key items on the Government's agenda for the next phase of financial sector reforms. These measures are supported by the Bank and the IMF. (b) (c) (d) Infrastructure. The main objective of the Government is to ensure adequate infrastructure for private sector development, while containing the impact on the consolidated public sector deficit. The Government is therefore committed to increase private sector participation in the provision of infrastructure. Bank assistance includes an FY96 study on private participation in infrastructure and three projects currently under preparation. The study will provide guidance on the various options for demonopolization and privatization. It will cover transport and selected municipal services, such as water and electricity distribution, urban transport and solid waste management. The results of this study are expected to be incorporated in the design of several projects currently under preparation. They include: (i) a power sector reform loan which will support the private production of electricity by independent power producers, issuance of an Electricity Code, establishment of a Regulatory Agency, and unbundling of the National Power Authority; (ii) a municipal finance project which aims at fostering competition in local government financing, developing private provision of municipal services, and reforming the state-owned fund which provides term lending to local governments; and (iii) a second sewerage and water reuse project focussing on cost recovery and the viability of autonomous agencies dealing with power and water distribution in large cities in view of their privatization, which in turn will be the main objective of a FY98 project in the sector. Vocational Training. An FY96 vocational training project is being developed in coordination with the EU and USAID and will increase the role of private firms in the design and financing of their vocational training programs, and enhance the role of their professional associations. Enterprise Competitiveness. An ongoing Competitiveness Assessment study financed by the EU and the Moroccan private sector, and for which the Bank is executing agency, aims at identifying "clusters" of competitive industries and at strengthening their longterm viability in the context of the forthcoming free-trade agreement with the EU. In addition, the Bank is preparing an industrial infrastructure project (FY97). The objectives of this project are to alleviate the shortage of industrial sites, a major constraint to domestic and foreign investment, and strengthen support institutions for private industry. Specifically, the project will focus on: (i) developing privately operated industrial parks through private concessions; and (ii) providing financing and technical assistance to strengthen the national system of standards, certification, and technology diffusion. IV. PROGRAM OF FINANCIAL SECTOR REFORMS 37. To complement the continued macroeconomic stabilization and acceleration of the privatization program, the authorities have developed a second phase of the reform program in the financial sector. The main objectives of this program are to: (a) establish a market-based financial system, free of any major constraint in the allocation and the pricing of financial resources; and (b) develop capital markets as a main supplier of long-term capital for private investment. A central piece

19 13 of the Government's program is to transform the stock of government debt held by banks at below market interest rates (about DH 1.7 billion) into securities issued at market rates. Such a major substitution needs to be supported by an improved bond market infrastructure, namely, revamping Treasury bond instruments and issuance procedures. Other major reforms include the elimination of remaining controls on interest rates, the implementation of indirect monetary control, the establishment of a foreign exchange market as a preparatory step towards a market-determined exchange rate and capital account convertibility, and the privatization of banks. The main elements of the authorities' medium-term vision of the financial sector are: (a) (b) (c) (d) Financial markets. The first step concerns the reform of the market for government securities to increase liquidity, provide a market-based interest rate structure, which can serve as a benchmark for the pricing of other securities, and ensure that the Treasury can meet its domestic borrowing requirements. Complementary reforms of capital markets will lead to more private equity and bond issues to be measured by an overall increase in market capitalization and new listings. The Treasury will implement a modern domestic debt management system and acquire the know-how for its efficient operation. It will enable the Government to finance its borrowing requirements at market terms and discontinue its practice of intercepting savings before they can reach the private sector, thus removing a major constraint to private investment. It will also bring about greater fiscal discipline on the Government. The Central Bank. The Central Bank will aim to maintain a low inflation rate, which has been achieved since the late eighties, and implement a monetary policy based on indirect instruments including open market operations. In parallel, as a first step towards a fully market-determined exchange rate, and to provide private investors with market-based instruments to hedge foreign exchange risk, the Central Bank will establish a foreign exchange interbank market. The Banking System will continue to be financially sound and operate according to internationally accepted prudential norms. The remaining state-owned banks will be privatized in line with the Government program, with the exception of the agricultural bank. SFIs will compete freely with commercial banks and will either develop a competitive edge in their original market niche or disappear. Following the elimination of the tax on banks represented by the mandatory placements, a downward movement on interest rates is expected to take place. Lending to small and medium enterprises is expected to increase as banks become free to price their loans according to the risks and administrative expenses attached to this category of borrowers. As banks are given greater latitude for lending, their loan portfolios will become more vulnerable, requiring further strengthening of bank supervision. 38. The proposed operation would support the new phase of financial sector reforms. The Government program includes reforms in four main areas: (a) reform of Treasury financing including the removal of mandatory placement ratios for banks; (b) indirect monetary control including the liberalization of lending rates; (c) development of capital markets; and (d) banking system (privatization, establishment of a foreign exchange market, and bank supervision). A set of indicators will be monitored to assess the outcome of the program of financial reforms.

20 14 A. Reform of Treasury Financing 39. Progress to date and remaining constraints. In the eighties, the Treasury secured a large part of the financing of high public sector deficit through foreign borrowing, debt relief and preferential access to credit at administered interest rates, mainly below market. In 1988, the authorities created an auction market for T-bills. The share of this market segment progressively increased to 15 percent of the total domestic debt in The end of foreign debt rescheduling in 1992 combined with renewed pressure on the budget deficit led to a sharp increase in Government domestic borrowing requirements, to DH 8.5 billion in 1993 from DH 1.9 billion in In , the authorities reduced the percentage of Treasury paper that is placed at below market rates with the banking sector from 35 to 25 percent of sight deposits. However, the remaining ratio of 25 percent imposed on banks, taxes the banking system and prevents a market-based allocation of its resources. Furthermore, rigid placement rules imposed on institutional savers are used to channel long-term savings to the Treasury, and constrain the development of capital markets (para. 44). 40. Program to be supported under the FMDL. The Treasury will increasingly rely on market mechanisms to finance its borrowing requirements. The development of an efficient market for government securities also represents a critical step towards the development of capital markets. Among the key measures of the Government program, detailed in Annex 1, are: (a) the elimination of banks' mandatory placements in Treasury bills; (b) reduction of the number of T-bond issues and introduction of new securities with modern features in order to enhance their marketability; and (c) the elimination of fiscal incentives on Treasury bonds. B. Indirect Monetary Control 41. Progress to date and remaining constraints. Since 1991, the authorities have established the basis for an indirect monetary policy by abolishing credit ceilings, reducing access to the rediscount window, and introducing refinancing at variable rates at the Central Bank. These measures have created the basis for a more open and competitive environment in the banking system. However, the Central Bank's refinancing mechanism at variable rates has had limited use as an instrument of indirect control of liquidity and has not played the role of benchmark for interest rates as originally envisaged by the authorities Program to be supported under the FMDL. The Government program complements the reforms of , and includes: (a) strengthening the Central Bank's indirect control instruments through introducing repurchase agreements auctions and open market interventions; (b) liberalizing of all lending rates; and (c) modifying in the calculation of mandatory reserves from a daily minimum ratio to an average daily reserve requirement over a monthly period. These measures will further develop the money market and facilitate the shift to indirect and market-based instruments of credit control. First, through the auction of repurchase agreements, the Central Bank will establish a market determined refinancing rate. This refinancing rate will operate as a benchmark for the banking system and the elimination of all interest rate ceilings will enable its effective transmission in the interest rate structure. Second, banks will have a wider degree of latitude in their treasury management since significant variations in their daily reserve account balances will be allowed. This liquidity can be used for market making activities in the T-bill market and promoting a more active interbank market. 9/ Originally set at 13.5 percent and now at 9 percent, the Central Bank refinancing rate does not reflect the status of liquidity of the banking system. Since the beginning of 1994, banks have refinanced themselves mainly on the interbank market at a rate which was at 5 percent by end-december 1994.

21 15 C. Development of Capital Market 43. Progress to date and remaining constraints. Capital market reforms undertaken so far include the implementation of a basic legal, regulatory and institutional framework including the creation of a Securities Commission'. As a result of these reforms and of the privatization drive of the last two years, there has been a significant increase in the market capitalization of the CSE since 1992 (para. 31). However, investors concentrate their savings in short term, mainly Treasury instruments and bank deposits (Annex 8), many enterprises are overleveraged towards the banking sector, and private firms have in the past not issued corporate bonds. Institutional investors play a growing, albeit still limited, role in the financial sector (para. 27). The correlation that exists between growth, savings, and the development of institutional investors in fast-growing developing economies, suggests that the institutional savings sector could play a more active role in supplying long-term capital to private entrepreneurs and promoting growth in Morocco (Annex 6). 44. Several constraints prevent the Moroccan capital market from playing a more active role in mobilizing savings, and providing long-term financing to the private sector. First, the regulatory framework needs to be further strengthened, notably through the enactment of several laws or decrees. Second, several policy constraints need to be removed. They include: (a) tax distortions and government guarantees on bonds issued by PEs; and (b) distortions in the transaction fee structure on and off the stock exchange floor, which contribute to the predominance of off-floor direct placements. Third, contractual savings institutions are required to invest scarce long-term resources in Treasury instruments or to place them at CDG, sometimes at below market rates 1 ". As a result, in 1992, 80 percent of CDG resources were invested in Government (38 percent) or Government guaranteed (42 percent) securities. Although CDG resources represent only about 15 percent of commercial banks' deposits, by this mechanism institutional savers mobilize long-term savings, and the Treasury siphons off a large share of it. 45. Program to be supported under the FMDL. Prior to Board presentation, several measures, detailed in Annex 1, were implemented. They mainly concern the accounting framework, the regulation of mutual funds, and the operation of the stock exchange. Further reforms will be implemented prior to second tranche release. They include: (a) presenting the draft law on corporations to the House of Representatives; (b) eliminating Government guarantees on domestic bonds issued by PEs; (c) revising trading fees in order to eliminate the distortions favoring off-floor transactions; (d) enhancing the role of institutional savings in securities markets on the basis of a comprehensive review of the institutional savings sector; and (e) strengthening the institutional capacity of the stock exchange and the Securities Commission. D. Banking System 46. Major reforms aimed at liberalizing the banking system and strengthening the prudential regulatory and supervisory framework were implemented in the early nineties and supported by the Bank (Annex 1). Further reforms will aim at: (a) completing the privatization of state-owned banks; (b) establishing an interbank foreign exchange market; and (c) further strengthening the supervision of banks and SFIs. 10/ They include: (a) 1992 legislation, making an accounting system mandatory for all enterprises and organizing the accounting profession; (b) a 1993 Securities Markets law and a series of implementing decrees and regulations; (c) legislation concerning the creation and operation of brokerage houses and mutual funds acting on the stock exchange; and (d) laws and decrees regulating the operation of the Securities Commission (Comit6 Deontologique des Valeurs Mobilieres - CDVM). 11/ Social security funds (Caisse Nationale de Sccuritr Sociale -CNSS), the postal savings system and the Savings Bank (Caisse Nationale de l'epargne - CNE) are forced to place all their resources in deposits at CDG at an administered rate. CNSS deposits at CDG are to be reviewed every three years. They have been set at 9 percent since 1990.

22 Bank Privatization. After the successful privatization of SNI and BMCE in (para. 23), the Government plans to privatize the remaining state-owned banks, with the exception of the agricultural development bank, CNCA. The shares of the State in the largest commercial bank (BCP), and in the two large development banks for industry (BNDE), and for housing and tourism (CIH), will be offered for sale prior to second tranche release. Depending on the financial condition and strategic orientation of each bank, the Government plans to use one of several of the following privatization methods: (a) IPO on the Casablanca stock exchange; (b) tender; (c) private placement and direct negotiation with strategic investors; and (d) direct sales to employees at 15 percent discount from share listing on the stock exchange. The current situation of the three banks and the Government's strategy for their privatization is summarized in Annex 4. CNCA, although well-managed, is not amenable to privatization" Foreign Exchange Market. The establishment of a foreign exchange interbank market is viewed by the Moroccan authorities as a preparatory step towards a fully market-determined exchange rate and capital account convertibility. It is expected to benefit the country through an increased inflow of foreign resources, in particular direct foreign investment which is critical to finance growth without debt. Combined with the liberalization of interest rates, the introduction of a foreign exchange market will provide the market signals needed by the Central Bank to set its exchange rate policy accordingly. Establishing a foreign exchange market will also involve some risks related to the volatility of foreign exchange markets and the lack of banks' expertise in these activities. Hence, it would be important to introduce simultaneously appropriate accounting rules and prudential regulations to minimize risk and record foreign exchange transactions accurately, increase the supervisory capacity of the Central Bank and provide training to the Central Bank and commercial banks' staff. 49. Government reforms aim at: (a) the gradual increase of prudential limits on open foreign exchange positions of banks; and (b) reduction of the requirement for banks to surrender foreign exchange to the Central Bank, within such limits. Specifically, they include: (a) easing the surrender requirement of all foreign exchange to the Central Bank; (b) allowing banks to buy and sell foreign currencies against Dirhams in the domestic market; (c) instituting accounting standards for the treatment of foreign currency operations by banks; (d) introducing prudential regulations limiting the foreign exchange risk position of any bank; and (e) increasing the Central Bank's ability to supervise and monitor the foreign exchange market through the training of Central Bank supervisors. Commercial banks intend to acquire experienced personnel and the basic equipment for foreign exchange operations, and to organize intensive specialized training programs for their staff. Close relationships with their foreign shareholders will facilitate this process. 50. Bank Supervision. In the early nineties, Morocco implemented several reforms to strengthen the prudential regulatory and supervisory framework, notably in the areas of capital adequacy, risk-classification and provisioning of assets. Further liberalization reforms supported by the FMDL, including the freeing of interest rates, removal of directed credit to the Treasury and the establishment of a foreign exchange interbank market, will increase bank latitude for lending and other risk-taking operations. Further strengthening of bank supervision will balance the relaxation of economic controls and ensure the stability of the banking system in a competitive environment. The following measures will be implemented: (a) issuance by the Central Bank of prudential regulations for the newly established interbank foreign exchange market; (b) harmonization of prudential regulations for banks and SFIs; and (c) more frequent on and off-site supervision of banks. 12/ This is mainly due to recurring droughts which force CNCA to periodically restructure its loan portfolio. CNCA is addressing this structural vulnerability by preparing a drought insurance scheme to be made available to farmers as of 1996 and by diversifying its traditional rural finance activities. However, the impact of these measures will take some tirne to materialize making CNCA an unlikely candidate for privatization in the short tern.

23 17 E. Capacity Building 51. Complementary to the success of the financial sector reform program is the institutional capacity required to implement the above regulatory and policy actions. During appraisal and negotiations, informal contacts took place between the Bank and bilateral donors on the scope and the funding of the technical assistance required. As a result of those discussions, there are good prospects that Canada and France will provide funding for the institutional development program summarized below. The Moroccan authorities will forward detailed requests to the donors concerned. 52. The main areas for which technical assistance would be made available are detailed in Annex 7. They include: (a) (b) (c) (d) The CSE is implementing a program, funded by France, to improve the main operational aspects of stock market trading including the establishment of a central depository system for securities for a total of about US$1 million. A request for technical assistance, including consulting services and training will be submitted to the Canadian International Development Agency to strengthen the core activities of the Securities Commission (CDVM), namely the issuance of visas for public offerings of securities and the supervision of market operations and intermediaries. Treasury debt management. There are already exchange programs for staff of the Moroccan Ministry of Finance at the French Treasury; the Ministry of Finance is preparing a new request for extending this program. The study on contractual savings institutions (para. 45). The terms of reference have been agreed with the Moroccan authorities and submitted to French authorities, which have expressed an interest to finance the study. e) French assistance would also be provided for the revision of accounting rules on consolidated financial statements, the reinforcement of the certified accountants' association and for the development of professional norms, ethical standards and uniform entry requirements. F. Fiscal Impact of Reforms 53. As summarized in Table 7, and detailed in Annex 3, the cost of reforms is estimated at about DH 2.2 billion (US$272 million) during the period when the Bank loan would be disbursed. Beyond this transitional period, the budgetary impact of the financial sector reforms is limited to 0.17 percent of GDP" 3. Sensitivity analysis shows that in case of a lower growth scenario of about 3 percent p.a., the budgetary impact of reforms beyond 1998 would remain below 0.20 percent of GDP, in line with the objective of maintaining a sustainable fiscal balance. 13/ The direct cost of the ftnancial reforms results from the fact that the Treasury substitutes market termis for the 4.25 percent rate it currently pays on forced borrowing from commercial banks which will be phased out. However, this cost is mitigated by three factors: (a) some of the additional revenues generated by the banking system will be taxed; (b) a downward pressure on interest rates expected to result from the elimination of the implicit tax on the banking sector and containment of the fiscal deficit; and (c) improvement of the domestic debt management, in particular a well-functioning settlement and clearing system for trading of governnment paper.

24 18 Table 7: Fiscal Inpact of Financial Sector Reforms Fiscal Cost of Reforms Three-year Program: DH million US$rnillion In % of GDP mid-1995 to mid Total " "Annual average Source: Annex 3 V. PROPOSED LOAN A. Loan Amount and Borrower 54. The proposed Bank loan, in the amount of US$250 million equivalent, will be made to the Kingdom of Morocco. The fixed rate single currency loan package would comprise a US$125 million US dollar Tranche and a FRF 600 million French franc Tranche, for up to 15 years. For each loan currency Tranche, each semester's aggregate disbursements (Disbursed Amount) will have a grace period of 3 years and a final maturity of 12 years, both beginning from the rate fixing date for such Disbursed Amount. The Government of Morocco is eligible for single currency loan terms, since it has authorized conversion of all its VLR 82 loans. Including the proposed loan, single currency loans to Morocco would aggregate US$250 million equivalent, about 40 percent of the Bank's planned FY96 lending to Morocco of US$ million equivalent. B. Rationale for Bank Involvement 55. The proposed FMDL will finance the temporary cost to the Moroccan Treasury of implementing the program of reforms over a period of three years until mid Beyond this transitional period, the budgetary impact will remain limited to about 0.17 percent of GDP per year and, therefore, consistent with macro-stabilization objectives. The use of the Bank adjustment lending instrument to help smooth out the incremental budgetary expenditures entailed by the financial sector reforms is warranted for the following reasons. First, as discussed in Chapter II, Morocco's balance of payments remains vulnerable to the external environment. Some reserves build-up is prudent, particularly in light of the 1995 drought and projected deterioration of the current account deficit of 3.5 percent of GDP, to maintain the level of external reserves at a minimum of 5 months of imports. Second, the policy reforms supported by the FMDL involve temporary fiscal costs which, in the absence of a narrowing of the private sector investment/savings gap, will translate into a higher current account deficit" 4. In fact, since this gap is projected to remain at about the same level of 1-2 percent of GDP during the period (Annex 2), the temporary increase in the current account would be very close to the increase in the public sector deficit. In practice, therefore, the fiscal cost of implementing the policy reforms and 14/ It may be useful to note the national accounts identity: (current account deficit)=(private investment-private savings) + (public sector budget deficit). If the public sector deficit increases temporarily, this will translate immediately into a higher current account deficit except to the extent that the private sector deficit narrows.

25 19 their balance of payments implications are almost identical. Third, Bank borrowing to finance the temporary increase in budget deficit is a relevant option in the absence of desirable alternatives, namely additional taxation or additional domestic borrowing. The scope for increasing tax revenues in the short run is limited. Raising import tariffs or export taxes, the main option to increase rapidly fiscal revenues, is likely to be distortionary and would choke off private investment. The reform of the tax system (para. 13) and the downsizing of the PE sector (para. 25) will only improve public savings in the medium-term. Domestic borrowing would be unwise until liquidity in the market for Government securities increases, following the development of a secondary market. It might raise interest rates, increase the cost of Treasury borrowing and could result in crowding out of private investment. 56. A limited increase in foreign financing is sustainable. The ratio of exports to GDP of about 22 percent shows that Morocco can generate the foreign exchange to service its external obligations and the relatively high debt service ratio (32.4 percent in 1994) is projected to decline rapidly. The program of reforms supported by the Bank loan is also likely to attract further support from the international community. The African Development Bank and the EU have expressed interest in providing parallel financing through quick disbursing operations. Preliminary contacts have also been established with the Export-Import Bank of Japan. The initial reaction has not been negative. C. Project Description 57. The proposed loan would finance imports in an amount of US$250 million equivalent. It would allow the Treasury to finance the incremental interest to be paid as a result of refinancing at market rate the stock of banks' mandatory placements of T-bills, currently set at 25 percent of sight deposits and bearing a below market rate of 4.25 percent. The loan would finance 100 percent of the foreign exchange cost (CIF) of goods imported from Bank member countries and Taiwan. D. Implementation Arrangements 58. The Government will be the Borrower. The Ministry of Finance and Bank Al-Maghrib will be responsible for the policy-related aspects of the loan while Bank Al-Maghrib alone will be responsible for procurement, disbursements, and the maintenance of the loan account. 59. Release of Funds and Tranching. The proceeds of the loan would be made available in two tranches. The first portion, of US$150 million equivalent, will be released upon loan effectiveness and drawn down on the basis of import certification. Several measures, detailed in Annex 1, were implemented as conditions of Board presentation" 5. Following the preparatory work on the financial sector carried out by the Ministry of Finance and the Central Bank in consultation with the Bank in 1994, some of these measures were implemented in late 1994 and early The second portion of the loan, of US$100 million equivalent, will be made available after the satisfactory completion of a mid-term review program, expected in the second half of The second tranche conditions will consist of: (a) continued satisfactory overall macroeconomic performance to be assessed in close cooperation with the IMF, with particular reference to progress towards achieving specific indicators agreed with the Government and set out in Attachment 1 of Annex 1; (b) satisfactory progress in the implementation of the Government's overall financial sector reform program as set out in the matrix of policy measures; 15/ They include: (a) the first step in the reduction of mandatory bank placements in Treasury bonds from 25 to 20 percent; (b) introduction of new negotiable govemment securities; (c) elimination of fiscal incentives on Treasury bonds; (d) establishment of a Central Bank base through the auctioning of repurchase agreements and the development of open market operations by the Central Bank; and (e) issuance of several decrees on the regulatory framework of the capital market.

26 and (c) achievement of the following specific conditions laid out in the legal documents: 20 (i) (ii) (iii) (iv) (v) elimination of the mandatory Treasury bonds-to-sight deposits ratio; elimination of the ceiling on lending rates; presentation of the draft law on corporations to the House of Representatives; establishment of a foreign exchange market; offer for sale of the State's shares in BCP, BNDE and CIH. 60. Procurement. The proposed loan would be used to finance the CIF cost of eligible imports and related services procured by the public and private sectors. It is expected that almost all items financed under the loan would be for the private sector. Ineligible items would include those financed from other sources, expenditures in the currency of the Borrower or for items supplied from the Borrower's territory, items intended for military or paramilitary use, and luxury items. Eligible expenditures for petroleum products and foodstuffs would be limited to US$50 million equivalent each. Commonly traded commodities may be procured through organized international commodity markets or other channels of competitive procurement, in accordance with procedures acceptable to the Bank. Contracts for the procurement of eligible imports estimated to cost the equivalent of US$5 million or more each shall be awarded through simplified International Competitive Bidding (ICB) in accordance with the Bank's Procurement Guidelines. Contracts for procurement of eligible imports estimated to cost less than the equivalent of US$5 million would be awarded on the basis of established commercial practice and/or the Borrower's public sector procurement procedures which are acceptable to the Bank. There will be no prior review of contract awards; verification of supporting documents will be on a postreview basis. 61. Disbursement. For procurement through ICB, supporting documents would be presented to the Bank prior to the submission of the first application for withdrawal of funds. Supporting documents for ICB would comprise evidence of bid invitations, record of bid opening, bids evaluation report, and the signed contract. For contracts valued below US$5 million equivalent, disbursements would be made on the basis of statements of expenditures (SOEs) prepared on the basis of information contained in customs certificates or other appropriate documents showing that eligible goods at least equal in value to the amount to be reimbursed under the Bank loan had been imported. Supporting documentation for SOEs would be retained for at least one year after receipt by the Bank of the audit report for the year in which the last disbursement was made. This documentation would be made available to the auditors and to Bank staff upon request. Withdrawal applications would be consolidated and submitted in amounts of not less than US$1 million equivalent. Contracts valued at less than US$50,000 equivalent would not be eligible for financing under the Loan. Goods imported after May 15, 1995 would be eligible for retroactive financing under the loan up to a maximum of US$50 million equivalent, or 20 percent of the loan amount, in view of the progress already achieved in implementing the reform program. The closing date of the loan will be June 30, Audit. Bank Al-Maghrib would be responsible for maintaining all records of transactions under the loan in accordance with sound accounting practices. All accounts would be audited within six months after the end of the Borrower's fiscal year by independent auditors acceptable to the Bank. Certified copies of the audit would be submitted to the Bank and would include a separate opinion with regard to claims submitted to the Bank on the basis of SOEs. 63. Monitorable Indicators. Table 8 includes a set of indicators closely related to the program of financial reforms. Deviations from the projections of Table 8 will trigger discussions with the Ministry of Finance and the Central Bank to identify underlying problems and explore corrective policy measures.

27 Environmental Aspects. The project is consistent with the Bank's environmental policies and will follow accepted Bank procedures in this area. In conformity with the policy for financial sector adjustment operations, no environmental rating has been assigned. Table 8: Indicators to be monitored under the FMDL Financial and Private Sector Monitoring period Development Indicators (estimate) Bond markets - Treasury bonds auctions/total Treasury domestic debt (%) - Issues of corporate bonds (DH billion) Stock Market - Market Capitalization/GDP (%) Indirect Monetary Control - Central Bank advance rate/interbank n.a rate maximum spread VI. RISKS 65. There are two main risks associated with the proposed loan. The first risk relates to the fiscal sustainability of the reform program. The budget deficit deteriorated from 2.2 percent of GDP in 1992 to 3.8 percent in 1994 and is projected at 4.7 percent in While some of this deterioration is due to adverse climatic conditions, there appears to be some slippage on fiscal discipline (para. 11). A continued high budget deficit would put pressure on interest rates. To contain the cost of Treasury borrowing, the Government could be tempted to re-establish administrative controls on interest rates and credit allocation. Reverting to such policies would tax financial intermediation and crowd-out private investment. Corrective measures to address the recent resurgence of macroeconomic imbalances are being prepared by the Government, in close cooperation with the IMF and the Bank and will reduce this risk. These measures, primarily designed to raise public savings, will include a reform of the tax system, a limitation in the increase in the Government's wage expenditures, and an acceleration of the program of privatization (para. 13). The Government's commitment to contain the fiscal deficit is recorded in the Letter of Development Policy. Furthermore, the impact of the above measures is reflected in the macroeconomic indicators which will be used to monitor macroeconomic performance prior to second tranche release. The second risk is a deterioration of the banks' financial condition. Freeing both interest rates and substantial resources for lending will increase the risks associated with greater latitude in bank lending. Establishing an interbank foreign exchange market creates the scope for risk-taking operations for which banks have no previous experience. As a result, banks' portfolios will become more vulnerable. Combined with increased competition as domestic financial markets develop, this may result in higher provisioning requirements and lower profitability. However, Moroccan banks have demonstrated their capacity to sustain a sound level of profitability since the first liberalization measures were implemented in the early nineties. Furthermore, the prudential and supervisory framework implemented in 1992, combined with prudential measures to be introduced with the new interbank foreign exchange market, will require banks to continue to operate within prudent guidelines. To ensure the effective

28 22 implementation of these guidelines, the Central Bank plans to increase supervision. This will provide the necessary balance to the relaxation of economic controls and minimize the risk that financial liberalization comes at the expense of the soundness of the Moroccan banking system. 66. Financial Benefits and Risks. The Borrower has selected fixed rate single currency loans in US dollars and French francs in order to improve the management of its external liabilities. The choice of the Bank loan currencies reflects the weight of French francs and US dollars in Morocco's foreign exchange receipts, of which about 35 percent is denominated in each of those two currencies. The choice of a fixed interest rate reflects the Borrower's preference to reduce the risk of interest rate volatility in view of its current exposure in floating rate loans which account for about 45 percent of its total external debt. In addition, the Borrower considers that the planning, budgeting and management of its external debt service obligations would be simpler for single currency loans than for currency pool loans. VII. OTHER BANK GROUP OPERATIONS 67. As of May 31, 1995, cumulative commitments to Morocco (less cancellations) amounted to US$6.6 billion, of which US$5.2 billion have been disbursed, US$2.1 billion have been repaid, and US$1.4 billion are undisbursed. During FY94, gross disbursements were US$310.7 million while repayments totalled US$251.7 million. Total IFC investments as of May 31, 1995, amounted to US$159 million and comprised sixteen operations. The Status of Bank operations is detailed in Annex 11. VIII. AGREEMENTS REACHED 68. During negotiations, the following agreements were reached and recorded in the loan documents. (a) The overall content of the Letter of Development Policy and the attached policy matrix (Annex 1). (b) The policy measures to be carried out prior to the release of the second tranche (para. 59). (c) Procurement, disbursement and auditing requirements (paras. 60, 61 and 62). IX. RECOMMENDATION 69. I am satisfied that the proposed loan complies with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Attachments Date: June 29, 1995 Washington, D.C. James D. Wolfensohn President

29 ANNEXES

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31 Annex 1 Page 1 of 3 (UNOFFICIAL TRANSLATION OF FRENCH VERSION) June 27, 1995 KINGDOM OF MOROCCO FINANCIAL MARKETS DEVELOPMENT LOAN LETTER OF DEVELOPMHENT POLICY Dear Mr. President: 1. Over the last decade, Morocco has implemented major adjustment and stabilization policies that have led to satisfactory economic and financial results. The encouraging progress achieved since 1983 is prompting us to preserve a stable macroeconomic framework and to ensure a solid foundation for economic growth and employment. To meet these challenges, annual average GDP growth must increase from 3 percent during to at least 6 percent in the medium term. A large part of this additional growth will be export-led. Morocco will also need to become an active partner in an area of international competitiveness that will be stimulated by the agreement to be signed with the European Union. 2. It is widely acknowledged in Morocco that the private sector will play a central role in accelerating growth and investment. The role of the State will be two-fold. First, it will ensure that growth is achieved in a stable economic and financial environment, which entails maintaining the budget deficit at a level compatible with a balance of payments position that encourages private external financing, in particular foreign direct investment. The State will also create a legal and regulatory framework that will enable the private sector to consolidate its performance in sectors where it is already active and to play a key role in others, especially the infrastructure and financial sectors. 3. To perform this dual role, the Government intends to pursue a program of economic development based on strengthening the private sector and maintaining a viable macroeconomic framework, as outlined in Attachment I to this letter. The private sector development program is the result of joint efforts by the authorities and the private sector that have been under way for more than a year, particularly through the Monitoring and Development Committee for the Private Sector established by the Government in June The work of this Committee has led to recommendations that have been submitted to the Government for approval. Four main areas are involved: * pursuing the liberalization of the financial sector and developing capital markets; * developing and modernizing infrastructure and public services via greater recourse to private investments; * ensuring a competitive business environment, in particular by pursuing trade liberalization and promoting competition; * developing primary education and a system of vocational training that responds flexibly to the needs of enterprises. 4. To ensure effective implementation of the private sector development program, the Government is seeking the assistance of the World Bank in the form of specific studies and financial support. The first operation, which is the main subject of this letter, concerns the financial sector.

32 Annex I Page 2 of 3 5. A healthy, modern and competitive financial sector is essential to our country's development objectives. At the beginning of the 1990s, the Government implemented a first series of financial sector reforms with the help of the World Bank. This first phase focussed on the liberalization of the banking system. Major reforms were undertaken, such as the removal of credit ceilings, elimination of selective credit policies, liberalization of interest rates and the introduction of a modem supervisory and prudential regulatory framework for banks. However, certain constraints continue to affect the financing of growth. The national savings and investment rates, about 19 percent and 20 percent of GDP respectively, are still appreciably below those of other rapidly growing countries. The reduction of the budget deficit and the acceleration of the privatization program should lead to an increase in public savings. At the same time, it is essential to pursue the financial sector reform so as to stimulate private savings and increase private investment. The key objective will be the establishment of a financial system relying on market mechanisms, as well as the development of capital markets as a major source of long term financing for enterprises. 6. The Government's program for financial sector development is detailed in Attachment 2 to this letter. It covers four areas of intervention: (a) Treasury financing. The measures include increased reliance on market mechanisms for Treasury financing and implementation of a modern infrastructure for issuing Treasury bonds. The mandatory Treasury bonds-to sight deposits ratio of banks has been reduced from 35 percent to 25 percent in the first phase. It will now be eliminated in order to improve private sector access to credit and accelerate the development of a domestic financial market. (b) Monetary control. The Central Bank will pursue an indirect monetary policy. Refinancing rates in the banking system will be determined on the basis of reference rates recently introduced by the Central Bank. The transmission of these rates within the banking system will be facilitated by the liberalization of lending rates which will also promote lending operations from the banking system to the private sector. (c) (d) Capital Markets. Following the restructuring of the legal framework in 1993, the implementation of a regulatory framework will be continued. An infrastructure adapted to the needs of a rapidly developing market will also be put in place. The objective will be the harmonization of the Moroccan securities market with international standards. Banking system. The measures will aim, among other things, at continuing the privatization of the banking system and the establishment of a foreign exchange market as the first step towards an exchange rate based on market mechanisms and, in the medium term, the convertibility of the Dirham, as soon as the prerequisites for this are satisfied. 7. Furthermore, the Government will implement a program aimed at strengthening some of the institutions which will manage the financial sector reform. Grants from bilateral and multilateral sources will be mobilized for the execution of the program. 8. The Moroccan authorities believe that the reform program will promote the development and consolidation of the country's capital markets, improve private sector access to the credit market, and result in an increase in private investment and saving rates. Indicators to measure these various parameters have been defined and will help to assess the results of the program.

33 Annex I Page 3 of 3 9. In conclusion, the Government considers that the financial sector reforms described in this letter constitute a key element of its policy to develop the private sector as the engine for strong and sustainable growth and a full employment economy. The Government is committed to achieving the objectives and implementing the measures set forth in this letter and the attached Annexes. To facilitate their implementation, the Government hereby asks the International Bank for Reconstruction and Development (IBRD) for a loan in the amount of 250 million US dollars. It also requests the Bank to support the efforts being undertaken in order to obtain cofinancing for this program. Yours sincerely, Mohamed Kabbaj Minister of Finance and External Investments

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35 Annex 1 Attachment No. 1 Page 1 of I KINGDOM OF MOROCCO FINANCIAL MARKETS DEVELOPMENT LOAN Macroeconomic Framework Selected Indicators (in Percent) Non-agriculture GDP Growth Foreign Debt Outstanding/XGS (As share of GDP) Current Account Budget Deficit' Fixed Capital Formation Including privatization receipts.

36

37 Annex 1 Attachment No. 2 Page I of 6 Kingdom of Morocco Financial Markets Development Loan Matrix of Policy Measures " Objectives Main Bank supported Policv Board Presentation Second Tranche Measures under the 1991 FSDP I. Treasury Financing - Treasury finances itself at - Reduction of mandatory - Reduction of the mandatory Treasury bonds- - Reduction to 15% before end 1995 and market terms Treasury bonds-to sight to sight deposits ratio to 20% elimiation of the mandatory Treasury bondsdeposits ratio from 35 to to sight deposits ratio 25% * Increase liquidity of - Opening of auction market - Adoption of a law on negotiable securities public securities and for Treasury bills to - Central Bank circular concerning T-bonds strengthen secondary insurance companies and tenders: market of T-bonds other enterprises * including negotiable securities and tap issues; and * defining the number of original maturities, and the number of Treasury securities issues at 13, 26, 52 weeks (every week); at 2, 5, 10, 15 years (every month) Eliminate remaining tax - Preparation of a study and - Elimination of fiscal incentives on Treasury bias against non- an action plan on the bonds Government fixed harmonization of fiscal income securities treatment of financial instruments - Strengthen public debt - Completion of training program in domestic management system debt management I/ Specific conditions of second tranche release as set forth in the Loan Agreement are underlined. - Strengthening of budgeting and forecasting system

38 Annex 1 Attachment No. 2 Page 2 of 6 Kingdom of Morocco Financial Markets Development Loan Matrix of Policy Measures " Objectives Main Bank supported Policy Board Presentation Second Tranche Measures under the 1991 FSDP II. Indirect Monetary Control - Implement an indirect - Removal of credit ceilings - Issuance of a Central Bank circular - Calculate the reserve requirement on an monetary policy establishing the terms and conditions of its average daily basis over a bi-weekly or intervention on the monetary market: monthly period * invitation to bid from Central Bank * repurchase agreements at banks' request * open market transactions at market terms - Establishment of a single rate - Base rates are set by Central Bank and on all variable rate advances represent the floor and ceiling rates of banks' from the Central Bank (7 refinancing days) - Liberalize interest rates - Liberalization of rates on - Elimination of ceiling on lending rates deposists > 3 months - Ceiling on lending rates set at li" time the weighted average rate of bank 6 and 12 months deposits over the preceding 6 months. Ceiling adjusted every semester

39 Annex I Attachment No. 2 Page 3 of 6 III. Kingdom of Morocco Financial Markets Development Loan Matrix of Policy Measures " Objectives Main Bank supported Policy Board Presentation Second Tranche Measures under the 1991,FSDP Capital Market Developen - Diversify financing - Review with the Bank projects - Issuance of a first series of decrees on the - Issuance of a second series of decrees on the sources for private to reform the Stock Exchange stock exchange and the OPCVM stock exchange companies, strengthen and to create mutual equity accounting framework, funds - Implementation of an accounting frarnework and deepen capital markets for the OPCVM - Presatation to the House of Rq reseatives of the draft law on corporations - Approval by the Prime Minister of the rules - Presentation to the Council of Government of governing the National Council for the draft law on preparation, publication and Accounting certification of consolidated financial statements - Elimination of Government guarantee on domestic bond issues by public enterprises - Increase institutional - Enactment of the law concerning accounting - Decree of the Minister of Finance setting the savings rules to be applied by insurance companies accounting rules applied to insurazce companies

40 Annex 1 Attachment No. 2 Page 4 of 6 Kingdom of Morocco Financial Markets Development Loan Matrix of Policy Measures " Objectives Main Bank supported Policy Board Presentation Second Tranche Measures under the 1991 FSDP - Terms of reference of a study on the situation - Development of an action plan based on the and potential role of institutional savers in the recommendations of the study development of financial markets; this study will focus on: * Improving the funding mechanisms of social security and pension funds * Revising investment regulations of insurance companies * Establishing a credit rating agency * Developing postal savings Encourage investors to - Enactment of a decree defining the level of trade securities on-floor trading fees and enhance transparency - Publication of transactions made by the of stock exchange Casablanca stock exchange (prices and operations volumes) Strengthen the Securities - Definition of an organizational chart of CDVM: Commission (CDVM) and CDVM, with a job description for key the Casablanca Stock positions * Preparation of two manuals covering (i) Exchange procedures related to the review of requests and the issuance of visas to OPCVM & brokerage houses; and (ii) issuance of visas for public offerings * Implementation of a training program in the area of market supervision, monitoring of brokerage houses and OPCVM

41 Annex 1 Attachment No. 2 Page 5 of 6 Kingdom of Morocco Financial Markets Development Loan Matrix of Policy Measures "' Objectives Main Bank supported Policy Board Presentation Second Tranche Measures under the 1991 FSDP IV, Banking System - Stock Exchange * Implementation of an ation plan to sigthen the regulatory and institutional framework of the market on the basis of the recommendations of the G-30, in particular implementation of a cural deository system and of a trade setdfmnet and delivmy system. * Conorming the manageent of stock exhange tradings, implementation of an automated quotation system which guarantees market transparency and equality of access - Accelerate privatization - Privatize BMCE and SNI - Ofr for sale of Stae's shares in BCP. BNDE program and CIH - Establish a foreign - Issuance of a letter of the Governor of - Issuance of a circular by the Office des exchange market Central Bank announcing the creation of a Changes establishing the foreign exchange foreign exchange market and inviting banks market where banks will be authorized to deal to prepare themselves for the implementation among themselves and with their clients with of this market by ensuring proper training of foreien exchange operations of foreign their staff and by acquiring the necessary currencies against fbreimn currencies and of equipment foreign currencies against Dirham in the domestic market - Eliminate the initial minimum provision of - Issuance by the Central Bank of accounting DH 100,000 required for opening non- standards for accounting treatment of foreign resident Moroccan accounts in foreign currency operations by banks currencies - Increase the foreign currency account limits of exporters of goods and services from 10% and 5%, respectively, to 20%

42 Annex 1 Attachment No. 2 Page 6 of 6 Kingdom of Morocco Financial Markets Development Loan Matrix of Policy Measures / Objectives Main Bank supported Policy Board Presentation Second Tranche Measures under the 1991 FSDP - Strengthen bank - Implement minimum 8% - Issuance of a circular by the Central Bank: supervision capital adequacy ratio * Specing the modalies for the fiintioning - Introduce classification of and operation of the interbank foreign exchange market problem loans and * Defining and limiting the maximum daily provisioning rules based on foreign exchange position of each bank in the basis of aging of arrears any single currency and in all currencies, and client financial situation which will not be lower than 20% of the equity of each bank Loan to a single beneficiary * Specifying the code of conduct and rules to limited to 7 % of bank be followed by the operators equity (15% for a single * Specifying the regulation supwvision and corporate group) monitoring of the market and the prudenial regulations for the foregn exdiange market. - Harmonization of - Arr&e of the Minister of Finances on the accounting standards harmonization of the prudential regulations between banks and for banks and specialized financial specialized financial institutions (BNDE, CIH and CNCA) institutions - Strengthening of banking supervision following llbealizatio measures on the basis of: * Training on monitoring of foreign exoange market * Off-site supervision * On-site supervision * Regular submission of reports prepared by independent, external auditors certified by the Central Bank

43 Annex 2 Morocco. Sunmary Macroeconomic Indicators Page 1 of 2 Medium-Term Outlook and Resource Requirements - Averages Est Projections Rates of Change (%p.a): Gross Domestic Product 3.6% 4.7% 3.9% -1.1% 11.8% -3.7% 9.0% 3.3% 3.9% 4.6% 5.3% Agriculture -0.7% 10.3% 1.8% -6.2% 65.0% -30.0% 44.0% 2.2% 3.0% 3.5% 4.0% Non-agriculture 4.5% 3.5% 4.2% -0.2% 3.7% 2.7% 3.2% 3.6% 4.1% 4.8% 5.6% Industry 1.6% 2.6% 3.4% -2.0% 2.3% 3.8% 3.3% 5.5% 6.8% 7.5% 8.2% (a/w. manufacturing) 3.8% 3.9% 4.4% -1.5% 2.0% 4.0% 3.5% 6.5% 8.0% 9.0% 9.0% Services 6.3% 4.1% 4.7X 0.7% 4.3% 2.2% 3.1% 2.6% 2.8% 3.4% 4.2% Per-Capita Consumption -0.9% 2.8% 2.4% -2.2% 8.9% -3.8% 5.5% 0.6% 1.0% 1.0% 1.9% Domestic lnflation 1/ 8.0% 8.1% 5.1% 3.8% 4.7% 4.5% 4.0% 2.6% 2.0% 2.0% 2.0% Exports of GNFS 2/ 4.4% 4.6% 4.0% 4.8% 4.6% 3.6% 7.2% 8.1% 8.1% 8.8% 8.1% Imports of GNFS -1.8% % 0.4% 5.2% 8.1% 6.3% 5.3% 5.0% 4.6% 4.9% Ratios to GDP (X): Gross Investment Fixed CapitaL Formation Central Government Other Public Sector Private Sector Domestic Savings Central Government Private Sector National Savings Private Consumption Total Credit Stock (Olw: Private) Exports of GNFS (O/u: mnufactured Goods) Imports of GMFS Current Acc. Balance Total Government Revenue Goverrnent Expenditure Fiscal Deficit, comit, basis Privatization receipts External Debt Burden (): Debt Outstand. (DOD/GDP) 3/ Debt Outstand. (DOD/XGS) 4/ Debt Service (TDS/XGS) 4/ Memo Items: Capital Effic.(5-year ICOR) 5/ Ext.Resarves (months of imports) Terms of Trade Index (1980=100) / Isplicit GDP deflator; 2/ GUFS denotes Goods and Nonfactor Services; 3/ External debt includes MLT, IMF, and short-term; 4/ XGS denotes export of goods & services; includes workers' remittances; 5/ ICOR denotes increaental capital-output ratio; Sources: Official data; staff estimtes and projections.

44 Annex 2 Page 2 of Morocco. Balance of Payments (USS, million) Exports of Goods & services Exports of GNFS Merchandise (FO8) Nonfactor services Imports of GNFS Merchandise (CIF) (0/w: freight & insurance) Nonfactor services Resource balance Net factor income Factor income receipts Investment income, receipts Interest receipts Direct investment income Factor income payments Investment income, payments Direct investment income Total interest payments Net curren transfers Total curren transfers, rec Private transfers Workers remittances Other private transf Official transfers Total curren transfers, payts Private transfers Official transfers Cur. Ac. bal., excl grants Official capital grants LT CapitaL Inflows Direct foreign investment Net LT Borrowing Disbursements (DRS) Repayment (DRS) Other capital flows (net) (Including short-term capital, and errors and omissions) Changes in net reserves Net credit from IMF Reserve changes n.e.i K Net intl reserves Gross reserves, incl. gold (In months of imports of GNFS) Sources: Official data (Office des Changes); staff estimates and projections.

45 Annex 3 Page I of 2 COST OF REFORMS (in DH million) Semestera/ A) UnderlvinR B) PEP Ratio C) PEP Size D) Interest E) Volume of P) Interest Cost G) Tob H) Toal 1) Incremental K) CR L) ICR in Years Deosit Base Cost of PEP Bonds to of Refuanced Interest Cost Interet Cost at Cost of Reforn In USS %of GDP (at 4.25%) Refinance at Bonds 4.25% (without (ICR) million Market Rites refonm) 1995: : : : : : : Total NA NA NA 899 NA A) = Total Demand Deposits; the forced T-bond placement at 4.25 percent below market rate (PEP: 'Plancher d'effets Publics') is computed as a percentage of an underlying demand deposits' base which is assumed to increase at a rate of 10 percent per year; B) = "Plancher d'effets Publics' (PEP) Ratio; C) = ASB; D) = C*(4.25/2) percent; E) = AS(0.25-B); F) = Eamacket cost of T-bonds for the Trewry: 9.5 percent ; falls to 8.5 percent in 1998 as a result of policies; G) = D+F; H) A*(0.25)*(4.25%/2); I) = G-H; Atating in 1997, the Teaury recover 10 percent of the cost of reforms through extr profit taxes on banks K) 5 1/8.4; L) I/GDP

46 Annex 3 Page 2 of 2 COST OF TREASURY REFINANCING AFTER REFORM YEARS TOTAL ORIGINAL REFINANCING COST OF PEP ELIMINATION DOMESTIC PEP OF PEP DEBT MLT ST IN DH IN USS IN % OF GDP % % % % Assumptions The Treasury refinunces the 'Plancher d'effets Publics' ( PEP) by borrowing 60 percent thruugh short term (Sl) bonds, 40 percent through medium-long term bonds (MLT). In addition, the impact on total domestic debt of the assumed I percent drop in interest rates is computed (it is assumed that 80 percent of all domestic debt can be refinanced, as 20 percent is due to mature later on). Other assumptions underlying the computation are: a) the PEP demand deposit base increases at 7 percent per year, down from 10 percent, as funds are increasingly allocated in alemative fuancial instruments; b) Traauiy recovers 10 percent of the cost of reforms through taxes on extra bank profits starting in 1997.

47 Privatization Indicators Annex 4 Page I of 5 Privatization Transactions ( ) Argentina 98 Turkey 92 Mexico 84 Pakistan Brazil 65 Philippines 61 Tunisia 27 Morocco 12 Egypt 7 Omlan5 Iran Develoiine Countries Privatization Revenue (USS billion) in latin America/Carib. $55 20 Europe/Central Asia $18 00 East/Asia/Pacllc ific 20 South Asia $3 60 Sub-Sahara Africa S240 Middle E./N. Africa $

48 Annex 4 Page 2 of 5 MOROCCO - PRIVATIZATION REVENUE (As of April 1995) CUMULATIVE PRIVATIZATION REVENUE Million DH 8, ,000 4,000 2,000 pril-93june Aug. Oct. Dec. Feb. April June Aug. Oct. Dec. Feb. April May July Sept. Nov.Jan.-94Mar. May July Sept. Nov.Jan.-95Mar. Cumulative revenue of $785 million PRIVATIZATION REVENUE BY COUNTRY Morocco Others 1.1%USA UK 6.7% France 6.5% 10.5% Sitzeriand 10.8%

49 [ Transfers done to 1 May 1995 Firm or hotel sold Activity Permentago Date1 Metod Buyer Price paid IMillionj I ~ sold Sold _ I _ DH)J BMCE C ommercial bank 14O0% 12/94 Casablanca Stock Exchange Moroccan underwriting from January.1995 issue I 2S''O'0'% Mzg' ren'der '' -... 'orocscan''ar'dinte'rn'a't'l'oat;...4'3: f4 financial institutions o~rkers iayment for 195 transfer io'ro' an CHELCO Ready-made clothing 32.00% Direct negotiation English, Courtaulds 10.2 CIOR Cement 51.00% Tender followed by direct negotiation Swiss, Holdercim subsidiary of Holderbank % Casablanca Stock Exchange 99.1% Moroccan % Workers Moroccan 10.0 CTM-LN Inter-urban bus company CTM-LN I er urban bu co npany 35 00% ~~~ % r Tender... Moroccan, consortiun of financial institutions onor.u.f...nia % Casablanca Stock Exchange 99.5% Moroccan % Workers Moroccans % Casablanca Stock Exchange Moroccans 48.7 CMH Marketing petroleum products 50.00% Tender followed by direct negotiation Moroccan, Hogespar Dragon-Gaz Marketing petroleum products 50.00% Direct negotiation Italian, Dragofina 0.85 General Tire Industry-Tires 20.00% Direct negotiation Moroccan, consortium of financial instiutions % Workers Moroccans 4.3 MOBIL Maroc Marketing petroleum products 50.00% Direct negotiation American, Mobil Petroleum Corporation MODULEC Electra-mechanical equipment % Direct negotiation Moroccan, oroccns %.work.s.moroca Ouazzani 1 Dirham PETROM Marketing petroleum products 51.00% Tender Moroccan, Groupe Bouaida SHELL Maroc Marketing petroleum products 50.00% Direct negotiation English, Shell Petroleun International SNEP Producer of chlorine, soda, bleach 90.00% Tender Moroccan, Group Ynna Dolbeau Dimatit and vinyl... 53%WresMoroccans Underway SNI Financial Holding 15.63% Casablanca Stock Exchang Moroccans % Tender Moroccan and international consortium of SODERS financial institutions Yeast manufacturer 33.34% Tender Moroccans and French (Lesaffre) W kscn-s N WorkHs Moroccans 1.6 e~~~~0 Po- >

50 I Transfers done to 1 May 1995 Firm or hotel sold Activity Perunbte Data MeUod Buyer Price paid (Million If ~ soldl Sold DHI) SOFACICREDIT Consumer credit 35.00% Tender Moroccan, consortium of financial institutions 89.3 i8.37% Casablanca Stock Exchae Moroccans % Workers Moroccans Underway TOTAL Maroc Marketing petroleum products 50.00% Direct negotiation French, Total Outre-Mer Hoteles Amandiers % Direct negotiation Moroccan, Societe Floride 5.0 Hotel Azghor % Tender Moroccan, Societb Touristique de Ouarzazate Hotel Basma % Tender followed by direct negotiation Moroccan/Libyan Consortium, Bassamate 50.0 Hotel Casablanca % Direct negotiation Moroccan, INTEREDEC-Maroc Hotel delles % Tender followed by direct negotiation Moroccan, Expertotel 20.0 Hotel Doukkala % Tender Saudi Arabian, Abdulmajid Abu Aliadayel Hotel Malabata % Tender followed by direct negotiation Saudi Arabian, Ste. Malabata International 55.0 Hotel Oukaimeden % Tender Moroccan, Kenzi Hotel 3.01 Hotel Rissani % Tender Moroccan, Ste. SHAT 8.1 Hotel Tarik % Tender Moroccan, United Moroccan Hotels 15.2 Hotel Toubkal % Tender Moroccan, Beach Club 38.5 Hotel Transatlantique-Meknes % Tender followed by direct negotiation Moroccan, Tikida Ismailia SA 41.0 Hotel Volubilis % Tender French, FRAM 35.0 Hotel Zalagh % 12/94 Tender Moroccan, Ste. Dar Si Aissa Sectoral Distribution of Firms to be Privatized (Exclusing Hotels) Sector Number of Entities Value-Added of Privatiables / Employment Total Value-Added of Sector Agriculture % 411 Extractive Industries % 1,543 Manufactures % 19,837 Financial Institutions % 6,751 Commerce % 3,285 Transport & Communications % 820 Services % 1,279 TOTAL 74 36,612 L 4

51 Annex 4 Page 5 of 5 GOVERNMENT'S STRATEGY FOR PRIVATIZING STATE-OWNED BANKS (a) (b) (c) BCP is the largest commercial bank in terms of assets (about DH 40 billion), deposits or number of branches. BCP is majority owned by the State (55 percent) and Bank Al-Maghrib (11 percent). BCP has specialized in banking services to Moroccan expatriate workers, small and medium industry lending and housing finance. It has a large portfolio of risk-free government securities and a relatively small loan portfolio. This explains that BCP's capital adequacy ratio has been adequate and generally above other commercial banks, although its profitability return on assets of about 0.5 percent is low in comparison with other banks. The Government intends to privatize BCP through a combination of tender, IPO on the Casablanca stock exchange and direct sale to employees. Given BCP's traditional banking products, its privatization is likely to attract mainly domestic buyers. The State plans to offer its shares of BCP for sale in BNDE is Morocco's industrial development bank. With total assets of about DH 6 billion, it plays a dominant role in medium- and long-term industrial lending. The State owns 34 percent of BNDE's shares and an additional 15 percent is held by other publicly controlled institutions. The Moroccan private sector owns 27 percent and foreign institutions 24 percent. Faced with competitive pressures from commercial banks, BNDE's profitability has eroded since the early nineties although it remains acceptable. BNDE is implementing a strategic plan aimed at developing an advisory and investment banking role and monitoring the structure of costs and revenue by banking product. This plan was prepared in 1992 under the technical assistance component of the Bank's last loan to BNDE. Given the nature of BNDE's operations and its strategic orientation, the Government has hired a foreign investment bank with the mandate to find a strategic investor. Once this investor has been identified, direct negotiations will follow to determine the sale price of the State's shares. BNDE's privatization is expected to be completed before the end of CIH. The State owns 49 percent of CIH's shares through CDG (36 percent) and Bank Al-Maghrib (13 percent) and about 10 percent through other publicly controlled institutions. The privatization of CIH (total assets of DH 21 billion) is scheduled in However, CIH's privatization is likely to be more difficult for two reasons. First, CIH is operating a subsidized housing lending scheme for the low-income population for which it receives direct budgetary support. This activity is barely profitable and a private investor is likely to require either a higher fee to operate the scheme or the right to stop its operation. Second, more than half of CIH's tourism portfolio is affected by arrears. Although tourism represents only about 20 percent of CIH's total assets and several rescheduling arrangements have recently been agreed upon, the quality of the tourism portfolio may make privatization difficult.

52

53 Annex 5 Page 1 of 3 MOROCCO - SECURlTIES MARKET SHARE TRADING VOLUME, NEW ISSUES AND MARKET CAPITALIZATION (DH million) Trading Volume (DH) Official Call Market percent 9.7% 3.0% 10.5% 2.1% 11.5% 74.1% 21.7% 26.5% -Direct Trades (off-floor) percent 90.3% 97.0% 89.5% 97.9% 88.5% 25.9% 78.3% 73.5% Market Capitalization (DH) 1' Market Turnover percent 2' 2.5% 7.4% 2.6% 6.6% 3.7% 3.5% 17.9% 21.7% Capitalization/GDP percent NA NA 2.6% 3.6% 5.1% 7.0% 10.3% 14.3% Price/Earnings ratio (P/E) 3/ NA NA Concentration (share in tot. trans. of 10 most traded stock) NA NA NA NA 80.0% NA 94.0% NA Average Daily Trading volume by market session (million DH) NA NA NA NA Impact of privatization on Average Daily Trading (percent due to NA NA NA NA 0.0% 0.0% 21.0% 27.4% privatization) 4 ' Percentage of shares traded 18% 41% 20% 28% 40% 59% 95% 83% Percentage of Bonds traded 82% 59% 80% 72% 60% 41% 5% 17% Number of listed companies / Market capitalization as computed by the stock exchange does not include the total market value of each listed company's share capital, but only the value associated with the number of shares submitted for listing. 2/ Percent of market capitalization. Shares only. Turnover statistics in the Casablanca stock exchange annual reports combine share and bond trading and do not reflect secondary market activity in listed shares. 3/ Excluding stock dividends. 4/ This value attained 55 percent in the first months of 1995 Source: Bourse de Valeurs de Casablanca, Statistiques, 1991, 1992, 1993, 1994

54 at ~~~m OD ~~~0 0 0 september m CD~~~~~~~~~~~~~~( ~~~~~~~~~~~~~~CD Ln 0)~~~~~~~~~ so X axcn cn cn~~~~~c S: 3 z a23v S xauuv

55 Annex 5 Morocco: Securities Market International Stock Exchange Comparison: 1993 Market Capitalization: Number of listed Value traded % GDP companies (USS million) Morocco Egypt Iran Jordan ,377 Tunisia Turkey ,242 Argentina ,339 Chile ,797 Colombia Greece ,713 India ,879 Kenya Nigeria Philippines ,785 Thailand ,934 Japan ,341 UK ,526 USA ,507,223 Source: M.A. El-Erian, M.S. Kumar (IMF), "Emerging Equity Markets in Middle Eastern Countries", Fobruary 1995 Market CaDitalizaton: 1993 International Comparison s0-6l 0 20 I*.iIM tssil~~~~~ U~~~~~ cl

56

57 Annex 6 Page 1 of 4 SITUATION AND ROLE OF INSTITUTIONAL INVESTORS 1. The size and the role of institutional investors (savings institutions, pension funds, social security, and insurance companies) appears relatively strongly correlated with the level of growth and savings in developing economies (Graph 1). Graph 1: Comparison Between Institutional Investors Sector, Savings Rate and Growth Rate * Stock of lnst. Savings/GDP 30 0 X Savings rate/gdp *Average Growth Rate Morocco Singapore Malaysia Chile Source: World Bank 2. In Morocco, by comparison, the share of institutional investors remains limited in the financial sector. Total assets managed by institutional investors are relatively small. In 1993, these funds amounted to about DH 45 billion or 18 percent of GDP (Graph 2). The pension and social security systems are underfunded (para. 6). Domestic savings modestly increased between 1970 and 1992, from 15 to 17 percent of GDP, thus lagging behind most fast growing middle-income countries. This is mainly due to the limited savings generated by the public sector and the low level of development of the contractual savings sector. Graph 2: Evolution of Reserves of Institutional Investors ~~~~~~~~~~El cen X 20 ~~~~~~~~~~~~~~~EResources ~ MI1 Res. of CNSS of Pension F. 10 ~ ~~~~~~~~~~~~~~~~~UInvest of Insurance Co Source: Central Bank and Ministry of Finance

58 Annex 6 Page 2 of 4 A. The Postal Savings 3. The "Caisse d'epargne Nationale" (CEN) plays a marginal role. Created in 1959, the CEN is part of the 'Office National des Postes et Telecommunications'. With 1319 branches covering most of the country, the CEN manages about 650,000 accounts, representing about 2.4 accounts per 100 inhabitants. This is a very low ratio compared to postal savings institutions in developed countries (30 percent in France), but also to most developing countries (more than 15 percent in Asian countries, and 8 to 10 percent in some West African countries). On total savings in Morocco (including term deposits in banks and other financial institutions), CEN's share amounted to only 2 percent. 4. Due to its particular position, and the large untapped savings pool (rural savings, clerks, civil servants), the CEN could mobilize a significant portion of low to middle income households' savings, if it provided better services and more efficiently managed its assets. There is a high concentration of deposits in a few accounts. Deposits greater than DH 24,000 are concentrated in 4 percent of accounts, while 82 percent of accounts have deposits of less than DH 1000 (51 percent of accounts have deposits of less than DH 100, and are probably inactive). Asset management is constrained as all the funds must be deposited at the 'Caisse des Depots et de Gestion' (CDG). These funds receive the interest rate offered to depositors, plus a spread of 0.9 percent to cover management costs. According to a recent audit of CEN funds management, the cost for the CEN is higher, probably about 1.5 to 2.5 percent. These relatively high uncovered costs limit the development potential of the CEN. 5. The role of postal savings and CEN will be reviewed in the context of the comprehensive study on institutional savings to be completed prior to Second Tranche release of the FMDL. B. Social Security and the Pension System 6. The pension system in Morocco is run by four main organizations (three public and one private) plus a few smaller pension programs run by the banking and insurance sectors. The two major public pension funds are underfunded, while the private one is profitable and well capitalized. (a) (b) The Caisse Marocaine de Retraite (CMR) is for civil servants who pay 7 percent each of their pensionable income. Membership is mandatory. Even though the Govermment is statutorily obligated to match this contribution, it pays only as much as is needed to permit payment of the pensions. In , Government contributions fell more than DH 4 billion short of those scheduled; total arrears of the Government vis-a-vis the pension system is estimated at DH 12 billion (5.6 percent of GDP in 1993). The CMR has no reserves, and given current demographics of the system, serious problems in the medium to long-term are foreseen. If the Government does not pay its obligations in arrears, either the pensions will need to be scaled down, or individual contributions will need to be increased. Affiliation in the Caisse Nationale de Securite Sociable (CNSS) is also mandatory and covers all private sector employees. It provides family allowances, short-term benefits in case of medical disability and death, and pensions. Each benefit category is in theory financed by separate contributions of employers and employees. The family allowance system was to be used to redistribute income while the pension system was to accumulate

59 Annex 6 Page 3 of 4 reserves. In fact, the various operations of the CNSS have been combined, hiding the fact that the surpluses are generated by the family allowance system, and the deficits by the pension system. Since 1985, the operational deficit has exceeded the interest received, and accumulated reserves have started to dwindle. Since 1989, the reserves of the pension system have stabilized; in 1992, they amounted to slightly less than six months of pension payments. At present, all the reserves of the CNSS are deposited with the CDG and are remunerated at an average rate of 8.8 percent.' The newly increased pension contribution rate will allow CNSS to generate surpluses for only a few years to come, after which pension payments will start again to exceed contributions. (c) (d) (e) The Caisse Interprofessionnelle Marocaine de Retraite (CIMR) is a non-profit organization which private sector employers can join on behalf of their employees to ensure a supplementary pension to that of the CNSS. Pension contributions are made both by the employer and the employee at a rate between 3 and 6 percent of the actual monthly salary. Employees can recover accumulated contributions, while employers' contribution must stay with the CIMR. CIMR reserves amounted to DH 2.5 billion at the end of 1993, or 3.6 times the amount of pensions paid that year. The CIMR portfolio includes government debt (29 percent), fixed income instruments (28 percent), real estate investments (5 percent), and stocks (38 percent). The investment experience of the CIMR has been positive; in 1993 the rate of return on its assets was 11.5 percent, while unrealized capital gains amounted to about DH 900 million. There are no government regulations (except on new foreign investments) regarding portfolio composition. The Caisse Nationale de Retraite et d'assurances (CNRA) provides pensions to contractual workers in government service, and is managed by the CDG. Affiliation is mandatory and in 1993 there were 184,525 contributing workers. At end-1993, total reserves amounted to DH 8.3 billion, 35 percent of which was invested in government paper, 18 percent in government-guaranteed bonds and 29 percent in equity. In 1993, the overall returns on investments were 24 percent, including unrealized capital gains. A number of state enterprises run their own pension schemes, while private schemes are also run by insurance companies. Professional associations maintain supplementary pension schemes, some of which are managed by CDG. Their reserves amount to about DH 2.5 billion. 1/I Deposits prior to end-1989 earn 8.5 percent, while deposits made since then earn 9 percent. These rates of compensation are to be reviewed in theory every three years.

60 Annex 6 Page 4 of 4 C. The Insurance Industry 7. The Moroccan insurance industry remains underdeveloped. The insurance industry includes 23 companies. The reinsurance business is managed by only one state reinsurance company. The turnover of the insurance industry increased by 13.5 percent in 1993 amounting to DH 6.1 billion (2.5 percent of GDP). Despite this upward trend, Morocco remains in the low range of developing countries (Graph 3). In 1993, insurance spending per capita p.a. averaged US$15, against US$890 in France, and US$1670 in the US. Graph 3: International Comparison or Insurance Premiums, /S Source: Sigma, World Ins urance in The financial situation of the insurance industry remains weak. During the last few years the technical deficit has remained high, due in large part to problems in the automobile insurance sector. This sector has realized losses for the last few years, and a number of companies heavily involved in this segment have gone bankrupt. This situation is partly explained by the fact that automobile insurance premiums, which are set administratively, are insufficiento cover the ensuing liabilities. In 1994, these premiums were raised by 12 percent, whereas a 36 percent increase would have been required to restore profitabil)ity. By end 1993, technical reserves amounted to DH 23.3 billion, an increase of 15 percent compared to, the previous year. These reserves are subject to prudential guidelines set by the Ministry of Finance. Forty percent of technical reserves are to be invested in public securities. At end-1993, 47 percent of total reserves were so placed, reflecting the absence of marketable securities; only 14 percent of reserves were invested in the equity market. The overall situation of the insurance industry and its role in the development of financial markets will be reviewed in the context of the planned study on contractual savings.

61 Annex 7 Page 1 of 3 Capacity Building Program 1. Institutional capacity reinforcement concerns the following areas: Treasury, CDVM, the Casablanca Stock Exchange (CSE), Accounting, and Contractual Savings. Technical assistance is being provided by bilateral donors, mainly France, according to independent arrangements, to BAM and the Treasury in the areas of monetary policy and domestic debt management. Other technical assistance requirements and possible funding arrangements with Canada and France are discussed below. The following box summarizes the areas covered and the potential sources of funding. AREAS Cost Time of Potential source of Status estimate implementation funding TREASURY: debt US$50, months France: Treasury and Exchange program management bilateral cooperation already in place; new request to be submitted CDVM: operations To be 12 months Canada Request to be upgrading, training determined submitted by CDVM/Finance Ministry CSE: central US$lmillion 12 months France First tranche of depository, delivery US$200,000 under vs payment (DVP) implementation system,training ACCOUNTING: US$75, months France Request to be training, consulting submitted by services Finance Ministry CONTRACTUAL US$600, months France Request to be SAVINGS: study submitted by and action plan Finance Ministry 2. CSE. The technical assistance program, under implementation, aims to cover the main operational aspects of stock market trading including the trade settlement and delivery system. A technical assistance contract proposal has recently been signed between France and Morocco. The agency SBF (Societe des Bourses de France) provides consulting services, training and software to improve the working of the market and the skills of its players. In particular, it will prepare: (a) an action plan to strengthen the institutional infrastructure based on the G-30 recommendation, notably the establishment of a central securities depository (CSD) and a delivery versus payment process (DVP); and (b) an electronic quotation trading system providing transparency and equality of market access to all investors.

62 Annex 7 Page 2 of 3 3. The modernization of secondary market trading operations also requires training programs for about 25 persons from the stock exchange organization and member firms. They will need to familiarize themselves with the automated quotation system, the new clearing and settlement procedures and the operations of the central depositary system. Intensive training will be required for four or five staff members of the stock exchange organization responsible for system operations associated with the quotation and the trade processing. Training will be provided under the second tranche of the French technical assistance to the CSE. 4. Accounting. The main areas for technical assistance for institutional reinforcement in the area of accounting were discussed and agreed upon during appraisal and negotiations with the Moroccan authorities. A proposal covering these areas has been submitted by the Finance Ministry to France for an amount equivalent to US$75,000. The areas covered include: (a) (b) (c) Ordre Marocain des Experts Comptables (OMEC). OMEC was created at the end of 1994, and several actions have to be undertaken to enable it to be recognized at the international level, and ensure a quality control on its own membership. A team composed of one foreign expert and two Moroccans should, over a period of 12 man/months, prepare a new manual of professional conduct, a quality control mechanism, the training for quality control, and organize a seminar for the association to introduce the professional norms of conduct and the standard requirements for its participants. Additional assistance may be required to allow the Moroccan order of accountants to join the international accounting associations such as IFAC and IASC. Consolidated accounts. The national accounting standards (Code Gen6ral de la Normalisation Comptable (CGNC), include a chapter on consolidated accounts. It is, however, obsolete and does not foresee the mandatory disclosure of consolidated accounts, even for publicly quoted companies. Technical assistance should be provided to revise this chapter to comply with the Seventh European Directive, and to prepare a draft law making disclosure and certification of consolidated accounts mandatory (at least for quoted companies). A consultant should work for 2 man/months with CNC to prepare the new chapter and the draft law, as well as audit and certification standards. Conseil National de la Comptabilite' (CNC). CNC was created in 1989 with the task of coordinating and summarizing the theoretical and methodological research projects undertaken in accounting. However, it lacks organizational structure and the logistics needed for its functioning. Technical assistance to this institution should allow an in-depth re-examination of its structure, its role and objectives, its funding and its relationships with the OMEC. A foreign consultant will be needed for a total of 3 man/months to coordinate the analysis and help prepare an action plan for CNC reform. 5. CDVM. The Securities Commission (CDVM) is not currently in a position to perform its basic role. Although CDVM's legal authority is currently effective, it has no established administrative procedures, and the active professional staff to undertake most of the interventions specified in its mandate is very limited (2-3 professionals). Extensive training is required in the two main areas of the Conseil's mandate: a) the issuance of visas for public offerings; and b) the supervision of market operations and intermediaries. The staff members of CDVM need to acquire the necessary skills and knowledge for the review of the information documents submitted by issuers; in addition, they need training on the supervision of prudential rules and the surveillance of marketing and investment operations of investment funds (OPCVMs) and securities firms.

63 Annex 7 Page 3 of 3 6. Finally, CDVM staff will need to learn the techniques, information requirements and investigation methods associated with the surveillance of stock market trading activities. In addition to training, the responsibilities and authority associated with key executive jobs need to be defined. Procedures, guidelines and a time frame for the review of information documents submitted by issuers must be put in place for the issuance of public offerings visas. Standardized models of information documents need to be developed as well as guidelines for issuers on the public disclosure of material information. 7. During appraisal, the Bank assisted CDVM and the Ministry of Finance in preparing a detailed proposal for a comprehensive technical assistance program to be submitted to the Canadian International Development Agency (CIDA). The technical assistance program would support CDVM through training of its staff, consulting services, creation of an information center and documents library, and computerization of some of its functions - direct link with the CSE, creation of a computerized database on listed companies. 8. Study on contractual savings. During appraisal, the Bank assisted the Ministry of Finance in finalizing the terms of reference for a comprehensive study on contractual savings. The study will focus on the financing and investment policies of the key institutional savers (the insurance industry, social security, pension system, mutual funds) and on how to enhance their role in the development of financial markets. It will present recommendations and will lay the grounds for the preparation of an action plan for reform. The Bank also assisted the Moroccan authorities in identifying possible funding (estimated at about US$ 600,000) for the study. The terms of reference of the study were informally discussed with official French representatives and will be submitted to the French bilateral assistance by the Moroccan authorities.

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65 Distribution of Financial Assets in Morocco / 140" 12 Others(bonds,etc) u # l F i j i F g A, ~~~~~~~~~~~~~Bank Dep osits 0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Source: Central Bank and Bourse of Casablanca

66 Annex 9 CONSOLIDATED BALANCE SHEET OF DEPOSIT BANKS AND MONETARY SURVEY Assets and Liabilities of Deposit Money Banks (In DH Million) Assets 114, Cash 12,405 7,253 8,772 - Claims on the Government 33,385 39,548 44,657 - Claims on the economy 54,218 61,833 65,840 - Portfolio of Securities 8,121 8,567 8,937 - Foreign Assets 1,623 1,902 1,811 - Fixed Assets 3,569 4,292 5,032 - Other Items Liabilities Sight Deposits 61,757 66,636 70,033 - Term Deposit 30,383 36,425 42,687 - Credit from the Central Bank 8,398 2, External Borrowing 2,179 3,205 3,729 - Capital Accounts 9,480 12,393 15,569 - Other Items 2,012 2,685 2,574 Monetary Survey (In DH Million) Net Foreign Assets 21,061 27,873 33,707 38,174 41,497 - Net Credit to the 48,556 51,367 55,470 59,412 65,229 Government - Credit to the 43,874 59,235 66,020 71,753 79,336 Economy " - Other Items 1,311-4,412-8,690-11,194-11,820 Money and 114, , , , ,242 quasi-money 1/ Private sector and public enterprises

67 Morocco Most Same region/income group Annex 10 Page 1 of 2 LtWst single year recent Mid-East Lower- higher Unit of estimate & North middle- income Indicator measure Africa income group Priority Poverty Indicators POVERTY Upper poverty line local curr. 2,568 Headcount index % of pop Lower poverty line local curr. 2,070 Headcount index % of pop GNP per capita USS ,040 1,980 1,590 4,350 SHORT TERM INCOME INDICATORS Unskilled urban wages local curr... Unskilled rural wages Rural terms of trade Consumer price index 1987= Lower incomne Fooda M Urban Rural SOCLAL INDICATORS Public expenditure on basic social services % of GDP Gross ernrollment rutios Primary % school age pop Male Female " Mortality Infant mortality per thou. live births Under 5 mortality Immunization Measles % age group DPT Child malnutrition (under-5) Life expectancy Total years Female advantage Total fertility rate births per woman Maternal mortality rate per 100,000 live births Supplementary Poverty Indicators Expenditures on social security % of total govt exp Social security coverage % econ. active pop Access to safe water total % of pop Urban Rural Access to health care Population growth rate GNP per capita growth rate Development diamondb 6+ (annual average, percent) (annual average, percent) Life expctancy Next GNP Gross I X k. I 2 0 per ~~~~~~~~~~~~~~~~~~~~ 0* l g I t 1 1 *^- \* capita \ / enrollment Access to safe water a Morocco Morocco - Lower-rniddle-income - Lower-middle-income a. See the technical notes, p b. The development diamond, based on four key indicators, shows the average level of developmnent in the country compared with its incomne group. See the introduction.

68 Annex 10 Morocco ~~~~~~Page 2 of 2 Most Same regloxnliaonse group Latest single year recent Mtd.Bat Lower- higher Unit of estima,te & North middle.- ixcome Indicator measure Africa incomse groaup Resources and Expenditures HUMAN RESOURCES Population (mre=-193) thousands ,816 25, , Age dependency ratio ratio Urban % of pop Population growth rate annual % Urban Labor force (15-64) thousands 4,656 6,676 8,567 71, ,136 Agriculture % of labor force Industry Female " " Females per 100 males Urban number Rural NATURAL RESOURCES Area thou. sq. km , , , Density pop. per sq. km Agriculturaland % of land area Change in agriculturaland Agriculturaland under irrigation annual % % Forests and woodland thou. sq. km Deforestation (niet) annual % INCOME Household income Share of top 20% of households Shame of bottom 40% of households % of income Share of bottom 20% of households EXPENDITURE Food %ofgdp Staples.. 9.4A Meat, fish, milk, cheese, eggs Cereal imports Food aid in cereals thou, metric tonnes ,509 2, , ,092 1,249 66,281 5,477 48, Food production per capita 1987 = Fertilizer consumption kglha Sham of agricultum in GDP %ofgdp Housing % of GDP Average household size persons per household Urban Fixed investment: housing % of GDP Fuel and power %ofgdp Energy consumption per capita kg of oil equiv , ,632 Households with electricity Urban * of households Rural Transport and communication % of GDP Fixed investmient: transport equipmient Total road length thou. km INVESTMENT IN HUMAN CAPITAL Health Population per physician persons 13,100 15,536 4, ,277 Population per nurse, Population per hospital bed oral rehydyration therapy (under-5) % of cases Education Gross enrollment ratio Secondary % of school-age pop Female Pupil-teacheratio: primary pupils per teacher Pupil-teacheratio: secondary Pupils reaching grade 4 % of cohort Repeater rate: primary % of total enroll illiteray % of pop. (age 15+) Female % of fern. (age 15+) News~r ciculation er thou.pop. 1 IS World Bank Intemational Econonmics Department, April 1995 Newt

69 The Status of Bank Groun Operations in Morocco Statement of Bank Loans and IDA Credits (As of May i Annex 11 Page 1 of 2 US$ Million Amount Loan or Fiscal (less cancellations) Credit No. Year Borrw Purpose Bank IDA Undsbursed Seventy-six loans and five credits fully disbursed 4, Of which SALs, SECALs, and Program Loans /a Kingdom of Morocco Industrial Trade Policy (SAP) Kingdom of Morocco Agriculture Sector I Kingdom of Morocco Industrial Trade Policy Adjustment II Kingdom of Morocco Education Sector I Kingdom of Morocco SAL I Kingdom of Morocco PERL I Kingdom of Morocco Agriculture Sector II Kingdom of Morocco Financial Sector Development Kingdom of Morocco SAL II Sub-total Disbursing Loans ONPT Telecommunications I BNDE, BCM, BMCE Industrial Export Finance I Kingdom of Morocco National Water Supply Rehab Kingdom of Morocco Greater Casablanca Sewerage Kingdom of Morocco Power Distribution Kingdom of Morocco Small & Medium Irrigation II Kingdom of Morocco Rural Primary Education Kingdom of Morocco Agricultural Research & Extension Kingdom of Morocco Public Administration Support Kingdom of Morocco, CIH Housing Finance II BNDE, BCM, BCME, CDM, Industrial Finance WAFA Kingdom of Morocco Forestry Development li Kingdom of Morocco Highway V (Sector) Kingdom of Morocco Health Sector Investment Kingdom of Morocco Rural Electrification II / Kingdom of Morocco/ODEP Port Sector Kingdom of Morocco Rural Basic Education Development * 1991 BNDE, BCP, SGMB, CDM Financial Sector Development BMCE, BCM, BMCI ONPT Telecommunication Restructuring Kingdom of Morocco Second Large Scale Irrigation Impr / Kingdom of Morocco, CIH, SGMB Land Development / Kingdom of Morocco, FEC Municipal Finance I Kingdom of Morocco Environment Management CNCA National Rural Finance / Kingdom of Morocco/ONEP Water Supply V Kingdom of Morocco Irrigated Areas Agric. Services Kingdom of Morocco ASIL II TOTAL 6, , Of which has been repaid (only amortization) 2, Total held by Bank and IDA 4, Amount sold of which repaid Total Undisbursed 1, * SAL, SECAL or Program Loan \a Approved after FY80

70 Statement of IFC Investments in Morocco (As of May Annex 11 Page 2 of 2 Original Gross Commitment Fiscal (US$Million) Year Obligator Tvoe of Business LQan Eauitv Total 1963 Banque Nationale pour le Dev. Development Finance Econ. (BNDE) Societe Miniere du Bou-Gaffer Mines (SOMIFER) 1987/ Credit Immobilier et Hotelier (CIH) Tourism / Settat Filature (SETAFIL) Textile Factory Compagnie Maritime Maroco- Ferry Service Norvegienne (COMARIT) 1991 Cerame Afrique Industries (CAI) Ceramics Societe ENNASR de Peche Agro-industry / Ciments du Maroc Cement (formerly CIMASFI) 1992 Banque Commerciale de Maroc Capital Markets (BCM) 1992 Banque Marocaine du Commerce Capital Markets Exterieur (BMCE) 1992 Credit du Maroc (CDM) Capital Markets Wafabank Capital Markets International de Financement et Financial Services et de Participation (INTERFINA) 1994 Societe Marocaine Capital Markets Siparex-Wafa Dev. Financial Services Societe Financiere Siparex Financial Services Total gross commitments Less cancellations, terminations, repayments, sales and exchange adjustments Total commitments held by IFC I16 of which undisbursed ' IFC net. Does not include participants from commercial banks

71 Annex 12 KINGDOM OF MOROCCO FINANCIAL MARKETS DEVELOPMENT LOAN KEY PROCESSING EVENTS Time taken to prepare Project prepared by 9 months Ministry of Finance and Bank Al-Maghrib with the assistance of IBRD staff Identification September 26 - October 6, 1994 Pre-Appraisal October 31 - November 11, 1994 Loan Committee April 28, 1995 Appraisal and Negotiations June 12-24, 1995 Board Presentation July 25, 1995 Expected Effectiveness August 10, 1995 Closing Date June

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75 MOROCCO K 4 S "AdD"-~~~T tn, an ci OMtTEOS~~~~~~~~" 5 L This mop hros boon prepared =luont T exolosfoely for the convemreece RVNECPTL of readers ond is for tire.,"s '_- -/t NATIONAL CAPITAL otlerool ose of Thre World BonkIc,'' Droop The desoinotiotlno osw Q TON AN CIIE ond the beoundornes shown], ^ - : N_ ttwsadcte on this mop do not imply 00 the ELVTO ABVE TO ETR part of The World Bank Droop, (5 T.Jl-. )T=loIooBTvt'EEAtNABV 00MTR any godbmeot on the legal ECNOI REEO BOUNDARIESS endorsement ntacceptance of * CNAIREONBUD IS soch boondaries.. ( * INTERNATIONAL 80UNDARIES w)athelu,,, =/ord, 32' ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~8.. I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~E T. w ~~~~ INTERNATIONAL BOUNDARY,. a#s r. (oppronirno's) - c,8t cuphrlim / r, 5U1 10U I50 L-L I I I u