For my department, the major assignment in postconflict economies consists in helping establish or transform central banking functions and the payment and banking systems. We’ve done this in Cambodia (1991-95), Albania (1991-94), Rwanda (1994-99), Bosnia and Herzegovina (since 1996), Kosovo and Timor-Leste (since 1999), and Afghanistan (since 2001), among other places. So Iraq is only the most recent case of the IMF supporting local capacity building by restoring or transforming central banking functions and the payment and banking systems.
Our department’s methodology emphasizes the sequencing of actions within a graduated approach. Key early decisions are the choices of a legal tender and an appropriate exchange rate regime. Setting up and operating a rudimentary payment system on an emergency basis will also be crucial if the established payment system has ceased to function. Preparation of key financial legislation—for example, for central banks, the banking sector, and the country’s currency—is also a high priority. Such legislation should be in line with international best practices but always adapted to local legal traditions. Over time, core central banking functions should be restored and clearly distinguished from commercial banking activities. The financial system is strengthened through the (re-)licensing, regulation, and supervision of banks and the reestablishment of an efficient and sound payment system.
For example, in Afghanistan, the IMF early in 2002 encouraged the central bank to use hawala, the indigenous informal funds transfer system. This was perhaps unexpected advice, but hawala is an extremely efficient payment system and, traditionally, has been the most vibrant part of the domestic financial infrastructure. Without the hawala system, the complex banknote exchange reform that took place in Afghanistan in the last quarter of 2002 would have failed. Also, without the hawala system, the central bank’s foreign exchange auctions, which have kept inflation under reasonable control, would not have taken place.
It should be noted that the hawala system is virtually unregulated. That is new for the IMF in the sense that we normally would recommend that the authorities use only institutions that are properly licensed, regulated, and supervised. But in this case, tight regulation of hawala would just kill the system or drive it underground, which has occurred in other countries and is not very constructive. Instead, attention is being devoted to fighting money laundering and the financing of terrorism.
Another novel field for the IMF has been the active use of microfinance institutions. In recent years, MFD has supported setting up such institutions in Kosovo and Timor-Leste, and in Afghanistan a microfinance bank was licensed in September 2003. So, we are expanding into areas that five years ago were simply not on the IMF’s horizon.
Following the declaration of the U.S. dollar as legal tender in January 2000, cash U.S. currency had to be purchased abroad and brought into Dili. In some cases, the transportation containers were used as storage because of the lack of functioning safes and vaults. The only surviving commercial bank building was taken over and converted into the state-owned Central Payments Office (CPO).
To pay salaries, government employees lined up outside the CPO and initially received their money in plastic sandwich bags handed out by MFD staff and resident experts. The first time that government salaries were disbursed, the CPO ran out of cash in the early afternoon while the lines were still long, and visiting IMF staff had to scrape together some more from travel advances to provide the CPO with a temporary loan. Everything was rather primitive and done manually as the supply of electricity was erratic, but in the end it worked.
The CPO was the rudimentary start of what is today the Banking and Payments Authority of Timor-Leste, a well-functioning institution slated to become the country’s first central bank.
In Kosovo, the choice was not very difficult because the deutsche mark was already widely used in parallel with the Yugoslav new dinar. Upon the IMF’s recommendation, the United Nations Interim Administration Mission in Kosovo decided to denominate its budget in deutsche mark (and subsequently in euros) and to use that currency for disbursements from the budget. But it was still possible to use Yugoslav new dinars to pay taxes and other public services.
In Timor-Leste, the future currency was an immediate political issue—the Timorese leadership did not want to continue using the Indonesian rupiah. After intensive discussions, it decided to adopt the U.S. dollar as legal tender because the main Timorese export (coffee) was priced in dollars, and future oil revenue will also be invoiced in dollars.
In Afghanistan, the preferred choice was to continue using the national currency in combination with a banknote exchange during the fourth quarter of 2002. In the new series of Afghanis—the legal tender—the security features were much improved, three zeros were dropped, and Afghanistan got its first unified currency since 1996.
An IMF staff mission visited Baghdad in June 2003 to make an initial assessment and explore early priorities for advice and technical assistance. Since then, and despite the bomb attack on the UN headquarters in Baghdad on August 19, in which several IMF staff were injured, the IMF has provided technical assistance on the introduction of new banknotes; central bank legislation and bank licensing; budget execution and public expenditure management; options for tax policy (including a fiscal regime for the oil sector); and the compilation and dissemination of economic statistics. As for macroeconomic policy, the IMF is assisting the authorities to develop a macroeconomic framework—including a fiscal budget for 2004 and a monetary and exchange rate policy regime—to ensure that macroeconomic stability is quickly restored and growth resumes.
A special problem in Iraq is that the economy is already in a state of shock, not so much because of the recent war or the subsequent widespread looting but because of decades of neglect. War and related military activities had priority at the expense of investment in infrastructure, education, health care, and society as a whole. This seems to have gone further in Iraq than in the former Soviet Union. So a tremendous future agenda is before Iraq and the international community.
Another lesson is that technical assistance in postconflict situations must be closely coordinated among key donors. Working with the authorities and major technical assistance providers, we can bring change for the better in many places. In Iraq, that work has just started and may well be the biggest challenge to date.
A special problem in Iraq is that the economy is already in a state of shock, not so much because of the recent war or the subsequent widespread looting but because of decades of neglect.
Åke Lönnberg’s paper “Building a Financial System in Afghanistan” was presented at a symposium in Bonn in June 2003 called “State Reconstruction and International Engagement in Afghanistan,” jointly arranged by the Crisis States Program of the Development Research Center of the London School of Economics and Zentrum für Entwicklungsforschung, Universität Bonn. The paper is available online at http://www.afghanistan-rg.de.vu/arp.