Kabul seeks IMF support for economy

Kabul, December 6, 2004 - The IMF released last month a detailed report based on its first review of the Staff-monitored Programme or SMP for Afghanistan. This 40-page report provides an insight into the current state of the Afghan economy. The 12-month SMP for fiscal year 05 (March 20, 2004-March 20, 2005) is aimed at maintaining financial stability and preparing the country to qualify for an IMF- supported arrangement under PRGF.

The report says that the GDP of the land-locked country may grow by 16 per cent to $5.802 billion in FY05, depicting no change in the growth rate over a year. But it says that per capita GDP may rise to $246 from $199 in the last fiscal year.

This GDP estimate excludes the opium production which, according to a recently released report of the United Nation's Office on Drugs and Crime, grew by 17 per cent to 4200 tons in 2004 from 3600 tons in 2003. The report says that the export value of this huge opium production rose by 22 per cent to $2.8 billion in 2004 from $2.3 billion in 2003.

The report says that year-on-year increase in CPI inflation during this fiscal year may reach 10.2 per cent, down slightly from last year's 10.3 per cent. Inflation used to be measured only in Kabul till the first quarter of FY05 ending in June 2004. The government is, however, trying to extend the CPI coverage to five other main cities. Year-on-year increase in CPI inflation for the first quarter of this year was recorded at 6.9 per cent, up from 2.5 per cent in the first quarter of the last fiscal year. This can be attributed to higher house rents, increase in education fees and transportation cost and more expensive healthcare.

The report says that real GDP grew by an estimated 16 per cent in the last fiscal year against an initial estimate of 23 per cent due to lower-than-anticipated output in the agricultural sector. The poor performance of the agricultural sector can be attributed primarily to the lingering drought affecting some regions and to a lower out turn in the hydroelectric sector, which also was adversely affected by the drought.

The external sector of Afghanistan may continue to show signs of weakness. The IMF report says that the current account deficit excluding grants may rise to $2.839 billion during this fiscal year from last year's $2.578 billion. But it says that with the donors' grants taken into account, this huge current account deficit will shrink to just $1.6 million, still up from last year's $900,000.

The Fund estimates that Afghanistan' exports including re-exports may reach $1.823 billion whereas its imports may touch $4.134 billion during this fiscal year. In the last fiscal year, exports were estimated at $1.701 billion and imports at $3.759 billion.

The IMF report says that the new Afghani, Afghanistan's currency unit, has remained strong through the first quarter of 2004/05, reflecting an increased willingness among the population, particularly in rural areas, to accept the new currency as a medium of exchange and a store of value. Da Afghanistan Bank (central bank of Afghanistan) or DAB had introduced the new Afghani on October 7, 2002 to ensure that the country uses a single currency. Earlier, various versions of the Afghani were in circulation across Afghanistan. The new currency unit was given the worth of 1000 old Afghanis because those had lost their value to the extent that people had to carry a sack full of them to do shopping. The Afghani remained strong in the last fiscal year also due to prudent macroeconomic policies including strict application of a "no-overdraft rule" by the ministry of finance and adherence by DAB to the monetary growth targets set out in the SMP.

The IMF report says that fiscal revenue for the first quarter of 2004/05 reached Af 2.64 billion, slightly exceeding the SMP target of Af 2.59 billion. Given the high level of demand for improved security, reconstruction, and poverty reduction, the IMF mission emphasized the need for the government to try and meet its spending objectives in these priority areas while ensuring that appropriate expenditure controls are in place to safeguard and account for these resources.

Future outlook: The IMF discussions with the Afghan authorities focused on maintaining macroeconomic stability in a period of massive economic change, along with capacity building and the structural reforms necessary to support successful performance under the SMP. The IMF remains concerned about potential downside risks to the macroeconomic outlook because of continued insecurity in a number of provinces and the re-emergence of drought. But "these appear balanced by the continuous delivery of external assistance following the March 31-April 1 Berlin donors' conference, growing confidence in the Afghani, and the expected coming on-stream of several projects in the agricultural and manufacturing sectors," says the IMF report. Besides, the pace of structural and policy reforms over the last two years has remained encouraging. Critical measures, such as licensing of commercial banks, passage of key customs and revenue reforms, improved financial and fiscal reporting, adoption of a comprehensive current and development budget, improved public expenditure management, and some initial steps in dealing with civil service pay reform and state-owned enterprises (SOEs), are laying a strong basis for future performance.

Fiscal issues: Meeting the revenue targets set out under the program will require concerted efforts by the authorities to address deficiencies in collection and transfer. The Afghan government has reiterated its commitment to fully implement a wide range of planned customs and tax reforms, step up collection efforts, particularly in the provinces for customs, and eliminate tax holidays and concession agreements. The IMF has urged upon the Afghan authorities that expenditure management must be improved if development objectives are to be met. "In spite of the slow pace of operating budget spending during the first quarter of the year, the (IMF) staff strongly supports the authorities' efforts to enforce appropriate expenditure controls to ensure accountability," says the IMF report.

Monetary policy: The built-in flexibility mechanism in the monetary program developed with the Fund staff in March 2004 will help the DAB to continue to effectively implement a monetary policy stance aimed at lowering inflation, while guarding against currency instability. In line with the SMP, the authorities continue to target currency in circulation and allow for some movement in the exchange rate. As designed, the monetary program allows the central bank some room to accommodate apparent shifts in money demand. Should the available flexibility in the monetary program prove insufficient, the staff stands ready to discuss with the authorities the need for an adjustment of the monetary policy framework. Close attention to available macroeconomic and financial indicators will be critical in this regard. However, as the current consumer price index (CPI)-which is limited to Kabul-is still a weak indicator for inflation across the country, relatively more attention will be devoted to exchange rate developments. Further attention must also be devoted to better understanding the factors driving monetary conditions in Afghanistan. Monthly cash flow projections from the ministry of finance, for example, will be one crucial element in this exercise.

After the July mission, and in consultation with Fund staff, DAB exceeded the target for currency in circulation to limit the appreciation of the Afghani. Structural reforms: The authorities have taken welcome steps to begin rationalizing the public enterprise sector and create an environment conducive to private sector-led growth. The authorities are currently conducting an assessment of the financial situation of SOEs, which will help them decide which enterprises are to be liquidated, which are to be privatized, and which are to remain in the government's portfolio. An action plan is also being prepared to address critical deficiencies in the investment climate. Key measures are to center on reform of the commercial code, property rights, and bankruptcy legislation.

The authorities intend to continue their efforts to create a sound financial system. In this context, the central bank will work toward improving the payments system, which is an essential element in extending the delivery of government services outside of Kabul. The DAB will also proceed with bank licensing and strengthen its supervision. In addition, the central bank is working toward having a proper balance sheet by eliminating its commercial activities and transferring non-monetary assets to the ministry of finance. Finally, an auction process for a short-term capital note will be introduced. That will be the first step in establishing a benchmark interest rate and domestic credit market.