Syrian Arab Republic -- IMF Article IV Consultation, Mission's Concluding Statement
IMF News, May 14, 2006
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- Published: May 14, 2006
Major challenges and strategic priorities
- The Syrian economy faces "daunting challenges" due to the dwindling of its oil reserves, which will "create a serious challenge to fiscal and external sustainability."
- Loss of oil income will make it harder to "preserve, let alone, expand living standards."
- A "budge in entrants to the labor market" will strain unemployment and increase pressure to protect redundant labor in an overstaffed public sector.
- Growing political uncertainties "cloud the country's overall business climate."
- Two inter-related policy pillars are prioritized:
- Maintain fiscal sustainability and financial stability via a "strong and credible fiscal consolidation strategy" with a transparent fiscal policy framework aiming for a steady improvement in the non-oil budget balance.
- Accelerate structural reforms to diversify and expand the production and export base and generate new buoyant sources of income.
- The reform challenge is to balance promoting growth and fiscal consolidation so that "lack of fiscal adjustment to underpin financial stability will undermine growth, and fiscal adjustment without growth would mean a painful contraction."
Reform momentum and institutional capacity
- Reforms already initiated:
- Encouraging private entrepreneurship, promoting market mechanisms, opening the economy, liberalizing the financial system, and strengthening the medium-term fiscal outlook.
- Increasing number of sectors opened to private enterprise (including insurance) and exposed to international competition (including textile and cement).
- Gradual liberalization of the foreign exchange regime.
- Simplification of the tax system and improvements in the regulatory framework for tourism.
- Revision of outdated business laws and groundwork for a securities market.
- Constraints: "weak domestic capacity and the quasi-absence of social safety nets" are main obstacles to achieving the 5-year plan goals.
- Institutional recommendations:
- Develop autonomous technical capacity; invest in civil servants with training, link wages to performance, and allow greater wage dispersion to attract top skills.
- Create core reform teams detached from day-to-day management, with adequate resources and delegated authority.
- Prioritize establishing efficient social safety nets to enable reform and protect vulnerable segments.
Recent macroeconomic developments (2004–2005)
- Non-oil GDP growth: "about 5½ percent" in 2005, up from "5 percent" in 2004 (overall growth limited to "3 percent" due to oil decline).
- Inflation: annual CPI inflation "7 percent" at end-December 2005, compared with "4½ percent" in 2004.
- Credit expansion: credit to the private sector grew by "45 percent" in 2005; "70 percent" of this credit was contributed by three state banks.
- Fiscal balances:
- Non-oil budget balance narrowed by "about 2½ percent of GDP" in 2005, on top of "1¾ percentage points of GDP" improvement in 2004.
- Non-oil tax revenues remained "about 10½ percent of GDP"; income and profit taxes "about 3½ percent of GDP."
- Overall budget deficit unchanged at "about 4¼ percent of GDP" in 2005 due to commensurate decline in oil revenues.
- Fiscal risks: surge in surplus of public enterprises was main driver of fiscal improvement; sustainability is uncertain due to poor accounting standards and opaque consolidation practices.
- Financing: net repayments of external debt and bank financing of the budget deficit contributed half of the overall expansion of broad liquidity, "competing with the private sector for scarce non-inflationary domestic financing."
Short-term outlook and policy priorities for 2006
- Growth outlook: non-oil GDP growth expected "slightly above 5½ percent" in 2006 supported by investment expansion and exports.
- Inflation target: with reined-in credit expansion and wage restraint, along with a strengthened exchange rate, inflation could be brought down to "about 5 percent."
- Fiscal outlook:
- The 2006 budget and subsequent measures expected to yield "close to ½ percentage-point" improvement in the underlying fiscal position.
- This reflects "1 percentage-point of GDP" yield from increases in cement and gasoline prices, partially eroded by wage increases.
- Narrowing of the overall budget deficit to "3¼ percent of GDP" is expected.
- Wages: a "20 percent across-the-board increase in public sector wages will increase the government wage bill by SP20 billion per year," creating a permanent entitlement equivalent to "1¼ percent of GDP." Any further expansion should be used to finance civil service reform.
- Monetary policy recommendations:
- Tighten monetary policy and lower overall credit ceilings.
- Maintain the "2 percentage-points" hike in interest rates until inflation pressures abate.
- Introduce greater upward flexibility in lending rates and greater flexibility in deposit rates for private banks.
Medium-term strategy and preparing for the future
- Medium-term challenges must be addressed urgently; the 5-year plan's broad strategy should be translated into a time-bound matrix of concrete actions.
- The 5-year plan targets:
- Accelerate growth "to 7 percent by 2010."
- Lower unemployment "to 8 percent by 2010."
- Contain the overall budget deficit below "5 percent of GDP" and limit public debt rise to "no more than 45 percent of GDP by 2010."
- The plan is consistent with a "5-6 percentage points of GDP fiscal adjustment during 2006-2010."
- Public debt guidance: the mission advises against a "7 percentage-points of GDP increase in public debt over 5 years" as "not be prudent."
Consolidating public finances: tax and subsidy reform
- Fiscal anchor recommended: focus on "a steady improvement in the non-oil budget balance" rather than overall balance.
- Key fiscal measures endorsed:
- Introduce a broad-based VAT; "If well designed, the VAT could yield 1.8 percent of GDP for each 5 percentage points for the rate."
- Phase out price subsidies (PPS): their implicit fiscal cost exceeds "10 percent of GDP" and phasing them out is "the fiscal measure par excellence."
- VAT design guidance:
- VAT should be imposed "on virtually all goods and services."
- Targeted assistance to the poor preferred over narrow VAT coverage: "for every SP 100 raised from the VAT, only SP 12 will be contributed by the 30 percent of the poorer segment of society. Raising SP 100 and returning to the poor SP 12 will yield a net revenue to the government of SP 88."
- Adopt an appropriately high threshold to exclude small retailers.
- Tax administration reforms needed:
- Launch a large taxpayer unit, unique taxpayer identification system, and self-assessment.
- Issue needed amendments to the tax procedure code to enable risk-based audits, penalty regime, and simple dispute resolution.
Exchange rate regime and current account convertibility
- Unification of the exchange rate and adoption of current account convertibility are recommended given improved BOP outlook.
- Exchange rate unification implications:
- The exchange rate used by the public sector should no longer be set administratively by the budget law; all current-account FX demand and supply should meet in a single market.
- Central bank to act to prevent excessive volatility and ensure a competitive rate.
- If downward pressures on the exchange rate occur, reducing public spending within approved ceilings can help stabilize the rate.
- Operational prerequisites:
- Central bank to complete preparations to launch a wholesale interbank foreign exchange market, following adoption of laws on foreign exchange bureaus and banks' open FX positions.
- If transfer of official reserves from Commercial Bank of Syria (CboS) to the central bank cannot be completed before the interbank market starts, adopt a special provision limiting CboS's weight in the FX market.
- Exchange rate management:
- Continue tight management in the near term to avoid high costs from volatility due to lack of hedging instruments and weakened anchoring of inflation expectations.
- Over time, greater flexibility will be needed to adjust the real exchange rate given oil depletion and trade liberalization.
- Managing the float could aim to prevent excessive volatility in the effective nominal exchange rate vis-à-vis currencies of major trading partners rather than the nominal bilateral rate vis-à-vis the US$.
Strengthening the monetary policy framework and financial sector
- Monetary framework: currently "rudimentary" and needs major strengthening to use indirect instruments and operate in a market-based financial system.
- Immediate actions for the central bank (CBS):
- Gain full control of direct instruments; have the right to decide on credit ceilings and credit policies of banks to ensure credit and monetary expansion consistent with price stability.
- Clearly define roles of the central bank and ministry of finance in bank oversight.
- CBS should have operational independence and institutional capacity for effective banking supervision.
- Supervisory measures urged:
- Give the CBS power to address noncompliance and safety and soundness concerns, and to ensure fit and proper criteria for senior bank staff and consistent credit policies.
- Allocate adequate resources to build capacity for banking supervision.
- Complete the banking supervision framework including a licensing manual.
- State bank restructuring:
- Undertake detailed independent audits and diagnostic assessments consistent with international auditing standards.
- Consider options including opening capital to strategic investors with full management control, liquidation of significantly under-capitalized banks, or cautious mergers. Independent audits should guide decisions.
Trade liberalization and business climate improvements
- Trade barriers:
- Tariff reductions and removal of import prohibitions for goods such as textile and cement noted as progress.
- Significant remaining non-tariff barriers (NTBs) are an impediment to growth; NTBs are non-transparent and increase costs.
- Priority actions to remove NTBs:
- Publish list of goods prohibited or restricted for imports.
- Phase out prohibitions or restrictions (except for security, environmental, health reasons); replace protectionist prohibitions with tariffs and reduce them gradually.
- Abolish industrial quota system that allows imports at lower customs rates.
- Ease other trade-related barriers (licensing requirements, obligations to import through Syrian ports, consular authorizations, complex fee computations).
- Customs tariff reform options:
- Reduce tariff dispersion to lower effective protection.
- Simplify the tariff structure to "3 or 4" bands.
- Publish tariff schedule on the web to increase transparency.
- Further reduce clearance time at customs.
- Regional agreements:
- Bilateral or regional agreements have positive effects but risk trade diversion; consider reducing relative preferences and lower Most Favored Nation tariffs to reduce preferential gaps.
- Business climate reforms:
- Draft law on competition and draft company law expected to improve the business environment; World Bank ease-of-starting-a-business ranking projected to improve from "135 to 91."
- Scrapping the onerous minimum capital requirement (currently "50 times GDP per capita") would raise Syria's ranking to "32nd place."
- Narrow tax incentives, broaden the tax base, and optionally introduce a low single corporate tax rate "of no more than 25 percent" with generous depreciation allowances; grandfather existing incentives.
Key numerical points and projections preserved
- Non-oil GDP growth: "about 5½ percent" in 2005 (non-oil); overall growth "3 percent" (including oil decline).
- Inflation: "7 percent" at end-December 2005; "4½ percent" in 2004.
- Private sector credit growth: "45 percent" in 2005; "70 percent" of that by three state banks.
- Non-oil tax revenues: "about 10½ percent of GDP"; income and profit taxes "about 3½ percent of GDP."
- Net oil foreign exchange receipts swing projected: surplus "about US$0.7 billion" in 2005 to deficit "about US$4 billion" in 2015.
- Oil revenues to the budget projected to decline from "8.8 percent of GDP" in 2005 to "about nil" in 2015.
- Fiscal targets in 5-year plan: growth to "7 percent by 2010"; unemployment to "8 percent by 2010"; overall balance below "5 percent of GDP"; public debt limit "no more than 45 percent of GDP by 2010."
- VAT yield estimate: "1.8 percent of GDP for each 5 percentage points for the rate."
- PPS implicit fiscal cost: "exceeding 10 percent of GDP."
- 2006 budget expected to improve underlying fiscal position by "close to ½ percentage-point."
- Narrow overall budget deficit to "3¼ percent of GDP" in 2006.
- Public sector wage increase example: "20 percent" across-the-board raises government wage bill by "SP20 billion per year," equivalent to "1¼ percent of GDP."
- Interest rate actions: a "2 percentage-points" hike in November; U.S. dollar interest rates rose "3 percent" since January 2005.
Concluding statement by the IMF mission, May 14, 2006.