CONTENTS u u u u u u u Syria the economicchallengesfacingSyriaoveryearsahead. monetary, governmentandforeignsectorsoftheSyrianeconomy isfirstrequiredinwhatfollowsbeforeputtingperspective structural reformsisprovidedintheconcludingsectionofthisreport. Adetailedanalysisoftherecentconditionsinreal, Syria’s economicperformanceinamediumtolongtermhorizon. TheeconomicpolicyoutlookforSyriainviewofneeded The prospectsofthegovernmentpushingaheadwithsignificant economicreformsshouldcriticallydeterminethepaceof commitment tostructuraladjustmentreforms. undoubtedly contributedtotheimprovementineconomicefficiency, suggestsageneralawarenessoftheneedandstrong to overUS$2pergallonasaresultoftheneededreductioninpetroleumsubsidies.Suchreformmomentum,whichhas stream ofunpopulareconomicmeasureswheneverrequired,aswitnessedrecentlywhenpetrolpricesroseby20%overnight private banksforthefirsttimeindecades,etc.Withinsamecontext,governmentseemstobewillingintroducea move towardsafloatingexchangeratesystem,thechangeofinterestratesforfirsttimein20years,establishment a a plan, callingforagradualreductioninthestate’sinvolvementeconomy,displaysseriouscommitmenttoreforms.Such Although theplandidnotdevoteagreatdealofattentiontodetaileconomicpolicy,underlyingdirection strengthening ofthemonetarypolicyframework. 8% by2010)andreducepoverty.Theplanhingesoverfar-reachingfiscalreforms,theunificationofexchangerate and tradeliberalizationasthecoreareasofstructuralreformstoaccelerategrowth(to7%by2010),lowerunemployment plan coveringtheyears2006to2010.Theidentifiesfinancialsectordevelopment,businessenvironmentenhancement medium termfiscaloutlook.ThebasisforSyria’seconomicpolicyoverthecomingperiodisrecentlydisclosedfive-year market mechanisms,openingtheeconomytorestofworld,liberalizingfinancialsystemandstrengthening A Syrian authoritieslookfullyawarethatthekeytoenhancedeconomicperformanceisthroughstructuraladjustmentreforms. control thattheCentralBankretainsoverforeigncurrencytransactions,evenassomelawsarerelaxed. defend thevalueofnationalcurrency,asaresultbothsignificantpositionstate-ownedbanksand rates, beforetheexchangerateretreatedbacktoSP53-55bracket.Thecountryisactuallybelievedbewellplaced intervening ontheforeignexchangemarketandraisinginterestratesbytwopercentagepoints,restoringpositivereal local currency’sexchangerateloosinggroundto60PoundsperUS$fromclose50earlier.Authoritiesreactedby The politicalpressuresthatSyriawassubjecttohasputtheSyrianPoundunderpressureinlastquarterof2005,with depreciation oftheexchangeratetowardsendyearonotherhand. impact ofloweringtariffs,theincreaseininflationwaseffectimproveddomesticdemandononehandbutalso inflation, asaverageannualCPIinflationreported7.2%in2005,comparedwith4.4%2004.Inspiteofthefavorableprice boosted non-oilGDPgrowthtoabout5.5%in2005,from5.0%2004.Growthwasyetcoupledwithasignificantrise Preliminary statisticssuggestastrengtheningofdomesticdemandtogetherwithrobustperformanceexportsmayhave When discountingtheeffectofdeclineinoilproduction,economyseemstobearelativelyhealthierstate. decades. IMF, Syriawillbecomeanetoilimporterwithinfourtosixyears,withsupplieslikelybeexhaustedincoupleof growth performance.Oildependenceisalsoasignificantconcernasoilproductionondecliningtrend.Accordingtothe political uncertaintiesandthedrasticreformrequirements,despiteprogressrecentlyreported,continuedtodampen larger inflowsemanatingfromworkersremittances,touristreceiptsandforeigninvestmentactivity.However,thewidening Over thepastyear,Syrianeconomyhasbenefitedfromrisingoilpricesandaregionalpost-Iraqwarboomtranslatinginto below potentialprivateconsumptionandinvestmentcomponentinviewofprevailinguncertainties. private demandcontinuestosufferfromthelackofadequatefinancing,restrictingitsleverageeffectongrowth,anda i Non-oil GDPgrowthmayhaverisentoabout5.5%in2005,from5%2004accordingtheIMF,mainlydrivenbybusiness average realGDPgrowthof1.8%perannum,accordingtothesamefigures,overperiodextendingfrom19992004. close to3%in2005(4.5%accordingofficialSyrianestimate).Itisworthrecallingthattheeconomyhadreportedan potential oftheeconomy.AccordingtoInternationalMonetaryFund(IMF),Syria’srealGDPgrowthratehasreported The Syrianeconomyiscurrentlywitnessinganimprovementinoutputperformance,thoughstillfarbelowtheprevailing The SyriaEconomicReportcanbeaccessedviainternetat thefollowingwebaddress:http://www.banqueaudi.com nvestment, householdconsumptionandnon-oilexports.Despitetherelativeimprovementineconomicconditions,Syria’s necessary andsufficientincentiveforimplementingreforms.Forindicativepurpose,wemention,amongothers,thegradual commitment toreformswasactuallyquiteevidentrecently,bearinginmindthattheproblemsafflictingoiloutputprovide number ofadjustmentreformshavealreadybeenlaunchedintheaimencouragingprivateentrepreneurship,promoting SYRIA’S MACROECONOMICPROGRESSNOTTOOVERSHADOWITS Conclusion Financial Sector p4 Public Sector p3 External Sector Real Sector p8 p5 p2 EconomicReport DRASTIC REFORMREQUIREMENTS -al:[email protected] E-mail Telefax Tel :11-2560 P.O.Box Riad ElSolh-BeirutLebanon Banque AudiPlaza,BabIdriss Research Department Bank Audisal-Saradar Group : : (01) 985622 (01) 994000 e :963-11-2454868 E-mail Fax Tel :6228,Damascus-Syria P.O.Box Mouhafaza Building-Damascus Headquarters: YoussefAzmehSquare Bank AudiSyrias.a : : [email protected] 963-11-2248510 September 2006 Gross Domestic Product Investment Bureau asserted that the number of licensed projects US$ billion in 2005 doubled to 550, having an aggregate value of US$ 7.8 35 7% billion, and out of which 237 are industrial ventures. Although 27.3 30 3.7% 3.7% 5% these figures indicate the government’s interest in bolstering 24.7 industrial activity, they do not indicate what is actually 25 2.3% 22.7 21.0 3% materializing. Indeed, manufacturing and mining output 22.8 2.9% 20 16.8 3.1% increased by 1.4% at constant prices in 2005. 19.9 1% 15 1.0% This focus on the agricultural and industrial sectors comes as oil -1% 10 production, the most important source of foreign currency receipts and a major driving force behind economic growth, is 5 -3% -3.1% facing many challenges. The primary and secondary sectors 0 -5% 1999 2000 2001 2002 2003 2004 2005 accounted for almost 50% of GDP in 2005 (23% and 27% respectively). Nominal GDP Real GDP growth rates

Source: IMF Syria is the only substantial oil producer and a net exporter in the Levant region. However, oil production is dwindling, as a result of technological obstacles and exhaustion of oil reserves. Production declined from 500,000 barrels/day to 414,000 barrels/day in 2005, 1. REAL SECTOR with further decline expected in 2006. In contrast, consumption is on the rise, putting pressure on net oil exports. Syria has been 1.1. Primary and secondary sectors putting significant efforts to attract the best offers from The Syrian economy is heavily dependent on agriculture activity, international companies for new explorations, in addition to remittances from Syrians living abroad and most importantly on turning more and more to the use of natural-gas power plants oil revenues. The agricultural sector accounts for 23% of GDP, instead of oil. employs almost one third of the labor force, and generates one Syria's main oil producer is Al-Furat Petroleum Co. (AFPC), a fifth of exports. Main crops are cereals, cotton, sugar beet and joint venture between the Syrian Petroleum Company (SPC), olives. The primary sector takes priority in the Syrian economy in Shell, and PetroCanada. Oil exploration activity has been slow in the context of a high growth population and as the government is recent years due to unattractive contract terms by SPC, poor implementing a strategy to secure food self-sufficiency, raise exploration results, and concerns about the possibility of export earnings, and lower rural urban-migration. additional US sanctions. For these reasons, only a few companies Indeed, 2005 was a fruitful year and the agriculture sector was a out of more than a dozen operating in the country in 1991 remain major growth driver. Agriculture output rose by 3.0% in real in Syria at present. terms, compared to 2004. Wheat production reached around 5.5 Syria's two refineries are located at Banias and Homs and are million tons (22% higher than the previous year), cotton 1 million producing 239,865 barrels/day. Syria is planning to construct a tons (26% year-on-year growth), and citrus 850 thousand tons third refinery in Deir el-Zor to supply products to the eastern part (almost unchanged from 2004). Syria has become a grain, of the country. Syria has signed a memorandum of understanding vegetables and fruits exporting country, possesses 87 million olive with a Russian company for the construction of a US$ 2.7 billion trees, and is among the top olive oil producers in the world. refinery and petrochemical plant in Deir-el-Zor. The project, to Cotton, a major Syrian crop, feeds into a thriving textile industry be completed in five years, would be built over a 650 hectare in Syria that accounts for around 10% of exports and 30% of non- surface. The petrochemical plant would have an annual capacity oil exports. Lint production is estimated at 350,000 tons. Total of 1.6 billion tons of gasoline. The refinery would produce about domestic lint consumption for yarn spinning is estimated at 140,000 barrels of refined products daily. 150,000 tons. About 200,000 tons of cotton lint is for export. Syria Another source of energy that Syria is planning to use to face the has increased its cotton ginning capacity after the opening of a decline in oil exports is natural gas that would be used in power new ginning plant in Deir-el-Zor with an annual capacity of generation and would free some of the oil for export. Syria has 100,000 tons. Cotton ginning is the monopoly of the state-owned also the highest proven natural gas reserves in the Levant, General Organization for Cotton Ginning and Marketing estimated by the Energy Information Administration at about 8.5 (CGMO). The new plant should increase the country’s trillion cubic feet. A number of new gas-fired power projects are production by around a third from current annual output of currently under planning or implementation. The most important 350,000 tons. With an expanding domestic cotton production and is the “Arab Gas Pipeline” network which links Syria to Egypt and low labor costs, Syria has developed an important textile industry. Jordan and would be extended into Syria and Lebanon. State-owned textile firms, grouped under the General Organisation of Textile Industries (GOTI), registered sales of SP 1.2. Construction and real estate 15.36 billion in 2005, up by 16% from SP 13.27 billion. The total Construction and real estate sectors in Syria witnessed a boom in production value of the organisation reached SP 21.33 billion, a 2005, with a number of mega real estate projects announced during rise of SP 1.3 billion over the previous year. The situation of the the said year. According to a research conducted by Zawya, Syria's state textile organisation was a major worry for the Syrian value of mega projects relative to GDP is the third largest in the government as massive investments had been conducted to region with some US$ 22 billion under development, the equivalent increase and modernize the production capacity, since technology of 95% of its current GDP. Syria's large population, intertwined and equipment used are quite archaic while competition is with its enormous tourism capacity, has made it very attractive for intensifying worldwide with the Agreement on Clothing and developers, especially that its land prices were at an all time low Textiles (ATC) expired at the beginning of 2005. while Damascus faces a shortage of residential and office supply, Just like the textile industry, other manufacturing sectors have due to a number of old restrictions. been subject to a number of reforms that began five years ago, in In addition, the demand for real estate can be attributed to a the aim of attracting the private sector and become more market- number of factors such as declining interest rates, favorable new oriented. Syria plans to increase industrial GDP, in real terms, by laws, and a jump in foreign demand from the arrival of hundreds of 10% in the next five years, especially that competition from other thousands Iraqis into the country. In December 2005, a new law Arab countries is heightening with the enforcement of the Greater was issued including new rates and valuation structure for taxes Arab Free Trade Area (GAFTA). Within this context, the Syrian

2 levied on real estate operations. Since taxes constitute a very positive performance was actually extended to 2006, as the Ministry significant part of the property cost, the new law is expected to push of Tourism reported tourism receipts of SP 13.8 billion, up by prices slightly down and stimulate activity. around 6% when compared to the same period of 2005. The Ministry’s plan is to attract some 7 million tourists by 2010 and The Syrian authorities have been working hard on attracting real generate around US$ 5 billion from the sector. estate investments. Mega real estate projects started in Syria, developed mainly by Gulf-based companies. The largest is the Syria As to the transport sector, the number of passengers using Syrian Bonyan City estimated at a cost of US$ 15 billion and consisting of airports amounted to 3 million in 2005, according to preliminary commercial, residential, and hospitality units. It is being developed figures from the Directorate General of Civil Aviation, up by 7.1% by the UAE-based Bonyan International Investment Group. from around 2.8 million in 2004. On the other hand, cargo traffic Another large project is developed by Aref Investment Group, a fell to 23,000 tons in 2005, down by 28.5% from 32,175 tons in Kuwaiti holding group in cooperation with seven other Kuwaiti 2004. firms. The US$ 4 billion project will serve as a financial district in In contrast, the volume of goods that are handled by Syria’s two Damascus, but also includes, health, educational and main container ports grew significantly. Total goods entertainment facilities in addition to other facilities in the IT field. unloaded and uploaded by Lattakia’s and Tartous’ ports The whole project is expected to be completed by 2010. increased by 24% to reach 19.6 million tons in 2005, Emaar, the UAE based developer, has also entered the Syrian according to Syria’s Ministry of Transport. market, with two projects estimated together at US$ 4 billion September The port of Tartous activity benefited from trade with (Damascus Hills and the Eighth Gate). The US$ 500 million Eighth Iraq. Merchandise handled amounted to 12.3 million Gate, which is a joint venture with the Syria-based Investments tons, i.e. up by 26.8% when compared to 2004. Total Group Overseas, will include different residential, commercial and 2006 revenues generated by the port’s activity rose to SP 3 retail compounds. Damascus Hills is the other US$ 3.5 billion billion versus from SP 2.5 billion in 2004. The port of project offering luxurious residential apartments and villas as well Lattakia handled 7.3 million tons in 2005 and generated as buildings for information technology, trade, business, shopping income of SP 2.46 billion, versus 6.10 million tons generating SP and other services. 1.84 billion in 2004. With the launch of such gigantic new investments in the Maritime traffic is expected to increase, under future plans to construction sector, the Syrian economy is in need of increased upgrade the existing ports. The Ministry of Transport is allocating cement production capacities. Many private investors were SP 11 billion under the current five-year plan (2006-2010) for the reported to have requested a license to build new cement plants. development of the Port of Tartous. Likewise, the government has For example, a state-owned Chinese company recently agreed with ambitious plans to build new airports and upgrade existing ones. a Syrian construction company to build a black cement factory in Under its five-year plan, it aimed to increase the aggregate capacity Adra near Damascus to produce up to 1.8 million tons of packed of Syrian airports to 17.5 million passengers, including the increase and liquid cement. In addition, recently two bids by the MAS group in the Damascus airport capacity to 10 million passengers, and a with annual production capacities of 2 million and 3.15 million construction of a new airport in Aleppo with a capacity of 7.5 tons of cement were both licensed by the Investment Bureau. million passengers by 2015. Overall, the real estate sector is believed to enjoy significant In line with the performance of the tourism and transport sectors, prospects as a result of considerable domestic demand triggered by the telecom sector reported a favorable performance in 2005. Total a large population growing at a high pace, in addition to an subscribers to the two GSM networks in Syria amounted to 2.83 increasing foreign interest, mainly from neighboring Arab million in 2005, increasing by 20% as compared to the previous countries. year, according to the Ministry of Communication and 1.3. Trade and services Technology. Likewise, landline subscribers amounted to 2.9 million last year, rising by 9.2% year-on-year. Internet users increased Despite the political pressures that Syria has been facing, the trade drastically (50%) to reach 1.2 million. Indeed, there are a number and services sector, which accounts for 46% of GDP, did well over of measures announced to further this expansion in the sector. the year 2005, driven mainly by an upbeat tourism activity. This These future steps include reduction in the one-time fee paid for sector has been benefiting year after year within a more the purchase and installation of a fixed land line, a cut in accommodating environment, as private sector banking came in international calls rates, and the announcement of the signing of a facilitating access to financing, and legislation became friendlier to Memorandum of Understanding with a Chinese company to build foreign investors. Trade and services output grew by 6% in real an Asymmetric Digital Subscriber Line (ADSL) network for a faster terms in 2005. internet usage in Syria. The number of tourists increased by 11% in 2005 compared to the previous year to reach 3.37 million. However, these exclude “one- day visitors” that come from neighboring countries like Lebanon 2. EXTERNAL SECTOR and Jordan. This category declined from 3.12 million to 2.5 million, Syria’s external sector was characterized in 2005 by a healthy i.e. by around 20%, mainly because less and less Lebanese visited improvement in foreign trade activity, mainly thanks to still high the country during 2005. On a more positive note, Europeans oil prices that offset both the continuous decline in oil production (coming through tour operators) showed increasing interest in the and the growing international pressures and sanctions on the country in 2005 and reported a 38% increase in nights spent to country. Numerous trade liberalization measures were 587,557 nights from 424,782 in 2004. Hence, with opposite trends, implemented, such as the streamlining of customs procedures, the tourism revenues managed to almost stay the same, since the latter simplification of import duties, the removal of import bans category of tourists has higher spending than the “one-day” (textile and cement), the elimination of import licenses (raw visitors, which are usually low spenders. Accordingly, income materials), and the opening of the markets to the private sector generated from tourism slightly rose to SP 115.5 billion (US$ 2.2 (cement and electricity). Other measures include the reduction of billion) from SP 111.5 billion in 2004. Out of this figure, SP 41.9 transaction costs, the lowering of tariffs and the signing of free billion were spent by Syrian expatriates visiting their homeland, trade agreements with several countries. Such steps contributed to down from SP 44.2 billion in 2004, a 5% fall. improving the country’s foreign trade activity. According to the Other tourists, meanwhile, spent a total of SP 73.571 billion in Economist Intelligence Unit (EIU), the volume of foreign trade is 2005, 9% higher than the SP 67.327 billion figure in 2004. This estimated to have reached US$ 12.9 billion in 2005, up by 12.5%

3 from the previous year. could undertake a series of measures targeted at bolstering the trade activity performance and strengthening its current account The rise in foreign trade activity was mainly due to a substantial balance. Syrian authorities should diversify their trade exports 16.2% increase in exports of goods due to the elevated worldwide away from oil products and derivatives. Syria could boost oil prices counterbalancing the drop in the volume of oil exports. agricultural and industrial exports and perhaps provide export It is important to mention that the enhanced export activity incentives to producers, in order to benefit from a more balanced comes after a two-year downward trend that started in late 2002. export structure and become less vulnerable to external Imports of goods rose by a 9.0% rate, mostly due to still high commodities’ price variations. worldwide oil prices, but also to a relatively improved overall domestic demand. Exports of goods actually amounted to an Moreover, the Syrian government should seek foreign exchange estimated US$ 6.5 billion versus US$ 5.6 billion in 2004, while unification and further trade liberalization. According to the IMF, imports reached an estimated US$ 6.5 billion, against US$ 5.9 authorities should ensure the lowering of persistently high non- billion in the previous year. As such, the trade balance registered a tariff barriers and the reduction of the wide tariff dispersion that very tiny deficit of US$ 5.8 million in 2005, following a deficit of is reinforcing effective protection and hampering long-term US$ 374 million in 2004. industrial development. Syrian authorities apparently agreed to eliminate industrial quotas, allowing imports at lower customs High worldwide oil prices and the ensuing exceptional levels of rates, increase transparency about remaining trade restrictions, liquidity in the Gulf region have triggered similar positive and committed to an early publication of tariff schedules and developments at the level of the current account balance, with negative lists, and to phasing them out gradually. In addition, spillover effects on tourism and investment, mostly in real estate, other measures include the simplification of the tariff structure, involving Gulf tourists and business people, respectively. Tourist and the further reduction of clearance time at customs, arrivals to Syria in the year 2005 are reported to have witnessed a considered high compared to several emerging economies. positive growth rate as compared to the year 2004, thereby generating a rise in tourism receipts. The authorities could also hasten the pace at which the numerous tourism projects announced in recent years are implemented, thus According to the Investment Bureau, which licenses private attracting a larger number of regional as well as international investment projects approved within the framework of Law 10 of tourists to the country. More generally, Syrian authorities should 1990 authorizing areas of the economy for foreign and domestic work on improving the overall investment climate. Syria ranked private sector investment and setting out a number of guarantees 16th in the MENA region and 124th in Euromoney’s semi-annual and inducements to investors, projects approved in 2005 country risk survey, scoring 36.04, i.e. well below the MENA increased by a yearly 85.7% to reach about US$ 7.8 billion. Such region average of 51.20. Also, Syria ranked 11th out of 12 projects are mainly accountable for by foreign investors. The countries in the Fraser Institute’s latest Index of Economic decline in the number of approved projects from 759 in 2004 to Freedom in the Arab world survey. Measures more conducive to 550 last year reflects the trend towards larger scale projects. The foreign trade and investment at large would somehow offset the real estate sector accounted for the largest individual schemes, tense political climate in light of increasing international pressures mainly involving UAE-based firms. and sanctions on the country, thus allowing the country to start Although the latter data does not reveal the number of projects shifting towards an open economy. currently underway or the sums of capital that have been delivered, the said projects are foreseen to have triggered External Sector Indicators substantial inflows to the country during the year 2005. Such positive developments led to a growth in the current account 149.6% surplus by more than 2.5 times to reach an estimated US$ 533 145% 138.2% 5.9% 7% million in 2005. 6.7% 135% 130.1% 5% 5.4% 133.3% The strong oil prices are expected to remain an offsetting force to 125% 2.3% 2.3% 3% the decrease in oil output this year, thus easing the pressure on the 1.1% 115% 3.2% 0.9% trade and current account balances. Nevertheless, Syria is deemed 1% to become a net oil importer around the year 2010 and could 105% 106.0% 99.9% exhaust its oil reserves towards the late 2020s, in the absence of 93.7% -1% new discoveries in the fields of oil and natural gas. Hence, further 95% declines in export volumes are foreseen in 2007 and onwards, thus 85% -3% adversely affecting the trade balance. Besides, income debits 75% -5% should remain elevated, partly resulting from the debt- 1999 2000 2001 2002 2003 2004 2005 rescheduling agreement with Russia, thus weighing on the current Exports/Imports Current account/GDP account balance in the short to medium term. Source: Economist Intelligence Unit In order to improve its external sector activity, Syrian authorities

Syria’s share of Inter-Arab Private Investments (in US$ million) 3. PUBLIC SECTOR 1800 1,672.6 Syria’s public finance performance in 2005 was marked by a status 1500 quo at the level of the overall fiscal position, as the fiscal balance to GDP ratio stood still at an estimated -4.2%, notwithstanding a 1200 continued healthy improvement in the non-oil budget balance resulting from reform measures adopted by the Syrian 900 government. 600 427.2 According to IMF estimates, budget revenues are estimated at SP 300 224.0 377.1 billion in 2005, up by 9.7% from the previous year. Such an 8.7 43.5 46.5 42.4 increase was triggered by an augmentation of non-oil revenues of 0 24.2% that more than offset the 11.3% decline of oil-related 1999 2000 2001 2002 2003 2004 2005 revenues. Non-oil non-tax revenues favored the overall increase Source: Inter-Arab Investment Guarantee Corporation in government non-oil revenues, as they progressed by a massive

4 82.3% year-on-year in 2005, triggered in turn by a strong 84.4% would undermine the already weak financial position of public rise in public enterprises surpluses that could partly be attributed enterprises and possibly affect their ability to create jobs and to to higher dividends from the telecommunication company due to compete in a progressively more open economy. Besides, foreign a much wider use of mobile phones. On the other hand, non-oil debt is expected to record a mere 0.6% decline as per IMF tax revenues are estimated to have slightly nudged up by 1.9% to estimates, but would still account for around 23% of total GDP, SP 148.2 billion, in light of decreases in direct taxes and customs and the total government debt/GDP ratio would remain high at revenues, offset by an increase in indirect taxes. around 38% of GDP. At the level of expenditures, current expenditures registered an In light of the country’s imperative need to consolidate fiscal 11.5% surge to SP 267.9 billion, mostly favored by a 23.0% adjustment efforts and to deal with persistent structural increase in wages and salaries, while development expenditures imbalances, Syria’s State Planning Commission (SPC) adopted progressed by 7.7% to SP 168.6 billion last year. Such increases led last year a five-year plan aimed at triggering a series of economic to an overall 10.0% growth in public expenditures to SP 436.5 reforms expected to enhance the involvement of the private sector billion. As such, the overall estimated fiscal deficit stood at SP 59.4 in the economy. The plan aims to help Syria shift from billion in 2005, against a slightly lower SP 53.0 billion in 2004. a State-led economy to a market driven one. The 2006- 2010 plan attempts to alleviate further the In parallel, total government debt increased to SP 544.5 billion as government’s dependence on oil revenues, and per IMF estimates. Foreign debt stood at SP 356.7 billion last year, encompasses the introduction of the value-added tax and accounted for about two thirds of total government debt. (VAT) by 2008, in an aim to contain overall fiscal deficit September Domestic debt increased by 57.9% to SP 187.8 billion. It is worth at less than 5% of GDP. recalling that Syria successfully managed in early 2005 to settle part of its outstanding foreign debt. The government obtained a The IMF’s latest Article IV Consultation Mission 2006 73% write-off of its US$ 13.4 billion debt owed to Russia, while Report welcomed the five-year plan but recommended agreeing with the Russian authorities to restructure the remaining a more comprehensive fiscal consolidation program amount. The country also fully reimbursed some US$ 500 million and accelerated structural reforms, focused on further in debts owed to the World Bank and has cleared up arrears owed bolstering the non-oil balance, and warned against delays in the to Japan, in addition to negotiating debt agreements with Eastern practical implementation of all measures. As such, comprehensive European countries. tax and expenditure reforms include the adoption of a broad- based VAT imposed on all goods and services expected to entail In 2006, Syria’s public finances are expected to register a more additional revenues up to 5% of GDP, the improvement in tax favorable performance. The non-oil balance should improve administration, the restructuring/privatization of public further thanks to recent actions undertaken by the Syrian enterprises, and the phasing out of the petroleum price subsidy. authorities, and would be supported by a modest increase in oil The latter measure is foreseen to generate large fiscal savings and revenues due to the hike in international oil prices. On the other efficiency gains, and promote long-term growth by protecting hand, total expenditures are bound to progress, mainly driven by spending on education, health and infrastructure. Should these the 12% across-the-board public sector wage increase granted in structural reform measures not be hastened, Syria’s fiscal February 2006. Nonetheless, the improvement in government sustainability would be adversely affected, and the country could revenues is foreseen to offset the growth in expenditures, leading be locked in a cycle of financial volatility, fiscal deterioration, low to an improved overall fiscal deficit to GDP ratio of 3.2% in 2006, growth and rising unemployment. as per IMF forecasts. The improved outlook for the public sector this year should not shift the focus away from implementing various fiscal reforms and 4. FINANCIAL SECTOR improving the public finances at large. Oil output is bound to decline further in 2007, thus generating a drop in the 4.1. Monetary situation government’s oil revenues, offsetting any positive step taken in Over the past year, a number of important reform measures were terms of bolstering the non-oil balance and thus weighing heavily introduced by the Syrian monetary authorities, following the slow on Syria’s public finance outlook. Moreover, the granted wage liberalization process that started a few years ago. In fact, the increase in early 2006 should not encourage further and sustained Central Bank’s base rate has been raised for the first time in increase in the short to medium term. Additional wage increases decades, Certificates of Deposits were launched for the first time would exert pressure on the fiscal balance, but more importantly

Selected Public Finance Indicators in SP billion 2001 2002 2003 2004 2005E Var Var Var Var CAGR 02/01 03/02 04/03 05/04 01-05 Revenues 306.0 295.8 321.6 343.9 377.1 -3.3% 8.7% 6.9% 9.7% 5.4% Expenditures 282.7 318.4 350.6 396.9 436.5 12.6% 10.1% 13.2% 10.0% 11.5% Fiscal balance 23.3 -22.6 -29.0 -53.0 -59.4 -197.0% 28.3% 82.8% 12.1% -

Government debt 226.6 273.8 287.1 367.1 544.5 20.8% 4.9% 27.9% 48.4% 24.5% Domestic debt 49.1 82.9 83.5 118.9 187.8 68.8% 0.7% 42.4% 57.9% 39.8% Foreign debt 177.5 190.9 203.6 248.2 356.7 7.5% 6.7% 21.9% 43.7% 19.1%

Revenues/GDP 30.1% 26.2% 28.5% 27.4% 26.5% -3.9% 2.3% -1.1% -0.9% - Expenditures/GDP 27.8% 28.2% 31.1% 31.6% 30.7% 0.4% 2.9% 0.5% -0.9% - Fiscal balance/GDP 2.3% -2.0% -2.6% -4.2% -4.2% -4.3% -0.6% -1.6% 0.0% -

Government debt/GDP 22.3% 24.2% 25.5% 29.2% 38.2% 1.9% 1.3% 3.7% 9.0% - Domestic debt/GDP 4.8% 7.3% 7.4% 9.5% 13.2% 2.5% 0.1% 2.1% 3.7% - Foreign debt/GDP 17.4% 16.9% 18.1% 19.7% 25.0% -0.5% 1.2% 1.6% 5.3% - Source: IMF

5 ever, banks were allowed to set their exchange rate within a year, according to the same source. It is important to mention that narrow band around the fixed Central Bank rate, and Syrians were the share of currency in circulation in M2 is significantly high in permitted to open bank accounts in foreign currencies and to Syria at 29.7% at end-2005. As such, the foreign reserves to Money trade in foreign denominations. Further reforms were lately Supply ratio stood at close to 22%, outlining a moderate level of introduced by the Syrian monetary authorities and aimed at foreign exchange sustainability. legalizing activities on the foreign exchange market, as a new law The exchange market pressures left their imprints on domestic has been enacted in April 2006 allowing the establishment of prices. Inflationary pressures started to arise in the past year, with money exchange brokerages in Syria. inflation reaching a relatively high level of 7.2% by end-2005 Maybe the most important monetary development recently according to the IMF, versus 4.4% in 2004. Several factors have observed in Syria is the exchange rate fluctuation registered by the contributed to such a rise, according to the IMF’s latest Article IV end of 2005 and the beginning of 2006. Within the context of Consultation Mission Report, including: an expansionary pressures on the Syrian pound, the exchange rate of the national monetary stance (with a significant growth in credits to the private currency has declined during the last quarter of 2005 to reach a sector), the depreciation of the exchange rate around the time of peak of SP 60.75/US$ in November. The Syrian monetary the confidence crisis in September-December, larger public sector authorities responded by intervening on the market to protect the wage increases in mid-2004, and an increase in commodity local currency, and by adopting new measures related to interest import prices. The recovery of the national currency since the rates and flexibility on the foreign exchange market. As such, the beginning of the year 2006 has not yet led to a return to normal in Syrian pound-to-US Dollar exchange rate started to recover at the retail prices. beginning of the year 2006 and ended up quoted at SP 51.65/US$ It is important to mention that the IMF has recommended, in its by end-August 2006. According to the IMF, the recent latest Article IV Consultation Report, tighter monetary and strengthening of the exchange rate should be monitored carefully income policies to reduce inflation. To this end, the IMF added in view of the prospective decline in oil exports and the need to that credit ceilings should be tightened. Deposit interest rates promote other exports. should be maintained until inflationary pressures recede further. Within the same context, the Syrian government decided in mid- Moreover, greater upward flexibility in lending rates should be February 2006 to switch all of its foreign currency transactions introduced to increase efficiency in credit allocation and from US Dollar to Euro. The decision came before the US treasury strengthen banks’ profitability. ordered in March 2006 all commercial banks in the United States Regarding the introduction of new tools on the financial markets, to end their relationships with the Commercial Bank of Syria Syrian authorities are currently looking forward to issue a six- (CBS) and its Lebanese subsidiary, the Syrian Lebanese month or a one-year Syrian pound treasury bill by the end of the Commercial Bank. year 2006, which would target domestic investors and will be used The foreign exchange reserves excluding gold reached US$ 5.3 to finance public sector borrowing requirements, according to the billion at end-2005, versus US$ 4.9 billion at end-2004, thus Central Bank Governor. This plan comes amid expectations of a increasing by US$ 400 million, according to the Economist decline in oil production and in oil proceeds in the coming years, Intelligence Unit estimates. It is worth mentioning that the and follows the issue of Certificates of Deposits at the end of 2005. foreign currency reserves have reported an increase despite the Last but not least, Syria is currently moving toward the creation of Central Bank’s intervention on the foreign exchange market. This a stock market. In fact, the Syrian government has formed in is mainly due to the positive impact on oil proceeds of rising oil February 2006 the “Syrian Securities and Exchange Commission” prices during the year. The Syrian pound money supply (M2) (SSEC), whose task will be to draft a stock exchange law and to reached SP 1,185.4 billion at end-2005, rising by 11.9% year-on- overview the set-up of the future Damascus Stock Exchange (DSE). It will be responsible for monitoring the disclosure of Money Supply and Inflation information related to financial papers, regulating the issuance of these papers, specifying the conditions under which the stock 30% 10% 7.2% market will operate. It is worth mentioning that the establishment 24.7% 8% 5.8% of the Syrian stock market will be of great importance to the 4.4% 6% 20.0% 3.4% encouragement of investments through the mobilization of 20% 18.4% 4% 2% Syrians' savings into development projects, in addition to opening 13.4% 0% the way for the privatization of government assets. 13.2% 11.9% -3.7% -0.5% -2% 8.1% 4.2. Banking activity 10% -4% -3.9% -6% The banking sector in Syria witnessed a strong growth in the year -8% 2005, with all banking indicators reporting a solid progression 0% -10% year-on-year. Measured by total assets, the banking activity grew 1999 2000 2001 2002 2003 2004 2005 by 7.4% last year to reach SP 1,342,954 million. Such an increase Money supply growth Consumer Prince Inflation (avg) was mainly driven by a rise in customer deposits of SP 63,592 Source: Central Bank of Syria, IMF, Bank Audi’s Research Department million, or a strong 9.5%, moving from SP 669,661 million in 2004 to SP 733,253 million last year. Out of total deposits, 11.4%

Monetary Situation Flows in SP million 2001 2002 2003 2004 2005 Var Var Var Var CAGR 02/01 03/02 04/03 05/04 01-05 Net foreign assets 118,196 84,881 25,870 52,814 13,087 -28.2% -69.5% 104.2% -75.2% -42.3% Claims on the public sector 41,928 -3,276 17,204 23,934 72,393 -107.8% -625.2% 39.1% 202.5% 14.6% Claims on the private sector 2,126 5,198 25,468 38,366 74,759 144.5% 390.0% 50.6% 94.9% 143.5% Total 162,250 86,803 68,542 115,114 160,239 -46.5% -21.0% 67.9% 39.2% -0.3% Money supply (M2) 144,231 134,969 70,363 123,637 126,011 -6.4% -47.9% 75.7% 1.9% -3.3% Other items (net) 18,019 -48,166 -1,821 -8,522 34,228 -367.3% -96.2% 368.0% -501.6% 17.4% Source : Central Bank of Syria

6 are accounted for by foreign currency deposits. Also, capital emerging countries. Further, deposits/GDP ratio reached 55.4%, accounts grew by an important 35.8% to reach SP 73,137 million against a higher average of 69.0% for the MENA region and at year-end 2005. 102.3% for emerging countries. Although the claims to the private Perhaps the most significant development in Syria’s banking sector have surged last year, loans/GDP attained 16.8%, much sector was the considerable surge in claims to the private sector, lower than the MENA countries average of 39.7% and the rising by a massive 50.6% to SP 222,420 million. This pick-up in emerging countries average of 88.1%. credit creation undoubtedly reflects an enhanced liquidity and a As such, prospects for further development of a promising and relative relaxation of previously highly restrictive central credit profitable banking sector to meet the needs of a growing economy allocation rules. With this rapid pace of growth, private sector are good. In order for such potential and foreseen expansion to claims accounted for 52.7% of total domestic credit in 2005, while materialize, the Syrian authorities should work on removing the the claims on central government and public sector accounted for numerous hurdles that still prevail. The latest IMF report stresses the remaining 47.3% of total domestic credit in 2005. In fact, that the fast-paced credit expansion is likely to have weakened the claims to the private sector have accounted for more than half of quality of banks’ loan portfolios, given the currently total credits, i.e. a larger stake than that of credit to the weak risk management practices. In addition, the lack government and public sector, for the first time ever in 2005. of progress in restructuring state-owned banks is Such positive developments are mainly owed to the Central Bank deemed to hamper interest rate liberalization and the of Syria that has been exerting laudable efforts to create the development of deep and liquid money markets. September appropriate environment for operating banks. Over the past two Besides, a high proportion of loans is still granted to the years, a multitude of regulations has been put in effect to facilitate public sector. The government finances the public the work of banks in general. Indeed, the Syrian authorities’ deficit through loans from the public banks, thus 2006 strategy of developing the financial sector by opening it to private creating pressures on the financial resources available initiative largely contributed to enticing and expanding private for the private sector. banking activities. According to the IMF, five new private banks Another hurdle is the high proportion of cash money in have already gained more than 10% market share while others circulation. The structure of the liabilities of the Syrian banking have decided to increase their capital base. Three additional banks sector indicates a high percentage of demand deposits compared are expected to open in 2006. to total deposits. Foreign currency assets constitute more than Although private banks in Syria retain a minority share in a 50% of total assets in the public sector banks. Other problems banking sector still dominated by state-owned institutions, they include the need for providing liquid placement vehicles for have grown at a rate higher than expected. The total amount of banks, the need to upgrade clearing and settlement procedures, deposits in private banks is currently estimated at around SP 100 the need for improved corporate transparency and disclosure, the billion (approximately US$ 2 billion), only two years after their need to establish a Credit Bureau or at an earlier stage a Central launch. In view of this rapid growth, private banks are now Office for Credit Risk, the need to encourage and promote micro seeking new tools to invest their growing deposits and were raising financing operations, etc. Such issues cannot but call for the calls for the Central Bank to issue bills and bonds that are expected urgent need to bolster banks’ supervision and adopt a cautious to provide them with safe and sound returns. licensing policy among other reforms, in addition to restructuring public sector banks. Moreover, the law related to the establishment of private banks in Syria is expected to be amended in the near future. In fact, the All such measures are crucial for Syria’s banking activity today, private ownership of banks could be raised to a majority of 60% although they are not claimed to be exhaustive. Others could to 70% from a current ceiling of 49% prior to the end of this year. figure on any priority reform agenda. The most important thing, Also, the minimum capital requirement might more than double after the preliminary achievements of the past few years, is to from its current level of SP 1.5 billion (around US$ 30 million). On another note, a new law has been enacted in May 2005, Banking Sector Comparative Aggregates (2005 estimates) allowing the establishment of Islamic banks in the country. 120% Islamic banks are subject to the legal forms and measures 102.3% incorporated in Law No. 28 that allowed the establishment of 100% 88.1% private banks. A major difference applying to Islamic banks is the minimum capital requirement that has been set at SP 5 billion 80% 69.0% 59.5% (around US$ 100 million), instead of SP 1.5 billion for non- 60% 55.4% 54.4% Islamic banks. The Syrian government has granted until now its 39.7% preliminary approval for the establishment of three Islamic 40% banking ventures, the first of which is set to open its doors this 16.8% year. 20% 0% In spite of the improvement in banking activity over the past year, Syrian MENA Emerging Developed banking coverage remains low both in absolute and relative terms. Arab republic countries countries countries Assets to GDP stood at 101.4%, against a higher average of 124.3% Bank loans/GDP Customers' deposits/GDP for the MENA region, and a much higher average of 135.7% for Source: Central Bank of Syria, Bank Audi’s Research Department

Banking Activity SP million 2001 2002 2003 2004 2005 Var Var Var Var CAGR 02/01 03/02 04/03 05/04 01-05 Total assets 973,239 1,075,094 1,183,367 1,250,260 1,342,954 10.5% 10.1% 5.7% 7.4% 8.4% % change in assets 20.4% 10.5% 10.1% 5.7% 7.4% -9.9% -0.4% -4.4% 1.8% - Total deposits 469,883 571,834 618,199 669,661 733,253 21.7% 8.1% 8.3% 9.5% 11.8% % change in deposits 29.6% 21.7% 8.1% 8.3% 9.5% -7.9% -13.6% 0.2% 1.2% - Total credit to private sector 78,552 83,681 109,281 147,651 222,420 6.5% 30.6% 35.1% 50.6% 29.7% % change in credits 2.8% 6.5% 30.6% 35.1% 50.6% 3.7% 24.1% 4.5% 15.5% - Source: Central Bank of Syria, Bank Audi’s Research Department

7 maintain the pace of reforms or even try to speed it. A dynamic registered in the overall monetary policy framework. The overall banking sector liberalization policy, in addition to the liberalization trend observed in recent years is to expand in the amendment of certain laws and regulations, cannot but ensure the forthcoming future. There has been some significant movements needed stimulus to economic activity through the channeling of a away from the pegged interest rates that have governed the greater share of domestic savings towards more productive private monetary system for the past two decades, most recently to placements and investments within the country. contain pressures on the foreign exchange market. In parallel, foreign currency rules have been relaxed to a certain extent. The challenge of monetary policy from now on rests on a further CONCLUSION liberalization requirement, the containment of inflation pressures Despite the relative improvement in Syria’s economic conditions, through monetary tightening and the use of indirect instruments the state-oriented economy requires deep and broad reform if of monetary control to operate effectively in a financial system higher levels of growth and better living standards are to be that will increasingly become market based. achieved. There is actually little debate among analysts that the At the level of exchange rate policy, Syrian authorities have Syrian economy is in need of reform and that such reforms must showed their determination to address the rigidities of the foreign take place as soon as possible. There are divergent views however exchange regime, but further drastic reforms need to be on the type of reforms needed in Syria and the likelihood of such introduced. The observed improvement in economic conditions reforms taking place. Below is what we believe are the key policy offers a favorable environment for unifying the exchange rate and issues that need to be addressed in Syria of nowadays. achieving current account convertibility. Exchange rate At the level of macroeconomic policy, Syrian authorities seems to unification means that all private and public demand and supply be fully aware of the challenges facing its economy, as clearly of foreign exchange emanating from current account transactions recognized by the aspirations of the country’s five-year plan. should meet in a single market, with the Central Bank acting to However, specific policy initiatives and measures to address prevent erratic volatility and to ensure an adequately competitive structural problematic issues and enable reforms to proceed market rate. Managing the float would protect the export sector remain relatively thin on the ground. Attention should be given to competitiveness and dampen the adverse effect of exchange rate efficiency improvement of public enterprises as a whole, with volatility on inflation. some view on the potential role of the private sector in terms of public/private partnership or privatization. The hurdles afflicting At the level of banking policy, the recent liberalization efforts oil output, which seems to have dropped last year much more started to bear fruit. Lending to the private sector expanded sharply than expected, should provide a serious incentive for significantly in 2005 within the context of a noticeable accelerating such reforms. A slowdown in structural reforms improvement and diversification in banking activity at large. Still, could possibly dissuade investors who have recently shown serious hurdles are facing banking activity, calling for the increasing interest in the country’s potential. The uncertainty implementation of further reforms. These include, among others, surrounding the regional environment represents a considerable the need for providing liquid placement vehicles for banks, the source of downside risk. need to upgrade clearing and settlement procedures, the need for improved corporate transparency and disclosure, and the need to At the level of fiscal policy, despite some favorable developments mainly at the level of debt alleviation, serious challenges rise at the establish a Credit Bureau or, at an earlier stage, a Central Office horizon. Government policies should focus on maintaining fiscal for Credit Risk, in addition to the need to enhance the Central sustainability by adopting a strong and credible fiscal Bank institutional capacity to exercise effective banking consolidation strategy within a transparent fiscal policy supervision. framework aiming for a steady improvement in the non-oil In the concluding statement of the recent IMF Article IV budget balance. After a five-year period of double-digit spending Consultation Mission released last August, the IMF foresees a growth, the pace of increase should ease, especially with growing positive outlook for 2006 but says that the improvement in concerns over weakening oil production and external political outlook should not allow for any complacency in view of the threats. In parallel, reform in the prevailing tax policy, significant medium term challenges and which need to be improvement in tax administration and greater effort in addressed today without delay. To ensure fiscal and external combating tax evasion is needed to reinforce overall resource sustainability in the future, and boost non-oil growth on a durable mobilization to represent important pillars of the required fiscal basis, there is now an urgent need to translate the broad policies adjustment in Syria. and strategies recently defined into a time-bound matrix of At the level of monetary policy, a significant amelioration was concrete policy actions 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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