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Country Report

Syria

August 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Syria at a glance: 2006-07

OVERVIEW Following the outbreak of war in Lebanon between Israel and Hizbullah in mid-July, and the subsequent fragile ceasefire agreed in mid-August between the two parties, Syria�s political outlook looks more uncertain and, arguably, appears even more intimately connected to developments in Lebanon and the wider Middle East. The president, Bashar al-Assad, has sought to present the achievements ofHizbullah guerrillas in Lebanon during their battle with Israeli forces as a vindication of his own position with respect to Israel and the internal Lebanese political scene. Syria will continue to face intense international pressure to ensure that the supply of weapons from its territory to Hizbullah does not resume, and the regime faces serious consequences from the ongoing UN investigation into the 2005 assassination of the former Lebanese prime minister, Rafiq al-Hariri. Mr Assad also appears determined to continue to obstruct efforts by the Lebanese government to assert its sovereignty and will continue to try to foment further discord between Lebanon�s already fractious confessional groupings. The declining trend in oil output will constrain economic growth, which will remain weak over 2006-07. Inflation will decline but remain relatively high.

Key changes from last month

Political outlook • Syria�s political outlook appears even more intricately linked with

developments in Lebanon and the wider Middle East, following the July-August war in Lebanon. Although threats to Mr Assad�s position have increased, it is unlikely that they will be of a magnitude that could unseat him over the forecast period, given the strength and ruthlessness of his regime and security services.

Economic policy outlook • The Economist Intelligence Unit has revised its budget forecasts in line with

new data released by the IMF. We now expect budget deficits in 2006-07.

Economic forecast • We have revised upwards our inflation estimates and forecasts given recent

data released by the IMF.

The Economist Intelligence Unit

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ISSN 0269-7211

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Syria 1

Country Report August 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

Contents

Syria

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 9 Economic policy outlook 10 Economic forecast

14 The political scene

22 Economic policy

24 The domestic economy 26 Oil and gas 28 Infrastructure 28 Financial and other services

29 Foreign trade and payments

List of tables 9 International assumptions summary 12 Forecast summary 25 Increase in credit to the private sector, 2004-05

List of figures 13 Gross domestic product 13 Consumer price inflation

Syria 3


Syria August 2006

Summary

Following the outbreak of war in Lebanon between Israel and Hizbullah in mid-July, and the subsequent fragile ceasefire agreed in mid-August between the two parties, Syria�s political outlook looks more uncertain and, arguably, appears even more intimately connected to developments in Lebanon and the wider Middle East. The president, Bashar al-Assad, has sought to present the achievements of Hizbullah guerrillas in Lebanon during their battle with Israeli forces as a vindication of his own position with respect to Israel and the internal Lebanese political scene. Syria will continue to face intense international pressure to ensure that the supply of weapons from its territory to Hizbullah does not resume, and the regime still faces serious consequences from the ongoing UN investigation into the 2005 assassination of the former Lebanese prime minister, Rafiq al-Hariri. Mr Assad also appears determined to continue to obstruct efforts by the Lebanese government to assert its sovereignty and will continue to try to foment further discord between Lebanon�s already fractious confessional groups. The declining trend in oil output will constrain economic growth, which will remain weak in 2006-07. Inflation will decline.

The war unleashed by Israel on Lebanon in mid-July has major political implications for Syria, which is a primary supporter of Hizbullah. Mr Assad has been giving contradictory signals in dealing with European governments, and has reverted to threatening talk against the Lebanese government.

The five-year plan, which provides the outline for the evolution of Syria towards a �social market economy� has been signed into law. The IMF has issued its full Article IV report on Syria stating, among other things, that there was relatively robust growth in the non-oil sector, but also commented on the scale of the challenges facing the economy.

The non-oil economy has been showing robust rates of growth. The IMF has observed that declining oil output poses a serious challenge to fiscal and external sustainability, and that the unemployment situation is �precarious� and the business climate clouded with �growing political uncertainties�.

A private-sector developer has been engaged to operate and upgrade the container terminal at Tartous port. IMF estimates suggest that the current account deficit was US$592m in 2005, compared with a 2004 deficit of US$3m. However, other IMF data sources still indicate historical surpluses.

Editors: Hania Farhan (editor); Robert Powell (consulting editor) Editorial closing date: August 16th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Outlook for 2006-07

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Syria


Political structure

Syrian Arab Republic

Republic

Based on the constitution of 1973

250-member Majlis al-Shaab (People�s Assembly) directly elected for a four-year term

Universal adult suffrage

2003 (legislative), 2000 (presidential); next election due by 2007 (legislative)

President, directly elected for a seven-year term. The president appoints the vice-presidents, the prime minister and the Council of Ministers. Bashar al-Assad, who was elected unopposed as president in July 2000, also holds the posts of commander-in-chief of the armed forces and secretary-general of the Baath party.

The prime minister heads the Council of Ministers, a large number of which are drawn from the Baath party and its partners; last reshuffle in February 2006

Seven parties form the ruling National Progressive Front: Arab Socialist Baath Party; Arab Socialist Party; Arab Socialist Unionist Party; Communist Party; Syrian Arab Socialist Union Party; Unionist Socialist Democratic Party; Union Socialist Party

Prime minister Mohammed Naji al-Otari Deputy prime minister for economic affairs Abdullah al-Dardari

Agriculture & agrarian reform Adel Saffar Awqaf (Islamic endowments) Mohammed Ziyad al-Ayoubi Communications & technology Amr Nazir Salem Defence Hassan Turkomani Economy & foreign trade Amer Lutfi Education Ali Saad Electricity Ahmed Ali Finance Mohammed al-Hussein Foreign affairs Walid al-Muallim Health Maher Hussami Higher education Ghiath Abdel-Wahab Barakat Housing & construction Hammoud Hussein Immigrant affairs Buthaina Shaaban Industry Fouad Issa Jony Information Mohsen Bilal Interior Bassam Abdel-Majid Irrigation Nader al-Buni Justice Mohammed al-Ghafri Labour & social affairs Diyala al-Hajj Aref Local administration & environment Hilal al-Atrash Petroleum & mineral resources Sufyan Allaw Presidential affairs Ghassan Lahham Tourism Saadallah Agha al-Qalah Transport Yacoub Suleiman Badr

Adib Mayaleh

Official name

Form of state

Legal system

Electoral system

Legislature

National elections

Head of state

Executive

Main political parties

Key ministers

Central Bank governor

Syria 5


Economic structure

Annual indicators

2001a 2002a 2003 a 2004 b 2005b

GDP at market prices (S£ bn) 954.1 999.5 1,059.3 1,075.0 1,139.3

GDP (US$ bn) 20.6 21.6 22.9 22.2 23.5

Real GDP growth (%) 5.1 5.9 1.1 2.0 2.8

Consumer price inflation (av; %) 3.4 -0.5 5.7 4.5 7.2

Population (m) 17.2 17.7 18.1 18.6 a 19.0

Exports of goods fob (US$ m) 5,706.0 6,668.0 5,762.0 5,561.0 a 6,462.9

Imports of goods fob (US$ m) 4,282.0 4,458.0 4,430.0 5,935.0 a 6,468.7

Current-account balance (US$ m) 1,221.0 1,440.0 728.0 205.0 a 532.8

Foreign-exchange reserves excl gold (US$ m) 3,462.0b 4,221.0b 4,559.0 b 4,934.0 5,334.0

Total external debt (US$ bn) 21.3 21.5 21.6 21.5 8.4

Debt-service ratio, paid (%) 3.3 3.1b 4.2 b 3.6 6.0

Exchange rate (av) S£:US$ 46.30 46.30 46.30 48.50 a 48.50

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003a % of total Components of gross domestic product 2003a % of total

Agriculture 25.3 Private consumption 59.3

Mining, manufacturing, electricity & water 24.6 Government consumption 13.7

Wholesale & retail trade 17.2 Fixed investment 23.0

Transport & communications 13.0 Exports of goods & services 34.6

Government services 10.2 Imports of goods & services -30.6

Principal exports 2000b US$ m Principal imports cif 2000b US$ m

Crude oil 3,169 Machinery & transport equipment 863

Fruit & vegetables 259 Food & livestock 742

Textiles 317 Metal & metal products 615

Cotton 196 Chemicals & chemical products 397

Main destinations of exports 2005 Main origins of imports 2005

Iraq 43.4 Ukraine 11.0

Turkey 37.8 Turkey 8.7

Saudi Arabia 29.9 Saudi Arabia 6.9

Italy 23.6 South Korea 5.9

a Official estimates. b Principal exports and imports are derived from the Central Bank of Syria, Quarterly Bulletin, converted at neighbouring countries exchange rate. Exports of goods and services are taken from the IMF�s International Financial Statistics.

6 Syria


Quarterly indicators 2003 2004 2005 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 QtrFinancial indicators Exchange rate S£:US$ (av)a 46.3 46.3 46.3 46.3 46.3 46.3 46.3 46.3Exchange rate S£:US$ (end-period)a 46.3 46.3 46.3 46.3 46.3 46.3 46.3 46.3M1 (end-period; S£ bn) 628.3 642.3 604.6 605.7 636.7 635.1 639.4 670.2 M1 (% change, year on year) 27.0 28.7 20.1 16.5 1.3 -1.1 5.7 10.7M2 (end-period; S£ bn) 889.4 894.3 952.2 967.4 1,025.5 1,033.3 1,046.7 1,089.4 M2 (% change, year on year) 7.8 7.4 14.4 14.6 15.3 15.5 9.9 12.6Foreign tradeb (S£ m) Exports fob n/a 54,900 74,800 66,697 52,600 n/a n/a n/aImports cif n/a -66,600 -78,700 -92,440 -89,250 n/a n/a n/aTrade balance n/a -11,700 -3,900 -25,743 -36,650 n/a n/a n/a

a Neighbouring countries rate. b Trade data is calculated using multiple exchange rates determined by the Ministry of Economy and Foreign Trade.

Sources: International Energy Agency, Monthly Oil Market Report; IMF, International Financial Statistics; Economist Intelligence Unit.

Syria 7


Outlook for 2006-07

Political outlook

Following the outbreak of war in Lebanon between Israel and fighters from the Lebanese Shia group, Hizbullah, in mid-July, and the subsequent fragile ceasefire agreed in mid-August between the two parties, Syria�s political outlook looks more uncertain and has arguably become even more intimately connected to developments in Lebanon and the wider Middle East.

The president, Bashar al-Assad has adopted a combative approach since the end of the conflict. Having survived the initial pressure from the West over Lebanon and the assassination of the former Lebanese prime minister, Rafiq al-Hariri, he seems to no longer feel the need to seek a compromise that might eventually lead to his regime being rehabilitated in international (namely Western) eyes. This has also been apparent in the firm support that he has given Iran over its nuclear programme, and in his increasing efforts to reassert influence in Lebanon. Mr Assad may also feel that the concessions necessary to make a deal pose a greater threat to his domestic position than the prospect of sanctions and isolation, particularly if they required him to surrender key members of the regime for trial. Indeed, although the threat of a coup�particularly from the military�has increased since the assassination of Mr Hariri, and there have been some signs of a growing disaffection within the elite over Mr Assad�s handling of several key policy issues it remains unlikely that the regime will collapse under heightened internal pressures in the near term. Mr Assad has tightened his grip on power, stepped up his repression of local opposition groups and appointed his own close allies to key posts. This has enhanced his control, albeit at the cost of narrowing his power base. Importantly, the core of the elite are drawn from Mr Assad�s minority Alawi sect, and are acutely conscious that, whatever their concerns over the president�s performance, to move against him would risk endangering the Alawi hold on power. Moreover, the security forces and intelligence services remain effective and, despite the frustration many within the elite feel, organising against the regime carries a high risk of detection and retribution.

The president has sought to present the achievements of Hizbullah guerrillas in Lebanon during their battle with Israeli forces as a vindication of his own position with respect to Israel and the internal Lebanese political scene. In particular, Mr Assad has claimed that the international effort, led by France and the US, to rid Lebanon of Syrian influence and to bring about the disarmament of Hizbullah has been primarily motivated by a desire to enable Israel to dictate terms for a regional political settlement. In as much as Hizbullah has emerged strengthened from the recent conflict, while Israel has suffered a symbolically significant military setback, the prospects for the Syrian regime would appear to have been enhanced. However, Syria will continue to face intense international pressure to ensure that the supply of weapons from its territory to Hizbullah does not resume, following UN resolution (Resolution 1701) and agreement by all parties concerned to abide by a �cessation of hostilities� agreement. Moreover, the Syrian government still faces serious consequences from the

Domestic politics

8 Syria


ongoing UN investigation into the February 2005 assassination of Mr Hariri. The recent political advances made by Syria�s allies in Lebanon�notably Hizbullah�will therefore not easily translate into strategic gains for Syria itself, for example in terms of recovering its dominant position in Lebanon, or ultimately, achieving a full Israeli withdrawal from the occupied Golan Heights, given the still intense pressure on the country to abide by recent UN resolutions regarding Lebanon.

Despite this, the tenor of a speech given on August 15th by Mr Assad also suggests that Syria is unwilling to accept the Lebanese government�s efforts to assert its sovereignty to the detriment of Syria�s interests in the country. It is therefore highly likely that Mr Assad will continue to attempt to foment further discord between Lebanon�s already fractious confessional groupings, increasing the risk of more serious conflict erupting between the various Lebanese groups. Mr Assad also claimed that there was an elaborate conspiracy against his regime, a claim which could turn into a self-fulfilling prophecy if he attempts to interfere in Lebanese affairs more directly, as his many regional and international adversaries could then be expected to deploy a wide range of pressures, both overt and covert, aimed at hastening his demise.

There is little scope for internal political reform, although the ruling Baath party did set up a committee to examine changes to the political parties law at its congress in mid-2005. Mr Assad is virtually assured of being re-elected president for a second seven-year term when his current mandate expires in mid-2007. The current system entails the election being conducted in the People�s Assembly (parliament), where the ruling Baath party dominates, subject to approval by popular referendum.

The Lebanon crisis has prompted renewed calls for effective international action to address the core issues of the Arab-Israeli conflict�primarily the Palestinian question, but also including the unresolved Golan Heights issue. Even Israel, which has previously brushed aside offers from Mr Assad to resume bilateral peace negotiations from the point at which they were broken off by his father in 1996, has shown some interest in reviving the Syrian track of the now largely discredited peace process. However, no progress is likely to be made on this front in the near future. Moreover, Mr Assad has not made matters easy for those seeking to help Syria out of its diplomatic isolation. A visit to Damascus by the Spanish foreign minister, Miguel Angel Moratinos, in early August ended in acrimony when the Syrian government contradicted remarks made by Mr Moratinos at a press conference prior to his departure. A few days later, the German foreign minister, Frank-Walter Steinmeier, cancelled a planned visit to the Syrian capital at the last minute after being informed of the content of a speech by Mr Assad that included a strong attack on European policy towards the Middle East, and a vicious attack on the current Lebanese parliamentary majority and government. In addition, following what seemed to be an improvement in relations with key Arab governments (following a serious deterioration in the wake of the Hariri murder in early 2005), Mr Assad attacked the stance of those Arab regimes who are involved in the so-called peace process, and who were strongly critical of Hizbullah, particularly in the early stages of the war�although he did not name them. Relations with Arab

International relations

Syria 9


countries will therefore remain tense. However, Mr Assad will continue to forge strong relations with Iran, Hizbullah and the two main Palestinian Islamist groups, Hamas and Islamic Jihad, while the regime considers it is in its interests to do so.

Economic policy outlook

The likelihood of the government pushing ahead with significant economic reform remains limited. Last year�s conference of the Baath party approved several resolutions on economic policy, including one that symbolically replaced �Arab socialism� with �market economics� as the ruling party�s official strategy. Several high-profile advocates of economic reform within the president�s circle also gained promotion around the time of the congress, and they have continued to stress the necessity of far-reaching change. The problems afflicting oil output, which appears to have dropped far more sharply over the past 18 months than officials had previously suggested, provide a strong incentive for reform, especially given the fast rising oil import bill which is straining the country�s external accounts. Government officials also recognise that liberalisation that promotes economic growth is a means to counter domestic political frustrations.

However, the prospect of substantive reform measures being implemented soon is poor, partly as a result of the latent threat of sanctions associated with the Hariri killing and the country�s stance towards the new �post-Syrian� Lebanese government. Although it is unclear what form sanctions�if they are introduced�might take, they would prove further obstacles to the already difficult task of overhauling the Syrian economy, not least to efforts to draw in foreign investment. Even US measures such as the recently announced bar on financial transactions between US banks and the Commercial Bank of Syria deepen the country�s isolation, provide a further disincentive to investment and hinder reform. Moreover, despite the elevation of a few reformers, there does not appear to be a consensus within the elite over the necessity or direction of economic reform, particularly on sensitive measures such as cuts to the subsidy system or restructuring the country�s highly inefficient state-owned enterprises. In addition to political concerns, the reform process continues to be slowed by the limited capabilities and the generally conservative stance of many within the upper and middle ranks of various state institutions, which leave them ill-placed to support a task as complex and contentious as structural reform.

Despite the anticipated decline in oil production, the Economist Intelligence Unit has revised its forecast for revenue upwards, following adjustments to the projections for international oil prices. We now expect overall revenue to reach around S£394bn (US$8bn) per annum over the forecast period, as declining oil production is offset by rising oil prices. (We have raised our forecast for average oil prices to US$70/b in 2007.) However, weak economic growth will keep non-oil earnings low. After a five-year period of double-digit spending growth, we expect the pace of increase to ease as concerns over weakening oil production and external political threats persist. Nevertheless, with oil prices high, rises in spending will prove difficult to resist, particularly given the steady expansion in

Policy trends

Fiscal policy

10 Syria


the size of the adult population and the country�s pressing capital spending needs. Assuming the pace of expenditure growth is restricted to around 6% this year and 3% in 2007, we expect the budget to record a deficit equivalent to 3.5% of GDP this year and 4.4% in 2007. This is a substantial revision from our previous forecast, and it is based on data recently released by the IMF (as well as revisions to our oil price forecasts). Downside risks remain, however, with the imposition of sanctions that curtailed Syria�s capacity to export oil, or that led to a freeze on its foreign assets, likely to put the public finances under considerable additional pressure.

The piecemeal liberalisation of monetary policy apparent in recent years will persist into the forecast period, although the threatening political environment is likely to see the pace of change remain very slow. There has been some movement away from the fixed interest rates that have dominated the monetary regime for much of the past 25 years, most recently to offset pressure on the Syrian pound. Coupled with this, foreign-currency rules have been relaxed and the first steps have been made towards the establishment of an interbank market�a key development if liquidity management is to become more effective. However, there is still a long way to go. The Central Bank of Syria continues to lack flexible, indirect monetary tools, and recent changes in interest rates on savings and the promise to introduce local-currency certificates of deposit are only a first step towards establishing a more effective monetary policy. Credit continues to be predominantly centrally driven, and the banking sector is still dominated by state-owned institutions. The new private banks, though liquid, struggle to find reliable private-sector outlets for funds. The Central Bank also continues to constrain the workings of the still small private banks, setting interest rate caps, for example, and retaining restrictions on foreign-currency operations. These shortcomings will be addressed, but only cautiously, as the authorities seek to build capacity and guard stability, as well as protect the public-sector entities that would be heavily exposed by rapid moves towards a fully market-oriented system.

Economic forecast

International assumptions summary (% unless otherwise indicated)

2004 2005 2006 2007

Real GDP growth World 5.5 4.9 5.3 4.7

OECD 3.1 2.6 3.0 2.2

EU25 2.4 1.7 2.6 2.1

Exchange rates ¥:US$ 108.1 110.1 114.1 100.3

US$:� 1.244 1.245 1.255 1.365

SDR:US$ 0.675 0.677 0.678 0.641

Financial indicators � 3-month interbank rate 2.13 2.15 3.06 3.86

US$ 3-month commercial paper rate 1.48 3.49 5.21 5.26

International assumptions

Monetary policy

Syria 11


International assumptions summary (% unless otherwise indicated)

2004 2005 2006 2007

Commodity prices Oil (Brent; US$/b) 38.5 54.7 71.1 70.0

Cotton (US cents/lb) 62.0 55.2 60.1 62.5

Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.5 8.9 -4.5

Industrial raw materials (% change in US$ terms) 21.0 10.3 43.6 -3.2

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

We expect the global economy to grow by around 5.3% at purchasing power parity exchange rates this year, little changed on last year and slightly above the long-term average. The pace of growth is expected to ease in 2007, but at 4.7%, will remain relatively strong. The benchmark dated Brent Blend is expected to average around US$70/barrel over the forecast period, helping to offset the negative effect on Syria�s external accounts of declining oil output. The continued strength of prices reflects in large part the geopolitical tensions in the region, and the difficulty of expanding supply quickly enough to keep pace with demand. With most producers operating at close to their maximum, the market has little spare capacity, putting prices under sustained upward pressure.

Long delayed monetary data for 2005 suggest that domestic demand growth was stronger last year than expected. Nevertheless, we continue to expect the overall rate of economic growth to be weak, averaging some 2.5% in 2006-07. The forecast is driven in large part by declining oil production, which will curb industrial output and lead to a sustained contraction of exports in real terms throughout the forecast period. The hostile political environment also damages growth prospects, and is likely to see local and foreign investor confidence remain weak�a position that will undermine Syria�s efforts to draw urgently needed foreign finance into the oil and gas sectors. The political issues absorbing the regime�s energies also make it unlikely that there will be significant forward movement with economic reform, further harming growth prospects. Firm oil prices will support some increase in government consumption, however, and the booming economies of the Gulf may provide a modest increase in regional investment and tourism demand. The large number of Iraqis that are now living and working in the country has also provided an additional impetus to local demand. Nevertheless, the risks remain on the downside, particularly if sanctions are imposed that compromise Syria�s capacity to export oil. A bar�or partial bar�on investment or access to key imported inputs would also push the country rapidly towards recession.

The weakness of the US dollar, to which the Syrian pound will retain its peg, will continue to create inflationary pressure, keeping the cost of various imported goods high, particularly those sourced from the euro zone. Cuts to fuel-price subsidies will also create some price pressures. According to the IMF, these factors, combined with an expansionary monetary stance (with strong growth in credit to the private sector) as well as previous increases in public-sector wages, helped push average inflation up to 7.2% in 2005. Price pressures

Inflation

Economic growth

12 Syria


are expected to moderate over the forecast period, but inflation will remain relatively high, averaging 5.5% in 2006 and 4.2% in 2007.

The governor of the Central Bank, Adib Mayaleh, has signalled his deter-mination to address the rigidities of the foreign-exchange regime, and we expect to see further reforms introduced over the forecast period. These will probably include the abolition of the few remaining secondary exchange rates and a further liberalisation of the foreign-currency laws, following on from the recent announcement that private money-changers are to be legalised for the first time. If the government follows through, this could all but end the black market in foreign currency, which has run parallel to the official currency regime since the balance-of-payments crisis of the late 1980s.

It is highly unlikely, however, that the currency will be allowed to float freely, with the government continuing to favour stability over the emergence of a potentially more volatile market rate. As a result, we expect the prevailing legal rate for the pound to remain at close to S£50-55:US$1 and the quoted fixed rate at around S£48:US$1. The regime is well-placed to protect the value of the pound, as a consequence both of the dominant position of the state-owned banks and of the control that the Central Bank retains over foreign-currency transactions, even as some laws are relaxed. Political developments since the assassination of Mr Hariri have put the pound under periodic pressure, with the publication of the most recent UN report pushing the local currency as low as S£60:US$1 on the unofficial free market in Syria and in neighbouring countries. The government responded by intervening in the market, however, and by raising interest rates�an unusual step for a regime that has traditionally relied on more direct means (usually a clampdown on illegal traders) to protect the currency. The outlook for international oil prices suggests that liquidity should remain sufficiently strong to support government efforts to maintain this more liberal approach.

Nevertheless, the proven responsiveness of the exchange rate to political risk and the threat of international sanctions have increased the downside risk, with the imposition of punitive economic measures (such as a freeze on Syrian foreign assets) likely to lead to a dramatic increase in pressure on the pound. This would probably prompt the government to reverse�or, at the very least, suspend�some of the liberalisation measures that have been introduced, thereby allowing it to tighten controls on the allocation and management of foreign exchange. This would leave convertibility in doubt and, assuming substantial reform had been introduced earlier, would lead to the rapid re-emergence of the black market.

We have revised substantially our forecasts for the current account, in the light of recently released data in the IMF Article IV Syria report (published in August). Export earnings are expected to rise by about 13% this year to around US$7.3bn�a record high�before easing in 2007, largely in line with the decline in oil output. Import spending growth, however, will be stronger than previously thought, as a result of an upward revision to our projections for the country�s oil import bill, particularly in the light of our higher forecast for oil

Exchange rates

External sector

Syria 13


prices in 2007. Imports are now expected to rise to US$7.4bn in 2006 (from US$6.5bn in 2005), and to US$7.9bn in 2007.

Non-merchandise earnings strengthened in the aftermath of the US invasion of Iraq, as large numbers of Iraqis (both business people and those fleeing the conflict) arrived in Syria, and there was some pick-up in transshipment of goods into Iraq. This upward trend is unlikely to gain momentum in the forecast period, given prevailing political conditions. Remittances from expatriate workers will be slow to recover from last year�s downturn, which was set in motion by antipathy towards Syrian workers in neighbouring Lebanon. Income debits will remain high, partly as a result of last year�s debt-rescheduling agreement with Russia, which boosted servicing costs. High oil prices will ensure that foreign oil firm profit repatriation remains strong, although there should be some downturn in line with falling oil output. The net effect of these trends will be a current account that is almost in balance this year, but a deficit of around US$750m (3.1% of GDP) in 2007.

Forecast summary (% unless otherwise indicated)

2004 a 2005 a 2006b 2007b

Real GDP growth 2.0 2.8 2.6 2.3

Oil production (�000 b/d) 443.8 420.0 405.0 395.0

Gross agricultural production growth 1.2 4.0 3.5 3.0

Consumer price inflation (av) 4.5 7.2 5.5 4.2

Government balance (% of GDP) -3.5 -3.0 -3.5 -4.4

Exports of goods fob (US$ bn) 5.6 c 6.5 7.3 7.1

Imports of goods fob (US$ bn) 5.9 c 6.5 7.4 7.9

Current-account balance (US$ bn) 0.2 c 0.5 0.0 -0.8

Current-account balance (% of GDP) 0.9 2.3 0.0 -3.1

External debt (year-end; US$ bn) 21.5 8.4 8.4 8.3

Exchange rate S£:US$ (av) 48.50 c 48.50 48.50 48.50

Exchange rate S£:¥100 (av) 44.86 c 44.06 42.52 48.38

Exchange rate S£:� (av) 60.32 c 60.37 60.88 66.20

Exchange rate S£:SDR (year-end) 75.32 c 69.32 73.66 76.02

a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

Syria Middle East & North Africa

Gross domestic product(% change, year on year)

Syria Middle East & North Africa

Consumer price inflation(av; %)

0

1

2

3

4

5

6

7

20

01

02

03

04

05

06

07

-4

-2

0

2

4

6

8

20

01

02

03

04

05

06

07

14 Syria


The political scene

The war unleashed by Israel on Lebanon following the July 12th crossborder raid into Israel by the Lebanese guerrilla group, Hizbullah, has major political implications for Syria. Despite the �cessation of hostilities� that went into effect on August 14th, there is an ongoing risk of renewed conflict, and of it evolving to include Syria itself, although, given its evident military inferiority, the Syrian government will make every effort to avoid giving Israel sufficient justification for such action. There is also little sign of Israel being interested in complicating matters by taking the fight to Syria.

In the meantime, the war has provided Syria with the opportunity to claw back some of the regional influence that it has lost since the ejection of its forces from Lebanon in the wake of the February 2005 assassination of Rafiq al-Hariri, the former Lebanese prime minister. During the conflict, several commentators in Europe and the US argued that the time had come to engage seriously with Syria, offering the president, Bashar al-Assad, the prospect of being involved in a regional peace settlement and the promise of economic aid in return for his co-operation in stabilising Lebanon. There was little sign of such arguments making any impact in key foreign policy decision-making centres in the West, however, and Mr Assad himself made clear in a seminal speech delivered in the capital, Damascus on August 15th that he has no interest in becoming involved in any effort to �warm up� a Palestinian-Israeli peace process that had so manifestly failed to deliver results. It was clear from his speech that Syria will make every effort to continue to sustain the military capabilities of Hizbullah, and that Mr Assad wishes to exploit to the full the reflected glory from the success that its Lebanese ally had in blunting Israel�s offensive. This will be important in securing his domestic front, as he can depict his own position as being faithful to Arab and Islamic principles and that of his opponents as, in effect, serving the interests of a brutal and aggressive Israel. Set against that, Mr Assad risks further alienation from Arab and European states that play an important part in supporting the Syrian economy.

The Hizbullah raid, which resulted in the capture of two Israeli soldiers, was the actual trigger for the conflict, but there had already been a lengthy build-up, involving Syria to varying degrees. The critical question with regard to Lebanon was the role of Hizbullah as an armed entity. Following Israel�s final withdrawal from South Lebanon in 2000, Hizbullah had secured political justification for retaining its weapons on the basis of its leading role in pushing the Israelis out, and through the claim that the Shebaa Farms enclave, occupied by Israel since 1967, was in fact part of Lebanon and not Syrian territory as certified by the UN. The Lebanese government at the time, which was under heavy Syrian influence, was content to endorse this claim. Syria itself has conspicuously avoided asserting its own claim over the territory, although it has stopped short of making any formal move to cede sovereignty to Lebanon. The Shebaa Farms question has enabled Hizbullah to present its military wing as a legitimate resistance organisation. This was useful for Syria as a means to maintain a proxy military threat to Israel and thereby ensure that its own right to recover the Golan Heights was not ignored. The Hizbullah dynamic has

Role of Hizbullah in Lebanon is crucial for Syria

War in Lebanon has major implications for Syria

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changed over the past two years, however. The passage of UN Security Council Resolution 1559 in September 2004 was aimed primarily at censuring Syria for engineering the extension of the term of the Lebanese president, Emile Lahoud, but also called for the disarming of all Lebanese and non-Lebanese militias. Mr Hariri, in the decade and a half since he had become actively involved in Lebanese politics, had always been careful to desist from direct criticism of either Syria�s role in the country or of Hizbullah. However, the passage of Resolution 1559 gave him the potential to take a more forthright stance on both these questions, if he had been allowed the opportunity to relaunch his political career after the body blow of Mr Lahoud�s extension. His assassination prevented that happening, but the domestic and international reaction to that event was sufficiently powerful to make Syria�s continued presence in Lebanon untenable.

Mr Hariri�s political inheritors formed a powerful bloc encompassing Sunni Muslims, Druze and Christians. However, they were not strong enough to take on Hizbullah in a direct confrontation. Hizbullah�s leader, Hassan Nasrallah, is also a sufficiently astute politician to appreciate the need to build bridges with other communities and political forces in the country. Hizbullah formed a political alliance with the Free Patriotic Movement of General Michel Aoun, a Christian former army commander who had been exiled to France in 1990 after an abortive rebellion against Syrian forces in Lebanon, but returned to Lebanon after Syria�s withdrawal. Hizbullah also agreed to participate in the government formed by Fouad Siniora, one of Mr Hariri�s closest associates, after the mid-2005 election and took part in a national dialogue process that started in late 2005 with the aim of resolving fundamental political questions, including the role of Hizbullah�s armed wing.

The national dialogue made little headway, but one of its few concrete achievements was an agreement to disarm Palestinian groups in Lebanon. Mr Aoun, who has emerged, with Syria�s apparent approval (the president, Bashar al-Assad, spoke approvingly of the former general in an interview published by Al Hayat, a London-based Arabic daily, on June 26th), as a leading candidate to succeed Mr Lahoud as president next year, signed a separate Memorandum of Understanding (MoU) with Hizbullah in February 2006. This included provision for the Shia movement to disarm on condition that the Shebaa Farms were internationally recognised as Lebanese territory and were evacuated by Israel. The agreement also emphasised the importance of establishing normal diplomatic relations with Syria. The MoU was not substantially different from the position of Mr Siniora, who had been seeking to open negotiations with Syria about delineating the common border and devising a new structure for diplomatic relations, notably including the establishment of respective embassies.

Mr Siniora�s position was buttressed on May 17th by the UN Security Council, which passed Resolution 1680, calling on Syria to respond positively to the Lebanese government�s requests to open discussions on these issues (and reiterating the demand for the disarmament of militias). Five days before this resolution was passed, several hundred Lebanese and Syrian intellectuals and political activists signed the �Beirut-Damascus Declaration�, calling for the

16 Syria


normalisation of relations between the two neighbours, and appealing to the UN to lend its support. One of its ten points urged the Syrian government to make a formal statement to the effect that it recognised Lebanese sovereignty over the Shebaa Farms. The Syrian government�s response was to arrest several of the signatories of the declaration, including Michel Kilo, a prominent campaigner for press freedom, and Anwar al-Bunni, a well-known human rights lawyer. The National Organisation for Human Rights announced in mid-June that 17 government officials had been dismissed from their posts for having expressed support for the Declaration. The Syrian government, meanwhile, maintained that it had given Mr Siniora ample opportunities to discuss bilateral issues, but that the Lebanese prime minister had not responded.

Another important aspect in the build up to the Lebanon war was the deteriorating situation in the Gaza Strip. Syria is less directly concerned with Palestinian affairs than it is with developments in Lebanon, but it does, in theory, have some leverage over events there owing to the presence in Damascus of leaders of Hamas and Islamic Jihad, the two main Palestinian Islamist groups. Following its election victory in January, Hamas has been unable to form an effective government because of the refusal of Israel and the international community to provide essential aid and financial transfers until the movement explicitly recognises Israel�s right to exist and commits itself to uphold existing international agreements, notably the Oslo accords. Efforts by Hamas political leaders to address this question through negotiation were complicated by the continued firing of rockets into Israel by Islamic Jihad militants, which elicited increasingly violent Israeli reprisals, resulting in the deaths of up to 100 Palestinian civilians. However, by mid-June Hamas had made some progress in its negotiations with the Palestinian president, Mahmoud Abbas, over a political programme that included implicit recognition of Israel and was supposed to open the way to the formation of a government of national unity. This agreement was overtaken by events on June 25th when a group of militants, reportedly including members of the military wing of Hamas, kidnapped an Israeli soldier in a raid through a tunnel into Israel from the southern part of the Gaza Strip. It remained unclear whether this Palestinian operation was an entirely local initiative, or whether it had been sanctioned by Hamas military officials in Gaza or, indeed, in Damascus. Whatever the case, it prompted an escalation of Israeli military actions against the Palestinians in Gaza, amounting, in effect, to a siege of the territory. The subsequent Hizbullah operation across Israel�s northern border appeared to be designed, at least in part, to stretch Israeli resources by opening up a second front.

Syria�s perspective on the Israeli-Palestinian issue has been that any settlement�whether imposed by Israel or negotiated by the Palestinians�that falls short of a complete withdrawal from the territories occupied in 1967 does not serve Syrian interests, as it would set a bad precedent for the occupied Golan Heights. Syria has therefore taken any opportunity to prevent such an outcome, while maintaining that it is ready to resume direct negotiations with Israel on the basis of previous understandings, in particular those said to have

Palestinian-Syrian angle to Lebanon war

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been made by the former Israeli prime minister, Yitzhak Rabin, before his assassination in 1995.

Syria has always considered that it has a vital interest in maintaining a large degree of influence in Lebanon, because the inherent weakness of the Lebanese state, based on the co-existence of multiple religious confessions and factions, means that other external actors would quickly move in should the Syrian role be removed. Syria has historically viewed Lebanon as a buffer between it and Israel. The US-French effort to assert Lebanese independence and national sovereignty through UN Resolution 1559 was therefore regarded by Syria as a direct threat. Indeed, the foreign minister, Walid Muallem, during his visit to the Lebanese capital, Beirut on August 6th-7th, depicted the Israeli actions in Lebanon as an attempt to impose that resolution by force after peaceful means had failed. Mr Assad, in his August 15th speech, also spoke at length about the significance of Resolution 1559, describing it as a critical element in a conspiracy aimed at reviving the agreement signed on May 17th 1983 between the Lebanese government of Amin Gemayel and Israel, which was intended to lay the basis for a bilateral peace treaty. He referred repeatedly to the Lebanese political front headed by Mr Siniora as the �May 17th group�, holding it �responsible for destruction, massacres and the war from first to last�.

It is clear that the war in Lebanon has suited the Syrian regime�s interests, all the more so given the military difficulties that Israel experienced on the ground in South Lebanon. The Israeli prime minister, Ehud Olmert, has been unable to make any headway with his plans for further unilateral withdrawals from the West Bank owing to the military operations he is conducting on two fronts, thus supporting Syria�s demand for a multilateral approach to achieving a Middle East settlement. Hizbullah, a long-term ally of Syria, has enhanced its standing in Lebanon and in the Arab world, and the anti-Syrian alliance formed after the Hariri assassination has been further weakened. The effectiveness of Hizbullah�s resistance to Israel�s operations has also contributed to dispelling the sense of weakness in the Arab world in the face of the military might of both Israel and the US. However, despite the potential political gains Syria could accrue from the situation there is still no hard evidence that the Syrian regime orchestrated events in the sense of colluding with Iran, Hizbullah, Hamas and Islamic Jihad on a specific programme of action. Nevertheless, Syria has undoubtedly played an important role in enabling Hizbullah to build up its military capabilities and in providing a safe haven for the radical wing of the Palestinian Islamist movement.

There is also little question as to the growing importance of Syria�s alliance with Iran. This was highlighted in January by the state visit to Damascus by the Iranian president, Mahmoud Ahmadinejad. Iran�s concern to maintain its close connections with Hizbullah through Syria had earlier been emphasised when Mr Ahmadinejad appointed Mohammed Hassan Akhtari, who had been closely involved in backing Hizbullah�s operations against Israeli forces in Lebanon while serving as an envoy to Damascus between 1989 and 1997, as the new ambassador to Syria. More recently, in mid-June, the Syrian defence minister, Hassan Turkomani, signed a Memorandum of Defence Co-operation

Syria still views its role in Lebanon as vital to its interests

The war in Lebanon has suited Syria�s interests

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with Iran during the course of a four-day official visit to Tehran. Al Hayat reported that the Syrian delegation had expressed interest in procuring a wide range of weapons from Tehran, including anti-aircraft missiles, T-72 tanks (Russian models which are assembled in Iran) and short-range Scud missiles. Iran evidently views Syria and South Lebanon as front lines of defence in any military confrontation with the US and/or Israel stemming from the dispute over Iran�s nuclear programme. It remains unclear, however, whether Iran envisaged a major flare-up in South Lebanon at the current juncture, or whether it would have preferred Hizbullah�s military assets in the area to remain latent. In any case, the scale of the fighting was to a large extent determined by Israeli decisions on how to respond to the July 12th incident. Neither Hizbullah nor the other interested parties (including Syria) could have been sure precisely what actions Israel (under a new government headed by Mr Olmert) would take.

The challenge for Mr Assad is whether he will be able to capitalise on the Lebanon war. One approach could entail seeking to use the situation as a lever to repair Syria�s relations with the West, thereby opening the way to a negotiated peace settlement with Israel and to the enhanced economic support that Syria will need as its oil reserves dwindle over the coming decade. However, Mr Assad is likely to be wary of giving up too much without solid guarantees regarding the immunity of his regime from attack (and prosecution in respect of the Hariri investigation) and concerning future political and economic benefits. At the other extreme, taking too aggressive a position could expose Syria to risks on a number of fronts�internal unrest, fomented by Mr Assad�s regional adversaries (including Arab states), stiffer economic sanctions and a cut-off of aid from the Arab world and Europe, and, ultimately, military confrontation with Israel.

However, it is not clear what the regime intends. An example of the ambiguities in Syria�s broad policy positions came at the end of a visit to Damascus by the Spanish foreign affairs minister, Miguel Angel Moratinos, in early August (while the fighting was still raging between Israel and Hizbullah). Mr Moratinos was the first senior European official to visit Damascus since the Hariri assassination, and his presence had added significance for the Syrian government given his previous role as the EU special representative to the Middle East between 1996 and 2003. He held intensive discussions with Mr Assad, Mr Muallem and the vice-president (and former foreign minister), Farouq al-Shara. On his departure on August 3rd he was quoted as saying by Agence France Presse (AFP) that: �The Syrian authorities are going to exert all their influence over Hizbullah and over the various actors.� He said that he had asked Syria to be �constructive� and that he had received positive answers. �Syria wants to be part of the solution; Syria doesn�t want to be part of the problem,� AFP quoted him as saying. This appeared to signal a desire by Syria to play an active role in resolving the crisis, and would have encouraged officials in other Western states who have advocated re-engaging with the Assad government. However, the impact of the Spanish minister�s reported statement was quickly dissipated when, within hours of his departure, the Syrian Arab News Agency quoted an unnamed Syrian official as saying that

Contradictory signs in dealings with European officials

Challenge to Mr Assad is to capitalise on Lebanon war

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Mr Moratinos had never made the comments attributed to him, and that, as such, they had no basis. AFP subsequently announced that its correspondent in Damascus, Joelle Bassoul, had been expelled from the country. AFP explained that Ms Bassoul had taken her quotes directly from Mr Moratinos in Spanish at a press conference, but that the translator present had not provided an Arabic version of these remarks for the local press. AFP also noted that the website of the Spanish Ministry of Foreign Affairs had quoted Mr Moratinos as saying that the Syrian authorities �will exercise all their influence on Hizbullah�.

This affair was quickly picked up by the French president, Jacques Chirac, who was quoted by the Italian news agency, Ansa, as saying that it demonstrated the untrustworthiness of the Syrian regime. Mr Chirac made a pointed reference to the Shebaa Farms issue, claiming that Syria had stated on numerous occasions that it was prepared to accept the Lebanese identity of the territory, but had �never accepted to prove its agreement in writing, even when this is a legal demand, so that the UN could adjust the border�. The Moratinos affair has evidently served to fortify France�s conviction that it is pointless engaging in substantive political discussions with the Syrian regime. This illustrates a critical problem in Syria�s approach because, unlike on other issues related to the Middle East, there appears to be little difference between the policies of France and the US over Syria.

Following the �cessation of hostilities� in South Lebanon in mid-August, Syria appeared to have an opportunity to repair relations with the EU when the German government announced plans for a visit to Damascus by its foreign minister, Frank-Walter Steinmeier. However, the visit was abruptly cancelled after the German minister, who had reportedly already boarded a flight in Jordan en route for the Syrian capital, received news of the content of Mr Assad�s speech on August 15th�which included harsh references to European policy in the Middle East and strong attacks on the current Lebanese government.

Mr Assad�s speech was delivered to the fourth general conference of the Arab Journalists Union�such gatherings of Arab professionals are a favoured forum for the Syrian president to present his views on regional issues. His premise was that most of the Arab states and their leaders, whom he sarcastically referred to as �wise men�, had blundered in their approach to the Middle East peace process by closing off any option of exerting coercive pressure on Israel, with the result that the Arab side has made repeated concessions with nothing of substance in return. �That is why we see the Palestinians paying the price now, and that is why Syria refused, through its vision, to abandon any of its rights.� He argued that the only situation in which the Western powers will take the rights of Arabs seriously is when �Israel is in pain�, and that this can only occur when the Arabs exert effective pressure. He claimed that �the countries concerned with the peace process, and they are mostly European, are responsible for what is happening� owing to their refusal to exert any pressure on Israel to change its behaviour. In this respect, Mr Assad maintained that the continued deployment of the �resistance��in other words, Hizbullah�in South Lebanon after Israel withdrew from the area in 2000 had been essential as �a deterrent to Israeli aggression�, and that the recent Israeli attacks had been

Mr Assad reverts to threatening talk in August

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prepared long in advance in order to neutralise this threat. He suggested that the May 17th group (a derogatory reference to the March 14th movement that emerged after the Hariri assassination) had colluded with Israel in its plans to seek the disarmament of Hizbullah by force. He also implied that certain Arab states had also been party to the conspiracy, whose latest manifestation was UN Security Council Resolution 1701, which was passed on August 8th and laid the basis for the eventual ceasefire. �Now we can establish the correlation between resolutions 1559, 1680 and 1701, the assassination of Hariri and the last war, on the one hand, and the role of these Lebanese forces and certain Arab forces on the other,� he said.

The implications of Mr Assad�s speech are that he will strive to prevent the full implementation of Resolution 1701, so as to ensure that the �Arab side� can derive full benefits from what he termed the victory of the resistance: �As a bottom line, we have to change the military victory into a political victory, at least in the peace process.� In other words, there is no question of Syria consenting to the disarmament of Hizbullah unless there is substantive progress towards a peace settlement based on a full Israeli withdrawal from Arab territories occupied since 1967. In practice, this means that Syria is likely to keep up its pressure on the government of Mr Siniora, which holds a large majority in the Lebanese parliament. His disdain towards Mr Siniora and his associates was made plain in his speech. �Before the blood of the victims dried, before anything else, and before even the displaced headed back to their villages, the May 17th group members started to talk about disarming the resistance movement,� he said. �This means that one of their future tasks after the war failed is saving the current Israeli government and Israel�s domestic front.� He predicted that they would fail in this effort and that �their fall is looming�. The severity of Mr Assad�s tone towards a political alliance encompassing a large part of Lebanon�s Sunni, Christian and Druze communities suggests efforts to foment confessional conflict in the country.

Mr Assad�s position is also likely to be of deep concern to countries contemplating the dispatch of troops to take part in the UN force that is supposed to oversee the South Lebanon ceasefire and ensure the �disarmament� of Hizbullah. Syria played an important part in forcing the pull-out of the ill-fated multinational force deployed in Lebanon after the 1982 Israeli invasion, in co-ordination with Hizbullah and Iran, and it seems likely that it may seek to repeat this outcome with the proposed new force.

If, as has been suggested, France accounts for the bulk of the UN force in Lebanon, it will add to the personal animus between Mr Assad and the French president. The Syrian leader made a passing reference to Mr Chirac in his August 15th speech, referring to him (sarcastically) as �that French official bursting constantly with enthusiasm towards Syria� and asking whether he would call for a commission of inquiry in the killing of civilians by Israel in its bombardment of Qana on July 30th and other such incidents, as he did after the assassination of Rafiq al-Hariri. Mr Assad has consistently maintained that the murder of the former Lebanese prime minister was the responsibility of those involved in weaving the conspiracy against Syria and the Lebanese resistance.

Mr Assad�s comments are worrying

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However, the UN commission of inquiry into Mr Hariri�s assassination has focused its investigations on the Syrian intelligence services. The commission�s mandate was extended by a year to June 2007 just before the recent conflict in Lebanon, but it remains questionable whether it will be able to complete its task, particularly if stability is not quickly restored. The commission�s latest report, published in early June, is peppered with references to the need for �evidential� results, indicating that much work still needs to be done before a prosecution case can be submitted to the proposed international tribunal. However, any relief in Damascus on this score has to be set against the clear determination of the commission�s head, Serge Brammertz, to persist until he has built a comprehensive case that would stand up in court.

A large part of the report (the second prepared by Mr Brammertz, and the fourth since the commission was set up) is devoted to presenting the results from the ongoing investigation into the blast itself, which killed Mr Hariri and 22 other people on the Beirut seafront in February 2005. Mr Brammertz states his conclusion that the blast was most likely to have been caused by a bomb planted in a Mitsubishi Canter truck that was seen close to Mr Hariri�s motorcade shortly before the explosion. The report says that the extent of the damage and the pattern of the blast indicate that at least 1,200 kg of high explosive was used. Forensic investigation has established that it was likely that the bomb was set off by the driver of the truck, and that this individual was definitely not Ahmed Abu Adass, who appeared on a videotape released to news organisations after the attack claiming responsibility for it. The remainder of the report is more circumspect. Mr Brammertz offers little new on the way in which the attack was organised and carried out, and he says that several hypotheses are still being examined as to the motive or motives for the assassination. These include �political motives, personal vendettas, financial circumstances, and extremist ideologies� or any combination of these. Mr Brammertz has also drawn attention to the likelihood that the Bank al-Madina scandal�involving a Beirut bank alleged to have been plundered by Syrian military officials�was relevant to the killing of Mr Hariri, including the possibility that funds from the bank may have been used to finance the operation.

The report describes the level of co-operation provided by Syria as �generally satisfactory�, adding that �full and unconditional co-operation from Syria� remains crucial for the further progress of the investigation. There is the suggestion in the report�s conclusion that the extent of Syria�s willingness to continue to co-operate is likely to be put to the test more forcefully in the coming period. Mr Brammertz says that the commission expects to have completed its work on the crime scene and associated events on the day of the attack by September or October, including, �to a satisfactory evidentiary standard, all forensic results and final conclusions�. In the meantime, the investigators plan to increase their efforts to clarify aspects relating to the commissioning of the crime and to establish linkages to the crime scene.

In a telling comment in the report, Mr Brammertz notes that �establishing evidential links between the person/s who commissioned the crime and the act itself is extremely complex�. Despite the difficulty of this task, it seems clear

Inquiry into Hariri murder moves forward slowly

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that Mr Brammertz is intent on unravelling the entire story and drawing up his eventual charge sheet accordingly. This suggests that, if the Assad regime is implicated to a high level, it has no grounds for complacency, despite the investigation�s apparent lack of real progress in recent months and the broadly positive write-up of Syria in the latest report. The Hariri affair has been relegated to the background asa result of the Hizbullah-Israel war, but it is unlikely to disappear as long as the former prime minister�s supporters retain political influence in Beirut. That factor goes some way to explaining the vehemence of Mr Assad�s verbal assaults on the �May 17th group�.

Economic policy

The five-year plan, which provides the outline for Syria�s evolution towards a �social market economy� between 2006 and 2010, was finally signed into law by the president, Bashar al-Assad, on May 7th. The plan was drawn up by a team led by Abdullah al-Dardari, the deputy prime minister for economic affairs and the head of the State Planning Commission. Mr Dardari has made clear that attaining the plan�s aims of stimulating high levels of growth in the non-oil economy, based primarily on attracting private investment, will require a fundamental change in both political and economic attitudes at all levels of the state. The plan is thus rooted in a vision of political reform�the introduction to the plan states that the objective of moving to a social market economy �will certainly require a new social contract between the major forces in Syrian society, comprised of the state, the private sector and civil society�. This statement appears to be starkly at odds with the reality of the Syrian political scene, as Mr Assad�s regime has recently intensified its repression of liberal activists looking to promote precisely the kind of transformation that is advocated in the plan.

There has been little public debate of the plan in the Syrian media or in parliament. However, the government appears to have�at least for the time being�embraced a policy of transparency by proxy as regards economic affairs, primarily through authorising the publication of the full details of its Article IV consultations with the IMF. This policy first became evident in October 2005, when the government took the unprecedented step of approving the publication of the full text of an IMF Article IV report. This process was taken further in 2006, when the IMF issued an initial assessment of its discussions with the government at the end of May, only a few weeks after the Fund�s team had left Damascus. The full Article IV report appeared in early August. In his remarks to the local press Mr Dardari highlighted the positive elements in the report, notably the IMF�s acknowledgement that Syria�s non-oil economy may be growing at a rate of 5.5% in real terms. However, the IMF report also includes some blunt comments about the scale of the challenges facing the Syrian economy in light of its dwindling oil production, the sharp increase in the oil import bill, and the heavy burden of petroleum price subsidies. �Although pleased with the recent improvement of the economy, the authorities are increasingly concerned with the considerable risks involved in delaying adjustments and in postponing structural reforms,� the IMF notes.

Five-year plan finally signed into law

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Mr Dardari has frankly acknowledged the challenges that Syria is facing, given its historically poor economic performance and dwindling oil revenue. The five-year plan aims to accelerate economic growth to 7% by 2010 and to bring down unemployment to 8% (from about 20% now). The means to achieve these targets are identified in general terms as the liberalisation of trade and investment, combined with a policy of fiscal consolidation. The plan envisages containing the overall budget deficit below 5% of GDP and limiting total public debt to no more than 45% of GDP by 2010. The IMF observes that to achieve the fiscal target, the government would need to boost the non-oil budget balance by 5-6 percentage points of GDP during the period of the plan. It has also expressed its reservations about the public debt target, noting that it would entail a 7 percentage point increase over the current level.

One critical element in the plan�s fiscal consolidation strategy is the scheduled introduction of value-added tax (VAT) in 2008. The IMF applauds the government�s intention to bring in VAT, but urges the authorities to apply the tax to virtually all goods and services, rather than limiting its coverage to a few sectors in a bid to shield the poor from price increases�that latter goal can arguably be better achieved through imposing thresholds and targeted financial assistance. At present, Syria has a tax/GDP ratio of only about 10.5%, and increasing revenue from taxation is clearly going to be essential for the government to compensate for the decline in oil export earnings over the coming period. The IMF calculates that a �well-designed VAT� could bring in additional revenue equivalent to 5% of GDP if levied at a rate of 15%. (This would be over and above the 1.5% of GDP yield of the existing consumption tax, which would be replaced by VAT.) The IMF has expressed some concern that the preparations for introducing VAT are moving slowly, and that critical choices about the design of the new system have not yet been made.

Another key element in the government�s approach to meeting its fiscal challenge is reducing petroleum price subsidies, the cost of which is expected to be about 14.5% of GDP in 2006, according to the IMF. A government working group has carried out a comprehensive analysis of the issue with the assistance of a number of international experts, including the World Bank, and is considering a programme of action focused on the price of diesel, which currently enjoys the highest level of subsidy. The first step would entail closing 60% of the gap between the domestic price and the international price, with the remaining adjustments to be phased in over the next five years. (The current domestic price of diesel is S£8,702/tonne, equivalent to US$170/tonne, compared with an international price of S£26,474/tonne. A certain share of the gross fiscal gains would be returned to households in the form of a flat-rate cash compensation per person. As well as generating direct fiscal benefits, a reduction in petroleum price subsidies would also be likely to depress demand for petroleum products, as well as reduce smuggling. The IMF calculates that the government could deliver the five-year plan�s fiscal targets, but only if it were to adhere rigorously to its VAT and fuel subsidies policies.

The IMF report reflects the efforts that the Syrian government is making to insulate economic policy from wider political considerations. This strategy has

Focus on non-oil sector

Scheduled introduction of VAT in 2008 critical element

Attempt to separate economic and political reform

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been moderately successful so far, but its longer-term viability depends on whether the Assad regime can manage to navigate its way out of the storms created by its activities in Lebanon. The war between Hizbullah and Israel provided Mr Assad with the opportunity to affirm the role that Syria can play in achieving regional political stability. However, there is little sign of the US or the EU responding with any serious overtures towards Damascus. Such a shift is unlikely to occur unless Syria provides incontrovertible evidence of its goodwill towards the current Lebanese government, through agreeing to its request for the establishment of normal diplomatic relations and through establishing beyond any doubt that it has choked off weapons supplies to Hizbullah. The ongoing UN investigation into the assassination of Rafiq al-Hariri, the former Lebanese prime minister, represents another major obstacle to Syria�s political rehabilitation (see The political scene).

While Syria maintains its present adversarial stance vis-à-vis Western powers, the government�s ability to press forward with reforms based on free-market models could come increasingly into question. Discussing illustrative scenarios with IMF economists is a far cry from actually implementing policies that will have a considerable impact on large swathes of Syrian society. In its initial report published after the visit of the Article IV mission to Syria, the IMF alluded to this potential difficulty, saying that the government should not become over-reliant on the technical assistance it receives from international agencies, and should devote adequate resources to develop an autonomous technical capacity to design and monitor policies. This observation can be seen as an implicit, but gentle, warning to Mr Dardari of the pitfalls of using the IMF and donor agencies as proxies in the internal debate on economic policy.

The domestic economy

The government�s claim that the Syrian economy is performing well has been endorsed�with some important qualifications�by the IMF in a report issued following a round of Article IV consultations in Damascus in mid-May. The main positive elements are that the non-oil economy is showing robust rates of growth, the short-term balance-of-payments outlook provides no reason for concern, and the fiscal accounts have shown marked improvement over the past two years, even though oil-related proceeds have declined by almost 6 percentage points of GDP. On a more sobering note, the IMF observes that the dwindling oil reserves pose a serious challenge to fiscal and external sustainability, that the unemployment situation is �precarious�, and that the business climate is clouded with �growing political uncertainties��a reference to the pressures faced by the government of Bashar al-Assad as a result of its presumed role in the assassination of Rafiq al-Hariri, the former Lebanese prime minister, in February 2005, and in light of Syria�s increasingly fractious relations with the US, Europe and many Arab states.

Shortly before the publication of the IMF report the deputy prime minister for economic affairs, Abdullah al-Dardari, announced at a business conference in Damascus that real GDP growth in the non-oil sector was 5.5% in 2005, reflected in higher non-oil exports and a big increase in tourism income.

Non-oil economy performing relatively well

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Mr Dardari omitted to give a detailed breakdown, and the published reports of his remarks did not include any reference to overall GDP growth, including the oil sector. The initial IMF report offered some illumination. It stated that preliminary data suggest that a strengthening of domestic demand, together with a robust performance of exports, �may have boosted non-oil growth� to about 5.5% in 2005, from 5% in 2004. It appended a footnote stating that �overall growth was limited to 3%, given the decline in oil production�. In its full Article IV report, published in early August, the Fund adjusted that figure slightly downwards, to 2.9%. The IMF noted that economic growth was fuelled to a large extent by excess liquidity in the Gulf Arab states and by a loosening of credit controls in Syria itself. Its analysis of the sharp increase in credit to the private sector in 2005 indicated that most of the new funds came from state-owned banks, with a strong bias towards consumer loans. It added that this rapid expansion of credit is likely to have weakened the quality of banks� loan portfolios. It was also an important factor in the rise in consumer inflation to 7% at end-2005, compared with 4.5% in 2004.

The IMF also provided some critical context to the improvement in Syria�s fiscal indicators, with the non-oil budget deficit narrowing by 2.5 percentage points of GDP in 2005, following a 1.75-point reduction the previous year. It said that the main reason for this was a sharp rise in public enterprise surpluses, arising principally from the government�s share in expanding mobile-phone revenue and from public-sector bank profits. As such, the IMF commented that this raises questions about the sustainability of this �ostensible improvement�, particularly given the poor accounting standards in Syria and the opaque way in which public enterprise accounts are consolidated. The overall budget deficit remained unchanged at 4.2% of GDP, owing to the decline in oil revenue (higher prices failing to offset falling output), according to the IMF. The government itself has not published any recent data on actual fiscal outturns. The Economist Intelligence Unit�s own estimate of the budget deficit is lower than that of the IMF, at 3% of GDP.

The latest edition of the IMF�s monthly International Financial Statistics (IFS) bulletin includes no fresh data on Syria�s monetary situation. However, the May edition provided several months of fresh data, with figures running up to October 2005. This was a significant update, given that previously the most recent monetary aggregates were for March 2004. The figures highlighted a number of developments, most notably an 11% increase in narrow money (M1) over the first ten months of 2005, giving some credence to government claims of a pick-up in consumption. Quasi-money and the broader M2 also rose, albeit by a more modest 7.5%. In its Article IV report, issued in August, the IMF provided preliminary monetary data for the whole of 2005, confirming the trends apparent in the IFS data. The whole-year figures show M2 growing by 12.9%, compared with 11.1% in 2004, and credit to the private sector increasing by 45.9%, compared with 35% in the previous year. According to the Fund, the bulk of this growth was accounted for by three state banks (not including the largest, the Commercial Bank of Syria), which had relaxed their limits on lending in response to the easing of central credit allocation rules and additional flexibility given to senior bank officials. The contribution of the new

Rise in surpluses of public enterprises

M1 and M2 growth continues

26 Syria


private banks to total credit remains marginal, at 7.8% of the total at end-2005, but is growing rapidly.

Increase in credit to the private sector, 2004-05 (S£ bn unless otherwise specified)

2004 2005 Absolute change % change % contribution to changeTotal 147.7 215.4 67.7 45.9 100.0State banks 143.3 198.6 55.3 38.6 81.7 Commercial Bank of Syria 15.4 19.0 3.6 23.7 5.4 Real Estate Bank 46.3 63.1 16.8 36.3 24.8 Popular Credit Bank 25.4 50.7 25.3 99.6 37.4 Savings Bank 3.9 11.2 7.3 188.6 10.8 Agricultural Bank 27.1 27.6 0.5 1.8 0.7 Industrial Bank 25.2 26.9 1.8 7.0 2.6Private Banks 4.4 16.8 12.4 281.7 18.3

Sources: IMF; Central Bank of Syria.

Syria�s net foreign assets rose marginally in 2005 to reach the equivalent of US$18.4bn, according to the IMF. This sum includes US$5.9bn held by the Central Bank of Syria, with the remainder held by commercial banks.

Oil and gas

International crude oil prices have remained extremely strong in recent months, reflecting mainly concerns over the security and sustainability of supplies, which were exacerbated by ongoing insurgency in Nigeria, increasing violence in Iraq, the stand-off between Iran and the West over the Iranian nuclear programme�a major day-to-day driver of market sentiment�and the Israeli attacks on Gaza and Lebanon. An additional spur to oil prices was the news in July that BP would have to close down much of its Alaskan production of 400,000 barrels/day (b/d) owing to pipeline corrosion.

Against this backdrop the benchmark dated Brent Blend, which rose from US$60/barrel at the beginning of March to US$75/b by the end of April, went on to trade within a range of US$68-75/b. In mid-July, at the height of Lebanon-related concerns, the benchmark crude price peaked at over US$76/b, before easing slightly after a ceasefire came into effect on August 14th. We expect the oil price to remain high as a result of regional political tensions, limited growth in supply, and continued growth in demand. We have accordingly raised our oil price forecast for 2007 to US$70/b.

For Syria the benefits of high oil prices are rapidly eroding, as domestic production continues to decline and the cost of importing petroleum products increases. Based on the Syrian authorities� latest projections for oil output, the IMF estimates that the country will become a net oil importer by 2010. (Production is now just under 400,000 b/d, and consumption is some 250,000 b/d.) Net foreign exchange receipts from oil will swing from a surplus of US$700m in 2005 to a deficit of about US$4bn in 2015, the IMF calculates, while the contribution of oil revenue to the budget will fall from 8.8% of GDP to zero over the same period.

Oil prices remain exceptionally strong

Syria may become a net oil importer by 2010

Syria 27


The government has made no recent announcements regarding the current level of oil and gas production. However, a modest amount of new exploration activity is continuing, and the Ministry of Petroleum is negotiating a number of new production-sharing agreements arising from the most recent licensing round, held in March 2005. Gulfsands Petroleum, a US-based oil firm, completed its initial drilling operations in Block 26, in the north-eastern corner of the country, in May. The company announced that it had encountered �a series of live oil and gas shows� in its first well, but added that it did not find any �moveable oil�. A second well was scheduled to be drilled in August. Gulfsands has also published the results of a reservoir evaluation carried out for the block by Ryder Scott, a US-based petroleum consultant with considerable Middle East experience. The study identified separate oil and gas scenarios for the Tigris field identified within the block, estimating possible oil and condensate reserves of some 38.8m barrels, probable gas reserves of around 204.1bn cu ft, and possible gas reserves of 149.8bn cu ft.

Loon Energy of Canada announced on June 2nd that it is negotiating a production-sharing agreement for Block 9, which lies to the north of the Palmyra gas basin. According to the oil minister, Sufyan Allaw, talks are also being held with Shell (which is the largest foreign operator in Syria) and a Ukrainian firm about agreements for other blocks from the March 2005 round. He also said the Petro-Canada is in talks about acquiring part or all of the shares in a block held by Marathon Oil in the Palmyra area. Marathon recently signed a renewed production-sharing contract for this block, where it discovered gas in the 1980s, allowing it to sell on its stake to a third party. Neither Petro-Canada nor Marathon has commented on reports of an imminent deal on this block. None of the gas fields identified in the block has yet been developed.

Russia�s Stroytransgaz is currently working on the development of three gas fields in the Palmyra region for the Syrian Gas Company, according to a contract awarded late last year. The Russian firm is also negotiating an extension of this contract to cover more fields in the area, according to the Middle East Economic Digest. The entire project, involving some 15 fields, was originally offered to international oil companies on a production-sharing basis, but this approach was abandoned in early 2005, after negotiations with the selected consortium, led by Petro-Canada, broke down. The Russian firm is working on the basis of an engineering, procurement and construction contract. The project ultimately aims to produce some 6m cu metres/day of gas. Syria currently produces about 22m cu metres/d, of which 12m cu metres/d is non-associated, and the remainder is associated with oil production. Additional supplies of gas are scheduled to be forthcoming from the Arab Gas Pipeline, originating in Egypt. The pipeline has now reached northern Jordan, and Stroytransgaz has the contract to build a 324-km stretch from the border with Jordan to Homs, in central Syria. The Islamic Development Bank recently signed a Memorandum of Understanding with Syria�s State Planning Commission for a US$51.7m loan as part-finance for the Russian firm�s US$160m contract for the Syrian stretch of the pipeline. The pipeline will have a capacity to transport 10bn cu metres of gas per year.

28 Syria


Infrastructure

A scheme aimed at attracting private investment into the cement industry has been shelved for the time being. The government has attributed the suspension of its plans to involve private investors in developing the cement industry to �labour issues�. The General Organisation for Cement and Building Materials had announced in late 2005 plans to awarded build-operate-transfer (BOT) contract for the upgrade and expansion of five local cement plants, in two batches. A tender was issued earlier this year for the first two plants, at Adra and Tartous, and a number of regional and international firms indicated their interest, albeit with some reservations about the terms of the project. The reference to labour issues in explaining the scheme�s suspension reflects the sensitivity surrounding privatisation in Syria, although the influence of local business groups involved in importing cement may also be a factor. Syria currently produces about 5m tonnes/year of cement, not enough to satisfy demand, which is in excess of 7m tonnes/year.

Financial and other services

Syria Gulf Bank (SGB), the seventh private bank to be licensed in Syria, is aiming to start operations in January 2007, according to its adviser, Costi Chehlaoui, as quoted in The Syria Report, a Paris-based periodical. SGB�s principal shareholder, with 24% of the equity, is United Gulf Bank, which is based in Bahrain. Another entrant to the Syrian banking scene expected early next year is Syria Albaraka Bank, the first Islamic bank to be set up in the country. The Bahrain-based Albaraka Group holds a 49% stake in the bank.

Many of the first wave of private banks in Syria are increasing their capital to enable them to develop their long-term lending activities. The most recent move came from the International Bank for Trade and Finance (49% owned by Jordan�s Housing Bank), which has announced plans to increase its capital to US$60m, and eventually to US$150m. The largest state-owned bank, Commercial Bank of Syria, is also planning to increase its capital substantially, according to the finance minister, Mohammed al-Hussein. He said that as part of a draft law being prepared to allow the bank to expand its activities, its capital will be increased to S£70bn (US$1.4bn), from just S£4bn at present. The increase is also reportedly aimed at improving compliance with the recommendations of Basel II, the updated capital-adequacy framework for internationally active banks. The bank has total assets of about US$19bn.

At the end of June Mr Hussein presided over a ceremony to mark the start of operations of Syria�s first private insurance company. He said that the government intends to make it obligatory for Syrian companies to take out their insurance policies with local insurance firms to help them establish themselves. He said that the measure will take effect at the start of 2007, allowing time for companies to switch policies from foreign insurance providers to local ones. The first new firm to start up on the basis of the 2005 Insurance Law was United Insurance Company. Three more firms have been awarded licences and are expected to launch their operations by year-end.

New banks enter market

Private-sector involvement in cement sector suspended

Syria 29


Foreign trade and payments

A private-sector developer has been engaged to operate and upgrade the container terminal at Tartous port. The Tartous port concession was awarded to International Container Terminal Services Incorporate (ICTSI) of the Philippines, following an international tender in which European and Gulf port operators also participated. ICTSI has committed to invest US$37m over the ten-year period of the contract in the purchase of new equipment. The contract entails payment of a fixed annual fee and a variable fee per container moved to the Tartous General Port Company. There is an option for the contract to be extended by five years. The terminal is relatively small by regional standards�it handled 53,628 20-foot equivalent units (TEUs) in 2004, the most recent year for which detailed figures of port activity are available. Overall traffic at Tartous port showed a year-on-year increase of 27% in 2005, to 12.3m tonnes. Syria�s other port is Latakia, which handled 231,000 TEUs in 2004. Total traffic through Latakia was 7.3m tonnes in 2005.

The government has yet to issue any full balance-of-payments data for 2005. However, according to estimates included in the IMF Article IV report issued in August, the current account showed a deficit of US$592m last year, compared with a US$3m shortfall in 2004. This marks a clear shift in Syria�s external position, as the current account recorded surpluses of over US$1bn in each of the preceding four years. The overall balance of payments has shown a similar trend, sliding from a surplus of almost US$3bn in 2001 to a deficit of US$171m in 2005.

The principal reason for this shift is the decline in oil production, and consequently exports. According to the IMF, the oil balance�comprised of exports minus imports and repatriated profits to foreign companies�amounted to a surplus of only US$687m, compared with US$1.3bn in 2004, US$2.5bn in 2003 and over US$3bn in each of the preceding two years. Although the value of Syria�s gross oil exports has been sustained by the rising price of crude oil, this factor has also contributed to a sharp increase in petroleum import costs, which rose from US$171m in 2001 to a record US$2.5bn in 2005, according to the IMF. Non-oil exports showed a modest year-on-year increase in 2005 to US$3.5bn, from US$3.4bn, while non-oil imports increased to US$5.7bn from US$5.5bn. Services income also rose slightly to US$3bn from US$2.9bn, largely as a result of increased receipts from tourism (mainly from visitors from the Gulf and from Iraqis seeking refuge from the conflict in their own country). On the capital account the most notable change is a significant rise in direct investment to US$534m, from US$275m the previous year, again reflecting the growing interest of Gulf investors in carrying out projects in Syria.

However, figures produced by another IMF source, the monthly International Financial Statistics (IFS), give a different picture, with a current-account surplus of US$205m reported for 2004. The Economist Intelligence Unit uses the IFS as a base for historical data, which form the baseline for our forecasts.

Private-sector developer to upgrade Tartous port

IMF reports widening current-account deficit in 2005

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