We thank staff for the concise report and the high quality engagement with the Afghanistan authorities during the negotiation of this program. The authorities are also appreciative of the continued support to Afghanistan by the Executive Board and management, and agree with staff analysis and recommendations.
Over the last decade, Afghanistan has made significant progress in rebuilding the economy and institutions, improving human development indicators, and achieving macroeconomic stability. Further progress, however, has run into strong headwinds stemming from the international troop withdrawal, continued security challenges, and political uncertainty. As a result, growth dropped from an average of 11 ½ percent in 2007–12 to 1 ½ percent in 2013–15, and unemployment, and emigration rose markedly.
The authorities are determined to address these challenges through wide-ranging reforms to promote higher and more inclusive growth, while maintaining financial stability and preparing the groundwork for reduced reliance on donor financing. Having successfully completed a nine-month Staff-Monitored Program (SMP) in December 2015, the authorities are now requesting Fund assistance under a three-year Extended Credit Facility in an amount of SDR 32.38 million, equivalent to 10 percent of quota. Given the absence of an immediate balance-of-payments need, once donor grants are taken into account, the program aims mainly at catalyzing donor support. The authorities welcome the indication that access under the arrangement could be augmented if a balance of payments need were to emerge.
Recent Economic Developments and Outlook
The growth slowdown that started in 2013, accelerated in 2015, with real GDP growth dropping to 0.8 percent. Low oil and food prices and weak domestic demand pushed inflation to negative territory last year (-4.9 percent y/y in July 2015), before it recovered to a positive reading late in that year on account of the sharp depreciation of the Afghani triggered by emigration-related capital outflows.
Despite the weak economic activity, fiscal performance was very strong, with a 22 percent increase in domestic revenue and contained operating budget expenditure, which significantly reduced the operating deficit before grants. The remarkable revenue performance reflected the impact of the tax and revenue administration measures introduced during the second half of 2015, as highlighted in the staff report on the second review of the SMP. The current account deficit, excluding grants, declined, with lower exports more than offset by lower imports, but remained large at 3 ½ percent of GDP and was more than covered with official grants. Gross international reserves remained at a comfortable level of about nine months of imports.
Preliminary indications for 2016 point to some strengthening in economic activity, with growth estimated at 2 percent, inflation picking up to 4 ½ percent, and further improvement in revenue collection. While the current account deficit before grants will remain large, pressure on the exchange rate has eased in the first few months of 2016, in connection with a slowdown in emigration.
Economic prospects over the medium term are relatively favorable, depending on implementation of the reform agenda, good governance, security improvement, and continued donor support. Downside risks related to any one of these factors cannot be ruled out, and given the challenging tasks ahead, we agree with staff that the payoff of the reforms is likely to be gradual. Under the staff’s medium-term scenario, growth would increase gradually to reach 6 percent in 2021, as enhanced governance and improved business climate boost private sector investment and growth. Trade integration and the development of Afghanistan as a hub for regional transportation also hold some growth potential over the medium term. Other quantitative indicators of the medium-term scenario seem sensible, notwithstanding the challenging environment and the high degree of uncertainty surrounding future security developments and donor assistance.
Policies under the proposed program will be geared toward preserving macro-financial stability, supporting growth and employment, and maintaining a comfortable buffer of international reserves. Fiscal policy will be prudent to ensure that the overall budget, including grants is in balance in 2016 and beyond, with the bulk of the fiscal improvement coming from stronger revenue performance underpinned by wide-ranging structural fiscal reforms (see below). Over time, the operating budget balance, excluding grants, will become the fiscal anchor. Monetary policy will continue to focus on maintaining low inflation, with reserve money being the nominal anchor due to weak transmission channels, while the flexible exchange rate regime will be maintained to absorb exogenous shocks. The authorities will endeavor to reduce dollarization and strengthen confidence in the Afghani, and DAB will enhance its communication via regular publications.
The critical role of structural reforms in establishing solid foundations for growth has been recognized over the years, including by the Afghanistan National Development Framework, and re-confirmed at several donor meetings, including the London Conference in December 2014. Focusing on the areas in the Fund’s purview, the proposed program puts emphasis on: (i) fiscal reforms to strengthen domestic revenue mobilization and raise the quality of government spending; (ii) completing financial sector restructuring and enhancing its contribution to growth; (iii) strengthening governance and the fight against corruption; and (iv) improving the business environment in collaboration with the World Bank and other development partners.
Revenue mobilization will focus on further strengthening the revenue and customs departments along the lines of the five-year rolling reform plans established in consultation with development partners as detailed in the MEFP (¶22–23). Building on the important steps taken in recent years, key priorities going forward include improved cooperation and information sharing between the two administrations and strengthening their human and technical capacity, which will improve compliance and reduce corruption. While there is limited room for introducing new taxes, the authorities will explore the possibility of tapping other sources of revenue, including excises on selected goods and services, and reducing tax exemptions. They agree with staff that VAT introduction can be considered over the medium term after implementation capacity has been strengthened. They intend to develop by end-2017 an effective and transparent fiscal regime for natural resources in compliance with Extractive Industries Transparency Initiative (EITI) requirements, and with IMF technical assistance, which should help enhance and diversify the revenue base as the sector develops.
A strengthened public finance management system is necessary to enhance the efficiency of public spending, make a better use of diminishing donor resources, and ensure that budget allocations are aligned with national development priorities. Key priorities will be to improve the formulation and execution of the budget and follow up of development projects, strengthen commitment control and cash management, and enhance fiscal reporting and transparency. The authorities plan to address these issues through various reforms that are outlined in the Public Finance Management Road Map II and the MEFP (¶25), and will continue to work toward establishing a consolidated national budget to integrate the operational and development budgets while engaging donors to increase flexibility of funding. They will also improve monitoring of the performance of state-owned enterprises and strengthen the MOF’s oversight over their finances. To this effect, they intend to work with Parliament to amend the laws governing public enterprises and corporations.
The financial sector strategy under the program aims at bringing the resolution of Kabul Bank to an end, strengthening prudential regulations and bank supervision, and developing a more inclusive financial intermediation infrastructure. In this regard, preparatory work is underway to develop a National Financial Inclusion Strategy with World Bank assistance to improve access to finance, broaden the range of financial instruments available to the private sector, strengthen consumer protection, and improve financial literacy.
Progress has been achieved in asset recovery and settlements related to the defunct Kabul Bank, with the New Kabul Bank (NKB) now transitioning from a temporary bridge bank to a deposit-taking institution and close to becoming profitable. The authorities intend to recapitalize NKB by end-December 2016 and relieve it from any future exposure linked to the liquidation of Kabul Bank. Eventual privatization of NKB will be kept under review. Similarly, Da Afghanistan Bank’s (DAB) balance sheet will be cleaned from the lender-of-last resort loan to Kabul Bank (US$ 825 million) in steps over the next three years involving budget transfers to the Kabul Bank receivership and assignment of DAB’s 2015 profits (MEFP ¶28). The authorities are committed to facilitating completion of an updated assessment of DAB under the Fund’s Safeguards Assessment Policy by the first program review.
Efforts will be made in cooperation with the World Bank to address governance and management shortcomings at the three state-owned commercial banks (SOCBs), and a newly established unit will monitor and report on the fiscal risk posed by SOCBs. More broadly, the authorities will continue to build capacity in the areas of prudential regulations and bank supervision by implementing the recommendations of the 2014–2018 Strategic Action Plan developed with assistance from the Middle East Technical Assistance Center. Building on the progress in establishing a legal framework for AML/CFT, the authorities will ensure its effective implementation, in particular with regard to the regulation on currency reporting at borders and the fit and proper regulation. They are committed to implementing the action plan agreed with the Financial Action Task Force (FATF) by September 2016 in order to exit the FATF’s monitoring process promptly.
The authorities are aware of the significant challenge posed by corruption and its debilitating effect on the Afghan economy. They are putting together a comprehensive strategy to strengthen the anti-corruption framework, and have established a High Council for Good Governance, Justice, and Anti-Corruption chaired by the President to coordinate actions by various agencies and enforcement authorities. The authorities’ plan under the ECF is to improve the legal framework to ensure that acts of corruption are criminalized in line with the UN Convention against Corruption, and there are plans to establish a special court for financial crimes. Moreover, while declarations of assets of top-ranking officials are already published, the authorities will strengthen the asset declaration regime including by improving transparency of asset declarations of other high level officials in customs and tax administrations and law enforcement agencies (MEFP ¶37). The authorities will continue to work with the World Bank to improve the business climate and address serious challenges related in particular to licensing procedures, property registration, enforcement of contracts, connecting to electricity, and trading across borders.
The authorities are determined to address the many challenges facing the economy, and are committed to implement the policies and reform agenda under the proposed-ECF-supported program. They are hopeful that the donor community will remain fully engaged with them during this difficult transition while they prepare for shouldering an increasing share of the financing and build adequate implementation capacity. The authorities are grateful for the Fund support and look forward to continued close cooperation under the new program.