Afghanistan Development Update: August 2018
Afghanistan has experienced slow growth since 2014, with the draw-down of international security forces, accompanying reductions in international grants, and a worsening security situation (growth has averaged 2.3 percent between 2014-2017).
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.
Reflecting slow recent growth, the new Afghanistan Living Conditions Survey (ALCS) shows a significant increase in the proportion of Afghans living below the national poverty line from 38 percent in 2011/12 to 55 percent in 2016/17. Living 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.
Period-average inflation for 2017 reached 5 percent. Inflation peaked in June (7.5 percent), driven by food prices which moderated later in the year. Inflation in 2018 is projected to remain stable, at around 3 percent, with continued weak food price inflation offsetting increasing international energy prices.
Exports grew by around 28 percent during 2017, driven by new air corridors for exports to India and resolution of border issues that constrained trade with Pakistan in 2016. Exports remain low in absolute terms at around 6 percent of GDP. The trade 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 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.
The 2017 budget outturn saw a deficit of around 0.5 percent of GDP, with rapid 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 nondiscretionary 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.
Credit to the private sector grew by around 3 percent over 2017, after remaining flat through 2016. 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 endDecember 2017. Total credit to the private sector remains well below 2014 levels.
Under current projections, Afghanistan is unlikely to make major progress in reducing poverty. Growth is expected to accelerate to around 3.7 percent by 2021. But with a current population growth rate of around 2.7 percent, a much faster 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.