SUBSIDIES CREATING HEAVY FISCAL BURDEN

C O N F I D E N T I A L SECTION 01 OF 02 DAMASCUS 001696

SIPDIS

SIPDIS

NEA/ELA
TREASURY FOR GLASER/SZUBIN/LEBENSON
NSC FOR ABRAMS/DORAN/SINGH
EB/ESC/TFS FOR SALOOM

E.O. 12958: DECL: 04/13/2016
TAGS: ECON EFIN EINV SY
SUBJECT: SUBSIDIES CREATING HEAVY FISCAL BURDEN

REF: A. DMS 5045


B. DMS 0893

C. DMS 1273

D. DMS 0716

Classified By: Charge d'Affaires Stephen Seche, reasons 1.4 b/d.


1. (C) Summary: The SARG spends billions of dollars on
subsidies and support for inefficient State-Owned Enterprises
(SOEs) that are consuming a growing portion of state revenue.
The subsidies are the largest fiscal pressure on the SARG
budget with oil revenues declining, and their removal
represents the economic issue most capable of triggering
social unrest. As a result, the SARG currently is spending
down its foreign currency reserves to finance the subsidies,
and contacts say that the SARG may be willing to sustain them
in order to avoid increased inflation and alienating the
public at a time when renewed outside pressure is still
possible. End summary.


2. (SBU) Last month, the Syrian public widely expected an
increase in diesel prices from 7 SYP/liter to 12 SYP/liter.
The decrease in the diesel subsidy was part of a larger plan
to gradually rationalize domestic prices on basic commodities
with those of other countries in the region. The plan, which
Deputy Prime Minister for Economic Affairs Abdallah Dardari
announced in October 2005, was hailed by reformers in and out
of government as a way to reduce pressure on the budget,
abolish black market trading in commodities, and decrease the
incidence of cross-border smuggling through which Syria loses
an estimated 20% of its diesel supply every year (ref A).
Recently, however, the SARG has begun to publicly back away
from talk of subsidy reductions. Dardari stated last week
that the SARG will keep subsidies intact, and that the
government can sustain the diesel and other price supports
for the foreseeable future.


3. (C) Contacts among independent Syrian economists contend,
however, that Dardari's comments belie the tremendous strain
that the cost of subsidies is placing on Syria's fiscal
position. Contacts estimate that the SARG spends more than
$6 billion annually on all subsidies and price controls,
which equates to more than 60% of the $9.9 billion 2006
budget or almost 28% of GDP. The subsidy on imported diesel
is the single largest subsidy, on which the SARG spent $2
billion in 2005 to keep the domestic price 23 SYP/liter below
the regional price. Contacts point out that the $6 billion
price tag for subsidies far exceeds the $500 million
allocated for "price stabilization" in the 2006 budget.
Therefore, they state, subsidies will increase the budget
deficit far above the $1.18 billion anticipated for the
coming year (ref B).


4. (C) Besides diesel, the $6 billion includes subsidies for
staples such as bread, sugar and rice, which contacts
estimate may exceed $400 million in 2006. Further, the SARG
spends approximately $2 billion each fiscal year to cover the
operational deficits of SOEs that distribute a wide range of
agricultural, energy and industrial subsidies, including an
estimated $350 million subsidy for wheat exports. (Note:
Syria produces wheat at a cost of $80/ton above the world
price for the commodity. End note.) Most of the rest of the
$6 billion worth of subsidies is spent on keeping electricity
costs low. Despite the fact that the SARG has reduced
subsidies and price controls on cement and some oil
derivative products such as heavy fuel oil and gasoline over
the past year, contacts state that those reductions have not
done enough to reduce the magnitude of the subsidy load and
that a reduction in the diesel subsidy is necessary to
release the immediate fiscal pressure.


5. (C) Increased consumption of diesel is cancelling the
benefit the SARG could realize from the high price of oil.
Syria historically imports half of the diesel that it
consumes. Diesel consumption rose 10% last year, while
domestic production remained stagnant, and is expected to
increase another 10% in 2006. With oil production declining
by an estimated 15% per year, contacts contend that if no
action is taken soon to either reduce the subsidy or increase
domestic production, the SARG will not have sufficient oil
revenue to cover subsidies and its rising deficits. Dardari
recently was quoted as saying that 2006 will be the first
year in which Syria's imports of oil derivatives equal its
export of oil. Though other economists have expressed some

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skepticism that Dardari's pronouncement is accurate, it does
indicate how seriously the SARG views its declining oil
production and revenues. Therefore, contacts say, if the
SARG wishes to sustain subsidies at their current levels, it
will have to assume even larger opportunity costs of lost
investment and future support for the currency by spending
down its accumulated hard currency reserves.


5. (C) Contacts report that despite the fiscal pressure of
sustaining subsidies and its drain on foreign reserves, the
SARG is hesitant to reduce the diesel subsidy in part because
of its potential inflationary effect (ref C). Local media
has been seized with the issue of price inflation in the
major metropolitan areas since late 2005, with almost daily
articles complaining about Syrians' eroding purchasing power.
Abdulkadr Housrieh, one of the intellectual authors of the
SARG's subsidy reform plan, stated that the SARG is placing
more emphasis on the possible social repercussions of a
diesel price increase- including the possibility of public
manifestations of anger toward the regime- than on the
economic repercussions of sustaining the subsidy. He
lamented that the current subsidy policy effectively
sacrifices the future in order to keep people happy and
"asleep" in the present.


6. (C) Comment: The SARG is between a rock and a hard place
concerning the diesel subsidy. Reducing the subsidy would
create additional inflationary pressure and make it harder
for ordinary Syrians to make ends meet. However, by
sustaining it, the SARG faces ballooning deficits and a rapid
erosion of its fiscal position. While the SARG may have
enough foreign reserves to sustain its subsidies for the
short term, this course would force it to scrap its ambitious
development plans. Additionally, using its accumulated
reserves to support subsidies would make them unavailable for
use to defend its currency (ref D),leaving it vulnerable if
the SARG is again subjected to intense international
pressure.
SECHE