Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 52301-MA

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT

FOR A PROPOSED LOAN

IN THE AMOUNT OF €133.1 MILLION (US%200 MILLION EQUIVALENT)

TO THE

KINGDOM OF MOROCCO

FOR A

SUSTAINABLE ACCESS TO FINANCE DEVELOPMENT POLICY LOAN

December 22,2009

Social and Economic Development Group Middle East and North Africa Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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KINGDOM OF MOROCCO - GOVERNMENT FISCAL YEAR January 1 "-December 3 1 St

AfDB A L M A M 0 A T M B A M BCP BNDE C A M CAR CCG CDG CDS CDVM CFAA CIH CIMR CMA C M M CMR CNC CNSS CPM CPS DAPS DPL EET EU EUR FBPMC FDI FNAM GAAP GCC GDP GNFS GNI GST IBRD ICA ICR IDA IFC

CURRENCY EQUIVALENTS US$l = 7.73 Moroccan Dirham (MAD)

(Exchange rate effective as o f 30 October 2009)

ABBREVIATION AND ACRONYMS

African Development Bank Asset and Liability Management Assurance Maladie Obligatoire Automated Teller Machine Bank A1 Maghrib Banque Centrale Populaire Banque Nationale de Developpement Economique Credit Agricole du Maroc Capital Adequacy Ratio Caisse Centrale de Garantie Caisse de DepBt et de Gestion Credit Default Swap Conseil Deontologique des Valeurs Mobilieres Country Financial Accountability Assessment Credit Immobilier et Hotelier Caisse Interprofessionnelle Marocaine de Retraite Capital Market Authority Caisse Marocaine des Marches Caisse Marocaine de Retraite Conseil National de la Comptabilite Caisse Nationale de SCcuritC Sociale Credit Populaire du Maroc Country Partnership Strategy Direction des Assurances et de la Prevoyance Sociale Development Policy Loan Exempt, Exempt, Tax (Contributions, Interest Earned, Benefits) European Union Euro Fondation des Banques Populaires pour le Microcredit Foreign Direct Investment Federation Nationale des Associations de Microcrgdit Generally Accepted Accounting Principles Gulf Cooperation Council Gross Domestic Product Goods and Non Factor Services Gross National Income Goods and Service Tax International Bank for Reconstruction and Development Investment Climate Assessment Implementation Completion and Results report International Development Agency International Finance Corporation

FOR OFFICIAL USE ONLY IF1 IFRS IMF IPO IT MAD MFI MIGA MIS MIX MOF MOU MTPL NBFI NPL OPCVM PARL PAYG PCG POS PPP PSIA RBC RCAR ROSC RTGS SAP SGG SME SMS TTT UCITS USD USSD VAT WCA

International Financial Institution International Financial Reporting Standards International Monetary Fund Initial Public Offering Information Technology Moroccan Dirham Microfinance Institution Microcredit Association Multilateral Investment Guarantee Agency Management Information System Microfinance Exchange Ministry of Economy and Finance /Ministry o f Finance Memorandum Of Understanding Motor Third Party Liability Non Bank Financial Institution Non Performing Loan Organisme de Placement Collectif en Valeurs Mobilikres (UCITS) Public Administration Reform Loan Pay As You Go Partial Credit Guarantee Point Of Sale Purchasing Power Parity Poverty and Social Impact Analysis Risk-Based Capital RBgime Collectif d’ Allocation de Retraite Report on the Observance o f Standards and Codes Real Time Gross Settlement System Statutory Accounting Standard Secretariat GBndral du Gouvernement Small and Medium Enterprises Short Message System Tax, Tax, Tax (Contributions, Interest Earned, Benefits) Undertaking in Collective Investment in Transferable Securities United States Dollar Unstructured Supplementary Service Data Value Added Tax Workers’ Compensation Administration

Vice President: Shamshad Akhtar Country Director: Mats Karlsson

Sector Director: Ritva Reinikka Sector Manager: Simon Bell

Task Team Leader: CBdric Mousset

I I

This document has a restricted distribution and may be used by recipients only in the performance o f their of f ic ia l duties. I ts contents may not be otherwise disclosed without Wor ld Bank authorization.

TABLE OF CONTENTS

I . INTRODUCTION ........................................................................................................................................ 1

I1 . COUNTRY CONTEXT ............................................................................................................................... 2

A . B . C .

I11 . A . B . C .

I V . A . B . C . D . E .

IMPRESSIVE MACROECONOMIC PERFORMANCE IN THE DECADE ........................................... 2 THE IMPACT OF THE GLOBAL FINANCIAL CRISIS ........................................................................ 3 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ..................................................... 7

THE GOVERNMENT PROGRAM ..................................................................................................... 10

OVERVIEW OF THE MOROCCAN FINANCIAL SYSTEM ............................................................... 10 EARLIER FINANCIAL REFORM EFFORTS ....................................................................................... 12 THE GOVERNMENT’S REFORM PROGRAM .................................................................................... 14

BANK SUPPORT TO THE GOVERNMENT STRATEGY .............................................................. 26

LINK TO CAS ......................................................................................................................................... 26 COLLABORATION WITH THE IMF AND OTHER DONORS ........................................................... 26 RELATIONSHIP TO OTHER BANK OPERATIONS ........................................................................... 27 LESSONS LEARNED ............................................................................................................................. 28 ANALYTICAL UNDERPINNINGS ....................................................................................................... 28

V . THE PROPOSED SUSTAINABLE ACCESS TO FINANCE LOAN ................................................... 29

OPERATION DESCRIPTION AND POLICY AREAS .......................................................................... 29 EXPECTED OUTCOMES OF THE OPERATION ................................................................................ 34

OPERATION IMPLEMENTATION ................................................................................................... 35

POVERTY AND SOCIAL IMPACT ....................................................................................................... 35 ENVIRONMENTAL ASPECTS ............................................................................................................. 36 IMPLEMETATION, MONITORING, AND EVALUATION ................................................................ 36 FIDUCIARY ASPECTS .......................................................................................................................... 37 DISBURSEMENT AND AUDITING ..................................................................................................... 38 RISK AND RISK MITIGATION ............................................................................................................ 39

A . B .

V I . A . B . C . D . E . F .

ANNEX I . ANNEX I1 . PROGRAM MATRIX ANNEX I11 . ANNEX I V . ANNEX V . ANNEX V I . ANNEX VI1 .

LETTER OF DEVELOPMENT POLICY

THE BANKING SECTOR AND ITS REGULATION THE INSURANCE AND PENSION SECTOR ACCESS TO FINANCE. MICROCREDIT AND FINANCIAL INCLUSION FUND RELATIONS NOTE COUNTRY AT A GLANCE

The Sustainable Access to Finance Development Policy Loan was prepared by a core team comprising: CCdric Mousset. Task Team Leader and Sr Financial Sector Specialist . MNSED. Roberto Rocha, Sr Advisor. MNSED. Anderson Caputo da Silva, Sr Debt Specialist. GCMSM. Laurent Gonnet. Sr Financial Sector Specialist. MNSED. Loic Chiquier. Manager. GCMNB. Xavier Reille. Lead private sector development specialist. CGAP. Douglas Pearce. Sr Private Sector Development Specialist. MNSED. Alejandro S . Alvarez de la Campa, Private Sector Development Specialist. CICRA. Raha Shahidsaless. Consultant. CICRA. Rodney Lester. Consultant. Patrick Simonnet. Consultant. Andrea Corcoran. Consultant, Stefan0 Patemostro. Lead Economist. MNSPR. David C . Freese. Sr Finance officer. CTRFC. Jean-Charles de Daruvar. Sr Counsel. LEGEM. Eavan O’Halloran. Sr Country Officer. MNCO1. Youssef Saadani Hassani. Consultant. MNSED. Subika Farazi. Consultant. MNSFP. Steve Wan Yan Lun. Operations Analyst. MNSFP. and Khalid Alouane. Language Program Assistant. MNSED .

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties . Its codtents may not otherwise be disclosed without World Bank authorization .

LOAN AND PROGRAM SUMMARY

KINGDOM OF MOROCCO

SUSTAINABLE ACCESS TO FINANCE DEVELOPMENT POLICY LOAN

Borrower

Main Policy Areas

output/outcome indicators

Contribution to CPS

Kingdom of Morocco

Ministry o f Economy and Finance

IBRD loan in the amount of 133.1 million EUR (US $200 million equivalent). Two tranche Development Policy Loan. The first tranche (88.6 million EUR) will be disbursed following Board approval, which will be conditional on the realization o f specific reforms and the second tranche (44.1 million EUR) upon the fulfillment o f a detailed set of measures.

Individuals’ access to finance SME access to finance Financial regulation and supervision Capital market development

Progress in expanding access to households: increase in the number of accounts, higher number of consultations on households in the credit bureau and reduced non performing loans in the microcredit industry,

9 Increase in SME access to credit: higher number o f consultations on enterprises in the credit bureau, Progress in strengthening the regulatory and supervisory framework: higher average capital adequacy ratios in the banking system, Progress in developing capital markets: improvements in the functioning o f the government debt market (e.g. reduced number o f lines o f Treasury bills).

While the financial system has grown significantly, access remains an issue and new risks have emerged. The rapid growth o f financial institutions in recent years has contributed to Morocco’s growth performance and expanded the frontiers o f finance. However, it i s also apparent that, despite significant improvements, the financial system i s not yet providing services to large segments o f low income households and SMEs. Moreover, this rapid growth has also generated new risks in the banking, insurance and microcredit sectors that need to be effectively managed. The global financial crisis added importance to further reforms. The Government has launched a four pillar reform program that addresses effectively the dual objectives of access and stability. The first pillar contains measures that promote access to individuals while the second pillar comprises measures to enhance access to small and medium enterprises. The third pillar strengthens the resiliency of the financial system through further and important improvements in financial regulation and supervision. The fourth pillar, capital market development, contributes both to access and stability, by promoting competition to banks, and introducing better instruments o f risk management. The Morocco CPS i s currently being finalized for presentation to the Board

i

Risks and risk mitigation

~ ~~

Project ID Number

in January 2010. The Financial Sector DPL i s a key element of the CPS and contributes to the objectives of the CPS pillar o f Growth, Competitiveness and Employment by supporting (i) improvements in financial intermediation to enhance competition and growth, (ii) increased household and SME access to finance, and (iii) strengthened financial regulation and supervision to ensure sustainable gains in access. In addition, further enhancements o f corporate and bank governance are covered by the DPL program which thus contributes to the cross-cutting objective of the CPS as regards strengthening governance. 0 In the short term, Morocco i s confronted with uncertainties on the timing

and speed o f the recovery from the global crisis. Risks are mitigated through continued strong macroeconomic management and Morocco’s track record suggests that it i s well placed to face the current uncertainties.

0 A deterioration o f the credit portfolios of some institutions could jeopardize expected improvements in access. Although non-performing loans seem to be leveling off in the microcredit industry, further deterioration cannot be ruled out. The Government has proved i ts resolve to handle the situation and has taken measures to strengthen the capacity o f the microcredit institutions to grow in a sustainable way. Likewise, the slowdown o f non-agriculture output may put some stress in bank portfolios, but the government has also taken measures to strengthen the banks’ solvency and their capacity to manage new risks.

0 The resumption o f long-term bond issues, which i s essential to market development, may imply some increase in the reference rate for existing floating rate mortgage holders. However, low income mortgage holders only have fixed rate mortgages (floating rate mortgages are not eligible to the housing subsidy scheme) and the impact would remain limited for other households.

0 In the wake of the global crisis, some initiatives may be received with more caution and text approval may prove more difficult (e.g. on securitization or regulated future market). The Government i s addressing this risk by proposing only simple and tested instruments which bring clear benefits to the country, by setting up appropriate regulations to reduce risks and by reaching out to all concerned parties.

P117201

ii

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A SUSTAINABLE ACCESS TO FINANCE LOAN

TO THE KINGDOM OF MOROCCO

I. INTRODUCTION

1. Morocco has made substantial progress in developing its financial sector. The total assets o f Moroccan financial institutions have grown significantly and exceed 200 per cent o f GDP, a ratio that i s well above the level predicted by Morocco’s per capita income. This progress in financial development has been the result o f sound macroeconomic policies and important financial sector reforms earlier in the decade, which positioned Morocco to take advantage o f favorable conditions (e.g. abundant liquidity and global economic growth). These financial reforms were supported by the Bank through a Financial Sector Development Policy Loan in 2005, and included the restructuring o f state-owned financial institutions, the strengthening o f the regulatory framework and the improvement o f financial infrastructure.

2. While the financial system has grown significantly, access remains insufficient and new risks have emerged. The rapid growth o f financial institutions has expanded the frontiers o f finance and contributed to Morocco’s growth performance. However, despite significant improvements, the financial system i s not yet providing services to segments o f l o w income individuals and SMEs. Moreover, this rapid growth has also generated new risks in the banking and insurance sectors that need to be effectively managed. In the microcredit sector, an industry characterized by very low default rates, the rapid growth combined with inadequate governance and risk management resulted in portfolio problems. The global financial crisis added importance to further reforms, for having produced a credit slowdown that typically affects the most vulnerable sectors. Moreover, the global crisis has also shown the need to strengthen financial infrastructure and regulation to ensure that further access gains are sustainable.

3. The Government has launched a new financial reform program that addresses effectively the dual objectives of access and stability. I t includes four mutually reinforcing pillars which build on major improvements in the soundness and risk management capacity o f financial institutions. The f i rst pillar contains measures that promote access to households while the second pillar comprises measures to enhance access to small and medium enterprises. The launch o f a credit bureau and revised partial credit guarantee mechanisms will allow further progress in access and improved risk management. The third pillar strengthens the resiliency o f the financial system through further improvements in financial regulation and supervision. I t will allow an early identification o f r isks and will avoid a repeat o f the difficulties experienced by the microcredit sector. The fourth pillar, capital market development, contributes both to access and stability. I t promotes competition to banks which will encourage them to go down market, and will make new information and instruments available therefore making further gains in long term financing (e.g. mortgage loans or investment credits) possible.

4. Against this background, the Government requested World Bank support to its financial reform program through a Development Policy Loan. The proposed

1

Sustainable Access to Finance Loan would contribute to Morocco’s reform efforts, both financially and technically. First, it would contribute to a balanced financing package, helping the Government meet i t s larger borrowing requirements resulting from the global crisis, while avoiding excessive pressures on the domestic financial market. Second, it would support an important reform that will contribute to growth and poverty alleviation. Third, it would allow the Bank to remain engaged in the design o f more challenging reform components, contributing to their quality. Finally, the Moroccan reform provides important lessons for other countries, for recognizing explicitly the need to combine the objectives o f access and stability.

5. Based on its program, the Government has requested a two tranche loan. The program supported under the proposed operation would be implemented by the Ministry o f Economy and Finance. As requested by the Government, the proposed operation is undertaken in parallel to one from the African Development Bank; these two operations are being structured in two tranches around a largely common policy matrix.

11. COUNTRY CONTEXT

A. IMPRESSIVE MACROECONOMIC PERFORMANCE IN THE DECADE

6. Morocco’s economic performance improved significantly during the decade, as indicated by higher and sustained output growth, falling unemployment, rising investment ratios, and low inflation. As shown in Figure 1 and Table 1, economic growth rates averaged 5.1 percent over the period 2001-08, almost twice as high as the average o f the previous decade. Per capita income almost doubled over the decade to reach US$2,850 in 2008. Growth became less volatile and less dependent on agriculture, although the primary’ sector s t i l l accounts for 15 percent o f GDP. Unemployment declined from 14 to 9.6 percent. The investment rate increased sharply from 25 percent o f GDP to more than 35 percent o f GDP, improving the prospects o f sustained strong performance. Inflation remained subdued at 2 percent p.a. Finally, Morocco became more integrated in the global economy, although the share o f trade i s s t i l l l o w (76 percent o f GDP), and exports remain undiversified, revealing room for improvements.

7. Morocco’s improved performance was largely due to sound macroeconomic policies and structural reforms. The Government ran fiscal deficits in the first hal f o f the decade but was s t i l l able to reduce moderately the debt ratio from 67 to 62 percent o f GDP. After 2005 the Government maintained very sound fiscal policies, as indicated by budget surpluses in 2007 and 2008. These surpluses resulted in a steady decline in the debt ratio to 47 percent o f GDP. Moreover, prudent public debt management entailed an increasing share o f long-term issues and the increasing duration o f domestic debt. Financial sector reforms entailed inter alia the restructuring o f state banks, stronger financial regulation and supervision, and improved financial infrastructure. Furthermore,

2

the government deepened the integration into the world economy through the signing o f free trade agreements and the adoption o f the advanced status program with the EU.’

B. THE IMPACT OF THE GLOBAL FINANCIAL CRISIS

8. Morocco has not been spared from the effects o f the global financial crisis, but has been able to manage its effects well and to preserve a reasonable growth performance. Morocco, l ike al l other emerging countries, suffered from the sharp reduction in risk tolerance and the overall retrenchment o f capital flows. As shown in Figure 2 depicting the impact o f the financial crisis in the world, following the collapse o f Lehman Brothers in September 2008, stock prices fell, Credit Default Swap (CDS) spreads increased and borrowing spreads increased as well. In Morocco, the movements in prices and spreads were less pronounced than those in most other countries, reflecting a sound macroeconomic management, but prices and spreads have not yet returned to the pre-crisis levels. The current account o f the balance o f payments shifted into a deficit o f about 5.4 percent o f GDP in 2008 (Figure 1 and Table l), due to the impact o f the crisis on workers’ remittances and tourism, as well as the drop in exports. The poor export performance reflects the contraction o f export markets, the l o w diversification o f exports and an underlying problem o f lack o f competitiveness.

9. The banking system has proved resilient to the crisis, but the rapid pace of deposit mobilization decreased, leading to a slowdown of lending activity. The direct impact o f the crisis on Moroccan banks was very limited, as the banks did not hold toxic assets and had not resorted to wholesale external resources to find their lending. However, the fast growth o f deposits observed in previous years (driven largely by demand deposits) was interrupted, as shown in Figure 2. This is to some extent related to the reduction in workers’ remittances, tourism, and other external inflows in the same period (Table 1). The banks eventually reduced the pace o f lending to contain the loan to deposit ratio below 100 percent. The slowdown o f credit also reflects a decrease on the demand side, driven by the slowdown o f non-agriculture output. In the MENA region, the credit slowdown was somewhat sharper than the one in other non-GCC countries, as Moroccan banks had been expanding faster, but milder than the one observed in GCC countries, which were over-extended and directly affected.

10. The credit slowdown i s welcome, given the high growth of the recent years and the need for banks to adapt to a less liquid environment and tighten risk management. Banks have financed infrastructure and housing, expanded finance to MFIs, and expanded finance to SMEs as well, especially medium enterprises. However, the fast credit growth has generated new risks that need to be addressed, including credit, liquidity and interest rate risks. The Central Bank allowed credit growth to cool down while implementing countercyclical policies in 2009 to prevent tensions. This included lowering of reserve requirements in steps from 15 percent in December 2008 to 8 percent

On the basis o f these achievements Morocco gained investment grade rating in 2007 from one rating agency. Other agencies acknowledged Morocco’s good macroeconomic management and performance, while also indicating the need for further debt reductions, further export and output diversification, and further decline in unemployment and poverty.

3

in October 2009. At the same time, the Central Bank has also taken steps t o ensure the resi l iency o f the banking system. This has included a f i rst increase in minimum capital requirements from 8 to 10 percent in 2008. The Government's program includes further measures designed to ensure the resi l iency o f the banking system (Section 111).

Figure 1. Macroeconomic achievements over the decade

Improved growth performance (in YO): higher level, less volatilitv and less dependencv on agriculture

Higher investment ratios have improved future growth prospects (in YO of GDP)

14 0 SO 0

S O

s o

2 0

- 1 0

-4 0

-7 0 . - v - -

-GDP --- Agricultursl Output (rightsria) Poly. (GDP)

6 0 0

4 0 0

20 0

0 0

-20 0

-40 0

-60 0

Unemployment has steadily declined (YO)

2 0 % 32%

1 5 % 24'%

I 0 % i 6 %

5 % 8%

0% 0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

$ 1 111 Narional - Urhsn

- Urhin Youth-right .XIS U c h l n Women-r ight 81x1.

- 12

The external position remains solid with recent vulnerability in trade (in YO o f GDP)

1 10 20

15 10 5 0 -5 -10

i/

35 0 7 0

30 0 - I - - - - -

- 5 0

4 0

3 0

2 0

1 0

0 0

2004 2005 2006 2007 2008

I Lrivate nndSOh a public A d m ~ l l r t r a a o n n H o u r e h o i d r FDlr(rightax~r)

Public Finances have improved (in YO of GDP)

12% '

10% . 30%

8% ' 25% 6% '

4% . 2% .

# 20%

0% -2% 10%

5% -6%

8% J - 0% 95 96 97 98 99 00 01 02 03 04 05 06 07 OB

- - - Consumersubsidies Tots1 nvonueli(Rlght Axis) Fiscal delisit - wag.* 8 *Pla"e*

The Central Government debt i s declining and i s sustainable (in % o f GDP)

80%

70% . \---- 60% .

-

-5

40%

20%

10%

40%

20%

10%

0% 1 . . . . . . . . . . . . . . 95 96 97 98 99 00 01 02 03 04 05 06 07 08

- Forolgn ' ' " DOmestIo - Total Debt

Source: Moroccan Government and Staff estimates

4

11. The Government has implemented a stimulus package to support the income of the population and help the most affected sectors. The income support package includes an increase o f 10 percent in the wages o f c iv i l servants at the lower end o f the salary scale and the Minimum Wage for private sector employees. Direct support measures for affected firms included financial re l ie f (guarantees on loans; rescheduling o f debt; help with export insurance). One additional measure, effective January 2009, entailed a cut in the marginal income tax from 42 percent to 40 percent, and the upper end o f the exempt income bracket was extended.

12. Public finances continue to be well managed, despite the impact o f the global crisis and the stimulus package. The effective expenditure and tax management over the last few years have been critical in maintaining public finances on a sustainable path. After two years o f surpluses (2007 and 2008), the budget shifted into a deficit in 2009, due to falling revenues impacted by the global crisis and the introduction o f the stimulus package to respond to the crisis. However, the deficit has been contained at a reasonable level, enabling a further decline in the ratio o f debt to GDP to an estimated 46.5 percent, down from 53.5 percent in 2007 and 47.3 percent in 2008. The inclusion o f the four public pension funds in the definition o f the general government would entail smaller deficits and lower net debt ratios, as these institutions s t i l l run surpluses and have accumulated assets that exceed 20 percent o f GDP. This i s a positive aspect o f the overall fiscal situation that i s not sufficiently highlighted2.

13. The Government made tactical debt decisions that involved a decline in average duration, but plans to resume long-term issues with the return to stability. The share o f long-term public debt declined from 87 to 76 percent in recent years, resulting in a decrease in average duration to 5.8 years. This was due to a tactical decision by the Treasury to avoid issuing higher cost long-term debt (in the aftermath o f the crisis, interest rates increased3). However, the average duration remains at a reasonable level - the median durations o f countries rated as BBB and BB by Fitch are 5.0 and 3.1, respectively4. Moreover, the resumption o f long-term issues and the build-up o f a reliable and liquid yield curve i s part o f the Government’s program, as noted in Section 111.

14. Morocco’s growth performance has been remarkably good, in light o f the global crisis and its effects on the economy. GDP growth reached 5.6 percent in 2008 and i s expected to be 5 percent in 2009, compared with only 2.7 percent in 2007. This performance is mainly due to a good agricultural output in both years, largely offsetting the slowdown o f non-agriculture GDP growth since 2007 (Table 1). This i s a positive outcome overall, although it also reveals the dependency on agriculture and weather conditions (albeit with less intensity than in the past). The unemployment rate continued to decline to around 9 percent in the first hal f o f 2009 down from 9.6 percent

* In the absence o f reform, two public pension funds are projected to run deficits in the 2010s and deplete their assets before 2020, while the third and largest pension fund should run deficits early in the 2020s and deplete i ts assets during that decade. Whi le this actuarial imbalance must be addressed, the fact i s that in many countries the social security system i s already in deficit and has no assets to back future obligations. In the world, investors also demanded higher spreads on long-term emerging sovereign debt. Morocco i s rated BBB- by Fitch, BB+ by Standard & Poor’s and Ba l by Moody’s.

3

4

5

the previous year, although this reflects to some extent a decline in labor force participation, and in urban areas unemployment remains high (1 3.4 percent). Finally, the central bank showed i t s commitment to price stability, as indicated by the reduction in the annual inflation rate to 1.5 percent during the f i rst 8 months o f the year , down from 3.9 percent over the same period in 2008.

Figure 2. The Impact of the Financial Crisis (Stock Prices, Borrowing Spreads, Money and Credit)

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 07 e 7 07 0 7 ~ 8 H i g ~ ~ n c 0 $ $ 0 8 ~ a. 0gGce9 09 -+-- BRI

--Bc Non-GCC -Morocco

500

Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul &? 08 08 08 08 0 &J 09 09 09 East Asia + MENA

I

(Morocco: --- black line)

10% - 70%

5% 65%

0% 60%

2002 2003 2004 2005 2006 2007 2008 2009

-Credit Growth Deposit Growth

-_I_x -P--*p--wp-* - Sources Bloomberg, IFS, Central Bank o f Morocco

1 B *LAC I)- ECA --&- East Asia 1 +GCC + Non-GCC -Morocco

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 1 07 07 07 07 08 08 08 08 09 09 09

* ---._I___ __--________ ----"~ lew*l

759/. DwositsjGDP (?$l akd Share of Demand Deposits [%) I

- -r 50% 1 60% I_____ I __ - _ - _

-+Demand Deposits to Total Deposits +Total Deposits/GDP (rhs)

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr 06 06 06 06 07 07 07 07 08 08 08 08 09 09 ---+-- GCC Non-GCC Emerging - Non-GCCState-dominated - Morocco

*

6

Table 1. Selected Macroeconomic Indicators (YO of GDP unless otherwise indicated)

1. Output and Prices GDP Growth (YO) Non Agriculture GDP growth (%) Unemployment (%) Consumer price (%. yearly average) 11. National Accounts Gross Investment Gross National Savings Government Investment Government Savings 111. Public Finances Total Revenues Current Expenditure Capital Expenditure Global Balance Public Debt o f CG Total interest paymentsmax revenues Share o f MLT Debt in Domestic Debt Average Duration o f Domestic Debt IV. External Accounts Imports GNFS Exports GNFS Trade Balance Tourism receipts Workers' remittances Current Account Balance Foreign Direct Investment Reserves (months o f GNFS imports) External debt stocWGDP Source: Government and Staff estimates.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Est. Proj.

7.6 5.7

12.5 0.6

26.1 30.4

2.6 -1.2

22.4 21.9

5.1 -5.7 67.1 21.6 66.6

3.7

32.6 29.6

-10.3 6.8 8.6 4.3 7.6 9.2

3.3 3.2

11.6 2.8

25.9 29.6

2.2 -0.1

22.1 20.6

4.5 -4.1 63.7 19.1 79.8

4.1

32.9 30.2 -9.9 6.5 7.1 3.7 1.4 9.4

6.3 4.8 3.6 4.7

11.6 11.0 1.2 1.5

27.4 29.1 30.5 30.8

2.1 2.1 -0.7 -0.3

21.6 22.2 20.6 20.8

4.1 4.2 -4.4 -4.0 69.1 58.3 18.4 17.4 71.2 80.4 3.8 4.8

32.0 34.8 28.6 29.2

-10.9 -13.9 6.5 6.9 7.2 7.4 3.2 1.7 4.9 1.9

10.4 10.2

3.0 5.6

11.2 I .o

28.8 30.7

1.9 -2.2

23.8 24.1

3.9 -5.2 62.1 15.2 87.0

6.4

38.2 31.6

-17.0 7.8 7.7 1.9 5.0

10.3

7.8 5.4 9.7 3.3

29.4 31.6

2.1 1.6

25.1 21.5

4.1 -2.0 57.3 14.5 83.9

6.6

39.8 33.1

-18.3 9.1 8.3 2.2 4.6

10.4

2.7 6.5 9.8 2.0

32.5 32.4

2.3 3.3

27.3 21.6

4.6 0.2

53.5 12.5 82.3

6.4

46.0 36.2

-22.3 9.5 8.9

-0.1 6.2 9.2

5.6 4.2 9.6 3.9

36.3 30.9

2.8 4.2

29.5 22.6

5.5 0.4

47.3 9.7

76.2 5.8

51.3 36.9

-24.3 8.0 7.8

-5.4 2.3 7.0

5.0 3.0 1.7 4.5 9.0 9.0 2.5 2.0

33.6 34.2 29.8 30.9

2.7 2.8 2.9 3.3

26.5 26.7 21.2 20.8

5.5 5.7 -2.7 -4.5 46.3 47.6 10.3 10.3

40.4 41.9 26.5 27.8

-20.5 -21.1 6.2 6.5 6.5 7.2

-5.8 -5.3 1.5 2.6 6.9 6.2

49.8 44.5 36.5 29.6 27.2 27.1 27.3 23.4 24.4 25.1

C. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

15. Sound macroeconomic policies and the efforts to improve competitiveness will allow Morocco to manage effectively the global crisis and benefit from the recovery of the world economy. It i s assumed that the government wi l l maintain a prudent fiscal stance and sustain the reform momentum o f recent years, continuing to implement the main sector strategies, including financial sector reforms. This wil l consolidate investment levels and generate fkrther efficiency gains, enabling a sound growth performance. Moreover, the world economy i s expected to slowly recover from the current crisis, allowing the on-going export promotion strategies to bear fruit.

16. The external position deteriorated but i s expected to remain sustainable over the medium term. After 2008 and 2009, during which the current account deteriorated , the improvement should be gradual in the following years, as the impact o f the sector strategies take hold. In 2009, the trade deficit should improve (around 20.5 percent o f GDP), with falling imported commodity prices compensating for lower exports. The balance o f payments i s expected to progressively improve, with lower trade and current

7

account deficits, which would benefit from improved export potential and a recovery o f tourism and workers’ remittances. Foreign Direct Investment (FDI) i s expected to recover gradually to the 2008 levels. This i s rather conservative assumption given the higher FDI ratios before the crisis. However, these FDI levels would contribute to the projected gradual decline in the ratios o f external debt to GDP and exports.

17. This scenario assumes that Morocco would reap the fruits o f its continued reform efforts, its sound macroeconomic and fiscal policies, and targeted sector strategies. These policies would entail sustaining large public investment in infrastructure, which would increase the return o f private investments and induce an increase in their volumes, including FDIs, leading in turn to progressive gains in export competitiveness and key service sectors such as tourism.

Table 2. Base-line Medium Term Macroeconomic Indicators

Projections 2008 2009 2010 2011 2012 2013

Growth Rates in percent Real GDP Real private consumption Real Gross Domestic Investment Export Volume (GNFS) Import Volume (GNFS) GDP deflator Ratios to GDP Gross Domestic Investment Fiscal Balance Central Government Debt Current Account balance FDI

5.6 5.0 3.0 4.4 5.1 5.2 9.4 8.0 2.6 3.6 4.0 3.8

11.7 4.6 4.7 5.0 5.2 5.5 -1.1 -9.4 6.5 7.2 7.7 8.0 10.9 -4.4 5.5 5.1 5.6 5.5 5.9 2.5 2.2 2.0 1.9 1.9

36.3 33.6 34.2 34.4 34.4 34.5

47.3 46.3 47.6 46.9 45.4 43.9

2.3 1.5 2.6 2.7 2.8 2.9

0.4 -2.7 -4.5 -2.9 -2.4 -2.2

-5.4 -5.8 -5.3 -4.8 -4.1 -3.2

External Debt 23.4 24.4 25.1 24.9 24.1 23.0 Source: Moroccan Government and Staff estimates

18. After a temporary higher deficit in 2010, the fiscal stance should remain sound, with fiscal deficits under the targeted threshold o f 3 percent of GDP over the medium term, and debt ratios should decline further. The budget deficit i s expected to edge up to 4.5 percent o f GDP in 2010, before improving to around 2.2 percent by 2013. Reaching this outcome assumes success in ongoing tax reform to broaden the tax base, improve the efficiency o f the Value Added Tax, strengthen tax administration, and remove tax exemptions in order to reduce tax expenditures. These measures would offset the reduced top rates on income taxes. Under these assumptions, tax revenue is projected to stabilize at around 25 percent o f GDP. On the expenditure side, the consolidation o f public finances relies on achievement o f o i l and food subsidies reform and tight control o f the wage bill. Under these conditions, public debt will stabilize in 20 10 at almost the same level as that o f 2008 before following a downward trend to decline to less than 44 percent o f GDP in 2013. The average duration o f the debt i s expected to stabilize and gradually increase in later years as the Treasury resumes long-term issues.

19. The projected budget deficits and amortizations should be comfortably financed from the domestic market and increased recourse to external loans in 2010. As shown in Table 3, domestic financing would remain the main source, although

8

external financing would increase i t s contribution. Indeed, since 2006, net external financing reversed i t s long negative trend to turn positive, reflecting the government's strategy to slightly change the debt composition in favor o f external borrowing. This financing strategy i s more balanced and would avoid excessive pressure on domestic financial markets, now that the money market i s less liquid than in recent years. It is also consistent with the intention to maintain a comfortable level o f foreign reserves.

20. A comprehensive analysis o f public debt sustainability shows that the fiscal framework i s robust to downside risk in the medium term (Figure 3). The sustainability o f the fiscal framework i s robust to shocks: under alternative scenarios, several shocks to the baseline scenario are simulated5, and public debt sustainability i s preserved in all o f them. In the medium term, the external accounts are also expected to remain manageable, with ample foreign reserves (corresponding to an average 6.2 months of imports) and declining current account deficits in 20 1 0- 1 3.

Table 3. Financing Requirements o f the Central Government (In percent of GDP)

Projections 2008 2009 2010 2011 2012 2013

Financing required Budget deficit (+) Amortization Domestic External Total Financing available Domestic financing External disbursement Others (Privatization, capital grants, . . .)

Source: MEF and staff estimates

9.4 10.3 12.1 10.5 9.8 9.4 -0.4 2.7 4.5 2.9 2.4 2.2 9.7 7.6 7.5 7.5 7.4 7.2 8.3 6.8 6.7 6.7 6.6 6.3 1.4 0.8 0.9 0.8 0.9 0.9 9.4 10.3 12.1 10.5 9.8 9.4 6.1 8.0 9.3 8.2 7.7 7.6 2.0 2.1 1.9 1.4 1.3 1 .o 1.3 0.2 0.9 0.9 0.8 0.8

Figure 3, Public Debt remains sustainable under various alternative scenarios ( O h of GDP)

j 5 0 0

46 0

4 4 0

42 0

4 0 0

3 8 0

3 6 0

3 4 0

3

2009 2010 2011 2012 2013 2014

Base Line Keyvariablesat their Historical Averages -___ No Policy Change

The other shocks are: (1) Real interest rate i s at baseline plus one standard deviations; (2) Real GDP growth i s at baseline minus one-half standard deviation; (3) Primary balance i s at baseline minus one-half standard deviation; (4) Combination o f (1)-(3) using one-quarter standard deviation shocks; (5) One off 30 percent real depreciation in 20 10; (6) increase in 'other debt-creating flows' in 20 10 o f 10 percent o f GDP.

9

111. THE GOVERNMENT PROGRAM

A. OVERVIEW OF THE MOROCCAN FINANCIAL SYSTEM^ 21. The total assets of Moroccan financial institutions exceed 200 per cent of GDP, reflecting the country's progress in financial development. As shown in Table 4, the assets o f banking and non-banking institutions (NBFIs) have grown significantly and amount to 114 and 91 percent o f GDP, respectively. These ratios are well above the levels that would be predicted by Morocco's per capita income, size, and other characteristics. Morocco has made more progress than other MENA countries in developing NBFIs7 (in most other MENA countries the combined assets o f insurance companies, pension funds, and mutual funds range between 10 and 15 percent o f GDP only).

22. Banks still dominate the financial sector and are licensed as universal banks, except for offshore banks. The banking system i s dominated by private banks - public banks account for only 15 percent o f total bank assets, or 33 percent if the large CPM group (Cre'dit Populaire du Maroc) i s defined as a public bank.' There are thirteen private banks and five public banks. These banks are also licensed as universal banks. Some maintain a sector focus due to their history, such as the CIH (Cre'dit Immobilier et Hotelier) which i s primarily involved in housing finance, and the C A M (Cre'dit Agricole du Maroc) which i s primarily focused on agriculture. For i t s part, the CPM s t i l l leads SME finance.

23. The banking system has performed well and the Central Bank has been tightening regulations to address new risks. Non-performing Loans (NPLs) are historically low (5.5 percent o f total loans in June 2009) and well provisioned, with no signs o f deterioration due to the credit expansion o f recent years. The increase in medium and long te rm credits such as mortgage and investment loans (half o f all credits in 2008) has generated a maturity mismatch but the banks have enjoyed a stable deposit base. Moreover, many banks issued subordinated debt in 2008 to reduce their reliance on short term deposits and bolster solvency ratios. After a marked decline in 2007 due to rapid credit growth and new Basel 2 capital charges, solvency improved in 2008 as the Central Bank raised the minimum capital adequacy ratio (CAR) to 10 percent (1 1.2 percent on average in 2008 compared to 10.6 percent in 2007). The Central Bank has issued new regulations to ensure that banks manage effectively the new risks that have emerged.

Annexes 111 through V provide more detailed analyses o f the banking, insurance, and microcredit sectors. The assets o f NBFIs are somewhat inflated by double counting, as more than half o f insurance assets and

part o f pension assets consist o f quotas o f mutual funds. This group has a specific ownership structure, including, Banque Centrale Populaire (BCP), a bank with

subsidiaries, which i s the apex o f the CPM group which and i s 5 1 percent owned by the state, and eleven regional banks legally structured as cooperatives.

6

7

10

Table 4. Assets o f Financial Institutions ( O h of GDP)

111. MFIs

2003 2005 2007 2008 80.6 87.8 108.4 113.9

0.2 0.3 0.9 0.8

66.9 12.7

1 .o 65.1 16.1 14.8 14.2 9.0

11.0

IV. Total assets (I + I1 + 111)

74.3 12.1

1.5 74.9 16.1 19.3 16.4 9.6

13.5

145.9 163.0 196.5 206.1

90.7 96.1 15.6 14.8 2.1 3.0

87.2 91.4 17.8 17.3 20.9 24.4 21.4 23.5

9.6 9.1 17.4 17.1

24. Morocco i s one of the few MENA countries that has been able to develop the insurance sector to a significant extent, but this growth has also created risk management challenges. Insurance premia increased from 2.4 to 2.9 percent o f GDP in recent years and are among the top ones in the MENA region. The l i fe sector accounts for one third o f the premium and i s one o f the largest in the region. The assets o f the insurance sector have not grown recently, but this i s largely due to the drop in equity prices. The growth o f the sector i s a very positive development, but the providers wil l need to manage the associated risks, especially in the fast growing l i f e sector.

25. Morocco has become a recognized leader in microcredit in the region, but the industry has recently experienced portfolio problems. MFIs serve 1.3 mi l l ion clients and their credit portfolio reached almost one percent o f GDP in 2007. MFIs are primarily regulated by the Ministry o f Finance (MOF) and supervised by the Central Bank. Funding primarily comes from commercial banks. The rapid gain in outreach was a positive development, but shortcomings in governance and internal control did not make the management o f this rapid growth possible and the accumulation o f portfolio problems started creating financial stress. This to tighten regulation and supervision. In this environment, two large MFIs decided to jo in forces, which permitted to alleviate the difficulties of one of them; the authorities supported this decision.

26. The stock market has grown rapidly but i s concentrated on a handful o f large companies, and private fixed income instruments remain undeveloped. Market capitalization i s high by regional standards (77 percent o f GDP in 2008), but the free float i s small (26 percent), only 77 companies are listed, and the market remains very concentrated, as indicated by the high share o f the ten largest companies in market capitalization (70 percent) and turnover (74 percent). Traded value improved but remains below emerging countries' benchmarks largely due to a limited float. The market for private fixed income instruments remains modest, despite some recent bank issues.

27. Despite the growth of the financial system in recent years, the scope for further improvements in access remains substantial. As shown in Figure 4 and Annex

11

V , Morocco i s above the international benchmark regarding financial depth, measured either by the ratio of deposits to GDP or credits to GDP. However, Morocco has much lower ratios o f deposits and loans per population than would be expected given the depth indicators. This difference suggests the potential for further and substantive gains in access. Enterprise surveys show a similar picture. Despite the remarkable progress in recent years, a larger share o f enterprises in Morocco reports access to finance as a major constraint than the equivalent averages in MENA and low middle income countries. This i s especially true for smaller enterprises (Figure 4).

28. All in all, these outcomes indicate that Moroccan policy-makers face the challenge of expanding further the frontiers of finance to households and enterprises, while also ensuring that further access gains are sustained. The expansion o f infrastructure and housing finance has contributed to output growth and social objectives, but opened a maturity gap that needs to be effectively managed. Expanding further SME finance will require better tools to identify and manage credit risk The growth o f the insurance sector i s positive, but the industry needs to strengthen risk management capacity and also have access to better risk management tools. The NPLs in microcredit institutions deriving from rapid credit growth reveal the need to strengthen governance and risk management at that level as well. These are the challenges that are being addressed by the Government in i t s reform program.

B. EARLIER FINANCIAL REFORM EFFORTS

29. Morocco’s continued progress in financial development has been the result of important reforms earlier in the decade. In 2004-2005, Morocco launched an important reform package that was supported by a Financial Sector Development Policy Loan (discussed in detail in Section IV C) and that included substantive policy measures in three main areas, namely: (i) Restructuring o f specialized state-owned financial institutions (ii) Strengthening o f the regulatory framework in banking, insurance and capital markets; and (iii) Enhancement o f the financial sector’s infrastructure.

30. The restructuring of state-owned financial institutions addressed the dire financial and operational conditions of three key institutions. The liquidation o f the former National Development Bank (Banque Nationale de Development kconornique - BNDE) has been initiated and i t s major assets already sold. The C I H and the C A M were financially and operationally restructured. These actions have resulted in a substantive improvement in their capital positions and N P L ratios.

12

Figure 4. Depth and access indicators

Depth. DepositdGDP and Percapita Income

250

2 200 . r ) 4 0 150 I

0

0 20000 40000 60000

GDP per capita

Depthversus Accesr 4000

:: 5 3000 -

0 50 100 150 200 250 Deposiis % o f GDP

Note 1 Deposit account? mclude commercial banks only

Depth. LoadGDP and Per capita Income 150

0 10000 20000 30000 40000 GDPper capita - .

Depthversus Access IS00

5 0 so 100 150 Loans%of GDP

Percentage of firms identifying access to finance as a major constraint in 2007

~ ~ ----- - _ _ - -_-- - - - -- 50% -qy, ~

-

r Small Medium Large

Morocco a Middle East &North Afnca Lower Middle Income

Sources. CGAP, IFC

31. The strengthening o f the regulatory framework for banking, insurance and capital markets contributed to the positive results in recent years. The banking regulatory reforms included revised Central Bank Statutes and Banking Law that inter alia strengthened the autonomy o f bank supervision, introduced consolidated supervision, and contributed to a well functioning banking system. The insurance reforms included a revised insurance Code, the liberalization o f price setting in insurance premia, and generalization o f insurance on work-related accidents, which contributed to the growth of the insurance sector. The laws on the stock exchange and the capital market regulator were amended to improve transparency and regulatory powers.

13

32. The enhancements in financial infrastructure included inter alia improvements in the payments system and upgrading of accounting and auditing standards. The improvements in payments systems included the introduction o f an RTGS system to handle large value payments, and the replacement o f paper-based methods in retail payments. These changes reduced the cost, time, and risk in processing payments. The upgrading o f accounting and auditing standards included the development o f a financial information registry and the adoption o f IFRS standards, with initial focus on companies making public offerings.

C. THE GOVERNMENT’S REFORM PROGRAM

33. While the financial system has grown significantly in recent years, the Government i s aware that additional reforms are necessary to expand further access to underserved sectors while containing the risks that have emerged. The credit growth in recent years has contributed to Morocco’s growth performance and expanded the frontiers o f finance. However, it i s also apparent that the financial system i s not yet providing services to large segments o f l ow income households and SMEs. Moreover, this rapid growth has also generated new risks in the banking and insurance sectors, and even in the microcredit sector - an industry generally characterized by very low default rates - the lack o f proper risk management and internal controls resulted in portfolio problems. The global financial crisis added importance to the reform, not only for having produced a credit slowdown that typically affects the most vulnerable sectors, but also for having shown the need to strengthen financial infrastructure and financial regulation to ensure that any further access gains are sustainable.

34. The Government’s reform program addresses the two main challenges in the financial sector - expanding access further while preserving stability - and consists of four major components o r pillars. The first pillar contains measures designed to ensure sustainable improvements in individuals’ access to finance. The second pillar consists o f measures to ensure sustainable improvements in SME access to finance. The third pillar aims at ensuring the resiliency and stability o f the financial system by strengthening further the regulatory and supervisory framework for banking, insurance, and capital markets. Finally, the fourth pillar promotes the further development o f capital markets, with focus on the introduction o f long-term funding instruments and risk management tools, thus contributing both to access and stability.

1. First Pillar: Improving Individuals’ Access to Finance

Creation of a Postal Bank with broad geographical presence to expand access

35. The Government i s creating a Postal Bank building on the existing strengths of the Post Office. The post office already provides some basic services (savings passbooks and checking accounts) to a large customer base (4.3 million people). In recent years, it has successfully leveraged on the large postal network (1,762 branches in 2008) to attract a significant number o f unbanked customers (14 percent o f the Moroccan population have postal accounts in 2008, up from 10 percent in 2005). I t i s often the only institution serving the low income population, including the rural population, the self- employed, and people with irregular incomes, which do not have access to banking

14

services because of cost or branch locations. The amount o f resources collected i s s t i l l modest, amounting to only 3 percent o f bank deposits. The Post office has a good track record in terms o f governance and has proven i t s ability to finance i t s operations without significant financial support for the Government.

36. The Postal Bank i s expected to play a significant access role, by offering a wider range o f banking services to underserved categories of the population. The design o f the Moroccan Postal bank draws on successful international experiences (e.g. French “Banque Postale”). The Postal Bank, a subsidiary o f the Post Office, will target individuals with a monthly income below 3,000 MAD with an objective o f 5.4 mi l l ion clients by 2015 (a 26 percent increase compared to 2009). These customers are not yet targeted by commercial banks. N e w services (transfers, payments, debit cards, overdrafts, mortgage loans) will be introduced, with riskier services (lending) only introduced in a later stage. Existing services will be upgraded to better serve existing customers and attract new ones. The separation o f postal and financial activities should improve the quality o f services, while outreach should be improved with the specialization o f branches and staff, as well as the opening o f new branches (550 new branches by 2018) and distribution channels (1 00 mobile branches and 50 cash points by 201 8).

37. The Central Bank granted the license to the Postal Bank in July 2009, As the new institution ventures into new territories, risk management and internal controls will need to be strengthened. In recent years, the Post Office has improved i t s financial operations with the assistance o f consultants (IT systems, branches, back offices, audit), including improvements in internal controls required by the Central Bank during the two year licensing process. The Postal Bank will also take a very progressive approach to rol l over i t s business plan, to ensure that risks are always adequately addressed. For instance, mortgage products will only be offered as o f 201 1. An agreement was signed in July 2009 with the group’s trade unions illustrating their complete adherence, as well as that o f the staff, to the project o f creating a Postal bank.

38. The Postal B a n k i s expected to start i t s operation in 2010, without material distortion of competition wi th commercial banks. A draft law i s with the Parliament which will allow the Post Office to transfer its financial activities to a subsidiary, allow overdrafts and modernize the regime o f postal checking accounts, which dates back to the 1920s. Interests on postal savings passbooks (which will be offered by the postal bank) are not taxed contrary to those on products offered by commercial banks. However, due to different types o f index for these two types o f products, their after tax yield i s curRently comparable. The Postal Bank will be subject to the supervision o f the Central Bank, like other commercial banks.

Ensuring the sustainable growth of the microcredit industry

39. Morocco i s a regional leader in microcredit, with 40 percent o f MENA’s client outreach. The sector scored well until recently on all performance metrics including growth, depth o f outreach, asset quality, and profitability. It experienced very rapid growth between 2004 and 2007, as shown in Table 5. At the end o f 2007 it had 1.3 million customers accounting for 7 percent o f the working age population and 17 percent of the population below the poverty line. It had assets o f 5.6 billion MAD, accounting for about 3.6 percent o f household credits, and managed by 13 microcredit associations

15

(MFIs), with five o f them controlling three quarters o f the sector's assets. The Ministry o f Finance has primary responsibility over the sector, but the 2006 new Banking law delegated supervisory responsibilities to the Central bank. The microcredit law (1 999) prohibits microcredit associations from taking deposits and limits individual credit to 50,000 MAD.

Number of clients (1,000) Number o f clients / Working age population (%) Number o f clients / Number o f poor (%) Portfolio outstanding (million MAD) Portfolio outstanding / Credit to households (%)

Table 5. Evolution o f the Microcredit Sector, 2004 - 2008

I 2004 2005 2006 2007 2008 460 628 1,246 1,353 1,280

2.5% 3.3% 6.5% 7.0% 6.5% 5% 7% 15% 17% 15% 890 1,550 3,400 5,589 5,683 1.0% 1.5% 2.9% 3.6% 3.2%

16

43. The Government and the Central Bank are strengthening the regulatory framework of the microcredit sector. The Ministry o f Finance and the Central Bank have recently issued new and detailed rules on loan classification and provisioning. This will enable the authorities to measure the problem with accuracy, require adequate provisions and take additional measures. The Central Bank also issued in September 2009 a new directive on governance, risk management and internal control for MFIs. Moreover, the FedCration Nationale des Associations de Microcredit (the microcredit industry association) i s putting together a code o f ethics. Finally, the Central bank already carried out extensive on-site inspections in the sector and intends to maintain a close monitoring o f the different MFIs

44. The government i s also reviewing the overall legal and regulatory framework of the sector to determine if more structural changes are required. This review, which i s being conducted with external assistance, should be completed by mid-2010. In the short term, small and medium MFIs are planning to share resources such as back office systems or merge. The authorities are encouraging l i n k s with banks, so as to ensure liquidity (over two third o f the sector funding comes from local banks) and allow increased cross-selling which would benefit customers. These efforts are slowly paying o f f and a recovery i s expected for the first semester o f 20 10, even if some MFIs are likely to have to be restructured.

Increasing availability of housing jinance

45. The FOGARIM partial credit guarantee (PCG) scheme improved access to housing finance for the poor. Created in 2004, it provides guarantees covering 70 percent of mortgage loans made to people with low or irregular incomes who buy properties up to 200,000 MAD. It has been successful with 7.5 bi l l ion MAD worth o f credit guaranteed as o f August 2009 (7 percent o f the mortgage loan portfolio) and a l o w delinquency rate (less than 2 percent). Moreover, it fostered the entry o f new banks in this market, with eight active banks in 2008 compared to two public banks before i t s creation.

46. A new fund (Damane Assakane) was set up in 2009, taking over FOGARIM with increased resources to expand further access to housing finance for the poor. It benefits from increased resources thanks to the merger o f FOGARIM (600 mi l l ion MAD endowment) and FOGALOGE-public (350 mi l l ion MAD), whose resources were underutilized. Although eligible beneficiaries include middle class households, poor people are expected to remain the main beneficiaries o f this scheme. Moreover, the system i s now better managed and i t s self-sustainability will be ensured over the medium term, thanks to the introduction o f risk-based premiums linked to the share o f the loan guaranteed and the loan to value ratio.

Improving low income banking

47. The government wants to leverage the increasing importance of the retail segment for commercial banks and expand further banking services to the low income population. Banks have rapidly grown their branch networks (a 55 percent increase relative to 2005) to collect additional deposits. Retail credits increased considerably as well, amounting to 26 percent o f total credit. The authorities have encouraged banks to explore profitable l o w income banking (LIB) strategies. The four

17

major banks which control about 70 percent o f banking assets have prepared such strategies, which are at an early stage o f implementation.

2. Second Pillar: Ensuring Sustainable Improvements in SME Access to Finance

48. SME finance improved over the past years, but some segments remain underserved. The large Credit Populaire du Maroc (CPM) group has been traditionally involved in SME lending and accounts for a large share o f this market. Two private banks have entered the market in recent years, and one o f them (Attijariwafa bank) has made particular progress, through dedicated teams and branches. Despite the absence o f key pieces o f infrastructure such as a credit bureau, credit to SMEs represents almost 20 percent o f corporate loan portfolios which i s a remarkable achievement. However, i t seems that other banks finance SMEs to a lesser extent, key segments remain underserved, such as start ups, smaller enterprises, and long term finance.

49. The government program addresses constraints identified both by banks and SMEs. On the bank side, the main constraints relate to governance weaknesses, lack o f financial transparency, limited capital and the weakness o f the projects, while SMEs report too demanding conditions to access credit, especially in terms o f collateral and interest rates. The government’s strategy includes five components: (i) improving the reliability and availability o f credit information through a new credit bureau, (ii) improve the SME partial credit guarantee scheme, (iii) assist SMEs in the preparation o f their projects, (iv) improve SME governance and financial transparency, and (v) assist SMEs’ modernization to improve their competitiveness.

Introduction of a modern credit bureau

50. The banking law was amended in 2006 to allow the Central Bank to introduce one or more credit bureaus managed by private operators and replace its old credit registry. The credit registry had been set up in 1978. It provided valuable support to bank supervision by recording large individual credits, but did not report information on households and small enterprises and failed to facilitate their access to credit. The law establishes all the conditions o f a modern credit reporting system. As shown in Table 6, the law stipulates that al l credit institutions need to provide negative and positive information to the Central Bank, which will transfer this information to the credit bureau(s). This includes al l banks and finance companies (including leasing and factoring companies). These credit institutions are mandated to consult the credit(s) bureau(s) before grating a loan. Moreover, the credit bureau(s) will have to observe governance, confidentiality and information security rules. Borrowers can access and dispute their credit information. Some Microcredit institutions report , on a voluntary basis, information to the credit bureau(s).

5 1. In 2008, a first license to operate a credit bureau was granted to the private firm Experian through an open tender. The conditions for the license include a lower fee for MFIs (half o f the fee charged from the credit institutions) in order to encourage them to take part to this process. The lower fee i s however sufficient to cover the costs o f operating with MFIs (which are lower due to the simpler credit files). The license conditions also include the obligation for Experian to develop credit scores in a second phase, after the databases are consolidated.

.

18

Old System (Credit Registry) I

Reporting entities

Borrowers reported

Exposures reported

Credit behavior

Transmission o f Information

Consumer rotection

Use o f information

Credit scores

New System (Credit Bureau(s))

Compulsory for credit institutions Banks and finance companies

Enterprises

Loans > 100,000 M A D (20% o f credit)

Limited aggregated information (arrears and write-offs); no historical information Manual

Nor applicable

Not specified

No

MFIS also reporting to Central Bank

A l l borrowers

Al l exposures to all individuals and enterprises

Updated positive and negative credit information

Automated

Consumer right to access and dispute incorrect information Obligation to consult credit bureau before granting a credit To be provided after consolidation o f database I

Sources Ministry of Finance and Central bank

54. The Central Bank could consider the provision o f a second license to enhance competition, after the consolidation of the first credit bureau. The Central Bank will monitor the performance o f the new credit bureau and has indicated that it could consider the concession o f a second license to enhance competition and promote quality services at a l ow cost. However, it has also indicated that the priority in 2010 i s to ensure the consolidation o f credit databases and the adequate functioning o f the first credit bureau.

19

Reform of the partial credit guarantee scheme for SMEs

55. The program includes the reform of the partial credit guarantee scheme (PCG), enabling it to provide access to credit to a larger number o f SMEs with better loan origination incentives. A review by Deloitte in 2007 concluded that the potential o f the guarantee system was underutilized in light o f both SME needs and the banks’ strengthened capacities to allocate credit in a sound manner. I t also highlighted that Morocco had a mixed experience, with both successful experiences which could be replicated (specific funds with a clear mandate and ex ante risk coverage) and failed experiences in the 1990s due to poor risk management capacities and governance (allocation o f guarantees without initial risk identification, adequate coverage, and early remedial measures). Despite a f i rst round o f reforms in the 2000s, further reform appeared necessary before committing more fiscal support. In particular, the system: (i) remained complex, with three institutions involved (Caisse Centrale de Garantie, CCG, Dar Ad-Damane, and Caisse Marocaine des Marche‘s, CMM) and different rules for each guarantee; (ii) had cumbersome and time consuming application and approval procedures; (iii) was not well focused on SMEs and their financing needs, (iv) had a governance structure with poor representation o f the sector; (v) did not provide sufficient incentives for banks to recover delinquent loans, and (vi) did not allocate well funds to cover risks, which limited i t s ability to effectively manage i t s portfolio. This study also suggested improvements based on international best practice.

56. The new guarantee system has been designed so as to improve governance, simplify application and approval procedures, strengthen the focus on SMEs, and provide support to their lifecycle needs. As shown in Table 7, the CCG, a public institution licensed and supervised by the Central Bank, i s now the reference operator o f the PCG, while solutions are being defined for the Dar Ad Damane, a smaller private credit institution which i s s t i l l plagued by old and large losses, and which activity i s now limited.. SMEs and banks have more representation in the Board o f the CCG. Important improvements have also been achieved through the simplification and harmonization o f eligibility criteria related to the decision making process o f the CCG. New guarantees introduced in February 2009 are focused on SMEs (no guarantee can exceed 10 million MAD and combined guarantees on a single borrower cannot exceed 15 mi l l ion MAD, which ensure that guarantees are used for SMEs) and better match SMEs’ financial needs according to their l i fe cycle (investment, working capital, restructuring, and private equity).

57. Changes in the CCG’s operating rules should improve the incentives at loan origination, leading to a better selection of borrowers and an increase in the overall effectiveness of the scheme. First, the CCG will have access to the databases o f the credit bureau and will be able to screen new applicants. The coverage ratios are roughly similar to those in other countries. However, some o f the new rules provide more incentives for the banks to screen their applicants and recover loans in default. Under the old rules, banks received 100 percent o f the guaranteed amount upon default. Under the new rules, banks will receive only 50 percent o f the amount after a credit becomes delinquent. They will receive another 50 percent after three years or earlier upon proven efforts to recover the delinquent loan (and subject to a maximum equal to the losses covered by the guarantee). Moreover, the guarantee will not cover accrued interest and

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penalties. This should provide better incentives for banks to recover guaranteed loans and indeed to screen better the applicants in the origination phase.

58. The reform o f the CCG was accompanied by a significant increase o f its resources, so that it can develop its activities in a sound manner (Le. ex ante coverage o f risk). While it received 45 million MAD per year from 1998 to 2008 (roughly US$6 million at the current exchange rate), it was granted 130 million MAD in 2009 (US$17 million) and expects an equivalent annual amount until 2012. This wil l help the CCG cover a larger SME portfolio. Between January and September 2009, 1.8 billion MAD o f credit were guaranteed, s t i l l a small percent o f total credit, but a significant increase relative to the 1.3 billion MAD guaranteed in 2007. This increase in volume i s expected to be accompanied by an increase in efficiency, due to the greater focus on SMEs, better lifecycle support, and better incentives at loan origination.

Old System New System

Providers

Application and approval procedures

Types o f products

Eligible activities

Eligible enterprises

Access to borrower information

Coverage ratio

14 products, sector oriented

restricted to investment credits

SMEs and Large Enterprises

Access to the credit registry

l ~ w o main guarantee agencies lone guarantee agency (CCG)

7 products, covering all sectors

start-ups, investment, working capital, exports

SMEs

Full access to the new credit bureau

Decision on application within 10 days Cumbersome and long procedures (up to three months for an approval)

premiums Of Oa2% - Oe6% on outstanding debt Front end premium of0,5% 2%

Most lines: 50-75% Covered base: Principal

Most lines: 50% Covered base: Principal, interests,

100% upon default

Premiums

Reserve ratio

Payment rule recovery efforts (max. 3 years)

IBetween 3% and 12.5% IBetween 5% and 10%

Development ofprivate equity for SMEs

59. New mechanisms will be introduced to support the development o f growth and mature SMEs through improved availability o f private equity. In recent years, private equity quickly grew in size (assets worth 8 billion MAD in 2008, four times greater than 2005), number of players (20 funds, often tied to banks) and types o f products. Factors which underpinned this success should remain supportive, both in terms o f supply (assets represent 1.2% o f GDP compared to 3-4% in mature markets and half are not yet invested) and o f demand (Le. f i rms ’ capital needs to improve competitiveness, retirement o f CEOs etc.). The government intends to introduce new mechanisms to foster private equity investments in SMEs: a dedicated public private venture capital fund and a new guarantee fmd, managed by the CCG, to partially cover the risks o f such

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investments. The government also intends to revisit the private equity law to facilitate the development o f this industry.

3. Third Pillar: Strengthening the regulatory and supervisory architecture

Strengthening of crisis preparedness arrangements

60. With the support of the World Bank, Morocco was the first MENA country to carry out a crisis preparedness and crisis management exercise in April 2009. This i s a recognized best practice in the field o f financial stability. A realistic crisis scenario was run to test interactions among the main policy makers and regulatory authorities, the adequacy o f their powers and public communication. A few areas for operational improvements were identified, which the authorities decided to address in the coming months, through the development o f shared procedures for effective crisis management and response.

Further strengthening of bank regulation and supervision

61. Key reforms of bank regulation and supervision have been undertaken in recent years to meet international best practices and foster the modernization o f the banking industry. After the enactment o f the banking law (2006), the Central Bank promptly revised i ts regulations, introducing in particular the Basel 2 standardized approach for credit risk, new capital charges for market and operational risks, and new detailed requirements on internal control and risk management (including for liquidity and interest rate risks). Moreover, i t reacted to rapid credit growth and declining capital adequacy ratios, by raising the minimum ratio to 10 percent in 2008.

62. An independent bank governance review will be conducted with Bank support to assess the banks’ capacity to address the risks they currently face. After a major modernization o f the banking industry and o f its regulation, this review will assess the design and implementation o f governance arrangements established to measure, monitor and manage such risks. The authorities intend to prepare an action plan to address identified weaknesses, where appropriate.

63. As real estate exposures have significantly increased, the Central Bank i s developing additional approaches to monitor this risk, including a new real estate price index. Commercial banks’ exposures to the real estate sector represent almost a third o f credit portfolios (of which one third related to developers and the other two thirds comprising mortgage loans). The Central Bank i s developing additional tools to monitor such a risk, taking into account a new real estate price index developed in cooperation with the National Property Registry Agency. I t intends to regularly publish the index starting in the f i rst quarter 20 10.

64. The implementation of Basel 2 remains high on the agenda of the Central Bank with a short term emphasis on Pillar 2 (the supervisory review). Standardized credit risk approaches (Pillar 1) were introduced in 2006 and the Central bank intends to authorize advanced approaches over the medium term. I t has also been implementing Pillar 2 to ensure that banks have adequate capital to address the risks in their business. I t i s working on improved methodologies to link the assessment o f banks’ risk profiles with

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their interest, liquidity and concentration risks. The outcomes o f such assessments could result in higher capital charges.

Strengthening the independence and en forcement powers of the capital market supervisor

65. The creation o f a fully independent Capital Market Authority (CMA) will complete recent improvements in the supervisory process. Following the strengthening o f i t s powers in 2004, the capital market supervisor (Conseil DPontologique des Valeurs Mobili6res, CDVM) initiated a transition from compliance- to risk-based supervision (introduction o f individual risk assessments and new inspection techniques) and stepped up enforcement (e.g. 2008 sanctions against four brokers following a mismanaged IPO, including the withdrawal o f a custodian license). A draft law was submitted to the General Secretariat o f Government (SGG) in September 2009 to create a CMA, institutionalizing and strengthening supervisory independence and enforcement powers. This authority will be chaired by an independent person, have i t s own budget and a Sanction council solely responsible for making objective and independent decisions on sanctions.

66. The stock exchange’s governance structure i s being strengthened as well. The stock exchange recently upgraded i t s trading and transaction monitoring systems and revised its rule book (‘‘rdglement gkneral”) to improve i t s performance and integrity. The simplification o f i t s governance structure has been initiated and a draft law has been prepared to allow the opening o f i t s capital beyond stock brokers. This i s expected to instill more transparency and allow capital t ies with institutionals.

Strengthening the independence and enforcement powers of the insurance supervisor

67. A new and independent insurance authority will have statutory control over insurance, pension (subject to any specific laws) and annuity providers. A draft law was transmitted to the SGG to create a new authority independent both from the Ministry of Finance (while it currently i s one o f i t s departments) and from the insurance industry (which currently has the power to reject licensing applications). Powers to impose sanctions and issue. regulations will be increased and advisory bodies involved in the decision making. Regulatory initiatives will fol low directions set in the “contrat- programme” and include interim measures where final outcomes are too distant. In the short term, the introduction o f an investment regime consistent with an evolution towards risk based capital requirements i s contemplated to avoid excessive exposures to specific asset classes (e.g. equity).

68. Further modernization o f insurance regulation i s anchored on a “contrat- programme” (roadmap) negotiated between the authorities and the industry. The relative success o f the Moroccan insurance sector can in part be attributed to the close coordination that has existed between the government and the sector. A new comprehensive “contrat-programme” i s being negotiated for the period 2009-20 14, covering product development, compulsory classes, prudential controls, investment rules, internal controls and risk management, internationalization and implementation.

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4. Further strengthening the development of capital markets

Building a liquid and reliable Government yield curve

69. The domestic market has proven its ability to meet the Treasury’s funding needs, but it has stopped issuing medium and long term debt since 2007. Domestic debt accounted for 80 percent o f the total public debt stock as o f December 2008 (up from 50 percent in 1998). The Treasury had made progress in issuing long term debt and increasing i t s average duration but has not issued Treasury bills with maturities above 5 years since the first quarter o f 2007 (securities up to 52 weeks accounted for 95 percent o f issuances in 2008). This tactical move was motivated by two factors. First, the focus on short term issues allowed the Government to borrow at lower interest rates and contain interest expenses. Second, the Government also avoided long-term issues to prevent a possible negative impact o f higher rates on the cost o f floating-rate mortgage loans, which are indexed to long-term Treasury bills rate.

70. The normalization o f market conditions i s allowing the Treasury to resume its long-run focus in public debt management. The current approach o f only issuing short-term paper i s clearly not sustainable over a long period o f time, and has also interrupted the previous progress in building a yield curve. The lack o f continued issuance at different segments o f the yield curve has stimulated buy-and-hold behavior in an already shallow market. The absence o f reliable price references and market making activity has discouraged secondary trades, affecting the quality o f portfolio valuation. However, the normalization o f market conditions, reflected in declining long-term interest rates (Section II), has allowed the Treasury to resume i t s long-run focus.

71. Recent changes on the rules and remuneration o f the Treasury current account and the launch o f an electronic auction platform promote the implementation o f a sound debt management strategy. The remuneration o f the Treasury current account at the Central Bank and the flexibility to invest or borrow cash directly in the market will enhance the Treasury’s capacity to implement cost-effective cash management practices. This in turn will facilitate the issuance o f benchmark securities and buybacks o f less liquid instruments, allowing the Treasury to reduce debt fragmentation and build a liquid yield curve. Moreover, a new electronic auction platform removes uncertainty to market participants on sales and prices, a key prerequisite to build efficient primary and secondary markets.

72. A modification o f the reference rate for new floating long-term loans will facilitate the issuance o f long term Treasury bills. The Ministry o f Finance will soon change the reference rate of the variability o f interest rates for new floating rate loans, from Treasury bills to a reference to short term instruments. This i s consistent with international practice and will also allow the Treasury to fol low a consistent issuance policy, primarily based on public debt management objectives. I t will also prove beneficial for capital market development and the banks’ asset and liability management (by improving the predictability o f loan repricing).

73 I The government i s considering approaches to address remaining bottlenecks and build a more liquid and reliable yield curve while keeping funding costs affordable. There i s no single measure to reach such a goal and a set o f policy measures

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needs to be mapped. The government i s considering the design and implementation o f an action plan to tackle different areas in an orderly and effective way, exploiting synergies among them. This action plan could encompass, among others: a review o f primary dealers’ rules, a strategy for liability management transactions (buybacks and switches) and several measures to improve price dissemination.

Further development of private f l e d income instruments

74. A revised securitization law passed in December 2008 creates better incentives for a sound development o f this market, but still lacks critical implementing regulations. Only one bank used the securitization framework created in 1999 as plenty o f cheap funding was available and cost proved a deterrent. In an environment o f scarcer liquidity and growing banks’ needs for long te rm funding, a new law was passed in December 2008. It allows more eligible assets and flexible structuring (multi-sellers, rechargeable assets, tranching). However, it will only become effective after key implementing regulations are passed.

75. The government will prepare the ground for the introduction o f covered bonds, to facilitate a reduction o f banks’ maturity mismatch and provide funding for housing loans at lower rates. Covered bonds are the most common instrument used for funding mortgage loans in several EU countries. It allows the banks to match the duration o f their assets, while also providing funding at lower interest rates due the additional security provided to investors (covered bondholders have priority rights on the flows o f income from housing loans). With this objective the M O F will prepare a draft law on covered bonds.

Further development of stock markets

76. The government wants to attract more investors to the market, increase the number o f listed firms, and position the Moroccan market as a regional player. The authorities see the future o f the Moroccan market as a regional player with close l i n k s to the EU, and consider a gradual convergence o f regulations towards EU standards as the best approach to achieve this.

77. Improved investor protection i s at the core o f the government’s program. Despite supervisory efforts, there i s s t i l l a perception that the market i s not a level playing field and that insiders do not always adhere to the highest ethical standards. The government intends to broaden i t s recent efforts by establishing comprehensive rules on the distribution o f financial instruments, enhancing the professionalism o f key individuals, introducing business conduct rules, further strengthening corporate governance standards, and enhancing internal control and risk management requirements for, market intermediaries. Analysis o f existing gaps (including a corporate governance ROSC which the World Bank will carry out) are being prepared.

78. The government wants to improve incentives for companies to list. Beyond existing measures, the government expects that enhanced market integrity, marketing vis- a-vis large private f i rms and improved conditions o f access to the market will draw new companies to the market. Over the medium term, the listing o f foreign firms could also help market development (e.g. companies from MENA and African countries which do not have stock exchanges).

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Introduction ojsound and liquid listed derivatives markets

79. The government i s introducing an organized future market to help Moroccan firms better hedge their risks, A draft law creating the key legal underpinnings to set up such an exchange was adopted by the Council o f Government in July 2009. Key decisions on the implementation o f these provisions will be taken once the law i s enacted (e.g. types o f contracts, market f i rms, clearing house). To ensure the success o f the market, contracts will only be offered on standardized and liquid instruments and trading i s only expected when this prerequisite o f liquidity has been fulfilled. Financial supervisors aim at working on specific regulatory measures to avoid any excessive risk- taking by financial and non-financial f i r m s once the market i s launched.

IV. BANK SUPPORT TO THE GOVERNMENT STRATEGY

A. LINKTOCPS

80. The Bank’s support to the implementation of financial sector reform i s detailed in the FY10-13 Country Partnership Strategy (CPS) that will be discussed by the Board of the Bank in January 2010, prior to the submission of this operation for approval. The new CPS builds on the successful experience o f the 2005 CAS and retains financial sector reform as one o f the cornerstones o f the Bank’s partnership strategy. I t i s organized around three main pillars: (i) enhancing growth, competitiveness and employment, (ii) improving the access and quality o f services, and (iii) ensuring that Morocco’s development is sustainable and meets natural resource and climate change challenges. In addition, the CPS places a strong emphasis on governance.

8 1. The new Sustainable Access to Finance DPL i s fully consistent with the first pillar of the CPS of growth, competitiveness and employment. More specifically, the proposed DPL contributes to the first pillar’s objectives through the following areas o f focus: (i) improvements in financial intermediation to enhance competition and growth, (ii) increased individuals and SME access to finance, and (iii) strengthened financial regulation and supervision to ensure financial stability and sustainable gains in access. In addition, further enhancements o f corporate and bank governance are covered by the program and will contribute to the CPS goal o f strengthening the governance reform agenda. The FYlO lending program envisaged in the CPS encompasses the proposed DPL operation.

B. COLLABORATION WITH THE IMF AND OTHER DONORS

82. The World Bank and the IMF maintain close collaboration in Morocco. Regular contacts between the IMF and World Bank country teams are customary, with discussions focused on the respective work programs, country priorities, recent developments and prospects. Collaboration between the Fund and the Bank in Morocco has been seamless, with a shared assessment o f the critical macroeconomic challenges facing the country. The Fund regularly participates in Bank project review meetings

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where relevant. Similarly, Bank staff contributed to the IMF’s 2008 and 2009 Article IV consultation missions to Morocco. The IMF conducted i t s 2009 Article I V consultations in November 2009 with a view to submit it to their management by January 2010.

83. Collaboration with the African Development Bank (AfDB) i s an integral component of this operation. At the request o f the Government, this operation i s being prepared joint ly with AfDB. The proposed D P L and the AfDB operation have the same two tranche structure and support joint ly the Government’s reform program through the common policy matrix. This has benefited the client by building credibility for the reform, but also by focusing the attention and expertise from multilateral donors on a comprehensive reform program.

84. The Bank i s also collaborating closely with the IFC which has a long-term engagement in the financial sector in Morocco, particularly as regards support to the development o f SMEs and financial services to the poorer segment o f the population. Over the past several years, IFC has been active in supporting investment funds bringing much needed capital and expertise to over 25 high-growth small and medium companies in Morocco. I t has also worked with leading Moroccan banks to help them develop profitable SME banking operations. IFC also undertook various initiatives to develop the country’s financial and credit information infrastructure, and helped establish joint ly with the Central Bank a best practice private credit bureau. IFC’s support to the microcredit sector has helped over 500,000 small borrowers’ access much needed financial services. O n the Treasury front, IFC issued a bond in Morocco denominated in dirhams - a transaction that was the first domestic bond offering by a multilateral institution in Africa as well as in the Middle East - thus contributing to the broadening o f the financial markets in the country. This D P L operation draws on the depth o f IFC’s experience and addresses areas where progress has not been sufficient or where new risks are emerging. I t aims at increasing both breadth and depth, while enhancing financial stability.

C. RELATIONSHIP TO OTHER BANK OPERATIONS

This operation builds on the positive experience of the Bank’s past engagement in the financial sector, particularly the 2005 Financial Sector DPL. The CAS Completion Report assesses that Morocco’s strong commitment to carrying out financial sector reform and the Bank Group’s support to the financial sector during the period o f the last CAS was overall satisfactory. The ICR o f the Financial Sector DPL noted that the operation helped strengthen the legal and institutional environment for financial intermediation and risk management, and increase the private sector’s participation in the provision o f financial services. Three key state-owned institutions in dire financial and operational conditions were restructured, the regulatory framework for banking, insurance and capital markets was strengthened and financial infrastructures were upgraded (e.g. payments and settlement system, accounting and auditing standards). All targets o f the D P L were met and the operation was rated satisfactory for Development Objectives and highly satisfactory for Implementation Progress. The I C R concluded that the Government’s performance was Highly Satisfactory. The Ministry o f Finance was simultaneously the champion o f reforms, the ministry responsible for i t s implementation

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and the direct beneficiary o f the DPL funds to the national budget. This created a more conducive environment for effective implementation and hence success.

D. LESSONS LEARNED

85. The recent financial crisis has highlighted the need to pay as much attention to stability as to access. The global expansion o f credit in recent years improved access o f households and enterprises to finance, but was not always accompanied by effective regulation and supervision in many countries. Morocco’s supervisory authorities have managed effectively the expansion o f the banking system, but are aware o f the need to strengthen regulation further to prevent the problems that emerged in other countries. Moreover, the increase in the NPLs o f MFIs in Morocco illustrates well the problems that may be generated by rapid credit growth and inadequate risk management capacity. As noted in the I C R o f the Financial Sector D P L and the CAS Completion Report, the Government had strong ownership and exercised good leadership o f the reform program supported by the ICR and its performance was rated highly satisfactory.

86. Strong ownership and strengthened capacity of the institutions involved in the reform are key factors o f success. Ensuring ownership at the highest levels o f government as well as at the technical levels i s essential for increasing commitment to the project development objectives and facilitating implementation. Moreover, technical assistance to implement the program and build capacity are essential, as well as high level o f consultation during the drafting o f regulations reflected in the policy matrix.

87. Partnership with the client and donor coordination play a major role in program success. The shift from assistance to partnership with the Moroccan Government introduced with the 2005-2009 CAS has allowed for greater flexibility and adaptation o f the program to client needs. In other operations (e.g. the PARL series), coordination with different organizations (AfDB, EU) based on the same programmatic framework have benefited the client by building credibility for the reforms, and ensuring an effective combination o f the technical expertise from multilateral donors in support to a complex program o f reform.

E. ANALYTICAL UNDERPINNINGS

88. The Financial Sector Assessment Program Update of 2008 and other diagnostic work provided strong analytical underpinning to the design o f the proposed operation. The preparation o f this DPL benefited from the detailed analysis and recommendations o f the FSAP on banking, insurance and capital markets, as well as on access to finance in Morocco. The Financial Sector Stability Assessment which includes a detailed presentation of the outcomes o f the FSAP was published in October 2008 (following authorization by the Moroccan authorities). Other diagnostic work also contributed to the design o f the operation, including Reports on the Observance o f Standards and Codes (ROSCs) on Insolvency and Creditor Rights (2006), and Payments and Securities Clearance and Settlement Systems (2007). Investment Climate Assessments (ICAs) conducted in 2003 and 2007 also contributed to the design o f sub- components o f the proposed operation.

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V. THE PROPOSED SUSTAINABLE ACCESS TO FINANCE LOAN

The objective o f the proposed operation i s to support the Government’s efforts to expand further the access of households and enterprises to finance, while ensuring the stability of the financial system. Expanded access o f individuals and enterprises to finance will contribute to a sound growth performance and further reductions in poverty, but sustained improvements in access require further strengthening o f financial regulation and supervision, and effective management o f all the risks involved. Unlike other countries, Morocco has been able to preserve financial stability since the start o f the international crisis, but needs to ensure that further gains in access are well managed and sustainable.

89. The Government’s program addresses effectively the dual objectives o f access and stability and merits the Bank’s support. I t s f i rst two pillars contain measures that promote access to individuals and enterprises to finance, while the third pillar contains measures designed to strengthen further financial regulation and supervision. The fourth pillar - capital market development - contributes both to access and stability, by promoting competition to banks and introducing better instruments o f risk management. The program i s coherent and balanced, provides lessons to other countries, and merits the Bank’s support.

90. The Bank has supported Morocco in its past financial reform efforts and should be present in this important phase o f financial reform as well. The 2005 D P L focused on the restructuring o f state banks, banking regulation and supervision, and elements o f financial infrastructure. One o f the major objectives was the restoration o f solvency o f state banks and the promotion o f competition. The current D P L focuses more closely on access, while strengthening further the regulatory and supervisory framework o f banking, insurance, and capital markets, to ensure the sustainability o f access gains. The current operation i s a joint operation with the AfDB, which i s also supporting Morocco weather the effects o f the financial crisis.

91. The proposed operation contributes to Morocco’s efforts, both financially and technically. First, it contributes to a balanced financing package, helping the Government meet i t s larger borrowing requirements resulting from the impact o f the crisis, while avoiding excessive pressures on the domestic financial market. Second, it provides support to an important reform that will contribute to growth and poverty alleviation. Third, i t will allow the’Bank to remain engaged in the design o f more challenging reform components, contributing to their quality. Fourth, the Moroccan reform provides important lessons for other countries, for recognizing explicitly the need to combine the objectives o f access and stability.

A. OPERATION DESCRIPTION AND POLICY AREAS

92. The proposed operation supports the Government’s current financial reform program. As shown in Section 111, this program has four major pillars and the operation i s structured accordingly. Therefore, the operation supports key policy actions designed to: (i) ensure sustainable improvements in household access to finance; (ii) ensure sustainable improvements in SME access to finance; (iii) strengthen financial regulation and supervision; and (iv) develop further capital markets and instruments. Box 1

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summarizes the overall reform program in order to emphasize i t s internal coherence and cohesiveness. The key policy actions supported by the operation are bolded and described in further detail below.

93. The operation i s structured in two tranches. The government considered the two tranche structure appropriate, as the key steps o f the reform agenda have been well discussed in Morocco and are well advanced, and the construction was deemed to facilitate the coordinated oversight with the AfDB. The first tranche consists o f policy actions implemented prior to Board approval, while the second tranche comprises policy actionsg required for i t s release, planned for the last quarter o f calendar year 2010. The operation has been prepared in close coordination with the AfDB, ensuring a very high degree o f convergence between the two operations.

Pillar 1 : Ensuring Sustainable Improvements in IndividualsAccess to Finance

94. Introduction of a Postal Bank with wide penetration inside the country and able to offer a wide range of services to the low income population. The creation o f a Postal Bank i s considered a key policy action due to i t s potential for enhancing access to finance for households. For the first tranche, the operation supports the issue o f a license for the new Postal Bank, which will be legally and operationally separate from the post office, but will utilize i t s infrastructure. The second tranche o f the operation will support the initiation o f operations o f the new Postal Bank.

95. Strengthening the regulatory framework o f the microcredit sector. The operation focuses on the regulatory improvements that will critically enhance the future effectiveness and performance o f the whole industry. Therefore, the f i rs t tranche supports the issue by the Ministry o f Economy and Finance o f loan classification and provisioning rules to measure accurately the portfolio problems and ensure adequate provisions, as well as a the issue by the Central bank on governance, risk management, and internal controls to avoid the problems observed in recent years.

96. Set up o f the new housing guarantee fund Damane Assakane to facilitate sustainable access of low and middle income households to housing finance. The f i rs t tranche supports the set up o f the new guarantee fund Darnane Assakane, which benefits from the resources o f a previously under-utilized fund, and operates with risk- based premiums designed to improve incentives and sustainability. This i s an important reform component that should contribute to sustainable improvements in access to housing finance for the poor.

In Morocco, draft laws are examined in chronological order: (1) by the General Secretariat o f Government (SGG), an administrative body which assesses the legal compliance and quality o f the text, (2) by the Council o f Government which regularly gathers al l Ministers, and chaired by the Prime Minister (3) by the Council o f Ministers, which i s chaired by the King; and (4) by the Par1iament:Previous operations showed that the timelag between the adoption by the Council o f Government and the transmission to Parliament were relatively short in practice.

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Pillar 2: Ensuring Sustainable Improvements in SME access to Finance

97. Improvements in credit information through introduction of a credit bureau managed by a private operator. This i s one o f the most important components o f the reform program, as it will contribute both to enhanced access and more effective risk management by all credit institutions and MFIs. The f i rst tranche supports the start o f operations o f the new credit bureau, which took place in October 2009, after a period o f collection and testing o f databases, including the receipt of data from 5 MFIs accounting for at least 33 percent o f a l l MFI loans. The second tranche supports the broadening of the credit bureau, the receipt o f data from MFIs accounting for at least 50 percent o f all MFI loans.

98. Reform of the Partial Credit Guarantee (PCG) Scheme to improve access of SME to finance while preserving sound incentives for banks and borrowers. The first tranche supports the reform o f the PCG scheme and new governance rules for the CCG. These actions enhance sustainable access by removing obstacles in guarantee application and approval procedures and focusing on SMEs rather than sectors, while also improving incentives for good loan origination by granting access o f the CCG to the credit bureau and conditioning full payment of the guarantee to the banks’ efforts in collecting their debts. The second tranche would support the verification inter alia o f the internal control and risk management framework through an on-site inspection by the Central Bank.

Pillar 3: Strengthening Financial Regulation and Supervision

99. Strengthening of bank governance. As mentioned in Section 111, the Central Bank i s addressing the risks that have emerged as a result o f the recent credit expansion. This includes further strengthening o f risk management rules, and the introduction o f new supervisory tools based on new information such as a real estate price index. A key policy action supported by the operation entails an in-depth bank governance review to assess the architecture and practice o f governance in the main individual banks. Therefore, under the f i rst tranche, the Central Bank will commit to a comprehensive review o f the quality o f bank governance following best international practice and conducted joint ly with World Bank staff. The second tranche supports the completion o f the governance review and the elaboration o f an action plan by the Central Bank to address the weaknesses identified by the review.

100. Strengthening of insurance regulation and supervision. The creation o f a new and independent insurance supervisor addresses a critical weakness in the regulatory and supervisory architecture. This measure will ensure that the fast growing insurance sector i s effectively regulated and supervised, thus also ensuring i t s sound future growth. The f i rs t tranche supports the submission to the general General Secretariat o f the Government (SGG) o f a draft law creating a new and independent insurance supervisor, while the second tranche would support the adoption by the Council o f Government o f the draft law establishing the new and independent insurance supervisor.

101. Strengthening of capital market regulation and supervision. The first tranche supports the submission to the General Secretariat o f Government o f a draft law creating

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a Capital Market Authority with strengthened legal, operational and financial independence. The second tranche supports the adoption by the Council o f Government o f this draft law. As in the case o f the insurance sector, the aim o f this key policy action i s to establish a supervisor which i s capable o f addressing the main regulatory weaknesses and enforcing prudential and investor protection regulations, thus driving the sound growth o f the market.

Pillar 4: Further Development of Capital Markets

102. Build up of a reliable and liquid Treasury bill yield curve that serves as benchmark for private fixed income instruments and promotes capital market development. As noted before, the Government i s resuming i t s efforts to build a reliable and liquid yield curve. This has already included a recent M O U between the Treasury and the Central Bank that allows for more active cash management and facilitates debt management, and the introduction o f an electronic auction system that reduces operational risks and enhances price transparency. Further measures are envisaged for the future. The proposed operation would support - in the second tranche - the issue o f a key regulation by the MOF changing the reference rate for the variability o f interest rates on floating rate credits from Treasury bills to a reference to short term instruments. This would ensure consistency with best international practice and remove one o f the main obstacles for issuing long term bonds and building a yield curve.

103. Introduction of long-term private financial instruments that provide funding while addressing balance sheet risks. The government’s program includes maintained efforts for the issue o f regulation essential to the entry in force o f the new securitization law and the submission for comments to relevant stakeholders o f a draft law introducing covered bonds, thereby enabling more effective funding and risk management o f the banks’ exposures. Covered bonds, an instrument which does not yet exist in Morocco, are the preferred instrument used to finance housing in several EU countries, as it retains the incentives for good loan origination, reduces maturity mismatches and reduces credit risk for investors, thus allowing the financing o f housing at lower rates than ordinary bonds. With this objective, the second tranche would support the elaboration o f a draft law by the MOF creating covered bonds to fund housing loans.

104. Introduction o f a new future market that provides risk management tools for financial institutions and enterprises. The first tranche would support the adoption by the Council of Government o f a draft law on the future market establishing a sound derivatives market that focuses on standardized instruments and follows best practices, enabling more effective risk management while avoiding the mistakes observed in the recent crisis.

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BOARD PRIOR ACTIONS Policy Actions Taken Prior to Board Approval

Pillar 1: Ensuring sustainable improvement in access to finance for individuals

Licensing by Bank A I Maghrib (Central bank) of A I Band Bank (Postal bank)

Order of the Minister of Economy and Finance related to the classification and provisioning of microcredit associations’ loans Directive of Bank AI Maghrib related to the governance (including risk management and internal control) for microcredit associations Set up of the new housing guarantee fund Damane Assakane facilitating access to housing for low income households

Decree reorganizing the CCG

SECOND TRANCHE ACTIONS Policy Actions Required for Second Tranche Release

Transfer of the financial services of Barid AI Maghrib (Post Office) t AI Barid Bank (Postal bank)

Initiation of operations of the Credit bureau activities, demonstrated by the receipt by the Central Bank of data from credit institutions and microcredit associations (MFI) accounting for at least 33% of MFI loans Reform of the SME credit guarantee products (guarantee products based on companies’ l i f e cycle and improved procedures to approve and call on the guarantee)

Strengthening of the governance structure o f the Casablanca stockexchange

Broadening of the Credit bureau activities, demonstrated by the receipt of data microcredit associations (MFI) accounting for at least 50% of MFI loans On-site inspection of the Caisse Centrale de Garantie by Bank Al- Maghrib, to assess inter alia the adequacy of governance, internal controls, and risk management

Adoption by the Council of Government of the draft law allowing the opening of the capital of the Casablanca stock exchange beyond brokers

Completion of a crisis simulation/management exercise involving all financial sector authorities (with World Bank participation)

Agreement on a comprehensive review of the quality of bank governance to be jointly conducted with the World Bank and following international best practice

Submission of a draft law to the General Secretariat of Government establishing a new and independent insurance and pension supervisory authority (CC Autorite de ContrBle des Assurances et de la Prevoyance Sociale D)

Submission of draft law to the General Secretariat of Government establishing a Capital Market Authority ( a Autorite des Marches des Capitaux n)

Establishment of a Memorandum of Understanding between the Ministry of Economy and Finance and financial sector supervisors establishing procedures and exchange of information in the event of a financial crisis

Completion of the review of bank governance and draft action plan by thl Central Bank addressing identified weaknesses Elaboration of a new supervisory methodology to assess banks’ credit risks related to real estate by taking into account new real estate price indexes published by the Central bank Adoption by the Council of Government o f a draft law establishing e new and independent insurance and pension supervisory authority ((< Autorite de Contrdle des Assurances e t de la PrbvoYance Sociale )):

Adoption by the Council of Government of a draft law establishing s Capital Market Authority ( M Autorite des Marches des Capitaux D)

33

Conclusion of a MOU between the Treasury and BAM for more active Treasury cash management that also promotes more effective debt management Set up of an electronic auction system for government securities that reduces operational risks and price uncertainty for all participants

Adoption by the Council of Government of draft law on the future market

Issue by the Ministry of Economy and Finance of an order (“Arrtt6” changing the reference rate of the variability of interest rates of floating rate credits from Treasury bills to a reference rate linked to short term instruments, fostering better public debt management Elaboration and initial implementation o f a debt management strategy to build a liquid and reliable yield curve Enactment of Decree implementing the amendments to securitization law 33-08 that expands the range of securitizable assets and adoption o f prudential regulations to ensure a sound use of these instruments Submission for comments to relevant stakeholders of draft law creating covered bonds

B. EXPECTED OUTCOMES OF THE OPERATION

105. The operation aims at achieving sustained improvements in access to finance to individuals and SMEs, while ensuring a resilient and stable financial system. Capital market development i s an important objective as well, as it contributes both to access and stability. Evaluating the contribution o f the operation to the achievement o f i t s long-run objectives requires the selection o f a number o f indicators, including some indicators measuring the achievement o f intermediate outcomes. The period o f program evaluation begins in mid-2009, when most figures are available by the time o f appraisal, and ends in mid-20 1 1 , which i s the expected date o f ICR preparation.

106. By the end of the program, progress in expanding access to individuals would be reflected in a number of indicators, including increases in the number of accounts and branches relative to the population (aggregating data from commercial banks and the Post office).

107. The increase in individuals’ access to credit would be reflected in the number of consultations on individuals in the new credit bureau, as well as the number of MFI clients. The increase in consultations would provide evidence that banks, MFIs, and finance companies are using the credit bureau to evaluate the creditworthiness o f a larger universe o f households. The reduction o f the IMFs’ NPL ratio i s an important intermediate outcome indicator that wi l l also be monitored.

108. Increase in SME access to credit would also be reflected in the number of consultations on companies in the new credit bureau. Again, this would provide evidence that banks and finance companies such as leasing companies are using the new system to evaluate the creditworthiness o f a larger segment o f SMEs. Expanded access o f SME to finance would also be reflected in an increase in SMEs” share o f banks’ total corporate credit portfolio.

109. Progress in strengthening the regulatory and supervisory framework for the financial system would be reflected in improvements in performance indicators and measures of institutional development. By the end o f the program, average capital adequacy ratios in the banking system should be higher, including the capital ratios o f public banks, reflecting the regulatory and supervisory actions being implemented by the Central Bank. The publication o f the new real estate price index i s another important outcome, as it would prove an important tool o f supervision and market discipline.

110. Progress in developing further the capital market would first be reflected in improvements in the functioning of the government debt market. Progress in building a reliable Treasury bill yield curve, in turn, would be first reflected in the resumption of medium- and long-term debt issues and the reduced fragmentation o f Treasury bi l l debt issues. The increase in the outstanding value o f private fixed income instruments (with an initial maturity over a year) to GDP (including bank issues).

34

Table 8. Long run objectives and expected outcomes

Plllar 1 Increased access of the population to financial services at reasonable conditions, including payments, savings, and loans

Pillar 2: lncreased access of SMEs to finance at reasonable terms, especially smaller SMEs, contributing to the growth o f formal employment

Pillar 3: Strengthening o f the regulatory and supervisory framework in banking, insurance, and capital markets

Pillar 4: Further development of capital markets and private instruments, especially fixed income instruments

KEY EXPECTED OUTCOMES BY THE END OF THE PROGRAM (June 201 1)

Increase in number of total accounts of banks and Barid AI Maghrib per population Baseline (Dec. 2008): 43%

Decrease in the number of habitants per branches of banks and Barid AI Maghrib Baseline (Dec. 2008): 6,300

Reduction in the NPL ratio of MFIs Baseline (September 2009): 12%

Increase in the number of monthly consultation on individuals to the credit bureau Baseline (November 2009): 1,217

Increase in the number of monthly consultations on companies to the credit bureau Baseline (November 2009): 371

Increase in the share of SMEs (as defined by BAM prudential regulations) in total bank lending to companies Baseline (June 2009): 22 %

Increase in the average capital adequacy ratio of the banking system Baseline (June 2009): 11.7%

Quarterly publication of the real estate price index by the Central Bank starting in the f i rs t quarter 2010

Increase in the share of medium and long term issues in total annual government debt issues Baseline (2008): 5 percent of the total

Reduction of the number of lines of Treasury bills Baseline (June 2009): 170 lines

Increase in the outstanding value of private fixed income instruments to GDP with an initial maturity over a year [including bank issues) Baseline (June 2009): 4,6%

VI. OPERATION IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACT

1 1 1. In line with OP 8.60, the Bank advised the Moroccan authorities on the need to undertake consultations on the reform program with the various stakeholders. The authorities confirmed that the Moroccan Government had been conducting consultations with the various stakeholders. They also indicated that further consultations on the reform program underpinning this proposed operation will take place.

112. Consultations on key aspects of Morocco’s reform program supported by the Bank were conducted with key stakeholders (financial institutions, donors, public authorities, industry associations etc.) throughout the process of preparing the DPL.

35

A formal consultation also took place on 8 December 2009 with representatives o f c iv i l society (microcredit associations, associations representing customers, young entrepreneurs etc.). Moreover, this DPL which i s fully aligned with the CPS benefit from the extensive consultations held with c iv i l society and private sector representatives (including SMEs), the donor community, and Government officials for the preparation of the CPS.

113. The proposed DPL supports measures that will enhance competitiveness and growth, access to finance, and financial stability, all of which contribute to positive social outcomes. The focus o f the operation i s centered on reforms aimed at: (i) ensuring sustainable improvements in household access to finance, (ii) ensuring sustainable improvements in SME access to finance, (iii) strengthening financial regulation and supervision, and (iv) developing further capital markets and instruments. As such, none o f the activities supported by this operation have distributional implications that would warrant a poverty and social impact analysis (PSIA). Indeed, the reform supported by the proposed operation has a number o f components that are expected to generate direct benefits to the lower income segments o f the population, as well as indirect benefits such as employment opportunities generated through general economic growth and SME growth in particular.

1 14. The Government remains committed to monitoring the distributional impact of all key policy reforms and economic events. PSIAs have been done in the past or are planned in the coming months to inform critical policy issues. For example, a PSIA was completed in 2008 to inform the design o f the solid waste management reform program and two were done for the water sector reform. In the context o f the envisaged reform o f the social protection system, Government i s currently evaluating the distributional impact o f various options including the introduction of subsidized health insurance and conditional cash transfer programs in education. PSIA i s also foreseen for the potential reform o f the energy tari f f system.

B. ENVIRONMENTAL ASPECTS

115. The DPL program does not pose any significant environmental effects. I t i s a development policy credit in support of a broad program o f policy and institutional reforms, for which the environmental requirements o f O P B P 8.60 apply. However, none o f the activities supported by the program pose any l ikely and significant effects on the environment and natural resources. Furthermore, the Bank’s overall strategy focuses on strengthening o f the Government’s legislative and institutional capacity to address environment and natural resource management through a dedicated large portfolio o f analytical and operational activities.

C. IMPLEMETATION, MONITORING, AND EVALUATION

116. The responsibility for implementing the program rests with the Ministry o f Finance, in collaboration with the Central Bank. The Government will take the lead in monitoring progress in implementation and in updating the program policy matrix as appropriate. The Ministry o f Finance i s coordinating inputs from all the relevant authorities. Bank staff will continue to maintain dialogue with the key counterparts and

36

the relevant sector ministries and will conduct periodic reviews in close coordination with the AfDB. In this context, dialogue and joint reviews will continue to focus on the impact outcomes o f the program and eventual adjustments that may be to take into account the latest country developments, stakeholder support, and feasible options for realizing the intended development goals. Consequently, specific attention will be devoted to monitoring indicators and goals o f the program.

D. FIDUCIARY ASPECTS

117. N o major fiduciary issues are expected for the proposed DPL. The Moroccan public administration operates in a structured and reliable control environment.

118. Financial Management Diagnostics and Risk Rating: In response to the government request, the Bank issued a Country Financial Accountability Assessment (CFAA) update in 2007 following the first CFAA o f 2003. Like the f i rst one, the CFAA update assessed the Moroccan public sector fiduciary risks as low. Morocco’s public finance system i s governed by a well-developed legal and regulatory framework, and generally provides adequate reliability and transparency. This system i s predicated on the principle o f the strict separation o f the roles o f payment authorizer (“ordonnateur ’7 and public accountant, who are financially responsible to the Audit Office, and on the principles governing ex ante expenditure control and internal and external audits. The rating i s due in large part to the steady and continued Government efforts and major reforms to modernize and improve the efficiency o f the public sector including the public financial management o f the past several years. These reforms are st i l l ongoing.

119. The CFAA update recommended improvements in a number of areas; including (a) reducing the delays to produce the year end government financial statements and accounts and the audited accounts by the Auditor General (“Cour des Comptes”), (b) further simplification o f the a priori internal controls while continuing the strengthening of the ex-post controls and internal audit already underway, and (c) continuing the progress in the Management Information System. Public financial management reforms to further enhance the efficiency o f the public financial system remain central to the government reform program, CFAA recommendations have been integrated in the agenda and progress in implementation has taken place.

120. Funds Flow. Morocco has had no safeguards assessment by the IMF. However, over the many years o f working with the Moroccan government, the Bank has had no major fiduciary issues in relation to the funds flow. The Government budget i s comprehensive, unified and subject to centralized treasury account. Cash f low and debt are professionally managed by the Treasury Department o f the Ministry o f Finance under generally satisfactory conditions. Loan proceeds are deposited in a government designated account at the Central Bank and transferred to the Treasury single account for government budget.

37

Principle 1 Reiiforce ownersEi@ o f this operation has been fully client driven and thus enjoys soli ajor reforms o f public banks and of the industry regulation, the Gov

2008 its co~M~i~rnent to move to a new phase of financial sector reform. The C initiated the preparation of the operational ~ ~ p l e ~ e n ~ a t i ~ n of key eo

Principle 2: Agree up front with the GawrnnzePtt OR other finmicia1 partaers ott R coordipluted

The a ~ c o ~ ~ t a b i l j ~ framework delineated in the policy matrix contains very specific associated indicators for measuring results to gauge success of the program. The program i s very closely coordinated with the African Devcllopment Bank.

Principle 3: Custoinite the u ~ ~ ~ u ~ i t u ~ ~ I ~ ~ frunzewark and modalities of Bunk suppod io country cirw Pnstarices. The financing package associated policy measures are specifically geared to the Government's needs

orocco's sirnation. Meetings were held will all the major stakeholdcrs and a formal place on 8 December 2009 with representatives o f civil society (microcredit

ociations representing customers, young entrep

Principle 4: Choose un& actioPts c ~ i t i ~ R l ~ o r a The policy actions are maintained at a modest that are considered crucial in ~ ~ g c l m e n t s and dev a proccss o f extensive consultations with the Ministry o f Finance and the Central bank.

Principle 5: Coiiiluc'f frunspureitf progrew reviews conducive tu predicfuble arid perfortnunce-bused fir,unciul support. Monitoring of the prograni wil l take place during loan iniplementation as a second tranche i s embedded within the ~rnplern~n~at~on period, Close coordination with the AfDB will be maintained throughout this operation.

E. DISBURSEMENT AND AUDITING

121. The proposed loan would be in an amount of 133.1 million EUR, with two tranches. Upon effectiveness, front end fees of 0.3 will be paid from loan proceeds. The first tranche in the amount o f 88.6 million EUR would be disbursed following Board approval, which will be conditional on the realization o f specific reforms and compliance with the tranche and withdrawal conditions in the legal agreement. The attached draft policy matrix lays out the proposed conditions for each tranche. The approved tranches will not be linked to any specific purchases, and no procurement requirements will be needed. The loan proceeds will be deposited by the IBRD in an account designated by the Borrower and acceptable to the World Bank at the Central Bank o f Morocco (Bank A1 Maghrib). The Borrower should ensure that upon deposit o f

38

the Loan proceeds into said account an equivalent amount i s credited in the Borrower’s budget. The loan proceeds will be administered by the MOF.

122. Although an audit of the use of the funds may not be required, IBRD reserves the right to require audits of the deposit account at any time.

123. The proposed two-tranche structure of the operation reflects the Bank’s and the authorities’ assessment that the proposed reform program represents a consistent and self-reinforcing package to be implemented over a 12 to 18 month timeframe. In this context, the f i rst tranche aims at locking in as soon as possible a set o f irreversible policy measures and at supporting the reform momentum. The second tranche conditions encompass measures which require more time for preparation and will deepen the structural changes.

F. RISK AND R I S K MITIGATION

124. In the short term, Morocco i s confronted with uncertainties on the timing and speed of the recovery from the global crisis. While there are encouraging signs of an end to the crisis, i t i s too early to predict how the global economy will emerge from the recession, particularly in the EU, Morocco’s key international partner. Consequently, i t i s not yet clear to what extent Morocco will continue to be confronted with the impact o f the economic slowdown on exports, remittances, FDI flows, and the sustainability of i t s public stimulus program. The economic risks are mitigated through continued strong macroeconomic management and Morocco’s track record suggests that it is wel l placed to face the current uncertainties. The Bank will help mitigate this risk through continued monitoring and dialogue with the authorities on the overall macroeconomic context, as well as analysis o f options for remedial measures as eventually requested by the Government.

125. A deterioration of the credit portfolios of some institutions could jeopardize expected improvements in access. Although non-performing loans seem to be leveling o f f in the microcredit industry, further deterioration cannot be ruled out, especially if urban unemployment i s to rise. However, the Government has proved i t s resolve to handle the situation and has taken measures to strengthen the capacity o f the microcredit institutions to grow in a sustainable way. Likewise, the slowdown o f non-agriculture output may put some stress in bank portfolios, but the government has also taken measures to strengthen the banks’ solvency and their capacity to manage new risks.

126. The resumption of long-term Treasury bill issues may imply some increase in the reference rate for existing mortgage holders. The link between long-term bond rates and floating rate mortgages was one o f the reasons why the government stopped issuing long-term Treasury bills at the start o f the crisis, when long term rates increased and the effects o f the crisis were uncertain. However, the current policy o f keeping interest rates on floating mortgages constant by not issuing long-term Treasury bills i s simply not sustainable from a debt management perspective. The envisaged change in the reference rate for new mortgages ( f iom Treasury bills rates to a reference to short term instruments) i s aligned with international practice and essential for sound debt management. Existing mortgage holders may experience some increase in mortgage payments as long-term Treasury bill issues resume, but the impact i s likely to moderate

39

for several reasons. First, floating mortgages account for less than hal f o f total mortgages. Second, long-term rates have declined significantly relative to crisis levels. Third, the average ratio o f debt service to income i s moderate. Finally, l o w income mortgage holders have benefitted from fixed rate mortgages covered by the housing subsidy scheme (floating rate mortgages are not eligible to this scheme).

127. The Government may experience difficulties in having specific capital market reforms approved. Critical implementing regulations for the new securitization law have not yet been approved by the Council o f Ministers because o f the opinion issued by the Auditor general (“Cour des comptes”) emphasizing the negative role played by complex securitizations in the current global financial crisis. In the wake o f this crisis, more caution towards new market mechanism may emerge (e.g. securitization or future market). The government is addressing this risk by introducing only new instruments which are simple, tested and bring clear benefits to the country, by setting up appropriate prudential regulations to reduce risks and by reaching out to all concerned parties.

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ANNEX I Page 1 of 5

ANNEX I. LETTER OF DEVELOPMENT POLICY

ANNEX I Page 2 of 5

, . 2. &k&zg€! clii Gouvcmt-mcnt

L e G o u r e r n e m c n t entend poiirsuivtr scs e f f o r t s r t r dPveloppemcnt et de mtxternisation de l'enscmblc des composantcs c h Scctcur financier marocaia. I1 cst plcincmcnt conscicnt quc des r k fom ies supp'lkmentaires sont nkcessnires pour e l a r p l'acces aux semiccs hnanuers, tout en r e d a n t B ce que tous les rnkcanisrncs nicessaites k une bonne rnaitrise des risyues wiriit Pti place. I ,a c n i s w n c r rilpicte dii r 4 i t R cimrnbui. B l a croissancc du p z ~ s et B faciLtP 1'acck iius ~ ~ f n i c c s finnncicrs a un nornbre crorssi int d'entrcpnses ct: dc parnculiccs marocains, mais de non ib reus particulicrs i faiblc r e ~ c n u ct petites e t moyennes entreprises (PME) o n t encore diff ialcrnent accPs il ces services. L a cnse financiPre rnondiale a, en outre, w-wlipni. I'impnrtanw ifrrriw de l a r6fnrmr et I a nGcessit4 de rmfcsrcer l'infrfrasmtctcrre et h r+&sxmtntion hanci&rcs pow assurcr la pCrennitP des prop& en tcrmes d'accis aux services fmanucrs.

13~11s cc contextc, l e Gout-erncmcnt a pns l a r p m e n t en considemtion les analyses ec recnmrnanctations du Prc )pprnme d'Eva1uation Ju Secteur l;mancier, rthltst en 2007, pour Mttr im nouveau programme de r t f o r m e financic\rc ri.pondatlt e fficnccmetit a u s dcus objccnfs d'acccs c t dc stabiiit6. (:e progmmmc coniporte yuatrc piliers yui sc reiifurccnt mumellernent e t s'appuicnc sur dcs amdioraf ior is rnqcurcs de la soldire et d e la capacitt. de gestion des r isyues des institurions fmanciikes. L e premier pilter c o m p r e n d des mcswrcs de p ru rno t i on de l'iuclusion fjllanci2rc des paracul lers tandts que IC. cfeuxi6rnc: p iker propose des mesures &ant ii amdliorer l'accts aux services finail cicrs des pctitcs e t nioycimes nitrcpuscs. L e troisieme pilier cnmporte des amCliorations Importantcs c n niatierc de rltglcmen t a t m i l c t de supervision finanei&xc, favorisant une idcntificauon cc ui ic gesuon precoce des usques. 1 .c quatnPrne pil icr porte s u r le dCveloppcrnent des march fs d e caprtaux e t contribue i la fois aiix objccufs d'acci-:, ct de stabilitk, en renf rxynt In conrurrcncc pour les baizqut.s c t c i i introduisiirmr de meilleurs instrumenas de gesnon des tisques.

L e programme d'ilctlcm du Gouvemcment s'appme sur les qustrc pliers suivants :

(a) Prenuer p l l r e r : Assurer unc amblioxation durable de l'acc6s des mCnages nux sttn.ices financiers

I x Chuvcrncmenr cntcnd accd&er les progtks dms I'inclusiun fmanciere des parricdiers marowns h t m w r s l a crkaaon 8-U Barid Bank. Ckttc n o u r c l l e bmiquc debutern ses sctiriti:: dks 2010 et v ienc i r i complCrs+ k 'o f f rc des autrcs banqucs de la place. I,e d&.i~eioppcrnent progressif de ccs activitCs, la cpaliti. dcs dispositifs de conrr6le interne et de gouvemance ainsi quc la supervis ion cxercke par Rank ~V-hL+-ib sorit l e gage d'unc boniic rnaimsc des riques de cette i i o u d l c benyue.

L e Goewememerit poursuirra scs e f f o r t s poux garantu l e d&veloppcmcnt pkrennc! du e- * cteur du microcrkdit, qui constiruc une cornpusanre importanre du sys teme financier avec plus d'un million cfe clients. LA cxoissmce SMS prCc6dent &I sccwur 'rt m i s c n bvidcncc quclques faiblesses des associations, eri 6gard i l a progxession des crCances ai souffrancc iiotamment, Cctte situatlnn est sui& de pres par les autontCs maroctunes qui ont engng6 le renforcement du cadre r&jernentairr. c9u microcr6dit (nomes dc classification et de provisionnerncnt des

ANNEX I Page 3 of 5

crkances en souffrance, e t ges t ion des nsques er gwvemance). Plus g8tiPmlement, les aucoricks marocaines r r a ~ ~ a i l t e n t cn drroite coordination avec i'ensemble des pames ptenantes pour perrnettre au secceur du microcr&iit wie Cvolution pdreiirie et sans ?I coups.

Enfin, l e f';nurcrnement renforcc les dispositifs permetfanr aus menages a faibics rcwnus dc fmancer l'itcquisirion ct'un Ingemcnt. 1Jn fonds de gseintie de crPdits i i n m o b i l i e r s (Damane .lssaltatie) a ainsi Pte crek en 2009, qui s'appuic s u r l e succ@s du FOGARIXI yu'll a absorbe. Ses rcsotircefi accrues et ses mCcanismes de gcsnoii srnCliorts perrnet t ront de faci l i tet I'acci"~ a l a propri4tc des populations pawres mars aussi des classes moyenncs. Lnc tkklexion a, cn outre, PtC: engag& sur la mise en place de produits d'6pargiie logemerit qui pcrmettmient dc faciliter l'accis au credit imn:obilier dam des condittons de nsque mdtnstes.

(t> D e u x i h c pilicr : Assurer une smdlioration durablc de I'acc2s a u financement pour les Petitcs et hloycnnes Entreprises

J A 7nisc e n place d'un t( Cred i t bureau N const~tuc unc mesure essentielle qui compl&te les autres initiative; engagees pour reduire les conrraintes c k finaiicemcnt ausquellcs xrtains s e p e n t s de la population e: des PhiG coimnuctit fairc face. T1 lcur permectra d'Crablir leur historiquc de cri-dit, tout en fournissiliit aux institutions financieres des itiformanotis et ouuls nkcessaircs pour &valuer les empn in reu rs et @res lcurs risyues plus eff-caccment. L e Credir bureau r) vient de demarrex 5es act.kiti?s et s o n impact devrait progresm-ement se matinahser avec sa rnoi idc en puissincc cn 201 0. Iu-deih des Ctablissernents dc crklit, l e Gouvcmemect encourage I'mclusion progrcssivc dcs associaucins de rrUcrocrC&t dam IC champ du r( (,red:t Imrcau >\, ce qui hbn6ficiera i leurs clients et bvonscm u n e bonne m a i t m e des risques dans IC srcteur.

T,c Gouvetnement a e n p g i l a rPformc du r C p p ~ e de ga r in t i e des c r i d t t s aus eiitrcpriscs pennettant d'offnr de f a p n sa im uxi acces au credit a un iiombrc aicru d c skfoime d'ensemblc de l'offrc existante cr de ses conditmns de gesnon condui rn i une mal leu re selectloti des empn in teu rs c t tin ren forccmtn t de l'efficacici. globale du systcmc.

n c nouveaux rnecanismes wmnr e n t i n adopt& pour sotitcnir le dCveloppemcnt des PAZE i fort porentiel Je croissancc ou matures g r k e a une mcillcure disp;mibilid de capita-- investisscnwnt. J x Gouvernement envisage itinar de mettre en place de IIOUV~~LLLY mkcaniismcs pour favoriser les invest issencnts en capital-mvcsussemcrit daiis les PnlE (fonds public pnve, fonds de garantie dkdi4 e t exarnen Jc l'opporrunitd de r k i s e r l a loi sur le capital risque),

(c) Troisitme pifier : ltenforccr l'archrtectwe de rdglcmcntation e t dc supervision

L e Gouvcrncment entcntf po~~rwivre CPS pffnrrs pow ren forcer IC dispnsitif de stabdiet: finimcikre marocam, en s'inspirant des meillcures pranques intematinnales. ,lvec l'appui de la f3anrpie moiidiale, le M a r o c a a ins i t t 4 l e premier pays de l o r4ppfi B ef fcctuer tin escrcice de prkpararion er de gesnon de crise en avnl2003. I.,c Cowerticmait engagera a court tesme I t s nwstircs r i6ccswirc.~ pi.ir mc*ttre eri mivr'c les v o w s d'atnelmr~twns opPrmonneHes iclcntifii.cs i l'isaue de cct exrrcicr. I C;ouvcrncmcnt ct la Daiique Ccnualc cntendciit crsm-enir AP pmrk l t l tcs C t dcs mcrdslit6s ci 'tchanges d'informarions entre IC's dif fkrenres parties prenantes e n sifiratic:n de crise finitnciixe sysrirmque. Lc ( ;ow crncment continuera

ANNEX I Page 4 of 5

cn outre A suivre l'kolution des meilleures pratiques internationales e11 ce domame, afin d'exfiminer ii t n o y r n rerme l'opporrunit6 ti'ivolutions d e p lus g r m d c arnplcur,

Aprks l r s rkfornies mdjeLIfeS entreprises au d c u des aimies 2000, les autoritks entmdent poursukrc I C s efforts constants d'adaptation de la supervision bancaire af in yu'elle demeure cn phase avec l'bwlutitrn dcs risques bancaires ct dcs rneillcures pratiques intcrnanonalcs. l i n e revue iiidCpnidantc de la gouvcmancc ctcs banrpcs sera au.lsi m e n i e en 201 0 avcc I'appui de la Hanque hiondiale pour Aaluer la capaciri. des banques h f.ke face aux risques auxquels e l k s scmt confront6ca. Par aillcurs, la misc c i i application de BPle 2 rcste unc prioritk pour la Banquc Ceiitrdc, avcc un accent ;i court ternic sur IC Pilicr 2 (processus de sumcdlancc pmdcntiellc). I 'nfin, la I3anqiie Ckntrak puhliera en 2010 un nnuve l indice des prix imrnobdicrs, dont les rksulrats wont r6guMrcrnent utilisCs pour apprkcicr l'&wlution clcs risques bancaires.

Soucicuu de la ndcessitb dc prcinunir notrc sectcur iitli~1iciCr des risqiics cic dnerses natures 170u~7ant entanier sa solidit6 e t sachaiit clue cct objecuf passe n6ccssairetneiit par In consolidation des organcs de cuntrOlc e t de supervision du sectcur financier, les autoiiids comprent procider, e n 2010 s i ics projets de loi respcctifs sont adoptes par IC l'arlemenr, B l a refonre du cadrc ligal c t r6glglerncnraire r6gissant Ies ;tutc)ritCs de contrde m charge dti marchk des ciipitaux et du secttwr des assiirRiices ; la fin&& i m i t (le rneifre en placr des insri tut icws de supervision ind6pendantes, rbpondant plcinerncnt aux itnp4ratifs J'unc rCgulation cfficacc, c n phase avcc les cxigcnccs d'un march4 en dcveloppemmt rapide et en conformti. aux mcdlcurcs nornies et pratiqucs mternationales.

I h s l e doiiiairic des marcbCs dc capitaus, le renforcenient d e l a protecaon des in\-estisseurs restem unc priontt et l e renfcircement de la gouvernance de la Rourse sera poursuivi i t m w s

l'ouv'erture du capital de cctte institution qui favorisera une p l u s grande implicatloii des principaux intcn-enants dc l a place dam sa stratdgic dc di.vcloppcmeiit. Iinfin, c u i n o w c a u c o n t r a t - p r o ~ ~ r n m e di7~d.E couvrant la pcnode 2OO!L2U1 I sera f innhsk avec IC sccteur dcs assurances. ='\ court terme, l' introduction d'un regime d'investissement cnrnpatlblr ayec une 6vulution vers des c s i p i c c s en f o n d s proprcs b a s k s s u r i r s nsyucs scra exaniinie pour &iter des cspositions cxcessives 21 des classes d'actifs particuiikrcs {actions, par escniplc).

d) Quatriknie pilier : poursuite du renforcement des marches de capitaux

L e (;ouveriieiiicnt cntend rcnforccr ses efforts pow sboutir A w e courbe des taux des bons de 'l'rbsor plus lirpkk et fiable, afm de favonser le dGvcloppemcnt des m;irchi.s cic capitiiux. Au-del& des modificaaons r i c m t e s en madere de geestion de l a tresorerie publique cr de lanccrnent d'unc plate-forme dc tili.-adju&cations, imc niodi f icauon des t a w de rkfkreslce des taus d'inrirtt pour les nouveaux prtts ii taux variablc intervienctrsi en 2010 fiicilitmt les kmissions du 'I'resnr h long termc.

L c Gouserncmenr souhaite ireridre les instruments i la disposition dcs ins t i t u t i ons rnarocaincs POLK girer leurs risques. L e Gouvernement compte &si prbpaser l'incroduction ct'obligations stl.cutisCcs (G covcrcd bonds N), afui de facilircr uric r k luc t i on dc l a tratisforrnauon des baiiques e t fournir des resources pcrmcttant de fmancer des prets immobiliers A des t a m infkrieurs.

ANNEX I Page 5 of 5

L e Gout-ernemcnt Souhaxc egalcmcnt amrc r p lus d‘investrsseurs stir l e march4 boursier, nugnaenter IC nombre d‘cratreprises coties et f&e du march& marocain u t i scteur dgion;il. L‘amCliorarioii de la p ro tec t ion des invesrisseurs est a u cmur du programme du C~ouvcrr~emcn t qui cumpie C t d i J r t C r e f f o r t s rkccrirs par l’ckablissement de regles dbtdlli.es. Outre les mesures existaiires, le C;ouvemement s‘attrtid B cc que l e r c n f r m e m m t dc Yiiit&grit& du march&, le dkmarchage de Fandes cntrepriscs priydes et l’amtlioration des conditions d‘acc6s att iren t dc tinur.ellcs soci6ti.s w r s l e marcti&

L e Gouvemement n prCsend au Pnrlement un texte ktabliusnnt les fondcmcntu d’un march6 A cermr d’insrruments financiers permerrant aux etitrcprises rnarocaines de mieux couvr i r leurs risyuies. 13ex ddcisions clcs s u r Ia mise en uxiwx de ccs &sposinons seront prises aprks l a promulgstion de l a loi (pT,es de cnnrmts, n i i s r c*n p i a r t . l a srx iCtP gestic3mairr ct. de la

chanibre de compensation, dispasitif pixdenriel, ctc.) CT l e Gouverncmcnt s’assurera que les supernseurs flriaricicrs concmiis prcndron t les mesiires necessarres pour cvitcr tourc pnsc de risque excessive par dcs scicii‘tbs financieres ou tion finatiat‘res. Le lanceineiir dc cc rnarche devrait intenrenir au- deli de 2010 et portct initialemerir uniyuement s u r u11 tiombre rbduit dc ContratR standard is ts portant sur des sous-jacents hyuudes.

‘I’clles som, h k ~ i i s i c u i le 1’1C~idc11~, IC> gritdb i lxes de L C R ~ no)iivelles Etape dans IC praccssus continu de rCforine e t de modenisation dc notre secteur firiancier dotit la m i s t e n auvrc dev-ra conrribuer au renforcement d e la mobhation de l’kpargne et ?I l‘anidlioration des condinons dc financetnciit cic 1’i.conomie iiu profit d‘une croiswiice fcrrtc c t durable.

Ln POUS remexuanr de votre prkcieux nppui pour l t i mist cn am-rc dc cct ambiticux programme, je vous pric d’agrcer, hfoi is icur IC P d d e m . l’expressioti de ma haute consid @ran on.

UNOFFICIAL TRANSLATED TEXT

THE MINISTER

Sustainable Access to Finance Development Policy Loan

ANNEX I Page I of 5

Development Policy Letter

Mr. President,

Since the early 1990s, the Kingdom o f Morocco has been engaged in a process o f thorough modernization o f i t s financial sector. As a result o f the government’s resolve and o f the dynamism o f the private sector, significant progress has been made. The Moroccan Government initiated a new phase o f reform to sustainably strengthen financial access for individuals and small and medium enterprises, as well as financial sector development. We would like the World Bank to accompany us in this important phase o f reform, as was successfully done in the past (including .as part o f a financial sector development policy loan in 2005).

1. Characteristics o f the financial sector

Morocco has made very substantial progress in developing i t s financial sector in the past five years, with financial institutions’ total assets now exceeding 200% o f GDP. This success has been made possible by the sound macroeconomic policies implemented by the Moroccan Government and by the important financial sector reforms carried out earlier in the decade (especially, restructuring o f state-owned banks and strengthening o f financial supervision and infrastructure).

Thanks to these reforms, al l banks’ performances are now satisfactory with rapid credit growth associated with a good management o f all risks, a strengthening o f credit institutions’ financial strength (solvency and profitability especially) and the vigilant and proactive supervision o f Bank A1 Maghrib. Morocco i s also a regional leader for microcredit and the authorities promptly reacted when problems in asset quality appeared, so as to ensure the sustainability o f this industry. The Government will maintain i t s efforts as part o f this Program. Eventually, the international financial crisis validated Moroccan choices in terms o f financial sector development. This sector was not directly affected by this crisis and proved i t s capacity to maintain a sound development in a difficult environment

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2. Governement’ stratew

The Government intends to maintain its efforts to develop and modernize al l components the Moroccan financial sector. It i s fblly aware that additional reforms are necessary to broaden financial access, while ensuring that all necessary mechanisms for good risk management are in place. Rapid credit growth contributed to the country’s growth and facilitated financial access for a growing number o f Moroccan companies and individuals, but many low income individuals and small and medium enterprises (SME) s t i l l face difficulties to access such services. Moreover, the global financial crisis highlighted the increased importance o f reform and the need to strengthen financial infrastructure and regulation to ensure sustainable improvements in access to finance.

In this regard, the Government largely took into account the analyses and recommendations o f the Financial Sector Assessment Program undertaken in 2007 to build a new program o f financial reforms which efficiently addresses the two objectives o f access and stability. The f i rst pillar contains measures designed to ensure sustainable improvements in individuals’ access to finance and the second pillar consists o f measures to ensure improvements in SME access to finance. The third pillar includes improvements in financial regulation and supervision, fostering an early identification and management o f risks. The fourth pillar covers further development o f capital markets and contributes both to access and stability, by strengthening competition for banks and introducing better instruments to manage risks.

3. Government’s Program

The Government’s program i s based on the following four pillars:

(a) First pillar: Ensuring sustainable improvement in access to finance for households

The Government intends to accelerate progress in financial access for individuals thanks to the creation o f A1 Barid Bank. This new bank will start operations in 2010 and will complement services offered by other banks. The gradual development o f its operations, the quality o f internal control and governance frameworks as well as supervision carried out by Bank A1 Maghrib will guarantee good risk management by this new bank. The Government will maintain i t s efforts to ensure the sustainable development o f the microcredit industry, which i s an important component o f the financial system with over a mi l l ion customers. The unprecedented growth o f this sector revealed weaknesses, as shown inter alia by an increase in non-performing loans. This situation is being closely monitored by the Moroccan authorities who initiated the strengthening o f the regulatory

UNOFFICIAL TRANSLATED TEXT ANNEX 1 Page 3 of 5

framework o f the microcredit sector (especially regulations on classification and provisioning, as well as risk management and governance). More broadly, the Moroccan authorities are working in close cooperation with all stakeholders to make possible a sustainable and smooth evolution o f the microcredit industry. Eventually, the Government i s strengthening measures allowing l o w income households to access housing finance. A mortgage loan guarantee scheme (Damane Assakane) was set up in 2009, which leverage on the success o f FOGARIM, which it absorbed. I t s increased resources and improved risk mechanisms will facilitate access to home ownership for poor people, as well as the middle class. Moreover, the Government has started thinking about housing savings products which would facilitate access to mortgage loans and ensure a good control o f risks.

(6) Second Pillar: Ensuring sustainable improvement in access to finance for small and medium enterprises

The establishment o f a credit bureau i s a key measure which complements other initiatives which aim to reduce the access to finance constraints s t i l l faced by part o f the population as wel l as SMEs. It will allow them to build their credit history, while providing financial institutions with the necessary information and tools to screen borrowers and efficiently manage risks. The credit bureau has commenced i t s operations and its impact should gradually become evident in 2010 as i t s operations develop. Beyond credit institutions, the Government supports the gradual inclusion o f microcredit associations in the credit bureau, which will benefit their customers and foster better risk management in the industry. The Government has initiated the reform o f the credit guarantee scheme for companies, allowing sound improvement in access to credit for a larger number o f SMEs. This comprehensive reform o f the existing scheme and o f i t s management will result in a better selection o f borrowers and a strengthened efficiency o f the system. Eventually, new mechanisms will be introduced to support the development o f growth or mature SMEs through improved availability o f private equity. The government i s contemplating introducing new mechanisms to foster private equity investments in SMEs (a public private fund, a new dedicated guarantee fund and possible amendments to the private equity law).

(c) Third Pillar: Strengthening the regulatory and supervisory architecture

The Government intends to maintain i t s efforts to strengthen the Moroccan framework for financial stability, based on international best practices. With the support o f the World Bank, Morocco was the f i rs t MENA country to carry out a crisis preparedness and crisis

UNOFFICIAL TRANSLATED TEXT ANNEX I Page 4 of 5

management exercise in April 2009. Over the short term, the Government will initiate the necessary measures to implement operational improvements identified at the end o f this exercise. The Government and the Central Bank intend to agree on procedures and information exchange mechanisms between the different stakeholders in time o f systemic financial crisis. Moreover, i t will keep monitoring developments in international best practices in this area, with a view to assess the opportunity o f larger scale changes over the medium term.

After the implementation o f major reforms in the mid-2000s, the authorities intend to maintain the constant efforts to adapt banking supervision so that it remains on top o f changes in banking risks and international best practices. An independent bank governance review will be conducted in 2010 with World Bank support to assess the banks’ capacity to address the risks they face. In addition, the implementation o f Base1 2 remains high on the agenda o f the Central Bank with a short term emphasis on Pillar 2 (the supervisory review). Eventually, the Central Bank will publish, in 2010, a new real estate price index, which will be used to assess changes in banking risks.

Aware o f the need to protect our financial sector from diverse risks which could weaken i t s strength and knowing that such a goal requires the consolidation o f financial regulatory and supervisory bodies, the authorities plan to undertake, in 2010 if the respective draft laws are passed by Parliament, the revamp o f the legal and regulatory framework applicable to the regulatory authorities responsible for the capital market and insurance sectors ; the ultimate objective being to set up independent supervisory bodies, fully capable o f meeting the need for efficient regulation, adapted to the requirements o f a rapidly growing market and complying with international best practices and standards. With respect to capital markets, improved investor protection remains a priority and the strengthening o f the governance o f the stock exchange will be pursued through the opening o f the capital o f this institution which will foster the increased participation o f key stakeholders o f the sector in i t s development strategy. Eventually, a new detailed roadmap for the period 2009-2014 will be finalized with the insurance industry. In the short term, the introduction o f an investment regime consistent with an evolution towards risk based capital requirements will be examined to avoid excessive exposures to specific asset classes (e.g. equity).

d) Fourth Pillar: Further strengthening the development of capital markets

The Government intends to strengthen i t s efforts to build a more liquid and reliable Treasury bill yield curve, to encourage capital market development. Beyond recent modifications o f public cash management and the launch o f an electronic auction

UNOFFICIAL TRANSLATED TEXT ANNEX I Page 5 of 5

platform, a modification o f the reference rate for interest rates on floating rate loans will take place in 201 0, easing long term issuance by the Treasury. The Government wants to broaden the range o f instruments available to Moroccan institutions to manage their risks. The Government will prepare the introduction o f covered bonds, so as to facilitate a decrease in maturity mismatch and create resources for the funding o f mortgage loans at lower rates. The Government also wants to attract more investors to the stock market, to increase the number o f listed companies and turn the Moroccan market into a regional player. Improving investor protection i s at the core o f the program o f the Government, which intends to reinforce i t s recent efforts by establishing detailed rules. In addition to existing measures, the Government expects that strengthened market integrity, marketing efforts towards large private companies and improved listing conditions will attract new companies to the market. The Government tabled in Parliament a text establishing the foundations o f a futures market allowing Moroccan companies to better hedge their risks. Key decisions on the implementation o f these provisions will be taken once the law i s enacted (e.g. types o f contracts, clearing house, managment, prudential framework etc.) and the Government will ensure that relevant financial supervisors take necessary measures to avoid any excessive risk-taking by financial and non-financial f i rms. The market should be launched after 2010 and will only cover a limited number o f standardized contracts related to liquid underlying instruments.

These are, Mr. President, the main directions o f this new phase in the ongoing process to reform and modernize our financial sector, whose implementation will contribute to strengthened savings mobilization and improved financing conditions within the economy, supporting strong and sustainable growth.

We would like to thank you for your valuable support in the implementation o f this ambitious program.

Very truly yours,

n

ANNEXIII Page 1 of 2

ANNEX 111. OVERVIEW OF THE BANKING SECTOR

1. The Moroccan banking system i s concentrated, but appears competitive. Two well-established local private banks (Attijariwafa and Banque Marocaine du Commerce Exte'rieure, BMCE) and a public and mutual group (Cre'dit Populaire du Maroc, CPM) control almost two thirds o f bank assets. Smaller foreign-owned banks (mostly French- controlled) and public banks are also active and spur competition. However, market entries are rare. Before two large Spanish banks set up branches in 2009, prior entries had mostly taken the form o f buying into existing banks.

2. Public banks still have a significant role, but do not distort market mechanisms. The Government plays a key role in three large banks: the CPM and two smaller institutions which restructuring was supported by the 2005 Financial sector DPL (Cre'dit Immobilier e t Hbtelier, CIH, and Cre'dit Agricole du Maroc, CAM). The Government wields significant influence in the CPM group thanks to statutory provisions and control o f more than 50% o f Banque Centrale Populaire (BCP), a large bank and the apex for eleven regional mutual banks. The CPM group i s one o f the three largest Moroccan banks with a 22% market share, while CIH and C A M have a combined share o f 13% in 2008. The soundness o f CIH and C A M improved dramatically since 2005: (i) solvency was restored with capital adequacy ratios respectively at 14.1% and 7.4% in 2008, while they both had negative equity in 2005 and (ii) non performing loans (NPLs) declined significantly (19.4% in 2008 compared to 40% in 2005 for CIH and 14.2% and 21.3% respectively for CAM) while their coverage improved.

3. Banks took advantage of an environment of abundant liquidity to grow their portfolio while improving their capacity to mobilize resources and strengthening their risk management capacities. Abundant liquidity was fuelled by tourism receipt and remittances, and also benefited from the rapid expansion o f banking networks (3,138 branches in 2008, +41% in four years).

4. Bank soundness markedly improved with declining non performing loans and improved solvency thanks to initiatives from the Central bank. At the same time, banks risk profiles significantly changed and a deterioration o f the quality o f asset portfolios following a period o f rapid growth remains a possibility.

ANNEXIII Page 2 of 2

Table 1. Key financial and prudential indicators for Moroccan banks

Number o f branches 2,223 2,447 2,748 3,138 41 %

Share o f the three largest banks in total assets 64% 64% 63% 65% 1 Yo

Tier 1 ratio

Liauidity

Customer deposits (million MAD) 313 437 516 513 54%

Liquidity ratio 101.3% 130.0% 125.0% 106.0% 5%

Credit portfolio

Growth rate 12% 22% 30% 24%

NPLs net o f provisions /Own funds 40.9% 25.8% 18.2% 13.9% -27%

Profitability Return on Assets 0.5% 1.3% 1.5% 1.2% 1 Yo

* percentage changes appear in italics, differences in normal charcters Source: Bank AI Maghrib

ANNEX I V Page I of I I

ANNEX IV. THE INSURANCE AND PENSION SECTOR

1. Overview of the Insurance Sector

1. Morocco has the second largest insurance market in Africa after South Africa. With total premia and assets amounting to 3 and 18 percent o f GDP, respectively, Morocco sits wel l above i t s benchmark as determined by i t s GDPhapita, size, and population density. This relative success reflects a number o f factors including:

e

e

e

e

e

e

2.

The existence o f well policed mandatory insurance classes - including motor third party, workman's compensation (WCA), professional liability and mortgage related coverages. The historical major role the sector has played in providing comprehensive health insurance, although this role i s likely to be modified; The rapid emergence o f banc-assurance. A stable political environment. A stable macroeconomic framework, in particular the low rate o f inflation (high inflation i s problematic for l i fe and personal lines o f non l i f e insurance). An excellent, and relatively unique, working relationship between the industry and regulatory authorities. The sector has historically derived i t s approach to products and regulatory norms

from France although the market also reflects local conditions. There are 17 licensed insurers in the market o f which one (La Marocaine Vie) specializes in life, 11 are grandfathered composites (including 3 mutual insurers)", 3 are assistance companies, 1 is a specialist credit risk underwriter and 1 i s the national reinsurer (SCR). The industry has recently seen two 'mergers', one o f which involved an effective takeover o f a troubled institution and the top 5 insurers now account for more than 90 percent o f the premium.

3. Two o f the larger insurers (AXA and RMA Watanya) have significant French insurance interests. The largest insurer i s now WAFA following a portfolio transfer from AXA and the rapid growth o f i t s banc-assurance business in partnerships with Attijariwafa Bank and the Post Office. WAFA has O N A as a significant shareholder. The second largest insurer RMA Watanya has B M C E bank and A C M (France) as shareholders. CDG and the industrial group Holmarcom each have a 40 percent interest in Atlanta and Sanaad. C D G is also a major shareholder in SCR. Societe GenCrale has an interest in La Marocaine Vie.

4. Distribution i s through brokers (approximately 300), tied and semi-tied agents (approximately 1,000) and bank branches (approximately 2,780 counters not including the post office, and dominated by the Cre'dit populaire du Maroc, Attijariwafa Bank and BMCE). Brokers and agents need to be accredited through examination. The postal service also distributes some socially desirable classes such as health. At present banks are restricted to life, assistance, credit, and health and accident, and already account for

A decree issued early in 2006 bans the issue o f any further composite licenses. I O

ANNEX I V Page 2 of I1

more nearly 70% o f l i f e and assistance insurance sales. The largest class, motor (90% o f which i s mandatory third party insurance) i s mainly handled by agents. A relatively high commission rate on mandatory motor insurance o f 12% of premium applies, although commission levels have been liberalized for some time.

5. The insurance industry has shown remarkable growth in recent years (Table 1). This has been largely in the l i f e account following the introduction o f banc-assurance under the new 2002 Code. However the growth o f the mortgage market has also been a factor. L i f e sales growth has come largely from sales to individuals through bank branches. There i s some concern that some policyholders do not fully understand the contract terms, despite the efforts to introduce consumer protection regulations.

(billions MAD) Non life

Motor PA and VHI WCA

Other Fire and Transport

2008 2007 2006 2005 2004

5.99 5.43 4.88 4.66 4.43 2.46 2.23 1.91 1.75 1.54 1.66 1.48 1.38 1.22 1.25 1.66 1.48 1.36 1.31 1.21 1.35 1.15 1.03 0.91 0.89

Source: Annual summary reports - DAPS

6. Total assets o f insurance companies amounted to 120 bi l l ion MAD in 2008, or the equivalent o f 18 percent o f GDP, a very high ratio for a country with Morocco’s per capita income, and by far the highest ratio in the MENA region. Financial assets under management by the sector reached 96.49 bil l ion MAD in the same period. The composition o f the financial investments o f insurance companies i s not entirely clear. Estimates based on available data point to approximately 30% o f aggregate insurer assets being in equities and property. However discussions with the sector indicate that the equity portfolio has in the recent past been substantially higher for some insurers. This i s in part due to the absence o f risk-based capital requirements.

2. Overview o f the Pension Sector

7 . The Moroccan pension system consists primarily o f four major pension schemes - also called pension funds or “Caisses de Retraite” - that cover formal private sector workers, c iv i l servants, the military, employees o f state owned enterprises and other public bodies. These pension funds include the CNSS (Caisse Nationale de Securitk Sociale), the basic scheme for private formal sector workers, the C M R (Caisse Marocaine de Retraite) for tenured civ i l servants and the military, the RCAR (Rkgime Collectif d ’Allocation de Retraite) for employees o f para-statal organizations, and the

ANNEX I V Page 3 of 11

CIMR (Caisse Interprofessionelle de Marocaine de Retraite), which i s a non- governmental supplementary fund.

8. The CNSS (2.5 mi l l ion affiliates), the CMR (800 thousand affiliates), and the RCAR (200 thousand affiliates) are mandatory, although they cover less than 30 percent o f the labor force due to labor informality. The C I M R (250 thousand affiliates) i s voluntary and complementary. The CNSS and the C M R operate defined benefit schemes financed o n a pay-as-you-go (PAYG), while the R C A R operate both a defined contribution plan and a defined benefit plan, also financed on a PAYG basis.

9. Morocco does not have private pension funds o f significant size, but i ts four major pension schemes have accumulated a large volume o f assets (Table 2), due to their surpluses and the policy o f prefunding o f future PAYG liabilities. The R C A R assets back both i t s defined benefit plan and i t s defined contribution plan. The assets o f the CNSS and the R C A R are managed by the C D G (Caisse de DkpGt et de Gestion) while the assets o f the CMR and the CIMR are managed internally.

Million MAD

Insurers

Pension Funds CIMR CMR RCAR CNSS"

Total

Equities Mutual Fund Fixed Mutual Fund - Mutual MM and ST Other / Property Total ' Equity interest Divers. Fund - Mutual Fund Deposits

LMT 11,026.7 8,457.6 18,866.9 2,996.5 27,579.5 8,812.7 3,932.6 3,916.7 85,589.2 Equities Mutual Fixed Negotiable Other/ Property

Funds Interest debt Deposits

3,483.5 681.9 2,390.1 526.8 209.5 7291.8 7,703.2 839.2 43,719.5 453.7 52,715.5

** ** 35,133.7 4.7 423.4 75,273.0 21,077.2 2 1,077.2

241,946. 7

ANNEX I V Page 4 of I1

for more liquid assets and shorter durations. The CDG has indicated that this switch takes into consideration the possibility o f reforms that would preserve the surpluses o f the C M R for a longer period.

12. Together, the assets o f the insurance and pension sectors in Morocco amount to about 38 percent o f GDP, by far the largest ratio in the MENA region. The two sectors have the capacity to absorb a large volume o f financial assets issued by domestic financial and non-financial institutions and promote further more capital market development. This capacity has been to some extent under-utilized due to the insufficiency o f prudential rules reducing the duration mismatch o f both banks and insurance companies. However, the ongoing efforts o f the Central Bank to reduce banks' maturity mismatch, and the plans o f the insurance regulator to migrate towards risk-based capital requirements (see below) should promote the supply and demand for assets with longer duration. The current plans o f the two major pension funds should have a similar effect.

13. The taxation o f longer term savings broadly follows international norms, although s t i l l being some way from the EET ideal. In practice a TTT system applies but with the exit tax reducing considerably (in some cases to zero) when a contract has been maintained for more than 8 years (recently reduced from 10 years). A project i s currently underway to examine further strategies to encourage long term savings.

3. Regulation and Supervision

14. Supervision o f insurance and pensions i s currently carried out through an arm o f the Ministry o f Finance and Privatization called DAPS (Direction des Assurances et de la Pre'voyance Sociale). This unit has a staff o f 150 of which approximately two thirds are technical operatives. Costs are met by levies on the industry which go into general revenues.

15. As noted, DAPS has the benefit o f a relatively modern insurance law passed in 2002 and which became largely effective with the issuance o f relevant regulations and circulars by the end o f 2005, although the Minister o f Finance has wide powers to change some regulatory parameters. Conservative assumptions are applied under the law in establishing technical reserves including a maximum technical interest rate o f 3.75% for l i f e rating and reserving purposes (the current technical interest rate i s 2.75%). Solvency rules broadly fol low current EU practice, although they were recently modified to allow a proportion o f unrealized capital gains to be included in net assets for solvency purposes.

16. A Consultative Committee consisting o f representatives o f the insurance industry (including intermediaries), CDG, MOF, a representative o f the National Council for Prevention o f Road Accidents and a financially qualified magistrate has had to date oversight o f new regulatory developments, sanctions and the issuance o f new licenses. This committee will be disbanded under a new draft law to set up an independent insurance supervisory body, and more targeted consultative arrangements will take i t s place.

17. Accounting standards in Morocco do not differentiate between SAP (statutory accounting standards) and GAAP (Generally Accepted Accounting Principles). These can be quite different in industrial countries as the former assumes a wind up scenario (Le.

ANNEX I V Page 5 of I1

having a balance sheet orientation) and the latter primarily attempts to identify economic earnings. Moroccan banks broadly fol low international standards and listed holding companies have the option. Individual companies other than banks have to follow Moroccan standards which s t i l l adopt a historical cost approach.

18. Accounting standards for insurance and pensions are promulgated by DAPS. At present listed equities and mutual funds are held at market or quoted value. Historical cost accounting applies to the remaining financial assets including: (i) Government debt and dept guaranteed by the government held directly; (ii) Certificates o f deposit; and (iii) Bank bonds. This approach appears to arise from a view that it should not be possible over time to see a profi t or loss from a fixed interest security issued at face value. Thus any realized losses or profits (after tax) need to be taken to a special capital reserve and are not available for distribution, although they are available in part to support insurer solvency ratios.

19. Another area where a graduated approach i s being taken i s the introduction o f Takaful insurance. Rather than introduce Sharya law to the financial sector, Morocco has created substantial scope for the creation o f mutual insurers. This i s in contrast to a number o f other Islamic countries, particularly in the GCC, but does not appear to have affected the growth o f the insurance sector. In discussions with the insurers it became clear that the broad logic for the development o f the sector i s linked to compulsory insurance and banks’ clients.

4. Current Reforms

20. Although the insurance sector has grown in recent years, the Government i s aware o f the regulatory and supervisory weaknesses and the need to ensure the sound growth o f the sector, especially the fast growing l i f e sector. The prudential regulation o f the insurance sector i s not a trivial matter as attested by the complex technical discussions surrounding the introduction o f Solvency I1 in the EU. Morocco is making an effort to harmonize i t s regulatory framework with the EU. Progress towards this goal will require inter alia a more stable supervisory framework and enhanced supervisory capacity.

Establishment of an independent insurance supervisor

21. The Government has recognized the need for more supervisory independence through a draft law that creates a new and independent supervisor and which currently sits with the Secretariat o f the Government. The draft law gives the new authority (“Autorite‘ de ContrGle des Assurances et de la Pre‘voyance Sociale ”) statutory control over insurance, pension funds (subject to any specific laws) and annuity providers.

22. The draft law i s well structured and provides a reasonable regulatory balance between the supervisor (who should have basic technical regulatory authority) and the Ministry (which should retain power over policy matters). In practice, most Ministerial level decisions will fol low recommendations emanating from the Authority and the Ministry will maintain oversight through a government commissioner.

23. The authority will be structured around a Board (Conseil), a President (appointed under Article 30 o f the Censtitution) and two commissions. The Board will act much as a normal oversight body, setting overall policy, approving the annual report and budget,

ANNEX I V Page 6 of 11

designating the external auditor, approving the accounts, setting remuneration, and deciding the organization chart and Director level appointees (on the President’s recommendation). The Council will consist o f the President o f the Authority, the Vice Governor o f the Central bank, Bank Al-Maghrib, the Director o f the Treasury, the Director General o f the securities supervisor and three experts in insurance or pensions (four year terms, renewable once). The Board will meet at least twice a year, although any 3 members can call an ad hoc meeting.

24. The President i s responsible to the Board for information flows and may delegate management responsibilities to his staff. In the event the President i s impeached the Bank Al- Maghrib Vice Governor or Director general would fill in.

25. A sanctioning commission (Commission de Discipline) will advise the President o f the Authority on such matters as sanctions to be applied and recovery plans submitted by insurers and pension funds. It will consist o f two o f the experts from the Board plus a third person expert in this specific area, a representative o f the insurance and reinsurance sector, a representative o f mutual societies (only present for discussions concerning mutuals) and a representative o f the pensions sector (again only present when matters relevant to their sector are being discussed). The Commission can take testimony from outside experts, the party concerned or their legal representatives. Only the specialist member will be remunerated for services rendered. Recourse against decisions o f the Authority will be available via the Rabat administrative tribunal.

26. A regulatory commission will advise the President o f the Authority on proposed legal and regulatory matters. This consists o f two representatives o f the Authority (acting as president and vice president o f this commission), 6 representatives o f the insurance and reinsurance sector, 2 representatives o f the intermediaries. One representative o f the credit grantors, 2 to 4 representatives o f the pension sector, 4 representatives o f mutual societies and 2 representatives o f the compulsory health insurance sector. The insurance sector, intermediaries and credit grantors are able to designate their representatives. As a general rule, representatives may only attend sessions related to their sector.

27. The Authority will be financed from the markets it supervises (as i s the Insurance Department already) and will be permitted to reserve up to three years o f recent average expenditure.

28. Discussions with the industry evinced a general concern over the demise of the current consultative body, the creation o f the sanctions commission and the loss o f industry oversight o f new license applications. However the M O F Insurance Department Director has made it clear that the sanctions commission will effectively be an independent decision making body (although the industry representative’s input will be advisory only - he or she will not have a vote). In addition, the recourse mechanism appears consistent with good international practice.

Program Contract between the Sector and the Government (2009 - 2014)

29. It has been pointed out that the relative success o f the Moroccan insurance sector can in part be attributed to the close coordination that has existed between the government and the sector, and a forward looking approach when it comes to approval o f

ANNEX I V Page 7 of I1

innovative marketing mixes. The introduction o f banc-assurance i s one good example o f this - although market conduct standards may need to be examined.

30. The next phase o f this coordination will be effected through a Contract Program to be agreed between the sector and the government. Formally this entails a document laying out the commitments and roles o f the various parties in the presence o f the King and the Prime Minister. The production o f this contract i s being coordinated by the M O F and as a starting point a report laying out all o f the relevant issues and possible reform actions was commissioned from Oliver Wyman (an arm o f Marsh) and Actuaria (a French actuarial consultant). The report l i s ts 75 measures covering product development, compulsory classes, prudential controls, investment rules, internal controls and risk management, internationalization and implementation. Most measures are sensible although there i s probably too much emphasis on the addition o f new compulsory classes, and the introduction o f modern risk management and prudential standards i s allowed a rather generous timeframe.

5.

Insurance and pension sector Asset and Liability Management (ALM) and risk coverage - capital market linkages

31. Measures 33 to 36 o f the draft program contract deals with prudential matters. The contract anticipates a transfer by 2013 o f safety margins requirements from asset coverage o f conservative technical reserves to capital standards (i.e. to a solvency margin determined by a Risk-based Capital, RBC, formula). One initiative already underway will see the sector installing formal internal control systems (envisaged by a 2008 Circular) by December 2010. Others see ALM and risk management processes being introduced over the next 3 years. A the same time, the Program Contract sees excess asset coverage o f reserves being reduced, limits on equity investments being withdrawn and assets eligible to cover technical reserves being extended to include equity in foreign insurance subsidiaries. These latter proposals will be carefully considered, as some are probably undesirable.

32. One highly desirable recommendation sees the establishment o f a recognized actuarial role and in particular a requirement that a responsible actuary sign o f f on insurers’ accounts.

33. The proportion o f technical liability coverage that can be invested in listed equities was increased from 50% to 60% in a decision issued in March 2009. Given the scope provided by the estimated asset allocation as at December 3 lst, 2008 it i s not clear why this step was seen as being necessary. However the implication i s that some insurers may wish to have up to 60% o f relevant assets in listed equities - a risky strategy given that most liabilities o f the Moroccan insurance sector involve contingent guarantees. If a comprehensive RBC regime were already in place there would be grounds for liberalizing investment rules for insurers - however the current solvency regime i s based largely on EU Solvency I which assumes a conservative investment portfolio and caters largely for liability side risk.

34. In the circumstances there is recognition o f the need to establish an interim regime while the new prudential regime i s being developed and implemented. Two

Main Issues that will be Addressed by Program - Contract

ANNEX ZV Page 8 of I1

possible approaches are to a) reduce the limits on risky investments or b) to add asset loadings to the current liability based minimum solvency level. The major insurers appear to be well capitalized and the latter approach would ensure that a larger proportion o f their net assets were secured against asset value fluctuations.

Limited operational and financial control of Long Tail insurance classes- MTPL and Workman 's Compensation

35. Aside from the potential for high exposures to risky investments the major risk facing the insurance sector i s the potential volatility (and even secular decline) o f technical underwriting results from long tail classes o f non l i f e insurance - in particular compulsory third party motor and workman's compensation. M T P L and W C A account for two thirds o f gross non l i f e premiums in Morocco and a larger proportion o f technical reserves. Morocco i s one o f the ten worst countries in the world for motor related deaths relative to vehicle usage. Public transport experience i s particularly bad and a separate insurer (CAT) set up for this market segment and owned by all participating insurers has been in operation since 1992. 36. An increasing frequency o f losses has rendered these classes marginal in terms o f profit. In addition there i s chronic under reporting o f payrolls by employers and W C A premium revenues are either inadequate or rates need to become artificially high. These two classes are also subject to legal and social trends and economic conditions: implicit pure premiums can change significantly over short periods and the current minimum non l i f e solvency margin i s almost certainly inadequate to cover even liability risk alone. In order to be able to respond it i s critical that the industry has access to a consolidated and up to date database and relevant analytical capabilities (Le. actuarial skills).

37. Other identified factors in controlling these classes are active risk control (e.g. safe driver campaigns and industrial safety measures) and professional claims management. In most industrial countries the insurance sector plays an active role on the loss control front. Finally there i s a need to ensure compliance with the relevant laws by all drivers/ employers, and to control fraud.

38. While premium setting for these important classes was partially deregulated in 2006 (however very limited use o f rating factors i s permitted for motor - only fue l type and power level may be employed) the industry i s not really prepared for, or permitted, to act as a fully liberalized market. In particular there i s a need to establish a clean and complete claims and exposure database and to introduce relevant actuarial methodology - the insurers association has initiated a project along these lines. This in turn will mean training the sector in the maintenance o f appropriate policy and claims records and establishing an affective central database manager and electronic data transfer capabilities.

Statutory and financial accounting standards

39. As noted, Morocco does not differentiate between financial and statutory accounting standards. Most standards are promulgated by the Conseil National de la ComptabilitC (CNC). However banking and insurance accounting standards are established by the relevant supervisory bodies. Accounting standards for banks broadly follow EU standards (Le. are close to international standards).

ANNEX ZV Page 9 of I 1

40. In contrast insurance accounting methodology, which was most recently reaffirmed under Articles 38 through 40 o f the Ministerial decision updated in March, 2009 (No 5718), continues to follow a classical historical cost formulation. In particular capital gains are required to be transferred to a permanent reserve and are not available for distribution. Where price discovery i s not readily available an expert valuation must be sought.

41. Article 41 provides an exception from historical cost accounting for investment linked contracts and unrealized gains can in part be taken into account for solvency purposes. 42. This rather dated approach reflects combination o f a a desire to maintain hidden reserves (i.e. maintain balance sheet strength) while solvency standards are weak and asset limits are relatively unconstrained and some concern as to whether Solvency I1 can be applied in emerging markets such as Morocco. However the Moroccan insurance accounting plan does not encourage insurer management and boards to think about ALM issues (Le. relative durations and convexity and liquidity) and if macro settings change significantly this could see the industry balance sheet significantly weakened. In addition there i s no incentive for the sector to push for the development o f the medium and long term debt markets - at present the average duration o f private sector debt instruments i s only 3 years. The duration o f public debt instruments i s a l i t t le longer at between 5 and 6 years. No long te rm debt has been issued by the Government for 2 years and this market i s currently effectively illiquid. 43. Foreign insurers such as AXA are subject to local and group risk models but other local insurers are not necessarily so aware o f modern risk management techniques. Under the circumstances there i s good reason to hasten the introduction of mandatory ALM analysis and related risk management requirements (see paragraph 34 above) as an interim step towards the introduction o f international accounting standards and a more fully fledged RE3C regime.

Taxation of life insurance - investment only products

44. Non l i fe insurers are subject to normal company tax with offsets for withholding tax on interest income and capital gains. The company tax rate for financial institutions i s higher than for other enterprises although the rate was reduced from 39.5% to 37% in 2008. L i f e insurance i s treated similarly to non l i f e (there i s no statutory fund concept so an insurance policy is considered to be purely a contract with the l i f e insurer) and longer term savings are encouraged through reduced or nil tax (for capitalization policies paid from un-deducted premiums) on proceeds taken after 8 years.

45. A crude imputation system means that dividends are effectively taxed l i t t le more than once and differential tax rates between individuals and companies means that investment income received via a l i f e contract i s potentially treated more generously than dividends received directly by an individual. Short term capital gains on fixed interest securities are taxed at 20% while those arising mainly from equities are taxed at 15% - reinforcing the bias towards equities for trading portfolios.

46. A clear anomaly i s that capitalization policies (Le. pure savings and investment contracts) are subject to a 3.45% tax on premiums. Reasons given for this included:

ANNEX I V Page 10 of 11

0 A tax on the r ich 0 A replacement for there being no VAT ( VAT and GST i s not applied to

insurance in most countries) A tradeoff for the 8 year plus concession. It copies French practice - not borne out by an investigation o f French practice

47. Global best practice i s to tax services not capital and the result o f this tax has been to effectively kill the capitalization market. Ideally capitalization contracts would be put onto a similar tax basis as normal long te rm l i f e insurance contracts.

Catastrophe Fund

48. Morocco has a history o f weather and earthquake related disasters and to date relief, rehabilitation and reconstruction have been funded largely out o f state revenues (including privatization proceeds) and donations from other countries (Saudi Arabia in particular). A draft law to establish a compulsory catastrophe and terrorism classes o f insurance has been with the Secretary to the Government for some years. This law would establish a Catastrophe/ Terrorism Pool to be run by the national reinsurer, Soci6t6 Centrale de R6assurance (SCR) and potentially remove a large contingent liability from the government's balance sheet. However the proposed arrangement would not cover drought - this i s sensible given the special characteristics o f this risk in Morocco.

49. A second important reason given by M O F for establishing such a fund i s that it would support additional FDI , particularly in the tourist industry, where terrorism insurance i s not readily available. Presumably awareness o f insurance at household level would also rise: insurance penetration is currently very l o w within the household sector (mortgage and motor related coverages aside).

50. A further side benefit would be that the transition o f SCR to a stand-alone reinsurer without the benefit o f compulsory cessions would be eased - SCR could aspire to become a regional catastrophe and terrorism pool manager. Compulsory cessions to N C R have to cease in 2012 under an international trade and services agreement. To date Morocco has been complying by gradually removing classes subject to compulsory cession with motor, the largest class, due to be the last to be removed.

Access to health insurance

0

0

51. The insurance industry has been offering voluntary group health insurance to private sector employers in Morocco for several decades. In 2005 a basic public health insurance scheme called Assurance Maladie Obligatoire (AMO) was introduced. This covers 4 1 relatively serious interventions, ambulatory care and hospitalization with a 30% co pay for the medical interventions and 10% for hospitalization. Employers with existing insurance arrangements were given 5 years grandfathering before having to enter the public scheme. The contribution rate i s 4% (2% employer/ 2% employee) and there i s some concern that as the scheme i s extended to previously uninsured workers with accumulated health issues this will prove to be inadequate. This i s offset by a concern that lower paid workers will not be able to access some medical interventions because o f the size o f the co-pay.

ANNEX I V Page I1 of I1

52. Other insurance arrangements include mutuals de santC (mainly for local authorities) and CNSS which runs a number o f clinics. In addition the post office i s distributing a privately underwritten coverage for the se l f employed, supported by the government's micro-finance initiative. Feedback during the mission questioned the efficacy o f this latter initiative. Subsidized mutuals (mutuelles de sante) have proved to be more effective for delivering health funding to the informal sector in other developing markets.

Investment linked life contracts

53, Investment linked l i fe insurance (effectively mutual funds with insurance tax wrappers) products have been approved, but to date have not gained a significant market presence. La Marocaine Vie launched the f i rst products in November, 2007, managed by Gestar, a Socie'te' Ge'ne'rale subsidiary. These products are extremely complex in practice - particularly in terms o f accounting, reserving and tax - and it i s not clear that either the supervisor or the industry as a whole, fully understand the technical and system requirements.

ANNEX V Page I of 10

ANNEX V. ACCESS TO FINANCE, MICROCREDIT AND FINANCIAL INCLUSION

Financial Sector Depth vs. Access

1. The Moroccan financial sector i s large relative to GDP, whether measured by deposits or credits. As shown in the upper part o f Figure 1, Morocco has ratios of deposits and credits to GDP o f about 90 percent, much higher than expected for i t s per capita income. The large volume o f remittances from Moroccans living abroad i s probably one o f the main factors that have contributed to this outcome, although macroeconomic and financial stability and sound financial regulation have probably contributed as well.

2. However, Morocco’s financial depth s t i l l does not translate into access. While it i s true that Morocco made an impressive progress in financial inclusion, as indicated by the increase in the number o f commercial banks’ deposit accounts per population, from 15 percent in 2002 to 29 percent in 2008, access ratios are not particularly impressive by international comparison. As shown in the Figure 1, the ratios o f deposits and loans per population are not particularly remarkable, and are even slightly below the levels that would be predicted by Morocco’s per capita income.

3. The scope for further gains in access becomes even more apparent in the bottom part o f Figure 1. A country with Morocco’s high ratios o f deposits and loans to GDP would be expected to have much higher ratios o f deposits and loans per 1,000 adults. These results imply higher rates o f concentration in the case o f Morocco, and the scope for further gains in access to larger segments o f the population and o f enterprises.

4. Measures o f physical access show a similar picture. As shown in Figure 2 and Table 1, Morocco seems to have a relatively better level o f physical access to financial services through branches but lags behind in ATM and, especially, points o f sales coverage. Compared with other MENA countries Morocco has also comparable levels o f branch network but has markedly fewer ATMs or POS per population, helping explain why access to financial services i s low. Banking density remains heavily skewed to urban locations (5,800 per branch) as versus rural locations (1 12,000 per branch).

Table 1. Indicators o f Physical Access: Regional and Intl Comparisons

Countrv GDP Der caDita Branches ATMs POSS (constant 2.000 per 100,000 adults per 100,000 adults per 100,000 adults

Algeria 2 190.74 5.33 4.13 8.37 Iran 2227.79 28.81 23.97 1,353.14 Jordan 2371.70 16.17 Lebanon 5726.07 29.12 38.55 1,292.92

Morocco 1769.98 11.60 16.65 45.87 Syria 1289.40 2.24 0.95 Tunisia 2759.93 13.64 14.26 171.85 Yemen 558.02 1.82 2.44 16.96

Source: CGAP-Financial Access 2009 and World Development Indicators

ANNEX V Page 2 of I O

Figure 1. Depth versus Access: Deposits and Loans

0 . 0 l a m 0 25500 30000 4000

Xerem- Loarls 1300

4

0 10000 20000 30000 400t GPPper capita

1 Depth vetnro .&cress - Lorrris

I500

0 20 40 60 80 100 120 1 4

Loans % o f CDP I

ANNEX V Page 3 of 10

Figure 2. Physical Access: Branches, ATMs and POSs

$ 100 1. a 50 4

0

* 4 0

1

*

0 10000 20000 30000 40000 50000 60000 70000 GRP pet C'npitn

8000

0 1 lS000 20000 30000 40000 50000 60000 70000

GDY ptr C'apita

Source: CGAP, Financial Access (2009) and WDI

ANNEX V Page 4 of 10

Firms' Access to Finance

5. According to the latest Investment Climate Assessment (2007), access to finance improved dramatically in Morocco between 2004 and 2007. In 2007, 32% o f f i r m s identified access to finance as a major constraint, compared to 78% in 2004, as illustrated in Figure 3. In spite o f this improvement, a larger share o f Moroccan enterprises s t i l l reports access to finance as a constraint than enterprise in MENA and lower middle income countries. As shown in Figure 4, this i s particularly true for smaller enterprises.

6. One o f the obstacles faced by small f i r m s i s the level o f collateral which seems to be high by international standards. Moroccan banks tend to require from loan applicants a whole range o f collaterals (Table 2), including land, buildings, personal assets, and fonds de commerce (goodwill). According to the banks, this conservative behavior is a result of the financial opacity o f Moroccan f i rms. The Investment Climate survey shows that f i r m s with more reliable information for banks, whose financial statements are audited by external auditors, tend to get more credit with lower collateral (Figure 5). These results also suggest that more information on credit histories could also contribute significantly to greater access to credit.

Figure 3. Firm Perceptions o f Access to Finance as a Constraint

% of firms identifying access to finance as a major constraint r " *

90

80

70

60

50

40

30

20

10

0 -

78% J a 79% ,j: ; I

, i

2004

I 2007 I

AI I [5-20[ [r;a-neo[ [%@a-

Source ICA Morocco, 2004 and 2007

ANNEX V Page 5 of 10

Figure 4. Percentage of Firms Identifying Access to Finance as a Major Constraint in Morocco, MENA, and Lower Middle Income Countries

Table 2. Types of Collateral Required by Banks

YO firms using this type o f collateral Collateral

Land, buildings 71.5 Machinery and equipments including movables 66 Fonds de commerce (goodwill) 78.1 Personal assets o f owner 75.6 Other 37.9

Source: ICA Morocco, 2007

ANNEX V Page 6 of 10

Figure 5. Financial Audit and Access to Credit"

96 firms having a bank loan V ~ l u e o ~ C o l l ~ t e r a l N e e d ~ f o r a ~ a n ~ ~ o f ~ h e ~ a n A m o u ~ ~

60 250 50

50 194

40

&20[ [20-100[ POo- 15-N [rn-ioo[ I lW

&Audited NotAudited I Audited Not Audited

Source: ICA Morocco, 2007

The Moroccan microcredit sector

7. Morocco i s a recognized leader in microcredit for the MENA region, with 40% o f client outreach in the Arab world. There are 12 licensed microfinance institutions (MFIs) in Morocco servin about one mi l l ion clients, with combined assets o f 5.7 bi l l ion MAD (705 mi l l ion U S D ). The industry is heavily concentrated and the four largest institutions account for over 90% o f the outreach. Between 2004 and 2007, the sector enjoyed one o f the most rapid growth rates seen in the microfinance industry so far. As shown in Table 3, the number o f clients increased by a factor o f three and the coverage ratios increased by similar rates. l3

8. This high growth rate was driven by four associations: Zakoura, Al-Amana, Fondation des Banques Populaires pour le Microcre'dit, and Fondep. These institutions scored wel l on al l microfinance performance metrics including scale, depth o f outreach, asset quality, and profitability. These impressive results did not go unnoticed and Al- Amana and Zakoura were awarded several international prizes (including MIX best performing MFI in the world, European prize for microfinance).

9. Commercial banks are unusually significant backers o f microcredit in Morocco. Banque Centrale Populaire and Cre'dit Agricole created two o f the largest microcredit associations and are funding 85% o f the sector's assets. Their exposure to the sector was estimated at USD 600 mi l l ion in 2008. And over the past four years the commercial funding liability ratio o f the sector has gone from 9.5 percent to 71 percent.

15

The horizontal axis i s in terms o f employees. 3 Is' December 2008 USDiMoroccan Dirham Exchange Rate (1USDl8.08 MAD) 12

l3 Microfinance Information Exchange (MIX) Trend lines

ANNEX V Page 8 of 10

areas. Non-performing loans started to r ise significantly from one o f the lowest levels o f the world, 0.42% in 2003, to 1.9% in 2007. The sharp rise in non-performing loans took place in 2008 and affected all MFIs. Portfolio at risk (30 days) increased significantly to 5% in December 2008 and reached an alarming level o f 9% in June 2009. In May 2009 Zakoura, one o f the Moroccan flagship institutions, experienced major difficulties and was rescued by the initiation o f a merger with another institution. Some MFIs are st i l l facing serious management and portfolio quality challenges. These problems resulted in a loss o f outreach in the period, as shown in Table 3.

13. The roots o f the credit crisis can be found in the institutional capacity o f microcredit associations. The unprecedented growth overstretched their capacity, translating into lenient credit policies, obsolete Management Information Systems (MIS) systems, lack o f internal controls and substandard governance. Multiple lending to the same clients was an aggravating factor. A study conducted by the central bank estimated that 40% o f microcredit beneficiaries had more than one loan. The problem i s particularly acute in urban areas.

Figure 6. Portfolio at Risk (30 days) in the Moroccan Microcredit Sector

k 2004 2005 2006 2007 2008 June2009

Source: MIX market and BAM (2008 and 2009 data)

14. The Ministry o f Finance supported the initiation o f the merger o f the worst affected association, Zakoura, by the Fondation des Bungues Populaires pour le Micorcre'dit, a large microcredit association associated to the Cre'dit Populaire du Maroc, to restore confidence and avoid further contagion effects on loan delinquency. l5

15. Microcredit associations have put in place aggressive recovery plans. Their plans encompass some bold actions, including management changes and freezing new disbursements. Associations are tightening their credit processes, putting in place 'SWAT' teams focusing on loan recovery, and are taking judicial action with a demonstration effect on delinquent borrowers. They are also exchanging credit

~

15 The merger o f Zakoura and Fondation de Ranques Populaires pour le Microcredit (FBPMC) was announced in May 2009. FBPMC has taken over control o f Zakoura, but there remains legal issues to fully complete the merger.

ANNEX V Page 9 of I O

information on a weekly basis to control over-indebtedness. Finally, small and medium size microcredit associations are planning to share resources such as back office systems or to merge. These efforts are slowly paying o f f and a recovery i s expected for the first semester o f 2010. However, some associations have been severely hit and will have to be restructured; others are emerging stronger and well positioned for another phase o f growth.

16. The first priority o f the government i s to consolidate the microcredit sector. Several actions are underway in collaboration with the central bank and the Federation o f Microcredit Associations, FNAM16. This includes a directive to strengthen the governance o f the associations and introduce tighter financial reporting requirements. The Moroccan government has also secured 46 mi l l ion USD from the Millennium Challenge Account to support the sector, provide new liquidity through a country fund JAIDA, and strengthen management information systems and internal control.

17. The credit bureau was launched in October 2009, and collects borrower information from large microcredit associations. This i s a major step forward that allows microcredit associations and banks to improve credit analysis as well as to control client over-indebtedness. The third priority i s to secure liquidity. The government i s encouraging linkages between microcredit associations and banks. Two o f the largest associations have already been established by banks. Smaller institutions are encouraged to find bank sponsors.

18. The fourth and final priority i s to improve the regulatory framework. The Ministry o f Finance has launched a survey with funding from the Millennium Challenge Corporation to assess the strengths and weaknesses o f the sector and to provide recommendations to improve the regulatory framework for microfinance. The study will also look at the transformation o f some o f the largest institutions into commercial, prudentially regulated, entities. The results o f the survey should be available in the second quarter o f 2010 and discussed with FNAM and the industry in the second hal f o f 2010.

Banks in Microfinance

19. L o w income banking (bank down-scaling) appears to be poised for take-off. Four large commercial banks have launched new financial products targeting l o w income groups. However it i s not clear how far banks will penetrate into rural and semi-urban areas, beyond their urban concentration. Each bank has a specific strategy, linked to diverse distribution channels which make it possible to have a competitive banking offer for l ow income individuals.

20.

Government Support to Microfinance and Financial Inclusion

21 I The growth o f the microfinance sector could not have happened without the strong support of the Moroccan government. The Microfinance L a w o f 1999 provided a clear framework for the development o f the industry, and the fund Hassan I1 helped to capitalize the first microcredit associations. The sector also benefited from the support o f

The second priority i s to control over-indebtedness.

Federation Nationale des Associations de Micro credit 16

ANNEX V Page 10 of 10

the international donor community, notably U S A I D and the European Commission, now relayed by International Finance Institutions (IFIs) such as the IFC or the German KfW. 22. The Government has also provided a strong lead in promoting financial inclusion. In 2008 for example banks were invited to develop financial inclusion strategies, and the central bank more recently has signaled to banks that it i s open to allowing innovations in products and delivery mechanisms. The establishment o f the A1 Barid bank (the Postal bank), which will use the postal branch network to extend access to a wider set o f financial services to l ow income clients, i s an important measure to extend access to financial services and to encourage competition. The current framework for mobile phone banking i s s t i l l in development but doesn’t seem to hamper innovations in the markets

23. The Government has recently encouraged l i n k s between banks and MFIs, for example in supporting the merger between Zakoura and FBPMC. Banks are already well regulated and can offer a range o f financial services, so developing service delivery and client monitoring arrangements with microcredit associations that take advantage o f their networks, market knowledge, and customer base, offers considerable potential. The expense and demands on supervisory resources that a law allowing deposit-taking microfinance institutions would imply, on the other hand, will be carefully assessed against the potential use and benefits o f such a law.

ANNEX VI Page 1 of 2

ANNEX VI. FUND R E L A T I O N S NOTE

MOROCCO-Assessment Letter to the World Bank Macroeconomic Performance and Policies”

1. Despite the recession in partner countries, notably the euro area, economic performance in Morocco has remained favorable. With l i t t le financial sector l i n k s to international financial markets, the main impact o f the global crisis has been on the real sector. Activity in manufacturing, tourism, and trade slowed considerably starting in the last quarter o f 2008, but now appears to be stabilizing, and growth in nonagricultural output o f about 2% percent i s expected for 2009. Combined with exceptional output in the cereal sector, overall GDP growth in 2009 i s projected at around 5 percent. Average inflation i s expected to fall below 2 percent in 2009 from 3.9 percent in 2008 as international commodity prices fall. The unemployment rate stabilized at 9.8 percent in the third quarter o f 2009, but youth unemployment i s higher and remains an important challenge.

2. Morocco’s external current account i s expected to improve following a deterioration in late 2008 and the first half o f 2009. As a result, after registering a deficit o f more than 5 percent in 2008, the current account deficit should narrow to below 4% percent o f GDP in 2009 as exports, tourism, and remittances stabilize. On the other hand, the capital account i s expected to deteriorate reflecting the sharp decline in net foreign direct investment. Gross international reserves slipped in late 2008 and the first half o f 2009, but have been recovering since then and are expected to remain strong at 7 months o f prospective imports by the end o f the year.

3. A fiscal deficit o f about 2% percent o f GDP i s expected in 2009 following a very strong performance in 2008. Revenue i s expected to fall considerably as a share o f GDP, primarily reflecting the slowdown in nonagricultural activity, but also the lowering o f certain tax rates, and the expiration o f exceptional factors that boosted revenues in 2008. On the spending side, the government launched a stimulus package to mitigate the economic downturn which includes a boost in public investment and several specific initiatives targeted at exporting industries. Outstanding government debt f e l l to 47 percent of GDP in 2008. The projected debt-to-GDP ratios for 2009 and 2010 are 47 and 48 percent, respectively..

4. In the context of low inflation, and consistent wi th the exchange rate peg, monetary policy has been loosened this year. The Central Bank lowered i t s key interest rate by 25 basis points to 3.25 percent. Broad money has slowed significantly, increasing by only about 3 percent since the beginning o f the year, while NFA has broadly stabilized. With declining liquidity in the market during the f i rst half o f the year, the central bank has lowered reserve requirements gradually from 15 percent to 8 percent since end-2008.

This assessment reflects information drawn from the IMF Mission on the 2009 Article I V Consultation 17

Discussions with Morocco, which took place from November 2-13,2009.

ANNEX V I Page 2 of 2

5. The economic outlook for Morocco should improve in 2010, but will remain partly conditioned on developments in the external environment. Growth in the euro area, Morocco’s main trading partner, i s projected to be low, but slightly positive, contributing to a gradual recovery. Coupled with a further fiscal expansion in 2010, helping to boost domestic demand, nonagricultural growth should r ise to about 4 percent in 2010. However, agriculture output i s projected to return to trend levels, pulling down overall GDP growth to 3-3s percent. Inflation i s projected to be around 2 percent, and the current account deficit i s expected to remain stable.

6. The authorities intend to loosen fiscal policy further in 2010 to support economic recovery. To this end, the 2010 budget envisages a deficit o f 4% percent o f GDP (excluding privatization receipts). With a further r ise in public investment, spending will increase by about % percent o f GDP relative to 2009. Revenues are projected to fall by about 1 percent o f GDP, due both to tax policy changes and automatic stabilizers playing out. While the fiscal loosening i s appropriate given the economic conditions, the crisis i s a temporary phenomenon, and thus the authorities should aim at bringing the deficit under 3 percent o f GDP over the medium term to stabilize the debt-to-GDP ratio.

7. The direct impact of the global crisis on Morocco’s banks has been limited. The global integration o f Morocco’s banking system i s limited: banks and corporates have very l o w external debt, there i s no exposure to toxic assets, and the system i s effectively non-dollarized. Moreover, the capital account is only partially open, further shielding the financial system from the global crisis. The impact on Morocco o f the recent events linked to Dubai World i s expected to be very small. Moroccan banks have very limited exposure to Dubai financial institutions and corporate entities. NPLs have been under control, but the rapid rise in credit in 2005-08 raises concerns about future loan deterioration. In this context, banks have tightened lending standards, and the central bank intends to increase the minimum capital adequacy ratio o f some banks according to their risk profile by end-2009. Moreover, a credit bureau has recently become operational, which will further improve credit monitoring.

8. The authorities are deepening structural reforms to increase productivity and competitiveness, which should help boost growth and reduce unemployment. In the agricultural sector, the Plan Vert i s moving ahead, with the aim o f boosting productivity and ensuring that the sector serves as a source o f economic growth. Likewise, reforms in the education sector are ongoing to achieve a better match o f skilled labor to the needs o f the market, a critical effort to reduce the longstanding problem o f youth unemployment. In addition, the authorities have initiated a reform o f the justice system, and will continue ongoing efforts in the energy, industrial and tourism sectors. They are also proceeding with a reform o f the universal subsidy system. In this respect, the ongoing pi lot schemes to better target subsidies are welcome, but should only be extended as the universal subsidy scheme i s scaled back to avoid having two systems in place. On trade, the authorities are lowering tar i f fs in the context o f their trade agreements while more broadly aiming to simplify the tari f f regime and lower maximum rates.

ANNEX VII Page 1 of 3

ANNEX VII. COUNTRY AT A GLANCE

MO~QCCO at a glance B ?#B

I I r t A r d F l o w 1

2 0 0 8

ANNEX VI I Page 2 of 3

E&ernal Debt and Resource FIolrvs

Composrtion oftotat extwnaldrbt,2008

1

2 0 0 8

e 0.2 47

2 0 0 7

W J 626

0 3 4 e 5

Governance Indicators, 2000 and 2507

&-to dcr r iaar

Techno l o g y a n d Infrastructure 2000

ANNEX VII Page 3 of 3

c

Millennium Development Goals Nwocco

G o a l B develop a global partnership f o r development 17

Education indicators f%) d I I