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Islamic Republic of Afghanistan: Joint World Bank/IMF Debt Sustainability Analysis Update

Author(s):
International Monetary Fund
Published Date:
August 2012
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Afghanistan continues to be at a high risk of debt distress.1, 2 Following debt relief under the enhanced HIPC initiative and MDRI, Afghanistan’s external and public debt burden indicators have improved. However, and as noted in the HIPC Initiative Paper prepared in early 20103 and the November 2011 debt sustainability analysis,4 debt burden indicators could deteriorate rapidly if Afghanistan’s substantial financing needs were met with new loans, even concessional ones, instead of the hoped for grant financing, which would be discussed at the upcoming Tokyo Conference. Afghanistan’s vulnerability is illustrated by the country-specific alternative scenarios.

A. Macroeconomic Outlook

1. The growth outlook underlying the DSA remains cautiously optimistic and is predicated on a stable security situation and grant-financed social and development spending. Real GDP growth rates are projected to reach an average of 5.5 percent during 2013–20 and to decline to about 4 percent thereafter (Box 1).5 The mining sector, as part of industry, is expected to become an important contributor to growth, in addition to agriculture and services. To support sustainable inclusive growth, Afghanistan’s business environment and economic governance will need to be strengthened significantly.

Box 1.Macroeconomic Assumptions Comparison Table 1/
DSA Nov. 2011DSA June 2012Differences

(current vs. previous)
2011-152016-3020122012-162017-32Medium termLong term
Real growth (%)6.14.66.45.94.4-0.2-0.2
Inflation (GDP deflator, %)6.24.39.06.15.0-0.10.7
Nominal GDP (Bil. Afghani)10822947102812983586216639
Revenue and grants (% GDP)24.022.917.229.935.15.912.2
Grants (% GDP)11.45.58.917.418.56.113.0
Primary expenditure (% GDP)25.124.917.430.336.45.211.4
Primary deficit (% GDP)-1.2-2.1-0.3-0.4-1.20.80.8
Exports of G&S (% GDP)16.022.415.814.824.5-1.22.2
Imports of G&S (% GDP)48.432.460.954.847.46.515.0
Noninterest current account deficit (% GDP)-2.6-1.52.2-1.3-2.01.3-0.5
_______________________

The differences in projections between the current and the previous DSAs are largely explained by new and improved information available at this stage. In particular, higher imports and grants reflect better accounting for the off-budget activities by the international community.

The differences in projections between the current and the previous DSAs are largely explained by new and improved information available at this stage. In particular, higher imports and grants reflect better accounting for the off-budget activities by the international community.

2. Over the medium term, domestic revenue is expected to be boosted by tax measures and mining revenues. The implementation of a VAT in 2014 could generate about 2 percent of GDP. In addition, the updated DSA incorporates the introduction of excises in 2018, yielding about 1 percent of GDP, to achieve the authorities’ revenue target presented at the Bonn Conference in December 2011; alternative revenue measures could be considered. Fiscal revenue stemming from mining projects could reach 2 percent of GDP by 2020, but there is significant uncertainty over the timing and level of these revenues. With these measures and developments in place, domestic revenue could reach 17 percent of GDP by 2025; a level that is in the upper range of what comparable countries achieve.

3. Expenditures will be driven by security, the take-over of the recurrent costs associated with donor projects, and the size of the civil service, and development needs:

  • Security-related outlays are estimated by the International Security Assistance Force (ISAF) to reach US$4.1 billion in 2017 (or 14 percent of GDP). These projections assume that the size of the security forces is reduced by about one third in 2015–16—about 120,000 troops. The authorities believe that such a sharp reduction may not be feasible over such a short period of time. If the troop size stayed at 350,000, security costs would be about US$700 million higher in 2017 (2½ percent of GDP). Beyond 2017 and with a constant troop size, security costs would decline only marginally as a share of GDP.
  • Operating expenditures are expected to rise by a cumulative 4–5 percent of GDP by 2018, as the government assumes responsibility for previously donor-funded projects. In addition, operating expenditures will be pushed up by increases in the size of the civil service, mainly in the education and health sectors. At the same time, wage growth is projected quite conservatively at 1 percentage point over inflation, implying that the civil service would not benefit in full from the gains of real GDP growth. This may create wage pressures and could lead to even higher spending.
  • Given Afghanistan’s large development needs, the government is assumed to target development spending of 10 percent of GDP.

4. In view of these revenue and expenditure trends, Afghanistan’s total financing needs are expected to remain higher than those of comparable low-income countries. Over the long term, the overall deficit (excluding grants) will remain at around 25 percent of GDP (Figures 1 and 2). A small share of this is likely to be financed from external concessional loans, and there is also some scope for domestic financing through the sukuk instrument that will be introduced in 2014—mainly for market development and liquidity management purposes. The remaining financing gap is expected to stabilize at just over 20 percent of GDP in 2020 and beyond.

5. In this scenario, Afghanistan would continue to rely on donor support even for nonsecurity operating spending. Fiscal sustainability—defined as domestic revenues covering operating expenditures—is becoming a more distant goal, likely to be reached only after 2032. In the November 2011 DSA, fiscal sustainability was projected to be reached in 2025. The reason for this deterioration in outlook is that the current projections—based on better information—now incorporate the full operations and maintenance costs related to donor-funded projects in both security and the nonsecurity sectors. In the November 2011 DSA, this had been included as a risk since full information on the cost implications was not available.

Figure 1.Afghanistan: Current Account Balance Excluding Grants

(In percent of GDP)

1/ Estimated activity off-budget by international community.

Figure 2.Afghanistan: Current Account Balance Including Grants

(In percent of GDP)

6. The scenario desribed above is only viable if donors meet the government’s financing needs of 20 percent of GDP with grants through 2025 and beyond. The May 2012 Chicago NATO summit fell short by US$300 million of the US$4.1 billion target considered necessary to cover Afghanistan’s security spending needs through 2017, implying that security remains underfunded. The summit also asked that the government of Afghanistan should assume full responsibility for its financing needs by 2024, hence eliminating its dependency on donor aid in this sector. While a progressive increase in Afghanistan’s contribution to the financing of its security needs is incorporated in the scenario, full financing of security by domestic revenues could only be achieved by (i) cutting security spending, or (ii) reallocating substantial domestic resources toward security spending at the cost of development spending, leaving the latter significantly underfunded. This increases the pressure on development assistance, which will be discussed at the Tokyo Conference on July 8th. At the time of writing, the authorities were still finalizing their own projections and financing request for this conference.

7. In case donor funding should not be forthcoming over the longer term in the amounts needed to fill the financing gap, the authorities will face difficult decisions. Any grant shortfall will have to be met by additional revenue measures, which may be limited, or by spending cuts. Such fiscal consolidation is likely to weigh on short-term and long-term growth. There is only very limited scope to substitute debt financing for grants.

8. Given the large trade-off between civilian and development spending, the authorities should conduct regular public expenditure reviews to ensure that the expenditure mix remains appropriate. Under the baseline scenario, security spending remains high at 14.5 percent of GDP, compared to about 2–5 percent of GDP in other post-conflict countries, though security situations are not easily comparable. The adequate provision of security services will remain a principal development objective in Afghanistan. However, over the years, the authorities should periodically review the country's security needs in line with developments. If the security situation were to be better than what underpins ISAF's projections, security spending might be lower than currently expected. In this context, the authorities can explore opportunities for more efficient, effective and transparent spending in all areas of government activity.

B. Debt Sustainability Analysis

9. Although Afghanistan’s external and public debt burden indicators have improved significantly, following debt relief under the enhanced HIPC initiative and MDRI, the country remains at high risk of external debt distress. In 2011, Afghanistan’s external public and publicly guaranteed debt amounted to US$1.2 billion, or 7 percent of GDP, in 2011 (Tables 1 and 2). The bulk of this debt was owed to Paris Club and multilateral creditors. In present value terms, it reached about 4 percent of GDP at end-2011. Under the baseline scenario—in which Afghanistan’s financing needs are fully met by grants—the present value of public external debt would reach about 5 percent of GDP by the end of the projection period, below the indicative debt-burden threshold applying to a country like Afghanistan.6 However, as set out in the alternative scenarios below, significant risks remain.

Table 1.Afghanistan: External Debt Sustainability Framework, Baseline Scenario, 2009–2032 1/(In percent of GDP, unless otherwise indicated)
ActualHistorical 6/Standard 6/Projections
AverageDeviation2012-20172018-2032
200920102011201220132014201520162017Average20222032Average
External debt (nominal) 1/9.38.27.06.66.76.86.97.07.27.48.4
o/w public and publicly guaranteed (PPG)9.38.27.06.66.76.86.97.07.27.48.4
Change in external debt-20.5-1.1-1.2-0.40.00.20.10.10.20.10.1
Identified net debt-creating flows-8.8-7.9-6.1-3.7-3.6-2.9-0.9-0.30.1-0.3-0.5
Non-interest current account deficit-1.7-3.9-3.4-2.32.5-1.8-0.60.73.03.73.62.41.22.1
Deficit in balance of goods and services76.762.658.358.454.850.046.640.437.532.531.9
Exports4.94.54.44.64.85.76.38.19.316.916.8
Imports81.667.162.762.959.655.852.948.546.749.448.6
Net current transfers (negative = inflow)-60.2-50.8-47.8-51.628.7-48.3-45.5-40.6-35.4-28.8-26.3-23.2-21.5-22.6
o/w official-57.6-48.5-45.7-46.3-43.6-38.8-33.6-27.1-24.6-21.7-20.3
Other current account flows (negative = net inflow)-18.2-15.7-13.8-11.8-9.9-8.7-8.1-7.9-7.5-6.8-9.2
Net FDI (negative = inflow)-2.4-2.0-1.7-2.21.4-1.6-2.7-3.4-3.7-3.8-3.4-2.5-1.5-2.3
Endogenous debt dynamics 2/-4.7-2.0-1.0-0.3-0.3-0.2-0.2-0.2-0.1-0.2-0.2
Contribution from nominal interest rate0.10.00.00.10.10.10.20.20.20.10.1
Contribution from real GDP growth-5.3-0.6-0.4-0.3-0.4-0.4-0.4-0.3-0.3-0.3-0.3
Contribution from price and exchange rate changes0.4-1.4-0.7
Residual (3-4) 3/-11.76.74.93.33.63.11.00.40.10.40.6
o/w exceptional financing-8.50.00.00.00.00.00.00.00.00.00.0
PV of external debt 4/4.03.94.04.14.24.24.34.65.6
In percent of exports90.685.383.171.666.252.146.727.333.6
PV of PPG external debt4.03.94.04.14.24.24.34.65.6
In percent of exports90.685.383.171.666.252.146.727.333.6
In percent of government revenues38.334.735.330.729.729.129.727.732.7
Debt service-to-exports ratio (in percent)2.41.01.01.83.54.43.12.52.11.11.6
PPG debt service-to-exports ratio (in percent)2.41.01.01.83.54.43.02.52.11.11.6
PPG debt service-to-revenue ratio (in percent)1.10.40.40.71.51.91.41.41.31.11.6
Total gross financing need (millions of U.S. dollars)-497.6-930.1-922.9-665.8-697.5-583.2-114.629.0116.131.6-27.9
Non-interest current account deficit that stabilizes debt ratio18.8-2.8-2.2-1.4-0.70.52.93.63.52.31.1
Key macroeconomic assumptions
Real GDP growth (in percent)21.08.45.88.86.05.26.55.95.95.34.25.54.44.04.4
GDP deflator in US dollar terms (change in percent)-1.517.78.68.86.23.83.41.81.01.01.02.01.21.31.1
Effective interest rate (percent) 5/0.50.50.50.40.21.11.92.32.52.52.42.11.21.31.3
Growth of exports of G&S (US dollar terms, in percent)-15.117.312.59.212.012.715.328.617.137.120.521.914.05.410.1
Growth of imports of G&S (US dollar terms, in percent)6.44.97.411.56.19.64.20.91.4-2.41.52.57.75.65.8
Grant element of new public sector borrowing (in percent)32.533.633.737.137.237.335.237.938.738.2
Government revenues (excluding grants, in percent of GDP)10.311.010.511.311.313.414.014.514.516.717.216.8
Aid flows (in millions of US dollars) 7/1,2761,7481,7992,3942,6802,8736,8546,2105,7637,58312,000
o/w Grants1,2761,7481,7982,3762,6592,8506,8296,1835,7347,53611,887
o/w Concessional loans0.30.20.218.520.722.824.826.928.946.6113.4
Grant-equivalent financing (in percent of GDP) 8/12.012.312.227.123.120.420.018.919.3
Grant-equivalent financing (in percent of external financing) 8/98.296.396.298.798.598.398.397.898.1
Memorandum items:
Nominal GDP (millions of US dollars)12,48715,94018,31519,99722,03023,74725,40727,04328,44738,17163,883
Nominal dollar GDP growth19.327.714.99.210.27.87.06.45.27.65.75.35.5
PV of PPG external debt (in millions of US dollars)7137708679581,0371,1191,2061,7333,536
(PVt-PVt-1)/GDPt-1 (in percent)0.30.50.40.30.30.30.40.40.40.4
Gross workers’ remittances (millions of US dollars)0.00.00.00.00.00.00.00.00.00.00.0
PV of PPG external debt (in percent of GDP + remittances)4.03.94.04.14.24.24.34.65.6
PV of PPG external debt (in percent of exports + remittances)90.685.383.171.666.252.146.727.333.6
Debt service of PPG external debt (in percent of exports + remittance1.01.83.54.43.02.52.11.11.6
Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 2.Afghanistan: Public Sector Debt Sustainability Framework, Baseline Scenario, 2009-2032(In percent of GDP, unless otherwise indicated)
ActualEstimateProjections
Average 5/Standard Deviation 5/2012-172018-32
200920102011201220132014201520162017Average20222032Average
Public sector debt 1/9.38.27.06.66.77.17.38.18.29.816.2
o/w foreign-currency denominated9.38.27.06.66.76.86.97.07.27.48.4
Change in public sector debt-20.5-1.1-1.2-0.40.00.40.30.80.10.40.9
Identified debt-creating flows-12.9-3.2-0.23.02.01.01.3-0.60.70.01.0
Primary deficit1.3-0.90.52.43.21.00.7-0.30.81.40.90.80.41.50.9
Revenue and grants20.522.020.323.223.425.440.937.434.736.435.8
of which: grants10.211.09.811.912.112.026.922.920.219.718.6
Primary (noninterest) expenditure21.821.120.924.224.125.141.738.735.636.837.3
Automatic debt dynamics-5.5-1.9-0.7-0.6-0.5-0.3-0.3-0.3-0.2-0.4-0.5
Contribution from interest rate/growth differential-5.3-0.8-0.5-0.4-0.4-0.3-0.3-0.3-0.3-0.4-0.6
of which: contribution from average real interest rate-0.1-0.1-0.10.00.00.00.00.10.00.00.0
of which: contribution from real GDP growth-5.2-0.7-0.4-0.3-0.4-0.4-0.4-0.4-0.3-0.4-0.6
Contribution from real exchange rate depreciation-0.2-1.1-0.2-0.3-0.10.00.10.10.1
Other identified debt-creating flows-8.7-0.3-0.12.61.91.60.7-1.80.00.00.0
Privatization receipts (negative)-0.2-0.3-0.1-0.4-0.30.0-0.4-2.5-0.40.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)-8.50.00.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.02.92.11.61.10.70.30.00.0
Residual, including asset changes-7.62.0-1.0-3.3-2.0-0.6-1.01.4-0.50.40.0
Other Sustainability Indicators
PV of public sector debt4.03.94.04.44.65.35.47.013.4
o/w foreign-currency denominated4.03.94.04.14.24.24.34.65.6
o/w external4.03.94.04.14.24.24.34.65.6
PV of contingent liabilities (not included in public sector debt)
Gross financing need 2/1.3-0.90.61.10.8-0.11.01.51.10.62.0
PV of public sector debt-to-revenue and grants ratio (in percent)19.816.917.117.111.214.115.419.337.5
PV of public sector debt-to-revenue ratio (in percent)38.334.735.332.532.636.436.842.178.2
o/w external 3/38.334.735.330.729.729.129.727.732.7
Debt service-to-revenue and grants ratio (in percent) 4/0.10.10.40.40.60.70.30.30.40.61.4
Debt service-to-revenue ratio (in percent) 4/0.20.20.70.91.11.30.80.80.91.32.9
Primary deficit that stabilizes the debt-to-GDP ratio21.80.21.71.40.6-0.70.60.60.80.00.6
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)21.08.45.88.86.05.26.55.95.95.34.25.54.44.04.4
Average nominal interest rate on forex debt (in percent)0.50.50.50.40.21.11.92.32.52.52.42.11.21.31.3
Average real interest rate on domestic debt (in percent)2.24.40.22.30.60.50.6
Real exchange rate depreciation (in percent, + indicates depreciat-0.7-13.4-2.4-7.44.6-3.8
Inflation rate (GDP deflator, in percent)-4.79.413.39.56.29.06.75.14.85.05.05.95.15.05.0
Growth of real primary spending (deflated by GDP deflator, in percent)0.20.00.00.20.10.20.10.10.80.00.00.20.10.00.0
Grant element of new external borrowing (in percent)32.533.633.737.137.237.335.237.938.7
Sources: Country authorities; and staff estimates and projections.

Refers to net public debt of the central government.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Sources: Country authorities; and staff estimates and projections.

Refers to net public debt of the central government.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

10. The first alternative scenario depicts a deterioration of the fiscal outlook with more limited access to grants. As a proxy for the above, Tables 3a, 3b, and 4 and Figures 3 and 4 present the results of a customized alternative “lower grants” scenario in which grants are expected to fall short by 50 percent compared to the baseline. This implies that Afghanistan would still receive about 10 percent of GDP in grants, the upper range for comparable low-income countries. The government is assumed to have access to concessional loans, and hence the economy adjusts by borrowing both externally and domestically to offset the shortfall in grants. As a result, Afghanistan would face a rapid deterioration of debt burden indicators, with the PV of the debt-to-GDP ratio reaching 105 percent, the PV of the debt-to-exports ratio projected at 628 percent, and the PV of debt-to-revenue ratio reaching exceeding 600 percent by the end of the projection period. Other thresholds would also be breached. A shortfall in grants may also entail external adjustment needs, i.e. pressure on the exchange rate, which would add to the debt burden.

Figure 3.Afghanistan: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2012-2032

Sources: Country authorities; and staff estimates and projections.

Figure 4.Afghanistan: Indicators of Public Debt Under Alternative Scenarios, 2012-2032

Sources: Country authorities; and staff estimates and projections.

1/ Revenues are defined inclusive of grants.

Table 3a.Afghanistan: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2012-2032(In percent)
Projections
20122013201420152016201720222032
PV of debt-to GDP ratio
Baseline44444456
A. Alternative Scenarios
A1. Lower real GDP growth rate44445568
A2. Lower grants847977758189111105
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2013-201444444556
B2. Export value growth at historical average minus one standard deviation in 2013-2014 3/44666666
B3. US dollar GDP deflator at historical average minus one standard deviation in 2013-201444444456
B4. Net non-debt creating flows at historical average minus one standard deviation in 2013-2014 4/420323130302615
B5. Combination of B1-B4 using one-half standard deviation shocks41012121212118
B6. One-time 30 percent nominal depreciation relative to the baseline in 2013 5/46666668
PV of debt-to-exports ratio
Baseline8583726652472734
A. Alternative Scenarios
A1. Lower real GDP growth rate8583737055502936
A2. Lower grants1823164713411192999967663628
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2013-20148582706551462733
B2. Export value growth at historical average minus one standard deviation in 2013-2014 3/851091601451131005558
B3. US dollar GDP deflator at historical average minus one standard deviation in 2013-20148582706551462733
B4. Net non-debt creating flows at historical average minus one standard deviation in 2013-2014 4/8540755649337432315691
B5. Combination of B1-B4 using one-half standard deviation shocks852303112782131859471
B6. One-time 30 percent nominal depreciation relative to the baseline in 2013 5/8582706551462733
PV of debt-to-revenue ratio
Baseline3535313029302833
A. Alternative Scenarios
A1. Lower real GDP growth rate3535323233343857
A2. Lower grants742699575535556613667608
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2013-20143536323130312934
B2. Export value growth at historical average minus one standard deviation in 2013-2014 3/3539444240403636
B3. US dollar GDP deflator at historical average minus one standard deviation in 2013-20143535302929292732
B4. Net non-debt creating flows at historical average minus one standard deviation in 2013-2014 4/3517323822120920515989
B5. Combination of B1-B4 using one-half standard deviation shocks3586918581806547
B6. One-time 30 percent nominal depreciation relative to the baseline in 2013 5/3549424140413845
Table 3b.Afghanistan: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2012-2032 (continued)(In percent)
Debt service-to-exports ratio
Baseline23432212
A. Alternative Scenarios
A1. Lower real GDP growth rate23433212
A2. Lower grants234310173483
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2013-201423432212
B2. Export value growth at historical average minus one standard deviation in 2013-2014 3/24764423
B3. US dollar GDP deflator at historical average minus one standard deviation in 2013-201423432212
B4. Net non-debt creating flow s at historical average minus one standard deviation in 2013-2014 4/239118777
B5. Combination of B1-B4 using one-half standard deviation shocks24986545
B6. One-time 30 percent nominal depreciation relative to the baseline in 2013 5/23432212
Debt service-to-revenue ratio
Baseline11211112
A. Alternative Scenarios
A1. Lower real GDP growth rate11212223
A2. Lower grants11216103480
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2013-201412211112
B2. Export value growth at historical average minus one standard deviation in 2013-2014 3/11222212
B3. US dollar GDP deflator at historical average minus one standard deviation in 2013-201411211112
B4. Net non-debt creating flows at historical average minus one standard deviation in 2013-2014 4/11455577
B5. Combination of B1-B4 using one-half standard deviation shocks11322233
B6. One-time 30 percent nominal depreciation relative to the baseline in 2013 5/12322222
Memorandum item:
Grant element assumed on residual financing (i.e., financing required above baseline) 6/3636363636363636
Sources: Country authorities; and staff estimates and projections.1/ Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.2/ Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Sources: Country authorities; and staff estimates and projections.1/ Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.2/ Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 4.Afghanistan: Sensitivity Analysis for Key Indicators of Public Debt 2012-2032
Projections
20122013201420152016201720222032
PV of Debt-to-GDP Ratio
Baseline444555713
A. Alternative scenarios
A1. Lower real GDP growth rate4457101244191
A2. Lower grants84798191100109131124
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2013-204456781325
B2. Primary balance is at historical average minus one standard deviations in 2013-20147111111111217
B3. Combination of B1-B2 using one half standard deviation shocks469910101117
B4. One-time 30 percent real depreciation in 2013466666814
B5. 10 percent of GDP increase in other debt-creating flows in 201349999101218
PV of Debt-to-Revenue Ratio 2/
Baseline1717171114151938
A. Alternative scenarios
A1. Lower real GDP growth rate171720182434107434
A2. Lower grants361338379312364407445423
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2013-201718211519233468
B2. Primary balance is at historical average minus one standard deviations in 2013-2011730432730333448
B3. Combination of B1-B2 using one half standard deviation shocks1726352226283149
B4. One-time 30 percent real depreciation in 20131724221417182140
B5. 10 percent of GDP increase in other debt-creating flows in 20131740362225283350
Debt Service-to-Revenue Ratio 2/
Baseline01100011
A. Alternative scenarios
A1. Lower real GDP growth rate011011317
A2. Lower grants011124823
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2013-2001111113
B2. Primary balance is at historical average minus one standard deviations in 2013-20101111113
B3. Combination of B1-B2 using one half standard deviation shocks01111112
B4. One-time 30 percent real depreciation in 201301111112
B5. 10 percent of GDP increase in other debt-creating flows in 201301211113
Sources: Country authorities; and staff estimates and projections.1/ Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Sources: Country authorities; and staff estimates and projections.1/ Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

11. Risks to the outlook are tilted to the downside, linked to security prospects and the strength of future reforms.7 A fragile security situation, in combination with delays in key reforms, would potentially discourage investment and external support, and also result in lower exports, as well as a slowdown in revenue effort. Under the second alternative scenario, real GDP growth falls from 3 percent on average (instead of 5.5 percent in the baseline) in the medium-term (2013–20) to 1 percent (instead of 4 percent in the baseline) in the long-term (2025–30). Tables 3a, 3b, and 4 and Figures 3 and 4 present the results of a customized alternative “low-growth” scenario, depicting the absence of gains in security, governance, and public sector reforms, as well as a slower reform path with respect to financial sector reform and the business environment. Under this scenario, the PV of debt-to-GPD ratio approaches 200 percent, while the PV of debt-to-revenue ratio is expected to reach 434 percent by the end of the forecast period, leaving very limited fiscal space for investments or social expenditure. Accordingly fiscal debt indicators set out on an explosive path, threatening the sustainability of government functions.

C. Conclusions

12. Afghanistan remains at high risk of debt distress after the HIPC completion point and delivery of debt relief under the MDRI. Despite the substantial amount of debt forgiven under the HIPC and MDRI, Afghanistan’s very high security and development spending needs as well as risks to the macroeconomic outlook underscore the importance of substantial long-term grant financing, in combination with a strong reform agenda and progress in security and governance. Should donor support be insufficient to meet the country’s financing needs, security fail to stabilize, or structural reforms and governance improvements fail to materialize, Afghanistan’s debt burden would become unsustainable, and the government would be forced to undertake significant fiscal adjustment. As such, the government needs to prioritize very carefully its spending needs and avoid rapid expenditure increase until continuous financing has been clearly identified or domestic revenue mobilization picks up commensurately.

1

The results presented here are based on an update of the debt sustainability analysis based on the joint IMF/World Bank debt sustainability framework for low-income countries (see http://www.imf.org/external/pubs/ft/dsa/lic.htm and http://www.imf.org/External/np/pp/eng/2005/032805.htm).

2

The LIC DSA compares the evolution over the projection period of debt-burden indicators against policy-dependent indicative thresholds, using the three-year average of the World Bank’s Country Policy and Institutional Assessment (CPIA). With an average 2010 CPIA of 2.5, Afghanistan is classified as a “weak performer” according to the Debt Sustainability Framework (DSF).

3

Afghanistan: HIPC Initiative Paper, IMF Country Report No. 10/40 (http://www.imf.org/external/pubs/ft/scr/2010/cr1040.pdf); and Memorandum and Recommendation of the President of the International Development Association to the Executive Directors on Assistance to the Islamic Republic of Afghanistan under the Enhanced Heavily Indebted Poor Countries Initiative and the Multilateral Debt Relief Initiative Report No.51184-AF.

5

GDP estimates do not reflect opium production.

6

Afghanistan is classified as a “weak performer” and its thresholds therefore: 30 percent of NPV for the debt- to-GDP ratio; 100 percent of NPV for the debt-to-exports ratio; 200 percent for the debt-to-revenue ratio; 15 percent for the debt service-to-exports ratio; and 25 percent for the debt service-to-revenue ratio.

7

This DSA does not include the standard stress tests, as these would not be characterized by additional vulnerabilities.

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