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p. 1 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Levels

Afghanistan: Country Strategy and Program Updates 2004-2006

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I. Current Development Trends and Issues

A. Recent Political and Social Developments

1. Despite daunting challenges, Afghanistan is undergoing one of the most promising phases of political and economic development in its recent history. Whether peace and stability are restored and progress toward political normalcy and economic renewal continues depends largely on the ability of the Kabul authorities to reconstruct an economy devastated by more than two decades of conflict and natural disaster, and to overcome a myriad of security and drug-related difficulties. It also depends on the international community's abiding agreement to provide longer-term commitments and significant technical and financial support for new programs and projects, and to address security requirements.

2. The installation of a transitional Government with Mr. Hamid Karzai as President in 2002; the adoption of a new constitution in January 2004 designating Afghanistan as an Islamic republic including a strong centralized presidency, a bicameral legislature, and gender equality in principle; the approval of an electoral law in May; and the prospect of presidential and parliamentary elections with universal suffrage in September constitute a strong framework for recovery and development. The Government has demonstrated its commitment to political, economic, and social reform and to developing a free and competitive economic system and private sector-driven growth. It has initiated important steps to reduce the political influence of the country's warlords and to create a strong, cohesive national army. The authorities have shown strong ownership of the reconstruction effort, working closely with funding agencies on rebuilding critical physical infrastructure and on transforming Soviet-style public sector institutions into those that promote market-led development. Despite enormous challenges associated with macroeconomic planning and management of the reconstruction effort (e.g., the Government's limited technical and revenue-generating capacities, numerous aid sources and implementing agencies, deficient statistical information, weak service delivery systems, and manifold laws and regulations requiring revision), the authorities have succeeded in providing basic social and humanitarian aid to a rapidly growing population possessing some of the worst socioeconomic indicators in the world (poverty and social indicators are presented in Table A1.3). The inadequate telecommunication and transport infrastructure and nascent commercial banking and legal systems notwithstanding, business infrastructure is improving rapidly and Afghanistan is reintegrating into the global marketplace.

3. Afghanistan needs to become an effective state with authority across the whole country, and which is democratic and accountable, can guarantee security and the rule of law for its citizens, addresses the needs of the poor, and ensures an enabling environment for private sector-driven economic growth. However, warlordism in many areas, the revival of the Taliban, the survival of Al-Qaeda as a coherent force, and increased fighting and banditry all menace Afghanistan's cohesion and threaten the political transition and economic development. Although the situation in Kabul is stable due to the presence of the forces of North Atlantic Treaty Organization (NATO), Afghan National Army, and police forces, the city is also home to Taliban loyalists and extremists, and is experiencing periodic missile attacks and bombings as well as increased crime and lawlessness¹. Security considerations outside the capital mirror the complexities of Kabul. Taliban elements are returning to Afghanistan's southern, southeastern, and eastern provinces from Pakistan's border areas. In recent months, anti-government political and religious factions have stepped up their attacks on aid agency representatives to disrupt the electoral process. The situation is particularly important for Asian Development Bank (ADB) operations in these areas: security considerations at project sites, especially for transport and energy projects, will determine the pace at which ADB-supported projects can be implemented.

4. Afghanistan is once again the world's largest producer of illicit opium. The current ban on cultivation has had extremely limited effect; indeed, planting opium is a major cash income source for farmers due to its ready profitability and lack of other livelihood alternatives. According to the UN Office on Drugs and Crime (UNODC), opium was cultivated on 80,000 hectares (ha) in 2003, an increase of 8% over 2002; production increased by 6% to 3,968 tons, 20 times more than in 2001, the last year of Taliban rule. Poppy was grown in 28 of 32 provinces in 2003, up from 18 in 1999. UNODC estimates that 264,000 families-or about 7% of Afghanistan's population-are producing poppy, each cultivating an average of 0.3 ha. UNODC estimates average earnings at $3,900 per opium-growing family (or $594 per capita) in a country where per capita gross domestic product (GDP), as estimated by the International Monetary Fund (IMF), is only $207. The share of poppy production in the economy is large; IMF estimates that including opium exports would raise the FY2002/03 GDP by 40% to $6.5 billion. Drug export income generates substantial demand, production, and income in other sectors of the economy. Any reduction in poppy cultivation will have a negative impact on economic growth-and possibly on poverty reduction, the balance of payments, and macroeconomic stability-unless matched by alternative livelihood schemes.

5. Poppy cultivation, narcotics production and trade, and profits from these activities constitute a major threat to Afghanistan's security, political normalization, and economic development, and chain a poor rural population to domestic warlords and international crime syndicates. To combat this problem, the Government has developed a national counternarcotics strategy, and is working with aid agencies involved in the security sector on interdiction and eradication activities and on support for alternative livelihoods. ADB operations in natural resources and agriculture cover rehabilitation of irrigation systems and agricultural support services, and will have a positive impact on reducing poppy cultivation by providing alternatives to its production, using a demand-driven, participatory, and community-based approach.

B. Economic Assessment and Outlook

6. The Government is strongly committed to achieving financial stability and maintaining fiscal discipline to support economic reconstruction and recovery. It is coordinating and managing the reconstruction and development effort, which was strengthened following adoption of the National Development Framework (NDF) in April 2002. The NDF focuses on three pillars of development: (i) security and human development, (ii) rebuilding physical infrastructure, and (iii) creating a viable private sector as the engine for sustainable and inclusive economic growth. For each pillar, broad sector programs have been developed and individual, in-country consultative groups (CGs) established to identify and select projects and coordinate foreign aid flows. Preparation of annual national development budgets, which seek to translate the NDF's broad programs and priorities into detailed, prioritized investment programs to be funded through the formal budgetary process, has followed. A strong Government-aid agency partnership will be crucial to effective implementation of these investment programs.

7. The Government's reform agenda has been based on sound macroeconomic policies. Impressive progress has been made in achieving macroeconomic stability, and the economy shows it. IMF estimates that real GDP, excluding opium production, grew by about 30% in 2002/03 and 23% in 2003/04. The growth resulted from recovered agricultural production after years of drought, an urban construction boom, and increased service establishments driven by the international community's spending and emergency assistance efforts. Since the successful currency conversion in early 2003, prices have remained broadly stable and the exchange rate has fluctuated around AF48-50 per dollar, reflecting sound monetary and fiscal policies, ample staple food supplies, and confidence in the new currency. Continued strong growth in agriculture, services, and construction is expected in 2004.

8. The treasury has been reorganized and revenue and expenditure systems restructured; the tax regime is being simplified and international standards of auditing and accounting established². Efforts are under way to increase the central Government's control over provincial finances: the recent streamlining of the Government's accounts in the provinces and their planned consolidation into the central accounts at Da Afghanistan Bank (DAB) will help achieve effective revenue centralization. These efforts are reaping dividends: domestic revenues are budgeted at $300 million, an increase of about 50% over SY1382, leaving $309 million to be covered by external assistance and carryover funds³. The Government is adhering to a strict policy of no deficit financing: it will not borrow from the banking system to cover any shortfall.

9. A major step forward is the recent adoption of the new Central Bank Law and Banking Law, facilitating further central bank modernization and the entry of several commercial banks, including the Afghanistan International Bank (AIB), supported by ADB⁴. The new Central Bank Law provides a framework for an independent yet accountable monetary policy, and the creation of a sound financial system. The Government has also drafted a new Law on Domestic and Foreign Private Investment addressing such areas as tax waivers, land leasing, transfer of capital and profits, seizure and confiscation, and dispute resolution. Three presidential decrees have paved the way to implement a Public Administration Reform and Economic Management Program to build accountable, transparent, and efficient public services.

10. Despite strong economic recovery and recent progress in structural reform, the remaining reform agenda and financial requirements for continued progress are vast. With a per capita GDP of only $207, reducing poverty, or even attaining the income levels of neighboring countries, will require strong economic growth for many years to come and substantial international assistance to sustain recovery, growth, and poverty reduction. Ultimately, the Government's ability to maintain political and macroeconomic stability and to adopt strong policy measures, as well as noneconomic factors such as security and institutional capacity, are key⁵.

C. Implications for Country Strategy and Program

11. The Government of Germany hosted an international conference- "Afghanistan and the International Community: A Partnership for the Future"- on 31 March-1 April 2004 in Berlin. The Government presented a strategy document entitled "Securing Afghanistan's Future: Accomplishments and the Strategic Path Forward," prepared with support from ADB, IMF, United Nations Development Programme (UNDP), and World Bank⁶. The report sets economic growth targets for Afghanistan that are aligned with the Millennium Development Goals and covers all sectors of intervention including the security sector. Putting Afghanistan on a sustainable development path is going to be a long and costly exercise; total financing of $31.8 billion is needed through 2010 to raise Afghanistan to an annual per capita GDP of about $500 by 2015, including an external financing requirement of $27.6 billion over 7 years, or about $4 billion/year⁷. The report emphasizes that assistance should be looked on as an investment in stability, peace-building, and development at local, regional, and global levels, which will reduce the global threats of drugs and terrorism, and permit major reductions in the costs of coalition and ISAF forces of about $13 billion per year, and the costs of responding to humanitarian needs of about $2 billion per year that a failed state would have no capacity to address.

12. During the 2-day meeting, 33 contributors pledged $8.2 billion for March 2004-March 2007, or 69% of the Government's target of $11.9 billion. More than $4.5 billion was pledged for March 2004-March 2005, or 102% of the Government's target of $4.4 billion. Some contributors made multiyear pledges and commitments of various time frames of between 1 and 5 years. Although the pledges met the Government's expectations, reconstruction assistance to Afghanistan, measured per capita, has been far lower than for other postconflict countries.

13. In Berlin, ADB pledged to consider assistance of about $800 million in Asian Development Fund (ADF) loans and grants during 2005-2008, subject to the outcome of ongoing ADF negotiations and the future availability of ADF. ADB also identified loan and equity investments of up to $100 million in partnership with local and foreign investors, and guarantees of about $100 million to catalyze private investments. With these initiatives, it is expected that total assistance provided by ADB to Afghanistan will exceed $1 billion in 2005-2008, and $1.5 billion in 2002-2008.

14. Afghanistan's postconflict status calls for a large amount of external finance on highly concessional terms. However, the importance of domestic contribution to reconstruction must not be understated. Afghan leadership and participation at all stages are crucial for longer-term sustainability of these initiatives. At present, nearly all activity is externally-driven; far too many international consultants continue to perform tasks that Afghans should be doing by now. While consultants have played essential and constructive roles, "Afghanization" of the reconstruction effort has hardly begun. Without it, sustainable growth and poverty reduction will not take place. Major investments in human and social capital are required over an extended period to develop the necessary Afghan professional, technical, and vocational skills base. Meantime, external consultants will continue to be required, but need to focus more on building Afghan capacity at central and local levels to lead the reconstruction and development process.

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