On behalf of our Afghan authorities, we would like to thank management and staff for the constructive discussion for this first review of the ECF-supported program. All quantitative targets were met, with the exception of the one on revenue collection, which was missed by a small margin. Advances in structural reforms were achieved with five out of six structural benchmarks being completed. The authorities have requested completion of the first review and a waiver for the minor deviation from the quantitative target on revenue collection by the central government, for which the authorities are taking corrective action.
Recent developments and prospects for 2012
The economy grew by 6 percent in real terms in 2011/12, or slightly above program projections, which is significant given the poor harvest compared to the previous year. With a rebound in agricultural production in 2012, real GDP is expected to grow by 7 percent. Inflation decelerated further in 2011 to single digits, and is expected to be around 7½ percent in 2012, reflecting some easing of international commodity prices and the planned tightening of monetary policy. The operating fiscal deficit was contained at 6.1 percent of GDP in 2011/12, as operating expenditures were reduced in the face of a small revenue shortfall.
The current account deficit, excluding official transfers, increased due to trade disruptions with neighboring countries and higher fuel imports. The deterioration, however, was more than offset by donor support, leading to a larger-than-programmed current account surplus, including official transfers, and higher-than projected accumulation of international reserves.
When considering Afghanistan’s request of a new ECF in support of its program in November 2011, the Executive Board recognized the considerable challenges lying ahead and stressed the importance of strong implementation. Indeed, Afghanistan continues to face severe adverse conditions, including among others, the dire security situation, the disruption of trade with neighboring countries, the economic fallout of the Kabul Bank problem, and the impact of the expected reduction in international presence in the country. Notwithstanding these difficulties, advances have been made in several areas.
In line with the program objectives, the authorities’ efforts have focused on moving forward with the agreed strategy to resolve the Kabul Bank problem, while seizing this opportunity to address broader issues of financial sector reform and economic governance. They also stepped up efforts to achieve other objectives under the ANDS, including revenue mobilization, efficiency in public spending, fiscal sustainability, and poverty reduction.
The Afghan authorities have difficulties with the staff report’s mixed messages. While the report indicates that “the authorities have made substantial progress on their reform objectives under the program,” it also points out that “program implementation has been weak.” The authorities disagree with the latter statement, which is not borne out by actual accomplishments since the program was approved, as detailed in the MEFP and the accompanying Table 1. While delays in tackling structural reforms and complex legal and financial problems are to be expected in a war-torn country with limited capacity, the authorities have taken decisive steps to achieve agreed objectives. Accordingly, they believe that delays in some instances should not be seen as reflecting lack of program ownership. More generally, the authorities are concerned that the unduly negative tone of the report could send the wrong signal to the Tokyo conference and risk undermining donor support to Afghanistan.
Financial sector reform
Resolving the Kabul Bank problem remains a top priority. New Kabul Bank is being readied for privatization, following approval by the cabinet, and an advisor has been appointed to this effect. The bank will be put up for sale in a transparent way to qualified bidders as specified in the structural benchmark for end-September 2012, or wound down by December 2013 if the sale does not materialize.
Following a difficult start, asset recovery from Kabul Bank beneficiaries has accelerated since April 2012 through cash payments and takeover of property. As detailed in the MEFP, further steps to strengthen asset recovery have been taken, including the issuance of a presidential decree on April 4, 2012, mandating that all Kabul Bank beneficiaries shall promptly repay amounts owed in full or face legal action, and establishing a special tribunal in coordination with the Supreme Court to hear Kabul Bank related cases. The authorities have initiated legal proceedings against each beneficiary for the amount indicated in the forensic report, and have brought forward criminal charges against the main architects of the fraud. The authorities have also accelerated civil collections against other beneficiaries, referring cases to the Financial Dispute Resolution Commission for action. Finally, the authorities have made a formal request for mutual legal assistance to the United Arab Emirates in connection with properties located in that country and to trace funds that may have passed through that jurisdiction. To foster transparency of the asset recovery process, progress will be posted on the Central Bank’s website starting in September 2012. While the amount of recovered assets so far, including the book value of seized properties, is not insignificant, the process that has been put in place could yield more tangible results going forward. The authorities are committed to ensuring the success of the asset recovery program, which together with accompanying reforms, will send the right signal about the rule of law and the protection of the financial system.
Aside from Kabul Bank, efforts have focused on addressing other issues of safety, governance, and development of the financial sector (MEFP ¶21–24). On the basis of audits of 10 small banks, which revealed inadequate capitalization, deficiencies in governance, and excessive exposure, the authorities are developing strategies to address these issues, with implementation expected to start in December 2012. Recapitalization of the central bank is expected to be completed before 2014, and the Ministry of Finance and DAB have signed a memorandum of understanding to this effect. Efforts are also underway to upgrade the regulatory framework and strengthen DAB’s supervision capacity.
Finally, the authorities have adopted a broad strategy aimed at combating economic crimes and strengthening cooperation among relevant government entities, and integrated that strategy into the National Priority Program “Justice for All.” An Economic Crime Task Force is being established to coordinate the activities of various government entities related to economic crimes, including among others, enhancing the capacity of the justice system to deal with money laundering, terrorist finance, and asset recovery (MEFP ¶29). In addition, the authorities are taking steps to strengthen the AML/CFT framework in collaboration with the Financial Action Task Force (FATF). New AML/CFT laws will be submitted to parliament in September 2012, and implementation of an action plan agreed with FATF will start at that time (MEFP ¶30).
Progress in structural reforms has been made in several important areas as indicated by staff. In line with the authorities’ strategy to broaden the tax revenue base and raise its share to GDP, a draft VAT law, prepared in consultation with Fund staff, has been submitted to the Ministry of Justice for review and will be sent to parliament for approval in December 2012. The VAT will apply to large taxpayers, who will be identified in the context of the preparatory work underway. To prevent the erosion of the tax base, all “concessions” for importers will be eliminated.
Development of the mining sector will generate significant revenue, which the authorities intend to channel to the budget in a transparent manner under a sound fiscal regime for mineral resources. Preparatory work for this regime is underway in collaboration with the Fund and the World Bank, leading to the submission of draft amendments to the appropriate laws to the ministry of justice by end-June 2013. The fiscal regime for mineral resources will be in full compliance with the Extractive Industries Transparency Initiative.
Efforts have also focused on expenditure, as detailed in the MEFP, including improvements in budget planning and implementation through introduction of budget planning, identification and reduction of fiscal risks stemming from state-owned enterprises, and improvement in cash management, through the planned issuance of Sukuks (Sharia compliant instruments).
Macroeconomic policies will continue to be guided by the need to achieve the ANDS objectives within the ECF-supported program framework, with a particular focus on revenue mobilization to cover an increasing share of operating spending, improved public financial management, lowering inflation, and achieving financial stability. The 2012 budget is in line with the program objectives, monetary policy is appropriately geared toward reducing inflation, and the floating exchange rate will continue to reflect market fundamentals, with DAB intervention limited to smoothing out volatility and achieving its reserve money and international reserves targets.
Afghanistan’s financing needs in connection with the high cost of security and the country’s enormous development needs are very large in relation to the country’s capacity to generate revenue, and its limited room for debt financing. The updated debt sustainability analysis confirms the earlier finding that Afghanistan is at high risk of debt distress and underscores the importance of meeting financing needs with concessional loans and grants, supported by a strong reform agenda. The outlook, however, appears more difficult, as a growing share of the security cost and operating expenditure will be transferred to the domestic budget, and the security cost has been substantially revised upward. As such, fiscal sustainability, as defined in the program, is now projected to be reached in 2032 instead of 2025.
While the authorities are yet to finalize their projections and financing request for the Tokyo conference, they reaffirm their commitment to the reform strategy under the ANDS, which has been endorsed by the donor community, and will seek adequate financing for its full implementation commensurate with the large developmental and poverty-reduction needs and the objectives of maintaining macroeconomic stability and achieving debt sustainability.
Performance under the ECF-supported program has been adequate and the authorities have demonstrated their commitment to achieving the agreed objectives despite the severe adverse conditions. The authorities are aware that the road toward achieving their development objectives will be long and arduous, and are determined to persevere with reforms in all relevant areas, with adequate donor support. They are highly appreciative of Fund support and technical assistance, but wish to underscore the importance of flexibility and better understanding of the extraordinary difficulties under which reforms are being carried out.