Press Release No. 06/144

Press Release: IMF Executive Board Approves US$119.1 Million PRGF Arrangement for the Islamic Republic of Afghanistan

June 26, 2006

The Executive Board of the International Monetary Fund (IMF) today approved a three year, SDR 81.0 million (about US$119.1 million) arrangement under the Poverty Reduction and Growth Facility (PRGF) for Afghanistan, which is designed to support the nation's economic program through March 2009 and build upon progress made under the IMF's Staff-Monitored Program (SMP).

As a result of the approval, Afghanistan will receive an initial disbursement under the PRGF arrangement amounting to SDR 13.2 million (about US$19.4 million).

Following the Executive Board's discussion of Afghanistan, Mr. Agustín Carstens, Deputy Managing Director and Acting Chair, said:

"Afghanistan's economy continued to perform strongly under the staff-monitored program, resulting in rapid economic growth, inflation declining to single digit levels, and the international reserves position strengthening further. At the same time, the authorities implemented key structural reforms in the fiscal and monetary areas, while bringing to fruition the political framework envisaged under the 2001 Bonn agreement. These achievements, carried out in an extremely challenging environment characterized by lingering insecurity, poor infrastructure, and weak institutions, have paved the way for a comprehensive three-year reform program to be supported by a Poverty Reduction and Growth Facility arrangement from the Fund.

"The authorities' economic program draws on the government's Interim Afghanistan National Development Strategy (I-ANDS) paper and focuses on furthering capacity building, consolidating macroeconomic stability through sound fiscal and monetary policies, reducing poverty, and creating an investment climate conducive to private sector investment and sustained growth.

"Nonetheless, risks remain considerable. In addition to those related to the security situation, the government faces the challenges of dealing with persistent opium-related activities, weak implementation capacity, and uncertainties about donor assistance.

"In the fiscal area, the authorities seek to enhance revenue mobilization, including by strengthening the large taxpayers' office, improving transparency and simplifying procedures, and upgrading administrative capacity. On the spending side, the authorities will strengthen the enforcement of the manpower and appropriation ceilings, while moving gradually to a new pay and grading system. These efforts will be complemented by further improvements in implementation capacity to increase much-needed development spending.

"The authorities' continued tight monetary policy in the context of a managed float exchange system is warranted. The authorities intend to strengthen the monetary policy framework by developing the central bank's analytical capacity, modernizing the monetary policy instruments, and improving the monetary statistics. Financial sector reforms will seek to enhance private savings and investment.

"The authorities place a welcome emphasis on structural measures aimed at promoting good governance and strengthening the institutional framework, simplifying business regulations, and divesting public sector activities. This will facilitate a more efficient use of resources, improvements in the investment climate, and continued mobilization of much-needed external assistance.

"A prudent external financing strategy, comprehensive debt relief, and continued donor support on highly concessional terms are necessary in light of Afghanistan's large development needs and limited repayment capacity," Mr. Carstens said.

The PRGF is the IMF's concessional facility for low-income countries. PRGF-supported programs are based on country-owned poverty reduction strategies adopted in a participatory process involving civil society and development partners and articulated in the Poverty Reduction Strategy Paper (PRSP). This is intended to ensure that PRGF-supported programs are consistent with a comprehensive framework for macroeconomic, structural, and social policies to foster growth and reduce poverty.

PRGF loans carry an annual interest rate of 0.5 percent and are repayable over 10 years with a 5½-year grace period on principal payments

ANNEX

Background

Economic activity in Afghanistan remained strong, inflation declined, and international reserves increased into the period ended December 2005. Fiscal and monetary developments were also broadly in line with projections under the SMP, although domestic revenue exceeded program targets. All but one of the structural benchmarks set under the SMP were observed and progress was made more generally in the area of structural reform.

Looking forward, Afghanistan still faces challenges in sustaining rapid growth and achieving the goals set out in the I-ANDS Paper. The medium-term outlook remains clouded by lingering insecurity, weak institutional capacity, and a still fragile social consensus. Afghanistan's economic program supported by the PRGF arrangement seeks to address these challenges and to help resolve outstanding debt issues, possibly in the context of the Heavily Indebted Poor Countries Initiative. Over the next three years, the IMF-supported program will aim to sustain real GDP growth of about 10 percent a year, reduce inflation to about 5 percent, and further strengthen the country's external position. The program seeks to increase budgetary revenue to more than 8 percent of GDP by 2010/11, while improving the provision of health and education services.

For 2006/07, the program assumes real GDP growth of 12 percent and a decline in year-on-year inflation to 9 percent. The operating budget deficit is targeted to decline to 2.9 percent of GDP, from 3.7 percent in 2005/06, through a combination of revenue measures and expenditure restraint. The fiscal program provides some flexibility to accommodate higher development spending if Afghanistan's implementation capacity improves, and to incorporate operating expenditures in the budget that are currently financed off-budget by donors. Monetary policy will continue to target currency in circulation in the context of a managed float system. Structural measures will focus on fiscal and banking reforms, steps to enhance the statistical framework and to improve Afghanistan's business environment.

The principal risks to Afghanistan's economic program are related to the security situation, the government's weak control over the provinces, and significant capacity constraints. The authorities will have to also deal with persistent opium-related activities, expenditure pressures and medium-term uncertainties about donor assistance.