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CFC Thematic Report - Economics of Self-Sustainability: The Future of Afghanistan’s Economy, 08 August 13

CFC Thematic Report - Economics of Self-Sustainability: The Future of Afghanistan’s Economy, 08 August 13

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Published by CFC Cimicweb
This report provides an in depth review of Afghanistan’s post-2014 prospects for financial self-sustainability by
examining the national budget and reviewing the past, present and future of international aid commitments. The
feasibility of the opportunities for economic growth on which the international community has pinned its hopes is also
discussed.
This report provides an in depth review of Afghanistan’s post-2014 prospects for financial self-sustainability by
examining the national budget and reviewing the past, present and future of international aid commitments. The
feasibility of the opportunities for economic growth on which the international community has pinned its hopes is also
discussed.

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C I V I L - M I L I T A R Y

F U S I O N

C E N T R E

AFGHANISTAN
August 2013

IN TRANSITION
Comprehensive Information on Complex Crises

Economics of Self-Sustainability: The Future of Afghanistan’s Economy
Nekia Lane
Assistant Desk Officer afghanistan@cimicweb.org

Edited by

Rainer Gonzalez Palau
Afghanistan Team Leader rainer.gonzalez@cimicweb.org

This report provides an in depth review of Afghanistan’s post-2014 prospects for financial self-sustainability by examining the national budget and reviewing the past, present and future of international aid commitments. The feasibility of the opportunities for economic growth on which the international community has pinned its hopes is also discussed. Further information on these issues is available at www.cimicweb.org. Hyperlinks to source material are highlighted in blue and underlined in the text.

F

iscal analysis conducted by the World Bank indicates that Afghanistan faces the upcoming transition from positions of both strength and weakness with regard to economic growth and financial stability. Afghanistan remains a nation weighed down by the lack of institutional capacity to enhance development budget execution rates, which currently stand at approximately fifty per cent, according to the 2011-2012 Annual Fiscal Report published by the Afghan Ministry of Finance (MoF). The past, present and future of Afghanistan’s economy is uniquely dependent upon foreign aid, with total military and civilian foreign aid disbursements to Afghanistan in 2011-2012 reaching USD 15.7 billion, a figure roughly equivalent to 100 per cent of the nation’s GDP, reports the World Bank. In light of the 2014 withdrawal of coalition forces, and the subsequent decline in aid, it remains uncertain to what extent Afghanistan can rely on funds pledged at the 2012 Tokyo Conference to support the transition. Experts posit that Afghanistan’s path towards financial self-sustainability requires comprehensive intervention to improve agricultural and extractive industries, and maximise domestic revenue, a subject that will be explored in this paper.

The Civil-Military Fusion Centre (CFC) is an information and knowledge management organisation focused on improving civil-military interaction, facilitating information sharing and enhancing situational awareness through the CimicWeb portal and our weekly and monthly publications. CFC products are based upon and link to open-source information from a wide variety of organisations, research centres and media sources. However, the CFC does not endorse and cannot necessarily guarantee the accuracy or objectivity of these sources. CFC publications are

independently produced by Desk Officers and do not reflect NATO or ISAF policies or positions of any other organisation.

AFGHAN ISTAN I N TRA NSITION / / ECONOM ICS OF SEL F -SU STAINA BIL ITY

Current National Budget and Source of Funds
At the very foundation of economic stability is a nation’s budget; a balance must be struck between revenue and expenditure. A study on the budget formulation process by the Afghan’s Coalition for Transparency and Accountability (ACTA) warns that the proper distribution of resources among the various sectors still remains a significant challenge for the Government of the Islamic Republic of Afghanistan (GIRoA). Although Afghanistan receives billions of dollars in international aid assistance, state institutions struggle to provide good governance, deliver basic services and uphold the monopoly of violence. The International Crisis Group says that Afghanistan follows the pattern of other post-conflict contexts with high rates of international aid, which often leads to the neglect of state institutions and limits the government’s ability to raise revenues to finance development expenditures or cover operational costs. Nonetheless, the World Bank adds that experiences elsewhere have shown that economic deterioration is not inevitable provided financial planning is programmed to alleviate effects of gradual decline in aid. According to data released by the MoF1, Afghanistan’s total national budget in Fiscal Year (FY) 2013-2014 increased by 47 per cent compared to the national budget at the start of FY 20122, rising from AFG 244.7 billion (USD 4.7 billion) to AFG 354 billion (USD 6.8 billion). The country has two parallel budgets: an external budget and a national core budget. The former is composed solely of donor funds. The latter encompasses both international aid and domestic revenues collected by the Afghan government and is usually separated into two primary allocations: the operating budget and development budget. The operating budget primarily covers government wages as well as nonwage operation and management (O&M) costs. The development budget covers the capital and operating costs of the government-run projects, which are predominantly donor-financed3. Table 1 shows the operating and development budgets (core budget) for each of the main sectors in FY 2013. Likewise, Table 2 provides a breakdown of fund allocation by ministry of the operating budget for the same fiscal year.

Table 1. Core Budget 2013 (FY 1392)
Sectors Security Infrastructure Education Agriculture Governance Health Economic Governance Social Protection Contingency codes Total Operating (USD ‘000’) 2,174,829 62,167 654,803 39,163 213,510 65,305 53,609 44,722 467,412 3,775,519 Development (USD ‘000’) 754,714 901,795 373,760 504,723 75,526 187,422 121,711 21,343 92,659 3,033,655 Total (USD ‘000’) 2,929,543 963,962 1,028,564 543,886 289,037 252,727 175,320 66,066 560,071 6,809,175 % in Total 43.0% 14.2% 15.1% 8.0% 4.2% 3.7% 2.6% 1.0% 8.2% 100% % operating 58% 2% 17% 1% 6% 2% 1% 1% 12% 100% % development 25% 30% 12% 17% 2% 6% 4% 1% 3% 100%

Source: Afghanistan Ministry of Finance, 1392 Financial Year National Budget.
1

The World Bank warns there are “large margins of uncertainty” with regard to the information that is available due to the difficulty of collecting reliable data within Afghanistan. 2 Until 1391, Afghanistan’s fiscal year was based on their solar year calendar (22 March – 21 March the following year), but Public Financial Expenditure Management Law was changed by Parliament in October 2011 to implement a new parameter for the fiscal year (21 December – 20 December the following year). As such, FY 1391 was only nine months long running from 21 March 2012 to 20 December 2012. 3 According to the World Bank, in 2010-2011 only fifteen per cent of the core development budget was domestically financed.

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National military expenditure in 2011 was 4.4 per cent of the nation’s total gross domestic product (GDP), a figure that is projected to increase to more than 17.5 per cent of GDP by 2021 – 2022. As Tables 1 and 2 further indicate, a great majority of the national budget is dedicated to security-related spending, in addition to the roughly USD 242.9 billion spent on foreign military operations and international peacekeeping forces. The GIRoA and the international community aim, with this security-focused strategy, a secure and investor-friendly environment as a precondition for private sector investment. Nonetheless, political and economic analysts argue that it has been a waste of energy and resources to pursue such a strategy rather than one that forms an economic structure that can bring about a modern state and a developed economy, writes The Asian Foundation. Analysts emphasise that a shift in focus is necessary so that resources go towards improving infrastructure and human resources development, institutional capacity-building approaches, targeted and coordinated economic strategies as well as transparent government policies and procedures. The details of suggested policies to accomplish such a shift are detailed in the final section of this paper.

Table 2. Ministries with Largest Share of Operating Budget (FY 2013-2014)
Budgetary Units
Ministry of Defence Ministry of Interior Affairs Ministry of Education General Directorate of National Security Ministry of Public Health Ministry of Higher Education Ministry of Foreign Affairs Directorate of Local Governance Ministry of Public Works Ministry of Finance Total (10 Ministries)

(USD ‘000’)
2,938,182 2,195,252 1,522,507 503,835 174,716 164,165 136,342 126,996 27,456 94,462 7,883,918

% share in total Operating Budget
29.1% 21.7% 15.1% 5.0% 1.6% 1.7% 1.3% 1.3% 0.3% 0.9% 78.1%

Source: Afghanistan Ministry of Finance, 1392 Financial Year National Budget.

According to the World Bank, financing the Afghan budget depends greatly on external aid, with donor funds providing 85 per cent of the development budget and 28 per cent of the operating budget. Table 3 provides a breakdown of the progressive increase in donor assistance to Afghanistan over a period of seven years. As aiddependent as Afghanistan is, it is important to understand how aid affects the economy and the potential impact during the transition. Another World Bank study suggests that aid inflates the government’s role in the economy by raising the public consumption. For instance, public consumption between the period 2006/07 – 2008/09 increased from 10.8 per cent to 47.5 per cent of GDP. Notwithstanding, “spending ‘on’ Afghanistan does not equal spending ‘in’ Afghanistan”, as much foreign spending finances security costs such as military personnel salaries, logistics and research of international forces as well as development projects implemented by companies or organisations from overseas, which have a limited direct impact on the country’s economy. Hence, many doubt that the effects of the withdrawal could be less than expected.

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Table 3. Donor Assistance (USD million)
Donor assistance Civilian aid Security-related aid On-budget support Total % of GDP 2005/06 2,416 988 720 4,124 66% 2006/07 1,350 1,905 717 3,972 56% 2007/08 2,188 7,028 1,069 10,284 118% 2008/09 2,675 2,750 1,024 6,449 61% 2009/10 3,942 5,470 1,275 10,686 86% 2010/11 5,262 8,594 1,886 15,742 98%

Source: World Bank “Afghanistan in Transition: Looking Beyond 2014” Volume 2: Main Report, May 2012.

Given that aid flows are set to decline following international troop withdrawal, a key economic question for Afghanistan’s transition is whether large decreases in aid to other post-conflict countries have negatively affected their economies. One comparator identified by the World Bank is Mozambique, where aid was equal to roughly 60 – 80 per cent of Gross National Income (GNI) in the first three years of transition, but declined to less than twenty per cent and stayed in the 20 – 30 per cent range for the rest of the fifteen-year transition. Yet real per capita GDP growth in Mozambique maintained average annual growth of over 4 per cent. Another comparator is Bosnia and Herzegovina, where aid declined early in the post-conflict from 57 per cent of GNI in 1995 to 6 – 8 per cent in 2002 – 2004 and 2 – 3 per cent in recent years. In this case, the country saw an initial slowdown of GDP growth, but growth picked up to 5-7 per cent in the period from 2004 – 2008. Therefore, as evidenced by these cases and others, World Bank economists claim the impact of large aid reductions on economic growth may be less dramatic than expected, although it is important to highlight a number of factors distinguishing Afghanistan as uniquely different. In Mozambique and Bosnia and Herzegovina, aid was reduced early in the post-conflict period at a time when post-conflict economic recovery was still strong and could offset the loss of aid. Crucially, in both examples peak levels of aid were temporary, so their economies did not develop a reliance and form to expect high aid flows. Afghanistan, on the other hand, has surpassed its post-2001 economic boom and has become highly adapted to high aid flows. As a result, Afghanistan crucially needs strategic and gradual aid tapering to allow the economy to adjust to new opportunities for growth and warns that a rapid decline could lead to serious macroeconomic instability and negative socioeconomic consequences. Domestic revenue collection has improved dramatically in the last decade, according to leading international organisations. The World Bank and the International Monetary Fund (IMF) cite an increase in Afghanistan’s domestic revenue by twenty per cent a year in the four years leading up to 2011, rising from three per cent of GDP in 2002 – 2003 to eleven per cent of GDP in 2010 – 2011. The World Bank attributes revenue growth to the introduction and strengthening of sound public management systems and to the maintenance of fiscal discipline. Specifically, Afghanistan has undergone an improvement of the Large Taxpayers Offices (LTOs), a key structure to guide large taxpayers, including medium and large-sized businesses, through complex tax procedures. The establishment of such institutions in facilitating tax payment compliance has significantly increased revenues, with LTOs contributing thirty per cent of all tax revenues raised by the MoF and heightening tax administration efficiency. Medium Taxpayer Offices (MTOs) have been targeted for improvement alongside the LTOs by the United States Agency for International Development (USAID) as part of the organisation’s Economic Growth and Governance Initiative (EGGI) and have also contributed to boost Afghanistan’s tax revenue. Furthermore, in 2010 the UK Department for International Development (DFID), in collaboration with the World Bank, introduced the Standard Integration of Government Tax Administration System (SITGAS) in Herat, Balkh, Nangarhar, Kunduz and Kandahar provinces. SITGAS is an automated database that re-engineers tax administration delivery and makes various aspects of tax management more systematic.

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Additionally, improvements have been made in domestic revenue collection with the introduction of a two per cent Business Receipt Tax (BRT), greater revenues from the state fuel company and the amendment of the income tax law, adds the World Bank. Finally, the implementation of the planned Value-Added-Tax (VAT) for 2014 will further also increase domestic revenues. While the gains made in domestic revenue collection have exceeded expectations and fiscal targets, fiscal consolidation remains dependent upon donor funding. Economists foresee significant growth in expenditure will overtake gains in domestic revenue and as donor funding declines domestic revenue, Afghanistan could reach a projected financial gap of 25 per cent of GDP, approximately USD 7.2 billion a year.

Table 4. Inflows: Revenues and Grants
Item TOTAL REVENUES AND GRANTS Total Domestic Revenue Tax Revenues Income, profits & capital gains International trade & transactions Goods and services Other Non-Tax Revenues Grants Grants to operating budget Grants to development budget FY 2012-2013 (USD) % of GDP FY 2013-2014 (USD) % of GDP (projected) 23.4% 11.3% 8.8% 2.7% 3.4% 2.2% 0.5% 2.5% 12% 8.1% 4.0%

3,648,201,736 1,758,991,318 1,374,534,931 413,393,964 551,880,942 343,116,990 66,143,034 384,456,386 1,889,210,416 1,221,579,164 667,631,252

22.9% 11 8.6% 2.6% 3.5% 2.1% 0.4% 2.4% 11.9% 7.7% 4.2%

5,510,541,546 2,666,391,070 2,666,391,070 638,693,675 793,716,411 527,077,304 115,750,310 593,220,338 2,844,150,474 1,909,880,115 934,270,359

Source: International Monetary Fund Country Report No. 12/245, August 2012

Capacity of the Government in Budget Execution
The inability of the Afghan government to address its challenges regarding budget execution4 is an issue that has been widely explored by experts, insofar as improper allocation of resources proves a major detriment to economic stability. Budget analysis conducted by Afghan’s Coalition for Transparency & Accountability (ACTA) claims that during the period 2011 – 2012, budget expenditure figures show approximately 94 per cent of the operating budget was executed; for the same period only fifty per cent of the development budget was executed. The World Bank notes that the predictable or recurrent costs associated with the operating budget (e.g. staff salaries) are where governments maintain efficiency whereas the development budget, which covers one-time expenses such as training and education programmes, is associated with institutional improvement or expansion. In this regard, the World Bank’s analysis of Afghanistan’s public financial management identifies four areas of improvement with regard to budget execution. Firstly, financial management processes must guarantee that funds reach service delivery units. Secondly, reform and progress in public financial management laws is necessary to strengthen the control framework for public spending. Thirdly, progressive implementation of the Procurement Law is necessary to establish a fair and transparent procurement system. Lastly, external examination and audit

4

The term “budget execution” refers to a government’s ability to plan and use the funds it has at its disposal.

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are crucial to keep the GIRoA accountable for the use of public funds. Overall, progress in these four areas will address the overarching challenge of corruption by addressing the core governance problems. Further studies addressing public financial management cite donor practices as a major culprit behind GIRoA’s weak budget execution. One issue complicating the process to execute the budget is the diversity of different delivery mechanisms, programme monitoring and financial systems of each donor. In these circumstances, it is hard for the Afghan government to know the amount of money it has and how and when the funds are to be received. In addition, donor’s annual budgeting obliges the government to approach budget execution in the shortterm, rather than allowing for long-term, high-cost investments. In December 2012, the lower house in Afghanistan’s parliament voted in favour of the impeachment of eleven ministers who failed to spend at least fifty per cent of their fiscal-year budgets, reports Tolo News. The eleven ministers were summoned in early 2013 to undergo a vote of confidence in parliament. In April 2013, two ministers received votes of confidence during the parliamentary sessions to question the ministers’ budget spending and vote on impeachment. As an illustration of the nation’s sustained struggle to improve government capacity to properly disperse funds, Figure 1 depicts budget execution against percentage efficiently allocated and executed from 2005/2006 - 2010/2011.

Figure 1. Core Operating and Development Budget Execution, 2005/06 - 2010/11 (per cent and USD millions)

Source: World Bank “Afghanistan in Transition: Looking Beyond 2014” Volume 2: Main Report, May 2012

Decline of International Aid during the Transition
The withdrawal of international troops and the transfer of security responsibilities to the Afghan National Security Forces are expected to be completed in correspondence with the next Afghan election cycle. Along with the handover of military functions it is expected a decrease in foreign aid assistance, an impact that might be deepened if the Afghan government fails to satisfy the conditions set by donors at the Tokyo Conference.

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Tokyo Conference Commitments and the Conditionality Seventy representatives from around the world convened at the Tokyo Conference5 in July 2012, where they pledged USD 16 billion in aid6 to Afghanistan over the next four years. The funds promised by the delegations are subject to the Tokyo Mutual Accountability Framework (TMAF), which states some conditionality for the funds to be handed over. This is a clear indication, according to some experts, that donors are not willing to make indefinite commitments. As the largest donor, the United States government announced it will maintain the level of assistance that has been provided to Afghanistan over the last ten years, approximately USD 2 billion a year until 2017 according to The Guardian. Similarly, Japan, the second-largest donor, committed USD 3 billion over a four-year period through 2016, USD 2.2 billion of which will be provided in grants for infrastructure development programmes, said Japanese Foreign Minister Koichiro Gemba. Also, Germany made a pledge of USD 536 million a year until 2016, with Foreign Minister Guido Westerwelle emphasising that Berlin will diligently tie its aid to government reforms. Moreover, Canada made a commitment of USD 227 million in development aid between 2014 and 2017, on top of its initial pledge of USD 300 million for 2011 to 2014. The money is to go towards “empowering women and girls in the areas of education, human rights and humanitarian assistance”. Australia’s Foreign Minister Bob Carr announced his country is set to provide USD 1 billion over four years for education, rural jobs and development of the mining industry beginning in 2015-2016. Furthermore, the European Union announced that it will provide funding in line with current levels of EUR 1.2 billion a year, on the condition that progress is achieved in women’s rights and rule of law. The Asian Development Bank will provide USD 1.6 billion through 2016. The logistics of the financial aid pledged at the Tokyo Conference are detailed in the Tokyo Declaration, a document agreed on by conference participants, which lays out the Tokyo Mutual Accountability Framework (TMAF). The TMAF identifies reciprocal principles set to ensure each side monitors and honours its commitments, so that donors follow through with pledged assistance and the Afghan government secures delivery and accountability in light of fears of corruption and poor governance. The aid is tied to a mechanism of conditionality linked to the government performance and includes benchmarks to measure progress in various sectors, including corruption, human rights, gender equality, finance management and democratic processes, amongst others. In order to receive at least twenty per cent of the committed funds, the GIRoA must reduce corruption and meet governance standards, according to the New York Times. The conditions include free and fair presidential and parliamentary elections in 2014 and 2015, and the implementation of a law regarding violence against women. A major problem with the pledges from the Tokyo Conference, as identified by the Center for Strategic and International Studies (CSIS), is that they are not linked to any credible assessment of actual requirements.

Pledges versus Actual Disbursement
Despite the fact that donors have pledged large amounts of funds for Afghanistan reconstruction, the 2010 briefing paper “Afghanistan: Tracking major resource flows 2002-2010” questions the reliability of donor commitments. While donors pledged USD 62 billion in aid for the period 2002-2013, in 2009 only 43 per cent (USD 26.7 billion) of the total had been disbursed to development projects and activities. Table 5 illustrates whether the commitments have been met for each of the donors. These past trends and the challenges the Afghan government

5

For a detailed breakdown of the 2012 Tokyo Conference, see CFC publication “Second International Tokyo Conference on Afghanistan”. 6 For the purpose of this report, use of the term “aid” henceforth refers to official development assistance (ODA), either a grant or loan, from a bilateral agreement or a multilateral agency.

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will face after the withdrawal of international troops will definitely test donor fatigue in Afghanistan7. Other experts warn of presuppositions that aid can be relied upon to shape a stable state, for many of the reasons raised above- including neglect of state institutions and an inability to provide basic services- as well as the reliability of donors to deliver on their pledges. In response to the pledges made at the Tokyo Conference in 2012, Louise Hancock, Oxfam Afghanistan’s head of policy and advocacy expressed concern over how much of the funds are new investments or how the international community will approach aid to Afghanistan after 2017, remarking, “It will take decades, not five years, to pull Afghans out of poverty.” Scholars at CSIS approach the matter of aid pledges with similar weariness, positing that the broader problem with future aid will strike at the ability (or inability) for donors to deliver on their pledges for Afghan aid. A CSIS study titled “Creating the Economic Conditions and Civil-Military Aid Efforts Needed for Transition” claims “Nations often do not make good on even their short-term pledges, turn aid into loans, and tie aid to specific projects and priorities regardless of need”. Hence, in looking towards the future of Afghanistan’s economy, rather than concentrating on a donor driven economy, experts recommend the GIRoA and the international community must shift the focus to natural-resource extraction, agricultural and rural development and efficient domestic revenue collection.

Table 5. Aid Pledges, Commitments and Disbursements
Total Pledged 20022013 (USD billion) United States EU Institutions United Kingdom Germany Canada Japan Netherlands Norway India* Sweden Italy Turkey Australia Iran (Islamic Republic of)* Spain Denmark France Finland Russia* Switzerland Multilateral agencies 38.0 2.0 2.9 1.2 1.7 1.9 0.8 0.9 1.2 0.3 0.5 0.2 0.4 0.9 0.5 0.7 0.2 0.2 0.1 0.1 5.3 Total Committed 2002-2009 (USD billion) 28.4 2.0 1.8 1.0 1.2 1.4 0.9 0.6 1.2 0.5 0.4 0.2 0.2 0.3 0.1 0.3 0.2 0.2 0.1 0.1 4.0 Total Disbursed 20022009 (USD billion) 10.9 2.1 1.8 1.3 1.2 1.0 0.8 0.7 0.4 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.2 0.1 0.1 0.1 2.7 % of Pledges Disbursed by End 2009 28.8% 102.8% 63.3% 108.0% 70.3% 52.5% 102.4% 71.0% 36.1% 147.3% 79.6% 213.7% 98.8% 39.5% 59.8% 40.2% 105.9% 97.0% 104.1% 102.9% 50.6%

7

For a broader discussion of donor fatigue and consequences see CFC’s publication “Prospect for a Crisis post-2014” by Katerina Oskarsson.

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Others Total

5.9 62.0

3.3 46.1

0.7 26.7

12.3% 43.1%

Source: Global Humanitarian Assistance “Afghanistan: Tracking Major Resource Flows 2002-2010”, January 2011. *Note: all disbursements are based on OECD DAC data, excluding India and Russia, which are based on Afghanistan DAD data.

Prospects for the Future of Self-Sustainability
Afghanistan’s real GDP growth increased from 7.3 per cent in 2011 to approximately 11.8 per cent in 2012, but is expected to slow down in 2013 and 2014 due to political and security uncertainties, writes the World Bank’s “Afghanistan Economic Update”. Moreover, the World Bank projects an annual growth of 4.9 per cent between now and 2025, with the potential to increase to 6.9 per cent in the same time period depending on progress achieved in some sectors. Measures emphasised by experts to achieve this figure include: i) putting in place an enabling regulatory, legal, and infrastructural system for the mining sector; ii) investing in agricultural irrigation systems, new production and post-harvest processing technologies; and iii) strengthening domestic tax revenue mobilisation.

Natural and Mineral Resources
Expectations for the untapped mineral deposits of oil, gold, copper and iron ore within Afghanistan are immense, holding an estimated value of USD 1 trillion, according to the New York Times. Afghan Minister of Mines Wahidullah Shahrani has called this a conservative estimate, claiming the nation’s mineral wealth could reach USD 3 trillion, reports NY Daily Times. Regardless of the exact figure, putting in place a sound regulatory and legal structure for the mining sector is crucial to take advantage of the lucrative opportunities, not only to boost economic growth, but also as a source of revenue for the Afghan government8. The World Bank projects that in a scenario with higher investment in mining development, “growth could increase to 6.9 per cent on average until 2025, and fiscal revenues could reach 2-4 per cent of GDP by the early 2020s, depending on the number and scale of the exploited mines and the pace of their development”. Similarly, the IMF reports that under a “cautiously optimistic scenario”, mining revenues could yield about two per cent of GDP by 2025. Nonetheless, the potential revenues of the mining sector cannot be considered a guarantee as mining investments and operations are very sensitive to Afghanistan’s economic and political uncertainties. Aynak copper mine project, located in Afghanistan’s notoriously dangerous Logar province, is an illustrative example of how these uncertainties can jeopardise the normal progress any investment. Assessments evaluate Aynak as the secondrichest unexploited copper deposit in the world. Five years behind schedule the thirty-year contract was won by state-owned China Metallurgical Group Corporation (MCC) for USD 3 billion in 2007, reports McClatchy. Development of the mine has not progressed as planned, as insurgents aiming to sabotage the government’s flagship project increased attacks in the area, causing Chinese workers to flee and the project to halt, according to Reuters. Currently, MCC is waiting for the Afghan government to pass a new mining law in order to renegotiate the terms and conditions of the project and increase the legal and physical protection of the mine. The discovery of 2,000 year-old Buddhist monasteries has further complicated the situation and prevented exploration from beginning, reports the Guardian. Recent progress has been made to improve mining laws, a vital move to attract foreign investment (and secure planned investment), with new legislation being discussed in Parliament, according to Tolo News. Although previous versions of the law have failed to go through, Parliament is expected to pass this new law that will bring
8

For an in-depth report by the World Bank on this subject, consult “The Afghanistan Mining Sector as a Driver of Sustainable Growth: Benefits and Opportunities for Large-Scale Mining”.

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the mining sector in line with international standards. The law is expected to issue improved security of tenure for investors and more transparent guidance on licensing, tendering and other obligations. With multi-billion-dollar commitments from international firms pending, the law’s passing will allow the implementation of large-scale resource-extraction projects that have been held up due to insecurity and uncertainty. Another such delayed project is the Hajigak iron ore deposit in central Bamian province, which is worth up to USD 11 billion. An investment plan for the project with a consortium led by the Steel Authority of India Ltd (SAIL) is in limbo awaiting the passing of the new legislation, reports Reuters. The broader plans around the USD 1.8 billion tonnes of iron ore reserves include a crucial 600 km-long rail corridor linking Bamian to the new Chahbahar port in Iran, according to the Economic Times. Both the Aynak and Hajigak mines will result in large amounts of materials requiring feasible transportation out of the country, and per contract the companies exploiting the mines have to invest in new railway infrastructure. Even with such growth, economists at the World Bank point out the direct impact of mining may not be as directly transformative as expected. As an economic activity, the mining sector is capital-intensive and does not result in significant job creation. Estimates for the best-case scenario state mining will bring about 100,000 to 125,000 jobs in Afghanistan over the next ten years, a figure that wanes in comparison with the 400,000 – 500,000 people who will enter the workforce each year in the same period. Moreover, the report points out that those job opportunities in the mining sector will be predominantly for skilled and semi-skilled workers, thus direct benefits to the poor and low-skilled workers will be limited. In order to maximise the economic benefits of the mineral wealth, strategic planning and investment on the part of the Afghan government is called upon through World Bank’s Resource Corridor approach “which rests on the idea of using mining development as an anchor for the infrastructure that underpins the viability of the other sustainable activities”. The approach was built on the theory that with development of a resource corridor the state has an opportunity to leverage economic growth and diversification so that more can benefit from a spillover effect. Essentially, the mines provide the incentive and opportunity to create an initial resource corridor that brings transport and power infrastructure to rural regions, which then stimulate economic development in tandem with the mining industry. A GIRoA-led programme focused on resource corridors is built upon the knowledge that if such infrastructure is well designed, “a resource corridor could emerge providing incentives for the discoveries of additional minerals and the development of industries both related and not related to mining”. In late-2012, China National Petroleum Corporation (CNPC) began oil production in the Amu Darya basin in northern Afghanistan. With around 1,950 barrels of oil produced per day, the number is expected to grow to more than 4,000 barrels per day by the end of 2013. According to Reuters, “The venture with CNPC, which has invested hundreds of millions of dollars, was expected to produce billions of dollars over the next two decades CNPC will pay a fifteen per cent royalty on oil, twenty per cent corporate tax and give 50-70 per cent of its profit from the project to the government”. The expected contribution of Amu Darya oil to the Afghan budget through royalties and taxes is approximately USD 250 million annually for 25 years. While the development of the natural gas sector, a USAID-led programme for rehabilitation and reconstruction of the poorly maintained gas pipeline in Sheberghan, began in 2012. This initiative is an important step towards becoming self-reliant in energy production.

Agricultural Development
Agricultural development is frequently identified by experts as the most important sector the government can pursue to achieve inclusive and sustainable growth. Agriculture weighs heavily in the outcome of Afghanistan’s GDP, accounting for one fourth to one third of the nation’s overall economic growth, according to the World Bank. Figure 2 demonstrates how the cyclical pattern of agricultural output is strongly correlated to real GDP
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growth. Agricultural productivity has far reaching benefits and is an important source of growth and income, absorbing sixty per cent of the working population, with three out of five Afghan workers relying on farm-related activities as their main source of income. The International Labour Organisation (ILO) has highlighted that with joblessness as a recognised root cause of destabilisation and conflict, job creation is known to have a positive impact on national peace and security, both directly and indirectly9. A more peaceful and productive Afghanistan is better positioned to grow economically with a greater labour force, stimulated markets, internal demand and further spillover benefits to other sectors.

Figure 2. Real GDP and Agriculture Growth Rates

Source: World Bank “Afghanistan Economic Update” April 2013

The variability of the outcomes of the agricultural sector in terms of percentage of the GDP depends on a series of factors that significantly affect the agricultural production. On one hand, agriculture is of course highly dependent upon weather conditions, with much of the harvest being rain-fed. On the other hand, agricultural sector is at the mercy of the vacillating prices in regional and local markets, and yet the sector is insufficiently resilient to shocks. Moreover, the country’s illicit opium production continues to play a significant role in agriculture as a highly important cash crop for many households in rural areas, with the last three years showing an increase in opium cultivation, according to the United Nations Office on Drugs and Crime (UNODC). With such impediments preventing the exploitation of the agricultural sector, experts agree that it is necessary to address the challenges and potential of agriculture as a crucial yet volatile piece of Afghanistan’s prospect for economic selfsustainability. The World Bank’s economic update on Afghanistan emphasises that with agricultural productivity currently below fifty per cent of its pre-war level, the present challenges can be tackled by investing in agricultural irrigation systems, new production and post-harvest processing technologies. Actions to achieve competitive agricultural development must include what the ILO refers to as “the simultaneous development of supporting supply-chain services” (again implementing and benefiting from the Resource Corridor approach), as Afghanistan undergoes transition. More specifically, the Afghan government is advised to invest in agricultural irrigation systems, as there is a lack of irrigated land and irrigation infrastructure, which often leads some farmers to grow
9

For a detailed exploration of the state of employment in Afghanistan, and its effects on economic and social stabilisation, see the ILO’s report “Afghanistan: Time to move to Sustainable Jobs”.

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opium10 rather than vegetables, cereals or fruits. A working paper published by the International Water Management Institute states that the principal barrier to agricultural productivity is the lack of proper infrastructure to route water for agricultural use, and large portions of land are underutilised mainly due to lack of water and low soil quality. In addition, fertiliser use in Afghanistan is low, used by only 63 per cent of farmers, with even less farmers using pesticides or herbicides or learning about proper crop planning methods, say field studies conducted by the University of California. The Food and Agriculture Organization has stressed it is vital that the government invest in programmes to educate rural populations about such planning and production strategies, as well as post-harvest processing technologies. Despite the importance of the agricultural sector in Afghanistan’s economy, analysts at the CSIS warn against overestimating growth projections, as the sector’s performance is reliant upon varying factors. Nevertheless, investment in rural development and agricultural training can position Afghanistan to promote vitally inclusive sources of economic growth, and in turn stabilise its preparedness for economic independence.

Fiscal Policies and Value Added Tax (VAT)
The IMF foresees that domestic revenues after 2014 will only cover half of the government spending. An underlying theme of the World Bank’s paper on public finances for development is that increasing domestic revenue mobilisation needs to be given a very high priority: it will reduce aid dependence over time, create fiscal space necessary for development and make clear to the Afghan population GIRoA’s commitment to progressing toward fiscal sustainability. In projections for Afghanistan’s economic outlook in 2013, the World Bank stresses that structural reform should focus on measures that bring about the highest pay-off with regard to revenue mobilisation. Their analysis concludes that reform in areas of tax policy and customs and introduction of the planned Value Added Tax (VAT) to increase domestic revenue are important steps the Afghan state should follow. IMF calculations project successful implementation of a VAT in 2014 will generate approximately two per cent of GDP, while an excise tax, assumed by analysts to be introduced in 2018, will generate about one per cent of GDP. Taken together with other sources of domestic revenue (including mining and agriculture) and what is referred to by the IMF as a “cautiously optimistic scenario”, total fiscal revenue are expected to reach seventeen per cent of GDP by 2020.

Conclusion
The international community and the GIRoA recognise that one of the most challenging aspects of the transition process in Afghanistan is ensuring its economic self-sustainability in the medium- to long-term. The capacity of the GIRoA to run the country with minimum amount of foreign assistance will be critical to determine the success of the long-lasting state-building process. In this regard, foreign aid is equivalent to almost 100 per cent of the country’s GDP; the 85 per cent of the development and 28 per cent of the operational budgets, respectively, are funded with international aid. Hence, experts have projected that with the decline of foreign assistance in the coming years the fiscal gap could reach 25 per cent of the GDP. Also, the GIRoA is still struggling to accomplish budget allocation, with only fifty per cent of the development budget being allocated for the period 2011 – 2012. In order to keep economic growth, enhance governance and make progress in fiscal sustainability, the GIRoA has to focus on three fronts: benefiting of the potential of natural and mineral resources, consolidate agricultural development and increase domestic tax revenue. Yet reforms and progress on these sectors are challenging and require long-term timeframes. As a result, Afghanistan crucially needs strategic and gradual aid tapering to allow the economy to adjust to new opportunities for growth and political reforms and, a rapid decline could severely lead to macroeconomic instability and negative socioeconomic indicators in the short-term.
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For an in depth exploration of this topic, see CFC publication “The Decision to Plant Poppies: Irrigation, Profits & Alternatives Crops in Afghanistan”.

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