Assessing The Impact Of Fuel Subsidy Reform

BMI View: The Moroccan government has implemented a fuel price indexation system, aimed at reducing the budgetary cost of future oil subsidies. We have made a number of revisions to our consumer price inflation and fiscal and current account forecasts, and now see largely downside risk to our 2014 real GDP growth outlook. We do not expect the government to backtrack on subsidy reform, despite popular anger against the move.

Following months of preparation, the Moroccan government began implementing a fuel price indexation system on September 16, aimed at reducing the budgetary cost of future oil subsidies. On the back of this, w e have made a number of revisions to our consumer price inflation and fiscal and current account forecasts, outlined in the table below. We leave our GDP growth forecasts unchanged for now, projecting the economy to expand in real terms by 4.1% and 3.0% in 2013 and 2014 respectively (with growth this year largely driven by the agricultural sector). However, the government's subsidy reform adds a clear source of downside pressure to household consumption, investment, and exports through the coming quarters , and the 2014 outlook looks particularly at risk .

We have long highlighted the urgency of energy subsidy re form for MENA net oil importers, which since the start of 2011 have remained acutely exposed to elevated global commodity prices, slower foreign capital inflows, elevated political instability, and growing demands for increased government spending (see 'Subsidy Reform: Is The Time Nigh?', January 25) . Over the last few weeks, the threat of a US-led air strike on Syria had pushed up global oil prices significantly, adding pressure on Morocco's government to implement immediate subsidy reform.

Rapid Growth In Consumption
Morocco - Energy Use (kg of oil equivalent per capita) and Energy Imports as % of Total

BMI View: The Moroccan government has implemented a fuel price indexation system, aimed at reducing the budgetary cost of future oil subsidies. We have made a number of revisions to our consumer price inflation and fiscal and current account forecasts, and now see largely downside risk to our 2014 real GDP growth outlook. We do not expect the government to backtrack on subsidy reform, despite popular anger against the move.

Following months of preparation, the Moroccan government began implementing a fuel price indexation system on September 16, aimed at reducing the budgetary cost of future oil subsidies. On the back of this, w e have made a number of revisions to our consumer price inflation and fiscal and current account forecasts, outlined in the table below. We leave our GDP growth forecasts unchanged for now, projecting the economy to expand in real terms by 4.1% and 3.0% in 2013 and 2014 respectively (with growth this year largely driven by the agricultural sector). However, the government's subsidy reform adds a clear source of downside pressure to household consumption, investment, and exports through the coming quarters , and the 2014 outlook looks particularly at risk .

FORECAST REVISIONS
2012 2013 Forecast 2014 Forecast
Source: BMI
Real GDP Growth 2.4% 4.1% 3.0%
Fiscal Account (% of GDP) -7.2% -6.3 % ( previously -6.6% ) -5.7 % ( previously -6.1% )
Current Account (% of GDP) -10.0% -7.4% -6.0 % ( previously -6.5% )
Consumer Price Inflation , Avg. 1.3% 2.5% ( previously 2.0% ) 3.5 % ( previously 2.5% )

We have long highlighted the urgency of energy subsidy re form for MENA net oil importers, which since the start of 2011 have remained acutely exposed to elevated global commodity prices, slower foreign capital inflows, elevated political instability, and growing demands for increased government spending (see 'Subsidy Reform: Is The Time Nigh?', January 25) . Over the last few weeks, the threat of a US-led air strike on Syria had pushed up global oil prices significantly, adding pressure on Morocco's government to implement immediate subsidy reform.

Under the country's generalised subsidy system, introduced in 2000 and in effect until now, retail prices were fixed by the government - with the difference between the administered price and the recovery price supported by the central government's budget. This remained the case even as world oil prices and domestic energy consumption increased at a rapid pace : between 2000 and 2010, Morocco's energy use rose by 46.3%, according to World Bank data. S ubsidies accounted for MAD27.2bn (EUR2.4bn) in 2010, equivalent to 3.6% of GDP and 13.0% of total public spending. By 2012, this had risen to MAD54.9bn, or 6.6% of GDP and 20.8% of government expenditure.

Rapid Growth In Consumption
Morocco - Energy Use (kg of oil equivalent per capita) and Energy Imports as % of Total

Under the new price indexation scheme (already used in Morocco between 1995 and September 2000), the cost of petrol, diesel and fuel oil will be reviewed on a monthly basis. Any change in international oil prices of more than 2.5% over a two-month period will trigger an adjustment to the domestic retail price; some of the state's exposure to world oil price volatility under the previous system has therefore been transferred to households. Following the move, the retail price of diesel rose by 8.4% to EUR0.79/litre, while the price of petrol increased by 4.8% to EUR1.14/litre.

The reform is ambitious in intent, although more modest than plans mooted in June by general affairs and governance minister Najib Boulif , who had told Reuters in that Morocco would begin deregulating prices for energy products and sugar within two weeks ( thus theoretically starting in early-July) , with the aim of cutting this year's subsidy spending by 20%. In the end, coalition troubles in the government forced the date for the implementation of reform to be pushed back. We also note that butane gas, which typically accounts for approximately a third of total subsidy spending, will remain fully covered by the old generalised subsidy scheme. The prices of sugar and flour will also stay unchanged. Moreover, t he government will use hedging strategies and insurance mechanisms to protect against global oil prices rising above US$115-120/bbl.

Subsidies Spending To Fall Further
Morocco - Fiscal Components (January to August period), MADbn and % chg y-o-y

Latest data from Morocco's Ministry of Finance shows that subsidy spending fell by 8.8% annually to MAD34.0bn over the first eight months of the year (20.0% of total spending), on the back of lower fuel consumption and a mild decline in global oil prices during that period. Given the new reform, we expect further improvements over the remainder of the year, and project total 2013 subsidy spending to be 14.0% lower relative to 2012, equivalent to MAD47.2bn or 5.4% of GDP. We then forecast a further 12.0% fall in the subsidy bill for 2014, to MAD41.5bn (4.4% of GDP).

Following these revisions, we expect the 2013 budget deficit to reach 6.3% of GDP, narrowing to 5.7% in 2014 (from 6.6% and 6.1% previously). However, weak fiscal revenue intakes, an elevated public wage bill, and rising debt interest payments will prevent larger improvements in the fiscal account over the near term.

On The Decline At Last
Morocco - Weight of Subsidies

We also project a modest narrowing of the current account deficit for 2014, with fuel imports set to decline over the coming quarters. Latest data from the Office des Changes, Morocco's foreign-exchange regulator, shows that this trend has already taken place since the beginning of the year: the value of energy imports (accounting for 26.2% of the total) is down by 4.3% y-o-y for the January to August period . Our Oil & Gas research team forecasts the price of Brent to average US$103/bbl in 2014, down sharply from US$111/bbl for this year , helping to support further improvements . We now forecast a current account deficit equivalent to 6.0% of GDP in 2014, revised from 6.5% previously.

Vulnerabilities Diminishing, But Still Elevated
Morocco - Fiscal and External Accounts

On the downside, the reform to fuel subsidies is certain to trigger a rise in consumer price inflation (CPI), with higher energy prices set to feed through to the costs of transportation, food, and housing in particular. This will compound the ongoing tightening of household spending, and provide another headwind for the domestic economy. Inflation in Morocco has remained mild over the last few years, averaging 2.2% y-o-y in the first eight months of 2013, up from just 1.0% in the same period of 2012. However, we now forecast CPI to average 2.5% this year and 3.5% in 2014 (from 2.0% and 2.5% previously) - the highest rates since 2008.

Inflation Set To Spike
Morocco - Consumer Price Inflation, % chg y-o-y

Could The Government Backtrack On Subsidy Reform?

Popular anger against the government's fuel hikes has brought together various opposition movements. A demonstration in th e capital Rabat on September 22, attracting thousands of protesters, was led by the Istiqlal party - until July a partner in Morocco's ruling coalition, whose leader Hamid Chabat has long been a vocal opponent of subsidy reform . The Al-Adl Wal Ihsane movement, the country's main Islamist opposition group, has also called for the formation of a protest front against subsidy cuts. A trade union in the transport sector has threatened to hold a 72-hour general strike.

This raises the question of whether the government could be forced to backtrack on the move - a perpetual risk given the precedent set by previous subsidy reform efforts in Morocco. As we have noted in the past, the lifting of food subsidies in 1981 was met by widespread riots, as well as two days of strikes brought down only by the violent intervention of the army. While a repetition of this scenario is unlikely today, the government remains vulnerable politically, given its present lack of a majority in parliament and our lacklustre outlook for 2014 economic growth .

That said, we do not expect an about-turn to the latest reform. Although the government's attempts to form a new coalition have taken longer than expected, a deal with the central liberal National Rally of Independents party remains the most likely option, and could favour the passage of further structural reforms going forward (see 'Potential New Coalition Could Boost Reform Prospects', August 15) . The ruling coalition also remains relatively popular: s ome 59.4% of respondents reported trust in the government in a June survey by the Averty Institute and Tariq Ibn Ziyad center , while Prime Minister Abdelilah Benkirane enjoyed a 68.5% approval rating. The fuel price hikes will dent these numbers, but the opposition parties are unlikely to see much political gain : in the same poll, 82.2% of respondents did not consider the opposition capable of performing a better job if elected .

Moreover, the government has invested much political capital in subsidy reform since the start of the year (with Benkirane repeatedly emphasising the importance of fiscal consolidation), and would suffer a large loss in credibility if it chose to withdraw now. The continued support of the IMF is also dependent on the subsidy reform programme. Finally, Rabat will be encouraged by Jordan's success in liberalising energy prices since November 2012 despite strong popular opposition - although the kingdom also provides a cautionary tale, given our weak near-term forecasts for private consumption and macroeconomic growth (see 'Not Yet Out Of The Mire', September 5) .

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Sector: Country Risk
Geography: Morocco
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