Islamic Republic of Afghanistan
Staff Report for the 2019 Article IV Consultation and the Sixth Review Under the Extended Credit Facility Arrangement
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International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
20 Dec 2019
eISBN:
9781513523958
Language:
English
Keywords:
ISCR; CR; Afghanistan; right; authority; debt; self-reliance strategy; export promotion initiative; Executive Board discussion; Kabul money exchange market; self-reliance agenda; Currencies; Credit; Budget planning and preparation; Global; Middle East; Asia and Pacific; Afghan authorities; foreign currency; reform effort; accounting firm; promissory note; Inflation
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December 4, 2019

Abstract

December 4, 2019

Contents

December 4, 2019

Key Issues

Context: Afghanistan is a fragile, aid-dependent country where insecurity combined with episodes of political uncertainty and adverse weather events have kept real GDP growth below 3 percent in recent years. In early September, U.S.-Taliban talks on a U.S. troop withdrawal as a basis for peace negotiations were suspended, with uncertainty as to the timing of their resumption. Presidential elections were held at end-September, but results have yet to be announced. The international community continues to support Afghanistan with civilian and military assistance and is pressing for intra-Afghan peace talks and an immediate reduction in violence. The authorities have expressed an interest in a new financial arrangement to support reforms.

Outlook and Risks: Supported by a recovery in agriculture, growth is projected to reach 3 percent in 2019 and rise to 3.5 percent in 2020. Inflation is projected to average about 2 percent this year and rise gradually to 5 percent in the medium term. Reserves are ample at about 12 months of import cover. Risks to the outlook are tilted to the downside, and include a deterioration in security, heightened political tensions, a significant drop in aid, and reform slippages. On the upside, durable peace would boost confidence and economic activity.

Article IV discussions: Discussions focused on policies needed to preserve macroeconomic stability, secure sustainable inclusive growth, and attain self-reliance. There was broad agreement between staff and authorities on the policy mix needed to raise the pace of growth and make it more inclusive, with staff emphasizing the importance of macroeconomic policy discipline to sustain confidence in an uncertain environment complemented with structural reforms particularly in the governance area.

Program Performance: Program performance has been satisfactory. All end-June quantitative performance criteria and end-September 2019 indicative targets were met. Similarly, all but one of the seven structural benchmarks were met. Staff supports completion of the sixth and final review under the Extended Credit Facility arrangement and a disbursement of SDR 5.38 million, bringing the cumulative amount under the program to SDR 32.38 million (10 percent of quota).

Approved By

Subir Lall and Martin Sommer

Discussions took place in Dubai during October 3–10, 2019. The mission comprised Christoph Duenwald (head), Mariusz Sumliński, Boaz Nandwa (all MCD), Daisuke Ishikawa (FAD), Kathleen Kao (LEG), Keiichi Nakatani (SPR), and Gayon Hosin (MCM). Mr. Mojarrad (OED) joined the policy discussions. The team met with Acting Finance Minister Qayoumi, Acting Central Bank Governor Nosher, Deputy Finance Ministers Sarabi and Tamim, and other senior officials. Tetyana Sydorenko (MCD) provided research assistance and Maria Orihuela-Quintanilla (MCD) managed document production.

Contents

  • CONTEXT

  • RECENT DEVELOPMENTS

  • OUTLOOK AND RISKS

  • ARTICLE IV POLICY DISCUSSIONS

  • A. Safeguarding Macroeconomic Stability

  • B. Structural Reforms: Strengthen the Foundation for Higher and More Inclusive Growth

  • SIXTH REVIEW UNDER THE ECF ARRANGEMENT

  • STAFF APPRAISAL

  • BOXES

  • 1. Economic Development Plans

  • 2. What Drives Inflation in Afghanistan?

  • 3. Afghanistan’s National Financial Inclusion Strategy, 2019–24

  • FIGURES

  • 1. Real Sector

  • 2. External Sector

  • 3. Fiscal Sector

  • 4. Monetary Sector

  • 5. Banking Sector

  • TABLES

  • 1. Selected Economic Indicators, 2016–20

  • 2. Medium-Term Macroeconomic Framework, 2016–24

  • 3. Poverty, Vulnerability, Inequality, and Social Indicators

  • 4a. Central Government Budget, 2016–24 (In billions of Afhanis)

  • 4b. Central Government Budget, 2016–24 (In percent of GDP)

  • 5a. Central Bank Balance Sheet, 2016–24 (In billions of Afghanis)

  • 5b. Central Bank Balance Sheet, 2015–19 (At program exchange rates)

  • 6. Monetary Survey, 2016–24 (In billions of Afghanis)

  • 7. Balance of Payments, 2016–24 (In million of U.S. dollars)

  • 8a. Financial Soundness Indicators

  • 8b. Financial System Structure

  • 9. Proposed Schedule of Reviews and Disbursements Under the ECF Arrangement

  • 10. External Financing Requirement and Sources, 2016–20

  • 11. Projected Payments and Indicators of Capacity to Repay the Fund

  • 12. Quantitative Performance Criteria and Indicative Targets Under the Extended Credit Facility, December 2017–September 2019

  • 13. Authorities’ Response to Past Policy Recommendations

  • 14. Quantitative Performance Criteria, June 21, 2019

  • 15. Sixth Review Structural Benchmarks

  • ANNEXES

  • I. Risk Assessment Matrix

  • II. Medium-Term Fiscal Challenges for Afghanistan

  • III. External Sector Assessment

  • IV. Governance and AML/CFT

  • V. Illuminating the Provinces: Estimating Subnational GDP in Afghanistan Using Satellite Imagery

  • APPENDIX

  • I. Letter of Intent

    • Attachment I. Memorandum of Economic and Financial Policies

Context

1. Despite substantial gains against many indicators, Afghanistan, in conflict since the 1980s, remains a poor, fragile country. The conflict of past decades has taken a large human and economic toll, and security requirements have imposed significant costs on the government, with total security spending estimated at 30 percent of GDP. Social development has been held back in general despite noticeable improvement in some indicators relative to 2001: GDP per capita has quadrupled, life expectancy is up to 64 years from 56 years, and maternal mortality declined to 396/100,000 births from 1,600. Nonetheless, GDP per capita is the lowest in the immediate region, and a recent household survey shows that the poverty rate increased from 33.7 percent in 2007/08 to 54.5 percent in 2016/17, while inequality as measured by the Gini coefficient rose from 0.28 to 0.33 during the same period. Most vulnerability and social indicators show Afghanistan underperforming other low-income countries (Table 3). Moreover, corruption is perceived as very high in a weak institutional environment. Per capita GDP growth has on average been negative during 2012–18 with growth falling after the withdrawal of international troops coupled with a spike in violence and a reduction in aid. Large fiscal and current account deficits are financed by aid of nearly 40 percent of GDP.

Table 1.

Islamic Republic of Afghanistan: Selected Economic Indicators, 2016–20

(Quota: SDR 323.8 million)

(Population: approx. 34.7 million; 2016)

(Per capita GDP: approx. US$547; 2018)

(Poverty rate: 54.5 percent; 2016–2017)

(Main exports: dried and fresh fruits and vegetables, medical seeds, 2018)

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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.

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.

Table 2.

Islamic Republic of Afghanistan: Medium-Term Macroeconomic Framework, 2016–24

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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 2031.

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 3.

Islamic Republic of Afghanistan: Poverty, Vulnerability, Inequality, and Social Indicators

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Sources: UNDP Human Development Reports (2018) and IMF staff calculations.

GDP Growth and Weighted Conflict Index

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Cross-National Time-Series Database; and Afghan authorities.

Poverty and Inequality

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

GDP Per Capita in Low-Income Countries

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.

Official Aid and Real GDP Growth in Low Income Countries

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF WEO,WDI.

2. The government has made good progress on economic reforms despite the difficult circumstances. The reform agenda laid out in the Afghanistan National Peace and Development Framework 2017–21 (ANPDF) presented during the Brussels pledging conference in 2016, was recently supplemented by a post-settlement economic plan and the Afghanistan Self-Reliance Accelerator Package (ASAP) aiming to accelerate Afghanistan’s progress toward economic self-reliance (Box 1). Donors have generally met their pledges from Brussels with the government effectively implementing its commitments. At the November 2018 Geneva donor conference, the government and donors agreed on deliverables for 2019–20, including on reaching agreement on a successor Fund-supported program by mid-2020 before the next pledging conference expected in late 2020.

3. A challenging political and security environment complicates policymaking. The last parliamentary elections took place in October 2018, and while voter turnout was good, it was marked by violence and unresolved disputes regarding the outcome. Presidential elections were held on September 28, 2019 without major disruptions but marked by low voter turnout. The election results have not been announced yet. U.S.-Taliban negotiations on a phased drawdown of U.S. troops in exchange for a Taliban crackdown on terrorist groups were suspended in September, with uncertainty as to the timing of their resumption.

4. Traction of 2017 Article IV policy recommendations has been broadly satisfactory (Table 13). The authorities have continued to make notable progress in enhancing fiscal discipline, strengthening the financial sector, and improving the business environment. Sustained efforts are needed to safeguard macro-financial stability, improve governance, and strengthen structural reforms to boost private sector participation in the economy and reduce poverty.

Table 4a.

Islamic Republic of Afghanistan: Central Government Budget, 2016–24

(In billions of Afghanis)

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Source: Afghan authorities and Fund staff estimates and projections Note: Government Finance Statistics Manual 1986 presentation Overall budget balance including grants for 2018 revised budget excludes repayment to DAB and treasury cash balance.

ARTF: Afghanistan Reconstruction Trust Fund; LOTFA: Law and Order Trust Fund for Afghanistan; CSTC-A: Combined Security Transition Command – Afghanistan (now NTM-A: NATO Training Mission – Afghanistan) ARTF and other grants are reclassified into the grants to development budget.

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.

Revenue includes an Af 9.0 billion transfer of DAB profits to the Treasury.

Table 4b.

Islamic Republic of Afghanistan: Central Government Budget, 2016–24

(In percent of GDP)

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Source: Afghan authorities and Fund staff estimates and projections Note: Government Finance Statistics Manual 1986 presentation Overall budget balance including grants for 2018 revised budget excludes repayment to DAB and treasury cash balance.

ARTF: Afghanistan Reconstruction Trust Fund; LOTFA: Law and Order Trust Fund for Afghanistan; CSTC-A: Combined Security Transition Command – Afghanistan (now NTM-A: NATO Training Mission – Afghanistan) ARTF and other grants are reclassified into the grants to development budget.

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.

Revenue includes an Af 9.0 billion transfer of DAB profits to the Treasury.

Table 5a.

Islamic Republic of Afghanistan: Central Bank Balance Sheet, 2016–24

(In billions of Afghanis, unless otherwise indicated)

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Sources: Afghan authorities and Fund staff estimates and projections. Note: Monetary indicators are calculated based on modified methodology and, thus, differ from the numbers reported in the previous staff reports.

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).

International reserves for Dec 2016 were revised relative to June 2017 report.

Table 5b.

Islamic Republic of Afghanistan: Central Bank Balance Sheet, 2015–19

(At program exchange rates) 1/

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Sources: Afghan authorities and Fund staff estimates and projections. Note: Monetary indicators are calculated based on modified methodology and, thus, differ from the numbers reported in the previous staff reports.

Program exchange rates as of May. 21, 2016 are applied to value 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 Bank.

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

International reserves for Dec 2016 were revised relative to June 2017 report.

Table 6.

Islamic Republic of Afghanistan: Monetary Survey, 2016–24 1/

(In billions of Afghanis)

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Sources: Afghan authorities and Fund staff estimates and projections. Note: Monetary indicators are calculated based on modified methodology and, thus, differ from the numbers reported in the previous staff reports.

End of period (Dec.21). Data underlying the survey are not fully consistent because DAB and the public banks use the solar calendar, while commercial banks use the Gregorian calendar.

Table 7.

Islamic Republic of Afghanistan: Balance of Payments, 2016–24 1/

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

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Sources: Afghan authorities and Fund staff estimates and projections.

BoP data exclude the narcotics economy.

As the breakdown between capital grants and current grants is difficult to identify, all grants are included in current transfers.

Excluding IMF.

Disbursements in 2017–19 are conditional on the board approval of ECF reviews.

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

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

Table 8a.

Islamic Republic of Afghanistan: Financial Soundness Indicators 1/

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Source: Afghan authorities.

NPLs include loans 121 to 481 days or more past due for payment of principal and/or interest. This differs from the IMF’s FSI Compilation Guide which advises recognition of loans 90 days or more past due payment of interest or principal as NPLs.

Net open positions are due to high and persistent dollarization.

Table 8b.

Islamic Republic of Afghanistan: Financial System Structure

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Sources: DAB Note: ...Stands for information not available.
Table 9.

Islamic Republic of Afghanistan: Proposed Schedule of Reviews and Disbursements Under the ECF Arrangement

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Source: International Monetary Fund.
Table 10.

Islamic Republic of Afghanistan: External Financing Requirements and Sources, 2016–20

(In millions of U.S. dollars)

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Sources: Afghan authorities and Fund staff estimates and projections.

Disbursements in 2017–19 are conditional on the board approval of ECF reviews.

Table 11.

Islamic Republic of Afghanistan: Projected Payments and Indicators of Capacity to Repay the Fund 1/

(In millions of SDRs)

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Source: Fund staff estimates and projections.

Projections are based on current interest rates for PRGT loans.

Based on the proposed level and phasing of access, and subject to the approval of the IMF’s Executive Board.

Excluding reexports.

Table 12.

Islamic Republic of Afghanistan: Quantitative Performance Criteria and Indicative Targets Under the Extended Credit Facility, December 2017–September 2019 1/

(Cumulative in Af billion unless otherwise indicated)

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Source: Afghan authorities and IMF staff estimates/projections.

The quantitative targets, indicative targets, their adjustors, and program exchange rates are defined in the Technical Memorandum of Understanding (TMU).

Cumulative from the beginning of the year.

These quantitative targets are applied on a continuous basis.

Excludes IsDB loan (53.2 million Islamic Dinars) contracted in 2017.

Afghanistan owes a small amount (US$10 million) of pre-HIPC Initiative arrears to a non-Paris Club creditor, which continue to be deemed away under the revised arrears policy for official creditors.

Prospective concessional borrowing.

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

Table 13.

Islamic Republic of Afghanistan: Authorities’ Response to Past Policy Recommendations

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See IMF Country Report No. 17/377, Afghanistan: 2017 Article IV Consultation Staff Report.

5. A three-and-a-half-year Extended Credit Facility (ECF) arrangement, expiring at end-December 2019, has anchored macroeconomic stability. The arrangement made available SDR 32.38 million (10 percent of quota) to support the government’s reform efforts and to help catalyze donor funding. The authorities are interested in a successor arrangement in line with the Geneva commitment. They see the Fund program as a critical driver of reforms and as a tool to secure domestic support for reforms and lay the foundation for stronger private sector-led growth.

Recent Developments

6. The security situation has remained strained. In 2018, civilian deaths reached a new record and the high level of violence continued into the third quarter of 2019, with the UN Assistance Mission in Afghanistan (UNAMA) recording the highest quarterly number of overall civilian casualties since they were first documented in 2009. Afghanistan also remains the second highest source of refugees in the region. A protracted post-election political transition risks another increase in violence.

Economic Development Plans 1/

There is broad recognition that any political settlement would require an economic development plan to sustain peace and to harness its dividends. Indeed, in November 2018, the Geneva Ministerial Conference on Afghanistan called on the international community to develop a “specific action plan, consistent with fundamental values and existing frameworks, in support of broad-based program of economic initiatives which would advance: a post-settlement return of Afghan overseas capital; increased economic priorities building on existing programs and institutions.

The World Bank, in consultation with the authorities and international partners, has outlined related initiatives. It focuses on the following areas for inclusive and sustainable development:

  • Protecting and investing in people. More than half of the Afghan population lives below the poverty line. Poverty could be reduced through expansion of basic services, public works schemes, community development programs (Citizens Charter) and cash transfers to benefit the worst off.

  • Improving rural livelihoods. Agriculture is key to reducing poverty and improving employment opportunities. The sector would benefit from investments to improve agricultural productivity and resilience to weather-related shocks, and to support infrastructure and irrigation networks.

  • Securing and attracting investment. Private sector investment will be key to Afghanistan’s economic success, and constraints (including a poor regulatory environment and limited access to infrastructure) and risks need to be addressed. Expanding access to finance, improving the legal and regulatory environment for investment, supporting private investment in infrastructure through public-private partnerships, and providing financial products to offset risks to investors would be critical.

  • Strengthening international linkages. Regional economic integration would increase exports, attract FDI including in the extractive sector, develop regional connectivity and infrastructure in energy roads, and rail, and expand employment opportunities beyond national economies.

The authorities have also devised an investment package to strengthen growth in line with priorities identified in the Post-Settlement Economic Plan. The “Afghanistan Self-Reliance Accelerator Package” (ASAP) focuses on investments, both public and private, to accelerate economic growth. The sectors targeted for investment include energy, affordable housing, and agriculture. ASAP emphasizes the use of highly concessional financing and private sector involvement wherever possible.

Donor aid remains necessary to support such initiatives given Afghanistan’s large financing needs The authorities rightly remain focused on achieving self-reliance, but in the meantime, aid should continue to support basic services and infrastructure. Indeed, aid still finances around three-quarters of public service, infrastructure, and security needs, and, with pledges for civilian assistance timing out at the end of 2020, discussions are underway for a ministerial conference to consider pledges for 2021–24.

1/ Prepared by Keiichi Nakatani.

7. Domestic and regional shocks have affected the population. In 2018, a severe drought forced major internal displacements, with nearly 300,000 people migrating to urban areas. Humanitarian agencies assisted nearly 4 million people in 22 provinces. The economic slowdown in Iran due to re-imposition of U.S. sanctions caused about 0.8 million Afghans to return (about 0.4 million in 2019 to date) 1 straining public services. The return of Afghans from Pakistan has slowed as some 1.4 million Afghans residing in Pakistan were granted extension of residency until end-June 2020. 2

Civilian Deaths and Injuries

(Thousands, January to September 2009–19)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: United Nations Assistance Mission in Afghanistan.

Refugees by Country of Origin and Internally Displaced Persons

(2018, thousands)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: United Nations High Commissioner of Refugees, WDI.

8. In 2018, GDP growth was muted owing to a drought. Constrained by persistently difficult security conditions and political uncertainty, real GDP growth has been below 3 percent in recent years. In 2018, estimated growth of 2.7 percent was lower than the 2.9 percent recorded in 2017, reflecting the impact of the drought (Figure 1). Inflation moderated from 3 percent y/y at end-2017 to 0.8 percent at end-2018, reflecting weak demand due to lower drought-affected rural incomes, lower priced imports compensating for domestic food shortages, and increased domestic vegetable production. In the first half of 2019, inflation increased to 4 percent reflecting the pass-through from the earlier exchange rate depreciation. The pass-through was somewhat limited by cheaper imports of consumer goods from Iran. In September, inflation eased to 1.8 percent helped by declining food prices due to a good harvest and modest appreciation of the Afghani. Core inflation also edged lower from 3.5 percent to 3 percent in September (Box 2).

What Drives Inflation in Afghanistan? 1/

Historically, inflation in Afghanistan has been moderate but with high volatility. End-period average annual inflation over a 12-year period (Jan 2007–May 2019) was almost 6 percent y/y which is consistent with DAB’s objective to keep inflation within a single digit corridor. However, over this period, Afghanistan experienced bouts of inflation volatility, with 12-month inflation ranging from –15 percent to nearly 37 percent, driven mainly by swings in food prices (which account for half of the CPI basket), exchange rate fluctuations, and foreign troop movements.

Consumer Price Inflation

(yoy, percent)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghanistan authorities.

Understanding the main drivers of inflation is key to guiding monetary policy. There is considerable empirical literature on the determinants of inflation, incorporating both domestic and external factors,2 and a broad consensus that low and stable inflation is conducive to healthy economic growth and improved welfare. For low income countries like Afghanistan, domestic supply shocks, typically related to the weather, and external shocks (e.g., commodity prices) are usually important factors driving inflation. The type of exchange rate regime and the degree of monetary policy credibility are also important institutional factors.

A single equation model (OLS) is estimated to analyze inflation developments in Afghanistan. The model is expressed as:

p=f(pt−1,rm,cred,exr,compix,temp)

where p is CPI (dependent variable), rm is reserve money, cred is credit to the private sector, exr is the nominal exchange rate of Afghani versus USD, compix is the global commodity price index weighted by imports, and temp is temperature (a proxy for supply shocks to agriculture). Common to the literature, all the variables are in logarithms, differenced, and seasonally adjusted. A positive shock to the variables is expected to increase Afghanistan’s inflation. Dummy variables are incorporated to account for NATO troops surge and withdrawal and a change in CPI methodology in 2010.

Estimated results provide elasticities of the impact of changes in the variables on Afghanistan’s CPI. Monthly data over 2007M1–2019M05 is used to estimate the model. Coefficients of the estimated model are presented with t-statistics in brackets. The results should be interpreted with caution given data limitations and likely structural breaks in the series, a major constraint to modeling inflation developments in Afghanistan. Reserve money and credit to the private sector were found to be insignificant, likely owing to high dollarization (see ¶22, 24) and weak credit uptake due to insecurity and uncertainty, in addition to potentially long and variable lags between these variables and inflation not captured by the regression. For brevity, the results are not reported. All the other variables have expected signs and are significant at the 5 percent level. Inflation is persistent, with an increase in the previous month’s inflation by 1 percent raising current inflation by almost 0.3 percent. Depreciation of the exchange rate in the previous month leads to a 0.2 percent increase in inflation in the current month. Similarly, an increase in commodity prices raises inflation by almost 0.1 percent. Shocks to agriculture, through adverse weather conditions, increases inflation by 0.02 percent.

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Source: IMF staff estimates
1/ Prepared by Boaz Nandwa and Farid Talishli. 2/ For a recent comprehensive analysis see Ha, J., A. Kose and F. Ohnsorge (2019), Understanding Inflation in Emerging and Developing Economies, Policy Research Working Paper No. WPS 8761, World Bank.
Figure 1.
Figure 1.

Islamic Republic of Afghanistan: Real Sector

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities, United Nations Assistance Mission in Afghanistan, and IMF staff calculations.1/ In 2016, the decline in exports volumes reflects a fall in growth of services exports for two reasons: the fall in imports growth (insurance and freight are recorded as service exports) and in service exports to foreigners (transport, communication, financial services, issuance of visas, other) due to the security situation.

9. Grants continue to finance a large underlying current account deficit, while exchange rate pressures have eased recently, and international reserves remain ample. The current account deficit (excluding official transfers) remained large in 2018 despite import substitution of some consumption goods and strong export growth partly reflecting the establishment of subsidized “air corridors.” The Afghani depreciated by almost eight percent versus the U.S. dollar in 2018. In the first half of 2019, the Afghani depreciated by eight percent. The pressure on the currency was mainly attributable to increased political risks prior to the presidential elections and outflows of U.S. dollars to take advantage of arbitrage opportunities in Iran. Since June, the outflows appear to have receded and the Afghani has appreciated by over 3 percent through end-September. Overall, on a nominal trade-weighted basis, the Afghani has been broadly stable given the appreciation against regional currencies. 3 International reserves increased slightly since the beginning of the year to nearly 12 months of imports.

Gross International Reserves and Current Account Balance

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

Exchange Rate

(Index 2010=100)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities and IMF staff calculations.

10. The fiscal outturn in 2019H1 was strong, but revenue growth has slowed. In 2018, the overall fiscal balance including grants moved to a surplus of 1.5 percent of GDP, from a deficit of 0.6 percent of GDP in 2017 because of an increase in grants by nearly 2 percent of GDP and domestic revenues expanding by 1 percent of GDP. In 2019, rising (albeit at a declining rate) revenues benefitted from improved collection efficiency and increased customs revenue reflecting the Afghani’s depreciation earlier in the year. However, revenue growth has declined significantly in recent months reflecting uncertainties stemming from the presidential elections, and hence the budget target for revenue is now likely to be undershot. The extent to which this revenue slowdown is temporary is uncertain. 4 Reflecting prudent management of budget resources, cash balances remain comfortably above the program floor of Af 10 billion, providing a liquidity buffer in case of revenue underperformance. Public debt remains low at around 7 percent of GDP.

Domestic Revenues Growth

(Y-o-y change; in percent)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.

Total Treasury Discretionary Cash Balances

(In billions of Afghanis)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.

11. Monetary aggregates have grown moderately but credit growth and financial inclusion remain weak. At end-September, reserve money in local currency grew by 8.5 percent y/y, reflecting an uptick in government spending partly offset by increased intervention by Da Afghanistan Bank (DAB). Credit to the economy contracted by almost 1 percent owing to lower demand for trade credit and DAB’s mandated nonperforming loan (NPL) write-offs. Loan and deposit dollarization have fluctuated more noticeably in 2019 than previously, reflecting heightened political uncertainty and insecurity, but remain close to 60 percent. Despite some recent improvements, access to financial services has remained limited.

Credit to Economy

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

Dollarization of Loans and Deposits

(Percent of Total)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

12. Rising strains in some banks since end-2018 have prompted intensified monitoring by the central bank. The banking system’s financial soundness indicators show a mixed picture for the six months to June 2019 (Table 8a). The gross NPL ratio increased by four percentage points to 12.8 percent owing to an ongoing DAB mandated clean-up of the portfolio, while profitability remains weak. Liquidity and capital levels continue to be well above the minimum, and NPLs remain adequately provisioned although the ratio of NPLs net of provisions to capital ratio widened from 3.4 to 6.3 percent. Low profitability mainly reflects a challenging economic environment and the high business cost given the difficult security situation. The weak banks remain under intensified monitoring by DAB. In March 2019, DAB revoked the licenses of two foreign banks’ branches since they did not perform financial intermediation services. In June 2019, a capital injection in one large private bank restored its capital adequacy ratio to the regulatory minimum capital adequacy ratio.

Financial Soundness Indicators

(In percent)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source:Afghan authorities.

13. Structural reforms are advancing, despite a constrained environment. The government’s five-year development plan, ANPDF, embodies a strong commitment to fighting corruption and strengthening the rule of law to achieve self-reliance and private sector-led sustainable growth. The impact of the reform efforts is already evident in tax administration and enactment of anti-corruption legislation.

Outlook and Risks

14. The outlook envisages a modest pickup in growth and inflation. Supported by a recovery in agriculture, growth is expected to pick up modestly to 3 percent in 2019, although political uncertainty and insecurity continue to weigh on investment and growth prospects. In 2020, growth should strengthen modestly conditioned on a smooth political transition following the recent presidential elections. By 2024, growth may reach 4 percent assuming no significant security deterioration, continued reforms, and sustained aid. Over time, extractive industries and regional trade integration could support growth and job creation. Projected growth over the medium term has been revised down since the fifth review under the ECF arrangement in part reflecting a more conservative outlook for aid (and hence lower government spending). Inflation, forecast at 3.5 percent for end-2019, rises modestly thereafter as domestic demand picks up. Contingent on continued (albeit declining) aid inflows, the external position will remain comfortable with international reserves averaging about 10 months of imports cover during 2019–24.

15. Risks to the outlook remain tilted to the downside (Annex I). The outlook is clouded by significant uncertainty, especially with respect to the prospects for peace talks and the political transition after the September presidential elections; possible lapses in reforms, including fiscal slippages due to election-related disruptions to revenue collection and expenditure discipline; shortfalls in donor aid; and regional developments, especially the impact of sanctions on Iran on remittances and migrant movements. On the upside, a durable peace that spurs repatriation of overseas capital and boosts private sector confidence and investment, could improve economic prospects significantly.

16. The authorities broadly shared staff’s perspective about the outlook and assessment of risks. Citing their strong record in policy implementation, the authorities reiterated their commitment to maintain policy discipline and advance structural reforms despite the difficult environment. They expressed concerns about possible adverse spillovers from insecurity and political uncertainty undermining the already subdued economic outlook and the pace of reforms.

Article IV Policy Discussions

Discussions focused on devising a robust development strategy that encompasses the safeguarding of macroeconomic stability and fostering inclusive growth and poverty reduction. While emphasizing the need for a robust peace agreement to boost the trajectory of growth, staff recommended maintaining policies that safeguard recent gains in macroeconomic stability. These need to be complemented with structural reform efforts that focus on strengthening governance, broadening financial inclusion, boosting the business environment, fostering increased human and physical capital formation, and deepening regional integration. A well-targeted social safety net that protects the most vulnerable would also be critical to help reduce poverty and nurture social cohesion.

A. Safeguarding Macroeconomic Stability

Development Strategy

17. Staff stressed that development plans and efforts should be embedded in a robust and sustainable medium-term macro-fiscal framework supported by disciplined policies. Regarding the ASAP investment package, staff supported the objective of boosting growth, while reiterating the need to first develop capacity to assess investment projects, their financing, and related debt sustainability. Developing debt management capacity is a first step in this process. Staff also cautioned against non-concessional borrowing and repeated previous calls to establish a database of potential infrastructure projects with government funding. The authorities indicated that they would resort only to highly concessionally loans to finance investment projects, which would be carefully selected based on priorities and rates of return.

Fiscal Policy

18. Staff noted that the overall balance including grants should remain the fiscal anchor targeting a broadly balanced budget, aligned with the medium-term fiscal framework (Annex II). The government’s recent strategy of boosting prospects for self-reliance through domestic revenue mobilization— which increased the revenue-to-GDP ratio by 3 percentage points over 2016–18— combined with expenditure restraint and supported by aid has been successful. This strategy has preserved a broadly balanced budget, ample cash reserves, and low public debt. Going forward, fiscal policy should continue to target an overall fiscal balance at or near zero, supported by continued expenditure restraint and efforts to mobilize more domestic revenues. The operating deficit before grants should also be gradually reduced to reinforce prudent use of domestic resources, while allowing expenditure composition to shift toward pro-growth and pro-poor outlays. In this context, staff welcomed that pro-poor spending had risen from 2.9 percent of GDP in 2016 to 3.4 percent in 2019. 5

Fiscal Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

19. Prudent fiscal outcomes are envisaged in 2019–20, with contingency measures in place to offset a potential revenue shortfall. The revenue and spending forecast for 2019 generates a 0.1 percent of GDP surplus of the overall balance including grants. 6 However, domestic revenue growth has recently declined, implying that collections could well miss the 2019 budget target. In such an event, the authorities are prepared to cut up to 0.8 percent of GDP in non-essential spending and rationalize capital spending to achieve a near-balanced budget or a small deficit depending on the size of the revenue slippage. For 2020, a deficit of 0.3 percent of GDP is projected, as one-off revenue items from 2019 run out. 7 Projected on-budget grants have been revised downward relative to the fifth review after discussions with the authorities and the World Bank regarding the on/off budget split within the committed grants envelope. Expenditure has also been revised down in line with the lowered grants.

20. Over the medium term, a priority is to create fiscal space given Afghanistan’s considerable spending needs. Domestic revenue mobilization is crucial to self-reliance as external assistance declines. Since 2016, revenue collection has increasingly relied on ad-hoc one-offs which are uncertain going forward. Building a sound and predictable domestic revenue base and reducing dependence on donor aid will be pivotal to realizing self-reliance. There is still scope to improve customs and tax administration and compliance. Immediate steps could involve embracing technology, reinforcing controls, and sanctioning non-compliance. On the spending side, much progress has already been made in raising expenditure execution, helped by improved public investment management reflecting the adoption of a unified process for project appraisal and the related technical committee. Staff encouraged further progress in these areas, including implementation of related TA recommendations, while bringing off-budget aid on budget given that off-budget spending is considerable and at times less transparent.

21. The authorities largely concurred with staff’s views, emphasizing their commitment to a broadly balanced budget, moving Afghanistan towards self-reliance, and boosting the efficiency of spending. They are committed to making continued efforts to mobilize domestic resources, including by expanding the tax base. They observed that their domestic revenue mobilization strategy is focused on developing permanent revenue sources, away from one-offs. They highlighted intensification of anti-fraud measures and establishment of a Single Large Taxpayer Office (SLTO) and their commitment to adopt a value-added tax (VAT) by early 2021 as key elements in this strategy. They also plan to increase priority spending by progressively raising development budget execution rates and working with donors to bring off-budget aid on budget given considerable off-budget spending that is not always consistent with the government’s priorities and lacks transparency. However, they acknowledged the need to strengthen resource management at their end and pointed out that limited capacity in the relevant line ministries reduces the scope for higher quality pro-growth spending.

Monetary and Exchange Rate Policies

22. DAB has delivered on its price stability objective, even though its policy toolkit is constrained by high dollarization. Inflation has been moderate in Afghanistan averaging about 3 percent per year since 2016, reflecting weak domestic demand and prudent monetary policy. Staff emphasized the need to strengthen monetary transmission, including by continued efforts to de-dollarize and broaden the use of domestic currency denominated instruments, to better control monetary conditions in the economy. Over time, for effective control over inflation, building DAB’s analytical capacity to forecast inflation and thereby promulgate credible inflation forecasts could help anchor inflation expectations. Finally, DAB should also continue to develop its communication strategy to help boost the transparency of its operations.

Headline Inflation and Reserve Money

(y-o-y change, percent)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

23. DAB has maintained its commitment to allowing the currency to move in response to market forces, in line with staff’s recommendations. Foreign exchange intervention has declined significantly under the current ECF ($2–2.4 billion per year in 2016–18 versus $3.5 billion in 2012–14). In the last two years, DAB preferred to build its reserve buffers, mainly for precautionary reasons given aid volatility along a declining trend and the uncertain political context.

24. The authorities reiterated their commitment to price stability and a flexible exchange rate. DAB will continue to use reserve money and auctions of foreign exchange and the capital notes as instruments to achieve its price stability objectives. The authorities also reiterated their commitment to allow market forces to determine the exchange rate and maintain price stability. They noted that both insecurity and uncertainty had contributed to high exchange rate volatility, compelling DAB to resort to foreign exchange interventions to smooth volatility and mitigate pass-through of imported inflation, given the high import content of domestic consumption. The authorities noted that the proposed introduction of sukuk bonds will greatly contribute to development of domestic financial markets and raise the use of domestic currency. In addition, they agreed that enhancing transparency and communication was important to increase the use of domestic currency. However, they observed that this will take time as high illiteracy rates, limited media penetration, and low financial education would limit the impact of such measures.

FX Intervention and Exchange Rate

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

External Sector Issues

25. Afghanistan’s external position is broadly in line with fundamentals (Annex III). External stability hinges on continued aid inflows and requires steady resilience to external vulnerabilities. The large trade deficit including imports related to security and donor-funded projects has been financed by grants and transfers. Exchange rate developments are dominated by factors separate from competitiveness considerations, including ongoing violence, regional developments, the likelihood of civilian and military aid disbursements, spending by foreign troops, and dollarization developments. The analysis is also hampered by data shortcomings and a high share of the informal economy. Anecdotal evidence suggests that the economic sanctions on Iran had a substantial impact including through a drop in remittances and increased imports from Iran given the Afghani’s appreciation against the rial. The authorities have been implementing measures to diversify export destinations (for instance, developing “air corridors”) and increase import substitution. In the long term, increased regional integration could alleviate constraints due to the landlocked location and improve economic prospects. The stock of gross foreign reserves exceeds by a large margin all traditional metrics of reserve adequacy with its close to 12-month import coverage. Afghanistan is considered a large net creditor based on the latest International Investment Position due to high foreign reserves and low levels of external public debt.

Reserve Adequacy, 2018

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.

26. Afghanistan remains at a high risk of debt distress. As shown in the debt sustainability analysis (DSA), at about 7 percent of GDP, Afghanistan’s public debt is currently low and highly concessional, and with a limited amount of concessional borrowing going forward is not projected to become unsustainable under the baseline scenario. More broadly, Afghanistan’s debt sustainability is predicated on continued grant inflows, combined with sound fiscal policies and economic reforms. A decline in grants and a shift to debt financing would breach one of the debt burden ratios (debt service-to-exports) in the long term. The debt sustainability challenges underscore the need to sustain efforts to mobilize domestic revenues while raising the efficiency of public spending. The authorities need to enhance their capacity to evaluate prospective financing and monitor/analyze risks to debt sustainability. More reliance on debt-financed investment should be preceded by adoption of a proper project selection process in terms of profitability and priorities. This also includes accounting for and evaluation of government guarantees stemming from future private-public partnerships (PPPs).

27. The authorities concurred with staff’s analysis. They noted their intention to keep a high foreign reserve buffer given elevated political and aid uncertainty and import needs. They agreed with continued pursuit of a stronger external position in view of the expected gradual decline of grant inflows. The authorities agreed with the findings of the DSA, including on the need to rely on grants and highly concessional loans to finance their development needs. They emphasized their commitment to increase self-reliance given the prospects of diminishing aid in the long term. They also committed to implement TA advice on recording and monitoring public debt and fiscal risks.

Financial Sector Policies

28. The financial sector remains vulnerable given the high-risk operating environment and capacity challenges. To mitigate risks, DAB is closely monitoring the weak banks in accordance with its weak banks plan. There have been improvements in capital adequacy, governance and liquidity, and NPL clean-up. Staff recommended an independent review of operations, information systems, and asset quality of the high-risk weak banks with the support of the World Bank, to strengthen the credibility of the plan.

29. DAB is working to strengthen the supervisory framework and financial safety net arrangements. The authorities established the Financial Stability Committee to better manage risks. DAB is extending its supervision to non-bank institutions and plans to introduce prudential risk-based supervision, early warning and stress testing regimes, and improve the deposit insurance framework, as well as to strengthen the bank resolution framework in line with forthcoming IMF TA. While keeping in mind broader financial stability implications that might arise in a worst-case scenario, staff encouraged the development and implementation of coordinated contingency arrangements and strategies for crisis management, including funding that may be required and communication strategy with the public.

30. Unregulated financial institutions are joining the formal financial sector. Approximately 90 percent of financial transactions takes place through informal channels, mainly hawalas. The authorities are encouraging development of agent banking to bring hawalas into the formal sector. Similarly, DAB intends to corporatize money service providers (MSPs) and foreign exchange dealers (FXDs). DAB also plans to coordinate risk management capacity building for all supervised sectors and will be upgrading the collateral infrastructure and contract enforcement regime.

31. Boosting credit to the private sector and deepening financial intermediation are key enablers for higher and more inclusive growth. A “National Financial Inclusion Strategy” (NFIS) developed with World Bank support was launched in September (Box 3). The strategy includes a timebound results-based framework. Staff welcomed the strategy and emphasized the need to improve credit and financial services access for the traditionally disadvantaged groups, particularly women, and cautioned that boosting private sector credit would need to be mindful of financial stability considerations.

Financial Sector Depth and Development, 2014

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: World BankWDI.

Financial Sector Depth and Development, 2018

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: World Bank WDI.

Afghanistan’s National Financial Inclusion Strategy, 2019–24 1/

Afghanistan is characterized by low financial intermediation and inclusion (FI). In 2017 (the latest year for which such data are available), only about 15 percent of the adult population had a bank account, compared to about 35 percent on average for low income countries. The ratio of loans to deposits was 19.7 percent, domestic deposits to GDP 17.4 percent, and private credit to GDP 3.6 percent—the lowest among peers. Most credit related services are handled by the informal sector through hawalas.

Bank Account Ownership, 2017

(percent of adults)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Global Findex Database, World Bank.

The authorities are intensifying efforts to advance FI. FI increases access to finance, thereby raising opportunities for entrepreneurship which should help raise investment, inclusive growth, and employment. In September 2019, the government launched a National Financial Inclusion Strategy (NFIS) prepared with assistance from the World Bank. The government and stakeholders (development partners, public and private financial institutions) will work to agree on an implementation plan for the NFIS by end-2019. The NFIS will be implemented starting in early 2020. The strategy aims to: i) improve access to financial services for individuals, micro, small, and medium enterprises (MSME), ii) develop agriculture finance, iii) increase consumer protection and financial literacy, and iv) develop payment and digital financial services. The NFIS’s implementation will be guided by an inter-agency group comprising NFIS Coordination Council, Secretariat, Technical Committee, and various working groups. DAB’s Financial Inclusion Department, created in 2016, will head the group.

DAB had undertaken initiatives to improve FI even before the adoption of NFIS. DAB has promoted mobile banking services, relaxed conventional and Islamic banking regulations related to collateral for small and micro loans to lower the cost of lending and implemented prudent credit guarantee schemes to incentivize lending. In addition, DAB is monitoring the impact of its reserve requirements and interest rates and reviewing regulations of risk management, credit administration, and financing of MSME with a view of adjusting them as required to support prudent expansion of financial intermediation. DAB will also be introducing tiered know-your-customer account opening requirements to facilitate small, low risk accounts, improving the payments infrastructure, and continuing phased expansion of the credit information system.

The development of branchless banking and digital accounts could boost FI in Afghanistan. The development of traditional banking requires costly infrastructure. In many low-income countries, agent-based finance in rural regions and digital finance have been advancing FI. The access to mobile services in Afghanistan is one of the lowest in the region—50 mobile money accounts per 1,000 adults in 2018. Significant gains in FI in Afghanistan could therefore be achieved with the help of mobile money. Mobile money could also support equality in access to financial services. The traditional bank accounts display gender disparity as only 7 percent women have a bank account versus 23 percent of men.

Mobile Money Account Ownership, 2017

(percent of adults)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Global Findex Database, World Bank.

Significant risks, most notably the on-going conflict, present headwinds to successful NFIS implementation. The risks are present on the supply and demand sides, as was discussed in a workshop co-organized with the World Bank earlier this year that brought together DAB and private sector representatives. On the demand side, the high-risk business environment, low level of financial literacy, lack of collateral, and lack of Sharia compliant financial options have hampered growth of formal financial institutions. On the supply side, poor infrastructure, weak contract laws, and lack of information about creditworthiness of borrowers raise the cost of access to credit. These challenges must be overcome to ensure the success of NFIS implementation in Afghanistan.

1/ Prepared by Gayon Hosin and Boaz Nandwa.

32. The state-owned commercial banks (SOCBs) are being restructured to minimize related financial stability and fiscal risks. The SOCBs account for over one-quarter of the system’s assets. The strategy, guided by the World Bank, was adopted in November 2017 and its implementation has progressed haltingly. The authorities have committed to accelerate its implementation including by adopting a new corporate governance framework and individualized operational reform plans. Staff noted that given the systemic importance of the SOCBs and quasi-fiscal risks, it is critical that the reform momentum be accelerated.

33. Staff commended the authorities for extinguishing DAB’s lender-of-last resort exposure to the Kabul Bank crisis. With the last transfer to DAB executed at end-September 2019, a major chapter of the Kabul Bank crisis has been closed. 8 Staff emphasized the importance of reviving the recovery of assets stolen during the Kabul Bank crisis, which has stalled at about 40 percent of the estimated total. The acceleration of recoveries was adopted as a structural benchmark for the sixth ECF review (see below).

34. The authorities broadly agreed with staff’s views and recommendations. They committed to continue efforts to contain risks in the weak banks and to consult and share information with staff. They agreed that the independent reviews with the World Bank’s help would strengthen the effectiveness of the weak banks’ plan and committed to continued vigilant enforcement of supervisory standards and adoption of supervisory corrective measures in line with good banking practices. In parallel, they considered that keeping in mind broader financial stability risks that might materialize in a worst-case scenario, development and implementation of coordinated contingency arrangements and strategies for crisis management including funding required and communication with the public was a prudent undertaking. They also reiterated their commitment to implement the SOBCs strategy and to recover the remaining Kabul Bank assets.

B. Structural Reforms: Strengthen the Foundation for Higher and More Inclusive Growth

Governance and Corruption

35. Progress notwithstanding, corruption continues to impact confidence and prospects for economic growth (Annex IV). Afghanistan has made some progress, but corruption (particularly in the form of bribe-solicitation and giving) and weak governance continue to hinder the effectiveness of state bodies and undermine confidence in the government. The legal framework to combat corruption is relatively well developed, with the institutional framework still evolving. 9 The authorities have also made several high-level anti-corruption commitments including on asset declarations and the National Anti-Corruption Strategy. However, the multiple and partially overlapping plans and strategies may complicate their implementation and enforcement. Staff noted that enforcement has been progressing but still faces significant challenges and does not always target key corruption risks. The focus should be on implementation and prioritization of existing mechanisms and commitments. Strengthening the institutional structure and building the capacity of anti-corruption bodies should be a priority. Staff advised the authorities to mobilize anti-money laundering/combatting the financing of terrorism (AML/CFT) tools to help identify and recover proceeds of corruption.

Indicators of Governance, 2000–18

(Estimate range from -2.5 (weak) to 2.5 (strong))

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Worldwide Governance Indicators.Note: Estimates of control of corruption are derived from perceptions-based data. Caution is needed when comparing these indicators across countries and over time.

36. The extent of proceeds from illicit activities poses a challenge for financial oversight. Illicit production and trafficking of drugs remains an important part of the economy, estimated by the UN at 6–11 percent of GDP. 10 The extent of illicit proceeds, coupled with the highly unstable environment and financial integrity risks from sanctions on Iran, have pressured correspondent banking relationships (CBRs). As a result, few domestic banks have CBRs, hampering formal cross-border transfers and remittances.

37. Strengthening the AML/CFT regime would help mitigate ML/TF risks and support the development of the formal financial sector. With the assistance of the World Bank, Afghanistan has finalized its first national ML/TF risk assessment, and an action plan is being developed for 2020–22. DAB should continue strengthening AML/CFT supervision, including by updating the regulatory framework applicable to banks, MSPs, and FXDs, stepping-up enforcement actions against unlicensed MSPs/FXDs, building supervisory capacity, and offering related training. In addition, the relevant capacity of law enforcement and customs agencies should be reinforced. An AML/CFT risk assessment guideline for banks and a related training needs have also been approved.

38. The authorities broadly agreed with staff’s assessment and reiterated their dedication to fight corruption. They acknowledged the need to prioritize and develop viable benchmarks within realistic deadlines and recognized that capacity building and training (for instance, among law enforcement authorities) would be helpful for enforcement efforts. Efforts are underway to staff the Anti-Corruption Commission and the newly established Offices of the Ombudsman. The authorities noted that digitalization efforts are underway, both in the Administrative Office of the President, as well as other parts of the government. The authorities also confirmed their commitment to the implementation of the AML/CFT measures. They recognized the challenges posed by the illicit economy. DAB places strong emphasis on AML/CFT in its financial sector reform efforts. A three-year strategy, which contains an AML/CFT component, is underway. Staff and the authorities agreed that effectively fighting corruption would also require strengthening governance across a range of state functions (e.g., fiscal governance, financial sector governance, and the business climate) as elaborated below and in Annex IV.

Structural Fiscal Reforms and Fiscal Governance

39. Staff and the authorities discussed progress on fiscal reforms and governance.

  • Improvement in budget execution and project management: Staff welcomed much improved execution rates in the development budget over the past few years. 11 The authorities have made the budget an effective policy tool, which requires sustaining improvements in execution rates and the commitment to a realistic multi-year development framework. The authorities have increased transparency in the budget execution process by tracking contractual commitments through the Afghanistan Financial Management Information System (AFMIS) in line with the related third review structural benchmark. They have also bolstered customs administration in regional offices, a benchmark in the fourth review, by adopting risk-based customs clearance procedures to improve the detection of fraud. In addition, revenue developments are reported online in near-real time. 12 Staff also welcomed the authorities’ intention to further strengthen public investment management, thereby improving the management of resources and boosting the government’s ability to fill infrastructure gaps in the future.

  • Improvement in transparency and oversight of state-owned corporations (SOCs): There are about 54 active SOCs 13 including three SOCBs, nearly all of which need better accounting practices and reporting standards. The authorities adopted a new State-Owned Corporation Law in line with the benchmark in the fourth review to improve management of fiscal risks and strengthen the governance of public corporations. These efforts are advancing and recently the authorities shared with staff income statements and balance sheets of the five largest SOCs to illustrate their efforts to improve the governance and transparency of SOCs. Staff also encouraged the authorities to amend the relevant public financial management (PFM) law to strengthen fiscal risk oversight over SOCs. Regarding the extractive sector, Afghanistan is expecting the second Extractive Industries Transparency Initiative (EITI) validation to commence in July 2020. This follows its suspension in January 2019 when the first EITI validation concluded that Afghanistan had made “inadequate progress” implementing the EITI Standard. In the meantime, Afghanistan has advanced efforts in reporting on the mining industry as agreed with the EITI.

  • Development of PPPs: The authorities adopted a new PPP Law in line with the fourth review structural benchmark to improve the identification and management of fiscal and contingent risks connected with PPP activities. The authorities plan to increase their reliance on PPPs to improve infrastructure financing and delivery. While it requires the Ministry of Finance to become a key player in supporting the development of PPPs, clear recognition of financial implications of PPPs seems lacking. Availability of detailed information on the contingent liabilities emanating from PPPs would support this development.

  • The authorities are working on a “sukuk law” which will provide the legislative framework for issuance of the Sharia compliant financial products. A first draft of the law may be ready in 2020. Staff encouraged a measured approach to the introduction of sukuk and other Sharia complaint financial products and suggested that due consideration be given to the experience of the relevant comparators. Currently, the authorities are guided by Malaysia’s experience. Staff cautioned that there would be a need to establish the relevant infrastructure before launching the new financial instruments and that the prospective projects which the issuance would finance need to be supportive of macro-fiscal stability and sustainability.

  • Afghanistan’s budget, in its design and presentation, is approaching international standards. Afghanistan had the best rating (49/100 compared to 21/100 in 2010) in the 2017 Open Budget Index among South Asian countries. Since 2018, the budget includes information of past performance and medium-term fiscal projections. It also includes details about the ministries, projects, and provinces. In 2018, the authorities abandoned carry-over of unspent amounts from year to year, thereby improving the realism of projections and the control of corruption. The budget also includes discussions of projections of major macroeconomic variables, the evaluation of contingent liabilities, contingency measures, and a critical review of the budget’s gender responsiveness. The citizen’s budget is available online. 14

Budget Execution Rates

(In percent)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities.

40. The authorities shared staff’s views and noted that capacity constraints would likely limit progress in some areas and expressed interest in a related TA. The authorities noted that improved budget execution reflected their effort for more effective project appraisal and selection (e.g., dropping poorly performing projects in favor of those ready for execution), timely budget approval, adoption of a new digital disbursement system, and timely payment execution. They committed to improved transparency and oversight of the SOCs. However, amending the relevant PFM law by end-2019 would not be possible because of limited capacity amplified by the institutional changes and the constraints on legislative process due to the presidential elections. Finally, they explained that developing capabilities for quantification of contingent liabilities from PPP has not progressed so far due to capacity constraints.

Business Climate

41. The business environment needs improvement. Infrastructure gaps, insecurity, weak governance and institutions prevent Afghanistan from becoming a transit hub and attractive investment destination. In 2019, Afghanistan ranked 167th out of 190 in the World Bank’s Doing Business index, a notable improvement from 183rd position in 2018. 15 However, areas such as starting business, enforcing contracts, registering property, and protecting minority investors still have particularly low rankings due to issues with timeliness and quality of judicial proceedings (e.g., case management). Judicial reform measures to streamline court proceedings and reduce corruption vulnerabilities are underway and should continue. Further, Afghanistan ranks poorly relative to its peers in terms of quality of education and gender equality. Skills mismatch and gender inequality will thus increasingly become an obstacle to competitiveness and strong inclusive growth. Institutional reform is also needed to enhance the role of the private sector as a driver of strong and sustained private sector-led growth.

Doing Business Indicators

(distance to frontier, 2019)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: World Bank Doing Business Database.

42. The authorities agreed with staff views. They noted economic fragility, conflict, and insecurity posed formidable obstacles to conditions for doing business. Nevertheless, they are committed to continue structural reforms to improve the business environment. Authorities also noted that they are working with development partners on reforms that would buttress investor protection laws.

Other Issues

43. Data quality and availability needs to continue to improve (Annex V). The national accounts, the external sector data, and price statistics suffer from weaknesses in coverage, consistency, and frequency. The authorities confirmed their on-going interest in follow-up TA in these areas.

Sixth Review Under the ECF Arrangement

44. Program performance was satisfactory.

  • a. All end-June 2019 quantitative performance criteria and September indicative targets were met, some with notable overperformance (MEFP ¶12, Table 14).

  • b. Six out of seven structural benchmarks were met (MEFP ¶12, Table 15). The benchmark on reinvigorating the Kabul Bank asset recovery was not met because of difficulties in selecting the forensic audit firm. The authorities implemented it during October and November. On October 13, they contracted a major international accounting firm which, on November 15 delivered an interim report on their forensic audit of the Kabul Bank assets recovery process. On November 20, the firm delivered a final report with a list of SMART 16 recommendations. The timeline for implementation of recommendations ranges from an immediate implementable action to ones to be carried out in six months or more. The recommendations include measures to improve effectiveness and operation of the receivership unit. The authorities have already advanced the implementation of several recommendations and are committed to its speedy progress. The process is shepherded by DAB’s senior management.

Table 14.

Islamic Republic of Afghanistan: Quantitative Performance Criteria, June 21, 2019 1/

(In Afghani billion, unless otherwise indicated)

article image
Source: Afghan authorities and IMF staff estimates/projections.

The quantitative targets, indicative targets, their adjustors, and program exchange rates are defined in the Technical Memorandum of Understanding (TMU).

Cumulative from the beginning of the year.

These quantitative targets are applied on a continuous basis.

Excludes IsDB loan (53.2 million Islamic Dinars) contracted in 2017.

Afghanistan owes a small amount (US$10 million) of pre-HIPC Initiative arrears to a non-Paris Club creditor, which continue to be deemed away under the revised arrears policy for official creditors.

Table 15.

Islamic Republic of Afghanistan: Sixth Review Structural Benchmarks

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45. The completion of the sixth review under the ECF arrangement would mark the first time that Afghanistan has successfully completed all reviews under a Fund financial arrangement since 2003 when it cleared its arrears to the Fund. The 2016–19 ECF arrangement contributed to preserving macroeconomic stability, improving economic governance, and laying the basis for stronger private sector activity. With four out of five success indicators met, as shown in the table, the program can be considered successful. It supported progress towards self-reliance and catalyzed donor assistance while helping to sustain reform momentum. Under the program: the domestic revenue intake has improved by more than 3 percentage points of GDP, contributing to near-zero fiscal balances and healthy cash reserves; inflation remained contained at below 5 percent; and the financial sector’s resilience improved as DAB deployed its expanded supervisory and crisis management toolkits. The ECF supported the strengthening of the policy making framework, including through the adoption of anti-corruption legislation, legislation to manage state assets and control related risks, the establishment of the Financial Stability Committee to ensure MOF-DAB coordination, and relieving DAB from the impact of the 2011 liquidation of Kabul Bank by extinguishing the lender-of-last resort exposure. Similarly, fiscal institutions have been strengthened through a more transparent and realistic budget, supported by a medium-term fiscal framework. The ECF arrangement and ANPDF have established a good foundation to continue to tackle the challenges of lackluster growth and widespread poverty (see ¶1, 8 above). While growth and social development outcomes continue to disappoint, without a lasting cessation of violence it will be difficult to make significant inroads into poverty and unemployment. Afghanistan and the international community need to continue to work together to overcome these challenges.

Indicators of Program Success 1/

(In percent of GDP; unless otherwise indicated)

article image
Note: IT=indicative target. Indicators are considered met when the average projection error (actual minus projected) for 2016–18 has a favorable sign. ECF approved mid-2016. 1st program review considered end-2016 outcomes.

See “2018 Review of Program Design Conditionality” for PRGT programs methodology.

46. The authorities agreed that the ECF arrangement achieved its objectives (LOI, MEFP ¶3, 12). Going forward, they remain committed to the policies that have supported macroeconomic stability and catalyzed donor support (MEFP ¶13, 15) and to structural reforms that advance their agenda to fight corruption, strengthen institutions, and boost self-reliance while laying the foundation for higher and more inclusive growth including for women and disadvantaged groups (MEFP Section D).

47. The calibration of the program and the capacity to repay the Fund remain adequate (Table 11). The program is fully financed. The current and projected levels of reserves are adequate, and the public debt outlook is sustainable contingent on continued donor support. Upon completion of the sixth review, a disbursement of SDR 5.38 million would be made.

Staff Appraisal

48. Afghanistan continues to face deep-seated challenges in its transition to self-reliance. Sustained violence and political uncertainty continue to undermine confidence and investment, hindering the country’s drive for self-reliance and development. Given the large development needs, policies should remain focused on preserving macroeconomic stability, strengthening institutions, and accelerating reform momentum to prepare the ground for sustainable private sector-led growth. Continued financial support by donors with multi-year commitments to facilitate budget planning is needed to help preserve macroeconomic stability, support reforms, and finance security and development needs.

49. Higher and more inclusive growth is required to create jobs and reduce poverty. Growth is projected at 3 percent in 2019, rising modestly to 4 percent in the medium term, insufficient to significantly reduce poverty and create enough jobs for the growing population. Risks to the outlook are on the downside, and include intensified violence, heightened political uncertainty due to a potentially long-drawn out political transition following the presidential elections, a significant drop in aid, and reform fatigue. If these risks materialize, gains made in recent years could be lost or even reversed. On the upside, durable peace would improve economic prospects significantly by increasing confidence needed to spur increased private sector activity.

50. Under these challenging circumstances, continued macroeconomic policy discipline complemented by structural reforms is needed. Macroeconomic policies that instill fiscal discipline, stabilize inflation, support a flexible exchange rate, and safeguard financial stability are critical to ensure credibility with domestic and international stakeholders. Reforms to strengthen institutions, build capacity, and fight corruption will be needed to strengthen the economy’s resilience to continuing stress due to violence and to harness a possible peace dividend, should that opportunity present itself. At the same time, economic development plans currently being considered should be grounded in a robust and sustainable macro-fiscal framework that takes into account Afghanistan’s still limited debt carrying capacity and its high risk of debt distress. The latter consideration argues for continued reliance on grants and highly concessional borrowing, supplemented by efforts to strengthen capacity in debt management and assessment of investment projects.

51. The government’s strategy of attaining self-reliance through domestic revenue mobilization combined with expenditure restraint should continue going forward. The overall balance including grants should remain the fiscal anchor preserving a broadly balanced budget (including grants), a prudent cash buffer, and low public debt. This policy should be supplemented with a gradual reduction of the operating deficit before grants to prudently use domestic resources, shift expenditure composition toward pro-growth and pro-poor outlays and create fiscal space to meet the country’s considerable development needs. Structural fiscal reforms should target sustainable revenue collection with an expanding tax base, increased efficiency, and VAT introduction as planned by early 2021. The authorities should also gain command over public assets, fully account for contingent and noncontingent liabilities, and develop the financial infrastructure, including Sharia compliant instruments, to harness domestic savings for development.

52. Monetary policy remains appropriately focused on price stability, supported by exchange rate flexibility. The current monetary policy framework, combined with exchange rate flexibility, continues to serve Afghanistan well in containing inflationary pressures while maintaining a high international reserves buffer. Foreign exchange intervention should be deployed only to help smooth out unexpected exchange rate volatility.

53. Safeguarding financial stability remains a key policy priority. DAB should continue to address the shortcomings among the weak private banks and strengthen the framework for crisis prevention and resolution. The implementation of the strategy to reform the SOCBs through both a new corporate governance framework and individualized operational reform plans should continue apace. The authorities’ intention to foster financial intermediation through the implementation of the NFIS, including for disadvantaged groups such as women and rural populations, should remain on schedule. Unregulated financial entities should be brought fully under the supervision of DAB.

54. Progress on anti-corruption legislation and institutions is encouraging but needs to be cemented with implementation. Progress notwithstanding, corruption in the public sector is perceived as widespread and considered by both domestic and international stakeholders as one of the country’s intractable challenges. The on-going anti-corruption efforts need to be properly prioritized in cooperation with donors and based on a solid institutional framework with independent agencies. The government has enacted an Anti-Corruption Law and updated the National Strategy for Combatting Corruption. The remaining gaps in the criminalization of corruption offences should be closed swiftly. The newly established institutions should be staffed and operationalized as a priority. The digitalization of records, processes, and procedures should be introduced as a priority to increase efficiency of anti-corruption measures.

55. Addressing structural headwinds to improve business environment is important to catalyze private sector-led growth and achieve higher and more inclusive growth. Insecurity, large infrastructure gaps, lack of access to financial services, weak regulatory framework and institutions, and a dearth of skilled labor hamper Afghanistan’s competitiveness and attractiveness as an investment destination. The authorities should redouble their efforts to improve the business environment by strengthening governance and the regulatory framework and implementing the NFIS to boost financial inclusion, especially for women.

56. The quality and timeliness of economic data hinders assessment of the economy and policies. Reliable statistics are critical for sound economic policy-making. There are deficiencies in real and external sector statistics, and IMF TA will continue to be available in these and other areas.

57. Staff supports the completion of the sixth (final) review under the ECF arrangement given the satisfactory performance. Staff welcomes the authorities’ commitment to continue with disciplined policies and reforms following the expiration of the ECF at end-2019.

58. Staff proposes that the next Article IV consultation with Afghanistan take place on the standard 12-month cycle.

Figure 2.
Figure 2.

Islamic Republic of Afghanistan: External Sector

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.
Figure 3.
Figure 3.

Islamic Republic of Afghanistan: Fiscal Sector

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.
Figure 4.
Figure 4.

Islamic Republic of Afghanistan: Monetary Sector

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

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 5.
Figure 5.

Islamic Republic of Afghanistan: Banking Sector

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.1/ NPL’s include loans 121 to 481 days or more past due for payment of principal and/or interest. This differs from the IMF’s FSI Guide which recognizes loans 90 days or more past due payment of interest or principal as NPLs.2/ Adversely classified loans include loans classified as substandard, doubtful and loss – 60 to 481 days or more past due for payment of principal and/or interest.

Annex I. Risk Assessment Matrix 1 (Continued)

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Annex II. Medium-Term Fiscal Challenges for Afghanistan 1

The purpose of this annex is to discuss medium-term fiscal challenges for Afghanistan in the context of large spending needs and uncertainty about future aid flows. Compared to other low-income countries (LICs), expenditures are high (partly reflecting security needs) while the financing envelope is likely to fall over the medium term as aid flows normalize. This annex sets out different fiscal adjustment scenarios to a possible fall in donor aid and finds that a current, rather than development, spending-based adjustment may be less costly in terms of the growth impact. From a policy perspective, strong fiscal institutions, including a robust medium-term fiscal framework (MTFF), will help Afghanistan deal with the coming fiscal challenges and improve resource allocation in the face of uncertainty.

A. The Central Fiscal Challenge: Large Expenditure Needs but a Declining Resource Envelope

1. Afghanistan’s public expenditure is high, partly reflecting conflict and fragility. Expenditure, especially current, is higher than in an average LIC. The compensation of employees and expenditure on goods and services is relatively high, reflecting the presence of a large security sector. Capital spending is broadly in line with LIC averages. Domestic revenue is lower than MENAP oil importers’ and LICs’ average by 6.8 and 2.0 percentage points of GDP, respectively. Aid is among the highest in the world, financing 75 percent of total on- and off-budget expenditure and 56 percent of on-budget spending.

Current and Capital Expenditures

(On-budget, in percent of GDP, 2018)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF FAD Expenditure Assessment Tool (EAT), IMF staff estimates.

Breakdown of Spending

(On-budget, in percent of total, 2018)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF FAD Expenditure Assessment Tool (EAT), IMF staff estimates.

Spending Classified by Security and Civilian

(On-budget, in percent of total, 2018)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF staff estimates.

Domestic Revenue

(in percent of GDP, 2018)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF staff estimates, WEO.

2. Expenditure needs are likely to rise over time. The share in GDP of total social expenditure is comparable to an average LIC’s, but much lower in per capita terms. For example, education spending as a share of GDP is comparable to LICs, but on a per-student basis is much lower than comparators, especially tertiary. Similarly, on a per-capita basis, health spending is far below the comparators. This suggests that individual needs are not met by social spending and that higher social spending may be needed in the future. 2

Social Spending

(In percent of GDP, latest value available)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: IMF FAD Expenditure Assessment Tool (EAT), IMF staff estimates.

Government Education Expenditure per Student

(PPP$ adjusted, latest value available)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Health Indicators and Health System Characteristics Indicators

(Latest value available)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

3. The resource envelope is likely to decline. While we expect domestic revenues to continue to rise from 13.3 percent in 2018 to 16.9 percent in 2024, on-budget grants are expected to stabilize at 14 percent of GDP by 2022, down from about 15 percent in 2018. Total on- and off-budget grants are assumed to fall by 13 percent of GDP over the medium term. 3 These projections are further elaborated in the next section.

B. The Baseline Fiscal Scenario

4. In the baseline scenario, we assume that the security situation will not deteriorate, reforms will continue, and aid will be sustained (albeit at declining levels). Specifically, we assume that:

  • The overall balance including grants will remain at or near balance.

  • Domestic revenues will increase to around 17 percent of GDP by 2024, which reflects both policy changes and improvement in revenue collection efficiency. In January 2021, the authorities are planning to introduce a value added tax (VAT), which may bring up to 1.8 percent of GDP of additional revenue. 4 Transit fees from a regional natural gas pipeline project (TAPI) could bring an additional 1.3 percent of GDP beginning in 2023.

  • On-budget grants will stabilize at around 14 percent of GDP by 2022. Both security and civilian grants are envisaged to slightly increase as off-budget spending moves on-budget. The current donors’ commitments for civilian assistance end in 2020 and security in 2021. Hence, figures from 2020/21 forward are staffs projections for the illustrative purposes of this analysis.

  • Operating expenditure will increase to around 21 percent of GDP by 2024 due to increase in recurrent spending on social sectors and operation and maintenance outlays moving from off-to on-budget.

  • Development expenditure will gradually increase to around 10 percent of GDP by 2024 in order to support pro-growth and social spending.

  • Operating deficit excluding grants declines gradually reflecting the government’s commitment to create fiscal space for development expenditure in the medium- to long-run.

Baseline Fiscal Scenario

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Sources: Afghan Ministry of Finance and IMF staff estimates.

C. Estimation of Total Grant Needs

5. Given the above assumptions, the required total grants (on- and off-budget) are estimated at $6.4 billion on average, broadly at the current level.

  • Total expenditure (on- and off-budget) increases from $9.1 billion in 2020 to $10.6 billion in 2024. Security expenditure needs are broadly unchanged at $4.4 billion for 2020–24, as we assume that security will not deteriorate. 5 Civilian expenditure needs increase from $4.6 billion in 2020 to $6.3 billion, which reflects increasing demand for basic public services by the growing population. 6

  • Domestic revenues average $3.4 billion per year, rising over time.

  • The required total grants (the difference between total expenditure needs and government revenues) amount to $6.4 billion per year on average.

Total expenditur and grant needs

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF staff estimates.

Total expenditure and grant needs

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF staff estimates.

D. Illustrative Scenario Analysis of Adjustment to Lower Aid

6. There is considerable uncertainty about the levels of civilian and security assistance over the medium term. As outlined in the previous sections, Afghanistan will remain heavily dependent on grants for some time to come. At the same time, grants are likely to decline in the medium term, and may well be lower than current staff assumptions.

7. As a result, we examine two possible adjustment scenarios to lower-than-expected grants. We use fiscal multipliers (FMs) to assess the growth impact of fiscal adjustment in response to lower aid. We make the simplifying assumption that Afghanistan will not have additional domestic or external financing sources to fund a deficit, hence a cut in aid necessitates a cut in spending. As Afghanistan’s dependence on aid, albeit diminished, continues post-2024 and with still limited external and domestic financing sources, we consider that a balanced overall budget together with a declining operating deficit (excluding grants) and low public debt is the best anchor for fiscal policy for the time being.

8. Fiscal multipliers for Afghanistan are likely low. For a country like Afghanistan, data constraints and short time series suggest using a “bucket approach” to estimate a fiscal multiplier. 7 The bucket approach is a heuristic method that determines a fiscal multiplier by identifying which of the six structural characteristics considered to impact the size of the fiscal multiplier are present in the economy in question. The more characteristics are present, the higher the multiplier. For Afghanistan, the bucket approach suggests a total spending multiplier of 0.2 (between 0.1 and 0.3) and a short-term tax multiplier of –0.1 (between –0.05 and –0.15). In line with the empirical literature, we also assume that the multiplier of government investment is higher than consumption due to positive and lasting impact of development expenditure on output We assume multipliers for government consumption and investment of 0.13 and 0.28, respectively. 8

9. Using the multipliers as determined above, we assess the impact from declining aid/expenditure on growth post-2025. For simplicity, we assume all fiscal variables, except expenditure which adjust to the assumed cut in aid, remain at their 2024 levels in percent of GDP. We assume that on-budget grants after 2025 gradually halve by 2030. The adjustment can happen by reduction in either current or development expenditure.

  • Scenario 1: Aid declines by 7 percentage points of GDP through 2030 and only operating expenditures adjust. The annual effect on real growth is estimated to be -0.3 percent (2025–30 average), relative to the baseline. 9 Hence, the cumulative loss in output would be nearly 2 percent of GDP.

  • Scenario 2: Aid declines by 7 percentage points of GDP through 2030 and only development expenditures adjust. The annual effect on real growth is estimated to be -0.6 percent (2025–30 average), relative to the baseline. Hence, the cumulative loss in output would be 4 percent of GDP.

Given that a cut in operating expenditures is less detrimental to growth, when adjusting to a cut in aid it would be advisable to protect development spending or rely on a combination of adjustment in current and development expenditure, while recognizing the importance of maintaining or even increasing social spending given its importance for inclusive growth and public support for reforms in the medium term. It is important to note that we trace only the fiscal impact on growth from the cut in aid; in a general equilibrium framework, the growth impact of a significant cut in aid would be much larger and run through multiple channels, with feedback effects on public finances (e.g., lower growth would imply lower domestic revenues via automatic stabilizers).

Illustrative Scenario

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Sources: Afghan Ministry of Finance and IMF staff estimates

E. Conclusion

10. Given uncertainties about grant inflows and available debt financing, a prudent approach to fiscal planning is needed. Targeting a balanced budget (including grants) and a lower operating deficit (excluding grants) while planning for a reduction in aid levels is prudent given the uncertainties that lie ahead. More predictability in donor aid disbursements, including through multi-year commitments, would contribute significantly to reducing uncertainty. The adjustment to lower aid will need to comprise continued domestic revenue mobilization, including from the planned VAT, and expenditure rationalization while protecting the vulnerable and shifting the composition of spending to pro-growth outlays. The simulations in this paper suggest that adjustment to unexpected aid declines should occur through lower current rather than capital spending to minimize the growth impact. The authorities’ fiscal strategy paper for the 2020 budget rightly touches on these key challenges, and the further development of an MTFF, in addition to strengthening public financial management that should help raise the efficiency of spending, will assist Afghanistan in planning effectively for an uncertain future and ensure that scarce resources are deployed effectively. 10

Annex III. External Sector Assessment 1

Afghanistan’s external position assessed with the updated EBA-lite methodology appears broadly in line with fundamentals. This assessment must be interpreted with caution as the sizeable external financing needs are filled with large foreign aid, equivalent to around 40 percent of GDP. The aid inflows have progressively declined alongside increasing self-reliance which will need to be supported by growing domestic resources, higher private capital inflows, and increased exports. These alternatives to aid would depend on a durable peace, spurring repatriation of overseas capital and boosting private sector confidence and pro-growth investment. In the meantime, while mindful of macroeconomic stability, the authorities should continue strengthening competitiveness and the business environment, including by improving key infrastructure.

1. Afghanistan’s external position assessed with updated EBA-lite methodology 2 appears broadly in line with fundamentals. The current account balance is largely determined by security and aid-related imports financed by the equivalent grant inflows. 3 Since all grants are counted as current grants due to data deficiencies, the current account (CA) returned a surplus in recent years. The CA excluding grants was in deficit of nearly 30 percent of GDP in 2018. For the assessment with EBA-lite CA approach we assumed roughly 30 percent of aid inflows to be capital transfers and removed these from the CA. The CA approach shows that Afghanistan’s current account deficit is in line with fundamentals with the negative current account gap within one percentage point of GDP and the REER approach showing a positive gap of a similar magnitude.

Current Account Approach

(In percent)

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2. Exchange rate developments are dominated by factors other than competitiveness considerations. They include risks due to ongoing violence and regional developments, the level of civilian and military aid disbursements, spending by foreign troops, and dollarization developments. The impact of real effective depreciation observed since 2012 on exports has been dominated by these factors.

Current Account Balance (excl. Grants) and Effective Exchange Rates

(+=appreciation; 2010=100)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities and IMF staff calculations.

3. The authorities, in line with staff’s advice, have allowed the exchange rate to balance the market and intervened only to dampen excessive exchange rate volatility. The 2018 Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) classified Afghanistan’s de facto exchange arrangement as “crawl-like” while the de jure exchange rate arrangement is “managed floating.” There is no target on real exchange rates, and the REER broadly mirrored the NEER in recent years with a gradual depreciation trend. The NEER has depreciated by around 1 percent in the first three quarters of 2019. DAB supplies the foreign exchange market through auctions conducted three times a week. In the first three quarters of 2019, the authorities sold around US$1.7 billion compared with US$1.6 billion in 2018.

4. A quantitative assessment of the impact on Afghanistan’s external flows from U.S. sanctions on Iran is not possible due to a lack of data. Anecdotal evidence suggests a drop in remittances to Afghanistan, 4 increased imports from Iran, and increased round-tripping of foreign exchange taking advantage of arbitrage opportunities. The U.S. has exempted from sanctions Chabahar port (see map)—a joint infrastructure project between India, Iran, and Afghanistan, which allows marine transportation to and from India (one of a few trade partners against which Afghanistan runs a trade surplus).

Note: The boundaries, colors, denominations, and any other Information shown on the maps do not imply, on the part of the International Monetary Fund, any judgment on the legal status of any territory, or any endorsement of such boundaries

5. The authorities have been adopting measures to improve the trade balance. These include efforts to diversify export destinations and increase import substitution. Afghanistan’s exports are very small at around 4.5 percent of GDP and dominated by agricultural products (nearly three quarters of exports). The origins of imports are more diverse than export destinations. Afghanistan has been running trade deficits against majority of its trading partners.

Export Destinations

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: DOT, IMF

Origins of Imports

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: DOT, IMF

Trade Balance vis-a-vis Major Trading partners

(2018)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: DOT, IMF

6. While the business environment has improved, the economy is still facing structural impediments to competitiveness primarily due to the on-going conflict. Afghanistan improved the most in the 2019 World Bank Doing Business indicators, with its ranking jumping to 167th from 183rd out of 190 countries. The improvement comprised simplified business registration, strengthened minority investor protections, corporate governance structure, and insolvency framework. Improvements in the business environment should continue.

Doing Business Report

(Rank, 2019)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: World Bank Doing Business Report 2019

7. The country’s trade competitiveness is weighed down by the conflict and landlocked location. This is reflected in Afghanistan’s poor score in the World Bank’s 2018 Logistics Performance Index (LPI). To ease those constraints, the authorities have established air corridors including to India, China, Turkey and some European countries, which helped to increase exports over the past two years.

8. Regional integration could alleviate constraints due to the landlocked location. 5 Improved regional connectivity would be key to unlocking trade potential including of the natural resources. Afghanistan is intensifying regional cooperation and investment in trade, transport, and energy. This includes a trilateral sea and land transit agreement with Iran and India, and participation in transit and trade corridors such as the “Five Nations Railway Corridor” (AFG, CHN, IRN, TJK, KGZ) and the “Lapis Lazuli Corridor” (AFG, TKM, AZE, GEO, TUR). The inclusion in cross-border electricity transmission networks will boost Afghanistan’s trade and transit activities between Central and South Asia. The completion of a regional natural gas pipeline project (TAPI) exporting natural gas (TUR, AFG, PAK, IND) would increase gas supply in Afghanistan and tax revenue from fees for the use of the pipeline by Pakistan and India.

9. Foreign direct investment (FDI) and capital flows are negligible due to high risk related to the ongoing conflict. Annual FDI flows into Afghanistan-mostly from the United Arab Emirates and China-were less than 1 percent of GDP per year during 2011–18. Afghanistan does not have access to international capital markets. While according to the Extractive Industries Transparency Initiative (EITI), Afghanistan’s vast reserves of mineral wealth, including gold, copper, iron, rare-earth metals, and uranium-could exceed one trillion U.S. dollars, a poor regulatory framework and investment environment due in large part to political and security uncertainties have prevented meaningful investment in this area. In early 2019, Afghanistan’s membership in EITI was suspended due to inadequate progress in implementing the EITI standard.

10. Errors and omissions have been persistently large despite some improvements in BoP statistics. Large negative errors and omissions might be attributable to unreported smuggled imports, overestimation of off-budget grants, and unrecognized cash holdings of foreign currencies by the private sector outside the formal financial system (which is recorded as an increase in assets under “other investment”). Other important flows missing in the current BoP statistics are remittances through the “hawala” scheme and opium exports. Both would rely on cash holdings. Anecdotal evidence suggests as much as US$1 billion could be passing through unrecorded hawalas, while the United Nations Office for Drugs and Crime (UNODC) estimated that Afghanistan’s opium production (farm-gate value) would be US$ 0.6 billion in 2018, a significant decline by 56 percent relative to 2017.

11. The stock of gross FX reserves exceeds by a large margin all traditional metrics of reserve adequacy. With gross reserves close to 12 months of imports and 40 percent of GDP, reserves are adequate. Reserves are also a multiple of total external debt, which is long term and highly concessional, and exceed money supply by 28 percent. The methodology for “Assessing Reserve Adequacy in Credit-Constrained-Economies (ARA-CC)” does not produce meaningful results because of data limitations and very high levels of aid dependency (e.g., lack of a proxy for costs of holding reserves).

Gross International Reserves and Exchange Rate

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.

Reserve Adequacy

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Sources: Afghan authorities and IMF staff calculations.

12. Afghanistan is a large net creditor based on its International Investment Position (IIP) due to large foreign reserves and low levels of external public debt. The net assets are about US$5.3 billion (about 30 percent of GDP). In addition to international reserves (US$8.3 billion), currency and deposits in deposit-taking institutions are the largest IIP assets (US$1 billion). Liability positions are mainly general government external debt (US$2.1 billion, including some US$900 million pending pledged debt relief commitments) and foreign direct investment (US$1.6 billion). Like the BoP, significant data uncertainties pertain to direct investment, and other assets and liabilities of the private sector.

13. The authorities agreed with the thrust of the assessment and policy recommendations which are broadly in line with their policies aimed at maintaining a sustainable external position and policy buffer preparing for the expected gradual decline of grant inflows.

Annex IV. Governance and AML/CFT 1

The purpose of this annex is to discuss Afghanistan’s legal and institutional framework, including enforcement mechanisms, to combat corruption and money laundering. Towards this end, the annex examines the main policy priorities and commitments made both domestically and internationally. Afghanistan’s progress in addressing its significant and well documented corruption and governance weaknesses is encouraging. While institution building and adoption of laws and strategies are clear signs of commitment to fight corruption, results are still lagging intentions, and hence stepped up efforts are needed to make decisive inroads into strengthening governance.

A. Anti-Corruption

1. The detrimental effects of corruption on political and social stability and state building efforts are widely recognized. 2 In fragile states where institutions may be nascent or lacking capacity, and public confidence in government bodies is low, governance weaknesses can be even more damaging. In Afghanistan, corruption has long been linked to conflict and poses a challenge to reconstruction and peace efforts, the delivery of aid and public services, and an efficient security sector. Conversely, conflict is also recognized as a driver of corruption. Reducing the exposure of citizens to corruption in their daily lives, addressing corruption risks in vital sectors, and improving accountability in government will be instrumental to fostering trust and re-building a secure society. Likewise, the government’s efforts towards peace are also an important aspect of its anti-corruption agenda.

2. In this difficult context, Afghanistan has had notable achievements strengthening its anti-corruption laws. Supported by the IMF’s Extended Credit Facility (ECF) arrangement and other donors, Afghanistan has greatly improved its legislative framework, including by criminalizing corruption offences in line with the United Nations Convention Against Corruption (UNCAC). Laws were also passed to codify obligations of public officials to declare their assets, protect reporters of corruption, and improve access to information. Recent amendments to the Anti-Corruption Law have clarified the legal bases for the establishment and operations of key anti-corruption bodies.

3. Although important improvements have been made, Afghanistan’s institutional framework for fighting corruption needs to be solidified with appropriate safeguards. The overarching institutional framework for combating corruption has been evolving. 3 The main bodies currently involved in anti-corruption include the High Council for Rule of Law and Anti-Corruption, 4 the Administrative Office of the President (AOP), the Anti-Corruption Justice Center (ACJC), and the Office of the Attorney General (AGO) (which jointly investigate and prosecute corruption offences). Missing from the institutional framework is a body responsible for the development and implementation of preventive measures. To this end, an Anti-Corruption Commission is being established, but progress is slow. Further, due to the conditions in public service inherited by the current administration (weak capacity and high corruption vulnerabilities) many anti-corruption functions have been concentrated in the executive. The High Council—tasked with oversight of the National Strategy and the conduct of line ministries—is the main body generating anti-corruption policies and priorities. Further, the system of asset declarations is currently overseen by the AOP. While this arrangement arose from capacity and security concerns and was envisioned to be temporary (pending the operationalization of the Anti-Corruption Commission), vesting the office of the executive with oversight of the asset declarations of public officials has a significant potential for political interference.

4. The authorities recognize the country’s corruption challenges, but a proliferation of commitments has resulted in difficulties in prioritizing. Afghanistan has made several high-level commitments, both domestically and internationally, to fight corruption. The government’s main policy priorities are captured in the Afghanistan National Peace and Development Framework (ANPDF) 2017–2021, the Geneva Mutual Accountability Framework (GMAF), and Afghanistan’s 2017 National Strategy for Combatting Corruption. While the priorities of the ANPDF have been integrated into the Anti-Corruption Strategy, less overlap exists with the GMAF. In addition, Afghanistan has agreed on other benchmarks with donors and international organizations. While these agreements demonstrate the government’s commitment to governance reforms, they have resulted in an overambitious agenda of activities, which do not provide a clear roadmap for addressing the country’s main corruption risks.

5. Afghanistan’s asset declaration regime has significantly improved, but its utility is limited. The AOP has been recognized for its successes registering asset declarations, receiving 17,500 asset declarations in 2018 and 17,255 in the first seven and a half months of 2019 (of a total of about 22,000 positions 5 subject to disclosure). 6 Officials who do not file their asset declarations are subject to a salary freeze and restrictions on other liberties (such as travel). In 2019, 758 officials (including 12 former Ministers and one sitting Minister) are under such a sanction; all non-declarants sanctioned in 2018 have since filed to receive their salaries. Further, two Provincial Governors, two Members of Parliament, one Deputy Minster, and one former Minister have been forwarded to the prosecutor’s office for submission of false declarations. However, a very small percentage of asset declarations have been verified. Submissions are vetted by the AOP’s registration and analysis department, which has flagged approximately 3,600 declarations. Due to difficulties cross-checking and corroborating information, only 100 of these declarations have been verified. Resource limitations are compounded by shortcomings in Afghanistan’s registries (e.g., land, property, municipality, transport, companies), which are often not digitalized (where they exist) or are incomplete or inaccurate. Verification of bank accounts, on the other hand, can be performed quickly with the assistance of FinTRACA (Afghanistan’s financial intelligence unit). Declarations are also not digitalized, which does not allow for them to be published, linked to other databases, easily made available to other agencies. Although digitalization efforts are underway, at present, they are focused on storage (scanning of hard copies) starting with the oldest asset declarations.

6. Afghanistan has made progress in its efforts to pursue criminal cases of corruption. The ACJC was created in 2016 as a specialized structure 7 to handle cases of corruption and financial crime involving high-ranking officials and implicating amounts exceeding Af 10 million (approximately US$114,000). 8 The mandate and jurisdiction of the ACJC were recently clarified in the new Anti-Corruption Law passed in 2018. Cases falling outside of the ACJC’s jurisdiction will be handled by the Deputy Attorney General for Anti-Corruption and progress through the regular court system. In all instances, the main responsibility for detecting corruption (and other criminal offences) lies primarily with police bodies (including the Major Crimes Task Force). From its establishment until May 2018, the ACJC Primary Court has tried a total of 57 cases involving 223 defendants, resulting in 177 convictions. Allegations against the President, Ministers, and sitting judges of the Supreme Court are investigated pursuant to special procedures; cases are heard before special courts established on an ad hoc basis. Cases against two Ministers are currently ongoing. Legislative updates are also underway to fully operationalize the Office of Asset Recovery situated in the Deputy Attorney General for Anti-Corruption. At present, only assets that have been seized as evidence during an investigation are able to be recovered, but new regulations are being developed to allow for more effective tracking, tracing, and freezing of assets related to corruption.

7. Enforcement actions still face significant obstacles and do not effectively target proceeds of corruption. Security concerns and capacity constraints are key impediments to corruption investigations in Afghanistan. In addition to direct threats to the personal safety of law enforcement, the security situation also poses evidentiary challenges (gathering information and securing witnesses in the provinces). Investigators also vary in their ability to identify and uncover criminal conduct giving rise to more complex offences. The timelines stipulated in the Criminal Procedure Code also constrain the ability of investigators to pursue more difficult cases. As a result, cases do not routinely forge links between acts of corruption and money laundering. The most frequently laid corruption charge is misuse of authority, for which investigators do not regularly identify a financial dimension. Most cases of misuse of authority are not accompanied by other criminal charges; however, the authorities have been increasing their focus on connections with other corrupt acts (such as bribery and embezzlement). 9

8. The authorities also face difficulties ensuring the presence of the accused resulting in a high number of cases being tried in absentia. The Criminal Procedure Code allows prosecutors to release defendants or without bail (which can be no less than the loss incurred by the offence), or upon the guarantee of another individual. Guarantors are required to pay the amount of bail only where they are not deemed to be “reliable and credible.” The frequency of bail being conditioned upon the verbal guarantee of a reliable and credible guarantor and difficulties policing the borders has resulted in a large number of absconders

9. The authorities are working to align enforcement actions with priorities identified by the National Anti-Corruption Strategy. On the one hand, police corruption has been targeted (Ministry of Interior is the agency most frequently implicated in enforcement actions), but on the other, relatively few corruption cases reaching trial have involved officials from Ministry of Defense 10 despite the security sector being named as the most critical. Difficulties securing judgments against high-ranking officials may stem partly from above challenges as well as a need to raise capacity among judges and prosecutors.

Recommendations:

10. Prioritize policies and deliverables. In coordination with donors, focus policies and priorities around the most critical corruption risks with the understanding that establishing longer-term timeframes does not necessarily signal a diminishment of importance. Action plans and strategies need to be appropriately sequenced and reflect realistic timelines, manageable actions/deliverables, and the capacity of relevant agencies and stakeholders. Ministries and agencies should establish and manage their own action plans separate from but harmonized with national plans for more effective and measurable implementation.

11. Solidify the institutional framework and strengthen independence of agencies. The Anti-Corruption Commission should be operationalized as the preventive body and could absorb several functions now carried out by separate bodies. As overall capacity is strengthened, a strategy should be developed to gradually cede more anti-corruption responsibilities to relevant agencies.

12. Harmonize legal framework. Ensure that the legal framework does not contain conflicting provisions upon the establishment of the Anti-Corruption Commission. Ensure that the authority responsible for asset declarations is able to request and access information as needed for verification confidentiality or non-disclosure provisions in other laws notwithstanding.

13. Enhance system of asset declarations. The AOP’s capacity should be strengthened while it retains temporary responsibility over the asset declaration regime. The criteria for verification should be clarified and consideration could be given to separating the processes for verification and validation (addressing inconsistencies). Finally, digitalization efforts should focus on the creation of an electronic filing system that would provide a machine-readable database and allow for publication of declarations.

14. Continue e-governance efforts and strengthen registries. Strengthen the quality and comprehensiveness of land and property cadasters. “Zombie” entities should also be removed from the company registry.

15. Improve the capacity of enforcement bodies. The authorities should build the capacity of investigative bodies to better identify and detect specific corruption offences, which could lead to more complex cases of corruption. They should also improve the knowledge and abilities of investigators to conduct parallel financial investigations on a regular basis to facilitate the identification and recovery of corrupt proceeds. Law enforcement should be empowered and equipped to pursue cases against high-level officials, particularly those in sensitive sectors. Further training should be provided to prosecutors to improve their ability to try corruption cases.

16. Strengthen pre-release procedures. The Criminal Procedure Code should clearly stipulate bail conditions. The authorities should consider amendments requiring bail to be paid by either the defendant or a guarantor and to allow for more flexibility in setting the bail amount. The capacity of prosecutors and judges to determine bail and assess flight risk in corruption cases should be enhanced.

B. Anti-Money Laundering and Combatting the Financing of Terrorism (AML/CFT)

17. Afghanistan’s economy is highly exposed to illicit flows, including those emanating from corruption. According to the authorities, a significant (but unquantifiable) amount of the country’s financial flows either originate from an illegal source or pass through illegal channels. In its 2018 Afghanistan Opium Survey, the United Nations Office on Drugs and Crime (UNODC) estimated that the opiate economy accounted for about 6–11 percent of GDP. Illegal drug production also represents a significant source of funding for insurgent forces. Corruption is both a significant source of illicit flows and an obstacle to the effective control of proceeds-generating crimes.

18. Underground financial activities are also a channel for corrupt proceeds. The Afghan economy is primarily cash-based with the majority of financial activities taking place through informal channels, such as hawalas and cash couriers. These entities include both unlicensed money service providers (MSPs) and foreign exchange dealers (FXDs) as well as entities operating outside the legal framework. This sector is therefore considered to pose a high risk of money laundering and terrorism financing (ML/TF). Afghan authorities estimate that unlicensed businesses account for approximately 20–30 percent of financial flows and there are an unknown but considerable number of illegal operations.

19. The AML/CFT regime can be a powerful instrument in a country’s anti-corruption efforts. Corruption and money laundering are intrinsically linked. As with other economic crimes, the Illicit origin of gains derived from corrupt acts generally needs to be disguised for such gains to be enjoyed. A country’s AML/CFT regime not only can help shield the financial sector from such illicit flows but can be instrumental in the detection and enforcement of corruption offences and the identification and recovery of corrupt proceeds. It also provides an additional channel for international cooperation, which is critical as major proceeds of corruption are often laundered abroad. Pursuant to AML/CFT rules, individuals, such as politically exposed persons (PEPs), who are more exposed to corruption risks by virtue of their position or standing, should be subject to higher scrutiny. The AML/CFT regime also promotes transparency of corporate ownership and calls for the identification of the ultimate beneficiaries of assets and financial transactions. When properly operationalized, an asset declaration system can help detect illicit enrichment and the laundering of proceeds of corruption. Finally, financial investigations may yield evidentiary support for the underlying criminal conduct and can bolster the ability of investigative bodies to detect specific corruption offences.

20. At present, the Afghan AML/CFT regime is not sufficiently leveraged to tackle proceeds of corruption. The authorities are in the process of finalizing the National ML/TF Risk assessment, which has preliminarily identified MSPs/FXDs and the real estate sector as being the most vulnerable. This finding notwithstanding, AML/CFT supervision of non-financial sectors (notably, real estate) has not yet commenced. With the help of regulatory authorities, the understanding and application of preventive measures by Afghan financial institutions has been improving, but further strengthening is needed. Trends noted in DAB’s latest cycle of inspections, included customer due diligence (CDD) deficiencies, incorrect risk profiling, and failure to identify domestic PEPs. Banks’ transaction monitoring systems are also still being refined, which could be one reason red flags related to corruption are not frequently identified• Only seven suspicious transactions relating to corruption were flagged by banks in 2018 (constituting 1.9 percent of all transactions labelled suspicions). Understanding of beneficial ownership also varies across the financial sector. Non-bank financial institutions, such as MSPs and FXDs lag considerably further behind banks in their ability to identify and verify the identity of customers. Towards this end, DAB has intensified its supervisory activities, including by conducting targeted inspections (e.g., on PEPs). Likewise, FinTRACA has been conducting outreach activities specifically to raise awareness CDD/KYC rules among the MSP/FSD sector and has imposed sanctions (in the form of monetary penalties, suspension of activities, and revocation of license) where deficiencies have been identified.

21. Corruption enforcement could be better supported by parallel financial investigations. Although corruption is acknowledged as a significant source of illicit flows, only one corruption case has been accompanied by a money laundering charge. Investigative bodies do not regularly conduct financial investigations in parallel with investigations into the underlying criminal conduct, nor do money laundering investigations appear to reinforce criminal investigations. Authorities are not yet pursuing complex money laundering cases; all but one of the money laundering cases heard by the primary ACJC court to date have been standalone. These limitations also impact the ability of authorities to identify and recover proceeds of corruption.

Recommendations

22. Improve coordination of national AML/CFT and anti-corruption priorities. National AML/CFT and anti-corruption policies and priorities should be harmonized, and the respective national committees should coordinate. The findings of the National ML/TF Risk Assessment also should be reflected and disseminated to relevant stakeholders.

23. Undertake targeted measures to reduce illicit financial channels. Supervisory, intelligence, and enforcement agencies should work together to identify and shut down unlicensed entities providing financial services.

24. Improve implementation of AML/CFT preventive measures. The authorities should continue to improve the implementation of preventive measures among reporting entities, notably with respect to enhanced due diligence for politically exposed persons and beneficial ownership requirements through outreach and training. The overall legal framework (e.g., pertaining to the corporate registry) could be refined to improve the availability and accessibility of beneficial ownership information. Finally, the asset declaration regime should be mobilized to facilitate detection and investigation of the laundering of proceeds of corruption.

25. Strengthen AML/CFT supervision over high risk sectors. Efforts to strengthen AML/CFT supervision of financial entities, in particular over MSPs and FXDs, should be continued. The authorities should also initiate AML/CFT supervision over non-financial sectors at high risk of ML/TF, such as in the real estate sector. Penalties for compliance deficiencies should be effective, proportionate, and dissuasive.

26. Enhance capabilities of law enforcement to allow for ML and corruption cases to complement each other. Improve the understanding of investigative bodies of the importance of pursuing parallel investigations, particularly in corruption cases, and raise their capacity to do so on a routine basis. Pursuing more complex cases of corruption could advance such efforts. The priority of pursuing money laundering cases in conjunction with predicate offences (notably, corruption) should be elevated.

Annex V. Illuminating the Provinces: Estimating Subnational GDP

in Afghanistan Using Satellite Imagery 1

Afghanistan currently does not produce GDP estimates by province. In this paper, we estimate annual subnational GDP in Afghanistan employing an innovative method that uses publicly available, high frequency satellite nighttime lights data. The estimated subnational GDP levels are consistent with the distribution of major economic centers. We also estimate national level GDP using elasticities between nighttime lights and economic activity estimated for economies comparable to Afghanistan. We find that such estimates track the official estimates relatively closely.

1. In this annex, we estimate annual subnational GDP in Afghanistan using satellite nighttime lights data. In Afghanistan, official subnational GDP estimates are currently unavailable, and national level GDP data are published annually with a half-year lag. Alternative methods of estimating GDP, such as the one described here, are becoming increasingly popular in developing countries as they provide additional information in the absence of reliable official data (including due to conflict and lack of capacity), help to estimate aggregate output of the informal sector, and provide a comparator for the estimates that use traditional statistical methods.

2. Satellite nighttime lights data have been shown to correlate with economic activity. This correlation was first documented in Henderson, et al., (2012) 2 for all the countries with available nighttime light data. This work paved the way for the subsequent literature, including applications to conflict affected countries and estimations of subnational GDP, also at the IMF. For example, Debbich (2019) 3 uses nightlights to estimate the contraction of economic activity in Yemen throughout the ongoing conflict. Also, Beyer et al., (2018), 4 5 propose a measure of monthly economic activity in South Asia at the district level based on nightlights data and rural population estimates. The above applications aimed at overcoming data deficiencies due to conflict in largely rural economies suggest that this method may be usefully employed for Afghanistan.

Satellite Nighttime Lights Image for Afghanistan

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: National Oceanic and Atmospheric Administration, and IMF staff calculations.

3. We obtained nighttime lights data from the National Oceanic and Atmospheric Administration. Currently, the data are collected and managed by the Colorado School of Mines. Data, published monthly, and may be aggregated to any well-defined subnational geographical level, including for example provinces or districts.

4. To estimate GDP for Afghanistan using nightlight intensity we proceed as follows:

  • a) Noting that agriculture is largely unlit and its contribution to GDP would not be picked up by nighttime lights, we use the official estimates of agriculture’s contribution to GDP, 6 7 To obtain estimates of the provincial shares of agriculture we proxy the relevant GDP shares of each province using the provincial distribution of rural population.

  • b) Non-agricultural GDP is estimated using nighttime light intensity and is allocated to each province per the distribution of nighttime lights. Nighttime light intensity clearly identifies the respective shares of each province in aggregate economic activity.

  • c) Next, we sum the estimates for agricultural and non-agricultural sectors for GDP per province. Below figure shows estimated total GDP and GDP per capita at province level in 2018. Economic centers like Kabul, Balkh and Herat are clearly recognizable with GDP over Af 40 billion (about 2 percent of total). In line with priors, per capita GDP figures are the highest in provinces neighboring Kabul, including Parwan and Nuristan with GDP per capita over USD 600. Panel titled “Afghanistan: Province Level GDP” shows time series of provincial GDP in Afghanistan for 2002–18 period (see also Table 1).

Table 1.

Afghanistan Province Level GDP (constant Afs, million) 1/

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Source: IMF staff estimates.

GDP estimates are based on nighttime lights data.

Afghanistan: Province Level GDP in 2018

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF staff calculations.

5. National level GDP may also be estimated using nighttime lights to GDP elasticities estimated for other economies comparable to Afghanistan. Such estimates provide another benchmark for our estimates or the official estimates, or a substitute for the latter should they be unavailable. In the figure to the right we plot official and estimated measures of Afghanistan’s GDP for 1992–2018. The estimated and official GDP follow broadly similar trends. For 1992–2002 the estimated GDP (official estimates are not available) shows a largely stagnant economy, as expected for a country engulfed in a full-scale civil war.

Official and Predicted Measures of Afghanistan’s GDP

(1992–2018, log of GDP in constant Afs)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: Afghan authorities, and IMF staff calculations.

6. Subnational GDP estimates are used to calculate province-level contributions to the economy. Unsurprisingly, Kabul had the highest contribution to growth from 2017 to 2018 at 2.3 percent (2.7 cumulative national growth), while Balkh and Nangarhar had the highest contribution to Afghanistan growth over the past decade at 7.2 and 6.7 percent respectively (87 cumulative national growth from 2008 to 2018).

Afghanistan: Provincial Contributions to GDP Growth

(Percent)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Source: IMF staff calculations.

7. GDP estimation using satellite imagery has many potential applications. One could estimate economic activity for various geographical aggregates to inform investigations of tax intake, shadow economy activities, or to evaluate the effect of economic shocks on GDP growth or a near-real time impact of various policy interventions. At the same time, the estimates based on satellite imagery should best be thought of as complementing GDP estimates based on traditional methods to maximize the informational benefits of both methods.

Afghanistan: Province Level GDP

(2002–18, constant million Afs)

Citation: IMF Staff Country Reports 2019, 382; 10.5089/9781513523958.002.A002

Appendix I. Letter of Intent

Kabul, December 3, 2019

Ms. Kristalina Georgieva

Managing Director

International Monetary Fund

Washington, DC 20431

Dear Ms. Georgieva:

At its meeting on July 20, 2016, the Executive Board of the International Monetary Fund (IMF) approved a three-year Extended Credit Facility (ECF)-supported arrangement with the government of Afghanistan to help raise growth by consolidating progress on the macroeconomic and structural fronts and catalyzing continued support from donors. On December 7, 2018 the arrangement was extended until end-2019 and its final review rephased to be assessed based on June 20, 2019 data. The extension provided more time for the completion of the sixth review, enabled the implementation of additional reforms, and ensured uninterrupted engagement with the Fund through the election year of 2019.

The implementation of this agreement has supported our efforts to retain macroeconomic stability despite the challenges of insecurity, political transition, and adverse shocks while also laying the foundation for durable and inclusive economic growth.

The ECF-supported program has achieved its objectives. Consequently, the government is requesting the completion of the sixth review, and the disbursement of the final tranche in the amount of SDR 5.38 million based on overall performance and the government’s policy intentions for the future.

In line with our commitment to transparency, we hereby request that the staff report, this Letter of Intent (LOI), the attached Memorandum of Economic and Financial Policies (MEFP), and all annexes and attachments, be published on the IMF website.

Sincerely yours,

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Attachment (1)

Attachment I. Memorandum of Economic and Financial Policies

A. Introduction

1. This memorandum reviews recent economic developments and lays out our economic objectives and policy framework following completion of an Extended Credit Facility (ECF) arrangement with the IMF.

2. We, the government of Afghanistan and its central bank, are committed to on-going implementation of economic reform and addressing structural weaknesses in the economy. We are addressing economic vulnerabilities and pressing ahead with the reform program through a series of policy and legislative actions.

3. The ECF arrangement supported our macroeconomic policy and reform agenda through 2019. It addressed economic vulnerabilities and facilitated our engagement with the international community to sustain donor support and helped us make progress on the deliverables under the Self-Reliance Mutual Accountability Framework (SMAF). The ECF arrangement assisted us in preserving macroeconomic stability, improving economic governance, and laying the basis for stronger private sector activity.

B. Recent Economic Developments

4. Economic activity continues to be weak. We expect growth to reach about 3 percent in 2019, exceeding the last year’s growth of 2.7 percent, as agriculture has rebounded from last year’s drought.

5. Inflation was low last year, at 0.8 percent at end-2018, but it picked up somewhat in 2019. In the first half of 2019, inflation increased to 4 percent owing to the passthrough from the earlier exchange rate depreciation and seasonal effects. In September, inflation eased to 1.8 percent as food prices declined owing to a good harvest and some appreciation of the exchange rate.

6. International reserves remain comfortable, while the large trade and current account deficits continue to be financed by donor grants.

7. In the first half of 2019, the Afghani has depreciated by about 8 percent versus the U.S. dollar. The recent depreciation was mainly attributable to increased political and security risks and outflows of U.S. dollars in part to take advantage of arbitrage opportunities in neighboring countries. Since June, the outflows have likely receded as the Afghani appreciated by 3.6 percent.

8. Fiscal performance has been strong in 2019, although revenue growth has moderated recently. Through June, domestic revenue increased by 7.3 percent y/y, as collection efficiency improved, and customs revenues were boosted by the Afghani’s depreciation. Also, the treasury received from the central bank an Af 9 billion profit transfer. While we saw a slowdown in revenues through September we are focusing on increasing collection efficiency and remain confident that the end-year revenue target remains well within our reach. Cash balances are high, and they are expected to remain above the Af 10 billion floor. We expect to achieve the agreed-upon small deficit including grants, and on current trends a small surplus appears likely, although we see some risk that revenues will undershoot the budget target. Public debt remains low at around 7 percent of GDP. Execution of the development budget improved to about 93 percent.

9. Despite some improvements, the financial sector remains vulnerable to adverse shocks. In 2019Q2, capital adequacy stood at more than twice the minimum, while the system’s liquidity remained high. However, while profitability improved, the gross NPL ratio increased two percentage points to 12.8 percent (while NPLs net of provisions to capital increased from 4.5 to 6.3 percent), owing to an ongoing DAB mandated clean-up of the portfolio. The weak banks remain under a watchful monitoring regime of Da Afghanistan Bank.

10. Support from our international partners remains vital as aid flows help meet immediate financing requirements and reduce fiscal vulnerability. During the November 2018 Geneva conference, donors pledged sustained financial assistance in exchange for continued reforms. Most donors confirmed pledges made in 2016 in Brussels and a few (including Norway and Sweden) pledged additional resources for the drought. The government and donors adopted deliverables for 2019–20 including a commitment by the government to agree a successor ECF by mid-2020. Donors tasked the World Bank to work with the government and the international community to formulate a post-peace settlement development plan. We anticipate a donor pledging conference in the fall of 2020 and will work towards updating and extending our national development strategy to cover the pledging period 2021–24.

11. The fight against corruption is one of our top priorities, with some 1,635 cases of corruption tried by the Attorney General’s office leading to 468 people sentenced to prison and more than US$14 million in fines. National Procurement Authority’s (NPA) compliance with the publication of high-value/above-threshold contract has increased to 77.5 percent in 2018. These gains followed launching of the National Strategy for Combatting Corruption—a key step in establishing the rule of law and ending corruption—at a Senior Officials Meeting in October 2017.

C. Program Implementation

12. Performance under the sixth and final review of the ECF-supported program was satisfactory despite a challenging security environment, heightened political risks, and a difficult social environment. We met all the quantitative performance criteria at end-June and all indicative targets at end-September 2019. Progress on structural benchmarks for the sixth review was satisfactory as well. Out of the seven structural benchmarks, six were met. In particular, the measures related to improving governance were met, capitalizing on the progress made in previous reviews. We also made the last transfer to the budget to eliminate the outstanding lender of last resort balance related to the Kabul Bank crisis, which we consider a major achievement under the ECF given the country’s difficult circumstances. A small amount (about Af 0.2 billion) of a residual principal and interest accrued remains to be paid to the central bank and we are committed to do that in Q1 2020. The benchmark on reinvigorating the Kabul Bank asset recovery process has been delayed by difficulties in selecting the forensic audit firm. We have already contracted one of the big-ten accounting firms to work with us and we intend to intensify efforts to implement this structural benchmark before end-November 2019.

D. Future Economic and Structural Policies

13. We reaffirm our commitment to the policies and reforms described below. Following the Presidential elections on September 28, 2019 we will be refining our development strategy that will serve as the basis for our request for a new arrangement with the Fund. We plan to conclude the negotiations with the Fund with the aim of having a new arrangement in place by mid-2020 in line with the commitment made during the Geneva November 2018 donor conference. We are strongly committed to maintaining sound policies and continuing reforms during the time between the expiration of the current and start of the new arrangement.

14. Poverty reduction is a top priority. Our policies are guided by the 2017–2021 ANPDF. They focus on low inflation, pro-poor budgeting, and inclusive economic growth propelled by investment in agriculture, more regional economic integration, the fight against corruption, and greater gender equality. To provide sufficient political impetus for a strategic approach to poverty reduction, in August 2017, the President formed a High Council for Poverty Reduction, whose purpose is to oversee and accelerate pro-poor budgeting, policy reform, and investment. On March 8, 2017, a national program for women’s economic empowerment was also launched that provides labor-intensive jobs for women in female friendly occupations. Over 75,000 women have already received training in horticultural and small livestock production. A Gender Responsive Budgeting Policy was prepared to reiterate Afghan Government’s firm commitment to employ budget as a tool to advance gender equality, promote women development related programs, and more importantly to protect women’s rights as outlined in the ANPDF. Both a policy framework and an action matrix for returnees were passed by Cabinet in February 2017 to assist with absorption of returning migrants and internally displaced people (IDPs). The Displacement and Returnees Executive Committee (DiREC) was established to implement the Matrix and EZ-KAR project that provides job opportunities for repatriates in 13 provinces. In addition, the President issued a decree on distributing residential land to returnees to integrate them in the economy. Although security outlays continue to burden the budget as conflict persists, we will ensure that we allocate adequate resources to increase opportunities for the poor.

Macroeconomic Policies

15. Our macroeconomic policy framework is designed to preserve macroeconomic stability and promote growth. It targets a gradual pick-up in GDP growth, single-digit inflation, low debt (less than 10 percent of GDP), and a comfortable international reserves position.

16. We expect a small overall budget deficit after grants in 2019 and will continue maintaining a prudent fiscal position afterwards. The 2019 budget implies a deficit of about 0.8 percent of GDP, in line with the program at the time of budget approval. We are prepared to implement additional spending cuts, while preserving priority social spending, as part of budget implementation mandate (particularly from lower bonuses and cuts in operation and maintenance expenditures), to counter any shortfalls in revenues or grants developments. We expect to maintain the treasury’s discretionary cash balance at or above Af 10 billion which we consider to be a prudent buffer. Over the medium term, we will continue to target a zero-overall fiscal balance including grants and a gradual decline in the operating deficit excluding grants. Our program aims to mobilize additional revenue for growth-enhancing development spending and to reduce aid dependence. We will pursue our plan to implement a value-added tax (VAT) before January 2021 in line with our WTO commitment. We will only borrow on a concessional basis (60 percent of grant element) for specific projects in consultation with international partners. We will set aside any revenues earned from extraordinary currency exchange gains for building the government’s cash reserves and will allocate these gains in the budget for spending by budgetary units when needed.

17. We plan to carefully manage money growth, continue exchange rate flexibility, and safeguard international reserves. Reserve money will continue to be the operational target for monetary policy, with the objective of containing inflation to 5 percent on average in the medium term. We stand ready to tighten money growth in case inflation exceeds desirable levels on a sustained basis. We will let the Afghani move with market trends and will only intervene to avoid excessive exchange rate volatility. We remain committed to an independent central bank that sets monetary policy with a view to maintaining moderate inflation and managing prudently shocks including persistent changes in foreign exchange flows. We will continue coordination between DAB and the MOF to strengthen the conduct of monetary policy, facilitate cash management, and promote market development by finalizing the institutional framework and supportive legislation to set up primary and secondary markets for Sharia compliant securities issued by the Ministry of Finance (sukuk). We will continue our efforts to reduce dollarization including by reducing use of foreign currencies in the border areas.

Structural Reforms

18. The focus of our fiscal reform agenda will be the complementary LTO reforms and VAT adoption, by 2019 and 2021, respectively. In line with the IMF’s TA advice we consolidated all large taxpayers under a fully functional single LTO in October 2019 (sixth review benchmark). The LTO collected only about 28 percent of 2018 domestic tax revenues (or about 16 percent of domestic revenues including customs). We aim to increase this figure to 45 percent of domestic tax revenues by the end of 2021. We aim to introduce a VAT before January 2021. We appointed a VAT implementation team and established a VAT steering committee to carry out the plan. To simplify the tax structure, the VAT, which will eventually replace the BRT 1 on firms that are registered for the VAT, will have the same threshold as the LTO.

19. We will continue to improve administration in ACD. We are committed to comply with the World Trade Organization (WTO) Trade Facilitation Agreement (TFA) and the World Customs Organization’s (WCO’s) requirements to meet international obligations to facilitate trade. We have adopted 5-year Strategic Plan (2018–2022) which reflects priorities of the ACD and draws on international best practices guided by the TFA requirements and the WCO guidelines. Over the next three years, we will link Afghanistan Central Business Registry (ACBR) and Afghanistan Payments System (APS) interfaces to facilitate automated information sharing on taxpayers and taxpayer transactions to improve revenue collection efficiency. In addition, we will introduce an identity verification program to combat fraud and misreporting of customs declarations.

20. We will continue to strengthen public financial management.

  • We will enhance existing budget software with an improved budget builder or procure the budget module associated with Afghanistan Financial Management Information System (AFMIS). In the medium term, we will move to a robust e-Governance solution.

  • We are improving review of proposed projects with support of the technical committee established under the fifth review benchmark. We endorsed the Terms of Reference (TOR) for this committee under the signature of the competent authority and prepared a comprehensive set of guidelines that includes financial and economic appraisal with the World Bank assistance in April.

  • We will develop new systems for fiscal space creation in key areas (e.g., revenue, expenditure, and aid). We aim to update and enhance donor and government financed project data so that estimates of fiscal space, utilized for better investment in high priority national programs, become more accurate. We began this process, during preparation of 2020 budget.

  • To strengthen budget preparation, we adopted forward baseline estimation (FBE) methodology at end-2018. By end-March 2019, we prepared and carried out an FBE exercise for the top 15 budget units. The ministries/agencies are also initiating plans to establish systems for preparing medium-term costed development strategies with an output orientation and forward estimates (Portfolio Budget Statements). These will be linked to the forward estimates issued by the MOF. These will be prepared starting with key priority sectors (such as infrastructure, energy, and agriculture) and will be sequentially rolled out to all ministries. We plan to initiate this process with one ministry producing a Portfolio Budget Statement and preparing an annual report with financial statements by the end of 2019. Based on this experience we will adopt these procedures in other ministries.

  • We will review the capacity of the department of state-owned corporations to assess needed staffing and seek technical assistance to improve staffs capacity for operational and financial oversight of the SOCs. The department will then start collecting information on financial flows between the government and the SOCs and prepare annual analytical reports on their financial performance which will be annexed to the budget starting in FY 2020.

  • We will not contract non-concessional loans. The government will consult with the IMF staff on the terms and concessionality of any proposed new external debt in advance of contracting it. The government will continue to use grants and concessional financing (60 percent of grant element under the current conditionality of the program) to finance high-yield and properly evaluated development projects. We will continue strengthen project selection process for debt financing as well as debt recording, monitoring and managing capacity in consultation with development partners.

  • The Ministry of Finance will also monitor and record contingent liabilities stemming from PPP agreements. We will seek appropriate technical assistance in these areas. Building on the ongoing technical assistance from the World Bank, the government aims to strengthen its debt management framework, measuring and properly recording and monitoring contingent liabilities of the PPP projects and state-owned entities.

  • In parallel, the government will continue to negotiate with its bilateral creditors to expedite the delivery of remaining debt relief.

Financial Sector Policies

21. The weaker commercial banks will continue to be tightly monitored and their corrective Action Plans decisively enforced, including closure when warranted. DAB will closely assess progress, including through regular rounds of in-depth on-site examinations, and specialized reviews by independent experts as may be necessary.

22. We will continue to implement the SOCBs reform strategy with World Bank support. We intend to comply with all legal covenants and deliver on all the actions required under the strategy. We will also foster a closer coordination between the team in charge of the project and the DAB supervisors in charge of the prudential monitoring of the SOCBs.

23. We will continue to strengthen the AML/CFT framework including to ensure effective implementation of AML/CFT measures in the financial sector. The national ML/TF risk assessment was concluded in mid-2019. DAB’s Governor became the chair of the High-Level Coordination Commission for AML/CFT in early 2019 which is committed to promoting inter-agency coordination. DAB continues to strengthen its AML/CFT supervisory capacity over financial institutions, including through the development of internal procedures, protocols, and manuals. We also continue to improve the resources for AML/CFT supervision. A full team of almost 60 AML/CFT examiners (covering banks and MSPs) will be in place by end of 2019. DAB has also developed an AML/CFT Action Plan for the financial sector aimed at improving the capacity and compliance systems in the industry. In 2019, DAB conducted 17 on-site examinations (including full-scope, targeted, and special inspections). Monetary penalties were imposed on 9 banks and 4 warning letters were issued for non-compliance with AML/CFT rules. FinTRACA has imposed AFN 300,000 financial penalties. DAB has also been active in promoting effective AML/CFT controls in money service providers (MSP) through inspections, enforcement actions (including revocation of licenses) and guidance. Fifty-two inspections of this sector have been carried out thus far and another 26 are envisioned. Monetary penalties in the amount of AF 20,078,000 were imposed on 847 licensees and 65 unlicensed individuals were referred to law enforcement agencies. In the future, we will develop a methodology for basic ML/TF risk assessment and risk profiling of MSPs. We expect to develop a strategic plan on MSPs by end of 2019 to guide regulatory reforms. Important components of this strategy include incentives to corporatize, capacity building of this sector, and further enhancing the regulatory framework.

Reinforcing the Crisis Prevention Framework

24. We will continue to upgrade our crisis preparedness and response capacity. We will advance our plan to introduce changes to our banking law to upgrade our resolution framework in line with good international practices. Those changes will include: (i) clear objectives and scope of the resolution regime; (ii) distinction between early intervention and resolution; (iii) revision of grounds for appointing a conservator and petitioning for receivership; (iv) strengthening DAB’s and conservator’s powers in resolution; and (v) introduction of recovery and resolution planning. In addition, we are developing a roadmap to strengthen the deposit insurance system and reviewing the current framework of DAB’s emergency liquidity assistance (ELA). We expect speedy implementation of these changes, supported by Fund TA.

Toward a More Inclusive and Growth-Friendly Financial Sector

25. We adopted the National Financial Inclusion Strategy with the technical support of the World Bank staff in August 2019 with implementation expected from January 2020. The strategy will encourage the promotion of formal channels and includes a comprehensive “financial inclusion” agenda, including for women, and the remote areas of country. It also targets underserved parts of the populations. The strategy targets an improvement in the financial sector infrastructure and credit information, introduction of a wider range of financial instruments, facilitation of financial intermediation and support for innovative financing for the private sector. The strategy will also consider strengthening consumer protection and improving financial literacy. We will also develop Islamic banking to offer access to financial products to untapped markets.

26. We are proceeding with development of digital finance. Our strategic vision is to leverage the high penetration of mobile devices and to make available to the public a wide range of core financial services that are efficient and safe, thereby gradually moving towards an economy not dependent on cash alone. In February 2019, under the auspices of the Ministry of Finance, the cross government working group in charge of public sector salaries payments through mobile money developed a comprehensive digital payments road map for mobile salary payments. With the support of the World Bank, we will be implementing the PAISA Project that will develop structures and mechanisms for digital salaries payment. Also, DAB will continue to expand and modernize the retail payment infrastructure.

27. We are also coordinating with the banking profession to prudently foster intermediation and expand the range of financial instruments and techniques. We will support prudent financial innovation to deepen financial intermediation. We will promote broader use of the publicly accessible credit and collateral registries by banks as well as encourage risk sharing and partial credit guarantee schemes. We will build on these measures to encourage term lending instead of bank overdrafts. We are also preparing a regulatory and institutional framework for issuance of government sukuk that will enable the mobilization of private funds for large scale infrastructure projects.

Economic Governance

28. Our government will remain committed to determined and robust anti-corruption efforts. We updated the National Strategy for Combating Corruption in November 2018 which includes benchmarks with specified timelines. The Anti-Corruption Law was enacted in September 2018. The government is committed to accelerating the fight against corruption and is developing an action plan for implementation in 2020.

29. We have made progress in enforcing the Penal Code with respect to corruption offences, in particular through the Anti-Corruption Justice Center’s operations. Its activities since it became operational in June 2016 till end-2018 were published on the Attorney General’s Office’s website on April 8, which include the number of persons charged for corruption, the number of persons convicted for corruption by primary courts, appellate courts and the Supreme Court, the aggregated number of penalties imposed, and compiled decisions on corruption cases of primary courts, appellate courts and the Supreme Court respectively 2 (fifth review benchmark). We plan to continue this practice in 2020. Furthermore, we are considering amending the Penal Code to provide for mandatory publication of reasoned court judgements on individual corruption cases.

30. We aim to fully implement and enforce the requirements on asset declaration in 2019. By end-October 2019 we published on the AOP’s official website qualitative and quantitative information (using the templates defined in the TMU), in Dari and in English, on implementation of the Law among officials mentioned in Article 154 of the Constitution and other senior officials (sixth review benchmark). We are committed to updating such information on the website annually.

31. We will work to improve the timeliness and quality of our statistics. We recognize the importance of reliable statistics for sound policy making. There are several deficiencies we plan to correct, particularly in the area of national accounts and balance of payments data. To help us with this effort, we are requesting continued technical assistance and training from our international partners, including the IMF.
2

See: UNHCR welcomes Pakistan cabinet’s decision to extend stay of Afghan refugees.

3

The U.S. sanctions on Iran have likely reduced remittances given the number of returnees, but a lack of data prevents a quantitative assessment.

4

The revenue slowdown in recent months needs to be seen in perspective. In 2014, the last election year, revenues fell around 33 percent below target, before rebounding the following year; the current slowdown, while concerning, is comparatively modest, and the government’s cash buffers are stronger than in the earlier episode.

5

See Annex II for a discussion of trends in social spending needs in the medium term.

6

Projected revenues were raised during the mid-year budget review in July, based on the strong collections in 2019H1, including from customs reflecting the Afghani’s depreciation and one-off revenues comprising of a transfer of central bank’s profits to the Treasury received in May as well as tax arrears collections and one-off non-tax fees that are expected in Q4.

7

Since the 2020 budget was still under preparation at the time of the mission, the discussion focused on broad parameters.

8

A small residual amount (about Af 0.2 billion) of principal and accrued interest remains to be paid to the central bank in early 2020 (see MEFP ¶12).

9

The High Office of Oversight (the old anti-corruption agency) has been replaced by other bodies, including the High Council for Anti-Corruption and the Anti-Corruption Judicial Center (ACJC). A body dedicated to anti-corruption prevention in line with UNCAC article 6 (the Anti-Corruption Commission) has been established, but it has not yet become operational.

10

2018 Afghanistan Opium Survey, United Nations Office on Drugs and Crime (UNODC).

11

The execution rate in the development budget at end-2018 was about 93 percent.

13

In public security, construction, transport, agriculture, and extractive industries.

15

Similarly, The Heritage Foundation Index of Economic Freedom has shown an upward trend since 2017 when Afghanistan’s economic freedom was graded for the first time. The 2019 improvement was led by advances in labor freedom, property rights protection, and judicial effectiveness.

16

SMART= Specific+Measurable+Achievable+Realistic+Timely.

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

1

Prepared by Daisuke Ishikawa and Mariusz Sumliński, with research support provided by Tetyana Sydorenko.

2

This is also indicated by other social indicators, such as higher malnutrition rate among children under age five (40.9 percent, vis-à-vis the LICs’ average of 34.8 percent), and lower literacy rate among adults above 15 years old (32 percent, vis-à-vis the LICs’ average of 49 percent). See Table 3 in the main text (Poverty, Vulnerability, Inequality, and Social Indicators in Afghanistan).

3

In nominal terms, they are assumed to decrease from $7.2 billion in 2018 to $6.2 billion in 2024.

4

The additional revenue gains are assumed to kick-in gradually as VAT administration improves

5

Total security expenditure needs are based on the Warsaw conference in 2016 which pledged to support an estimated total security outlays of around $5 billion. Actual execution could be lower than the one envisaged in Warsaw.

6

Total civilian expenditure needs, in percent of GDP terms, are assumed to be broadly constant.

7

N. Batini et. al., (2014), “Fiscal Multipliers: Size, Determinants, and Use in Macroeconomic Projections,” Technical Notes and Manuals, Fiscal Affairs Department, International Monetary Fund find the following characteristics are associated with high fiscal multipliers: low trade openness, rigid labor market, small automatic stabilizers, fixed exchange rate, low public debt, and effective PFM (measured by PEFA assessment). For Afghanistan, only low public debt is unambiguously present.

8

M. Cerisola et. al., (2015), “Assessing the Impact of Fiscal Shocks on Output in MENAP Countries,” Technical Notes and Manuals, Middle East and Central Asia Department, International Monetary Fund find that government consumption (including subsidy and transfer) and investment multipliers for the MENAP lower income countries (but excluding Afghanistan) are 0.5 and 1.1. We assume that (i) a total spending multiplier for the MENAP lower income countries is the average of these two at 0.8, and (ii) for Afghanistan, multipliers for government consumption and investment can be inferred by prorating the estimated total spending multiplier of 0.2 with the comparators’ ones (i.e., 0.2*0.5/0.8=0.13, and 0.2*1 1/0.8=0.28)

9

Here, we assume that cut in spending is identified as a fiscal shock (i.e., purely discretionary and exogenous change). We multiply the change in spending (i.e., fiscal shock) in a given year with the fiscal multiplier to obtain the first-year impact on growth. The fiscal shock has long-lasting effects on growth in later years but is assumed to decay at a rate of 0.6 per year. For technical details, see Batini et. al., (2014). Lower growth would also translate into lower domestic revenues. Assuming tax elasticity of one, decline in growth by 0.3 and 0.6 percent (2005–30 average) in scenario 1 and 2 would imply a reduction in domestic revenue by 0.3 and 0.6 percent of GDP, respectively.

10

A detailed discussion of the role of fiscal institutions in the Middle East and Central Asia region can be found in Chapter 5 of the October 2019 Regional Economic Outlook for the region.

1

Prepared by Keiichi Nakatani.

2

For detailed methodological updates, please see “The revised EBA-Lite Methodology” https://www.imf.org/en/Publications/Policy-Papers/Issues/2019/07/03/The-Revised-EBA-Lite-Methodology-47088

3

International development partners pledged US$15.2 billion over 2017–20 at the Brussels Conference held in October 2016, while annual military assistance of US$4 billion was pledged at the Warsaw NATO summit in July 2016.

4

A significant amount of remittances is sent through a money transmission scheme commonly used in this region (hawala), which is difficult for the authorities to fully capture under the BoP.

5

See Selected Issues Paper included in 2017 Article IV, “Afghanistan’s Integration in Regional Trade: A Stocktaking.”

1

Prepared by Kathleen Kao.

2

For an analysis focused on the Middle East and Central Asia, see “Curbing Corruption through Better Economic Governance” IMF 2019, forthcoming.

3

Several agencies that were previously involved in anti-corruption (notably, the High Office for Oversight and Anti-Corruption and the Independent Joint Anti-Corruption Monitoring and Evaluation Committee) have been abolished and their functions absorbed into existing agencies.

4

The High Council’s membership is stipulated by the Decree and comprises the President, Vice-President, Chief Justice of the Supreme Court, National Security Advisory, AOP Chief of Staff, Ministries of Finance, Justice, and Internal Affairs, Attorney General, Director General of National Security, Advisor to the President on Transparency and Anti-Corruption Affairs, the Heads of various commissions and offices.

5

Approximately 20 percent of these positions are vacant.

6

Until 2018, the number of asset declarations submitted historically since 2009 totaled 11,000.

7

The ACJC is comprised of three layers: (i) investigative (embedded in the police); (ii) prosecutorial (situated in the AGO); and (iii) adjudicative (specialized courts with final appeal heard by the Supreme Court).

8

With the exception of the offences of bribery and money laundering, which will fall within the jurisdiction of the ACJC if the funds implicated exceed five (5) million Afs.

9

Out of the 21 cases of misuse of authority that have been heard by the primary ACJC court, 11 were standalone, 3 were accompanied by a charge of forgery, and 7 were accompanied by a charge of bribery or embezzlement.

10

In its 2019 report on Afghanistan’s Fight Against Corruption, UNAMA reported that no Ministry of Defense officials were tried in 2018–2019, although several were indicated. A case involving 10 former Ministry of Defense officials is currently under appeal.

1

Prepared by Tetyana Sydorenko. Comments and guidance from Mariusz Sumliński gratefully acknowledged.

2

Henderson, J. V., Storeygard, A., & Weil, D. N. (2012). Measuring economic growth from outer space. The American Economic Review, 102(2), 994–1028.

3

Debbich, Majdi, 2019, “Assessing Oil and Non-Oil GDP Growth from Space: An Application to Yemen 2012–17” forthcoming IMF Working Paper.

4

World Bank, 2017, “Growth Out of the Blue,” South Asia Economic Focus.

5

Beyer, T., Chhabra, E. & Galdo, V. (2018). Measuring Districts’ Monthly Economic Activity from Outer Space (No. 8523). World Bank Policy Research Working Paper.

6

The relationship between nightlight intensity and agricultural output is judged to be weak. See: Ghosh, T., Elvidge, C., Sutton, P. C., Baugh, K. E., Powell, R., & Anderson, S. (2010b). Shedding light on the global distribution of economic activity. The Open Geography Journal. 3, 147–160.

7

Bundervoet, T., Maiyo, L., & Sanghi, A. (2015). Bright Lights, Big Cities—Measuring National and Sub-National Economic Growth from Outer Space in Africa, with an Application to Kenya and Rwanda (No. 7461). World Bank Policy Research Working Paper.

1

The VAT should replace the BRT except possibly for taxpayers not registered for VAT that have business receipts above the threshold for BRT (in line with previous IMF TA recommendations). The case for retaining BRT for medium-sized taxpayers that are not voluntarily registered for VAT may be that the large taxpayers required to register and charge VAT will argue that smaller taxpayers should also be subject to VAT or at least something that brings them into the tax net. Retaining BRT for medium-sized taxpayers would not likely be a major revenue producer.

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Cover IMF Staff Country Reports
Islamic Republic of Afghanistan: Staff Report for the 2019 Article IV Consultation and the Sixth Review under the Extended Credit Facility Arrangement-Press Release; Staff Report; and Statement by the Executive Director for Islamic Republic of Afghanistan
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2019: Issue 382
Publisher:
International Monetary Fund
ISBN:
9781513523958
ISSN:
1934-7685
Pages:
127
DOI:
https://doi.org/10.5089/9781513523958.002

GDP Growth and Weighted Conflict Index

Poverty and Inequality

GDP Per Capita in Low-Income Countries

Official Aid and Real GDP Growth in Low Income Countries

Civilian Deaths and Injuries

(Thousands, January to September 2009–19)

Refugees by Country of Origin and Internally Displaced Persons

(2018, thousands)

Consumer Price Inflation

(yoy, percent)
Figure 1.

Islamic Republic of Afghanistan: Real Sector

Gross International Reserves and Current Account Balance

Exchange Rate

(Index 2010=100)

Domestic Revenues Growth

(Y-o-y change; in percent)

Total Treasury Discretionary Cash Balances

(In billions of Afghanis)

Credit to Economy

Dollarization of Loans and Deposits

(Percent of Total)

Financial Soundness Indicators

(In percent)

Fiscal Balance

(In percent of GDP)

Headline Inflation and Reserve Money

(y-o-y change, percent)

FX Intervention and Exchange Rate

(In millions of U.S. dollars)

Reserve Adequacy, 2018

(In billions of U.S. dollars)

Financial Sector Depth and Development, 2014

Financial Sector Depth and Development, 2018

Bank Account Ownership, 2017

(percent of adults)

Mobile Money Account Ownership, 2017

(percent of adults)

Indicators of Governance, 2000–18

(Estimate range from -2.5 (weak) to 2.5 (strong))

Budget Execution Rates

(In percent)

Doing Business Indicators

(distance to frontier, 2019)
Figure 2.

Islamic Republic of Afghanistan: External Sector
Figure 3.

Islamic Republic of Afghanistan: Fiscal Sector
Figure 4.

Islamic Republic of Afghanistan: Monetary Sector
Figure 5.

Islamic Republic of Afghanistan: Banking Sector

Current and Capital Expenditures

(On-budget, in percent of GDP, 2018)

Breakdown of Spending

(On-budget, in percent of total, 2018)

Spending Classified by Security and Civilian

(On-budget, in percent of total, 2018)

Domestic Revenue

(in percent of GDP, 2018)

Social Spending

(In percent of GDP, latest value available)

Government Education Expenditure per Student

(PPP$ adjusted, latest value available)

Health Indicators and Health System Characteristics Indicators

(Latest value available)

Total expenditur and grant needs

Total expenditure and grant needs

Current Account Balance (excl. Grants) and Effective Exchange Rates

(+=appreciation; 2010=100)

Export Destinations

Origins of Imports

Trade Balance vis-a-vis Major Trading partners

(2018)

Doing Business Report

(Rank, 2019)

Gross International Reserves and Exchange Rate

Reserve Adequacy

(In billions of U.S. dollars)

Satellite Nighttime Lights Image for Afghanistan

Afghanistan: Province Level GDP in 2018

Official and Predicted Measures of Afghanistan’s GDP

(1992–2018, log of GDP in constant Afs)

Afghanistan: Provincial Contributions to GDP Growth

(Percent)

Afghanistan: Province Level GDP

(2002–18, constant million Afs)