The IMF-supported economic program’s key objectives are to make significant progress toward a stable and sustainable macroeconomic position while managing the challenges of the withdrawal of the international presence in Afghanistan; strengthening the banking system and addressing the governance and accountability issues highlighted by the Kabul Bank crisis; moving toward fiscal sustainability; and improving the transparency and efficiency of public spending and services to protect the poor.Following the Executive Board’s discussion of Afghanistan, Ms. Nemat Shafik, Deputy Managing Director and Acting Chair, said:

Despite a difficult political and security situation, Afghanistan has made important achievements in recent years. Growth has averaged over 10% in the last five years, inflation was moderate, and domestic revenues increased by 3% of GDP.

After the collapse of Kabul Bank, the authorities took action to contain the situation and prevent a broader financial meltdown, including providing a full deposit guarantee. Since then, Kabul Bank was split into a good bank and a bad bank, and an in-depth audit is under way to establish who benefited from the fraudulent activities. Asset recovery and legal actions against the architects of the fraud have lagged and need to be pursued more forcefully. It is important that the relevant prior action is fully met before the first review of the program.

Over the next three to five years, the withdrawal of the international military presence and an expected decline in foreign aid will pose significant economic policy challenges. The government will have to take over activities currently financed by donors, including shouldering a larger share of security spending. Thus, while donor support is projected to remain substantial, the expected gradual decline will curtail the fiscal space and require external adjustment.

The authorities’ three-year program, supported by the Fund’s Extended Credit Facility, will help address these short and medium-term challenges and provide the basis for sustained inclusive growth and poverty reduction in line with Afghanistan’s National Development Strategy. It is important that the authorities accelerate measures to enhance governance, including strengthening the banking law and financial sector supervision, as well as the framework for anti-money laundering and combating the financing of terrorism. They are also encouraged to be more ambitious on domestic revenue mobilization, which may require measures in addition to the planned revenue administration reforms and the introduction of a value-added tax in 2014.

Recent Economic Developments

The authorities have taken steps to lay the foundation for economic stability and growth, despite a very difficult security situation and the challenges associated with building political and economic institutions. As a result, economic activity has been robust, with real GDP growth averaging more than 10% annually over the past five years. The government has increased revenue collection to 11% of GDP in 2010/11 from 8% in 2008/09, though current collection levels cover only about two-thirds of central government operating expenditures.

Some poverty indicators have improved over the last decade, but Afghanistan remains one of the poorest countries in the world. Per-capita income was $530 in 2010/11. The national poverty rate was 36% in 2007/08, as measured by the National Risk and Vulnerability Assessment, and the rates are higher in rural and mountainous areas that account for about 80% of the population.

Program Summary

Stabilizing the economy. Despite an expected decline in overall donor assistance, the authorities’ goal is to sustain annual real GDP growth at about 6-7% over the next three years, supported by an expansion in the non-agricultural sector and mining investment. Cognizant of the negative effects of inflation, particularly on the poor, the authorities also plan to strive to bring inflation down. Sustained donor funding and a stable economy will support the balance of payments and provide the basis for high and inclusive growth.

Strengthening the banking and financial sectors. The authorities have designed and started implementing a comprehensive strategy to strengthen the banking system, to lower fiscal costs associated with Kabul Bank’s failure, and to address governance issues. This strategy includes resolving Kabul Bank, drawing lessons from its failure, promoting transparency, governance and the framework for protecting the financial system from economic crime, as well as addressing moral hazard, and strengthening banking supervision and safeguarding a financial system based on integrity and the rule of law.

Moving toward fiscal sustainability. Fiscal sustainability will depend on sustained increases in revenues together with prioritized spending reflecting development and security priorities. The program envisages an increase in domestic revenues of 0.6% of GDP in the next three years. Looking beyond the program period, the planned introduction of a VAT in March 2014 is expected to raise an additional 2% of GDP, and the authorities are aiming for a revenue-to-GDP ratio of about 16% of GDP by 2017/18.

Prioritizing development spending. In line with the government’s Afghanistan National Development Strategy (ANDS), which aims at improving the delivery of government services, aligning foreign development assistance with Afghanistan’s national priorities, and channelling more resources through the budget. In particular, although it will be necessary to allocate increasing amounts of spending to security, adequate resources will be allocated to help the poor.