By Angus McDowall
Afghanistan’s economic recovery is imperilled by poor security, the high volume of opium sales and the misspending of international aid
One figure demonstrates better than any other how precarious are the chances of developing a stable, open economy in Afghanistan. In 2006 two-thirds of its gross domestic product came directly from international aid and opium exports.Underpinning the country’s difficulties is a resurgent security crisis – brought starkly home by a recent and brazen attempt on president Hamid Karzai’s life. Not only does this put off investors, but it makes it impossible to run private enterprises larger than subsistence farms in large swathes of the country.
The enormous – and growing – inflow of money from the poppy crop meanwhile undermines legal structures, generating corruption and tempting farmers and businessmen away from legitimate business. The economy depends on large sums of international aid: but these are poorly coordinated and are often targeted to benefit the donor instead of addressing the country’s most pressing needs.
For all these concerns, multilateral organizations working in Kabul are cautiously optimistic. “What came out of Afghanistan’s long conflict was a very flexible, informal economy that responds well to shocks and interacted very closely with neighbouring economies,” says William Byrd, a World Bank adviser on South Asia.
“Afghanistan’s economy has been growing at double-digit rates for the last five years, which is respectable, even though it’s from a very low base. The big challenge is to create sustainable structures for a formal economy,” he adds.Surveys of Afghan businesses have found that besides security, their four main complaints were the cost and legal difficulty of acquiring land, the intermittent nature of the electricity supply, access to finance and pervasive corruption. While power plants can be rebuilt and lines laid with enough capital and security, the other problems are harder to address.
The trouble with land
The government is not only short on experienced administrators, but its members are often expected by their families and tribes to redistribute the rewards of office, according to numerous reports. Corruption in such circumstances is almost impossible to eradicate. It in turn affects the purchase or rent of land. Because so many records were lost or rewritten during the long civil war, almost every plot in large cities is subject to dispute, which is often resolved only with political clout or large bribes.
With the lack of ready credit hampering grass roots development in many parts of the country, the development of Afghanistan’s financial institutions is crucial. Last year, credit extended to the private sector accounted for only around 5% of Afghanistan’s GDP, less than half the level in neighbouring Kyrgyzstan and less than a fifth the level in Pakistan. Bank deposits meanwhile were less than 10% of GDP, according to a February IMF report.
The level of interest rates (20% for loans, 7% for deposits) on the local currency, the afghani, highlights another set of problems: the high cost of doing business, the absence of competition, the lack of collateral for loans and insufficient bank capacity for proper risk management. That 77% of total deposits and loans last September were denominated in US dollars shows the extent of continued reliance on foreign currency.
The number of domestic banks is growing and they are profitable – but only just. In the first nine months of last year, total net profits in the sector amounted to Af2.7 billion – an annualized return on assets of just 1.75%, with interest income accounting for 45% of total income. Supervision of banking regulations has improved but enforcement remains weak.
The government meanwhile is battling inflation – which rose to 13% in 2007-08 because of the increased cost of imported fuel and food – and moving to stabilize the exchange rate. But Afghanistan has been hit hard by the rising price of food, and while some Afghans have taken to the streets to protest, most wonder how they will get by.Largely reliant on imports of wheat and flour, Afghanistan has been particularly badly hit as Pakistan, faced with its own food problems, has restricted the flow of flour to its neighbour.
Meanwhile, large inflows of aid money drive up the costs of labour and construction, making it harder for Afghan private businesses to operate.
Movement of aid
Foreign aid accounts for about half the licit economy and 90% of all public expenditure, which stood at $2.6 billion in 2006. But while the country relies heavily on this cash, it is often misspent, said a report compiled by Oxfam on behalf of a group of non-governmental organizations (NGOs) early this year. Moreover, much of the promised aid never arrives at all, with the ADB and India disbursing only a third of their commitments in the period 2002-08.
More worrying still, because contracts are often tied to the donor country, some 40% of all foreign aid goes straight back in the form of salaries and corporate profits. The report estimated that international construction contracts in Afghanistan have only a 10–15% local impact. Even when most of the work is carried out by an Afghan subcontractor, the main international contractor pockets a much larger fee – sometimes taking profits of 50%.
The government in Kabul is growing increasingly frustrated. It says it has no information on how one-third of all international aid in the country since 2001 has been spent, according to Byrd. A 2005 study for the Organization for Economic Cooperation and Development (OECD) said very little of the technical aid from the EU, ADB, Germany, Japan and the UK was spent in programmes coordinated with the government’s redevelopment strategy. This haphazard approach to aid has economic repercussions.
“The private sector is neglected in aid and needs more emphasis,” says Byrd. “If it is used to build infrastructure that business needs, it will eventually help the private sector. What is striking is that the cost of aid outside the government budget is higher – for example, building a road is more expensive when not handled through the government. The government makes a strong case that pushing aid through its budget makes sense.”
He suggests that aid could be better targeted towards economic development. One possibility is helping to set up industrial parks, where private businesses are spared the trouble of acquiring their own land, while dedicated power, water and security facilities help bring down costs. Several such parks already exist – run by both the government and the private sector – and are popular with entrepreneurs.
In the country
Such schemes have little application, however, in the rural areas that need them most. Over 70% of Afghans rely either directly or indirectly on agriculture for their livelihoods, and 2.5 million people face severe food insecurity. Yet agriculture has received in aid only $400–500 million since 2001, according to Oxfam.
The importance of agriculture is evident in economic growth figures, even though they do not take account of poppy cultivation. Drought was the main reason given for real growth falling from 16.4% in 2005-06 to 6.1% in 2006-07. With the drought over, it is projected to have climbed back to 13.5% in the year 2007-08.
“The agricultural economy stops and starts – it’s very uneven,” says Paul Fishtein of the Afghanistan Research and Evaluation Unit in Kabul. “In some areas of the country vegetables have done really well, even replacing opium. But it happens in one-year cycles. The prices go up for a product, and suddenly everyone is growing onions. And then they sit in a field and rot.”
But opium production is a constant temptation. The UN Office of Drugs and Crime (UNODC) says the gross income from a hectare of wheat in 2006 was $530. For poppies, it was $4,600. It says the total export value of Afghanistan’s 2006 opium harvest was $3.1 billion – almost half the country’s licit GDP of $6.7 billion, or 32% of the whole (black and white market) economy.
The office estimates that only $560 million went to farmers and their households. With 2.9 million Afghans involved in opium poppy cultivation, that translates to income of about $193 a year for each person. The other $2.34 billion was taken by traffickers, with obvious knock-on effects on corruption and security.
“The opium economy is very attractive and profitable, so people at all levels are drawn to it,” says Byrd. “It is very hard for other activities to break out. The drug economy is one of the greatest factors undermining governance and state building. The sheer amount of money would suggest it is a big factor in corruption.”
Recent reports – based on anecdotal evidence – suggest that the country’s opium crop is forecast to fall this year after 2007’s record harvest. Some farmers are switching to legal crops because of the rising price of food, it is claimed.
Yet profits from planting opium poppies are still much higher than from other produce such as wheat, so there is little immediate incentive for farmers to switch crops, according to the UN Food and Agriculture Organization. Afghanistan produces 93% of the world’s opium, which is processed to make heroin and exported across the world.
Drugs and insecurity are two seemingly intractable – and utterly intertwined – problems for Afghanistan. But if no solution is found, the economic recovery will wither and perish. Even in 2005, when the security situation was less tense, companies spent an average of 15% of their revenue on security. Few businesses can afford to do that forever.