Fitch: Morocco Reserve Fall Unlikely to Prompt FX Policy Shift

Fitch Ratings still expects an eventual widening of the Moroccan dirham's floating bands, despite the fall in foreign-currency reserves in 2Q17. Reserves have now bottomed out and we expect the authorities to implement gradual alterations to the foreign exchange framework while trying to achieve a more robust anchoring of policy expectations by fine-tuning their communication strategy.

A broadening of the dirham's floating bands was widely expected at end-June, but the announcement was postponed against the backdrop of a rapid fall in foreign exchange reserves. Morocco's net international reserves (NIR) had dropped by 14.3% in US dollar terms at 7 July from their end-April level, reaching USD20.9 billion, their lowest level in nearly two years. Consequently, the goods and services import coverage ratio receded to just above five months in July, down from seven at end-December 2016 based on Bank al-Maghrib (BAM) estimates.

The NIR drop partly reflected residents buying foreign-currency instruments for hedging or profit ahead of the expected end-June announcement. Moroccan banks increased their foreign-currency assets by 56%, equivalent to USD1.6 billion, between 28 April and 7 July. The sharp fall of the Egyptian pound following full liberalisation and recent pressures on the exchange rate in Tunisia might have stoked fears of substantial dirham depreciation, although the likelihood of this is very low in our view. The Egyptian pound was widely judged to be substantially over-valued, while the dirham is close to its equilibrium value.

The decline is also due to higher balance-of-payments outflows. Higher amortisation than drawings, partly related to the late approval of the 2017 budget, pushed the government's net foreign loan financing down to -USD0.52 billion in the first seven months of 2017 from USD0.23 billion a year earlier. Higher oil prices contributed to a USD0.6 billion widening in the goods and services trade deficit. FDI outflows rose threefold on purchase of foreign assets by residents, including the regional expansion of the domestic banking sector.

The gradual disbursement of foreign financing and the tighter scrutiny of foreign exchange transactions should support a further partial recovery of the reserve-to-import ratio. Reserve losses due to hedging strategies may be gradually reversed but the contribution of higher other balance-of-payments outflows could be more enduring. Morocco's NIR have already bottomed out, rising by USD2 billion from early July.

The authorities' plan is to widen the floating bands to +/-2.5% from +/-0.3%, according to a statement by Prime Minister Othmani. The phasing-in of a full float regime is only a long-term prospect in our view.

As the floating bands will initially be relatively narrow, the direct benefits for external competitiveness and economic shock-absorption capacity will still be modest. However, it would be an important step towards more flexible exchange rates that could help provide a buffer against external shocks and increase BAM's leeway to gear monetary policy towards inflation targeting.

We would expect even a more substantial widening of the bands to pose little risk to macroeconomic stability, given banks' low foreign-currency exposure and the high share of dirham-denominated government debt. We expect dirham volatility to remain limited after the widening (the exchange rate is broadly aligned with fundamentals), although renewed temporary pressures on reserves are possible. Foreign exchange reserves and the IMF's precautionary and liquidity line are buffers to exchange rate pressures.