Economy & Development

Economic Management in Afghanistan: Thoughts on what worked, what didn’t and why


Photo: Christine Roehrs

The Afghan government and its international partners will meet in Kabul next month at the Senior Officials Meeting (SOM) to review progress since last December’s London Conference and to discuss specific reform programs for the future. Discussions are complicated by the fact that Afghanistan’s economy remains weak and its fiscal situation dire. In the deliberations on how to respond to these challenges, the SOM would do well to factor in lessons from Afghanistan’s past experience with economic management, which has seen both notable successes and salient failures. A new paper for AAN by Bill Byrd provides some provocative thoughts.

In a new paper for AAN (download here), Bill Byrd reviews several economic policies during the period 2002-2014 and argues that despite Afghanistan’s current economic difficulties economic management – macroeconomic and public financial management in particular – has been an area of relative success. Economic growth has been rapid (an average of over nine per cent per year), average per-capita income has risen sharply, inflation has been contained, and the exchange rate has been relatively stable following the successful currency reform of 2002–03. But there are also important caveats: economic growth has been variable over time, it has not been very inclusive (the proportion of Afghanistan’s population that lives below the poverty line has not declined), and the system remains vulnerable to shocks. A poor agricultural harvest, a substantial worsening of the security situation, or a political breakdown could easily send the country’s economic growth into negative territory.

Virtually all important achievements in the economic management and public financial management spheres were set in motion in the first few years after 2001. The fluidity of the situation and the relatively less-entrenched political interests at the time left space to put in place sensible economic policies and reforms. Early successful initiatives included the currency reform, public financial management improvements and the setting up of a trust fund that incentivised on-budget development aid. Afghanistan’s experience illustrates that once a window of opportunity has closed, it becomes much more difficult to build and sustain momentum for progress.

The currency reform, in particular, was a good example of progress that was facilitated by relying on existing capacity and practices (and ignoring international advice). Instead of opting for a dollarisation of the economy, as initially advised by the IMF, or hiring an expensive external consulting firm, the Afghan government decided to rely on the hawala system to collect and exchange the old banknotes. The process was messy, but ultimately successful. Another such example was the decision to use the existing Afghan budget accounting system as a basis for initial public financial management improvements, rather than starting with a completely new system.

Afghanistan’s problems would have been greatly exacerbated if macroeconomic management had been poor. The macroeconomic instruments that were introduced were rudimentary but appropriate, including most prominently the regular auctions of US dollars by Da Afghanistan Bank to stabilise the exchange rate, manage the money supply, and limit inflation. The Afghanistan Reconstruction Trust Fund (ARTF) also started out with a simple design, as well as flexibility to evolve over time. Moreover, the early adoption of a no-overdraft fiscal rule gave an important message of fiscal restraint and buttressed the credibility of the Afghan currency. The no-overdraft policy may have outlived its usefulness in the country’s current recessionary economy, but it certainly played a positive role in the early years.

The relative success of Afghanistan’s economic management was further helped by the “confluence of incentives and dynamics.” A good example of this was the efforts around on-budget international aid that was channelled through the ARTF and made possible by improvements in public financial management. Key success factors included a broad consistency of objectives among the main actors, incentives in the right direction, and the willingness of a pro-active donor to take an informed and well-timed risk, which enabled the ARTF’s start-up and facilitated initial progress, making it easier for others to follow suit.

In general, progress has been greater where the responsible Afghan government institutions have had strong leadership and management teams, and limited where these were not in place, irrespective of the ex ante level and quality of international support. Donors, in these cases of progress, did not drive the process, but rather ‘flocked to success,’ providing increased funding as programme implementation got going and achieved initial results. The main public financial management improvements, moreover, came about through successive years of implementation, starting from a small and rudimentary base. Implementing computerised payments and accounts, enhancing the quality of the Afghan national budget, and developing a more programmatic approach in key sectors were all examples of learning-by-doing.

Like in other sectors, progress has tended to be easier for activities that were overtly ‘technical’ in nature and that did not attract much political attention. This included the more technical aspects of macroeconomic management and nuts-and-bolts public financial management, for example sound accounting and payment mechanisms. Sometimes political imperatives aligned reasonably well with technical achievements – for example in the case of the currency reform and maintenance of a stable exchange rate for the Afghani, where considerations of national sovereignty came into play. In other cases, where the political profile was higher, especially if intertwined with high-level political interests reaping financial benefits (for instance in the case of the Kabul Bank), not only was progress slower, but there was also a risk of adverse, even disastrous outcomes.

But even in more technical areas, political space for progress has been essential. This calls for greater political awareness on the part of donors and a political strategy by the government to provide the necessary political space – the latter cannot be left to chance, as was largely the case in the previous administration. Afghanistan’s experience, moreover, shows that if financial accountability and integrity are not prioritised up-front, it becomes more difficult to deal with corruption later, when it has become entrenched. In shielding institutions or departments from corruption, it helped for them to not be overly lucrative or attractive in terms of resources. In some cases (such as monetary and exchange rate management and the budget process) the resources for looting were pretty limited, whereas in others (public financial management) early actions reduced the vulnerability to corruption while the amounts of money involved were still relatively small. At the opposite extreme, Kabul Bank represented an enormous opportunity for theft and fraud with inadequate oversight while customs revenues were another major target for corruption.

Looking ahead 

While there have been important examples of success, Afghanistan’s experience also shows the limits to progress in the macroeconomic management and public financial management spheres. Looking ahead, Afghanistan is likely to face several challenges.

The political space, even for the more technocratic reforms, appears to have significantly narrowed over the years, as a result of the entrenchment of elite networks and pervasive patterns of patronage. Whereas in the past the most widespread and more egregious forms of corruption could sometimes be avoided in certain sectors, ministries, or areas of activity – effectively creating relative ‘islands of integrity’ – it may prove increasingly difficult to maintain the integrity of core public financial management functions in the future.

With the declining levels of aid, important positive incentives towards solid macroeconomic and public financial management that were in place in the first half of the post-2001 period will decrease. While there were also negative incentives at the time, these functioned within an overall environment of increasing on-budget resources. A key question is whether, in the current fiscal squeeze, having only negative incentives can continue to stimulate public financial management improvements. A related question is whether the threat of negative incentives can be credible when they might, at the extreme, result in non-payment of salaries.

Finally, Afghanistan’s rapid economic growth in the past, fuelled by large inflows of resources, meant that difficult trade-offs in macroeconomic and fiscal management could be avoided. In particular, the negative impact of tight fiscal policy on aggregate demand was not relevant since the economy was, if anything, already overstimulated by financial inflows. This does not detract from Afghanistan’s achievements in macroeconomic management, but it does mean that in the current low-growth environment and facing a fiscal crisis, macroeconomic management by the Ministry of Finance and the Da Afghanistan Bank will be much more difficult.

Find the full report here.

Bill Byrd is a senior expert at the US Institute of Peace, where he has been working on Afghanistan since April 2012. From 2002 to 2006, he was stationed in Kabul, Afghanistan, where he served as the World Bank’s country manager for Afghanistan and then as economic adviser. His publications on Afghanistan include reports and papers on the country’s economy, public financial management, regional economic cooperation, corruption, transition, opium economy, security sector financing and reform. 

Tagged with: , , ,
Thematic Category: Economy & Development