Public Information Notice No. 10/42

Public Information Notice: IMF Executive Board Concludes 2009 Article IV Consultation with the Syrian Arab Republic

March 25, 2010

On February 26, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Syrian Arab Republic on a lapse of time basis.¹

Background

The impact of the global financial crisis on Syria has been relatively moderate and mostly through linkages to trading partners in the GCC and Europe. GDP growth is estimated to have decelerated in 2009 by 1 percentage point to 4 percent. Lower growth in manufacturing, construction, and services was partially offset by a moderate recovery in agriculture and a small increase in oil production. Unemployment is estimated to have increased to almost 11 percent. Inflation declined sharply to about 2.5 percent, reflecting trends in global prices. Fiscal policy aimed at mitigating the impact of the global crisis. The fiscal deficit increased by about 2.5 percentage points to 5.5 percent in 2009. Total expenditure grew by about 5 percent of GDP, reflecting increases in public investments, as well as the wage bill and transfers to compensate for raising fuel prices and removal of petroleum subsidies. Non-oil revenue increased, partly due to strong tax collection, which resulted from improved administration and incentives to settle arrears.

The external current account deficit widened to about 4.5 percent, as the decline in exports exceeded that of imports. However, tourism receipts were buoyant, and both FDI and remittances dropped only slightly. Gross reserves remained comfortable, at about US$17 billion.

With the Syrian pound pegged to a basket (within a band), broad money is estimated to have grown by about 10 percent in 2009. Credit to public enterprises decelerated sharply due to the reduction in energy subsidies, which were financed by borrowing. Nonetheless, growth of credit to the private sector remained at about 25 percent, driven by the expansion of private banks.

The outlook for 2010 and beyond point to an overall strengthening in economic performance. The ongoing recovery in Syria’s trading partners is expected to contribute to a gradual increase in exports, remittances, and FDI. Agriculture is likely to continue to recover from the severe drought of the past two years. The fiscal and current account are expected to stabilize as a result of the fiscal reforms, including the introduction of value added tax (VAT) in 2011, a further deepening of subsidies reform, and expenditure restraint. A delay in global recovery or faltering reform implementation could worsen the outlook and impede Syria’s economic growth.

While some progress has been made in advancing structural reforms, there were a few negative developments. Steps were taken to simplify investment procedures, modernize accounting standards, and streamline the tax system. Effective June 2009, the authorities raised the minimum thresholds for exemption from wage taxes. As an offsetting measure, the top income tax rate for individuals was increased to 22 percent (from 20 percent). The authorities also introduced reference prices and customs duties that vary by country of origin to protect against unfair trade practices.

Executive Board Assessment

Executive Directors concurred that the impact of the global financial crisis on Syria has been relatively moderate. Preliminary data for 2009 indicate that non-oil growth decelerated as lower growth in most sectors was only partially offset by a moderate recovery in agriculture. Inflation declined sharply, reflecting trends in the global prices of basic commodities. Despite the important progress made in subsidies reforms, the fiscal deficit widened as the consolidation of public finances in the past few years provided room for the authorities to implement counter-cyclical measures to mitigate the effects of the global economic crisis. The current account deficit increased slightly, as the decline in exports exceeded that of imports. Tourism receipts, however, remained buoyant, and both FDI and remittances dropped only slightly despite the global economic crisis.

Directors considered the widening in the fiscal deficit in 2009 to be appropriate to mitigate the impact of the global recession. They noted that this widening in the fiscal deficit in 2009 partly reflects enhanced fiscal transparency as substantial extra-budgetary spending related to petroleum subsidies was brought on budget. However, Directors underscored the need for a gradual resumption of fiscal consolidation going forward in order to preserve fiscal sustainability. In this regard, they encouraged the authorities to revisit the large increase in public investment budgeted for 2010, especially after its large increase in 2009. They noted that this would be more in line with absorptive capacity and would help reduce the overall fiscal deficit to about 4.5 percent of GDP. Directors also urged the authorities to ensure that increases in public wages are linked to performance and to civil service reform.

Directors commended the authorities for the recent reforms of petroleum subsidies that have led to considerable efficiency gains and a reduction in waste and leakages as reflected in the decline in domestic consumption. They noted that the replacement in December 2009 of the diesel coupons with cash transfers is likely to enhance the targeting of assistance and consolidate efficiency and fiscal gains. Directors encouraged the authorities to prevent a re-emergence of the large inefficient price subsidies of the past.

Directors welcomed the substantial progress in the preparation for the VAT, but underscored the need for further efforts. They supported the emphasis on making progress in reorganizing tax administration, including by shifting more responsibilities to the General Commission for Taxes and Fees. Directors welcomed the streamlining of the tax system, and advised against a further increase in the personal income tax rates. They encouraged the authorities to streamline excise taxes in line with the recommendations of past technical assistance missions.

Directors welcomed the efforts to improve public financial management are welcome and should continue. They recommended that the budget classification be further enhanced to reflect standardized economic classifications. In addition, Directors underscored the importance of supporting the plan to cast the budget formulation and execution in a medium-term framework by further empowering the newly established Fiscal Forecasting and Planning Units at the Ministry of Finance (MoF) and facilitating a more timely flow of data and information between these units and the different departments at the MoF. Directors encouraged the authorities to expand the use of the program- and performance-based budgeting approach. They also emphasized the importance of bringing on budget the remaining quasi-fiscal operations.

Directors underscored the need for a shift in the financing of the budget deficit from bank borrowing to issuing treasury bills. They recommended that the interest rate on these bills be market-determined. At the same time, Directors underscored the importance of ensuring that public investment projects yield high economic and social return in order to justify the cost of their financing.

Directors welcomed the progress made in implementing the reform agenda to modernize the Central Bank of Syria (CBS) and the monetary policy framework. They noted that enhancing the CBS operational independence will be important to strengthen its ability to formulate and implement monetary policy. Directors also encouraged the authorities to utilize treasury bills as an instrument of monetary policy to withdraw excess liquidity. They recommended that, otherwise, the CBS would have to issue its own certificates of deposit. Directors concurred that considerations be given to securitizing the stock of government debt to the CBS.

Directors encouraged the authorities to phase-out some of the decisions that were taken in response to the global crisis. They recommended that the legitimate intended objectives of differentiated reserve requirements or increased credit exposure limits for development projects be achieved through other means that are more effective and entail lower risks for banks and lesser burden for the supervision department.

Directors welcomed the good start at implementing the recommendations of the 2008 FSAP report, including by strengthening the regulatory and supervisory framework and improving collection of data on public banks. They encouraged the authorities to continue to strengthen supervision in order to maintain the health of the financial sector, especially in view of the rapid growth of private banks’ credit. Directors also encouraged the authorities to adopt the amended central bank law as soon as possible.

Directors concurred that the priority in the period ahead be given to public banks’ reform. They welcomed the closer collaboration between the MoF and the CBS regarding supervision of these banks. Directors noted that strengthening the CBS’s supervisory and regulatory independence with respect to these banks would ensure their compliance with prudential regulations and help address deficiencies identified in the supervisory process.

Directors agreed that the Syrian pound’s de jure peg to a band around the Special Drawing Rights (SDR) can provide a strong monetary anchor, while allowing some flexibility in the pound’s rate vis-à-vis major currencies. They noted that in practice, the pound appears to be de facto pegged to a basket in which the dollar has a larger weight than its weight in the SDR basket. Directors concurred that adjusting the de facto basket in line with the de jure regime would be more consistent with Syria’s direction of trade. They noted that the dollar has the largest share in the SDR basket, which is also consistent with the key role it has in foreign exchange markets and international trade pricing and payments. Directors considered that a gradual move toward greater flexibility over the medium-term as the monetary policy framework develops would further increase monetary policy independence and maintain external stability. Directors agreed that preliminary econometric estimates suggest that the pound may be moderately overvalued in real effective terms, although they are still subject to uncertainties given the serious data shortcomings. Directors, however, did not recommend a change in the current nominal exchange rate level in the present context.

Directors welcomed the progress made in transition to a market economy, but noted that the remaining structural reform agenda is substantial. They supported the emphasis on further reducing the number of goods subject to administrative pricing, and modernizing of the legal and regulatory framework in order to encourage private investment and enhance competitiveness. Directors recommended that the authorities reverse the recent introduction of customs duties that vary by country of origin, and address suspected unfair trade practices by other measures such as enhancing customs’ capacity to examine invoices through computerization and cross border cooperation.

Directors welcomed the authorities’ intention to accept the obligations of Article VIII of the IMF’s Articles of Agreement. They recommended that the authorities remove any remaining restrictions in preparation for the acceptance of the obligations of Article VIII. Directors noted the staff readiness to conduct a comprehensive review of the exchange system upon the authorities’ request.

Directors urged the authorities to improve data quality and provision to facilitate better analysis of developments and guide policy formulation.