Regions and Countries

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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

Country Strategy and Program Update 2006-2008: Afghanistan

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I. Current Development Trends and Issues

A. Recent Political and Social Developments

1. Since the last country and strategy program update¹ (CSPU) in August 2004, Afghanistan has continued to make good progress with state building following almost 25 years of devastating war and civil conflict. The landmark presidential election on 9 October 2004 featured a high voter turnout, including participation by women, and was an important milestone in Afghanistan’s further transition to a stable, democratic country. Following his election and inauguration as Afghanistan’s first democratically-elected president, Hamid Karzai appointed a new cabinet in December 2004. In addition to appointing a mostly technocratic cabinet, the president attempted to balance regional and ethnic interests, as well as to either marginalize or co-opt key regional “warlords”. Delayed parliamentary and provincial council elections are now scheduled for 18 September 2005. While the logistics of these elections will be considerably more difficult than those of the 2004 presidential election, the Government is optimistic that they will be successfully carried out. A total of 2,707 candidates (including 328 women) will stand for the 249 Wolesi Jirga (lower house) seats in the parliamentary election and 3,025 candidates (including 247 women) will stand for 420 seats in the 34 provincial councils.² Once these elections have been held, Afghanistan will have essentially completed the political normalization process mapped out as part of the Bonn Agreement of 5 December 2001.³

2. The Government of Afghanistan has already begun discussions with its international partners on the next stage of the country’s political development, tentatively designated the “Kabul Process”. The Government plans to enter into a compact with the international community to set benchmarks for the normalization and reconstruction process. The Government has made it clear that it will require the continued commitment of the international community to ensure the country’s security and stability. This includes continued engagement of the American-led anti-terrorism coalition and the International Security Assistance Force (ISAF) as well as a continued leadership role for the United Nations Assistance Mission to Afghanistan (UNAMA).

3. In spite of its political progress, Afghanistan continues to face huge challenges, including extreme poverty, insecurity, weak human capacity, and gender inequality. While the country has managed to avoid a resurgence of major civil conflict, insecurity continues to hamper its reconstruction and development. Following a lull in incidents involving antigovernment elements during the winter, since May 2005 there has been an upsurge in violence, including attacks directed at foreign forces and international aid personnel. In addition, instability in some of Afghanistan’s neighboring countries poses a threat to both national and regional security. Cultivation of opium poppy has increased and now takes place in more provinces, posing a threat to Afghanistan’s long-term stability.

4. Disarmament and demilitarization of ex-combatants across the country continues through the UN-backed Disarmament, Demobilization, and Reintegration (DDR) program and the Afghanistan’s New Beginnings Programme (ANBP) administered by the United Nations Development Programme (UNDP). As of the end of July, more than 63,000 former combatants had been disarmed. More than 56,000 of these former Afghan Military Forces (AMF) commanders and soldiers had been provided with ANBP reintegration assistance, including vocational training. In addition, much of the heavy weaponry under the control of local warlords has been contained under central government control. Despite such efforts, there are still illegal armed groups not linked to known militia forces, including some under the patronage of warlords and/or drug barons. Although such groups—which may include up to 180,000 men across the country—do not pose a direct threat to the authority of the state, they remain a serious obstacle to the restoration and credibility of state institutions at the provincial and district levels. In June the Government announced the official start of the Disbanding Illegal Armed Groups (DIAG) program. The ANBP will continue to support the Government during this process, with eight weapons verification teams now dispatched throughout the country.

5. Although more than 3.5 million Afghan refugees have returned to Afghanistan since the start of the United Nations High Commissioner for Refugees (UNHCR) voluntary repatriation program in early 2002, Afghanistan continues to be by far the largest country of origin of refugees under the care of UNHCR. As of the end of 2004, 2.1 million Afghan refugees were reported by 78 asylum countries, constituting 23% of the global refugee population. Despite continued repatriation, during 2004 the number of Afghan refugees dropped by only 2%.⁴ In addition, as many as 1.9 million Afghans continue to live in urban areas in Pakistan, some of whom also may be refugees. Among returnees, there is increased frustration that, even in urban areas, roads and buildings remain in ruins, power supplies are irregular, medical facilities are poor, school construction is delayed, and supplies of clean drinking water and sanitation facilities are insufficient. The population of Kabul has increased from less than 1 million during the Taliban period to an estimated 3 million to 4 million by mid-2005, placing extreme pressure on housing and urban services as well as leading to higher levels of crime as a function of widespread poverty and lack of employment opportunities.

6. The first-ever Afghanistan Human Development Report (HDR) noted that Afghanistan was ranked 173 out of 178 countries included in UNDP’s 2004 human development index.⁵ The HDR notes that the country’s poverty is compounded by a lack of social services, poor health, education, and nutrition, gender inequality, and human displacement. The HDR emphasizes that, despite progress in many of Afghanistan’s development sectors, basic human needs and the genuine grievances of the Afghan population—the lack of jobs, health, education, income, dignity, and opportunities for participation—must be addressed. The report also notes that “human security” and “human development”, rather than military force and diplomacy alone, are key to resolving Afghanistan’s complex problems.⁶

7. The third annual Afghanistan Development Forum (ADF) was held in Kabul on 4–6 April 2005 with the theme “accelerating economic development”. It featured frank discussions between the Government and the donor community on a range of issues, including economic and private sector development, regional cooperation, security, and antinarcotics activities. It is expected that the Government of the United Kingdom will host a further donor meeting for Afghanistan in late 2005 or early 2006. The proposed meeting will consider Afghanistan’s achievements under the Bonn Agreement, benchmarks for the “Kabul process”, and the country’s continued need for both development and security assistance, including further donor support for national priority programs and designated trust funds administered by UNDP and the World Bank.

8. The Government has indicated its intention to prepare an updated national development strategy (NDS) by the end of 2005. This updated strategy will serve as the basis for the preparation of ADB’s full country strategy and program in 2006 (covering 2007–2009). Other donor agencies, including the World Bank, will also prepare new country strategies for Afghanistan in 2006, providing an opportunity to harmonize program cycles and improve operational coordination.

B. Economic Assessment and Outlook

9. After 2 years of double-digit growth, Afghanistan’s economic growth slowed in 2004 to an estimated 7.5% as the agricultural sector continued to be affected by drought. In FY2005, gross domestic product (GDP) amounted to approximately $5.9 billion (excluding an estimated $2.8 billion from illicit opiate receipts). Other sectors, such as construction and services, continued to perform strongly mainly because of links to the reconstruction effort financed by external assistance. Per capita income is estimated to have increased from $199 in FY2004 to $252 in FY2005.

10. According to the International Monetary Fund (IMF), year-on-year inflation for FY2005 was 16.3%, somewhat higher than the 10.2% rate for FY2004. Since its introduction in early 2004, the afghani has traded in the range AF45-50 to $1, reflecting widespread acceptance of the new currency, prudent macroeconomic policies, and the Government’s commitment to keep broadly within targets for monetary growth under the IMF-led Staff-Monitored Program (SMP). Currency in circulation grew by some 37.5% as of the end of FY2005.

11. Five years of drought reduced food security in as many as 12 provinces, and contributed to a further deterioration in living standards among affected populations. While heavy winter snow and rain in early 2005 promised an end to drought conditions, some provinces experienced consequent flood damage.

12. A November 2004 report of the United Nations Office on Drugs and Crime (UNODC) found that that poppy cultivation rose 64% to a record 131,000 hectares in 2004, despite falling farm gate prices (down 67%) and lower yields due to bad weather and disease.⁷ In 2004, Afghanistan produced an estimated 4,200 tons of opium (equivalent to 87% of the world’s total supply). UNODC estimates that the numbers of families involved in the opium economy rose by 35% to 356,000 in 2004, representing some 2.3 million people or 10% of the population. While only about one third of the production value of opium poppy accrues to farmers (who often become indebted to traders who finance crop inputs), opium production is far more profitable than legitimate crops and is Afghanistan’s largest source of personal income and spending. Opium production has a substantial impact on growth in the non-drug economy, private import financing, and construction and land speculation activities.

13. The IMF-led SMP has been implemented since March 2004 with the aim of maintaining macroeconomic and financial stability, promoting essential structural reforms, and building statistical capacity. SMP performance has been strong and most of the targets and structural benchmarks have been met. Bottlenecks in the legal system, due largely to lack of capacity in the Ministry of Justice, have postponed the promulgation of key laws relating to financial management, investment, and statistics functions. The SMP has been extended to at least September 2005 to encourage further strengthening of the Government’s macroeconomic policy framework and administrative capacity.

14. The Government’s economic development strategy was laid out in the Berlin Conference document, Securing Afghanistan’s Future.⁸ The Government’s objective is to cover the wage bill by FY2009 and all government operating expenditures by FY2014. The current revenue to GDP ratio amounts to approximately 4.5% and is expected to reach 12.5% by 2015. Achieving this ambitious target will require continued careful macroeconomic and expenditure management as well as substantial efforts to augment national revenue. Progress has been made in domestic revenue generation, which increased from $132 million in FY2003 to $208 million in FY2004 and to $269 million in FY2005. Tax policy reforms were enacted in early 2004. They included a final wage withholding tax on higher income employees, an improved income tax regime, and a limited range of consumption taxes on services such as telecommunications, air travel, hotels, and restaurants. A large taxpayer’s office was established. According to the FY2006 budget, total domestic revenue is projected at $333 million, equivalent to an annual growth of approximately 30% (compared to annual real GDP growth estimated at around 10% and inflation of 10%). Nevertheless, as much as 50% of the Government’s operating budget will require financing though foreign assistance.

15. A key pillar of administrative reform is the priority reform and restructuring (PRR) program, which enables government departments to transfer or appoint key staff at higher pay scales for a fixed term. This has become necessary because the many international and nongovernment organizations (NGOs) have distorted the labor market, which already suffers greatly from a lack of qualified personnel. Administrative and civil service reform is proceeding relatively slowly. In addition, considerable technical assistance, including a large number of expatriate advisors in most ministries, has in some cases contributed only marginally to overall government capacity, particularly outside Kabul.

16. There is concern about the fiscal implications of PRR and civil service reform as growth in the overall wage bill far outpaces growth in domestic revenue generation. The wage bill (70– 75% of the operating budget) is expected to increase by 50% in FY2006 because of recruitment of teachers, civil service pay increases related to the implementation of the PRR program, and increases in police salaries. It has also been proposed that the Afghan National Army (ANA), currently funded by external grants, will be incorporated into the core budget over coming years, creating a further fiscal problem for the Government unless continued external funding is provided through the government budget to cover ANA salaries.

17. The Government is slowly moving from postconflict crisis management to more longterm sustainable development planning. The country’s high growth rates, however, have been fuelled primarily by donor-supported relief and reconstruction activities. Reconstruction-related activities and growth in the service sector are likely to sustain overall growth of about 10% for FY2006 and FY2007. However, to achieve the government's own growth targets over the medium term and gradually to replace receipts from opium production, there is a need to shift to more broad-based and sustainable development and to identify new drivers of growth. This is particularly important in light of the Government's plans to reduce, if not eliminate, opium poppy production. Concerted eradication efforts or a significant drop in farm gate opium prices could have severe adverse effects on Afghanistan’s overall economy and also could exacerbate already widespread poverty. Considering the size of the opium economy, a holistic strategy that creates alternative livelihoods in the rural economy, combined with interdiction, eradication measures, and legal reform is required, accompanied by broad-based economic growth. Addressing the challenges of Afghanistan’s opium economy will require sustained Government and donor commitment.

C. Implications for Country Strategy and Program

18. As of the end of 2004, ADB had fulfilled its Tokyo Conference pledge of $500 million in highly concessional loans and grant-financed technical assistance and private sector investments.⁹ ADB’s Berlin Conference pledge in April 2004 of some $800 million in ADF loans and grants over the 2005–2008 period established the overall resource envelope for ADB’s continued support to Afghanistan’s further reconstruction and development.

19. Following his appointment in December 2004, the new minister of finance assured Afghanistan’s donor partners of continuity in the Government’s approach to the country’s further reconstruction and development, including strong focuses on poverty reduction (or wealth creation), capacity development, private sector-led economic growth, as well as provision of basic services to the country’s impoverished population. The minister endorsed ADB’s threepronged approach to reconstruction through (i) building capacity, (ii) establishing appropriate policy and institutional frameworks, and (iii) rehabilitating essential infrastructure. The minister also confirmed that ADB’s support should continue to focus on loan and technical assistance to the transport, energy, and natural resource management sectors, as well as grant and program loan support to the governance and financial sectors. In addition, no change is anticipated in ADB’s private sector support to the banking and telecommunications sectors. ADB’s overall program is congruent with the Government’s emphasis on infrastructural development as expressed in pillar 2 of the National Development Strategy.

20. At ADB’s 38th annual meeting of the Board of Governors in May 2005, the Afghanistan governor and minister of finance, Dr. Anwar Ul Haq Ahady, stated: “We are very pleased not only with the scale of ADB’s support in recent years, but also the quality of that assistance. ADB’s programmatic approach and willingness to put the Afghan Government in the driver’s seat has set an example that other donors should follow”.

21. The Government intends to update the NDS by the end of 2005. The updated NDS will be designed to fully meet the requirements of an interim poverty reduction strategy paper (IPRSP). A full country and strategy and program will be prepared in 2006 in line with any changes or other refinements in the Government’s overall development strategy. As the United Kingdom Department for International Development (DFID), the World Bank, and other donors similarly will undertake country strategy exercises following the further elaboration of the NDS there will be an opportunity for even greater donor coordination and harmonization.

22. The heightened security situation in Afghanistan, which has included kidnapping or attempted kidnapping of foreign aid workers as well as recent anti-American demonstrations, poses unique challenges for ADB’s Afghanistan Resident Mission. Special arrangements are in place to ensure the security of staff and consultants based in Kabul or on mission outside the capital. Insecurity also continues to be a constraint to effective and timely program delivery.

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