Cablegate: Morocco Moves Gingerly Towards Foreign Exchange


DE RUEHRB #1712/01 3111713
R 071713Z NOV 07





E.O. 12958: N/A

1. Sensitive but unclassified - entire text. Please handle

2. (SBU) Summary: A series of new circulars issued by
Morocco's Office des Changes this fall represents further
intensification of preparations for the country's medium term
goal of transitioning to a freely floating exchange rate.
Central Bank and government officials speak officially of a
three year transition period, but privately tell us that they
hope that the change can occur more rapidly, given
difficulties in managing the current fixed or basket peg.
Exporters have clamored for the change, citing competitive
problems that have resulted from the dirham's appreciation
against the dollar and currencies in the region (given the
weight of the Euro in the currency basket). The IMF,
however, concluded earlier this year that "the dirham is not
misaligned." End Summary.

3. (U) Morocco is currently one of only 9 countries that
applies a basket peg exchange rate mechanism. Its current
exchange regime dates to April 2001, when the basket to which
the dirham is pegged was adjusted away from the dollar in
favor of the Euro. The move reflected the country's
increasing economic integration with the European Union, and
followed a decade in which the dirham appreciated by 21
percent in real terms because of the dollar's then strength.
The shift brought an immediate five percent devaluation in
the dirham. The peg has worked well since that time, and the
dirham has not come under pressure recently, as evidenced by
the country's relatively low real interest rates and healthy
official reserves (which currently represent nearly a year of
imports). Those reserves have grown steadily despite the
country's structural trade deficit, thanks to transfers from
Moroccans abroad, tourism, and burgeoning foreign direct
investment. Central Bank officials indicate, however, that
the peg has at times been "difficult" to manage, and that
complications could increase as the country pursues further
capital account liberalization.

4. (U) The most frequent complaint about the current system
stems from the fact that as the Euro has appreciated against
the dollar, it has pulled the dirham along in its wake. The
IMF concluded this year in its Article IV consulations with
the Moroccan government that the "dirham is not misaligned,"
but exporters have not agreed. They point to the fact that
since 2001 while the dirham has depreciated by 9 percent
against the Euro, it has appreciated by some 28 percent
against the U.S. dollar. This has also entailed significant
appreciation against other competing currencies in the
region, including those in Tunisia and Egypt. Casablanca
market analysts are reluctant to give a figure to the impact,
but concur that the change has undoubtedly slowed the
country's export growth. Though Morocco has continued to run
a current account surplus in recent years thanks to tourism,
transfers and investments, analysts have sounded the alarm at
the fact that exports now cover only 48 percent of imports.

5. (SBU) A recent study by Morocco's leading bank,
Attijarawafa, highlights the fact that Morocco is at the
crossroads between a fully flexible system and its current
peg. The current system, the bank concludes, is best adapted
to small countries with open economies that are "insulated"
from external influences and have the ability to deal with
temporary shocks through fiscal policy. In contrast, the
bank argues, a flexible exchange rate is best suited for
large well-integrated economies that have significant trade
flows and strong labor mobility. Morocco, in the view of
Attijarawafa is precisely in midstream, having graduated from
the former category thanks to its policy of trade
liberalization and openness to international commerce (which
now constitutes 55 percent of GDP), but it is not yet in the
latter category, given the small size of its economy and the
weakness of its labor market. As a result, Chakib Erquizi,
Director of Market Activities argued to us in a recent
meeting, Morocco is in need of three to five years of reforms
to put in place the mechanisms that will permit it to
successfully implement a floating or flexible rate.

6. (SBU) Houssam Barakat, who handles exchange transactions
at rival BMCE Capital, concurs that the moment is approaching
for Morocco to begin the move to a more flexible monetary
policy. The current system, he told us, has ensured
stability vis-a-vis Morocco's principal European partners,
and has also minimized currency risk for foreign investors,
contributing to their confidence in the Moroccan economy.

For Moroccan markets to take the next step, however, the
country should graduate to a a floating regime. Both Erquizi
and Barakat believe that market sophistication has greatly
improved since the foreign exchange market was launched in
Morocco in 1996. They note the existence of varied
instruments including swaps and options that were not present
at that early date. The continued increase in Morocco's
currency reserves, in their view, also demonstrates the
country's readiness for the transition. What is lacking,
they argue, is a "culture of risk" and full understanding by
Moroccan market players of the range of international options
open to them. In their view, however, the new measures
announced by the Ministry of Finance and its Office des
Changes in August open the door to significant progress in
these areas.

7. (U) Those measures, contained in eight circulars, include
significant new measures to further liberalize Morocco's
capital account. Among them are a reduction in the surrender
requirement on export proceeds, partial liberalization of
trade-related credits and payments, expansion of the range of
transactions that can be covered by currency hedging
instruments (together with lengthened maturities for such
instruments), and partial liberalization of portfolio
investment by securities firms, insurance companies and
mutual funds. Foreign direct investment by firms and
Moroccan residents was also liberalized. The measures are in
line with recommendations by IMF staff, and aim at helping
market players develop the savoir faire that will enable them
to compete and prosper in a fully globalized marketplace. In
remarks in early August, Morocco's alternative Executive
Director at the IMF characterized the measures as "important
additional steps" on the road toward capital account
convertability, which should encourage more efficient use of
resources and risk diversification, while facilitating the
task of liquidity management," thereby helping assure
continued control of inflation.

8. (SBU) The new rules are not the only significant change in
Morocco's foreign exchange regime. Central Bank Governor
Jouahri also earlier this year lifted the veil of secrecy
that surrounded the exact composition of the dirham basket,
revealing that the relative weight is 80 percent for the Euro
and 20 percent for the dollar. Specialists had earlier
roughly determined this by modeling the currency, but public
confirmation brought a welcome dose of transparency to the
system. Morocco also signed a "Master Derivatives Agreement"
with the World Bank to help it hedge currency risks related
to its external debt.

9. (SBU) Attijarawafa's Erquizi predicted to us that the new
measures announced by the Office des Changes will have a
positive impact on overall market dynamics in Morocco, as
currently "the yield curve doesn't fully reflect the
economy." Instead, liquidity has been trapped in the
Moroccan economy, keeping interest rates down and leading to
inflated prices for assets that "sometimes do not reflect
fundamentals." He pointed particularly to several IPO's on
the Casablanca Stock Exchange, which have dramatically
appreciated since their launch. (Overall, the Casablanca
exchange has been one of the best performing in the region,
rising 70 percent in 2006 and a further 40 percent this year,
despite a brief correction in May.) The impact of the
current system on Moroccan real estate, he said, has been
similar. If the market were not closed, he argued, investors
would have other assets abroad, and prices would be more in
line with the Moroccan economy's underlying fundamentals.
The new rules, he said, should start to begin this
transition. Barakat cautioned, however, that this will not
happen overnight, given the extremely high profits that
investors have realized from Moroccan assets in recent years.

10. (SBU) Erquizi noted that deepening of capital makets and
greater investment bank expertise are nt all that Morocco
needs, however. In his view,further structural reforms in
the Moroccan econoy are necessary as well. These include
particularly reform of the Moroccan labor market to provide
for added "flexibility of employment." Erquizi greed with
the point that Treasury Director Geneal Chorfi and others
have made in public that a iberal regime does not
necessarily imply a devaluation of the dirham, given that
demand has exceedd supply for the last five years. He
cautioned,however, that this may not be the case once locals
have greater opportunity to place their assets aroad.

11. (SBU) Comment: Change is coming to Morocco's foreign
exchange markets, and while full liberalization is still some
distance away, experts concur that the changes announced this
fall represent a dramatic break with the past and clear
evidence of the seriousness of Moroccan plans to move to a
floating rate. How fast the change occurs will depend on the
success of these initial reforms and how adept Moroccan
traders are at exploiting them. Historically Morocco has
preferred to adopt a gradual approach in this sensitive area,
however, so the transition is likely to be longer rather than
shorter. End comment.

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