Chapter II. Recent Macroeconomic Developments4
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International Monetary Fund
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Publication Date:
21 Sep 2003
eISBN:
9781451800159
Language:
English
Keywords:
Taliban regime; banking arrangement; U.S. dollar; state intervention; balance of payments; Currencies; Commercial banks; Budget planning and preparation; Exports; Exchange rates; Middle East; Europe; Central Asia; Global; partner country trade data; transit trade; level Afghanistan; tariff regime; Imports
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23. Afghanistan is a landlocked, mountainous, and arid country, with a wide ethnic diversity. Its population is estimated at about 22 million currently within its borders, and up to 25 million if all refugees were to return. Afghanistan’s pre-war economy was mainly based on agriculture and animal husbandry, some light industry, and some natural resources (mainly gas and minerals). The country was largely self-sufficient in food and was even an exporter of agricultural products. Agriculture was largely concentrated in narrow river valleys and plains where irrigation water from snowmelt is available. Afghanistan experienced a modest degree of economic development until the late 1970s, when the country was still at peace. Modernization was largely concentrated in major cities and government services had limited reach in rural areas.

Abstract

23. Afghanistan is a landlocked, mountainous, and arid country, with a wide ethnic diversity. Its population is estimated at about 22 million currently within its borders, and up to 25 million if all refugees were to return. Afghanistan’s pre-war economy was mainly based on agriculture and animal husbandry, some light industry, and some natural resources (mainly gas and minerals). The country was largely self-sufficient in food and was even an exporter of agricultural products. Agriculture was largely concentrated in narrow river valleys and plains where irrigation water from snowmelt is available. Afghanistan experienced a modest degree of economic development until the late 1970s, when the country was still at peace. Modernization was largely concentrated in major cities and government services had limited reach in rural areas.

I. The Starting Point

23. Afghanistan is a landlocked, mountainous, and arid country, with a wide ethnic diversity. Its population is estimated at about 22 million currently within its borders, and up to 25 million if all refugees were to return. Afghanistan’s pre-war economy was mainly based on agriculture and animal husbandry, some light industry, and some natural resources (mainly gas and minerals). The country was largely self-sufficient in food and was even an exporter of agricultural products. Agriculture was largely concentrated in narrow river valleys and plains where irrigation water from snowmelt is available. Afghanistan experienced a modest degree of economic development until the late 1970s, when the country was still at peace. Modernization was largely concentrated in major cities and government services had limited reach in rural areas.

24. By the end of 2001, however, Afghanistan was a country ravaged by war and natural disasters. More than two decades of conflict, as well as droughts and earthquakes had resulted in widespread destruction and human suffering. Afghanistan’s social and economic structures had been largely destroyed. Most of the country’s infrastructure had been severely damaged and traditional irrigation systems had greatly suffered from destruction and lack of maintenance. Agricultural production had collapsed, livestock herds had been depleted, and industries had ceased functioning. Most skilled professionals had fled the country. Similarly dramatic was the breakdown of the state and civil society and the erosion of institutions, both modern and traditional. Government services, including health care and education, had essentially stopped functioning, resulting in a dramatic decline in social indicators, particularly affecting women (see Box In 1996, Afghanistan ranked 169th out of 174 countries in the UN’s Human Development Index and conditions deteriorated further in the following years. The health situation was grim. Infant and under-five mortality was estimated by UN agencies to be among the highest in the world in 2001 and malnutrition affected over 50 percent of children under age five. The average life expectancy was little more than 40 years.

25. A new opportunity for the peaceful development of Afghanistan emerged with the fall of the Taliban regime in late 2001 and the political agreement reached between the various Afghan factions in Bonn in December 2001. This chapter describes macroeconomic developments since then, as well as the main features of the country’s external sector. The chapter starts out, with an overview of the large amounts of foreign assistance Afghanistan has received so far, and without which the country would not be where it is today. But it also puts this assistance in a broader perspective, comparing it to the levels of assistance received by other recent post-conflict cases.

Social Indicators

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Sources: Central Statistics Office of Afghanistan; UNDP, Human Development Indicators, 2003; UNICEF, The State of the World’s Children, 2003; and World Bank, World Development Indicators, 2003.

II. A Comparison of Donor Assistance

26. Afghanistan’s reconstruction would not be possible without strong support from the international community, including financial assistance. At a donor meeting in November 2001, the World Bank, the Asian Development Bank (AsDB), and the United Nations Development Program (UNDP) were asked to produce a preliminary needs assessment for Afghanistan’s reconstruction. These agencies presented their findings at the International Conference on Reconstruction Assistance to Afghanistan held in Tokyo in January 2002. According to this assessment, $14.6 billion would be needed over a period of 10 years in external assistance to support Afghanistan’s economic and social recovery, excluding humanitarian assistance, with requirements for the first year estimated at $1.7 billion and, for the first 2½ years, $4.9 billion. This assessment was well received by donors and the Tokyo conference generated pledges totaling $4.5 billion for the first 5 years, but with most of these covering the first 2½ years and $1.8 billion in pledges for the first year (these amounts also include humanitarian assistance). Including some additional pledges made following the Tokyo conference, pledges for the first 15 months (covering 2002 and the first quarter of 2003) totaled $2.1 billion in grants. During that period, virtually all of these pledges were committed and over $1.8 billion in grants were actually disbursed, plus $0.1 billion disbursed in loans.

27. At a first glance, the size of disbursements appears to be well in line with the pledges made by donors and with the preliminary needs assessment. However, the needs assessment excluded humanitarian assistance, while the bulk of disbursements so far have been meet humanitarian needs. Aid flows geared toward reconstruction are only just beginning to gear up. To some extent, this pattern mirrors other recent post-conflict cases and fits reasonably well with the country’s early needs and capacity.5 In a typical post-conflict case, donors first strive to address the immediate humanitarian emergency, providing shelter to displaced people and ensuring minimum levels of consumption to those unable to fend for themselves. This is followed by reconstruction aid, as donors aim to repair or rebuild the destroyed infrastructure and institutions, and restore the provision of basic public services that were disrupted by the conflict, such as security, health care, and education. The reconstruction aid typically takes longer to materialize, because it needs more preparation (feasibility studies, design, more complex procurement procedures, etc.) than humanitarian aid. Experience shows that early attention to critical elements of infrastructure (primary roads and telecommunication) and capacity building within the government is crucial to get the reconstruction process going. Over time, as the reconstruction process gets underway and institutions are restored, a country’s capacity to absorb reconstruction aid will quickly increase. Donors and country authorities need to find the right balance between speed and capacity to effectively absorb aid. But a country will also need to beware of donor fatigue. As has been observed in other post-conflict cases, donor interest often declines sharply after a few years, just when a country’s capacity to absorb reconstruction aid actually starts to increase significantly. In the case of Afghanistan, there is a risk that the decline in donor attention may happen even sooner, as other post-conflict cases compete for funds.

28. The level of foreign assistance Afghanistan has received so far appears to be on the low side compared to other recent post-conflict cases, particularly when looking at the level of aid per capita (Figure II.1).6 Using a population estimate of 22 million, the total amount of assistance Afghanistan received over the period January 2002-March 2003 translates into $67 per capita per year. This is far less than Bosnia and Herzegovina, which received on average $249 per capita per year in aid during 1995–97; Timor-Leste, which received on $256 per capita per year during 1999–01;7 and West Bank and Gaza, which received $219 per capita per year during 1994–01. Rwanda, with $98 per capita per year in aid during 1994–96, received far less than these other countries, but still more than Afghanistan did last year. One could argue that the price level in places like Bosnia and Herzegovina or West Bank and Gaza is much higher, so that $1 in assistance “buys” less relief there than in Afghanistan. But this is only partly true, because many items, including foreign staff, are procured internationally. Moreover, the cost of transportation and providing adequate security to relief and reconstruction efforts appear to be at least equally high, if not higher, in the case of Afghanistan compared to other cases.

Figure II.1.
Figure II.1.

Post-Conflict Countries: Comparison of Foreign Assistance

Citation: IMF Staff Country Reports 2003, 299; 10.5089/9781451800159.002.A002

Sources: Afghan authorities; World Bank, World Development Indicators.1/ January 2002-March 2003.

29. An alternative approach is to compare levels of foreign assistance expressed in percent of (estimated) GDP. Of course, GDP estimates are highly uncertain, but based on available information, Afghanistan received close to 40 percent of GDP in aid in 2002/03, which is similar to Bosnia and Herzegovina during 1995–97, and much higher than the 13 percent West Bank and Gaza received during 1994–2001. On the other hand, aid to Afghanistan expressed in percent of GDP remains below the ratio for Timor-Leste and Rwanda, which both averaged about 60 percent per year during 1999–2001 and 1994–96, respectively. But one can argue that GDP may be low, and thus the ratio of aid-to-GDP high, because an economy has been largely destroyed. If so, bringing a country back to a level where it can successfully sustain itself will require high levels of assistance and most likely for a longer period of time. The latter is clearly the case in Afghanistan, where fighting has been going on for over 20 years and has destroyed much of the country’s economic capital, both human and physical.

30. All in all, it does appear that, so far, aid flows to Afghanistan have been relatively low compared to other recent post-conflict cases. While disbursements have been high compared to pledged amounts, pledges may have been low compared to actual needs. Without continued and substantial foreign assistance over several years to come, Afghanistan will not be able to reach a level from which it can further develop on its own. Instead, Afghanistan could run the risk of becoming a country that remains dependent on foreign aid, with large parts of the population remaining poor. Or worse, the country could descend into a downward spiral of violence, criminal activity, and widespread corruption financed by the proceeds from opium production.

III. Output and Prices

On the road to recovery

31. It should be stressed upfront that any analysis of economic developments continues to be very difficult as reliable statistics are still mostly unavailable. Most data presented here are rough estimates at best and should be interpreted as such. That said, the Afghan economy appears to have started on the road to recovery. This recovery has been driven by the international community’s assistance and spending, as well as by a sharp rebound in agriculture following the end of a three-year drought. As the recovery started from extremely depressed levels of activity, a strong rebound was to be expected. Economic growth in 2002/03 is estimated by the Central Statistics Office of Afghanistan (CSO) to have reached almost 30 percent, based on indicators of agricultural production (excluding poppy production), construction (import and production of cement), and electricity production (Table II.1). According to the CSO, the start of the recovery brought 2002/03 GDP to a level of about $4 billion, again excluding opium production. This GDP estimate was derived from the expenditure side, making crude assumptions regarding consumption, investment, and exports and imports. Using a population estimate of almost 22 million, this implies a per capita GDP of some $180–190, still one of the lowest levels in the world.8

Table II.1

Afghanistan: Gross Domestic Product, 2001/02–2002/03

(In millions of U.S. dollars, unless indicated otherwise)

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Sources: Central Statistics Office of Afghanistan; UNODC; and IMF staff estimates.

Government spending from the operating budget.

32. The impact of international assistance is most visible in the services and construction sectors, which appear to be expanding rapidly, based on observations in cities, especially Kabul. The improvement in security and the large number of returning refugees also have helped promote economic growth. Many destroyed buildings have already been rebuilt or are under reconstruction. Returning refugees have tried to reclaim and rebuild their former homes. Retail trade has expanded significantly in the last 18 months, as has the number of taxicabs. Rush hour congestion in Kabul now resembles many cities in other countries.

33. Although trade, services, and construction appear to be expanding rapidly, Afghanistan is still primarily an agricultural economy. The agricultural sector is estimated to support over three-quarters of the population and to account for over 50 percent of GDP.9 In 2002/03, agriculture benefited not only from increased rainfall, but also from an increased availability and better quality of seeds, fertilizers, and other inputs. The Food and Agriculture Organization (FAO) and the World Food Program (WFP) estimated that total cereal production (mostly wheat) in 2002 was up by 80 percent, reaching 3.6 million metric tons, compared to 2 million metric tons in the preceding year (Table II.2). The production of fruits and vegetables, as well as of livestock-related products, such as dairy items, meat, wool, and hides, also increased. However, it will take longer for the production of these items to reach pre-conflict levels. The total livestock population in Afghanistan was largely depleted due to the many years of armed conflict and prolonged droughts, and the associated distress selling. Similarly, many orchards were cut down for firewood during harsh winters or destroyed during fighting.

Table II.2.

Afghanistan: Selected Indicators of Economic Activity, 1999–2003

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Sources: FAO/WFP; UNODC; and CSO.

34. Agriculture is expected to expand again considerably in 2003/04. With continued snow and rainfall, cereal production increased by another 50 percent, reaching 5.4 million tons, the level Afghanistan needs to be self-sufficient.10 Contributing to this increase was the use of many land plots that were left unused during the drought. By putting virtually all of these plots back in use at the same time, cereal production has reached an upper limit within the current production capacity. Next year, many plots will need to be fallow before they can be planted again, which may result in a lower production level. With the continued strong growth in agriculture, as well as in services and construction, overall GDP is expected to grow by about 20 percent in 2003/04.

35. Alleviating poverty in Afghanistan will require strong economic growth for many years to come. Donor inflows will continue to contribute to economic growth in the coming years, but sustained growth will require large amounts of investment. Further increases in agricultural production, for example, will require investment in (repairing) irrigation facilities. So far, investment in Afghanistan, apart from donor-funded projects such as road reconstruction, has been largely small-scale: rebuilding damaged stores, repairs on farms, or importing taxicabs. Large-scale private investment has been limited to telecommunications and, more recently, the (re)construction of hotels. A significant increase in large-scale private investment requires first and foremost adequate security, but also a market-oriented regulatory framework, a functioning and fair legal system, and a functioning banking system. In this context, a new investment law has been adopted and the authorities recently established an investment agency. The Afghan Investment Support Agency was opened in August 2003. Over the past year there has been a sharp increase in livestock licenses issued, reflecting a strong investment sentiment. Modern financial sector legislation is under preparation that will pave the way for the emergence of new commercial banks.

A rebound in opium production

36. Poppies have again become a major cash crop for Afghanistan. Although Afghanistan was not a traditional poppy growing country, the increasing lawlessness in large parts of the country during the many years of conflict, the high profitability of opium production, plus the fact that poppies flourish in the Afghan climate, had resulted in the country becoming the largest producer of illicit opium in the world by the mid-1990s. The Taliban introduced a ban on poppy cultivation in July 2000 that was brutally enforced. As a result, only very small quantities (185 tons) of opium were produced in 2001, mainly in the northern provinces, compared to over 3,000 tons in 2000. The new government that came to power in late 2001 also banned poppy cultivation, but the authorities’ limited control over the provinces and favorable weather conditions, as well as rural poverty and lack of alternative livelihoods, have led to a sharp recovery in poppy production in 2002, yielding almost 3,500 tons of opium or 75 percent of the record 1999 harvest. Opium production is expected to have increased further in 2003.

37. The impact of the poppy and opium sector on the economy is large. The value of opium exports (including derivatives like morphine and heroin) in 2002 is estimated by the United Nations Office on Drugs and Crime (UNODC) at about $2.5 billion. This makes opium Afghanistan’s largest source of export earnings. Accounting for opium exports in GDP estimates is complicated because estimates for private consumption and imports are likely to already reflect to some extent the proceeds from opium exports. Depending on these considerations, the share of opium in the economy could range from 40–60 percent. Estimates for GDP including opium could reach as high as $6.5 billion. This high-end estimate would translate into a per capita GDP of $300, but obviously this would not be spread evenly across the population. A more detailed description of poppy and opium production and trade can be found in the annex to this chapter.

Toward low inflation

38. Consumer prices in Afghanistan are very much influenced by exchange rate movements (Figure II.2). Price data are limited, but the CSO has maintained a consumer price index covering 50 main items, mostly food, for Kabul. Recently, this index was expanded to cover over 200 items, while the collection of price data is about to be expanded to cover major provincial cities as well. Domestic prices—and the exchange rate—fluctuated widely in late 2001 and the first few months of 2002, reflecting the rapidly changing political and economic conditions and large uncertainties (Table II.3). But as the new government started to steadily implement its economic policies and more goods became available, inflation came down quickly. Monthly inflation averaged 3.5 percent in the first 8 months of 2002. Uncertainty regarding the introduction of a new currency, however, caused the exchange rate to depreciate in the fall of 2002.11 This resulted in a sharp spike in prices. Consumer prices rose by a cumulative 60 percent during September-November 2002 and the 12-month inflation rate reached almost 100 percent by end-2002. When the exchange rate strengthened in late 2002, prices came down as well. With the successful completion of the currency conversion process in early January 2003 and a relatively tight monetary policy, as well as an increased supply of major food staples, prices remained broadly stable in the first 8 months of 2003, with the average monthly inflation rate close to zero. As a result, the 12-month rate of inflation had fallen to 51 percent by August 2003.

Figure II.2.
Figure II.2.

Afghanistan: Price and Exchange Rate Developments, 2001–03 1/

Citation: IMF Staff Country Reports 2003, 299; 10.5089/9781451800159.002.A002

Sources: Central Statistics Office of Afghanistan; Da Afghanistan Bank.1/ Last observation: August 2003.
Table II.3.

Afghanistan: Consumer Prices (Kabul), 2001–03

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Source: CSO.

IV. The External Sector

Balance of payments

39. Estimating the balance of payments for Afghanistan is hampered by a severe lack of data. Estimates presented here are based on customs data to the extent available, partner country trade data, information supplied by international donors, and a trade survey conducted in 2000 by the UNDP and the World Bank.12 Customs data are believed to cover only two-thirds of total imports and only a fraction of exports because of smuggling. As such, while the broad structure and trends of the estimates are likely to be correct, the magnitude of the flows is subject to greater uncertainty than usual for a low-income country. Moreover, the figures do not include an estimate of opium exports which in 2002/03 were very large, in the order of $2.5 billion (as discussed above and in the annex) equivalent to around half of GDP and roughly equal in value to estimated non-opium exports. When compared with Afghanistan’s own non-opium exports (that is, excluding reexports) opium exports are the overwhelming source of export revenues generated with domestic resources. The balance of payments figures also exclude external flows related to the U.S. military operations and most of those related to the International Security Assistance Force (ISAF) activities for which there is no available information.

40. Overall, the balance of payments for 2002/03 is estimated to have shown a small surplus, after grants and donor assistance (Table II.4). The composition of the balance of payments and its evolution reflect in large part the donor-financed reconstruction effort and the revival of private sector activity. A large current account deficit (before grants) is funded mainly by official transfers; official loan disbursements were small.

Table II.4.

Afghanistan: Balance of Payments, 2001/02–2002/03 1/

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Source: Fund staff estimates.

Excludes opium (and opium derivative) related exports which would imply a large trade surplus in 2002/03. These would be offset by opium related imports and other external payments, as well as the banking abroad of illicit earnings. The data also do not include flows associated with U.S. army and most ISAF activities.

41. Exports are expected to grow rapidly, although mostly in the form of re-exports. Own exports are a small fraction of Afghanistan’s total exports; these include primarily agricultural products and have been boosted by the return of rains after several years of drought. Reexports comprise transit trade and “unofficial” (smuggling) exports. Transit trade is expected to increase steadily with the reopening of normal trade relations with transiting countries and the signing of new transit and trade agreements. The bulk of reexports are “unofficial” and are mainly to Pakistan; these exports are largely imported (officially and unofficially) via Iran. The demand in Pakistan for smuggled imports from Afghanistan arises because of the opportunity to avoid relatively high import tariffs and domestic sales taxes. Future growth in these unofficial reexports is expected to slow as the reform of customs administration becomes effective. The rapid growth of imports reflects both the revival of private sector activity and the more liberal environment—areas of particularly rapid growth in 2002/03 are cars, televisions, and refrigerators. Commodity food aid is expected to decline in 2003/04 with the rebound in domestic cereal production. Unrecorded imports comprise duty-exempt donor imports, transit trade, and smuggled goods.

42. The bulk of service receipts and payments are a function of donor activities. Receipts comprise donor payments of local staff salaries, as well as expatriate accommodation and restaurant expenses. In addition, tourist travel and the local staff cost of ISAF and local expenditures of ISAF personnel are included. Payments comprise the payment of expatriate salaries, travel abroad, and the cost of embassies abroad. Interest payments on AsDB and the International Development Association (IDA) loans resumed in 2003/04. Current transfers are mainly official donor grants to fund the budget and national development plan. Private transfers include remittances from Afghans living abroad net of the remittance of expatriate salaries not spent domestically. Net errors and omissions are small and positive. While by its very nature the combination of flows captured in this term is unknown, it could reflect transactions related to military operations for which information is not available, and changes in the holdings of foreign currency by residents which may be significant given the co-circulation of, in particular, the U.S. dollar and Pakistani rupee in Afghanistan.

43. If opium (and opium derivative) related exports were to be included, the balance of payments would show a large surplus broadly equal in size to the additional opium exports. This surplus would be offset by an equally large additional errors and omissions outflow. The latter would be consistent with the banking abroad (and increase in foreign currency holdings within and outside Afghanistan) of illicit earnings related to opium, as well as with unrecorded imports likewise related, which have not been included in the estimates reported in Table II.4.

The pattern and composition of trade

44. Based on data from partner countries, Afghanistan’s direction of export trade appears to have been relatively stable over the past five years. For imports the pattern has changed in recent years with the effects of reconstruction since 2001 emerging in 2002. Further changes in this respect are very likely. Partner country trade data and data from the CSO show similar patterns of exports but differ for imports (Tables II.5 and II.6).13 Export data cover official trade only and exclude a large amount of smuggled “unofficial” exports, primarily to Pakistan, which are imported officially and unofficially, largely across the Afghanistan-Iran border. The UNDP/World Bank survey of trade in 2000 estimated that out of total exports of about $1.2 billion, about $1 billion was unofficially exported. Exports to Iran and Pakistan account for about one-half of total exports, with Iran’s share rising during 2001–02. Other export destinations that each account for 5 percent or more of exports are Belgium, Germany, Russia, the United Arab Emirates, and the United States. For imports, the source of one-third of imports is unclassified. In 2002, imports from Japan and the United States increased sharply reflecting the reconstruction and rejuvenation of the economy. Much of the increase is accounted for by cars, televisions, refrigerators, and other electrical appliances. The main origins of imports are Japan, Korea, and Pakistan, together accounting for about 40 percent of imports, of which most (in 2002) came from Japan. Other significant sources of imports, which in total account for about 15 percent of imports, are Germany, India, Iran, Kenya, Turkmenistan, and the United States. Most of Afghanistan’s own exports are agricultural goods and carpets (Table II.7). On the import side, the major categories of goods are machinery and equipment, household items, fabrics and footwear, and food.

Table II.5.

Afghanistan: Direction of Trade 1, 1997/98–2002/03

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Source: Central Statistics Office.
Table II.6.

Afghanistan: Direction of Trade 2, 1997–2002

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Sources: Direction of Trade Statistics, IMF; and U.N. Statistics Division.

Data for Iran is from U.N.

Table II.7.

Afghanistan: Commodity Composition of Trade, 1997/98–2002/03

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Table II.7.

Afghanistan: Commodity Composition of Trade, 1997/98–2002/03 (concluded)

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Source: CSO.

Transit trade—A corridor for growth

45. Afghanistan is dependent on other countries for access to the sea and to other markets. It is also a potentially important transit country for trade and higher volumes of transit trade could generate considerable revenues. Afghanistan provides access to the Indian Ocean and Pakistan for Central Asian countries, and also is a transit country for west-east trade. At present, most of Afghanistan’s transit trade is with Iran and Pakistan, while transit trade with its northern neighbors was very limited during the Taliban period and continues to be small. Important obstacles to realizing Afghanistan’s potential as a transit route, especially for its northern neighbors, are the poor quality of its transport infrastructure, poor security, and cumbersome border administration. For example, imports destined for Kabul and other eastern provinces from Iran are often routed through Uzbekistan rather than directly across the Iran-Afghanistan border, in order to by-pass a long stretch of travel in Afghanistan. This is motivated by the poor road conditions and frequent unofficial “tolls” charged by various factions in Afghanistan. To help overcome these obstacles to trade, several infrastructure improvements are underway, such as for the Kandahar-Kabul road, and more are in the pipeline. To improve conditions for transit trade, the Afghan authorities are renewing and improving existing transit trade agreements and establishing new ones with neighboring countries (see Box II.2). These would also be consistent with a number of regional initiatives, including improving regional trade amongst members of the Economic Cooperation Organization (ECO) under the existing ECO transit trade agreement.14

Exchange and trade system

46. During the late 1980s and early 1990s, Afghanistan had many official controls in the exchange system. Da Afghanistan Bank (DAB) maintained an official exchange rate (largely for government debt-service payments) and a commercial rate that was linked to the free rate in the money changers market on which the authorities did not impose any controls. This implied a multiple currency practice. Reflecting the orientation of trade, Afghanistan had bilateral payments agreements with Bulgaria, China, and the former Soviet Union, with settlement made in bilateral accounting U.S. dollars at rates set under the agreements. Outside of the payments agreements, foreign exchange proceeds from the main agricultural exports had to be surrendered immediately at the commercial rate. The bilateral payments agreements have now lapsed. There were some restrictions on invisible payments, primarily limits on foreign exchange cash to be taken abroad for personal travel, and foreign employees had to convert 60 percent of their foreign currency salaries into Afghanis at the official exchange rate. Foreign direct investment required prior approval and ownership could not exceed 49 percent. Capital could be repatriated only after five years and at annual rate of 20 percent of total registered capital.

Trade, Transit, and Transport Agreements

1. At present, the main transit trade agreement is with Pakistan for Afghanistan’s imports and exports through Pakistan, largely to and from the southern port of Karachi and Port Quasim. This agreement was established in 1965, but during 1994–96 the Pakistan authorities had unilaterally banned several items from the eligible list; since 1996, 18 items have been banned. The ban was imposed because of concerns that a large part of these imports were being smuggled back into Pakistan. Following a series of meetings since 1991 between the two countries, the issues of disagreement are expected to be resolved by end-2003. Six of the banned items have recently been restored to the list and the time taken for processing and clearing procedures of transit goods has been reduced from 20 to 5 days. At the same time, it has been agreed that some categories of imports for which Afghanistan has little need and are clearly intended to be smuggled back into Pakistan will be eliminated from the eligible list. To reinforce this measure it is expected that Afghanistan will levy punitive import tariffs on these goods. Both countries are committed at a meeting later in the year to making substantial progress on lifting the ban on the remaining 12 restricted items. In addition, agreement was reached, with the support of aid from Pakistan, that the Torkham (the railhead in Pakistan) to Jalalabad (in Afghanistan) road would be repaired and a new road parallel to the existing one would be constructed by early 2005.

2. Longstanding (since 1973) trade, transit, and transport agreements with Iran have been revised. A new transport agreement was signed in January 2003, and final approval of the trade and transit agreement was expected in mid-2003. Under these new agreements, changes included lifting previous restrictions on the routes that could be used by Afghanistan trucks between the border and destination cities and Afghan truckers were allowed to buy Iranian fuel at the same subsidized price as Iranian truckers.1/ Discussions on trade and transit agreements have been initiated with Kyrgyzstan, Tajikistan, and Uzbekistan. In August 2003, a Memorandum of Understanding was signed by the Uzbekistan and Afghanistan authorities, and a draft agreement with Tajikistan is under discussion in order to establish mutually beneficial trade, transit, and railway development treaties.

3. In March, 2003, Afghanistan and India signed a new preferential trade agreement, which replaced an earlier one that was little used because of the Taliban presence and strained relations between India and Pakistan. Under the new agreement India has granted 50–100 percent tariff reductions on 38 export items from Afghanistan and duty-free access has been given to India for eight tariff lines. In June, 2002, preferential access to European markets was obtained under the Everything But Arms agreement, and in January, 2003, the United States granted Afghanistan GSP access to its domestic market. On April 10, 2003 Afghanistan applied for membership to the World Trade Organization.

4. Iran, India, and Afghanistan signed a Memorandum of Understanding in January, 2003, to improve access to the Iranian port of Chabahar on the Indian Ocean, along the Chabahar-Malik-Zaranj-Delaram route into Afghanistan. Under this understanding, Iran will build a new transit route to connect Milak in the southeast of Iran to Zaranj inside Afghanistan including the Milak bridge over Helmand river.2/ For its part, India will build a new road connecting Zaranj to Delaram, which is on the main Herat-Kandahar road. These improvements will shorten the transit distance between Chabahar and Delaram by some 600–700 kilometers. Also, India and Iran will build a railroad from Chabahar to the Iranian Central railway station on the railroad between Karachi and Tehran (and further west), and Iran will extend its railway to port of Islam Qaleh. This would provide cheaper access to Chabahar and open up markets along the railroad and to Europe. In addition, Afghanistan was granted full access to the duty-free zone at the port of Chabahar. The Iranian authorities are also providing storage facilities and have permitted Afghan inspectors and trade representatives on-site. Port fees have been cut by 90 percent and warehousing and other charges by 50 percent; smaller cuts were granted for oil tankers.

1/ Previously, Afghan truckers had to pay the unsubsidized fuel price; the subsidy element is about 20 percent. 2/ At present, a main highway connects Chabahar and Malik (in Iran, south of Zaranj) with only a secondary road connecting to Zaranj. The bridge will shorten significantly the time taken to travel between Malik and Zaranj.

47. In recent years, the exchange and trade system has radically changed and in effect is now very liberal and open (see Box II.3). Many of the rules and regulations that applied in the past are formally still in place, but in practice a liberal exchange and trade system is now being applied by the authorities. In any event, given the disrupted financial system, the erosion of capacity in customs and trade administration, and a relatively sophisticated Hawala system, controls would be difficult to enforce. More importantly, the authorities are committed to establishing a liberal and open exchange, payments, and trade systems. In order to formally achieve this and give a legal basis for the system, DAB intends to replace the existing set of rules and regulations for exchange and payments with new ones that conform with a liberal regime. For this purpose it has sought assistance from the IMF.

Exchange and Trade Arrangements in Afghanistan

1. Afghanistan now has a de facto unified exchange rate system. DAB quotes on a daily basis an official Afghani-U.S. dollar exchange rate based on the early morning rate in the free market of the money changers.1/ This rate is used for all transactions including with the government. DAB exchange rates for other currencies are based on cross-rates with the U.S. dollar. DAB uses the buy and sell rate from the free market rather than applying a fixed spread around a central rate. During the first half of the year, the spread between the two rates (for cash transactions) has rarely exceeded 0.6 percent, while during the latter half of 2002 spreads were usually larger than in 2003 and on two occasions exceeded 2 percent.2/ In addition a small commission is charged on travelers checks and on international transfers. For transfers, fees are 0.25 percent of the amount, with a small minimum fee, and for letters of credits, fees are 0.25–0.5 percent of the amount.

2. In practice, virtually no controls are enforced or are in place on imports and exports, payments, invisibles, and capital transactions. Traders (who for the most part carry out other domestic commercial activities and are thus classified and licensed as commercial businesses) are required to hold a commercial license, which is also required for all businesses; under this license exporting and importing is permitted, and no further export or import license is required. However, a few imports are subject to licenses and quotas. These comprise certain pharmaceutical products, mining items, and petroleum products for which a special license is required. The import of certain drugs, liquor, arms, ammunition is prohibited on grounds of public policy or for security reasons; special permission is required for these imports. Exports of opium and museum pieces are prohibited. Imports and exports should be registered with the Ministry of Commerce for recording and statistical purposes and to establish their eligibility for export incentives.

1/ Each morning, DAB calculates a simple average of the buy rate and the sell rate of ten reputable and large licensed money changers and quotes them as the official buy and sell rates. DAB quotes rates for cash and transfer transactions. 2/ The IMF considers a spread greater than 2 percent in official transaction to be a multiple currency practice.

48. Under the existing customs regime, there are 25 customs import tariff bands with rates ranging from 7 percent to 150 percent allocated across 888 items.15 The majority of items fall within the 0–50 percent range and the unweighted average tariff rate is 43.3 percent. The effective tariff rate is much lower because an undervalued exchange rate (Af 4.5 per U.S. dollar) is used to obtain the taxable value of imports. In addition, there is a Red Crescent fee of 2.5 percent and a withholding incomes tax of 4 percent. These two levies use different exchange rates for valuing the base on which the taxes are assessed. For exports and imports, a 4 or 2 percent withholding tax reclaimable against the income tax is levied. Customs procedures are not applied consistently across the customs houses. The authorities are reviewing a new simplified tariff regime which is expected to be in place this year and have embarked on a reform of customs administration (see Chapter IV).

49. In principle, the Chamber of Commerce is supposed to carry out the valuation of imports (which is to be used as the basis for customs tariffs charges) and charges a fee of 2.5 percent for nonmembers and 2 percent for members. The fee is assessed on the c.i.f value calculated using the customs exchange rate, which is much more depreciated than the market exchange rate, and as a result the effective fees are currently much lower.16 But in practice, only a small part of imports are valued by the Chamber and the majority of valuations are carried out by the customs houses, for which no fee is charged.

50. In the absence of functioning commercial banks, most trade financing is done by cash or through the Hawala system. The central bank did not open letters of credit in its own name before 2003. During the first half of 2003, it opened 15 letters of credit for government agencies under the World Bank Donor Flow Management Program.17 Earlier limits on the amounts that can be taken out of the country for tourist and business travel have been eased, limits on payments for medical treatment abroad are no longer enforced, nor is the requirement that foreign employees convert 60 percent of their foreign currency salaries into Afghani.

51. Foreign investment is required to conform to the new Domestic and Foreign Private Investment Law of 2002. Foreign and domestic investment require prior approval and investments in construction of pipelines, telecommunications, infrastructure, oil and gas, mines, and minerals are regulated under separate legislation. Full foreign participation is allowed and there are no limits on the transfer of capital and profits out of Afghanistan. The law provides tax holidays of up to seven years and a four-year exemption on export tariffs and duties. However, the Law is being reviewed with consideration being given to eliminate the tax holidays.

Annex II.1. The Poppy Dimension in the Afghan Economy18

52. Afghanistan is by far the largest producer of opium in the world, accounting for more than 70 percent of world supplies on average over the last decade according to the United Nations Office on Drugs and Crime (UNODC).19 Afghanistan, however was not a traditional opium exporting country. The cultivation of the poppy on a large scale is a relatively recent phenomenon, dating back to the early 1980s when strict bans on opium production introduced in Turkey, Iran, and Pakistan pushed up the world price of opium. At the same time, governments in Afghanistan were progressively losing control over rural areas. Faced with strong international demand and virtually no legal or social impediments, poppy cultivation flourished. It did not take long for Afghanistan to displace the so-called Golden Triangle (Thailand, Lao P.D.R., and Myanmar) as the main supplier of opiates to Europe and the Middle East.

53. The almost complete collapse of any form of central government after the Soviet withdrawal, the warring parties’ needs for alternative sources of financing, and the fact that opium was a crop well adapted to the prevailing circumstances, greatly added momentum to this trend. Opium became firmly entrenched in the economy. While the annual rate of growth of opium production had been, on average, 14 percent per year between 1979 and 1989, it accelerated to 19 percent per year between 1989 and 1994. Afghanistan’s share in world production grew accordingly from about 20 percent in 1980 to 50 percent in 1995, just prior to the Taliban takeover, and to 79 percent in 1999.20 Opium became the country’s largest cash crop and its only significant source of (illicit) export earnings. Two decades of expanding Afghan production has contributed to the dramatic decline in the street price of heroin (in real terms) in Western Europe, which fell from the equivalent of about $300 per gram (after adjusting for inflation) in 1987 to $70 per gram in 2000.

54. In spite of the illicit nature of the opium economy, a wealth of information is available. This is mainly thanks to the dedicated work of the UNODC, which as part of its global Illicit Crop Monitoring Program (ICMP) operates a poppy crop monitoring system in Afghanistan, now in close cooperation with the new transitional government of Afghanistan. As part of this monitoring regular opium surveys are conducted that combine satellite imagery with cross-checking on the ground to produce a detailed mapping of poppy cultivation. The surveys are complemented by in-depth interviews with farmers and traders, the collection of comprehensive price data, and studies of seizure data in neighboring countries. The results are published annually, normally a few months after the end of the April-June harvest season, and supplemented by interim reports. Most of the analysis presented in this annex is based on information from the 2002 survey and some preliminary data for 2003. It is expected that the 2003 survey will be available in early October 2003.

Growing production

55. From 1994 to 2000, annual opium production is estimated to have averaged around 3,000 tons per year (Table AII.1). During this period, the acreage under cultivation fluctuated between about 53,800 hectares to 91,000 hectares. On average this represented less than one percent of the country’s arable land. But yields per hectare in Afghanistan in the areas cultivated with poppy are on average more than three times higher than in Myanmar, the world’s second largest producer.21 With virtually no restrictions on poppy growing at the time, year-on-year fluctuations reflected the normal pattern of an annual agricultural crop affected by changes in climatic conditions and the supply response to price changes, typically lagged one year. Production has been mainly concentrated in two provinces, Helmand (40 percent of total production in 2002) and Nangarhar (27 percent), but has been rising more rapidly in the north, particularly in Badagshan.22 These provinces have some of the most productive agricultural land in the country.

Table AII.1.

Afghanistan: Indicators of Opium Cultivation, 1994–2002

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Source: UNODC.

56. Excess rain in 1998 caused crop damage during the harvest, and production sagged. In 1999, exceptionally favorable climatic conditions together with a rise of acreage under cultivation led to a record harvest of 4,565 tons. In September of that year the Taliban, in an effort to stave off looming international sanctions, ordered poppy growers to reduce their planting by one-third. Weakly enforced, this decree had little effect, although production was, in the event, reduced to 3,276 tons in 2000 because of a drought. In July 2000, now faced with the prospect of severe international repercussions, the Taliban issued a total ban on poppy cultivation that was soon resolutely enforced. Virtually no poppies were planted in the region under their control. Production fell by 95 percent and only small quantities of opium were harvested in 2001, mainly in the northern provinces. The 2001 sowing season coincided with the collapse of the Taliban regime. The resulting power vacuum incited widespread replanting, and acreage under cultivation soon returned to the record levels of the late 1990s.

57. One of the first acts of the new Afghan Interim Administration (AIA) was to issue, on January 17, 2002, a decree forbidding all poppy cultivation and trading, although this was too late to prevent the sowing of poppies which had already taken place. An ambitious eradication campaign soon followed this decree together with efforts to provide alternative livelihoods to farmers. But the government’s still weak authority over the provinces, and delays in donor assistance for alternative crops and farmer support, made progress difficult. With favorable climatic conditions, the 2002 harvest produced 3,422 tons, similar to the 2000 harvest. No official UNODC estimates are yet available on the size of the 2003 harvest. Preliminary indications suggest that areas under cultivation have remained extensive despite stepped-up eradication efforts. While there was progress in reducing planted acreage in traditional poppy growing areas, an interim UNODC survey has reported that this appears to have been offset by proliferation in other areas and by the tendency of farmers to plant poppies in increasingly remote and inaccessible places.23 As a result, cultivation was seen in several new districts for the first time. Overall, it is probable that the 2003 harvest could be of a similar order of magnitude to the 2000 and 2002 harvests or maybe slightly larger.

Development of prices

58. During each year the fluctuation in opium prices tends to follow a typical annual agricultural cycle, reaching a low during the harvest period (April to June) and then gradually rising until a few weeks before the next harvest period. As opium can easily be conserved for long periods, all market participants, including farmers, traders, and processing laboratories, have relied on stock building and depletion to help limit price fluctuations and stabilize incomes.24 In the complete absence of a working financial system, opium has also played a significant role in rural areas as a store of value. In remote locations it was often considered more liquid than any other assets, including foreign currency. There were strong incentives therefore, even for individuals normally not involved in the trade, to hold opium.

59. Until recently local opium markets were fragmented, with large price disparities persisting between producing regions. These price disparities reflected a combination of regional differences in the quality of opium and difficulties in arbitraging between regions during the civil war. Regional opium centers therefore tended to be oriented toward specific export routes with the local price level reflecting a specific route’s costs and risks. Opium centers in the south turned to Iran and southern Pakistan (Baluchistan), those in the east to northern Pakistan (North West Frontier Province) and those in the north to Tajikistan and Central Asia. Prices generally were the lowest in areas with the tightest controls at the border. The last two years have seen a pronounced integration of regional markets as the reduction in factional fighting has made it easier for traders to exploit the best trading routes.

60. From 1994 to 2000 average farm gate prices (as monitored by UNODC at harvest time), have fluctuated between a low of $23 per kg and a high of $40 per kg (Table AII.1). With international demand for opium growing relatively steadily, price fluctuations have reflected mainly domestic supply factors. Downward pressures have also occurred when trafficking networks or laboratories in the region were dismantled, creating temporary gluts on the Afghan markets. By contrast, large-scale purchases by traders occasionally caused temporary spikes. Market expectations have also played an important role in price formation.

61. The Taliban ban started a sharp increase in opium bazaar prices, which by April 2001 had risen almost tenfold to $380 per kg, before peaking $700 per kg just prior to September 11, 2001. In the following weeks prices crashed to $90 per kg, as stocks were quickly liquidated in anticipation of military operations. Prices recovered over the next few months and soon exceeded $400 per kg. in reaction to the transitional government’s January 2002 prohibition decree and expectations of substantial donor assistance to help enforce it. With the start of the eradication campaign in April 2002 prices rose further to a high of nearly $600 and after a period of erratic fluctuations settled back after the 2002 harvest to around $400 per kg. There are indications that, by the end of the 2003 harvest, prices had fallen further.

Farming the poppy: the incentives

62. UNODC estimates that the number of farmers involved in cultivating opium has fluctuated in recent years about 200,000 households. They tend to be representative of the general farming population in their region with average land holdings of one and a half hectares, of which one-third is usually devoted to poppy growing. Cash earnings are the main reason why farmers plant poppies. But surveys have revealed that, until the recent tenfold increase in prices, returns were not irresistibly high compared to other cash crops and often fluctuated widely. With few restrictions on cultivation during the civil war period, markets were fairly competitive. Other crops can sometimes turn out to be more attractive. A UNODC study shows that, for example, for the 1998/99 season opium was by far the most profitable crop because of a combination of high prices, a bumper harvest, and poor yields and prices for competing crops. But this situation reversed in the next season of 1999/2000, when the return per hectare on several alternative crops, including, grapes, onion, black cumin, and other fruits comfortably exceeded that of opium.25

63. A number of other factors have also made opium well suited to the needs of farmers during the difficult years of the civil war, and provided at times stronger incentives to produce opium than mere cash returns. First, as discussed in more detail below, opium production is extremely labor intensive. UNODC surveys reported that this was an important consideration for farmers supporting a large household in relation to the size of their land holdings. Second, a poppy crop presents a number of technical advantages. It does not require as much attention to irrigation as, say, wheat. It is relatively weather resistant with a short growing season, giving it an advantage over a crop such as black cumin, which needs three years to come to maturity. The early harvest frees resources to harvest other crops later, and makes it even possible in semitropical areas to plant a second crop. Third, opium is easy to store, transport, and sell. The destruction of the transportation infrastructure in many areas has often made it virtually impossible for farmers to grow other cash crops in remote districts. Fourth, opium is currently the only crop against which farmers in Afghanistan can easily obtain credit, albeit at usurious rates. A 1999 UNODC study reports that over 60 percent of traders interviewed made advance purchases of opium well before the harvest.26

64. As there is no reliable information on the actual price at which farmers sell their opium crop, it is difficult to accurately estimate the gross income they derive from it, but broad estimates can be constructed. Table AII.2 shows the value of production valued at the prices monitored by the UNODC a few weeks before each harvest. The accuracy of this measure of farmers’ income is compromised by two problems, however, each pulling in the opposite direction. On the one hand, many farmers sell their crop forward at a discount usually exceeding 50 percent of the harvest price. On the other hand, prices tend to be the lowest just before harvest time. Better-off farmers generally hold on to their production with the intention to gradually sell it in subsequent months in the expectation of higher prices.

Table AII.2.

Afghanistan: Estimate of Farmers’ Net Income from Opium, 1994–2002

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Source: UNODC.

Farming the poppy: employment and know-how

65. Opium is by far the most labor-intensive cash crop in Afghanistan. To cultivate and harvest one hectare of poppy requires, on average, about 350-person days. This compares with 41 person-days for wheat and 135 person-days for black cumin, the second most labor-intensive crop in the country. Even more significant, most of this labor is needed at harvest, which requires about 250 person-days per hectare. The majority of growers therefore have to rely on hired help, usually six to seven itinerant harvesters per hectare. They are normally paid in-kind, a share of the harvest that has varied between one-fifth and one-sixth. Because of this high labor requirement UNODC estimates that about one million persons are involved in the opium harvest every year. Since production is concentrated in two provinces, this has a very pronounced effect on local labor markets. Acute labor shortages have been reported at harvest time in poppy growing areas, with schools and colleges emptying and public works programs coming to a standstill due to lack of manpower.

66. Two further considerations are important to understand the role of labor in the development of the opium industry—skilled labor and itinerant workers. In the earlier years availability of qualified labor was a limiting factor in poppy cultivation. Lancing of poppies is a delicate task that requires experience and knowledge as it can greatly affect the final yield. As experience was acquired this constraint was progressively lifted and a vast pool of competent workers emerged. This human capital stock now undoubtedly gives Afghanistan a large comparative advantage relative to other potential producers. But it only makes eradication efforts more difficult. The need for an itinerant workforce has contributed, in turn, to the rapid propagation of poppy growing. Having acquired know-how to cultivate poppies and having established the necessary contacts to sell the opium that they usually receive as a payment, itinerant laborers, once back in their home village, started to experiment with opium production. As a result from the mid-1990s cultivation gradually expanded from the core areas of Helmand, Nangarhar, and Badakshan to neighboring districts and provinces. Consequently, according to UNODC, the number of poppy growing villages in Afghanistan rose from 2,008 to 6,645 villages over the 1994–2000 period.27

Trading and commodity markets

67. Traders are the essential link between opium produced in remote, nearly inaccessible Afghan villages and heroin sold on the streets of Europe. UNODC estimates that approximately 15,000 persons participate in the concentric trafficking circles that funnel opiates out of Afghanistan. It is much more difficult and dangerous to obtain information on this segment of the opium economy. But studies suggest the following:28

  • On the outer rim are the itinerant farm gate buyers. They buy from farmers and push them to produce by providing advice and incentives such as credit. They are the most numerous traffickers and have a relatively small average turnover. Surveys have found that they generally received a longer formal education than the population average and it is not uncommon to find teachers and government workers among them. Indeed, respondents often cited the lack of alternative employment opportunities, for those who had received an intermediate level of formal education, as an important consideration for going into opium trafficking. They especially bemoaned the absence of government jobs paying living wages. Until recently profits from small-scale trading were not substantial in absolute terms, but were attractive in relation to alternative sources of income. This suggests that trading was competitive and that there was no significant risk premium.

  • Further toward the center of trafficking circles are the shop owners in the regional opium bazaars. They either buy directly from farmers, from itinerant traders, or from other shopkeepers. They sell to local consumers, clandestine laboratories, wholesale traders, other shop owners, foreign traders, or anyone interested in taking a position in opium. They may pool resources and put together large shipments when the demand so requires. Opium bazaars, therefore, which in some areas had as many as 200 shops, effectively operated as thriving regional commodity exchanges where opium was openly and actively traded. Recent intervention by the authorities has greatly curbed these activities.

  • Finally at the center of the opium trade are the bulk buyers or large-scale specialist traders who buy opium throughout the year and organize shipping to border areas or directly abroad, sometimes amounting to several tons. This is the backbone of the narcotics industry. It consists of a relatively small number of traders, often linked by family ties, and willing to commit substantial capital. They can reap phenomenally large rewards, but also face substantially higher risks. Until recently, these included shipments being stolen, ransomed, lost to interdiction, or deception, and the sometimes rapidly fluctuating price of opium. Not surprisingly, one way to reduce these risks was to collude with or pay protection money to those in power.

68. The biggest risk and therefore rewards are for moving opium across the borders. Large-scale trafficking by Afghan nationals has usually been limited to trade within Afghanistan and the country’s immediate neighbors. Afghans do not generally participate in lucrative international trafficking. Specialized traders that are members of tribes living on both sides of the border often undertake the actual border crossings. The deeper those traders are able to get into the neighboring country, the higher the profit. Prices are highest in Iran, but the penalty associated with being intercepted with drugs in Iran is also far higher than in other countries neighboring Afghanistan.

Clandestine laboratories

69. Data from border seizures in neighboring countries suggest that in recent years only about 30 percent of Afghan opium is exported raw, and that the remainder is transformed into either morphine base or heroin. UNODC estimates that out of a total production of 3,276 tons in 2000, 1,081 tons were exported as raw opium, 1,146 tons were transformed into base morphine, and 1,048 tons into heroin.29 This is a relatively new development indicative of the maturing of the opium industry in Afghanistan.

70. Processing within Afghanistan began in the mid-1990s when laboratories moved from Pakistan into eastern Afghanistan and progressively multiplied in other border locations. This development appears to have been prompted by a more supportive environment for trafficking in Afghanistan, and the desire to lessen cost and risk by transporting less bulky and more easily concealed heroin, as well as the higher profit margins associated with heroin trade. It is difficult to obtain precise information on these activities but refining seems to take place typically in small to medium-scale laboratories producing about 10 kg a day of brown heroin. There are reports of a relatively small number of large-scale laboratories located in heavily defended strongholds becoming dominant in the industry and producing top quality heroin. This suggests a move toward vertical integration and growing capacity. One indication of rising processing capacity is that the domestic spread between opium prices and high quality heroin has fallen significantly from 1997 to 1999.

71. The large recent increase in the price of raw opium prices is likely to have been a strong incentive for laboratories to improve the efficiency of their processes. While it used to take 10 kg of raw opium to produce 1 kg of heroine efficiency gains have reportedly lowered the required input to as little as 6 kg. Aside from raw opium the largest costs for producing heroin is that of the precursor chemical acetic anhydride. Since the mid-1990s a thriving market has developed in acetic anhydride, with imports reportedly coming from Europe and Russia, often via Turkmenistan. Its average cost has fallen by two-thirds in Afghanistan since then, and has fluctuated in recent years between $15 per liter and $36 per liter. Approximately four liters are needed to produce one kilo of heroin. One of the first steps of the new authorities at the start of their interdiction campaign was to close several bazaars where precursor chemicals were traded.

Taxes and other levies on opium

72. The legal or de facto rulers of the areas in which opium was cultivated or through which it transited have also likely benefited from the opiate industry. These may have included, at various times and places, warlords, local commanders, provincial administrators, tribal leaders, and even the central government until the fall of the Taliban regime. Opium is believed to have played an important role in financing the war against the Soviet occupation, and thereafter the civil war, either indirectly through levies on producers and traders, or directly through the active and personal involvement of those in power. Taxes levied on opium by local authorities have also helped to strengthen the power of the regions over the center, and thereby reinforced the process that was at the origin of the opium economy. Surveys report that most farmers continued to dutifully pay the traditional agricultural taxes. Acceptance of this payment by the local authorities was often interpreted by the farmers and itinerant workers as implicit support for the cultivation of opium. Small-scale and bazaar traders have also indicated that they regularly paid taxes on their income.

Exports of opium and its derivatives

73. UNODC estimates for export volume and prices of raw opium, morphine, and heroin are only available for 2000 and there is no breakdown between heroin and morphine for 2002. In Table AII.3, it is assumed heroin and morphine were exported in 2002 in the same proportions as in 2000. No figures are available at all for 2001 as the Taliban ban, the disarray resulting from the collapse of their regime, and the unsettled security situation made it impossible to obtain meaningful estimates for that year. It is likely, however that exports were substantially higher than the small quantities produced because stocks accumulated in earlier years were likely to have been liquidated.

Table AII.3.

Afghanistan: Revenues from Opiates, 2000–02

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Sources: UNODC; and IMF staff estimates.

74. These estimates suggest that the value of opium exports and opium derivatives increased substantially in 2002, in comparison to 2000 to a total of $2.5 billion, mainly on account of higher prices. Of this, half relates to exports of raw opium and the remainder relates to exports of morphine and heroin, in roughly equal amounts. These estimates suggest that opium production would represent somewhere between 40–60 percent of Afghanistan’s GDP, depending on the measure of non-opium GDP (itself subject to uncertainty) and is roughly equal in value to Afghanistan’s legitimate (mostly transit) trade (see Chapter II).

75. The estimates also suggest that about half the income from opium exports probably accrues to farmers. This income is also likely to be mostly either spent or saved domestically. The other half of the gross export earnings of opiates would then accrue to refiners and traders after payment to farmers. These agents are probably better connected and bank their profits abroad. While these estimates provide an indication of the probable magnitude of revenue accruing to Afghanistan, they do not represent the value that exports of Afghan opiates fetch on the world market. The latter is probably substantially more than 10 times the value that Afghan exports of opiates fetch at the border.30 Most of the money made from trading Afghan opiates is therefore earned by international dealers and traffickers.

Conclusion

76. As the foregoing analysis makes clear, the rise of the opium economy is a relatively recent phenomenon that has occurred only over the last twenty years. The long-term failure of the Afghan state and its institutions, the breakdown of law and order, the degradation of agriculture, the absence of commerce or any alternative economic opportunity, and the destruction of infrastructure, made poppy cultivation one of the few viable economic activities in many areas of Afghanistan. This foundation was progressively built upon by raising productivity, by developing a qualified labor force, by expanding trade routes, and by investing in laboratories. A large number of stakeholders now have vested interests in the survival of this industry.

77. Reversing this process will require a substantial and prolonged commitment by the authorities and by the international community. This commitment will have to go beyond efforts at eradication and law enforcement. It will also demand a comprehensive strategy for building a stable and unified Afghan state, and for the development of a growing economy that provides alternative livelihoods throughout the country. Absent early and visible progress in these areas, a dangerous potential exists for Afghanistan to progressively slide into a narco-state where all legitimate institutions become penetrated by the power and wealth of traffickers.

References

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4

Prepared by Ron van Rooden and Louis Dicks-Mireaux.

6

This was first pointed out by CARE International 2002 (policy brief). See also Dobbins et al. (2003).

7

Data from World Development Indicators (2003), World Bank.

8

For comparison, average per capita GDP in 2002 in Iran was $1,610; Pakistan, $446; Yemen, $437; Sudan, $418; Mauritania, $355; and Ethiopia, $89.

9

This estimate is based on data for the early 1990s. The share of agriculture in Afghanistan’s GDP may well be even larger, given the level of destruction of the country’s infrastructure and industries.

10

This does not automatically mean that Afghanistan would no longer require food assistance. While sufficient grains may be available, not every Afghan will have access to it. Many Afghans remain dependent on food aid.

11

A new currency was introduced on October 7, 2002, with 1 new Afghani replacing 1,000 old ones. The conversion process ended on January 2, 2003. For more details, see Chapter V.

13

The customs data, as reported by CSO data, differ from the Direction of Trade (DOT) data beginning 1999. For exports, CSO data show a slightly higher amount destined for Pakistan and India, which is reflected in a slightly higher value of total exports. For imports, the CSO data show much larger imports from Japan (with the discrepancy rising) and under unclassified.

14

ECO members comprise Afghanistan, Azerbaijan, Iran, Kazakhstan, Pakistan, Tajikistan, Turkey, Turkmenistan, and Uzbekistan.

15

See Chapter IV for a detailed description of the tariff structure and its application.

16

Following the customs policy reform (see Chapter IV), customs valuation will use the market exchange rate.

17

The World Bank provides a special commitment letter to the correspondent bank in which the World Bank commits to guarantee payments made under the letter of credit; this obviates the need for the usual advance collateral deposit.

18

Prepared by Bruno de Schaetzen.

19

For a detailed discussion of world illicit opiates markets, see United Nations International Drug Control Program (UNDCP; 2002b).

21

UNDCP (2001a and 2002b).

27

UNDCP (1999b, 1999c, 2000a, and 2000b).

30

UNODC estimate that in Europe alone more than $20 billion was spent on Afghan opiates.

Same Series

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Cover IMF Staff Country Reports
Islamic State of Afghanistan: Rebuilding a Macroeconomic Framework for Reconstruction and Growth
Author:
International Monetary Fund
Volume/Issue:
Volume 2003: Issue 299
Publisher:
International Monetary Fund
ISBN:
9781451800159
ISSN:
1934-7685
Pages:
140
DOI:
https://doi.org/10.5089/9781451800159.002
  • <sup><xref rid="RA02fig01" ref-type="fig">Figure II.1</xref>.</sup>
    View in gallery
    Figure II.1.

    Post-Conflict Countries: Comparison of Foreign Assistance

  • <sup><xref rid="RA02fig02" ref-type="fig">Figure II.2</xref>.</sup>
    View in gallery
    Figure II.2.

    Afghanistan: Price and Exchange Rate Developments, 2001–03 1/

Figure II.1.

Post-Conflict Countries: Comparison of Foreign Assistance
Figure II.2.

Afghanistan: Price and Exchange Rate Developments, 2001–03 1/