Posted by Joshua on Wednesday, June 20th, 2007
The following IMF report is consistent with much anecdotal evidence and the readily apparent consumer and building boom going on in Syria. Government bureaucracies remain inefficient. Everyone is preparing for the stock market and companies are getting educated about going public. Alison Brooks, the woman from whom I am renting my apartment and who recently sold the financial education company that she ran for 20 years in Britain, has been approached by a number of firms to consider offering financial education classes here. Many Lebanese and Egyptian firms are putting in bids because the few good Syrian economists are overstretched and cannot fulfill the demand for financial expertise. The six public banks that dominate Syrian banking have no formal human resource development or training departments. The lack of training and financial know how is tremendous. There is a huge need for education and technical know how. An EU funded Syrian Bank Training Center has been set up in Damascus to offer training and expertise. Damascus has the feel of the wild West as banks and newly licensed financial intermediaries, brokers, dealers, investment managers and consultants scramble to get in on the ground floor.
The Arab European University – one of Syria's new private universities – is establishing a set of new courses in business administration. A teacher at the university told me that the university could not find local professors to teach the needed courses and went to Beirut to recruit Lebanese. The Lebanese professors asked for $4,000 a month and got it. That is a king's ransom to Syrian professors, but indicative of the new salaries being offered. One must remember that there are almost no taxes.
There are perhaps only 20 or so companies preparing to go public and of these, I am told, only about 6 or 7 have already established modern book keeping that completely separates corporate from family finances.
Syrian Arab Republic
IMF Article IV Consultation
Mission Preliminary Conclusions
May 16, 2007
1. The Syrian economy did remarkably well in 2006. Despite an unsettled regional environment, the economic recovery that started in 2004 remained on track. Non-oil GDP grew at a brisk pace (tentatively estimated at 6-7 percent), job creation picked up steam driving unemployment below 10 percent, private investment gathered momentum, and exports made strong gains, particularly in some Arab markets. The surge in the volume of investment approvals hints at brightening investment prospects with companies jockeying to position themselves in the fledgling market. Not only was Syria able to raise the living standards of its own citizens, it also offered shelter, food, medicine, schools, and hospitals to the 1½ million Iraqis that sought refuge in Syria. Despite the large demand shock this represented, inflationary pressures have been fairly contained thanks to tighter credit policy and fiscal discipline.
2. This economic revival owes much to the reform impetus initiated 2-3 years ago and sealed by the adoption of the ambitious 10th 5-year development plan. Broad-based reforms have made significant changes in the economic and financial landscape. The exchange rate has been effectively unified and virtually all restrictions on access to foreign exchange to finance imports have been eliminated. Most economic sectors have been opened to private enterprise, boosting the contribution of the private sector to non-oil GDP above 80 percent. A dynamic private banking sector is now leading financial sector growth, and the Damascus stock exchange is set to open early next year after being closed for 40 years. A new investment law has liberalized the investment regime further, created a one-stop-shop for investors, and put foreign and domestic investors at par. Complex, opaque and prohibitive taxation has been replaced by more efficient and equitable taxes and tax administration has been modernized to support the new tax legislation. In addition, law number 51 enacted in October, 2006 unified tax incentives for investment. The local industry has been exposed to greater international competition through several rounds of tariff cuts—which brought the average tariff rate to 14½ percent down from close to 20 percent three years ago and the maximum rate from 225 percent to 60 percent; a reduction in the number of prohibited imports; a relaxation of import licensing procedures; and a simplification of customs clearance. Strides are being made in building the regulatory frameworks to govern the new market economy, most notably in the banking, insurance, and capital markets, and in housing and real estate. Last but not least, improvement in the efficiency of the taxing system and strict fiscal discipline ensured a timely adjustment to a large and precipitous loss of oil revenues.
3. Notwithstanding the progress in the reform agenda the remaining challenges are still daunting. According to the latest projections of oil production, government revenues from oil, which have fallen more rapidly than initially anticipated, are projected to decline by a further 5 percentage points of GDP in the next 10 years, while the net oil import bill could reach US$6 billion (about 7-8 percent of GDP) ten years from now. Macroeconomic instability will heighten and the growth momentum will falter if the government will to undertake the difficult fiscal reforms ahead wanes and if the structural reform drive is not sustained and accelerated. Under this scenario, time could be bought by drawing down the large stock of international reserves. This would support the nominal exchange rate for a few years, but monetary financing of the widening budget deficit will fuel inflation and crowd out the private sector through an appreciation of the real exchange rate, dampening the economy's growth potential. Once international reserves are exhausted, a forced adjustment through an inflation-cum-depreciation spiral would become unavoidable. An additional cumulative fiscal adjustment of some 10 percent of GDP in the next 10 years is needed to avert this scenario.
Analysis of recent economic developments is increasingly constrained by data weaknesses. These have been amplified in the recent past as the acceleration of structural reforms has severely tested the ability of a weak statistical infrastructure to cope with the changes. The situation in Iraq added to the challenge. The main drivers of the ongoing economic revival, namely exports, private investment, and private sector activities in general are not adequately surveyed. Pervasive subsidies and weak accounting standards in public enterprises (PEs) are a major challenge to the weak methodological framework underlying the compilation of the national accounts and introduce a significant margin of error in growth estimates. The move to a new CPI, although based on a more representative consumer basket, has unfortunately introduced uncertainty about the level of inflation and its trend. Revisions to weak customs data—to account among other things for the intensification of shuttle trade with Iraq—have blurred the picture as to the underlying strength of the non-oil current account balance.
5. Economic analysis and macroeconomic management are complicated in this statistical vacuum, and the authorities are encouraged to be vigilant in monitoring the state of the economy, particularly inflation and foreign trade. Utmost priority should be given to mobilizing the needed expertise to upgrade statistics. Pending tangible improvements in the quality of the data, research units at the Deputy Prime Minister's Office, the Ministry of Finance (MoF), the Central Bank, and the State Planning Commission should not be constrained by the use of "official data" and should be encouraged to work closely together to fill in the data gaps with economic analysis and consistency checks among the key sectors (fiscal, monetary, external, and real sectors) to come to a reasonable understanding of current developments. Given the data weaknesses, the mission's assessment is only tentative.
I. Recent Developments and Near-term Outlook
6. Staff estimates growth of non-oil GDP at around 6-7 percent in 2006. Given a 6½ percent drop in oil production, this would be consistent with an overall growth of 4½ -5 percent. Growth appears to have been mainly driven by private consumption and non-oil exports and may have been supported by some strengthening of private investment. Private consumption was boosted by employment and wage gains, a good harvest (particularly for olives whose production doubled); and the boom in real estate and rental prices, which translated into a significant wealth effect for property owners; amidst the influx of Iraqis. The strong performance of non-oil exports, which are estimated to have increased by about 30 percent in 2006, reflects the surge in exports to Arab countries, which were boosted by stronger demand as well as the granting of free access under the Great Arab Free Trade Area.
7. The improved business climate might be supporting a steady growth in private investment, but a real take-off does not seem to have materialized yet. Nonetheless, the impressive volume of approved projects under Law No 10 in 2006—which reached SP 470 billion (US$9.2 billion and 26 percent of GDP) more than 2½ times the level in 2004—and their diversity augurs well for growth prospects in the near- to medium-term. 1 Almost three-fourths of the volume of these investments are in increasingly diversified industrial projects (including cement, steel, food processing, pharmaceutical, textile, and power generation), and another 20 percent are in the transport sector. Investment in the much publicized real estate projects (consisting of commercial, recreational, and other services associated with government housing projects) represented only about 15 percent of the total approved projects in 2005 (SP 60 billion) and their social returns—which are feared to be low in some circles—may actually be quite high if they are part of a well diversified investment strategy. The share of foreign direct investment (FDI) is estimated to have remained fairly stable at about 20 percent.2 Diversity in the investment strategy is also evidenced by the equally strong growth in investment approvals in tourism. Prospects in that sector are strengthening, with the ministry of tourism now preparing to launch mega projects, based on the success it achieved in attracting investors' interest in smaller projects.
8. The build-up of inflationary pressures since mid-2005 seems to have abated in recent months. While average inflation increased from 7.2 percent to 10 percent in 2006, trend inflation as measured by the increase in the price level in March 2007 compared to March 2006 has come down to 4 percent, bringing average inflation to below 8 percent. Half of the increase in inflation in 2006 is attributed to an increase in food prices, which may have reflected weather-related shortages plus stronger domestic demand as well as demand from neighboring countries hit by similar inclement weather. The increase in the dollar price of imported non-fuel commodities together with some pass-through of the exchange rate depreciation at end-2005 may have been additional contributing factors.
9. The large influx of Iraqis put strong pressures on the economy. The number of refugees grew by 40 percent in 2006 to about 1.5 million (8 percent of the Syrian population). In addition to contributing to inflationary pressures, including notably in rental and real estate prices, the surge in refugees strained government expenditures, particularly on energy and food subsidies, and spending on health and education.
10. Credit policy played a useful role in controlling domestic demand. State banks were instructed to slow their lending to the private sector, which helped cool the credit boom experienced in 2004-05. The actual pace (18½ percent), while still fast, reflects the process of financial re-intermediation related to the nascent private banking sector, whose loan portfolio increased by more than 100 percent, accounting for almost half of the credit growth in 2006. The increase in net lending to the public sector contributed the largest share in the increase in money. Administered deposit interest rates, which turned negative during most of 2006, are now back to positive territory, thanks to the deceleration of inflation.
11. Timely and significant fiscal adjustment largely offset the decline in oil revenues, thereby containing the fiscal deficit. Over the last three years, fiscal policy had to contend with a loss of oil revenues in excess of 10 percentage points of GDP. This has reflected both a sharp contraction of oil production from about 480 thousand barrels per day to about 400 thousand and a galloping growth in domestic demand (an annual average rate of 10½ percent) owing to a decline in the prices of refined products in real terms, increased smuggling to neighboring countries, and the impact of the Iraqi refugees. A cumulative improvement in the non-oil budget deficit of 7 percentage points of GDP narrowed the non-oil budget deficit to about 10 percent of GDP, strengthening significantly the medium-term prospects of fiscal sustainability.
12. The quality of the fiscal adjustment was commendable. During the last three years, corporate income tax rates have been lowered drastically—with the top marginal rate coming down from 65 percent in 2003 to 28 percent in the latest amendment—and tariffs rates have been reduced significantly. Tax administration improvements together with higher growth fully compensated for the cut in rates and helped maintain a stable tax intake as a percent of GDP and increase its total volume. The bulk of the fiscal adjustment has been contributed by caps on investment spending and an increase in dividend payments from profitable public companies, mainly in telecommunication, which boosted nonoil revenues by close to 3 percentage points of GDP during 2004-06. The compression in capital spending is largely believed to have represented cuts in wasteful spending, and at 9 percent of GDP, its level in 2006 is still fairly high. The creeping rise in current expenditures reflected mainly the increase in subsidies to loss making PEs and pension and social assistance payments.
13. The growth outlook for 2007 remains favorable. The critical mass of reforms implemented in recent months, the continued direct and indirect support of aggregate demand from the Iraqi presence, and favorable growth prospects globally and in the region are expected to continue to underpin private consumption and non-oil exports, as well as a possible strengthening of private investment. These factors could sustain the growth momentum at about the same pace as in 2006. Any slowdown of capital inflows associated with the Iraqis will dampen aggregate demand directly and through second round effects, including an unwinding of the wealth effect induced by the real-estate boom. However, a normalization of the political situation in Iraq could open a large market for Syrian products.
14. To keep inflationary pressures in check, macroeconomic policies should remain appropriately tight. The current level of benchmark interest rates is appropriate and state banks' lending should remain in line with the monetary objectives. Fiscal policy should aim to reduce the overall budget deficit to about 5 percent of GDP mainly by phasing out petroleum price subsidies and further rationalizing of expenditures. Civil service wage policy, which leads wage policy in the rest of the economy, has a major role to play in curbing inflation, by ensuring that wage increases do not run ahead of productivity gains.
II. Building for the Future
15. Syria needs to continue to grow faster but it also needs to grow better in the coming years. The growth acceleration in the past two years seems to have been largely driven by private consumption, with an initial impulse originating from the influx of Iraqis. For this growth to strengthen and solidify, it is important that the sources of growth be rebalanced toward investment and durable gains in external market shares. Stronger investment growth and higher productivity are the bedrocks of high and sustainable growth in the long run.
16. To rebalance growth, Syria should continue to strengthen its macroeconomic policy frameworks and to accelerate structural reforms. Policies geared toward accelerating reforms and preserving financial stability could validate investors' expectations and strengthen savers' confidence about returns on Syrian assets. A positive synergy—such as the one witnessed in the rapid take-off of private banking—between an increased willingness on the part of savers to invest their funds in Syria rather than abroad or in idle foreign currency, and an increased willingness of investors to take the risk of starting new projects could turn the promise from the large increase in investment approvals into a reality.
17. The remainder of this statement focuses on: (i) policies to protect fiscal solvency, (ii) a more explicit monetary policy framework in the context of the unified exchange rate regime to anchor price stability, and (iii) key structural reforms.
18. The timely adjustment to the secular trend decline in oil revenues in the past three years is highly welcome. Looking forward, there is a need to sustain this effort as oil revenues continue to dwindle. Addressing all the pockets of inefficiency in public spending associated with technical losses and across-the-board subsidies to consumers, producers, and public employment will achieve durable fiscal savings while enhancing the supply side of the economy. A large share of the freed up resources could be channeled to finance targeted support to the most vulnerable segments of society and to productive expenditures on basic infrastructure, higher education, and research and development. This will complement private investment by enhancing its potential returns.
19. In this regard, a comprehensive public expenditure review is essential. It should focus on: (i) settling the inter-enterprises arrears among PEs and stopping any such accumulation in the future as this practice dampens incentives for sound and transparent financial management and leads to a lack of accountability; (ii) reviewing the efficiency and effectiveness of expenditures in major sectors such as education, health, and public transportation with a view to reprioritization and deep reforms; and (iii) reviewing the social protection system—the current system is mostly based on rationing (coupons) and on inequitable and inefficient price subsidies. It needs to be reformed toward means-tested targeted transfers.
20. Phasing out the inequitable petroleum price subsidies (PPS), whose cost exceeds 15 percent of GDP, is a key pillar of fiscal reform. Beyond large fiscal savings, it would provide significant efficiency gains, improve equity, entail a smaller negative fiscal impulse, and contribute to BOP adjustment. We are encouraged to know that some preparatory work is being done to launch this reform, and urge the authorities not to delay it further. Each day the public coffers loose SP 750 million (i.e. close to US$15 million, three times the annual budget devoted to promoting tourism) on a policy that has lost all purpose, while so many legitimate claims on public money remain unfulfilled.
21. Stepping up preparations to introduce a VAT is needed to ensure that the VAT is phased in on time to help offset the future drain on oil revenues. The mission agrees that an ill-prepared launch could damage the credibility of this new tax, and indeed many steps, including the adoption of a tax procedures code and an integrated IT system, have yet to be completed. However, preparation could move much faster, if the authorities were to choose a simple design, an option that would very much be in line with the new vision driving tax policy reform toward simpler taxes and lower rates. A uniform rate with very few exemptions lowers the compliance costs on taxpayers and the burden on the tax administration and closes loopholes, which create opportunities for corruption. Concerns about social equity are best addressed by excises on luxury goods, well targeted spending programs, or by enhancing the progressivity of income taxes.
22. The authorities view the PE reform as an important element in the reform program. For that the authorities issued: