Islamic Republic of Afghanistan: First Review Under the Under the Extended Credit Facility Arrangement and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Islamic Republic of Afghanistan

1. Afghanistan continues to be affected by the Covid-19 pandemic and its fallout. Stringent containment measures were removed by late 2020, and only a few restrictions remain in place. That said, Afghanistan appears to be facing a third wave of infections.1 The pandemic has imposed a heavy socioeconomic toll—it forced thousands into poverty,2 set back progress toward self-reliance, and caused a permanent output loss.

Abstract

1. Afghanistan continues to be affected by the Covid-19 pandemic and its fallout. Stringent containment measures were removed by late 2020, and only a few restrictions remain in place. That said, Afghanistan appears to be facing a third wave of infections.1 The pandemic has imposed a heavy socioeconomic toll—it forced thousands into poverty,2 set back progress toward self-reliance, and caused a permanent output loss.

Context

1. Afghanistan continues to be affected by the Covid-19 pandemic and its fallout. Stringent containment measures were removed by late 2020, and only a few restrictions remain in place. That said, Afghanistan appears to be facing a third wave of infections.1 The pandemic has imposed a heavy socioeconomic toll—it forced thousands into poverty,2 set back progress toward self-reliance, and caused a permanent output loss.

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COVID-19 Infection and Death Rate

(Per million, 7-day moving average)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Sources: Johns Hopkins CSSE (May 16, 2021) and IMF staff calculations.
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COVID-19 Containment Measures and Stringency

(Stringency Index)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Oxford COVID-19 Government Response Tracker

2. The government responded with wide ranging measures to protect people, livelihoods, and the economy. Supported by substantial donor financing, including the Rapid Credit Facility and first ECF disbursements, the government spent Af 32 billion (2.1 percent of GDP) on pandemic mitigation in 2020. Most of it was for health, food security, and social needs, including 0.8 percent of GDP via the World Bank-funded Relief Effort for Afghan Communities and Households (REACH) program targeting households with incomes of $2 per day or less, twice the national poverty line. To alleviate liquidity pressures among taxpayers, the government extended the business receipt tax (BRT) filing and payment deadlines. DAB stepped in to ensure continued bank operations, froze loan classifications, suspended the enforcement of selected prudential requirements, and promoted digital finance. Most anti-crisis measures were phased out last year.

COVID-19-related Expenditure, 2020

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Source: Afghan authorities.

COVID-19-related Financing, 2020

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Source: Afghan authorities.

DSSI provides rescheduling of debt service payments due in 2020.

3. The government aims to vaccinate 60 percent of the population. Inoculations began in February, with the COVAX facility and donors expected to finance vaccines for 48 percent of the population. The government hopes to identify additional grants and donations (about $60 million) to cover the remaining target population. Vaccine availability remains the main constraint, but the inoculation campaign is also facing administrative challenges and vaccine hesitancy among the public.

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COVID-19 Vaccinations

(Cumulative percent of population)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Sources: Oxford University based on national authorities’ data and IMF staff calculations

4. Rising insecurity and uncertainty have eroded confidence and policymaking. A wave of targeted attacks on public figures and civil servants, including DAB employees, has shaken confidence in a peaceful settlement of the armed conflict and overshadowed concerns about the pandemic. Tensions between the government and parliament delayed the approval of the 2021 budget, which was rejected twice, to late February and thwarted consideration of DAB law amendments.

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Civilian Deaths and Injuries

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: United Nations Assistance Mission to Afghanistan

5. The peace talks have stalled, and foreign troops have started to depart. The talks between the government and Taliban hit an impasse in early January over a future governance system and transitional arrangements. While President Ghani signaled openness to the previously rejected idea of an interim power-sharing government, a peace conference planned in Istanbul was postponed after the Taliban declined to attend. The U.S., NATO, and allies are withdrawing their troops, to be completed by September, while affirming continued assistance to Afghanistan.

6. Donor support remains critical. Following the approval of the ECF arrangement, donors committed some $12 billion civilian aid for 2021–24 at the Geneva conference last November. The amount is about 20 percent lower than pledged at the 2016 conference, underscoring the need to advance toward self-sufficiency.

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Aid Dependence 1/2/

(4-year averages, 2017–20)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Sources: WEO and IMF staff calculations.1/ Grants include all non compulsory current or capital transfers to the country.2/ Size of the bubbles shows aid in percent of GDP.3/ CA inflows include exports of goods and services and inflows of current transfers.

Recent Economic Developments

7. The economy has continued to recover from the pandemic.

  • GDP contracted by 2 percent in 2020, less than the 5 percent contraction projected at the program approval. Activity rebounded strongly in the second half of the year, and favorable weather boosted agriculture which grew by 5 percent, partially offsetting the decline in industry and services. Working hours, mobility, and cross-border traffic are broadly back to pre-crisis levels, and most flights, including for exports via air corridors, have resumed.

  • Annual inflation was 4.4 percent in March. After peaking at 17 percent in April 2020 due to border closures and panic buying, food inflation moderated thanks to a trade resumption and good fall harvest. Nonfood inflation remained low throughout given weak demand and Afghani’s appreciation.

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Google Mobility Index

(Percent deviation from median Jan. 3-Feb. 6, 7-day average)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Sources: Google Mobility Reports; and IMF staff calculations
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Inflation

(Y-o-y change, in percent)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.

Selected Economic Indicators, 2019–22

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

Excluding the narcotics economy.

8. The external position strengthened in 2020 thanks to grants, subdued imports, and resilient exports and remittances.

  • The current account deficit before grants improved to 24.3 percent of GDP. It narrowed sharply during the lockdown as imports, which at five times exports dominate the current account, fell. This was reversed when imports rebounded as the economy reopened in the third quarter. In 2020 as a whole, exports fell by 2 percent and imports by 5 percent. Formal remittances rose as migrants, unable to travel, used wire services, and more money dealers registered with DAB, increasing the coverage. After large grants, the current account surplus reached 14.2 percent of GDP.

  • As a result, the Afghani appreciated even as DAB reduced its foreign exchange sales. The latter, coupled with official inflows, including IMF disbursements, and valuation gains boosted gross international reserves (GIR). By end-April 2021, GIR stood at $9.4 billion, 123 percent of the reserve adequacy metric comprising 100 percent of currency in circulation, all foreign currency deposits, and three months of imports.

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Exports: Goods

(Cumulative; USD billion)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.
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Imports: Goods

(Cumulative; USD billion)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.
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Exchange Market Pressure and the US$/Afs Exchange Rate

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: IMF staff calculations.
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FX Sales and Gross International Reserves

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.1/ At program exchange rates.

9. Revenue shortfalls and pandemic spending widened the fiscal deficit to 2.3 percent of GDP in 2020. Domestic revenue fell by 16 percent compared to 2019—tax revenue by 7 percent— reflecting the economic downturn and weaker collection. Spending rose by Af 21 billion, to 28½ percent of GDP, to accommodate Covid-19 outlays financed by new and reallocated grants. However, spending undershot the program level thanks to savings in the wage bill and purchases of goods and services and slower execution of donor-financed development projects, the latter in large part due to the pandemic. As a result, the 2020 fiscal deficit came in 0.7 percentage points of GDP below programmed, and the treasury cash balance closed the year at Af 32 billion—three times the program’s floor.

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Domestic Revenue

(Cumulative, billion Afs)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.
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Domestic Revenues

(Billion Afs)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.
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Expenditure

(Cumulative, billion Afs)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.
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Overall Balance

(Billion Afs)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.

10. The pandemic is straining the banking sector, eroding the asset quality and profits. Although the pandemic’s full impact on borrowers’ ability to service debt is yet to be realized, the small loan portfolio (12 percent of bank assets) limits potential losses. After DAB ended the freeze on loan classification and resumed the enforcement of prudential requirements in July, nonperforming loans (NPLs) rose to reach 22 percent of total loans by end-2020. The ensuing increase in provisioning and a drop in returns on overseas assets, which comprise one-third of sector assets, weighed on profits.

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Asset Composition and Quality

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.
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Capital Adequacy and Liquidity

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Source: Afghan authorities.

Outlook and Risks

11. Assuming broadly unchanged security conditions, the outlook envisages a recovery, with near-term growth weighed by the pandemic and an incipient drought.

  • Growth for 2021 has been revised down to 2.7 percent from 4 percent during the ECF approval after factoring in a weaker base effect and the drought’s expected impact on the harvest. Supported by structural reforms and regional integration, growth is expected to settle at 4–4½ percent over the medium term, at about staff’s pre-Covid estimate of potential growth. This implies a 9 percent permanent output loss due to the pandemic.

  • Inflation is projected to rise to 5.8 percent by end-2021 (see ¶24).

  • External sector. The current account is expected to deteriorate in 2021 as imports continue to rebound and Covid-19 grants taper off. The current account deficit before grants is projected to improve over the medium term thanks to exports growth and as aid and related imports decline.

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GDP Losses: 2019–21 vs. 2019–24

(Percentage point difference between Jan 2020 WEO and April 2021 WEO projections)

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Note: 45* line marks a return to pre-Covid medium term growth path; countries below it recoup some of the projected growth loss due to COVID.Sources: IMF World Economic Outlook, and IMF staff estimates.
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Growth Projections: Average 2023–24

Citation: IMF Staff Country Reports 2021, 138; 10.5089/9781513587202.002.A001

Sources: IMF World Economic Outlook, and IMF staff estimates.

12. Considerable downside risks weigh on the outlook (Annex I). Large uncertainty surrounds the implications of the troops withdrawal as well as what comes next in the peace talks and their outcome. While a sustained peace would lift development prospects, failure of the talks could inflame the violence, which could lead to a loss of life, destruction, and potentially a refugee crisis, hamper the authorities’ ability to undertake reforms underpinning the outlook, and fuel capital outflows. Drought has emerged as a near-term risk, while shortfalls in aid, policy slippages, and adverse security developments could also harm the recovery and fiscal position. While the pandemic continues to weigh on health and social outcomes, the direct risk it poses to economic activity has moderated as the authorities are unlikely to impose blanket restrictions in response to an infection spike.

13. The authorities are developing contingencies should the drought intensify, or infections flare up again. They plan to boost health and social spending and food security measures by deploying contingency budgetary funds and reprioritizing the budget. If needed, they would introduce one-off revenue measures and seek additional grants, including through frontloading.

Program Performance

14. Program implementation remains satisfactory overall. Despite pandemic and security challenges, the authorities have continued to demonstrate their commitment to the program.

  • All end-December PCs and all but two end-December ITs were met (MEFP, Table 3). The IT on revenue and the IT on social and other priority spending were not observed, the former due to a shortfall in nontax revenue and the latter for classification reasons. Social and other priority spending amounted to Af 78½ billion in 2020, slightly above the Af 78 billion target, but spending under some social programs, e.g. REACH, was classified as development expenditure, outside the program’s definition covering operating expenditure only. The definition has now been modified to include all social and other priority spending regardless of whether such spending is classified as operating or development expenditure.

  • Based on preliminary data available for selected end-March ITs, two end-March 2021 ITs were not observed. The IT on revenue was missed due to a fire at the second largest customs office in February. The IT on net international reserves was missed as the late-2020 surge in government spending necessitated higher than programmed foreign exchange sales in January-March, partly unwinding the earlier overperformance.

Table 1.

Islamic Republic of Afghanistan: Selected Economic Indicators, 2018–22

(Quota: SDR 323.8 million)

(Population: approx. 32.9 million; 2020)

(Per capita GDP: approx. US$601; 2020)

(Poverty rate: 54.5 percent; 2016–2017)

(Main exports: dried and fresh fruits and vegetables, medical seeds, 2020)

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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.

Current account ratios include COVID emergency financing grants.

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

Index annual average, 2010=100

Table 2.

Islamic Republic of Afghanistan: Medium-Term Macroeconomic Framework, 2018–26

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Sources: Afghan authorities and IMF 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 2031.

Defined as domestic revenues minus operating expenditures.

Current account ratios include COVID emergency financing grants.

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

Table 3a.

Islamic Republic of Afghanistan: Central Government Budget, 2018–26

(In billions of Afghanis)

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Sources: Afghan authorities and IMF staff estimates and projections

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.

Social and other priority spending would amount to Afs 78.5 billion in 2020 if spending under REACH and Citizen Charter social programs were included. The definition has been expanded starting 2021 to cover social spending benefiting the poor and vulnerable populations in areas of education, healthcare, food and nutrition security, social safety net, pensions for martyrs and disabled, refugees and repatriates, skills development, women empowerment, and pandemic and natural disaster relief, within the central government’s operating and development budget.

Table 3b.

Islamic Republic of Afghanistan: Central Government Budget, 2018–26

(In percent of GDP)

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Source: Afghan authorities and IMF staff estimates and projections.

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.

Social and other priority spending would amount to Afs 78.5 billion in 2020 if spending under REACH and Citizen Charter social programs were included. The definition has been expanded starting 2021 to cover social spending benefiting the poor and vulnerable populations in areas of education healthcare, food and nutrition security, social safety net pensions for martyrs and disabled, refugees and repatriates, skils development, women empowerment and pandemic and natural disaster relief, within the central government’s operating and development budget.

15. Progress with SBs was mixed. Two out of four first review SBs were met (MEFP, Table 1). The authorities submitted the 2021 draft budget with a 2.2 percent of GDP deficit to parliament (November SB) and adopted targeted and graduated measures to increase tax filling and compliance among large taxpayers (December SB). Regarding the remaining two SBs which were not met:

  • The authorities encountered significant delay in contracting advisory support for the merger of two SOCBs due to capacity constraints and procurement complexities (April SB). They have now reset the timeline and intend to sign the contract by November (proposed reset date, second review SB).

  • The authorities were unable to bring the DAB law amendments aimed at strengthening DAB’s autonomy and governance structure for parliament’s consideration (March SB). They affirmed their commitment to DAB’s independence and to continue working with parliament toward enacting the amendments.

Policy Discussions

A. Fiscal Policy

16. A looser fiscal stance in 2021 aims to sustain the recovery and protect social spending. The authorities intend to target a 2.5 percent of GDP deficit this year, 0.3 percent of GDP higher than envisaged during the ECF request. A slightly higher deficit is justified by the need to continue pandemic spending and support the recovery and can be financed given higher than projected treasury cash balances. To protect the socially vulnerable and enhance their access to basic services, the authorities plan to spend Af 91 billion (5.6 percent of GDP) on social and other needs (IT), covering education, healthcare, food and nutrition to the needy, pensions for martyrs and disabled, refugees and repatriates, women empowerment, and natural disaster relief. This amount includes most of the planned 0.9 percent of GDP pandemic spending, two-thirds accounted for by the remainder of the REACH program. It can form the basis for a future social safety net, and staff encouraged the authorities to engage the World Bank and other donors for related technical assistance and financing.

17. The authorities have aligned their 2021 spending with a realistic revenue projection. Hitting the 2021 budget’s ambitious revenue target became challenging after January–March revenue disappointed due to the customs fire. While the authorities hope to make up the lost ground thanks to renewed revenue efforts, they agreed to a lower revenue target under the program (8 percent below the 2021 budget’s). To align spending with the reduced revenue envelope, the authorities are putting on hold slower-performing and lower priority administrative and infrastructure projects while protecting social and other priority spending. Should revenue overperform, the authorities intend to revive and execute these projects.

2021 Budget and Program Parameters

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Sources: Afghan authorities and IMF staff calculations.

18. Medium-term fiscal policy remains anchored on advancing toward self-reliance. The authorities intend to reverse the 2020–21 fiscal loosening in 2022 supported by improved tax collection and the value-added tax (VAT) adoption, and as pandemic spending phases out. Progress toward self-reliance requires improving the operating balance excluding grants and reducing the overall deficit to under 1 percent of GDP over the medium term to contain public debt and rebuild government deposits. To achieve this while protecting priority spending as grants decline, the authorities plan to mobilize revenue and optimize spending.

19. The revenue strategy is underpinned by the VAT adoption in 2022 and revenue administration gains.

  • VAT (Annex II), which would replace the BRT, could yield 1.2 percent of GDP net revenue while eliminating the BRT’s distortions. Staff called on the authorities to step up lagging preparations for the reform, which is supported by the EU, IMF, and World Bank. The authorities are on track to submit to parliament by June legal amendments to eliminate the BRT under the VAT threshold (second review SB), which would allow Afghanistan Revenue Department (ARD) to concentrate on VAT payers. The authorities are designing a simple tax scheme for taxpayers below the threshold to keep them under the tax net.

  • Restoring tax compliance. The ARD intends to introduce by September the risk differentiation framework, with risk profiles for all large taxpayers (second review SB). Further, by end-December, it will formulate a compliance improvement plan for the Single Large Taxpayers Office (SLTO) containing a treatment strategy for each identified priority risk in registration, filing, payment, and reporting, and implement it in 2022 (Table 11). The authorities are also taking steps to bolster a compliance culture.

  • Reducing leakages in customs. To reduce non-compliance, the authorities are improving targeting by enhancing multi-criteria risk profiles, equipping mobile verification teams which spot check shipments after customs release, and installing digital scanners. These efforts will be supported by increased automation, including electronic declarations and e-payments, as well as improved integrity among customs officials.

  • Mining revenue. While investment in extractive industries, which hold large revenue potential, has been hampered by ongoing insecurity, the authorities are moving toward effective and transparent fiscal regime for natural resources. Afghanistan’s January 2019 suspension from the Extractive Industries Transparency Initiative (EITI) was lifted last October in recognition of progress in implementing the EITI Standard.

Table 4a.

Islamic Republic of Afghanistan: Central Bank Balance Sheet, 2018–23

(In billions of Afghanis, unless otherwise indicated)

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Sources: Afghan authorities and IMF 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.

The sum of Afghanistan’s outstanding credit to the IMF and SDR allocation minus the sum of SDR holdings, reserve tranche position and the outstanding credit under the 2016–19 ECF arrangement (see ¶ 20, TMU).