Country Report Syria at a Glance: 2005-06

Country Report

Syria

Syria at a glance: 2005-06

OVERVIEW Syria has responded to international pressure stimulated by the assassination of the former Lebanese premier, Rafiq al-Hariri, in February by withdrawing its troops and intelligence officers from Lebanon. This has ended in a matter of weeks a military presence that had lasted 30 years and underpinned Syria’s complete dominance of its neighbour for the past 15. Although the unexpectedly rapid withdrawal has reduced the threat of sanctions and other forms of direct action against it, Syria remains isolated and US-led pressure on it is likely to continue. There will be some forward movement with economic reform, but the hostile political environment makes far-reaching change unlikely. Economic growth will be slow, but the buoyant outlook for oil prices will ensure that government finances remain comfortable and the trade and current account return healthy surpluses.

Key changes from last month Political outlook • It appears likely that a number of liberalisation measures will be revealed at the conference of the ruling Baath Party in June. However, it seems unlikely at this stage that the measures announced will lead to real changes in power, or introduce democratic curbs on the power of the regime. Economic policy outlook • The endorsement of a new five-year economic plan at the Baath Party congress will create additional momentum behind the cautious programme of economic reform pursued unevenly over the past few years. While the Economist Intelligence Unit continues to expect progress on some aspects of the agenda (such as the foreign-currency regime), the overall pace and scope of change is likely to be relatively limited, curtailed by technical challenges, institutional shortcomings and political concerns. Economic forecast • Our economic forecast is unchanged since our previous report.

May 2005

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Contents

Syria

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2005-06 7 Political outlook 9 Economic policy outlook 10 Economic forecast

13 The political scene

22 Economic policy

25 The domestic economy 25 Oil and gas 28 Financial and other services

29 Foreign trade and payments

List of tables

10 International assumptions summary 12 Forecast summary

List of figures 6 Oil production 6Money supply 13 Gross domestic product 13 Consumer price inflation

Country Report May 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005

Syria 3

Syria May 2005 Summary

Outlook for 2005-06 Syria has responded to international pressure stimulated by the assassination of the former Lebanese premier, Rafiq al-Hariri, in February by withdrawing its troops and intelligence officers from Lebanon, ending in a matter of weeks a military presence that has lasted 30 years. Although the unexpectedly rapid withdrawal has reduced the threat of sanctions and other forms of direct action against it, Syria remains isolated and US-led pressure on it is likely to continue. There will be some forward movement with economic reform, but the hostile political environment makes far-reaching change unlikely. Economic growth will be slow, but the buoyant outlook for oil prices will ensure that government finances remain comfortable and the trade and current account return healthy surpluses. The political scene The regime has been pushed on to the defensive in the aftermath of Mr Hariri’s murder, for which it has been widely blamed (although only circumstantial evidence links it to the attack). The government has indicated that a series of political reforms will be announced at the June congress of the ruling Baath Party. This is likely to include the legalisation of currently proscribed parties as a first step toward multiparty elections, although it is unclear how much real power the regime will actually cede as a result of the promised measures. Economic policy A report prepared for the State Planning Commission ahead of the new five- year plan has condemned policy failings over the past “seven wasted years” and stressed the overwhelming importance of reform. The Central Bank of Syria has pledged to liberalise the foreign-exchange regime, but a leading advocate of reform in the president’s office has been forced from his post. The domestic economy International oil prices have continued to rise, offsetting for the time being at least the impact of falling production. The government is seeking partners to reverse the downturn in output, but interest has so far been relatively limited, impeded in part by concerns over US sanctions. More private banks are preparing to start operations in Syria, with the Central Bank undertaking to improve the operating environment by broadening the range of activities in which private banks can become involved. Foreign trade and payments No external account data have been released in recent months, but proxy indicators suggest the trade and current account remained comfortably in surplus. Although a number of Syrian workers left Lebanon as the political situation deteriorated, it is likely that they will return and that the country will remain an important source of employment and foreign-currency earnings.

Editors: Simon Williams (editor); Hania Farhan (consulting editor) Editorial closing date: May 6th 2005 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report May 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 4 Syria

Political structure

Official name Syrian Arab Republic

Form of state Republic

Legal system Based on the constitution of 1973

Legislature 250-member Majlis al-Shaab (People’s Assembly) directly elected for a four-year term

Electoral system Universal adult suffrage

National elections 2003 (legislative), 2000 (presidential); next elections due by 2007 (legislative)

Head of state President, directly elected for a seven-year term. The president appoints the vice- presidents, the prime minister and the Council of Ministers. Bashar al-Assad, who was elected president unopposed in July 2000, also holds the posts of commander-in-chief of the armed forces and secretary-general of the Baath Party. The vice-presidents are Abdel- Halim Khaddam and Zuheir Masharka

Executive The prime minister heads the Council of Ministers, a large number of which are drawn from the Baath Party and its partners; last reshuffle in October 2004

Main political parties Seven parties form the ruling National Progressive Front (NPF): Arab Socialist Baath Party; Arab Socialist Party; Arab Socialist Unionist Party; Communist Party; Syrian Arab Socialist Union Party; Unionist Socialist Democratic Party; Union Socialist Party

Prime minister Mohammed Naji al-Otari Key ministers Agriculture & agrarian reform Adel Saffar Awqaf (Islamic endowments) Mohammed Ziyad al-Ayoubi Commerce Ghassan al-Rifai Communications & technology Mohammed Bashir al-Munajjid Culture Mahmoud al-Sayed Defence Hassan Turkomani Economy & foreign trade Amer Lutfi Education Ali Saad Electricity Munib Assad Sayeem al-Daher Finance Mohammed al-Hussein Foreign affairs Farouq al-Sharaa Health Maher Hussami Higher education Hani Murtada Housing & construction Nihad Mshantat Immigrant affairs Buthaina Shaaban Industry Ghassan Tayyara Information Mehdi Dakhlallah Interior Ghazi Kenaan Irrigation Nader al-Buni Justice Mohammed al-Ghafri Local administration & environment Hilal al-Atrash Oil & mineral resources Ibrahim Haddad Presidential affairs Ghassan Lahham Social affairs & labour Diyala al-Hajj Aref Tour ism Saadallah Agha al-Qalah Transport Makram Obeid

Central Bank governor Adib Mayaleh

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Economic structure

Annual indicators 2000a 2001a 2002a 2003b 2004b GDP at market prices (S£ bn) 903.9 954.1 999.5 1,041.0 1,081.0 GDP (US$ bn) 19.5 20.6 21.6 22.5 22.3 Real GDP growth (%) 0.6 3.8 4.3 2.6a 1.8 Consumer price inflation (av; %) -3.8 3.0 1.0 1.5 2.0 Population (m) 16.6 17.0 17.4 17.8 18.2 Exports of goods fob (US$ m) 5,146.0 5,706.0 6,668.0 5,762.0a 6,427.2 Imports of goods fob (US$ m) 3,723.0 4,282.0 4,458.0 4,430.0a 4,607.2 Current-account balance (US$ m) 1,061.0 1,221.0 1,440.0 728.0a 1,386.7 Foreign-exchange reserves excl gold (US$ m) 2,450.0b 2,950.0b 3,750.0b 3,500.0 3,925.0 Total external debt (US$ bn) 21.7 21.3 21.5 21.7 22.0 Debt-service ratio, paid (%) 4.5 3.2 2.9b 3.6 3.6 Exchange rate (av) S£:US$ 46.30 46.30 46.30 46.30a 48.50a a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003a % of total Components of gross domestic product 2003a % of total Agriculture 25.3 Private consumption 65.6 Mining, manufacturing, electricity & water 25.0 Government consumption 13.7 Wholesale & retail trade 17.0 Fixed investment 20.8 Transport & communications 12.8 Exports of goods & services 30.2 Government services 10.1 Imports of goods & services -30.3

Principal exports 2000b US$ m Principal imports cif 2000b US$ m Crude oil 3,169 Machinery & transport equipment 863 Fruit & vegetables 259 Food & livestock 742 Textiles 317 Metal & metal products 615 Cotton 196 Chemicals & chemical products 397

Main destinations of exports 2003 Main origins of imports 2003 Germany 23.2 Germany 12.1 Italy 15.0 Italy 12.0 Turkey 10.6 China 10.7 UAE 9.0 France 10.0 a Official estimates. b Principal exports and imports are derived from the Central Bank of Syria, Quarterly Bulletin, converted at neighbouring countries exchange rate. Exports of goods and services are taken from the IMF’s International Financial Statistics.

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Quarterly indicators 2002 2003 2004 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Prices Consumer prices (2000=100) 102.6 105.9 110.3 105.7 n/a n/a n/a n/a Consumer prices (% change, year on year) -0.6 1.2 3.2 -3.2 n/a n/a n/a n/a Financial indicators Exchange rate S£:US$ (av)a 46.3 46.3 46.3 46.3 46.3 46.3 46.3 46.3 Exchange rate S£:US$ (end-period)a 46.3 46.3 46.3 46.3 46.3 46.3 46.3 46.3 M1 (end-period; S£ bn) 423.2 462.7 494.7 498.8 503.5 519.7 628.3 642.3 % change, year on year 7.6 23.8 17.8 25.4 19.0 12.3 27.0 28.7 M2 (end-period; S£ bn) 726.9 764.9 824.8 833.0 832.1 844.2 889.4 894.3 % change, year on year 16.7 22.4 18.5 21.0 14.5 10.4 7.8 7.4 Sectoral trends Crude oil production (m barrels/day) 0.49 0.55 0.55 0.54 0.53 0.52 0.52 0.52 Crude oil production (% change, year on year) -5.8 7.8 5.8 10.2 8.2 -5.5 -5.5 -3.7 Foreign tradeb (S£ m) Exports fob 79,250 83,360 94,030 n/a n/a n/a n/a n/a Imports cif -66,530 -54,380 -65,320 n/a n/a n/a n/a n/a Trade balance 12,720 28,980 28,710 n/a n/a n/a n/a n/a a Neighbouring countries rate. b Trade data is calculated using multiple exchange rates determined by the Ministry of Economy and Foreign Trade. Sources: International Energy Agency, Monthly Oil Market Report; IMF, International Financial Statistics; Economist Intelligence Unit.

Oil production Money supply m barrels/day % change, year on year

0.56 30 M1 0.55 M2

0.54 25

0.53

0.52 20

0.51

0.50 15

0.49

0.48 10 0.47

0.46 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 5 2002 03 04 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2002 03 04 Sources: Economist Intelligence Unit; International Energy Agency, Monthly Oil Market Report. Source: IMF, International Financial Statistics.

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Outlook for 2005-06

Political outlook

Domestic politics While the immediate threat of sanctions and other forms of international action has eased in recent weeks, Syria’s political outlook remains unfavour- able. Pressure on Syria increased dramatically in mid-February following the assassination of Lebanon’s former prime minister, Rafiq al-Hariri. Although there is no evidence to directly link the regime in Damascus with the killing, Mr Hariri’s emergence as a powerful opponent of Syria’s dominance of Lebanon led many within Lebanon and abroad to hold Syria responsible. The US and France led the international response, with the former immediately withdrawing its ambassador from Damascus. The two states also warned that Syria faced severe consequences if it failed to comply at once with UN Security Council Resolution (UNSCR) 1559, which requires, among other things, the full withdrawal of Syrian forces from Lebanon. They also called on Syria not to interfere in the Lebanese general election due to be held in May and set in motion a formal UN investigation into the assassination to report!in public!on who should be held responsible for Mr Hariri’s murder. The assassination of a leader as well connected and influential as Mr Hariri was always likely to carry substantial risks. However, the response to the assassination has been particularly marked as it took place against a background of growing international hostility toward the Syrian regime. This has been emerging since the September 11th 2001 attacks on Washington and New York, part of the US response to which has been to make increasingly forceful demands that Syria end its links with “terrorist” groups and abandon its alleged weapons of mass destruction programme. This hostility has been deepened by US frustrations over Iraq, the invasion of which was vociferously opposed by Damascus, and where the US believes Syria is continuing to back the insurgency. Even before Mr Hariri’s assassination in February, anti-Syria sentiment had broadened and deepened, following Syria’s decision in August last year to override Lebanon’s constitution and insist that its ally, Emile Lahoud, remain as Lebanon’s president for a further three years beyond the legal end point of his six-year term in office. This decision, which also led to Mr Hariri standing down as premier and joining the opposition camp, prompted France to join with the US in pressing UNSCR 1559 through the Security Council last year. It also resulted in France blocking the ratification of the EU Association Accord with Syria!a stance that has become more firmly entrenched since Mr Hariri’s murder. Initially, Syria appeared ready to resist the pressure that emerged after Mr Hariri’s killing, with the foreign minister, Farouq al-Sharaa, announcing that while Syrian forces would leave Lebanon, the process would take “at least a couple of years”. However, as the gravity of the situation became clear, the regime changed tack and began to withdraw its troops from Lebanon, committing itself to removing all of its forces by the end of April. The Lebanese general election also seems set to go ahead on schedule and without interference from Syria. This should result in the anti-Syrian opposition gaining

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authority in Lebanon, putting an end to 15 years of near complete Syrian control over its neighbour. The sudden volte-face has reduced the otherwise high risk that Syria would face punitive action to force its troops out of Lebanon. However, although the pressure has eased, risks remain. UNSCR 1559, for example, also appears to require the Syrian-backed Lebanese Shia group, Hizbullah, to be disarmed!a demand that Syria has so far indicated it will not support. Nevertheless, this issue is less pressing than the withdrawal of forces, and has less support in Lebanon or abroad. It could become of greater weight, however, if the crossborder conflict between Hizbullah and Israel increases in intensity. There is also the prospect that the UN investigation into Mr Hariri’s murder might establish that the Syrian government or Syrian intelligence personnel were complicit and should face trial!a conclusion that would almost certainly be rebuffed. It is also possible that despite the withdrawal of its troops, Damascus and its allies will seek to reassert their influence either by manipulating the elections, or by undermining the new government formed thereafter and thus opening the way for punitive action. Even without this, however, the rapid and very public reversal of its fortunes in Lebanon has pushed the regime in Damascus on to the defensive, leaving it more isolated!and appearing more vulnerable!than it has for many years. There is a clear possibility that the US will take this opportunity to increase pressure on Syria over other issues of dispute, such as Iraq and alleged Syrian support for hardline Palestinian groups. As well as pursuing the stated goals, many believe this overall approach appears to have an underlying objective of effecting “regime change” in Damascus through non-military means. While this is unlikely to be successful, it is possible that it could lead to “regime transfor- mation”. This would see the regime accelerate political and economic reform, as the president, Bashar al-Assad, concludes that his best option is to embrace change and reposition Syria internationally and at home. There are some early signs that this approach is being discussed, with officials indicating that a number of potentially significant reform measures will be discussed when the ruling Baath Party holds its congress in June. However, it is perhaps more likely that feeling under threat, the regime will make only superficial changes in order to ensure that it retains the power it needs to protect itself. At the same time, pressure from abroad may boost tensions within the regime as rival factions apportion blame for recent failures and disagree over how Syria should move forward. Mr Assad’s response to this is likely to be to seek to contain the rivalry as best he can, rather than to side forcefully with one faction, leading to policy inconsistency and inertia.

International relations Syria’s isolation has strengthened the position of Israel at its expense. In a bid to ameliorate the pressure it is under, Damascus has offered to recommence peace talks with Israel and has sent out a number of signals of intent. However, Israel has come under no pressure to accept, and has instead been able to set preconditions for talks to take place!a position that has been endorsed openly by the US and tacitly by a number of European states. Unless Syria falls in line with these demands, and co-operates with US-led policies in the region over Iraq and Lebanon, there is little prospect of real efforts being made to restart

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peace talks with Israel. Indeed, the pressure is likely to focus instead on Syria being an obstacle to peace between Israel and its Arab neighbours through its support for militant Palestinian groups, which will increase the likelihood of Israel carrying out military strikes against positions in Syria in response to attacks by Palestinian groups in Israel.

Economic policy outlook

Policy trends Those close to the president continue to stress the importance of economic reform, and hope to propose a programme of change when the government’s new five-year plan is put before the ruling Baath Party some time during 2005. The plan is likely to include commitments to overhaul the subsidy system and the large, inefficient state-owned enterprises that dominate much of the economy, as well as to promote greater private-sector activity and investment. It is also expected to give additional momentum to some of the changes that are already under way, including the progressive liberalisation of the foreign- currency regime. Some acceleration of banking sector reforms is also probable, stimulated in part by the weakening of Syria’s position in Lebanon. Prospects for far-reaching structural reform remain relatively poor, however, undermined by ongoing political tensions, with the recent stand-off over Lebanon providing an additional, compelling case for those opposed to reform to argue that the time is not right to introduce potentially destabilising change. These concerns have added to pre-existing fears within the regime over the political impact of reform given the large number of Syrians who are dependent on state salaries and subsidised basic goods. Key sections of the elite also derive their personal wealth and political power from the current structure of the economy, and they will resist measures that threaten their privileged positions. The long delay now likely in bringing the EU Association Accord into effect has also removed a potentially useful framework for reform, and a lever to implement change.

Fiscal policy The Economist Intelligence Unit has revised its forecast for fiscal revenue upward in line with amendments to its projections for international oil prices. Despite an anticipated downturn in oil production, revenue is expected to strengthen to the equivalent of 26.7% of GDP this year compared with some 26.2% in 2004. Earnings are projected to fall to around 25.5% of GDP in 2006 as oil prices drop and production continues to decline, although this is a more positive outlook than previously anticipated. Assessing spending trends remains hazardous given the paucity of official data, but the strength of international oil prices together with significant political pressures are likely to ensure that government spending continues to rise, although the modest increases in expenditure included in the recently released 2005 budget suggest the pace of growth may be lower than previously assumed. All told, we now expect Syria to record a deficit equivalent to around 1.4% of GDP this year, compared with an estimated 1.6% in 2004. We expect the shortfall to rise to 2.7% of GDP in 2006.

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Monetary policy There are likely to be some further reforms to monetary policy over the forecast period, continuing the process of slow liberalisation apparent over the past two years. During this period, interest rates have been altered for the first time in 20 years, foreign currency rules have been relaxed and the first steps have been made toward the establishment of an interbank market!a key development if liquidity management is to become more effective. However, there remains a long way to go. The Central Bank of Syria continues to lack flexible, indirect monetary tools and interest rates remain unresponsive to liquidity conditions. Credit continues to be predominantly centrally allocated, and the banking sector remains dominated by state-owned institutions. The Central Bank also continues to constrain the workings of the small private banks, setting interest rate caps, for example, and retaining restrictions on foreign-currency operations. These shortcomings will be addressed, but only slowly, as the authorities seek to build capacity and guard stability, as well as protecting the public-sector entities that would be heavily exposed by rapid moves toward a fully market orientated system.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Real GDP growth World 3.9 5.1 4.2 3.9 OECD 2.0 3.3 2.4 2.3 EU25 1.1 2.4 1.9 2.1 Exchange rates ¥:US$ 115.9 108.1 102.7 93.8 US$:€ 1.132 1.244 1.350 1.400 SDR:US$ 0.714 0.675 0.646 0.628 Financial indicators € 3-month interbank rate 2.33 2.13 2.10 2.25 US$ 3-month commercial paper rate 1.10 1.48 3.31 4.38 Commodity prices Oil (Brent; US$/b) 28.8 38.5 46.0 40.0 Cotton (US cents/lb) 63.3 62.0 53.0 58.5 Food, feedstuffs & beverages (% change in US$ terms) 6.6 9.1 -6.5 -1.4 Industrial raw materials (% change in US$ terms) 13.0 21.0 3.5 -6.7 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Our outlook for the global economy is largely unchanged, with the exceptional pace of growth over 2004 (estimated at around 5.1% using purchasing power parity exchange rates) expected to ease towards a medium-term trend rate of just over 4% in 2005 and 2006. We have, however, raised our forecast for international oil prices since our previous report, largely to reflect new data showing non-OECD oil consumption growing more rapidly than anticipated. Non-OPEC production also looks set to grow more modestly than previously expected. These factors will serve to keep the market tight, with the price of Brent consequently now forecast to rise to US$46/barrel this year!an increase of 20% on the average in 2004, which was itself an all-time high. Prices will

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ease in 2006 as the market loosens, but remain very high by historical norms at around US$40/b.

Economic growth The poor outlook for economic growth has worsened as a result of recent political developments, which have damaged local and international confidence, undermining prospects for investment spending and curbing consumption. The anticipated slowdown in the already cautious programme of economic reform will also constrain growth, although this has been offset to some degree by the upward revision to our oil price forecast. At present we expect real growth to stand at just 1.5% this year and around 2% in 2006, curbed by a projected fall in oil output this year and next, which will undermine export volumes and negate the gains anticipated from an increase in non-oil sales to Iraq. Domestic demand growth will be a little more marked, with high oil revenue feeding through into the domestic economy through public spending. The development of Syria’s gas resources will also spur growth, although it is unlikely that production will come on stream until the end of the forecast period at the earliest. The strength of the harvest will also have an impact on domestic demand given the large number of people employed in the agricultural sector.

Inflation The weakness of the US dollar, to which the Syrian pound will retain its peg, will create some inflationary pressure, boosting the cost of various imported goods, particularly those sourced from the euro zone. However, the slow pace of economic growth together with the likely maintenance of the subsidy system on key goods (such as basic foods) and services will keep consumer price inflation in check, and all told we expect prices to rise by an annual average of less than 3%!little changed on 2004. Nevertheless, official data are patchy and there are signs that the consumer price basket does not reflect real trends in a number of unregulated areas of the economy (notably private- sector rents), where prices may be rising more strongly.

Exchange rates The governor of the Central Bank, Adib Mayaleh, has signalled his deter- mination to address the rigidities of the foreign-exchange regime, and we expect to see further reforms introduced over the forecast period. This will probably include the abolition of the few remaining secondary exchange rates, and a further liberalisation of the foreign-currency laws. If the government follows through, this could all but end the black market in foreign currency, which has run parallel to the official currency regime since the 1980’s balance- of-payments crisis. It is highly unlikely, however, that the currency will be allowed to float freely, with the government continuing to favour stability over the emergence of a market rate. As a result, we expect the dominant legal rate for the pound to remain at close to S£50:US$1. The regime can support this approach through the overriding position of the state-owned banks and the control the Central Bank will retain over foreign-currency transactions, even if some laws are relaxed. Given the outlook for international oil prices, the currency is unlikely to come under pressure over the forecast period, unless there is a further deterioration in the political environment (such as the threat of economic sanctions). This would almost certainly lead the government to reverse whatever liberalisation measures had been introduced, as it sought to

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protect the currency by tightening controls on the allocation and management of foreign exchange. This would leave convertibility in doubt and, assuming substantial reform had been introduced earlier, would lead to the rapid re- emergence of the black market.

External sector We have revised our forecast for export earnings upward since our previous report in line with the improved outlook for international oil prices. From an estimated US$6.4bn in 2004, we now expect revenue to rise to around US$6.9bn, before returning to close to last year’s levels in 2006. Import spending will trend upward, largely as a result of higher prices, although there will also be some pick-up in volumes. Overall, however, Syria’s trade surplus is expected to rise to around US$2.2bn in 2005!an increase of some US$330m on last year’s performance, and significantly ahead of our previous forecast. The surplus will ease to a still substantial US$1.6bn in 2006. Non-merchandise earnings appear to have strengthened during 2004, due largely to the arrival of large numbers of Iraqis (both business people, and those fleeing the conflict) and some pick-up in tourism. This upward trend is unlikely to gain momentum this year given prevailing political conditions, while remittances from expatriate workers are likely to ease given antipathy toward Syrian workers in neighbouring Lebanon, although they will probably recover in 2006. Income debits will rise this year following the debt rescheduling agreement reached with Russia in January, which will boost servicing costs. Higher oil prices will also push foreign oil firm profit repatriation upward. The net effect of these trends will be to leave the current account with a surplus of around US$1.7bn (7.2% of GDP) in 2005, following an estimated surplus of about US$1.4bn in 2004. The current account will record a surplus of some US$1.2bn in 2006.

Forecast summary (% unless otherwise indicated) 2003a 2004b 2005c 2006c Real GDP growth 2.6 1.8 1.5 2.0 Oil production ('000 b/d) 530.0 506.3a 472.5 466.3 Gross agricultural production growth -2.7 3.0 3.0 3.2 Consumer price inflation (av) 1.5b 2.0 2.6 2.9 Government balance (% of GDP) -1.9b -1.6 -1.4 -2.7 Exports of goods fob (US$ bn) 5.8 6.4 6.9 6.4 Imports of goods fob (US$ bn) 4.4 4.6 4.7 4.8 Current-account balance (US$ bn) 0.7 1.4 1.7 1.2 Current-account balance (% of GDP) 3.2b 6.2 7.2 4.7 External debt (year-end; US$ bn) 21.7b 22.0 8.5 8.6 Exchange rate S£:US$ (av) 46.30 48.50 48.50 48.50 Exchange rate S£:¥100 (av) 39.95 44.86 47.25 51.73 Exchange rate S£:€ (av) 52.42 60.32 65.47 67.90 Exchange rate S£:SDR (year-end) 68.80 75.32 76.87 77.05 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

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Gross domestic product Consumer price inflation % change, year on year av; %

Syria Middle East & North Africa Syria Middle East & North Africa 6.0 8.0

5.0 6.0

4.0 4.0

3.0 2.0

2.0 0.0

1.0 -2.0

0.0 -4.0 01 02 03 04 05 06 01 02 03 04 05 06 2000 2000

The political scene

Assassination of Lebanese The assassination of Lebanon’s former prime minister, Rafiq al-Hariri, in Beirut premier triggers crisis on February 14th has triggered the worst crisis yet to face the regime of the Syrian president, Bashar al-Assad. He faces a struggle for survival amid growing international pressure and internal criticism. His strategy for dealing with this crisis has involved acceding to the demands for Syria to withdraw its forces and intelligence services from Lebanon, and offering the prospect of reform to the domestic political system. Mr Assad seems to have calculated that with US attention and resources still focused on Iraq, such steps will garner sufficient support from Arab states, Turkey, Russia and China to deter the US from actively seeking to overthrow his regime. He is also seeking to keep alive the possibility of signing an association agreement with the EU that will help to underpin economic reforms being promoted by a new generation of Western- oriented technocrats whom Mr Assad has placed in key positions, including at the State Planning Commission and the Central Bank of Syria. Signing the accord would also go someway toward easing the regime’s political isolation. To be successful, this strategy will require the UN to confirm the withdrawal of all Syrian forces from Lebanon, as demanded by UN Security Council Resolution (UNSCR) 1559. After some initial prevarication, Mr Assad appears to have achieved this, with the last units pulling out of Lebanon on April 26th. It is also vital for Syria’s chances of international rehabilitation that the Lebanese parliamentary elections go ahead as scheduled by the end of May, or with only a limited delay, and without any evidence of Syrian interference. The new Lebanese government appointed in mid-April has prepared the ground for elections to take place between May 29th and June 19th. If the Lebanese opposition takes power after the election it is likely to press for the release of Lebanese prisoners held in Syria and for the establishment of normal diplomatic relations, with embassies in the respective capitals!demands to which Mr Assad will be required to respond favourably. Another critical test will be the results of the UN investigation into the Hariri assassination!the UN’s initial report stated bluntly that Syria bore responsibility for the political tensions that led to the Beirut bombing. The coming investigation will seek to

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establish the identity of the perpetrators. On the domestic front, Mr Assad’s plans to open up Syria’s political system also poses risks to the regime, both from entrenched security and business interests anxious to protect their privileges and from unpredictable political forces that could be unleashed by such reforms.

Syria widely blamed for From the moment that Mr Hariri’s motorcade was blown up by a powerful Mr Hariri’s murder explosion on the Beirut seafront, Syria found itself branded as the prime suspect. The government issued a stream of denials, saying that not only was there no evidence to link Damascus to the murder, but that it was also not logical for Syria to carry out an act that would damage Syria’s interests so seriously. Mr Assad observed in an interview with an Italian newspaper, La Repubblica: “If we had really killed Hariri, for us it would be political suicide. In fact, besides ethical and human principles, the important question is: who benefits? Certainly not Syria.” However, these protestations carried no weight with large swathes of the Lebanese population, who came out on to the streets of Beirut in huge numbers to denounce Syria. Mr Assad had already shown how tenaciously Syria was prepared to fight to hold on to its influence in Lebanon. In August 2004 he shocked most international observers and outraged many Lebanese by extending the presidential term of his ally (and Mr Hariri’s fierce rival), Emile Lahoud, for three years beyond its constitutional expiry point in November. This act was a body-blow to Mr Hariri, who had made it clear that he would not contemplate serving under Mr Lahoud in an extended term. However, not only were Mr Hariri’s views ignored, but the premier was pressurised into lining up his parliamentary bloc behind the Lahoud extension when it was formally passed by the Lebanese parliament. The message that opposition to this move would not be tolerated was driven home when Marwan Hamadeh, a pro-Hariri minister and a close ally of opposition leader Walid Jumblatt, narrowly escaped an attempted assassination in a car-bomb attack that killed one of his bodyguards. In the weeks before his death Mr Hariri had been preparing a political fight- back by contesting the parliamentary elections that were supposed to take place in May. A victory by Mr Hariri at the polls would have been a humiliating reverse for Damascus and could have been viewed as an act of defiance in the face of clear warnings to Mr Hariri not to challenge Mr Lahoud. From this perspective, the assassination of Mr Hariri was a logical extension of the policy that started with the decision to prolong Mr Lahoud’s term in office. That course of action may indeed end up being self-defeating, but it was ultimately the policy set in train by Mr Assad and the inner political circle of the Syrian regime.

Syria attempts to withdraw The series of huge anti-Syrian demonstrations in Beirut triggered by the assas- from Lebanon with dignity sination, together with the collapse of the Syrian-backed Lebanese government at the end of February, made it clear that Mr Assad had to face up to the reality that Syria’s 30-year military presence in Lebanon and 15 years of absolute political control was drawing to an end. Unable to protect his position, his task became one of bowing to international pressure without seeming to be defeated. The president travelled to Saudi Arabia to gauge whether one of the

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most powerful Arab states would be prepared to help Syria to make a dignified exit from Lebanon over a period of months, rather than the precipitate withdrawal called for by the Lebanese opposition and their international supporters, led by the US and France. His task was not helped by the fact that Mr Hariri was a protégé of the Saudi royal family, and even held dual Lebanese and Saudi nationality. Mr Assad received an uncompromising message in Riyadh that he must pull out of Lebanon forthwith. The chief of Egyptian military intelligence, Omar Suleiman, delivered a similar message from Egypt’s president, Hosni Mubarak, who disclosed that he had advised the Syrian president two years previously that the time had come for Syria to get out of Lebanon. Mr Assad gave a number of interviews to the foreign media to try to put across the view that Syria was not behind the Hariri assassination and that he was prepared in principle to pull out his forces. These interviews also served to prepare the ground for him to announce his plans to disengage from Lebanon to the Syrian public. He told Time magazine that the withdrawal would be carried out in a matter of months, but that the details depended on talks to be held with the UN special envoy, Terje Roed-Larsen, in early March. “It’s a technical issue, not political,” he said. “I could not say we could do it in two months because I have not had the meeting with the army people. They may say it will take six months. You need to prepare when you bring your army back to your country. You need to prepare where you will put the troops.” In an interview with an Italian daily, La Repubblica, published on February 27th, Mr Assad added another condition. “Technically the withdrawal can be managed within a year. Strategically, however, it will only happen if we obtain serious guarantees. In one word, peace.”

Damascus presents Lebanon On March 5th Mr Assad delivered a speech to the Syrian parliament in which crisis as regional issue he sought to defend Syria’s policy towards Lebanon and other regional issues as being consistent and based on sound principles. He said that while his approach was always determined in part by the “protection of national and pan-Arab interests”, he also sought to be flexible and pragmatic in dealing with concerned parties, “realising the nature of the international conditions in recent years and the equation between the possible and the desirable”. Based on this, he went on to claim that Syria had been prepared to co-operate over the contentious issues of the Arab-Israeli peace process, conflict in Iraq and the situation in Lebanon, but it had been faced with premeditated hostility from the US and France in particular. He said that UNSCR 1559 had been prepared by the US and France well before the supposed trigger event (the extension of Mr Lahoud’s presidential term). As evidence for this, he cited an interview that the US president, George W Bush, had given to a French newspaper in which he said “[T]here is no connection between the resolution and the extension of President Lahoud’s term of office”. However, Mr Assad maintained that Syria was still prepared to respect the resolution, despite profound reservations about its legality and actual purpose. In a reference to the public demonstrations against Syria in Beirut, he said: “We should not remain in Lebanon one day after there is a consensus over our presence.” Mr Assad went on to suggest that the killing of Mr Hariri was part of a wider scheme (led, it was implied, by the US and Israel) to impose a new order on the

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Middle East that would rob the Arabs of their rights. “There is a hidden provision not in 1559, but in the uses of 1559; and it is settling Palestinian refugees in Lebanon,” he said. “We found that there was a momentum for the Palestinian track. The assassination of Arafat, the assassination of Prime Minister Hariri, pressure on Iraq, pressure on Syria, all that creates a scene that I am sure you can understand. The atrocious crime that claimed the life of Prime Minister Hariri targeted Lebanon’s stability and unity; and it also targeted the role and position of Syria in Lebanon and the whole region.” He also attacked elements of the opposition in Beirut, saying that Syria had sought to get along with all parties in Lebanon on an equal basis, but that it found that certain Lebanese groups “used to sell and buy positions” in what he likened to a political “slave trade”. He said that “the problem started with those people who started talking about sovereignty " We discovered that it is not the sovereignty of the Lebanese; it is rather the sovereignty of any country except Syria, over Lebanon.” He recalled how Syria and “patriotic” Lebanese groups had foiled a previous attempt to impose outside control over Lebanon through the May 17th agreement between Israel, the US and the former Lebanese president, Amin Gemayel, in 1983. He warned that “another 17th of May is looming on the horizon”, but he added that the majority of the Lebanese could be relied on to oppose such a development. “I want to say to all Syrian citizens who have feelings of frustration and disappointment towards treachery, betrayal and lack of loyalty towards what Syria offered to Lebanon: this is not the general case in Lebanon. This represents a number of groups we know fully well and those who stand behind them. Notice how the TV cameras usually zoom in on to a small group of people, but if they zoom out, you will discover there are not so many people supporting them.”

Pro-regime demonstrations This defiant speech was followed by large demonstrations in Syria pledging held in Damascus and Beirut support for Mr Assad on the occasion of the March 8th anniversary of the seizure of power by the Baath Party in 1963. There was also a major pro-Syria demonstration in Beirut organised by the Shia Hizbullah movement, which showed the international community and Mr Assad’s domestic audience that Syria had important supporters in Lebanon and was not isolated. Utilising this moment of apparent strength to seek to show that it was acting of its own volition rather than being forced, Mr Assad started to pull his forces out of the country over the following weeks, and by the end of April the withdrawal was substantially complete.

Withdrawal may not end The rapid withdrawal puts Syria in a position to claim that it has satisfied its Syria’s Lebanon problem basic obligation under UNSCR 1559. The next test will be whether the Lebanese elections go ahead on schedule and without Syrian interference. The prospects for that happening have improved following the appointment of a new government in Beirut in late April, with Najib Mikati (a businessman who, despite his ties to Syria, is respected in Lebanon as an independent) as prime minister. Mr Assad also has to cope with the investigation to be carried out into Mr Hariri’s assassination mandated by UNSCR 1595, passed on April 7th. The investigation commission is expected to include up to 100 people and will have a three-month mandate, which can be extended by up to three months. Potentially, the report could name Syrian officials it judges to be responsible for

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Mr Hariri’s murder and call on them to be tried!a demand Damascus would find difficult to accede to, and which could yet trigger the sanctions the US and others threatened to impose had Syria not withdrawn its forces. UNSCR 1595 was passed, unanimously, after the submission of an initial report to the UN secretary-general, Kofi Annan, by a fact-finding mission headed by Peter Fitzgerald, a deputy commissioner of the Irish police force. Although the report does not offer any direct conclusions on the identity of the perpetrators, it provides a damning indictment of the operations of Syrian military intelligence in Lebanon and makes clear that it holds Syria to be ultimately responsible. It claims that important evidence was either removed or destroyed without record by agents with close links to Damascus, although it hold backs from saying whether this was a result of incompetence, or as part of a deliberate strategy to protect the guilty. In an apparent refutation of claims by Lebanese officials that the bombing was carried out by a previously unknown Islamist group, the UN mission also concluded that the “assassination would have required access to considerable finance, military precision in its execution, substantial logistical support and would have been beyond the capacity of any single individual or small terrorist group”. The report also blames Syria for the political tension that preceded the assassination of Mr Hariri, noting that it “exerted influence that goes beyond the reasonable exercise of co-operative or neighbourly relations. It interfered with the details of governance in Lebanon in a heavy-handed and inflexible manner that was the primary reason for the political polarisation that ensued " it is obvious that this atmosphere provided the backdrop for the assassination of Mr Hariri.” The report also carries an account of Mr Assad’s final meeting with Mr Hariri in which the president is quoted as saying that opposing the extension of Mr Lahoud’s term was tantamount to opposing Mr Assad himself, and that he “would rather break Lebanon over the heads of [Mr] Hariri and [the Druze leader and key opposition figure, Walid] Jumblatt than see his word in Lebanon broken”. The report alludes to further threats being made to Mr Hariri by security officials in case he abstained from voting for an extension to Mr Lahoud’s term or “even thought about leaving the country”. No account of the meeting was made from the president’s side, as Mr Assad declined to meet with Mr Fitzgerald’s team. In a letter to Mr Annan, the Syrian foreign affairs minister, Farouq al-Sharaa, called for the passage on the Hariri-Assad meeting to be excised from the report on the ground that “it is untrue and lacks any material evidence”. Mr Annan declined to do so. Mr Assad also criticised the Fitzgerald report, saying that its analysis was overly political and not based on hard facts and evidence.

Uncertainty surrounds regime The dramatic unravelling of Syria’s Lebanon strategy has raised questions about decisions over Lebanon the decision-making processes in Damascus. Mr Assad has made no attempt to shift responsibility for his government’s policy towards Lebanon on to anyone else by, for example, publicly dismissing senior figures from his government or security services. The one exception was the appointment of his brother-in-law, Brigadier-General Assef Shawkat, as the head of military intelligence on February 14th, the same day as Mr Hariri’s assassination. He replaced General Hassan Khalil, who, according to Reuters news agency, had reached the

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retirement age that day. However, General Shawkat was previously deputy head of military intelligence and widely regarded as the real decision-maker in the organisation. Indeed, General Shawkat, married to Mr Assad’s elder sister, Bushra, has been one of the linchpins of the Syrian security establishment since the latter days of the rule of Hafez al-Assad, who died in June 2000. General Khalil had been largely a figurehead, installed in his position in early 2000 following the dismissal of Ali Duba, formerly one of the most powerful men in the elder Mr Assad’s regime. The other key figures in what is sometimes referred to as the “new guard” in the current regime include Mr Assad’s younger brother Maher, who heads the Republican Guard, and General Bahjat Suleiman, the head of the internal division of the General Intelligence Directorate and widely credited with engineering the smooth accession to power of Mr Assad. The other key member of the regime’s inner circle is Rami Makhlouf, a cousin of Mr Assad and one of Syria’s most prominent business- men. On the fringes of this circle are two leading “old guard” figures who previously played dominant roles in Syria’s policy towards Lebanon: the vice- president, Abdel-Halim Khaddam, and the current interior minister, General Ghazi Kenaan. The decision that set the recent Lebanon crisis in train!retaining Mr Lahoud in power rather than allowing the election of a new president!remains a cause of considerable confusion. Although Mr Lahoud is close to Mr Assad and has demonstrated his absolute loyalty to Damascus, he has no support in Lebanon or abroad, and his retention was bound to ignite considerable opposition. Moreover, there was no shortage of alternative, equally reliable candidates whose election in place of Mr Lahoud would have been assured and would have generated little controversy. Ultimately, the decision on the extension was taken by Mr Assad, and in subsequent speeches he went to some lengths to defend it. However, it is not clear whether the decision was the product of consensus among the top figures in the Syrian regime, or whether there were competing factions within the elite. It has been suggested that Mr Khaddam (who was close to Mr Hariri and was the only senior Syrian politician the Hariri family allowed to present condolences in person) was opposed to the Lahoud extension. General Kenaan, who served as head of Syrian military intelligence in Lebanon for 20 years before being replaced by General Rustom Ghazaleh in 2002, is also said to have had reservations. Given the emergence of clear divisions between Mr Hariri and Mr Lahoud it is likely that some factions in Damascus were more closely tied to the late prime minister, whereas others would have developed privileged ties to the entourage of the Lebanese president. The decision over Mr Lahoud’s fate could thus have been heavily influenced by competition within these groups for domestic standing, with the extension of his term serving as an opportunity to defeat the old guard. The regime may also have simply underestimated the reaction (both abroad and in Lebanon) that interfering in the poll would generate. The likelihood that at the May elections Mr Hariri and the opposition would challenge the gains the pro-Lahoud camp had made when his term was extended would also have been a serious cause for concern.

Syria’s position in Lebanon Although the Hariri killing brought the Lebanon issue to a head, Syria’s position had been weakening for years has been under growing pressure for some time. The original purpose of Syria’s intervention in Lebanon in 1976 was to prevent the coalition of Palestinian and Lebanese Muslim and leftist militias from achieving an outright victory in the civil war over the Christians!a development that would have risked provoking intervention by Israel and Western powers led by the US and France. The Syrian regime has continued to maintain that it plays an essential role as an arbiter between Lebanese factions and as a guarantor of stability. During the period of Israeli occupation of large parts of Lebanon between 1982-2000, Syria was also able to claim that its presence was justified by a real military threat to its western flank from Israeli forces stationed in Lebanon. As Lebanese politics stabilised in the 1990s, the political justification for Syria’s military presence became increasingly weak. In recognition of this, Syria lowered its military profile and reduced its troop numbers to about 14,000 at the end of 2004, compared with a peak of 40,000. However, Syria used its intelligence services to maintain tight supervision of Lebanese politics. The argument that Syria faced a threat from Israel via Lebanon also lost currency after Israel pulled its forces back over the border in mid-2000. Pressure from the US on Syria to withdraw from Lebanon and curtail its support for Hizbullah (the Shia political party whose guerrilla forces led the campaign against the Israeli occupation, and which continues to mount periodic attacks on a small pocket of disputed territory controlled by Israel) has grown steadily since Mr Bush became president. Heavy lobbying in Washington by pro-Israeli and exiled Lebanese Christian groups led to the passage of the Syria Accountability and Lebanese Sovereignty Restoration Act at the end of 2003. The act provided for sanctions to be applied if Syria did not withdraw from Lebanon, curtail its weapons of mass destruction programme and break all ties with hardline Palestinian groups. Mr Bush was initially reluctant to proceed against Syria, in part because he hoped to persuade it to help stabilise Iraq as well as retain US access to Syrian intelligence. However, US views against Damascus hardened as its officials began to conclude that Syria was failing to prevent its territory being used as a rear base for the Iraqi insurgency. Mr Bush’s announcement in May 2004 of economic sanctions against Syria should have sent a clear signal to Damascus that the US administration had decided to move Syria up its foreign policy agenda. Syria’s decision to extend Mr Lahoud’s term, coupled with what the US viewed as an inadequate response to its concerns over the Iraqi insurgency, resulted in a further deterioration in relations and pushed the US to work with France on UNSCR 1559.

US may opt to play long game Mr Assad now faces a formidable challenge of damage limitation from a policy over regime change in Syria that has further blackened Syria’s international reputation and left him no choice but to relinquish his hold on Lebanon, giving up what Syria has long claimed to be a valuable strategic asset. Within the higher ranks of his regime there are likely to be a number of figures who stand to lose materially from the withdrawal from Lebanon and who have reason to blame Mr Assad for what now appears to be a series of dire miscalculations. However, the narrow basis of the regime, with most of the key security positions held by members of Mr Assad’s Alawi minority, means that an internal power struggle could be

viewed by other groups in Syria as a sign of weakness. This provides a measure of security for Mr Assad, as both potential internal rivals and outside powers favouring a change of regime have to consider the uncertain outcome of such a process, particularly in light of developments across the border in Iraq. The Washington Institute for Near East Policy, an influential research body with links to the present US administration, argued in a paper published in mid- March that the US should persist with a policy of “constructive instability” with the ultimate aim of ending the sway of the Baathist regime. The author, Robert Satloff, the institute’s director, said that the first task for the US was to improve its intelligence about the inner working of the regime. This echoed a statement by the then deputy defence secretary, Paul Wolfowitz, in an early February briefing to the US Senate Armed Services Committee. “There’s some argument as to whether President Assad is fully in control in Syria or not,” he said. “But we do know this is a police state and somebody’s in control and we have a list of, sort of, who the top 12 leaders are.” Mr Satloff said that once the Syrian army leaves Lebanon, “Washington should turn the spotlight on Syria’s egregious behaviour toward its own citizens”. He suggested that the starting point could be pressing for a change to the Syrian constitution, which vests the Baath Party with control of the country’s political leadership. He also argued that the US “offer no lifelines to this regime”, and should reject any attempt by Mr Assad to deflect pressure on him by offering conciliation on the Arab-Israeli question. Mr Satloff called on the US administration to “maintain a dogged incremental persistence” in its approach to generating change in Syria, “neither overplaying its hand nor recoiling at the first sign of setback”. This seems to be an accurate depiction of Mr Bush’s approach. There is as yet no sign of the US actively working to overthrow the regime of Mr Assad through mobilising dissidents or preparing for an eventual military assault. However, it is clear that Mr Assad will have to accomplish a long list of tasks before Washington treats him as an acceptable head of state whose views are worthy of consideration. The withdrawal from Lebanon is only the first step. Syria will also be required to stand back and allow the Lebanese elections to go ahead on schedule, and Mr Assad will be judged on the question of whether Hizbullah agrees to disarm. He will also need to clamp down harder on the Palestinian armed groups with offices in Damascus (the most important of these, Hamas, has already shifted most of its Syrian operations to Egypt), and take a tougher line against Iraqi insurgents and former associates of the deposed Iraqi president, Saddam Hussein.

Baath Party expected to initiate The swift withdrawal from Lebanon may indicate that the message from reform at June congress Washington is getting through to Mr Assad. He is also taking a number of measures on the internal political front that could be seen as a response to US pressure on the questions of democracy and human rights. In early June the Baath Party is scheduled to hold its regional congress, an event that has been planned for some time, but postponed ostensibly because of the situation in Iraq. The Baath Party regional congress provides an opportunity for Mr Assad to validate the argument that gradual reform is feasible in Syria. The previous congress (the ninth) assembled in June 2000 after the death of Hafez al-Assad. Its main function was to approve the appointment of the current president as

secretary-general of the regional command. The tenth congress is expected to debate proposals for fundamental changes to the role and outlook of the party. It is anticipated that this will entail revoking a clause in the Syrian constitution (as amended in 1973) that states that the Baath is the leading party in the Syrian state and society. Although a law was passed in 1974 allowing political parties to be formed, they were restricted to being junior members of the Baath- dominated National Progressive Front, and were required to proclaim “Arab socialist” principles. The tenth congress is also expected to debate a resolution on changing the party’s economic principles from the current formula of centrally planned socialism to an explicit endorsement of the free market.

President promises multi-party In a strong indication of the direction along which he expected the Baath Party elections congress discussions to progress, Mr Assad said in an interview with Spanish newspaper editors at the end of March that he envisaged the creation of freely constituted political parties as the next stage in Syria’s reform process. He also said that he expected this to lead to Syria holding multi-candidate elections, including for the presidency. His own term runs out in 2007. The conditions envisaged for the establishment of new parties will provide an important initial marker of how substantial this reform process is likely to be. Syrian press reports have already indicated that parties explicitly based on religion will not be allowed!a condition presumably aimed at preventing the Muslim Brotherhood from forming a party. The new law is also likely to prohibit the formation of parties based on ethnic affiliation. This would prevent the emergence of parties designed solely to campaign for Kurdish interests. In the lead-up to the congress, the government has made some conciliatory gestures to both the Muslim Brotherhood and the Kurds, notably by releasing several hundred prisoners, including the Kurds detained after riots in March 2004. The government has also allowed a number of prominent exiles to return home. They include: General Jasem Alwan, a Nasserist officer who staged an anti-Baath coup attempt in 1963; Yousef Abdelki, an artist who had been previously arrested for his communist views; and Abdel-Hamid Saraj, the director of intelligence during the period of union with Egypt (1958-61). Press reports have also suggested that the congress will recommend the abolition of Law 49 of 1980, which stated that membership of the Muslim Brotherhood is punishable by the death sentence. The law was passed after an assassination attempt on Hafez al-Assad by a Brotherhood member. The passage of a new party law is likely to result in attempts to resurrect some of the parties that were active before the Baathist takeover in 1963. The main ones are the People’s Party (founded in Aleppo), the National Party (whose core supporters were in Damascus) and the Syrian Social National Party, which was banned in Syria in 1955, but has continued to operate in Lebanon. It could also provide an opportunity for the people involved in the brief “Damascus spring” that lasted for a few months after Mr Assad came to power in mid-2000 to revive their activities and press for the release of their leaders. The most prominent of these figures was Riyad al-Seif, a businessman and an independent MP who was jailed in 2002 as part of the clampdown on unauthorised political activity. Mr Seif, a trenchant critic of Syria’s state-dominated economic

policy, had sought to form a political party under the name of the Movement for Social Peace. His prison term ends in 2007.

Baath Party shows early signs The Baath congress is termed “regional” (“qutri”) because the party was of resistance conceived (in 1947) as a pan-Arab party not confined to the state borders drawn by the imperial powers. However, the previous “national” congress of the party was held 25 years ago. There have been reports that a national congress will be held in May that will in effect abolish the pan-Arab shell of the party, and reduce it to a committee within the Syrian Baath Party. However, the sensitivity of this issue was highlighted in March when the commander of the Popular Army (the Baath militia), Brigadier Mohammed Ibrahim Ali, said during the course of an interview on state television that the national leadership of the Baath should be abolished. His comments resulted in the television discussion programme on which he appeared!Madarat!being taken off the air and its presenter, Nidal Zaghbour, transferred to other duties. A few weeks later it was announced that a new director of state television had been appointed!Diana Jabour, a former editor of a state newspaper, al-Thawra. Brigadier Ali was to be investigated by a special Baath Party panel. The episode suggests that any attempts to push through substantial changes to the Baath from within the party itself will face formidable obstacles. Indeed the party’s rules limit the changes of personnel on the various elected bodies! including districts, branches and the regional command itself!to 10%. There were indications that sitting officials managed to ensure that in the preliminary elections before the congress the number of new members voted in was significantly less than 10%. Assuming that Mr Assad is genuinely in favour of political reform, the “old guard” standing in his way extends far beyond the inner circle of security officials and includes thousands of Baath Party officials who will do their utmost to protect their privileges, however meagre these are.

Economic policy

Political tensions impede The Syrian government has acknowledged that a substantial increase in economic reform investment is essential to enable the economy to emerge from a trough of low growth and high unemployment. However, the rising tensions in Syria’s relations with a wide range of international powers have made it hard to lay solid foundations for increased flows of foreign aid and investment. The tense political atmosphere is also likely to affect the efforts of reform-minded technocrats who have been seeking to increase the influence of market mechanisms in the economy. Since the late 1990s the Syrian regime has been seeking to build a reform programme around an economic association agreement with the EU. That agreement was finally initialed in October 2004 after a lengthy delay caused by a dispute over the wording of a clause on weapons of mass destruction (November 2004, The political scene). However, the agreement still has to be formally signed, and will not take effect until it has been ratified by the parliaments of all 25 member states of the EU. Preparations for the next steps in the process, such as translating the agreement into the various languages of the EU, are getting under way.

However, there is little prospect of the agreement being signed, let alone ratified, until Syria’s political relations with the EU show a significant improve- ment. The prompt withdrawal of Syrian forces from Lebanon after the assassination of the former Lebanese prime minister, Rafiq al-Hariri, is a first step towards Syria’s political rehabilitation, but it remains unlikely that the EU would risk endorsing the Syrian regime through signing the association agreement until the UN investigation into the Hariri killing has been completed. In the meantime Syria is pressing ahead with some aspects of reform. A free- trade agreement with Turkey is set to come into force in mid-2005, for example, and the newly appointed governor of the Central Bank of Syria, Adib Mayaleh, has taken steps to stimulate the nascent private banking system and spoken in favour of liberalising the exchange rate. The State Planning Commission is preparing to launch a market-based five-year plan at the upcoming Baath Party congress.

Important economic reformer On assuming office, the president, Bashar al-Assad, signaled his commitment to sacked economic reform by promoting a number of relatively young Western- educated technocrats to prominent positions in the realm of economic policy. However, the ability of these figures to impose change on Syria’s deeply entrenched bureaucracy, and on the hierarchies of the Baath Party and the security establishment, has appeared increasingly open to question. One of the most important members of the reformist team, Nibras al-Fadhel, for example, has announced that he is leaving his post as economic adviser to Mr Assad. In an interview with the pan-Arab Al Hayat, Mr Fadhel said he regretted that he had been unable to participate more effectively in making changes to the structure of the Syrian economy. He said his inability to effect change was partly a result of his advisory role, but was also because of “the absence of systematic principles in the presidency, the lack of authority and the weakness of the capabilities available”. He said that he had been notified on April 14th by the minister for presidential affairs, Ghassan al-Lahham, that his contract, which was due to run until the end of 2005, has been terminated on the instructions of the president. Mr Fadhel stated that he planned to return to Paris, where he had been working as an academic and an economic consultant until he was appointed to his current position at the start of 2003. He was a leading member of the team that conducted the negotiations with the EU about the association agreement. Mr Fadhel, aged 45 and the son of the former president of Damascus University Mohammed al-Fadhel (assassinated by a member of the Muslim Brotherhood in the early 1980s), had been outspoken on the scale of the challenges facing the Syrian economy. In an earlier interview with Al Hayat, published one week before his dismissal, Mr Fadhel had appeared to stray on to political territory when he said that the only way that Syria could deal with the current crisis was to press ahead with internal reforms, “which demands addressing the concerns of Syria’s citizens and their economic and political aspirations, as well as enabling them to participate in strategic decisions”. Mr Fadhel had also spoken extensively about the necessity for economic reform to be buttressed by political changes in an interview published by the Daily Star, a Beirut-based English-language daily, on April 9th. His reference in this interview to the need

for “good governance and democratic values, promoting human rights, dignity and freedom, and not pitting different religious, ethnic and other population groups against each other” may have been too much for his superiors to accept.

Abdullah al-Dardari remains The departure of Mr Fadhel leaves the head of the State Planning Commission bullish on reform prospects (SPC), Abdullah al-Dardari, as the principal advocate of economic reform. Mr Dardari, like Mr Fadhel, has sought to emphasise that Syria’s political difficulties should not be a barrier to progress with economic reforms. At a press briefing at the Damascus offices of the UN Development Programme at the end of March, Mr Dardari denied suggestions that Syria’s political isolation had adversely affected the efforts to develop the country’s external economic relationships. He pointed to an increase in the operations of the European Investment Bank in Syria from #40m (US$52m) per year to #300m, the continued support of French development agencies for financial reforms and to the opening up of the banking sector. He said that the basic principle of the new five-year plan, which will run from 2006-10, will be that economic reform requires greater convergence with the global economy. The plan aims to increase the rate of real GDP growth from below 3% a year to more than 7%, based on attracting annual foreign investment of US$8bn per year. He denied that there was any obstacle to signing the EU Association Accord.

Official report slams Syria’s The efforts by Mr Dardari to put a positive gloss on Syria’s economic situation “wasted years” contrasts with the much more sober assessments made by the SPC. The SPC commissioned a report from a group of Arab and Western economists aimed at providing an independent analysis of the state of the economy in the lead- up to implementing the new five-year plan. According to excerpts published in Al Hayat, it concludes that the Syrian economy is beset by “fundamental distortions” that need to be addressed urgently through structural reforms, a crackdown on corruption and effective measures to co-ordinate economic policy. The report describes the period between 1997 and 2003 as “seven lost years” during which GDP per head declined in real terms. The report notes that the majority of the Syrian population is now aged under 24, which means that the pressures to find jobs for new entrants to the labour market are set to increase. It identifies the low level of investment as one of the principal causes of the economy’s weakness. Between 1992 and 1997 the report says that total investment was equivalent to 21% of GDP, while the savings rate was 17%, indicating a reasonable level of foreign investment in the economy. However, the figures were reversed between 1998 and 2003, with gross investment of 18% of GDP and a savings rate of 24%. The report also highlights the basic weakness of Syria’s fiscal situation, with gross tax receipts (excluding oil) amounting to only 10% of GDP, compared with 13% in Lebanon and 21% in Tunisia.

Central Bank liberalises Efforts to restructure the economy are receiving growing support from the foreign-exchange regime Central Bank under the control of its new reformist governor, Mr Mayaleh. In early April Mr Mayaleh announced that decrees would be passed soon to “establish a free market for foreign exchange”. Although he provided few other details, he did say that the new system would be “competitive”, suggesting that there would be some movement away from the current fixed exchange-rate

system. Underscoring the movement toward a more liberal foreign-exchange regime, the government at the end of March authorised the state-owned Commercial Bank of Syria to lend foreign currency to businesses to finance their imports. This was followed in mid-April by the approval of a decree allowing private banks to lend in foreign currency to private- and mixed-sector importers to finance purchases of raw materials and intermediate and capital goods, not including transport equipment. Although the announcements form part of a long-term strategy, the timing is likely to have been influenced by developments in Lebanon, on which Syria has long-relied for trade finance and other facilities.

Interest rates adjusted to The Central Bank has also made a number of adjustments to interest rates, with attract longer-term funds the apparent aim of supporting long-term lending by providing incentives for savers to invest in long-term deposits. Rates on deposits for one year and over have risen from 6% to 7%, while those for shorter-term deposits have been reduced to 4% from 5%. Current accounts will now pay 1.5%, rather than 2%. The rates on investment bonds have gone up by one percentage point to 7.5%. The Commercial Bank of Syria has also been authorised to extend medium- and long-term loans to the private sector.

Decree passed to establish The Credit and Monetary Council (CMC) has issued a decree enabling the interbank market establishment of an interbank market. The move follows discussions between the heads of private banks and Mr Mayaleh, who is also head of the CMC. The private banks, which started operations in 2004, have been highly successful in attracting deposits, but have limited opportunities to invest these funds. The result has been a build-up of excess liquidity, which, under current rules, must be maintained as a cash reserve with the Central Bank. According to one private banker, these reserves are kept in plastic boxes, colour-coded to identify the particular bank. The launch of an interbank market should help to resolve this problem. The Central Bank is considering issuing Treasury bills as another means to absorb liquidity, but has yet to provide details.

The domestic economy

Oil and gas

Oil prices continue to climb International oil prices have remained very high over recent months, with the benchmark dated Brent Blend averaging just under US$49/barrel over the first four months of the year. This is some 50% ahead of the performance over the same period of 2004, the year in which Brent recorded its highest ever annual average price. The performance is in part a reflection of robust growth in global oil demand, particularly China-led increases in non-OECD Asia consumption, which has continued to exceed the expectations of most market analysts. These includes the oil exporters’ cartel, OPEC, which in late 2004 announced that it would cut output from its year-end highs from early 2005, fearing that softening demand growth would leave the market in surplus by the second quarter of this year. Those concerns have now evaporated, however, and, despite renewed OPEC commitments to boost production, prices have been driven upward by

fears that global supply will struggle to meet demand over the coming year. More immediately, prices have been boosted by an awareness that oil suppliers inside and outside the cartel are now producing at close to capacity. This leaves them with little scope to deal with unexpected disruptions to supply, which could as a consequence push the market sharply into deficit This could drive prices significantly beyond their current levels!a market position that has inflated the risk premium.

Syria seeks partners to stem The surge in prices has offset, for the time being at least, the downturn in oil production decline output. In the late 1990s Syrian production reached a peak of around 600,000 barrels/day (b/d), but has since declined, and currently stands at around 450,000 b/d. The oil and mineral resources minister, Ibrahim Haddad, said recently that according to studies carried out by the state-owned Syrian Petroleum Company (SPC) production could fall to 250,000 b/d by 2020!a level of output that would probably render Syria a net importer. However, much of Syria’s potentially oil- bearing territory has yet to be explored and the government is actively seeking foreign partners to locate and develop new resources in order to stem the rate of decline. In early March, for example, the government signed an agreement with a Norwegian firm, InSeis Terra, to perform seismic survey work over a 4,700-sq km area in Syria’s Mediterranean waters. The data will form the basis of an offshore oil and gas exploration bid round that is expected to be launched in 2006. The results of the Norwegian firm’s surveys will be the only recognised official dataset. In the meantime, the fifth oil and gas licensing round is under way, with bids due to be submitted by early October. Nine open blocks covering a total area of 65,000 sq km are included in the licensing round, which will be awarded on the basis of 25-year exploration and production sharing agreements (EPSAs). The EPSAs will offer a 12.5% royalty from the total amount produced, while recovery costs are put at 40%. The response to earlier rounds has been patchy with Chinese, Russian, Indian and Canadian companies showing some interest. In March the government awarded two blocks to Stratic Energy of Canada and Tatneft of Russia. Stratic initialled an EPSA for Block 17 in the centre of the country. The agreement requires the investment of US$5.2m in an initial phase of three and a half years. Stratic will be investing in the field in partnership with the Kuwait Foreign Petroleum Exploration Company (Kufpec). Stratic will own two-thirds of the project and operate it while Kufpec will own the rest. Stratic said that it is seeking another financial investor to bring down its share to 35%. Tatneft signed a contract to search for oil in Block 27 in the east of the country, with investment of US$7m in the initial three-year period.

Another US firm withdraws Efforts to draw in foreign investment and expertise, however, continue to be from oil sector undermined by political factors, notably US sanctions. Although there is not a direct ban on US firms investing in the oil sector, trade restrictions do bar the import of US equipment into Syria and complicate financial flows. There are also fears within the oil industry that sanctions could be extended further. The latest blow was the withdrawal in March of Devon Energy, one of the largest US independent oil companies. Devon Energy signed a production-sharing agreement for Block 26, in north-eastern Syria in May 2003. It held 80% of the

contract, with an affiliate of another US-based firm, Gulfsands Petroleum, holding 20%. A Devon spokesman said that the firm had made the decision because it “had encountered roadblocks” when trying to progress with its work, and that US sanctions had made its operations “problematic”. He added that negotiations were being held with Gulfsands and other parties interested in acquiring the Devon Energy stake. Gulfsands later confirmed that it was keen to continue to work in Syria and in April the Houston-based firm raised £30m (US$57m) from a share-placement on the London alternative investment market (AIM), the proceeds of which it said would be used to finance planned oil and gas exploration and development in Syria, as well as in the US and in southern Iraq. The chief executive of Gulfsands, John Dorrier, told the Economist Intelligence Unit that he remained optimistic over prospects for investment in the country, adding that US trade sanctions were not, in his experience, “a problem of the magnitude suggested by Devon”. He also noted, however, that his firm was less vulnerable to US pressures than Devon because “Gulfsands Petroleum plc is a British company and the interest holder in the block is Gulfsands Petroleum Syria Ltd, a wholly owned subsidiary and a Cayman Island company that has no US offices or directors.” He said that the firm plans to start seismic acquisition this summer, with possible spudding of the first exploration well late this year or early next year.

Tender previously agreed with The departure of Devon Energy follows the scrapping of a US$750m gasfield US firm reissued contract for which a consortium including Occidental Petroleum of the US had been selected for negotiations. Mr Haddad said in January 2005 that the deal had fallen through because the consortium had been unable to satisfy the government’s request for project guarantees in light of the threat of further US sanctions. Petro-Canada, the consortium leader, said that it had been notified that the government had decided to carry out the project “in-house”. The Canadian firm, which is a minority partner in Syria’s largest crude oil producer, Al Furat Petroleum Company, declined to comment on the possible reasons for the decision. In April the Syrian Gas Company (SGC) issued a tender invitation for a project that appears to incorporate the main elements of the first phase of the contract that was being negotiated with the Petro-Canada-led consortium, the third member of which was Petrofac International, a UK-based firm with a long-term presence in Syria. The new tender is for phase one of the South Middle Area Gas Exploitation Project, and will entail the tie-in of the wells in three non- associated gasfields west of Palmyra!Abo Rabah, North al-Fayed and Qomqom!and the construction of a central gas treatment plant with a capacity of 6m cu metres/day. The closing date for bids is June 20th. The decision to move ahead with the development of these fields is likely to have a bearing on the plans of Croatia’s INA Naftaplin for developing the nearby Jihar gas and condensate field. The Croatian firm issued a notice of commercial discovery for the field in April 2004, and said that it expects production to start in 2006 at a rate of about 2.5m cu metres/d. Some of the facilities for the South Middle Area Project could be shared with Jihar. SGC has also invited bids by June 8th for a contract to build the first phase of the Syrian section of the Arab Gas Pipeline, which originates in Egypt. The work entails laying a 324-km pipeline from the

Jordanian border to the Al Rayan area, near Homs, with a branch to the Deir Ali power station. The initial section of the pipeline, linking Egypt to Aqaba in southern Jordan, was opened in July 2003. The trans-Jordanian section is currently under construction.

Financial and other services

Private banking attracts more More regional financial institutions are preparing to begin operations in Syria, interest despite the teething troubles encountered by the first batch of private banks to open their doors last year. The Ministry of Finance and the Central Bank of Syria have sought to address some of the concerns raised by the banks. Recent initiatives include authorising interbank lending, allowing banks to lend to importers in foreign currency, studying plans to issue Treasury instruments and revising stamp-duty regulations. Two of the first three private banks operating in Syria are partly owned by Lebanese banks. Banque du Liban et d’Outre Mer (BLOM) holds a 39% equity stake in Bank of Syria and Overseas and exercises managerial control. Banque Européenne pour le Moyen-Orient has a 22% stake in BEMO Saudi Fransi (BSF). Syria’s third private-sector bank, the International Bank for Trade and Finance (IBTF), is 49% owned by Jordan’s Housing Bank for Trade and Finance. Three other banks are preparing to launch their services once they have completed raising the minimum capital of US$30m, of which 51% must be owned by Syrian shareholders. The first is the Jordan-based Arab Bank, which raised 24.3% of its start-up capital through a heavily oversubscribed initial public offering in February. Arab Bank itself holds the maximum allowable 49%, and the remaining capital has been paid in by prominent Syrian business people. Banque Audi, one of Lebanon’s leading financial institutions, is also pressing ahead with plans to open an affiliate in Syria, but has decided to increase its start-up capital to US$50m from the minimum required level of US$30m. Basel Hamwi, an adviser to the bank’s chairman, said that a Gulf investor had agreed to take a 2% stake in the Syrian venture. Banque Audi will hold 47% and the remaining equity will be held by Syrians, including a 20% block that will be offered to the public. He said that the bank had decided to opt for higher capital to allow it more scope to build up its Syrian pound business from the start. The non-Syrian portion of capital must be retained in US dollars, and so the only means to increase local-currency equity is to start from a higher overall capital base. Banque Audi received its initial licence to set up banking operations in Syria in mid-2004. Another leading Lebanese player, Bank Byblos, also received a licence in 2004 to set up a Syrian affiliate. It is teaming up with the OPEC Fund for Development, which has agreed to take a 7.5% stake, leaving Byblos with 41.5%. The cabinet on March 29th approved a law allowing the establishment of Islamic banks. It is similar to the law covering the existing privately-owned banks, but has a higher minimum capital requirement. A number of Gulf- based Islamic institutions are said to have expressed interest in investing in Syria!including Qatar International Islamic Bank and Saudi Arabia’s Dallah Albaraka Group.

Government looks to improve Besides encouraging private investment in the banking sector, the government operations of state banks is also taking steps to upgrade the operations of the state-owned banks. At the end of April the president, Bashar al-Assad, issued decrees stating that four of these banks would henceforth enjoy “financial and administrative indepen- dence”, and would be free to lend for a much wider range of activities than they can under their current restricted status. These four banks are the Savings Bank, the Real Estate Bank, the Popular Credit Bank and the Agricultural Bank. The first three will be required to raise their capital to the equivalent of US$30m, while the capital of the Agricultural Bank will be increased to US$100m. It is unclear how this additional capital will be generated. There is no change in the status, however, of the dominant state-owned financial institution, the Commercial Bank of Syria. The government has also approved a law covering the modernisation of a financial training centre that will seek to improve the skills of people working in the banking industry. The law stipulates that the Central Bank will take over responsibility for the centre from the finance ministry. The project is to be financed by a #6m (US$7.9m) grant from the EU.

Foreign trade and payments

Current-account surplus likely No external account data have been released since the Economist Intelligence to have widened over 2004 Unit’s previous report. The most recent figures now date back to 2003, and show Syria generating trade and current-account surpluses of US$1.3bn and US$730m respectively. It is likely that both surpluses grew strongly during 2004, primarily as a result of high oil prices!which will have driven export revenue sharply upwards, despite a downturn in average production. Non-merchandise earnings are also likely to have risen, with officials claiming in April that the number of foreign visitors to the country rose by 45% year on year during 2004. These visitors include a significant number of Gulf Arabs spending holidays in Syria. However, many of these Arab visitors are either business people or traders, whose numbers have been swelled over the past two years by Iraqis seeking a safe haven from the ongoing conflict across the border. This includes a number of wealthy figures, many of whom have also used Syria as a base for trade-orientated business in Iraq. Import spending is likely to have increased, particularly in light of the weakness of the US dollar against the currencies of many of Syria’s main trade partners, which will have added to the dollar price of many foreign-sourced goods and services. With domestic demand remaining relatively weak, however, the overall rise is likely to have been modest, and is unlikely to have matched the increase in export earnings. Income debits are likely to have strengthened during the course of the year, as high oil prices boosted the profits of foreign oil firms.

Lebanon will remain key The recent crisis in Lebanon and the forced withdrawal of Syrian troops from source of foreign exchange the country may have a less marked impact on Syria’s external accounts than some have feared. Lebanon has been an important source of foreign-currency earnings, the value of which it is widely believed are underestimated in official data. Perhaps most importantly, Lebanon has provided work for a large number of Syrian expatriates. Although the size of the workforce in Lebanon has

declined from its peak in the mid-1990s, most estimates suggest that there were around 300,000 Syrian workers in the country at the end of 2004. Lebanon is also an important market for Syrian goods!according to the most recent data, merchandise exports were worth around US$200m in 2003, although it is likely that the real total was higher. The Lebanese banking sector has also been an important means for the private sector to sidestep the restrictions prevalent in Syria and tap foreign-currency credit and other forms of capital. In the weeks immediately after the assassination of the former Lebanese prime minister, Rafiq al-Hariri, in February there were reports of large numbers of Syrian workers fleeing Lebanon as the anti-Syrian mood in much of the country deepened and there were a series of attacks on expatriate workers. However, the majority of Syrians remained in the country, and it is likely that those that departed will be drawn back as they are by far the cheapest and most convenient option for the Lebanese who employ them on construction sites, in hotels and restaurants and on farms. Syria’s proximity should also safeguard much of its merchandise trade with Lebanon, and it is highly likely that plans for Syria to supply natural gas will not be affected by recent political developments. It is also very unlikely that Syria will lose access to Lebanon’s banking sector, which continues to view Syria as an important avenue through which to grow their business. There will be some losses, however, although they are difficult to quantify. Since Damascus first sent troops to Lebanon in 1976, and more forcefully since it assumed near complete control of its neighbour with the end of the war in 1990, Syria has used its political power to build interests in many areas of the Lebanese economy. With its forces gone and its allies weak, these interests are likely to whither, cutting the commercial and other financial revenue streams that Syrian government officials have otherwise been able to profit from.

Free-trade accord signed with The Lebanon crisis has blocked progress toward Syria signing an economic Turkey Association Accord with the EU. However, a free-trade deal with Turkey is proceeding. The agreement, signed at the end of 2004, is likely to come into force in the middle of this year, the deputy economy and trade minister, Ghassan Habash, said in an interview with a Damascus-based monthly, the Syria Report. He said that it is modelled on the agreement that Syria and the EU initialled in October 2004 and will entail a gradual elimination of Syrian import tariffs over 12 years. Once the agreement comes into force the maximum tariff will be set at 50%, except for car imports. Tariffs on cars with engines of less than 1.6 litres will be reduced to 65% from 145% in the initial three years. For larger cars the rate will be decreased to 150% from 255% in the first phase. Mr Habash said that he expects Turkish exports to Syria to rise by 50% in 2005 to US$1.2bn in response to the agreement. He noted that the main benefit for Syria would be increased flows of Turkish investment, in particular in the manufacture of components for industries based in Turkey.