Islamic Republic of Afghanistan: Staff-Monitored Program

EXECUTIVE SUMMARY Context: Political and security uncertainties and an inadequate policy response led to lower growth and emergence of important fiscal and banking vulnerabilities in 2014. The establishment of a national unity government and the December 2014 London Conference has helped build confidence and reconfirmed donor support for Afghanistan. The proposed staff-monitored program (SMP) will foster continued close engagement with Afghanistan, address vulnerabilities, and help manage risks. An independent staff team is preparing an ex post assessment of the Funds’ engagement with Afghanistan since 2006 and its report will be sent to the Executive Board separately. Focus of the SMP: In the attached Letter of Intent, dated May 6, 2015, the authorities requested a new SMP covering the period April 1, 2015–December 31, 2015. The SMP will aim to mobilize revenue and address urgent banking vulnerabilities. Successful performance under the SMP would support a future request for an IMF financial arrangement, foster macroeconomic stability and inclusive growth. Policy recommendations: Fiscal policy will focus on mobilizing domestic revenue and rebuilding the treasury’s cash balance. Monetary policy will aim to preserve low inflation and maintain exchange rate flexibility to protect international reserves and competiveness, and avoid excessive volatility. Structural reforms will focus on: (i) revenue mobilization, expenditure control and repayment of arrears; (ii) financial sector reforms to deal with weak banks, promulgate the new banking law, amend the central bank law, strengthen banking supervision, and address weaknesses in state banks including New Kabul Bank; and (iii) improving economic governance by strengthening the anti- corruption, anti-money laundering, and countering the financing of terrorism regimes. Risks to the SMP: Risks, mostly on the downside, are related to adverse security developments, inadequate implementation of economic policies, political instability, and donor fatigue. Large security and development expenditure needs mean that Afghanistan will remain dependent on donor financing for an extended period. On the upside, a political agreement that improves security conditions, stronger domestic demand and early development of mining projects would result in faster growth.

Abstract

EXECUTIVE SUMMARY Context: Political and security uncertainties and an inadequate policy response led to lower growth and emergence of important fiscal and banking vulnerabilities in 2014. The establishment of a national unity government and the December 2014 London Conference has helped build confidence and reconfirmed donor support for Afghanistan. The proposed staff-monitored program (SMP) will foster continued close engagement with Afghanistan, address vulnerabilities, and help manage risks. An independent staff team is preparing an ex post assessment of the Funds’ engagement with Afghanistan since 2006 and its report will be sent to the Executive Board separately. Focus of the SMP: In the attached Letter of Intent, dated May 6, 2015, the authorities requested a new SMP covering the period April 1, 2015–December 31, 2015. The SMP will aim to mobilize revenue and address urgent banking vulnerabilities. Successful performance under the SMP would support a future request for an IMF financial arrangement, foster macroeconomic stability and inclusive growth. Policy recommendations: Fiscal policy will focus on mobilizing domestic revenue and rebuilding the treasury’s cash balance. Monetary policy will aim to preserve low inflation and maintain exchange rate flexibility to protect international reserves and competiveness, and avoid excessive volatility. Structural reforms will focus on: (i) revenue mobilization, expenditure control and repayment of arrears; (ii) financial sector reforms to deal with weak banks, promulgate the new banking law, amend the central bank law, strengthen banking supervision, and address weaknesses in state banks including New Kabul Bank; and (iii) improving economic governance by strengthening the anti- corruption, anti-money laundering, and countering the financing of terrorism regimes. Risks to the SMP: Risks, mostly on the downside, are related to adverse security developments, inadequate implementation of economic policies, political instability, and donor fatigue. Large security and development expenditure needs mean that Afghanistan will remain dependent on donor financing for an extended period. On the upside, a political agreement that improves security conditions, stronger domestic demand and early development of mining projects would result in faster growth.

Background and Recent Developments

1. Presidential elections were completed in late-September with the inauguration of President Ghani and Chief Executive Abdullah, but formation of the new government was prolonged and a central bank governor has not been confirmed. President Ghani and Chief Executive Abdullah introduced a new cabinet of ministers and candidate for Da Afghanistan Bank (DAB) governor in January. Parliament confirmed nine of 25 ministerial candidates in January, including the new finance minister, and another 16 nominees in mid-April. The appointment of the DAB governor is pending.

2. Political and security uncertainties in 2014 resulted in lower economic activity and the emergence of significant fiscal and banking vulnerabilities. Those uncertainties peaked during the second round of presidential elections in 2014. The withdrawal of international troops, the prolonged political transition, and inadequate policy response resulted in lower economic confidence and activity. Fiscal vulnerabilities emerged as spending pressures increased, despite a significant revenue shortfall. The treasury cash balance was eroded and payment arrears and unfunded allotments emerged in 2014. Banking sector vulnerability increased because of lax enforcement and delays in financial sector reforms. Dangerous weaknesses emerged in two banks, including a systemic one, while six other banks’ financial condition remained weak.

3. In early 2015, donor support and policy actions helped to redress these vulnerabilities. Additional donor financing was used to clear part of the arrears2 and the treasury cash balance has recovered. Moreover, the authorities prepared credible revenue measures as part of a revised 2015 budget and committed to contain expenditures. The authorities also acted to address banking sector vulnerabilities and weaknesses.

4. Donors reaffirmed their support at the December 2014 London Conference. They welcomed the government’s plans to strengthen revenue collection and the banking sector, to prioritize expenditure and to improve the investment climate. The authorities committed to deliver on their plans ahead of the Senior Officials Meeting (SOM) in 2015.3 Donors reaffirmed their Tokyo commitments. In March 2015, the U.S. announced a slower withdrawal of its noncombatant troops and reconfirmed its support.

Economic Performance in 2014 and Early 2015

5. The Extended Credit Facility (ECF) arrangement expired in November 2014. The first program review was completed in June 2012 but subsequent reviews were delayed, because performance was not in line with the targets set at the first review, due to unanticipated shocks, an inadequate policy response, and delays in structural reform implementation. In late 2013, the authorities and staff agreed on a set of informal quantitative targets and structural measures for 2014. These targets and measures aimed at maintaining macroeconomic stability and structural reform momentum. The authorities’ adherence to the quantitative framework was uneven and structural reforms were delayed (Table 1).

Table 1.

Islamic Republic of Afghanistan: Performance Under 2014 Informal Framework 1/

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Source: Afghan authorities.

The quantitative targets, indicative targets, their adjustors, and program exchange rates will be defined in the Technical Memorandum of Understanding (TMU). Program exchange rates as of December 20, 2012 are used.

These quantitative targets apply on a continuous basis.

Includes operating and development donor assistance, external loans, and sale of non-financial assets.

6. Economic performance in 2014 suffered from political and security uncertainties. Growth is estimated to have declined to 1.5 percent in 2014 from 3.7 percent in 2013. While agricultural output remained close to the bumper level of 2012, nonagricultural growth slowed significantly as uncertainties sapped private sector confidence. Inflation declined to 1.4 percent year-on-year in December, supported by lower fuel and food prices and a sharp decline in housing prices, despite accommodative monetary policy. Lower imports helped contain the pressure on international reserves. The exchange rate depreciated slightly against the U.S. dollar. Net international reserves increased somewhat and import cover remained comfortable.

7. Revenue underperformance coupled with increasing expenditures eroded the treasury’s cash balance. Weak growth, declining imports, and lower compliance resulted in lower domestic revenue collection in 2014, which was Af 100 billion, below Af 109 billion collected in 2013 and the 2014 target of Af 128.8 billion. Operating budget expenditure increased, because off-budget security-related spending was moved on budget (with donor grant financing), and because of higher social spending resulting from new benefits for martyrs and disabled people. Lower revenue and higher expenditures eroded the treasury’s discretionary cash position in the second half of 2014.

A01ufig1

Cumulative Treasury Cash Balances

(In billions of Afghanis)

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

Sources: Afghan authorities; and IMF staff calculations.

8. Monetary policy was accommodative, but the exchange rate and international reserves remained broadly stable. A notable change in 2014 was that the contribution of net foreign assets to reserve money growth declined substantially, and net domestic assets contributed to money creation as the government drew down its deposits to finance spending. DAB did not sterilize the drawdown of government deposits, caused by the erosion of the treasury’s cash balance. The money multiplier also declined, indicating declining confidence in banks. The exchange rate depreciated by 4.1 percent in nominal terms in 2014 and the central bank maintained a comfortable reserve buffer, gross international reserves were $7.2 billion at the end of 2014 or 7½ months of imports. Notwithstanding accommodative monetary policy, inflation remained low.

A01ufig2

Central Bank Survey: Components of Net Domestic Assets

(In billions of Afghanis)

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

Sources: Afghan authorities; and IMF staff calculations.
A01ufig3

Composition of Reserve Money Growth

(Y-o-y change; in percent)

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

9. Financial sector vulnerability increased during 2014. Weak governance and regulatory forbearance early in 2014 led to a deterioration in the financial positions of some banks (lower asset stock quality and capital), which was partly mitigated by stepped-up enforcement in late 2014. Eight of the 15 banks are classified as weak (rated 4 or 5 according to CAMEL methodology). In late 2014, corrective measures started to be implemented.

10. Some progress was made with important economic reform laws. New anti-money laundering (AML) and countering the financing of terrorism (CFT) laws were enacted in late June and early July 2014, respectively, and CFT regulations to implement the relevant United Nations Security Council Resolutions finalized in October 2014, based on IMF Legal Department technical assistance. However, the introduction of a VAT was postponed. In response to the authorities’ concerns, staff reviewed the tax administration’s readiness for a VAT introduction, concluded that it is not in a position to facilitate a successful introduction in the near term, and VAT introduction should be postponed while the tax administration is strengthened. The banking law is in parliament and amendments to the DAB law are being reviewed by the ministry of justice.

11. Kabul Bank asset recovery has been limited. Between February 28, 2014 and January 31, 2015 cash recoveries amounted to $4 million bringing total cash recoveries to $179 million. The new president has issued a decree to reinvigorate asset recovery efforts and review criminal cases in October. Following the completion of judicial review, the two largest former shareholders were sentenced to repay about $375 million and their jail sentences were increased from 5 to 15 years each. Also, the authorities sent requests for mutual legal assistance to a number of foreign jurisdictions to facilitate asset recovery.

12. Fiscal and monetary developments in the first quarter of 2015 were affected by a larger than expected external inflows to the budget. Discussion of the revised 2015 budget delayed its approval to January 28, 2015. Revenue was higher than targeted, expenditure lower (in part due to the delay in budget approval), and grants exceeded their projected level substantially. As a result, the budget recorded a substantial surplus in the first quarter of 2015 (2 percent of annual GDP higher than projected). The government accumulated substantial deposits in DAB, which together with seasonal factors, reduced reserve money in the first quarter by 7.8 percent. Although NIR increased during the first quarter, because of the large external financing to the budget, they increased less than planned, because of foreign exchange market intervention, particularly in January when there was high demand for foreign exchange. As a result, the authorities met the all end-March indicative targets, except the adjusted NIR target. Inflation moved into negative territory in the first quarter falling to -0.7 percent year-on-year in March, driven by declines in housing, transportation, and food prices.

Macroeconomic Outlook 2015–16

13. Growth is projected to recover to 3.5 percent in 2015 and increase to 5–6 percent per year in the medium term. The projected recovery in 2015 is based on declining political uncertainty. With continued reform, donor support and increased confidence, growth is projected to pick up in 2016 and inflation to remain in single digits, supported by favorable global food prices. The recovery of growth over the medium term will depend on a recovery in domestic demand, large mining projects, and security conditions.

14. The outlook is subject to significant downside risks. If domestic or regional security conditions deteriorate, the anticipated recovery in economic confidence could be delayed, which would slow investment and growth. If agricultural output were to decline, it would affect growth and might cause food price pressures. Also, the recovery in economic confidence will depend on consistent implementation of reform policies, which is needed to facilitate donor support. A continued and predictable flow of donor assistance will support macroeconomic stability. Further delays in large mining projects could reduce growth prospects. On the upside, a political agreement that results in a rapid improvement in security conditions, a faster recovery in domestic demand, and early development of large mining projects could result in higher confidence, and economic activity.

The Staff-Monitored Program

A. The 2015 Program

15. The authorities are determined to improve the economy and living conditions of all Afghans. Their vision for the Afghan economy, their program, and policy priorities were laid out in their Realizing Self-Reliance paper prepared for the December 2014 London Conference.4 Discussions on an SMP were initiated at the 2014 Annual Meetings and continued over the past months. The authorities started to address economic vulnerabilities through enforcement actions in banking sector and a revised 2015 budget. The authorities consider the successful implementation of the SMP as being critical to increase economic confidence and generate support for their reforms. Good performance under the SMP will help sustain donor flows and the SMP’s reforms will inform the updating of the Tokyo Mutual Accountability Framework at the 2015 SOM.

16. The SMP will address immediate fiscal and banking vulnerabilities, preserve macroeconomic stability, and seek to lift growth. The macroeconomic policy mix will maintain buffers (of low debt and international reserves), low inflation and protect competitiveness. Fiscal policy will support growth by mobilizing domestic revenue (and catalyze donor support) to finance projected expenditure, and build the treasury’s cash balance, while avoiding debt accumulation. Monetary policy will aim to preserve low inflation and exchange rate policy will protect international reserves and competitiveness. Structural reform will focus on: (i) fiscal revenue mobilization and expenditure control; (ii) the financial sector; and (iii) economic governance. The nine-month SMP is designed to build a track record and successful performance would support a future request for an extended credit facility (ECF) arrangement from the authorities. A possible future ECF supported program would maintain macroeconomic stability, improve the business environment and economic governance to foster private sector activity and facilitate broad-based inclusive growth and an improvement in social indicators.

Macroeconomic Framework

17. The macroeconomic framework aims at preserving macroeconomic stability and promoting growth. It projects a pick-up in real GDP growth to 3.5 percent and average inflation of about 4 percent in 2015. It will maintain low debt and protect international reserves position. It also envisages protecting competitiveness, with the overall budget in broad balance and the current account in surplus initially and moving to a deficit over the medium term. The operating balance excluding grants remains the fiscal anchor to assess the need for donor support to finance operating outlays, while reserve money remains the monetary anchor. The budget and external deficits are projected to be financed by donor grants.

18. Improving revenue performance is a critical objective. Domestic revenue is projected to increase by 1 percentage point of GDP (to 9.6 percent of GDP) supported by both measures and improved compliance. Additional revenue measures in 2015 are projected to raise about Af 10 billion (0.8 percent of GDP). These measures include an increase in the business receipts tax rate, higher import tariffs, introducing a telecommunications tax, tripling the fuel fee collected at customs, and increasing overflight fees for using Afghanistan’s airspace. Improvements in compliance are projected to increase revenues by Af 4 billion (0.3 percent of GDP). The authorities have already increased import tariffs and overflight fees, which are projected to yield Af 1.5 billion in 2015. They plan to implement the other measures in June 2015, which are projected to yield Af 8.9 billion in 2015 and need parliamentary approval. In addition, the authorities have identified contingency measures totaling Af 4 billion that can be deployed swiftly, if budget execution is not in line with their plans.

19. The revenue measures to be introduced in 2015 will support medium-term revenue mobilization. These measures will mobilize extra revenue of over 1 percent of GDP per year in the medium term and so mitigate the revenue impact of the postponement of the VAT introduction. In addition, a strengthening of the tax administration will also help build revenue, improve governance, and facilitate VAT introduction in the medium term.

20. The SMP will target strict expenditure control and reducing waste. Operating spending is expected to increase slightly from 19.5 percent of GDP in 2014 to 20.2 percent in 2015, as the move of security-related expenditures on-budget (with grant financing) adds to operating spending, but not the overall deficit. Capacity constraints are expected continue to limit execution of grant-financed budget outlays. The rationalization of nonsecurity spending is expected to proceed while protecting pro-poor spending, which will be maintained at 2.6 percent of GDP, close to its 2014 level. In particular, payments to martyrs and disabled—currently at 66 percent of total pension spending—will be better targeted, while safeguarding spending on health and education. The operating deficit, excluding grants, is projected to decline to 10.5 percent of GDP in 2015 from 11.0 percent in 2014. Discretionary development spending will be higher than in 2014.

21. Improved coordination of the ministry of finance’s budget and treasury departments is a priority. The ministry will link in-year allotments to cash availability to ensure that the government’s payment obligations remain within projected cash availability to avoid arrears and ensure the treasury’s discretionary cash balance does not fall below Af 5 billion during 2015. Implementation will start with weekly meetings of a cash management committee chaired by the minister of finance. All arrears lawfully incurred in 2014 will also be settled.

22. Monetary policy will aim to preserve low inflation and exchange rate policy will protect international reserves and strengthen competitiveness. DAB will carefully manage money growth with continued exchange rate flexibility to ensure it meets its net international reserves targets going forward. More active coordination between the ministry of finance and DAB on expected amounts and timing of revenue and external financing to the budget and expenditure execution will help manage reserve money. To improve further monetary policy operations, the authorities have introduced shorter maturity, seven-day, capital notes and plan to make further improvements that could include reserve requirement averaging and reinvigorating DAB’s standing credit and deposit facilities, which were little used recently.5 A modest pick-up in money demand is anticipated in 2015 as economic confidence recovers. The monetary program envisages a modest accumulation of net international reserves (NIR) ($150 million). International reserve cover will remain at 7½ months of imports. The authorities will intervene to avoid excessive exchange rate volatility.

Structural Reforms

23. The SMP aims to reinvigorate structural reform. Fiscal reforms will focus on revenue mobilization, efficient use of public resources, and avoiding pressures on the cash balance. Financial sector reforms will address immediate vulnerabilities in the banking sector, deal with weak banks, and strengthen banking supervision. Economic governance reform will strengthen the AML/CFT regime and legislative and institutional framework to combat corruption.

Fiscal Reforms

24. Better tax administration will mobilize revenue and improve governance. The SMP will strengthen the capacity of the Afghan Revenue and Customs Departments (ARD and ACD). The taxpayer register for Kabul will be updated by end-May 2015 and extended to provinces as soon as feasible, which in some areas will depend on security conditions. This updating will facilitate effective revenue collection and compliance. ARD will implement its Strategic Plan and establish a Risk Analysis and Case Selection Unit by end-May 2015 also to improve compliance. Further, tax arrears records will be reviewed to distinguish between collectible and uncollectible amounts. ARD will also establish performance indicators to assess risk-based audits and update audit policies, procedures, and guidelines. The authorities will continue to implement their action plan to strengthen customs administration with the capacity development assistance from donors.

25. A strengthening of public financial management is planned. The authorities will improve the medium-term fiscal framework (MTFF), work to identify better recurrent and capital expenditures, and associated output targets. Further, they plan electronic registration of invoices across all ministries and provinces and a database for ongoing capital projects. The authorities will prepare quarterly reports on financial performance of state-owned enterprises and companies, their fiscal impact and risks in the MTFF. In addition, they will carry out quarterly reviews (by a cabinet-level committee) of budget execution and prioritization of next quarter’s expenditure, and if needed, reduce budget allocations in light of the previous quarter’s budget performance.

26. A sound and robust fiscal regime for natural resources is being designed. This regime should help attract investment and ensure the government receives a reasonable share of the economic rents. The Fund has provided capacity development assistance to review the current framework and will provide recommendations on tax administration for the fiscal regime for natural resources in full compliance with the Extractive Industries Transparency Initiative.

Financial Sector Reforms

27. The authorities have acted to address banking vulnerabilities. DAB has issued enforcement actions for the vulnerable systemic bank to ensure the bank recorded losses on its assets and restored capital levels and ratios. The bank has made significant progress in these areas. DAB will continue to monitor the bank closely and is ready to put the bank under conservatorship in the case of noncompliance. DAB has also issued enforcement actions against the other vulnerable state-owned bank, which needs improved management and additional capital. The bank has been prohibited from extending any further loans and its management positions will be filled with fit and proper bankers swiftly. An independent external party will be hired to audit bad debt recoveries. The authorities also committed to restore capital to required minimum levels by end-2015. The bank will also prepare a five-year operating strategy, which will be submitted to DAB by end-June 2015 and finalized by end-August 2015. Should the strategy not be effective, and the bank is not able to achieve an operational break-even within 18 months, i.e., by end-February 2017, the bank will be put into conservatorship followed by its liquidation or sale. For other weak banks, DAB has started to implement a plan to address their weaknesses and increase their CAMEL ratings significantly by end-February 2016.

28. The sale of New Kabul Bank (NKB) will be re-started. NKB’s management has already cut losses significantly, from $22 million in 2012 to $6 million in 2014 and plans further measures to reduce losses that will make NKB profitable by end-2015. The authorities believe that NKB’s improved profitability will attract more bidders and a higher sales price at its privatization, which they will initiate by end-September 2015. The World Bank is working on national payment system upgrades that over time will facilitate the transfer of the government salary function.

29. The new banking law will be promulgated by June 2015. The legislation drafted in consultation with Fund staff strengthens corporate governance, capital requirements, large and related parties lending exposures, enhances supervision and bank resolution provisions. Revised regulations and information circulars will be issued once the new banking law is enacted. The authorities will also submit to parliament amendments to the central bank legislation by end-December 2015 to make its new capitalization framework operational, a critical ingredient for central bank independence.

30. The DAB’s Financial Supervision Department (FSD) will continue to be strengthened. DAB will continue to implement FSD’s five-year strategic plan, launched in July 2013, to implement its new organizational structure, and approve the complete organizational file for the department, including duties and responsibilities, reporting lines and job description of each staff position by end-September 2015. DAB plans to enhance offsite supervision with a new manual and revised offsite reports. It also plans to enhance onsite supervision, with a new manual for inspections and training for its implementation. The Supervisory Enforcement Committee will continue its regular reviews of banks’ compliance with FSD’s supervisory orders. Furthermore, revised banking regulations will be prepared on (i) asset classification and provisioning by end-September 2015; and (ii) related party lending and corporate governance by end-December 2015.

31. The authorities will promote financial market development. Financial intermediation remains weak and is a constraint on growth. The authorities are preparing the sukuk law, along with supporting legislative infrastructure, and an implementation plan. They also intend to promote secondary trading with existing instruments, starting with capital notes and wish to foster the development of the interbank market. DAB will work with the Afghan Bankers Association to guide discussions with dealers on the protocol for agreeing a “Code of Conduct.”

Governance

32. The authorities are committed to strengthen further Afghanistan’s AML/CFT legal framework. Amendments to the AML Law have been approved by decree and will be published in the Official Gazette. Those amendments incorporate into the law: the inclusion of the proceeds of predicate offenses committed abroad in the law, increases in the fines for legal persons, and specify that imprisonment and fines are not alternative penalties but may be applied cumulatively. The authorities will finalize a new regulation on currency reporting by end-June 2015 to strengthen the monitoring of cross border transportation of currency and negotiable bearer instruments. Also, to mitigate the money laundering and terrorism financing risks, they plan to submit to DAB’s Supreme Council by end-September 2015 the draft AML and Proceeds of Crime Regulation-Preventive Measures for Financial Institutions.

33. The authorities are determined to tackle corruption. They plan to submit to parliament by end-December 2015: (i) legislation to criminalize bribery of foreign public officials, trading in influence, illicit enrichment, bribery and embezzlement of property in the private sector, in line with the United Nations Convention against Corruption; and (ii) an amendment to Article 12 of the Law on Overseeing the Implementation of the Anti-Administrative Corruption Strategy to provide for the mandatory publication of asset declarations by public officials, to bring it in line with Article 154 of the Constitution, by end-December 2015.

B. Program Modalities and Monitoring

34. The SMP will cover a 9-month period, April 1 to December 31, 2015 and will be monitored based on quantitative targets and structural benchmarks (MEFP, ¶39 and Tables 1 and 3). Actions taken before approval of the SMP include issuance of enforcement action against the vulnerable systemic bank and implementation of revenue measures that do not require parliamentary approval. Structural benchmarks focus on strengthening revenue performance, addressing vulnerabilities in the banking sector, and improving the AML/CFT framework. Structural conditionality is targeted and takes into account implementation capacity. Quantitative targets reflect the program’s main policy objectives. The SMP will be monitored based on performance at two test dates: June 21, 2015 and December 21, 2015 and indicative target for September 22, 2015.

Table 2.

Islamic Republic of Afghanistan: Selected Economic Indicators, 2012–15

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Sources: Afghan authorities; United Nations Office on Drugs and Crime; and Fund staff estimates and projections.

Excluding the narcotics economy.

Revised with improved coverage.

For comparison, 2011 and 2012 are recalculated from data reported on the solar fiscal years basis (March 21-March 20). Since 2013, the fiscal year runs December 22-December 21 (in most years), which is closer aligned with the Gregorian calendar year.

Comprising mainly current spending.

Defined as domestic revenues minus operating expenditures commitment.

Public sector only. Incorporates committed but not yet delivered debt relief.

In months of next year’s import of goods and services.

CPI-based, vis-a-vis the U.S. dollar.

Items presented on the Afghan solar year’s basis.

Staff Appraisal

35. Afghanistan has maintained macroeconomic stability and is addressing the vulnerabilities that emerged in 2014. Political and security uncertainties weighed on economic performance. These uncertainties, combined with an inadequate policy response, led to the emergence of fiscal and banking vulnerabilities. The authorities were able to contain these vulnerabilities with donor support and action in the banking sector.

36. The new administration is resolved to lay the foundation of a vibrant economy that benefits all Afghans. The conclusion of the presidential election, agreement on a national unity government, and appointment of a cabinet of ministers helped reduce uncertainties and restore confidence. The authorities are committed to maintain macroeconomic stability and implement reforms to promote sustainable, inclusive, and gender-balanced growth. To this end, they passed a revised 2015 budget, supported by revenue measures and contingency plans, and committed to contain expenditures. They have also taken enforcement actions against the vulnerable systemic private bank, started to implement a plan to deal with other weak banks, and are moving forward with their plans to reform public banks, including the sale of New Kabul Bank.

37. The authorities’ policy package could address the immediate macroeconomic vulnerabilities. They have noted the importance of addressing resolutely the fiscal and banking vulnerabilities to assure continued macroeconomic stability. The SMP would support their macroeconomic policy and reform agenda for 2015, with a framework to address economic vulnerabilities, manage risks, and facilitate engagement with the international community to improve aid predictability. The SMP will focus on mobilizing revenue, strengthening financial sector enforcement and DAB independence, improving economic governance, and laying the basis for high growth in the period ahead. The SMP will strengthen the legal infrastructure for economic activity, be accompanied by capacity development assistance to strengthen economic institutions from the IMF and other donors, and facilitate private sector activity.

38. Improving revenue performance and implementing agreed revenue measures will be critical. Afghanistan’s has one of the lowest revenue collections in its peer group and has lost ground over the past few years. Improved revenue performance is needed to finance security and development expenditures and will lessen Afghanistan’s dependence on donor support. Staff welcomes the authorities’ commitment to mobilize revenue including the adoption of new revenue measures that will also support revenue mobilization over the medium term. Staff also welcomes the commitment to manage expenditure carefully and recommends increasing the efficiency of social and infrastructure spending.

39. Consistent monetary policy implementation is needed to preserve low inflation and protect international reserves. DAB should manage money growth carefully and allow exchange rate flexibility to ensure it meets its net international reserves targets.

40. Consistent implementation of actions to address banking vulnerabilities is vital for financial stability and financial sector development. Staff is encouraged by DAB’s recent enforcement actions that have reduced bank vulnerabilities, and its plan to deal with weak banks. Staff recommends that DAB continues to monitor weak banks closely and takes further actions if necessary, including the use of conservatorship in the case of noncompliance with enforcement actions. On the vulnerable state bank, staff welcomes the preparations for a new operating strategy, urge the authorities to fill management positions with fit and proper bankers swiftly, and restore its capital to required minimum levels by end of 2015. It will be critical that DAB takes necessary enforcement action if the new operating strategy is not effective and bank does not achieve an operational break-even by early 2017. Staff welcomes the authorities’ plan to sell NKB after implementing measures to make it profitable. If it is not possible to sell NKB, it should not be merged with another state bank and wound up as soon as the government salary function has been transferred to other banks.

41. Complementary financial sector reforms are needed. Staff urges timely passage of the new banking law, which will strengthen corporate governance, capital requirements, large and related party lending exposures, and enhance supervision and bank resolution provisions. Once the law is passed, new banking regulations should be finalized promptly. Amendments to the DAB law are needed to buttress DAB’s independence. Staff welcomes plans to strengthen DAB’s FSD, which include implementation of new organizational structure and improvements in on and offsite supervision.

42. Staff welcomes the commitment to strengthen further Afghanistan’s AML/CFT legal framework and tackle corruption. The recent amendment to the AML Law and progress made to finalize a new regulation on currency reporting at the border are important steps forward. Staff welcomes plans to submit to parliament legislation criminalizing bribery of foreign public officials, trading in influence, illicit enrichment, bribery and embezzlement of property in the private sector and the planned legislative amendment to provide for publication of public officials’ asset declarations.

43. The SMP faces significant risks. These risks include domestic and regional security conditions and inadequate implementation of policies, political instability, unpredictability of aid flows, and donor fatigue. Spillovers from regional conflicts or stepped up attacks by insurgents could undermine security and set back reform efforts. A delay or partial parliamentary approval of revenue measures or their inadequate implementation could make achievement of the fiscal targets infeasible. Further regulatory forbearance and delays in implementation of enforcement actions and reforms in banking sector could weaken confidence. Any stalling of reforms could also affect the size and timing of donor support. On the upside, successful conclusion of peace talks, a faster recovery in domestic demand, and early development of large mining projects could result higher confidence and economic activity.

44. The authorities recognize the SMP’s implementation risks, but are committed to program objectives. The authorities have started to stem important banking and fiscal vulnerabilities, agreed to measures that should address fully these vulnerabilities, and implemented some reforms earlier than envisaged. The overall policy package is solid and achievable as it takes into account Afghanistan’s fragility and its limited administrative and institutional capacity. The SMP also provides a path forward with quick wins and pro-reform incentives to support a revival in economic confidence, a pick-up in activity and is an important step toward mitigating fragility.

Figure 1.
Figure 1.

Islamic Republic of Afghanistan: Real Sector

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

Sources: Afghan authorities; United Nations Department of Safety and Security; and IMF staff calculations.
Figure 2.
Figure 2.

Islamic Republic of Afghanistan: Fiscal Sector

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

Sources: Afghan authorities; and IMF staff calculations.1/ Estimated activity off-budget by international community.
Figure 3.
Figure 3.

Islamic Republic of Afghanistan: Monetary Sector

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

Sources: Afghan authorities; and IMF staff calculations.1/ The drop in credit to the private sector in 2011 reflects the write-off of Kabul Bank loans.
Figure 4.
Figure 4.

Islamic Republic of Afghanistan: External Sector

Citation: IMF Staff Country Reports 2015, 140; 10.5089/9781513508962.002.A001

Sources: Afghan authorities; and IMF staff calculations.
Table 3.

Islamic Republic of Afghanistan: Medium-Term Macroeconomic Framework, 2012–19

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

Excluding the narcotics economy.

Revised with improved coverage.

For comparison, 2011 and 2012 are recalculated from data reported on the solar fiscal years basis.

Comprising mainly current spending. It is assumed that donors’ recurrent expenditure off-budget is moved onto the budget by 2020. The actual rate of transfer on-budget is uncertain.

Defined as domestic revenues minus operating expenditures.

In months of next year’s import of goods and services.

Public sector only. Incorporates committed but not yet delivered debt relief. Debt relief recorded fully at time of commitment.

Incorporates the 2012 revision to the UN World Population Prospects.

Table 4.

Islamic Republic of Afghanistan: Central Government Budget, 2013–15

(In billions of Afghanis)

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

ARTF: Afghanistan Reconstruction Trust Fund; LOTFA: Law and Order Trust Fund for Afghanistan; NTM-A: NATO Training Mission - Afghanistan

Positive number indicates that expenditures have been recorded, but not yet executed.

Includes signature bonus payments for the Aynak copper mine.

Propoor spending covers ministries of: education, labor and social affairs, martyrs and disabled, public health.

Adjusted to include assessment of revenue, operating budget execution rates, restraint of discretionary development spending (taking into account expected revenue and donor disbursements).

2015 figure includes about Af 7 bn discretionary development arrears.

2015 figure contains about Af 2.85 bn arrears.

2015 figure includes USD 50 million which are contingent on agreement of a framework for meeting O&M spending needs with the World Bank; Af 93.6 billion of the Af 193.6 billion included in the budget were disbursed before December 21, 2014 and are therefore not included in 2015 grants but consistent with cash accounting as a financing item in the cash balance.

Table 5.

Islamic Republic of Afghanistan: Central Government Budget, 2013–15

(In percent of GDP)

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

ARTF: Afghanistan Reconstruction Trust Fund; LOTFA: Law and Order Trust Fund for Afghanistan; NTM-A: NATO Training Mission - Afghanistan

Positive number indicates that expenditures have been recorded, but not yet executed.

Includes signature bonus payments for the Aynak copper mine.

Propoor spending covers ministries of: education, labor and social affairs, martyrs and disabled, public health.

Adjusted to include assessment of revenue, operating budget execution rates, restraint of discretionary development spending (taking into account expected revenue and donor disbursements).

2015 figure includes about Af 7 bn discretionary development arrears.

2015 figure contains about Af 2.85 bn arrears.

2015 figure includes USD 50 million which are contingent on agreement of a framework for meeting O&M spending needs with the World Bank; Af 93.6 billion of the Af 193.6 billion included in the budget were disbursed before December 21, 2014 and are therefore not included

Table 6.

Islamic Republic of Afghanistan: Central Bank Balance Sheet, 2012–15

(At current market exchange rates)

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

A nonmarketable security issued to DAB by the ministry of finance for the cost of a lender of last resort assistance to Kabul Bank.

Includes Afghanistan’s SDR holdings (MoF is the fiscal agent for the IMF).

Table 7.

Islamic Republic of Afghanistan: Central Bank Balance Sheet, 2012–15

(At program exchange rates) 1/

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

Program exchange rates as of Dec. 21, 2014 are applied to evaluate foreign currency-denominated components.

A nonmarketable security issued to DAB by the ministry of finance for the cost of a lender of last resort assistance to Kabul

Includes Afghanistan’s SDR holdings (MoF is the fiscal agent for the IMF).