## _cr05128

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---

### Executive Summary — Performance Under the Staff‑Monitored Program
- Performance during the third quarter of the SMP was strong despite the October 2004 presidential elections and formation of a new government diverting human resources.
- All end-December 2004 indicative quantitative indicators and structural benchmarks were met, except the benchmark related to the publication in the official gazette of the central bank law and the commercial banking law (publication of the latter delayed for technical reasons).
- The authorities requested an extension of the SMP through end-September 2005.
- Understandings reached on an update to the MEFP; some structural benchmarks initially set for end-March 2005 were moved to end-June 2005 or end-September 2005 to avoid bunching and accommodate capacity constraints.

### Recent Developments (real sector, prices, fiscal, monetary, external)
- Real sector
  - Agricultural output estimated to have fallen by 15–20 percent during the first nine months of 2004/05 (adverse weather).
  - Activity buoyant in construction, transportation, and other services.
  - Poppy production increased substantially as cultivation spread to new areas; drop in farm gate prices observed.
- Prices and inflation
  - Consumer prices in Kabul increased by 4.0 percent between September and December 2004.
  - Excluding food items, consumer prices rose by 0.9 percent between September and December 2004.
  - Year-on-year inflation reached 11.9 percent at end-December 2004 (6.6 percent excluding rents and petroleum products), compared with 14.1 percent at end-September 2004.
  - CPI that includes five other major cities increased by 3.4 percent during the third quarter of 2004/05 and 8.4 percent over the first nine months of 2004/05.
- Fiscal developments
  - Domestic revenue for the first nine months of 2004/05 estimated at Af 8.9 billion, exceeding the SMP indicative target of Af 8.6 billion.
  - Rise in customs revenue in December likely reflected delays in posting transactions during the October presidential elections and Ramadan.
  - Development spending remained below budget projections due to lack of implementation capacity, delays in mobilizing donor funding, and insecurity.
  - Total government employment around 375,000 at end-December (including 134,000 for police and defense), compared to budget estimate of 406,000; shortfall mainly in education.
- Monetary developments
  - Monetary growth lower than programmed during the third quarter of 2004/05.
  - Interest rates on short-term capital notes: 1–2 percent overnight; 3–4 percent for 30-day notes.
  - Most Hajj pilgrims financed their journey by depositing Afghanis in Da Afghanistan Bank.
  - Foreign exchange reserves continued to increase; nominal exchange rate about Af 48 per U.S. dollar at end-December 2004.
- External sector
  - Preliminary data: current account deficit (excluding grants) narrowed to 32 percent of GDP in the first three quarters of 2004/05, down from 39 percent a year before; primarily financed by donor grants.
  - Including grants, current account recorded a surplus equivalent to 2.9 percent of GDP, compared with 0.3 percent of GDP a year before.
  - External borrowing disbursements estimated at $172 million.
  - Authorities continue progress in verifying external obligations to bilateral creditors.

### Macroeconomic Outlook and Policy Framework
- Objectives and projections
  - Real GDP growth projections: 8 percent for 2004/05 and 10 percent for 2005/06.
  - Inflation: projected to reach 13 percent year-on-year at end-2004/05; projected to decline to 10 percent in 2005/06.
  - Domestic savings: expected to improve from -15.7 percent of GDP in 2004/05 to -8.6 percent of GDP in 2005/06.
  - Investment: projected to decline from 26.5 percent of GDP to 24.6 percent of GDP.
  - Current account balance including grants: projected to swing from a surplus of 1.8 percent of GDP in 2004/05 to a deficit of 1.7 percent in 2005/06.
- Risks and policy stance
  - Major risks:
    - continued volatile security and political uncertainty ahead of legislative elections scheduled for September;
    - economic impact of programs to deal with the drug economy, successful or not;
    - donors’ attention shifting to other regions;
    - still low implementation capacity of the authorities.
  - Staff cautioned on fiscal implications of some recently envisaged initiatives; emphasis on macroeconomic sustainability, transparency, and long-term, pro-growth structural agenda.
  - Renewed intra-governmental cooperation and coordination critical for implementation.

### Fiscal Policy and Budgetary Framework
- 2005/06 budget aims for a planned increase in domestic revenue of about 26 percent.
- Continued reliance on the “no-overdraft rule.”
- Staff recommendations:
  - Follow tax and customs reform agendas; avoid quick fixes that generate temporary revenue gains.
  - Stop granting exemptions; amend the revenue code so investment incentives are given only through relevant tax legislation (end-March 2005 structural benchmark).
  - Further consolidate current and capital budgets and improve fiduciary standards.
  - Establish arrangements to avoid disruptions from late adoption of the budget.
- Budget timing and risks:
  - Payment delays occurred at the start of previous two fiscal years, particularly for salaries, due to lack of coordination between budget allotment process and employee register.
  - 2005/06 operating budget expected to be adopted by end-2004/05; core budget likely adopted shortly after the start of the fiscal year (March 21).
- Wage bill and donor financing:
  - Wage bill represents about 75 percent of the operating budget.
  - Under donor-supported civil service reforms, the wage bill envisioned to rise, including recruitment of around 37,000 new teachers, widening operating budget deficit in 2005/06 and over the medium term, requiring additional donor financing.
  - Staff argued for a wage cap; authorities agreed on the concept but sought to (a) assess impact and benefits, and (b) gain Cabinet support.
- Medium-term civil service restructuring (footnote)
  - Civilian wage bill in SAF envisaged to rise from 6.5 percent of GDP in 2003/04 to about 10.5 percent of GDP in 2008/09.
  - Domestic revenue expected to cover the wage bill in about five years.

### Development Budget and Medium‑Term Fiscal Sustainability
- Development budget totally donor-funded and expected to expand in 2005/06, although less than initially envisaged due to weak implementation capacity.
- Government emphasis on infrastructure to address lack of visible effect of donor money.
- Staff call: prepare a medium-term budget based on realistic assumptions about revenue growth, donor funding, and implementation capacity to preserve medium-term fiscal sustainability within I-PRSP context.

### Monetary Policy, Central Bank Reform, and Banking Sector
- Monetary policy objectives and approach
  - Continue to aim at lowering inflation within a floating exchange rate framework.
  - Guided primarily by indicative targets for currency in circulation as set out in the SMP.
  - Intervene to avoid unwarranted short-term exchange rate fluctuations, but not resist persistent pressures should they emerge.
  - Flexibility essential if substantial decline in opium- and donor-related inflows occurs.
- Money demand and program flexibility
  - High uncertainty in money demand; program remains flexible; authorities should stand ready to tighten monetary policy if warranted.
- Targets and projections
  - Monetary targets for 2004/05 kept unchanged given slowdown in consumer prices in the third quarter.
  - For 2005/06, program consistent with slowdown in pace of monetization.
  - Foreign exchange reserves projected to increase further in 2005/06, to the equivalent to 5.5 months of prospective imports of goods and services.
  - Indicative floors for DAB’s gross international reserves for end-June 2005 and end-September 2005 set consistent with a five-month coverage of imports.
- Central bank modernization and market development
  - External audit of DAB’s 2003/04 financial accounts initiated; findings expected to be presented to DAB management shortly.
  - Progress toward finalizing transfer of DAB’s commercial accounts to other entities.
  - New banking data reporting requirements implemented.
  - Publication of the central bank law in the official gazette noted as positive.
- Banking sector regulation and state-owned banks
  - Need to intensify efforts to restructure relicensed state-owned banks and resolve those not relicensed.
  - Delays in restructuring persist due to weak supervision and management capacities and ownership uncertainty; no decision yet on resolution process for three state-owned banks not relicensed (these ceased commercial operations but continue to pay employee salaries using substantial rental revenue).
  - Authorities committed to decide by end-June 2005 on resolution process.

### Monetary Instruments and Market Conditions (Box 1 summary)
- Current reliance on foreign currency auctions, organized weekly, to control currency in circulation; auctions open to money changers with fixed allocations to commercial banks after each auction.
- Plans (deferred) to introduce automated auction system open to commercial banks and phase out current system to bring money changers into banking accounts; deferred because:
  - Lack of foreign currency demand by banks.
  - Commercial banks’ reluctance to offer accounts to money changers, partly due to difficulties complying with banking and AML/CFT legislation.
- Interest rate structure:
  - Overnight rates: 1–2 percent (liquidity surplus and state-owned banks' behavior).
  - 30-day rates: 3–4 percent (limited interest in longer maturities and underbid auctions).
- Constraints on money market development:
  - Lack of instruments for collateral.
  - Poor management of state-owned banks.
  - Need to strengthen legal framework for market operations.
- Benefits of a money market:
  - Facilitate transfer of excess liquidity to private banks.
  - Improve DAB control of broad money and increase efficacy of monetary policy.

### External Sector and Debt Management
- Balance of payments and current account
  - Data weaknesses complicate projections.
  - Over medium term, current account expected to widen somewhat due to strong demand for imported industrial inputs and consumer goods, and gradual decline in external grants.
  - Over longer term, revival of exports and replacement of some imports with domestically-produced goods expected to improve current account.
- External borrowing and debt management
  - External borrowing expected to remain relatively modest with high degree of concessionality.
  - Staff encouraged authorities to finalize identification of debts incurred by previous governments, reconcile amounts with external creditors, and complete survey of external debt by end-March 2005.
  - Staff advised caution given large structural changes, weaknesses in external sector data, and lumpiness in donor disbursements.

### Structural Reforms to Improve Private Sector Development
- Obstacles: administrative barriers, legal constraints, poorly developed infrastructure, and high input costs.
- Mission urged implementation of key reforms:
  - Publish the investment law in the official gazette.
  - Adopt laws governing mortgages, land ownership, and bankruptcy.
  - Restructure state-owned enterprises to improve external competitiveness.
- Work on an Interim Poverty Reduction Strategy Paper (I-PRSP) initiated; expected completion by October 2005.

### Drugs and Rural Livelihoods
- Authorities developed a multi-pronged strategy combining eradication, interdiction, and alternative livelihoods.
- Anecdotal information that planting down this year; some voluntary switches by poppy farmers to other crops due to decline in farm gate poppy prices and increased dangers associated with anti-narcotic campaign.
- Staff advice: combine eradication with stronger interdiction and decisive efforts to ensure transition to alternative livelihoods; without complementary efforts, shift to legitimate agriculture may be cyclical.

### Program Monitoring, Timelines, and Next Steps
- Updated macroeconomic framework for 2004/05 and 2005/06 and quantitative indicators and structural benchmarks for end-June 2005 and end-September 2005 agreed.
- Authorities prefer to wait until after legislative elections scheduled for September 18, 2005 to consider a PRGF-supported program; SMP extension through end-September 2005 to strengthen policy framework and administrative capacity.
- Tentative SMP review schedule:
  - Fourth review: end-July 2005.
  - Fifth review: end-October 2005.
  - Sixth review: end-January 2006.
- I-PRSP timetable:
  - I-PRSP expected to be completed by end-October 2005; institutional framework including an Inter-Ministerial Committee (IMC) being established.

### Key Statistics and Selected Quantitative Highlights (preserved exactly as in source)
- Real GDP growth projections: 8 percent (2004/05); 10 percent (2005/06).
- Inflation projections: 13 percent (end-2004/05); 10 percent (2005/06); later tapering to 5 percent in ensuing years.
- Domestic revenue projected/estimated:
  - Staff projected domestic revenue of Af 12.8 billion for 2004/05 (budget estimates and MYR adjustments cited Af 13.1 billion for 2004/05 in some tables).
  - Domestic revenue for first nine months of 2004/05 estimated at Af 8.9 billion (SMP indicative target Af 8.6 billion).
- Currency in circulation: Af 37.1 billion at end of third quarter of 2004/05 (slightly below SMP indicative ceiling Af 38.1 billion).
- Foreign exchange reserves: $1.2 billion at end-December (equivalent to 5.3 months of 2005/06 imports); projections to about $1.2 billion at end-2004/05 and increase to equivalent of 5.5 months of prospective imports in 2005/06.
- Exchange rate: about Af 48 per U.S. dollar at end-December; average on Kabul money exchange market Af 48.65 per $1 as of March 20, 2005.
- Preliminary external current account (before grants) narrowed to deficit equivalent to 32 percent of GDP in first three quarters of 2004/05 (from about 39 percent a year before).
- Opium-related figures (table excerpts):
  - Opium production (metric tons): 200; 3,400; 3,600; 4,200; ...
  - Opium value (millions of U.S. dollars): ...; 2,540; 2,300; 2,800; ...
- Selected table values (preserve exact figures where cited):
  - GDP (millions of U.S. dollars, excluding opium): 2,463; 4,084; 4,585; 5,526; 6,687.
  - GDP (millions of Afghanis): 133,987; 182,862; 225,108; 275,397; 333,258.
  - Real GDP growth rate (percent): ...; 28.6; 15.7; 7.5; 10.1.
  - GDP per capita (U.S. dollars): 123; 182; 199; 234; 275.
  - CPI (Kabul, year-on-year change; percent): -43.4; 52.3; 10.3; 13.0; 10.0.
  - Gross foreign exchange reserves (millions of U.S. dollars): ...; 426.1; 815.5; 1,246.3; 1,413.0.
  - Exports of goods (including reexports): 708.9; 1,290.6; 1,893.9; 1,953.0; 1,856.9.
  - Imports of goods: 1,645.0; 2,508.2; 3,785.9; 3,835.0; 3,815.4.
  - Current account deficit (excluding grants): -1,363.7; -2,334.7; -2,333.7; -2,223.0.
  - Current account deficit (including grants; percent of GDP): ...; -3.5; 1.7; 1.8; -1.7.
  - Afghani/U.S. dollar (average): 54.4; 44.8; 49.0; ...... 
  - Afghani/U.S. dollar (end-year): 31.0; 52.6; 50.3; ...... 
  - Sectoral shares of GDP (percent): Agriculture 49.8; 48.5; 38.4; 35.6; 34.0; 32.6. Industry 20.1; 21.3; 23.5; 24.5; 25.5; 22.5. Services 30.1; 30.2; 38.0; 38.0; 40.5; 44.9.
  - Domestic government revenue (percent of GDP): 3.2; 4.5; 4.8; 5.0; 5.2; 5.4.

### World Bank and Donor Financing Highlights
- For FY 2005, four projects approved in July 2004 totaling $145 million:
  - Programmatic Support for Institution Building ($80 million).
  - Kabul Urban Reconstruction Project ($25 million).
  - Investment Guarantee Facility ($5 million) (with MIGA).
  - Education Quality Improvement Program ($35 million).
- Additional project approved January 2005: Public Administration Capacity Building ($27 million).
- ARTF mobilization/disbursement:
  - SY 1381: mobilized $185 million and disbursed $65 million.
  - SY 1382: paid-in contributions $286 million; disbursements $254 million.
  - Pledges for SY 1383: $426 million.
- World Bank program as of February 2005:
  - Active IDA portfolio of 15 investments and one budget support operation.
  - Total commitments $753 million, 40 percent disbursed as of January 2005.

### Program Benchmarks and Structural Priorities (selected)
- Publish amendments to revenue laws, including new Customs code (structural benchmarks).
- Publish central bank law (already published) and commercial banking law (delayed; publication expected soon).
- Publish the banking law in the official gazette by end-March 2005 (structural benchmark).
- Complete survey of external debts and reconciliation with bilateral creditors by end-March 2005.
- Design and implement comprehensive external debt management strategy by end-September 2005.
- Gazette the investment law by end-September 2005.
- Complete I-PRSP by end-October 2005.
- Establish statistical master plan work program by end-March 2005; funding projected at $6.5 million.
- Assessment of technical assistance to be completed and TA plan adopted by end-December 2005.

*Executive Summary — IMF staff report (cr05128) — January 19, 2005.*

### Executive Summary ......................................................................................................

### Executive Summary

### Performance Under the Staff-Monitored Program
- Performance during the third quarter of the SMP was strong despite the October 2004 presidential elections and formation of a new government diverting human resources.
- All end-December 2004 indicative quantitative indicators and structural benchmarks were met, except the benchmark related to the publication in the official gazette of the central bank law and the commercial banking law (publication of the latter delayed for technical reasons).
- The authorities requested an extension of the SMP through end-September 2005.
- Understandings were reached on an update to the MEFP; some structural benchmarks initially set for end-March 2005 were moved to end-June 2005 or end-September 2005 to avoid bunching and accommodate capacity constraints.

### Recent Developments (real sector, prices, fiscal, monetary, external)
- Real sector
  - Agricultural output is estimated to have fallen by 15–20 percent during the first nine months of 2004/05 (reflecting adverse weather conditions).
  - Activity remained buoyant in construction, transportation, and other services.
  - Poppy production increased substantially as cultivation spread to new areas and requires less water than most other crops, leading to a drop in farm gate prices.
- Prices and inflation
  - Consumer prices in Kabul increased by 4.0 percent between September and December 2004.
  - Excluding food items, consumer prices rose by 0.9 percent between September and December 2004.
  - Year-on-year inflation reached 11.9 percent at end-December 2004 (6.6 percent excluding rents and petroleum products), compared with 14.1 percent at end-September 2004.
  - The consumer price index that includes five other major cities increased by 3.4 percent during the third quarter of 2004/05 and 8.4 percent over the first nine months of 2004/05 (compared with 12.6 percent in Kabul).
- Fiscal developments
  - Domestic revenue for the first nine months of 2004/05 is estimated at Af 8.9 billion, exceeding the SMP indicative target of Af 8.6 billion.
  - The rise in customs revenue in December likely reflected delays in posting transactions during the October presidential elections and Ramadan.
  - Rate of development spending remained below budget projections due to lack of implementation capacity, delays in mobilizing donor funding, and insecurity.
  - Total government employment was around 375,000 at end-December, including 134,000 for the police and defense force, compared to a budget estimate of 406,000; the shortfall was mainly in the education sector.
- Monetary developments
  - Monetary growth was lower than programmed during the third quarter of 2004/05.
  - Interest rates on short-term capital notes remained low at 1–2 percent overnight and 3–4 percent for 30-day notes.
  - Most Hajj pilgrims financed their journey by depositing Afghanis in Da Afghanistan Bank.
  - Foreign exchange reserves continued to increase; the nominal exchange rate depreciated somewhat to about Af 48 per U.S. dollar at end-December 2004.
- External sector
  - Preliminary data indicate the current account deficit (excluding grants) narrowed to 32 percent of GDP in the first three quarters of 2004/05, down from 39 percent a year before; it was primarily financed by donor grants.
  - Including grants, the current account recorded a surplus equivalent to 2.9 percent of GDP, compared with 0.3 percent of GDP a year before.
  - External borrowing disbursements were estimated at $172 million.
  - Authorities continue to make progress in verifying external obligations to bilateral creditors.

### Macroeconomic Outlook and Policy Framework
- Objectives and projections
  - Real GDP growth projections: 8 percent for 2004/05 and 10 percent for 2005/06.
  - Inflation: projected to reach 13 percent year-on-year at end-2004/05; projected to decline to 10 percent in 2005/06.
  - Domestic savings: expected to improve from -15.7 percent of GDP in 2004/05 to -8.6 percent of GDP in 2005/06.
  - Investment: projected to decline from 26.5 percent of GDP to 24.6 percent of GDP.
  - Current account balance including grants: projected to swing from a surplus of 1.8 percent of GDP in 2004/05 to a deficit of 1.7 percent in 2005/06.
- Risks and policy stance
  - Major risks to program implementation include:
    - (a) continued volatile security and political uncertainty in the run-up to the legislative elections scheduled for September;
    - (b) the economic impact of programs to deal with the drug economy, successful or not;
    - (c) the focus of donors’ attention on other regions of the world;
    - (d) the improving, but still low, implementation capacity of the authorities.
  - Staff cautioned against short- and medium-term fiscal implications of some recently envisaged initiatives; discussions centered on maintaining macroeconomic sustainability, transparency, and a long-term, pro-growth structural agenda.
  - Renewed commitment to intra-governmental cooperation and coordination is critical for implementation.

### Policy Areas and Actions
- Drugs and rural livelihoods
  - Authorities developed a multi-pronged strategy combining eradication, interdiction, and alternative livelihoods to address the rising drug economy.
  - There is anecdotal information that planting is down this year; some voluntary switches by poppy farmers to other crops have been observed due to recent decline in farm gate poppy prices and increased dangers associated with the anti-narcotic campaign.
- Fiscal policy
  - Authorities are likely to meet the SMP revenue target for 2004/05 of Af 12.8 billion (4.8 percent of GDP).
  - Domestic revenue is expected to fall short of the budget target of Af 15.4 billion due to slower-than-anticipated implementation of the tax reform program and capacity constraints in passing legislation and restructuring the Ministry of Finance.
  - The revenue shortfall is expected to be offset by lower operating expenditures and additional donor funding.
  - Recurrent expenditures projected to rise sharply during the fourth quarter but remain well below the budget for 2004/05.
  - Improved compliance with financial management procedures should continue to raise reimbursement rates from the two multi-donor trust funds.
  - Further mobilization of fiscal revenue is predicated on steadfast implementation of the tax and customs reform programs.
  - There is a need to control wage increases to those stemming from ongoing civil service reform initiatives in the face of pressures to increase spending.
  - The budget process is complicated by uncertainty regarding donor support.
- Monetary policy and banking sector reforms
  - The 2005/06 monetary program is consistent with a slowdown in the pace of monetization of the economy, reflecting the high degree of monetization already achieved, expected development of the banking sector, and envisaged decline in drug-related activities.
  - Authorities need to intensify efforts to restructure the relicensed state-owned banks and resolve those that were not relicensed.
  - Further progress was made in modernizing Da Afghanistan Bank (DAB) and strengthening the commercial banking regulatory framework:
    - External audit of DAB’s 2003/04 financial accounts was initiated; findings expected to be presented to DAB management shortly.
    - Progress toward finalizing the transfer of DAB’s commercial accounts to other entities.
    - New banking data reporting requirements have been implemented.
    - Publication of the central bank law in the official gazette is a positive development.
  - Delays in restructuring state-owned banks persist, partly because of weak supervision and management capacities and uncertainty regarding ownership; no decision yet on resolution process for the three state-owned banks that were not relicensed (these entities have ceased commercial banking operations but continue to pay employee salaries using substantial rental revenue).
- Structural reforms
  - Agenda focuses on improving the regulatory environment for private investment and maintaining external competitiveness.
  - Work on an Interim Poverty Reduction Strategy Paper (I-PRSP) has been initiated and is expected to be completed by October 2005.
  - Authorities and donors intend to step up efforts to deal with the drug economy through eradication, interdiction, and alternative livelihoods.

### Program Monitoring and Next Steps
- An updated macroeconomic framework for 2004/05 and 2005/06 and a set of quantitative indicators and structural benchmarks for end-June 2005 and end-September 2005 were agreed; if met, these objectives should help ensure continued macroeconomic stability and strengthen administrative capacity.
- The authorities prefer to wait until after the legislative elections scheduled for September 18, 2005, to consider a PRGF-supported program; the SMP extension through end-September 2005 will be used to further strengthen the policy framework and administrative capacity.

*Executive Summary — IMF staff report (cr05128) — January 19, 2005.*

### 16.      The 2005/06 budget will aim at a further increase in domestic revenue, of about

### The 2005/06 budget will aim at a further increase in domestic revenue, of about

### Fiscal policy and budgetary framework
- Planned increase in domestic revenue of about 26 percent.
- Continued reliance on the “no-overdraft rule.”
- Staff recommendations and cautions:
  - Follow the tax and customs reform agendas; avoid quick fixes that generate temporary revenue gains.
  - Stop granting exemptions and adopt amendments to the revenue code to ensure investment incentives are given only through the relevant tax legislation (end-March 2005 structural benchmark).
  - Further consolidate the current and capital budgets and improve fiduciary standards (see paragraph 20 of the MEFP).
  - Establish appropriate arrangements to avoid disruptions from late adoption of the budget (concern based on similar disruptions in previous two fiscal years).
- Budget timing and risks:
  - Payment delays occurred at the start of the previous two fiscal years, particularly for salaries, due to lack of coordination between the budget allotment process and the employee register.
  - 2005/06 operating budget expected to be adopted by end-2004/05; core budget likely to be adopted shortly after the start of the fiscal year.
- Wage bill and donor financing:
  - Wage bill represents about 75 percent of the operating budget.
  - Under donor-supported civil service reforms, the wage bill is envisioned to rise, including recruitment of around 37,000 new teachers, widening the operating budget deficit in 2005/06 and over the medium term, thus requiring additional donor financing.
  - Authorities face pressures for additional generalized or sector-specific wage increases; staff warned such increases would put medium-term fiscal sustainability at risk and could undermine comprehensive civil service reform.
  - Staff argued for a wage cap; authorities agreed on the concept but sought to (a) assess impact and benefits, and (b) gain Cabinet support. Several donors raised concerns that a wage cap would hinder the administrative reform program agreed to in Berlin.
  - A strategy for containing the wage bill will be discussed further during the next review.
- Medium-term magnitude of civil service restructuring (footnote):
  - Civil service restructuring strategy in SAF envisages the civilian wage bill to rise from 6.5 percent of GDP in 2003/04 to about 10.5 percent of GDP in 2008/09 (while employee numbers remain relatively stable).
  - Domestic revenue is expected to cover the wage bill in about five years.
- Other donor-financed programs of concern:
  - Security sector and counter-narcotics efforts with large recurrent costs and substantial medium-term fiscal implications (e.g., incorporation of the Afghan National Army into the budget proposed for 2005/06 would significantly increase reported operating costs; police funded through LOTFA with large pay increases proposed).

### Development budget and medium-term fiscal sustainability
- Development budget is totally donor-funded and expected to expand in 2005/06, although less than initially envisaged, partly because of weak implementation capacity.
- Government emphasis on infrastructure to address public frustration about lack of visible effect of donor money.
- Staff call: prepare a medium-term budget based on realistic assumptions about revenue growth, donor funding, and implementation capacity to preserve medium-term fiscal sustainability within the context of the upcoming I-PRSP.

### Monetary policy and central bank reforms
- Monetary policy objectives and approach:
  - Continue to aim at lowering inflation within the framework of a floating exchange rate.
  - Guided primarily by indicative targets for currency in circulation, as set out in the SMP.
  - Intervene, when consistent with the monetary program, to avoid unwarranted short-term exchange rate fluctuations, but not resist persistent pressures on the exchange rate should they emerge.
  - Flexibility may be essential to ensure balance of payments sustainability in the event of a substantial decline in opium- and donor-related inflows.
- Money demand and program flexibility:
  - Due to high uncertainty surrounding money demand, the monetary program will remain flexible; authorities should stand ready to tighten monetary policy if warranted by price and exchange rate developments.
- Targets and projections:
  - Understandings reached to keep the monetary targets for 2004/05 unchanged given the slowdown in consumer prices in the third quarter and monetary tightening implied in the program.
  - For 2005/06, the monetary program is consistent with a slowdown in the pace of monetization of the economy.
  - Foreign exchange reserves are projected to increase further in 2005/06, to the equivalent to 5.5 months of prospective imports of goods and services.
  - Indicative floors for DAB’s gross international reserves for end-June 2005 and end-September 2005 were set consistent with a five-month coverage of imports of goods and services.
- Central bank modernization and market development:
  - Authorities intend to further modernize the central bank (DAB) and implement measures to allow DAB to focus on core functions, including the transfer of its commercial activities and noncore assets (see paragraph 22 of the MEFP).
  - Staff encouraged DAB to move toward development of interbank money and foreign exchange markets and stressed the importance of developing the money market to facilitate transfer of excess liquidity from state-owned banks to private banks and to establish a market-driven benchmark interest rate.
- Banking sector regulation and state-owned banks:
  - Need to strengthen commercial banking regulatory framework and resolve unlicensed state-owned banks.
  - Urged prompt publication in the official gazette of the commercial banking law and regulations adopted by DAB’s Supreme Council.
  - Ensure strict implementation of conditions attached to relicensing of the three state-owned banks.
  - Cautioned against reviving the three state-owned banks that have not been relicensed; decision on their resolution process to be taken and implemented promptly. Authorities committed to take such a decision by end-June 2005 (see paragraph 23 of the MEFP).

### Monetary instruments and market conditions (Box 1)
- Current reliance on foreign currency auctions, organized weekly, to control currency in circulation; auctions open to money changers with fixed allocations to commercial banks after each auction.
- Central bank plans (deferred) to introduce automated auction system open to commercial banks and phase out current system to bring money changers into banking accounts; deferred because:
  - Lack of foreign currency demand by banks (banks almost never used the foreign currency allocation).
  - Commercial banks’ reluctance to offer banking accounts to money changers, partly due to difficulties complying with recently enacted banking and AML/CFT legislation.
- Interest rate structure:
  - Overnight rates have been pushed downward to 1–2 percent due to liquidity surplus and state-owned banks' behavior.
  - 30-day interest rates are higher at 3–4 percent due to limited interest in longer maturities and underbid auctions.
  - Private commercial banks largely stopped participating in auctions because they lack Afghani liquidity and consider current interest rates too low.
- Constraints on money market development:
  - Lack of instruments to serve as collateral for lending operations.
  - Poor management of state-owned banks; need for these banks to seek better-remunerated investments, review deposit interest rates, and lend to other banks.
  - Need to strengthen legal framework for market operations.
- Benefits of a money market:
  - Facilitate transfer of excess liquidity to private banks.
  - Improve DAB control of broad money and increase efficacy of monetary policy by enabling money market operations that affect overall banking sector liquidity.

### External sector and debt management
- Balance of payments and current account:
  - Data weaknesses complicate balance of payments projections.
  - Over the medium term, the current account expected to widen somewhat due to strong demand for imported industrial inputs and consumer goods, along with a gradual decline in external grants.
  - Over the longer term, revival of exports and replacement of some imports with domestically-produced goods expected to contribute to gradual improvement in the current account.
- External borrowing and debt management:
  - External borrowing expected to remain relatively modest over the medium term with a high degree of concessionality (see paragraph 26 of the MEFP).
  - Staff encouraged authorities to finalize identification of debts incurred by previous governments, reconcile amounts with external creditors, and complete survey of external debt by end-March 2005.
  - No immediate pressure on the balance of payments, but staff advised maintaining caution and vigilance given large structural changes (notably in the opium sector), weaknesses in external sector data, and lumpiness in donor disbursements.

### Structural reforms to improve private sector development
- Obstacles faced by private sector: administrative barriers, legal constraints, poorly developed infrastructure, and high input costs.
- Mission urged implementation of several key reforms beyond fiscal and financial benchmarks:
  - Publish the investment law in the official gazette to simplify and clarify investment procedures.
  - Put in place enabling environment for private sector activity, including adopting laws governing mortgages, land ownership, and bankruptcy.
  - Restructure state-owned enterprises to improve external competitiveness.

### Other issues
- Technical assistance (TA):
  - Authorities conducting an overall assessment of TA provided so far; findings expected by end-2005 to serve as basis for a plan to utilize TA more efficiently.
- Statistics:
  - In January, authorities decided to place the Central Statistics Office (CSO) under the authority of the Ministry of Economy.
  - Staff cautioned against this move, noting concerns about CSO’s possible loss of independence and potential negative impact on implementation of reforms in the statistics area and donor support.

### Competitiveness and labor costs (Box 2 highlights)
- Statistical limitations constrain competitiveness assessment; use of bilateral wage-based and CPI-based real exchange rates with main trading partners (Pakistan and Iran).
- Evidence of loss in external competitiveness: since 2001 the Afghani has steadily appreciated in real terms against Pakistani and Iranian currencies.
- Drivers of real appreciation:
  - Initially nominal appreciation; since then primarily driven by relatively higher inflation (prices or wages) in Afghanistan.
  - Donor- and opium-related activities putting upward pressure on wages (analogy to “Dutch disease”).
- Wage dynamics:
  - Wage increases exceed neighboring countries, eroding competitiveness of tradable sector.
  - In 2003/04, nominal wage growth in Afghanistan amounted to 52 percent in dollar terms, compared with 5 percent in Pakistan.
- Infrastructure constraints:
  - Lack of infrastructure, especially energy, raises input costs; electricity production remains well below demand and electricity supply bottlenecks impede local industry development.

### Program monitoring and timelines
- Quantitative indicators and structural benchmarks agreed for end-June 2005 and end-September 2005 (LOI; paragraph 31 of MEFP; Appendix I, Tables 1–2).
- Tentative SMP review schedule:
  - Fourth review: end-July 2005.
  - Fifth review: end-October 2005.
  - Sixth review: end-January 2006.
- I-PRSP timetable:
  - I-PRSP expected to be completed by end-October 2005; authorities establishing institutional framework including an Inter-Ministerial Committee (IMC) (see paragraph 28 of MEFP).

*IMF Country Report excerpt (selected paragraphs and boxes).*

### 29.      Afghanistan’s overall economic performance remained strong during the third

### _cr05128 - 29.      Afghanistan’s overall economic performance remained strong during the third

### Economic performance and macro outcomes
- Output continued to grow despite the lingering drought that affected agricultural performance.
- Inflation declined.
- Fiscal revenue and monetary growth were in line with the program targets.
- Structural benchmarks under the SMP were largely met, improving administrative capacity.
- Major challenges remain: lingering insecurity, the continued prevalence of drug-related activities, and pervasive poverty.

### Findings on the drug economy
- Government is advised to combine eradication of poppy crops with:
  - stronger interdiction of opium trade, and
  - decisive efforts to ensure the transition to alternative livelihoods.
- Without complementary efforts, the apparent shift to legitimate agriculture may be a cyclical response to the recent decline in farm gate prices for poppy.

### Fiscal policy, revenue mobilization, and budget management
- Afghanistan needs further progress in mobilizing domestic revenue; quick fixes are not a substitute for comprehensive tax and customs reforms.
- Full implementation of the tax and customs reform programs is necessary, requiring close collaboration between finance, justice, and interior ministries.
- Delays in adoption of the 2005/06 budget should not disrupt fiscal operations; arrangements must ensure payments—particularly for salaries—are not disrupted.
- New budget law is now slated to be adopted by June 2005 because of a backlog in the Ministry of Justice.
- Staff encouraged the government to manage public expectations and pass realistic budgets reflecting limited absorptive capacity.

### Public spending, service delivery, and absorptive capacity
- Fundamental weaknesses in delivering basic government services and infrastructure remain.
- Limited capacity to execute spending plans, particularly for major reconstruction projects.
- Experience of other post-conflict countries shows it takes time to improve planning, financial management, procurement, and audit capacity.
- Staff encouraged realistic policy changes guided by realistic assumptions regarding domestic revenue growth and available donor financing.

### Public administration and wage policy
- Afghanistan needs an effective and affordable public administration.
- Authorities urged to rule out generalized or sector-specific wage increases as they would:
  - erode ability to carry out comprehensive civil service reform, and
  - crowd out priority spending in other social sectors.
- Agreed to initially limit increases in the wage bill to those stemming from ongoing PRR reform initiatives.
- Issue of a wage ceiling will be explored further during the next review of the SMP with authorities and donors.

### Monetary policy and financial sector
- Current monetary framework effective in moderating inflation but scope exists to extend monetary instruments and indicators.
- Monetary policy implemented almost exclusively through foreign exchange auctions, limiting DAB’s capacity to affect overall liquidity (including U.S. dollars); consumer prices are affected primarily through the exchange rate.
- Recently adopted reserve requirements will broaden DAB’s monetary instruments.
- Staff encouraged:
  - defining a broad strategy including development of a money market,
  - strengthening DAB’s control over liquidity,
  - expanding the set of monetary indicators and developing monthly monetary survey,
  - intensifying efforts to restructure relicensed state-owned banks and resolving former state-owned banks that were not relicensed.

### External borrowing, debt reconciliation, and donor support
- Authorities’ prudent approach to external borrowing welcomed given potential fragility of the balance of payments and limited foreign exchange and fiscal resources.
- Need to complete reconciliation of pre-existing debts with bilateral creditors by the end-March 2005 deadline as a necessary precursor to seeking debt relief.
- Importance of a comprehensive external debt management strategy emphasized—a structural benchmark for end-September 2005.

### Poverty reduction and I-PRSP
- Poverty reduction is a key priority; authorities initiated work on a poverty reduction strategy and to complete the I-PRSP by end-October 2005.
- Coordination is critical to avoid duplication and overstretching capacity.
- IMC (ministers and deputy ministers cross-section) formed to coordinate I-PRSP work—welcome first step.

### Structural reforms, competitiveness, and institutions
- Strong and sustained growth requires aggressive approach to eliminating structural impediments.
- Priority: tackle rigidities in regulatory framework and ensure a well-defined legal framework to facilitate investment and private sector development.
- Support for agenda including rationalization of state-owned enterprises to improve external competitiveness.
- Continuing performance of the Technical Coordination Committee (TCC) viewed positively; TCC should develop analytical capacity, reach out to other agencies, and coordinate with I-PRSP working groups.
- Improvement of the statistical database is a pillar of the SMP; requires an independent CSO and implementation of the statistical master plan with donor support.

### Program extension and prospects
- Authorities requested extension of the SMP through end-September 2005; staff welcomed the request.
- Reform agenda for the upcoming nine months is ambitious; staff confident about Afghanistan’s capacity to deliver.
- Successful implementation of the SMP could pave the way for an arrangement under the PRGF.

### Program risks
- Risks include:
  - insufficient progress in improving security and strengthening government control over provinces,
  - political pressures around and after legislative elections delaying reform implementation,
  - the 2005 campaign to reduce opium-related activities potentially disruptive to security and the economy,
  - donor fatigue and/or increased attention to other countries affecting long-term support.

### Key statistics and projections (as reported)
- GDP (in millions of U.S. dollars, excluding opium production): 2,463; 4,084; 4,585; 5,526; 6,687 (years listed in source table).
- GDP (in millions of Afghanis): 133,987; 182,862; 225,108; 275,397; 333,258.
- Real GDP growth rate (in percent): ...; 28.6; 15.7; 7.5; 10.1.
- GDP per capita (in U.S. dollars): 123; 182; 199; 234; 275.
- CPI (Kabul, year-on-year change; in percent): -43.4; 52.3; 10.3; 13.0; 10.0.
- Domestic currency in circulation (annual change; in percent): ...; 20.1; 40.9; 38.0; 27.1.
- Gross foreign exchange reserves: ...; 426.1; 815.5; 1,246.3; 1,413.0 (in millions of U.S. dollars).
- Opium production (in metric tons): 200; 3,400; 3,600; 4,200; ...
- Opium value (in millions of U.S. dollars): ...; 2,540; 2,300; 2,800; ...
- Exports of goods (including reexports): 708.9; 1,290.6; 1,893.9; 1,953.0; 1,856.9.
- Imports of goods: 1,645.0; 2,508.2; 3,785.9; 3,835.0; 3,815.4.
- Current account deficit (excluding grants): -1,363.7; -2,334.7; -2,333.7; -2,223.0.
- Current account deficit (including grants; in percent of GDP): ...; -3.5; 1.7; 1.8; -1.7.
- Afghani/U.S. dollar (average): 54.4; 44.8; 49.0; ...... 
- Afghani/U.S. dollar (end-year): 31.0; 52.6; 50.3; ...... 
- Real GDP growth (annual change; in percent) (memorandum): 28.6; 15.7; 7.5; 10.1; 9.7; 9.6.
- Sectoral shares of GDP (in percent): Agriculture 49.8; 48.5; 38.4; 35.6; 34.0; 32.6. Industry 20.1; 21.3; 23.5; 24.5; 25.5; 22.5. Services 30.1; 30.2; 38.0; 38.0; 40.5; 44.9.
- Domestic government revenue (in percent of GDP): 3.2; 4.5; 4.8; 5.0; 5.2; 5.4.

*Source: IMF staff report content (Excerpts provided in the supplied content).*

### 1.4 Livelihoods and Social Protectio

### 1.4 Livelihoods and Social Protectio

### National Priority Programs and Core Budget (in percent of GDP)
- National Priority Programs total: 2.79, 9.1, 0.2, 0.2, 12.4
  - Education and Vocational Training: 0.1, 0.4, 0.0, 0.0, 0.3
  - Health and Nutrition: 0.2, 0.4, 0.1, 0.2, 2.0
  - National Emergency Employment Program: 1.2, 0.8, 0.0, 0.0, 1.1
  - National Solidarity Program: 0.4, 2.5, 0.0, 0.0, 3.7
  - Afghanistan Stabilization Program: 0.0, 1.4, 0.0, 0.0, 1.9
  - National Transportation Program: 0.6, 3.1, 0.0, 0.0, 1.5
  - National Irrigation Program: 0.2, 0.5, 0.0, 0.0, 1.6
  - National Feasibility studies program: 0.0, 0.0, 0.0, 0.0, 0.4
  - Unclassified: 0.0, 0.0, 0.0, 0.0, 0.0

- Operating budget balance (excluding grants): -5.3, -5.3, 5.4, -3.4, -5.5, -5.4
- Operating budget balance (including grants): -0.1, -0.8, 0.0, 0.0, 0.3, 0.0
- Core budget balance: -0.1, -2.4, 0.0, 0.0, 0.3, 0.0
- Float and adjustment: 4/-0.4, 0.8, 0.0, 0.2, -0.1, 0.0

### Financing (in percent of GDP)
- Total Financing: 0.0, 1.7, 0.0, -0.2, -0.2, 0.0
  - External Loans (net): 1.6, 0.0, 1.8, 1.8, 1.2
  - Domestic (net): 0.0, 0.1, 0.0, -2.0, -2.0, -1.2
    - Net transfers from foreign currency deposits 5/: 0.2, 0.0, -2.4, -2.4, -1.2
    - Domestic banking financing 6/: -0.3, -0.1, 0.0, 0.4, 0.4, 0.0
  - Other financing 7/: 0.8, 0.0, 0.0, 0.0, 0.0, 0.0

### Macroeconomic Memorandum items (exact figures preserved)
- Real GDP growth (in percent): 28.6, 15.7, ......, 7.5, 10.1
- Inflation (year-on-year): 52.3, 1.0, ......, 13.0, 10.0
- Current account (percent of GDP): -3.5, 1.7, ......, 1.8, -1.7

### Notes and data caveats (as provided)
- Sources: Ministry of Finance; Da Afghanistan Bank; and Fund staff estimates and projections.
- 1/ Budget estimates. Staff projected domestic revenue of Af 12.8 billion for 2004/05.
- 2/ Staff projections. Government budget projections for core development spending in 2005/06. These projections represent commitments, while historical data are actual expenditures.
- 3/ Government program classification. The authorities have not been able to fully reconcile the program classification with government accounting data. This is due to classification problems. A new chart of accounts has been prepared for 2005/06 to overcome these problems.
- 4/ Variation between the fiscal position recorded at Ministry of Finance and DAB. This discrepancy is due to the difference (''float") between checks issued and checks cashed.
- 5/ Net transfers from foreign currency deposits. This includes temporary financing to bridge intra-year cash shortfalls for the operating budget, due to delays in the disbursement of grant funds. A positive sign corresponds to a decline in balances and a negative sign to an increase in balances.
- 6/ Banking financing refers to changes in the domestic government accounts with DAB. A positive sign corresponds to a decline in balances, and a negative sign to an increase in balances.
- 7/ In 2002/03, includes one-off transfers of overflight revenue and customs valuation fees accumulated over several years and the sale of telecommunication licenses.

---

### Monetary Program (Da Afghanistan Bank) — selected balances and indicators (levels in millions of Afghanis unless otherwise indicated)
- Net foreign assets 1/: 19,602; 41,147; 47,876; 55,267; 56,245; 64,805; 62,917; 64,932; 67,098; 69,175; 71,422
- Foreign assets (components)
  - Foreign exchange reserves: 19,602; 40,644; 47,343; 54,483; 55,445; 64,044; 62,117; 64,082; 66,198; 68,225; 70,422
  - Gold: 9,030; 14,015; 14,015; 14,015; 14,015; 14,015; 14,015; 0; 14,015; 14,015; 14,015
  - Other: 10,572; 26,628; 33,328; 40,468; 41,430; 50,029; 48,102; 64,082; 52,183; 54,210; 56,407
  - Other foreign assets: 0; 503; 533; 784; 800; 761; 800; 850; 900; 950; 1,000
- Net domestic assets: 1,074; -10,023; -16,117; -19,252; -17,179; -25,853; -21,361; -20,811; -20,260; -19,460; -18,659
  - Domestic assets: 14,361; 6,796; 3,308; -598; 1,676; -4,868; -1,049; -799; -549; -49; 451
  - Net claims on general government: 14,361; 6,796; 3,308; -598; 1,676; -4,868; -1,049; -799; -549; -49; 451
    - Net claims on government before 2002/03: 14,951 (repeated across periods)
    - Net claims on government in 2002/3–2004/05: -590; -8,155; -11,643; -15,549; -13,274; -19,819; -16,000; -15,750; -15,500; -15,000; -14,500
  - Domestic currency deposits 2/: -344; -1,984; -1,069; -466; -733; -1,488; -1,500; -1,500; -1,500; -1,500; -1,500
  - Foreign currency deposits 2/: -245; -6,171; -10,574; -15,083; -12,541; -18,331; -14,500; -14,250; -14,000; -13,500; -13,000
  - Other items net: -13,287; -16,818; -19,425; -18,653; -18,856; -20,984; -20,312; -20,011; -19,711; -19,410; -19,110
- Reserve money: 20,676; 31,124; 31,759; 36,015; 39,066; 38,953; 41,555; 44,121; 46,837; 49,715; 52,763
  - Currency in circulation 4/: 20,676; 28,801; 30,172; 35,054; 38,066 3/; 37,116; 39,755 3/; 42,208 3/; 44,812; 47,578; 50,513
    - Banknotes and coins issued: 21,302; 29,726; 31,226; 36,226; 39,316; 39,426; 41,555; 44,058; 46,712; 49,528; 52,513
    - less cash holdings 4/: 626; 925; 1,054; 1,172; 1,250; 2,310; 1,800; 1,850; 1,900; 1,950; 2,000
  - Bank deposits with DAB and capital note holdings: 0; 2,323; 1,587; 962; 1,000; 1,836; 1,800; 1,913; 2,025; 2,138; 2,250

### Monetary indicators and other memorandum items (as presented)
- Currency in circulation (year-to-date change): ...; 40.9; 4.8; 21.7; 32.2; 28.9; 38.0; 6.2; 12.7; 19.7; 27.1
- Currency in circulation (year-on-year change): 20.1; 40.9; ...; ...; ...; ...; 38.0; 39.9; 27.8; 28.2; 27.1
- Gross international reserves (end-of-period level; in millions of U.S. dollars): 426.1; 815.5; 949.9; 1,093.2; 1,112.5; 1,285.0; 1,246.3; 1,285.7; 1,328.2; 1,368.9; 1,413.0
- Consumer prices in Kabul (quarterly change): -4.0; -0.6; 6.8; 1.3; ...; 4.0; ...; ...; ...; ...; ...
- Consumer prices in Kabul (annual change): 52.3; 10.3; 15.5; 14.1; ...; 11.9; 13.0; ...; ...; ...; 10.0

### Monetary program notes
- Sources: Da Afghanistan Bank; Central Statistics Office; and Fund staff estimates and projections.
- 1/ Foreign currency amounts converted into Afghani at the program exchange rate (Af 49.84 per U.S. dollar in 2004/05–2005/06); gold valued at $400 per ounce in 2004/05–2005/06.
- 2/ In 2002/03, includes only Ministry of Finance deposits.
- 3/ The projections are consistent with the quarterly indicative ceilings on the cumulative changes in currency in circulation.
- 4/ In 2002/03, cash holdings only include cash in DAB treasury vaults. Starting in 2003/04, they also include cash in DAB's six major branches.

---

### Balance of Payments (In millions of U.S. dollars)
- Trade balance: -1,217.6; -1,892.0; -1,882.0; -1,958.5; -1,999.4; -2,000.0
  - Exports of goods 1/: 1,290.6; 1,893.9; 1,953.0; 1,856.9; 1,644.8; 1,461.2
    - Domestic exports: 276.8; 376.8; 418.2; 575.3; 669.5; 723.4
    - Reexports: 1,013.9; 1,517.1; 1,534.8; 1,281.6; 975.3; 737.8
  - Imports of goods: 2,508.2; 3,785.9; 3,835.0; 3,815.4; 3,644.1; 3,461.2
    - Recorded imports: 1,142.3; 1,688.5; 1,937.2; 1,974.4; 1,877.8; 1,883.4
    - Commodity food aid: 94.0; 40.9; 23.6; 0.0; 0.0; 0.0
    - Unrecorded: 1,271.9; 2,056.5; 1,874.2; 1,841.0; 1,766.3; 1,577.9
- Services: -145.1; -439.3; -455.8; -277.7; -318.6; -244.9
  - Receipts: 50.8; 105.5; 119.6; 83.1; 113.6; 106.8
    - Donor-related: 45.9; 94.2; 100.1; 56.9; 70.9; 54.5
    - Other: 4.9; 11.3; 19.5; 26.2; 42.7; 52.3
  - Payments: 195.9; 544.8; 575.4; 360.8; 432.2; 351.8
    - Donor-related: 195.9; 544.8; 575.4; 360.8; 432.2; 351.8
      - Wages of expatriates: 131.3; 470.9; 500.5; 284.6; 354.6; 272.7
      - Other: 64.6; 73.9; 74.8; 76.2; 77.6; 79.1
- Income (net): -1.1; -3.4; 4.1; 13.2; 19.2; 23.1
  - Receipts: 0.0; 4.9; 13.8; 25.3; 32.8; 38.3
  - Payments (interest) 2/: 1.1; 8.3; 9.7; 12.1; 13.7; 15.3
- Current transfers 3/: 1,221.7; 2,413.7; 2,435.9; 2,110.1; 2,058.0; 1,978.4
  - Public: 1,170.1; 2,358.7; 2,354.1; 2,016.0; 2,006.0; 1,926.4
    - Commodity food aid: 94.0; 40.9; 23.6; 0.0; 0.0; 0.0
    - Other: 1,076.2; 2,317.8; 2,330.5; 2,016.0; 2,006.0; 1,926.4
  - Private: 51.6; 55.0; 81.7; 94.1; 52.0; 52.0
  - Other: 0.0; 0.0; 0.0; 0.0; 0.0; 0.0
- Current account balance (including grants): -142.0; 79.0; 102.2; -112.9; -240.8; -243.5
- Current account balance (before grants): -1,363.7; -2,334.7; -2,333.7; -2,223.0; -2,298.8; -2,221.9
- Capital financial account: 144.0; 147.7; 265.5; 269.2; 289.9; 292.4
  - Public loans: 94.0; 89.9; 165.2; 158.8; 168.8; 168.8
    - Disbursements: 100.2; 96.1; 171.5; 165.0; 175.0; 175.0
    - Amortization paid 2/: 6.2; 6.2; 6.2; 6.2; 6.2; 6.2
  - Direct investment: 50.0; 57.8; 100.3; 110.4; 121.1; 123.6
- Net errors and omissions: 153.3; 152.3; 52.2; 0.0; 0.0; 0.0
- Overall balance: 155.3; 379.0; 419.9; 156.3; 49.1; 49.0
- Financing: -155.3; -379.0; -419.9; -156.3; -49.1; -49.0
  - Change in net foreign assets of DAB: -101.0; -389.4; -430.5; -167.0; -60.0; -60.0
  - Fund credit (net): 0.0; 0.0; 0.0; 0.0; 0.0; 0.0
- Exceptional Financing: -54.3; 10.4; 10.6; 10.7; 10.9; 11.0
  - Arrears 2/: -54.3; 10.4; 10.6; 10.7; 10.9; 11.0
  - Debt rescheduling: 0.0; 0.0; 0.0; 0.0; 0.0; 0.0
  - Debt forgiveness: 0.0; 0.0; 0.0; 0.0; 0.0; 0.0
- Financing gap: 0.0; 0.0; 0.0; 0.0; 0.0; 0.0

Memorandum items:
- Official foreign exchange reserves (in millions of U.S. dollars): 426; 816; 1,246; 1,413; 1,473; 1,533
- Official foreign exchange reserves (in months of prospective imports) 4/: 1.8; 3.4; 5.2; 5.5; 5.7; 6.1
- Current account balance (In percent of GDP), including grants: -3.5; 1.7; 1.8; -1.7; -3.1; -2.7
- Current account balance (Excluding grants): -33.4; -50.9; -42.2; -33.2; -29.8; -25.1
- GDP (In millions of U.S. dollars): 4,084; 4,585; 5,526; 6,687; 7,705; 8,864

Notes:
- 1/ Excludes opium exports and, because information is unavailable, flows associated with U.S. Army and most ISAF activities.
- 2/ Debt service projections are based on recognized obligations, reconciled with creditors. Arrears shown here represent an estimate by Fund staff, on the basis of loans which have been verified with creditors, but are not being serviced.
- 3/ Includes all grants. The core budget tables (3a and 3b) reflect only grants to the core budget and not those financing projects implemented directly by donors.
- 4/ In months of prospective imports of goods and services, excluding imports for reexport.

---

### Relations with the Fund (As of January 31, 2005)
- Membership Status: Joined July 14, 1955; Article XIV.
- General Resources Account: Quota 161.90 SDR Million, 100.00 percent; Fund holdings of currency 161.92, 100.01 percent; Reserve position in Fund 0.00, 0.00 percent.
- SDR Department: Net cumulative allocation 26.70 SDR Million, 100.00 percent; Holdings 0.04, 0.14.
- Outstanding Purchases and Loans: None.
- Financial Arrangements: None.
- Projected Obligations to Fund (SDR million; based on existing use of resources and present holdings of SDRs) — Forthcoming:
  - 2005–2009 Principal: 0.00 across 2005–2009
  - Charges/Interest: 0.61 (2005); 0.62 (2006); 0.62 (2007); 0.62 (2008); 0.62 (2009)
  - Total: 0.61; 0.62; 0.62; 0.62; 0.62
- Implementation of HIPC Initiative: Not Applicable

### Exchange Arrangement and Monetary Operations
- Afghanistan is an Article XIV member country. Authorities are implementing a liberal exchange system; based on information currently available, no exchange restrictions and multiple currency practices are currently in place.
- Authorities intend to formalize the current liberal regime through the adoption of new laws and regulations; technical assistance (TA) requested from the Fund.
- Afghani has been floating at least since end-2001; more recently authorities implement a managed float with no predetermined path for the exchange rate. As of March 20, 2005, the average exchange rate on the Kabul money exchange market was Af 48.65 per $1.
- To conduct monetary policy, authorities rely on foreign exchange auctions since May 2002. Auctions are open to all licensed money changers; DAB has introduced transparency measures and improved auction mechanics. Auctions are linked to the overall monetary program and held at 1–2 week intervals.

### Article IV Consultation
- Last Article IV consultation discussed by the Executive Board on January 19, 2005. Consultations on the standard 12-month cycle.

### Technical Assistance, 2002–05 (departments and purposes; selected entries)
- Interdepartmental: January 27–31, 2002 — Initial assessment of TA needs.
- FAD: February 10–21, 2002 — Fiscal management; May 13–26, 2002 — Tax policy and administration; January 5–18, 2003 — Fiscal management; October 22–November 4, 2003 — Expenditure management; March 2004 (ongoing) — Resident Treasury Expert; March 22–April 3, 2004 — Tax policy and administration; April 18–May 2, 2004 — Customs administration.
- MFD: February 27–March 7, 2002 — Financial sector reform; May 19–June 2, July 10–27, 2002 — Financial sector reform; December 11–16, 2002 — Financial sector legislation workshop; September 7–16, 2003 — DAB restructuring program and creation of a central bank short-term debt instrument; February 2–6, 2004 — Anti-money laundering legislation; March 21–30, 2004 — DAB capital adequacy and balance sheet structure; December 2005 (ongoing) — Training coordinator; February 2–15, 2005 — Implementation of DAB balance sheet reconstruction and capital adequacy recommendations.
- LEG: February 27–March 7, 2002 — Financial sector legislation; December 11–16, 2002 — Financial sector legislation workshop; February 2–6, 2004 — Anti-money laundering legislation; March 3–21, 2004 — Fiscal revenue legislation; January 29–February 12, 2005 — Income Tax Law.
- STA: Multiple missions on multisector statistics, Consumer Price Index, Government finance statistics, Monetary and financial statistics, Balance of Payments statistics across 2002–2005 (detailed mission dates listed in source).
- Additional TA notes:
  - A resident treasury expert for the Ministry of Finance, Mr. Platais, appointed March 2004.
  - Afghanistan participates in the Middle East Technical Assistance Center (METAC).
  - Resident multisector statistical advisor, Mr. Soulatha, stationed July 17, 2002; STA peripatetic missions began January 2004, suspended July 2004 due to security, recommenced January/February 2005.
  - Resident MFD expert posted July–October 2002 at DAB as accounting adviser; several experts visited April 2002–February 2003 for payment systems, restructuring, and bank supervision.
  - Sweden Technical Assistance SubAccount financed training activities for DAB in 2004 and a monetary policy peripatetic advisor for December 2004–December 2005.

### Resident Representatives
- Fund resident representative in Pakistan, Mr. Ghesquière, assisted relations in early 2002. Resident representative, Mr. de Schaetzen, took post in Kabul on August 24, 2002.

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### Relations with the World Bank (As of January 31, 2005) — key points
- Second Transitional Support Strategy (TSS) presented March 2003 focusing on: improving livelihoods; fiscal strategy; institutions and management; governance and public administration reform; enabling private sector development.
- World Bank intended to update country strategy for Afghanistan in 2005; a country assistance strategy covering a three-year period could be finalized in FY 2006 based on I-PRSP preparatory work.
- FY 2002: World Bank staff prepared and negotiated four projects using IDA grant funds totaling $100 million. After arrears clearance, first IDA credit for $108 million (Emergency Transport Project) approved March 2003. By end FY 2003, three additional projects approved totaling $215 million for the year (Emergency Health Sector Rehabilitation $59.6 million; Emergency Public Administration II $8.4 million; National Emergency Employment II $39.2 million).
- FY 2004: Five IDA credits/grants negotiated totaling $293 million:
  - Emergency Communications Project $22 million
  - Emergency Customs Modernization and Trade Facilitation $31 million
  - National Solidarity Program II $95 million
  - Emergency Irrigation Rehabilitation $40 million
  - Emergency Power Rehabilitation $105 million

*Source: _cr05128 - 1.4 Livelihoods and Social Protectio (IMF staff estimates, tables, and appendices as provided in the source content).*

### 4. For FY 2005, four projects were approved in July 2004, for a total of $145 million:

### _cr05128 - 4. For FY 2005, four projects were approved in July 2004, for a total of $145 million:

### World Bank approved projects and planned commitments
- For FY 2005, four projects were approved in July 2004, for a total of $145 million:
  - Programmatic Support for Institution Building ($80 million) — the first budget-support operation.
  - Kabul Urban Reconstruction Project ($25 million).
  - Investment Guarantee Facility ($5 million), together with MIGA.
  - Education Quality Improvement Program ($35 million).
- An additional project, Public Administration Capacity Building ($27 million), was approved in January 2005.
- Three other projects are planned, for an additional commitment of $113 million:
  - A supplemental financing for the Emergency Transport.
  - The Strengthening Higher Education project.
  - The National Solidarity Program.

### Afghanistan Reconstruction Trust Fund (ARTF) performance and role
- ARTF became effective in May 2002 and plays a critical role in funding the recurrent costs of government.
- In its first year of operation (SY 1381—March 21, 2002 to March 20, 2003):
  - ARTF mobilized $185 million and disbursed $65 million.
- Paid-in contributions for SY 1382 (March 21, 2003 to March 20, 2004) amounted to $286 million, while disbursements reached $254 million.
- Pledges for SY 1383 (March 20, 2004 to March 20, 2005) amount to $426 million.
- ARTF is increasing its financing of investments and has the potential to support tighter donor coordination, simplified processes, and fast results.

### World Bank advisory, analytical work, and institutional strengthening
- The World Bank released a country economic report in September 2004: “State Building, Sustaining Growth, and Reducing Poverty.”
- Current analytical and advisory work includes:
  - Civil service reform.
  - Urban development and land management.
  - Education policy reform.
  - Labor market and pensions.
  - A gender assessment.
  - Oil/gas infrastructure development.
  - Broader regional trade work encompassing issues with Afghanistan’s neighbors.
- The World Bank has initiated a major Public Finance Management (PFM) Review, incorporating:
  - A review of public expenditures and fiduciary aspects, including procurement and financial management.
- Fund staff contributions to the PFM review include providing an analysis of domestic revenue prospects.
- The World Bank has actively utilized the Post Conflict Fund and continues to use the Japan Social Development Fund resources to provide on-the-ground support to the government and communities.

### World Bank program size and staffing
- As of February 2005, the World Bank’s program comprises:
  - An active IDA portfolio of 15 investments and one budget support operation.
  - One project has closed.
  - Total commitments add up to $753 million, of which 40 percent has been disbursed as of January 2005.
- The World Bank’s office in Kabul is fully functional and growing rapidly:
  - A country manager, several other international staff, and a growing number of national staff are now in place.

### SMP, MEFP, and government engagements with IMF (summary from attachments)
- The Government of Afghanistan held discussions with Fund staff in the context of the third review of the staff-monitored program (SMP), put in place in March 2004.
- The government and IMF staff reached understandings on an extension of the current SMP for six months—through end-September 2005.
- The government reported meeting all the end-December 2004 quantitative indicators and structural benchmarks, except for the benchmark on publishing the central bank and banking laws in the official gazette:
  - The central bank law has already been published.
  - Technical delays slowed gazetting of the commercial banking law; publication expected in the immediate future.
- Several benchmarks initially set for end-March 2005 were moved to end-June 2005 or end-September 2005 to avoid bunching and accommodate capacity constraints associated with newly appointed cabinet and senior officials.

### Macroeconomic developments and projections (2004/05 and medium term)
- Agricultural output is expected to fall by 17 percent in 2004/05, due to adverse weather conditions.
- Overall, real GDP growth would amount to about 8 percent in 2004/05.
- Consumer prices in Kabul:
  - Increased by 4.0 percent during the third quarter of 2004/05.
  - Rose by 12.6 percent through the first nine months.
  - Excluding food items (whose prices increased by 6.9 percent), the consumer price index is estimated to have risen by 0.9 percent through the first nine months.
  - Year-on-year inflation amounted to 11.9 percent at end-December (6.6 percent excluding rents and petroleum products), compared to 14.1 percent at end-September.
- The consumer price index that includes five other major cities increased by 3.4 percent during the third quarter of 2004/05 and 8.4 percent over the first nine months of 2004/05.
- Domestic revenue for the first nine months of 2004/05 is estimated at Af 8.9 billion, exceeding the SMP indicative target of Af 8.6 billion.
- Operating budget expenditures amounted to Af 18.2 billion during the first nine months of 2004/05, compared with the annual budgeted amount of Af 30.3 billion.
- Core budget development spending was Af 8.4 billion while direct donor spending was reported at $1.5 billion, compared to the budget estimates of Af 38.4 billion and $3.5 billion, respectively, for the year as a whole.
- Reasons for slow development spending included:
  - Lack of capacity in line ministries and implementing agencies.
  - Delays in mobilizing donor funding.
  - Concerns over the level of insecurity.
- Total government employment was around 375,000, including 134,000 for the police and defense force, compared to a budget estimate of 406,000.
- Currency in circulation amounted to Af 37.1 billion at the end of the third quarter of 2004/05, slightly below the SMP indicative ceiling (Af 38.1 billion).
- Pilgrims’ deposits with DAB totaled Af 2.5 billion.
- Foreign exchange reserves increased to $1.2 billion at end-December (equivalent to 5.3 months of 2005/06 imports).
- The nominal exchange rate was about Af 48 per dollar at end-December.
- Preliminary external current account (before grants) during the first three quarters narrowed to a deficit equivalent to 32 percent of GDP, down from about 39 percent during the same period in 2003/04.
- Disbursements of external loans were limited and on highly concessional terms.
- Positive errors and omissions in the balance of payments suggest continued presence of unrecorded inflows.

### Program outlook and medium-term targets
- Inflation is expected to reach about 13 percent year-on-year at end-2004/05.
- Real GDP is projected to grow by 10 percent in 2005/06 and over the medium term.
- Agriculture is projected to maintain an average growth rate of 4.5 percent.
- Inflation projected to decline to 10 percent in 2005/06 before tapering off to 5 percent in the ensuing years.
- To achieve the levels of growth necessary to reduce poverty and diminish the need for external resources:
  - Investment will need to average about 24 percent of GDP over the medium term.
  - Private savings are projected to rise to 0.5 percent of GDP in 2007/08, up from dissavings of 10.6 percent of GDP in 2004/05.
  - Private consumption is expected to decline from 106 percent of GDP to 94.1 percent over the same period.
- The government intends to implement a multi-pronged strategy to respond to the illegal opium economy, supported by the donor community:
  - Strategy to be implemented when many poppy farmers plan to turn voluntarily to other crops due to low farm gate prices and increased risk associated with government intervention.
  - The strategy will be supported by an interdiction campaign.
  - Full attention to providing alternative livelihoods to limit adverse economic impact on the most vulnerable.

### Fiscal policy and mid-year review (MYR) adjustments
- Domestic revenues are expected to total around Af 13.1 billion for 2004/05, exceeding the SMP target of Af 12.8 billion, but below the budget target of Af 15.4 billion.
- The MYR adjustments will reduce the operating budget allocations by at least Af 1.9 billion.
- The MYR introduced new projects totaling Af 3.9 billion ($78.4 million) into the core development budget, which is wholly donor-funded:
  - Projects receiving government discretionary funds by Presidential Decree after completion of the 2004/05 budget: Af 1.3 billion ($25.8 million).
  - New projects not included in the 2004/05 budget: Af 2.6 billion ($52.6 million).
  - Reallocation of discretionary funds within the existing budget toward faster-spending projects to increase spending on physical infrastructure.
- No changes were made to the external development budget, which is directly implemented by donor agencies.
- The MYR was approved by Presidential Decree.

*Source: _cr05128 - 4. For FY 2005, four projects were approved in July 2004, for a total of $145 million:*

### 17.      An acceleration of customs and tax reforms is required to boost domestic

### 17.      An acceleration of customs and tax reforms is required to boost domestic revenues

### Priority fiscal and revenue reforms
- Publish the amendments to the revenue laws, including the new Customs code (both are structural benchmarks).
- Introduce the updated import valuation schedule for customs and continue strengthening border facilities.
- Fully implement measures in last July’s tax reform package—including the services tax in Kabul (where compliance has been poor)—and the airport departure tax.
- Accelerate the implementation of the Priority Reform and Restructuring (PRR) of the revenue headquarters and the Kabul provincial revenue office.
- Give high priority to measures aimed at improving tax administration law and corporate law to give the MoF enforcement and collection powers; aim to have these published in the official gazette by end-September.

### Budget process, fiscal rules, and expenditure management
- Intend to approve the operating budget before the start of the fiscal year (March 21); the Core budget will be presented shortly after.
- Slight delay anticipated in adopting the Development budget for 2005/06 and some slippage in structural reforms due to the change in government; donors forum delayed to early April.
- Maintain the no-overdraft financing rule for FY 2005/06: fund the operating budget only from domestic revenue and external grant resources.
- Continue to limit borrowing to highly concessional external loans to fund development expenditures.
- Salary costs represent about 75 percent of operating expenditures and are expected to increase significantly over the medium term due to ongoing public administration reforms; formal arrangements to contain the wage bill will be discussed with the IMF during the next review of the SMP.
- Continue consolidation of government operations and improve fiduciary standards: treasury single account, cash planning, piloting new payment and payroll systems, and a single chart of accounts agreed for 2005/06.

### Monetary policy and central bank reform
- DAB will maintain the current stance on monetary policy aimed at maintaining low inflation while guarding against currency instability.
- Objective to reduce inflation from 13 percent in 2004/05 to 10 percent in 2005/06.
- Indicative targets for currency in circulation for the first half of 2005/06 are consistent with a 5 percent increase in monetization in 2005/06, compared with a projected 13 percent increase in 2004/05; program allows accommodation of up to an additional 5 percent perceived shifts in demand for Afghani.
- By end-March 2005 implement measures to allow DAB to focus on core activities: (i) transfer of DAB’s commercial accounts to other entities; (ii) transfer of its commercial holdings and potential liabilities to the MoF; and (iii) transfer to DAB of ownership of the monetary gold and silver held in the palace vaults.
- Publish DAB’s external audit financial statements by end-June 2005; if DAB is undercapitalized, decide on recapitalization by end-June 2005.
- Introduce an automated foreign auction system to allow access to commercial banks in a more market-based way.

### Banking sector reform
- Publish the banking law in the official gazette by end-March 2005 (structural benchmark).
- Strengthen supervision through enforcement of recently adopted DAB regulations.
- Modernize relicensed state-owned banks with technical assistance; by end-June 2005 decide on and start implementation of specific resolution processes for each of the three former state-owned banks that were not relicensed.

### External accounts, reserves, and debt management
- Afghanistan is one of the most open economies in the region, with a simple average applied tariff of only 4 percent.
- External current account (including grants) projected at a surplus of 1.8 percent of GDP for 2004/05—roughly the same level observed in 2003/04.
- Foreign exchange reserves would amount to about $1.2 billion at end-2004/05, equivalent to over 5 months of prospective goods and services imports.
- For 2005/06 expect some improvement in the merchandise trade account; under relatively conservative assumptions donor and private investment inflows, expect the external current account balance to deteriorate to a deficit of about 2–3 percent for the next two years, before gradually improving over the medium term.
- Complete a survey of external debts and reconciliation with bilateral creditors by end-March 2005.
- Design and implement a comprehensive external debt management strategy by end-September 2005.
- Continue contracting only highly concessional external loans; disbursements have been limited and strategy remains guided by the indicative target on minimum concessionality established under the original SMP (March 2004).

### Structural reforms to support private sector development
- Continue efforts to eliminate constraints on private sector activity, including:
  - Reform of the legal and judicial framework for business with donor assistance.
  - Tax reforms to modernize and simplify procedures for enterprises.
  - Financial sector modernization.
  - Gazetting of the investment law by end-September 2005.
- Work to improve competitiveness via accelerated projects in energy, transportation, and telecommunications.
- Restructure state-owned enterprises and adopt a classification plan for these firms (by restructuring method) by end-September 2005.

### Poverty reduction and institutional arrangements
- Develop a poverty reduction strategy called the National Development Strategy.
- Complete an interim poverty reduction strategy paper (I-PRSP) by end-October 2005 based on a preliminary consultative process in Kabul and at the provincial level.
- Establish an Inter-Ministerial Committee (IMC) of ministers and deputies to coordinate the I-PRSP; form a predominantly Afghan technical working group under IMC; establish an External Advisory Group (EAG) of UN agencies, international financial institutions, key donors, and NGOs.

### Statistical improvement and technical assistance
- Central Statistical Office (CSO) to report to the newly created Ministry of Economy.
- Work, in coordination with key donors, to implement the statistical master plan; work program expected to be completed by end-March 2005.
- Funding of the statistical master plan is projected at $6.5 million.
- An evaluation of technical assistance (TA) is underway; complete assessment and adopt a TA plan by end-December 2005.

### Program monitoring and IMF relations
- Program monitored using definitions, data sources, and frequency in the attached TMU; quantitative indicators for end-March 2005, end-June 2005, and end-September 2005 included in Table 1; structural benchmarks in Table 2.
- Technical Committee of Coordination (TCC) to continue implementing the SMP, providing core data and deepening analytical functions.
- Fourth review of the program scheduled for early May 2005 based on indicative targets and benchmarks for end-March; indicators and benchmarks for end-June and end-September 2005 may be revised at that review.
- Given donor support and absence of an immediate balance of payments need, a six-month extension of the current SMP to end-September 2005 is proposed to build administrative and statistical capacity and allow broad ownership of the reform strategy until after the legislative elections.

### Selected quantitative and benchmark highlights (preserve original numeric detail)
- Salary costs represent about 75 percent of operating expenditures.
- Inflation target: reduce from 13 percent in 2004/05 to 10 percent in 2005/06.
- Monetization targets: 5 percent increase in monetization in 2005/06 versus projected 13 percent increase in 2004/05; program flexibility to accommodate up to an additional 5 percent.
- External current account (including grants): surplus of 1.8 percent of GDP for 2004/05.
- Foreign exchange reserves: about $1.2 billion at end-2004/05, equivalent to over 5 months of prospective goods and services imports.
- External current account balance expectation: deficit of about 2–3 percent for the next two years under conservative assumptions.
- Statistical master plan funding: $6.5 million.
- Key structural benchmark target dates: end-December 2004; end-March 2005; end-June 2005; end-September 2005; end-October 2005; end-December 2005; March 21 (start of fiscal year).
- Structural benchmark status note: Only the central bank law was published in the Official Gazette (table footnote).

*Source: IMF staff report (Attachment II: program text and structural benchmarks) contained in content unit _cr05128 - 17. An acceleration of customs and tax reforms is required to boost domestic revenues.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05128.pdf_