|
Islamic Republic of Afghanistan and the IMF Country's Policy Intentions Documents |  | |
|
Islamic State of Afghanistan—Letter
of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding Kabul, March 24, 2004
Ms. Anne Krueger Acting Managing Director International Monetary Fund Washington, D.C. 20431 U.S.A. Dear Ms. Krueger: More than 20 years of conflict and natural disasters have devastated the political, economic, and social fabric of Afghanistan, leaving our country among the world's most destitute. The establishment of a legitimate and effective government has been a formidable challenge. During its brief two-year tenure, the government has made significant strides in terms of crisis management and restoring basic government services and operations. Notable achievements include: (a) the legal formation of a transitional administration; (b) provision of peace and security over much of the country; (c) agreement on the national development framework and national budgets; (d) facilitating the return of over 2 million Afghans from refuge, which helped boost agricultural production and reach self-sufficiency in 2002/03; (e) renewal of the country's administration through a public administration reform program; (f) the signature of trade agreements with a number of neighboring countries; (g) the creation of millions of days of employment for poor and vulnerable groups; (h) creation of an environment in which the private sector has begun to be active; and (i) the renewal of the infrastructure. |
We are now determined to move beyond the basic building blocks, and work toward a more comprehensive medium-term strategy. Toward this end, we will build on our recent success and continue to pursue an ambitious reform program, with a view to strengthening administrative capacity, diversifying the economy, facilitating private sector activity, accelerating economic growth, and reducing poverty.
The central pillar of the government's reform agenda has been close adherence to sound macroeconomic policies. The government has made significant efforts to improve revenue collection, strengthen budgetary management, re-establish commercial banking, and ensure stable monetary conditions—including the introduction of a new currency. A comprehensive program for 2004/05 was prepared in consultation with Fund staff, which includes quantitative targets and structural reforms to support our ongoing efforts.
The attached Memorandum of Economic and Financial Policies (MEFP) presents our medium-term objectives and policies for 2004/05 and includes: (a) the budget for 2004/05 and the supporting measures; and (b) key financial sector objectives that will aim at monetary stability and strengthen the development of the banking system. The detailed objectives and policies focus on the period March 2004-March 2005, and include quantitative targets and structural reforms, which together constitute a Staff-Monitored Program (SMP). In light of the uncertainties surrounding monetary conditions, the SMP has been designed to provide some flexibility. We hope that the successful implementation of the SMP will lead to a successor program for 2005/06 that can be supported by the use of Fund resources.
The government believes that the policies set forth in the attached MEFP are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. The government of Afghanistan will consult with the Fund on the adoption of these measures and in advance of any revision to the policies contained in the MEFP, in accordance with the Fund's policies on such consultation.
| /s/ Ashraf Ghani Minister of Finance Ministry of Finance | /s/ Anwar Ul-Haq Ahady Governor Da Afghanistan Bank |
Attachments:
Memorandum of Economic and Financial Policies
Technical Memorandum of Understanding
Memorandum of Economic and Financial Policies
I. Introduction
1. The Afghan Transitional Authority began its task of reconstruction in an environment that was virtually unparalleled. Two decades of conflict had reduced physical and social infrastructure to skeletal proportions. Coherent government and administration were nonexistent. Social indicators were among the world's lowest, and simply maintaining security was an immense challenge. During the first two years of administration, the government's central focus has been on crisis management, and working to establish or rebuild the fundamental institutions and services necessary for any state. Now that many of these building blocks are in place, the government's goals are increasingly focused on establishing a greater sense of economic and political `normalcy,' while ensuring a high degree of government transparency and accountability.
2. Establishing the institutions and processes necessary for a peaceful political transition have been at the forefront of our agenda, and in line with commitments made at the Bonn Conference. The constitution approved by the Loya Jirga in early January 2004 was signed into law by President Karzai on January 26, and is a critical first step in re-establishing a unified state. The new constitution establishes a strong presidency with wide ranging powers and a bicameral legislative body. Although Dari and Pashto are identified as the national official languages, other regional languages were given official status in the regions where they are spoken. The adoption of the new constitution provides for national elections in 2004, and fulfills the timetable agreed upon at the Bonn Conference. Voter registration is proceeding, although slower than hoped, partly reflecting the security conditions.
3. Rebuilding economic and financial institutions and implementing sound macroeconomic policies have been clear priorities. Important economic and institutional reforms have been undertaken. In the fiscal sector, the Government of Afghanistan (GoA) has focused on improving budgetary management, enacting some important tax policy measures, introducing an ambitious program of customs reform, and gaining control over national revenue. The budget has been guided by the "no-overdraft rule," which will remain a pillar of fiscal policy for 2004/05. A draft public financial management law will be presented to the Cabinet early in the new fiscal year. A new currency was successfully launched and is gaining increased acceptance by the public. Monetary policy has been conducted with a view to guarding against inflation, providing a stable exchange rate, and building an adequate level of international reserves. New financial sector legislation has established autonomy for the central bank and paves the way for the creation of a modern banking sector. The economy is growing again, benefiting from external support and the end of the drought.
4. After reviewing recent economic developments, this memorandum sets out our main economic and social objectives for 2004/05.1 The memorandum also presents in detail the quantitative targets and structural reforms for the period March 2004-March 2005, which together will constitute a staff-monitored program (SMP) with the IMF. The quantitative benchmarks for end-June 2004, end-September 2004, end-December 2004, and end-March 2005, along with the prior actions and structural benchmarks for this period, are presented in the attached Tables 1 and 2.
II. Recent Economic Developments
5. During 2003/04, real GDP (excluding opium) is estimated to have grown by 23 percent, following 29 percent in 2002/03, although these high figures represent growth from a very low base. Construction and service sectors benefited from donor assistance, while agricultural production recovered as a result of increased rainfall, the return of refugees to their lands, and an expansion of cultivated acreage. However, the government is deeply concerned about a similarly strong recovery in opium production, which represents an estimated 40 percent of formal GDP.2
6. Consumer prices rose by 52 percent in 2002/03. While prices remained relatively flat during March-October 2003, prices rose by 3 percent in both November and December, mainly driven by food prices which were associated with Ramadan and colder than usual weather at year-end. Prices in January and February fell modestly, with year-on-year inflation expected to be 9 percent by the end of 2003/04.
7. These encouraging developments reflected a monetary policy focused on maintaining price stability, in the context of a relatively stable exchange rate. Monetary policy was executed through control over the growth of currency in circulation.3 Despite the lack of sophisticated monetary policy instruments, the government has had considerable success in meeting its monetary objectives. Increases in money demand brought about by increases in real growth and increased use of the Afghani have been accommodated while simultaneously avoiding excessive inflationary pressure. Currency in circulation increased by 38 percent through February and is estimated to have grown by 35 percent in the 12 months to March 2004, somewhat more than envisaged in the indicative monetary program for 2003/04 agreed with IMF staff (30 percent by year-end).4 This growth was also reflected in higher-than-envisaged accumulation of foreign exchange reserves. International reserves increased by $346 million through March 2004, to a level equivalent to three months of imports.
8. The enactment of the new central bank and commercial banking laws paves the way for modernization of Da Afghanistan Bank (DAB) and the entry of new commercial banks. The new laws provide a framework for an independent and accountable central bank and the creation of a sound financial system. Progress has already been achieved in reorganizing and modernizing DAB, including building an information technology (IT) system, designing a national payment network, and re-establishing communications between DAB's headquarters and some of its territorial branches. The monitoring of monetary developments has also improved substantially. Further, consistent with the Central Bank Law, a new corporate structure has been established, including the appointment of a Supreme Council to oversee DAB's operations and to ensure accountability. In addition, five new commercial banks were licensed in 2003/04.5
9. Fiscal policy in 2003/04 facilitated monetary control through continued adherence to the "no-overdraft rule," which forbids monetary financing of the budget. Domestic revenue for the operating budget is expected to have reached the Af 9 billion budgetary target.6 Spending was slow early in the year, due to delays in budget allotments, procurement constraints, and weak financial management capacity. However, ministries steadily accelerated their pace of spending through the course of the year, and expenditures should reach an estimated Af 21.1 billion ($430 million) by the end of the financial year, compared with a budgeted amount of Af 24.8 billion ($550 million). The lower level of spending compared to the budget principally reflects lower outlays by the education, health, defense, interior, and foreign affairs ministries. Donor disbursements are expected to have amounted to about $272 million in 2003/04 (compared to a budgeted level of $350 million), allowing for the financing of the budget and some carry-over of available financing into the upcoming year. Donor commitments for 2003/04 covered about 70 percent of the requirements expressed in the National Development Budget adopted in March 2003. As a result, we were able to implement high-priority projects in infrastructure, education, and other critical areas.
10. Significant progress has also been made in fiscal management, where the immediate task has been to identify and eliminate waste and to reassert transparent control over public finances. The major achievements include: (a) the introduction of Afghanistan's Financial Management Information System (AFMIS), a computerized system for expenditure recording, payment processing, and financial reporting; (b) the assignment of fiscal advisors to provincial offices of the Ministry of Finance (MoF) (Moustoufiats) as well as to a number of line ministries to assist with financial management and reporting; (c) a budget process for 2004/05 which evolved from a top-down approach controlled by the MoF to one that was driven by the ministries; (d) the progressive consolidation of government bank accounts to strengthen treasury control over cash flows; (e) initial steps toward a modern payroll system; (f) the increased integration of the operational and development budgets;7 and (g) considerably more comprehensive tracking of external resources by MoF and other ministries through the Donor Assistance Database and integration with the budget preparation process. The comparatively slow progress in the provinces highlights the need for continued focus and support to bring responsible fiscal management to the country as a whole.
11. On the revenue side, a landmark customs reform package was enacted, which will in effect make Afghanistan one of the most open economies in the region. The package includes using the market exchange rate for import valuation, streamlining the tariff structure, putting in place new broker processes, and lowering tariff rates from the current range of 0 to 150 percent to six rates ranging from 2.5 to 16 percent. In addition, an important set of new revenue measures was enacted, including a final wage withholding tax on higher-income employees, an improved income tax regime, a tax on a limited range of services consumed by high income earners (e.g., telecommunications, air travel, hotels, and restaurants), and other revenue measures (rent tax, land tax, and an airport departure fee). While progress has been made in securing the transfer of provincial revenues to the center in 2003/04, a few provinces continue to retain some revenue, and a reliable mechanism to verify the total amount of provincial revenues and expenditures has yet to be established.8 Furthermore, we recognize the need to address the loss of revenue resulting from multi-year tax holidays and concession agreements. The Cabinet signed a declaration recognizing that the loss of prospective tax revenue arising from multi-year tax exemptions granted under the current investment law, and from concessions granted outside the legal framework, is unacceptable and created an Inter-ministerial Committee (IC) to draft legislation.
12. Notably, the government has already begun to establish a strong track record with regard to meeting adjustment targets set by international development banks and other donors. Over the past two years, Afghanistan has benefited from concessional lending provided by the Asian Development Bank and the World Bank, and the government has fulfilled all of the benchmarks and other conditions required under those loans.
13. Reforms in other areas have only recently been initiated. Regarding civil service reform, the government designed a program to decompress the civil service salary structure to help the government attract and retain qualified staff in key positions.9 In July 2003, the government adopted a decree allowing for interim additional salary payments for key civil service personnel. This measure was followed by the government's approval in December 2003 of a large proportional increase in the base salary of civil servants, excluding the military, police, and teachers who had previously received a separate pay increase. This increase ranged from 13 percent for the lowest grade to 130 percent for the highest grade, with an overall average increase of about 25 percent. Efforts have also been made by the government to eliminate "ghost" workers from public payrolls. Public enterprise reform so far has been limited to establishing a census of state-owned enterprises (SOEs). Audits of the assets of SOEs are underway, but have been hampered by lack of records and absence of foreign assistance in this area. Although the government remains committed to the private sector as the engine of future economic growth, little progress on privatization is expected in the immediate future. A Priority Reform and Restructuring (PRR) program was launched by decree in July 2003 and provides the primary mechanism for promoting administrative reforms across government departments and agencies. Managed by the Independent Administrative Reform and Civil Service Commission (IARCSC) under the oversight of the Ministerial Advisory Committee on public administration reforms, the PRR framework enables departments to transfer/appoint key staff in reformed units to higher salary scales. By the end of 2003/04, 36 departments had been granted PRR status and approximately 3,000 civil servants were transferred to the PRR scales in these departments. For 2004/05, a more ambitious target of 30,000 civil servants has been established, of which 20 percent will be at the provincial level.
14. The GoA considers poppy cultivation and heroin production to be one of the most serious obstacles to developing Afghanistan into a secure, stable democracy with a prosperous economy. Many Afghan farmers have been driven into poppy production by decades of deep poverty and lack of alternative livelihoods. But the drug economy has benefited mostly international narcotics and terrorist networks. We are deeply committed to root out this grave threat to Afghanistan's future, and have therefore passed broad anti-narcotics legislation, banning all opium production and trading. We have also established an Anti-Narcotics Directorate and adopted a National Drug Control Strategy that aims to reduce opium production by 70 percent by 2008, and eliminate it altogether within 10 years. An ambitious eradication program was launched that led to the destruction of more than one quarter of the poppy fields during the 2002-03 season.
III. Government Program for 2004/05
A. Main Challenges
15. Notable economic and structural reforms have been accomplished in a short period and under extremely difficult circumstances. Nevertheless, Afghanistan's prospects remain clouded by a number of daunting challenges, namely (a) security issues; (b) the rise in illegal economic activities linked to opium production; (c) limited administrative capacity; (d) unpredictable aid flows and low domestic revenue; and (e) limited private sector development. Further, social indicators are among the lowest in the world: life expectancy at birth is estimated at 42.8 years; and access to water and other basic social services remains very limited for a large segment of the population.
16. We are determined to confront these challenges by pursuing and intensifying our macroeconomic program and undertaking structural reforms, including actions to help diversify the economy, achieve sustainable economic growth, and reduce poverty on a lasting basis. The country has growth potential in agriculture, manufacturing and services, including commerce, transit trade, and telecommunications. This potential could be realized by a significant pick-up in private investment, but will require reforms to restructure the public sector, develop a sound banking system, modernize the central bank, establish a market-oriented legal framework conducive to private sector development, strengthen good governance and transparency, and continued efforts to increase domestic revenue and strengthen expenditure management. In support of these adjustment efforts, Afghanistan is seeking increased assistance from the international community, particularly in the form of grants and external debt relief.
B. Macroeconomic Objectives
17. In line with the recently revised reconstruction needs assessment,10 the government aims to achieve real GDP growth (excluding opium) of 15 percent in 2004/05 and 11 percent per annum on average during 2005/06-2007/08, sustained by foreign assistance, an improvement in the business environment, and adequate security. Growth is expected to be driven mainly by diversification in agriculture, new initiatives in private manufacturing, and continued expansion of the services sector. To meet these objectives, the overall investment rate is envisaged to stabilize at about 22 percent of GDP during the same period. The average annual inflation rate is expected to be contained to 5 percent, reflecting the pursuit of prudent fiscal and monetary policies.
C. Macroeconomic Policies
18. For 2004/05, our macroeconomic policy stance will remain broadly unchanged. Fiscal policy will continue to be guided by the "no-overdraft rule." Monetary policy will be geared toward ensuring price stability, while simultaneously meeting money demand and limiting exchange rate fluctuations.
Fiscal policy
19. Raising the level and quality of government services while ensuring fiscal sustainability is a key objective over the medium term. Revenue mobilization will be crucial in this regard. We are keenly aware that donor support for the operating budget cannot continue indefinitely and that much of the upcoming external assistance will fund projects rather than support recurrent expenditures under the budget. Further, to preserve fiscal sustainability and given limited foreign exchange resources, the government will refrain from nonconcessional external borrowing, and will even minimize concessional borrowing to levels consistent with priority economic development requirements. The government's medium-term objective is to increase domestic revenue such that the operating budget will be fully financed with domestic resources by 2012. Meeting this goal will require new policy initiatives, strengthening the capacity of the revenue and customs departments, and improvement of tax operations in the provincial offices.
20. For the GoA to realize its revenue goal, provincial revenues must be regularly and fully transferred to the recently established Treasury Single Account (TSA). Further, the ministries that collect revenues must also allow these revenues to be regularly "swept" into the TSA. Both of these actions represent important governance issues and are included as structural benchmarks under the SMP.
21. Consistent with these medium-term objectives, the budget law for 2004/05 aims to achieve total domestic revenues of Af 15 billion, compared with an estimated Af 9 billion in 2003/04. The revenue target is based on the full effect of the customs and tax measures adopted last year and further administrative measures, including increased enforcement and compliance, to improve tax collection. As importantly, a new investment law will be enacted by end-June that ensures that investment incentives will be granted through accelerated depreciation rather than tax holidays. Given the erosion of the revenue base related to extensive tax holidays granted over the last two years, existing exemptions will be grandfathered and phased out in line with the new law. The tax concessions that have been granted by various ministers are a serious case of concern and the government will take action to address this issue. Furthermore, the new financial management law that will be adopted this year provides the appropriate degree of control over new concession agreements.
22. The government is committed to pursuing the reforms needed to improve current revenue systems. The IMF staff supports the government's efforts to achieve a suitably ambitious revenue target, as attaining self-sufficiency for the operating budget will be a pillar of future economic success. However, given potential difficulties in implementation and uncertainty surrounding the net revenue impact of reforms, the SMP will target a lower, but still ambitious domestic revenue target of Af 12.8 billion ($256 million), representing a 35 percent increase over 2003/04.
23. In customs administration, the GoA is guided by a comprehensive five-year customs reform plan, supported by substantial technical and other assistance from donors.11 Streamlining administrative procedures remains a priority, and simplified customs clearance procedures in the provinces were adopted last year.12 For 2004/05, we intend to implement the following customs measures: (a) a progressive implementation of a system of licensed customs brokers; (b) an exemptions monitoring system; (c) a centralized customs data reporting system; (d) establishment of regional customs valuation units; (e) initiation of Automated Systems for Customs Data (ASYCUDA); and (f) introduction of the Afghan Harmonized System Tariff reflecting the new import tariff policy and using the official rate as published by DAB. A new Customs Code is being drafted and will be enacted this year. Reform of domestic tax administration is to be guided by a five-year plan, and will include establishment of a large taxpayer unit and reorganization of moustoufiat revenue operations in a few provinces.
24. Total current expenditures are projected to increase significantly this year and the budget is expected to reach Af 30.3 billion ($609 million). Much of the increase reflects spending that could not take place last year because of limited capacity; financial management capacity was weak outside the MoF and in several ministries-most notably education—staff needed to be hired. In addition, the evolution of the budget process away from the top-down approach is expected to continue and enhance broader ownership of the budget. Lastly, there has been a large increase in the budget allocated to internal security; newly hired recruits are now paid as regular staff and the Ministry of Interior has taken on expenditures that were previously paid by donors. The budget also provides for a temporary increase in pension payments for retired civil employees, aimed at helping one of the poorest and most vulnerable part of the population. Recognizing that this action provides only a temporary solution, the GoA will work toward designing a long-term, financially sustainable, pension reform program. Given the expected level of domestic revenue, the budget will need additional financing of about $310 million.13 The GoA anticipates at least $300 million from donors at the Berlin Conference and expects the residual to be financed from the carry-over of bank balances. However, even if revenue falls short of planned expenditures, the annual appropriation and newly drafted financial management laws prohibit bank financing "no-overdraft rule." Finalization of the development budget is contingent upon the outcome of the upcoming donors' conference. However, unlike 2003/04, where the development budget reflected a list of projects, only some of which were funded, the 2004/05 development budget will contain only those development expenditures with assured funding.
25. The government is continuing reforms to enhance the effectiveness and transparency of budgetary management.14 These reforms include (a) passing a budget systems law; (b) restructuring the MoF; (c) mid-year budget reviews to adjust appropriations as well as quarterly reviews to help both ministries and the MoF in budget implementation and control; (d) reporting of consolidated fiscal accounts;15 (e) streamlining the budget allotment process, especially for the provinces; (f) reforming the salary disbursement process; and (g) strengthening the AFMIS by enforcing expenditure control, improving revenue information, introducing automated reconciliation of treasury and bank accounts, linking payroll disbursement to pay period, and extending the AFMIS system to provinces.16 In addition, we will also work to ensure Cabinet approval of year-end government accounts for 2003/04.17
Monetary and exchange rate policy
26. Monetary policy will aim at maintaining low inflation and the exchange rate will continue to be flexibly determined by market forces. DAB's weekly auctions will primarily focus on achieving the monetary growth targets, but will try to prevent large and undesirable exchange rate movements. The DAB will continue to use the domestic money supply (currency in circulation) as an intermediate target. The monetary program for 2004/05 is based on demand for money (currency in circulation) growing in line with nominal income (20 percent, including 5 percent inflation), with an additional 5 percent for continued remonetization, equivalent to what was observed in 2003/04. The indicative 26 percent monetary growth rate target for 2004/05 compares with an estimated 2003/04 outturn of 35 percent.
27. Significant uncertainties surround money demand, including real income growth, the pace of remonetization, and the role of recently licensed private banks. The monetary target will thus need to be flexible, while also guarding against inflation and currency instability. Therefore, while the program target is set at 26 percent, the program will allow for growth of currency up to 31 percent. However, if currency growth appears to jeopardize the quarterly target consistent with the 26 percent growth rate, the government will discuss developments with the IMF, with a view to assessing the implications for price and exchange rate stability. Currency outturns consistent with rates of growth over 31 percent, however, will trigger a formal consultation with the IMF. The DAB will provide the IMF with monthly reports to ensure effective surveillance in this regard, and regular quarterly reviews will naturally include a thorough discussion of monetary developments.
28. Given the "no-overdraft rule" policy and pending the introduction of alternative market-based monetary instruments,18 the monetary projection implies a path for net international reserves, as there is little scope for changes in net domestic assets (which include government deposits) and none for domestic credit. But to allow the DAB room for maneuver, the indicative floor for international reserves will be below the programmed path with a minimum objective of $828 million or 3.3 months of imports by end-2004/05 (from $773 million or 3 months at end-2003/04).
29. The government believes that a floating exchange rate regime remains the appropriate choice for Afghanistan, given the potential for large structural changes in the near future and the associated difficulties in projecting demand for the Afghani. Potential vulnerability to external shocks and uncertainty regarding the future of the balance of payments also argues for a regime that will allow flexibility and adjustment. While stability of the Afghani is desirable, the DAB will not resist persistent pressures on the exchange rate, should these emerge.
30. We will take further steps toward modernization of the central bank and the creation of a sound financial system. The reorganization of DAB will be accelerated in line with best international practices in two-tier banking systems. DAB will transfer by September 2004 to other entities (commercial banks, government agencies) all activities which are inconsistent with the new central bank and commercial banking laws.19 Considerable emphasis will be placed on improving DAB's operations, including the resolution of issues pertaining to DAB assets, and the development of a central bank balance sheet and a monetary survey (including a balance sheet for the commercial banking system).20 DAB will also focus on further increasing its capacity to license and supervise commercial banks. In this regard, DAB will address the future of the six state-owned banks in line with banking laws enacted in 2003. Among these six banks, those that did not reapply for a license by March 15, 2004 will immediately cease operations and their resolution will be initiated by a conservator. For those that do reapply for licenses, DAB will assess their applications and make a decision by June 15, 2004. For those banks whose licenses are rejected, the procedures will be the same as for those banks who did not apply for a license. In addition, the government is committed to enact Anti-Money Laundering and Controlling Financial Terrorism (AML/CFT) legislation this year. DAB has already received assistance from the IMF in this area and follow-up is expected in June.
External sector policies
31. Data and information on the balance of payments is extremely limited, and a priority for the government will be to improve data collection so as to better evaluate external sector developments. Initial estimates indicate a small balance of payments surplus in 2002/03, which resulted in an increase in international reserves of DAB. Preliminary estimates for 2003/04 suggest another surplus, largely resulting from donor inflows as well as unrecorded exports. The outlook for 2004/05 for the balance of payments is uncertain, however, as a substantial amount of foreign exchange receipts depend on, as yet unknown, donor assistance and unofficial trade flows. Against this background, domestic exports are projected to reach $190 million; recorded domestic imports (i.e., excluding those related to the re-export trade, smuggling, and donor imports) are expected to total $740 million, largely reflecting economic recovery and reconstruction. The projected current account deficit, equivalent to about 5 percent of GDP, is expected to be covered by donor assistance and some private capital flows.
32. The government remains committed to an open trade and exchange system. Following passage by the Cabinet of a new customs decree, work is underway to identify and eliminate trade and payments restrictions that remain on the books (but are not enforced). A joint IMF mission from the Legal and Monetary and Financial Systems Departments is expected to visit Kabul to review the exchange and payments system and identify priority reforms in this area. Looking forward, the government will seek to avoid imposing restrictions on payments and transfers for international transactions, to introduce new or intensify trade restrictions for balance of payments purposes, or resort to multiple currency practices. The government will also continue to discuss with IMF staff the possibility of accepting the obligations of Article VIII, Sections 2, 3, and 4 of the IMF's Articles of Agreement.
33. One of our priorities is to strengthen external debt management and normalize its relations with all creditors. The government's intention is to enhance debt monitoring, analytical capacity, and debt reporting systems in the(MoF). To that end, the recently created Debt Unit in the (MoF) is expected to complete a detailed inventory of the status, terms, source, and size of Afghanistan's stock of external debt within six months. Subsequently, the Debt Unit will submit quarterly reports to the government on the external debt situation, including debt service obligations and accumulated arrears. The government intends to normalize its relations with key creditors. To ensure that the external debt burden remains manageable, the government will refrain from any nonconcessional external borrowing. The GoA will also seek to develop a medium-term debt strategy, the central pillar of which will be to minimize external borrowing to levels consistent with the country's debt servicing capacity and its economic development needs, and to ensure that loans are associated with investments with a positive net return. Support from the international community will be critical to ensure that foreign borrowing can be accomplished at highly concessional terms, with equal treatment from all creditors in this regard. The GoA will also continue to seek generous debt relief from bilateral creditors.
D. Structural Reforms, Poverty Reduction, and Good Governance
34. We are committed to implement an ambitious structural reform agenda to diversify economic activity, promote the development of the private sector, enhance good governance, and sustain economic growth to reduce widespread poverty.
Civil service reform
35. The GoA will establish by end-June 2004 a timetable for key reforms aimed at establishing a verified payroll of government employees, and further decompression of civil service wages consistent with medium-term fiscal sustainability and other reforms in the civil service.
Private sector development
36. The government recognizes that improving the business environment, fostering competition, and providing adequate infrastructure are crucial to stimulate private investment. With the advice of partners, the authorities will prepare an action plan by end-September 2004. The strategy/action plan would be aimed at prioritizing and sequencing the policy, as well as the legal and institutional reforms required to create an investment climate that helps accelerate private investment in Afghanistan. The action plan will also cover privatization, support to small-and-medium enterprises, and the institutional framework for enabling policy-making for private sector development, including mechanisms for systematic consultation with the private sector.
Public enterprise reforms
37. By end-June 2004, we will prepare an action plan to regularize the operations of state-owned enterprises and continue to subject them to hard budget constraints. The GoA intends to complete an assessment of the financial position of these enterprises by end-September 2004, in particular through finalizing the audit of their assets. On this basis, a timetable will be developed for rationalizing the state-owned enterprise sector, including, when appropriate, closure or divesture to the private sector through an open and transparent process.
Poverty reduction and social policy
38. In light of Afghanistan's weak social indicators, the government places the fight against poverty high on its agenda. The government will initiate work to prepare a strategy to alleviate poverty. In this context, we will define a work program by end-September 2004 and take measures toward developing a participatory framework to produce a Poverty Reduction Strategy Paper (PRSP). In the interim, the government will initiate work on an Interim-PRSP (I-PRSP).
Opium eradication
39. The GoA intends to further intensify its action to combat opium cultivation and narcotics trafficking. We see this as critical to thwart the possible emergence of a narco state. We will continue to closely work with donors to achieve the objectives of the National Drug Control Strategy, and will develop action plans that will focus on five main areas: (a) strengthening law enforcement, including stepped up eradication interdictions; (b) accelerating judicial reform; (c) developing alternative livelihoods; (d) raising public awareness; and (e) reducing domestic demand.
Statistical issues
40. Considerable progress has already been made in improving the timeliness and quality of Afghanistan's economic and social statistics, due in large part to support and technical assistance from the international community. These improvements were reflected in the recent publication of the Afghanistan Statistical Yearbook—the first in many years, and a major achievement given the low level of statistical and administrative capacity. The government remains firmly committed to expanding and improving the statistical database as a key measure supporting macroeconomic management and policy formulation. Toward this end, we will seek the continued support of the international community to achieve further improvements in data for prices, national accounts, balance of payments, and other key sectors. A concrete step in this regard will be the extension of the consumer price index (CPI) survey outside of Kabul to include five other major cities in 2004/05.
IV. Program Monitoring and Technical Assistance
Program monitoring
41. The period covered by the SMP will be March 20, 2004-March 20, 2005. Performance under the program will be monitored using quarterly indicative targets, structural benchmarks, and quarterly reviews. Indicative targets for end-June 2004, end-September 2004, end-December 2004, and end-March 2005, as specified in Table 1, relate to currency in circulation, net claims of the banking system on the central government, gross international reserves of the central bank, fiscal revenue of the central government, and contracting of new external debt. These targets are further elaborated in the Technical Memorandum of Understanding (TMU) attached to this document. The SMP also includes a number of structural benchmarks, as specified in Table 2. Approval by the management of the IMF of the Letter of Intent (LOI) and the MEFP and their transmission to the Executive Board are subject to the implementation of the prior actions listed also in Table 2.
42. To coordinate and monitor implementation of the SMP, the GoA has put in place an IC. The IC coordinates government action, defines broad economic and social guidelines, and promotes macroeconomic and structural reforms related to the SMP. The IC is assisted by a technical committee in charge of implementing the SMP.
Technical assistance needs
43. To improve Afghanistan's capacity to design and implement policies and monitor macroeconomic developments, a broad technical assistance program is envisaged by the IMF. This will be coordinated with the substantial assistance already provided by other donors. In particular, and in response to the recommendations of a previous IMF technical assistance mission, an IMF Fiscal Affairs Department resident treasury expert for the Ministry of Finance has recently been appointed. In the area of statistics, the IMF Statistics Department is providing technical assistance through periodic visits by technical experts. The monetary authorities have requested technical assistance in the form of a resident expert at DAB to advise on monetary policy and oversee the provision of data for program monitoring. Furthermore, various technical assistance missions are expected to be fielded during the year by FAD, MFD, LEG, and STA to strengthen the government's capacity in the fiscal, monetary, and statistical areas.
44. The government believes that the policies described herein will further strengthen our macroeconomic stabilization and structural reform efforts, and that they are adequate to achieve the objectives of our economic program for 2004/05. We intend to remain in close consultation with the IMF, in accordance with IMF policies on such consultation, and will provide the IMF with information it requests for monitoring economic developments and implementation of policies under the program. The government stands ready to take further measures, in consultation with the IMF staff, which might be necessary to ensure that the overall objectives of the program can be achieved.
45. To promote transparency, we hereby request that the LOI and the MEFP be published on the IMF website.
|
Table 1. Islamic State of Afghanistan: Quantitative Indicators, 2004/05 (In millions of Afghanis, unless otherwise indicated; cumulative changes from March 20, 2004) | ||||
|
| ||||
|
Jun. 20 |
Sep. 21 |
Dec. 20 |
March 20 | |
|
Currency in circulation (ceiling) |
1,827 |
3,774 |
5,848 |
7,384 |
|
Claims of the banking system on the central government (ceiling) |
0 |
0 |
0 |
0 |
|
Gross international reserves of the central bank (floor) (in millions of U.S. dollars) |
13.3 |
29.1 |
47.6 |
55.4 |
|
Fiscal revenue of the central government (floor) |
2,585 |
5,506 |
8,649 |
12,784 |
|
|
||||
|
a) New medium- and long-term nonconcessional external debt (with original maturities of one year or more) contracted or guaranteed by the government (ceiling) 1/4/ |
0 |
0 |
0 |
0 |
|
b) New nonconcessional debt, contracted or guaranteed by the government, with an original maturity of less than on year (ceiling) 2/3/ 4/ |
0 |
0 |
0 |
0 |
|
|
||||
|
Currency in circulation (level triggering consultation) |
1,977 |
4,093 |
6,359 |
8,785 |
|
Source: Fund staff estimates and projections. | ||||
International Monetary Fund
Islamic State of Afghanistan
Technical Memorandum of Understanding
1. This memorandum sets out the understandings between the Afghan authorities and the IMF staff relating to the monitoring of the staff-monitored program (SMP). It is organized as follows: Section I specifies the quantitative indicative targets; Section II provides definitions of the principal concepts and financial variables; and Section III relates to the reporting requirements.
I. Quantitative Indicative Targets
2. Monitoring of the implementation of the program will be conducted on the basis of an assessment of the observance by the Government of Afghanistan (GoA) of the quantitative indicators and structural benchmarks at specified dates.
3. The quantitative indicators are specified in Table 1 of the MEFP attached to the letter of March 24, 2004. They are as follows:
• a ceiling on currency in circulation of Da Afghanistan Bank (DAB);
• a ceiling on net claims of the banking system on the central government;
• a floor for the build-up of gross international reserves of the DAB;
• a floor on fiscal revenue of the central government;
• a ceiling on new medium and long-term nonconcessional external loans contracted or guaranteed by the government; and
• a ceiling on new nonconcessional debt contracted or guaranteed by the government with an original maturity of less than one year.
II. Definitions
A. Program Exchange Rate
4. For purposes of monitoring under the program, a program exchange rate will be used. This program exchange rate will be the average of the U.S. dollar/Afghani buy and sell cash rates, as reported by the DAB as of February 29, 2004 (Af 49.84 per U.S. dollar). The program exchange rate will be used to convert into Afghanis the U.S. dollar value of all foreign assets and liabilities denominated in U.S. dollars. For assets and liabilities denominated in SDRs and in foreign currencies other than the U.S. dollar, they will be converted in U.S. dollars at their respective exchange rates prevailing as of February 29, 2004, as published in the International Financial Statistics (IFS).
B. Currency in Circulation
5. Currency in circulation is defined as total currency (new Afghani) issued by DAB, and includes currency held in DAB branch vaults, but excludes currency held in the DAB main vault and in the presidential palace vault.
C. Net Claims of the Banking System on the Government
6. Net claims of the banking system on the government are defined as the difference between the banking system's claims on the government and the deposits of the government with the banking system.
D. Gross International Reserves
7. Gross usable reserves of the DAB are reserve assets, as defined in the balance of payments (BOP) manual, that are controlled by the DAB, are immediately and unconditionally available to the DAB for meeting balance of payments needs, and are not earmarked by the DAB for meeting specific payments. They consist of balances on accounts maintained with overseas correspondent banks, foreign exchange banknotes in the vaults of the DAB, monetary gold, SDRs, and Afghanistan's reserve position in the IMF.
E. Nonconcessional Public Sector or Publicly Guaranteed External Debt
8. Table 1 of the MEFP specifies limits to the contracting or guaranteeing of new external debt by the government. For program purposes, "government" includes the central government and government departments and official agencies which do not seek profit and whose budgets are issued independent of the annual operational or development budgets. Government and government-guaranteed external debt covers all external debts incurred or guaranteed by the government.
9. The limits specified in Table 1 of the MEFP apply to the contracting or guaranteeing by the government of new, nonconcessional external debt with an original maturity of more than one year. This limit applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt in Fund Arrangements (Decision No. 6230-(79/140), August 3, 1979, as amended by Decision Nos. 11096-(95/100), October 25, 1995, and 12274-(00/85), August 24, 2000), but also to commitments contracted or guaranteed for which value has not been received. Excluded from this limit are leases of real property by Afghan embassies or other foreign representations. External debts will be expressed in U.S. dollar terms, with debts in currencies other than the U.S. dollar converted into U.S. dollars at the market rates of the respective currencies prevailing on February 29, 2004, as published in IFS.
10. The limits specified in Table 1 of the MEFP also apply to the contracting and guaranteeing by the government of new, noncessional external debt with an original maturity of one year or less. The term "debt" has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt in Fund Arrangements (adopted by the Executive Board of the IMF on August 24, 2000). Excluded from this limit are normal import-related credits. External debts will be expressed in U.S. dollar terms, with debts in currencies other than the U.S. dollar converted into U.S. dollars at the market rates of the respective currencies prevailing on February 29, 2004, as published in IFS.
11. For purposes of the program, the guarantee of a debt arises from any explicit legal obligation of the government or DAB or any other agency acting on behalf of the government to service such a debt in the event of nonpayment by the recipient (involving payments in cash or in kind), or indirectly through any other obligation of the government or DAB to cover a shortfall incurred by the loan recipient.
12. Concessionality will be based on currency-specific discount rates based on the Organization for Economic Co-operation Development (OECD) commercial interest reference rates (CIRRs). For loans of an original maturity of at least 15 years, the average of CIRRs over the last 10 years will be used as the discount rate for assessing the concessionality of these loans, while the average of CIRRs of the preceding six-month period will be used to assess the concessionality of loans with original maturities of less than 15 years. To the ten-year and six-month averages of CIRRs, the following margins will be added: 0.75 percent for repayment periods of less than 15 years; 1 percent for 15-19 years; 1.15 percent for 20-30 years; and 1.25 percent for over 29 years. Under this definition of concessionality, only loans with grant element equivalent to 60 percent or more will be excluded from the debt limits. The debt limits will not apply to loans contracted for debt rescheduling or refinancing.
F. Fiscal Revenues of the Central Government
13. Fiscal revenues of the government include revenues collected in Kabul as well as revenues collected by the provincial offices of the government and transferred to the government account at DAB. They include revenues from corporate income tax, personal income tax, business receipts tax, fixed withholding taxes on imports and exports (and creditable against the income tax), presumptive taxes in lieu of the income tax, import duties and other charges and fees (the Chamber of Commerce import/export valuation charge, the Red Crescent fee, permit fees from the Ministry of Commerce, fees and charges from the Ministry of Communication, and over flight fees collected by the Ministry of Civil Aviation). It excludes revenue from privatizations or other sale of state assets, grants, and other direct transfers. It excludes provincial revenues accrued between March 20, 2004 and March 20, 2005 but where funds are not transferred to government's DAB accounts by April 20, 2005. It also excludes revenue accrued before February 21, 2004, even if funds are transferred to government accounts between March 20, 2004 and March 20, 2005. All revenue must be supported by the relevant documentation.
G. Structural Benchmarks
14. The structural performance benchmarks are specified in Table 2 of the MEFP attached to the letter of March 24, 2004. They are elaborated further as follows:
• Consolidation of all line ministry accounts into the Treasury Single Account (TSA). All revenue collected by ministries must be deposited into the main government account (including sub-accounts), and no ministry may have its own bank account without the explicit written consent of the Minister of Finance.
• Regular transfer of provincial moustoufiat balances into the TSA at DAB headquarters. Transfers will take place, where possible, on a weekly basis, but at a minimum on a monthly basis. Also the provinces may not make expenditures from their revenue accounts. This will be verified by the records of DAB.
• Development of consolidated fiscal accounts including provinces and operating and development budgets. This should be prepared on a monthly basis, with a six-week lag, for the operating budget, using a functional, ministerial, and economic classification. For the development budget, which would include those transactions that pass through the Treasury, these accounts must be prepared on a quarterly basis, with a six-week lag, using the classification structure under the National Development Framework. Development expenditures implemented directly by donors will be included if data are available.
• Extension of the consumer price index survey to main cities beyond Kabul. This must include at least five other cities.
• Development of a monetary survey, including the balance sheets of commercial banks. The survey is to include only those banks licensed under the new banking law.
• Adoption of presidential decree precluding tax exemptions and concession. Appropriate legal enactment to ensure statutory tax rules prevail over nonstatutory concessions in agreements.
III. Provision of Information to the Fund Staff
A. Data
15. To permit the monitoring of developments under the program, the government will provide to Division A of the Middle Eastern and Central Asia Department (MCD), through the office of the Resident Representative of the IMF in Afghanistan, the information specified below and summarized in the list of reporting tables provided by IMF staff to the Technical Committee. The program is designed with quarterly quantitative targets and the actual outcome should be provided within six weeks following the end of the quarter. However, in order to facilitate regular monitoring, many of the indicators should be provided with the frequencies indicated below.
• DAB gross foreign exchange reserves (weekly) from March 20, 2004. This should be reported no longer than 2 weeks after the end of the week.
• Monetary statistics, including exchange rate data (daily), government accounts with the DAB and currency in circulation (monthly) from March 20, 2004. This should be reported no longer than 3 weeks after the end of the month.
• Foreign trade statistics (imports, exports, re-exports) (quarterly) from March 20, 2004. This should be reported no longer than 8 weeks after the end of the quarter.
• Operational budget operations and their financing should be reported on a monthly basis no more than 4 weeks after the end of the month.
• Detailed data on foreign grants and loans disbursed, contracted, or guaranteed by the central government; foreign debt amortization and interest payments, including new external arrears (if any); and total outstanding amount of arrears (quarterly) from March 20, 2004.
• List of short, medium, and long-term government or government-guaranteed external loans contracted during each quarter; identifying for each loan: the creditor, the borrower, the amount and currency, the maturity and grace period, and interest rate arrangements (quarterly) from March 20, 2004.
• National accounts data (quarterly) from March 20, 2004. This should be reported no longer than 8 weeks after the end of the quarter.
• Consumer price index (CPI) for the city of Kabul (monthly) from March 20, 2004; then starting in October 2004, CPI covering 5 major cities (monthly). These should be reported no longer than 4 weeks after the end of the month.
B. Structural Reforms
16. Review of the structural reforms. The GoA will prepare and send to the IMF reports, with appropriate documentation, indicating progress achieved, explaining any deviations relative to the initial planning, and specifying expected revised completion date.
C. State-Owned Banks
17. The authorities will provide staff with relevant documents and information dealing with the proceedings associated with the relicensing and/or closure and resolution of commercial banks.
D. Other Information
18. Other details on major economic and social measures taken by the government that are expected to have an impact on program sequencing (such as changes in legislation, regulations, or any other pertinent document) will be sent in a timely manner to IMF staff, for consultation or information.
19. The Inter-ministerial Committee will provide Division A of the Middle East and Central Asia Department with any other information that may be required by the staff of the IMF for the effective monitoring of the program.
E. Program Monitoring
20. For the purposes of program monitoring, working meetings are planned, at least bi-weekly, with the participation of representatives of the Ministry of Finance, the DAB, the committee in charge of overseeing implementation of the program, and the IMF resident representative.
| /s/ Ashraf Ghani Minister of Finance Ministry of Finance Date: March 24, 2004 | /s/ Anwar Ul-Haq Ahady Governor Da Afghanistan Bank Date: March 24, 2004 |
2 Temporarily banned in 2001, opium production has returned to the level of the late 1990s and prices are relatively high. The United Nations Office on Drugs and Crime estimates opium earnings in 2002 and 2003 at $2.5 billion and $2.3 billion, respectively. The street value of Afghan opiates in Europe and elsewhere is reported to be ten times these amounts. Afghanistan is believed to supply three quarters of the world's opium. The growing importance of opium in the economy is further straining the country's internal security and political stability.
3 Foreign exchange accumulates at DAB mostly through the conversion of donor funds into Afghani. Because of the magnitude of these inflows, DAB has held periodic auctions to limit the growth of currency in circulation. As DAB holds no marketable domestic assets, currency growth is controlled entirely through periodic foreign exchange auctions (the exchange rate has been used as a leading indicator of monetary conditions).
4 Currency in circulation includes currency held in DAB branch vaults, the size of which is not precisely known, but which has most likely risen substantially since the beginning of the year. Excluding these sums would suggest somewhat lower growth for currency in circulation.
5 Standard Chartered, National Bank of Pakistan, Afghan International Bank, First Microfinance Bank, and Habib Bank.
6 In dollar terms, IMF staff expects domestic revenue to amount to about $190 million, compared to a budget target of $200 million. The shortfall in dollar terms vis à vis Afghani is due to the depreciation of the currency.
7 Much of the coordination of the development budget between donors, ministries, and implementing partners is being carried out through the Consultative Groups that were established to take responsibility in different program areas.
8 Afghanistan is structured as a unitary state and the provinces are in effect the local agents of the central government, responsible for the collection of revenues and payment of expenditures on behalf of the center. All revenues must be remitted to the center, which in turn provides the provinces with the necessary resources for the payment of wages and other local expenses. In the early part of the year, many of the provinces have been acting as semi-independent states, remitting only a part of their revenues to the center and undertaking substantial local expenditures (including public investment) with the withheld resources.
9 The pay differential between the most junior and most senior officials was in the range of $10 per month. Because base salaries are so low, the budgetary impact of this measure is expected to be manageable (about $22 million in a full year). The government intends to seek offsetting budget cuts elsewhere, as well as ministerial commitments to abjure all other "ad hoc" wage increases.
10 The document, "Securing Afghanistan's Future," was prepared with the help of the World Bank, the Asian Development Bank, and the United Nations, and was circulated to donors as background for the upcoming conference. The last such exercise was conducted for the Tokyo Conference in early 2002. The conference will take place March 31-April 1 in Berlin and update the financing needs of the country to address the issues of security, illegal economy, role of the private sector, and stabilization and productivity of aid flows.
11 The government adopted a five-year customs administration plan (2003-07) aimed at (a) revamping the customs department and its regional offices; (b) training of customs officials; (c) reforming customs procedures; (d) centralizing customs revenues collected by the provinces; and (e) rehabilitating progressively customs infrastructure, equipment, and communications.
12 In addition to adopting a single administrative document for customs clearance, the government's focus is on improved monitoring of exemptions, progressive introduction of the harmonized tariff classification system for commercial goods, and development of a comprehensive database for customs valuation.
13 Based on IMF domestic revenue projections, the additional financing needed would be $352 million.
14 These reforms are in line with the recommendations of the November 2003 FAD technical assistance mission on public expenditure management.
15 The government will report on all expenditures and revenues in the operating budget. For development expenditures, it will report expenditures that pass through the treasury system. It will also report on commitments, disbursements, and expenditures reported to the government by donors. In 2003/04, the data from donors was often not provided or provided with long lags.
16 The GoA envisages organizing a donor's workshop to discuss how their fiduciary requirements could be met within the budgetary and treasury system.
17 Although the 2002/03 accounts were a mixture of paper and computerized records, the accounts for that year were finalized, although it is unlikely that they will be externally audited.
18 DAB, in line with technical assistance recommendations from the IMF, will consider introducing a short-term debt instrument that could be used as an investment instrument by financial institutions and would contribute to developing a financial market.
19 Currently, DAB engages in some commercial banking operations. Under the law, DAB may continue these operations as long as it is not competing with private banking operations (i.e., one private bank operating in the same geographic area).
20 DAB will be assisted in this effort by experts from the IMF.