Statement by the IMF Staff Representative on Islamic Republic of Afghanistan

Afghanistan has made substantial progress toward macroeconomic stability, but structural reforms need to be accelerated. The uncertainty affecting the fiscal outlook warrants a prudent expenditure policy. Monetary policy has been instrumental in reducing inflation and safeguarding external stability, but it needs to be strengthened. The government should resist pressures for expanding its role in the economy and focus on fostering competition and improving economic governance. The current exchange rate level appears in line with fundamentals. The government should increase its efforts to improve Afghanistan’s statistical database.

Abstract

Afghanistan has made substantial progress toward macroeconomic stability, but structural reforms need to be accelerated. The uncertainty affecting the fiscal outlook warrants a prudent expenditure policy. Monetary policy has been instrumental in reducing inflation and safeguarding external stability, but it needs to be strengthened. The government should resist pressures for expanding its role in the economy and focus on fostering competition and improving economic governance. The current exchange rate level appears in line with fundamentals. The government should increase its efforts to improve Afghanistan’s statistical database.

1. This statement summarizes information that became available since the issuance of the staff report on January 29, 2008. Staff visited Kabul during January 26–February 5, 2008 to assess Afghanistan's performance with respect to the indicative quantitative targets under the PRGF-supported program through December 2007, and to reach understandings on corrective measures to address a revenue shortfall. The new information does not change the thrust of the staff appraisal.

2. The three prior actions for the completion of the third review under the PRGF arrangement have been implemented. President Karzai issued a decree approving the appointment of KPMG as Da Afghanistan Bank's (DAB) external auditor until 2010/11, and a special audit confirmed DAB's foreign exchange reserves, as reported to the Fund at the September 2007 test date. The authorities have also made the legislative changes necessary to eliminate the discriminatory application of the 1 percent tariff rate on imports of raw materials.

3. Performance under the program during the third quarter of 2007/08 shows some slippages (see Table). Specifically, the indicative floor on fiscal revenue and the ceiling on currency in circulation (CiC) were each missed by approximately Af 1 billion (0.2 percent of GDP). Prudent execution of the core operating budget permitted observance of the indicative targets on the operating budget deficit and net central bank financing of the government, but the revenue shortfall underscores the need to implement promptly measures to bolster revenue collection, as agreed with staff during the November 2007 mission.

4. Higher prices of imported fuel and foodstuffs led to a significant increase in consumer prices, with 12-month (end-of-period) inflation reaching 17 percent in December 2007. Following increased reliance on auctions of foreign exchange and capital notes (CNs) to absorb excess liquidity, the Afghani has appreciated by 1 percent against the U.S. dollar since end-December 2007.

5. In early February 2008, the authorities implemented the measures covered by the structural benchmarks for end-November 2007 that had been delayed, including the issuance of regulations on credit-granting standards and the credit-monitoring process, and on setting limits on sectoral loan concentration. DAB also proceeded expeditiously with the issuance of two circulars informing banks of changes to the minimum capital requirement and repealing the requirement to invest 80 percent of bank deposits domestically.

6. Regarding the draft 2008/09 operating budget, expenditure exceeds the level agreed with Fund staff in November 2007 by Af 2 billion (0.4 percent of GDP), on account of the contingency for accelerating recruitment by the Afghan National Army. The authorities also reallocated the cash fuel allowance of Af 1.5 billion for the Ministry of Interior to other expenditure items following commitments of offsetting in-kind donations. In addition, there has been a reallocation of expenditure from operation and maintenance to salaries. The operating budget envelope will be reevaluated at the time of the fourth review.

7. DAB recognizes the need to improve liquidity management to ensure that the March 2008 ceiling on CiC is observed. To that end, DAB is engaging the Ministry of Finance (MOF) in efforts to improve the projection of the government's cash-flow needs. As noted above, consistent with program understandings, DAB has already increased the issuance of CNs. It is also preparing the legal framework for the secondary market in these instruments, with Fund technical assistance.

8. The authorities and the World Food Program (WFP) have launched a joint appeal to distribute wheat to areas affected by shortages. Additional efforts to mitigate the effect of rising prices may, however, be necessary. Staff stressed the advantages of targeted cash transfers to vulnerable households.

Islamic Republic of Afghanistan: Performance Criteria and Indicative Targets for 2007/08 1/

(Cumulative changes from March 20, 2007; unless otherwise indicated)

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

The performance criteria and indicative targets envisaged under the program, and their adjustors, are defined in the Technical Memorandum of Understanding.

These performance criteria apply on a continuous basis.

The program provided for additional Af 3,800 million in the first half of 2007/08 in donor-supported security spending. At the midyear review, the additional security spending was incorporated in the budget.

Islamic Republic of Afghanistan: 2007 Article IV Consultation and Third Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Request for Waiver of Performance Criterion: Staff Report; Staff Statement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for Islamic Republic of Afghanistan
Author: International Monetary Fund