PROGRAM INFORMATION DOCUMENT (PID) APPRAISAL STAGE July 5, 2013 Report No.: AB7362 (The report # is automatically generated by IDU and should not be changed) Operation Name AF: Development Policy Programmatic Series Region SOUTH ASIA Country Afghanistan Sector Public administration- Financial Sector (34%);General public administration sector (33%);General energy sector (11%);Other Mining and Extractive Industries (11%);Compulsory pension and unemployment insurance (11%) Operation ID P118027 Lending Instrument Development Policy Lending Borrower(s) GOVERNMENT OF AFGHANISTAN Implementing Agency Ministry of Finance Date PID Prepared July 5, 2013 Estimated Date of Appraisal July 1, 2013 Estimated Date of Board August 8, 2013 Approval Corporate Review Decision Following the corporate review, the decision was taken to proceed with the preparation of the operation. Country and Sector Background Afghanistan is undergoing a major security and political transition. At the Kabul and Lisbon Conferences in 2010, the North Atlantic Treaty Organization (NATO) and the Afghan government agreed that full responsibility for security would be handed over by 2014. The country now faces the prospect of a drawdown of most international military forces that so far have supported the fight against the on-going insurgency. At the same time, Afghanistan is gearing up for a presidential election in April 2014 which many anticipate to be a difficult process given the complex political environment and challenging logistics. The transition process carries major economic implications. The operations of international troops were supported not only by a high level of military but also civilian aid that financed reconstruction efforts and the provision of public services. Aid is therefore set to decline as the international troops leave, presenting Afghanistan with a new economic reality to which it will need to adapt to. The transition process has already begun to negatively affecting Afghanistan’s economy and fiscal revenue. Afghanistan vision is to become more self-reliant by 2025. The Government is cognizant of its donor dependence and the implications of the anticipated decline in aid. In order to prepare itself for the challenges ahead, it has embarked on an ambitious reform program that aims at fostering domestic sources of economic growth and enhancing revenue mobilization. In addition, the Government has put in place a series of measures to mitigate the currently deteriorating fiscal trends, including stronger expenditure controls and increase in selected custom duties and fees. Still, Afghanistan will need to rely heavily on donor financing over the next decade to ensure the continued provision of public services and investment over the transition period. In 2012 the Government secured sufficient pledges for funds for the security sector and for civilian aid to balance the budget throughout the transition period and for a few years beyond. In return, the Government of Afghanistan committed to hold timely elections, strengthen human rights, improve governance, public financial managements and macro-economic management, including stronger efforts in revenue mobilization (formalized in the “Tokyo Mutual Accountability Framework�). Operation Objectives This operation is a first in a series of two programmatic grants to Afghanistan. The proposed first operation is in the amount of US$50 million, out of US$100 million for the programmatic series The objective of this operation is to support policy reforms in selected areas critical for strengthening revenue mobilization and improving the enabling environment for investment in sectors with a high growth potential. With this, the operation expects to contribute to the government’s strategy towards developing greater economic and fiscal self-reliance. To this end, the operation supports legal, regulatory and institutional reforms in customs, land administration and management, mining and Information and Communication Technologies (ICT). In the long-term, these measures are expected to (i) boost investment in mining, agriculture, and ICT, and (ii) increase fiscal revenue through enlargement of the tax base in these key sectors and improved collection of customs duties. Intermediate outcomes include an increase in customs revenues, improved controls at customs, more affordable ICT services and an increase in ICT usage, a stronger legal, regulatory and institutional environment for mining and land management as well as better coordination in the deployment of public network infrastructure. Rationale for Bank Involvement The transition process present Afghanistan with unprecedented challenges: (i.) Fiscal sustainability: Currently, 65 percent of the budget is financed by Donors. Public expenditures are expected to grow significantly as a result of the handover of security responsibilities and donor-built assets from foreign actors to the Afghan government. Higher expenditures are also required to further expand and improve the provision of public services that are still limited in coverage and quality. (ii.) Macroeconomic stability: Afghanistan’s export base is currently very small and the country only receives little foreign direct investment. At the same time, the country is highly dependent on food and oil imports. The country relies on foreign aid inflows to balance its current accounts. While Afghanistan currently enjoys a strong foreign reserve position, adjustment processes in tradable sectors is expected to be slow and could further compound external imbalances. Progress on implementing structural reforms under the IMF-supported Extended Credit Facility has been slow. (iii.) Economic growth: The reduction of foreign aid is bound to have a negative impact on economic activities that have so far benefited from aid, especially construction and services industries. World Bank analysis suggests that even a gradual decline in aid could significantly reduce Afghanistan’s growth prospects to about half of its current average – not enough to reduce the country’s high poverty rates and create jobs for the 400,000 to 500,000 young people who will be entering Afghanistan’s labor markets every year. (iv.) Political economy: The anticipated decline in aid is increasing incentives of Afghanistan’s power brokers for rent-seeking activities and exposes public finance institutions, such as customs, to more corruption. In order to manage these challenges, the Government is implementing a set of revenue-enhancing measures to deal with the current fiscal imbalances and has put forward an ambitious structural reform agenda which includes introducing a VAT, strengthening the institutional framework for dealing with economic crimes, improving the enabling environment for the natural resources sector, strengthening banking supervision, customs and tax administration. The reform program is ambitious, especially in light of the upcoming elections, but it is strongly supported by the Government, key stakeholders and Donors. Many reforms proposals get mired in Afghanistan’s political context; and there is a risk that this could also happen to some of the reforms under this operation. However, the support that comes with operation increases the probability of implementing the reform program and can provide leverage to the Ministries that are carrying these reforms forward. This operation is also expected to create synergies with the IMF supported ECF and the Tokyo Mutual Accountability Framework. Tentative financing Source: ($m.) BORROWER/RECIPIENT 0 International Development Association (IDA) 50 Borrower/Recipient IBRD Others (specifiy) Total 50 Institutional and Implementation Arrangements The Ministry of Finance (MoF) will be responsible for overall implementation and monitoring of the DPG. The Ministry will organize monthly monitoring meetings with all implementing partners to discuss progress on the implementation of the reform program. Subsequent to the meeting, the MoF will submit a brief progress report to the World Bank team. Regular meetings between MoF and the World Bank will be organized to discuss the implementation of the reform program and any need for technical assistance. Risks and Risk Mitigation The risks to this operation are considered high. Many of these risks cannot be mitigated. Risks and options for mitigation include: Security risks: The security situation has deteriorated over the past several years and may become even more challenging over the transition period and the run-up to the presidential elections. Political uncertainty related to presidential elections in spring 2014 also remains an important factor. The operation acknowledges these risks but their mitigation is beyond the scope of this operation. Governance and Political Economy risks: Political uncertainty and instability could aggravate rent seeking incentives of individuals bound to lose from lower aid, potentially affect public finance institution and lower fiscal revenue. This risk is directly addressed by intensifying customs reforms which should reduce the scope for rent-seeking. Another risk is that the reform progress could slow as the attention of decision makers shifts increasingly to the elections or the reforms themselves becomes subject of political campaigns. This is compounded by the already long backlog of issues that are pending cabinet approval. The design of the DPG takes this risk into consideration by balancing institutional with legislative actions, and by moderating them to the extent that they can be implemented before the political campaigns intensify. Economic risks: The transition process may pose continued challenges to macroeconomic stability over the coming few years, including further slow-down in economic growth. The government has only few instruments to respond to adverse macroeconomic developments. The ongoing dialogue of the Government with the IMF and with the World Bank through its ongoing analytical work operations on economic and fiscal issues intends to mitigate this risk. Beyond this dialogue component, the DPG objective and actions are specifically geared to address some of these risks. The customs reforms aim at increasing fiscal revenues. The implementation of the economic reforms supported by this DPG is expected to support the economic development process in the long-run. However, large, negative shocks (e.g. prolonged drought) can undermine the results of the operation. Programmatic risks: The reform program supported by the proposed operation may face headwinds due to capacity constraints and weak policy coordination. These risks are mitigated as follows: First, the DPG actively counteracts coordination failure by encouraging ministries to use the DPG itself as an instrument for coordination. Second, the proposed DPG also mitigates overall implementation and coordination failure risks by ensuring that technical assistance is provided at all levels of government that are concerned with the implementation of the reforms. Fiduciary risks: Fiduciary risks are significant despite good progress in most phases of budget operations. Previous DPGs and investment operations have helped to put in place adequate processes and practices for financial management, procurement and control. Afghanistan has a relatively strong public finance capacity track record as noted in the 2013 PEFA. However, fiduciary risks remain high due to limited internal and external controls. For the most part, the DPG relies on the self-reinforcing actions committed to under the PFM Roadmap, the ARTF Incentive Program, the IMF Program and the Second Public Financial Management Reform Project. The ARTF Incentive Program, in particular, focuses heavily on the timely implementation of PFM measures, including internal and external audits, procurement certifications, and budget transparency. Notwithstanding these high risks, the benefits to Afghanistan’s development process, in our view, far outweigh the cost of this operation. This operation helps the Government of Afghanistan to carry on momentum and discipline reforms during challenging times. Even if not fully measurable in the short- term, the reforms supported by this operation are designed to have a tangible, positive impact not only on fiscal and economic developments but ultimately also on the life of the people of Afghanistan. Without it, the chances of achieving these results are lower. Poverty and Social Impacts and Environment Aspects The DPG is supported by a substantive Poverty and Social Impact Analysis (PSIA) and stakeholder dialogue. The PSIA includes an initial assessment of the likely poverty and social consequences of the DPG’s prior actions and triggers was carried out based on pre-existing analytical work. This was complemented by a first round of stakeholder consultations with representatives from Government, civil society, media and the private sector. Knowledge gaps identified in the initial assessments have been addressed through a series of PSIA policy briefs1 which will be completed in October 2013, prior to commencement of DPG 2. The effects of all DPG prior actions and triggers on poor and vulnerable groups are expected to be significant and positive in the longer-run. Particularly the reforms under the fiscal management pillar are expected to alleviate some of the fiscal pressures and should make service delivery in infrastructure services more efficient, including ICT services for the poor. The new mining law is expected to generate increased revenues for the general budget. Dependent on adequate management of governance and fiduciary risks, this may not only allow for expansion of public service provision and poverty reduction, but also provide an opportunity to indirectly include women into benefit sharing2. Amendments to land laws are expected to have the most pronounced positive poverty impact through better protection of property rights and improved and recognized dispute settlement mechanisms. This will ultimately improve not only the regulatory and investment climate, but also tenure security for small land holders. However, several risks to the livelihoods of poor people and vulnerable groups need to be carefully managed. Land acquisition from and resettlement of communities living in mining areas (currently estimated at 2,500 households or 15,000 individuals in total across Aynak copper, Hajigak iron, coal districts and hydrocarbon deposits) can have a significant negative impact on livelihoods. The current Land Management Law provides limited recognition of customary claims to land and no recognition of user rights to pasture land. It is estimated that mining and hydrocarbon development could affect a total of 85,000 ha of agricultural land, potentially impacting food production as well as employment for the local population. There is also a risk that grievances from mining related broader social and environmental impacts may not be properly addressed due to a lack of clear institutional mandates and weak institutional capacity, potentially leading to local conflicts. The Government is aware of the above concerns and has been in dialogue with the Bank regarding appropriate mitigation measures. Prior actions and triggers have been chosen to directly mitigate social impact. Environment Aspects: Increased mining activities, if not well governed and mitigated, can pose significant risks to the environment. According to a recently completed Strategic Environment & Social Assessment, mining may cause significant adverse effects on Afghanistan’s environment. In this respect, the Government has worked towards the establishment of a legal and institutional framework for environmental protection and the sustainable use of natural resources. Achievements in this field include the promulgation of the National Environmental Protection Act and the establishment of the National Environmental Protection Agency (NEPA) as an independent entity in charge of environment matters. Prior actions required in the DPG directly address the improvement of environmental safeguards in mining development. 1 on land management and amended mineral law impacts, Community Development Agreements as mitigation mechanisms and perception of communities affected by mining 2 The Minerals law includes a specific clause on the requirement of concession holders to enter into CDA with mining communities. In this respect, current work on the Resource Corridor and SDNRP2 aims at specifically targeting women in the development of CDA regulations and pilot activities. Furthermore, according to government policy, all development activities at local level should be channeled through Community Development Councils, where women are allocated a 50% representation. Contact point World Bank Contact: Claudia Nassif Title: Sr Country Economist Tel: 5232+3359 / 93-70-113-3359 Email: cnassif@worldbank.org Location: Kabul, Afghanistan (IBRD) Borrower Contact: Adris Walli Title: Aid Coordination Officer Tel: +93 (0)70 2329 101 Email: adris.walli@budgetmof.gov.af For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop