AFGHANISTAN DEVELOPMENT UPDATE August 2018 Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the Governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries Copyright Statement: The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, http://www.copyright.com/. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail pubrights@worldbank.org. Photo Credits: Cover: ©The World Bank, 2018 AFGHANISTAN DEVELOPMENT UPDATE August 2018 Preface The Afghanistan Development Update, which is published twice a year, provides a comprehensive report of the state of the Afghan economy. It covers recent economic developments and the medium-term outlook for Afghanistan. Each edition includes more in-depth analysis on specific focus topics. The Afghanistan Development Update is intended for a wide audience, including policy makers, the donor community, the private sector, and the community of analysts and professionals engaged in Afghanistan’s economy. This report was prepared by Tobias Haque with Habiburahman Sahibzada, Saurabh Shome, Bernard Haven, and Taehyun Lee. Special topic sections were provided by Nandini Krishnan and Christina Wieser, Nathalie Lahire, and Alvaro Espitia and Nadia Rocha. The report was prepared under the overall guidance of Manuela Francisco (Manager for South Asia, Macroeconomics, Trade, and Investment) and Shubham Chaudhuri (Country Director). The authors are grateful for the cooperation received from Government officials in sharing data and statistics and providing comments on draft versions of the report. The authors also gratefully acknowledge the comments and suggestions received from the International Monetary Fund. Key Messages in Charts Economic growth is gradually gaining pace, but is expected to remain sluggish. Real GDP Growth by Sector (Percent) 4% 3% 2% 1% 0% -1% 2016 2017 (est.) 2018 (proj.) 2019 (proj.) 2020 (proj.) 2021 (proj.) Agriculture Industry Services Real GDP Poverty has increased, reflecting declining per capita incomes. Poverty Rate and Per Capital Income 800 60% GDP Per Capita Poverty Rate Nominal USD 600 40% 400 20% 200 0 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 GDP per capita Poverty rate Macroeconomic management remains sound, with sustained strong revenues and moderate inflation. Revenue by source as % GDP CPI Inflation (12 month percent change) 15 14 9 10 % GDP 4 5 -1 0 -6 Jun-15 Nov-15 Dec-17 Jul-17 Oct-13 Aug-14 Apr-16 Sep-16 Feb-17 May-13 Mar-14 May-18 Jan-15 2012 2013 2014 2015 2016 2017 Tax revenues Customs duty and fees Headline Food Non-Food Nontax revenues Some indicators suggest that recent recovery may be at risk with declining confidence in the context of upcoming elections. Business Sentiment Index 40 30 20 10 0 -10 -20 -30 -40 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Small and Medium Large A fgh an ista n D ev el op m ent Up dat e Executive summary Action is required to Afghanistan has experienced slow growth since 2014, with the draw-down of sustain the gradual international security forces, accompanying reductions in international grants, and a recovery Afghanistan worsening security situation (growth has averaged 2.3 percent between 2014-2017). has seen since 2015 Following a period of political instability after the 2014 elections, the economy has slowly regained momentum as reforms have been implemented and confidence restored. From a low of 1.5 percent in 2015, real GDP growth accelerated to 2.3 percent in 2016, and is estimated at 2.7 percent for 2017. Building momentum now appears to be at some risk, with increasing election-related violence, declining business confidence, worsening drought conditions, and some apparent slowing of economic activity. Growth is projected at 2.4 percent in 2018, with substantial downside risks arising from the prospects of political instability around upcoming parliamentary and presidential elections. Risks can be partly mitigated and recent momentum maintained through: i) continued reform progress, demonstrating to investors that the deterioration in governance seen in 2014 will not be repeated; and ii) continued donor commitment to sustained grant support. Poverty has Reflecting slow recent growth, the new Afghanistan Living Conditions Survey increased and (ALCS) shows a significant increase in the proportion of Afghans living below the humanitarian national poverty line from 38 percent in 2011/12 to 55 percent in 2016/17. Living pressures remain standards are also threatened by continued drought conditions which are negatively impacting wheat harvests, generating food insecurity in many areas of the country. The displacement crisis also continues, with more than 1.7 million Afghans internally displaced, and more than 2 million returning to Afghanistan – mostly from Pakistan and Iran – since 2015. Inflation was Period-average inflation for 2017 reached 5 percent. Inflation peaked in June (7.5 moderate through percent), driven by food prices which moderated later in the year. Inflation in 2018 is most of 2017 projected to remain stable, at around 3 percent, with continued weak food price inflation offsetting increasing international energy prices. Export performance Exports grew by around 28 percent during 2017, driven by new air corridors for is strong and the exports to India and resolution of border issues that constrained trade with Pakistan external position is in 2016. Exports remain low in absolute terms at around 6 percent of GDP. The trade comfortable deficit remained stable at around 40 percent of GDP reflecting offsetting import growth driven by higher energy prices and increased food imports in the context of drought. The current account remained in surplus at end-2017, reflecting large aid inflows. Foreign exchange reserves now stand at more than US$8.2 billion, or more than one year of merchandise import cover. Rapid export growth continued into the first quarter of 2018, but the trade balance is expected to remain unchanged, reflecting offsetting import growth driven by continuing high energy prices and drought-induced food imports. The current account surplus is expected to turn into a small deficit in 2019, reflecting declining Au gus t 2 01 8 THE WOR LD B A NK I A fgh an ista n D ev el op m ent Up dat e aid inflows. Foreign exchange reserves will decline slightly while remaining at comfortable levels. The exchange rate depreciated gradually over 2017 reflecting the resumption of inflation. Depreciation accelerated in the first half of 2018, driven mostly by general strengthening of the US dollar. Budget reforms have The 2017 budget outturn saw a deficit of around 0.5 percent of GDP, with rapid had a positive impact revenue growth (15 percent in nominal terms) offset by a shortfall of grant revenues. Reforms to the 2018 budget process, including ending the practice of automatically carrying over the balance of unspent development project funds into the next budget, have seen project execution rates improve for both discretionary and non- discretionary development budget expenditures. Revenue growth is expected to moderate in 2018. This mostly reflects the exhaustion of opportunities for revenue growth from strengthening administration and enforcement after several years of improvement. Customs control may come under pressure in the context of upcoming elections. Revenue data for the first half of 2018 shows collections at roughly the same level as for this period in 2017. Amendments to the 2018 budget saw additional allocations for development expenditures, financed partly through reductions in recurrent allocations and partly through an additional ‘unfunded’ budget deficit of around AFS14.3 billion (US$209 million). These revisions doubled the projected deficit after grants to around 2 percent of GDP. With domestic revenues and grants now projected to exceed budgeted levels, the deficit is now expected to be restrained to around 0.5 percent of GDP. Financial sector Credit to the private sector grew by around 3 percent over 2017, after remaining flat activity remains through 2016. Credit to the private sector declined rapidly over the first four months subdued of 2018 before recovering in May, but is still around 2 percent lower than end- December 2017. Total credit to the private sector remains well below 2014 levels. Over the medium- Under current projections, Afghanistan is unlikely to make major progress in reducing term, a step-change poverty. Growth is expected to accelerate to around 3.7 percent by 2021. But with a in growth current population growth rate of around 2.7 percent, a much faster growth rate will performance is be required to significantly improve incomes and livelihoods for most Afghans, or required to provide jobs for the approximately 400,000 young Afghans entering the labor force significantly reduce every year. poverty In the short term, improved rates of economic growth could be driven by: i) careful prioritization of public investment towards sectors where the direct economic impacts are highest; and ii) addressing avoidable constraints to private investment, including unnecessary regulatory barriers. Over the medium-term, economic development progress will depend on mobilizing the sectors with greatest capacity to support increased growth, job creation, exports, and government revenues. This is likely to require a balanced growth strategy, including increased investment in agricultural productivity (including through expanded irrigation), increased investment in human capital, and the realization of Afghanistan’s substantial extractives potential. Au gus t 2 01 8 THE WOR LD B A NK II A fgh an ista n D ev el op m ent Up dat e Table of contents A. RECENT ECONOMIC DEVELOPMENTS ..................................................................... 1 1. Political and Security Context ....................................................................................................... 1 2. Real Sector Activity ....................................................................................................................... 2 3. External sector .............................................................................................................................. 7 4. Fiscal sector................................................................................................................................... 9 5. Monetary and financial sector developments ..............................................................................12 B. OUTLOOK AND MEDIUM-TERM PROSPECTS ......................................................... 14 C. FOCUS SECTION I: AFGHANISTAN’S TRADE POTENTIAL................................... 17 D. FOCUS SECTION II: POVERTY AND WELFARE ....................................................... 25 D. FOCUS SECTION III: PROMOTING EDUCATION UNDER FRAGILITY .............. 31 Au gus t 2 018 THE WOR LD B A NK A fgh an ista n D ev el op m ent Up dat e LIST OF FIGURES Figure 1: Growing insecurity poses risks to growth and investment .............................................................................................. 1 Figure 2: Services drove growth in 2017 .............................................................................................................................................. 3 Figure 3: Business climate perceptions improved through most of 2017 but business registrations were down .................. 3 Figure 4: Consumer prices are declining, despite increasing international energy prices ............................................................ 4 Figure 5: Opium production reached record highs in 2017 ............................................................................................................. 5 Figure 6: Poverty has increased substantially ...................................................................................................................................... 5 Figure 7: The number of urban poor is increasing, while employment outcomes deteriorate .................................................. 6 Figure 8: The trade balance deteriorated, despite surging exports .................................................................................................. 7 Figure 9: Imports in 2017 were dominated by food, energy, and machinery ................................................................................ 8 Figure 10: Import growth in 2017 was driven by increased food, fuel, and machinery imports ............................................... 8 Figure 11: Export growth in 2018 was driven by high-value fruit exports, mostly to India....................................................... 8 Figure 12: The afghani continues to depreciate, while foreign exchange reserves build ............................................................. 9 Figure 13: Revenue growth has been strong for several years, but is now slowing ................................................................... 10 Figure 14: Execution of the development budget has improved .................................................................................................. 11 Figure 15: Money demand declined through 2017 even as credit to the private sector expanded .......................................... 13 Figure 16: Budgets will remain highly dependent on aid inflows .................................................................................................. 16 Figure 17: Trade-to-GDP ratio in Afghanistan, 2012–16 (%) ....................................................................................................... 18 Figure 18: Average Applied Tariffs on country exports, 2016 ....................................................................................................... 18 Figure 19: Time to export, Afghanistan and comparators, 2005-14 ............................................................................................. 21 Figure 20: Logistical Performance Index for Afghanistan and neighboring countries, 2016 ................................................... 23 Figure 21: Timeline of key events and GDP per capita .................................................................................................................. 26 Figure 22: GDP per capita – Afghanistan and Comparators ......................................................................................................... 26 Figure 23: Refugees and battle-related deaths by country............................................................................................................... 27 Figure 24: GDP growth, insecurity, and investment trends ........................................................................................................... 28 Figure 25: Conflict and displacement trends ..................................................................................................................................... 28 Figure 26: Poverty rate and number of poor ..................................................................................................................................... 29 Figure 27: Timeline of key events and GDP per capita .................................................................................................................. 33 Figure 28: Timeline of key events and GDP per capita .................................................................................................................. 34 Figure 29: Public education expenditure as a share of GDP and government expenditure ..................................................... 35 Figure 30: Contributions by international donors through the national budget and directly to projects, 2011 to 2015 ..... 36 Au gus t 2 018 THE WOR LD B A NK A fgh an ista n D ev el op m ent Up dat e A. Recent Economic Developments 1. Political and Security Context Conflict and Conflict negatively impacted economic activity in 2017, and prospects for 2018 and instability continue beyond will be heavily influenced by political and security developments. to profoundly influence During 2017, civilian casualties reached similar levels to the previous year, with 10,451 Afghanistan’s civilians killed or wounded (down slightly from the peak of 11,418 in 2016). The slight economy and decline in civilian casualties was due to reduced harm to civilians from ground economic fighting, while the number of casualties from suicide and complex attacks continued development to increase. Violence remained intense throughout the early period of 2018, with 763 prospects civilian deaths and 1,495 wounded in the period to March, similar to record-high casualty levels sustained during the same period in the previous two years. Internal displacement driven by conflict remains at extremely high levels, with 509,075 conflict-induced internally displaced recorded in 2017 (substantially above historical average levels, but well below the peak of 674,698 seen in 2016). Upcoming elections Parliamentary and district council elections are scheduled for October 2018 and present risks to Presidential and provincial council elections are scheduled for April 2019. Anti- reform and economic government elements have already begun election-related attacks, targeting civilians management in 23 election-related incidents up to April 2018. Prospects for increasing election- related violence, as accompanied the 2014 presidential elections, present a significant risk for confidence and investment. Disruption to reforms, revenue collection, and expenditure discipline are possible in the context of political instability in the lead-up to and aftermath of elections. On the other hand, recent movements towards a negotiated peace agreement with the Taliban, including an unprecedented mutual ceasefire over Eid al-Fitr in June, provide some cause for cautious optimism regarding prospects for an improvement in the security situation over coming years. Figure 1: Growing insecurity poses risks to growth and investment a. Civilian casualties b. Conflict-driven displacements 14000 800,000 12000 700,000 10000 600,000 8000 500,000 6000 400,000 4000 300,000 2000 200,000 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 100,000 0 Civilian Deaths Civilian Injured 2012 2013 2014 2015 2016 2017 Source: United Nations Assistance Mission in Afghanistan (UNAMA) and UNHCR Au gus t 2 018 THE WOR LD B A NK 1 A fgh an ista n D ev el op m ent Up dat e 2. Real Sector Activity Real sector activity Afghanistan has recently experienced a sustained economic slowdown. Having remains muted, but maintained an average growth rate of 9 percent between 2003 and 2013, economic there were some growth slowed to 2.7 percent in 2014, declining further to 1.5 percent in 2015. This signs of returning decline was driven by a range of factors, including: i) declining aid levels associated confidence during with the drawdown of international security forces (from US$12.5 billion in 2009 to 2017 around US$8.8 billion in 2015); ii) increasing violence and insecurity; and iii) political instability associated with the 2014 elections. Since 2015, there has been a slight recovery, with growth accelerating slightly to 2.3 percent in 2016, reflecting increased investment and business confidence compared to 2015, in the context of relative political stability and strong progress against a range of reforms and infrastructure initiatives, including WTO accession, rollout of electronic taxpayer systems, progress with the CASA-1000 electricity transmission project, and opening of the Chabahar port. Recovery continued in 2017, with the economy growing by 2.7 percent. Growth was driven mostly by the services sector, which expanded by 2.5 percent. Growth of the service sector partly reflected improved investor confidence through most of 2017. Investor perception surveys showed improving investor sentiment through the first three quarters of 2017, including improved perceptions of the security situation (despite continuing elevated levels of violence). For the first time since 2014, more than half of businesses responding to the ACCI Bottleneck Survey reported that security conditions had improved. Large businesses reported positive sentiment, on average, through the first three quarters of 2017, while small-and-medium enterprises reported net negative sentiment, but remained more positive than during the trough of late 2015. The agriculture sector grew by around 3.8 percent despite drought conditions. Major declines in cereal production (down 10 percent) were offset by increased production in fruit. Rainfed wheat production was only 43 percent of the five-year average for 2012-2016 - the third worst year on record since 2005. Overall new business license applications declined slightly in 2018, down 20 percent from 2016. New business registrations continued to be concentrated in the services sector. Service and manufacturing sector registrations were down by around 20 percent while construction sector registrations increased by around 40 percent. Au gus t 2 018 THE WOR LD B A NK 2 A fgh an ista n D ev el op m ent Up dat e Figure 2: Services drove growth in 2017 (percent) a. Real GDP growth by sector b. Contributions to real GDP growth 20% 14% 15% 12% 10% 10% 8% 5% 6% 0% 4% 2012 2013 2014 2015 2016 2017 2% -5% 0% -10% -2% 2012 2013 2014 2015 2016 2017 Real GDP Growth Agriculture Agriculture Industry Industry Services Services Real GDP Sources: Central Statistics Organization (NSIA) and Bank staff projections Available indicators Business sentiment across nearly all indicators and business types deteriorated in the suggest a slowing of last quarter of 2017, potentially reflecting expectations of political instability and recent momentum in violence associated with upcoming elections (Figure 3). Continued violence in early the first half of 2018 2018 and the large number of election-related incidents may reinforce negative sentiment. While precipitation improved late in the October 2017-May 2018 wet season, seasonal totals in some areas remained below 50 percent of the historical average. Overall rain and snowfall was well below average levels, and wheat production in 2018 is projected at the lowest level since 2011. Figure 3: Business climate perceptions improved through most of 2017 but business registrations were down (percent) a. Business sentiment b. New business registrations 40 3500 30 3000 20 2500 10 2000 0 1500 -10 1000 -20 500 -30 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 -40 2015 2016 2017 Agriculture Construction Manufacturing Small and Medium Large Other Services Sources: Afghanistan Chamber of Commerce and Industry Business Sentiment Survey, Government of Afghanistan Au gus t 2 018 THE WOR LD B A NK 3 A fgh an ista n D ev el op m ent Up dat e Consumer prices The annual inflation rate remained moderate through 2017, with period-average increased moderately inflation of 5.0 percent for the year. Inflation peaked during the second quarter of through 2017 2017, reaching 7.5 percent in June, driven by food price increases, particularly for fruit and vegetables. Inflation moderated later in the year, declining to 3.1 percent by December, as price increases for both food and non-food items slowed. Slowing food price inflation later in the year reflected moderation of fruit and vegetable prices and weakening international prices for imported grains. Inflation during 2018 has remained moderate to date, despite recent depreciation of the afghani against major trading currencies, peaking at 4.3 percent in in January and declining steadily to -1.0 percent by May. Recent deflation has been led by food prices, and more specifically vegetable prices, despite increasing international energy prices. Food price inflation reached -3.6 percent in May 2018. Recent drought is not expected to have a major impact on food prices, with Afghanistan already heavily reliant on imported wheat and facing relatively stable world prices. Figure 4: Consumer prices are declining, despite increasing international energy prices (12-month percentage change) a. Consumer prices b. Commodity prices 14 80 60 9 40 4 20 0 -1 -20 -40 -6 -60 Jul-17 May-13 Jun-15 Nov-15 Apr-16 May-18 Mar-14 Jan-15 Aug-14 Sep-16 Feb-17 Dec-17 Oct-13 Nov-15 Nov-16 Nov-17 Feb-16 Feb-17 Feb-18 May-15 Aug-15 Aug-16 Aug-17 May-16 May-17 May-18 Headline Food Non-Food Energy Grain Source: Central Statistics Organization, and World Bank Global Economic Monitor (GEM) Opium production Opium production reached a new peak in 2017, with production reaching nearly and the area under 9,000 tons with 328,000 hectares of land under cultivation. This represented a 90 poppy cultivation percent increase in production and a 60 percent increase in land under cultivation increased relative to 2016 levels. The UNODC estimates that the value of the overall opium dramatically in 2017 economy is now between US$4.1-US$6.6 billion, or around 20 percent to 30 percent of GDP. This is a substantial increase over 2016, when the value of the opium economy was estimated at around 15 percent of GDP. The value of licit agriculture, by comparison, is around 18 percent of GDP in 2018. Strong growth of the opium economy was due to the absence of diseases that affected the 2016 crop, reduced government control in some opium-growing areas, and increased uptake of fertilizer and pesticides by opium farmers. More generally, the opium economy has benefited from continued weak rule of law, easy access to trade routes, and the continued decline in availability of alternative livelihood opportunities. Au gus t 2 018 THE WOR LD B A NK 4 A fgh an ista n D ev el op m ent Up dat e Figure 5: Opium production reached record highs in 2017 (units) 350 10 Cultivation area (Thousands ha) 300 Production (Thousand tons) 8 250 200 6 150 4 100 2 50 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Poppy Cultivation Area (Ha) Poppy Production (Tons) Sources: UNODC Poverty has The newly-released 2016/17 Figure 6: Poverty has increased substantially increased markedly, Afghanistan Living Conditions (poverty headcount, in percent of population) due to slowing real Survey shows that 54.5 percent of 60 economic growth the Afghanistan population now live % Population below the poverty line below the national poverty line, 50 relative to 38.3 percent in 2011/12.1 This equates to roughly an additional 40 five million Afghans living below the poverty line. This rapid increase in 30 poverty reflects economic growth lagging population growth in the 20 context of ongoing insecurity, with declining per capita incomes since 10 2012. Additional pressure has arisen from internal displacement and the 0 large number of returnees. Urban 2007-08 2011-12 2016-17 poverty has become more Source: Afghanistan Living Conditions Survey, 2007/08, widespread, with the number of 2011/12 and 2016/17 surveys urban poor doubling since 2007, with 18 percent of Afghanistan’s poor now living in urban areas. Food insecurity has increased from 30 percent in 2011/12 to 45 percent in 2016/17. Vulnerability to poverty is extremely widespread, with simulations showing that a 30 percent reduction in incomes would lead to a poverty rate exceeding 80 percent. Poverty is subject to Poverty has increased in all regions between 2011/12 and 2016/17, but regional regional variation disparities have become more pronounced. The largest increases in poverty between and closely 2011-12 and 2016-17 were in the Central, East, North and North-East regions, correlated with between 17 and 20 percentage points. The South West region recorded the highest demographic factors poverty rate in 2016-17, at 72 percent. Larger households are more likely to live in poverty. While a third of households with 1 to 5 members live below the poverty line, roughly 60 percent of households with 8 members or more are poor. Poverty is also 1 The poverty line represents the national norm for the cost of covering basic needs including a set of food items that deliver 2,100 kilocalories per person per day as well as necessary non-food expenditures on housing, clothing, education and transportation. In 2016-17, the poverty line was 2,064 Afghanis per person per month, around $1 a day in current exchange rate terms. Au gus t 2 018 THE WOR LD B A NK 5 A fgh an ista n D ev el op m ent Up dat e correlated with education levels. 73 percent of the population belong to households where the household head has no education, but these households account for 82 percent of the poor. Households who derive their main source of income from agriculture, livestock or non-formal employment (such as wage or day labor) have high poverty rates of 65, 66 and 68 percent respectively. Almost 60 percent of poor Afghans live in such households. Unemployment has Employment and labor force participation has fallen between 2013 and 2017. The increased employment to working age population ratio fell from 42.9 percent in 2013/14 to 41 percent in 2016/17. This decline was most pronounced among rural women, where employment to working age population ratio declined from 21.2 percent to 18.3 percent, equivalent to the loss of nearly 130,000 jobs. The labor force participation rate fell from 55.4 percent in 2013/14 to 53.9 percent in 2016/17, equivalent to an increase in discouraged workers (i.e. those that are of working age, not currently employed and not seeking employment) of around 118,000. Employment of working age males between the ages of 25 and 50 declined from 93.4 percent in 2011/12 to 84.3 percent in 2016/17, equivalent to a reduction in employment by around 176,000 jobs. Figure 7: The number of urban poor is increasing, while employment outcomes deteriorate (Percent) a. Share of urban and rural poor b. Employment to working-age-population ratio 100 80 80 60 60 40 40 20 20 0 0 2007/08 2011/12 2016/17 All Male Female Rural Urban 2011/12 2016/17 Source: Afghanistan Living Condition Surveys 2007/2008, 2011/12, 2016/17 Continued Afghanistan continues to face a humanitarian crisis arising from large numbers of displacement and returning migrants (more than 2 million since 2015) and a large and growing internally drought are leading displaced population (1.7 million). Displacement and a large internally displaced to humanitarian population presents both a risk and an opportunity for Afghanistan. Successful pressures integration into productive employment of generally better-educated returnees could provide a boost to productivity and growth. On the other hand, concentration of returnees and the internally displaced in urban centers risks overwhelming services and generating large humanitarian needs. Drought conditions are contributing to humanitarian needs. Poor households that are dependent on rainfed wheat production are expected to face difficulty in meeting consumption requirements in northern, northeastern, and northwestern Afghanistan. Au gus t 2 018 THE WOR LD B A NK 6 A fgh an ista n D ev el op m ent Up dat e 3. External sector 2017 saw a surge in Exports increased from US$614 million in 2016 to US$784 million in 2017, exports, but the trade representing growth of 28 percent. Export growth was driven by the establishment deficit continues to of new air corridors to India, the resolution of border issues that constrained trade grow with Pakistan during 2016, and continued gradual depreciation of the afghani relative to major trading currencies. Total exports remain very limited however, concentrated in a narrow range of commodities (dried fruits, nuts, and textiles) and with a value equal to around 6 percent of GDP. Imports also grew substantially from US$6,636 million in 2016 to US$7,355 million in 2017. Import growth reflected the overall pick-up in economic growth, resolution of the disruptions at the Pakistani border that had contributed to a decline in trade during 2016, increasing energy prices, and increased grain imports driven by drought conditions. With the increase in import values outstripping increased export values, the merchandise trade deficit widened from 31.6 percent of GDP in 2016 to 33.6 percent of GDP in 2017. The service trade deficit also increased during 2017, expanding from 4.2 percent to 5.6 percent of GDP. The trade deficit was financed almost entirely by foreign aid inflows, which remained roughly stable, at around 40 percent of GDP. Capital account and financial account flows remained modest. In the first quarter of 2018, rapid import and export growth continued. Exports for first quarter 2018 were up by nearly 50 percent on the same period in 2017, while imports were 28 percent higher than during the same period in 2017. Export growth was concentrated in high-value fruit products, reflecting improved market access to India via air corridors. Import growth was driven by the continued depreciation of the afghani, increased energy prices, and high grain imports in the context of continuing drought conditions. Figure 8: The trade balance deteriorated, despite surging exports (units) 500 0 -500 -1000 -1500 -2000 -2500 -3000 Exports Imports Trade balance Sources: NSIA Au gus t 2 018 THE WOR LD B A NK 7 A fgh an ista n D ev el op m ent Up dat e Figure 9: Imports in 2017 were dominated by food, energy, and machinery (Percent) Other Vegetable Products 14% Chemical Products 19% 5% Vehicles and Transport Equipment 5% Animal or Vegetable Fats and Oils Mineral Products 7% 18% Machinery and Appliances 7% Base Metals Textiles Prepared Foodstuffs 8% 9% 8% Sources: Afghanistan Customs Department Figure 10: Import growth in 2017 was driven by increased food, fuel, and machinery imports (Change from 2016 to 2017) 20 50% Billion Afs 15 40% 30% 10 20% 5 10% - 0% Animal Wood Plastics Chemical Animal or Stone, Textiles Vehicles Prepared Machinery Mineral Vegetable Products Pulps and products Vegetable Plaster, and Foodstuffs and Products Products Rubber Fats and and Transport Appliances Oils Ceramic Equipment Products 2017 import growth in Afs 2017 import growth in percent Sources: Afghanistan Customs Department Figure 11: Export growth in 2018 was driven by high-value fruit exports, mostly to India a. Export Share by country, Q1 2018 UAE, 2% Iran, 3% Others, 11% Turkey, 4% Pakistan, India, 53% 27% Source: Afghanistan Living Condition Surveys 2007/2008, 2011/12, 2016/17 Au gus t 2 018 THE WOR LD B A NK 8 A fgh an ista n D ev el op m ent Up dat e The afghani After appreciating slightly at the end of 2016, the afghani depreciated steadily by gradually around 4 percent against the US dollar during 2017 (end period). Depreciation against depreciated over 2017 the Euro was more pronounced, reaching 16 percent over 2017. In contrast, the and into the first afghani remained stable against the Pakistani Rupee. Despite increased US dollar sales quarter of 2018 by Da Afghanistan Bank, aimed at stabilizing the currency, depreciation against the US dollar accelerated in the first half of 2018, driven mostly by general strengthening of the US dollar but potentially reflecting capital outflows associated with political uncertainties. The afghani fell by 6 percent against the US dollar between end- December 2017 and end-June 2018. As of end-June, 2018, the afghani exchange rate stood at 73.6 per US dollar and 85.6 per Euro. Foreign exchange The current account remained in surplus through 2017, at approximately 1.6 percent reserves continue to of GDP. The continued current account surplus in the context of a wide trade deficit accumulate reflects continued large aid inflows. Driven by the current account surplus, foreign exchange reserves continued to accumulate, reaching an estimated US$8.2 billion at end-2017, equivalent to more than one year of merchandise import cover. This represents an 11 percent increase in reserves over end-2016 levels. In the three months to March 2018, foreign exchange reserves increased slightly with slowing imports offsetting declining exports, before declining in the first two months of the second quarter. Figure 12: The afghani continues to depreciate, while foreign exchange reserves build (Percent) 80 8.5 96 USD Billion 78 75 91 73 8 70 86 Euro/AFN USD/AFN 68 81 7.5 65 63 76 60 7 58 71 55 66 53 6.5 50 61 Jun-15 Nov-15 Oct-13 Dec-17 Jul-17 Apr-16 Sep-16 Feb-17 May-13 Aug-14 May-18 Mar-14 Jan-15 6 2016M11 2017M1 2017M11 2016M1 2016M3 2016M5 2016M7 2016M9 2017M3 2017M5 2017M7 2017M9 2018M1 2018M3 USD/AFN Euro/AFN 2018M5 Source: Afghanistan Living Condition Surveys 2007/2008, 2011/12, 2016/17 4. Fiscal sector Revenue collection Domestic revenues grew strongly for the third consecutive year in 2017, reaching remained strong in AFS169 billion. This exceeded budgeted revenues of AFS160.6 billion by around 5.5 2017 percent. Nominal revenue growth in 2017 was around 15 percent, following total revenue growth of 20 percent in 2016 and 22 percent in 2015. In the absence of major tax policy changes, the improvement is largely attributable to tax and customs administration and enforcement and increased non-tax revenues associated with new fees and charges. These improvements led to increases in the average value of customs declarations by around 6 percent, reflecting a reduction in under-valuation of imports. Revenue performance is now at a record high for Afghanistan. As a share Au gus t 2 018 THE WOR LD B A NK 9 A fgh an ista n D ev el op m ent Up dat e of GDP, domestic revenues reached 12.3 percent of GDP in 2017, exceeding the previous peak of 11.7 percent achieved in 2011/12. Revenue growth is expected to moderate in 2018. Following consecutive years of rapid revenue growth within a slow-growing economy, the potential to further achieve revenue improvements from administration and enforcement improvements is near exhaustion. Customs control may come under pressure in the context of upcoming elections based on the experience of past election periods. Revenue data for the first half of 2018 shows only a slight improvement over collections for the same period in 2017, with the difference only slightly exceeding the rate of inflation. Figure 13: Revenue growth has been strong for several years, but is now slowing a. Revenue composition b. Revenue performance 2017-2018 14 180 12 160 10 140 120 % GDP 8 Billion AFS 6 100 80 4 60 2 40 0 20 2012 2013 2014 2015 2016 2017 0 Tax revenues Customs duty and fees Nontax revenues 2017 2018 Source: Ministry of Finance data Expenditures Total expenditure growth in 2017 reached only 0.5 percent. An 8 percent reduction increased only in security expenditure drove a 2.5 percent decline in overall recurrent spending. slightly in 2017 Reduced security expenditures reflected reduced allocations for goods and services in Ministry of Defense and Ministry of Interior. Declines in security expenditures largely offset growth in civilian spending, especially in the discretionary development budget.2 Civilian expenditure growth was led by a large jump in discretionary development expenditures (nearly 40 percent, or around AFS 11.6 billion) and strong growth in wage and salary expenditure (7.4 percent, or around AFS 4.4 billion). Increased discretionary development expenditure was supported by improvements in execution of the development budget, which increased from 55 percent in 2016 to 68 percent in 2017. The 2017 budget Despite improved revenue performance and declining expenditure, the 2017 fiscal delivered a modest deficit was equal to around 0.5 percent of GDP, up from a roughly balanced budget deficit in 2016. This outcome reflected declines in both discretionary and non-discretionary on-budget grants, with discretionary grants declining by more than 2 percent of GDP in 2017. Total grants in the 2017 budget fell short of budgeted levels by around US$600 million, reflecting both a shortfall of discretionary grants and weak execution of development projects. 2 The development budget is divided between ‘discretionary’ and ‘non-discretionary’ categories. The discretionary budget is used for government projects while the non-discretionary portion is used for on-budget donor projects. Au gus t 2 018 THE WOR LD B A NK 10 A fgh an ista n D ev el op m ent Up dat e Execution of the Reforms introduced through the 2018 budget process laid the foundation for development budget continued improvements in budget execution. Formulation of the budget saw an end continues to improve to the practice of automatically rolling over unspent balances allocated to development projects into the following year, with 2018 allocations subject to careful review based on project quality and execution performance. The 2018 budget also introduced a medium-term framework at the project/program level to make the ongoing costs of budgeting decisions transparent and to enforce consistency between aggregate macro-fiscal projections and expected expenditures at the program level. Partly because of the elimination of automatic carry-overs, project execution has strengthened in 2018, likely supporting an improvement in the overall budget execution rate for the year. As of end-June 2018, execution of the non-discretionary development budget was at 29 percent, relative to 19 percent in 2017. Execution of the discretionary development budget was at 24 percent relative to 21 percent in 2017. Improved execution rates are generally driven by reduced budgeted expenditures rather than improved execution capacity, with actual execution in afghani terms tracking close to 2017 levels. The mid-year budget Amendments to the 2018 budget saw additional allocations for development review projects a expenditures, financed partly through reductions in recurrent allocations and partly deficit of around 0.5 through an additional ‘unfunded’ budget deficit of around AFS14.3 million (US$209 percent of GDP million). These revisions to the budget more than doubled the projected deficit after grants from around 0.8 percent of GDP to around 2 percent of GDP. Government, through its mid-year budget review, is now seeking to restrict the deficit to around 0.5 percent of GDP. Some development expenditure has been restrained through a review of project performance and the identification of savings through reallocation away from poorly-performing projects. Discretionary grants and revenues are also expected to exceed budgeted levels, supporting a reduction in the deficit to within targeted levels. The deficit will be financed mostly from cash reserves, which remain at comfortable levels (around AFS 40 billion). Figure 14: Execution of the development budget has improved (Execution rate in percent, and total cumulative expenditures to date) a. Non-discretionary development budget b. Discretionary development budget 25 40% 15 30% Billion AFS Billion AFS 20 30% 15 10 20% 20% 10 5 10% 5 10% 0 0% Jan Feb Mar Apr May Jun 0 0% Jan Feb Mar Apr May Jun 1397 Afs 1396 Afs 1397 Afs 1396 Afs 1397 % 1396 % 1397 % 1396 % Source: Ministry of Finance data Au gus t 2 018 THE WOR LD B A NK 11 A fgh an ista n D ev el op m ent Up dat e 5. Monetary and financial sector developments Money demand Da Afghanistan Bank targets monetary aggregates. The broad money (M2) growth declined slightly in rate, which include currency-in-circulation and deposits in commercial banks, 2017 increased during 2017 (4 percent year-on-year, at end-December in nominal terms). This represented a much slower growth rate than during 2016 (9.7 percent over the previous period). The year-on-year currency-in-circulation growth rate also slowed during 2017 to 2 percent (year-on-year at end-December) from 10 percent in the previous period. Growth in commercial bank deposits was similarly subdued. Commercial deposits in afghanis grew by only around 11 percent in 2017, relative to 21 percent in 2016, while deposits in US dollars grew by just 1 percent, relative to 8 percent in the previous year. This partly reflected a reduction in Da Afghanistan Bank’s capital notes rate. Credit growth Credit to the private sector resumed gradual growth in 2017, increasing by 3 percent resumed in 2017 over the year to December, 2017, after remaining flat through 2016. Growth in credit to the private sector is consistent with the recent uptick in economic activity and improvement in investor sentiment observed through the first three quarters of 2017, but was supported by exchange rate effects, with depreciation of the afghani driving an increase in the value of USD-denominated loans in local currency terms. Local currency credit to the private sector grew by around 2.4 percent from 2016, while credit denominated in USD grew by around 3.8 percent. Total credit to the private sector, however, remains well below 2014 levels. Reflecting high dollarization of the Afghan economy, the shares of foreign- denominated loans and deposits remain substantial, at 58 percent and 68 percent respectively at end-2017. In both cases, this is a slight decline from the previous year (59 percent and 70 percent respectively). The quality of bank assets improved slightly, with non-performing loans declining to 12.2 percent at end-2017, from 12.7 percent at end-2016. Banks remained profitable through 2017, with most profit being derived from non-interest income. Available financial Broad money and currency in circulation year-on-year growth rates to May 2018 sector indicators slowed significantly relative to the same period the previous year (currency in suggest declining circulation grew by just 1.5 percent, relative to 8 percent the previous year). Deposits confidence in the in afghanis increased, while foreign exchange deposits declined over the five months first half of 2018 to May 2018 (21 percent increase compared to 25 percent decrease), potentially indicating transfer of assets overseas. Dollar outflows may be driven by the informal currency trade in Iran, which is facing a shortage of US dollars in the context of international sanctions. Credit to the private sector declined rapidly over the first four months of 2018 before recovering in May, but is still around 2 percent lower than end-December 2017. Da Afghanistan Bank is expected to continue to reduce the capital notes rate in an effort to stimulate increased lending to the private sector. Au gus t 2 018 THE WOR LD B A NK 12 A fgh an ista n D ev el op m ent Up dat e Figure 15: Money demand declined through 2017 even as credit to the private sector expanded (year-on-year percent change) a. Growth of monetary aggregates b. Growth of deposits and loans 30% 35% 25% 30% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% -5% -10% -5% -15% -10% -20% 2016M1 2017M1 2018M1 2013M1 2013M5 2013M9 2014M1 2014M5 2014M9 2015M1 2015M5 2015M9 2016M5 2016M9 2017M5 2017M9 2018M5 2013M1 2013M5 2013M9 2014M1 2014M5 2014M9 2015M1 2015M5 2015M9 2016M1 2016M5 2016M9 2017M1 2017M5 2017M9 2018M1 2018M5 Broad Money Currency in Circulation Deposits Loans Source: Da Afghanistan Bank The financial sector Assets of the banking sector totaled 23 percent of GDP in 2018. The value of credit remains intermediated to the private sector by banks, however, remains at around 3.3 percent underdeveloped, of GDP (down from around 3.6 percent of GDP in 2016). Consequently, bank asset- constraining to-deposit ratios remain extremely high, at around 74 percent at end-2017. Weak investment and intermediation reflects under-development of the financial sector, including limited growth access to financial services for many Afghans, as well as weak confidence constraining credit demand and difficult economic conditions constraining the number of viable projects. Au gus t 2 018 THE WOR LD B A NK 13 Afghanistan Development Update B. Outlook and Medium-Term Prospects Growth is expected Growth over 2018 is expected to reach 2.4 percent, a slight decline from 2.7 percent to remain sluggish growth in 2017, reflecting continued drought conditions and investor uncertainty in over coming years the lead-up to parliamentary and presidential elections. Government consumption and investment is expected to increase only slightly. Private consumption is expected to be depressed by continued drought conditions, while private investment will likely be adversely impacted by uncertainty approaching the elections. International sanctions on Iran are expected to negatively impact the Afghan economy given Iran’s role as a trading partner and source of remittances. Over the medium-term, growth is expected to gradually accelerate as drought conditions abate and confidence picks up. Growth is expected to reach 2.8 percent in 2019, and increase gradually to 3.6 percent by 2021. A small deficit is Reflecting current strong performance against revenue targets and the expectation of expected in 2018 additional discretionary grants, the budget deficit for 2018 is projected at 0.4 percent of GDP. Revenues are expected to remain constant in percentage GDP terms, with a nominal increase of around 2 percent. Expenditures are projected to grow by around 5.2 percent, driven mostly by security and non-discretionary development project expenditures. Security expenditure increases are driven by Government taking on greater responsibility for provision of security services, while growth of the development budget reflects continued efforts by development partners to move aid on-budget. On-budget donor grants are expected to reach around 13.7 percent of GDP. Over the medium-term, revenues are expected to remain stable as a proportion of GDP over 2019-2021. Revenue projections do not currently include the potential impacts of the proposed VAT, which is scheduled to be implemented in 2021. This policy reform could have a significant impact on domestic revenue performance. The current account The trade balance is expected to widen to around 40 percent of GDP. While the surplus will pace of export growth will exceed import growth, absolute increases in imports will evaporate as grants continue to outstrip absolute increases in exports. The current account balance will decline remain in slight surplus (around 0.2 percent of GDP) supported by aid inflows. As aid declines over the medium-term, the current account is expected to move into deficit, reaching a deficit of 4.1 percent of GDP by 2021. As the current account surplus narrows, foreign exchange reserves will stabilize in 2018, before beginning to decline from 2019. Reserves are expected to remain at comfortable levels, however, equal to more than 10 months of merchandise import cover by end-2021. Consumer price inflation is expected to slow to 3 percent in 2018, reflecting the slight decline in economic activity, credit growth, investment, and money demand. As growth picks up slightly, over the medium-term inflation is expected to accelerate to around 5 percent. This assumes continued stability of international commodity prices, as currently predicted, and gradual depreciation of the afghani against major trading currencies. Au gus t 2 018 THE WOR LD B A NK 14 Afghanistan Development Update 2015 2016 2017 2018 2019 2020 2021 Actuals/Estimates ----Staff projections---- Growth and prices Real GDP growth (%) 1.5 2.3 2.7 2.4 2.8 3.2 3.6 Nominal GDP (Af billion) 1,223 1,314 1,376 1,450 1,564 1,693 1,839 CPI Inflation (period average, %) -0.7 4.4 5.0 3.1 5.0 5.0 5.0 Fiscal % GDP Revenues and grants 25.3 26.9 25.3 25.4 26.0 26.5 26.4 Domestic Revenues 10.0 11.2 12.3 12.3 12.3 12.3 12.3 Foreign grants 15.3 15.8 13.0 13.1 13.7 14.2 14.1 Total expenditures 26.0 26.9 25.8 25.8 26.2 26.6 26.6 Recurrent expenditures 19.3 19.8 18.4 18.4 18.6 18.9 18.9 Development expenditures 6.7 7.1 7.4 7.4 7.5 7.7 7.7 Overall balance (incl. grants) -0.7 0.0 -0.5 -0.4 -0.2 -0.1 -0.2 Overall balance (excl. grants) -16.0 -15.7 -13.5 -13.5 -13.9 -14.4 -14.3 External % GDP Merchandise Trade balance -35.8 -31.6 -33.6 -34.4 -34.2 -33.4 -32.3 Current account balance (incl. grants). 7.5 7.1 1.6 0.2 -1.2 -1.6 -4.1 The short-term Afghanistan faces substantial risks in the short-term arising from the possibility of outlook is subject to political instability and violence in the context of upcoming elections. Elections of significant 2014 saw a major and unexplained declines in revenues (from 9.6 percent of GDP uncertainties, given in 2013 to 8.5 percent of GDP in 2014), likely driven by increased revenue leakage the unpredictable in the context of election-related political economy pressures. The formation of the political and security National Unity Government saw a disruption in reform progress as political situation competition came to delay the appointment and confirmation of senior officials. Political instability undermined investment confidence, with negative impacts on growth (which declined from 5.6 percent in 2013 to 1.5 percent in 2015). A similarly disruptive election period could have major negative impacts on revenues, investment, and growth over 2018, 2019, and beyond. On the other hand, progress with a negotiated peace settlement with the Taliban could have a major positive impact on investment confidence, potentially spurring accelerated growth and improved government revenues. Afghanistan remains Economic projections are highly sensitive to the level and modality of aid flows. heavily dependent Grants to Afghanistan are currently estimated at around 40 percent of GDP. on aid External grants are currently relied on to finance more than half of budget expenditures and vital off-budget security and service delivery functions. The substantial trade deficit (around 40 percent of GDP) is financed almost entirely by aid inflows. Aid levels are expected to approximately halve by 2030 (to around 20 percent of GDP), remaining substantially above the average for low-income countries (around 10 percent of GDP). With the Government of Afghanistan facing major upcoming Au gus t 2 018 THE WOR LD B A NK 15 Afghanistan Development Update expenditure pressures related to taking on increased responsibilities in the security sector and meeting the maintenance costs of donor-financed assets and infrastructure, any sudden reduction in aid levels below currently committed levels would have major implications for fiscal sustainability. Failure by development partners to move an increasing share of aid on to the budget over time would similarly constrain Government’s capacity to meet looming expenditure pressures without major disruptive adjustments, with likely negative impacts for service delivery. Figure 16: Budgets will remain highly dependent on aid inflows (Percent of GDP) 30 25 20 15 10 % GDP 5 0 2015 2016 2017 2018 2019 2020 2021 -5 -10 -15 -20 Development Recurrent Security Recurrent Civilian Revenues Fiscal Deficit Excluding Grants Sources: Ministry of Finance data, World Bank staff projections A step-change in Under current projections, Afghanistan is unlikely to make major progress in growth is required reducing poverty. Growth is expected to accelerate to around 3.6 percent by 2021. for substantive But with a current population growth rate of around 2.7 percent, a much faster poverty reduction growth rate will be required to significantly improve incomes and livelihoods for most Afghans, or provide jobs for the approximately 400,000 young Afghans entering the labor force every year. In the short term, improved rates of economic growth could be driven by: i) careful prioritization of public investment towards sectors where the direct economic impacts are highest; and ii) addressing avoidable constraints to private investment, including unnecessary regulatory barriers. Over the medium-term, economic development progress will depend on mobilizing the sectors with greatest capacity to support increased growth, job creation, exports, and government revenues. This is likely to require a balanced growth strategy, including increased investment in agricultural productivity (including through expanded irrigation), increased investment in human capital, and the realization of Afghanistan’s substantial extractives potential. Au gus t 2 018 THE WOR LD B A NK 16 Afghanistan Development Update C. Focus Section I: Afghanistan’s Trade Potential 1. Background Trade could be Trade can promote the efficient allocation of resources; allow a country to realize an important economies of scale and scope; facilitate the diffusion of knowledge; foster channel for technological progress; and encourage competition in both domestic and accelerating international markets, which leads to an optimization of production processes growth in and the development of new products. Complementary policies—regarding Afghanistan infrastructure, skills, institutions—can enhance the impact of trade on growth and poverty. This focus section answers the following questions: • What explains Afghanistan’s recent trade performance? • What strategy should Afghanistan pursue to maximize the benefits of trade? • What are the prospects of transit trade for Afghanistan and what are the priorities for realizing transit trade opportunities? Box: Key messages for policy • Improving productivity in high potential sectors such as agriculture will help meet domestic demand, substitute imports, and potentially promote exports in the short- and medium-term. • In the short term, exports could be improved by tackling export delays related to customs and border procedures, or high risks during transportation in the short term. In the long run, improvements in trade facilitation and logistics coupled with Afghanistan’s productivity converging to regional levels could lead to a more than six-fold increase in exports. • Efficient logistics, well-designed and maintained infrastructure, and an adequate framework of regulation and regional cooperation are pre-requisites for Afghanistan to realize the potential benefits of transit trade in commodities and energy. 2. What explains Afghanistan’s recent trade performance? Trade has played Afghanistan’s recent trade performance has been driven by reconstruction and aid a limited role as inflows. Large aid influx has driven high imports in a variety of consumption goods an engine for and equipment. In the last two decades, the country’s trade balance has been growth in negative. Over the period 2012-16 Afghanistan’s exports of goods and services rose Afghanistan from US$1.13 billion to US$1.34 billion, an increase of only 18.5 percent. Imports grew at a similar rate (18.7 percent) from US$8.04 billion to US$9.54 billion. The structural trade deficit in goods and services has remained around 40 percent of GDP in recent years, reaching 42.1 percent in 2016, and exports amounted to only 6.9 percent of GDP in 2016 (Figure 17). Au gus t 2 018 THE WOR LD B A NK 17 Afghanistan Development Update Figure 17: Trade-to-GDP ratio in Afghanistan, 2012–16 (%) (Percent of GDP) 60 40 Percent of GDP (%) 20 0 -20 2012 2013 2014 2015 2016 -40 -60 Exports of goods and services Imports of goods and services Trade Balance Sources: Calculations based on the World Bank’s World Integrated Trade Solutions (WITS) database. Afghanistan’s trade A gravity analysis3 suggests that Afghanistan underperforms in trade, even performance is compared to its neighbors and countries at similar levels of development. In weak despite addition, Afghanistan exports less than expected to markets where it has access, relatively good suggesting that there are barriers to trade that are common to most of the access to destinations instead of a lack of market access. Afghanistan faces relatively lower international markets tariffs than its neighbors do (see Figure 18Error! Reference source not found.). It also has preferential access via GSP to the EU and the United States, two of the largest markets outside its neighbors. On average, Afghan exports are benefiting from tariff rates that are 10 percent points lower than its competitors.4 Figure 18: Average Applied Tariffs on country exports, 2016 (Percent) 8.0 Average Applied Tariff (%) 6.0 4.0 2.0 0.0 Nepal Afghanistan Bangladesh India Pakistan Sri Lanka Maldives Simple Average Trade Weighted Sources: ITC/World Bank database from Espitia, Mattoo, Mimouni, Pichot and Rocha (2018) Afghan firms The low proportion of exporters among all Afghan companies, and their poor exhibit poor performance in export markets, suggest low export capabilities and high barriers to export trade. According to the World Bank Enterprise Survey, only 6.7 percent of the 410 performance surveyed Afghan firms were exporters in 2014 (see Table 1). This share is low 3 Gravity analysis uses econometric techniques to evaluate individual observations on trade between countries over time, against the gravitational ‘mass’ of explanatory variables such as GDP and distance that describe the characteristics of bilateral trade between partners. Anderson and van Wincoop (2003), Feenstra (2004), and Baldwin and Taglioni (2006), among others, present exhaustive literature reviews on the gravity equation as applied to international trade. 4 Calculations based on competition adjusted preference margins. See Espitia, Mattoo, Mimouni, Pichot and Rocha (2018) for reference. Au gus t 2 018 THE WOR LD B A NK 18 Afghanistan Development Update compared with averages for the South Asia region (13 percent) and Organization for Economic Co-operation and Development countries (36 percent). Low export performance is associated with low levels of foreign investment, which can provide an important conduit for acquiring knowledge and technology. Foreign direct investment (FDI) flows into Afghanistan were less than 1 percent of GDP in recent years. Table 1: Share of firms exporting at least 1 percent of sales, Afghanistan and comparators, 2013-14 % of Exporter firms Pakistan 18.60 Afghanistan 6.70 Kazakhstan 5.00 Azerbaijan 1.90 South Asia 12.9 High income: OECD 35.70 Source: World Bank Enterprise Surveys Note: Shares for Afghanistan are from 2014; for Pakistan, Kazakhstan, and Azerbaijan are from 2013. 410 enterprises were surveyed in Afghanistan in 2014. The sectors covered are manufacturing (40 percent), retail (20 percent), and services (40 percent). Heavy trade During 2014-16, average exports were concentrated in a handful of vegetable concentration products such as grapes, insect resins and tropical fruits, representing 17.3 percent, renders 8.7 percent, and 8.6 percent of total exports, respectively. The top 10 exported Afghanistan product categories represented more than 70 percent of Afghanistan’s total exports susceptible to (see Table 2). Afghanistan also exports a limited number of goods to a restricted external shocks list of destinations. The top five destinations—Pakistan, India, United Arab Emirates, United States, and Turkey—account for 94.8 percent of exports (see Table 3). On the import side, the top 10 imported goods represented 43.9 percent of the country’s total imports in 2016 and 70 percent of Afghanistan’s imports originated from few neighbors or war-related partners. In addition, the limited value of intermediary imported inputs suggests weak integration in GVCs and confirms that imports might not translate into productivity gains. Table 2: Top-10 trade sectors in Afghanistan, Average 2014-16 (HS-4) Industry Exports Share of total (%) Industry Imports Share of total (%) Grapes 137,777 17.3 Telephones 1,035,231 14.7 Coal Briquettes 70,566 8.9 Wheat Flours 489,011 6.9 Raw Cotton 70,387 8.8 Refined Petroleum 302,650 4.3 Insect Resins 68,996 8.7 Raw Sugar 290,458 4.1 Tropical Fruits 68,398 8.6 Armored Vehicles 199,679 2.8 Scrap Iron 47,003 5.9 Aircraft Parts 192,100 2.7 Other Nuts 46,436 5.8 Other Engines 173,563 2.5 Dried Legumes 28,721 3.6 Cement 171,179 2.4 Soapstone 21,648 2.7 Jewelry 128,881 1.8 Onions 19,157 2.4 Rice 117,308 1.7 Top-10 Industries 579,089 72.7 Top-10 Industries 3,100,060 43.9 Source: Calculations based on the World Bank’s World Integrated Trade Solutions (WITS) database Note: Calculations are made using mirror data. Average exports do not include 2016 gold exports as they do not reflect Afghanistan export basket and might be related with transit trade. Au gus t 2 018 THE WOR LD B A NK 19 Afghanistan Development Update Table 3: Top 10 Afghanistan trade partners, Average 2014-16 Destination Exports Share of total (%) Origin Imports Share of total (%) Pakistan 384,069 48.2 United Arab Emirates 2,162,653 30.6 India 280,923 35.3 Pakistan 1,657,034 23.5 United Arab Emirates 17,411 2.2 United States 611,081 8.6 United States 14,908 1.9 India 479,603 6.8 Turkey 12,592 1.6 Kazakhstan 397,614 5.6 China 11,210 1.4 China 395,003 5.6 Germany 10,089 1.3 Russian Federation 246,319 3.5 Russian Federation 9,347 1.2 Azerbaijan 169,873 2.4 France 7,584 1.0 Turkey 164,385 2.3 Finland 6,807 0.9 Germany 97,944 1.4 Total 796,693 Total 7,066,110 Source: Calculations based on the World Bank’s World Integrated Trade Solutions (WITS) database 3. What strategy should Afghanistan pursue to maximize the benefits of trade? Insufficient Afghanistan’s export base is still extremely narrow, reflecting the country’s limited production agricultural production and very small manufacturing base. The GDP share of both capacity is agriculture and industry is on average 20 percent and has not increased over time. Afghanistan’s Top exported products such as fruits and nuts represented only one-fourth of largest constraint agricultural GDP in 2015. Other traded products such as textiles, wood, and paper for production represented less than 1 percent of manufacturing GDP. and trade Increased productivity in the agricultural sector is fundamental to meet domestic demand, substitute imports, and potentially promote exports in the short and medium term. Given limited government resources, intervention should focus on sectors with high potential such as agriculture and agribusiness. They all enjoy comparative advantage and could be the first movers of the agricultural sector toward substituting imports, which would assist in increased food security and open new export opportunities. Increases in competitiveness should also be coupled with action plans to enhance female participation in agricultural activities, given that they represent a significant source of income for the female population. Three complementary actions could improve agricultural productivity in the short- medium run: • Improvement of adequate irrigation facilities. Afghanistan’s irrigated lands can be substantially increased with the rehabilitation of traditional irrigation systems. High-level coordination among line ministries and improvement of irrigation water management through definition of a legal and regulatory framework are also key. • Better access to high-quality inputs. Efforts should focus on the creation of an effective regulatory system and on strengthening the capacity of Ministry of Agriculture, Irrigation and Livestock to enforce certification of seeds and veterinary medicines and vaccines, among others; control banned pesticides; constantly monitor domestic supplies; and prevent imports of low-quality and hazardous agricultural inputs. • Better access to technology. To deliver better technologies for farmers and increase yields and productivity, the capacity of the national research system needs to be strengthened, for example, through the rehabilitation and strengthening of the existing networks of research stations, and Au gus t 2 018 THE WOR LD B A NK 20 Afghanistan Development Update collaborations with international research centers working in similar agroecological areas. While productive Afghanistan is a landlocked country with complex topography, underdeveloped capacity is the road infrastructure, and high transportation costs. Firm-level surveys suggest that main constraint, delays at the border, followed by domestic transportation, are the main causes of trade is also export delays. It took Afghan exporters 86 days on average to ship their goods in impaired by 2014, compared to 33 days on average for South Asia, 21 days for Pakistan, 25 days logistics and for the Islamic Republic of Iran, 21 days for China, and 17 days for India (see Figure infrastructure 19). Enterprise surveys suggest that nearly half of surveyed firms see transport as a major or severe obstacle to export. In addition, there is an increasing share of surveyed firms reporting customs and trade regulations as a major or severe obstacle to export. Around 85 percent of total time spent to export is related to documentary compliance, and 15 percent is due to border compliance. Figure 19: Time to export, Afghanistan and comparators, 2005-14 (Days) Number of days to export 80 60 40 20 - Afghanistan China India Iran, Islamic Rep. Pakistan South Asia 2005 2010 2014 Sources: Doing Business Survey (2018) Improvements in Even with existent infrastructure, export flows could be improved by 20 percent trade facilitation in the short term by tackling export delays related to customs and border and logistics procedures or high risks during transportation. A simulation exercise suggests that could enhance reducing export delays to 25 days could increase overall exports in goods by 20 exports in the percent, which corresponds to US$160 million on average per year. Three short term complementary methods could improve trade logistics: • Improve efficiency of documentation requirements and processes. The number of documents and authorizing signatures required for trade operations should be reviewed for consistency with international good practices. In the medium term, the Government of Afghanistan should work to automate all trade-related requirements and procedures into a National Single Window (NSW) system. • Reduce waiting times at the border. Opportunities exist to review and rationalize border operations to eliminate inefficiencies. These include improving cooperation and information sharing among the various government agencies mandated to operate at the border; operationalizing the ASYCUDA World’s advance declaration and manifest functionalities Au gus t 2 018 THE WOR LD B A NK 21 Afghanistan Development Update to allow prescreening of consignments prior to their arrival at the border; reducing congestion by separating pedestrian and truck traffic; expanding border capacity and related infrastructure; and implementing cargo tracking to better manage the risks associated with movement of goods. • Improve interagency cooperation on trade facilitation matters. Consistent with the commitments of the World Trade Organization (WTO) Trade Facilitation Agreement (TFA), it is recommended that the Government of Afghanistan formally mandate customs and other key border management agencies to maintain a National Trade Facilitation Committee (NTFC) to provide a formal mechanism for enhanced interagency cooperation and improved dialogue with the private sector. In regional Strengthening trade agreements would facilitate visa processing and improve cooperation, transport and logistics, and help with the harmonization and simplification of existing trade customs procedures in line with international standards and regional commitments. agreements with In the case of Pakistan, the main destination and transit country for Afghanistan’s regional partners exports, a strengthening of the dialogue between the two countries to accelerate can be deepened de-bottlenecking of the Afghanistan-Pakistan Transit Trade Agreement would be and expanded fundamental to reduce uncertainties related to merchandise transportation and to more broadly ensure gains from trade. 4. What are the prospects of transit trade for Afghanistan and what are the priorities for realizing transit trade opportunities? Potential gains Transit trade in goods is often emphasized as an obvious opportunity for from Afghanistan, but until recently it has not been clear how large this potential is. merchandise Approximately US$5.7 billion of trade in goods could potentially transit through transit trade may Afghanistan. Gains for the country could grow to an estimated 5 percent of that be slow to amount (US$285 million per year), around 1 percent of GDP. Gains from transit materialize trade are realized through the collection of transit revenues, and through job creation in associated activities, such as rest stops and servicing. There could also be indirect benefits of increased transit trade, through reductions in transport costs for Afghan traders. Realizing these benefits requires efficient logistics, well-designed and maintained infrastructure, and a propitious framework of regulation and regional cooperation. Globally and within the region, Afghanistan shows the weakest performance in the logistics and transportation category of the World Bank’s Logistics Performance Index (LPI), ranking 150th out of 160 countries in 2016 (Figure 20). Logistics efficiency in Afghanistan is challenged by long waiting times at borders and complex customs procedures. Infrastructure is also likely to be a serious constraint, as Afghanistan’s transportation (roads and railroads) network is currently very underdeveloped. With its challenging terrain and after decades of internal conflict, Afghanistan has consistently ranked in the lowest group of the LPI infrastructure index, well below South Asia and the world average (Figure 20). Achieving a competitive edge in transportation and logistics will require large investments in Au gus t 2 018 THE WOR LD B A NK 22 Afghanistan Development Update transportation and border infrastructure, which will compete with infrastructure demands in productive sectors. Figure 20: Logistical Performance Index for Afghanistan and neighboring countries, 2016 a. Rankings b. Score 2.8 2.8 2.8 2.6 2.6 2.4 2.4 2.4 2.2 2.1 2 1.9 1.8 1.8 1.1 2007 2010 2012 2014 2016 Afghanistan South Asia World Source: Logistical Performance Index Note: The infrastructure index is one of the components of the LPI. This index scores the quality of trade and transport infrastructure of countries in a scale from 1 to 5, with 5 representing the best quality. A sensible A transit trade development strategy should: approach to transit trade • Resolve existing congestion at important trade points (see trade facilitation development recommendations above). should also be based on careful • Meet emerging needs in domestic productive sectors such as agriculture and prioritization of extractives. Implementation of plans to connect all provinces via highways infrastructure should also aim to connect regional and local roads to the national investment transportation network. These plans include, for example, the completion of the National Ring Road which, when finished, will connect resource-rich regions in Afghanistan and neighboring countries more directly. • Create partnerships with the private sector. Public-private initiatives aimed at improving infrastructure would decrease the weight of the infrastructure bill in the government budget. Transit trade potential is also shaped by sensitive political and geopolitical considerations that are not entirely under Afghanistan’s control. Considering recent international and regional developments, Afghanistan should focus its effort on: • Updating APTTA. A revised version of the APTTA should contemplate factors such as the shift to a transport trade regime based on reciprocity. The enforcement of measures aimed at minimizing the incidence of customs fraud and avoidance, and monitoring and curbing informal trade is also key. Au gus t 2 018 THE WOR LD B A NK 23 Afghanistan Development Update • Deepening and expanding existing agreements with regional partners. Improvements in visa regimes, harmonization, and simplification of custom procedures would be fundamental to facilitate transit trade. • Improving harmonization of transportation standards among countries. This has been a recurring challenge, for example, in planning new railways, since there are three different gauges in neighboring countries. With regards to energy trade, Afghanistan has a geographic advantage for becoming an energy transit hub that would boost economic growth and revenue. Energy transit trade could add 3.1 percent to export growth annually and contribute US$530 million to revenue by 2030 (1 percent of GDP. Building regional connectivity for energy transit trade can deliver important revenues for the country and help meet its own acute domestic shortages. Major regional energy projects like the Turkmenistan-Afghanistan-Pakistan-India (TAPI) Pipeline5 and CASA-10006 are evidence of the commitment of countries in the region to integrate and will help build regional connectivity. Full completion and operationalization of large-scale infrastructure projects such as CASA-1000, TAPI, and TUTAP are essential for Afghanistan to fully benefit from energy transit trade. Although Afghanistan is not in the lead on these projects, the government should constantly monitor the developments of the proposed energy transit projects and be prepared to respond positively if action is required. A plan to respond to partner concerns regarding security, location of offtakes, cost sharing, transit tariffs, and other matters should be implemented. References Anderson, J. E. and E. van Wincoop (2003). “Gravity with Gravitas: A Solution to the Border Puzzle.” American Economic Review, 93(1): 170–92. Baldwin, R. and D. Taglioni (2006). “Gravity for Dummies and Dummies for Gravity Equations.” NBER Working Paper No. 12516, National Bureau of Economic Research, Cambridge Espitia, A, A. Mattoo, M. Mimouni, X. Pichot, and N. Rocha. (2018) “How preferential is preferential trade?”. World Bank Policy Research Working Paper forthcoming Feenstra, R. C. (2004). Advanced International Trade: Theory and Evidence. Princeton, NJ: Princeton University Press. Rocha, Nadia (2017). “Trade as a Vehicle for Growth in Afghanistan: Challenges and Opportunities”. World Bank, Washington, D.C. 5 https://www.adb.org/projects/44463-013/main. 6 http://www.casa-1000.org/. Au gus t 2 018 THE WOR LD B A NK 24 Afghanistan Development Update D. Focus Section II: Recent Developments in Poverty and Welfare 1. Background Afghanistan has From 2007 to 2012, Afghanistan witnessed unprecedented economic growth. achieved much While the benefits of growth were narrowly concentrated, the period saw major progress over the gains in health and education. Since the 2014 security transition the country has past decade, but faced slow economic growth rates, a deterioration in security, and a displacement progress is now crisis, arising from both internal displacement and large numbers of returnees. As at risk job quality remains poor and agriculture stagnant, food insecurity has risen sharply, and one in two Afghans today lives below the national poverty line. This stark deterioration in welfare poses a humanitarian crisis, and is a call for concerted action. This focus section answers the following questions: • What are the long-term patterns in income growth and population movement? • What progress was achieved during the period of reconstruction? • How has poverty and welfare changed since the drawdown of international security forces? 2. What are the long-term patterns in income growth and population movement? Economic In 1960, Afghanistan was the 6th poorest country in the world in terms of GDP growth has been per capita in current US$. By 2016, it had risen a bare 6 ranks. This bleak picture repeatedly and of long term stagnation masks both advancement and loss. The country’s GDP per severely capita in 2002 was below the last recorded estimate, two decades prior. Since then, disrupted over and until 2012, the economy grew at faster rates than ever before. Despite this the past four recent growth, Afghanistan remains firmly within the group of low income decades countries, having been left behind by its regional neighbors, and well below the average for other fragile and conflict affected states. Au gus t 2 018 THE WOR LD B A NK 25 Afghanistan Development Update Figure 21: Timeline of key events and GDP per capita (Current USD) 800 Withdrawal of 700 NATO troops 600 GDP per capita (current US$) 500 Taliban rule 400 Soviet Civil war 300 US led intervention invasion 200 100 0 1974 2006 1960 1962 1964 1966 1968 1970 1972 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2008 2010 2012 2014 2016 Sources: World Development Indicators Figure 22: GDP per capita – Afghanistan and Comparators (Current USD) 2000 GDP per capita (current US$) 1500 1000 500 0 1988 1992 1996 2000 2004 2008 2012 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1990 1994 1998 2002 2006 2010 2014 2016 Afghanistan Fragile and conflict affected situations South Asia Low income Sources: World Development Indicators Conflict-induced Large scale population displacements and violence continue to characterize the population country. Conflict-induced population displacements have occurred on a massive displacements scale. After the Syrians, Afghans are the largest refugee population in the world, and violence have and with the Palestinians, among the most protracted refugee populations. been a recurrent Violence and risks to life have long been a feature of everyday life for Afghans. The feature of life for scale of battle-related deaths is only eclipsed by the Syrian civil war, the two ordinary Afghans Gulf/Iraq wars and the IS insurgency. Nowhere has the scale been sustained in the post-World War era over so long as it has in Afghanistan. Au gus t 2 018 THE WOR LD B A NK 26 Afghanistan Development Update Figure 23: Refugees and battle-related deaths by country 80 Thousands 7 70 Refugee population, by country of origin Millions Battle related deaths 6 60 5 50 4 40 30 3 20 2 10 1 0 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 0 2014 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2016 Syrian Arab Republic Syrian Arab Republic Afghanistan Afghanistan Iraq Somalia Yemen, Rep. Sudan Source: World Development Indicators 3. What progress was achieved during the period of reconstruction? Much was The 2001-2014 period was characterized by rapid economic growth and a relatively achieved during stable security situation. Over 2003-2013 the economy grew at an average rate of 9 reconstruction, percent per annum, while per capita incomes increased from around US$200 to but key around US$650. Huge gains were made in terms of access to services, with rapid vulnerabilities improvements in education provision and health outcomes. remained The scale of the long-term development deficits facing the country would take any country decades of sustained effort to address and reverse. Important problems, including lack of productive employment, illiteracy and low levels of education, and huge demographic pressures – remained pervasive. Throughout the period, most of the population remained highly vulnerable. Welfare gains were limited because growth was not inclusive and broad-based. The 2013-14 Afghanistan Living Conditions Survey (ALCS) showed that poverty reduction stalled from 2007, and a large share of the population adopted negative coping strategies when faced with shocks. The progress made on human development appeared to be at risk, with growing disparities in access to services. 4. How has poverty and welfare changed since the drawdown of international security forces? Afghanistan has Afghanistan has faced almost impossible odds since the 2014 drawdown of faced impossible international security forces and accompanying reduction of aid. The Afghan odds since the economy has grown at an average of 2.1 percent between 2013 and 2016, and GDP 2014 security per capita in 2018 is estimated to be around $100 below 2012 levels. As a ‘transition’ consequence, the poverty rate is estimated to have increased from 34 percent in 2007/08 to 55 percent in 2016/17. Mirroring the increase in poverty, food insecurity has climbed from 30 percent in 2011-2012 to 45 percent in 2016-2017, Au gus t 2 018 THE WOR LD B A NK 27 Afghanistan Development Update driven by an increase in the proportion of severely and very severely food insecure population. Figure 24: GDP growth, insecurity, and investment trends 20000 700 25% 18000 600 16000 20% 14000 Real GDP Growth Per Capita GDP 500 12000 400 15% 10000 300 10% 8000 6000 200 5% 4000 100 2000 0 0% 0 2007 2003 2005 2009 2011 2013 2015 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Per capita GDP GDP Growth Battle-related deaths New firm registrations Source: World Bank, UNAMA, AISA The deteriorating Since 2007, the number of injuries and deaths has increased five-fold, and in 2016 security situation and 2017, more than 1.1 million Afghans were internally displaced due to conflict. has led to large- At the same time, 2016 and 2017 witnessed the return of almost 1.7 million scale population documented and undocumented Afghan refugees, primarily from Pakistan and displacements Iran. Internal displacement and large-scale return within a difficult economic and security context pose risks to welfare, not only for the displaced, but also for the population at large, putting pressure on service delivery systems and increasing competition for already scarce economic opportunities. Figure 25: Conflict and displacement trends 800 140 1,200 Thousands Thousands Thousands 700 120 1,000 600 Injuries + Deaths 100 800 500 80 692 400 600 IDPs 60 300 40 400 663 200 564 100 20 200 373 0 0 59 - 58 2015 2016 2017 Injuries+Deaths Conflict-induced IDPs Documented returns Undocumented returns Source: UNAMA, IOM Au gus t 2 018 THE WOR LD B A NK 28 Afghanistan Development Update Slowing Sector specific trends in growth suggest further causes for concern. While agricultural agriculture’s contribution to GDP has declined steadily from around 30 percent in growth has had a 2007 to 22 percent in 2016, it remains an important sector as a source of livelihoods negative impact for the rural poor, in influencing the affordability of basic food items for the on livelihoods population, and its significant inputs into the manufacturing sector. Characterized and poverty by significant annual fluctuations, the agricultural sector grew, on average, 8 percent per year between 2007 and 2012. Since then, its annual growth rate has fallen sharply to 0.1 percent on average. Figure 26: Poverty rate and number of poor 18 Millions 60 16 % Population below the poverty line 14 Number of poor persons 50 12 40 10 30 8 16 6 20 10 4 8 10 2 - 0 2007-08 2011-12 2016-17 2007-08 2011-12 2016-17 Source: ALCS (NSIA) Population Few Afghans have access to productive or remunerative employment. Low levels growth far of educational attainment are pervasive: adult literacy rates stand at only 35 percent, outstrips job among the lowest in the world. More than four out of five Afghan adults (ages 25 growth, and most and above) have not completed any level of education. A quarter of the labor force employment is is unemployed, and 80 percent of employment is vulnerable and insecure, vulnerable comprising self- or own-account employment, day labor or unpaid work. With almost half the population below the age of 15, each year, large numbers of young Afghans continue to enter the labor market, most with little education and few productive employment opportunities. A natural consequence of the poor security situation and limited development resources, job creation has been unable to keep up with population growth, and good jobs are few and far between. Almost three-quarters of the population are below the age of 30, and roughly 25 percent are between the ages of 15 and 30. This large youth cohort of approximately 8 million is entering the labor market with little education and few employment opportunities. Though increasing over time, just over half (54 percent) of young Afghans are literate. Labor force participation rates of young Afghan women are particularly low due to higher rates of inactivity and unemployment among young women. Young Afghans (ages 15-24) have high unemployment rates of 31 percent and 42 percent are neither in employment, education or training (NEET). Progress with education is threatened by the security situation. Net attendance rates in Au gus t 2 018 THE WOR LD B A NK 29 Afghanistan Development Update secondary education fell from 37 to 35 percent between 2013 and 2016, driven by declining attendance among girls. Neither jobs nor Neither education nor employment are a guarantee out of poverty, as poor job education are quality and insecure employment is widespread. The lack of a strong link between enough to assure higher education, employment and lower poverty reflects the pervasive lack of a decent standard productive employment opportunities. The employment status of the head of the of living household does not sharply differentiate poor households from non-poor households. While poverty rates are highest among households with heads who are unemployed, they remain high irrespective of the employment status of the head. These findings These findings demonstrate the need to maintain progress and carefully manage are a call to risks associated with the upcoming election period. For Government, maintaining action services and building private sector confidence is vital if investment and employment opportunities are to expand. This will require continued sound macroeconomic and fiscal management, continued reform progress, and avoiding any repeat of the disruptive political transition that followed the 2014 elections. For development partners, continuation of aid support is vital to both service delivery and overall economic performance in an economy that remains heavily reliant on aid. Continued support is vital if gains of the past 15 years are to be maintained and any further deterioration of living conditions is to be avoided. Au gus t 2 018 THE WOR LD B A NK 30 Afghanistan Development Update D. Focus Section III: Promoting Education Under Fragility 1. Background Population The Afghanistan government has achieved substantial improvements in the growth far education section over the past decade, though significant challenges remain. The outstrips job government is committed to tackling issues of security, poverty reduction, growth, and most governance and shared and inclusive growth. It sees service delivery as playing a employment is dual role in Afghanistan: promoting social cohesion and trust in public institutions vulnerable while laying the foundation for job creation and growth. Afghanistan, is however, again experiencing increasing conflict and fragility. Attacks against students and schools continue to be major threats and causes for closing of schools or low rates of attendance. This focus section answers the following questions: • What is the current status of education in Afghanistan? • Is there a learning crisis? • Are there structural issues in education financing that are holding the sector back? 2. What is the current status of education in Afghanistan? Afghanistan has In 2016, more than 9.2 million students were enrolled in school, regardless of level; achieved rapid this represents a 9-fold growth from 13 years earlier. Since 2005, enrollment at the expansion in primary level grew every year, sometimes by more than 10 percent annually. enrollment, Expansion at the lower secondary level has been more erratic; with growth rates of especially at the 1-2 percent in one year followed by a 50 percent growth the next year. Since 2008, primary level this growth has plateaued and is now at the 2-4 percent range. Upper secondary enrollment has mostly not experienced such levels of growth, but since 2002, TVET enrollment has increased substantially. However, the overstatement of actual schooling and the existence of “permanently absent students” presents a misleading picture of enrollment. There has been a rapid increase in gross enrollment ratios (GER) since the early 2000s; primary GER is now at 111.7 percent compared to 73 percent in 2002. GER for lower and upper secondary levels stand at 66 percent and 43 percent respectively, whereas tertiary GER was 12 percent in 2013. Household data shows that GERs greatly overstate actual schooling. Only 43 percent of children and youth under the age of 24 actively attend schools – the GER for this group is estimated at 95 percent. One of the reasons for the gap between enrollment and attendance is the policy of keeping children on the enrollment logs for up to three years after a student stops attending school. Gender, regional Many school age children in Afghanistan are out of school. In fact, the gap in access inequalities and between male and female students starts in early grades and widens as students socioeconomic move up to higher grades. In 2014 alone, 51 percent of girls and 19 percent of boys status are at the lower secondary level were out of school. In fact, boys are 1.5 times more prominent in likely to attend middle school than girls; at the upper secondary level, boys’ access keeping school is twice the rate of girls. Provincial analysis shows that in 15 provinces, proportion Au gus t 2 018 THE WOR LD B A NK 31 Afghanistan Development Update age children out of children out of school exceeds 50 percent, ranging from 51 percent in Ghor to of school 88 percent in Urozgan. Children and youth from the lowest income quintile are nearly half as likely to attend school compared to children from the highest income quintile (33 percent v. 59 percent). Children of literate parents are three times more likely to attend than children of illiterate parents (57 percent v. 19 percent). School attendance is 61 percent in urban areas, 39 percent in rural areas and under 9 percent among the Kuchi. Work is a 29 percent of children between the ages of 7 and 12, and nearly half the youth common feature between the ages of 13 and 17 work; incidence of work is much higher among of life for Afghan males across both cohorts and among rural children. Domestic and agricultural children and activities – either helping on the family plot or with family animals or working for youth someone else – is likely to be the most common type of work children do. For Kuchi children, work is a part of life, with over 70 percent of children and 85 percent of youth engaged in some kind of work activity. Conflict and For girls, security concerns, family approval and distance/lack of schools are major family approval factors in why they do not go to school. Worsening conflict and increasing are major sources insecurity tended to affect girls’ school attendance the most. In 2013-14, for every of decline in girls’ ten boys, seven girls attended primary school in low-conflict areas, but only five access to girls attended school for every ten boys in high-conflict areas. education 3. Is there a learning crisis in Afghanistan? Student learning Limited data that exists on learning outcome show that only a small share of grade outcomes are low 6 students from 13 provinces achieve proficiency in math, reading and writing. A and represent a 2013 assessment showed that only 9 percent of students mastered proficiency levels real crisis of 9 and above, and 37 percent of the students scored at a level corresponding at level 6. In both reading and writing, girls appear to be better than boys. Au gus t 2 018 THE WOR LD B A NK 32 Afghanistan Development Update Figure 27: Reasons for staying out of school Sources: ALCS (NSIA) and author calculations Au gus t 2 018 THE WOR LD B A NK 33 Afghanistan Development Update Figure 28: Grade six proficiency Sources: ACER 2015 School supply Student learning is negatively impacted by the uneven prevalence of school supply indicators and indicators and the general under-qualification and irregular distribution of the quality and teacher force. Analysis of scores among grade 6 students along various school availability of characteristics show that availability of textbooks and strong monitoring of teacher teachers are absenteeism make the greatest difference in learning outcomes. Furthermore, there significant drivers are 45.6 students per teacher in general education and 44.5 teachers across all of the learning sectors. in 2011, 68 percent of general education teachers did not meet the crisis minimum standard of qualifications for trained professional teachers. Only one quarter (approximately) have completed Grade 14 (level equivalent to an associate’s degree), less than 10 percent hold an undergraduate degree and 19 percent have not even completed high school. Of the 14,252 general education schools, 44 percent did not have any buildings, instead operating out of makeshift places or rented locations. Over a third of all general education schools have two or more shifts. In 2012, only 10 percent of all general education schools had biology labs, 9 percent had chemistry and physics labs and only 6 percent had mathematics labs. Inequities impact Learning outcomes are affected not just by supply side variables and teacher learning workforce, but also by social inequalities. Comparing the school performances of outcomes 15-year-olds enrolled at lower secondary schools – household wealth is positively correlated with learning outcomes: youth from the lowest two wealth quintiles consistently underperform in all subjects. The gap is largest in writing, where youth Au gus t 2 018 THE WOR LD B A NK 34 Afghanistan Development Update from the least wealthy households score nearly one standard deviation below the mean. 4. Are there structural issues in education financing that are holding the sector back? Education If Afghanistan is going to strengthen the education sector, then the above findings financing has not indicate that the education sector needs to bolster its financing. Education kept up with financing has not kept up with student growth given the multiple demands on the student growth government budget. Between 2010 and 2015, the sector received AFS312 billion in funding, but the bulk of financing has come from international donors. Between 2011 and 2015, Afghanistan spent in total approximately AFS251.9 billion on the education sector, on average 4.4 percent of its GDP. Figure 29: Public education expenditure as a share of GDP and government expenditure (Percent) Public education expenditure as a share of GDP and government spending 30% 25% 25% 23% 20% 18% 18% 15% 13% 13% 10% 5% 4.3% 4.4% 4.5% 5.0% 4.7% 3.2% 0% 2010 2011 2012 2013 2014 2015 Public Education Expenditure as a percentage of GDP Public Education Expenditure as a Percentage of Government Spending Sources: World Bank and Ministry of Finance data Aid support to International donors have financed almost half of all education expenditures to education has make up for the government shortfall, but over time, their contributions have declined declined. Afghanistan remains reliant on international donors to make up the government shortfall in education expenditures and even though international donors have financed almost half of all education expenditures over the years, over time, their contributions have declined. Donors are now more likely to channel funds through the national budget as opposed to direct financing of projects. Total international funding peaked in 2013 with contributions over AFS30 billion, but since then this has declined to about AFS24 billion. In 2013, nearly half the total contributions were directly given to projects, but in 2015, this share fell to 22 percent. Au gus t 2 018 THE WOR LD B A NK 35 Afghanistan Development Update Figure 30: Contributions by international donors through the national budget and directly to projects, 2011 to 2015 (in AFS billions) a. Total contributions by international b. Share of off-budet contributions v. donors contributions through the national budget 90% 80% 78% 70% 64% 62% 60% $16.5 $15.6 54% 54% 50% 51% 49% 46% 46% $7.0 $19.1 40% 38% $9.6 36% 30% 22% $4.6 $7.5 20% $13.8 $13.1 $12.7 $9.1 10% $5.4 0% 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Off-budget Through National Budget Total Through National Budget Source: Ministry of Finance data and author calculations Security is the Interviews with donors reveal that they have some shared concerns and face similar primary reason challenges. The most commonly cited concern is security, which limits their ability for the decline in to find partners to implement projects and limit project staff’s ability to travel. international Insecurity also hampers the success of existing projects. For example, Germany, funding to the which has been investing in adult literacy programs, reported that in several education sector provinces, these courses were cancelled because facilitators, monitoring officers and provincial advisors were no longer able to attend. Similarly, Finland-supported projects could not find international consultants willing to work in various regions. At first glance, no significant waste appears within any particularly subsector, however when taking into consideration attendance, Afghanistan spends more per capita than other low-income countries. Afghanistan spends approximately AFS5,966 per student across all levels of education that is equivalent to almost16 percent of its per-capita income on per-pupil spending. At the primary and secondary levels combined, per pupil spending has equaled about 11 percent of per capita income. This puts Afghanistan on the higher end of spending across other low-income countries. 5. Recommendations Afghanistan has a Afghanistan has a demographic opportunity because population among younger window of people is growing at a rate slower than working age adults. This trend, which is opportunity to expected to continue over the foreseeable future, will ease pressure on the improve government to expand services and lead to decline in dependency rates due to education which parents might not need to depend on the labors of their children. To make outcomes this happen, the country must improve the equity of its education sector. The following specific policy recommendations are suggested: Au gus t 2 018 THE WOR LD B A NK 36 Afghanistan Development Update • Target investments towards improving quality. Assessment data suggest that the presence of teachers and learning materials have the biggest impact on learning. Poor learning conditions are linked to repetition, attrition, and dropping out. Afghanistan must invest in improving the quality of education by increasing spending on teaching and learning materials and making sure that there are enough learning materials for students and teachers. Given low literacy and poor learning outcomes in the 6th grade national assessment, importance of reading and writing in the early grades should be a key emphasis. • Expand/stabilize access and attendance through community-based education, especially in rural and conflict affected areas where school attendance comes at a considerable risk. However, given the variety in approaches and costs, designing a harmonized and cost-effective package of services should be a priority. • Develop a system for more equitable distribution of resources to schools and hold provincial education directorate accountable for their effective use. There are great disparities in the distribution of school supplies, infrastructure and teachers. Per capita operating expenditures in recent years have more heavily targeted provinces with low levels of schooling, but teacher deployment and school supplies remain in severe shortages in remote areas. At the provincial level, allocation to schools do not follow a systematic procedure. In fact, distribution to districts and schools are at the discretion of the PED with no accountability or reporting requirements. Deconcentrated structures should be required to report on the use of public resources and reporting outputs. • Involve communities in making education attractive. School Shuras need to be further strengthened, especially in the hard to reach areas, as they can play an important role in increasing retention and encouraging parents to send their children to school, especially girls. They have also served as local negotiators in conflict affected areas to re-open schools. The Citizen’s Charter is a promising platform for strengthening community engagement in education management and monitoring teacher absenteeism and learning time • Develop a long-term needs projection for the education budget. Afghanistan must focus on developing multi-year budget projections adjusted for the current and future needs of the education system. As the pressure for expanding school infrastructure at the national level slows down over time with the eventual reduction in the school age population, long term budgeting should take into account an increasing need for school repairs and maintenance as well as much needed school materials and supplies. New school construction in the short term should focus on the remote and underserved areas. • Make better use of the existing budget structure and the information systems for more transparency on allocation and use of public resources. Analyses of education sector performance and its financing point to the necessity to strengthen the comprehensiveness of data provided through the multiple management information systems. Institute integrated information management systems for better monitoring and reporting on outcomes and evaluation. The systems could be strengthened, starting with better projections of student and teacher requirements and instituting biometric IDs for student and teacher tracking. Integrated data collection systems of EMIS, Human Resources Management Information System, and payroll would also allow for closer and rigorous monitoring. Au gus t 2 018 THE WOR LD B A NK 37 Afghanistan Development Update Appendix Table 1: Standard Economic Indicators 2015 2016 2017 2018 2019 2020 2021 Output/Income Nominal GDP (billion Af) 1,223 1,314 1,376 1,450 1,564 1,693 1,839 Nominal GDP (billion US$) 19.9 19.0 19.5 19.9 20.5 21.1 21.8 GDP Per Capita (US$) 590 550 550 548 550 555 561 Population (million) 33.7 34.7 35.5 36.4 37.2 38.1 38.9 Real Economy Real GDP Growth 1.5 2.3 2.7 2.4 2.8 3.2 3.6 Agriculture -5.7 6.0 3.8 2.0 2.0 3.0 4.0 Industry 4.2 -0.8 0.4 2.0 2.0 3.0 4.0 Services 2.1 2.0 2.5 2.5 3.5 3.5 3.5 GDP Composition (% GDP) Agriculture 17.7 18.4 18.6 18.5 18.3 18.3 18.4 Industry 25.2 24.5 24.0 23.9 23.7 23.6 23.7 Services 53.3 53.1 53.1 53.1 53.4 53.6 53.5 Prices (12 month % change) CPI Inflation (period average) -0.7 4.4 5.0 3.1 5.0 5.0 5.0 CPI Inflation (end-period) 1.1 4.5 3.1 .. .. .. .. Core Inflation (Excl. fuel and cereals) 0.3 5.6 3.4 .. .. .. .. External Sector Exports of goods (million US$) 556 614 784 862 949 1063 1222 Imports of goods (million US$) 7,679 6,636 7,355 7,722 7,954 8,113 8,275 Merchandise trade balance -35.8 -31.6 -33.6 -34.4 -34.2 -33.4 -32.3 Net current transfers 36.2 39.6 40.4 40.6 39.6 38.4 34.5 Current account balance 7.5 7.1 1.6 0.2 -1.2 -1.6 -4.1 Foreign exchange reserves (Million USD) 6,752 7,330 8,129 8,163 7,915 7,573 6,681 10.6 Gross foreign exch. res. (months of merchandise imports) 13.3 13.3 12.7 11.9 11.2 9.7 External debt 6.2 6.5 6.6 6.8 7.0 7.2 7.4 Exchange rate (Af/US$, period average) 61.4 69.0 70.4 .. .. .. .. Exchange rate (Af/US$, end-period) 67.5 66.7 69.3 .. .. .. .. Monetary and Financial Statistics Broad money (M2) 33.9 34.6 34.5 30.7 32.3 33.9 35.6 Total deposits (% GDP) 17.7 20.1 19.9 18.0 18.4 18.8 19.1 Total deposits 3,514 3,819 3,882 3,596 3,776 3,965 4,163 Share of dollar deposits (%) 71.8 69.5 67.5 .. .. .. .. Credit to private sector, commercial banks 3.4 3.6 3.5 3.3 3.3 3.4 3.4 Loan-to-deposit ratio (%) 19.4 18.1 17.7 18.1 18.1 18.1 18.1 Au gus t 2 018 THE WOR LD B A NK 38 Afghanistan Development Update Appendix Table 2: Selected Fiscal Indicators 2015 2016 2017 2018 2019 2020 2021 In billion Afghanis unless otherwise stated Est. Proj. Proj. Proj. Domestic revenues 122.2 147.0 169.1 178.2 192.2 207.7 226.2 Tax revenues 59.2 65.4 75.9 80.0 86.3 93.1 103.0 Customs duty and fees 30.2 28.6 35.7 37.7 40.6 44.0 47.8 Nontax revenues 32.8 53.0 57.4 60.6 65.3 70.7 75.4 Donor grants 186.6 207.0 179.2 190.4 213.9 240.6 258.8 Discretionary grants 122.8 143.1 118.4 125.8 141.3 159.0 171.0 Nondiscretionary grants 63.8 0.0 63.9 0.0 60.8 0.0 64.6 0.0 72.5 0.0 81.6 0.0 87.8 0.0 Total expenditures 317.4 353.6 355.4 374.0 409.2 450.7 489.3 Recurrent expenditures 235.7 260.1 253.6 266.8 291.6 319.9 348.4 Security 143.1 145.6 133.9 141.9 156.1 171.7 187.2 Civilian 92.6 114.6 119.7 124.9 135.5 148.2 161.3 Wages and salaries 54.8 58.6 63.0 65.5 72.0 79.2 87.2 Operations and maintenance 17.4 29.7 29.1 30.2 32.0 34.6 37.7 Capital expenditure 2.3 2.3 2.8 2.9 3.1 3.3 3.4 Social transfers 17.0 22.3 23.0 24.4 26.4 29.0 30.7 Interest payments 1.2 1.6 1.8 1.9 2.0 2.1 2.2 Discretionary development 17.3 29.2 40.9 42.5 45.1 49.1 53.1 Nondiscretionary development 64.4 0.0 64.3 0.0 60.9 0.0 64.6 0.0 72.5 0.0 81.6 0.0 87.8 0.0 Discretionary balance -8.0 0.8 -7.0 -5.4 -3.2 -2.3 -4.3 Overall balance -8.6 0.4 -7.2 -5.4 -3.2 -2.3 -4.3 Overall balance excluding grants -195.2 -206.6 -186.3 -195.7 -217.0 -242.9 -263.1 Revenues to recurrent spending ratio (%) 51.9 56.5 66.7 66.8 65.9 64.9 64.9 Au gus t 2 018 THE WOR LD B A NK 39 Afghanistan Development Update Appendix Table 3: Selected Fiscal Indicators 2015 2016 2017 2018 2019 2020 2021 In % GDP unless otherwise stated Est. Proj. Proj. Proj. Domestic revenues 10.0 11.2 12.3 12.3 12.3 12.3 12.3 Tax revenues 4.8 5.0 5.5 5.5 5.5 5.5 5.6 Customs duty and fees 2.5 2.2 2.6 2.6 2.6 2.6 2.6 Nontax revenues 2.7 4.0 4.2 4.2 4.2 4.2 4.1 Donor grants 15.3 15.8 13.0 13.1 13.7 14.2 14.1 Discretionary grants 10.0 10.9 8.6 8.7 9.0 9.4 9.3 Nondiscretionary grants 5.2 0.0 4.9 0.0 4.4 0.0 4.5 0.0 4.6 0.0 4.8 0.0 4.8 0.0 Total expenditures 26.0 26.9 25.8 25.8 26.2 26.6 26.6 Recurrent expenditures 19.3 19.8 18.4 18.4 18.6 18.9 18.9 Security 11.7 11.1 9.7 9.8 10.0 10.1 10.2 Civilian 7.6 8.7 8.7 8.6 8.7 8.8 8.8 Wages and salaries 4.5 4.5 4.6 4.5 4.6 4.7 4.7 Operations and maintenance 1.4 2.3 2.1 2.1 2.0 2.0 2.1 Capital expenditure 0.2 0.2 0.2 0.2 0.2 0.2 0.2 Social transfers 1.4 1.7 1.7 1.7 1.7 1.7 1.7 Interest payments 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Discretionary development 1.4 2.2 3.0 2.9 2.9 2.9 2.9 Nondiscretionary development 5.3 0.0 4.9 0.0 4.4 0.0 4.5 0.0 4.6 0.0 4.8 0.0 4.8 0.0 Discretionary balance -0.7 0.1 -0.5 -0.4 -0.2 -0.1 -0.2 Overall balance -0.7 0.0 -0.5 -0.4 -0.2 -0.1 -0.2 Overall balance excluding grants -16.0 -15.7 -13.5 -13.5 -13.9 -14.4 -14.3 Revenues to recurrent spending ratio (%) 51.9 56.5 66.7 66.8 65.9 64.9 64.9 Au gus t 2 018 THE WOR LD B A NK 40 Afghanistan Development Update Appendix Table 4: Selected Fiscal Indicators 2015 2016 2017 2018 2019 2020 2021 In billion USD unless otherwise stated Est. Proj. Proj. Proj. Domestic revenues 2.0 2.1 2.4 2.5 2.5 2.6 2.7 Tax revenues 1.0 0.9 1.1 1.1 1.1 1.2 1.2 Customs duty and fees 0.5 0.4 0.5 0.5 0.5 0.5 0.6 Nontax revenues 0.5 0.8 0.8 0.8 0.9 0.9 0.9 Donor grants 3.0 3.0 2.5 2.6 2.8 3.0 3.1 Discretionary grants 2.0 2.1 1.7 1.7 1.9 2.0 2.0 Nondiscretionary grants 1.0 0.0 0.9 0.0 0.9 0.0 0.9 0.0 0.9 0.0 1.0 0.0 1.0 0.0 Total expenditures 5.2 5.1 5.0 5.1 5.4 5.6 5.8 Recurrent expenditures 3.8 3.8 3.6 3.7 3.8 4.0 4.1 Security 2.3 2.1 1.9 2.0 2.0 2.1 2.2 Civilian 1.5 1.7 1.7 1.7 1.8 1.8 1.9 Wages and salaries 0.9 0.8 0.9 0.9 0.9 1.0 1.0 Operations and maintenance 0.3 0.4 0.4 0.4 0.4 0.4 0.4 Capital expenditure 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Social transfers 0.3 0.3 0.3 0.3 0.3 0.4 0.4 Interest payments 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Discretionary development 0.3 0.4 0.6 0.6 0.6 0.6 0.6 Nondiscretionary development 1.0 0.0 0.9 0.0 0.9 0.0 0.9 0.0 0.9 0.0 1.0 0.0 1.0 0.0 Discretionary balance -0.1 0.0 -0.1 -0.1 0.0 0.0 -0.1 Overall balance -0.1 0.0 -0.1 -0.1 0.0 0.0 -0.1 Overall balance excluding grants -3.2 -3.0 -2.6 -2.7 -2.8 -3.0 -3.1 Revenues to recurrent spending ratio (%) 51.9 56.5 66.7 66.8 65.9 64.9 64.9 Au gus t 2 018 THE WOR LD B A NK 41 43