Syria reforms may slow down but will continue

SUBJECT: The outlook for economic reform in Syria.

SIGNIFICANCE: The recent opening of the Damascus stock exchange is the latest milestone in Syria's reform programme and underlines the government's commitment to the liberalisation of the economy. While the speed of reform will depend upon external factors, it will be sufficient to boost growth over the medium term.

Government spending has been increased recently by the large numbers of Iraqi refugees and by the commitment to a larger than average public sector.

Although the introduction of a value-added tax (VAT) has been approved in principle, its implementation has been delayed until 2010.

Reforms will continue to take place but at a pace determined by external events, such as the global slowdown and drought.

ANALYSIS:

Several factors have historically undermined the economy's growth: short-term macroeconomic policies, such as government expenditure, inflation and the current account deficit; and structural factors, including the financial system and trade policy.

Syria has put forward a reform programme to tackle these issues. However, some argue that financial liberalisation and increasing openness to trade and investment will not achieve growth unless accompanied by cuts in government expenditure. While this view is exaggerated, there is no doubt that the global slowdown will have a negative impact both on the timing of the reform programme's implementation and the country's economic outlook.

The immediacy of Syria's difficulties has been underlined by the 2009 budget deficit of 9.25 per cent of gross domestic product (GDP). While according to the government, the budget (including public spending) is in line with the tenth five-year development plan, the size of the deficit inevitably sets off warning bells about state finances.

Government spending has been increased recently by the large numbers of Iraqi refugees in Syria and, over the longer term, by the commitment to a larger than average sized (by developing country standards) public sector.

As a result, instead of job cuts, privatisation and the sale of public enterprises, the government will continue on the path of gradual liberalisation with the emphasis on facilitating private investments in sectors such as construction and tourism.

Syria's emphasis on achieving social harmony means that some scheduled reforms will be postponed. According to the International Monetary Fund in October, inflation was just below five per cent. However, Syria's three-year drought and the removal of some subsidies have pushed up prices:

This means that, although the introduction of a value-added tax (VAT) has been approved in principle, its implementation has been delayed until 2010.

Exchange rate liberalisation will also be delayed.

Senior officials have said recently that the price of the Syrian pound is determined in the market, and suggested that allowing the pound to depreciate would encourage exports. However, it is unlikely the pound will float freely in the foreseeable future as the current account, which is already in deficit, is expected to widen in 2009 to between $1 billion (Dh3.67 billion) and $1.5 billion (more than two per cent of GDP).

This year sees the end of net oil revenues, with the value of imports of refined products exceeding earnings form crude exports.

Remittances from Syrians working in the Gulf have fallen as a result of GCC governments seeking to reduce expenditure on foreign workers in the face of the global slowdown. Of an estimated 50,000 Syrian workers currently employed overseas, most are in the Gulf, and these hold middle-management positions making their remittances more significant than those of casual manual workers in Lebanon who have not been as badly affected. Remittances by Syrian workers in the Gulf have increased steadily over the past decade, reaching an estimated $850 million in 2008.

The most high-profile of the recent reforms has been the opening of the Damascus Securities Exchange (DSE) on March 10, after a hiatus of 50 years and frequent delays in the past few years:

In theory, the exchange will widen the sources of finance available to listed companies, so allowing them to expand their activities.

This is an enormous task as Syrian companies typically fund their expansion through internal finance and, thus, do not even have a tradition of banking relationships to prepare them for the leap of opening up to the scrutiny of publicly listed ownership.

It is difficult to tell how successful the market will be over the long term at channelling funding to listed companies, although the initial signs are promising.

The first hurdle lies with the listing of a sufficient number of companies across the different sectors of the economy.

The DSE began trading with six listed companies, although on the first day was it confined to one company, Banque Bemo Saudi Fransi.

Another four companies have received initial approval, and a number of Initial Public Offerings (IPO) are also planned.

Estimates of the number of companies expected to be listed by the end of the year range between 20 and 35 companies, with the former a more realistic number.

So far the diversity of listed companies is promising, with publishing, transport and tourism as well as the ubiquitous financial sector well-represented.

At the moment, demand is difficult to gauge. Although the DSE is open to foreign investors, falls in values in regional stock markets mean that much cross-regional investment will not immediately be forthcoming. Also, the type of legislation - such as providing tax breaks for retirement plans - that will trigger a surge in domestic investment is many years away.

Syria has long been criticised for being insufficiently open to foreign trade. However a major step was taken to rectify this in December, with the initialling of an updated version of the EU Association Agreement:

The Agreement, which should encourage greater trade with, and investment by, European companies in Syria, is now awaiting approval from European member states.

Last month, the government formed the 'Higher Council for Syrian European Association' with the mandate of finalising the agreement. Its membership - which includes the prime minister, deputy prime minister for economic affairs, the head of the State Planning Commission, the governor of the Central Bank and the presidents of the Chamber of Commerce and of Industry - underlines the seriousness with which Damascus is viewing it.

It is likely that the agreement will be signed before the end of the year.

With Western investments adversely affected by regional geopolitical insecurity and US sanctions, the main source of funding in Syria continues to be the Gulf.

While the regional economic slowdown will inevitably affect current Gulf investment, the outlook will improve over the medium term.

Gulf investment will be increasingly attracted by Syria's common language, geographical proximity and untapped resources.

Investment will focus on tourism, banking and construction, with Gulf Arabs taking holidays closer to home, and wealthy Syrians requiring more sophisticated banking services.

Last November, the governments of Syria and Qatar signed an agreement to establish a $5 billion joint holding company to invest in real estate, tourism and industry projects. The property arm of the Qatar Investment Authority has recently announced its intention to develop two real estate projects. The Al Kharafi Group, from Kuwait, also continues to show interest in developing infrastructure projects including electricity and water management.

CONCLUSION:

Syria's longstanding problem of rising government debt has been exacerbated by the global slowdown. Reforms will continue to take place but at a pace determined by external events, such as the global slowdown and drought. Gulf and - eventually - local investment will underpin future growth.