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p. 27 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Central Asia The Pacific III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia : South Asia

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Afghanistan

After two decades of war, an opportunity for peaceful development in the country emerged with the fall of the Taliban regime in late 2001, the creation of the Afghan Interim Administration, and in June 2002, the selection of an Afghan Transitional Administration by a special Loya Jirga (or traditional Afghan Grand Council). While much was accomplished during 2002, the tasks ahead in rebuilding the country are enormous and cannot be achieved without the strong support of the international community.

Macroeconomic Assessment

Analysis of the economy continues to be problematic as official economic statistics are almost nonexistent. Rough estimates suggest 2002 GDP at about $4.4 billion, with per capita GDP at $170. Observations in cities, especially Kabul, indicate a strong recovery in 2002, mainly in certain sectors such as services and construction, driven by the international community's spending and emergency assistance efforts. Given the deteriorated economic base, a rebound in real economic growth was expected.

The economy is primarily agriculture based (crops, livestock, and horticulture), supporting about 85% of the total population and accounting for about 50% of GDP by 1993 estimates. The annual food assessment of the Food and Agriculture Organization of the United Nations (FAO) and the World Food Program estimated 2002 agricultural production to be 82% higher than in 2001. The sharp gain was attributed to somewhat better rainfall than in 2001 and the increased availability and higher quality of seeds, fertilizers, and other key inputs. Rainfed wheat, in particular, recovered significantly in major growing areas of the north and western provinces from the levels of the previous 3 drought-affected years. Despite the recovery, aggregate 2002 cereal production is nevertheless estimated at 4% below the 1998 crop. Livestock provides a major source of cash income from the sale of dairy items, mutton, wool, animal hides, and the skins of karakul sheep in both domestic and export markets. A March 2002 FAO survey reports that the total livestock population in Afghanistan had declined by about 60% from 1998 levels due to continued distressed selling of animals, especially during the summer and autumn drought of 2001. Improved rainfall in 2002 is expected to have helped the situation a little.

According to a United Nations Office for Drug Control and Crime Prevention survey, estimated opium production in 2002 was 3,400 tons, similar to levels reached during the mid- to late 1990s. The Afghan Interim Administration issued a strong ban on opium poppy cultivation, processing, trafficking, and consumption in January 2002, though its ability to suppress production, which at the farm may have a gross value of as much as $1 billion, is limited.

The population of Afghanistan is estimated at 23-26 million. Almost 2 million refugees had returned by end-September 2002. Return rates have dropped from a peak of 20,000 a day in May 2002 to around 4,000 a day toward late 2002. While there are no reliable labor force or employment statistics, unemployment is clearly very high in all age groups, for both men and women. UN agencies and nongovernment organizations have supported employment programs and food- or cash-for-work programs.

In April 2002, the interim administration adopted an ordinary (recurrent) budget for FY2002 with $483 million in expenditures—$460 million for the fiscal year plus $23 million for clearance of wage arrears for the previous fiscal year. (FY2002 covers 21 March 2002 to 20 March 2003, the Solar Year SY1381.) With domestic revenues budgeted at $83 million, this left a financing requirement of $400 million. It is estimated that FY2002 expenditures would reach almost 90% of budgeted amounts in afghani terms. In dollar terms, this would be equivalent to $325 million, given that the afghani depreciated compared with the accounting exchange rate of Af34/$ used in the budget. Domestic revenues were estimated to reach about $100 million, leaving an estimated financing requirement of $225 million, which was fully met (i.e., there would be no remaining aid requirement).

In October 2002, the Central Statistics Office released its first CPI data since 1987 (the CPI covers only Kabul). After recording average monthly increases of about 1% in the early months of 2002, the CPI increased by 16% in September, 12.4% in October, and 22.7% in November 2002. These significantly higher inflation rates were mainly due to the depreciation of the exchange rate caused by speculation surrounding the introduction of unified new currency notes in October 2002 and by high food prices resulting from the drought and the end of the growing season. However, in December 2002 and January and February 2003, the CPI decreased by 4.4%, 3.8%, and 1.4%, respectively, reflecting turnaround appreciation of the new afghani currency by December 2002.

Trade statistics have not been published by the Afghan authorities since FY1992. A survey sponsored by the World Bank puts Afghanistan's total trade in 2000 at $2.5 billion, comprising about $1.2 billion in imports and about $1.3 billion in exports. However, about 90% of the estimated total exports were reexports of commodities to neighboring countries. Trade has since fallen sharply, except for emergency food aid and other imports. The Government announced in September 2002 that it would temporarily forgo customs tariffs to boost trade. In January 2003, the US made Afghanistan a beneficiary of the Generalized System of Preferences, eliminating US tariffs on approximately 5,700 Afghan products.

Policy Developments

Perhaps the most significant economic policy action in 2002 was the introduction of the new afghani currency, which exchanged 1,000 old afghani for one new afghani. The new currency replaced a mixture of notes in circulation. There were at least three versions of the domestic currency. It is not known how many reruns of the same series of the official banknotes were issued. The total amount of old afghanis collected was Af19 trillion; Af14 trillion in regular old notes were exchanged at face value and Af3.4 trillion of notes were converted at 50% of value. An additional Af1.8 trillion were absorbed through the foreign exchange auction during October-January. All in all, Af15.6 billion in new afghanis were issued through the conversion process.

By early March 2003, the amount of currency in circulation was somewhat over Af20 billion, reflecting both the currency conversion and government payments in the new currency during the period October-March. The new currency is a substantive symbol of national sovereignty and sets the stage for Da Afghanistan Bank (DAB), the central bank, to provide an attractive alternative to increased use of foreign currency. After an initial speculative depreciation up to Af70/$, around the time of the introduction of the new currency in October, the exchange rate came back to around Af45/$ in December (similar to the preconversion rate in mid-September), although the rate deteriorated slightly to Af51/$ by early March, possibly reflecting the uncertainty in the Middle East.

This favorable development reassured the international community to step up its delivery of the $5.2 billion pledged assistance at the International Conference on Reconstruction Assistance to Afghanistan in Tokyo in January 2002. In October 2002, the pledge was revised to $2.1 billion for 2002 and $1.5 billion for 2003.

DAB is not yet fully operational and there are no operating commercial banks. With government policy of no DAB financing of the budget, changes in the amount of afghani currency in circulation are determined by changes in DAB's net foreign assets. Since the Government needs to convert the donor foreign exchange assistance that it receives to finance the budget into local currency to cover expenditures (mostly for wages), the amount of such donor assistance would essentially determine the expansion in the money supply. Since at present the size of such assistance is necessarily very large, implying about a doubling of the money supply within a year, the money supply mechanism carried the potential for excessive expansion. To prevent this and control money growth, DAB has engaged in foreign exchange auctions. Participants in these auctions are the larger money traders who constitute the foreign exchange market and provide a larger import capacity. Deciding on targets and implementing policy in the present circumstances must necessarily be flexible and adaptive.

Without functioning commercial banks, the country depends on the traditional hawala system for money transfer, the only effective payment system in place, and the informal credit market meets the demand for liquidity. The National Development Framework (April 2002) highlights the importance of strengthening DAB in monetary control and banking supervision and in establishing a commercial banking sector and modern payments system. The pending Central Bank Law and Banking Law will facilitate the establishment and operation of banks and modernize the banking sector. A joint initiative by the Aga Khan Fund for Economic Development, the International Finance Corporation, and ADB aims to find a foreign private bank to establish a local institution to handle trade financing and microfinance, facilitating the emergence of a formal banking sector. In parallel, reforms are being undertaken to improve the functioning of the banking sector and support private activity.

In March 2003, the Government announced a comprehensive government budget for FY2003—comprising an ordinary (recurrent) budget of $550 million, of which $350 million will have to be financed by external assistance, and a development budget of about $1.7 billion. This formulation of the budget will facilitate keeping the reconstruction process as coordinated and controlled as possible. Notwithstanding this, the implementation of a responsible fiscal policy requires the central Government to quickly develop its capacity for managing the budget, especially increasing and streamlining revenue collection. The Government should also develop effective control measures for expenditures, accounting, and auditing. The Ministry of Finance is expected to receive substantial external assistance in developing tax administration capacity, especially in customs administration accounting, development of databases and a management information system, training needs assessment, and improvement in tax law. Already, the Ministry of Finance has made considerable progress in improving financial management with the help of international contractors. Besides, the Government's confirmed commitment to a no-overdraft rule, as well as the customs tariff and administration reforms currently in preparation, will help achieve and maintain fiscal and monetary balance.

Significant reconstruction efforts are required to establish basic administrative procedures and systems of accountability in the Afghan public service. Data on the size of the public sector are very poor, but estimates suggest a staff of about 240,000 (excluding military personnel) with a large proportion located in Kabul. Staff distribution is uneven with an imbalance between professional and administrative staff. Wages and salaries are very low and pensions negligible. The Transitional Administration has started working on improved payroll processes, staff capacity building, a merit basis for recruitment and promotion, an enhanced policy management process, a pay and grading review, and improved monitoring of staffing totals. The newly established Civil Service Commission has the overall responsibility for this.

Outlook for 2003-2004

Important challenges facing the Transitional Administration include writing a new constitution, preparing for the 2004 elections, and ensuring domestic security. Security and stability will remain problematic as long as the local power holders retain their own armed forces. Also, remnants of terrorist groups appear to be operational in pockets of the country and across borders. Efforts are under way to establish the rule of law, bring provincial and local authorities under central control, build a national army and police force, and extend the tenure and expand the role of the International Security Assistance Force. The Government is keen to root out corruption, as reflected in President Karzai's October 2002 announcement to sack a number of influential provincial officials on charges of corruption. The new Investment Law will go a long way to improve the overall business and investment environment.

It is very difficult to predict with any confidence how the macroeconomic picture will develop in 2003-2004 and beyond, as the prediction crucially depends on the improvement in the security situation, the Government's commitment to sound economic management (especially reasonable progress in revenue mobilization), and continued donor support for reconstruction. Provided that these preconditions are met, there are positive factors indicating strong economic growth. First, following such a long war, a sharp economic rebound can be expected once investments flow in. Second, while the return of large numbers of Afghan refugees puts an added burden on the urban infrastructure and environment, they bring with them skills and entrepreneurship. Third, reconstruction activities will generate substantial demand and provide business opportunities. Given these factors, provided that the international support to reconstruction sustains—the conflict and its aftermath in Iraq distracting donor commitment is a concern—annual economic growth in 2003-2004 could be well above 10%, with inflation kept in reasonable check.

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