Statement by the Staff Representative on the Islamic Republic of Afghanistan, May 16, 2014

KEY ISSUESContext. Over the past decade, Afghanistan has made enormous progress in reconstruction, development and lifting per capita income. Security and political uncertainties, and weak institutions have constrained growth and weighed on social outcomes. With significant reform efforts and donor support, Afghanistan has maintained macroeconomic stability, implemented important structural reforms, and built policy buffers, but significant vulnerabilities remain. The IMF has been supporting Afghanistan through technical assistance and a three-year Extended Credit Facility (ECF) arrangement. Reviews under the ECF arrangement have been delayed.Outlook and risks. 2014 is a crucial year in the political and security transitions and the run-up to the “transformation decade” (2015–24). Assuming smooth political and security transitions, continued reform and donor financing, the outlook should be positive. Large security and development expenditure needs and a limited domestic revenue capacity mean that Afghanistan will remain dependent on donor financing for an extended period. Macroeconomic stability, structural reforms, and political and security stability are needed to ensure inclusive growth. Risks, mostly on the downside, are related to adverse domestic or regional security developments, political instability, inadequate implementation of economic policies, and donor fatigue.Policy recommendations. The authorities’ economic strategy (maintaining macroeconomic stability, strengthening the financial sector, improving economic governance, and moving toward fiscal sustainability) remains appropriate and needs strengthened implementation. Sustained implementation of this strategy will safeguard growth and build buffers to help manage shocks. Policies should continue to aim at strengthening revenue collection, managing money growth to control inflation while preserving exchange rate flexibility, strengthening bank supervision, and quickly enacting anti-money laundering (AML), countering financing of terrorism (CFT), banking,central bank, and value-added tax legislation.

Abstract

KEY ISSUESContext. Over the past decade, Afghanistan has made enormous progress in reconstruction, development and lifting per capita income. Security and political uncertainties, and weak institutions have constrained growth and weighed on social outcomes. With significant reform efforts and donor support, Afghanistan has maintained macroeconomic stability, implemented important structural reforms, and built policy buffers, but significant vulnerabilities remain. The IMF has been supporting Afghanistan through technical assistance and a three-year Extended Credit Facility (ECF) arrangement. Reviews under the ECF arrangement have been delayed.Outlook and risks. 2014 is a crucial year in the political and security transitions and the run-up to the “transformation decade” (2015–24). Assuming smooth political and security transitions, continued reform and donor financing, the outlook should be positive. Large security and development expenditure needs and a limited domestic revenue capacity mean that Afghanistan will remain dependent on donor financing for an extended period. Macroeconomic stability, structural reforms, and political and security stability are needed to ensure inclusive growth. Risks, mostly on the downside, are related to adverse domestic or regional security developments, political instability, inadequate implementation of economic policies, and donor fatigue.Policy recommendations. The authorities’ economic strategy (maintaining macroeconomic stability, strengthening the financial sector, improving economic governance, and moving toward fiscal sustainability) remains appropriate and needs strengthened implementation. Sustained implementation of this strategy will safeguard growth and build buffers to help manage shocks. Policies should continue to aim at strengthening revenue collection, managing money growth to control inflation while preserving exchange rate flexibility, strengthening bank supervision, and quickly enacting anti-money laundering (AML), countering financing of terrorism (CFT), banking,central bank, and value-added tax legislation.

1. This statement summarizes information that has become available since the issuance of the staff report on April 23. The new information does not change the thrust of the staff appraisal, but does underscore the need to maintain the rate of 10 percent in the VAT law.

2. The preliminary results from the April 5 presidential elections indicate a second round in late-May or June. The April 26 preliminary results indicate that none of the candidates won an outright majority. Complaints will be adjudicated before the final results are announced, expected in May. The second round will be a runoff between the top two candidates from the first round and held within 15 days of final first round results.

3. Money and international reserves were close to projected levels at the end of first quarter of 2014. Inflation was 5.6 percent year-on-year in March. The Afghani depreciated by 2.2 percent since the beginning of 2014 and was Af 57.3 per U.S. dollar on May 7.

4. The treasury’s cash position is very constrained. The cash position has deteriorated significantly recently, as lower revenue and higher expenditures around the election ran down cash balances. On May 5, the cash balance was Af 4.5 billion compared to Af 54.5 billion at end-April 2013 and Af 21 billion at the beginning of the fiscal year. Thus far, the treasury has remained current on wages and salaries. However, risks remain that arrears could be incurred. Moreover, President Karzai reportedly signed a decree providing bonus payments to security personnel amounting to Af 1.5 billion, which, if implemented, could pressure further the cash position.

5. VAT legislation experienced a setback. The VAT law has been approved by the lower house of parliament, but the VAT rate was reduced from 10 to 8 percent. This law will be discussed by the upper house. The tax administration law (needed to implement the VAT) is awaiting parliamentary approval.

6. Further progress has been made in structural reform. The anti-money laundering and countering financing of terrorism laws were approved by the cabinet on May 5. The Economic Crimes Task Force (ECTF) has submitted its advice on categories of economic offences to be included in the penal code to the Criminal Law Review Working Group and the transfer of taxpayers from the small and medium taxpayer offices to the large taxpayer office has been completed. With the implementation of these two benchmarks, 21 of 24 structural benchmarks planned between June 2012 and December 2013 have now been completed. Efforts continue to implement other reforms. The mining law has also been approved by the lower house.