Press Release No. 14/236

Press Release: IMF Executive Board Concludes Article IV Consultation with the Islamic Republic of Afghanistan

May 21, 2014

On May 16, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with the Islamic Republic of Afghanistan.

Over the past decade, Afghanistan has made enormous progress in reconstruction, development, and lifting per capita income. Important steps have been taken to lay the foundation for macroeconomic stability and growth, to reduce poverty, and to achieve social and development objectives. However, security conditions, political uncertainty, and weak institutions continue to constrain growth and weigh on social outcomes. The international community has delivered substantial financial support and pledged to continue doing so over the medium term.

With significant domestic efforts and donor support, Afghanistan has maintained macroeconomic stability, implemented important structural reforms, and built policy buffers—namely a comfortable international reserves position, low debt and inflation, and balanced budget and external current account positions. Nonetheless, significant vulnerabilities remain and several reforms have been delayed. After the first review of Afghanistan’s IMF-supported program in June 2012 (Press Release No. 12/245), subsequent reviews were delayed due to missed quantitative targets and slower than planned implementation of structural reforms.

Over the past two years, economic activity has been affected by political and security uncertainties and the drawdown of international troops. These uncertainties reduced confidence, discouraged private investment, and held back economic activity. Growth slowed from 14 percent in 2012 (boosted by a bumper harvest) to an estimated 3.6 percent in 2013. Inflation remained in single digits (5.6 percent year-on-year in March 2014). International reserves also remained at a comfortable level equivalent to over seven months of imports.

Partly reflecting weaker economic activity, budget revenue performance deteriorated significantly in 2012–13, despite additional measures, and was short of the targets established in June 2012. The revenue shortfall resulted in a tight cash position for the treasury and required limiting expenditure. As a result, expenditure as a share of GDP declined in 2013. Progress was made in structural reform efforts, but implementation was slower than planned. Noteworthy accomplishments included: publishing the inquiry into the Kabul Bank crisis; submitting the new banking, value added tax (VAT), and tax administration laws to parliament; strengthening border control management; preparing a new sukuk law; and adopting a strategic plan for financial supervision. However, delays have been encountered in introducing the value added tax and submitting to parliament the laws on anti-money laundering and countering of financing of terrorism, and amendments to the central bank law.

This year, 2014, is crucial in the political and security transitions and the run-up to the “transformation decade,” which starts in 2015. Assuming smooth political and security transitions, continued reform and donor financing, the outlook should be positive. Large security and development expenditure needs and a limited domestic revenue capacity mean that Afghanistan will remain dependent on donor financing for an extended period. In addition to donor support, macroeconomic stability, structural reforms, and political and security stability are needed to ensure durable and inclusive growth. Risks to the outlook are mostly on the downside.

Executive Board Assessment²

The Executive Directors commended the authorities for the significant progress made over the past decade in reducing poverty and raising living standards, rebuilding infrastructure and institutions, maintaining macro stability, building up economic buffers, and continuing structural reform in a challenging security environment and in the context of weak administrative capacity. Strong support from the international community contributed to these achievements.

Nonetheless, Directors agreed that much more needs to be done to sustain high and inclusive growth, further alleviate poverty, and reduce outstanding vulnerabilities, including dependence on donor financing, limited domestic revenue capacity in the face of large public expenditure needs, and a fragile banking system. They noted that the growth outlook remains clouded by considerable downside risks, mainly related to possible adverse domestic or regional security developments, political instability, inadequate implementation of economic policies, and donor fatigue.

Directors supported the authorities’ economic strategy, focused on maintaining macroeconomic stability, increasing domestic revenue mobilization, reinforcing the banking system, and strengthening economic governance. They underscored, however, the importance of strengthened implementation.

Directors stressed that raising domestic revenue is a priority for fiscal sustainability and meeting development and security needs. In this regard, they emphasized the importance of reaching the domestic revenue targets and looked forward to the swift enactment of the VAT law, with a rate consistent with the need to increase revenue mobilization over the medium term, and the tax administration law. Directors encouraged the authorities to promptly finalize a fiscal regime for the natural resources sector and refrain from granting investment incentives and tax exemptions.

Directors concurred that continued efforts are needed to strengthen the banking system and promote financial deepening. They encouraged the central bank to monitor the banking system closely and enforce prudential regulations decisively. They looked forward to the rapid implementation of the strategic plan for strengthening financial sector supervision and recommended the prompt passage and implementation of the new banking law, amendments to the central bank law, and provisions to assure adequate legal protection of central bank supervisory staff. They encouraged stronger efforts to recover Kabul Bank assets and finalize the privatization of New Kabul Bank.

Directors recommended that economic governance reforms continue to focus on improving institutional capacity and the business environment and strengthening the regime against money laundering and the financing of terrorism, for which legislation in line with international standards should be submitted promptly to parliament for approval.

Directors stated that the Fund should continue its close engagement with the authorities, including within the agreed informal short term framework for 2014, to ensure continued macroeconomic stability and reform. Continued support from donors will also be crucial.