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s i t n n h h d d d i o b c g y y a a a e e e c . s s s s l l . , . , , c o o m m 2 A 0 u g 0 u s 7 t Gross Domestic Product sector, mainly the imminent shortage, underdeveloped SP billion infrastructure and limited refining capacity, yet this sector seems 2,000 7.1% 8% 6.8% 1,812.1 to have a relatively more promising outlook than oil. Syrian 5.9% authorities are also increasingly focusing on building the 6% 1,479.7 6.3% country’s gas capacity. Natural gas production currently stands at 1,500 8 billion cubic meters per year, 5-6 billion cubic meters per year of 1,253.9 5.2% 4% which is clean gas. Syria’s gas is all used domestically with local 1,067.3 consumption estimated at 5.1 billion cubic meters per year. 974.0 1,016.5 1,000 However, as the country’s power plants are all switching to gas, 2% demand is expected to double in a few years time, according to official sources. Plans are actually being made to meet this target. 1.1% 500 0% The completion of the Arab Gas Pipeline, expected in the second 2001 2002 2003 2004 2005 2006 part of 2007, would supplement the gas national requirement Nominal GDP Real GDP growth rates from Egypt. In the medium-term, there are some positive signs

Sources: Central Bank of Syria, Bank Audi's Research Department regarding new reserves with the Hayan development gas project, undertaken by Croatia’s INA, making progress. The latter project will bring two gas fields on-stream in the second half of 2007, adding 0.5 million cubic meters per day to current output. 1. ECONOMIC CONDITIONS Likewise, PetroCanada is developing Al-Shaer and Cherife gas fields that could be brought into production, around 2010, with 1.1. REAL SECTOR production estimated at 2 million cubic meters per day. 1.1. Oil Sector To sum up, the year 2006 marks a clear change in trends. Syria’s energy resources, despite all the efforts made, can not be The Syrian oil sector accounts for around one quarter of GDP, considered anymore as a buttress to the economy. This year’s 10% of fiscal revenues and 40% of exports’ value, making it a economic growth was constrained by lower oil and gas output and leading economic sector and the main source of foreign exchange next year is expected to remain as such. Authorities, having for the country. Syria’s oil reserves are estimated at circa 2.4 realized that, did not only intensify efforts in search for energy billion barrels with relatively more important gas reserves of 240 resources, but are also seriously focusing on economic billion cubic meters. However, over the past few years, Syria has diversification and encouraging private sector investments, with been witnessing a decline in oil production, with the country the non-oil sector reporting around 6% to 7% growth rate in turning into a net importer in 2006, as reported by the Finance 2006, thus, bolstering economic activity at large. Minister. The authority noted that the oil import bill was US$ 157 million higher than the exports’ receipts in 2006, expecting a 1.2. Agriculture and Manufacturing widening of the gap in the near term. Syria’s agricultural sector that accounts for almost one quarter of Oil production has been regularly dwindling, from the peak of the country’s GDP and employs one third of the labour force, was 600,000 barrels per day reported in the nineties, to reach an hit by climate conditions in the harvest year 2006/2007, as a result average of 380,000 barrels per day in 2006, down from 400,000 of drought and floods, damaging up to a fifth of annual production. barrels per day in 2005, according to the Petroleum Minister. In The year was not characterized as a disaster for Syria’s agriculture, the coming few years, forecasts bring down production to an but was rather a poor year in terms of harvest yields. This raised average of 300,000 barrels per day, unless new reserves are attention to the problems that agriculture suffers from, especially in identified. The Euphrates Basin fields, Syria’s major oil basin that light of efforts made to maintain food self-sufficiency, increase used to produce at its peak some 400,000 barrels per day, is export earnings, and lower rural urban-migration through agrarian currently producing 150,000 barrels per day. development. The unfavourable weather, nonetheless, coupled with problems at the level of land fragmentation, slow irrigation In light of the recent developments and the important role of oil reforms, and inefficient archaic agricultural production techniques, in the economy, the Syrian government is working hard to led to a decline in quantity and quality of harvest this year of major increase exploration and production activity. In addition to crops, like cereals and cotton. tender announcement for seven onshore blocks that have not yet been all awarded, the government is trying, for the first time, to Wheat output was 4.9 million metric tons in 2006/2007, down from attract bidders for locating offshore reserves. At the same time, 5.5 million metric tons the previous year, and is predicted to fall to efforts are being made to increase refining capacity, in the hope of 4.7 million metric tons in the following year, compared to what the benefiting from oil transported from nearby rich-energy previously projected yield of 5.3 million metric tons, according to countries. Syria’s two existing state-owned refineries in Banias official figures. However, Syria will still be able to meet its national and Homs, each with a capacity of 120,000 barrels per day, cannot wheat consumption estimated at 3.8 million tons a year. meet local demand estimated at around 350,000 barrels per day, necessitating the import of around 150,000 barrels per day. Syria is considered an important player in the international wheat export market, and is one of the seven countries in the world that Syria is, thus, looking into overhauling the refineries and, while have attained wheat self-sufficiency, according to Head of the plans have been made for that purpose, they remain unexecuted. General Establishment for Cereals Processing and Trade, the At the same time, a memorandum of understanding was signed in government-owned agency that subsidizes wheat production. The October 2006 for a new joint venture refinery east of Homs, government agency purchased in 2006 around 3.3 million tons of owned by Syria, Iran and Venezuela, and having a capacity of wheat from farmers and reported a growth of 100% in Syria's 140,000 barrels per day. Another memorandum of understanding export of wheat relative to the previous year. However, with the was signed with Kuwaiti Nour Financial Investment Company to deteriorating harvest, it recently announced the cancellation of all build a US$ 1.5 billion refinery in Deir el-Zour for a capacity of its 2007 export contracts for soft and hard durum wheat. 140,000 barrels per day. Also, studies are underway for another 70,000 barrels per day joint venture refinery in Deir el-Zour with Another major Syrian cash-crop is cotton that also reported lower a Chinese company, as reported in the Middle East Economic yields in 2006 with production down from 1 million tons in 2005, Survey. to 686,000 tons. Further, the 2006/2007 harvest is expected to drop to 650,000 tons. This deterioration was also reflected in the Syria’s gas resources suffer from the same challenges of the oil production of cotton lint that fell from 350,000 tons in the previous

2 year, to an estimated 225,000 tons in 2006/2007. Domestic such as this year’s weather that accentuates its internal weaknesses, consumption of cotton lint is forecast at 165,000 tons, including the industrial sector seem to have a relatively more promising 150,000 tons to be consumed by state-owned spinning plants. outlook with increased liberalization reforms, private investment Thus, cotton lint exports are also expected to decrease from 200,000 flows, and easier access to funding through the growing presence of tons to 75,000 tons in 2006/2007. private sector banks. The challenge for the secondary sector remains, though, at the level of competitiveness. Syria needs to Cotton and lint also feed into an important textile manufacturing meet international standards to access export markets, and even sector which is the second export foreign receipt source, after oil. locally compete with some imports flowing in following the The government's goal is to increase production of cotton yarn and relaxation of trade barriers. textiles and to increase exports of these products in lieu of cotton lint. Textile and footwear exports, which comprise raw cotton, According to the Arab Competitiveness Report 2006, published by yarns and garments, amounted to a total of SP 94 billion (around the World Economic Forum, Syria fared poorly in terms of the US$ 1.88 billion) in 2006, or around 19% of total exports. The competitiveness of its economy -assessed through a state-owned textile firms, grouped under the General Organization Competitiveness Index- and ranked only 12th out of the of Textile Industries (GOTI), are undergoing an overhaul to 13 Arab countries and 84th out of 128 countries modernize production techniques and meet world competition. surveyed in the world. Its weaknesses are at the level of Market efficiency (Rank: 114), Technological Readiness Most other manufacturing activities remain, likewise, under (109), Innovation (99) and Higher Education and government control, although authorities are introducing a Training (96). Syria ranked relatively better in Primary August number of economic reforms to move into a market-based Education and Health (45) and Macroeconomy (61). economy and to provide a business-friendly environment for investors. The main industrial firms, other than those specialized in 1.3. Construction and Real Estate 2007 textile, are in chemicals, food, metals and electronics, and are also grouped under state agencies; such as the General Establishment of The construction and real estate sectors in Syria Chemical Industries that announced a turnover of SP 9.3 billion in continued to witness a boom in 2006. The main drivers 2006, up by 7% from the previous year, and the General behind this buoyancy remain the large population, the number of Organization of Food Industries with sales of SP 5 billion in 2006, business executives flowing in and demanding high-end real estate, also up by 7.4% relative to the previous year. the focus on tourism and the upgrading of the related infrastructure. In addition, the Lebanese fleeing the Israeli war in Although most sectors are still under government control, Syria is 2006, adding to the regular flow of Iraqis, fuelled demand during increasingly attracting private local and foreign investments, this peculiar year. This has been coupled with the introduction of especially, since 2006, when administrative and legal measures were regulatory reforms and new laws to encourage investment and introduced to set up a new investment authority early in 2007. The facilitate property transactions. On the supply side, to relax the Syrian Investment Authority (SIA) started operations this year as a strained real estate market, the government is working on attracting “one-stop shop” for investors and licensed 77 investment projects mega foreign property development projects that would increase at a total investment cost of SP 35.4 billion. The most important commercial and residential capacity. However, demand has been recently licensed projects include a SP 2.6 billion sugar refinery that progressing at a much faster rate, driving prices upwards. will produce 320,000 tons of sugar a year, with half of this for According to a report by Kuwait Financial Centre, apartment prices export, a cotton threads’ plant with a capital of SP 2.5 billion, in major Syrian cities rose by 20% in 2006 while rents increased by producing 16,200 tons of threads for export, a cable manufacturing 40% year-on-year. plant with a capital of SP 1.2 billion and producing some 13,400 tons of different size cables for local consumption. In total, the Most of the real estate investments continuously flowing into Syria value of industrial projects licensed by the SIA in its latest meeting are Arab-Syrian partnerships, such as the already-started mega US$ in July 2007 was worth SP 8.8 billion, as stated in The Syria Report. 4 billion Emaar projects (Damascus Hills and the Eighth Gate) and the ongoing US$ 15 billion Syria Bonyan City project. Many other Another major public-private joint venture in 2006 is the Syrian- smaller size projects are also underway like the Syrian-Jordanian Iranian Automobile Manufacturing Company (SIAMCO), which is US$ 50 million Shahba Mall, Syria’s largest commercial centre a US$ 60 million joint-venture between Syria and Iran. SIAMCO expected to open doors in 2008, the US$ 25 million Palm Village aims to produce 10,000 units a year of its car brand “Cham” and is resort developed by the Saudi BinLadin group and completed this expected to capture 13% of the growing car market. The Syrian car year, and the US$ 120 million Yaafour Gardens requiring three market is estimated, in 2006, at 75,000 units, up by 36% from 2005 years to build starting early in 2008. and by 134% from 2004. Iranians also invested in the Syrian cement sector, with a partnership launched in 2006 to build the seventh Real estate investments are also being made by local investors, such cement plant in the country, adding to six government-owned as Cham Holding’s “Cham”, the largest private consortium of plants managed by the General Organization of Cement and Syrian businessmen. Cham will develop the US$ 100 million Hijaz Building Materials. The new plant will have a production capacity Station estate, which will spread over 11,000 square meters with a of 1 million tons a year, but would not be completed before 2008. built-up area of 133,000 square meters and will include mainly commercial and office real estate as well as an underground rail The cement sector is, indeed, attracting local and foreign investors’ station to link with the Damascus Airport. Cham will also build attention with a market size of 6.2 million tons in 2006, according three tourism resorts, of which a US$ 70 million five-star hotel with to government officials. Syria's six state-owned cement producers 250 rooms accompanied by 90 furnished apartments in the Mazzeh provide some 4.8 million tons a year and the balance is imported. district of Damascus that will be managed by Marriott. The two Syria has potential in this sector, with current annual consumption other resorts are two four-star hotels: one in Palmyra, which is still per capita standing at only 65% of the average in other in the preliminary studies stage and a 4-star hotel in Lattakia that Mediterranean countries, while prices are relatively high. The will cost US$ 20 million. market is expected to grow to 6.5 million tons in 2007, especially as the real estate boom continues to push demand much ahead of Overall, real estate is still attracting the private sector, especially supply. with favourable new laws and with the high profitability prospects it has, in a situation of a supply bottleneck and persistent demand To sum up, agriculture and industry in Syria need to play an growth. Indeed, with the government’s current five-year plan, increasingly important role, in the economy as part of the aiming to attract investments of up to SP 450 billion (nearly US$ 9 diversification plan. The two sectors do have potentials, yet whereas billion) in real estate before the year 2010, out of which less than the agriculture might still be hampered by unforeseen external shocks, quarter will be provided by state-owned entities, the sector shows

3 promising prospects in the short to medium-term. context of buoyant economic growth, have fuelled trade and retail activity. Indeed, consumer habits started changing in Syria and the 1.4. Trade and Services launch of several new commercial malls is among the most visible Trade and services enjoyed a good year and were, indeed, main of these new trends. The second half of 2006 saw the opening of economic drivers in 2006. Government efforts have been made, numerous shops offering famous international brands in major particularly to develop a growing tourism sector, and with it, other Syrian cities and allowing Syrians to purchase imported garments related activities. Reforms to ease regulations and to move into a for the first time in decades. relatively more liberalized economy have kicked in. Hence, maritime transport activity followed the trends in trade According to the Central Bureau of Statistics, the total number of activity and movement at Syrian ports increased, according to tourists visiting Syria stood at 3.1 million in 2006 (excluding one- figures of the Ports of Lattakia and Tartous. In 2006, the two main day visitors), up from 2.6 million in 2005, a growth of around 19%. maritime ports handled a total of 20.85 million tons of cargo and If Iraqis and Lebanese were included, the total number of tourists 510,619 containers, up by 5.8% and 20.9% respectively year-on- would stand at 4.4 million in 2006, versus 3.4 million in 2005, a rise year. Income generated from these activities remained almost stable of 29%. This growth is mainly coming from Arab and Turkish for the second continuous year. The total income stood at SP 5.44 visitors, whereas European and American visitors are on the billion (around US$ 108.8 million) in 2006, a slight growth of 1.1% decline, reflecting politics’ impact on the sector. from the previous year when revenues stood at SP 5.38 billion (about US$ 107.6 million). It is worth mentioning that the Port of Iraqi arrivals alone reached 1.15 million in 2006, a growth of 57.5% Tartous recently contracted with ICTSI from the Philippines for a from the previous year. Lebanese incomers more than doubled to 10-year concession to build and manage a container terminal. In stand at 0.82 million in 2006, from 0.37 million in 2005. Gulf fact, this growth in maritime transport in 2006 can be also partially visitors, in contrast, declined from 0.67 million in 2005 to 0.58 explained by the transit trade with Iraq in addition to the diversion million in 2006 (13.4%), whereas Jordanian tourists increased by of some of the activity of the Port of Beirut during the Israeli attacks 50% from 0.49 million in 2005 to 0.73 million in 2006. Turkish on Lebanon in the summer period. tourists reported a notable increase from 0.17 million in 2005 to 0.25 million in 2006 (around 47%). European tourists totalled 0.22 In line with the performance of the tourism and transport sectors, million in 2006, down from 0.25 million in 2005, and American the telecom sector reported a favourable performance in 2006. The tourists also fell to 54,000 from 57,000 in 2005. Accordingly, the number of subscribers to the two mobile networks reached 4.4 number of hotel nights (excluding Iraqis and Lebanese during the million in 2006, up by some 52% from 2.9 million in 2005. Syriatel months of July and August 2006) reached 7.50 million, up by 5% had around 2.43 million subscribers, including 1.79 million to its from 7.11 million in 2005. Income generated from tourism pre-paid cards service, while Areeba had 1.98 million subscribers, (excluding Iraqis and Lebanese during the months of July and including 1.44 million to its pre-paid service. Authorities are August 2006) rose to SP 110 billion (US$ 2.15 billion) in 2006, currently studying the prospects of introducing a third GSM compared to SP 103 billion (about US$ 2.0 billion) in 2005; a 7% operator in Syria. Likewise, landline subscribers increased by 12% growth. to 3,258,000 in 2006. In contrast to the growth in phone penetration rate, Syria still suffers from low internet penetration as To meet this increasing demand, the government has been inviting a result of the poor quality of services. proposals for investments in tourism and hospitality and, at the same time, launching a number of promotional events in the hope of turning this sector into a major hard currency earner and job 1.2. EXTERNAL SECTOR creator. According to the latest IMF report, tourism investment projects’ approvals in 2006 were estimated at SP 101 billion (almost Syria’s strong economic activity in 2006 was positively reflected in US$ 2 billion) up from SP 36 billion approved in 2005. Prospects in its external accounts. In spite of the decline in oil production and that sector are strengthening, with the Ministry of Tourism now consequently a drop in oil export earnings, the strong foreign preparing to launch mega projects, based on the success it achieved demand led to an overall 15.3% surge in exports that outpaced the in attracting investors' interest in smaller projects. For instance, in 3.6% rise in imports, thus reversing the previous year’s the latest Tourism Investment Market Forum, the Ministry of performance, and generating a trade surplus of SP 45.3 billion, Tourism offered around 100 projects for investment and against a small deficit of SP 7.4 billion in 2005, as per the Central development, with three huge locations offered for the first time Bank’s preliminary statistics. and expected to draw between US$ 13 billion and US$ 15 billion. The breakdown of exports, according to data obtained by The The largest is Snobar (US$ 8 billion), located south of the city of Syria Report, shows that crude oil continues to represent the most Lattakia, and covering an area of 13 million square meters that important export item, accounting for 40% of the total. Textile & includes the set-up of several tourist villages, hotels and apartments footwear, which comprises raw cotton, yarns and garments, in addition to different service, entertainment and sport facilities. followed with 19% then live animals and vegetable production The growth in tourism, and the increased liberalization, in a with 12.5%, chemicals with 5.7%, food and beverages with 5.0%, and base metals with 2.2%. Imports, in contrast, are mainly constituted of refined oil accounting for 30% of the total, Number of arrivals to Syria (in millions)* followed by base metals with 12.3%, chemicals with 12.3%, 7 machinery with 11.8%, transport equipment with 9.1%, live 6.15 5.84 6.01 6 animals and vegetables with 7.5%, food and beverages with 4.7%, and textiles with 4.2%. 5 4.39 4.27 Italy was Syria’s main export market with 20% of all the country’s 4 3.39 exports. France followed with 8.8% of total exports, then came 3 Saudi Arabia with 8.8%, Iraq with 6.4%, the United Kingdom with 4.4%, Jordan with 4.0%, and Egypt with 3.8%. On the 2 imports’ side, China topped the list with 6.8%, followed by Egypt 1 with 5.2%, South Korea with 4.1%, Italy with 3.3%, and Turkey 0 with 3.2% of total imports. 2001 2002 2003 2004 2005 2006 * Arrivals include one-day visitors In short, the external account managed to end this year on a Sources: Central Bureau of Statistics - Syria, Bank Audi's Research Department favourable note, yet Syria’s trade balance is expected to come

4 under pressure in the near term. Although non-oil export payments to foreign companies turned out to be higher than that revenues are expected to continue to rise next year, the decline in of the country’s crude oil exports. According to the EIU, this oil production, and the increased trade liberalization measures suggests that the drop in oil output from the Euphrates Basin and markets’ opening to the private sector, boosting imports, will fields discovered in the 1980s is gaining momentum. The overall have a negative effect on merchandise exchange. However, with oil production is estimated to have fallen by about 20,000 barrels the regular surpluses in the current account, reaching a high of SP per day to about 380,000 barrels per day, as per the Syrian 43.1 billion in 2006 (2.4% of GDP), up by 173% from a low of SP Petroleum Minister. 15.8 billion in 2005, according to Central Bank statistics, it is On the other hand, the drastic decline in tariffs rates and expected that the booming tourism sector, strong transit and corporate income tax rates in recent years, with the top marginal trade activity, and regular remittances would give further support rate coming down from 65% in 2003 to 28% in the latest to the services account and somewhat dilute the lower trade amendment, as reported by the IMF, triggered a higher volume of balance. Moreover, in order to maintain an inflow of hard non-oil tax receipts which, within the context of enhanced tax currencies, Syria needs further to buttress its capital account, by administration, led to a substantial surge in non-oil tax attracting capital investments; a trend that seems to have already revenues estimated at 18.9%. Also, the increase in the started in 2006. dividend payments on the part of profitable pubic companies, mainly in the telecommunications sector, generated a robust rise of about 17.4% in non-oil non- Foreign Sector Indicators tax revenues. August 140% 6% On the expenditures front, an estimated 1.8% 129.5% 130.0% 130% compression in capital spending is deemed to have 2007 somewhat alleviated wasteful spending, yet its level is 117.8% 3.6% 120% 3.5% 4% still high, standing at 8.9% of GDP, as per IMF 109.5% 110% estimates. An increase in subsidies to loss-making 3.2% 103.8% public enterprises and rising pension and social assistance 98.4% 100% 2.4% 2.4% 2% payments have contributed to an estimated 17.4% rise in current expenditures, thus pushing total expenditures up by about 10.4%. 90% 1.1% As such, although the rise in non-oil revenues has exceeded that of 80% 0% total expenditures and has lowered the non-oil fiscal deficit from 2001 2002 2003 2004 2005 2006 11.6% of GDP in 2005 to 10.2% of GDP last year, the more Exports/Imports Current account/GDP important than expected decline in oil revenues prevented a Sources: Central Bank of Syria, Bank Audi's Research Department similar improvement at the level of the overall balance, with the overall fiscal deficit to GDP ratio moving up by a yearly 1.7% to 5.7%, as per IMF estimates. In its latest Article IV Consultation Mission’s preliminary 1.3. PUBLIC SECTOR conclusion, the IMF asserted that while all these fiscal reforms are timely and appropriate, there is a need for the authorities to The healthy macroeconomic performance and the wave of sustain their efforts, especially as oil revenues are bound to reforms adopted by the Syrian authorities have yielded rather continue on their declining path. To this effect, the Fund suggests positive results on the public finance front. Although oil a series of additional reforms aimed at boosting public revenues production has been on the decline, thus entailing a drop in the and most particularly at lowering public expenditures, in an government’s oil-related revenues, several welcomed fiscal ultimate aim to improve the fiscal balance in a sustainable way. adjustment measures implemented by the government on both the revenues and expenditures side have led to an amelioration in On the revenues side, the IMF strongly encourages the the non-oil budget deficit, yet could not offset the decrease in oil introduction of a value added tax (VAT) right on time to offset the revenues, and resulted in an overall fiscal deficit of 5.7% of GDP expected continuing nosedive in oil revenues. On the last year as per IMF estimates, against a slightly lower 4.0% in expenditures side, the phasing out of the costly petroleum price 2005. subsidies, for which preparatory work is beginning, is viewed as a cornerstone of fiscal reforms. The Fund argues that, beyond Total government revenues are estimated to have progressed by a contributing to important fiscal savings, it would allow efficiency meager 2.0% year-on-year in 2006, as the 31.8% decline in oil gains, improve equity, and have a positive effect on the balance of revenues has more than offset the remarkable 17.0% rise in non- payments. oil revenues last year. On one hand, Syria became a net oil importer in 2006, as per a recent declaration of its Minister of Moreover, the IMF recommends, among other measures, to Finance, since the value of oil product imports and royalty review the efficiency and effectiveness of expenditures in

Selected Public Finance Indicators 2001 2002 2003 2004 2005 2006E Var Var Var Var Var CAGR 02/01 03/02 04/03 05/04 06E/05 01-06E Revenues/GDP 30.1% 26.2% 28.8% 27.2% 24.4% 21.9% -3.9% 2.6% -1.6% -2.8% -2.5% 26.4% Oil revenues/GDP 17.9% 12.5% 14.7% 11.2% 7.5% 4.5% -5.4% 2.2% -3.5% -3.7% -3.0% 11.4% Non-oil revenues/GDP 12.2% 13.7% 14.0% 16.0% 16.9% 17.4% 1.5% 0.3% 2.0% 0.9% 0.5% 15.0%

Expenditures/GDP 27.8% 28.2% 31.4% 31.4% 28.4% 27.6% 0.4% 3.2% 0.0% -3.0% -0.8% 29.1% Current expenditures/GDP 17.0% 16.2% 17.7% 19.0% 18.1% 18.7% -0.8% 1.5% 1.3% -0.9% 0.6% 17.8% Development expenditures/GDP 10.8% 12.0% 13.7% 12.4% 10.3% 8.9% 1.2% 1.7% -1.3% -2.1% -1.4% 11.4%

Non-oil fiscal balance/GDP -15.6% -14.5% -17.3% -15.4% -11.6% -10.2% 1.1% -2.8% 1.9% 3.8% 1.4% -14.1% Overall fiscal balance/GDP 2.3% -2.0% -2.6% -4.2% -4.0% -5.7% -4.3% -0.6% -1.6% 0.2% -1.7% -2.7% Sources: IMF, Bank Audi's Research Department

5 important sectors of activity such as health, education and public modernize the sector and address inflationary issues. transportation, in order to reprioritize and develop reforms. It The ongoing number of projects in the country and all foreign also strongly advises authorities to address all public spending- direct investments and subsequent inflows of capital pouring in associated inefficiencies such as across-the-board subsidies to allowed the Central Bank of Syria to continue benefiting from consumers and producers. Finally, the Fund stresses on the accrued net foreign assets in 2006. Indeed, the latter increased by imperativeness of pursuing and even intensifying all fiscal and a solid 9.6% last year, moving from SP 155.2 billion in 2005 to SP structural reforms, at the risk of halting the growth momentum 170.1 billion in 2006. In parallel, the enhanced economic activity and inviting macroeconomic instability back as a forefront player led to a year-on-year surge in money supply. Broad money M2, in the country’s permanent attempt to overcome its many defined as the sum of money supply M1 and quasi-money daunting challenges. components, increased by a healthy 8.3% to SP 1,182.4 billion. This could be mostly attributed to increased money creation Public Indebtedness reflected in a strong growth in banks’ credits to the private sector, US$ billion 25 120% as the latter progressed by a yearly 14.0% in 2006. 21.3 20.0 19.3 19.0 100% Such favorable happenings were nonetheless accompanied by 20 103.4% continuing inflationary tendencies. Central Bank figures indeed 91.3% 90.0% 80% 85.0% suggest that the average price index has increased from 7.4% in 15 2005 to an even higher 10.0% in 2006. A consistent part of the 60% reported figure is attributed to a rise in food prices, likely 10 6.6 6.6 40% mirroring weather-related shortages, an increase in worldwide oil prices that rendered imports more expensive, and a rise in both 5 30.7% 20% 23.8% domestic demand and foreign demand from peer Arab countries experiencing similar weather issues. Further, the large number of 0 0% 2001 2002 2003 2004 2005 2006 Iraqi refugees to Syria, estimated to have grown by 40% last year Foreign Debt Foreign Debt/GDP to nearly 1.5 million, is believed to be adding to inflation, by pushing rental and real estate prices upwards, and straining Sources: Economist Intelligence Unit, Bank Audi's Research Department government expenditures, especially those related to energy and food subsidies, health and education.

Exchange Market Indicators In the face of such increased pressures, the Central Bank of Syria went on with its modernization plan and announced the 200 SP million 30% 170.1 abandonment, as of the beginning of 2007, of the Syrian pound’s 175 155.2 peg to the green currency, which should largely contribute to 27% 150 140.8 alleviating imported inflationary pressures. The Central Bank 124.1 25.7% intends to replace the multi-exchange rate regime and move to a 125 106.0 24% 93.3 managed float of the Syrian pound. The peg to the US Dollar is to 100 22.9% 23.4% be abandoned in favor of a peg to a basket of currencies based on 22.2% 22.6% 21% 75 21.4% the IMF’s Special Drawing Rights (SDRs), according to a recent 50 EIU report. These SDRs, holding 44% in US Dollars, 34% in 18% Euros, and 11% each of Sterling pound and Japanese Yen, seem 25 well in line with Syria’s foreign trade portfolio. 0 15% 2001 2002 2003 2004 2005 2006 Net Foreign Assets Net Foreign Assets/Money Supply SP Sources: Central Bank of Syria, Bank Audi's Research Department Money Supply and Inflation 10% 30% 7.4% 24.7% 10.0% 8% 5.1% 4.4% 6% 3.0% 1.4. FINANCIAL SECTOR 20% 18.5% 4% 2% 1.4.1. Monetary Situation 13.2% 1.0% 11.9% 0% The continued favorable macroeconomic conditions reigning -2% 8.1% 8.3% over Syria in the year 2006 have had positive spillovers on the 10% -4% monetary sector, with a healthy increase in the Central Bank’s net -6% foreign assets and an ever-expanding money supply. Such positive -8% 0% -10% developments yet continued to foster inflationary pressures, thus 2001 2002 2003 2004 2005 2006 calling for the monetary authorities’ intervention to curb down the pressures on prices, with new monetary reforms, especially at Money supply growth Consumer Price Inflation the level of the foreign exchange system, adopted in an aim to Source: Central Bank of Syria, Bank Audi’s Research Department

Monetary Situation Var Var Var Var Var Flows in SP million 2001 2002 2003 2004 2005 2006 02/01 03/02 04/03 05/04 06/05 Net foreign assets (monetary system) 118,196 84,881 25,870 52,814 13,087 -13,811 -28.2% -69.5% 104.2% -75.2% -205.5% Claims to public sector 41,928 -3,276 17,204 23,934 72,393 20,236 -107.8% -625.2% 39.1% 202.5% -72.0% Claims to private sector 2,126 5,198 25,468 38,366 74,759 31,265 144.5% 390.0% 50.6% 94.9% -58.2% Total 162,250 86,803 68,542 115,114 160,239 37,690 -46.5% -21.0% 67.9% 39.2% -76.5% Money supply (M2) 144,231 134,969 70,363 123,637 126,011 98,231 -6.4% -47.9% 75.7% 1.9% -22.0% Other items (net) 18,019 -48,166 -1,821 -8,522 34,228 -60,541 -367.3% -96.2% 368.0% -501.6% -276.9% Sources: Central Bank of Syria, Bank Audi's Research Department

6 The sector regulator’s implemented measures to tighten limits on branch network all over the country but simultaneously mirroring credit extension are deemed to have curbed down the growth in the pent-up potential for the development of banks’ activities in credits to the private sector, as the aforementioned figure is low the country. compared to the 50.6% yearly progression recorded in 2005, and could very well curb down pressures on prices. However, the In spite of its recent growth, the banking sector’s dimension in the government’s intention to abolish its retail fuel price subsidy Syrian economy remains low in relative terms. In fact, the assets to system, coupled with its long-known conservatism that could lead GDP ratio stood at 85.2% in 2006, lower than the regional average it to favor currency stability over its free float, could slow down of 96.8% and the estimated emerging markets average 151.8%. the efficiency of all such measures. However, the EIU believes that Similarly, the deposits to GDP ratio stood at 49.0% last year, lower the dominant position of state-owned banks and the control that than the regional average of 61.8% and the estimated emerging the regulator retains over foreign exchange transactions, in spite markets average of 114.5%. Most particularly, the loans to the of relaxed laws, should allow the authorities to comfortably private sector to GDP ratio attained 15.5%, almost three times protect the value of the domestic currency. lower than the regional average of 44.1% and the estimated emerging markets average of 98.5%, thus further In any case, such measures are part of a more comprehensive reflecting the under-exploited potential of the sector series of steps aimed at modernizing the monetary sector. The and the large capacity to finance the growing needs of authorities intend to introduce this year new monetary the economy at large. instruments to the sector. Such tools include Treasury bills, which should provide an efficient benchmark yield curve and a risk free Within such a context, Syrian authorities have August rate of return, as per the IMF, both necessary for the proper undertaken several measures targeted at giving a boost financial assets pricing and the development of money and to the sector. The government is considering to increase 2007 interbank markets, and the development of a Syrian bond market, the ceiling of foreign ownership in banks from the which should contribute to containing the inflationary impact of current 49% to 60%, thus allowing foreign investors to negative budget balances. Both instruments are expected to allow hold a controlling stake in such institutions, whether henceforth the country to move further into a market economy. traditional or Islamic, in an aim to entice a larger number of foreign entities to the local banking market, and to 1.4.2. Banking Activity encourage existing banks to raise their equity level. Further, The banking sector in Syria has witnessed a positive growth in authorities plan to increase the minimum capital required to 2006, in line with the healthy overall economic activity. All major establish a bank, from SP 1.5 billion to SP 5 billion for private banking aggregates, namely total assets, customer deposits, loans banks, and from SP 5 billion to SP 10 billion for Islamic entities. to the private sector, and capital accounts, have reported an Existing banks will be given a grace period to abide by the new increase year-on-year in 2006. The sector’s size, measured by total capital requirements. assets, grew by 3.9% last year, moving from SP 1,343.0 billion in These relaxed regulations and positive performance of operating 2005 to SP 1,395.1 billion in 2006. banks have contributed to attracting additional players to the The growth in total assets was mainly favored by its two market. A third wave of banks, mainly of Gulf origin, is starting traditional drivers, i.e. customer deposits and loans to the operations or preparing to do so in the near future, encompassing economy. While the former has registered a 9.5% yearly growth in the first entities to provide customers with Islamic finance 2006 to reach SP 803.2 billion, the latter surged by 14.0% to SP services, at the image of Cham Bank, a joint venture between 253.8 billion, on account of enhanced consumption and Kuwaiti and Saudi Arabian institutions, the Islamic Development investment demand, and the agents’ increased financing needs. Bank, affiliated to the Arab League, and the Syrian International The deposit dollarization rate, defined as the ratio of deposits in Islamic Bank, a venture from the Qatar International Islamic foreign currencies to total deposits, stood at 19.5% in 2006, Bank. Syria Gulf Bank, on the other hand, is a traditional Gulf against a lower 13.1% in 2005, indicating an increase in FC deposits larger than that of local currency deposits. In parallel, the Banking Sector Comparative Aggregates (Year 2006) increasing number of banks and expansion of existing ones, most 160% 151.8% particularly the private banks, have led to a substantial rise in capital accounts by more than 2.5 times, moving from SP 73.1 140% billion to SP 195.0 billion, as per the latest Central Bank of Syria 120% 114.5% 96.8% 98.5% statistics. 100% 85.2% The overall positive performance of the banking sector pushed 80% 61.8% banking coverage ratios slightly upwards. Indeed, banks’ deposits 60% 49.0% 44.1% per capita progressed from SP 40.1 million in 2005 to SP 42.9 40% million in 2006, banks’ deposits per branch increased from SP 2.4 15.5% 20% billion in 2005 to SP 2.5 billion, yet such progressions have not 0% been strong enough to level up with regional, emerging and global Syrian MENA Emerging benchmarks. Further, the residents per branch ratio stood at Arab republic countries countries nearly 58,000, comparing quite unfavorably to the same Bank Assets/GDP Customers' deposits/GDP Bank loans/GDP benchmarks, thus calling for an increased expansion of the banks’ Sources: Central Bank of Syria, Central Banks of MENA countries, IMF, Bank Audi's Research Department

Banking Activity Var Var Var Var Var SP million 2001 2002 2003 2004 2005 2006 02/01 03/02 04/03 05/04 06/05 Total assets 973,239 1,075,094 1,183,367 1,250,260 1,342,954 1,395,134 10.5% 10.1% 5.7% 7.4% 3.9% % change in assets 20.4% 10.5% 10.1% 5.7% 7.4% 3.9% -9.9% -0.4% -4.4% 1.8% -3.5% Total deposits 469,883 571,834 618,199 669,661 733,253 803,200 21.7% 8.1% 8.3% 9.5% 9.5% % change in deposits 29.6% 21.7% 8.1% 8.3% 9.5% 9.5% -7.9% -13.6% 0.2% 1.2% 0.0% Total loans to private sector 78,737 83,935 109,403 147,769 222,528 253,793 6.6% 30.3% 35.1% 50.6% 14.0% % change in credits 2.8% 6.6% 30.3% 35.1% 50.6% 14.0% 3.8% 23.7% 4.7% 15.5% -36.5% Source: Central Bank of Syria, Bank Audi’s Research Department

7 bank whose main shareholder would be Kuwait’s KIPCO. The counter the decline in oil exports. Islamic banks are expected to benefit from the growing Syria is actually witnessing a consumer boom, with foreign brands conservatism and religiosity of Syrians, especially as they penetrate having entered the market for the first time in four decades. The an under-supplied Syrian market, as per a recent survey liberalization process is now gaining its own momentum, and the conducted by The Syria Report. need to offset the declining oil sector, combined with Syria’s aim The overall tendency towards modernization in the banking to win trade concessions from the EU, and eventually sector also comprises of other reforms, such as the European membership of the World Trade Organisation should provide the Union-financed 22-month training program managed by the incentive for reforms. The Syrian Investment Authority has European Commission on behalf of the local Ministry of Finance, apparently lisenced 30 projects worth US$ 240 million since its targeted at disseminating modern banking knowledge to local inception early this year and interest, particularly from the highly bankers and thus bolstering their professional and technical skills. liquid Gulf region, is strong. Also, the Central Bank unveiled plans to set up an interbank At the monetary level, the Central Bank of Syria has done a lending mechanism, and has lately decided to create a committee commendable job over the past couple of years in managing the whose tasks would be to oversee the modernization of the Syrian exchange rate arrangement. Progressive liberalization of access to payments system. All such reforms have the ultimate purpose of foreign exchange for current account transactions and skillful further modernizing the sector and rendering the banking system exchange rate management dismantled barriers within the an essential partner for the economy, catering to its entire funding previously segmented foreign exchange market and gradually needs, while contributing to enhancing economic performance at guided the parallel market rate closer to the official rates. The large. news that Syria is to drop its currency’s peg to the US dollar is seen Last but not least, Syrian authorities have formally established the as a positive sign that the Central Bank is doing its utmost to Board of the Damascus Securities Exchange (DSE) in October tackle inflation. The decision to peg the Pound to the IMF’s 2006. Work is now focused on building up software and currency is actually a favorable move, in line with the country’s administrative systems, and recruiting and training staff. trade portfolio. According to the EIU, the DSE is set for launching in late 2007 or Within this environment, Syria is witnessing an improvement in early in 2008. The exchange is set to allow the financing of new its global risk positioning. According to the latest country risk and growing enterprises, as most local ventures had to go through ranking undertaken by Euromoney, Syria has seen its ranking informal networks until now, and turn to banks abroad, or resort improving from the 138th rank in September 2005 to the 124th to their shareholders’ savings in order to secure needed funds. The rank worldwide in March 2007, i.e gaining 14 ranks over an 18- DSE is also anticipated to encourage local firms to upgrade their month period. The amelioration in global risk ranking is due to an accounting, financial and disclosure procedures so as to improvement in political risk indicators, economic performance ameliorate their capacity to source capital, and is thus expected to indicators and debt indicators at large. add to the country’s modernization and hasten the shift towards a true market economy. The outlook for 2007 remains relatively favorable. The critical mass of reforms implemented in recent months, the continued direct and indirect support of aggregate demand from the Iraqi CONCLUSION presence, and favorable growth prospects globally and in the region are expected to continue to underpin private consumption Syria has undeniably been enjoying an economic revival in recent and non-oil exports, as well as a possible strengthening of private years, with the economy doing remarkably well in 2006. Although investment. These factors could sustain the growth momentum in GDP growth rates differ according to the various sources, there is 2007 at about the same pace as in 2006. Although any slowdown no doubt that the economic recovery that started in 2004 of capital inflows associated with the Iraqis is expected to dampen remained on track. The Economist Intelligence Unit estimated aggregate demand directly, it should be kept in mind that a real GDP growth at 4% last year. The Syrian Central Bank normalization of the political situation in Iraq could open a large reported growth at 6.3% in 2006, against 5.2% the year before. market for Syrian products. The Syrian Finance Ministry stated that growth in the non-oil sector had come in at 7.0% in 2006. The non-oil sector continues According to the recent IMF Article IV Consultation preliminary to grow significantly, but the overall effect is masked in the overall conclusions, Syria needs to continue to grow faster but it also GDP figure, due to the decline in oil exports as oil output dries up needs to grow better in the coming years. The growth acceleration and consumer demand fuels import growth. in the past couple of years seems to have been largely driven by private consumption, with an initial impulse generated by the Growth has already fed into a drop in the rate of unemployment influx of Iraqis. For this growth to strengthen and solidify, it is from 11.7% in 2002 to 8.5% as of September 2006 according to important that the sources of growth be rebalanced toward Central Bank figures, but the latter remains a key concern within investment and durable gains in external market shares. Stronger the context of high population growth. Creating sustainable investment growth and higher productivity are the bedrocks of employment, particularly outside of the capital, is a real challenge high and sustainable growth in the long run. To that end, Syria for Syria, and one of which the government is keenly aware, given should undeniably continue to strengthen its macroeconomic its political implications. Moreover, creating employment is also policy frameworks and to accelerate structural adjustment necessary if consumer spending is to remain robust in order to reforms at large.

This publication is undertaken in the aim of informing and should not be considered as an encouragement to any form of financial or commercial activity. Although Bank Audi Sal considers the contents very reliable, it declines any responsibility for any action or decision based on contents herein.

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