Islamic Republic of Afghanistan
Last Updated: April 8, 2015
Over the past decade, Afghanistan has made enormous progress in reconstruction, development, and lifting per capita income. The authorities have taken steps to lay the foundation for economic stability and growth, to reduce poverty, and to achieve social and development objectives despite a very difficult security situation and the challenges associated with building political and economic institutions. However, security conditions, political uncertainty, and weak institutions continue to constrain growth and weigh on social outcomes. The international community has delivered substantial financial support and pledged to continue doing so over the medium term.
Afghanistan is one of the poorest countries in the world and relies heavily on donor grants to fund development and security spending. Per capita income for 2014 is estimated at about US$660, and the country ranks well below its neighbors on most human development indicators despite its progress toward meeting its social and development objectives and the Millennium Development Goals. For example, child mortality has been reduced and school enrollment increased, albeit from very low levels—the enrollment rate for primary school is less than 40 percent. At the same time, achievements in some areas are below expectations: more progress is needed in reducing the number of children under the age of five that are underweight; in increasing access to potable water and sanitation; and improving literacy rates for men and women aged 15 to 24. Overall, the low implementation rate of the development budget impedes more rapid progress toward poverty reduction. Despite these drawbacks, Afghanistan became one of 20 fragile and conflict-affected states that have already met one or more the Millennium Development Goals (MDGs).
Role of the IMF and IMF-Supported Programs
In 2001 Afghanistan’s infrastructure and institutions were in disarray as a result of years of conflict and erratic policies. The most pressing economic tasks involved restoring economic stability and rebuilding institutions, against the challenging backdrop of an unstable security situation. The IMF became involved in Afghanistan in 2002, to assist in rebuilding economic institutions and in providing advice to the government on economic policies and reforms. In addition to regular visits by staff teams to discuss economic policies, the IMF has had a permanent resident representative in Kabul during 2002-14 and has been providing technical assistance to develop monetary instruments, strengthen the central bank, modernize foreign exchange regulations, revamp tax and customs administration, establish a fiscal regime for the natural resources sector, enhance public financial management, and improve the national accounts, and price and balance of payments statistics.
With significant domestic efforts and donor support, Afghanistan has maintained macroeconomic stability, implemented important structural reforms, and built policy buffers—namely a comfortable international reserves position, low debt and inflation, and balanced budget and external current account positions, after grants. Improved economic performance and reforms implemented in key areas enabled Afghanistan to qualify for debt relief under the Heavily Indebted Poor Country Initiative in January 2010, leading to a 96 percent reduction in Afghanistan’s 2006 stock of external debt. Following this extensive debt relief, Afghanistan’s debt burden was alleviated significantly—external public and publicly guaranteed debt amounted to $1.35 billion, or 6.6 percent of GDP, at end-2014.
The first IMF-supported program during 2006–10 was broadly successful in maintaining macro stability and promoting reform. Under the second three-year IMF program which started on November 14, 2011, macro stability was preserved but reform implementation slowed. After the first program review in June 2012, subsequent reviews were delayed due to missed quantitative targets and slow pace of structural reforms. Notwithstanding delayed reviews, the IMF maintained a close dialogue with Afghanistan on economic policy and reforms through a set of informal quantitative targets and policy actions. The second program expired in November 2014.
Economic Performance in 2014 and Staff-Level Agreement on a Staff-Monitored Program (SMP)
Afghanistan has completed the first-ever democratic transfer of power in the country’s history in September 2014, with the conclusion of protracted presidential elections and establishment of the unity government. This peaceful transfer of power raised hopes and signaled Afghan people’s desire for change. Moreover, international community and key donors reaffirmed their partnership and commitment to Afghanistan’s future in the London Conference in December 2014. They welcomed the new government’s commitment to macroeconomic stability and reforms that will promote sustainable and inclusive growth.
Political and security uncertainties associated with presidential elections and the drawdown of international troops weighed on economic performance in 2014. They weakened confidence and growth declined to 1.5 percent in 2014. Inflation declined to 1.4 percent year-on-year in December 2014 due to lower international food prices and weak domestic demand. International reserves and the exchange rate remained broadly stable while the external current account and budget were financed by donor grants.
Fiscal and banking sector vulnerabilities emerged in 2014. Weak growth, declining imports, and lower tax compliance resulted in a decline in domestic revenue collection, while higher social and development expenditures added to spending. As a result, the treasury’s cash position was depleted and arrears were incurred. A deterioration in the banking sector’s asset quality exposed vulnerabilities and weaknesses, with eight of 16 banks rated as weak (reflected in CAMEL ratings of 4 or 5).
The new government is resolved to address economic vulnerabilities and push ahead with critical reforms in financial sector and revenue mobilization as well as improving governance. IMF staff had productive discussions with the new government on their policy framework and reform plans. These discussions culminated in announcement of a staff-level agreement on a nine-month Staff Monitored Program (SMP) on March 20, 2015. The SMP is designed to support the authorities’ reform agenda with a framework to address economic vulnerabilities and facilitate engagement with the international community to sustain donor support. The SMP will aim to address fiscal and banking vulnerabilities and preserve buffers (low debt and a comfortable international reserves position), maintain low inflation and strengthen competitiveness and therefore laying the basis for high growth.
Under the SMP, fiscal policy will focus on mobilizing domestic revenue to finance projected expenditure and rebuild the treasury’s cash balance. Monetary policy will aim to preserve low inflation, and exchange rate policy will protect international reserves and strengthen competiveness. Structural reforms will focus on: (i) revenue mobilization, expenditure control and repayment of arrears; (ii) financial sector reform to deal with weak banks, promulgate and implement the new banking law, amend the central bank law, strengthen banking supervision, and address weaknesses in state banks; and (iii) better economic governance by strengthening anti-corruption, anti-money laundering and countering the financing of terrorism.
Substantial grant financing from donors will be needed over the medium term to finance Afghanistan’s development and security needs, support the move toward fiscal sustainability, and enhance confidence in the Afghan economy.