institutions. The share of nonperforming loans (NPLs) in banks' assets dropped, and their provisioning increased. The surge in credit to the private sector reflects deepening financial intermediation and better access to credit in particular.
6. The first benefits of the improved economic performance are already tangible: In 2006, job creation reached 300,000, a 50 percent increase over its average since the turn of the century. Real per-capita GDP increased by 6 percent, bringing its total increase over the past six years to 25 percent. The key challenge for macroeconomic policy remains sustaining and strengthening the current performance in order to bring living conditions closer to those of emerging-market OECD countries. Higher growth would also help further reduce unemployment, as the latter is still high in urban areas, particularly among young people.
7. The information available for the first few months of 2007 seems to confirm the emergence of a new economic environment characterized by stronger, more resilient growth and a significant increase in investment, both domestic and foreign. Nevertheless, the likely contraction in agricultural production is expected to bring overall growth down from 8.1 percent in 2006 to 2.5 percent in 2007. A pickup in investment would partially offset the negative impact of lower growth on domestic demand, allowing nonagricultural growth to reach 5.5 percent in 2007, against 5.2 percent in 2006.
8. This new economic environment presents great opportunities to further enhance Morocco's economic performance. However, its rapid transformation will also present significant challenges to macroeconomic policies. In particular, the vigor of domestic demand—which has been the main growth engine—and the significant increase in capital flows will make the task of keeping inflation under control more challenging. Moreover, to sustain and possibly improve the recent growth performance, the external sector needs to emerge as a second growth engine.
Challenges and Opportunities
Monetary Policy and Inflation
9. Low inflation and macroeconomic stability have played a key role in improving Morocco's economic performance. In line with the mandate conferred by its new statutes, which granted BAM its autonomy, the central bank's main objective in 2007 is to continue to keep inflation under control as domestic demand remains strong. Moreover, in the context of Morocco's current exchange rate regime, keeping inflation under check would help limit real appreciation pressures on the dirham and help the external sector emerge as a second engine of growth. Indeed, the current dirham's real exchange rate seems in line with its equilibrium value, as estimated by both the Moroccan authorities and IMF staff.
10. Inflation reached 3.3 percent year-on-year at end-2006, up from 1 percent in 2005. This slight increase reflects the strength of domestic demand and the mechanical effects of indexing domestic fuel prices to international prices, which the authorities reintroduced after a hiatus in September 2006. BAM's decision to tighten monetary policy in two steps—first by using the seven-day auctions to mop up liquidity at 2.5 percent in April 2006 instead of the overnight facility and second by increasing the rate on these auctions by 25 basis points in December 2006—has helped limit the increase in prices.
11. Inflation slowed down during the first four months of 2007, reaching 2.2 percent year-on-year at end-April. However, uncertainties regarding the inflation outlook remain. In particular:
• The evolution of international oil prices remains uncertain;
• Net capital inflows, which largely reflect the importance of net foreign direct investment, could continue to increase in 2007, providing additional stimulus to domestic demand; and
• Notwithstanding the weakening of the relation between monetary aggregates and inflation, the strong increase in broad money and in credit to the private sector remain leading indicators of demand pressures.
12. The evolution of the price of financial and real-estate assets should also be taken into account to assess the inflation outlook. Real estate and financial-assets prices have increased substantially. Further, the yield curve for treasury securities has flattened. The positive aspects of these three developments—success of the government's policy to facilitate access to home ownership, acceleration in the pace of initial public offerings on the Casablanca stock exchange, and improved market confidence in macroeconomic policies—are evident. However, these evolutions can also carry inflationary risks. Thus, improved availability of statistical information on these sectors would be desirable in order to help BAM deepen its analysis of the linkages between inflation and asset prices.
13. Because of the uncertainty surrounding the inflation outlook, BAM is careful monitoring inflation developments. The stance of monetary policy remains appropriate. In particular, it has led to a new increase in the interbank market rate, which is now close to the central bank's key policy rate of 3.25 percent. However, in the event that inflationary pressures strengthen, a further tightening of monetary policy would be warranted.
14. The current situation offers a preview of challenges to come, and the authorities continue to work on how to adapt macroeconomic policies to best confront them.
• The authorities have started to consider options for a further gradual opening of the capital account. The progressive elimination of remaining restrictions on residents' transactions will help deepen the foreign exchange market, improve economy-wide risk management, and contribute to liquidity management in the medium term. In this regard, the authorities have requested the Fund's assistance, and the mission reiterated the staff's commitment to help them in this endeavor.
• In this context, BAM is preparing the transition to a more flexible exchange rate regime and the possible adoption of an inflation-targeting framework. To do so, the central bank continues to strengthen its analytical capacity, and has already fleshed out its analytical toolkit, including its understanding of the monetary policy transmission mechanism. The publication of its first two monetary policy reports, which present inter alia an assessment of economic developments and an inflation forecast based on a risk-balance approach, demonstrate the progress achieved in modernizing BAM's analytical and forecasting framework. The strengthening of BAM's communication strategy has helped increase the transparency of monetary policy and contributed to better anchoring inflation expectations.
The role of fiscal policy
15. Fiscal policy remains geared toward medium-term fiscal consolidation. The progress achieved in this area during the last few years has strengthened Morocco's economic performance. In the medium term, continued improvement of the public finances position will open up fiscal space, cement private sector confidence, and help consolidate growth. In the short term, continued fiscal discipline, particularly for the wage bill, will help contain demand pressures.
16. Early 2007 developments confirm that the fiscal deficit will stay below 3 percent of GDP for the second year in a row. Two main elements explain the substantial improvement in fiscal performance:
• Strong collection of all major taxes, thanks to (a) the widening of the tax base under the joint effect of economic growth and the pursuit of a reduction in tax exemptions, particularly for the VAT; and (b) the strengthening of tax administration, particularly through the reorganization of tax collection.
• Efforts to tackle the main sources of fiscal rigidities, including the wage bill, through (a) the success of the voluntary early retirement program for civil servants; (b) the stabilization of the headcount in the civil service; and (c) the modernization of human resource management.
17. In the short term, continued fiscal consolidation would help the deficit reach about 2.5 percent of GDP in 2007 and keep the stock of public debt (expressed as a percentage of GDP) around its 2006 level. Adherence to the indexation mechanism for fuel products will help maintain the overall cost of energy and food subsidy at or below the amount foreseen in the finance law (1.7 percent of GDP), which will facilitate the achievement of the deficit objective.
18. The authorities' focus is on their medium-term objectives for fiscal consolidation, which they support through (a) a comprehensive reform of the public administration and of the public expenditure management system; and (b) an increased predictability of fiscal policy through the development of the medium-term expenditure framework. These main medium-term objectives are as follows:
• Reducing the stock of public debt to bring it closer to the level of emerging-market OECD countries in the medium term;
• Maintaining the public wage bill at around 10 percent of GDP by continuing the no-new-net-hiring policy in the civil service and redeploying civil servants in priority sectors;
• Gradually reducing spending for food and energy subsidy expenditure, and replacing it with direct subsidies targeted to the most vulnerable segments of the Moroccan population;
• Accelerating the simplification of the tax system, particularly through the continuation of the VAT reform and the reduction of exemptions; and
• Continuing to modernize tax administration, with a particular focus on strengthening the collection function.
Deepening financial intermediation
19. By mobilizing domestic savings and ensuring their efficient allocation, deeper financial intermediation plays a key role in sustaining growth. The recent surge in credit to the private sector demonstrates the success of the authorities' policies in this area. The implementation of stricter information requirements on credit demand as well as supply, has contributed to improving risk assessment and hence to reducing its cost. The new privately managed credit bureau, expected to become operational in the first half of 2008, is also an important step forward and will be the first of its kind in the region.
20. Concurrently, important progress has been achieved in the area of financial supervision. The regular publication of annual supervision reports and the addition of specific studies on the evolution of real estate and consumption credit as well as interest rate-related risk are important developments. Furthermore, the implementation of the 2006 banking law has extended BAM's supervisory mandate to previously unsupervised institutions, and the cooperation between entities supervising different segments of the financial system has been strengthened.
21. The effort undertaken to strengthen the balance sheet of pension funds will contribute to enhancing financial sector stability and to increasing the maturity of available resources for economic activity. Finally, the ongoing study on the possible unification of the public loan guarantee system should help rationalize it and assess its possible impact on the budget.
Deepening Morocco's integration into the world economy
22. Morocco's successful integration into the world economy would help the external sector increase its contribution to growth through the diversification of growth sources. Three aspects are particularly important in this area:
• strengthening the economy's ability to adapt to a changing global environment;
• pressing ahead with trade liberalization; and
• continuing the preparation for the transition to a more flexible exchange rate regime.
23. Strengthening public infrastructure, particularly highways and ports, will continue to generate substantial productivity gains. The positive transition in export composition toward higher valued added sectors shows that the economy's ability to adapt to a changing international environment has improved. However, it is important to ensure that the expanded menu of sectoral incentives does not create further distortions and blur the predictability and transparency of the tax system, which the recent publication of the General Tax Code has improved. The systematic monitoring of tax expenditure over the past couple of years is an important element in the cost/benefit assessment of these policies.
24. Progress in the area of trade liberalization continues on both the bilateral and the regional levels. The progressive elimination of tariffs for European Union trade is proceeding according to schedule. The recent implementation of the Agadir agreement and the coming into effect of the free-trade agreement with Turkey in 2006 should stimulate trade within the signing parties as well as with the European Union, since it provides for diagonal cumulation of rules of origin. The free-trade agreement with the United States has already led to a significant increase in textile exports. In this context, the mission welcomed Morocco's efforts to deepen trade and financial integration in the Maghreb region and its decision to organize a meeting of financial integration expert in July 2007 with a view to finalizing an action plan.
25. In order to minimize trade diversion, liberalization efforts on the bilateral and regional levels should be complemented with progress in multilateral liberalization. The recent decision to lower unilaterally the maximum MFN import tax rate on industrial products by 5 percentage points is a good step forward in this area.
26. The current exchange rate peg of the dirham to a basket of currencies has played an important role in maintaining macroeconomic stability by anchoring inflation expectations.
However, as the Moroccan economy continues to open up and undergoes a structural transformation, a flexible exchange rate regime would give macroeconomic management additional flexibility.
Medium Term Outlook
27. Thanks to the positive developments that have contributed to strengthen Morocco's economic performance, and particularly to the steadfast implementation of the authorities' reform program, the medium-term outlook is favorable. The growth rate of non-agricultural activity would remain above 5 percent in the coming years. This scenario assumes a modest increase in total factor productivity reflecting the successful implementation of reforms. Tourism and remittances receipts would remain high. However, the robust pace of growth would reduce the current account surplus in the outer years. Gross official reserves would remain at a comfortable level, owing to buoyant foreign direct investment.
28. The mission welcomes the adoption and the publication of anti-money laundering legislation as well as the efforts to establish the financial intelligence unit as quickly as possible.
29. The mission also welcomes the authorities' decision to publish this concluding statement.