Islamic Republic of Afghanistan
Fourth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Request for Waiver of Performance Criterion: Staff Report; Staff Supplement and Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Islamic Republic of Afghanistan

This paper discusses key findings of the Fourth Review Under the Poverty Reduction and Growth Facility (PRGF) for Afghanistan and a Request for Waiver of Performance Criterion. Program performance during the second half of 2007/08 fell short of expectations. The performance criterion on fiscal revenue was missed, and the authorities fell behind on several program commitments. For 2008/09, real GDP growth is projected to moderate to 7.5 percent and inflation to decelerate to 15½ percent by year’s end.

Abstract

This paper discusses key findings of the Fourth Review Under the Poverty Reduction and Growth Facility (PRGF) for Afghanistan and a Request for Waiver of Performance Criterion. Program performance during the second half of 2007/08 fell short of expectations. The performance criterion on fiscal revenue was missed, and the authorities fell behind on several program commitments. For 2008/09, real GDP growth is projected to moderate to 7.5 percent and inflation to decelerate to 15½ percent by year’s end.

I. Introduction

1. On February 13, 2008, the Executive Board approved the third review of Afghanistan’s three-year PRGF arrangement and concluded the 2007 Article IV consultation. On that occasion, Executive Directors urged the authorities to accelerate structural reforms, enhance governance, overcome infrastructure bottlenecks, and promote private sector activities while reducing the government’s involvement in the economy. They also emphasized the importance of revenue enhancing measures to move Afghanistan toward fiscal sustainability.

2. The ANDS—Afghanistan’s PRSP—and the JSAN were discussed by the Executive Board of the IMF on June 2, 2008. Directors stressed the need for further prioritization of sectoral programs in the ANDS and strengthened mobilization of domestic revenue to prevent long-term aid dependence. During the Paris Conference held on June 12, 2008, donors pledged about $20 billion for the implementation of the ANDS. The horizon of donor pledges varied from two to five years; some donors are expected to make additional pledges in the period ahead.1

3. Security remains a major challenge and the political environment surrounding the program has become increasingly complex. The government continues to experience difficulties in assuming control over large parts of the country affected by the war and the illegal drug economy. Presidential elections are scheduled for 2009, to be followed by parliamentary elections in 2010.

II. Recent Economic Developments

4. Economic developments in the second half of 2007/08 were broadly favorable, but inflation increased significantly. Real GDP is estimated to have increased by 11.5 percent (Table 1). Higher prices of imported fuel and foodstuffs raised 12-month (end-of-period) inflation to 20.7 in March 2008—the end of 2007/08 (Figures 1a1b). The price level jumped by 20 percent in the first two months of 2008/09, reflecting the sharp increase in food prices following the imposition of export restrictions on wheat by Afghanistan’s regional trading partners (Figure 1c). Opium production reached a record level in 2007/08 and farm-gate prices of opium declined significantly reflecting the increase in supply.

Table 1.

Islamic Republic of Afghanistan: Selected Economic Indicators, 2005/06-2012/13

(Quota: SDR 161.9 million)

(Population: 26.7 million; 2006/07)

(Per capita GDP: US$290; 2006/07)

(Poverty rate: n.a.)

(Main export: carpets, US$186 million; 2006/07)

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

National accounts numbers were revised to reflect the authorities’ data, excluding the drug economy.

For Kabul.

Does not include core budget development spending and externally-financed development expenditures, which amounted to 8.4 percent of GDP and 50.6 percent of GDP, respectively, in 2006/07.

After HIPC and MDRI relief as well as debt relief beyond HIPC relief from Paris Club creditors. Debt also includes obligations to the IMF. The debt stock includes the capitalization of interest to Paris Club creditors until completion point under the Enhanced HIPC Initiative.

The 2008/09 number is for April 15, 2008.

Numbers have been revised as a result of more reliable data on public grants.

Includes official recorded exports plus staff estimates of smuggling; excludes reexports.

Excludes reexports.

In months of imports of goods and services, excluding imports for reexports and duty free imports by donors.

An increase in the exchange rate indices corresponds to an appreciation. For 2007/08, REER is for the period April to December.

Figure 1.
Figure 1.

Islamic Republic of Afghanistan: Price Developments January 2004-May 2008 1/

Citation: IMF Staff Country Reports 2008, 229; 10.5089/9781451800401.002.A001

Sources: Central Statistics Office of Afghanistan; and Fund staff estimates.1/ CPI data for Kabul only.

5. The domestic revenue target was undershot by 6 percent. As a percent of GDP, domestic revenue declined from 7.5 percent in 2006/07 to 7.0 percent in 2007/08 (Tables 2a and 2b). Although partly related to lower than projected imports, the revenue shortfall was mainly due to inadequate enforcement efforts and undervaluation of petroleum imports by customs. Nevertheless, the operating budget deficit excluding grants is estimated to have narrowed to 3.6 percent in 2007/08 (slightly lower than programmed), as the security spending envelope (which was significantly increased in mid-2007/08) was not fully used. Development expenditures are estimated to have been broadly in line with program projections, at Af 45 billion or 9.4 percent of GDP.

Table 2a.

Islamic Republic of Afghanistan: Core Budget, 2005/06-2012/13 1/

(In millions Afghanis)

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

Core budget includes domestic revenues, grants, operating and development expenditure, and financing that are accounted for by the central government.

Funding for operating budget from the multi-donor trust funds: The Afghanistan Reconstruction Trust Fund (recurrent window) and the Law and Order Trust Fund (LOTFA).

Interest due (cash only) reflects rescheduling under enhanced HIPC Initiative.

Government’s current program classification based on a simple aggregation of administrative units.

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

In 2005/06 and 2006/07 includes $40 million receipt from sale of telecommunications spectrum bandwidth and late overflight payment. From 2007/08 includes sale of land and buildings and privatization receipts.

Net change in government deposits with DAB (excluding provincial branch balances). A positive sign corresponds to a decline in balances.

Estimates from MOF and donors.

Security adjuster should ANA force strength increase to 86,000.

Possible purchase of $50 m worth of wheat for resale.

Table 2b.

Islamic Republic of Afghanistan: Core Budget, 2005/06-2012/13 1/

(In percent of

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

Core budget includes domestic revenues, grants, operating and development expenditure, and financing that are accounted for by the central government.

Funding for operating budget from the multi-donor trust funds: The Afghanistan Reconstruction Trust Fund (recurrent window) and the Law and Order Trust Fund (LOTFA).

Interest due (cash only) reflects rescheduling under enhanced HIPC Initiative.

Government’s current program classification based on a simple aggregation of administrative units.

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

In 2005/06 and 2006/07 includes $40 million receipt from sale of telecommunications spectrum bandwidth and late overflight payment. From 2007/08 includes sale of land and buildings and privatization receipts.

Net change in government deposits with DAB (excluding provincial branch balances). A positive sign corresponds to a decline in balances.

Estimates from MOF and donors.

Security adjuster should ANA force strength increase to 86,000

Possible puchase of $50 million worth of wheat for resale.

6. Structural reforms in public finance have been uneven. The authorities expanded the program budget pilots to help align public spending priorities with the ANDS, and initiated Treasury reforms to strengthen tracking of poverty related spending through reporting on government budget execution. Progress in these areas form part of the HIPC completion point triggers. Nevertheless, the linkage between budget formulation and subsequent execution and monitoring remains weak, and progress in integrating the operating and development budgets—a key objective of the program pilots—has been slow.

7. Da Afghanistan Bank (DAB) observed the end-year currency in circulation (CiC) ceiling. CiC growth was kept at 17.0 percent in 2007/08, significantly below the growth of nominal GDP (24 percent), which helped mitigate inflationary pressures in the latter part of 2007/08 (Table 3, Figure 2). DAB increased significantly the issuance of capital notes (CNs) during the second half of 2007/08. As a result, interest rates on 28-day CNs increased to 14.6 percent at end-2007/08, compared with 7.6 percent at end-2006/07. The Afghani strengthened by 1.1 percent vis-à-vis the U.S. dollar during 2007/08, and is estimated to have appreciated by 3.0 percent in real effective terms over the same period (Figure 3).

Table 3.

Islamic Republic of Afghanistan: Monetary Program (Da Afghanistan Bank), 2005/06–2008/09

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

Foreign currency-denominated components evaluated using the actual exchange rates at dates indicated.

Foreign currency-denominated components evaluated using applicable program exchange rates.

The gold does not include the gold held in the palace vaults.

Until March 2006, capital notes and foreign currency deposits of commercial banks with DAB were included in Reserve money (as banks could use capital notes to meet their reserve requirements; this possibility was removed in March 2006, at which time banks were also instructed to meet the reserve requirements in Afghanis only, against both Afghani and foreign currency deposits).

National currency only.

Program projections for Dec. 21.2008 and Mar. 19, 2008 have been realigned with the revised base for March 20, 2007.

Weighted average of bid rates; 30-day notes until March 2006; last observation: March 17, 2008.

Figure 2.
Figure 2.

Islamic Republic of Afghanistan: Monetary Developments

Citation: IMF Staff Country Reports 2008, 229; 10.5089/9781451800401.002.A001

Sources: Da Afghanistan Bank; and Fund staff estimates and projections.1/ Last observation: April 15, 2008.2/ 56-day notes until February 27, 2007.
Figure 3.
Figure 3.

Islamic Republic of Afghanistan: Foreign Exchange Reserves and Price and Exchange Rate Indices

Citation: IMF Staff Country Reports 2008, 229; 10.5089/9781451800401.002.A001

Sources: Central Statistics Office of Afghanistan; Da Afghanistan Bank; and Fund staff estimates.1/ An increase in the exchange rate indices corresponds to an appreciation.2/ CPI based; last observation: March 2008.

8. DAB continued modernizing its operations. The new accounting system at the DAB became fully operational, and now covers six regional branches. The authorities are also in the process of implementing the recommendations of the safeguards assessment and technical assistance in the areas of accounting and internal control. The ongoing modernization of DAB has been accompanied by a training program and restructuring of its workforce.

9. The external position continued to strengthen in 2007/08 due to improvements in the trade balance and higher than expected aid inflows. The current account balance (including grants) registered a surplus of 0.9 percent of GDP in 2007/08 (compared to a deficit of 4.9 percent in 2006/07). Gross international reserves increased to about US$2.8 billion (11 months of imports).

10. The authorities continued their efforts to regularize relations with external creditors, as required under the Enhanced HIPC Initiative. In January 2008, Saudi Arabia agreed to write off most of the eligible outstanding claims on Afghanistan (approximately $25.5 million; all in arrears) and restructure the remaining balance on terms comparable to those granted by Paris Club creditors. In May 2008, Iraq agreed to forgive Afghanistan’s debts (about $9.6 million in arrears). Negotiations on debt relief agreements are underway with the Kuwait Development Fund and the OPEC Fund for International Development. The authorities are also undertaking a review of DAB’s records regarding an unverified (pre-cutoff) claim by Iran, with a view to confirming its validity by mid-2008/09. In addition, the authorities continue to make good faith efforts to enter into debt relief negotiations with the remaining non-Paris Club creditors.

III. Performance Under The Program

11. Performance under the PRGF program in the second half of 2007/08 was mixed:

  • The authorities met all the quantitative performance criteria and indicative targets for end-2007/08, with the exception of the floor on domestic revenue (Supplementary Memorandum of Economic and Financial Policies (SMEFP); Attachment II, Table 1).

  • Four out of seven structural benchmarks were met (SMEFP Table 2). The benchmark on adopting a comprehensive restructuring/divestment plan for state-owned enterprises (SOEs) and government agencies engaged in commercial activities was not observed. DAB also missed the benchmark on monetary data reconciliation; however, this reconciliation has now been completed and the data for monitoring the 2008/09 program will be sourced directly from DAB’s accounting records. While the electricity company (DABM) was corporatized, enabling it to continue operating as a public entity but on strictly commercial basis, the authorities missed the structural benchmark on the conclusion of an agreement between the Ministry of Finance (MOF) and DABM on quarterly reform benchmarks in exchange for subsidy disbursements.

  • Many other commitments specified in the Memorandum of Economic and Financial Policies (MEFP) of January 28, 2008 were not fulfilled. These included, among others, a review of fiscal relations between the government and key SOEs, and the submission to Parliament of laws that are critical for private sector development.

IV. The 2008/09 Program

12. Discussions with the authorities on their policies for 2008/09 focused on (a) maintaining macroeconomic stability and other reform priorities; (b) prior actions to address the revenue shortfall in 2007/08 and other measures to strengthen revenue performance; (c) the monetary policy framework and bank supervision; (d) mechanisms to address the effects of rising wheat prices; and (e) structural reforms. Program discussions were guided by the MEFP of January 28, 2008. The changes to the program are reflected in the attached supplementary memorandum of understanding for 2008/09. In addition to three prior actions (¶14), the proposed program includes six new structural benchmarks for the fifth review and two more for the sixth review (Box 1). The new conditionality consists of actions that are deemed critical for improving the revenue performance, further developing the monetary policy framework, and strengthening public financial management (PFM) and bank supervision.

Rationale for Added Structural Conditionality

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A. Macroeconomic Outlook

13. Growth and inflation are both expected to moderate in 2008/09, and the external position is projected to improve. Real GDP growth is projected to decelerate to 7.5 percent as drought will affect negatively agricultural output. Average 12-month CPI inflation is projected at 24 percent, with end-period inflation declining to 15.6 percent by year’s end. This is an optimistic scenario that assumes a significant downward correction in food prices in the wake of government and donor efforts to bring adequate supplies of wheat into the country. Maintenance of this low inflation assumption is designed to keep the overall program targets (fiscal and monetary) tight. The inflation outlook is, however, subject to a significant upside risk (especially if food prices do not decline as envisaged), and the program may need to be revised if inflation through mid-year turns out to be significantly higher than projected. The external position is projected to improve further due to strong export growth, mining-related FDI, and aid inflows in excess of 50 percent of GDP.

B. Fiscal Policy

14. Three prior actions were incorporated into the program to bring government revenues back on track (SMEFP ¶ 8). The prior actions call for (i) introducing a system for timely updates of reference prices for petroleum products; (ii) collecting at least Af 79 million on the business receipt tax (BRT) and non-tax (landing/parking right fees) liabilities due by airlines and outstanding at end-2007/082; and (iii) ensuring that customs has the authority to verify independently the amount and quality of fuel imports stored at the depots of the state-owned fuel company. The prior actions address directly the key sources of revenue leakages and noncompliance in 2007/08, and are critical for ensuring the viability of the revenue objectives for 2008/09.

15. The operating budget deficit (excluding grants) is projected at 3.2 percent of GDP in 2008/09. Revenues are targeted to increase to Af 44.5 billion (7.0 percent of GDP, of which 0.4 percent of GDP is on account of prior actions and additional program measures—SMEFP ¶8). The operating expenditure envelope of Af 65.0 billion (10.2 percent of GDP) is slightly lower, relative to GDP, than the outturn for 2007/08. The program also provides for an additional Af 1.9 billion (0.3 percent of GDP), if needed, to enable acceleration of Afghanistan National Army (ANA) recruitment. The core budget deficit (including grants) would be Af 2.5 billion higher than originally envisaged, but the prospects of significant receipts from the recently announced privatization of Afghan Telecom, planned for mid-2008, have significantly reduced the need for domestic financing in 2008/09.

16. Despite the revenue measures incorporated in the program, the revenue-to-GDP ratio is not expected to rise in 2008/09. Higher food prices increase nominal GDP, but do not affect revenues because food is not taxed. The revised fiscal program, therefore, now aims only to stabilize the revenue-to-GDP ratio for 2008/09 (Figure 4); however, in nominal terms, revenue is projected to be 33 percent higher than in 2007/08.

Figure 4.
Figure 4.

Fiscal Sustainability: Changing Target Dates for Zero Operating Budget Balance Under the PRGF Supported Program, 2005/06-2013/14

(In billions of Afghanis)

Citation: IMF Staff Country Reports 2008, 229; 10.5089/9781451800401.002.A001

Source: MOF and Fund staff estimates.

17. Continued structural fiscal reforms are necessary to strengthen the fiscal outlook (SMEFP ¶¶11-13). The authorities plan to: (i) modernize the civil service by implementing the Pay and Grade reform; (ii) strengthen the financial management system in view of scaled-up aid in the context of ANDS by implementing the budget and treasury reforms; and (iii) regularize the relations between the budget and public enterprises. To this end, the authorities reconfirmed their commitment to initiate the review of fiscal relations between the government and key state-owned enterprises (SOEs).

18. The authorities intend to work with donors on mechanisms to help the poor cope with the impact of increased wheat prices. The authorities have thus far resisted the idea of providing aid via cash transfers to the needy, pointing to the lack of appropriate identification and distribution mechanisms, and have already imported about $50 million of wheat from neighboring countries at a price below the market price in Afghanistan with the intention of selling the imported wheat at a cost-recovery level (SMEFP ¶7).

C. Monetary Policy, Financial Sector Reforms, and External Sector

19. Monetary policy will aim to contain inflationary pressures; however, widespread dollarization will continue to limit its effectiveness. Foreign exchange auctions will remain a primary instrument of monetary policy, with the objective of maintaining CiC growth at or below the growth of nominal GDP (33.1 percent) and limiting exchange rate volatility without resisting the underlying trend in the Af/US$ exchange rate. Given the increasing importance of noncash transactions and the need to broaden the monetary policy framework, DAB intends to use an indicative ceiling on reserve money (RM) in addition to the quantitative performance criterion on CiC, and to strengthen its liquidity forecasting and monitoring (SMEFP ¶¶16-18). The introduction of the reserve money target will provide guidance for operations in CNs and help lower interest rate volatility. DAB also plans to take measures to develop the secondary market for conducting open market operations using CNs (SMEFP ¶17).

20. DAB will also continue to build its capacity and modernize its operations. The completion of the 2007/08 external audit (expected by end-June 2008) will form the basis for an action plan to strengthen further DAB’s capacity, including in accounting, reporting, and internal control.

21. DAB aims to strengthen the legal and regulatory framework of the banking sector, which has grown rapidly in recent years. To that end, DAB intends to develop an action plan to address the gaps in the legal framework based on the weaknesses identified in the self-assessment exercise against the Basle Principles. Also, regulations on risk management (credit, market, liquidity, country, and operational) are under preparation. In addition, DAB will continue to maintain restrictions on the growth of credit and branches of weak banks (SMEFP ¶¶20-21).

22. Foreign exchange reserves are expected to rise further to US$3 billion (about 11½ months of projected imports) by the end of 2008/09. Despite significant copper mine related imports (Box 2), the current account deficit (excluding grants) is projected to improve over the medium term, in line with the decline in donor-related imports and full delivery of debt relief under the HIPC initiative.

Afghanistan’s Mining Potential

Afghanistan has significant mineral resources, including copper, iron, gold, coal, and semi-precious stones. Despite considerable exploration and deposit identification, large-scale mining has had limited development, and represents less than one percent of GDP.

In November 2007, Afghanistan tendered the right for exploration of its first large-scale copper mine, Aynak. The mine is considered to be the world’s second largest untapped copper deposit, with estimated reserves of up to 13 million tons. Total FDI inflows associated with the project are projected at about $2.8 billion over the next six years, enabling annual production of up to 200,000 tons (1.3 percent of current world production), which will amount to about 2 percent of GDP in about ten years, when Aynak reaches its expected peak. Fiscal revenues in terms of royalties and taxes are projected at about $200 million a year. An ambitious program is also being planned to build the necessary infrastructure, which will boost activity in construction, water and electricity, coal, and transport.

Other mining projects are in the planning stages, including development of a large iron ore mine (with estimated reserves of about 1.8 billion tons), natural gas, and oil.

23. The updated debt sustainability analysis (DSA) suggests that Afghanistan continues to have a high risk of debt distress, absent debt relief.3 The DSA highlights the risk to Afghanistan’s debt sustainability of lower-than-expected official transfers and a slower-than-expected expansion of its narrow export base. However, full delivery of debt relief under the HIPC initiative and the Multilateral Debt Relief Initiative (MDRI) would be sufficient to reduce Afghanistan’s debt to sustainable levels.

D. Structural Policies, Poverty Reduction, and Statistical Issues

24. The authorities recognize the need to reinvigorate the structural agenda (SMEFP ¶¶22-25). In line with understandings reached in January 2008, they plan to: (i) strengthen fiscal control over the financial operations of DABS (former DABM); (ii) place key SOEs on a sound financial footing, with a view to creating conditions for their restructuring or privatization; (iii) prepare the petroleum company for privatization by completing its external audit by November 2008; and (iv) strengthen the legal framework for private sector development.

25. In the period ahead, the authorities will focus on the implementation of the ANDS. This is an ambitious program, which should bring important benefits to the Afghan people. However, the envisaged scaling-up of expenditure may overstretch the absorptive capacity of the economy. Prioritization and full costing of programs will be essential to ensure their maximum benefit without compromising fiscal sustainability.

26. The ANDS also presents an opportunity to address serious weaknesses in the statistical base. The current state of the statistical base is inadequate for monitoring development progress under the ANDS and poses difficulties for the monitoring of the PRGF-supported program. In this regard, there is a need to develop a strategy for strengthening the Central Statistical Office (CSO), while progressively broadening the coverage and reliability of the statistical base.

E. Staff Appraisal

27. Afghanistan’s performance in the second half of 2007/08 under the PRGF-supported program fell short of expectations. Looking ahead, continued macroeconomic discipline, progress in key structural reforms, improved conditions to facilitate private sector development (including state disengagement from economic activity), and political resolve to tackle difficult issues will be critical to the success of the program.

28. The overall fiscal strategy for 2008/09 strikes a reasonable short-term compromise. Nevertheless, achieving policy autonomy and financial independence from long-term aid will require a significant increase in domestic revenue, which remains one of the lowest in the world in proportion to GDP. The target date for covering operating expenditures with domestic revenue has slipped by one year to 2013/14, and the revenue shortfall in 2007/08 underscores the importance of high-level political support for revenue reforms. The authorities need to adopt a strategic approach to developing a modern tax and customs administration to meet their longer-term fiscal policy objectives.

29. Further progress is required in PFM reforms. In particular, there is a need for progress in improving the budgetary process, project preparation, procurement, expenditure execution, and tracking. The government must also overcome the inertia in the civil service (Pay and Grade) reform, strengthen the public sector’s human capital, and allocate efficiently the available human resources. Decisive steps to link the compensation system in the public sector to skills and performance are also needed. Meanwhile, the resurgence of inflation and the pressure for broad-based salary increases pose a major risk to the future of the civil service reform.

30. Monetary policy needs to remain focused on containing inflationary pressures. To that end, DAB needs to strengthen its cooperation with the MOF in preparing liquidity forecasts and design a framework for the timely monitoring of commercial banks’ liquidity. Staff welcomes DAB’s intention to increase the role of CNs auctions and develop the secondary market for these instruments. However, the volumes of CNs auctions should be commensurate with market conditions to avoid unnecessary interest rate volatility and further widening of the spreads between dollar-and Afghani-denominated instruments. As regards foreign exchange auctions, the staff urges DAB to ensure strict observance of the program ceilings for CiC and do not resist possible pressures toward an appreciation of the currency against the U.S. dollar should the demand for Afghanis turn out stronger than expected.

31. The rapid growth of commercial bank activities calls for further strengthening the regulatory framework and enforcement procedures. In particular, there is a need for strict and prompt corrective measures when warranted by bank examinations.

32. Structural reforms need to be accelerated to enhance the prospects for private sector development, foreign direct investment, and growth. This includes following up on commitments to improve transparency in the domestic petroleum sector and preparing for the privatization of the government-owned petroleum enterprise. There is also an urgent need to clarify the relationship between the budget and key public enterprises.

33. Regarding the government’s involvement in the wheat market, the additional efforts by the government should be complementary to those by the World Food Program and other donor agencies, with emphasis to be placed mainly on targeted cash transfers to vulnerable households instead of direct wheat imports. This approach would help avoid distorting the market and would ensure that support can be made available promptly.

34. The quality of statistics has improved in areas critical for program monitoring (e.g., fiscal and monetary statistics). However, progress in improving statistics in other areas (e.g., the real sector and the balance of payments) has been slow. The staff urges the authorities to take advantage of Fund technical assistance currently being provided in these areas.

35. The biggest risk to the program concerns the inflation assumption. If the jump in food prices is not partially reversed, inflation in 2008/09 will turn out higher. The program has assumed an ambitious inflation objective in order to keep the monetary targets tight and resist pressures for additional spending in the budget. If inflation turns out higher, the government revenue-to-GDP ratio is likely to fall, even if the program’s revenue targets are met.

36. The program remains vulnerable to the ongoing security problems and capacity constraints. In addition, the government’s inability to deliver on structural reforms is emerging as another major risk. Given that 2009 will be an election year, political support for the reform agenda may weaken in the period ahead.

37. Notwithstanding these risks, based on the authorities continued efforts and commitments, including the strengthened structural conditionality in reform areas of critical importance, the staff recommends the completion of the fourth review under the PRGF-supported arrangement. In view of the prior actions which will address the primary causes of the revenue slippage in 2007/08 and the additional measures aimed at ensuring that the improvement in the revenue performance will be sustained in 2008/09, staff supports the waiver of nonobservance of the quantitative performance criterion on the floor on fiscal revenue.

Table 4.

Islamic Republic of Afghanistan: Balance of Payments, 2005/06–2012/13

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

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

Excludes opium exports and, due to limited data availability, flows associated with U.S. Army and most ISAF activities.

Debt service projections are based on the total stock of external debt (including estimates of unverified arrears). Given lack of data on the rate of penalty interest and ongoing bilateral negotiations, interest on overdue obligations represent an estimate by Fund staff.

Assumes that Afghanistan will reach the completion point under the enhanced HIPC initiative and receive MDRI relief from IDA in 2009/10. Paris Club creditors are assumed to go beyond HIPC and provide 100 percent stock reduction on eligible debts and capitalized interest at completion point.

Includes foreign transactions recently reported by licensed money changers.

Arrears shown represent Fund staff estimates of debt service due, but not paid, on estimated overdue obligations. The 2006/07 and 2007/08 reduction in arrears corresponds principally to the July 2006 rescheduling of Paris Club debt on Naples terms, including the upfront cancellation of the majority of Russian claims consistent with Paris Club practice.

Debt rescheduling includes the capitalization of interest falling due to Paris club creditores until the completion point of the enhanced HIPC Initative, interim assistance from multilateral creditors, and HIPC debt relief from multilateral creditors after the completion point.

In months of imports of goods and services, excluding imports for reexports and duty free imports by donors. The definition of imports used for the calculation of reserve coverage has been changed to exclude duty free imports by donors that are fully financed.

After HIPC and MDRI relief as well as debt relief beyond HIPC from Paris Club creditors. Debt includes obligations to the IMF. The debt stock includes the capitalization of interest to Paris Club creditors until completion point of the enhanced HIPC initiative.

Exports exclude reexports.