OREANDA-NEWS. Such as Renault in 2007 and PSA Peugeot in June 2015--to develop its emerging automotive industry. In addition to the automotive sector, aeronautics, electronics, and renewable energy are set to continue growing rapidly in line with the country's industrial policy, which enjoys broad political support. In September 2016, the U. S.-based aerospace company Boeing reportedly announced plans to establish a new industrial hub in the country that officials hope will bring 120 Boeing suppliers to Morocco, create thousands of jobs, and raise about $1 billion in exports. In our view, Morocco will continue to attract FDI, its business environment should stay broadly supportive, and, importantly, this will help tackle the still high unemployment rate of around 9.5%.

Youth unemployment remains high at around 20%, despite annual average economicgrowth of 4% over the past five years. One of the reasons is the insufficient matching between the educational profile and actual labor market requirements, which leads to a large share of unemployed graduates. All of these factors, alongside the oversized workforce in agriculture, explain why Morocco's GDP per capita, estimated at $3,000 in 2016, remains one of the lowest among our 'BBB-' rated sovereigns.

We project that the fiscal deficit will reach 3.5% of GDP in 2016, down from 4.3% of GDP in 2015, as a result of subsidy and wage bill controls and low oilprices. We expect fiscal consolidation to continue apace, and the government to meet its fiscal target of a deficit of 3% of GDP by 2017. Subsidies on fueland food ballooned to over 6% of GDP following the start of the Arab Spring in2011. This led to wider fiscal deficits, and annual average changes in generalgovernment debt of more than 6% of GDP in 2011-2013. However, the government has since managed to cut its subsidies bill substantially. It has also taken measures to slow growth in other areas of current spending, such as public salaries. The state pension system reform, approved by parliament in July 2016, comprises an increase in the retirement age to 63 from 60 by 2022 and higher contributions from workers and the state. The pension reform will ease long-term pressure on public finances.

The projected fiscal consolidation will help the debt ratios stabilize over the medium term, according to our forecast. We expect general government debt to average 50% of GDP in 2016-2019, compared with 38% in 2011 (general government debt excludes from gross debt the government's liquid assets and the holdings of central government debt by other branches of state, such as public pension funds). The general government debt stock has risen quickly in recent years to fund wide deficits. External financing has increased, and the government successfully tapped the international dollar and euro markets in 2013 and 2014.

Morocco's current account deficit shot up to 9.5% of GDP in 2012, amid high prices for imported food and fuel products and weak demand for Moroccan exports from major markets in Europe, as well as weaker phosphate prices. We expect the deficit to continue narrowing to average about 2% of GDP in 2016-2019, compared with 6.6% in 2011-2015. This will reflect our projections for rising exports from newly developed industries (such as the automotive andaeronautic industries), and lower energy and food imports coupled with strong remittances, which will more than offset the impact of shrinking tourism related to increasing geopolitical risks.

For the next three years, we forecast a slight recovery of tourism receipts and higher export volumes of cars from the Renault factory in Tangier. Cars have become the country's leading export product with about 5% of GDP in 2015,exceeding the share of phosphates in exports (4.5% of GDP). We also anticipatethat increased phosphate production will support exports and, in turn, currentaccount consolidation. Our revised forecast for current account deficits in 2016-2019 factors in the potential impact of the U. K. Brexit vote on Morocco'skey European partners through slightly weaker trade, tourism, remittances, andFDI flows. We now project a wider external position in the next three years compared with our previous expectations, and we forecast narrow net external debt will drop slowly as a proportion of current account receipts (CARs) to average 31% in 2016-2019 from an estimated 39% in 2015. We also forecast the country's gross external financing requirements will be covered by its CARs over this period.

In recent years, Morocco successfully managed to reduce its fiscal and external imbalances and implement key domestic reforms with the support of twosuccessive 24-month International Monetary Fund (IMF) Precautionary and Liquidity Line (PLL) arrangements. We believe that the two previous PLL arrangements have provided useful insurance to Morocco in a context of uncertainty surrounding global oil prices, heightened sociopolitical and security risks, and weak growth of its main European partners. They have also anchored the country's reforms, and sent positive signals to market participants. The reduction in the level of access from about $6.2 billion at the time of the first PLL arrangement in 2012, to about $5.0 billion with the second PLL arrangement in 2014, and $3.5 billion in the third PLL renewed in July 2016, is testimony to the improvement in Morocco's economic fundamentals and the strengthening of its foreign exchange reserves. We project Morocco's reserve coverage will be higher than six and a half months of current account payments.

The Moroccan dirham is currently pegged to a currency basket comprising 60% euros and 40% dollars. The current foreign exchange regime limits monetary policy flexibility, in our view. However, we understand that the Moroccan Central Bank, Bank Al Maghrib (BAM), is considering moving gradually from the current peg to a more flexible exchange rate regime over the next six to 12 months. The monetary authorities are encouraged by the more supportive macroeconomic environment now in place--including the comfortable level of foreign exchange reserves, the improved external situation, the dirham's valuerelative to other currencies--and helped by the insurance provided by the IMF's PLL arrangement. While moving toward a more flexible exchange rate regime, we believe that the Moroccan authorities will maintain in the near term, or only gradually ease, restrictions on capital accounts to avoid any potential large-scale capital outflows. We expect BAM to accumulate a sufficiently large foreign exchange cushion over the next few years to maintain market confidence during this transition.

BAM's successive and substantial cuts to its reserve requirement ratio, to 2% in March 2014 from 15% in January 2008, have helped ease liquidity conditions in the domestic market and ensured adequate financing of the economy. The mostrecent interest rate cut on March 22, 2016, by 25 basis points to 2.25%, keepsmonetary policy accommodative amid slower nonagricultural growth. We expect credit to the economy to continue to grow at a moderate pace over the next fewyears, but at a lower rate than our projected nominal GDP growth. Inflation should remain low--we forecast it will average 2% in 2016-2019, compared with 1.6% in 2015.

We classify the banking sector of Morocco in group '7' under our Banking Industry Country Risk Assessment (BICRA). While we consider regulatory standards in Morocco to be generally conservative, Moroccan banks are still exposed to cyclical sectors (steelworks, tourism, commercial real estate, and construction). Thus, we consider that economic risks for the Moroccan banking sector remain high in a global comparison. We also assess the system's risk appetite as aggressive, given the rapid expansion of Moroccan banks, includingin higher risk African countries (about 20% of total lending was outside Morocco for the three main Moroccan banks in 2015).

OUTLOOK

The stable outlook reflects our expectation that the consolidation of Morocco's fiscal and external deficits will continue over the next few years, while economic growth improves under the influence of continued implementationof reforms and low energy prices.

We could lower the ratings if growth disappoints, leading to worsening of fiscal and debt outcomes, if the government deviates substantially from its structural reform agenda and fiscal consolidation path, or if the current account does not narrow as we anticipate.

We could raise the ratings if an increase in FDI supports stronger economic growth, reduces the unemployment rate, and significantly improves per capita GDP beyond our current expectations, or if net general government debt declines more rapidly.