By Suleiman Al-Khalidi

AMMAN (Reuters) - Syria and Iran signed a deal this week to activate a $3.6 billion credit facility to buy oil products to shore up President Bashar al-Assad's war battered economy, officials and bankers said on Wednesday.

The deal, which was agreed in May and will allow Iran to acquire equity stakes in investments in Syria, is part of Shi'ite Iran's broader support for Assad in his battle against a two-year insurgency by mainly Sunni rebels.

Tehran has already provided military assistance to Assad, training his forces and advising on military strategy. Iranian-backed Hezbollah fighters have also bolstered counter-offensives against rebels around Homs and Damascus.

"This will help Syria to import petroleum products that the country needs," said a Syrian trade official, referring to the credit facility. Underlining the acute nature of Syria's financial problems, he said authorities had tried to set a ceiling of $4 billion on the deal.

Syria is short of diesel for its army and fuel to keep the economy running, partly because of U.S. and European Union financial sanctions imposed after the crackdown on protests at the start of the crisis. Its main supplier of petroleum products by sea has been Iran.

Another $1 billion credit line to Damascus has already been extended to buy Iranian power generating products and other goods in a barter arrangement that has helped Syria export textiles, phosphates and some agricultural produce such as olive oil and citrus products, trade officials say.

"This will allow Syria to import Iranian products up to this ceiling, with almost half to buy electricity equipment for the sector," the trade official, speaking by phone from Damascus, told Reuters.

Alongside the favorable deferred payment terms of those financing facilities, Damascus has been in talks for months to secure a loan of up to $2 billion with low interest and a long grace period, the official said.

STRONG SIGNAL OF SUPPORT

Syria's economy has been hurt by depletion of foreign reserves that were estimated at around $16-18 billion before the crisis. The country had been earning some $2.5 billion a year from oil exports before the crisis.

With the economy on a war footing and military costs spiraling, Syria has been forced to rely increasingly on new credit lines from its main allies. Russia, Iraq and China have provided support - sometimes in the form of barter deals - but not on the scale of this week's deal with Tehran.

Syria's Deputy Prime Minister Qadri Jamil held talks in Moscow last week about a possible Russian loan to Damascus but no agreement has been announced yet.

The latest deal should also ease financial demands on an economy whose $60 billion GDP is estimated to have shrunk by around 30 percent since the conflict began two years ago.

"It's a strong psychological and political message of support from Iran. They are not just giving you a specific loan but they are giving you funds over a long period and (you can) draw as much as you want on items you choose," said Samir Aita, a prominent Syrian economist living abroad.

"The credit facility will allow Syria to spend much needed funds now tied up on other areas," he added.

Although the financing deal provides short-term relief for Syria, it will push up the long-term debt of a country that once prided itself on a low national debt, bankers say.

Bankers say the credit facilities, that will be channeled through the state-owned Commercial Bank of Syria and Iran's Bank Saderat, could also reduce the mounting pressure on the Syrian pound by limiting the need to pay for imported products and foodstuffs with scarce foreign currency.

The pound has crashed as low as one-sixth of its pre-crisis value against the dollar, leading to rampant inflation. Currency traders say the pound plunged to 300 to the dollar earlier this month before recovering to around 200.

"There will be less demand on the dollar when the state gets oil products and flour from Iran and we export to them textiles and some foodstuffs," said Essam Zamrick, deputy head of the Damascus chamber of industry.

Last year Iran and Syria arranged a gasoline-for-diesel swap, but the loss of Syria's main oil producing areas in the east meant that Damascus no longer has the light crude it produced nor the extra gasoline and naphtha it used to export.

Nevertheless, Iran has steadily expanded longstanding economic ties with Syria to help it withstand Western economic sanctions and sealed a free trade deal that granted Syrian exports a low 4 percent customs tariff.

Tehran used to supply Damascus with up to a $1 billion worth of oil products on similar credit terms in the early 1980s before Syria became an oil producer.

BANK VAULTS

Last January, Tehran agreed during a visit by Syrian Prime Minister Wael al-Halki to deposit $500 million in Syria's central bank vaults to prop up the local currency, banking sources say.

The latest credit facility deal was welcomed by a cash-starved business community that has little access to Western financial systems under sanctions.

"These credit facilities will help exporters and businessmen who are suffering from lack of credit and loans that have raised costs and led to a capital flight," said Zamrick.

The deal will also open the door to wider Iranian investments in infrastructure projects such as power plants and heavy industry.

Officials say Iran's strong political support will ensure it gets a lion's share of reconstruction projects, assuming Assad remains in power. Iran and Syria already have an existing car assembly plant, one of several multi-million dollar joint projects that began before the 2011 troubles.

Iranian firms have also been awarded more contracts in the power sector and have signed deals to construct several grain silos which will be financed through the expanded credit lines, one banking source said.

Under that credit financing deal, Syria has also received 250,000 tons of Iranian flour, easing bread shortages in government-held areas caused by the loss to rebels of almost half the northern city of Aleppo, where most of the country's milling capacity existed

(Editing by Dominic Evans and Giles Elgood)