# _Demand subsidies_

# <u>Interest Rate Subsidies on Mortgages Distributed by the Housing Bank.</u>

As noted above, this corresponded to interest rate subsidies on mortgages distributed by the CIH. The amount of the subsidy was 2 points of interest for mortgages taken out on dwellings valued at less than MDH 350,000 ( _régime général_ ), and 6 points for mortgages taken out on dwellings valued at less than MDH 200,000 ( _régime spécial_ ). All loans issued by the CIH for the construction of units valued at under MDH 500,000 were also exempt from VAT on loan interests (at a rate if 7%)<sup>45</sup> . In 1992, expenditures amounted to MDH 50 million under the _régime general_ , and MDH 130 million under the _régime special_ .

Although these subsidies were transparent and commercially simple to explain to buyers, they were not simple to manage because the State was obliged to keep track of every single loan and reimburse the CIH annually on the basis of the loan interest rates which varied. A special unit in the Treasury managed this system. On the incentive side, however, the existence of thresholds for eligibility under the _régime général_ and _régime special_ created strong incentives for developers to understate the value of the units in order to fall into advantageous brackets. As the same limits applied to various tax deductions and exemptions, it was common to understate the value of dwellings.<sup>46</sup> For the reasons mentioned above, interest rate subsidies were not adequately covering homebuyers, nor were they well-targeted. Moreover, since these subsidies were aimed at formal housing mortgage owners, they neglected those in the lower brackets of the income distribution.<sup>47</sup> A World Bank Study in 1995 based on documents from CIH showed that 80% of beneficiaries of _régime spécial_ loans declared annual incomes above MDH 60,000, which corresponds to deciles 6 and above in the income distribution scale. Subsidies under _régime spécial_ loans appeared better targeted, all of them targeting the poorest 40% of the population.

In the context of fixed-rate mortgages (FRMs) with fixed repayments applied in Morocco, affordability problems would arise at the beginning of the mortgage repayment period, either because of constraints on the maximum LTV (insufficient savings), or because payments were too high. In time, fixed nominal payments translate into decreasing real payments due to inflation; also, real incomes can increase. Thus, subsidies are needed mainly at the beginning of the loan. Instead, the interest rate subsidy as parameterized in Morocco would apply for the entire life of the loan, which is clearly inefficient. Moreover, under this scenario, the value of the _régime spécial_ subsidy was very high, equivalent to about 40% of the mortgage value.. Combined with other types of subsidies, this resulted in huge subsidies for few fortunate households able to obtain a mortgage. Lastly, this resulted in very high inertia of the system, in the sense that loans approved at any given time would continue to generate liabilities for the State for the next 15 years and thus, flexibility was very low.

As noted above, the main problem facing subsidies at that time was that they were granted only to CIH, _de facto,_ excluding other banks from competing in the mortgage market. However, the

> 45 This tax seems to exist only in Morocco.

> 46 This was amplified by the fact that the concept of value used for administrative purposes, the VIT, was based on administratively pre-set values for land, and on construction costs for dwellings, resulting in differences between the VIT and market value of the dwellings.

> 47 The subsidy also had a built-in regressive feature (within each bracket, the higher the unit value, the higher the subsidy).

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