OREANDA-NEWS. On November 18, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Islamic Republic of Afghanistan.

Since 2002, Afghanistan has made important strides in building its economy, infrastructure and institutions, supported by large aid flows. Afghanistan’s Human Development Index (HDI) increased by about 2.5 percent annually between 2000 and 2013, higher than average HDI growth in South Asia and Sub-Saharan Africa. Afghanistan has also established and maintained macroeconomic stability, implemented important structural reforms, and built policy buffers—namely a comfortable international reserves position, low debt, and inflation. Nonetheless, Afghanistan remains a poor fragile state far from self-reliance; donor grants finance the budget and external current account deficits. Afghanistan ranks 194 out of 213 countries by GNI per capita in 2013 (World Bank Atlas method). A large illicit narcotics sector, difficult security conditions, corruption and weak institutions undermine development, constrain growth, and weigh on poverty reduction.

Afghanistan had its first democratic transfer of political power in 2014 and the new national unity government wishes to tackle Afghanistan’s challenges. At the December 2014 London Conference, the international community welcomed plans to enhance productivity, stimulate private sector-led growth and mobilize domestic revenue, and reaffirmed their engagement with Afghanistan. Donors and the authorities also agreed on a Self-Reliance through Mutual Accountability Framework (SMAF) in September 2015, which will help sustain international support.

Significant fiscal and banking vulnerabilities emerged in 2014. Domestic revenue collection fell below its 2013 level because of lower growth, declining imports, and lower compliance, while operating expenditure increased. The treasury cash balance fell to dangerously low levels in the second half of 2014 and domestic payment arrears and unfunded allotments emerged. In addition, the financial positions of some banks deteriorated in early 2014. Two important banks were in a hazardous condition.

IMF management approved a Staff-Monitored Program (SMP) in May 2015. The SMP (April–December 2015) aims at addressing fiscal and banking vulnerabilities, preserving macroeconomic stability, laying the ground for inclusive growth, and building a track record for a future IMF financial arrangement. The first review of the SMP was approved by IMF management earlier this month.

Donor support and policy actions under the SMP helped address these vulnerabilities in 2015. Despite weak economic activity and limited revenues from new measures, domestic revenues increased in the first nine months of 2015 because of improved compliance and the treasury’s cash balance improved. Corrective measures against all weak banks started to be implemented in 2015 and decisive actions were taken to strengthen the two vulnerable banks. More generally, important progress was made in structural reform, with some delays. A new banking law and amendments to the anti-money laundering law were adopted while steps were taken to improve capacity of revenue and customs departments and the sale of New Kabul Bank has been re-started.

Nevertheless, political and security uncertainties have been a drag on economic activity in 2015. The delays in appointing a new government have delayed policy decisions and attacks by insurgents have slowed the economic recovery. Apart from agriculture, economic activity has been subdued. In 2014, real GDP growth declined to 1.3 percent and end-period inflation fell to 1.4 percent y-o-y. Inflation declined further to -1.9 percent y-o-y in September 2015, reflecting soft economic activity and lower global fuel and food prices.

The future path of the economy is highly dependent on the authorities’ delivering on their economic reform commitments, continued donor support, and improvements in security. Although the initial impact of the drawdown of international troops is over, economic activity remains subdued. The authorities’ ability to navigate this new landscape will determine the development path in the transformation decade (2015–2024). The government has expressed a strong commitment to reform and building a healthy economy to benefit all Afghans. It is paramount that reform policies are implemented to avoid compromising the hard-worked achievements to date, strong efforts will yield high returns, and inaction carries major risks.

Executive Board Assessment2

Executive Directors agreed with the thrust of the staff appraisal. They welcomed the important strides Afghanistan has made toward raising living standards, rebuilding infrastructure and institutions, establishing and maintaining macroeconomic stability, and implementing structural reforms. Directors noted the country’s first democratic transfer of political power and welcomed the new national unity government’s resolve to tackle the country’s challenges. They were encouraged by the good progress in policy implementation under the staff-monitored program despite continued security challenges, weak confidence, and fragile institutions, which hold back economic performance. Directors commended the authorities’ commitment to reform and economic transformation, but stressed that strong and sustained efforts, together with better security conditions and continued donor support, are needed to ensure high and inclusive growth.

Directors considered the macroeconomic policy mix to be appropriate and emphasized the need to improve confidence by strengthening policy implementation. They agreed that the fiscal position, including grants, should continue to remain broadly balanced to ensure sustainability, and that budget management should be improved to increase pro-poor and development expenditures. Directors underscored the need for monetary policy to continue to foster confidence in the domestic currency, including by developing domestic-currency denominated instruments, and welcomed the authorities’ continued commitment to a flexible exchange rate regime.

Considering Afghanistan’s high dependence on donor grants, Directors underscored the need to improve revenue mobilization. They recommended introducing new taxes, strengthening revenue administration, and improving the tax policy mix. Over the medium term, introducing a VAT, additional excises and property taxes, developing a fiscal regime for natural resource taxation, and improving enforcement and compliance will be important. Directors also noted the need to prioritize and increase the efficiency of spending. A few Directors saw room for financing high-return infrastructure projects, while a few others recommended caution in acquiring new debt, in order to preserve debt sustainability.

Directors welcomed the progress in bank restructuring, improvements of the regulatory and supervisory framework, and passage of the new banking law and the anti-money laundering and countering the financing of terrorism (AML/CFT) laws. They noted that continued efforts are needed to strengthen the banking system and promote financial deepening. They welcomed the offer for sale of New Kabul Bank and stressed the need for a swift strengthening of vulnerable and weak banks. Directors encouraged vigorous implementation of the new banking and AML/CFT laws and regulations, and a further strengthening of the central bank’s supervision capacity.

Directors stressed the importance of sustained governance reforms to boost confidence and improve the business environment, including through stepping up anti-corruption measures, enhancing institutional capacity, and continued strengthening of the AML/CFT regime. Directors urged the authorities to advance key aspects of their plan to promote inclusive growth.

Directors welcomed the candid ex post assessment of Fund long-term work in Afghanistan. They noted that Fund engagement has facilitated the establishment and maintenance of macroeconomic stability and donor support. However, security challenges have led to higher-than-projected security expenditure, delaying the attainment of fiscal sustainability. Volatile aid flows have also complicated policymaking. Looking ahead, Directors stressed the need to focus on macro-critical structural reforms while being mindful of implementation capacity and institutional constraints. They also emphasized the need for realistic assumptions for aid flows and security, stronger donor coordination, continued capacity building, and stronger ownership of reforms.

It is expected that the next Article IV consultation with the Islamic Republic of Afghanistan will be held on the standard 12-month cycle.