International institutions must help Afghanistan cope with its economic and humanitarian crisis
The author, a nonresident senior fellow at PIIE, served as consultant to the United Nations Development Program during September to November 2021.
Afghanistan faces an economic and humanitarian crisis, deepened by the international community's refusal to recognize the Taliban as the legitimate government of Afghanistan. After seizing power in August, the Taliban began immediately to carry out repressive policies, especially against women. Prospects for an internationally recognized Afghan government and resumption of vital aid in the near term are dim. Does that mean there is no hope of averting massive suffering and encouraging the Taliban toward a more inclusive political framework?
In fact, though the resumption of regular financing programs by the International Monetary Fund and World Bank is not in the works soon, the international community is taking some action, and some initiatives are under way. The United Nations has created a special trust fund for Afghanistan and bilateral donors are providing humanitarian assistance, including payments of some salaries for teachers and health workers. The World Bank is working to expend some of its frozen Afghanistan funds through humanitarian agencies. The challenge is how to get the money to the people of Afghanistan in a sanctions-compliant way.
The United States has also taken some steps to ease the transfer of money for humanitarian purposes. The United Nations Development Program (UNDP) has proposed some programs, including cash transfers, a cash-for-work program, and a cash subsidy program for small businesses.
These efforts, however welcome, will not be adequate for addressing the humanitarian task at hand, nor for two other important challenges: rebuilding socio-economic resilience and institutions.
Afghanistan's problems hardly began with the Taliban takeover. Economic and social conditions were difficult even prior to its takeover in the wake of the United States' and other countries' troop withdrawals on August 15. The economy was already weak and fragile, and the country was suffering its worst drought in decades, hitting 80 percent of the country, and ruining 40 percent of the wheat crop. The COVID-19 pandemic had weakened confidence and private sector activity.
But the Taliban takeover made everything worse. It abruptly halted official financial assistance, including from the IMF and World Bank, which in 2020 had amounted to about $7.5 billion annually—35 percent of GDP (see IMF 2021)—one of the largest sudden stops ever seen in a developing country. In addition, the United States and other countries froze Afghanistan's official reserves. These actions have devastated Afghanistan's public finances, balance of payments, and banking system. The Taliban's limitations on women working have not only grossly violated human rights but also aggravated the economic decline.
The list of economic shocks that the Taliban must grapple with is long:
- The balance of payments is in a deepening crisis. With external financing dried up, Afghanistan is experiencing a sharp contraction of imports, including of essential goods. Energy imports are also at risk.
- Since mid-August, the afghani has depreciated by about 17 percent, but the prices of key goods have risen much faster because of drought and disruption in trade in August and September. The exchange rate depreciation would likely have been much larger if the economy was not already highly dollarized (about 60 percent of bank deposits have been in foreign currency), government spending had not ground to a halt, and if bank deposit withdrawals were not restricted. The afghani's depreciation, which may fuel further inflation, could accelerate if the latter two restrictions are loosened in the coming weeks.
- With the decline in official assistance, the budget is under severe duress. The sharp fall in revenue collection and the freeze in grants have forced the Taliban to effectively halt spending, although they have recently announced plans to pay civil servants. The Taliban's scope for financing the budget through printing money is limited by their inability to print currency in the short term, as Afghan notes were printed abroad. But there is certainly a risk of inflationary finance down the road.
- Cut off from the international banking system and suffering severe dollar shortages, the banking system is largely paralyzed. Even the domestic payments system is not functioning well. Runs on banks have forced the central bank to impose deposit withdrawal limits. Moreover, banks' balance sheets have deteriorated rapidly, as they cannot access their foreign currency assets because the central bank's foreign reserves have been frozen. Nonperforming loans are rising rapidly as borrowers are having difficulties repaying loans.
- Afghanistan will also face difficulties servicing its external debt and running in arrears with international financial institutions such as the Asian Development Bank, the IMF, and the World Bank; if the country defaults on its loans, it will be more difficult to resume international aid and global banking activities.
Against this background, a recent UNDP report projects GDP to contract by 20 percent in 2021, and the IMF expects a decline of 30 percent. All these developments could spill over to neighboring countries and beyond, including through a refugee tragedy.
The severity of the near-term economic crisis and its humanitarian implications will depend not only on the magnitude of the shocks but also on the Taliban's governance capacities. As in other crisis cases, the nature and speed of recovery would depend on the authorities' ability to adopt an effective political framework, establish the rule of law and effective policy implementation, and communicate a strategy for economic revival. These abilities—historically small in Afghanistan—have suffered from the loss of experienced public officials, many of whom have fled the country.
At this stage, even the high-level economic strategy and policies of the Taliban are not clear. Furthermore, their ability to ward off a deep crisis is limited by the dearth of economic buffers that they could use in the short run caused by the freeze on their assets and inability to borrow domestically or internationally. They will therefore have very little policy space to stabilize the economy. Afghanistan's rapid decline into a severe humanitarian crisis seems inevitable.
According to the UNDP report:
- 97 percent of the population could fall below the poverty line by mid-July 2022 . More than half of the population is expected to need food assistance.
- Male unemployment may rise from about 15 percent in 2019 to 29 percent in 2022. With the restrictions on women working, female unemployment would rise much faster.
- The small but precious progress made in recent years regarding poverty, hunger, health, education and gender equality, and access to clean water will likely be reversed.
The international community lacks an effective framework for addressing the challenges of countries in conflict and failed states, including the provision of basic goods and services. Afghanistan is a case in point, albeit an acute example. In the absence of such a framework, the international community needs to intensify the stopgap measures it has adopted to allay the humanitarian crisis and address Afghanistan's development needs. China, India, Iran, Pakistan, and Russia are helping a little, and some countries in the Persian Gulf are trying to re-establish ties with Afghanistan; their re-entry could facilitate financial transactions and economic support. But none of them are likely to take the lead in providing or coordinating the needed resources to Afghanistan.
A workable solution to address Afghanistan's humanitarian and development challenges could be an international initiative, arranged and coordinated under the auspices of the United Nations, to include the World Food Program, the World Health Organization, the World Bank, the United Nations Children's Fund, and bilateral donors. Such a program could convey both cash (including expanded versions of the UNDP's cash transfer and programs: cash-transfers and cash-for-work) and in-kind international assistance directly to the people of Afghanistan without those resources flowing through the hands of the Taliban. Parallel to this UN-run program, efforts to encourage the Taliban to move toward a more inclusive political framework, respect for law, and human rights in return for aid should also be accelerated.
2. The Taliban are raising some revenues and using the government's deposits at the central bank.
3. Another risk would be the printing of parallel currencies, as some warlords did prior to the 2002 currency reform, which contributed to the collapse of the exchange rate and inflation at that time.
4. Before the Taliban ascendancy, monetary policy was cautious and geared to achieving low inflation—2.8 and 5.0 percent in 2019 and 2020, respectively.
5. Sovereign debt was only 7.5 percent of GDP at end-2020 but was already at a high risk of distress, according to the IMF and the World Bank. Afghanistan faces the strong likelihood of a sovereign default once the reprieve it received under the G20 Debt Service Suspension Initiative (DSSI) expires at the end of 2021.
6. The author contributed to the preparation of the macroeconomic outlook part of this report; the conclusions presented here are, however, his own.