The Post-War Afghan Economy
On 22 December 2001, following the defeat of the Taliban by a coalition of
US and Northern Alliance forces, an interim administration under Hamid
Karzai mandated from above by the Bonn peace agreement took charge of
Afghanistan. Being a relatively small, landlocked and poor country that
has experienced civil strife for more than two decades starting 1979, with
different degrees of external involvement, Afghanistan's economy at the
time of formation of the interim administration was both backward and
disintegrated. With 85 per cent of its population reportedly dependent on
agriculture and 53 per cent of the GDP estimated as originating in the
agricultural, livestock and forestry sectors, as compared with 28 per cent
in light industry, 8 per cent in trade and 6 per cent in construction, the
economy in 2002 was structurally in an early stage of development.
Extremely rough estimates quoted by the Asian Development Bank suggest
that in 2002, Afghanistan's GDP amounted to $4.4 billion, which implied a
GDP per capita of an abysmally low $170 per head.
These figures, however, could exaggerate the level of backwardness
implicit in the initial conditions from which Afghanistan must begin its
process of reconstruction and revival. Two factors have contributed to the
high 'aggregate poverty' indicated by a per capita income that is less
than half of the international poverty norm of a dollar per day per head
by 2001. The first is the war that led to the ouster of the Taliban. An
earlier estimate, also quoted by the ADB, relating to 1989, placed
Afghanistan's GDP at a much higher $6.9 billion and its per capita income
at around $300. The situation could have further improved in the years
following 1989, since reports indicate that at least in regions fully
occupied by the Taliban, economic conditions were stable during the early
and the mid-1990s. Underlying the subsequent massive contraction of the
economy was the war that devastated the limited infrastructure of the
country, triggered the exodus of more than 3 million refugees to Pakistan,
Iran and elsewhere and displaced a large number of people within the
country. This disrupted or even brought to a standstill much of the
economic activity within the country. A corollary of this role of the late
1990s war in worsening economic condition is that a concerted
reconstruction effort focused on quick-impact projects combined with the
observed large-scale return of refugees to Afghanistan, could ensure a
sharp rise in GDP and per capita income to levels in the early 1990s.
Secondly, nature too added to the woes of an already war-ravaged economy,
with protracted drought conditions that began in 1999 and lasted till
2001. Again according to estimates made by the international community, in
this case the World Bank, crop production was halved and livestock herds
substantially depleted, making the situation in 2002 as desperate as it
was. According to a March 2002 survey by the FAO, the livestock population
in the country declined by 60 per cent due to the distress selling of
livestock herds in the summer and autumn of 2001 triggered by the
persisting conditions of drought. The crucial role of drought in worsening
economic conditions is revealed by an FAO and World Food Programme
estimate which states that agricultural production in 2002 rose by 82 per
cent, following better rainfall conditions. However, even in that year
cereal production is estimated at 4 per cent below its 1998 level. Given
the importance of agriculture for employment and GDP in the economy, these
figures suggest that the rough GDP estimates relating to 2002 may be
exaggerating the poor state of the economy.
These real factors that perhaps exaggerate the extent of backwardness of
the economy could have been compounded by statistical errors that remain
uncorrected because of the temporary closure of the statistical system. It
is known that GDP and revenue estimates in Afghanistan are quite
unreliable given the large role of the unaccounted, underground economy in
the country. Two factors contribute to the magnitude of the unaccounted
segments of the economy. To start with, Afghanistan, being a landlocked
country, is also a hub for trade between some of its larger neighbours.
Such trade flows occur through its porous borders with Pakistan (2,450
km), Tajikistan (1,206 km), Iran (936 km), Turkmenistan (744 km),
Uzbekistan (137 km) and China (76 km). Unfortunately, figures on
Afghanistan's domestically directed and re-export trade are not available.
A June 2000–February 2001 UNDP study, based on an investigative survey of
border crossings and major trading centres, estimated that 'indigenous
exports' at $130 million constituted just 10.6 per cent of total exports,
while re-exports totalled $1097 million (Chart 1). Similarly, imports for
domestic consumption, based on type of commodity, amounted to $396 million
(33 per cent), whereas imports that were potentially for re-export
totalled $806 million (Chart 2). It is to be expected that the huge volume
of transit or re-export trade would sustain an economy whose activities
are not fully captured in estimates of GDP tracking the real economy. The
fact that much of this trade is not officially accounted for is well
known, so that profits accruing to Afghan nationals from such trade (in
which exports account for more than a quarter of estimated 2002 GDP) are
also likely to be inadequately captured by national income figures.
The second reason why the magnitude of the unaccounted economy is likely
to be great is the historically important role of poppy cultivation and
opium production in the rural Afghan economy. According to an estimate by
the United Nations Office for Drug Control and Crime Prevention, land
under poppy cultivation amounted to 82,171 hectares in 2000 and opium
production in 2002 was 3,400 tons, which was similar to levels that
prevailed in the mid-to-late 1990s. With the Taliban having imposed a ban
on opium production and the Karzai government having declared a ban on
poppy cultivation in 2002, it is inevitable that a large part of this
activity would occur in the underground economy. The economy surrounding
the cultivation of poppy, the production of opium and its trade would
generate a significant income, which again will go substantially
unrecorded.
Ignoring the potential areas for rapid reconstruction of war-damaged
assets, the effect of prolonged drought and the important role of
unrecorded economy tends to exaggerate the poor initial conditions, which
are then attributed solely to the long years of conflict. This is not to
say that the two-decade-long war had no serious consequences. To start
with, it did have damaging effects on the infrastructure of the country,
created by the historically important role of foreign aid in the country
because of its strategic and transit trade importance, making agriculture
more climate dependent, fragmenting the economy by damaging the
transportation and communications infrastructure and generating
bottlenecks in sectors like energy. Secondly, by driving out large
sections of the population and emasculating the state it undermined the
institutions of state including the central bank, the financial system,
tax collection and customs machinery, the statistical apparatus, the civil
service, and the law and order and judicial system. Finally, it undermined
the ability of the state to collect a share of the surplus being generated
within the economy to finance the expenditures necessary to take on
crucial governance and development responsibilities.
With regard to the last of these effects, we must recall that local
revenue in Afghanistan comes from its taxes on trade, much of which occurs
by land across the borders with its neighbours. A major problem being
faced by the current government in Kabul is to get provincial governors
(still referred to as warlords by many) to part with a reasonable share of
the revenue thus garnered. Even though a meeting in May saw twelve
governors signing an agreement to do so, and one of them delivered $20
million immediately thereafter, it is unclear how much of the revenue will
finally accrue to the central government.
Once these features of the Afghan economy are understood and the
unwarranted hopelessness deriving from perceptions of near-complete
devastation and penury is set aside, the direction of the aid-supported
reconstruction effort and its likely consequences can be easily deduced.
There are three pillars on which that effort should rest: (i) restoration
of the infrastructure with initial focus on quick-impact projects that can
yield substantial benefits in a short period; (ii) restoration of the
institutions of state and the powers of those institutions so that the
state can mobilize the revenues and undertake crucial developmental
expenditures, which only it can pursue since low per capita income levels
imply inadequate incentives for private investment in many areas; and
(iii) restoration of the 'economic space' within which the new state can
pursue a national development agenda.
A range of specific initiatives can be identified within this overall
framework. To begin with, a greater degree of security and an end to
periodic local conflict must be ensured. This must build on the intense
and easily observed desire of the Afghan people for peace and the
opportunity to get on with their lives and must be secured only by an
international, UN-mandated force that is seen as a source of support and
not an instrument of occupation. Second, the damaged and destroyed
infrastructure must be immediately reconstructed, with a large proportion
of aid diverted for the purpose, so that the economy is reintegrated and
rendered functional.
Third, the ability of the state to mobilize resources needed to finance
crucial developmental responsibilities must be restored for which an
appropriate monitoring, tax collection and revenue sharing system must be
worked out. Given the fact that Iran and Pakistan account for a
substantial share of Afghanistan's trade, and trade revenues constitute a
large share of the total, the initial task should not be too difficult.
But over time, it would be necessary to widen the tax base and obtain
resources from internal direct and indirect taxation, especially the
former.
Fourth, it would be necessary to rebuild the financial system with a
two-fold purpose: that of mobilizing household savings and of channelizing
those savings to priority areas, using mechanisms such as directed credit
and differential interest rates. This implies that an overemphasis on
microfinance and any neglect of the task of creating a well-regulated
formal banking system would be misplaced. Fifth, the rural infrastructure
needed to restore dynamism to agriculture, reduce dependence on rainfall
for irrigation and encourage growth of non-agricultural activities needs
to be created by the state.
Finally, Afghanistan needs to move out of being a mere transit hub for
trade between its neighbours and must seek to develop activities that add
value to imported inputs to produce outputs for export and benefit to a
greater extent from its crucial role in regional trade. The problem with
the transit trade is not that it adversely affects the balance of
payments. The field survey-based estimates quoted above show that though
there was a small deficit in terms of the indigenously directed and
originating trade, Afghanistan did not suffer from a trade imbalance that
needed significant external financing. The real difficulty is that
unregulated growth of such trade creates disincentives for investment
aimed at increasing domestic employment and value-added through processing
and production activities within Afghanistan.
Is this the direction in which the ostensibly UN-coordinated
reconstruction effort is heading to? Expectations were high when, soon
after the Bonn agreement that signalled peace, a meeting of donors in
Tokyo in January 2000 pledged to deliver sums, estimated at an aggregate
of $4.5 billion within a thirty-month period, to kick-start the
reconstruction effort. But a visit to Kabul, the capital city, close to a
year-and-a-half thereafter suggests that the process of reconstruction has
been slow. The inadequacy of the reconstruction effort is puzzling also
because the limited and scattered information on aid flows does suggest
that inflows have been significant even if not massive.
Aid
flows take many forms. They occur directly to the government, through the
World Bank administered Afghan Reconstruction Trust Fund, the Law and
Order Trust Fund (LOTF, which funds the police), the Afghanistan Trust
Fund (that pays for the army) and a number of other channels. They occur
through routes indirectly linked to the government, inasmuch as local and
international NGOs are supported by donors to undertake projects that are
in keeping with the National Development Framework adopted by the
government in consultation with the donor community. They also flow into
areas completely outside the governmental framework inasmuch as US
'coalition forces', other than the International Security Assistance Force
(ISAF), and international NGOs bring in their own funds and also in cases
where it is provided by donors abroad for activities that are not
necessarily reported in full.
The most easily accessed information is on money that is directly
contributed to the government. To coordinate these flows, donors have
constituted the ARTF in response to a government request that the budget
be made the central instrument to identify and allocate funds for
projects. From the government's point of view, a link with the budget
would help it guide and take credit for the reconstruction that aid
permitted. It would also ensure that aid could be used to meet the
recurrent expenditure of the government, including a large part of its
wage and salary bill. This request was, in turn, appreciated by the donor
community, because it ensured 'national ownership' of the policies that
open or covert aid conditionality prescribed and it ensured a degree of
transparency about the allocation and use of aid flows.
Moreover, with the ARTF being administered (for a fee) by the World Bank,
which sees in the Fund a means of appropriating the policy leverage that
the combined aid of numerous donors provides, powerful groups within
developed-country donors were sure that their interests would be
protected. In principle, the mandate of the ARTF is extremely wide.
Besides funding the government's recurrent expenditure including its
salary bill (which though anathema in the Bank's perspective is a source
of substantial leverage over a resource-starved state), the ARTF can
finance investment activities and programmes, including quick-impact
recovery projects, capacity-building projects and payments made to Afghan
expert-residents abroad who are willing to temporarily or permanently
relocate to their home country. The last two of these are also a major
means of influencing the decision making of the government.
Indications are that the Bank-led donor effort to direct aid flows to the
government and coordinate those flows through the agencies like the ARTF
and the Afghan Assistance Coordination Authority (ACCA) has progressed
substantially. During the first full financial year (FY) 2002–03 under the
new administration (coinciding with solar year 1381 stretching from 21
March 2002 to 20 March 2003), which came soon after the Tokyo meet and
before the aid coordination framework could be put in place, the budget
was not the principal means of centralizing aid flows and utilization. In
April 2002, the interim administration adopted a recurrent budget for FY
2002 involving expenditures of $483 million, including $23 million for
clearance of wage arrears. With domestic revenues estimated at $83
million, aid was expected to finance $400 million or 83 per cent of the
budget. However, figures collated by the ACCA indicate that total grant
disbursements during the last quarter of SY 1380 and the full SY 1381 (FY
2002) amounted to $1.84 billion, of which $295.9 went to the government
through the budget, the ARTF, the Law and Order Trust Fund and other
channels. The channels of disbursement and the local target agency for the
remaining money are unclear, but a substantial part ($700 million
according to one estimate) reportedly went to finance humanitarian
assistance in the context of the drought.
It is in the financial year starting 21 March 2003 (SY 1382) that the
process of coordinating aid flows is being consolidated. In March 2003,
the transitional government of Afghanistan announced a comprehensive
budget for FY 2003—comprising an ordinary (recurrent) budget of $550
million, of which $200 million is expected to be financed with local
revenues and $350 million by external assistance, and a development budget
of about $1.7 billion. According to ACCA, by June, financing from donors
of $211.2 million for the recurrent budget and $1.2 billion for the
development budget had been confirmed. Interestingly, only the $211.2
million for the recurrent budget has been channelled through the ARTF, the
LOTF and the Afghanistan trust Fund, whereas grant funding for development
programmes in the National Budget has come through other channels. The
process of using the World Bank to enforce conditionality appears to work
through a mechanism in which the Bank controls funding for the crucial and
politically sensitive recurrent budget and thereby is able to influence
both the government's policies and its utilization of the remaining aid
provided directly to the government.
Given the funding for FY 2003 confirmed so far, expectations are that the
budgetary target for external financing is likely to be fulfilled. The
evidence collated by the ACCA suggests that aid to the government through
various channels would by the end of FY 2003 amount to $ 3.36 billion.
Thus over a period spreading over twenty-six months after the Tokyo
meeting in January 2002, grants disbursed to the government would cover 87
per cent of the pledges made for a thirty-month period after the meeting
and 75 per cent of the total pledges made at and after the Tokyo meeting.
According to ACCA sources, it is this high rate of disbursement that has
made the Karzai administration bid for a $15–20 billion aid package over a
five-year period.
Though information on the flows through channels not directed at the
budget and monitored by the ACCA is as yet difficult to come by, the
actual disbursement of aid is likely to have been substantially more than
reported above. Even though a variety of sources in Kabul believe that the
sums involved would not be as large as that provided to the budget, it is
likely that such flows would significantly add to the total. Thus clearly,
overall disbursements have been in keeping with the expectations generated
at Tokyo.
What then accounts for the picture of a slow and clearly inadequate pace
of reconstruction? There are two obvious reasons why aid flows have not
worked to refurbish the infrastructure, even in Kabul. To start with, as
noted earlier, a large part of the flow that occurred prior to FY 2003
went to support the humanitarian assistance programme to deal with the
consequences of the protracted drought and took the form of food-aid, much
of which neither involved any capital spending nor involved expenditures
in Afghanistan, since the food was imported. Second, a large part of the
grant disbursement even in FY 2003 has gone to support the recurrent
expenditures of the government, especially its wage and salary bill, which
while spurring domestic consumption spending, has not contributed to
savings and investment.
This use of aid to support the recurrent expenditures of the state,
including its wage bill, has a number of implications. The inability of
the government to finance its own recurrent expenditures reflects the fact
that government in Kabul does not as yet have the legitimacy or the power
to garner a sufficient amount of revenue that is reportedly being
collected at the provincial level. A very large proportion of the
government's 240,000 non-military personnel are located in Kabul. This
creates a situation in which the government in Kabul is supported by the
donor community, whose leverage is therefore substantial. Simultaneously,
the expatiate presence and spending in Kabul has generated a
services-and-construction boom there, which is bound to widen
differentials between Kabul and the rest of the country. In a country
riven with ethnic and other divisions, this distancing of Kabul and its
identification with a foreign presence could further undermine the
legitimacy of the Kabul government, making it difficult for it to garner
the revenues it needs to do away with dependence on aid. A consequence is
that cycle of dependence of the government on aid would only be
strengthened.
The second set of reasons why aid has not created the expected impact is
related to allocation decisions. As Chart 3 indicates, budgetary
allocations for SY 1382 (FY 2003) indicate that while social sectors like
education, health and refugee rehabilitation are allocated a total of $775
million and another $210 million is to be spent on foreign investment
promotion, technical assistance and capacity-building in the areas of
trade and investment, public administration and economic management and
justice, only $509 million are allocated to the crucial areas of transport
and energy, and mining and telecommunications. When seen in terms of aid
commitments to finance these expenditures as of June 2003, this bias
appears even greater (Chart 4). Thus part of the reason for slow
reconstruction of infrastructure is that a small part of even the
development budget is being allocated for the purpose.
This overemphasis on technical assistance and capacity building is
justified in the name of reconstructing the damaged Afghan state. Much of
the money under these heads goes to institutions like the Adam Smith
Institute and to expatriate professionals who are paid huge consultancy
fees in foreign currency, not all of which is spent in Afghanistan. A
constant refrain heard among the expatriate population in Kabul is that
Afghans lack the capacity to manage their own affairs. Despite the fact
that these institutions and most NGOs manage their programmes, especially
those outside Kabul, with the aid of local partners, and though many
skilled personnel who left as refugees to Pakistan, Iran and elsewhere
have returned, this perspective overwhelmingly influences the management
of aid-financed programmes. It almost appears that the 'lack of capacity'
discourse supports a nexus of aid-financed professionals, who find in such
arguments the justification of their own dollar-funded presence in the
country, and of aid donors, especially agencies such as the World Bank,
who can use those arguments to prevent the entry of those more
nationalistic in orientation into the decision-making and implementation
process. This is not a fact that goes unnoticed among the Afghan
population. Interviews with Afghan professionals and members of the
faculty at the University of Kabul inevitably generate comments to the
effect that Afghan talent, more attuned to the socio-cultural and economic
context of the country, is being ignored, while expatriate and
non-resident Afghan 'experts' are imported even when not required.
The still-evolving policy framework in Afghanistan provides reasons why
nationalistic perceptions may be considered dispensable. It is to be
expected that with government expenditure substantially driven by aid
disbursements, explicit and implicit aid conditionality is bound to
influence the policy framework. The effort, therefore, is to ensure that
those manning the government 'own' the policies that such conditionality
implies. Unfortunately the policy framework is not of a kind that could
support the creation of a 'domestic economic space' within which the
Afghan state can fashion a nationally beneficial and egalitarian
development strategy. Though the government's donor-driven strategy is yet
in the making, it is clear that the inevitable import dependence of a
war-devastated economy is being intensified, by encouraging an open trade
policy that would discourage domestic industrial investment. Crucial areas
in the social sector like health provision are being handed over to
private entities and NGOs to run at a price, which though currently
subsidized by aid, could easily be charged to the user at a later date.
The state has adopted as law the principle that the central bank cannot
lend to the government. Thus deficit-financed expenditure to revive the
economy is ruled out, resulting in a near-complete dependence on aid for
budgetary finance. The battered publicly-owned financial sector, rather
than being supported and strengthened, in order to be leveraged for
domestic industrial financing, is soon to be subjected to competition from
private, especially foreign, players. Since the need for a banking system,
which can mobilize local savings and channelize it to priority investments
crucial to domestic private sector development, is great this shift can be
disastrous. Foreign banks would only wean away the most lucrative (mainly
expatriate) businesses from the local, publicly owned banking sector,
while refusing to take any responsibility for development. Finally, though
the new Afghani is formally the national currency, aid flows and the
expatriate presence is dollarizing the economy with the dollar being
traded on the streets and many service establishments quoting dollar
prices and expecting payment in dollars.
These developments proceed unchallenged partly because a vocal, urban
domestic elite is being incorporated into the aid economy. Not only are
salaries paid on time with the help of aid, but the demand for services
from the expatriate population is on the rise. Rents quoted in dollars are
rising fast because of the expatriate rush into Kabul and some other
cities. These and other opportunities are resulting in the emergence of a
new class of rich Afghans, living off the aid economy, happy with the
freedom that an open, dollarized economy provides.
All this is fine at the moment since aid flows are leading to foreign
exchange reserve accumulation with the central bank, which can use those
reserves to prop up the new Afghani and prevent local prices of imported
commodities from rising. But in the medium term, aid, import-dependence
and dollarization can all prove a burden. If the pace of aid inflow slows,
not only will the just-reviving economy contract but the Afghani would
depreciate pushing up the prices of essentials in that segment of the
economy still earning and living off the local currency. Stagflation, in
an already depressed economy, would be the result. On the other hand, if
aid inflows continue at present levels or rise in volume, inequalities
between Kabul and the rest of the country, across differentially endowed
regions and between income classes are bound to increase. That can have
dangerous implications in a country that is still scarred by a complex
chain of civil strife influenced by ethnic and religious divides.
The current model of development in Afghanistan is clearly unsustainable
for any discerning observer. But for those present in the country with
short-term military and economic interests in mind, who are protected by
the façade of altruism that a small dose of aid to a poor and devastated
nation helps provide, this appears to be of no concern.