In Focus: What's Next for the Afghanistan's Economy?

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What’s Next for Afghanistan’s Economy?

Afghan men work at a brick factory on the outskirts of Kabul.

(Xinhua/Ahmad Massoud)

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InFocus

What’s Next for Afghanistan’s Economy?

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fghanistan is in transition toward taking over security responsibility for all of its provinces by 2014. The country will then face two main challenges that will affect economic activity and growth in a major way:

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the departure of foreign troops by 2014 coupled with an increase of Afghan national security spending; a gradual decline in overall donor support over the medium term with a larger share of remaining donor support possibly being channeled through the Afghan government’s budget.

In light of these two developments, it is expected that donor contribution to the Afghan GDP will drop to below 34 percent in FY 2013–14 and continue to shrink gradually. In its most optimistic scenario, the IMF foresees GDP growth slowing down to a rate of 4–6 percent annually starting in FY 2012–13. Even with the proposed development of the mining sector and introduction of a VAT system, real GDP growth in the medium term is expected to be as low as 2 percent1 —in other words an 8–10 percentage points drop from the relatively robust growth figures of past years (more than 10 percent in previous years and 8–10 percent in 2010–11) coupled with only moderate inflation.

Sectors such as transport and construction, which are dependent on a military presence, will be most affected by the withdrawal of foreign troops, and Afghanistan could suffer a severe economic depression when foreign troops leave in 2014.2 However, if the decline in aid is gradual and predictable, an economic crisis can be avoided. The Afghan government and the international community must ensure early planning and effective fiscal sustainability measures in order to avoid an economic recession in 2014. An economic crisis in Afghanistan puts all security achievements at risk, at both the local and regional levels.

All of this underscores the importance of efforts to stimulate the economy, which will have an impact on both the domestic economy and Afghanistan’s economic interaction with other countries in the region.

1 IMF Executive Board Discussion report; a joint World Bank/IMF sustainability analysis; IMF Country Report No. 11/330 – November 2011.

2 US Senate Foreign Relations Committee report, June 2011.

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Mohammed Hawoub, 37, packs brooms to sell them at a Kabul market. Hawoub manufactures his “good-quality� brooms with material from Mazari Sarif, north of Afghanistan. The price of one broom in the market is 50 Afganis (US$ 1) (AP Photo/Emilio Morenatti)

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InFocus Source: The World Bank, 2011.

Economic growth largely externally driven Above all, Afghanistan will have to manage a transition from an economy supported by the presence of foreign troops to a more self-sustaining economy.

The Afghan government must orchestrate an economic transition from a contract economy to a market economy.

The effects of the 2014 troop withdrawal are difficult to predict in great detail, but they are bound to be very significant.

While private consumption has been the primary driver of economic growth over the past half decade (22.1 percentage points of 22.5 of real growth in 2009–103 ), behind that consumption growth, the World Bank has noted, lies the “security economy” that generated demand for goods, services and equipment. (Also important is donor spending and large off-budget contributions.4) Government spending contributed a meager 3 percentage points GDP growth in 2009–10. Investment saw moderate growth of 4 percentage points, again largely due to private investment in the security economy.

The tremendous challenge in the transition from a war/security sector–based economy to a “peace” economy is further aggravated by the fact that Afghanistan is highly aid dependent. According to the World 3 World Bank: Marcoeconomic and economic growth in South Asia, Recent Economic Growth in Afghanistan – February 2011 4 Private consumption is mostly focused in services, particularly: Communications (45% annual growth), Finance & Insurance (27%) and Transport (22%), with Wholesale and Retail trade lagging at a marginal 4% growth.

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Bank, foreign aid disbursements equaled 47 percent of GDP in 2008 and 2009. In that same period, private investment only reached 8 percent of GDP. 5

The fear of ‘self-fulfilling prophesies’ Afghanistan expects the dual challenges of increased spending and declining donor funds.

While this scenario can lead to an economic crisis, the World Bank argues that “the impact of declining aid on economic growth will be less than might be expected.” An overemphasis on the occurrence of an economic crisis in 2014 has strong negative impact on the economic activity in Afghanistan. Fear of a possible economic crisis in the future is already affecting the confidence of private businesses, investors and consumers in the local economy. Pessimistic expectations will negatively influence the behavior of economic agents and will validate the initial expectations of a crisis. Maintaining the 5 World Bank: Marcoeconomic and economic growth in South Asia, Recent Economic Growth in Afghanistan – February 2011

confidence of business owners and consumers is crucial to stimulate economic growth until and beyond 2014.

Regional diversification in the Afghan economy Every consideration of the economic potential of Afghanistan and its development has to take into account regional imbalances across ethnic and political lines.

In general, the economic benefits resulting from the presence of foreign troops are more substantial in the northern and western parts of the country than in the southern and eastern regions. Various factors contribute to this situation, which has resulted in accusations that the mostly Pashtun population living in the south and east of Afghanistan are being marginalized.

Any effort to achieve economic development and overall stability in Afghanistan will need to address these regional imbalances.

In a more narrow economic consideration, the northern provinces, mostly Tajik and Hazara areas, are home to a trade in precious stones

(especially from Badakhshan and Panjsher provinces), agriculture and related activities, trade and transit with Central Asia (especially with Turkmenistan), hydropower trade with Tajikistan through Kunduz province, and gas and oil imports from Turkmenistan through Jozjan province. The north has the largest potential in the country for multi-billion dollar mining. The transit trade potential is considerable, as is the potential for agricultural development.

The west of Afghanistan, mostly populated by Tajiks and Pashtun, profits from trade, transit and investment ties to Iran, notably in Herat and neighboring provinces. Herat has by far the most developed industrial production in the country.6 Agriculture remains a major economic activity. The economic relationship with Iran will be without doubt of major importance for economic development post-2014.

The mostly Pashtun-populated southern and eastern provinces of Afghanistan border Pakistan and Iran. Economic activity in the informal sector is particularly strong. The 6 Afghanistan Congressional Communication Hub, the New Strategic Security Initiative, March 2010

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areas also depend in a major way on the war economy, notably the procurement needs of ISAF troops and respective transport business. In addition, trade and transit with Pakistan, notably through the Karachi port, constitutes significant economic activity. This implies particular dependence on effective cross-border processing of transit, trade, and entry and exit procedures at the Karachi harbor.

Economic activity is highly focused on some leading Pashtu tribes and families notably the Karzais, the Shairzais and the Noorzais. The south has rich mineral resources, particularly industrial metals and rare earth minerals.

was a significant exporter of animal fiber and high value processed animal products.

Domestic Growth Potentials for the Afghan Economy

The development of agriculture as a major contributor for growth and employment in Afghanistan needs therefore to be carefully considered in connection with irrigation for agriculture. Total irrigated area in the country prior to 1979 amounted to 3.2 million hectares, but in 2007 (a year with relatively high precipitation) only 1.8 million hectares were irrigated. Only 600,000 hectares of the areas irrigated prior to the Soviet invasion have so far been rehabilitated. 14

Agriculture Afghanistan’s agricultural potential is very considerable. The United Nations Food and Agriculture Organization has suggested that the country can become self sufficient in food production soon.7 Even under difficult security and overall economic conditions, Afghanistan almost reached self sufficiency in wheat production in 2007.8 In 2009-10, agriculture contributed 7.3 percent to Afghanistan’s growth driven mainly by a good cereal harvest and strong livestock production.9 In the 1970’s before the Soviet invasion, Afghanistan produced 20 percent of the world’s raisins10 (compared to 3 percent at present11) and was self sufficient in the production of milk, meat and cereals. It 7 The United Nations Food and Agricultural Organizations, National Agricultural Development Framework, 2011.

8 Afghanistan Research Newsletter, AREU, 2011.

9 World Bank: Macroeconomic and economic growth in South Asia, Recent Economic Growth in Afghanistan – February 2011.

10 The Afghan ministry of Agriculture quoted by The Global Partnership for Afghanistan, and the Council on Foreign Relations; Nourishing Afghanistan’s Agricultural Sector, Greg Bruno, May 2009.

11 Global Agricultural Information Network, GAIN, Raisin Annual Report, 2011. http://gain.fas.usda.gov/Recent%20 GAIN%20Publications/2011%20Raisin%20 Annual%20_Kabul_Afghanistan_7-18-2011. pdf

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Experts point to the fact that Afghanistan has the potential of becoming the “bread basket” for the region with exports targeting Pakistan, India and the Middle East,12 all of which face shortfalls in food production.13

Afghan miners work at the Karkar coal mine in Pul-i-Kumri, about 170km north of Kabul. The Karkar mine, which hires 280 workers, produces about 100 tonnes of coal a day. The salary for a miner ranges from $70 to $110 per month.

(REUTERS/Ahmad Masood)

At the same time, the development of the agricultural sector remains highly dependent on weather conditions. The drought of 2008 led to a major GDP drop in FY 2008–09 due to the losses in agriculture.

While Afghanistan has developed a national water policy to address this issue, there are questions about its sustainability, notably relating to Afghanistan’s downstream neighbors as well as domestic issues such as integrated water management and sustainable agriculture.

Mining Mining is probably Afghanistan’s largest economic asset. Official sources have 12 Quoting an expert of the United Nations Food and Agriculture Organization, IRIN News, April 2008 13 A limited yet successful example of the potential of agricultural production in Afghanistan is the country’s pomegranate export that also underlines the relevance of (local) transport infrastructure in that regard: Doubling for the first time in 2008 its pomegranate exports, the country was able to export, via its Kandahar airport, 15 tons of pomegranates to Dubai in 2010.

Since the Kandahar airport management has established the conditions for the export of pomegranates, the airport’s monthly earning almost tripled from $50,000 USD to over $140,000 USD. 14 World Bank, Project: Additional Financing for Emergency Irrigation Rehabilitation, April 2009

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InFocus stones: current gemstones production is estimated at $2.8 million per year. If improved in production, cutting and finishing, the production can be raised exponentially to $300 million per year, according to USAID. However, this will require government intervention and good governance. The government has not yet formalized laws and regulations that govern the majority of the mines, and the majority of the stones produced are sold in the informal sector. Private investment in this is sector is largely deterred because of unclear processes of mining allocations, fees and royalties.

The market is also flooded with fake stones and imitation stones, and most Afghan gemologists do not have the required capacity and equipment to fight fakes.

estimated a wealth of $1 trillion in proven mineral resources and the potential for a further $3 trillion. Developing Afghanistan’s mineral resources is considered Afghanistan’s gate to prosperity and economic growth.

Major Current Mining Agreements are:

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The Anyak Copper Tender: an award given to China for exploration and production of copper, a contract worth a minimum of $1.3 billion (location: Logar province); The Qara-Zaghan goldmine: The investment value is $71 million plus a 26 percent royalty to the Afghan government.

The contract is very significant, not only for its financial value but also because it is supported by several leading investors—the United States, Turkey and Britain—and is intended to set an example to encourage foreign investment in Afghanistan (location: Baghlan province).

Despite its huge potential, mining currently represents a small contribution to economic growth in Afghanistan. In 2009–10 mining constituted 0.11 percent of GDP growth15. Mining is also capitalincentive and its impact on employment is limited.

For Afghanistan’s mining sector to create sustainable growth, it has to have linkages to other economic sectors (and subsectors).

Some examples of existing industries that could be supported to boost local industries link the large mining industry to smaller local businesses and increase local capital investment:

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Salt mines: It is estimated that 54,000 tons of salt, worth an estimated $21.6 million, is consumed in Afghanistan yearly. Salt can be obtained locally and replace imports.

Small scale mining of Gem-

15 World Bank: Macroeconomic and economic growth in South Asia, Recent Economic Growth in Afghanistan – February 2011

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Other Construction material (gravel, sand, crushed stones): Under government-controlled production prices, the annual value of construction material production could increase from the present $55 million to over $90 million. It may also be possible to generate $1.8 million per year in royalties from this production, assuming a 2 percent royalty.

Fired Bricks: The construction of homes and the urban growth in Afghanistan will require very large amounts of bricks that can be locally produced. With specific pricing and safety regulations, the government can rehabilitate coal mines and boost small-scale local production.

Afghanistan’s Marble industry can become a major player given the right technological and governance support. USAID reports that in 10 years the industry could be close to producing $700 million in exports, equal to more than 6 percent of current GDP. For example, Herat alone has a minimum of 20 marble factories and exports $3 million of marble. It is expected that the number of factories will grow, employ more people and export more than $10 million.

Economic Relations with Iran and Pakistan Pakistan and Iran are the most relevant regional economic partners for Afghanistan, both in terms of connectivity and trade and investment proper. The economic relationship with both countries is also marked on the one side by the ethnic and language affinities between Pashtun in Afghanistan and Pakistan and on the other between Dari-speaking Hazaras and Tajiks who are culturally influenced by Iran.

In 2010–11, Pakistan had $598 million of exports to Afghanistan, second to China ($704 million) and ahead of Iran ($386 million). Afghan exports to Pakistan amounted to $151 million and exports to Iran were $32 million. Thus Afghanistan has a large trade deficit with both countries; Pakistan, $447million; and Iran, $354million in 2010–11.

Iran Economic cooperation between Afghanistan and Iran has intensified in recent years. Half of Iran’s $1 billion in exports to Afghanistan in 2011 came in the form of oil, and the country receives an estimated two-thirds of its electricity from Iran, along with massive private investment.16 While Pakistan remains the most relevant of all Afghanistan’s neighbors in terms of economic partnership, Iran is very actively trying to increase its economic relevance in Afghanistan. In 2008, Iran, Afghanistan and Tajikistan agreed to form the Economic Council of the Persian-Speaking Union.17 Iran also has encouraged Afghan businesses to relocate their international offices from the United Arab Emirates to Iran.

Possibly, the greatest potential for Iran to grow its economic relevance in Afghanistan is by using the port of Chabahar instead of the Pakistani Karachi harbor as a major entry and exit point for Afghan goods and goods destined for Afghanistan. In May 2012, the governments of Iran and Afghanistan inked a deal securing Afghanistan’s access to the newly expanded 16 http://www2.canada.com/topics/ news/story.html?id=6166524 17 http://www.understandingwar. org/iran-and-afghanistan

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facility.18 Since January 2003, Afghan businesses have been able to use the Iranian port of Chabahar with a 90 percent discount on customs and port fees for non-oil goods and a 50 percent discount on warehouse charges, as well as transit rights on Iranian roads for Afghan trucks.19 Iran has also upgraded a tax-free trade route linking Chabahar, located at the southern end of the Sistan via Balochstan province, near the Oman Sea, to the southwestern border post of Malik in Afghanistan, and to Kandahar and Kabul. The road shortens the distance from the Persian Gulf to Afghanistan by 700 kilometers, and can significantly diminish the importance of the Karachi-Kandahar road, which is Afghanistan’s traditional roadway to international waters.20 In addition, a portion of the Afghan transit trade has shifted to Iran’s Bandar Abbas port from the Pakistani port of Karachi because of constant delays in the implementation of the Afghan Pakistan Transit Trade Agreement (APTTA).

The agreement took force on June 12, 2011, but complications in clearance and transportation of cargo are making Bandar Abbas increasingly the preferred route for cargo originating in or destined for Afghanistan.21 22 Iran’s economic interests have 18 http://tolonews.com/ en/business/6097-iran-openschabahar-port-to-afghan-traders 19 http://www.sais-jhu. edu/sebin/g/a/Pappas%20Afghan%20Policy%20Paper%20 v5.1.pdf 20 Ibid.

21 http://www. state.gov/r/pa/prs/ ps/2011/06/166078.htm 22 http://www.thenews. com.pk/TodaysPrintDetail. aspx?ID=42524&Cat=3& dt=4/20/2011

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been particularly noticeable in the Herat region. Equally, most of Iran’s pledged reconstruction assistance, estimated at $660 million, is in Herat.23 Iran’s investments in the Herat region involve infrastructure projects, road and bridge construction, education, agriculture, power generation and telecommunication projects.24

Source: Economic Cooperation Organisation

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While Afghan businesses are often not able to challenge their Iranian competitors leading to protests against “price dumping” and calls for higher import tariffs27, it is clear that the role of Iran in achieving an acceptable level of growth and productivity in Afghanistan post 2014 will be very important. Given the relatively successful economic performance of Afghanistan’s Western provinces - the economic importance of Iran to Afghanistan will increase after the 2014 troop withdrawal.

Pakistan Pakistan remains of all Afghanistan’s neighbors the most relevant in terms of economic relations. Pakistani exports to Afghanistan include basic food supplies such as rice, cooking oil, sugar and dairy products; 23 http://iranprimer.usip. org/resource/iran-and-afghanistan 24 Iran has helped rebuild Afghanistan’s radio and television infrastructure and has increased its own radio and television programs in Dari. The Iranian state telecommunications company began providing Internet transit services in Afghanistan and Iraq in 2010, acting as a carrier for both commercial and government traffic.

25 Page 251 of “Iran’s Policy Towards Afghanistan,” 2006, Middle East Journal.

26 http://www.renesys. com/blog/2010/09/iran-exporting-the-internet.shtml 27 http://www.afghanistan-today.org/article/?id=111

construction materials; and fertilizer. Pakistan is also an important exporter of pharmaceuticals to Afghanistan.

Afghan exports to Pakistan are typical of Afghanistan’s current spectrum of interests: fruits and vegetables, raw cotton and precious metals. The volume of bilateral trade has increased from $400 million in 2001 to $2.5 billion in 2011. Pakistan is targeting a further increase of up to $5 billion by 2015.

Afghanistan’s transit trade interests with India and Pakistan’s interest in reaching the Central Asian markets dominate the bilateral trade agenda.

On both points, political obstacles and vested interests prevent trade from reaching its full potential. According to Pakistani figures, the volume of transit trade between Afghanistan and Pakistan could reach $9 billion by 2015. The major Afghan concern regarding its transit trade through Pakistan is the implementation of its transit trade agreement with Pakistan with the goal of reaching the Indian market.

Afghan concerns center around the implementation of an existing bilateral agreement and other regulations.

Currently, Afghan cargo often

experiences delays in the harbor at Karachi. Ambiguities in the rules for handling open cargo (wheat, sugar) as well as container shipments from Pakistan to Afghanistan are major areas of concern. In that regard, shipments from Karachi harbor to Afghanistan fall victim to the troubled relationship between Afghanistan and its ISAF partners, as demonstrated by the recent blockage of over 700 containers destined for Afghanistan held up as ISAF’s supply lines through Pakistan. Trade was suspended after Pakistani troops were killed in a NATO attack on November 26, 2011.

For Pakistan, an important concern is the establishment of a trade corridor to Tajikistan that would considerably shorten its trade route to Central Asia that currently goes through Turkmenistan.

As the World Bank noted in 2004, trade in the region, in particular between Afghanistan and Pakistan, suffers from high transport and logistical costs. Continued outside assistance for infrastructure investments, progress on security and removal of non-tariff barriers are required to fulfill the potential of this bilateral trade relationship.

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InFocus Major recommendations often voiced in that regard remain valid:

1. Improving security throughout the 2.

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country both for persons and property; Completing the main road rehabilitation, extending telephone and other telecommunication systems and ensuring that reconstructed roads are maintained; Streamlining of border crossing procedures; Reestablishing formal financial and insurance systems including development of a effective clearance and settlement system; Implementing a national customs and transit system; Eliminating restrictions on direct transit; Removing internal check posts and en-route inspections; Increasing domestic trucking competition.

Other Time and again, though not in a systematic fashion, the issue of Reconstruction Zones (RZs) and Export Oriented Reconstruction Zones (ERZs) has been discussed. It would appear timely to address the topic in a more systematic manner in particular with a view of strengthening the Afghan-Pakistani relationship.

The Geopolitical and Economic Relationship between Afghanistan, Pakistan and GCC Countries Three out of Pakistan’s top ten trading partners are in the Cooperation Council for the Arab States of the Gulf (GCC) member states: the United Arab Emirates, Saudi Arabia and Kuwait. With regard to Afghanistan, the U.A.E. and Saudi Arabia are also among the most significant GCC partners on both economic (trade) and developmental levels.

GCC countries’ investments in the region are diverse, ranging from improving infrastructure and connectivity for trade routes to and from Central Asia to banking and

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telecommunications.

Currently, negotiations on a Free Trade Agreement between GCC and Pakistan are underway.28 Whether a free trade zone with Afghanistan is an option remains to be explored. So far, the issue has not been discussed.

The U.A.E.’s investments in Pakistan include banking, property and telecommunications. One of the most important new projects under construction in Pakistan is the $5 billion Khalifa Oil Refinery.

According to statistics published in the Pakistani press, Pakistanis have invested $2 billion in U.A.E. real estate and more than 6,000 Pakistani companies are now registered and operating in the U.A.E. Pakistani exports to the U.A.E. are valued at $2 billion per year. Bilateral trade between the two countries stands at $7 billion (FY 2008–09). Pakistan-U.A.E. bilateral trade has seen a great surge, particularly during the last six years. The trade volume which was around $2 billion during FY 2000–01 rose to $7 billion during FY 2010–11 with the U.A.E. emerging as the second largest destination for Pakistani exports. The U.A.E. is one of the largest sources of foreign direct investment in Pakistan.

Afghanistan is a significant potential partner for investment that has not been fully explored by the U.A.E. In 2010, the U.A.E. hosted the first Afghanistan International Investment Conference (AIIC). The AIIC “endeavors to attract significantly higher levels of public and private investment by 2012 in the sectors of infrastructure, mining and transportation in order to generate considerable increases in economic growth, job creation, and public revenue mobilization.”29 Investments of the U.A.E. and Saudi Arabia have been mostly centered on infrastructure (highway projects, Afghanistan constitutes an important gateway for trade to and from Central Asia),30 28 http://www.thenews.com.pk/ TodaysPrintDetail.aspx?ID=94250&Cat=3 29 http://gulfnews.com/business/ economy/afghanistan-investment-conference-in-dubai-1.718743 30 In December 2011, the U.A.E. and U.K. signed an agreement to launch a highway project.http://www.emirates247. com/business/corporate/uae-uk-in-afghanhighway-project-2011-12-21-1.433819

telecommunications (notably a $100 million investment by Etisalat in Afghanistan’s telecommunication business),31 agriculture and energy. In 2011, the U.A.E. pledged $250 million for the reconstruction of Afghanistan, to be managed by the Abu Dhabi Fund for Development (ADFD).

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The Afghan Business Council of Dubai,33 formed in 2005 by expatriate Afghan businessmen, traders and entrepreneurs residing in the U.A.E., aims to develop economic, cultural and social relations between Afghanistan and the U.A.E. as well as to promote the interests of the Afghan business community in Dubai. It would be beneficial to look at ways of improving such councils in order to attract more businessmen in investing in Afghanistan.

Migrant workers from Pakistan and Afghanistan contribute significantly to the economy of their home countries. GCC countries are host to around 2 million Pakistani workers that contribute around 7 percent to Pakistan’s GNP. There are around 150,000 Afghan migrant workers in the U.A.E. Numbers on migrant workers in GCC countries are either unavailable or inconsistent. This is largely due to the fact that many Afghan migrant workers obtain their work permits on the basis of their Pakistani passports and are thus excluded or counted for within the Pakistani numbers.

Jobs and income generation for Afghan people are two key elements to increase development and achieve stability in Afghanistan, where the jobless rate is around 40 percent or more. GCC countries could focus on developing Afghanistan’s migrant labor capacity in a targeted and systematic way in order to increase the prospects for income generation in the form of remittances.

31 U.A.E.’s Etisalat to invest $100 million in Afghanistan, http://www.reuters. com/article/2011/03/13/etisalat-afghanistan-idUSLDE72C02E20110313 32 http://www.uaeinteract.com/ docs/UAE_pledges_US$_250_million_for_ reconstruction_in_Afghanistan_Abdullah_ bin_Zayed/46544.htm 33 http://www.abcdxb.com/

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