IMF Executive Board Concludes 2011 Article IV Consultation with AfghanistanPublic Information Notice (PIN) No. 11/140
November 16, 2011
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
Afghanistan has made important achievements in recent years. 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. As a result, economic activity has been robust, with real GDP growth averaging more than 10 percent annually over the last five years (8 percent in 2010/11). The government has increased revenue collection to 11 percent of GDP in 2010/11 from 8 percent in 2008/09. Still, current collection levels cover only about two-thirds of central government operating expenditures and less than 20 percent of total public spending (defined as central government spending plus off-budget donor spending). Headline and core inflation have moderated slightly, but remain relatively high at about 10 percent year-on-year in September.
Last year’s crisis at Kabul Bank, the largest bank in Afghanistan, exposed the country’s serious governance problems, and highlighted the devastating effects of endemic corruption. The initial intervention by the central bank and the government’s decision to provide a full deposit guarantee prevented a full-blown banking crisis. However, the subsequent crisis management was slow, and somewhat reluctant to tackle some important but politically difficult issues such as asset recovery and filing charges against the main architects of the fraud. As a result, the financial system has been severely weakened and is not playing its role in facilitating private sector led growth.
Over the coming three to five years, Afghanistan will face additional challenges as the international military presence is wound down and the government has to take over spending currently financed by donors. Foreign troops are expected to gradually withdraw by 2014. As a result, Afghanistan’s security forces will have to take over more responsibility, leading to higher spending. At the same time, the government may lose revenues related to spending by foreign troops in Afghanistan. Moreover, it is likely that total grants decline from an estimated over 40 percent of GDP in 2010/11 to less than 30 percent of GDP in 2013/14.
These developments will weigh heavily on economic activity and require difficult decisions. Fiscal policy will need to accommodate growing spending pressures, while domestic revenue is likely to be adversely affected, the future level of budget grants is uncertain, and Afghanistan has limited scope for foreign borrowing. Therefore, the government will struggle to make ends meet in the near term. Moreover, the withdrawal of the international presence will entail lower foreign inflows that will require external adjustment, initially through competitiveness gains.
In this context, making quick progress towards Afghanistan’s social and development objectives will be challenging. Afghanistan remains one of the poorest countries in the world, with a per-capita income of US$530 in 2010/11 and a national poverty rate of 36 percent in 2007/08. The authorities have made inroads toward achieving some of the Millennium Development Goals. For example, child mortality was reduced and school enrollment increased, albeit from very low levels—the enrollment rate for primary schools is less than 40 percent. At the same time, the authorities also acknowledge that achievements in some areas are below expectations: more than 40 percent of children under the age of five are underweight; progress in increasing access to potable water and sanitation remains slow; and the literacy rates for men and women aged 15 to 24 are 51 and 22 percent respectively. Overall, the low execution rate of only 40 percent of the development budget reflects a generally limited absorption capacity, and impedes more rapid progress toward poverty reduction.
Executive Board Assessment
Executive Directors commended the authorities for the important achievements in recent years, despite the difficult political and security environment. Economic growth has been strong, the fiscal position has improved, inflation has remained moderate until recently, and the central bank has built up international reserves. There has also been improvement in some poverty indicators.
Directors agreed that the Extended Credit Facility (ECF)-supported program, accompanied by a technical assistance agenda, provides an appropriate framework for addressing the considerable challenges lying ahead, and a basis for continued engagement with the donor community. They highlighted in particular the importance of enhancing financial sector stability, strengthening revenue performance and expenditure management, improving the business environment, and reducing poverty. Noting the significant risks to the program, Directors stressed that strong commitment and ownership by the authorities of the program will be paramount.
Directors acknowledged the initial actions taken by the authorities to contain the crisis at Kabul Bank. However, subsequent efforts to manage the crisis have been slow. Directors urged the authorities to step up efforts in the areas of asset recovery, and ensure that banking regulations and relevant laws are fully enforced, including by bringing charges against the architects of the fraud. They stressed the importance of fully meeting the relevant prior action before the first review under the program. Directors also urged the authorities to press ahead with efforts to strengthen financial sector supervision and the overall legal and regulatory framework, including the Anti Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework. Restoring confidence in the banking system will be important for Afghanistan’s economic development in the upcoming transition period.
Directors noted that the planned withdrawal of foreign troops and the expected gradual decline of donor support will have implications for growth, external adjustment, and the fiscal position, which will need to be managed carefully. While welcoming the progress on revenue generation, Directors encouraged the authorities to aim for more ambitious targets to ensure fiscal and debt sustainability. Expediting the introduction of the Value Added Tax (VAT), improving revenue administration, and consideration of additional measures if needed would be important steps in this regard. On the expenditure side, public financial management reforms will ensure effective prioritization of spending, especially pro-poor spending.
Directors welcomed the authorities’ intention to tighten monetary policy to address inflation concerns. For monetary policy to be effective, they encouraged the authorities to enhance the independence of the central bank and reach an agreement on the capital requirement of the bank.
Directors stressed that significantly enhancing governance and taking wide-ranging measures to combat corruption and address the illicit economy are critical for Afghanistan’s economic development. They urged the authorities to implement reforms to improve the business environment, while maintaining a policy focus on inclusive growth and poverty reduction. Addressing delays in public enterprise reform and developing a framework to fully realize the potential from mineral resources will also be important.