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Islamic Republic of Afghanistan: Request for a Three Year Arrangement under the Extended Credit Facility—Debt Sustainability Analysis

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
July 2016
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Macroeconomic Outlook

1. The DSA’s baseline macroeconomic scenario assumes long-run improvements of security and political stability with continued reform and a gradual decline in aid dependence. Compared with the November 2015 DSA, perspectives for growth have weakened over the near term. This reflects a deterioration in security conditions, the continued impact of the troop withdrawal, a slower recovery in economic confidence, and delays in budget execution and in implementation of mining projects (discussed below). In the medium and long term, the baseline scenario assumes political stability with regular election cycles and continued economic reform with governments delivering on Afghanistan’s development goals and priorities that improve the business environment and governance to support private-sector-led inclusive growth. The scenario also assumes a more conservative (compared with the previous DSA) profile of donor aid disbursement. It is assumed to be sustained near current levels in this decade (averaging about $7 billion, or 35 percent of GDP, annually), and to be gradually declining afterwards, from about 30 percent of GDP in 2020 to 7 percent of GDP by 2035, with an increasing share being disbursed through the budget and provided to the civilian sector.2

Box 1.Macroeconomic Assumptions Comparison Table

DSA November 2015DSA July 2016Current vs. Previous
2015–192020–342015–192020–342015–192020–34
Real growth (%)4.04.93.15.0−0.90.1
Inflation (GDP, deflator, %)3.35.05.35.12.00.1
Nominal GDP (Billions of Afghanis)139939801446446746487
Revenue and grants (% GDP)31.332.227.628.2−3.7−4.0
Grants (% GDP)20.115.216.912.8−3.2−2.4
Primary expenditure (% GDP)31.333.027.828.8−3.5−4.3
Primary balance (% GDP)0.1−0.8−0.1−0.6−0.20.2
Exports of G&S (% GDP)14.923.911.716.9−3.2−7.0
Imports of G&S (% GDP)56.043.547.739.2−8.3−4.3
Noninterest current account balance (%GDP)−0.20.21.4−4.31.6−4.5
Sources: Afghan authorities; and IMF staff estimates and projections.
Sources: Afghan authorities; and IMF staff estimates and projections.

2. Growth is assumed to recover gradually as political stability takes hold and structural reforms are implemented. Given the highly uncertain environment, staff relies on scenarios rather than projections to quantify the outlook. The macroeconomic framework builds on a scenario presented in the May 2016 Staff Report3 and assumes implementation of a comprehensive structural reform package. These reforms gradually raise private demand and public investment financed by higher domestic revenues over the medium term. Afterwards growth somewhat declines but is driven by the private sector helped by the strengthened business climate, the impact of continued reforms aimed at macroeconomic and financial stability, and developments across the economy, including mining4 and large-scale electricity and gas transit projects (the Central Asia-South Asia Electricity Transmission and Trade Project, CASA-1000, and the Turkmenistan-Afghanistan-Pakistan-India natural gas pipeline, TAPI). Accordingly, the external current account deficit is expected to narrow gradually over the projection period.

Sources: Afghan authorities; and IMF staff calculations.

3. On the fiscal side, the baseline scenario assumes gradual progress towards long-term fiscal sustainability, although the financing gap net of domestic financing remains above 7 percent of GDP over the projection horizon.

  • On the revenue side, continuous reforms in revenue and customs administrations, the CASA and TAPI transit fees,5 and introduction of a VAT6 in 2022 are assumed to bring the revenue ratio to 12 percent of GDP by 2020 and close to 17 percent of GDP over the projected horizon, in line with World Bank estimates.7

  • Development spending, including the off-budget component, is projected to be about 10 percent of GDP over the transformation decade (2015–2024), with on-budget spending increasing by 2 percent of GDP to 9 percent of GDP, to address Afghanistan’s large social and infrastructure needs. Beyond 2024, development spending on budget would wind down gradually and stabilize at about 6 percent of GDP.

  • Operating expenditures are projected to increase as a share of GDP over the transformation decade, as operation and maintenance costs of existing and newly created capital rise,8 and the size and compensation of civil service gradually grow after 2020, especially in the health and education sectors. Security spending on- and off-budget remain substantial but decline from about 20 percent of GDP in 2020 to 10 percent of GDP in 2030 and 7.5 percent of GDP by 2035, with the size of security forces gradually declining after the transformation decade as security conditions improve.9 Thus, operating expenditures peak at around 23 percent of GDP by 2024 and decline to below 20 percent of GDP over the projection horizon as security outlays shrink.

  • Given these revenue and expenditure trends, the total budget balance excluding grants remains above 17 percent of GDP in the next decade and gradually declines to 8 percent of GDP over the projected horizon.

  • With limited scope for domestic financing through a sukuk, projected to be introduced towards the end of this decade for market development and liquidity management purposes, Afghanistan’s financing gap net of domestic financing remains over 15 percent of GDP until 2024, then declines to 7 percent of GDP by 2035.

  • While the operating budget deficit excluding grants is projected to fall gradually from more than 9 percent of GDP to less than 3 percent of GDP over the projection horizon, fiscal sustainability, defined as domestic revenues fully covering the operating spending, would not be reached before 2040.

Debt Sustainability Analysis

4. Afghanistan’s public debt remains modest Afghanistan passed the HIPC completion point and received debt relief in 2006. External public and publicly guaranteed debt, mostly to multilateral creditors, amounted to $1.2 billion, or 7.0 percent of GDP, in 2015.1011 It is equivalent to 4.0 percent of GDP in present value (PV) terms, about 38 percent of exports, and 40 percent of government revenues (Table 1a). Under the baseline scenario-in which Afghanistan’s financing gap, net of domestic financing, is entirely met by grants-the present value of public external debt would be about 3 percent of GDP by the end of the projected period, while total public debt would be 15 percent (Table 2a), both below the indicative debt-burden thresholds applicable to a country like Afghanistan. 12

Table 1a.Islamic Republic of Afghanistan: External Debt Sustainability Framework Baseline Scenario, 2013–361/(In percent of GDP, unless otherwise indicated)
ActualHistorical 6/ AverageStandard 6/ DeviationProjections
2013201420152016201720182019202020212016-2021 Average202620362022-2036 Average
External debt (nominal) 1/6.96.57.06.97.06.76.35.95.65.25.8
of which: public and publicly guaranteed (PPG)6.96.57.06.97.06.76.35.95.65.25.8
Change in external debt0.1−0.50.50.00.1−0.3−0.4−0.3−0.4−0.3−0.2
Identified net debt-creating flows−9.20.0−5.3−4.9−2.4−0.12.12.53.14.1−0.4
Non-interest current account deficit−8.70.7−4.7−8.710.6−4.5−1.10.62.83.33.95.30.84.0
Deficit in balance of goods and services35.935.934.337.737.135.635.633.631.623.710.1
Exports19.915.910.711.411.612.012.513.313.917.219.6
Imports55.851.745.049.248.747.648.146.945.540.829.7
Net current transfers (negative = inflow)−43.1−34.3−38.1−49.713.1−41.0−36.9−33.8−31.6−29.2−26.7−17.5−8.7−14.6
of which: official−43.8−34.9−38.2−41.1−36.9−33.7−31.4−28.9−26.3−16.6−6.7
Other current account flows (negative = net inflow)−1.5−0.9−0.9−1.2−1.2−1.2−1.2−1.1−1.0−0.9−0.6
Net FDI (negative = inflow)−0.5−0.6−0.9−1.30.8−0.3−1.1−0.5−0.5−0.5−0.5−1.0−1.0−1.0
Endogenous debt dynamics 2/0.10.00.2−0.1−0.2−0.2−0.3−0.3−0.3−0.2−0.2
Contribution from nominal interest rate0.00.00.00.00.00.10.00.00.00.10.1
Contribution from real GDP growth−0.3−0.1−0.1−0.1−0.2−0.3−0.3−0.3−0.3−0.2−0.3
Contribution from price and exchange rate changes0.30.00.3
Residual (3-4) 3/9.3−0.55.84.92.5−0.2−2.5−2.9−3.5−4.40.2
of which: exceptional financing0.00.00.00.00.00.00.00.00.00.00.0
PV of external debt 4/3.83.94.13.93.73.63.43.13.0
In percent of exports35.734.035.032.629.626.824.317.815.1
PV of PPG external debt3.83.94.13.93.73.63.43.13.0
In percent of exports35.734.035.032.629.626.824.317.815.1
In percent of government revenues37.737.638.035.432.329.727.319.317.7
Debt service-to-exports ratio (in percent)0.72.42.12.12.11.91.51.31.11.20.9
PPG debt service-to-exports ratio (in percent)0.72.42.12.12.11.91.51.31.11.20.9
PPG debt service-to-revenue ratio (in percent)1.54.52.22.42.32.01.61.41.21.31.0
Total gross financing need (Billions of U.S. dollars)−1.80.1−1.1−0.8−0.40.10.60.70.91.60.0
Non-interest current account deficit that stabilizes debt ratio−8.91.1−5.2−4.5−1.20.93.23.64.35.61.0
Key macroeconomic assumptions
Real GDP growth (in percent)3.91.30.87.86.32.03.44.35.25.66.04.44.84.84.9
GDP deflator in US dollar terms (change in percent)−4.4−0.4−4.04.68.1−8.41.52.42.82.82.80.61.61.91.7
Effective interest rate (percent) 5/0.40.40.50.20.10.50.60.80.80.80.90.71.01.11.0
Growth of exports of G&S (US dollar terms, in percent)7.3−19.6−34.610.026.6−0.56.710.113.215.013.89.78.18.89.1
Growth of imports of G&S (US dollar terms, in percent)−10.1−6.4−15.911.016.92.13.94.59.36.05.65.24.04.63.6
Grant element of new public sector borrowing (in percent)38.731.052.352.357.857.548.358.358.658.4
Government revenues (excluding grants, in percent of GDP)9.88.610.210.310.711.011.512.012.315.916.816.0
Aid flows (in Billions of US dollars) 7/3.03.22.93.23.43.63.94.24.55.14.5
of which: Grants2.93.12.93.23.43.63.94.14.55.04.3
of which: Concessional loans0.00.00.00.00.00.00.00.00.00.10.2
Grant-equivalent financing (in percent of GDP) 8/17.617.617.517.517.217.214.26.611.7
Grant-equivalent financing (in percent of external financing) 8/99.197.599.399.299.499.398.696.798.1
Memorandum items:
Nominal GDP (Billions of US dollars)20.220.419.718.419.320.622.324.226.435.869.1
Nominal dollar GDP growth−0.60.9−3.3−6.64.96.88.28.69.05.26.46.86.6
PV of PPG external debt (in Billions of US dollars)0.70.70.80.80.80.80.91.12.1
(PVt-PVt-1)/GDPt-1 (in percent)0.10.40.10.10.10.10.20.20.20.2
Gross workers’ remittances (Billions of US dollars)0.40.10.20.20.20.30.30.30.30.30.4
PV of PPG external debt (in percent of GDP + remittances)3.83.84.03.93.73.53.33.02.9
PV of PPG external debt (in percent of exports + remittances)32.230.531.529.627.124.722.616.914.7
Debt service of PPG external debt (in percent of exports + remittances)1.91.91.91.71.41.21.01.10.8
Sources: Afghan authorities; and IMF staff estimates and projections. 0

Includes both public and private sector external debt.

Derived as [r - g - p(1+g)]/(1+g + p+gp) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and �? = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; errors and omissions; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Sources: Afghan authorities; and IMF staff estimates and projections. 0

Includes both public and private sector external debt.

Derived as [r - g - p(1+g)]/(1+g + p+gp) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and �? = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; errors and omissions; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 1b.Islamic Republic of Afghanistan: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2016–36(In percent)
Projections
20162017201820192020202120262036
PV of debt-to GDP ratio
Baseline44444333
A. Alternative Scenarios
A1. Key variables at their historical averages in 2016-2036 1/41−4−8−13−17−34−47
A2. New public sector loans on less favorable terms in 2016–2036 244444445
Customized 1: Lower Grants457911142330
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2017–201844444333
B2. Export value growth at historical average minus one standard deviation in 2017–2018 3/45766655
B3. US dollar GDP deflator at historical average minus one standard deviation in 2017–201844444433
B4. Net non-debt creating flows at historical average minus one standard deviation in 2017–2018 4/44333333
B5. Combination of B1-B4 using one-half standard deviation shocks42−1−1−1−100
B6. One-time 30 percent nominal depreciation relative to the baseline in 2017 5/46555544
PV of debt-to-exports ratio
Baseline3435333027241815
A. Alternative Scenarios
A1. Key variables at their historical averages in 2016–2036 1/346−29−65−96−122−197−239
A2. New public sector loans on less favorable terms in 2016–2036 23436343129272426
Customized 1: Lower Grants344356728697135151
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2017–20183434322926241815
B2. Export value growth at historical average minus one standard deviation in 2017–2018 3/3455958778715240
B3. US dollar GDP deflator at historical average minus one standard deviation in 2017–20183434322926241815
B4. Net non-debt creating flows at historical average minus one standard deviation in 2017–2018 4/3438262421201513
B5. Combination of B1-B4 using one-half standard deviation shocks3419−8−7−7−6−32
B6. One-time 30 percent nominal depreciation relative to the baseline in 2017 5/3434322926241815
PV of debt-to-revenue ratio
Baseline3838353230271918
A. Alternative Scenarios
A1. Key variables at their historical averages in 2016–2036 1/386−32−71−106−137−213−279
A2. New public sector loans on less favorable terms in 2016–2036 2/3839363432302631
Customized 1: Lower Grants14192738485690140
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2017–20183838363330282019
B2. Export value growth at historical average minus one standard deviation in 2017–2018 3/3847615651473328
B3. US dollar GDP deflator at historical average minus one standard deviation in 2017–20183839393532302220
B4. Net non-debt creating flows at historical average minus one standard deviation in 2017–2018 4/3841282624221616
B5. Combination of B1-B4 using one-half standard deviation shocks3819−7−6−6−5−22
B6. One-time 30 percent nominal depreciation relative to the baseline in 2017 5/3853494541382825
Debt service-to-exports ratio
Baseline22211111
A. Alternative Scenarios
A1. Key variables at their historical averages in 2016–2036 1/2210−1−2−4−5
A2. New public sector loans on less favorable terms in 2016–2036 222221111
Customized 1: Lower Grants22222359
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2017–201822211111
B2. Export value growth at historical average minus one standard deviation in 2017–2018 3/23433332
B3. US dollar GDP deflator at historical average minus one standard deviation in 2017–201822211111
B4. Net non-debt creating flows at historical average minus one standard deviation in 2017–2018 4/22211111
B5. Combination of B1-B4 using one-half standard deviation shocks22211011
B6. One-time 30 percent nominal depreciation relative to the baseline in 2017 5/22211111
Debt service-to-revenue ratio
Baseline22221111
A. Alternative Scenarios
A1. Key variables at their historical averages in 2016–2036 1/2210−1−2−4−6
A2. New public sector loans on less favorable terms in 2016–2036 222222112
Customized 1: Lower Grants11111137
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2017–201822221111
B2. Export value growth at historical average minus one standard deviation in 2017–2018 3/22222221
B3. US dollar GDP deflator at historical average minus one standard deviation in 2017–201822222111
B4. Net non-debt creating flows at historical average minus one standard deviation in 2017–2018 4/22211111
B5. Combination of B1-B4 using one-half standard deviation shocks22211011
B6. One-time 30 percent nominal depreciation relative to the baseline in 2017 5/23322221
Memorandum item:
Grant element assumed on residual financing (i.e., financing required above baseline) 6/6060606060606060
Sources: Afghan authorities; and IMF staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Sources: Afghan authorities; and IMF staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 2a.Islamic Republic of Afghanistan: Public Sector Debt Sustainability Framework Baseline Scenario, 2013–36(In percent of GDP unless indicated)
ActualAverage5/Standard 5/ DeviationEstimateProjections
2013201420152016201720182019202020212016–21 Average202620362022–36 Average
Public sector debt 1/6.96.57.06.97.06.76.35.95.79.113.4
of which: foreign-currency denominated6.96.57.06.97.06.76.35.95.65.25.8
Change in public sector debt0.1−0.50.50.00.1−0.3−0.4−0.3−0.20.30.1
Identified debt-creating flows0.71.42.3−0.2−0.3−0.7−0.8−0.6−0.50.10.1
Primary deficit0.61.71.41.11.5−0.20.0−0.3−0.3−0.2−0.1−0.20.80.80.7
Revenue and grants24.324.025.027.828.128.528.829.129.329.823.0
of which: grants14.615.414.917.517.417.417.317.117.013.96.2
Primary (noninterest) expenditure25.025.726.427.628.128.128.528.929.330.523.8
Automatic debt dynamics0.1−0.10.9−0.1−0.3−0.4−0.5−0.4−0.5−0.7−0.7
Contribution from interest rate/growth differential−0.3−0.20.0−0.2−0.3−0.4−0.4−0.4−0.4−0.4−0.5
of which: contribution from average real interest rate−0.1−0.10.0−0.1−0.1−0.1−0.1−0.1−0.10.00.1
of which: contribution from real GDP growth−0.3−0.10.0−0.1−0.2−0.3−0.3−0.3−0.3−0.4−0.6
Contribution from real exchange rate depreciation0.40.10.90.20.00.0−0.10.0−0.1
Other identified debt-creating flows0.0−0.20.00.00.00.00.00.00.00.00.0
Privatization receipts (negative)0.00.00.00.00.00.00.00.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)0.0−0.20.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes−0.5−1.8−1.80.20.40.40.40.20.30.30.0
Other Sustainability Indicators
PV of public sector debt3.83.94.13.93.73.63.56.910.5
of which: foreign-currency denominated3.83.94.13.93.73.63.43.13.0
of which: external3.83.94.13.93.73.63.43.13.0
PV of contingent liabilities (not included in public sector debt)
Gross financing need 2/0.72.11.60.10.2−0.1−0.10.00.11.11.4
PV of public sector debt-to-revenue and grants ratio (in percent)15.314.014.513.712.912.211.923.345.8
PV of public sector debt-to-revenue ratio (in percent)37.737.638.035.432.329.728.343.862.9
of which: external 3/37.737.638.035.432.329.727.319.317.7
Debt service-to-revenue and grants ratio (in percent) 4/0.61.60.90.90.90.80.60.60.51.32.7
Debt service-to-revenue ratio (in percent) 4/1.54.52.22.42.32.01.61.41.22.43.7
Primary deficit that stabilizes the debt-to-GDP ratio0.52.20.9−0.1−0.10.00.10.20.20.40.7
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)3.91.30.87.86.32.03.44.35.25.66.04.44.84.84.9
Average nominal interest rate on forex debt (in percent)0.40.40.50.20.10.50.60.80.80.80.90.71.01.11.0
Average real interest rate on domestic debt (in percent)0.92.61.2
Real exchange rate depreciation (in percent, + indicates depreciation)6.00.914.7−1.17.62.5
Inflation rate (GDP deflator, in percent)4.03.32.36.75.34.56.07.07.06.96.96.45.04.04.7
Growth of real primary spending (deflated by GDP deflator, in percent)3.74.33.51.31.86.75.34.36.67.27.46.22.63.23.5
Grant element of new external borrowing (in percent)38.731.052.352.357.857.548.358.358.6
Sources: Afghan authorities; and IMF staff estimates and projections.

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Sources: Afghan authorities; and IMF staff estimates and projections.

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

5. Assuming continued donor support in the form of grants, Afghanistan’s debt outlook is benign. In addition to the existing debt stock, a limited amount of highly concessional borrowing from multilateral institutions, which is explicitly linked to big infrastructure projects with potentially high rates of economic and social returns, is planned for 2016. In the subsequent years, limited amounts of similar borrowing are assumed under the baseline scenario.

6. The standard DSA shocks do not result in very dramatic outcomes. There is a near-breach of the debt threshold (the present value of external debt to exports ratio), which suggests a vulnerability to distress in the balance of payments (exports). Other debt burden indicators do not respond significantly to the standard DSA shocks. However, it should be noted that the high past GDP growth rates incorporated in the standard shocks reflect a catch-up from a low post-conflict base as well as spending by international troops, while aid flows have been exceptionally large and front-loaded to finance post-conflict rehabilitation and reconstruction.

7. Potential risks to grant financing put Afghanistan at a high risk of external debt distress. A customized illustrative scenario assumes a change in the structure of the donor financing with a shift to loan financing and from 2019 on, 15 percent of grants, assumed under the baseline, are replaced by concessional loans.13 It is further assumed that the nominal GDP levels remain similar to those of the baseline, the level of public services envisaged in the baseline scenario is preserved, and no additional revenue is mobilized. Under such a scenario, two debt burden indicator thresholds (the present value of external debt to GDP and that to exports) are significantly breached.

Conclusions

8. Afghanistan’s debt sustainability critically hinges on continued donor grant inflows. Afghanistan’s public debt remains modest. Given continued donor support in the form of grants, Afghanistan’s debt outlook, under the baseline scenario, is benign. However, a change in the structure of donor financing with a shift to loan financing (a customized illustrative scenario) would quickly lead to an unsustainable debt burden. Moreover, the outlook is subject to significant downside risks in addition to aid shortfalls, including the fragile security situation, political uncertainty, domestic revenue shortfalls, migrant outflows, and exchange rate depreciation. Given these risks and large underlying fiscal and external current account deficits, Afghanistan remains at a high risk of debt distress.

9. The authorities broadly agreed with the conclusions of the DSA. They emphasized that continued donor financing is critical to ensure debt sustainability, while delivering on their commitments to donor community and keeping the debt level low. They recognized substantial risks going forward, including potential donor fatigue, and underscored the importance of prudent fiscal policy. The authorities also noted Afghanistan’s large upfront expenditure needs, particularly big infrastructure projects with potentially high rates of economic and social returns, which could support regional integration and growth, and were open to exploring options to mobilize other types of financing in addition to existing donor grants. They also acknowledged staff’s advice that contracting concessional loans would require careful project selection and independent appraisal of expected returns to maintain debt sustainability, given the limited debt service capacity, and for transparent recording of its financial impact. They shared staff’s view that domestic security markets should be developed and that sukuks (domestic borrowing) should be used as a liquidity management instrument and to build up the treasury’s cash balance, rather than to finance projects or recurrent fiscal deficits. They underscored that further aligning donor support with Afghan priorities and channeling more funds through the budget could potentially result in expenditure savings and improved efficiency.

Figure 1.Islamic Republic of Afghanistan: Indicators of Public and Publicly Guaranteeed External Debt Under Alternative Scenarios, 2016–361/

Sources: Afghan authorities; and IMF staff estimates and projections.

1/ The most extreme stress test (under the standardized stress tests) is the test that yields the highest ratio on or before 2025 among the six bound tests in Table 1b.

Figure 2.Islamic Republic of Afghanistan: Indicators of Public Debt Under Alternative Scenarios, 2016-361/

Sources: Afghan authorities; and IMF staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio on or before 2025.

2/ Revenues are defined inclusive of grants.

Table 2b.Islamic Republic of Afghanistan: Sensitivity Analysis for Key Indicators of Public Debt, 2016–36
Projections
20162017201820192020202120262036
PV of Debt-to-GDP Ratio
Baseline444443711
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages44555589
A2. Primary balance is unchanged from 201644444356
A3. Permanently lower GDP growth 1/4444451231
A4. Alternative Scenario: Low Grant457911132637
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2017–2018444445915
B2. Primary balance is at historical average minus one standard deviations in 2017–2018456655812
B3. Combination of B1-B2 using one half standard deviation shocks455555710
B4. One-time 30 percent real depreciation in 2017465555710
B5. 10 percent of GDP increase in other debt-creating flows in 20174887771013
PV of Debt-to-Revenue Ratio 2/
Baseline1414141312122346
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages1416171718192945
A2. Primary balance is unchanged from 20161414141312121828
A3. Permanently lower GDP growth 1/14151414141537123
A4. Alternative Scenario: Low Grant141926384755103173
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2017–20181415151515153165
B2. Primary balance is at historical average minus one standard deviations in 2017–20181418212019182851
B3. Combination of B1-B2 using one half standard deviation shocks1417191816162544
B4. One-time 30 percent real depreciation in 20171420191817162544
B5. 10 percent of GDP increase in other debt-creating flows in 20171428272524233355
Debt Service-to-Revenue Ratio 2/
Baseline11111113
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages11111112
A2. Primary balance is unchanged from 201611111112
A3. Permanently lower GDP growth 1/11111125
A4. Alternative Scenario: Low Grant11111138
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2017–201811111113
B2. Primary balance is at historical average minus one standard deviations in 2017–201811111113
B3. Combination of B1-B2 using one half standard deviation shocks11111113
B4. One-time 30 percent real depreciation in 201711111123
B5. 10 percent of GDP increase in other debt-creating flows in 201711111113
Sources: Afghan authorities; and IMF staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Sources: Afghan authorities; and IMF staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

This DSA was prepared by IMF staff with input from the World Bank, using the standard debt sustainability framework for low-income countries (LIC-DSA); see “Staff Guidance Note on the Application of the Joint Bank-Fund Debt Sustainability Framework for Low-Income Countries” http://www.imf.org/external/np/pp/eng/2013/110513.pdf. The LIC-DSA compares the evolution over the projection period of debt-burden indicators against policy-dependent indicative thresholds, using the three-year average of the World Bank’s Country Policy and Institutional Assessment (CPIA). With an average 2012-14 CPIA of 2.7, Afghanistan is classified as having “weak performance” under the LIC-DSF.

The assumptions on exports and imports of goods and services are substantially revised down from the previous DSA, partly reflecting the downward revision of the assumption on grants (with a particularly large impact on imports).

Big mining projects are not explicitly incorporated into the medium-term scenario, given that several contracts are being renegotiated and uncertainties stemming from low commodity prices.

Transit fees are assumed at a magnitude of $40 million annually starting in 2020 for the CASA and $250 million annually starting in 2022 for the TAPI.

The VAT is assumed to yield additional 2 percent of GDP over the current business receipt tax.

In Afghanistan Development Update, April 2016, the World Bank estimates that simply by improving enforcement and compliance Afghanistan could collect revenues of up to 14 percent of GDP, and improved tax policy, e.g., introduction of a 10 percent VAT, could raise the revenue intake up to 17 percent of GDP.

It is assumed that the operations and maintenance costs of civilian infrastructure projects that were previously funded and managed by donors off budget are by 2024 gradually transferred on budget and financed domestically.

It is assumed that the off-budget donor-funded security spending is gradually moved on budget by 2031, with an increasing share financed domestically in line with the increase in domestic revenue.

This debt stock is after delivery of the already-pledged debt relief commitments. Afghanistan is still following up with one Paris Club creditor on its debt relief commitments, as well as with several non-Paris Club creditors on debt relief on comparable terms. In terms of debt structure and composition, most of the external debt is owed to multilateral institutions, mainly regional and international financial institutions.

Afghanistan owes a small amount (US$ 10 million) of pre-HIPC Initiative arrears to a non-Paris Club creditor, which continue to be deemed away under the revised arrears policy for official creditors, as the underlying Paris Club agreement was adequately representative and the authorities have made best efforts to resolve the arrears. See “Reforming the Fund’s Policy on Non-Toleration of Arrears to Official Creditors” (https://www.imf.org/external/np/pp/eng/2015/101515.pdf)

Under the DSA framework, the external debt thresholds for countries with similar economic performance and income level as Afghanistan are: for the PV of debt—30 percent of GDP, 100 percent of exports, and 200 percent of revenues; for debt service, 15 percent of exports and 18 percent of revenues.

The DSA published in November 2015 assumed a reduction in grants of 50 percent relative to the baseline.

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