By the Blouin News Business staff

Troop pullout threatens Afghanistan’s economy

by in Asia-Pacific.

Men work at a brick-making factory outside Kabul July 23. Photo: Reuters

Men work at a brick-making factory outside Kabul July 23. Photo: Reuters

What is Afghanistan’s economic outlook when the country’s security forces take over by the end of 2014 and NATO forces leave? Uncertainty is widespread across the nation and the economy is no exception. Yet the Afghan government is aware of the financial challenge ahead and is attempting to bring the fragile situation under control. In an ambitious push, President’s Hamid Karzai’s government announced a new package of incentives to attract domestic and foreign investors: the provision of land at almost no cost to industrialists; seven-year tax exemptions for factory owners and 10-year low-interest loans for farmers; one-year multiple entry visas. Initially, the new incentives will remain in place for at least two and half years.

The government is on a mission to create a safeguard as the withdrawal of NATO troops will also wind down foreign aid — with over 90% of Afghanistan’s national budget coming from foreign donations it has become the backbone of its economy over the past decade. Afghanistan’s contingency plan relies on the country’s vast reserves of minerals, oil, and gas. If executed properly, the natural resources could attract new foreign investment and serve the country’s reserves greatly. Improving the governance of the extractives sector should be its priority but the issue is lingering since a mining bill is pending approval in Parliament.

Afghanistan GDP Sector Shares (in % of GDP)

Afghanistan- GDP Sector Shares copy

Source: The World Bank

Many believe that revenue derived from these resources has the potential to become a main source of income, as Afghanistan’s mineral reserves are huge and untapped. Recent numbers show the share of mining in aggregate output increasing from 0.3% of GDP in 2005 to 1.8% in 2012 (see graph above). The longer the bill is delayed the less probable it is that the mining industry will become a growth engine and an essential internal revenue source. International investors who have shown interest in the reserves can quickly look elsewhere, too.

But by any measure the country’s budget deficit is its biggest and most important challenge. In May, a confidential assessment by the International Monetary Fund estimated that the current account deficit is at 45% of gross domestic product. The multilateral body postponed the prospect of “fiscal sustainability” until after 2032.

Another major worry is opium poppy cultivation, which some predict that it will provide up to 90% of the global crop. Even if opium production is down 36% year-on-year in 2012 , it still stands higher than 2010 production levels. This suggests that Afghans are turning to illicit markets and crops, steering away from the real economy. Even more, the addiction the drug causes “along with the absence of the rule of law, precipitates joblessness, which leads to more addiction and disorder — the quintessential vicious cycle,” writes Tarun Khanna, professor at Harvard Business School.

              Real GDP and Agriculture Growth Rates

Afghanistan- Real GDP and Agriculture Growth Rates

Source: The World Bank

International donors don’t want Afghanistan to relive its history, and they claim they won’t flee all at once as the Soviets did in 1989. A year ago, a group of donors pledged to give Afghanistan $16 billion in development aid through 2015 reforms to fight widespread corruption. The big question here is whether this aid money will reach those to whom it’s intended, rather than to contractors or aid groups. A risky bet: along with North Korea and Somalia, Afghanistan is the most corrupt country in the world, according to Transparency International’s 2012 Corruption Perception Index.

While strides have been made in schooling children and improving access to health care a lot remains to be done. But with presidential elections to be held in April to replace Karzai, who came to power in 2001 after U.S.-led forces toppled the Taliban government, don’t expect any hard economic decisions to be made any time soon.