Islamic Republic of Afghanistan
Fourth Review Under the Staff-Monitored Program

This paper focuses on the Fourth Review Under the Staff-Monitored Program (SMP) for Afghanistan. Under the SMP, Afghanistan continued to make progress in improving macroeconomic management, strengthening its capacity to formulate policy, and creating conditions for sustainable economic growth. All indicative quantitative indicators and structural benchmarks for the fourth review were observed, except for the external debt survey, owing to the lack of cooperation of some creditors. Despite unfavorable weather, real GDP continued to increase at a steady pace, estimated at 7.5 percent in 2004/05.

Abstract

This paper focuses on the Fourth Review Under the Staff-Monitored Program (SMP) for Afghanistan. Under the SMP, Afghanistan continued to make progress in improving macroeconomic management, strengthening its capacity to formulate policy, and creating conditions for sustainable economic growth. All indicative quantitative indicators and structural benchmarks for the fourth review were observed, except for the external debt survey, owing to the lack of cooperation of some creditors. Despite unfavorable weather, real GDP continued to increase at a steady pace, estimated at 7.5 percent in 2004/05.

I. Introduction

1. One year into the SMP, Afghanistan has made marked progress in improving macroeconomic management, strengthening its capacity to formulate policy, and creating conditions for sustainable economic growth. Macroeconomic stability is largely achieved, as evidenced by moderate core inflation, monetary growth and fiscal revenue consistent with program objectives, a stable exchange rate, and increasing international reserves. At the same time, further progress was made in reestablishing political stability, in particular through the organization of the October 2004 presidential election and the formation of a new Cabinet in December 2004. Progress on the macroeconomic and political fronts contributed to the observance of all indicative quantitative indicators and almost all structural benchmarks over the last 12 months.

2. Notwithstanding these achievements, administrative capacity continues to be limited, private sector activity is constrained by complex procedures and rigidities, the security situation and the drug economy remain major concerns, infrastructure needs are substantial, and delivery of government services is still poor. The authorities’ main challenge is to achieve high and sustainable growth while preserving fiscal and external sustainability. Over the next few years, the Afghan economy will have to grow by an average rate of at least 10 percent so that significant inroads can be made in reducing poverty and advancing toward the Millennium Development Goals.1 To meet these objectives, the country needs to strengthen its structural reform agenda to encourage private investment, prioritize spending in favor of poverty reduction and investment, and increase domestic revenue. To support these reforms, given Afghanistan’s low domestic savings and limited scope for external borrowing, the country will require continued predictable and sizeable assistance from the donor community in the form of grant financing and concessional lending. In the short term, Afghanistan must focus its efforts on (a) diversifying the sources of growth; (b) implementing appropriate policies to maintain donor inflows and preserve external competitiveness; and (c) strengthening administrative capacity.

II. Recent Developments And Program Performance

3. All quantitative indicators and structural benchmarks for the fourth review were met, except for the survey of external debt, which was not completed owing to the lack of cooperation of some creditors.

4. The 2004/05 macroeconomic performance was in line with program projections. Economic activity continued to increase at a steady pace, with real GDP growth estimated at 7.5 percent in 2004/05, as the fall in agricultural output caused by weather conditions was offset by strong growth in construction, transportation, and trade (Tables 1 and 2). Poppy cultivation appears to have declined significantly in early 2005, due in part to the authorities’ anti-narcotics campaign and the fall in farm gate prices triggered by the 2004 bumper harvest. It was uncertain, however, whether the reduction in planted areas would bring a significant reduction in opium production, as yields were expected to rise as a result of improved rainfall.

Table 1.

Islamic Republic of Afghanistan: Basic Data, 2001/02–2005/061/

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

The fiscal year 2005/06 runs from March 21, 2005 until March 20, 2006.

Table 2.

Islamic Republic of Aghanistan: Savings-Investment Balances, 2002/03–2007/08

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

Data originating from the fiscal accounts.

Determined as a residual.

Equivalent to foreign direct investment reported in the balance of payments, and some new private investment.

5. Inflation was higher than projected in 2004/05 (paragraph 3 of MEFP and Figure 1). Year-on-year consumer prices increased by 16.3 percent in Kabul, compared with a SMP projection of 13 percent.2 The increase in inflation in 2004/05, up from 10.2 percent at end-2003/04, essentially reflected the acceleration of rents, education fees, and petroleum product prices.

Figure 1.
Figure 1.

Islamic Republic of Afghanistan: Price Developments, 2003–05 1/

Citation: IMF Staff Country Reports 2005, 237; 10.5089/9781451800227.002.A001

Sources: Central Statistics Office of Afghanistan; and Fund staff estimates.1/ Last observation: March 2005.

6. Provisional data indicate that fiscal revenue reached Af 12,800 million in 2004/05, slightly above the SMP indicative target (Af 12,784 million) but well below the budget forecast (Af 15,380 million; paragraphs 4–6 of the MEFP and Tables 3a and 3b). The SMP target was met as buoyant customs duties compensated for a shortfall in tax and nontax revenues stemming partly from delays in collecting about Af 800 million in overflight charges due to limited administrative capacity. As the shortfall in revenue relative to the budget target was more than offset by lower-than-expected operating expenditures, the operating budget recorded a surplus of Af 1.1 billion for the year. Despite a substantial rise during the fourth quarter, operating spending was also below the midyear review (MYR) projection, mainly due to continued delays in recruiting teachers and in implementing civil service reform. More timely grant disbursements from the multi-donor trust funds were facilitated by better expenditure controls and compliance. Development spending was again substantially below budget expectations, essentially due to the lack of security and the low capacity of line ministries and implementing agencies to develop and implement projects.

Table 3a.

Islamic Republic of Afghanistan: Core Budget, 2002/03–2006/07

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Sources: Ministry of Finance; Da Afghanistan Bank; and Fund staff estimates and projections.

Budget estimates. Staff projected domestic revenue of Af 12.784 billion for 2004/05.

Staff estimates.

Government program classification.

Variation between the fiscal position recorded at Ministry of Finance and DAB. This discrepancy is due to the difference (“float”) between checks issued and checks cashed.

Net transfers from government deposits with Da Afghanistan Bank. A positive sign corresponds to a decline in balances and a negative sign to an increase in balances.

In 2002/03, includes one-off transfers of overflight revenue and customs valuation fees accumulated over several years and the sale of telecommunication licenses.

Development spending outside Treasury accounts.

Table 3b.

Islamic Republic of Afghanistan: Core Budget, 2002/03–2006/07

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Sources: Ministry of Finance; Da Afghanistan Bank; and Fund staff estimates and projections.

Budget estimates. Staff projected domestic revenue of Af 12.784 billion for 2004/05.

Staff estimates.

Government program classification.

Variation between the fiscal position recorded at Ministry of Finance and DAB. This discrepancy is due to the difference (“float”) between checks issued and checks cashed.

Net transfers from government deposits with Da Afghanistan Bank. A positive sign corresponds to a decline in balances and a negative sign to an increase in balances.

In 2002/03, includes one-off transfers of overflight revenue and customs valuation fees accumulated over several years and the sale of telecommunication licenses.

Development spending outside treasury accounts.

7. The authorities adhered strictly to the monetary program for 2004/05 (paragraph 8 of MEFP). Currency in circulation amounted to Af 39.6 billion at year-end, compared with the SMP indicative target of Af 39.8 billion (Figure 2 and Table 4). During the fourth quarter, Da Afghanistan Bank (DAB) stepped up its foreign currency auctions to partly offset the monetary expansion caused by increased government spending and maintain money in circulation in line with the SMP indicative ceiling. Together with the government’s drawdown of its foreign currency deposits with DAB, this led to a slight decline in DAB’s foreign exchange reserves, to $1.3 billion at end-2004/05 (Figure 3). The interest rate on the overnight capital note remained low, at 1–2 percent, while the one-month auctions continued to be undersubscribed. The nominal exchange rate was broadly stable during the fourth quarter. The Afghani appreciated in nominal terms by 3.4 percent against the U.S. dollar in 2004/05, to Af 48.65 per dollar at year-end, and by 15.1 percent in real terms.

Figure 2.
Figure 2.

Islamic Republic of Afghanistan: Monetary Developments, 2003–05 1/

Citation: IMF Staff Country Reports 2005, 237; 10.5089/9781451800227.002.A001

Sources: Da Afghanistan Bank; and Fund staff estimates and projections.1/ Last observation: March 20, 2005.
Table 4.

Islamic Republic of Afghanistan: Monetary Program (Da Afghanistan Bank), 2003/04–2005/06

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Sources: Da Afghanistan Bank; Central Statistics Office; and Fund staff estimates and projections.

The second March 20 column takes into account the writing-off of DAB’s claims on the government anterior to 2002/03, as per the TMU signed by DAB and the Ministry of Finance. The difference in currency in circulation corresponds to a change in definition (see footnote 3).

Foreign currency amounts converted into Afghani at the program exchange rate (Af 49.84 per U.S. dollar in 2004/05-2005/06). The gold is valued at $400 per ounce in 2004/05-2005/06 and does not include the gold held in the palace vaults.

In 2003/04-2004/05, cash holdings only include cash in DAB’s treasury vaults and in DAB’s six major provincial branches. In 2005/06, they include cash in DAB’s Treasury vaults and in all DAB’s provincial branches.

Figure 3.
Figure 3.

Islamic Republic of Afghanistan: Foreign Exchange Reserves and Real Exchange Rate, 2003–05 1/

Citation: IMF Staff Country Reports 2005, 237; 10.5089/9781451800227.002.A001

Sources: Central Statistics Office of Afghanistan; Da Afghanistan Bank; and Fund staff estimates.1/ Last observation: March 2005.2/ An increase in the exchange rate indices corresponds to an appreciation. The real exchange rate is estimated using the U.S. and Afghan CPIs.

8. Preliminary data indicate that the current account deficit, excluding grants, reached 43.7 percent of GDP in 2004/05, down from 50.9 percent in 2003/04, reflecting essentially an increase in imports not associated with reexports (Table 5).3 While foreign direct investment and concessional borrowing increased, the deficit continued to be mainly financed by grants. Including grants, the current account was broadly balanced in 2004/05, compared with a 3.1 percent of GDP surplus in 2003/04. External borrowing remained limited and on highly concessional terms.

Table 5.

Islamic Republic of Afghanistan: Balance of Payments, 2002/03–2007/08

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

Excludes opium exports and, because information is unavailable, flows associated with U.S. Army and most ISAF activities.

Debt service projections are based on recognized obligations, reconciled with creditors. Arrears shown here represent an estimate by Fund staff, on the basis of loans which have been verified with creditors, but are not being serviced.

Includes all grants. Tables 3a and 3b reflect only grants to the core budget and not those financing projects implemented directly by donors.

In months of imports of goods and services, excluding imports for reexport.