Public Information Notice No. 07/104

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with the Syrian Arab Republic

August 15, 2007

On July 30, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Syrian Arab Republic.¹

Background

Over the past three years, Syria has recovered from a half decade of weak growth, notwithstanding an unsettled regional environment and a sharp drop in oil production. The economic recovery has gained momentum, benefiting from inflows from Iraqi refugees and abundant liquidity in the Gulf region. Private investment has strengthened owing to an improved business climate, and exports have made strong gains, particularly in some Arab markets, reflecting higher demand and improved access under the Great Arab Free Trade Area. Despite a sharp drop in oil proceeds (10 percentage points of GDP over the last three years) and the large demand shock associated with the Iraqi refugees, inflationary pressures have been contained, owing to the economy's supply responsiveness and a sustained, timely and sizeable fiscal adjustment. Public debt is still at a relatively moderate level, and the international reserves cover remains comfortable.

The near-term outlook for growth and inflation is favorable. The reforms implemented in recent months, continued stimulus to aggregate demand from the Iraqi presence, and favorable growth prospects both globally and in the region are expected to support consumption and non-oil exports, and to encourage higher private investment. In 2007, these factors would help sustain growth at about the same pace as in 2006, although deterioration in weather conditions, which recently hit the cereal and cotton crops, may dampen growth somewhat. Fiscal policy aims to reduce the overall budget deficit to 5 percent of GDP in 2007 (from 5.7 percent in 2006), notwithstanding an expected further decline in oil revenues of about ¾ percentage points of GDP. This would require a reduction in the non-oil budget deficit of some 1½ percent of GDP, which the authorities plan to achieve through a further rationalization of capital spending. Credit policy is expected to support the recent trend decline in inflation. The authorities intend to continue using the exchange rate as a nominal anchor, while allowing some limited flexibility.

Significant progress has been made on the structural front over the last two years, but the reform agenda remains substantial. Substantial progress toward exchange rate unification and current account convertibility has been achieved; a dynamic private banking sector is now leading financial sector growth; the investment regime has been liberalized; taxes have been simplified and tax administration is being modernized, and the local industry has been exposed to greater competition through several rounds of tariff cuts and a relaxation of trade restrictions. Regulatory frameworks for banking, insurance and capital markets, and for housing and real estate have been developed.

Executive Board Assessment

Directors noted that macroeconomic adjustment and structural reforms have helped the Syrian economy engineer a strong rebound from the subpar growth of the previous half decade and maintain financial stability, despite the abrupt drop in oil proceeds, the deterioration in the regional environment, and the pressures stemming from the large inflow of refugees from Iraq. While the short-term outlook is encouraging, the challenges posed by the further depletion of oil reserves are daunting. Directors underscored that growth will need to be solidified, including by persevering with quality fiscal adjustment and the steadfast implementation of the reforms embedded in the ambitious tenth five-year development plan.

Directors commended the authorities for the sustained, timely and significant fiscal adjustment and welcomed the lowering of corporate income taxes. They agreed that introducing a VAT and phasing out petroleum price subsidies would provide the main pillars of the required fiscal adjustment. A broad-based value-added tax (VAT) would have a strong revenue raising potential with only a limited impact on production and investment. Directors observed that phasing out petroleum price subsidies could generate significant efficiency gains and redress part of the social inequity in the existing policy. They recommended that the authorities accelerate the pace of tax administration reforms supporting the introduction of the VAT.

Directors commended the authorities for the significant progress toward exchange rate unification and current account convertibility. They stressed the need to enact a new foreign exchange law that would abrogate the existing complex set of foreign exchange laws and regulations and enshrine full current account convertibility, and a unified exchange rate. This would send a strong signal about the irreversibility of these reforms and the commitment of the authorities to re-entry into the global economy. Directors felt that although the level of the real

exchange rate appears broadly appropriate, the impact of its recent strengthening on external competitiveness should be monitored carefully, particularly in light of the depletion of oil reserves and the large uncertainties about the level of the current account deficit and the sources of its financing.

Directors welcomed the tightening of credit policy, which helped tame inflationary pressures, despite the large demand shock from the influx of Iraqi refugees. They considered that the adoption of a bank law that would grant the central bank operational independence in monetary and exchange rate management would establish credibility in operating the new exchange rate regime and strengthen the monetary policy framework. This would need to be supported by the introduction of market-based instruments of monetary control, the centralization of official foreign exchange reserves at the central bank, and the establishment of the long-delayed government securities market. The process of licensing the foreign exchange bureaus and launching an interbank foreign exchange market should be accelerated.

With respect to financial sector reform, Directors were pleased with the fast-paced expansion of private banks. However, they were concerned about the emerging vulnerabilities and the remaining impediments. They urged the authorities to give priority to strengthening bank supervision capacity and to speed the process of state bank restructuring to stem further accumulation of bad debt and allow greater competition. Directors also noted the liberalization of the investment regime and the adoption of a modernized basic finance law.

Directors welcomed the steady progress made in trade liberalization, including the recent publication of the tariff schedule and the unified negative list of imports. They encouraged the authorities to further streamline the list of prohibited imports, abolish the system of industrial quotas, reduce the number of tariff bands, and eliminate nontariff barriers. Continuing to work on improving the business climate is essential to enhance the incentives of the private sector to invest and to turn the promise from the surge in investment approvals into a reality.

Directors agreed that an overarching prerequisite for the success of reforms in all areas is to strengthen domestic capacity. They encouraged the authorities to introduce a special fast-track scheme to attract highly skilled managers and to provide intensive training to newly hired young graduates, while continuing to work toward a far-reaching civil service reform.

Directors urged the authorities to improve the quality and timeliness of economic statistics, especially in the external and real sector. They recommended that priority be given to improving the balance of payments statistics to provide a sounder basis for macroeconomic management.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.