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Join on Telegram Morocco’s central bank, Bank Al-Maghrib (BAM), is well-positioned to take the next step towards a fully floating dirham, according to a recent report by Capital Economics. The country’s improving balance of payments and sharp slowdown in inflation have created favorable conditions for this transition.
Since securing a $3 billion Precautionary and Liquidity Line (PLL) from the International Monetary Fund (IMF) in 2014, Moroccan authorities have been gradually moving towards greater flexibility for the dirham and an inflation targeting framework.
In 2018, BAM established a trading band of ±2.5% around a daily reference rate based on a currency basket consisting of 60% euro and 40% US dollar. This band was further widened to ±5% in March 2020.
“Morocco’s macroeconomic stability has improved markedly,” stated James Swanston, Middle East and North Africa Economist at Capital Economics. The country achieved current account surpluses in the first and third quarters of last year, a feat only accomplished in four quarters between 2014 and 2022. The current account deficit narrowed to 0.7% of GDP in Q3, the smallest shortfall since 2007, and is more than covered by stable direct investment inflows.
Bank Al-Maghrib has also bolstered its foreign exchange reserves to $34.3 billion, just shy of the record high of $35 billion reached at the end of 2020. Had the central bank not accumulated these reserves, the dirham would have strengthened.
The reserve coverage is substantial, covering Morocco’s short-term external financing requirement more than three times over, providing confidence in the central bank’s ability to support the currency if needed.
The improved balance of payments and strong support from the IMF, with Morocco currently benefiting from two deals totaling $6.3 billion, should pave the way for the next step in the foreign exchange regime. The IMF has made this a long-term goal of its support since 2014.
Rather than an immediate free float, the next step is likely to be a further widening of the dirham’s trading band. The real effective exchange rate is currently around 3% weaker than its late 2021 peak and 2% weaker than before the previous band widening in 2020.
Read also: All You should Know About ‘Floating Dirham’
“In the past, widenings of the band have led to appreciations of 2-3% of the dirham against the euro-dollar basket; we think the dirham would appreciate by around 3% by year-end this time round,” Swanston projected.
The shift towards a more flexible dirham would also mark a transition to an inflation-targeting framework, where the central bank’s pursuit of an inflation target serves as a price anchor rather than the exchange rate. Low inflation levels are expected to boost policymakers’ confidence in the success of this move.
In January, inflation in Morocco slowed to 2.3% year-on-year, the weakest pace since late 2021, following a surge driven by spillovers from the war in Ukraine.
Compared to other emerging market economies that have adopted inflation targeting frameworks, Morocco’s current inflation rate is at the average level at the time of adoption.
Encouragingly, for these economies, headline inflation continued to ease and remain low in the years following the adoption of inflation targeting.
The Capital Economics report highlights the favorable conditions for Morocco to take the next step in its gradual transition towards a fully floating dirham.
With improving macroeconomic stability, strong IMF support, and low inflation levels, the country is well-placed to move towards greater exchange rate flexibility and an inflation targeting framework.
This move is expected to lead to a modest appreciation of the dirham against the euro-dollar basket by the end of the year, marking a significant milestone in Morocco’s economic development.
