Syria - Some positive signs amidst daunting challenges

There have been some positive developments in Syria. The economy is benefiting from strong oil prices and the non-oil sector is performing strongly. Furthermore, the piecemeal reform program has accelerated over the last year. However, these positive developments have occurred in a backdrop of deep political and economic challenges. The economy continues to under perform and substantial reform is still required. Meanwhile on the political front, Syria faces a multitude of challenges internally and externally, not least the possibility of UN sanctions and increased international isolation following the war in Lebanon.

On the positive front, the IMF estimates that real GDP growth accelerated to 2.9% in 2005 (below the government estimate of 4.5%), compared with an average of 1.8% between 1999 and 2004. We forecast that economic expansion will accelerate marginally in 2006 to 3.1%. Notably, although the economy still remains dependant on the oil sector, which is benefiting from the strong global prices, there have been strong performances in the wider economy. The non-oil sector is estimated to be realising strong growth of over 5%. The agricultural sector has performed well, which is important for boosting private consumption as around one-third of the population is employed in the sector. Furthermore, private spending is being supported by stronger credit growth and wage increases since mid-2004.

As with the wider region, the Syrian economy is also benefiting from the strong performance and liquidity in the GCC. Remittance inflows have been increasing and have boosted both private consumption and investment levels, while direct investment from the GCC is also increasing (including in areas such as real estate, tourism, finance and telecommunications).

In a further positive development, the piecemeal reform program has picked up and there have been some important developments over the last year. In 2005, President Bashar al-Assad removed many of the old guard from the regime, while installing pro-reform loyalists. This was an important step in facilitating the pickup in the liberalisation process. Apart from domestic needs to provide jobs, economic liberalisation is seen as a way of limiting political isolation and attracting FDI from the region. Importantly, the recent reforms have focused in vital areas such as fiscal consolidation, exchange rate unification, and trade and financial reforms. Recent fiscal reforms have included reducing subsidies on gasoline and cement in January 2006, although the IMF has noted that the subsidy system was still unsustainable. Importantly, the trade reforms have already helped to boost non-oil exports.

In early October 2006, Assad approved seven decrees widening reforms in the areas mention above. One of the most significant reforms was the amendment to Law 23 of 2003, which reduces the top marginal corporate tax rate to 35% from 65%. The rates of the earning bands have also been reduced. The new rates will take effect from January 1st 2007. Assad also approved a new basic finance law, which will result in the separation of the operations of the public enterprises from the state budget from 2008. Furthermore, the government is also planning to introduce a value-added tax (VAT) in 2008 and is reviewing its system of petroleum price subsidies.

Meanwhile, steps have also been taken to liberalise monetary policy. Some of the measures were introduced to offset the downward pressure on the Syrian pound following the assassination of the ex-Lebanese Prime Minister Rafiq Hariri. The central bank base rate was increased for the first time in decades and there has been some movement away from the fixed interest rates that have characterised policy for the last 25 years. Furthermore, certificates of deposits have been launched for the first time and initial steps have been taken to establish an interbank market. However, despite these developments, the central bank still lacks the flexibility and tools to manage monetary policy.

On the exchange rate front, banks are now allowed to set their exchange rate within a narrow band around the fixed central bank rate. Going forward, further exchange rate reforms are expected, including the abolition of the remaining secondary exchange rates and further liberalisation of the foreign currency law.

Despite these positive developments, deep challenges remain. While real GDP growth has accelerated over the last two years, the growth rate was still relatively weak, especially given the performance of other regional oil (and non-oil) exporting countries and the domestic needs of the economy. A stronger growth rate is required for increasing job opportunities. Moreover, given the state of the Syrian economy, deeper and broader reforms are required if higher levels of growth are to be achieved and sustained. The need for reform is accelerated by the fact that oil reserves are falling and the oil import bill is increasing - Syria is set to become a net oil importer in 2010. The loss of oil income will add serious challenges to the fiscal and current accounts, let alone maintaining living standards. Negatively, the reform program will likely remain slower than required as the authorities continue to face capacity constraints and the absence of social safety nets to mitigate the impact of the reform measures.

Furthermore, political uncertainties and outside pressure add to the complexities of the challenges. Domestically, power is being increasingly concentrated in the hands of a few surrounding Assad, while opposition groups jockey for power. Meanwhile, the president has been weakened by the UN investigation into Hariri's assassination.

On the international front, Syria has become more internationally and regionally isolated following Hezbollah's conflict with Israel in Lebanon. Although Hezbollah's performance emboldened Syria (and Iran), Damascus has been isolated by many powerful neighbours, including Saudi Arabia.
Furthermore, the threat of sanctions (related to the assassination of Hariri) still remain a distinct possibility. Although the latest report by UN investigators (published at end-September) indicated Syria's co-operation with the inquiry has been 'generally satisfactory', the US ambassador to the UN John Bolton has indicated the latest report did not mean Syria was in the clear. Furthermore, US Secretary of State Condoleeza Rice has indicated Washington is hoping to gain support for new sanction in response to Syria's alleged role in destabilising Lebanon and supporting Hamas. Indeed, the US continues to place pressure on Damascus. In March, the US Administration's banned American banks from dealing with the Commercial Bank of Syria and its subsidiary, saying they had been used by terrorists to move their money. Although Syria is currently benefiting from stronger FDI inflows from regional countries, increased global isolation will continue to deter global investment and trade, which is vital for upgrading the economy and obtaining a higher growth potential.