Gul Masqood Sabit, former Deputy Minister of Finance, Islamic Republic of Afghanistan and Lecturer, Ohlone College, California – Written evidence (AFG0025)
Reviving Afghanistan’s Economy
October 22, 2020
Afghanistan’s total annual budget is roughly $5.5 billion, including security. The budget includes approximately $3.7 billion of operating and $1.8 billion in the development budget. Domestic revenue contribution is roughly 36% or $2 billion and the remaining $3.5 billion is financed with international aid. Afghanistan must generate an additional $3.5 billion annually in domestic revenues to move away from aid dependency. Approximately 95% of the economy’s GDP is linked with international aid. As aid declines, economic activities will also decline, resulting in the further reduction of domestic revenues, higher unemployment, and increased poverty. Additionally, the war economy will grow as formal economy contracts, which can further inflame the conflict. Addressing the challenges of key sectors will provide livelihood and lead the country to economic and fiscal sustainability.
Principal Economic Sectors
Afghanistan’s economy is mainly comprised of three sectors; Agriculture (23%), Services (60%), and Industry including mining (21%). Illegal drug trade and grey economy continue to be a significant source of income for many. Although the exact figures are not known, it is estimated that the drug trade and grey economy is approximately half of the economy. This is, partly, evidenced by reports that put the Taliban’s annual revenues at $1.6 billion. In the meantime, 3 million or slightly over 8% of the Afghan population is addicted to drug use. Opium production and trade of illegal drugs could be reduced with the right strategy for agriculture sector development providing a source of income to more than half of the population. Effective economic governance is essential for formalizing grey economy.
Afghanistan’s economic sustainability could be achieved through Agriculture sector development, natural resource extraction, transit trade, and a robust private sector.
Agriculture
More than 75% of Afghanistan’s population lives in rural areas and nearly 90% of them live in poverty. More than half of Afghan population and most rural population work and live on agriculture-related activities. Agriculture is least developed with the most economic potential and largest provider of livelihood and employment. The sector’s GDP contribution is on 25%. In other words, 75% of the population contributes 25% to GDP. Realizing agriculture sector growth potential could be challenging and will require game-changing policies, reforms, and investments. However, this would be possible given that, fortunately, Afghanistan has many catch-up opportunities —from revamping rural institutions, to re-building infrastructure and updating technology, that greatly suffered during the years of conflict— that offer the possibility of faster agricultural growth.
Afghan farmers and those in the business of agricultural products face several challenges. The full capacity of production has not been realized due to outdated farming techniques, little or no access to finance, shortage of water due to mismanagement and wastage, lack of processing and packaging facilities, inadequate transportation, and access to markets both domestic and international. Large amounts of fruits, vegetables, and other products get rotten on streets or sold at a price that does not recover the cost of production. To revamp the sector, some measures may include;
1. Building of cold storages; Agricultural products often get wasted due to the unavailability of cold storages that can keep the products for future use and trade.
2. Availing and providing small loans to farmers to increase production
3. Providing basic training on new techniques to farmers in rural areas of the country, especially in crop substitution such as growing of Saffron and others.
4. Providing improved seeds, fertilizers, and equipment to farmers
5. Rehabilitating and improving water management and the irrigation system. Large parts of agricultural land are not utilized due to the mismanagement of water. In some cases, the water could be flowing nearby but in the absence of a proper system of water distribution, agricultural lands remain dry.
6. Building of processing facilities in several geographical rural areas. The facilities will buy agricultural products, such as fruits, nuts, vegetables and intensive livestock such as milk, eggs, poultry meat, and others from farmers in rural areas, process and package them, and transport them to markets. The facilities that will add value, will operate as an intermediary between farmers and markets. Private sector with support from the government and development partners could build them.
With the right mix of policies and strategic investments, a large number of jobs could be created in the Agriculture sector with the above and other measures. It can leverage significant value addition and employment along value chains, and promote income, employment, and food security for large numbers of people since they are concentrated in areas where the greatest numbers of poor people live. The sector will also largely contribute to the national revenues and help reduce trade and fiscal deficit.
Mining (Extractive Industries)
Mining or overall extractive industries can be the second key sector that can raise Afghans from poverty and help the country in sustaining itself. Due to weak institutional and technical capacity, lack of clear goals and appropriate policies and regulations, and lack of strong political will, Afghanistan has not been able to benefit from the vast natural resources and are often illegally extracted and smuggled out of the country.
The extraction of natural resources could be costly and challenging due to security and need for large investment. However, with large amounts of extractions, the cost will decline. Possible actions may include the following.
1. Government must develop and implement a natural resource extraction policy, providing favorable conditions for international investment in the sector. The policy must be enforced without bias and announced worldwide to attract investors.
2. Key reforms in the Ministry of Mining and Petroleum are essential. The reforms must include revision of complicated and vague regulations, removal of unnecessary bureaucracy, and simplification of procedures. Capacity in project management, contract management, procurement, and project financing will greatly contribute to the successful extraction of the natural resources.
3. Government can partner with the private sector to extract the resources. The projects could be financed through government-issued bonds.
4. processing facilities for mines and other resources could be built by public-private sector partnerships or entirely private sector backed by effective government policies.
Revenues from natural resources in Afghanistan must not be spent in the operating budget. It should be part of the development budget and invested in long-term sustainable projects that will create jobs and revenues for the country. Effective extraction, possibly processing in the country for value addition, and trade of mines and other natural resources will eliminate fiscal and trade deficits providing employment and livelihood at a large scale.
State-Owned Enterprises (SOEs)
Afghanistan has 30 state-owned enterprises that employ over 11000 Afghans. Most of the SOEs are not operational and impose a cost on the government budget without any return. Some SOEs could greatly contribute to the economy if they are operationalized and managed properly while others waste resources. After a careful review, SOEs must be either sold to the private sector, liquidated, or operationalized to their full capacity.
Trade
As a landlocked country, Afghanistan has few choices in international trade. The country depends on Pakistani and Iranian ports for imports and exports. Sanctions on Iran and other political tensions repeatedly create hurdles for Afghan trade. Stringent political relationships between Afghanistan, Pakistan, and Iran often limit Afghan access to the ports and larger markets such as India and China. Trade agreements such as the Afghanistan-Pakistan Trade Agreement (APTA) are in place but often ignored.
Afghan economy cannot prosper until trade barriers are removed and Afghanistan gets access to trading partners through land and sea routes. Afghanistan will need support both with international trade facilitation and domestic reforms for trade and investment.
1. Traders’ concerns must be addressed both at Pakistani and Iranian ports. Agreements must fully be implemented, and new ones should be signed if needed. Pakistan must allow unconditional access to India through the Wagah crossing point. Afghanistan will need political support in gaining such access.
2. Sign trade/customs agreements with the United Arab Emirates. Chabahar, Gwadar, and Bandar Abas ports could facilitate such a trading link.
3. Sign new transit trade agreements between South and Central Asian countries. Build and improve transportation and road network in Afghanistan to enable transit trade between the two regions.
4. Expand Pakistan railway that ends in Landi-Kotal (near Durand line) to Jalalabad city of Afghanistan (82 KM). The connection will boost Afghan trade with Pakistan and beyond.
5. Freight train rail reaching Hairatan port from China via Kazakhstan, Uzbekistan, and Turkmenistan as part of the trilateral railway, which connects Afghanistan to international railway networks must be further expanded into Afghanistan.
6. More regional projects, such as powerline from central Asia to Pakistan (CASA-1000) and gas pipeline (TAPI), could significantly boost regional trade and peace. As a transit country, large scale employment opportunities can be created in Afghanistan.
Private Sector development
Afghanistan’s private sector could employ most of the labor force and increase the productional capacity of the country that can reduce Afghanistan’s trade deficit currently at around $6.2 billion. Afghan currency’s value is mostly managed through dollar auctions in the open market that can only be sustained until foreign aid flows into the country. Strengthening, developing, and expanding domestic production through the private sector is essential for sustaining a resilient economy. The private sector faces three main growth hurdles;
To support, strengthen, and develop the private sector, an enabling environment is essential for private investment to grow. The following measures will result in boosting the private sector.
Afghan banks hold $3.5 billion in bank deposits. Only $700 million of that money is loaned to businesses. Banks have invested the remaining amount in the central bank’s capital notes earning a very small percentage of interest. The money does not make it to the market due to high-interest rates and legal barriers for both lenders and borrowers. Banks require property or land to secure loans that are difficult for many borrowers to provide. Banks' requirements are strict due to high risk of default and several central bank regulations. A bank also goes through a long and messy court process to sell collateral of the borrower and recover money in the event of default.
A. The regulatory framework must be amended to enable banks to sell collateral based on the contract and without a long court process in the event of default.
B. Central bank must speed up work on a credit system and develop policies and regulations that allow both secured and unsecured loans and make it easier for businesses to borrow from the banks.
Afghan tax law is basic, less business-friendly, and has not been updated per new business realities. It is often not fully enforced, difficult to apply, and discourages investment in some cases. Article 3 of the Income-tax law imposes taxes of 10% and 20% on individuals regardless of their family size, responsibility, and marital status. A single person who does not support anyone pays the same amount of taxes as a person who is married with several children and parents to support.
Several kinds of taxes are levied upon businesses. These taxes include rent taxes, Business receipt taxes, income taxes, and customs duty as goods are imported. The rates may not seem high if compared with Europe or some other countries, but they are high in certain cases given the current fragile political and business environment of the country. Therefore, the tax law must be amended to more business-oriented and investment-friendly, considering Afghanistan’s needy and challenging situation. Measures will include;
A. Lowering of the current tax rates, imposing service-based fee in some areas.
B. Providing tax credits to those who employ Afghans and considering other concessions for certain business-enhancing activities.
C. Providing a tax credit for production inside Afghanistan.
D. Exempt new companies from most taxes for an appropriate period of time.
E. Simplify tax payment process and avail easy online filing.
For effective revenue collection and eliminating corruption, it is highly suggested to adopt a new tax and custom organizational structure. The structure suggested in the attachment must be discussed and possibly put into place as soon as possible (Please the attachment below).
Afghanistan must develop a clear and investment-friendly government policy focusing on enhancing both international and domestic investment. A government department or a newly created Economic Development Authority (EDA) should be responsible for its unbiased implementation. Security for investors, a clear conflict resolution process, easy repatriation of capital and profits, simple process for business formation and dissolution, access to financial resources and banks, transfer of money, tax credits, availability of land, and other needs of investors must be addressed and provided for in the policy. Involvement of the World Bank’s Multilateral Investment Guarantee Agency (MIGA) will significantly boost investment. Since the demand for investment monies is high all over the world and countries are doing everything possible to attract investment, Afghanistan must act beyond the normal ways of attracting investment.
Other Possible Reform Considerations in support of economic sustainability
Received 22 October 2020
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