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Program note

Islamic Republic of Afghanistan

Last Updated: April 8, 2014

Current IMF-Supported Program

On November 14, 2011, a three-year, US$130 million Extended Credit Facility (ECF) arrangement was approved by the IMF Executive Board and on June 29, 2012, the first review of Afghanistan's ECF-supported program was completed.

Background

Over the past decade, Afghanistan has made enormous progress in reconstruction and development, more than doubling its income per capita levels. Important steps have been taken to lay the foundation for macroeconomic stability and growth, reduce poverty, and raise living standards, despite difficult security conditions and the challenges of rebuilding institutions. With significant reform efforts and donor support, Afghanistan has maintained macroeconomic stability, implemented important structural reforms, and built policy buffers: a comfortable international reserves position, low debt and inflation, and balanced budget and external current account positions, after grants.

The authorities have taken steps to lay the foundation for economic stability and growth, despite a very difficult security situation and the challenges associated with building political and economic institutions. Improved economic performance and reforms implemented in key areas enabled Afghanistan to qualify for debt relief under the Heavily Indebted Poor Country Initiative in January 2010, leading to a 96 percent reduction in Afghanistan’s 2006 stock of external debt. Following this extensive debt relief, Afghanistan’s debt burden was alleviated significantly—external public and publicly guaranteed debt amounted to $1.3 billion, or 6.1 percent of GDP, at end-2013.

Afghanistan is one of the poorest countries in the world and relies heavily on donor grants to fund development and security spending. Per capita income for 2012 is estimated at about US$680, and the country ranks well below its neighbors on most human development indicators. Afghanistan has made progress toward its social and development objectives and the Millennium Development Goals, though substantial challenges remain. For example, child mortality has been reduced and school enrollment increased, albeit from very low levels—the enrollment rate for primary school is less than 40 percent. At the same time, achievements in some areas are below expectations: more progress is needed in reducing the number of children under the age of five that are underweight; in increasing access to potable water and sanitation; and improving literacy rates for men and women aged 15 to 24. Overall, the low implementation rate of the development budget impedes more rapid progress toward poverty reduction. Nonetheless, progress has also been made toward achieving social and development objectives, including the Millennium Development Goals (MDGs)—Afghanistan is one of 20 fragile and conflict-affected states that have already met one or more MDG targets.

Role of the IMF

In 2001 Afghanistan’s infrastructure and institutions were in disarray as a result of years of conflict and erratic policies. The most pressing economic tasks involved restoring economic stability and rebuilding institutions, against the challenging backdrop of an unstable security situation.

The IMF became involved in Afghanistan in 2002, to assist in rebuilding economic institutions and in providing advice to the government on economic policies and reforms. In addition to regular visits by staff teams to discuss economic policies, the IMF has had a permanent resident representative in Kabul during 2002-14 and has been providing technical assistance to develop monetary instruments, strengthen the central bank, modernize foreign exchange regulations, revamp tax and customs administration, establish a fiscal regime for the natural resources sector, enhance public financial management, and improve the national accounts, and price and balance of payments statistics. The first ECF-supported program during 2006–10 was broadly successful in maintaining macro stability and promoting reform. The second three-year ECF program started on November 14, 2011 and has also been successful in maintaining macro stability and promoting reform.

The 2011–14 ECF-Supported Program

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

In the near term, one objective of the ECF is to safeguard the fragile financial sector. Prominent among the measures is the strengthening of the banking law and central bank supervision and regulations, and resolution of issues related to the now-bankrupt Kabul Bank, including enforcing collection from the beneficiaries of $1 billion worth of loans and other assets sought for recovery. At the same time, a new bridge bank comprising Kabul Bank’s liabilities (public deposits) and government bailout money is being offered for sale. The central bank is taking steps concurrently to strengthen supervision and better enforce existing banking laws and regulations, while also reviewing, and improving as needed, the regulatory framework.

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

Finally, the third objective is to raise the government’s domestic revenue collection and move Afghanistan toward fiscal sustainability. While significant progress was made during 2007–11, with revenue collection increasing to ­11 percent of GDP from less than 7 percent, domestic revenue subsequently declined (to 9.5 percent of GDP in 2013) because of lower economic activity, slower dutiable import growth, a continued shift away from high-tariff imports, as well as lower compliance. The government plans to continue with reforms in revenue administration to further boost revenue collection. Moreover, the government is preparing for the introduction of a value-added tax, including adopting a value-added tax law, explaining this new tax to the private sector, and training the staff in revenue administration. It is also well advanced in preparing a fiscal regime for the natural resource sector that shares revenue with the government while preserving investment incentives.  Achieving fiscal sustainability calls for further reforms and may take more than a decade.

Within its limited budget means, Afghanistan will try to allocate sufficient resources to social and development spending. The withdrawal of foreign troops and security and political uncertainties in 2012–13 have affected economic growth and may affect revenue collection. At the same time, security-related expenditures will be needed. Nevertheless, the government is committed to protecting social spending, but will need to rely on donor support for years to come to make continued progress toward its development objectives. In this context, the authorities are also strengthening their budget implementation capacity.

Additional Challenges

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