Afghanistan’s economy continued to perform strongly under the staff-monitored program, resulting in rapid economic growth, inflation declining to single-digit levels, and the international reserves position strengthening further. At the same time, the authorities implemented key structural reforms in the fiscal and monetary areas, while bringing to fruition the political framework envisaged under the 2001 Bonn agreement. Risks remain considerable. In addition to those related to the security situation, the government faces the challenges of dealing with persistent opium-related activities, weak implementation capacity, and uncertainties about donor assistance.

Abstract

Afghanistan’s economy continued to perform strongly under the staff-monitored program, resulting in rapid economic growth, inflation declining to single-digit levels, and the international reserves position strengthening further. At the same time, the authorities implemented key structural reforms in the fiscal and monetary areas, while bringing to fruition the political framework envisaged under the 2001 Bonn agreement. Risks remain considerable. In addition to those related to the security situation, the government faces the challenges of dealing with persistent opium-related activities, weak implementation capacity, and uncertainties about donor assistance.

1. This statement contains information on recent economic developments in the Islamic Republic of Afghanistan that has become available since the supplement to the staff report was circulated to Executive Directors on June 13, 2006. This information does not alter the thrust of the staff appraisal.

2. Inflation (year-on-year) declined further, from 9.5 percent in March 2006 to7.5 percent in May. The slowdown was broad-based; and the only noticeable exception was a faster increase in transportation costs resulting, in part, from rising oil prices.

3. Preliminary data indicate that the operating budget deficit, excluding grants, amounted to 3.7 percent of GDP in 2005/06, in line with program projections. While higher than the staff-monitored program floor, revenue in terms of GDP, at 5.2 percent, was slightly lower-than-projected. This outcome reflected a continued underperformance of domestic taxes and fees, which was offset by better-than-anticipated customs receipts. Operating budget spending turned out slightly lower-than-programmed, owing largely to lower-than-envisaged transfers, salaries, and interest payments. Budget development spending exceeded expectations during the fourth quarter; but for 2005/06 as a whole, it amounted to only 5.8 percent of GDP, compared with a midyear review projection of 13.8 percent, due to continued weaknesses in implementation capacity.

4. Liquidity remained tight as Da Afghanistan Bank (DAB) continued to sell foreign exchange through its regular auctions during the first two months of 2006/07. As a result, the exchange rate remained broadly stable, fluctuating within a narrow range (Af/$49.5–50.0), while currency in circulation declined by 3 percent during the same period. Owing to a further accumulation of government deposits at the central bank, the decline in currency in circulation did not translate into a drop of international reserves, which remained largely unchanged, at more than $1.6 billion.

5. On the external debt, significant progress has been made in reconciling the Russian claims, but some issues are still outstanding. Discussions are ongoing.

6. The Finance Department has conducted a safeguards assessment of DAB. The assessment identified several vulnerabilities and made recommendations to remedy them. DAB has agreed to implement the proposed recommendations.