Afghanistan: The long road ahead (page 2 of 2)

The main problem here is not the access to the finances - donor spending in 05/06 was projected at 29% of GDP - but a lack of the authorities' capacity to implement the programs. Even the target of development spending to the tune of 14.2% of GDP is ambitious and 'will require a considerable effort to overcome constraints hindering spending capacity', according to the authorities' Letter of Intent (LOI) with the IMF. However, its importance should not be under-estimated for a government that is
increasingly under pressure.

Of course, all the above efforts could count for nought. In its LOI, the authorities
state the following: "Sustained robust growth is predicated on improved security
and a reduction in drug-related activities, together with the establishment of an
environment conducive to private investment."

Thus, a necessary condition for the economy's long-term stability is to manage the delicate balance of reducing the economy's reliance on poppy cultivation and provide alternative sources of employment. On the former, crucial to not only the government's standing in the international community, but also to keep the opium-funded Taliban in check, last year saw a 21% decline in poppy cultivation, although good weather almost entirely offset this decline in terms of production as yields rose. Unfortunately, this year there are already reports that poppy cultivation is once again on the rise - the UN estimates a 20% increase in 2006. While rising incomes from poppy cultivation may have spillover into the licit economy via increased spending, the negative aspects on stability are there for all to see.

The key problem for the government is President Hamid Karzai appears to have declining control. Meanwhile, the security situation is deteriorating as the Taliban
is starting to gain more influence outside of Kabul. The slow pace in the increase in standards of living - GDP per capita, excluding the opium sector, is estimated to have risen to USD 294 from USD 253 a year earlier - is providing the Taliban with support as it can provide much higher income levels. This is leading some constituencies to question the government's path and suggest a sharp reduction in local taxes, measures to protect domestic businesses from international competition and increased government involvement in the economy, something that is unsustainable in the long-run.

If this trend for reduced support of the government is not arrested and the government were to be replaced, the risks to foreign funding and the country's liquidity position would increase. As well as the obvious fiscal connotations of a sharp reduction in foreign aid, external funding is also crucial from a balance of payments perspective. The current account is estimated to have posted a small surplus in 05/06, but if you exclude grants this falls into a dramatic 42% of GDP deficit.

Of course, the international community would want to maintain good relations with the new government, but it would require the incoming government to show a willingness and ability to implement reforms currently being put in place. If the Taliban's influence within the government were to rise dramatically, then this would likely be problematic. Meanwhile, under such a scenario, poppy cultivation would soar once again. Therefore, while the Afghanistan economy is currently on an upward path, there are clearly many risks to the outlook.