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Reforms in reverse

Fearing revolt, government backpedals on open economy

by Executive Editors

In setting targets for foreign investment in Syria during a speech last year, the country’s then-Deputy Prime Minister for Economic Affairs, Abdullah Dardari, admitted that there was “a long way to go.”

“A competitive economy is a mindset, a new way of seeing things,” he said. “This is the real challenge. But the political determination is unquestionable. There is no going back.”

That, however, was before regional unrest in recent months spread to the home front and spurred a reshaping of Syria’s policy direction. The government’s almost decade-long embrace of an economy-first model unraveled as events unfolded in Tunisia and Egypt; to keep the wolf of revolt from Syria’s door, a slew of small appeasement packages and limited social reforms were implemented — sometimes in complete reversal of long-term economic strategies. This strategy initially appeared to have kept investor confidence high and popular unrest at bay but in the later half of March, previously unthinkable public demonstrations of dissent began in cities across Syria.

As Executive went to print a clampdown by state security forces had killed at least 61 in the southern city of Daraa and dozens more elsewhere, while hundreds had been injured and arrested throughout the country. Needless to say, Syria’s social and economic future seems somewhat uncertain. At least one major foreign investment was halted on March 23, according to Reuters, the same day stocks on the Damascus exchange dropped an average of 3 percent across the board.

In need of help

Syria’s economy is in bad shape. Ten years of reforms aimed at moving the country toward a free market system — such as opening up the banking sector, lures for private investment, a nascent stock market and cutting subsidy programs — had begun to nudge the economy into recovery after 50 years of centralized, national socialist policies.

But with declining oil reserves, inefficient and decrepit industries, weak and arbitrary trade and competition regulation, high inflation and an unemployment crisis looming, the economy still desperately needs more fixing. Reforms were recognized as being potentially painful for ordinary Syrians in the short term — especially in regards to an increased cost of living — but unavoidable if the country was to develop economic security, improve its standard of living and raise foreign investment to the targeted $55 billion.

The question now is, with unrest erupting across the country, how severely will short-term efforts to assuage the public derail the long-term plans to revamp the economy?

In the barrel

With Syria’s oil reserves diminishing rapidly, the cost of extraction rising and demand skyrocketing, the country has been looking to its neighbors to secure lucrative oil and gas pipeline deals and shore up domestic energy supplies. The country’s crude production peaked at 583,000 barrels per day (bpd) in 1996, but by last year had dropped to 390,000 and the country will deplete existing reserves within 18 years, according to its reserves-to-production ratio, as calculated by British Petroleum (BP).

Foreign investment is necessary to enhance old, inefficient oil refineries, such as those in Banias and Homs, which together have a capacity to refine 240,000 bpd — well below domestic demand of nearly 350,000, according to a 2007 study by Syrian economist Ziad Arbash. Syria worked hard to position itself as a regional transit hub for gas into Europe through proposals to extend the Arab Gas Pipeline — linking Egypt, through Jordan, to Syria — to connect to a pipeline between Syria and Turkey; an idea that was plugged during a recent presidential tour of Turkey and Eastern Europe.

Plans for a second auction of offshore exploration rights (the first failed to attract any investors) were also announced by Oil Minister Sufian Alao in February, covering a total of more than 5,000 square kilometers across the Mediterranean. Despite relatively lower yields and unfavorable production-sharing contracts, until now Syria’s political stability, as compared to other more oil-rich countries like Iraq, had worked in the country’s favor. But the ambitious plans to develop an extensive gas transport infrastructure now look uncertain. With instability across the region and the breakout of revolt at home, it is likely that the endeavors will be put on pause as nervous investors wait to see what unfolds.

These are long-term plans with the goal of increased price stability, easier access and less waste to meet demand. More immediately, Syria is looking to cut the costs of inefficient energy handling without unsustainably increasing the financial burden on households, and that means one thing: subsidies.

How severely will short-term efforts to assuage the public derail the long-term plans to revamp the economy?

Subsidies setting back the clock?

 On January 16 — one day after the Tunisians forced president Zine al-Abidine Ben Ali to flee the country — the Syrian government announced plans to reinstate fuel subsidies for public workers by 72 percent, up to the equivalent of $33 a month. Shortly after came the announcement of a $250-million package for 420,000 families, to combat poverty. Currently, approximately 14 percent of the population is below the poverty line. Last month, the state also reduced the cost of many imported food items.

These moves appear to be a complete reversal of a policy in recent years of repealing subsidies. Beginning in 2007, with subsidies costing an estimated $2 billion annually and artificially lowering retail prices, the government embarked on a three-phase plan to eradicate them. By doing so, it was reasoned, the government would not only allow fuel and electricity prices to meet international market levels, but make more funds available for public investment.

The plan had begun to yield results. The initial 2007 hike in gasoline prices succeeded in reducing fuel consumption by more than 50 percent per household, but electricity consumption shot up by an average 10 percent each year. Nonetheless, direct energy subsidies still cost Syria around 5 percent of gross domestic product.

But households were feeling the pinch. With energy and food previously subsidized by around 50 percent, under the new system food and energy were adding up to an average of 10 percent of monthly household income. Inflation, stable but high at around 3 percent between 2010 and 2011, after spiking at 15.7 percent in 2008, has still not been matched by an increase in wages, with the average family income sitting at 13,000 Syrian Pounds ($260) a month.

Following the 2011 National Household Survey, which showed overall higher living costs and a growing gap between rich and poor, sources told Executive that plans were already underway to use the results to implement a secondary study to assess how removal of subsidies affects popular approval of state policy.

But even if temporary and relatively modest reintroduction of subsidies may go some way to quell unrest, reversals might be hard to undo. “The size of the subsidy is not the important issue here, especially in the short-term,” explained Said Hirsh, Middle East economist at Capital Economics in the United Kingdom. “My concerns will be on its impact on medium-term structural reforms and economic policies. We don’t understand yet whether this will divert money away from more important investments, for instance, or if any are to be shelved/delayed due to this.”

Already, implementation of the value added tax has been delayed indefinitely, but the real test, according to Joshua Landis, director of the Center for Middle East Studies and associate professor at the University of Oklahoma, will come on April 1 when subsidies for heating fuel were supposed to be lifted.

“If the government cancels this, we can safely say that it is due to the mood of revolt in the Arab world,” said Landis.

Hirsh expects the short-term political gains to have long-term costs. “There is no doubt that these measures are targeted at short-term political survival,” he said. “They are dangerous in the sense that it is very difficult to reverse these policies, especially if there are no changes to living standards and an end to economic hardship. Syria is amongst the poorest countries in the region and there is still a big gap to fill before it is able to improve economic conditions.”

Looking to finance

In a secondary attempt to reduce the budget deficit and diversify its sources of finance, Syria last month announced its second ever offering of $63.9 million in treasury bonds.

Following the first bond offering in December, February’s offer was oversubscribed in a sign of optimism in the country’s political stability.

But with the sale only open to 14 local banks, and with yields well below the rate of inflation, analysts warned that such optimism is premature. For bonds to become a substantial source of funding, Hirsh said, the government will need to issue more and at longer maturities.

And, while traditionally opposed to dependence on foreign players, Syria may also need to consider extending the offer to foreign banks, a measure the International Monetary Fund (IMF) has long urged, if results are to have any real impact on treasury finance. Current yields will likely be unacceptably low to international investors, and recent events may make the prospect even less appealing.

“Although Syria’s government appears stable, this position may change very quickly given events elsewhere and Syria’s political and economic conditions,” said Hirsh. “Any international investor is likely to take this into account more than local banks.”

Selling debt locally may cover costs in the short term but, according to Landis, “it means little because the alternative for Syrian banks is to keep their money earning no interest… It is an expression of the lack of alternatives,” he said. “The below market interest rates make clear that Syria does not yet have a free market, which will have to be encouraged to up foreign investment.”

“Although Syria’s government appears stable, this may change very quickly given Syria’s condition”

The youth

If there is one thing that Arab governments should have learned by recent events, it is that securing youth employment and satisfaction is a priority. There is little doubt the protests are primarily linked to a failure of the country to secure jobs and growth. In many ways more so than elsewhere, the demands are particularly urgent. Amid falling oil revenues, the population has soared to 22 million since the mid-1980s. Birth rates are skyrocketing at a 2.7 percent annual increase. Syria already has one of the highest youth unemployment rates in the world and with 50 percent of the population under 30 and over 30 percent under 14, it is only likely to get worse, presenting a potentially disastrous youth unemployment bubble unless jobs can be created.

Aside from curbing population growth rates, the real challenge to this is encouraging the private sector and increasing youth job skills.

While the Syrian government has engaged in initiatives to promote entrepreneurship and business development, the 2010 “Silatech Index Report: Voices of Young Arabs” found that despite the growing need to shift a greater share of the country’s workforce from public sector to private sector jobs, 54 percent of young Syrians say they would still prefer to work for the government at a time when public sector jobs are increasingly scarce.

As a result, increasing private investment and job opportunities, has topped the government’s to-do list for the last two ‘Five Year Plans,’ but private investors still grumble about significant obstacles to entering the market. Despite the introduction of foreign banks, relaxed bans on trade and the opening of the Damascus Stock Exchange, private investment has remained low in the face of poor competitiveness ratings, inefficient industry, unsupportive legal frameworks and the perception of dogged corruption, not to mention the renewal of United States sanctions.

As of last year, foreign direct investment was expected to reach just $2.5 billion. Infrastructure investments, especially funds targeting agriculture, are going ahead, but without a specific timeline, such as the recently announced $2.1 billion irrigation project to pump 1.25 billion cubic meters of water from the Tigris to irrigate some 200,000 hectares (2,000 square kilometers) of land in the northeastern governorate of Hassakeh, the home of the country’s struggling drought-afflicted oil, gas, wheat and cotton industries.

Half way up and half way down

While investment plans plod along, the fundamental problems with the economy-first model are emerging in sharp relief. Stuck half way between a free-market economy and national socialism, Syria risks losing on both political and economic fronts by sitting on the fence.

“I think the economic reforms that Syria has started are important,” said Hirsh. “Nonetheless, it is still very slow and it is very difficult to see how the political class will handle the economic changes without any major political reforms or changes… At least, Syrians have to be prepared for major, and in some cases painful, re-adjustments to their way of life.”

As in Egypt, said Hirsch, this may provoke social and civil unrest. “Not everyone will be a winner through this process.”

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Executive Editors

Executive Editors are the collective voice of the magazine. Stories written by Executive Editors are the culmination of discussions, brainstorming, research and information-gathering by our editorial team. Over decades, our editorial team has applied a blend of seasoned expertise and a discerning eye to bring you insightful and engaging and substantive reads that eschew sensationalism.
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