Syria: Economic Overview: Economist

Syria: Economic Overviews
2007-10-15 (New York)

The president, Bashar al-Assad, is expected to remain in power in 2008-09. He will continue to rely on the strength and ruthlessness of the loyal security services, which will keep opposition forces weak and ineffective. Mr Assad has devoted considerable effort to ending Syria's political isolation, but with only limited returns. Numerous issues of contention remain in Syria's relations with the EU, the US and the leading Arab states. Economic policy in 2008-09 will focus on the need to diversify the economy and on encouraging investment, but structural fiscal reform will be constrained by the fear of alienating public opinion. Declining oil output will curb economic growth and inflation will stay relatively high, at an annual average of 6.7% in 2008-09. The current account will record deficits over the outlook period, as strong growth in non-oil exports and workers' remittances fails to offset the expected decline in the volume of oil exports and relatively strong import growth.

Domestic politics: Mr Assad, who is supported by key elements in the security services and by the Baath party, remains firmly in power. In May a referendum was held to give the public the opportunity to endorse parliament's selection of Mr Assad as the sole candidate in this year's presidential election. In the event, the official results showed that the choice of Mr Assad was supported by 98% of those who voted (or 11.2m people), with turnout reported at 96% of the 11.7m eligible voters (up from a turnout of just 8.7m in the 2000 referendum). The higher turnout reported by government officials lends support to the argument they put forward that conditions in Syria have improved since Mr Assad took over.

International relations: Mr Assad may have secured his domestic position, but he faces a number of challenges in the international arena (which will have a profound bearing on his popularity at home). In recent months both Israeli and Syrian officials have sent out mixed signals about their desire for a resumption of bilateral peace talks, but at the same time there have been mutterings about their readiness for war. An air strike by Israel on Syria in early September has added to the confusion about the two countries' intentions, but on balance appears to have strengthened Israel's hand. Syria's lack of a military response perhaps highlights its military weakness relative to Israel, but, more noteworthy was the absence of any significant objections from other Arab governments, most notably Saudi Arabia. This underscores the relative isolation of the Syrian government within the Arab world and would undermine its credibility in negotiations. Shortly after the raid, the Israeli prime minister, Ehud Olmert, declared his willingness to open peace talks with Syria, but the Israeli strike will make it more difficult for Mr Assad to engage openly in talks for fear of appearing weak in the eyes of his domestic audience. The air strike may also have been designed to strengthen Israel's deterrence in the region more generally, perhaps using Syria as a (weaker) proxy for a show of force against Iran.

Policy trends: The soaring cost of the fuel subsidy bill, which is placing an unsustainable burden on the fiscal accounts, has led to heated economic debate between the government's more reformist, technocratic elements, led by the deputy prime minister for economic affairs, Abdullah al-Dardari, and the more conservative Baath party members. Mr Dardari has been pushing for structural reform of the fiscal accounts, including cuts in fuel subsidies and the introduction of a value-added tax (VAT). In recent years there has been some reform on the tax front with the introduction of lower tax rates for business and individuals (in a bid to raise compliance), a simplification of the tax collection system and cuts in import tariffs, but the next step in the reform process is less politically palatable. At a time when Syria appears to be largely ostracised by its Arab neighbours, with the ever-present threat of conflict with Israel and/or more severe international sanctions, the establishment appears increasingly reluctant to foist painful economic reform upon the population. The proposed introduction of VAT has now been delayed until 2009 at the earliest, and there is currently a suggestion that some form of fuel rationing might be more acceptable to the public than an outright price increase. The Economist Intelligence Unit's economic forecasts assume that there will be no cut in fuel subsidies during the outlook period. Furthermore, even if the government were to cut fuel subsidies, the compensatory payments to low-income households would offset much of the positive impact on the fiscal account.

International assumptions: We forecast that world GDP growth will average 4.7% in 2008-09 (at purchasing power parity exchange rates), down from an estimated 5% in 2007, largely as a result of a sharp slowdown in the US economy in 2008. International oil prices (based on the benchmark dated Brent Blend) are expected to remain high, however, as buoyant demand in emerging markets offsets any slowdown in OECD oil demand. Prices are expected to remain at an average of nearly US$70/barrel in 2008, before easing slightly to US$63.8/b in 2009 as increased oil supply, particularly from Saudi Arabia, brings the market somewhat closer to balance.

Economic growth: Real GDP growth in Syria is expected to remain relatively weak in 2008-09, at an annual average of 3.3%, largely owing to falling oil production, which will lead to a sustained contraction of exports in and limit the government's ability to increase spending. Furthermore, the hostile regional political environment is also likely to affect investor confidence, undermining efforts to draw urgently needed foreign finance into the oil and gas sector, although Russia, Iran and some of the Gulf Arab countries will remain sources of capital. Our growth forecast is underpinned, however, by the expected recovery in the agricultural sector (after growth was depressed in 2007 by drought conditions in parts of the country). The services sector is expected to record relatively strong growth in the outlook period as a result of persistent demand for goods and services from the large Iraqi refugee population.

Inflation: According to the Central Bank, the official inflation rate stood at 9.2% year on year in September 2006, having risen steadily over the year, and we estimate that the full-year average was 10%. Inflation is expected to fall modestly over the outlook period to an annual average of just under 7%, partly as a result of the abandonment of the pound's peg to the dollar, which will help to contain imported inflationary pressure. Non-oil commodity prices are also expected to ease in 2008-09. Furthermore, there were clear signs in 2006 of an ongoing slowdown in credit growth–according to the IMF's Article IV report, published in May 2007, domestic credit to the private sector expanded by 4.6% in 2006, down from 8.9% in 2005. (This can perhaps be attributed in part to Central Bank measures to tighten the limits on credit extension.) However, if the government were to enact phased cuts in fuel price subsidies in 2008-09, this would lead to a significant upward revision to our inflation forecast. (It is worth noting that anecdotal evidence suggests that inflation is running at higher levels than indicated by the official data; there has been much grumbling about the influx of Iraqi nationals, who are blamed for generating demand-pull inflation, especially in the housing market.)

Exchange rates: Since the beginning of October 2007 there has been a marked appreciation of the pound against the US dollar, suggesting that the new exchange-rate regime–a peg to a basket of currencies based on the IMF's special drawing rights–has finally been implemented. In 2005-06 the composition of the country's foreign-exchange reserves was gradually altered, so that by the beginning of 2007 half of the stock of reserves was denominated in the euro. From 2007 all transactions in the public and mixed sectors will be euro-denominated. (The latter step is partly to avoid the negative impact of the US embargo.) In May the Credit and Monetary Council awarded its first operating licences to moneychangers–the companies are permitted to have multiple branches and to transfer sums abroad. Despite these initiatives, the currency will not be allowed to float freely, with the government continuing to prioritise stability. The regime is well-placed to protect the value of the pound, because of the dominant position of the state-owned banks and the control that the Central Bank retains over foreign-currency transactions, even as some laws are relaxed. Consequently, we forecast a relatively stable pound in 2008 (partly as a result of dollar weakness), before a modest depreciation in 2009 owing to concerns about the competitiveness of Syria's non-oil exports (and some strengthening of the dollar against the euro).

External sector: We estimate that the value of merchandise exports will have risen in 2007 as strong growth in non-oil exports more than offsets the decline in the value of oil exports. The estimated fall in oil export revenue is the result of lower Syrian oil production. Non-oil exports are continuing to benefit from the relaxation of foreign-exchange controls, which has led to more exports being officially recorded. Regional demand has also been strong, and Syria has been benefiting from its membership of the Greater Arab Free Trade Area. Although non-oil export revenue is expected to continue to rise robustly next year, we forecast that export earnings will increase by less than 3% because of the projected fall in crude oil production (and thus export volumes). Import spending growth will remain strong in 2008-09, partly as a result of the ongoing process of tariff liberalisation. As a result of these trends, the trade deficit is expected to widen from an estimated US$2.2bn in 2007 to US$3.1bn in 2009.

Oct/15/2007 22:16 GMT

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