Reconstructing AFGHANISTAN Adam Bennett, Editor Bruno de Schaetzen Louis Dicks-Mireaux Felix Fischer Thierry Kalfon Ron van Rooden International Monetary Fund ©International Monetary Fund. Not for Redistribution © 2005 International Monetary Fund Production: IMF Multimedia Services Division Cover design: Massoud Etemadi Figures: Theodore F. Peters, Jr. Typesetting: Alicia Etchebarne-Bourdin Cataloging-in-Publication Data Reconstructing Afghanistan/Adam Bennett, editor—[Washington, D.C.]: International Monetary Fund, 2004. p. cm. Includes bibliographical references. ISBN 1-58906-324-4 1. Afghanistan—Economic policy. 2. Afghanistan—Economic conditions. 3. Fiscal policy— Afghanistan. 4. Monetary policy—Afghanistan. I. Bennett, Adam. HC417.R43 2004 Mackenzie, G.A. (George A.), 1950– Price: US$25.00 Please send orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington, D.C. 20431, USA Tel.: (202) 623-7430 • Telefax: (202) 623-7201 E-mail: [email protected] Internet: http://www.imf.org ©International Monetary Fund. Not for Redistribution Contents Preface vii List of Acronyms ix Map x 1. Overview Ron van Rooden 1 The Political Landscape1 Coordination of Assistance1 Role of the IMF2 Economic Developments and Achievements3 Looking Ahead5 2. Recent Macroeconomic Developments Ron van Rooden and Louis Dicks-Mireaux 6 Comparison of Donor Assistance6 Output and Prices9 External Sector 12 Appendix 2.1. Poppy Dimension in the Afghan Economy 20 References 27 3. Fiscal Framework and the Budget Thierry Kalfon 28 A Slow Descent into Chaos 28 Dismal Situation but Resilient Structures 29 Reconstruction Strategy 31 Fiscal Policy Framework: Postconflict Budgeting 34 Appendix 3.1. Programs of the National Development Framework 42 Appendix 3.2. Comparing Afghanistan’s 2002/03 Operating Budget with Low-Income Countries’ Budgets 45 References 46 4. Structural Reforms: Revitalizing Fiscal Institutions Thierry Kalfon 47 Improving Public Expenditure Management 47 Reforming Revenue Policy and Administration 50 Revitalizing the Civil Service 52 Developing the Private Sector: Building a Market-Led Economy 54 iii ©International Monetary Fund. Not for Redistribution CONTENTS Appendix 4.1. Pay Structure for Government Staff and Tax Summary 55 5. Monetary and Exchange Rate Policy in a Postconflict Environment Ron van Rooden and Louis Dicks-Mireaux 59 Choice of Currency 60 Preconditions for a Successful Monetary Policy 62 Fixed or Flexible: Choosing the Exchange Rate Regime 64 Formulating a Monetary Program 66 Monetary and Exchange Rate Developments in 2002–04 69 Reference 71 6. Financial Sector Development in Afghanistan: Seeking a Renaissance Felix Fischer 72 After the Taliban: Financial System at the End of 2001 72 Modernizing the Financial Sector in Afghanistan 77 References 82 Text Boxes 1.1 Asian Development Bank in Afghanistan4 1.2 World Bank in Afghanistan5 2.1 Social Indicators7 2.2 Trade, Transit, and Transport Agreements 18 2.3 Exchange and Trade Arrangements 19 3.1 Public Sector and The Relationship Between the Center and Provinces 30 3.2 UN Immediate and Transitional Assistance Programs, 2001–02 32 3.3 Afghanistan Reconstruction Trust Fund 39 5.1 Introducing the New Currency 61 5.2 What Is the Right Exchange Rate Level? 65 5.3 Foreign Exchange Auctions 67 5.4 Considerations on the Level of Foreign Exchange Reserves 70 6.1 The Law on Money and Banking of the Islamic State of Afghanistan 74 6.2 Physical Infrastructure and Security of Da Afghanistan Bank 75 6.3 Six Licensed Banks in Afghanistan 76 6.4 Money Dealers in Afghanistan 78 Text Tables 2.1 Gross Domestic Product 10 2.2 Selected Indicators of Economic Activity 10 2.3 Balance of Payments 13 2.4 Direction of Trade 1 14 2.5 Direction of Trade 2 16 2.6 Commodity Composition of Trade 17 3.1 General Government Current Budget, 2002/03 36 3.2 Budget Execution, Center and Provinces, 2002/03 37 3.3 Operating Budget, 2003/04 41 3.4 Development Budget, 2003/04 42 5.1 Monetary Developments (Da Afghanistan Bank) 68 iv ©International Monetary Fund. Not for Redistribution Contents Figures 2.1 Foreign Assistance to Postconflict Countries8 2.2 Price and Exchange Rate Developments 11 3.1 National Development Framework: Relationship Between Pillars, National Development Programs, and National Priority Subprograms 33 3.2 Budget Execution: Economic Classification, 2002/03 38 3.3 Budget Execution: Functional Classification, 2002/03 38 5.1 Exchange Rates 71 Appendix Box A4.1 Civil Servant Salaries 56 Appendix Tables A2.1 Indicators of Opium Cultivation 21 A2.2 Estimate of Farmers’ Net Income from Opium 23 A2.3 Revenues from Opiates 26 A3.1 Afghanistan’s 2002/03 Budget Compared with Budgets of Selected Low-Income Countries 44 A3.2 Sample of Low-Income Countries Used for Comparison 45 A4.1 Tax Summary 57 The following symbols have been used throughout this paper: . to indicate that data are not available; — to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist; – between years or months (for example, 2002–03 or January–June) to indicate the years or months covered, including the beginning and ending years or months; / between years (for example, 2002/03) to indicate a crop or fiscal (financial) year. “Billion” means a thousand million. Minor discrepancies between constituent figures and totals are due to rounding. The term “country,” as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and pro- vided internationally on a separate and independent basis. v ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution Preface his study was prepared by an IMF staff team headed by Adam Bennett. Team T members included Louis Dicks-Mireaux, Felix Fischer, Thierry Kalfon, Ron van Rooden, and Bruno de Schaetzen. Reconstructing Afghanistan reflects the staff’s work in Afghanistan beginning in early 2002, with the establishment of the interim ad- ministration headed by President Hamid Karzai, through the first quarter of 2004. During this period, the staff focused on helping (often under difficult circumstances) the Afghan authorities quickly establish a basic framework for economic manage- ment and policies, including rebuilding key institutions, notably the Ministry of Fi- nance and the central bank, Da Afghanistan Bank. A preliminary version of this study was first published during the Annual Meetings of the IMF and the World Bank in Dubai in the fall of 2003, in the context of the IMF’s 2003 Article IV Con- sultation with Afghanistan. The authors are grateful for the excellent cooperation received from the Afghan authorities. In particular, our thanks go to Ashraf Ghani, Minister of Finance of Afghanistan (2002–04); Anwar Ul-Haq Ahady, Governor of Da Afghanistan Bank (2002–04); and Michael Carnahan, Larry Seale, and Martin Dinning, three key advi- sors in the Ministry of Finance and the central bank. The authors are also grateful to the United Nations Office on Drugs and Crime, which provided valuable information on and useful insights into the illicit drug sector in Afghanistan. The study covers the key areas in which the IMF staff has made important contributions toward the recon- struction of Afghanistan. In this regard, the authors would like to acknowledge the work of Paul Chabrier, Jean Le Dem, and Milan Zavadjil, who respectively led the staff team before Adam Bennett took over in the spring of 2003. The authors also ac- knowledge the work of the staff members of the IMF’s functional departments who have provided technical assistance to the Afghan authorities in their various areas of expertise, especially Steven Symansky and Emil Sunley of the IMF’s Fiscal Affairs De- partment, Ake Lönnberg of the Monetary and Financial Systems Department, Tobias Asser of the Legal Department, and Adriaan Bloem and Vilay Soulatha of the Statis- tics Department. The authors are also grateful for helpful comments and suggestions received from our colleagues in the IMF’s Middle East and Central Asia Department, especially George Abed and Mohammad Shadman-Valavi. The authors are indebted to Sheila Tomilloso for providing invaluable secretarial assistance, both at the IMF headquarters in Washington and in Kabul, and to Archana Kumar of the IMF’s Exter- nal Relations Department for editing this book and coordinating its publication. The views expressed here are those of the authors and do not necessarily reflect those of the IMF, its Executive Directors, or the Afghan authorities. vii ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution List of Acronyms AACA Afghan Aid Coordination Agency AFMIS Afghanistan’s Financial Management Information System AIA Afghan Interim Administration AIAF Afghan Interim Administration Fund ARCSC Administrative Reform and Civil Service Commission ARTF Afghanistan Reconstruction Trust Fund AsDB Asian Development Bank ATA Afghan Transitional Administration CG Consultative Group CIRR Commercial Interest Reference Rates CIT Corporate income tax CSO Central Statistics Office DAB Da Afghanistan Bank ECO Economic Cooperation Organization FAO Food and Agriculture Organization GMU Grant Management Unit IAS International Accounting Standards ICMP Illicit Crop Monitoring