Islamic Republic of Afghanistan: Request for a 42-month Arrangement under the Extended Credit Facility—Press Release; Staff Report; and Statement by the Executive Director for the Islamic Republic of Afghanistan
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
13 Nov 2020
eISBN:
9781513561127
Language:
English
Keywords:
ISCR; CR; asset declaration regime; COVID emergency financing grant; anti-corruption regime; ECF arrangement; economic reform program; foreign currency; Afghan authorities; debt relief; reform strategy; COVID-19; Credit
Download PDF (1.3 MB)

Request for a 42-Month Arrangement Under the Extended Credit Facility-Press Release; Staff Report; and Statement by the Executive Director for the Islamic Republic of Afghanistan

Abstract

Request for a 42-Month Arrangement Under the Extended Credit Facility-Press Release; Staff Report; and Statement by the Executive Director for the Islamic Republic of Afghanistan

Context

A. Background

1. The armed conflict and fragility continue to hinder Afghanistan’s development. The conflict has taken a heavy toll, causing large casualties, requiring security spending of 30 percent of GDP annually, and stunting economic development. Growth has been weak, unemployment high,1 and poverty rose to 55 percent in 2017 from 39 percent in 2013. Governance vulnerabilities are high, and corruption remains a concern.

2. Afghanistan depends heavily on aid. Grants of about 40 percent of GDP, about two thirds security-related, finance most of the underlying fiscal and current account deficits. With current aid commitments expiring by the year-end, the authorities and donors will hold a conference on November 23–24, where donors will pledge aid for 2021–24.

Aid Dependence 1/2/

(3-yea r averages, 2017–2019)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: WEO and IMF staff calculations.1/ Grants include all noncompulsory current or capital transfers to the country2/ Size of the bubbles shows aid in percent of GDP.3/ CA inflows include exports of goods and services and inflows of current transfer.

3. The political reconciliation reached in May has paved the way for a unified government ready to negotiate peace with the Taliban and step up reform implementation. The agreement signed by President Ghani and Mr. Abdullah, who is leading the peace talks with the Taliban, has also advanced government formation2 and is likely to buoy confidence. The U.S. is withdrawing its forces per the February agreement with the Taliban, in exchange for Taliban’s commitment to negotiate a political settlement to the conflict and cut ties to terrorism.

4. The authorities requested a Fund arrangement to support the recovery from the COVID-19 pandemic, catalyze aid, and address a protracted balance of payments need. They and the donors see the new arrangement as a vehicle to support a sound macroeconomic framework and underpin reforms for economic resilience, good governance, and inclusive growth, building on the 2016–19 Fund arrangement.

B. COVID-19

5. The pandemic has inflicted a heavy economic toll (see Annex I). It hit consumer and investor sentiment, already depressed by the conflict and political uncertainty. The lockdowns, on-off border closures, and social distancing led to aggregate demand shocks across goods, services, and labor. Services and industry appear to have suffered the most, as illustrated by Google’s Community Mobility Report indicators, while agriculture appears largely spared.3 Food prices jumped due to border closures and panic buying, pushing headline inflation to 8.7 percent in April.

Islamic Republic of Afghanistan: COVID-19 High Frequency Indicators

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

6. The crisis has imperiled people’s livelihoods and health. With employment concentrated in the informal sector with little job security4 and given the lack of an effective social safety net, income losses have been widespread, pushing thousands of families into poverty and possibly hunger. According to the World Bank (WB), the poverty rate has likely increased to 61–72 percent.5 The crisis exposed long-standing weaknesses in the health system, largely due to inadequate and ineffective spending and limited capacity.

Islamic Republic of Afghanistan: Health Infrastructure and Preparedness

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Recent Developments, Outlook and Risks

A. Recent Developments

7. The economy appears to be recovering from the pandemic-induced slump. As confirmed infections declined, the authorities progressively eased containment restrictions since end-May, with most removed by end-August (see Annex I); social distancing guidelines remain in place. Border crossings reopened, and trade and some domestic and international flights resumed in May-July. CPI growth moderated to 5.9 percent by end-August as resumed trade and a new harvest boosted foodstuffs supply, but inflation is probably higher given that food’s share in the consumption basket has likely risen.

COVID-19 Confirmed Cases

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Johns Hopkins CSSE (August 25, 2020}and IMF staff calculations.

8. The pandemic and the government’s response to cushion its impact have worsened fiscal accounts. Tax revenue dropped by 40 percent in April–May year-on-year, in part due to the 45-day extension of first quarter tax filing, with the shortfall offset by the transfer of Af 12.8 billion of Da Afghanistan Bank (DAB) profits. The government ramped up spending on urgent health and social needs, which amounted to 1.3 percent of GDP through June. As a result, the overall budget deficit in January–June widened to 1.6 percent of 2020 GDP. Revenue started to recover in recent months, and for January-September stood at 83 percent of the last year’s level.6

CPI Inflation

(y-o-y change, in percent)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Afghan authorities.

Domestic Revenue

(cumulative, billion Afs)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Afghan authorities.

Expenditure

(cumulative, billion Af5)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Afghan authorities.

Domestic Revenue

(billion Afs)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Atghan authorities. Domestic revenue-110m the Treasury‘s AFMIS database and breakdown from the Afghanistan Revenue Department's RMIS database.

Overall Balance

(billion Afs)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Afghan authorities.

9. The balance of payments has deteriorated. Border closures, including disruption of air corridors, hit exports, and remittances fell as Afghan workers returned from the host countries whose economic prospects soured, especially the oil exporters hit by the pandemic and the drop in oil prices. Imports held up better due to imports of essentials, medical supplies, and aid-financed imports. Hence, the current account deficit before grants is projected to widen to 31 percent of GDP this year. It will be financed by official grants of about 43 percent of GDP, with the increase over 2019 due to COVID-related aid.

Exports: Goods

(cumulative; USD billion)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: DOTS.

Imports: Goods

(cumulative; USD billion)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: DOTS.

10. The Afghani has been broadly stable against the U.S. dollar, and DAB’s international reserves increased. Subdued activity lowered demand for foreign exchange while supply was boosted as households and returning migrants used foreign exchange savings to supplement lost income. With DAB’s foreign exchange sales reduced, large official inflows fueled reserve accumulation. Staff considers reserves to be broadly adequate given the Afghanistan’s risk profile which the traditional reserve metric does not capture well. An adjusted metric, comprising 100 percent of currency in circulation, all foreign currency deposits, and three months of imports, accounts better for downside risks, including from fragility, insecurity, and faster-than-expected decline in aid. At $9.3 billion at end-July, gross international reserves are about 122 percent of the adjusted metric.

Exchange Market Pressure and the USS/Afs Exchange Rate

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source; IMF staff calculations.

FX Sales and Gross International Reserves

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Afghan authorities.

11. The fallout from the pandemic is intensifying strains in weak banks. There have been no liquidity pressures thanks to the sector’s high liquidity and DAB’s timely actions. However, the banking sector faces the pandemic with weak assets and profitability, the latter in part due to banks’ limited financial intermediation. In March, DAB introduced a freeze on loan classification, suspended enforcement of prudential requirements, and delayed the implementation of IFRS 9 to June 2021. Still, nonperforming loans (NPLs) rose since the beginning of the year as a number of banks applied internal loan classification rules or adopted IFRS 9, which requires recognition of NPLs on a forward-looking basis, ahead of the revised deadline.7

Asset Composition and Quality

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source?: Afghan authorities.

Capital Adequacy and Liquidity

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Afghan authorities.

B. Outlook and Risks

12. The outlook envisages a gradual recovery. The disruption in supply chains and impairment of household and company balance sheets due to the pandemic will weigh on near-term investment and growth. Assuming the infections continue to subside, the output could return close to the pre-pandemic level in the fourth quarter, implying a 5 percent contraction in 2020. Provided momentum continues, growth could rebound to 4 percent in 2021, and, assuming no significant security deterioration, continued reforms, and sustained aid, could settle at 4.0–4.5 percent over the medium term.

Quarterly GDP, projections

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: IMF staff calculations.

GDP Growth

(percent)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

13. The underlying external position is expected to strengthen over the medium term. The current account deficit without grants would improve thanks to sustained exports growth and expansion of domestic production substituting imports, supported by investment in agriculture, better connectivity, and reforms to boost productivity. The current account surplus after grants would shrink however as aid is projected to decline.

14. The depth and duration of the pandemic are the main risks to the outlook (see Annex II)• Should the pandemic intensify before the end-year, health and social outcomes would deteriorate, the recession in 2020 would be deeper and the projected recovery in 2021 shallower than under the baseline. Revenues would plummet and pandemic spending increase, widening 2020–21 budget deficits and amplifying financing needs. A strong policy response, possibly with emergency revenue measures, and larger donor support would be required to finance government operations, including health and social spending.

15. The outlook is also clouded by risks related to Afghanistan’s fragilities. The outcome of peace negotiations is uncertain, and its nature will have a major bearing on security and development of Afghanistan. A sustained peace would boost confidence and lift development prospects. Risks also stem from possible shortfalls in aid, reform fatigue, and adverse regional security developments. Finally, Afghanistan is vulnerable to natural disasters: floods, droughts, and earthquakes.

Extended Credit Facility

A. Strategic Issues

16. The 2016–19 ECF arrangement contributed to macroeconomic stability and improved economic governance (LoI ¶4, MEFP ¶2; Annex III)• The program catalyzed aid while supporting progress towards self-reliance. Nevertheless, growth disappointed due to 2018 drought and as private investment was held back by the armed conflict, political upheaval, weak governance, and constraints to doing business.

17. The authorities are finalizing their 2021–25 development strategy (LoI ¶3; MEFP ¶11, 12). It will be presented at the November conference as the second Afghanistan National Peace and Development Framework 2021–25 (ANPDF II).8 The ANPDF II has two phases. First, it will guide the transition from pandemic containment to a recovery while mitigating damage to health, livelihoods, and the economy. Next, with the recovery underway, it will support growth that creates jobs, reduces poverty, and facilitates human capital accumulation.

18. Strong private sector-led growth will be needed to absorb nearly 500,000 Afghans entering the labor force yearly. This requires political stability, an exit from fragility (see Annex III), and an improved investment climate. Ensuring that economic opportunities become accessible to broad segments of the society will be crucial to avoid the exclusion of the poor and disadvantaged and underpin future peace settlement (MEFP ¶13, 44).

19. The growth potential centers around agriculture, services, and mining (MEFP ¶12, 32). Agriculture, which accounts for a quarter of GDP and employs 40 percent of the workforce, could lift living standards in the rural areas, while services could fuel urban job growth, including thanks to regional integration. Once security and robust governance framework are in place, mining can generate large revenue to finance development. Given vulnerabilities to climate change, especially agriculture, the government has designated climate adaptation and mitigation among the selection criteria for public projects.

B. Design of the Program

20. The program’s objectives—restoring and preserving macro-financial stability and supporting sustainable growth and poverty reduction—rest on two pillars (MEFP ¶13, 17). Under the first pillar, the ECF arrangement will provide a macroeconomic framework to navigate the crisis and create conditions for a recovery. Under the second pillar, it will focus on addressing structural fragilities that obstruct sustainable and inclusive growth and equitable social outcomes (see Annex III). The program will aim to mobilize domestic revenue, improve the quality of public spending, bolster the financial sector, and support anti-corruption efforts, cementing gains and continuing reforms initiated under the 2016–19 ECF arrangement. Landmark reforms include VAT implementation, strengthening the anti-corruption regime, and, subject to fiscal space and donor support, building a social safety net over the medium term.

21. Strong ownership, sustained donor aid, and continued prioritization will be critical for the program’s success. The authorities established a solid track record under the 2016–19 ECF arrangement. However, their capacity to implement reforms has been strained by the pandemic and can be further challenged if the public grows dissatisfied with the government’s response to the pandemic. The program therefore balances ambition with realism through prioritization and close coordination with donors who are taking the lead in many structural areas. In recognition of the capacity limitations, there are only four structural benchmarks (SB) for the first review. Given the elevated uncertainty, the performance criteria feature adjustors and build in buffers (MEFP Table 1, Table 2; TMU ¶22–25).

Table 1.

Islamic Republic of Afghanistan: Selected Economic Indicators, 2018–21

(Quota: SDR 323.8 million)

(Population: approx. 32.2 million; 2019)

(Per capita GDP: approx. US$586; 2019)

(Poverty rate: 54.5 percent; 2016–2017)

(Main exports: dried and fresh fruits and vegetables, medical seeds, 2019)

article image
Sources: Afghan authorities, United Nations Office on Drugs and Crime, WITS database, and IMF staff estimates and projections.

Excluding the narcotics economy.

Comprising mainly current spending.

Defined as domestic revenues minus operating expenditures.

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

Public debt includes promissory note issued by MoF to settle DAB’s Kabul Bank exposure.

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

CPI-based, vis-a-vis the U.S. dollar. Positive – real appreciation of the Afghani.

Current account does not include COVID emergency financing grants.

Table 2.

Islamic Republic of Afghanistan: Medium-Term Macroeconomic Framework, 2018–25

article image
Sources: Afghan authorities and Fund staff estimates and projections.

Excluding the narcotics economy.

Comprising mainly current spending. It is assumed that donors’ recurrent expenditure off-budget, mostly in the security sector, is being moved onto the budget by

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.

Population figures are from the Afghan authorities.

Current account does not include COVID emergency financing grants.

C. First Pillar: Macro-Financial Stability

22. The program will promote macroeconomic stability and resilience (MEFP ¶17). Fiscal buffers and policy credibility built under the 2016–19 ECF afforded the authorities policy space to swiftly respond to the pandemic. Going forward, prudent fiscal policy, stable inflation with a flexible exchange rate, and financial stability will be critical for sustained growth and development. The program will aim to maintain low debt, a prudent discretionary cash balance, and an adequate level of international reserves.

Fiscal Policy

23. The program accommodates spending to mitigate the pandemic and its socioeconomic impact (MEFP ¶18). The authorities’ response to the crisis has been bolstered by substantial new and reallocated grants. The draft mid-year budget submitted to parliament envisages about 3.0 percent of GDP spending on COVID-19 in 2020, with about 60 percent directed to healthcare and social protection. To support the vulnerable, the authorities are rolling out a 1.5 percent of GDP social relief package financed by the WB, of which two-thirds will be executed this year. Targeting households with incomes of $2 per day or lower (twice the national poverty line), the package entails a near universal coverage as about 90 percent of households fall under this cut-off. The budget also includes outlays for agriculture to boost domestic food security and compensate for the loss of exports.

Mid-year Budget Amendment: Proposed Measures

article image
Source: Afghan authorities.

24. The authorities will target a 3.0 percent of GDP fiscal deficit this year (MEFP ¶19). Revenue should continue to recover through the rest of the year thanks to a gradual pick-up in activity and because no extensions were granted for the second and subsequent quarter tax filings. In addition, the authorities are cutting lower-priority spending (O&M, vehicle purchases, renovations, travel, etc.) and raising fees from the Telecom sector. Should revenues fall short, the authorities have committed to further rationalize expenditures, in addition to mobilizing aid. In 2020–21, ECF disbursements will be directed to the budget to ease the financing constraint to more adequately source health and social sectors and support the economy during the pandemic. Without the ECF disbursements, the government would have to tighten the fiscal stance—ill-advised given critical needs and the state of the economy—or risk exhausting the Treasury cash balances, the only source of domestic financing.

Evolution of the 2020 Budget Outlook

article image
Source: Afghan authorities; IMF staff calculations.

Includes REACH program.

25. In line with their intent to reverse the pandemic-induced fiscal loosening, the authorities will cap the FY2021 deficit at 2.2 percent of GDP (MEFP ¶20 and the first review SB). This will be supported by a projected rebound in tax revenue on the back of economic recovery and renewed revenue mobilization efforts (see ¶32–34). While spending is projected to decline, the budget needs to carefully balance preserving resilience and supporting the recovery, while continuing with pandemic spending projected at about 2 percent of GDP, including the WB-financed social support program. Should the risks to the outlook materialize, the authorities would need to adjust their fiscal stance and implement policies broadly outlined in ¶14.

26. Fiscal policy over the medium term is anchored on advancing toward self-reliance. To that end, the authorities aim to improve the operating balance excluding grants and bring the overall deficit to under one percent of GDP over the medium term, which will help keep public debt contained and rebuild government deposits. Protecting development spending within this envelope, in part owing to bringing on budget off-budget projects as the related grants decline, will require mobilizing domestic revenue.

27. The crisis has reinforced the need for stronger social protection (MEFP ¶11, 13). The authorities are increasing pro-poor spending9 from 3.7 percent of GDP in 2019 to 5.3 percent of GDP in 2020 and 4.7 percent of GDP in 2021 (indicative targets). To protect the level and improve the efficiency of social spending over the medium term, the authorities plan to build a targeted social safety net for which they intend to seek donor technical and financial assistance. The program will aid these efforts by creating fiscal space.

28. Despite low public debt, Afghanistan’s risk of debt distress is “high” (see Debt Sustainability Analysis). Even with the increase due to the pandemic, public debt would remain at about 10 percent of GDP by end-2025. Given small fiscal deficits (under 1 percent of GDP) projected over the medium term and the authorities’ commitment to borrow strictly on concessional terms, public debt would remain below 25 percent of GDP in the long term. The high risk of debt distress arises because, as grants are replaced with loans, the debt service to exports indicator breaches its threshold under the baseline in the 2030s. Debt sustainability hinges on sound fiscal policies, reforms, and continued aid. The government is preparing to issue sukuk next year, which would allow tapping domestic savings and catalyze debt market development (MEFP ¶21).

Monetary Policy and Financial Stability

29. DAB should continue strengthening the effectiveness of monetary policy (MEFP ¶22). With monetary transmission constrained, DAB will continue to target reserve money—with capital notes and foreign exchange auctions as the primary policy tools—to achieve its price stability objective. Operating within this broad objective and exercising due prudence on its foreign exchange sales, DAB will let the exchange rate move freely in response to external shocks. Enhancing DAB’s monetary policy toolkit and communication will be key to improve monetary transmission and anchor inflation expectations as will DAB’s ongoing efforts to increase the use of the Afghani, which will also contribute to financial stability. This would over time allow DAB to rely more on Afghani-denominated instruments for monetary policy operations although, as large official inflows are channeled through the budget, DAB will continue to supply foreign exchange to the market.

30. Banks are under enhanced monitoring, with DAB ready to intervene. With emergency measures largely unwound in July and DAB supporting prudent loan restructuring, banks are starting to report the worsening in asset quality due to the pandemic. While the system appears to have sufficient capital to absorb possible losses from its small loan portfolio, weak banks with impaired loans and low profitability will likely need capital injection. Staff supported DAB’s decision to resume the enforcement of all prudential requirements while exercising flexibility in the application of penalties and prudential triggers. DAB is implementing a post-pandemic sector recovery plan, which includes unwinding remaining emergency measures10 as warranted by developments, suspending dividend payouts by all banks, and encouraging credit access via digital means. The WB-funded capitalization of the Credit Guarantee Fund should boost its capacity to provide partial credit guarantee for SME loans, while the establishment of a dedicated department in DAB will strengthen consumer protection and financial literacy (MEFP ¶42). While nonbanks appear to have weathered the pandemic, the oversight framework is still in its infancy.

31. High-risk banks are under a dedicated post-pandemic plan (MEFP ¶36, 37, 41). It entails recovery, capital augmentation, and strengthening corporate governance and management monitored by DAB. The plan will also be informed by the special review to be undertaken with the WB. DAB is updating its contingency plans and establishing a dedicated unit to oversee the winding down of defunct institutions under its supervision. It has requested IMF TA to upgrade the framework for early intervention, resolution, and crisis management, and is working with the WB to strengthen the deposit insurance system. DAB’s capacity to identify and control sectoral risks will be further enhanced with application of a risk-based supervision framework, implementation of IFRS 9, and automation of off-site supervisory data collection.

D. Second Pillar: Structural Reforms

Fiscal Reforms

32. Raising domestic revenue will be key to reduce aid dependence and meet development needs (MEFP ¶25). Domestic revenue rose by 3 percentage points of GDP in 2016–19, but mostly due to one-offs and collection remains below potential, especially in customs. Revenue mobilization under the program will be underpinned by the post-pandemic recovery in compliance, VAT introduction in 2022, and, starting in 2023, fees from pipeline and power transmission projects. To increase the revenue stream and improve its reliability, the authorities will adopt targeted and graduated collection methodologies aimed at boosting taxpayer compliance (first review SB), create risk profiles for large taxpayers, and automate tax filing and collection.

33. VAT adoption will be a crowning achievement of tax policy reforms (MEFP ¶26). In view of the pandemic and in consultation with the IMF, WB, and EU, the authorities postponed the VAT implementation from 2021 to 2022. The 10 percent VAT, which would replace the cascading business receipt tax (BRT), could yield 1.2 percent of GDP net revenue while eliminating BRT’s distortions. The authorities requested the IMF TA to update the VAT’s yield estimate and will consider introducing a simple tax scheme for taxpayers below the VAT threshold to maintain them under the tax net when the BRT is abolished. To mitigate the impact on the poor, the authorities have exempted a number of basic goods and will study the need for compensatory spending measures.

34. Significant leakages in customs should be reduced (MEFP ¶27–31). The Customs Department’s action plan aims to encourage compliance, facilitate cross-border and transit trade, and modernize customs and its workforce. In 2019, the department developed multi-criteria risk profiles for major crossing points and inland customs offices to detect noncompliance through better targeting. Through June, it recommended the removal of licenses for 123 noncompliant trading companies. To better identify high-risk traders and shipments, the Customs Department will enhance its risk analysis by mid-2021. It will also launch mobile verification teams, transit vehicle tracking, and trader identity verification. These will be supported by further automation of customs processes which should improve information exchange with the customs of trading partners, detection of fraud, and internal risk management. The tax and customs administration systems will be linked with the warehouse inventory records, the appeal process, and—to facilitate e-payment— with the core banking system and DAB. Finally, strengthened internal control and a merit-based recruitment process to be adopted with WB’s support aim to improve workforce integrity and reduce corruption.

35. A public expenditure review (PER), a new civil service pay policy, and strengthened Supreme Audit Office (SAO) should improve budget planning, its execution and evaluation (MEFP ¶33, 34, 35). The PER with a medium-term perspective aiming to establish top-down parameters for savings is scheduled for 2021. It will aid strategic allocation and efficient use of public resources, which motivated a new 2019 civil service pay policy to be implemented in the Ministry of Finance (MoF) first. It links compensation with verified competencies to professionalize civil service and will be supported by an automated payment system for payroll verification. To strengthen control and transparency over the use of contingency reserves, budgeted up to 3 percent of spending, the authorities will define eligible purposes and establish reporting requirements by end-2020. Once implemented, a new SAO law will strengthen SAO’s authority and capacity to evaluate public finances.

36. There is a pressing need to advance the functionality of public financial management (PFM) (MEFP ¶35). The PFM system has some strengths, e.g., with budget preparation and reporting scoring better than regional peers.11 Now, PFM reforms need to advance the sectoral and project prioritization to improve alignment between the budget and national priority programs (MEFP Annex I). This exercise will be supported by the Fiscal Strategy Paper (FSP) that identifies priority sectors and guides budget allocations and medium-term costed development strategies subject to forward estimates issued by the MoF. It will be implemented first by the Ministries of Public Health and Education. New public investment management (PIM) regulations, to be adopted by end-2020, will strengthen the project implementation cycle, institutionalizing the Project Evaluation Committee and mandating rule-based project selection process. This will reduce opportunities for political interference and corruption.

37. The public finance needs to move towards a comprehensive oversight of public entities and risks (MEFP ¶35).

  • The budget process and its coverage have so far focused on central government fiscal operations and its direct liabilities. Given the authorities’ intent to increase reliance on PPPs, there is a need to strengthen the management of related fiscal risks and contingent liabilities, including their recognition, quantification, and reporting. To that end, the authorities are creating an integrated database of public investments and PPP projects which will include information on their life-cycle service payments and contingent commitments. The institutional arrangement for PPPs should entrust the MoF with strong budget and fiscal risk management authority at every stage of the project cycle.

  • Operational and financial oversight of state-owned entities (SOE) needs enhancing. They have been a go-to source for ad-hoc revenues, but little is known about their financials, including income and on- and off-balance sheet liabilities. This will be remedied by building the capacity of the MoF’s SOE department and collecting the relevant information. The authorities plan to have the 2020 financial statements of the five largest SOEs audited externally by September 2021 and will prepare a report on the financial performance of SOEs by end-2021. Further, the analysis of fiscal risks stemming from PPPs and SOEs will be included in the FY2022 FSP and budget.

Financial Sector Reforms

38. Forging ahead with the reforms of state-owned commercial banks (SOCBs) is critical for building a healthy and well-managed financial sector (MEFP ¶38, 39). Given SOCBs’ systemic importance—they hold over one-quarter of banking system’s assets—and quasi-fiscal risks they pose, the authorities plan to step up the implementation of haltingly progressing reforms. In August, the High Economic Council chaired by the President announced a merger of Bank-e-Millie Afghan and New Kabul Bank per the reform strategy under implementation with the WB support. Contracting advisors to support the merger, including in financial and operational due diligence and integration of processes, is the first review SB (MEFP Table 1).

39. To reduce informality in the financial sector, DAB is advancing the corporatization of unlicensed financial institutions (MEFP ¶40). Per the U.S. Treasury TA, DAB is implementing a phased corporatization of money service providers and foreign exchange dealers over the next three years. DAB has established a department to supervise nonbank financial institutions. As it builds capacity, the department is establishing the regulatory and supervisory frameworks, including AML/CFT, and preventing unlicensed operations.

40. Efforts to reduce the financial sector’s exposure to illicit flows should continue, guided by the 2019 AML/CFT National Risk Assessment (NRA) (MEFP ¶43). The NRA will be published by end-2020 and will inform a national action plan through 2023. In addition, by September 2021, DAB will prepare a national AML/CFT strategy that will prioritize risk mitigation measures. DAB has continued to enhance the AML/CFT supervisory framework during the pandemic, including through reviews of internal procedures and regulations in line with the NRA findings. All banks will undergo AML/CFT examinations by year-end, along with nine nonbank institutions examined already.12 The authorities have recently formed an interagency Oversight Committee to coordinate preparations for the 2022 AML/CFT assessment of Afghanistan by the Asia Pacific Group on Money Laundering.

Governance and Corruption

41. The legal and institutional framework for anti-corruption strengthened in recent years. The authorities developed a national anti-corruption strategy, enacted an anti-corruption law, established relevant institutions, and, under the 2016–19 ECF arrangement, adopted an asset declaration regime. Despite this progress, corruption remains widespread and continues to stifle development. Implementation has been tardy owing to overlapping reform agendas, weak capacity of anti-corruption bodies, and the challenging domestic environment.

42. The reform agenda under the program will focus on operationalizing and building capacity of anti-corruption institutions, boosting the effectiveness of the asset declaration regime, and strengthening accountability of public spending, including in response to the COVID-19 crisis:

  • Execution of emergency pandemic spending has raised concerns about its soundness and efficiency. Per its commitment in the context of the RCF, the government intends to publish its first quarterly report on pandemic spending by end-October. The other related RCF commitment—audit of select pandemic spending by the SAO and publication of audit reports— will be completed by June 2021 to allow time to conclude audits after the fiscal year ends in December (MEFP ¶48). The audit will focus on large domestically financed items given that most donors require a third-party audit of their programs.

  • As the program’s prior action (PA), on September 30, 2020, the authorities amended public procurement procedures to require that, starting November, all entities bidding for public contracts submit information about their beneficial owners to the National Procurement Agency, which will publish on its website beneficial ownership information of winning bidders within 30 days of contract signing (MEFP ¶48).

  • Identification and registration of the beneficial ownership of assets and entities is critical for effective operation of the AML/CFT framework. The government is making the regulatory and institutional changes required by the Financial Action Task Force (FATF) to advance this goal (MEFP ¶47). Relatedly, FATF standards will be used to develop rules applicable to politically exposed persons by June 2021.

  • To strengthen the anti-corruption regime, the authorities will operationalize the Anti-Corruption Commission, which will be fully staffed by March 2021 with the civil society’s input and begin its operations in June 2021 (MEFP ¶45). Once operational, the ACC is expected to take over the handling of asset declarations pursuant to the Anti-Corruption Law. The National Strategy for Combating Corruption, dating back to November 2018, will be updated by March 2021.

  • The asset declaration regime will be enhanced with digitization and a risk-based verification of declarations (MEFP ¶46). The Administrative Office of the President (AOP) will systematically digitize all current year asset declarations and publish online senior officials’ declarations. Making declarations publicly available in a machine-readable format will facilitate their verification and allow the civil society to play a watchdog role. Further, the work on improving and expanding public registries of land, property, and companies and integrating them with the asset declaration regime will continue as will joint efforts by the AOP, DAB, and donors to develop locally based training capacity on anti-corruption and asset declarations.

  • To improve the effectiveness of prosecution of corruption offences, the authorities plan to strengthen the criminal justice system and enhance anti-corruption structures (MEFP ¶47). The government is reviewing the Penal Code to tighten pre-trial custody procedures and improve transparency of court proceedings. Further, in line the Action Plan for Improving Detection and Prosecution of Corruption Cases and to formalize the affiliation of the Major Crimes Task Force (MCTF) with the Anti-Corruption Justice Center (ACJC), the authorities will develop the necessary regulations and protocols to clarify the coordination between ACJC prosecutors and MCTF inspectors and the MCTF’s reporting line to the Minister of Interior.

Business Environment

43. Improved business environment is a key element of the government’s reform strategy (MEFP ¶44). Insecurity, weak governance and institutions, and infrastructure gaps prevent Afghanistan from becoming a transit hub and attractive investment destination. Despite progress in recent years, significant challenges remain in areas such as investment freedom, including starting business, enforcing contracts, and quality of judicial proceedings. Further, Afghanistan lags its peers on financial intermediation, quality of education, and gender equality. Fund staff will support donors, particularly the WB, helping the authorities to improve the business climate.

2020 Index of Economic Freedom

(100= best)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: The Heritage Foundation Index of Economic Freedom.

Deposit Accounts with Commercial Banks, 2018

(per 1,000 adults)

Citation: IMF Staff Country Reports 2020, 300; 10.5089/9781513561127.002.A001

Source: Financial Access Survey, IMF.Note: Median values are used for country groups.

Program Modalities

44. Access, phasing, monitoring, risks and capacity to repay:

  • Access under the arrangement is proposed at 80 percent of quota (SDR 259.04 million, about $370 million or 1.8 percent of GDP). Phasing will be frontloaded in line with projected BOP needs (about $900 million in 2020–21) that emerged due to the acute impact of the pandemic on fiscal and external accounts. 71 percent of access will be available at the approval and first review, with small, even disbursements in 2022–23.

  • Disbursements in 2020–21 will be directed to the budget. Domestic financing sources are limited to government deposits,13 which need to be kept at prudent levels given the high-risk environment of Afghanistan. To that end, the program sets an indicative floor of Af 10 billion on the Treasury’s discretionary cash balance. Disbursements in 2022–23 will be directed to DAB.

  • Program performance will be monitored by semi-annual reviews using quantitative performance criteria and indicative targets, and SBs (MEFP Table 1, Table 2).

  • SBs for the second review. The mission reached preliminary agreement with the authorities on measures that could be proposed as SBs at the time of the next review (Table 11). These measures will be discussed with stakeholders to ensure consistency with the ANPDF II and donors’ initiatives and conditionality. Therefore, they are not proposed for IMF Executive Board approval at this time.

  • Program risks. The outlook is subject to high uncertainty (¶14), and program implementation faces substantial risks given the impact of the pandemic (¶5–6), longstanding fragilities (¶15), and capacity challenges. Broad contours of the authorities’ policy response in case of a more severe crisis are outlined in MEFP ¶24. The IMF TA will be mobilized to support the implementation of structural reforms (Annex III, Table 2).

  • Capacity to repay remains adequate. The IMF credit outstanding is projected to peak at 7.6 percent of reserves in 2023–24 and repayments at 4.8 percent of exports in 2027, but repayments could reach 17 percent of exports in 2027 under the most extreme downside scenario for exports in the DSA. The authorities’ track record of servicing the IMF debt is strong.

  • The authorities are seeking parliament’s authorization to request a disbursement.14 The RCF disbursement was initially rejected by the Lower House, which sought elaboration of government’s spending plans and terms of the loan. It was subsequently approved by the Upper House.

  • Debt Service Suspension Initiative. The authorities have received debt service suspension from bilateral creditors (0.02 percent of GDP of eligible debt service). Afghanistan has received the first tranche (SDR 2.4 million) of debt service relief from the IMF under the Catastrophe Containment and Relief Trust and will receive the same amount of relief under the second tranche.

Table 3a.

Islamic Republic of Afghanistan: Central Government Budget, 2018–25

(In billions of Afghanis)

article image
Source: Afghan authorities and Fund staff estimates and projections

Profits transfer from DAB of Afs12.8 billion is included in 2020.

LOTFA: Law and Order Trust Fund for Afghanistan; CSTC-A: Combined Security Transition Command – Afghanistan (now NTM-A: NATO Training Mission – Afghanistan)

Some of the grants to development budget can finance operating expenditures.

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

Pro-poor spending covers ministries of education, labor and social affairs, martyrs and disabled, public health.

Table 3b.

Islamic Republic of Afghanistan: Central Government Budget, 2018–25

(In percent of GDP)

article image
Source: Afghan authorities and Fund staff estimates and projections.

Profits transfer from DAB of Afs12.8 billion is included in 2020.

LOTFA: Law and Order Trust Fund for Afghanistan; CSTC-A: Combined Security Transition Command – Afghanistan (now NTM-A: NATO Training Mission – Afghanistan)

Some of the grants to development budget can finance operating expenditures.

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

Pro-poor spending covers ministries of education, labor and social affairs, martyrs and disabled, public health.

Table 4a.

Islamic Republic of Afghanistan: Central Bank Balance Sheet, 2018–22

(In billions of Afghanis, at current exchange rates, unless otherwise indicated)

article image
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).