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Friday, June 15, 2007


Economic reforms in Syria and Egypt.

The Media Online

Fiscal Deficit Represents Major Challenge for Syrian Economy

Written by Jihad Yazigi
Published Monday, May 07, 2007

Contrary to the expectations of many the Syrian economy recorded last year a significant increase in its Gross Domestic Product. Real GDP growth reached 5.3 in 2006 after a rate of 4.5 percent in 2005, also much better than most expected.

Direct investment from the Gulf countries and from Syrian expatriates has been flowing throughout the Syrian economy. Real estate is the prime target for these investors and city dwellers can witness this through the construction of new commercial centres, the opening of food and clothing chains selling international brands, the renovation of old buildings, etc. Investment in the tourism sector has also been growing with the announcement every other day of the building of a new hotel or the signing of a management contract between local investors and international hotel management firms. Meanwhile, the financial sector has gone through a revolution on its own and welcomed seven banks and eight insurance firms with foreign capital in the last three years alone. More significant of the health of the Syrian economy is investment in industry. The opening of hundreds of new factories in Syria’s three recently built industrial areas is probably the best reflection of the reverse of the country’s fortunes and the confidence of investors over the long-term prospects of its economy.

At the same time, the Syrian economy is suffering from woes unknown until very recently. One of these is inflation. While it remained relatively low during the nineties, below 5 percent on average during that decade, the official rate of the consumer price index had a two-digit growth last year. The situation in Iraq can be partly blamed for that: Iraqi refugees in Syria, whose number crossed the 1 million-mark, have increased demand significantly. Meanwhile, the closure of hundreds of factories in Iraq has increased demand for Syrian products and reduced supply of Syrian manufacturers to their local market. Also, the peg of the Syrian Pound to the US dollar has meant a fall in the value of the Syrian currency compared to the Euro and a concomitant increase in the value of imports from the Euro-zone, Syria’s main trading partner.

However, the major challenge facing the Syrian economy in the mid to long-term is the threat on its fiscal balance. In 2005, the budget deficit grew for the fifth year running representing 5 percent of GDP from only 1.7 percent in 2002. Oil proceeds are falling, along with output and exports, while subsidies are representing a growing drain on the treasury. Income from taxation is increasing but still represented only 12 percent of GDP in 2005.

Syrian decision makers are not hiding their worries. In a recent interview with a local publication, Mohammad Hussein, the Minister of Finance said, half jokingly, that he welcomed any new proposal to increase the Treasury’s income. In a previous interview he had said that he advised fellow members of the cabinet to think of how to collect money for their ministries before spending it. The single most important decision that would significantly alter the balance and give a margin of manoeuvre for the government would be a lifting of subsidies on petroleum products, mainly diesel. This is what international institutions have been recommending and what the government has said that it was aware it should do. But this would also require a political will and legitimacy that the Government does not appear to have.


Global Economic Forum

February 09, 2007

By Serhan Cevik | London

The continuing increase in Egypt’s public debt stock is a threat to stability. Egypt once achieved significant fiscal consolidation, lowering the government budget deficit from 17.5% of GDP in 1991 to 0.9% in 1997 and gross public debt from an average of 117.6% of GDP in the first half of the 1990s to 75.4% by the end of the decade. Unfortunately, that is now as much in the past as the country’s magnificent pyramids. The budget deficit widened to as high as 9.2% of GDP in 2002 and an average of 6.7% in the past six years, resulting in a marked increase in gross public debt to 96.1% of GDP in the last fiscal year. More importantly, net public debt snowballed from 47.4% of GDP in 2001 to 69.8% last year. Even though favorable global conditions and petrodollar liquidity have so far eased the debt burden and allowed the Egyptian economy to grow at an accelerating pace, we think that fiscal imbalances nevertheless remain an important source of economic distortion and a threat to financial stability.

Cyclical and one-off revenue increases lowered the deficit, but expenditures are growing fast. Thanks to strong growth, higher privatization receipts and the settlement of tax arrears, government revenues increased by 63% on a cumulative basis in the last three fiscal years and stabilized the budget deficit at 8.3% of GDP last year (marginally lower than the average of 8.9% in 2002-2005). However, public expenditures are still growing at a discomforting pace, even after increasing from an average of 32% of GDP a year in 2001-2005 to 38.8% in the past fiscal year. This is why we are worried about the risk of a cyclical downturn on the revenue side that could destabilize public finances.

In light of fiscal imbalances, negative real interest rates present a puzzle. With a disappointing fiscal performance, one would expect to see, at least, an increase in the risk premium. But real interest rates in Egypt have instead declined in recent years and even become negative in the last couple of months, as inflation surged from around 3% in 2005 to above 12% last year. So what is the explanation for this puzzle, especially when the government has no plan for significant fiscal consolidation? A recent IMF working paper provides insightful clues, not just for the Egyptian case but also for the rest of the Middle East (see Manal Fouad et al, Public Debt and Fiscal Vulnerability in the Middle East, January 2007). The authors argue that ‘special financing features’ have helped Middle Eastern countries to avoid debt crises, despite having much higher debt levels compared to other emerging economies. Indeed, all these countries share a similar funding structure, relying heavily on non-marketable debt instruments, a dedicated investor base and, of course, petrodollar liquidity. In addition, with its practically pegged exchange rate regime, Egypt is also attracting carry-trade investors who do not mind negative real interest rates as long as they receive the expected return in dollars and therefore provide even more (short-term) liquidity in the domestic debt market. Nevertheless, all these features do not mean that unsustainable fiscal policies have no effect on the country’s credit quality in the long run.

Good times offer an opportunity to put public finances on a sustainable path. Given the extent and strength of the global liquidity cycle, carry-trade and dedicated regional investors could keep the ball rolling in Egypt’s financial markets, even though macro imbalances have already resulted in overheating of the economy. According to the official statistics (which, by the way, underestimate inflation because of the weight of administered prices and methodological shortcomings), consumer price inflation increased from 3.2% in 2005 to 12.4% last year. We may see some degree of correction thanks to base effects and the aforementioned statistical quirks, but the expansionary mix of monetary and fiscal policies should keep fuelling unbalanced growth dynamics (see The Dangers of Overheating, December 14, 2004). Moreover, the authorities will — sooner or later — have to deal with the consequences of distortionary subsidies and face even more inflation pressures. Unfortunately, we believe that the government’s proposed fiscal adjustment package is too small and too gradual to put public finances on a sustainable path in the foreseeable future.


A very common view in Israel is that the Arab states around are stagnating economically. At least as far statistics are concerned this is not true. Egypt and Jordan have an annual economic growth of about 7 percent for a few years by now. Of the three, Jordan seems to have the most stable and healthy economy.

When it comes to Syria and Egypt the situation is less clear. What is clear is that Syria and Egypt experience similar problems at the macroeconomic level - runaway budget deficits and growing inflationary pressures. Syria is projected to turn into a net oil importer in 2008-2007. Yet as the first article describes the situation the regime maintains costly subsidies on oil products that stress the budget and stimulate the domestic demand for oil at the same time.

In fact the similarities between Syria and Egypt are striking. Both countries are almost forced into reforming their economies by the circumstances. Egypt is a classic case of the runaway Arab demographics and is becoming more and more a mega-Gaza. The country suffers from overpopulation and subsequent pressures on water resources and cultivated land. Food imports are huge as the country is no longer capable of feeding itself.

Syrian demographics are only slightly less intense. The fact that Syria has ways more of suitable land is countered by the huge overpopulation in the area of Damascus. It should be mentioned that the annual growth of 5 percent is not too much for Syria given how poor the country is and that the population growth is stuck at 2.5 percent, which means half of the economic growth is neutralized by the demographics.

Finally both countries are running huge military budgets. And by far the easiest way for them to find their way out of the mess is to cut military expenditures. This is clearly not an option for Syria, yet surprisingly neither it's one for Egypt. Egypt seems to be looking for an overwhelming military superiority over Israel, for reasons I will leave for my readers to figure out. The Egyptian armed forces outnumber the IDF in everything from planes to tanks and the military build-up continues.

There is a certain logic behind the similarities between Syria and Egypt and the differences between them and Jordan. Both Syria and Egypt practiced the Soviet style socialism and the problems they experience at the macroeconomic level are reminiscent of the transition to free market economy in countries of the former Soviet block. Probably those want to find clues to the future of both countries should look into the experience of the more poor members of the former Communist block - undeveloped and low income communist countries that were spared the pleasures of Soviet style industrialization.

Of the two, Syria seems to me a particularly hopeless case with an only half hearted commitment to the reform. Egypt's economic team seems to be ways more professional and dedicated and Mubarak's son, Gamal Mubarak, may reveal himself as a much more serious reformer than his father. Mubarak's son serves apparently a rallying point for the Egyptian reformers.

Probably the primary challenge facing the regimes in both countries is to survive the stage of structural reforms. Hundreds of thousands of workers are to be expected to be sacked in an attempt to rescue what can be still rescued of the state sector. Both regimes are expected to start slashing subsidies on food and gas this year, a measure that should set them on a collision course with their populations. Needless to say the populations are growing more and more susceptible to the fundamentalist message of the Muslim Brothers and the cheap pseudo liberal social populism of the so called secular liberals.

And of course the demographic explosion is still going strong. And we have the global warming. And the food prices are shooting up because of farmers migrating to biofuels and the growing demand from China. Finally thousands and thousands of Syrians, Egyptians and Jordanians work in the Gulf and are the first to be sent home if the move to low carbon economy starts in serious. So don't hold your breath . . . though you are allowed to slow it down a bit.

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