Program note

Islamic Republic of Afghanistan

Last Updated: July 12, 2012

Background

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 2011 is estimated at about US$530, and the country ranks well below its neighbors on most human development indicators.  Nevertheless, some progress has been made in recent years toward the country’s political, economic, and social transformation.

The authorities have taken some steps to lay the foundation for economic stability and growth, despite a very difficult security situation and the challenges associated with building political and economic institutions. As a result, economic activity has been robust, with real GDP growth averaging more than 10 percent annually over the past five years (8 percent in 2010/11), and inflation moderating. 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 of nearly US$12 billion.

Afghanistan has also made progress toward its social and development objectives and the Millennium Development Goals, though substantial challenges remain. 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 than 40 percent of children under the age of five are underweight; progress in increasing access to potable water and sanitation remains slow; and literacy rates for men and women aged 15 to 24 are 51 percent and 22 percent, respectively. Overall, the low implementation rate of only 40 percent of the development budget impedes more rapid progress toward poverty reduction.

Role of the IMF

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 to Kabul by staff teams to discuss economic policies, the IMF has a permanent resident representative in Kabul and has been providing technical assistance to develop monetary instruments, strengthen the central bank, modernize foreign exchange regulations, revamp tax and customs administration, and enhance public financial management. The first ECF-supported program during 2006–10 was broadly successful in maintaining macro stability and promoting reform. The second three-year ECF program started on November 14, 2011.

The 2011–14 ECF-Supported Program

Over the next three to five years, the country faces two main challenges: the scheduled departure of foreign troops by 2014, requiring the government to take over an increasing share of security spending; and an expected gradual decline in overall donor support over the medium term, with a larger share of donor support possibly being channeled through the budget. From an economic perspective, these developments will make it more difficult for the government to address Afghanistan’s large social and development needs. The authorities’ program, supported by the IMF’s ECF, will provide the macroeconomic framework to help manage these challenges.

In the near term, one objective of the ECF is to safeguard the fragile financial sector. Prominent among the measures is the resolution of issues related to the now-bankrupt Kabul Bank, including enforcing collection from the beneficiaries of nearly one billion U.S. dollars worth of loans and other assets sought for recovery. At the same time, a new bridge bank comprising Kabul Bank’s liabilities (public deposits) and government bailout money will be sold to a strategic investor, or liquidated in case none is found. The central bank is taking steps concurrently to strengthen supervision and better enforce existing banking laws and regulations, while also reviewing, and improving as needed, the regulatory framework.

A second objective of the program is to improve economic governance, in recognition of the serious threats posed to economic stability, development and—ultimately—the country’s economic viability, and by high levels of corruption, lack of the rule of law, and deficiencies in governance. As such, the recently developed economic crimes strategy aims to build capacity and foster cooperation among relevant government entities to enable them to respond to these threats.

Finally, the third objective is to raise the government’s domestic revenue collection and move Afghanistan toward fiscal sustainability. While progress has been made on this front, with revenue collection having increased to 11 percent of GDP in 2011 from less than 7 percent five years ago, the government will continue with reforms in revenue administration to further boost revenue collection. Moreover, the government will prepare for the introduction of a value-added tax in 2014, including adopting a value-added tax law and training the staff in revenue administration. Achieving fiscal sustainability calls for further reforms and may take more than a decade.

Within its limited budget means, Afghanistan will try to allocate sufficient resources to social and development spending. The withdrawal of foreign troops is expected to hold back economic growth and may affect revenue collection. At the same time, the government will have to shoulder expenditures currently paid for by donors.

Nevertheless, the government is committed to protecting social spending, but will need to rely on donor support for years to come to make continued progress toward its development objectives and the Millennium Development Goals. In this context, the authorities are also strengthening their budget implementation capacity.

Additional Challenges

An immediate challenge is for the government—together with the United Nations and its other partners—to stabilize the security situation and provide an environment that will encourage the private sector to play a greater role in Afghanistan’s economy and eventually become a main engine of growth. This will require further improving governance, safeguarding the rule of law, reducing the role of the illicit sector, and limiting the influence of vested interests. In this context, it is also important that a strong fiscal regime be in place to allow the nascent mining sector to contribute to growth.

 

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