Morocco's dirham: pressure building for change

Moroccan authorities have long resisted exporter pressure to devalue the dirham (MAD). This was mainly on the premise that the MAD, pegged to a basket of currencies, was not misaligned. While the IMF has endorsed that view, the Fund has nevertheless recommended moving to a more flexible FX regime to improve Morocco's resilience to economic shocks. While policymakers remain skeptical of the benefits of a flexible currency, recent economic developments are beginning to sway opinion.

The Moroccan central bank eased its rigid position on the currency last year, by suggesting that the MAD would be liberalised in the medium term. There are three reasons why we believe policymakers might be changing their minds on this issue:
1. The sustained strength of the euro, which is heavily weighted in the MAD's currency basket. Euro strength has accounted for much of MAD appreciation. In December 2004, EUR strength dragged the MAD to its strongest point in 10 years on a real effective exchange rate basis. Although the euro has recently fallen back against the US dollar we expect this weakness will be temporary.
2. Free Trade Agreements signed with the US and the EU/Mediterranean countries will increase the need for more exchange rate flexibility to maintain competitiveness
3. The end of the multi-fibre agreement, which will put pressure on Morocco's important textile exports. Increased competition from Asia saw textile exports drop by 34.6% y/y in January 2005.

But while there is an obvious need for a change to the peg, devaluation is not a done deal for now. Policymakers will draw some comfort from Morocco's strong balance of payments position, which allows it to withstand the shock to textile exports. Furthermore, ongoing structural reforms are attracting textile companies into Morocco. In May, three foreign textile companies announced investment projects worth USD 300m. This will help sustain the textile industry and create an estimated 2,500 jobs.

There are other reasons to suggest devaluation could be delayed. The peg has been helpful in generating macroeconomic stability and keeping inflation low. Inflation has averaged 2% since 1999. Any change to the FX regime would require the authorities to establish a monetary policy framework that would provide an alternative nominal anchor. More fiscal policy rectitude is also needed. Though the government has recently hiked fuel prices to dampen a spiraling fiscal deficit, we still expect the deficit to rise to 5.5% of GDP in 2005 from around 5.0% in 2004.

In addition, Morocco's worsening trade deficit has been more function of rising imports. In March 2005, imports increased by 9.1% y/y, and crude oil imports rose by over 50% -- accounting for much of the rise in Morocco's import bill. Moreover, other sectors of the economy are likely to add to pressure on import requirements. This year, the government is expected to confirm a poor cereal harvest. Output is expected to be 40% below the normal 6.0 million tons, implying that it might have to import a large quantity of wheat. A strong MAD would limit the inflationary impact rising imports could generate.

Taking all these factors into consideration, the monetary authorities should prefer to maintain the status quo on the currency in the near term, even as pressures start to rise. We do not expect any sweeping policy changes, and not before Q4 2006. FX reform will most likely be gradual and preceded by measures to strengthen monetary policy and Morocco's financial system.