Islamic State of Afghanistan: Staff Report for the 2003 Article IV Consultation
Author: International Monetary Fund
Publication Date:
22 Dec 2003
eISBN:
9781451800173
Language:
English
Keywords:
ISCR; CR; government; exchange regime; operating budget; customs policy reform package; US$; balance of payments; central bank; debt service; foreign currency; Budget planning and preparation; development budget
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The authorities have made solid progress in rebuilding institutions and implementing sound economic policies, although huge challenges still remain. The IMF has been providing extensive policy advice and technical assistance to the authorities. With the help of the international community, the authorities have made impressive strides in rebuilding institutions and implementing sound economic policies. The economic recovery is strong, but comes from a very low level. Preliminary data suggest that expenditures were again off to a slow start in 2003/04.

Abstract

The authorities have made solid progress in rebuilding institutions and implementing sound economic policies, although huge challenges still remain. The IMF has been providing extensive policy advice and technical assistance to the authorities. With the help of the international community, the authorities have made impressive strides in rebuilding institutions and implementing sound economic policies. The economic recovery is strong, but comes from a very low level. Preliminary data suggest that expenditures were again off to a slow start in 2003/04.

I. Introduction

1. The starting point for Afghanistan’s reconstruction at the end of 2001 was unusually dire. After more than 20 years of conflict, interspersed with earthquakes and drought, the new Afghan authorities confronted their task with largely defunct government and financial institutions, weak administrative capacity, and the widespread destruction of the country’s infrastructure (see Box 1). Social indicators were among the worst in the world.

2. With the help of the international community, the authorities have made impressive strides in rebuilding institutions and implementing sound economic policies.1 The economy shows strong signs of recovery. A new currency was successfully launched, and since the completion of this operation the exchange rate has been stable and inflation close to zero. Monetary policy has been restrained, supported by the adherence to strong fiscal discipline. Important institutional and economic reforms have been undertaken, while progress has continued to be made in implementing the political road map set out in Bonn in December 2001 (see Box 2).

3. But three serious risks remain. First, the security situation remains very fragile (see Box 3). Poor security complicates macroeconomic management and prevents reconstruction taking hold in most areas outside Kabul. Second, while the formal economy is recovering, so is the production of opium. This is having a profound impact on the economy and there is a risk that its pervasive corrupting influence could become entrenched. Third, as often happens in post-conflict cases, there is a risk that the financial support of international donors, which has been so critical to the recovery so far, could weaken prematurely.

Starting Conditions in the Ministry of Finance and the Central Bank

Budget policy by the end of 2001 was limited to the payment of salaries, which were subject to considerable delays and arrears. The tax base had shrunk and customs revenue was withheld by the provinces. Line-ministries and provincial offices (Mustufiats) of the Ministry of Finance (MoF) operated bank accounts, in the regional branches of the central bank and state-owned banks, outside the purview of the MoF. There was no reconciliation between the government bank accounts and treasury accounts in the MoF. The reporting system between the center and the Mustufiats had broken down. No government accounts had been prepared since 1989/90. Files were missing, including all records of the government’s external debt.

Afghanistan’s financial system had largely ceased to function by the end of 2001. The country had become almost entirely cash-based, with banks having largely stopped functioning. Most people used the informal “Hawala” system to change and transfer money. Confidence in the national currency, the Afghani, was low, as it had lost much of its value following years of high inflation. Moreover, the central bank, DAB, had little or no control over the issuance of currency. At least three versions of the national currency were circulating in the country. Reflecting the limited confidence in the national currency, foreign currencies were also widely used. Communication with and reporting by DAB’s regional branches had broken down. No balance sheet information was available for the central bank and what little recording took place used outdated procedures. Little or no capacity existed within DAB to design and conduct monetary policy or to supervise banks.

Bonn Agreement

On December 5, 2001, under the auspices of the United Nations (UN), an agreement was reached in Bonn between various Afghan factions providing a road map for the creation of a peaceful, democratic state. An Afghan Interim Administration (AIA) was appointed, headed by President Karzai, that governed the country for six months, until a special Loya Jirga (grand council) of some 1,500 delegates could be convened in June 2002. This Loya Jirga re-elected Mr. Karzai as President and chose a new Afghan Transitional Administration (ATA) that, as stipulated in the Bonn agreement, will remain in office until democratic elections can be held in mid-2004. In addition to preparing the elections (with the help of the UN), the Bonn agreement also charged the ATA with preparing a new constitution. Following a broad consultation of the Afghan population during the summer of 2003, a draft constitution will be submitted to a Constitutional Loya Jirga in December 2003.

International Security Efforts

Under the Bonn agreement, it was acknowledged that responsibility for security throughout the country resides ultimately with the Afghan authorities themselves. However, provision was made for the support of the international community toward the establishment and training of new Afghan security and armed forces. Assistance in building a new national army is provided mostly by the United States, while Germany has taken the lead in improving the police forces. Moreover, on December 20, 2001, the UN Security Council authorized the establishment of the International Security Assistance Force (ISAF) and for it to operate in Kabul and its surrounding areas. On October 13, 2003, the security council expanded the mandate of ISAF to allow it, as resources permit, to operate in the rest of the country as well.

Establishing nationwide security is also contingent upon an effective disarmament, demobilization, and reintegration (DDR) of the existing militias. The DDR process is only just starting, however, with pilot projects under way to disarm 1,000 ex-combatants in each of six major cities.

II. Recent Economic Developments2

A. Output and Prices

4. The economic recovery is strong, but comes from a very low level. Real GDP, excluding opium production, is estimated to have grown by almost 30 percent in 2002/03, driven by donor assistance and the end to a prolonged drought (Table 1).3 The impact of international assistance (and also of opium revenues), much of which has been spent domestically, is most visible in services and construction, which are expanding rapidly in urban centers. With Afghanistan being a largely agricultural economy, the agricultural sector contributed significantly to the recovery. Cereal production rose by over 80 percent in 2002/03, benefiting from increased rainfall and expanded acreage under cultivation. Agricultural production continued to increase this year—cereal production grew by a further 50 percent—and combined with further strong growth in services and construction, GDP is expected to grow by 20 percent in 2003/04.

Table 1.

Islamic State of Afghanistan: Basic Data, 2001-2004 1/

article image
ources: Afghan authorities, UNDP, UNODC; and Fund staff estimates.

The Afghan solar year 1381 ran from March 21, 2002 until March 20, 2003. The solar year 1382 runs from March 21, 2003 until March 19, 2004.

For 2002/03 calculated by multiplying quarterly percentage changes in estimated stocks.

5. Opium production also recovered dramatically. The ban on poppy cultivation imposed by the Taliban in 2000 was very successful, but in 2002 opium production was estimated by the United Nations Office on Drugs and Crime (UNODC) to have reached 3,400 tons, a level similar to that of the late 1990s. Production in 2003 increased to 3,600 tons. The value of exports of opium and opium derivatives accruing in 2002 to Afghan farmers and traders was estimated by the UNODC to have been about $2.5 billion, making it by far the largest source of export earnings from domestic sources. Revenues fell slightly in 2003 to $2.3 billion, reflecting lower prices.4 The opium sector has a profound impact on the economy and may account for about half of overall GDP. With climatic conditions well suited for the cultivation of poppies and following many years of conflict and lawlessness, as well as a lack of alternative livelihoods, opium has become the main source of income for many farmers.

6. Considerable progress has been made toward achieving low inflation. In the first 8 months of 2002, inflation rates for Kabul averaged 3.5 percent per month (Figure 1). But uncertainty regarding the introduction of the new currency caused the exchange rate to depreciate sharply and the price level to jump by 60 percent during September–November 2002 (Figure 2). When exchange rate tensions eased in late 2002, prices came down as well, although by somewhat less than the appreciation of the Afghani. Following the successful completion of the currency conversion in early January 2003 and reflecting sound monetary and fiscal policies, prices have remained broadly stable so far in the first 10 months of 2003 (the average monthly inflation rate has been close to zero).

Figure 1.
Figure 1.

Islamic State of Afghanistan: Price and Exchange Rate Developments, 2001-03 1/

Citation: IMF Staff Country Reports 2003, 391; 10.5089/9781451800173.002.A001

Sources: Central Statistics Office of Afghanistan; and Da Afghanistan Bank.1/ Last observation: October 2003.
Figure 2.
Figure 2.

Islamic State of Afghanistan: Exchange Rates, 1999-2003 1/

Citation: IMF Staff Country Reports 2003, 391; 10.5089/9781451800173.002.A001

Source: Da Afghanistan Bank.1/ In new Afghanis; last observation: October 22, 2003.

B. Fiscal Policy

7. During 2002–03, the authorities have shown a strong commitment towards fiscal discipline and refrained from monetary financing (the “no-overdraft rule”).5 This implied that government spending was constrained to the amount of domestic revenues the authorities were able to collect and the amount of donor assistance available. The government budget consists of an operating budget, which covers current expenditures and some capital expenditures aimed at quick repairs, and a development budget, covering reconstruction as well as humanitarian assistance projects.

Operating budget

8. The government’s first operating budget, for 2002/03, was in essence a very rudimentary going-concern budget. The bulk of expenditures was on wages and salaries (including in the provinces), while the rest was mostly on office refurbishment and basic equipment. The actual provision of public services was still quite limited, especially outside Kabul. After a slow start, the execution of the 2002/03 operating budget accelerated in line with the development of administrative capacity at the MoF and the more rapid disbursement of donor financing (Table 2). In Afghani terms, expenditures for 2002/03 are estimated to have reached over 90 percent of budgeted amounts. In U.S. dollars terms, this amounted to $349 million—about 8.5 percent of non-opium GDP—significantly less than the $460 million envisaged, due to the depreciation of the Afghani during the year compared to the assumption made at the time of formulating the budget. This depreciation and the associated inflation, however, meant that government expenditures in effect were squeezed in real terms in 2002/03.

Table 2.

Islamic State of Afghanistan: Operating Budget, 2002/03 1/

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Sources: Ministry of Finance; Da Afghanistan Bank (DAB); and Fund staff estimates.

The Afghan solar year 1381 ran from March 21, 2002 until March 20, 2003.

As reported to the MoF. However, a small part of this money is remitted to the center (transfers received by the MoF).

Provincial salaries were paid by the center except for Herat province, which paid the salaries of its government staff out of the revenues it collected.

Because no reliable data on nonwage provincial expenditures are available at the center on this date, these expenditures are assumed to equal the provincial revenues reported to the center plus net transfers from the center.

Variation between the fiscal position recorded at MoF and DAB. This discrepancy is due to the difference (“float”) between checks issued and cashed and the fact that the provinces’ accounts in DAB branches were not consolidated into the government’s central accounts at the end of the year.

Does not include grants received ($51.24 million) and Afghanistan’s reserve tranche in the Fund ($5.7 million) used to clear Afghanistan’s arrears to the AsDB, World Bank, and IMF in FY2002/03.

International Air Transport Association (LATA) accumulated overflight fees, sale of a telecommunications license, one-off transfer from the Ministry of Commerce, and transfer of previous year’s provincial surpluses.

This adjustment reflects the difference between the exchange rate used for donor grants (effective exchange rate at the time of deposit in the government’s accounts) and the average exchange rate used to convert into U.S. dollars the other components of the table ($1 = Af 44.46).

Including Af 750 million for the clearance of wage arrears related to payrolls incurred before the interim administration took over in January 2002.

The approved budget was expressed in Afghanis and was converted into U.S. dollars at the time of its adoption (March 2002), using an accounting exchange rate of $1 = Af 34. The depreciation of this rate to an annual average exchange rate of $1 = Af 44.46, results arithmetically in a downwards adjustment of the U.S. dollar amount of the budget.

9. Domestic revenues were much higher than expected in 2002/03, at $132 million (3 percent of non-opium GDP) compared to $83 million envisaged in the budget.6 Combined with the depreciation of the Afghani, this reduced the 2002/03 financing requirement to an estimated $217 million, considerably less than the budgeted $400 million. The financing requirement was largely met by available donor grants—the bulk of which were channeled through the Afghanistan Reconstruction Trust Fund (ARTF)—and to a lesser extent by donor loans and one-off revenues, such as the sale of telecom licenses and the receipt of accumulated overflight rights.

10. The execution of the 2002/03 operating budget was hampered by the fiscal system’s lack of cohesion. Only a very small amount of the revenues collected by provinces were transferred to the center ($36 million). Also, no reliable information was available on provincial nonwage expenditures, which therefore had to be estimated by the MoF at $89 million.7

11. The preparation of the 2003/04 operating budget showed a marked improvement compared to the previous year. The 2003/04 budget envisages expenditures equivalent to $550 million (11 percent of non-opium GDP), an increase of more than 50 percent over actual expenditures in the previous year. This reflects not only the enormous needs in the security, health, and education sectors following 23 years of conflict, but also the slow but steady increasing capacity to provide public services. Wages are budgeted to account for half of expenditures. Domestic revenues are budgeted to reach $200 million, leaving $350 million to be covered by foreign assistance (Table 3). Of this, $250 million in civilian expenditures is expected to be financed through the ARTF, and pledges received so far are close to the amount needed. Expenditures for the existing army and police forces—largely wages and some expenditures to rebuild police stations—are to be financed from domestic revenues and by $100 million in donor assistance channeled through the Law and Order Trust Fund for Afghanistan (LOTFA) and the Army Trust Fund, but pledges thus far fall well short of this amount.8

Table 3.

Islamic State of Afghanistan: Operating Budget, 2003/04 1/

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Sources: Ministry of Finance; Da Afghanistan Bank (DAB); and Fund staff estimates.

The Afghan solar year 1382 runs from March 21, 2003 until March 19. 2004, Execution during the first five months of 2003/04.

Checks issued by MoF.

Provincial salaries are paid by the center except for Herat province which paid the salaries of its government staff out of the revenues it collected.

Including $25.2 million paid in the first month by the Minsitry of Reconstruction in Herat province for the purchase of services (advance payments to contractors).

Variation between the fiscal position recorded at MoF and DAB. This discrepancy is due to the difference (“float”) between checks issued and the fact that the provinces’ accounts in DAB branches are not yet consolidated into the government’s central accounts. The importance of this adjustment reflects that the $25 million paid by Herat province in the first month is not included in the government’s central accounts at DAB.

The authorities intend to channel the proceeds of this loan to the development budget before the end of the year. They are therefore not counted in the annual financing projections for the operating budget

This adjustment reflects the difference between the exchange rate used for donor grants (effective exchange rate at the time of deposit in the government’s accounts) and the average exchange rate used to convert into U.S. dollars the other components of the table (Af 48.81 = $1).

The approved budget was expressed in Afghanis and was converted into U.S. dollars at the time of its adoption (March 2003), using an accounting exchange rate of Af 45 = $1. The depreciation of this rate to an annual average exchange rate of Af 48.81 = $1, results mechanically in a downwards adjustment of the U.S. dollar amount of the budget.

12. Preliminary data suggest that expenditures were again off to a slow start in 2003/04. This was initially on account of delays in ministerial spending submissions for the first quarter and subsequently because of delays in payroll disbursements to the provinces and security forces. Revenue collection in the first quarter showed a considerable improvement compared to the same period last year. Moreover, almost 70 percent of the revenues reported by the provinces in the first quarter were transferred to the center. This followed the reaffirmation by provincial governors in May 2003 of their commitment to adhere to the budget law and remit provincial revenues to the center.

Development budget

13. Assistance for reconstruction in 2002/03 was much less than aimed for at the donor conference held in Tokyo in January 2002. According to the preliminary needs assessment prepared for the Tokyo conference, $4.9 billion would be needed for reconstruction during the first 2½ years. The Tokyo conference generated $4.5 billion in pledges for this period, but much of this was dedicated to humanitarian assistance. Of the more than $1.5 billion in assistance disbursed by donors since the beginning of 2002—in addition to support for the government’s operating budget—almost two-thirds was humanitarian assistance. Although an early focus on humanitarian aid is warranted given a country’s most urgent needs following the end of conflict, this has meant that actual reconstruction is still proceeding slowly. Very little of the amounts disbursed in 2002–early 2003 went through the government budget—a first provisional development budget was presented in the fall of 2002—reflecting largely the government’s still very limited administrative capacity, particularly in line-ministries.

14. In 2003/04, most donor assistance for reconstruction and humanitarian assistance is expected to be channeled through the government’s development budget. The 2003/04 National Development Budget (NDB) provides a reconstruction roadmap consistent with the strategic priorities expressed in the authorities’ National Development Framework (NDF; see Box 4). It includes $1.8 billion of humanitarian and reconstruction (donor) projects, to be financed by donor grants, mainly focusing on infrastructure rehabilitation, health, social protection, assistance to refugees, and education.9 Commitments received so far are still about $500 million short of this amount. Moreover, in the first half of 2003/04, disbursements against the development budget were much lower than targeted (about 30 percent), reflecting also the lack of security in the provinces, which hampered the execution of a number of large projects, and the still limited implementation capacities in line-ministries. Nevertheless, major achievements so far included a sharp increase in school enrollment, assistance to more than 500,000 refugees and 200,000 internally displaced people, large vaccination and water sanitation campaigns in the provinces, and the start of the reconstruction of the roads linking the main Afghan cities.

National Development Framework

The authorities strengthened their responsibility to coordinate and manage the reconstruction effort by adopting a National Development Framework (NDF) in April 2002. The overall objectives of the NDF are poverty reduction and the creation of economic opportunity. The NDF, which was prepared through extensive consultations between the MoF, line-ministries, and the Cabinet, is based on five principles: (a) the development strategy must be domestically owned, with the government in the driver’s seat; (b) markets and the private sector are more effective instruments in delivering sustained growth than the state; (c) aid cannot be effective without the state investing in human capital and the creation of an institutional framework that allows the rule of law to prevail; (d) promoting sustainable economic growth requires the active participation of the population; and (e) donor-funded investment projects must be anchored in the government’s development program to be successful over the longer term.

The NDF focuses on three pillars of development: (a) security and human development; (b) rebuilding physical infrastructure; and (c) enabling the creation of a viable private sector as the engine for sustainable and inclusive economic growth. For these three pillars a total of twelve 12 sectoral programs has been developed and individual consultative groups have been established that provide the framework for identifying, coordinating, and implementing donor-funded projects. This process culminated in the National Development Budget (NDB), which in essence is a comprehensive agenda of donor-funded humanitarian and reconstruction projects. The 2003/04 NDB marked full ownership by the government of the development agenda and made the budget the focal point for decision-making on government policy and the allocation of domestic and external resources. For more detailed information, see IMF Country Report No. 03/299, Chapter III.

Fiscal reform

15. The MoF has made significant progress in improving fiscal management (see Box 5). The biggest strides were made in improving expenditure management. The authorities have also made important progress toward fiscal transparency and accountability. In mid-2002, the World Bank provided grant support for an Emergency Public Administration Project to fund the hiring of qualified international contractors in the areas of financial management, government procurement, and audit to assist the authorities in the performance of these functions and to build local capacities in order to hand over these functions to the authorities as soon as possible. Problems remain, however, in the public finances of the provinces. While provinces have transferred larger amounts of revenues to the center so far in 2003/04 and have started to report nonwage expenditures, there is no mechanism in place to verify provincial revenues and expenditures.

Major Structural Reforms in 2002-03

The Afghan authorities have undertaken several major structural reform measures in the past 1½ years. These are described in detail in IMF Country Report No. 03/299. Among them, the most important are:

Fiscal reforms:

  • With World Bank assistance and in line with FAD recommendations, a computerized system for expenditure recording, payment processing, and financial reporting has been developed in the MoF (“Afghanistan’s Management Information System”; AFMIS), providing detailed information on expenditures paid at the center as well as revenue data. It also accelerated budget payments through automation of check printing. The AFMIS is now being progressively rolled out to the provinces.

  • USAID-trained Afghan fiscal advisors have been assigned to all MoF provincial offices to assist provincial officials with financial reporting to the center. Satellite communication facilities are being set up in the largest of these provinces to facilitate exchange of information between the MoF and its regional offices.

  • Following FAD recommendations, steps have been made toward progressive consolidation of government bank accounts in order to strengthen treasury control over cash flows and minimize idle cash balances in multiple bank accounts. All government bank accounts in the provinces have been closed and replaced in each province by two new accounts, one for revenues and the other for expenditures.

  • The Cabinet recently approved a customs policy decree, consistent with FAD recommendations, to (a) mandate the use of the market exchange rate in customs valuation; (b) reduce the number of tariff bands from 25 to 5; and (c) lower the tariff rates from the current range of 0 to 150 percent to (five) rates ranging from 0 to 20 percent; this decree still needs to be signed by the president to come into force. Also adopted was a decree simplifying customs clearance procedures and setting out a comprehensive five-year plan to strengthen the administration of customs.

Financial sector reforms:

  • A new currency was successfully introduced, with the help of international experts from the Fund (MFD, LEG, and MCD), USAID, the Bundesbank, and the UN. This was a crucial step in the authorities’ efforts to establish financial stability. With the introduction of the new currency, DAB achieved full control over the printing and issuance of the national currency.

  • A new central bank law and banking law were recently adopted. These laws—which were prepared with the assistance of LEG and MFD—provide a framework for an independent, yet accountable, central bank and the creation of a sound, modem financial system

  • Foreign exchange auctions were developed, with the assistance of MCD, in early 2002 to provide DAB with an instrument to control the rate of monetary expansion. Procedures have been progressively improved to improve the transparency and operations of the auctions.

  • Significant progress has been made on improving the operational capacity of DAB, with the assistance of USAID and MFD, including computerization, steps to improve the domestic payments system, facilitating international payments, and setting up a banking supervision department.

16. With improved financial management, the immediate focus of reform has now shifted toward increasing revenue mobilization. To achieve this, the authorities have started modernizing customs and are about to approve an ambitious customs policy reform package. Key elements of this package include using the market exchange rate for customs valuation and streamlining tariffs. This is to be followed by a reform of tax policy and administration. The authorities are preparing draft decrees to: (a) reduce the top marginal taxrate for individuals and increase the personal exemptions; (b) restore wage withholding on higher-income employees; (c) introduce a rent tax and an airport departure fee; and (d) expand the business receipts tax to cover certain services provided to expatriates.10 These decrees are expected to be submitted to the Cabinet by early 2004. In parallel, a large taxpayer unit (LTU) will be established in the MoF by end-December 2003, with the specific tasks of administering the personal income tax, business receipt tax, and new rent tax.

17. Only limited progress has been made so far in civil service reform. Although the size of the civil service appears not to be large relative to the population, there is a serious lack of professional capacity, pervasive patronage, and over-staffing. The current pay and grading system is inadequate to attract, retain, and motivate skilled civil servants. A civil service reform commission was established in mid-2002 and a recently approved decree introduced an interim additional salary allowance for specific positions in ministerial departments considered critical for reform (e.g., customs, tax).

C. Monetary and Exchange Rate Policy

18. A major achievement of the Afghan authorities has been the successful introduction of the new currency (see Box 5 above).11 With this, DAB achieved full control over the printing and issuance of the national currency.12 Replacing all banknotes in a post-conflict country like Afghanistan in a short period posed tremendous challenges. Logistical problems during the first weeks of the conversion period and growing nervousness among the population about whether they would be able to convert old notes into new ones in time caused the Afghani to depreciate sharply in the fall of 2002. In mid-November, following foreign exchange auctions and the announcement of an extension of the banknote exchange period until January 2, 2003, the Afghani strengthened, stabilizing at about (new) Af 46 per U.S. dollar in January 2003. Despite the many difficulties, the authorities—assisted by the international community—managed to complete the changeover successfully on January 2, 2003, without major incidents.

19. The conduct of monetary policy in Afghanistan is complicated by the widespread use of foreign currencies and the substantial uncertainties that surround economic prospects and relationships. DAB developed a monetary program with the assistance of Fund staff aiming to control the domestic money supply (currency in circulation) as an intermediate target, although it recognizes the limitations of this approach in a highly dollarized economy.13 The indicative monetary program for 2003/04 targets a rate of monetary expansion of 30 percent. DAB aims to partially offset the monetary expansion that stems from donor aid being converted into local currency by selling foreign exchange through its foreign exchange auctions to the informal money market dealers—the only market-based instrument available in the absence of a functioning banking system. In the absence of data to gauge money demand—which is also likely to undergo structural shifts—to help determine how much foreign exchange to auction, DAB has used movements in the exchange rate as an early indicator of changes in the relative demand for the domestic currency. Currency in circulation grew by 22 percent in the first nine months of 2003, and by 13 percent in the first half of 2003/04, both in line with the indicative monetary program (Table 4). The rate of monetary expansion varied widely from quarter to quarter, however, possibly reflecting the volatility of money demand and seasonal factors. Reflecting DAB’s policy as well as the government’s continued adherence to the no-overdraft rule, money demand was entirely met by an accumulation of foreign exchange reserves. DAB’s foreign exchange reserves reached an estimated $568 million by late-September 2003.14 Reserves covered almost three months of (estimated) imports (excluding imports for reexports) and more than covered domestic currency in circulation.

Table 4.

Islamic State of Afghanistan: Indicative Monetary Program (Da Afghanistan Bank), 2001-04 1/

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Sources: All figures are fund staff estimates based on available data in Da Afghanistan Bank and the Central Statistics Office.

The Afghan solar year (SY) 1381 ran from March 21, 2002 until March 20, 2003. The solar year 1382 runs from March 21. 2003 until March 19, 2004.

Foreign currency amounts converted into Afghani at an exchange rate of Af 34/U.S. dollar until September 2002; thereafter a rate at Af 46/U.S. dollar; gold valued at $279 per ounce.

Increases reflect (net) flows plus recovered accounts abroad.

In Q3 2002/03 (SY 1381), includes payment by DAB of 116 million in costs for the currency exchange.

Changes in Q1 2002/03 (SY1381) reflect expenditures made and revenues booked for the 2001/02 (SY 1380) budget.

600100, 701101, and 731001 accounts, corrected for reallocation of 2002/03 (SY 1381) revenues to 2001/02 (SY 1380) for funding of 2001/02 (SY 1380) wage expenditures.

Including disbursed AIATF, ARTF, and LOTFA funds (accounts 701102 and 731002).

September 22, 2002 stock of currency in circulation calculated as January 21, 2003 stock of new Afghani in circulation minus net issuance of new Afghani during October 7, 2002-January 21, 2003 plus net withdrawal of old Afghanis (devided by 1,000) during during September 23, 2002-January 21, 2003.

Annual percentage increase in 2002/03 (SY 1381) calculated by compounding quarterly percentage changes.

20. Since the introduction of the new Afghani in early 2003, the central bank has placed greater emphasis on limiting exchange rate volatility. DAB has aimed to keep the exchange rate within a fairly narrow range, although this range is not firmly set nor announced. Decisions regarding the timing and volume of foreign exchange auctions have become predominantly determined by exchange rate movements and less so by the rate of monetary expansion itself (although thus far the resulting rate of monetary expansion has been consistent with the monetary program). Reflecting this shift in emphasis, the exchange rate has fluctuated in a narrow range around Af 48 per U.S. dollar since the beginning of 2003.

21. A major step forward in financial sector development has been the recent adoption of new central bank and banking legislation. The new laws—prepared with assistance from MFD and LEG—provide a framework for an independent, yet accountable, central bank and the creation of a sound financial system. This paves the way for further central bank modernization and the entry of new commercial banks into Afghanistan. The first three new (foreign) banks were recently licensed. No concrete steps have been undertaken so far to deal with the highly disfunctional and barely operational state-owned commercial and development banks, although plans for their possible restructuring are under consideration.

D. External Sector

22. The exchange and trade system is in effect very liberal and open. Many of the restrictive rules and regulations that applied in the past may, at least formally, still be in place, as it is unclear whether they have ever been amended or repealed. But the authorities do not wish to impose or enforce any of these restrictions—which in any event would be difficult—and are implementing a liberal exchange and trade system. Thus, available information suggests that the current system is free of restrictions.15

23. Although data are extremely poor, the formal balance of payments for 2002/03 is estimated to have shown a small surplus, after grants and donor assistance (Table 5). 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 5.

Islamic State of Afghanistan: Balance of Payments, 2001/02–2003/04 1/2/

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Sources: UNODC; and Fund staff estimates.

The Afghan solar year 1381 ran from March 21, 2002 until March 20, 2003. The solar year 1382 runs from March 21, 2003 until March 19, 2004.

Excludes opium (and opium derivatives) related exports which would imply a larger 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.

Does not include debt service on outstanding bilateral debt, on which no debt service payments have been made since 1991.

Does not take into account possible arrears of unknown size on bilateral claims in dispute.

24. Little is known about the balance of payments including opium, but it is likely to have been in significant surplus. As noted, exports of opium and its derivatives are believed to have amounted to some $2.5 billion in 2002/03 and $2.3 billion in 2003/04; about half of this is estimated by the UNODC to have been accrued directly to farmers and the rest to (a much smaller number of) processors and internal traffickers (see Box 6).

Opium and the Balance of Payments

Macroeconomic management in Afghanistan is made especially difficult on account of the growing influence of opium production.1/ The production of opium and its derivatives is estimated to bring in the equivalent of some $2.3 billion into Afghanistan.2/ Depending on one’s estimates of the formal non-opium economy, this means that opium could account for some 40–50 percent of GDP. Not all the $2.3 billion will be spent in Afghanistan. Some of it—perhaps about half—will be saved in cash holdings (by farmers), or banked abroad (by the more well connected processors and internal traffickers). But a substantial amount is being spent domestically, raising the standard of living of farmers and financing what little private investment is taking place. This means that efforts to eradicate opium production could have a significant depressing effect on economic growth, as well as on progress toward alleviating poverty. To offset this, as well as increase the chances that eradication will succeed, it will therefore be necessary to undertake extensive programs to develop alternative livelihoods for farmers who would otherwise grow poppies, as well as provide social support. Such programs will cost money, and will also require additional security (as poppies tend to be grown in the areas where security is weakest). The eradication of opium could therefore generate a significant balance of payments need, over and above what is being generated by the reconstruction of Afghanistan’s economy and infrastructure.

1/

See Chapter II, Annex I of IMF Country Report No. 03/299 for a more extensive discussion of the role of opium in Afghanistan’s economy.

2/

This is the estimate for 2003/04. The value of this opium and its derivatives on the open international markets is more than 10 times this. Afghanistan supplies three-quarters of the world’s opiates.

III. Report on the Discussions

A. Outlook

25. The authorities and staff agreed that the economy should continue to recover during the next few years, provided that weather conditions remain favorable, the security situation does not deteriorate, and donor support continues. Growth would mostly be concentrated in agriculture, reflecting ongoing repairs to irrigation systems and a better quality of inputs, and in the trade, services, and construction sectors, largely driven by donor inflows and the slow but steady improvement in incomes (including from opium production). In the authorities’ view, Afghanistan’s prospects, as well as most data and economic relationships, were still too uncertain for a quantified medium-term scenario to be meaningful. Staff concurred with this view.

26. Afghanistan is a predominantly agricultural economy that can be badly affected by natural events, such as prolonged droughts, or crop disease. Afghanistan is also prone to earthquakes. Diversification of economic activity and improved agricultural and building techniques could help mitigate these effects, but this will take time and continued assistance.

27. The authorities agreed with the staff that the outlook for Afghanistan was also clouded by the three risks of a continued lack of security, the infiltration of opium in the economy, and donor fatigue. None of these risks can be addressed without the attention and support of the international community. The authorities intend to impress upon donors the need for their assistance in increasing security, toward developing alternative livelihoods for farmers in place of poppy, and toward underpinning Afghanistan’s reconstruction.

28. The discussions focused on the appropriate policies for achieving and maintaining financial stability—including fiscal and external sustainability—and sustainable recovery and growth. In addition to macroeconomic policies, this includes the further development of key economic institutions.

B. Fiscal Policy

29. Improving revenue mobilization is key to attaining fiscal sustainability. Donor grants to fund Afghanistan’s operating expenses cannot be expected to continue indefinitely and the bulk of external assistance will increasingly be allocated to development expenditures. The authorities recognize this and aim to fully finance the operating budget through domestic revenues over the medium term.

30. Domestic resources could reach $200 million this fiscal year but this will depend on early implementation of customs reform.16 Progress is furthermore needed in the reform of tax policy and administration. The staff urged the authorities to move swiftly on this and to seek the establishment of a fair, transparent, and easy to implement tax system. This should include the revision of the income tax, the introduction of a wage withholding tax, and a services tax.

31. The staff noted the important progress made in improving fiscal management. The staff encouraged the authorities to continue to press for further improvements in the quality of fiscal data, the fiscal management of the provinces, and the monitoring of the development budget. Efforts are underway to increase the central government’s control over provincial finances. The recent streamlining of the government’s accounts in the provinces and their planned consolidation into the central accounts at DAB will help to achieve effective revenue centralization, but concrete progress will depend critically on provincial authorities’ adherence to their commitment to transfer revenues to the center. Recent successes in this regard are encouraging. The staff urged the authorities to continue to move ahead with these efforts, despite the delicate political issues involved.

32. The authorities emphasized that civil service reform is faced with considerable social, political, and practical difficulties. They are well aware, however, of the central role of civil service reform in the reconstruction process in general, and in the delivery of adequate public services in particular. The staff urged the authorities to move ahead more quickly in this area with the assistance from the World Bank. An important first step would be to establish a verified payroll of government employees. The staff welcomed the recent approval of a decree introducing an interim additional salary allowance for specific positions in key ministerial departments. This procedure should be preferred to an across-the-board wage increase for entire categories of government staff, as was recently done for teachers and police officers. The staff also urged the authorities to move ahead with wage decompression, but cautioned that any across-the-board pay reforms should remain compatible with medium-term fiscal sustainability. Also, with large numbers of staff having little or no capacity, redundancies will be unavoidable and delaying these too much could prove to be costly.

33. The restructuring of the state-owned enterprise sector has yet to begin. Significant progress is unlikely in the near-term without strong support from the international community. But the staff was encouraged by the authorities’ intention to close nonfunctioning public enterprises, or divest them to the private sector through an open and transparent process when possible.

C. Monetary and Exchange Rate Policy

34. The current exchange rate regime is best described as a managed float. The authorities consider a relative degree of exchange rate stability as important to instill confidence in the new currency and to support price stability, given the rapid and strong pass-through of exchange rate movements to prices. The central bank governor emphasized, however, that he does not intend to resist persistent exchange rate pressures should these emerge, and thereby risk losing reserves unduly.

35. The staff recognized the benefits of exchange rate stability, but cautioned the authorities against allowing the unofficial “range” to become too narrow or rigid, or resisting persistent pressures on the exchange rate should these emerge. The staff noted that the greater the management of the exchange rate, the less information it conveys regarding monetary conditions. If the exchange rate is kept within too narrow a range for an extended period, it could become more difficult to make needed adjustments in the future without adversely affecting expectations.

36. In the staff’s view, a (lightly managed) float remains the appropriate choice for Afghanistan. The Afghan economy is undergoing large structural changes and remains vulnerable to external and domestic shocks. Under such circumstances, it would be desirable for adjustment to work through the exchange rate rather than directly impact Afghan product and labor markets. In a fixed regime, the risks of an exchange rate misalignment and an undue loss of reserves would be high. Once the economy has moved beyond the early structural changes inherent to the reconstruction process, the choice of exchange rate regime could be revisited. For the period ahead, the staff recommended that monetary policy continued to focus on maintaining low inflation by limiting monetary expansion, which would contribute to exchange rate stability.

37. The staff welcomed the adoption of the new central bank and banking legislation. This was a major step toward financial sector development. Financial intermediation is of crucial importance for the further development of private sector activity and economic growth. Capacity to adequately license and supervise commercial banks will need to be strengthened further. In the meantime, the staff advised the authorities to allow only reputable banks to enter that are subject to solid home country supervision. Even with the emergence of new banks, the “Hawala” system is likely to continue to exist, as is the case in many other countries in the Middle East. The authorities intend to put in place, with assistance from the Fund, new legislation to counter money laundering and the financing of terrorism.

38. Regarding the existing state-owned banks, a key concern is to avoid (potential) costs to the budget and damaging confidence in an emerging banking system. Should an existing bank be deemed viable, the staff recommended that it be placed under new and qualified management, followed, if possible, by its privatization. Before such a bank could start operations, the staff stressed that it should reapply for a banking license. Banks that fail to meet the conditions for a new license will need to be dealt with quickly, to avoid an increase in potential future costs to the budget.

D. External Sector Policies

39. The balance of payments outlook is fraught with uncertainty. The current account deficit, before grants, is likely to remain sizable during the next several years, financed largely by donor grants and, much less so, loans. Exports and imports can be expected to grow in line with reconstruction efforts and the economic recovery. Whether a balance of payments need may arise depends on the scope and speed of Afghanistan’s reconstruction, as well as on the efforts by the authorities—with the help of the international community—to eradicate opium and provide farmers with alternative livelihoods and social support.

40. In the staffs view, Afghanistan’s current level of international reserves provides a reasonable cushion against negative shocks and a strong backing for the national currency. But even within the context of the current exchange rate regime, a higher level of reserves could be warranted given the large potential for adverse shocks and the country’s limited access to international capital markets.

41. Staff advised that new external borrowing should be very limited and only on highly concessional terms. Large amounts of external assistance will continue to be required to support Afghanistan’s reconstruction and development for years to come. Bilateral donors have thus far provided financial support in the form of grants, while multilateral institutions have provided a mix of grants and concessional loans. A provisional debt sustainability analysis discussed with the authorities suggested that Afghanistan’s capacity to service new external debt was very limited, taking into account again its vulnerability to exogenous shocks.17 This analysis also showed that sustainability was difficult to achieve without very generous relief of existing claims. Staff emphasized that the analysis did not suggest that financial assistance to Afghanistan should be limited, but rather that Afghanistan would need to rely overwhelmingly on grants to reach its development goals. The authorities concurred with this analysis.

42. The Afghan authorities have sought, with some success, cancellation of existing external debt on a bilateral basis with creditors.18 This has been their preferred approach. Creditors so far have not pressed Afghanistan to resume debt service payments.19 The bulk of external claims on Afghanistan, however, consists of claims of the former Soviet Union. These claims, now from the Russian Federation, are currently under dispute, as the Afghan authorities do not recognize these, because they were (largely) accumulated during the period of Soviet intervention in Afghanistan.20 The Afghan authorities have held discussions with the Russian authorities on resolving the status of these claims, but no conclusion has been reached so far.

43. The staff explained that if the authorities wish to approach the Paris Club for a debt restructuring, an upper credit tranche arrangement (or its equivalent) with the Fund would be required. Also, Afghanistan could be HIPC-eligible. The staff advised the authorities that the HIPC initiative would, in principle, expire in 2004, but eligible countries would still be able to benefit from HIPC relief after that time, provided they had a Fund arrangement in place by end-2004 and their program was on track.

44. The staff welcomed the recent establishment of a debt management unit. Afghanistan is making no debt service payments on its existing stock of external debt, other than to the AsDB and the World Bank. However, in the future, with the contracting of new loans and/or a restructuring of existing debt, the authorities will need the capacity to keep track of debt service-related payments on a timely basis. The staff urged the authorities to set up a functioning debt management system within the new unit.

45. The authorities intend to formally establish a liberal trade and exchange regime, and to prepare laws and regulations that conform to such a system with the assistance of the Fund. The staff welcomed this and encouraged the authorities, once this has been achieved, to accept the obligations under Article VIII of the Fund’s Articles of Agreement. The authorities noted they would consider this in due course, but that their inclination was positive.

E. Role of the Fund

46. Up to now the Fund’s role in Afghanistan has been to provide policy advice and technical assistance (TA). Fund TA in Afghanistan has involved assisting the authorities with establishing a road map for reforms, which are implemented by other TA providers that have much greater resources. Progress has been (and will be) subsequently reviewed—and the reform agenda adjusted where needed—by the Fund TA departments. In addition, the Fund has been providing TA in specialized areas, such as the currency conversion, financial sector and tax legislation, and the strengthening of statistical capacity.21 The authorities considered this approach was adequate and met their needs.

47. During the Annual Meetings in Dubai, the Afghan Minister of Finance requested closer Fund involvement in Afghanistan, possibly in the context of a Fund-supported program. The main objectives of this would be to provide a more detailed framework for economic policies and strengthen policy discipline, as well as to provide a positive signal to donors. So far, donors have not been insisting on a Fund-supported program and have been content with staff statements at donor conferences. But with substantial donor support needed in the period ahead, donors may wish to see greater Fund involvement as part of a concerted international effort and to provide assurances of sound macroeconomic management. Experience in other post-conflict countries suggests that donors prefer that a Fund-supported program be in place before embarking on major reconstruction efforts.

48. As in many other post-conflict cases, there are serious constraints that need to be taken into account when moving toward closer Fund involvement. These include: (a) the still limited institutional and administrative capacity to carry out a program that could be supported by the Fund; (b) severe data limitations and considerable uncertainty regarding economic relationships; (c) the likelihood of a change of government in mid-2004, whose commitment to a potential Fund-program cannot be assured;22 and (d) the continuing fragile security situation and the limited control of the government beyond Kabul.

49. The staff stands ready to assist the authorities in addressing these concerns. Taking into account the authorities’ objectives and the constraints, staff has agreed with the authorities to proceed first with an SMP. This would allow the authorities to build on their already good track record and establish—with increased TA, including from the Fund—an adequate level of capacity for a possible arrangement under the Poverty Reduction and Growth Facility (PRGF). The staff will work with the authorities to set out an enhanced Fund TA program. Emergency Post-Conflict Assistance (EPCA) could be considered in lieu of an SMP, or as a bridge between an SMP and a PRGF, if the conditions for such assistance were present.

IV. Staff Appraisal

50. The achievements of the AIA and its successor, the ATA, have been remarkable. The starting point after over 20 years of conflict was extremely inauspicious, with much of the country physically and institutionally in ruins. But in the space of 18 months, important progress has been made in rebuilding key institutions and in restoring macroeconomic stability. The economy has begun to grow again.

51. The adherence to the “no-overdraft rule,” prohibiting government borrowing from the central bank, remains a crucial cornerstone of fiscal policy and contributed to achieving financial stability. But with tight fiscal discipline, government spending is constrained by domestic revenues and available donor financing. The swift implementation of measures to make further progress in raising domestic revenue, both by deepening the sources of revenue through structural reform and by improving the enforcement of collection from the provinces, will be critical to ensure the independence of the operating budget from donor assistance in due course. While significant strides have been made in improving fiscal management, further progress is still needed, particularly to strengthen fiscal management in the provinces and fiscal reporting.

52. The reconstruction process is still proceeding only slowly. The preliminary needs assessment presented at the Tokyo conference in January 2002 provided an early estimate of Afghanistan’s reconstruction needs. However, much of the assistance provided so far to Afghanistan has been humanitarian assistance, which was not included in the preliminary needs assessment. There is a strong case for reviewing the needs assessment, now that the international community has been in the field for nearly two years and may be in a better position to make such an assessment. To some extent, the slow progress in reconstruction reflects Afghanistan’s limited absorption capacity and poor security. While a faster pace of reconstruction is needed, therefore, it must be combined with increased efforts to improve security and strengthen capacity.

53. The progress made toward the integration of donor projects in the development budget is welcome. The consolidation of projects into a single development budget is crucial for the comprehensive monitoring of projects, for their “ownership” by the authorities and for their consistency with the NDF. This process will become all the more important as the emphasis of donor assistance shifts away from budgetary support and toward development.

54. The introduction of the new currency was a notable success. The stability of its exchange rate since the conversion was completed in January 2003 is testimony to the prudent monetary policy—supported by strong fiscal discipline—that has been followed since. The exchange rate regime is a “lightly managed” float, which seems appropriate for a country which remains vulnerable to shocks, and while the exchange rate seeks its equilibrium in the context of structural change and reconstruction. To this end, it will be important for the exchange rate to reflect and be seen to reflect market forces.

55. Alleviating poverty in Afghanistan will require strong economic growth for many years to come. Notwithstanding the strong start of the recovery, per capita GDP in Afghanistan—estimated at only $180–190—is still one of the lowest in the world.23 Continued growth will depend, in the first instance, on maintaining a high level of donor support. In light of Afghanistan’s very limited debt servicing capacity—even after generous relief on existing claims—this support will need to be overwhelmingly in the form of grants.

56. Sustainable growth over the medium term will require substantial private investment. This will increasingly need to take the place of official assistance, which cannot be expected to last forever. A significant increase in private investment will require first and foremost adequate security, but also sound economic policies, a functioning banking system, as well as a market-oriented regulatory framework, and a functioning and fair legal system to firmly establish the rule of law and the security of property rights.

57. The commitment of the Afghan authorities to sound economic policies and toward establishing a liberal, market-oriented economy is welcome. As outlined in their overall strategy, the NDF, economic recovery and growth is to be based on liberal and open markets, led by private sector activity with low state intervention. The authorities also aim to establish transparency in government operations and improve economic management.

58. Afghanistan’s recovery faces substantial risks, the most prominent being poor security and the limited rule of law. Restoring adequate security throughout the country remains a key priority. The government’s control over the provinces is still very limited. An adequate level of security will need to be established in the provinces to permit the implementation of reforms and projects, as well as the resumption of private economic activity and the provision of basic public services.

59. There is a related risk that much of Afghanistan may become dominated by poppy cultivation and the production of opium. Opium production is back to the levels of the late 1990s and its pervasive influence threatens to become entrenched. Eradication programs must be intensified, but can only hope to succeed if they go hand in hand with economic development to provide alternative livelihoods and with improved security. Without this, Afghanistan could enter into a downward spiral of violence and corruption.

60. Another risk is that external assistance may fall short of what is required. Putting Afghanistan back on its own feet will continue to require sizable international assistance over the next several years. The experience of post-conflict countries shows that assistance typically starts to decline after a few years, just when the recipient country’s capacity to absorb aid and use it effectively is increasing.24

61. Notwithstanding these risks, ultimately Afghanistan’s outlook—and the donors’ willingness to support the country—will depend on the authorities ability to maintain political as well as macroeconomic stability and to adopt strong policy measures. It will be crucial to continue to adhere to strict fiscal and monetary discipline and maintain the momentum of rebuilding institutions and economic reforms, to foster private sector development, and thereby to provide donors with the necessary encouragement to mobilize the resources needed to underpin Afghanistan’s revitalization in the years to come.

62. The staff welcomes the authorities’ intention to formally establish a liberal trade and exchange regime and urges them move swiftly on this to resolve the current vacuum. Staff will assist the authorities in the drafting of the necessary laws and regulations with a view to prepare for the acceptance by Afghanistan of the obligations under Article VIII, Sections 2, 3, and 4.

63. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Table 6.

Afghanistan: Country Work Program, 2003–early 2004

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APPENDIX I: Islamic State of Afghanistan: Relations with the Fund

(As of September 30, 2003)

I. Membership Status: Joined 07/14/55; Article XIV.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):

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Nonfinancial Relations

VII. Exchange Arrangement

Afghanistan is an Article XIV country. At the time of the last Article IV consultation in 1991, Afghanistan maintained exchange restrictions and multiple currency practices that were subject to Article VIII. Today, the authorities are implementing a liberal exchange system. Based on information currently available to the staff, no exchange restrictions and multiple currency practices are currently in place. The authorities intend to formalize the current liberal regime through the adoption of new laws and regulations, for which they have asked for technical assistance from the Fund. At least since end-2001, the Afghani has been floating, and more recently the authorities have been implementing a managed float with no predetermined path for the exchange rate.

VIII. Article IV Consultation

The last Article IV consultation with Afghanistan was discussed by the Executive Board on on June 12, 1991. Consultations with Afghanistan are on the standard 12-month cycle. Article IV consultations since 1991 have been postponed because of the unsettled political and security situation.

IX. Technical Assistance, 2002–03

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A resident multisector statistical advisor, Mr. Soulatha, was stationed in Kabul on July 17, 2002. Several peripatetic advisors in the area of financial sector reform paid alternating visits to Kabul during 2002–03, with Messrs. Manning and Boothe covering payment system issues; Messrs. Bueno and Heng, accounting issues; Mr. Magvan, banking supervision issues; Mr. Rădulescu, central bank modernization; and Messrs. Bergstedt (Swedish Central Bank) and Ehlers (Deutsche Bundesbank), currency reform issues.

X. Resident Representatives

During the first half of 2002, the Fund’s resident representative in Pakistan, Mr. Ghesquiere, assisted in maintaining relations with the Afghan authorities. A new resident representative, Mr. de Schaetzen, took up his post in Kabul on August 24, 2002.

APPENDIX II: Islamic State of Afghanistan: Relations with the World Bank

1. A second Transitional Support Strategy (TSS) was presented to the World Bank Board of Executive Directors in March 2003. The TSS outlines a strategy for World Bank operations over the subsequent 18 months to 2 years until the establishment of a stable, representative government. The strategy focuses on four strategic areas: improving livelihoods, fiscal strategy, institutions and management, governance and public administration reform, and enabling private sector development.

2. In FY 2002, World Bank staff prepared and negotiated four projects to utilize IDA grant funds to a total of $100 million of which 35 percent has been disbursed. Following the clearance of Afghanistan’s arrears to the World Bank and Fund, through donor contributions, the first IDA credit for $108 million for the Emergency Transport Project was approved by the Board in March 2003. By the end of FY 2003 an additional three projects—Emergency Health Sector Rehabilitation ($59.6 million), Emergency Public Administration II ($8.4 million), and National Emergency Employment II ($39.2 million) were approved bringing to $215 million the total allocation for the year.

3. Seven IDA credits/grants are anticipated for FY 2004, for a total of approximately $290 million. The first of these, the Emergency Communications Project ($22 million) was approved by the Board on October 7, 2003. Additional planned projects include: Customs Reform, Urban Development, National Solidarity Program, Irrigation, Polio Eradication, and Fiscal Rehabilitation.

4. The World Bank also administers the Afghanistan Reconstruction Trust Fund (ARTF) which became effective in May 2002 and plays a critical role in funding the recurrent costs of government. In its first year of operation (SY 1381—March 21, 2002 to March 20, 2003) the ARTF mobilized $191 million. Pledges for SY 1382 (March 21, 2003 to March 20, 2004) amount to over $260 million. ARTF is increasing its financing of investments and has the potential to support tighter donor coordination, simplified processes, and fast results.

5. The World Bank is also actively engaged in advisory services to government and continues to respond quickly to a range of requests. Current analytical work includes work on the civil service reform, urban development and land management, education policy reform, labor market and pensions, a gender assessment and oil/gas infrastructure development, as well as broader regional trade work encompassing issues with Afghanistan’s neighbors. The World Bank has also actively utilized Post Conflict Fund and continues to use the Japan Social Development Fund resources to provide on-the-ground support to the government and communities.

6. The World Bank’s program is growing quickly and will have a portfolio of 15 projects by the end of FY 2003. As the country situation normalizes, the Afghan constitution is promulgated and elections are held, the World Bank plans to then start work on developing a Country Assistance Strategy.

7. The World Bank’s office in Kabul is fully functional and growing rapidly to take on increasing demands. A country manager, as well as several other international staff, and a growing number of national staff are now in place.

APPENDIX III: Islamic State of Afghanistan: Survey of Reporting of Main Statistical Indicators

(As of October 31, 2003)

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1

For details about the role of the Asian Development Bank (AsDB) and the World Bank in Afghanistan, see IMF Country Report No. 03/299 (9/21/2003), Islamic State of Afghanistan-Rebuilding a Macroeconomic Framework for Reconstruction and Growth, Boxes 1.1 and 1.2, as well as Appendix II to this paper.

2

A more detailed description of recent economic developments can be found in IMF Country Report No. 03/299. Chapter II.

3

The Afghan solar year 1381 ran from March 21, 2002 until March 20, 2003. The solar year 1382 runs from March 21, 2003 until March 19, 2004. The Afghan fiscal year coincides with the solar year.

4

See “Afghanistan, Opium Survey 2003,” UNODC, October 2003 for further details.

5

Small overdrafts occurred temporarily in the third quarter of 2002/03, reflecting weak cash management at the MoF and poor monitoring of the government’s accounts at DAB.

6

Revenue assumptions for the 2002/03 operating budget were conservatively based on revenue collection observed in the first months following the fall of the Taliban.

7

The difference between revenues reported by the provinces and (net) funds transferred by the provinces to the center.

8

Expenditures for building the new Afghan army and for DDR are outside the operating and development budgets. The majority of capital expenditures to improve the police forces are in the development budget. The costs of ISAF and U.S. military operations are the responsibility of the respective governments.

9

See IMF Country Report No. 03/299, Chapter III, for more details on the 2003/04 development budget.

10

Hotels, restaurants, telecommunications, and rental vehicles.

11

One new Afghani replaced 1,000 old Afghanis. See IMF Country Report No. 03/299, Box V.1 for details on the introduction of the new currency.

12

The amount of currency in circulation is calculated as the amount of currency delivered by the printer, less the amounts remaining in DAB’s Kabul vaults. Little or no information is available on a timely basis on amounts held in the vaults of DAB’s branches and therefore, until adequate communications are established with the branches, currency that may be held there is assumed to be in circulation.

13

The level of dollarization may have increased with the reemergence of the opium trade.

14

Including $196 million in gold valued at $279 per ounce.

15

Afghanistan is also in the process of negotiating a number of transit trade agreements with neighboring countries. See IMP Country Report No. 03/299, Box II.2, for details.

16

Domestic resources include central and provincial surpluses of the previous fiscal year.

17

For details of the debt sustainability analysis, see “Islamic State of Afghanistan—Debt Sustainability Analysis.” Notwithstanding some data changes since this analysis was undertaken, the conclusions drawn from it remain valid.

18

In 2002 and early 2003, Denmark (DKr 5 million), China (£8.8 million), and Germany (€34.4 million) cancelled debts owed by Afghanistan.

19

Afghanistan cleared its arrears to the AsDB, the World Bank, and the Fund in late 2002 and early 2003 as part of a coordinated plan supported by grant contributions from a number of donor countries. Arrears to the Fund amounted to SDR 8.1 million.

20

Russian claims amount to almost $10 billion. In line with the 1997 Memorandum of Understanding on the Russian Federation’s participation in the Paris Club this amount would be adjusted if entered into the Paris Club.

21

See Appendix I, Section XI, for details on the Fund’s TA program with Afghanistan.

22

A program with the Fund in the transition period would nonetheless be useful to reduce uncertainty about the direction of macroeconomic policy.

23

Including the value of opium exports accruing to Afghan farmers and traffickers brings per capita GDP to $300, which is significantly higher, but still among the lowest in the world.

24

See “Aid, Policy and Growth in Post-Conflict Countries,” Paul Collier and Anke Hoeffler, World Bank, 2002, for a discussion of aid effectiveness in post-conflict countries.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Islamic State of Afghanistan: Staff Report for the 2003 Article IV Consultation
Author: International Monetary Fund
Volume/Issue:
Volume 2003: Issue 391
Publisher:
International Monetary Fund
ISBN:
9781451800173
ISSN:
1934-7685
Pages:
49
DOI:
https://doi.org/10.5089/9781451800173.002

Islamic State of Afghanistan: Price and Exchange Rate Developments, 2001-03 1/

Islamic State of Afghanistan: Exchange Rates, 1999-2003 1/