Monetary policy

Under tightly regulated capital accounts and fixed exchange rates, monetary policy was a sovereign state policy for more than 30 years. Expansion of the money supply was tightly controlled by the Central Bank during the 1960s and the spread between the saving and lending rates balanced savings and investment. Money creation was basically within the purview of the state, and only an unsustainable shortage of foreign exchange could trigger inflation. However, one must note the usage of the official exchange rates (the overvalued rate) was undertaken for the purpose of subsidising the necessary consumption bundle of the working population: if foreign exchange rises, the over-valued official rate does not change allowing the same amount of Syrian pounds to be exchanged for the foreign currency, and hence, buying the same amount for effectively fewer pounds. One can also discern that in such a tightly controlled system, inflation would rise at a rate roughly commensurate with the ratio of imports to GDP - that is, how much Syria buys from abroad in foreign currency. But hyperinflation like what happened in the mid-1980s could only occur as a result of illicit outflows in the national currency.

The state banks lent to the public sector at a rate lower than the market rate of 7 per cent, while they lent private investors at a much higher rate (interview with the Ministry of Economy and Trade, 2007). The Central Bank managed the interest rate only to direct state transactions rather than to maintain a cap on inflation or to hold capital flows in check. It managed the interest rate to finance state-led investment in strategic sectors at concessional terms, according to a pre-determined credit allocation plan.

The Credit and Monetary Council (CMC) that has been responsible for conducting monetary policy operations during the liberalisation phase lowered the interest rate on saving deposits for the first time in 2003 - after holding it constant at 7 per cent for 22 years. Interest rates on loans were also reduced in order to stimulate financial intermediation between savings and investment. However, the CMC gave private banks the option to set their own rate on credit facilities (interview with Ministry of Economy and Trade, 2007).

Interest rate reduction did not transmit policy signals into changes in money supply and investment. As mentioned in Chapter 2, the risk factor holds primacy when deciding on investment and as such, the influence of interest rates diminishes when issues of risk and uncertainty are taken into consideration. Moreover, because the private banks were allowed to raise their own rates on lending - as in any other private banking system - private financiers made use of the difference between the official rate and the private lending rate to raise their earnings. In shallow financial markets in which lending for the purpose of finance is limited, lowering the interest rate does not implicate investment demand.

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