Transcript of a Press Conference Call by Mohamad Elhage, Chief of the International Monetary Fund's Mission to the Islamic Republic of Afghanistan, on the IMF's Article IV Consultation Report

February 20, 2008

Washington, D.C.
Wednesday, February 20, 2008

MR. BUENEMANN: Good morning to everyone here in the American time zones, and good afternoon or good evening to those who are further eastwards.

I'm Niels Buenemann of the IMF External Relations Department. I'm here together with Mohamad Elhage, who is leading the IMF's work on the Islamic Republic of Afghanistan. It's now 10:00 a.m. here in Washington. And I should like to welcome you to the conference call on a staff report dealing with the Third Review of Afghanistan's performance under the economic program supported by a three-year Poverty Reduction and Growth Facility arrangement, also known as PRGF.

The staff report and accompanying papers were made available three hours ago on the IMF's online media briefing center. This report and the contents of the conference call will be under embargo until 11:00 a.m. Washington time, which is 1600 GMT. That is one hour from now.

I should now like to give the floor to Mohamad Elhage for some opening remarks. Mohamad?

MR. ELHAGE: Thank you, Niels. Good morning, everyone. My name is Mohamad Elhage. I am the IMF's Mission Chief for Afghanistan. I would like to take this opportunity to report to you on the outcome of the discussions we had with the Afghan authorities in the context of the third review of the program under the Poverty Reduction and Growth Facility, known as PRGF, and the 2007 annual consultation.

For that purpose, we visited Kabul in November 2007 and in January-February 2008. The related Executive Board discussion took place a week ago, on February 13.

Despite a difficult security environment, Afghanistan continues to make satisfactory progress under the PRGF-supported program that was endorsed by the IMF Board in June 2006. The program focuses on achieving macroeconomic stability and strengthening the institutional framework for conducting monetary and fiscal policies.

Low domestic revenue and capacity constraints in the Ministry of Finance and at the central bank pose a major challenge. Recently, new challenges stemming from the unreformed status of the state-owned enterprises and the rapidly growing banking sector also came to the fore.

Afghanistan's overall economic performance under the PRGF-supported program has been strong. Since the beginning of the program, fiscal revenue has increased steadily and the monetary policy framework has been enhanced. After a drought-induced slowdown to about 6 percent in the fiscal year 2006/07, real GDP growth is expected to exceed 13 percent in the current fiscal year, which will end on March 19, 2008.

Inflation declined to 5 percent last year but rose to double digits this fiscal year, owing mainly to sharp increases in the prices of imported fuel and foodstuffs. The underlying trends, however, signal that domestic inflationary pressures are being contained. Confidence in the domestic currency, which has remained broadly stable against the US dollar, has been instrumental in this regard.

Maintaining a strong performance over the medium term will depend critically on confronting governance issues, overcoming infrastructure bottlenecks, notably in the electricity sector, and implementing structural reforms to support private sector development. The government will need to focus on fostering competition, improving governance, and resisting pressures to expand its role in the economy. It will also need to clarify its relations with state-owned enterprises with a view to stemming potential fiscal drains.

It needs to be recognized, and it has been acknowledged by major donor partners and the authorities, that the shortage of energy is a major obstacle to Afghanistan's development. Redressing it would have an enormously positive impact on the business environment and the well-being of the population. In this context, we welcome the authorities' intention to link subsidy disbursement to the state-owned electricity company to concrete reform benchmarks, which should help modernize the sector and boost electricity supply.

Although the program remains on track, the continued success of the program hinges on mustering political support for implementing important tax reforms and other revenue enhancing measures that are necessary to achieve fiscal sustainability. Of immediate concern is that the revenue collection in the first nine months of the fiscal year 2007/08 turned out lower than envisaged under the program. This needs to be promptly addressed.

Also, the financial sector needs to be thoroughly supervised and properly regulated. In this regard, the central bank should be commended for the steps taken recently to strengthen bank supervision and refine the regulatory provisions pertaining to banks' domestic investment and minimum capital requirements. In addition, the authorities should follow-up on IMF staff's recommendations to improve the accounting system and internal controls at the central bank.

The managed float regime in place has served Afghanistan well, and the level of the exchange rate appears appropriate. In the future, improving competitiveness will require acceleration of structural reforms and further efforts at promoting a transparent and liberal trade regime. The authorities should also avoid further ad hoc changes to the tariff schedule.

The authorities have made satisfactory progress toward completing their Poverty Reduction Strategy Paper, which is called the Afghanistan National Development Strategy. In the period ahead, they should align sector strategies with the growth objectives, while taking into account the economy's absorptive capacity.

Moving forward, the program has been strengthened to address several new challenges. In particular, new measures have been introduced to clarify the government's role in the domestic petroleum market, address potential fiscal drains in the public enterprises, and further strengthen the supervisory and regulatory framework for the banking system, particularly in light of its recent rapid growth. Thank you very much.

MR. BUENEMANN: Thank you, Mohamad. Now, we proceed to the Q and A session.

QUESTIONER: Thanks very much. I had two questions. One is on the poverty rate. I know this isn't exactly your guys' cup of tea, but I just wondered whether you had any figures on whether Afghanistan had made much progress in reducing poverty and if you could quantify that.

And the second quick question was on opium production. You had a very interesting little box on opium output, and it does seem to be a fairly disastrous picture in the sense that you seem to be saying that Afghanistan now produces about 93 percent of the world's opium.

This probably wasn't what American foreign policymakers had in mind. I wonder if you can comment a little on the opium economy.

MR. ELHAGE: You're right, we had an interesting box on opium production and how it has developed in the past few years. In this area the IMF does not have much expertise. However, you might be aware that there was a meeting, in Tokyo last week, among major donors on how to address this issue in the period ahead.

The role of the IMF in this area has been to promote the licit economy and to provide recommendations on how to improve the business climate for private sector. On opium, we basically reported in the box information coming from others, not from us.

On poverty, there is a major survey underway. The 2005 survey had some shortcomings. And the current survey, which we expect to be completed later in the year, will give us a more comprehensive assessment on poverty indicators.

But you're absolutely right. This is an area in which we at the IMF don't get too much into detailed assessments. We work with our colleagues at the World Bank. But I think that after we get the revised survey, which is more comprehensive, we will have a better picture on poverty indicators in Afghanistan.

QUESTIONER: I was wondering if you can maybe put in perspective for us how the violence has actually affected the economy and how do you think that the government can get around that? Because it seems that Afghanistan is at an interesting juncture.

So, I guess, just for us who are not in Afghanistan, if you could put that into perspective: exactly how you see the economy continuing as the violence continues and perhaps escalates.

MR. ELHAGE: It's a very important question, and it has two implications. One implication is clearly on the investment climate in the country. In case the security situation weakens, you're going to see less of private and foreign direct investment. We have seen a reduction, to some extent, in foreign direct investment.

Also, there is the implication on the budget, because more spending will be allocated to security either through the central government budget or through the extended budget, which is funded by donors.

So, clearly the security situation is not helping in terms of achieving fiscal sustainability in the period ahead, and also it's having an impact on the investment climate.

QUESTIONER: Is there any way that the government at this stage can continue to rebuild the economy while the security situation continues, et cetera, et cetera?

MR. ELHAGE: Yes, quite a bit of progress has been made on institutional capacity building. For example, if we look at the revenue performance during the last five years. Revenue almost doubled as a percentage of GDP. The banking sector continues to grow, and the central bank continues to strengthen bank supervision.

So, progress at the macro level continues to be made. However, the security situation is clearly going to have an impact in any country where it weakens. It will impact the investment climate and investors' willingness to invest in the country.

The authorities are to be commended for achieving a stable macro environment. Despite the weakening security situation, if we look at the macro level, the economy continues to perform well. The economy is expected to grow by double digits this year. Yes, inflation picked up, but it's mainly due to external factors, like in many countries, reflecting increase in fuel and foodstuff prices.

So overall, the macro picture is conducive to promote investment. On the other hand, the security situation is not helping in that regard.

QUESTIONER: Are you seeing any feed through from the money coming into the country from the opium cultivation? Can you see any of that feeding through into the economy?

MR. ELHAGE: Again, in the box we have in the staff report, we rely on data from others who have more expertise in this area.

Given the size of the opium economy, we reported that farmers received about one billion US dollar during the 2007 season, clearly, a good part of that amount is injected in the economy, in the form of consumption or higher saving. Also, a good part of it is used to import goods.

In the case of Afghanistan, we do not have comprehensive reliable database for us to assess how the opium receipts are being channeled into the economy.

But, my view is that when you have farmers getting revenue for their harvest, they will use that like any other income. Either for consumption or for investment or for savings.

QUESTIONER: I just wanted to seek two clarifications. One is the implications about, you know, security and about the investment climate being affected. Do we have any numbers in terms of how much private investments or FDI had been cut due to the concerns on the security front?

And two, how much growth minus the opium would you see in terms of GDP, for example?

MR. ELHAGE: Let me take your second question first. What we report in our documents relates only to the licit economy. So, when we're reporting a double-digit growth, that is excluding the opium economy. We do not take opium production into account in our estimate of GDP.

Regarding investment, we need to keep in mind one issue. Our assessment is that yes, a better security situation will lead to higher investment. But again, we don't see any decline in private investment. What we're seeing is a lost opportunity. If the security situation improves, one would expect investment to be higher than it is right now.

Regarding foreign direct investment, you see quite a bit of investment now in telecommunication. Also announcements of foreign direct investment in the mining and other sectors continue to be made.

So, it's not that investment is not taking place. Our assessment that investment would have been at a higher level if the security situation would have been better.

QUESTIONER: But just a quick follow up, I'm amazed at a double digit growth. Of course, it's from a low base. But how do you expect investors to go into Afghanistan when you hear of suicide bombings maybe every other day?

And how do you expect reconstruction to take place particularly in the south where the security situation is really bad, where even NATO troops are sometimes refusing to go?

MR. ELHAGE: Regarding your first question on investment, you have an economy coming out of a post-conflict situation. There is a lot of investment taking place in Kabul. If you look at the construction sector, it's doing very well. The economy is growing.

Also, we need to keep in mind that there's quite a bit of investment coming from donors, which "crowds in" private investment.

So, investment is taking place. However, there has been a slowdown in foreign direct investment in 2006-2007, that is according to official estimates.

We also need to make a distinction between foreign direct investment and domestic investment led by the public sector and donors.

QUESTIONER: Hello. I'd like to ask two questions if I may. One following up on what you were just saying about drugs and the billion dollars of receipts that go into the pockets of farmers. I wonder if, considering that statement, you agree with the report that was put out, I think last week to coincide with the Tokyo donor's conference, by Professor Brian Ruben at New York University, where he argues that a sort of strict eradication campaign to wipe out poppy would cause terrible economic problems for many normal Afghans. And it would lead to a localized economic contraction and that a longer term approach and a sort of gradual weaning the farmers off poppy as a source of income should be required.

The second point—my second question is just on this issue of private sector development. I wonder if you agree with the quiet well-respected Afghan entrepreneur who I was talking to this afternoon. He said, security, electricity, these are all problems, but for him, it was rampant corruption within government that is one of the biggest things holding back the developments of private business.

MR. ELHAGE: On your first question, again, we do not have the expertise and we do not have the mandate to give advice on what is the best way to deal with the opium issue in Afghanistan.

Our sister organization, the World Bank, which participated in the Tokyo Conference, issued a report on Economic Incentives and Development Initiatives to Reduce Opium Production. They are better qualified to give an opinion on how to deal with the opium production.

Regarding your second question on corruption. This issue is discussed in our report. You also mentioned electricity. Electricity is a major concern for us. Because of its shortage and unreliable supply, the private sector continues to generate its own electricity at a very high cost.

This is having an impact on the cost of production in Afghanistan. This is why we have strengthened the program in order to increase the transparency and accelerate the reforms in the electricity sector. And also, any disbursement of subsidies from the Ministry of Finance to the electricity company is now linked to progress in its restructuring.

On the issue of governance, there is a need, and most government officials will acknowledge that, for progress in addressing it.

You will see, for example, that one of the conditions in the program is to have an external audit of the state-owned petroleum enterprise. Also there are conditions in the program related to external audits of public enterprises. The authorities are on board with this strengthening of the program, and they are also of the view that governance issues need to be addressed if the private sector is to play a bigger role in Afghanistan.

QUESTIONER: I was just thinking two things. I noticed that the portion of foreign aid relative to GDP had gone up quite substantially. I just wonder—if you took out that billion dollars of opium from consumption and you take foreign aid back down to where it was a couple of years ago relative to the size of the economy, would the economy still be growing?

I guess what I want to get a sense of is how independently sustainable is this. I'm guessing if you took away 66 percent of GDP, which is the foreign aid given, the economy would completely collapse. Now, is that a fair assumption?

MR. ELHAGE: I will put it differently. As regards foreign aid, part of that is going towards increasing investment in the country, and is thus contributing to growth. Now, you have two channels of foreign aid going into the country, what goes through the central government budget and what goes through the external budget.

In 2006/07, foreign aid was estimated at about 67 percent of GDP, and this ratio fluctuates from one year to another. It has to do with the reliability of the data that we have. Secondly, for example, in the external budget, a good part of aid is being spent on security. So, we need to make a distinction between what is going to security spending and what is going towards infrastructure and rehabilitation.

Clearly if foreign aid slows down and the private sector investment does not pick up, one would expect growth in the economy to slow down. But what we project over the next five years—and we have it in the staff report—is a gradual decline in foreign aid as a percentage of GDP, but at the same time, we are projecting that private investment, and domestic revenue will pick up. So, this economy will mature gradually over time, with less dependence on foreign aid and more on domestic revenue.

And also, we're looking at the scenario where the government can use the domestic market to finance part of its investment. We're helping the authorities to develop the financial market in Afghanistan and to develop the secondary market for debt instruments.

Again, what's important here is really to look at this economy year after year. Considerable progress has been made. Yes, there has been some weakening in security, but the authorities are committed—through the PRGF arrangement they have with the IMF—to maintain macro stability and to implement reform measures and to address issues of governance in order to improve the business environment for the private sector.

And again, every time we visit Kabul, there are new issues on the table for us and the authorities to address. And you will see, when you have the opportunity to look at the staff report, that the program has been strengthened in areas you mentioned, such as electricity, petroleum sector, and transparency.

QUESTIONER: Thank you once again. We had an interview recently with the central bank governor, and he was pushing for the fact that the Afghanistan government wants aid to be directed through the government. Do you think that Afghanistan would be ready for that? And would it be one way of kind of building up the capacity of the government?

And then can I have a follow up on that one? The other one is about Afghanistan seeking membership of the WTO by 2010. Does the IMF back this and what do you see as benefits?

MR. ELHAGE: On your first question, we do support the authorities' objective to have greater proportion of the external aid be channeled through the central government budget. But again, what we need to take into account is the institutional and the absorptive capacity of the central government. We have seen this process improve over time.

As the government improves the functioning of its ministries, more technical assistance is being provided in that regard, we will see more aid channeled through the national budget. But again, this will have to be done gradually. We already see more aid being channeled through the national budget.

Regarding your second question on WTO, we are working with the authorities to ensure that they have an open, transparent, and liberal trade regime. We intend to follow up on the issue of WTO during the next mission in April. And we will be in a better position to give more complete assessment in our report on this issue.

QUESTIONER: How much has the fiscal turmoil in Pakistan affected Afghanistan? Do you see that seeding through in the economy in anyway?

MR. ELHAGE: There has been some disruption in trade. Trade links between Afghanistan and Pakistan are very strong. And clearly, if there is instability in Pakistan, it has an impact on Afghanistan.

For example, whatever happens in terms of prices in Pakistan, it has an impact on prices in Afghanistan.

MR. BUENEMANN: So, if we have no further questions, it just remains for me to thank you for participating. And I would like to remind you that the embargo is set for 11:00 a.m. Washington time, which will be in 25 minutes from now. Thank you very much for listening and for participating.


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