The Economics of… Afghanistan

The Economics of… Afghanistan.

Afghanistan: a place famed both for its stunning vistas, and its history of violence. A landlocked state the primary sector of the economy is the Agricultural one. Afghanistan is part of the golden triangle and is one of the largest producers of opium in the world. A problem which is still being grappled with and has a continuing legacy not just in Afghanistan, but also in the West (the majority of heroin available in the west comes from afghan poppies).

History:

Afghanistan has endured a harsh past, lying on a strategic gateway to India it has long been subject to the ambition of foreign powers, from Alexander the Great to the Soviet Union. The problem with having larger powers seeing your lands as strategic zone, rather than an economic bread bowl is a sluggish economy. This has been reflected thus far in Afghanistan. Afghanistan is by no means the poorest nation in the world, however it is far from prosperous, furthermore a lack of investment caused by its more recent political problems has left Afghanistan with significant economic pitfalls.

Since the pulling out of coalition forces in 2014, Afghanistan has experienced a significant economic downturn. It is an interesting point that as terrible as the war in Afghanistan was, it did cause economic growth and attract foreign investment, something that dried up after western troops left.

Current Fiscal Policies/ the Budget

The problems I mentioned above are still very much prevailing in Afghanistan. The legacy of the downturn from 2014 is a cash crunch which has pushed the fiscal policy of Afghanistan to be very conservative. Policy is still geared towards a medium term goal of “ensuring fiscal recovery from the downturn, and building the Government’s domestic resources” (National Budget 1395 pg. 3)

To this end new sources of revenue are being sought. Taxes on top up credit on mobile phones, the business rate tax and tariffs of some goods crossing the border are being raised. Critically a tax on imported fuel is also being included. Despite protestations by the Afghan government the increase in fuel fees will hurt everyone, and is not a luxury good.  

From National Budget 1395 Afghan Ministry of Finance

Forty percent of expenditure currently goes towards security (2.644 billion USD), five percent lower than previous years. This doesn’t just include armed forces expenditure, it also includes training for twenty one hundred personnel in the ministry of defence and general staff command centres. More interesting for me is the fact that this includes the planned destruction of 40,000 hectares of opium fields. Considering that Afghanistan has had a history of political and religious turmoil over the past thirty years it is understandable that such a large portion of the budget has been dedicated towards security. Whilst not directly contributing to economic growth, or opportunities of economic growth (such as infrastructure expenditure) the creation of a stable functioning security is crucial fighting corruption, maintaining political order and providing lasting peace. These are all key to attracting future investment from foreign markets.

Look at it this way, prior to the coalition’s withdrawal in 2014 if you were an investor you would feel that the security of the region, whilst fraught with difficulties would be stable enough to ensure the safety of your venture. This evaporated with the withdrawal and the subsequent outbreak of violence. Whom wants to invest in an economy where it is likely that your investment either disappears or is too unsafe to operate?

The second largest share of expenditure after security goes towards the infrastructure budget. This includes the ministry of mining. Spending was primarily on maintenance of existing infrastructure but also included the construction of over 100 kilometres of roads, connecting 15 universities to a fibre optic network, feasibility studies of a large dam in Kunar province.

This is crucial as infrastructure expenditure is one of the key engines of economic growth, I’m particularly impressed with the fact that there is some level of innovation tied to this expenditure, notably the fibre optic network.

Monetary Policy

The Afghans have a floating exchange rate under a central bank. This is good as it allows the central bank to intervene with low interest rates to make up fiscal shortfalls and boost economic growth. However this doesn’t appear to be the case, since 2014 when the aforementioned economic crisis started interest rates have ranged from fifteen too almost sixteen percent. 

The Afghan Interest Rate: from Trading Economics & Da Afghanistan Bank

To me this seemed very strange, as this quite high (by western economies standards) and would be lessening the ability of Afghan firms and individuals to invest, as well as contributing to a volatile unstable economy. However a look at the inflation rate somewhat explains this.

The Afghan Inflation Rate: from Trading Economics & Central Statistics Organisation of Aghanistan

The inflation rate fluctuates widely and whilst averaging an understandable four and a half percent, in the past three years the rate has been less than negative four percent (deflationary) and as high as six percent. Deflation is super toxic due to delayed expenditure, and it is understandable why interest rates are relatively high.

The Future:

From an economic perspective I see the potential for a large degree of growth in Afghanistan. I say this because if and only if Afghanistan manages to successfully grapple with its social problems, there is a wealth lying directly underground. Afghanistan has access to copper, gold, lithium and iron. A stable economy combined with a steady political climate will bring foreign direct investment back, and Afghanistan’s proximity to the economic powerhouse of China, and the rapidly expanding economy of India means that there will be continued demand for what comes from Afghan Mines.

Hence government fiscal policy should be pushed towards encouraging investment into the mineral sector, ensuring lasting political peace and continuing support for expanded infrastructure.

The central bank of Afghanistan has to get inflation to be stable, then lower interest rates to increase domestic investment. Failure to do this could consign Afghanistan economic obscurity for quite a while longer.