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Cablegate: Imf Bullish On Afghan Reform Efforts; Wraps Up Program

VZCZCXRO3408
PP RUEHDBU RUEHPW RUEHSL
DE RUEHBUL #3471/01 3021258
ZNR UUUUU ZZH
P 291258Z OCT 09
FM AMEMBASSY KABUL
TO RUEHC/SECSTATE WASHDC PRIORITY 2660
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC 0926
RUCNAFG/AFGHANISTAN COLLECTIVE

UNCLAS SECTION 01 OF 02 KABUL 003471

DEPT FOR S/RAP, SCA/FO, SCA/RA, AND SCA/A
TREASURY FOR M. KAPLAN, A. WELLER AND J. CASAL

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN EAID PGOV PREL AF
SUBJECT: IMF BULLISH ON AFGHAN REFORM EFFORTS; WRAPS UP PROGRAM
REVIEW

1. (SBU) Summary. At the urging of the Afghan Government and of the
U.S. and other donors, the IMF rescheduled its previously canceled
mission and traveled to Kabul to conduct the sixth review of
Afghanistan's Poverty Reduction and Growth Facility (PRGF). The IMF
mission's review of the program was favorable and team members
expressed confidence the Fund and the Afghan Government will
negotiate by mid 2010 a successor program entailing deeper financial
and structural reforms. The IMF team also assessed Afghanistan's
progress under the Highly Indebted Poor Countries (HIPC) Program and
found implementation of the various "triggers" within the HIPC
framework is progressing. The recommendation for "Completion Point"
and full debt relief from the Paris Club debtors is expected
sometime in early 2010.

2. (SBU) Reporting on the overall Afghan economy, the IMF mission
found that GIRoA has exceeded the IMF's revenue collection target
set last year due to stronger than expected revenue performance
(almost entirely increased customs receipts). Nevertheless, revenue
as a share of GDP remained unchanged at around 7 percent, extremely
low even for least developed countries. IMF staff stated that they
will likely adjust the revenue target upwards and press the Afghan
Government to broaden and strengthen its tax base. The IMF also
noted while banking sectors performance is satisfactory, it has
rapidly expanded and should be monitored carefully. Improved
banking supervision and stronger anti-corruption measures are
necessary. End Summary.

3. (U) An IMF mission visited Kabul October 20-27 to review
Afghanistan's Poverty Reduction and Growth Facility (PRGF) and to
look as well at Afghanistan's progress in achieving the requirements
("triggers") under the Highly Indebted Poor Countries (HIPC)
program. The team's visit was especially appreciated given its
refusal in September to come to Afghanistan, a decision which
produced sharp criticism from Finance Minister Zakhilwal as well as
from donor governments.

INCREASING AFGHAN GOVERNMENT REVENUES

4. (SBU) In an October 26 meeting with Ambassador Eikenberry and
senior Embassy officials, the IMF mission noted that compared to
other low income countries, Afghanistan's current revenue
performance -- collecting about 7% of GDP, or approximately $1.1
billion -- is significantly below average, even for post-conflict or
least developed countries. The good news is that while revenue
collection slowed in recent months due to political uncertainty
surrounding the elections, revenue collections grew 40% increase
during months 5 and 6 of the Afghan calendar year (August and
September) over last year. Increased trade and customs receipts
(particularly fuel duties), described by the IMF as "low hanging
fruits," are largely responsible for the improved revenue picture.
While good in the short-term, this change alone will not lead to
long-term fiscal sustainability. The IMF noted the key is to
increase quantitative targets in concert with qualitative reforms.
The latter, according to the IMF mission, will place Afghanistan on
a path toward sustainable increases in revenue -- potentially
achieving 15% of GDP in the next five to ten years. Even with these
reforms, Afghanistan's fiscal situation will remain fragile over the
next ten years given expansion of security forces and the need for
increased spending in other areas.

5. (SBU) Fund staff emphasized the importance of sustaining
long-term revenue potential by broadening the tax base, through
expansion of the Large Tax Payer Office (LTO) and the Medium Tax
Payer Office (MTO), and the eventual introduction of
consumption-based taxes, such as a Value Added Tax. Moreover,
long-term revenue improvements need to be structural. They will
depend too on strengthening tax administration, developing Afghan
customs, and curtailing corruption. The IMF stressed it will be
critical for donors to align their positions and push for meaningful
reforms during the next year as a part of a broader "reform
framework" with the new administration.

IMPROVING THE BANKING SECTOR

6. (SBU) The banking sector in Afghanistan has grown rapidly over
the past 5 years, which has generated concerns about its overall
health. The IMF does not believe there is an imminent danger, but
the extent to which the sector has expanded means donors -- and
GIRoA -- should maintain a close watch. The IMF staff stated
non-performing loans levels are manageable and the capital base
within banks is acceptable. Over the coming years, however,
Afghanistan will probably see some banks merge.

7. (SBU) Mission staff expressed concern that the commercial banking
sector seems reluctant to lend to certain businesses. The IMF team
said commercial banks still see loans to Afghan businesses as "too
risky." Moving forward, the government will need to build up its

KABUL 00003471 002 OF 002


credit information bureau (now housed at the Central Bank) and
collateral office so bankers can assess risk and better execute the
function of lending. In addition, the Central Bank will need to
strengthen its regulatory capability. Increased banking sector
growth has led to concerns about governance within individual banks
and the ability of supervisory authorities to keep pace. Until this
situation improves, a lower lending rate could be beneficial from a
regulatory standpoint.

OTHER KEY INDICATORS

8. (SBU) The IMF team also provided several points on Afghanistan's
macroeconomic and fiscal sustainability:

--Economic growth. IMF staff now expects real GDP growth in 2009-10
of 15.7 percent. For 2010-11 the Fund forecasts 8.6 percent growth,
slightly down from their earlier forecast of 9.0 percent.

--Revenues/GDP. The new revenue targets and GDP forecasts suggest a
revenue/GDP target of 7.7 percent for 2009-10 (compared to an
original program target of 7.3 percent).

--Inflation. Staff said interest rates are dropping and headline
inflation is negative, with core (i.e., non-food) inflation almost
flat. By contrast, Pakistan has 10-15% headline inflation.

--Reserves. This target was the only one missed, Staff said.
Accumulated reserves fell short because of data audit problems and
not GIRoA policy reasons.

TIMING GOING FORWARD

9. (SBU) Depending in part on political developments in the coming
weeks, the IMF will complete its Sixth PRGF review in December and
take the findings to the Board in January 2010. Despite a few
outstanding triggers (e.g., pension reform and mining regulatory
framework), the IMF and World Bank also expect to recommend HIPC
completion point in January 2010. Following Board approval, the
team plans to return to Afghanistan in January to discuss the
2010/2011 budget and begin negotiations on a new PRGF, which again
will be a three year program. The IMF team mentioned negotiations
for the new PRGF may be difficult, but this situation is to be
expected if more complex and meaningful reform measures are
implemented. As a result, they envision a possible extension of the
current PRGF through June to allow for new program discussions. The
GIRoA strongly supports a new PRGF program that would help move the
reform agenda forward. Formal negotiations for the new PRGF program
will probably start in April 2010. The parameters of the reforms
will focus on improving domestic revenue generation and fiscal
management as well as on privatization of public enterprises. Each
of the reform benchmarks will also include good governance and
anti-corruption elements as well.

EIKENBERRY

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