International Conference

«Conflicts in the Caucasus: History, the Present and Prospects for Resolution»

Baku (Azerbaijan) 22-23 October, 2012 and Tbilisi (Georgia) 25-26 October, 2012

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ECONOMY

Evgeni PASTUKHOV

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Evgeni Pastukhov, Researcher, Investment Profitability Research Agency (Almaty, Kazakhstan)

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In 2005, as in previous years, the economic situation in Afghanistan was sufficiently complicated. This is due to the country’s adverse natural conditions, an infrastructure that has not been restored after 25 years of civil war, the government’s inability to implement economic projects, and inadequate foreign assistance. The problem of illicit production and trafficking of narcotic drugs has not been resolved either.

At the same time, let us recall that the country’s current head of state, Hamid Karzai, ran for president on a platform that clearly defined the government line in the economy: self-reliance and mobilization of all domestic reserves for rebuilding the country. Having reaffirmed his commitment to the principles of the market economy, he promised to raise per capita income by the end of his term in office from $200 to $500, especially in rural areas.

It must be admitted that some positive changes have indeed been recorded in the economy: in the 2003/04 fiscal year, GDP grew by 16%, and a similar figure, according to preliminary data, was reached in 2004/05. Estimates by the Asian Development Bank Institute (ADBI) show that average annual GDP growth in 2006-2010 will amount to at least 10%. In the 2004/05 fiscal year, GDP totaled $5,536 million ($246 per capita). According to the country’s Finance Minister Anwar-ul Haq Ahadi, the state budget in fiscal 2004/05 amounted to $678 million, including $333 million of tax revenues and $345 million of donor aid, mostly provided by the U.S. and EU states. The Afghan budget is known to consist of tranches from donor countries and domestic taxes. Since 2003, the latter have steadily increased. In view of growing economic activity and changes in legislation, the share of tax revenues has increased from 30% a few years ago to about 50% today (over $300 million). In 2005, the Central Bank’s international reserves reached $773 million.

Consequently, since 2004 government revenues have obviously assumed particular importance in the Afghan economy. Given the heavy burden of expenditure (for restoring the economic structure, ensuring national security, etc.), over the past three years the government has taken a number of measures to strengthen the country’s finances, so boosting economic growth in general and government revenue in particular. In 2003, the country’s authorities carried out a currency reform. The old afghani was considerably depreciated: 1,000 old currency units were exchanged for 1 new one. This new money was issued in the amount of 16.5 billion afghanis, and the exchange rate stabilized at 46 afghanis per U.S. dollar. Since 2003, the Central Bank has pursued a policy designed to strengthen the banking system; that was also when the first five national commercial banks were licensed and began operations in the country. The incipient banking system has made it possible to accomplish one of the main tasks of economic policy: to attract funds from members of the Afghan diaspora in the Western countries.

In 2005, the Afghan government, which depends in large part on international economic aid, took a decision serving to increase government revenues: on 23 September, it introduced a progressive income tax. This tax is to be levied both on local companies and enterprises and on foreign citizens and firms operating in the country: incomes of over $200 per month are to be taxed at the rate of 10%, and over $2,000 per month, at the rate of 20%. Since the average monthly wage of government employees in the country is $25 per month, this tax is mostly oriented toward foreigners and Afghans employed by foreign companies and humanitarian organizations. According to official data, about 2,000 foreigners (excluding the military) are permanently resident in Kabul alone, and many of them work for various international organizations. Local analysts say that employees of some foreign firms earn close to $1,000 per day. Consequently, the new income tax, just as the measures taken to improve money circulation, to create a banking system and attract funds from the Afghan diaspora, will help to increase budget revenues.

Nevertheless, in the opinion of many observers and experts, the economic situation in the country remains extremely grave: there is a shortage of jobs, and the economy is on the verge of collapse. The main factor here is that the legal sector of the economy is almost entirely dependent on foreign aid. But foreign funds flowing into the country for rehabilitation and reconstruction purposes are utilized extremely ineffectively. A significant part of them is used to pay salaries to government officials and employees of international and other organizations. A recovery has been recorded only in the activities of small traders.

Overall, objective conditions in Afghanistan are not yet ripe for large-scale ambitious projects. At the same time, foreign investors and other businessmen have wide opportunities for developing small and medium business in such areas as construction, production of building materials, development of a network of auto repair shops, road repairs and irrigation. These areas of the Afghan economy attract investors from Iran, Turkey, Pakistan, China and India, while businessmen from the Central Asian states, especially Tajikistan and Uzbekistan, tap into the markets of the country’s northern provinces. Local experts believe that all conditions for a mutually beneficial inflow of investment into the country (including tax measures, liberal economic policy and other factors attractive to any business person) have already been created. In actual fact, however, the government lacks real power in the country, and this has a serious effect on the situation.

First of all, this applies to agriculture. The situation here, extremely grave as it is in view of the destruction of irrigation facilities and the degradation of irrigation systems, has in recent years been exacerbated by drought. Despite foreign assistance, about 40% of the population are now living below “survival” level: by U.N. standards, 6.4 million people in the country are malnourished. The main problem here is that agriculture is still largely geared to the production of drug crops. The cultivation of opium poppy and the production of opium and heroin have reached a huge scale. According to U.N. data, domestic drug trafficking in Afghanistan has exceeded $2.5 billion, while the value of locally produced drugs on the foreign market is close to $30 billion. According to information received from various sources, drugs account for about 60% of the country’s real GDP, and at least two-thirds of all Afghan farmers are involved in their production. In other words, over 1.5 million Afghans cultivate opium poppy.

Interior Minister Ali Ahmad Jalali reports that drug production in 2004 was almost 20% higher than in 2003. Whereas in 2002 the output of raw opium totaled 3,400 tons, in 2003 the figure was 3,600 tons, in 2004, 4,200 tons, and in 2005, according to preliminary estimates, 4,000-5,000 tons, which can be processed into 500 tons of heroin. In 2004, the amount of heroin smuggled out of the country reached 430 tons. Considering that Europe consumes about 70 tons (over 90% of all heroin supplied to France and up to 80% of the drugs sold in Britain are of Afghan origin), this means that over 300 tons of heroin remained in the CIS countries.

Contrary to expectations, the presence of coalition forces in Afghanistan has not helped to eradicate drugs or even to reduce the area under poppy cultivation. On the contrary, opium production has sharply increased. But the international forces stationed in the country are still disunited in the fight against this evil. Cautious attempts by the International Security Assistance Force (ISAF) to clamp down on the private mini-armies of the drug lords inevitably encounter resistance from U.S. army units deployed in the country, which often collaborate with the local warlords, many of whom are drug lords as well. Some foreign observers draw attention to the fact that many Afghan governors, army commanders and policemen are also involved in this criminal business. There are persistent rumors that even the Afghan president’s own brother, Qayum Karzai, who plays a significant role in Kandahar (in the south of the country), is connected with the drug trade.

The reasons for Afghanistan’s possible transformation into a “narco-state” lie in the continued political instability, in the lack of effective government and of a clearly formulated action program to counter the drug trade, and in the degradation of agriculture and the economic infrastructure. Most experts are convinced that in its efforts to curb the cultivation of opium poppy Kabul has met with resistance from the farmers because, first, virtually no new jobs have appeared in the country in recent years; second, conditions that would enable the farmers to give up poppy growing have not been created; and third, both Hamid Karzai himself and Washington behind him fear that a large-scale operation to destroy poppy crops without providing the farmers with alternative sources of livelihood could lead to a sharp increase in unemployment, famine and general destabilization. Considering that many drug dealers maintain illegal armed formations resembling mini-armies, the threat to the central authorities and the international forces is very real.

As regards the farmers, for them the advantages of poppy growing are quite obvious. Specialists say this does not require large tracts of land: in 2000, area under poppy cultivation constituted only 0.9% of the country’s arable land. Even in villages totally oriented toward the cultivation of this crop, it occupies no more than 8% of such land. Opium does not require as much labor or capital as wheat, rice or other grain crops. Poppy is best suited to Afghanistan’s arid climate and brings in a much larger profit than other crops: $4,600 per hectare compared to $390 for wheat. In 2003, this difference was much wider ($12,700 and $470, respectively). Whereas per kilogram of opium the farmer earns $600 to $1,000, per kilogram of rice he gets only $1.

In October 2004, newly elected President Karzai said that the fight against drugs was to become a priority of his government’s policy, because drugs are a greater threat to the country’s political and economic security than the Taliban or al-Qa‘eda. Two months later, in December 2004, the post of a deputy minister in charge of anti-drug efforts was instituted at the Ministry of the Interior, and a Counter-Narcotics Ministry was set up in place of the former Agency. In addition, the armed forces and the police were charged with the task of destroying opium poppy crops. And at the beginning of 2005 the government approved an anti-drug plan providing for the development of alternative agriculture, the creation of special anti-drug task forces and judicial bodies, destruction of poppy crops, reduction in the demand for opium, treatment of drug addicts, and regional cooperation. This is a ten-year program, but by 2008 it is already planned to reduce drug production by 75%.

However, international experts take a highly pessimistic view of the situation. In their opinion, over the next few years one should not expect any radical changes in the fight against the cultivation of opium poppy, because the government’s economic measures in this area can do nothing to improve the situation in agriculture. This is probably why in early 2005 the Karzai Administration considered the possibility of declaring a general amnesty for persons involved in the drug trade, provided they cease their criminal activities and invest the capital derived from such activities in the country’s economy. It should be noted that throughout the past year the country’s authorities (together with international organizations) discussed projects for legalizing drug production. In particular, they considered the possibility of allowing Afghan farmers to produce opium on legal grounds exclusively for medical purposes. It has been estimated that profits in this case could equal those made from illicit trafficking of this narcotic substance. And world demand for codeine and morphine to be produced in Afghanistan could exceed the supply of opium illegally produced in that country by a factor of two.

In September, a similar suggestion was made by French researchers from the so-called Senlis Council, whose employees jointly with Kabul University and scientific centers in Europe and North America had carried out a study resulting in a set of proposals for legalizing drug production. But at the end of the year official Kabul rejected that idea. In particular, in one of his speeches (back in September) Counter-Narcotics Minister Habibullah Qaderi questioned the timing of the Senlis Council’s report and noted: “We don’t want to confuse the Afghan people, because while the government on the one hand wants to control and stop cultivation, we are talking about licensing.” Qaderi argued that the country’s security system was still too weak to regulate the legal production of opium. Without an effective control mechanism, he added, a significant part of this opium would be processed into heroin and supplied to illegal markets in the West and elsewhere.

Incidentally, according to a U.N. study carried out in Afghanistan, in 2005 the amount of opium produced in the country fell by 2.4% from the previous year, and overall drug production and trafficking accounted for 52% of its GNP. Evidently, last year the Afghan authorities focused their efforts on the use of force in resolving the drug problem. Thus, a new law on combating illicit drug trafficking not only clearly defines the role and functions of official agencies in charge of work in this area, but also establishes criminal penalties for employees of state agencies who aid and abet drug dealers. This document also empowers the police, with court approval, to tap telephones and monitor the e-mail of persons suspected of involvement in the drug trade. Under another article of this law, citizens’ property derived from the drug trade is to be confiscated in favor of the state. The law was written by experts from Afghanistan, the United Nations, the U.S. and Britain according to Western models, but with due regard for local specifics. Clearly, its approval is an attempt to reduce the high level of crime and corruption, which is a serious obstacle to the country’s development. But one should not forget another revenue item of the criminal economy: trafficking in weapons, gold, precious stones, historical objects and other goods. This kind of business got an extra boost with the arrival of the coalition forces and international missions in Afghanistan. For example, one of the factors conducive to the theft of cultural objects is that foreign military personnel and employees of international missions are very well-paid (by Afghan standards).

In the spring of last year, reports began to appear on trafficking in human beings, especially children. For example, on 7 March, 2005, demonstrators clashed with police by the provincial governor’s residence in Kandahar when a thousand-strong crowd urged the authorities to take resolute action against kidnapping.

Against this background, the economic recovery, including the restoration of the industrial and agricultural infrastructure ravaged by years of civil war, remains unsatisfactory. There is a catastrophic shortage of money for the solution of numerous humanitarian problems, and the conditions of daily life of ordinary Afghans leave much to be desired.

At the same time, the construction of schools, hospitals, roads and other facilities funded by donor states has got underway in the country on a sufficiently large scale. As a rule, donors fund concrete projects, and only a small part of international aid goes to the Afghan government. For example, Iran is currently implementing four projects: the creation of a water resources and environmental research center with training of personnel; organization of water supply to the city of Zaranj, the center of Nimruz Province; a master plan study on water management in the Kabul river basin; and equipment of a number of weather stations in Afghanistan.

In July 2005, India pledged to allocate an additional $500 million for reconstruction projects in Afghanistan. Nevertheless, observers note that official Delhi, for all its interest in strengthening ties with Kabul, lags somewhat behind Iran, Pakistan and China in establishing political and economic contacts with Afghanistan. For example, goods from the PRC already constitute 25% of Afghan imports. According to Mohammad Azim Wardak, who is in charge of foreign trade at the Ministry of Commerce of Afghanistan, last year the share of Chinese goods on the Afghan market increased by 30% compared to 2004.

It should be noted that the country’s government is gradually going over from the use of funds provided by donor countries to domestic investment. In April 2005, President Karzai accused non-governmental organizations operating in Afghanistan of squandering aid money allocated for its reconstruction. He said, in particular, that his responsibility was to stop “corrupt, wasteful and unaccountable” nongovernmental organizations. That was how Hamid Karzai commented a law on NGOs prepared by the authorities effectively barring these organizations from participation in some of the largest projects. Under this law, the government intends to conclude contracts only with private tax-paying entities.

In July, the government adopted a law on natural resources. From now on, the share of private sector investment in the exploration, prospecting and development of mineral deposits and oil and gas fields can reach 100%. According to experts, the country has around 300 deposits of gas, uranium, copper, gold, coal and other minerals. Some experts note that in the first place work will probably be resumed in the oil and gas industry, since it is the only industry that has not suffered from the civil war. It includes oil and gas exploration facilities in the town of Shibergan; oil and gas wells; gas pipelines; a gas desulfurization plant in the Jar Quduq field, and compressor stations on gas pipelines. The potential capacity of the Afghan market for oil products is estimated at over 1.2-1.4 million tons a year, and proven oil reserves in the north of the country allow the production of up to 1 million tons of oil a year.

In addition, the government is conducting negotiations on the development of other natural resources. Potential foreign investors (China and South Korea) are particularly attracted by the copper deposit at Aynak (45 km from the capital), whose reserves are estimated at 360 million tons (from 0.7% to 1.5% of copper) with an approximate value $11.9 billion.

Last year the government also took active steps to develop a network of industrial parks. Let us recall that back in 2004 an Industrial Parks Development Authority was established under the High Commission for Investment. The Authority is engaged in the construction of well-equipped technology zones with all the necessary communications for the development of small-scale production. Such parks are being created in Bagram, Herat, Mazar-i-Sharif and Kandahar, and there are plans for their construction in Kamari and Deh Sabz, in the vicinity of Kabul and in Sinjet Dara. Allocations for this project are to total $20 million. For the first three parks the government has received a $10 million grant from the U.S. International Development Agency. The first industrial park, opened in November 2004, is located close to the capital (in Bagram). Its area is 24 hectares, and its users are provided with land parcels of 1,000 to 4,500 square meters. The park has electricity, water-supply and sewerage networks, a system of access roads, and a security perimeter.

The second park, lying 20 km south of Herat, was opened in June 2005. It has attracted about $350 million of private domestic investment. Out of the 420 diverse industrial companies founded under this project, 35 have already started work, employing 4,000 people. The head of the Mines and Industries Department of the city of Herat, Ghulam Mohammad Mudabbir, said at the opening ceremony that soft drinks, biscuits, chips, vegetable oil, ice, plaster, paints and other goods produced by plants in the park were already on sale.

In order to encourage domestic producers planning to trade with other countries, in September 2005 President Karzai issued a decree partially exempting exporters from customs payments for the next three years. Up to then, such payments had amounted to 2% of the value of exported goods. The country’s exports today total $300 million, or less than 10% of its imports. Incidentally, this decree does not apply to the export of natural resources, specially emphasizing that its purpose is to support domestic producers and improve the investment climate in the country.

In 2005, the construction of an industrial park also continued in Mazar-i-Sharif. Its main purpose is to develop textile production (with French and Russian investments). Apart from that, the French have acquired a 60% stake in the Bakhtar vegetable oil plant, which resumed work in December.

Active participation of foreign capital is due, among other things, to the fact that on 28 November the Afghan government announced the start of a campaign to privatize state-owned companies. Most of these companies are to be privatized over the next three years. According to some estimates, by November 2005 the state had on its balance sheet close to 60 enterprises with about 25 thousand employees. The authorities are also planning to transfer natural resources to private companies at public auctions held in accordance with the above-mentioned law on natural resources, approved by the government and signed by the president.

In summing up the results of the past year, one can say that it was not all that bad for the country’s economy. Just over three years since the ousting of the Taliban regime and the end of the long civil war, the country’s roads, bridges and big cities have for the most part been restored, and there is regular trade and close economic cooperation with neighboring states. The authorities have carried out a currency reform and are taking steps to develop banking, build industrial parks and create an investment system.

The country’s successes are obvious. However, Kabul’s declared intention to insist on a single national budget for 2006 is justified more from a political than from an economic point of view. By setting this ambitious task, the central authorities are apparently trying to adjust the image of the Administration of Hamid Karzai who is seen as a puppet of the West both at home and abroad. After all, the country’s economy is still heavily dependent on foreign financial infusions, while agriculture is oriented toward the production of narcotic drugs. Evidently, these two factors will continue to determine Afghanistan’s economic and sociopolitical development in the near future.