Afghanistan - The development prospects

RESTRICTED FCa Report No. AS-95a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION THE DEVELOPMENT PROSPECTS OF AFGHANISTAN February 18, 1963 Department of Operations South Asia and Middle East CURRENCY EQUIVALENTS Official basic rates Afs. 20 = $1. 00 Afs. 28 = $1. 00 Rate applied to imports of capital equipments Afs. 32. 35 = $1. 00 Free market rate, approx. Afs. 50-55 = $1. 00 A foreign exchange reform was agreed upon with the IMF on January 25, 1963. A par value of Afs. 45 = $1. 00 will be declared shortly. A free market rate will be allowed in addition to the new official rate. The new official rate has been applied, for the sake of convenience, throughout this report. at the rate of 45 Afs. = $1. 00 Afs. 1 = $0. 022 Afe. 1 million = $22, 200 Afs. 1 billion = $22. 2 million CONTENTS Page BASIC DATA i SUMMARY AND CONCLUSIONS ii - iv CHAPTER I, THE LAND AND THE PEOPLE History and Politics 1 Economic Geography 2 Population 3 CHAPTER II. THE ECONOMY Production and Income 5 Agriculture 5 Price Relationships and Factor Remuneration 9 Mining 11 Industry 11 Power 15 Handicrafts 16 Trade and Commerce 16 Transportation and Communication 17 Foreign Trade 18 CHAPTER III. DEVELOPMENT PROSPECTS Recent Development Efforts 20 Economic Planning 21 Investment Priorities 22 CHAPTER IV. FINANCIAL RESOURCES FOR THE SECOND PLAN The Problem of Internal Financial Resources 26 Financing the First Plan 27 The Government Budget 28 The Effects of the Foreign Exchange Reform on the GDvernment Budget 30 Price Stability 30 Projection of Internal Financial Resources 33 External Financial Resources 36 Matching the Inflow of Foreign Capital 37 The Balance of Payments 39 STATISTICAL TABLES: Summary of Government Finances 43 Money Supply Data 44 Foreign Assistance to First Plan 45 Estimate of Foreign Assistance to Second Plan 46 Estimated Debt-Service Payments 47 MAPS AfghMistan Econ-iiic Map BASIC DATA Area 245,000 square miles cultivable land as per cent of total area 15 Population, approximately 8 million of which, nomads 1.5 - 2 million settled, non-urban 5 - 5.5 Per Capita income, approximately $90 - 100 Government Finance (1960/61) Total Revenues: Afs. 2.3 billion of which, direct taxes 16% custom duties 37% other indirect taxes 12/d government monopolies 18% other 17% Total Exvenditures (excluding foreign aid) Afs. 3.1 billion of which, general administration 7% defense and security 21% education 7% agriculture, public works, industry transport and communication 41% other 24% Foreign Trade (1960/61) exports $ 51 million imports (including foreign aid) $107 million Foreign Assistance (1960/61) loans $43 million grants $26 million Foreign Assets of Da Afghanistan Bank (March 20, 1962) gold and silver $14.9 million net assets in convertible currencies $ 1.4 million Total $50.3 million Estimated Debt Service from 1962/63 to 1966/67 $54.8 million - 11 - THE DEVELOPMENT PROSPECTS OF AFGHANISTAN Summary and Conclusions 1. Afghanistan is not rich in terms of known exploitable re- sources. Her mineral wealth is quite limited and the possibility of developing a modern agriculture is confined to only a few areas in the country. However, a number of development possibilities in industry and agriculture are already evident, and a few projects, which require a relatively modest amount of capital and the applica- tion of well known techniques, can be worked out to benefit national output and the balance of payments. 2. A few years ago the Afghan Government started a serious drive toward economic and social development which is progressing despite tremendous difficulties due mainly to the lack of technically skilled personnel. Public development expenditure (excluding foreign aid) doubled during the last five years (the period of the First Plan) and is likely to grow further over the next five. Considerable progress is already evident despite the large amount of capital which has been locked up in capital-intensive, slow-yielding projects, well beyond justifiable investment in infrastructure. 3. In the last few years the Government's development effort has brought about a worsening of the balance of payments position of the country, since larger imports and payments of debt service were not matched by any significant increase of exports. The country's fiscal system was largely responsible for this, since it was not geared to the requirements of production, the largest burden of tax payments falling on producers of export commodities. 4. Despite the substantial increase in tax revenue during the First Plan period, local resources to finance development expenditures did not rise fast enough to match the inflow of foreign capital. The size of the ordinary budget expenditures also increased sharply in the last two years as a result of larger expenditures on defense and tribal affairs, directly or indirectly connected with the closing of the Pakistani border. In 1960/61 and 1961/62 the Government, in order to keep the amount of investment at a high level, resorted to somewhat excessive borrowings from Da Afghanistan Bank. 5. However, in the last few months the Afghan authorities have taken into consideration some measures of economic policy that show their willingness to proceed in a more orderly manner in the development of the country. The most important among these is the foreign exchange reform which has been agreed upon with the IMF on Jan- uary 2 1963 and is expected to become effective as of March 22. This measure is badly needed to encourage exports and rationalize the allocation of foreign exchange earnings among different uses. The - iii - reform might cause some loss of Government revenue in the short run, and will increase the size of the ordinary budget. As a result a ceiling to development expenditures will be set at a level lower than previously planned. The Government, however, has accepted this, recognizing that the capacity to absorb foreign capital in an orderly way is more important than the size of the investment program, and that increasing foreign exchange earnings are vital to further pro- gress of the economy. 6. Given Afghanistan's limited resources, economic development should be concentrated, for the time being, in the few more productive regions and highest priority sectors. However, a proper ordering of investment priorities and the availability of outside financial assistance will not in themselves carry forward Afghanistan's development. Afghanistan's Second Plan is only a set of project-ideas which are not backed by much technical and economic study. Project preparation is out of the reach of Afghan know-how for the time being and will have to be provided through foreign assistance, until the country's resources of technical skill are adequately increased. The lack of properly trained people and effective administrative organizations to implement develop- ment projects is likely to continue to be more severely restrictive than finance. This in turn underlines the need to step up investment in edu- cation in order to build up the basic resources of know-how that is needed to enlarge the country's capacity to absorb more capital and new ideas. 7. Afghanistan's own financial resources are quite limited, and her balance of payments position and existing foreign debt service require- ments would preclude financing additional investment on hard terms. Considerably greater effort will have to be made to mobilize domestic resources if the present rate of development is to be maintained and a greater strain on the balance of payments avoided, even if foreign financing continues at a high level on easy terms and covering a very large share of direct investment cost of development projects. However, to raise savings and government revenues to a level which would be com- parable to standards of similar underdeveloped countries, and which could be capable of supporting a substantially greater share of develop- ment expenditure, would still take a number of years. Foreign assistance financing of most of the cost may be justified in the interim. In some projects a sizeable Afghan contribution in the form of labor might be possible. 8. Afghanistan has in sight substantial foreign assistance for her Second Five-Year Plan from friendly countries. She would need a con- siderable amount of budget support to be able to absorb all foreign aid without resorting to excessive deficit financing and drawing further on her limited foreign exchange reserves. Nevertheless, there are some areas where a modest contribution from IDA could be very W. i-7 - beneficial to the economy. High priority sectors for IDA considera- tion are the education program and the agricultural development of the Kunduz-Khanabad river basin, - 1 - I. THE LAND AND THE PEOPLE History and Politics 1. Afghanistan as a national state dates from the middle of the eighteenth century when it was formed by Pushtun tribesmen, the "true Afghans". The area then controlled extended to Seistan in the west and the banks of the Amu Darya in the north and beyond the present boundaries of Afghanistan in the east and south to include Peshawar, the Indus Valley and part of Baluchistan. In the nineteenth century Afghanistan lost the areas beyond the Durand Line of 1893 to British India. The British controlled Afghanistan's foreign affairs and in effect guaranteed her boundaries from 1880 until the end of the last Anglo-Afghan war in 1919. Full sovereignty was restored to Afghanistan at that time, which the Afghans consider to be the date of their national independence. 2. Since the 1920's, Afghanistan has been a constitutional mon- archy; however, the constitution gives the King extensive powers. Under the present dynasty, Nadir Khan, 1929-33, and his son Zahir Khan, since 1933, some of these powers have been delegated to other members of the royal family. At present the outstanding leaders of the country are the King and two of his first cousins, the Prime Minister, Prince Daud, and the Foreign Minister and Deputy Prime Minister, Prince Naim. The Cabinet is responsible to the Prime Minister, who is appointed by the King. The bi-cameral parliament does not have extensive power, but its approval is secured on all major Government affairs. The House of Nobles (Majlis-i-Ayan) is an appointed advisory group of elders and the National Council (Shura-ye-Melli) is an elected body. The governors of the 14 provinces are appointed by the central government. 3. The present internal political stability is a relatively recent phenomenon. Internal unity has been made difficult by the topography and by the heterogeneous, partly nomadic, population. There is yet no revolution of rising expectations. There are fewer than 13,000 industrial workers and no unions. Although Afghanistan is still a traditional Islamic society, the facility for social and political change has been increasing at an accelerating rate in the last few years. 4. The power of the feudal landlords and religious leaders was broken by the Kabul Government during the last part of the nineteenth century and the first part of the twentieth. The present regime derives its support from the leaders of the Pushtun tribes, the ranking army officers, principal Government officials and the provincial governors. The ruling family is anxious to promote political as well as economic development, but this is difficult in the absence of political parties, an independent press or alternative centers of political power. A small "intellectual" group, working for the regime, is developing from among - 2 - the Afghans educated abroad over the last 30 years and from graduates of Kabul University. Another identifiable group is composed of wealthy traders and bankers. The most influential are represented by the Bank-e Melli, still the largest private bank, though now far less influential than it was a decade ago. In the push for development, the State is supervising banking and industry more closely. It pro- moted the establishment of four other banking institutions, including a central bank (Da Afghanistan Bank) which took over many of the Bank-e Melli's former functions, including the sale of karakul pelts abroad, control of the country's foreign exchange and the issuance of money. The Bank-e Melli's power company was nationalized, but this group still controls the few important industrial plants in the country, including the Textile Company (the Gulbahar and Pul-e Khumri mills) and the Sugar Company. 5. In foreign policy, Afghanistan is neutral. It has no military alliances, but has received military assistance from the Soviet Union since 1956. Next to maintaining its independence and neutrality, the regime's main concern in foreign relations has been promoting indepen- dence for the Pushtun tribesmen of the former North West Frontier Province, now part of West Pakistan. After the 1947 partition of British India, Afghanistan's championship of Pushtun independence in- creased. Pakistan retaliated by closing the border in 1950, 1955, 1959 and 1961. The earlier blockades were basically show-downs, but the one which commenced in August 1961 has been more complete. The resolu- tion of this problem is essential to Afghanistan's policy of neutrality, to trade with India and to large-scale assistance from the United States. Just as it has strained relations with Pakistan, so it has brought closer links with the USSR which has supported Afghanistan in this issue. The first trade agreement between Afghanistan and the USSR resulted directly from the 1950 border closing. Economic Geography 6. Afghanistan is a landlocked country bordering Pakistan, Iran and the Soviet republics of Turkmenistan, Uzbekistan and Tajikistan. Its area is 245,000 square miles, about three times that of Great Britain or about the same size as Turkey or Texas. Its latitude corresponds to Arizona and New Mexico in the USA, and to Algeria and Tunisia in Northern Africa. About 45 percent of the land is over 6,000 feet above sea level, and another 45 percent between 2,000 and 6,000 feet (see Map 1). The Hindu Kush mountain range covers a large portion of the country and effectively divides it into northern and southern regions. Although the more productive area is in the north, the political authority and military strength have for several centuries been concentrated south of the Hindu Kush. - 3 .- 7, Afghanistan has a dry, continental climate with a very short wet season (January through April). Except in the monsoon-influenced eastern range bordering Pakistan, where summer rains are common at higher altitudes, the country receives no more than 16 inches of rain- fall, all in winter, with one-third of the whole territory receiving less than half that amount. Summers are very hot. -inters are usually mild at lower altitudes, but severe frosts may occur. The low level of atmospheric humidity, the lack of summer rain and the high degree of evaporation inhibit the growth of vegetation; only in the higher valleys, and on the northern hills and plateaus is dry farming possible. In the rest of the country few crops can grow without irrigation. 8. Afghanistan's surface water resources are quite limited. The important rivers rise in the Hindu Kush range. Only a few have perennial flow and all of them are subject to wide seasonal fluctuations, which are, however, less acute in the Northern part of the country where important rivers are mainly snowfed. Groundwater resources have not been studied sufficiently, and little is known about the subject even in areas irri- gated by means of wells and karez.1/ 9. Little is known about the country's geology and mineral resources. Some sizeable coal and iron ore deposits have been discovered, but they are located in areas of difficult access. Sedimentary basins, likely to be oil bearing, are present boLh north and south of the Hindu Kush and some promising discoveries of oil have been made in the Mazar-e Sharif region. More recently, sizeable reserves of natural gas have been lo- cated in this area. The mountainous terrain offers a number of good sites for hydro-electric power development. Population 10. Official estimates place the population at about 13 million, but no census has ever been taken. If that estimate were correct, Afghanistan would be substantially more densely populated than Iran, a country with similar economic and social features. Total population should not exceed some 8 million, including 1.5-2 million nomads. Infant and childhood mor- tality are very high, with the result that the rate of population growth is still quite low. 11. Ethnically, Afghanistan's population is very mixed and related to the peoples across most of its international borders. The Pushtus (Pushtuns or Pathans) are the predominant linguistic and cultural group, representing perhaps over half, of the total. They were originally in the south and southeastern part of the country, but in recent decades many have settled in 1/ Karez is an underground aqueduct which collects and carries ground- water by natural flow to irrigation ditches. - 4 - the newer cultivated areas of the north. The cond largest group is represented by Persians, perhaps one-third of the total popula- tion. Other significant groups are Tajiks, Uzbeks, Hazaras and Turkomans. 12. Less than half the population, perhaps some 4 million, lives in a few widely-scattered large oases where water and soil conditions make agricultural production possible (See Map 2). With the exception of Herat in the northwestern corner of the country, all major settle- ments occur along the northern side of the Hindu Kush from the Kunduz- Kokcha valleys to the Mazar-e Sharif and Maimeneh oases, and along a northeast-southwest line through the Kabul and Jalalabad oases, down the Kabul-Kandahar road to the Kandahar oasis. The rest of the settled population is cut off from the main communication lines, living in small centers too isolated to be economically very significant. 13. In the above-mentioned main oases about 5 to 6 million acres of land are probably cultivated. The average land/labor ratio in those areas seems to be much higher than in the most productive areas of some neighboring countries (like India, Pakistan and Iran). With present production techniques there is not much surplus labor, and some shortage of manpower actually arises during peak season as soon as industrial crops are introduced. However, underemployment is seasonally quite high, and permanent unemployment is present in the urban areaso although the remarkable mobility of the labor force tends to overcome *t. II. THE ECONOMY Production and Income 14. There is considerable difference in estimates of Afghan GNP, varying from Afs. 27 billion to Afs. 40 billion, the lower estimate definitely appear- ing to be on the low side. Presuming that GNP would now range between Afs.30 billioa and ifs. 35 billion, per capita income would be located around $90 to $100, which is only slightly less then that of Iran, once the contribution of the oil sector is eliminated from the GNP of the latter country. The current import surplus is equivalent to over Afs. 3.5 billion and represents some 9%- 10;' of total resources. 15. Total consumption, private and public, is probably over 85 percent of total resources. About two-thirds of gross fixed investment is financed from abroad. Domestic savings as a fraction of total domestic expenditures are still lower than in neighboring countries, around 2-3 percent. Earnings fromi agriculture account probably for 65-70 percent of GNP, including those from livestock breeding. Of the remaining 30-35 percent, over half is account- ed for by services (including government administration, commerce and trade) and the rest by handicrafts, mining and industry, the latter two being probably no more than 5 or 6 percent of GNP. Agriculture !6. Though climate and topography severely limit the scope of agricultural output, Afghanistan's economy is still mostly based on agriculture, which supports perhaps 80 percent of the total population and accounts for practically all exports. However, in some areas of the country production could be considerably increased, at relatively low cost, if the application of a few fairly well-known and simple modern techniques could be instituted on a substantial scale. 17. Practically everywhere soils are low in nitrogen, phosphate and humus content, and these deficiencies are aggravated by present hus- bandry practices. In some of the largest oases soils (principally clay loams, but also sandy loans and heavy clays) are deep, well drained and would be satisfactorily productive if properly culitvated, irrigated and fertilized. A major area of the most productive soils lies north of the Hindu Kush, in the Kokcha and Kunduz river valleys and around Mozar-e Sharif. On the other hand, problems of shallow soils, waterlogging, salinity and alkalinity seem to be a serious limitation to extending culitvation in some areas south and west of the Hindu Kush range. 18. The typical farm is only a few acres, but there are some large private landholdings. The land tenure and pastoral rights are traditional. Almost all irrigated land is privately owned. Land which is not irrigated - 6 - belongs to the State and may be occupied for cultivation against a sub- sequent payment in kind to the government. The cultivator retains the right to occupy such land so long as he continues to farm it. A con- siderable area is cultivated by tenant farmers. Rental contracts are oral and commonly for one year at a time. Pastures are communal. The prevailing tenure system does not encourage good farming practices. Pasture improvement is impossible for the individual farmer to initiate, and proper range control still proves difficult for the government to manage. 19. Crop farming is not very intensive due to the lack of water and fertilizer and to the general ignorance of better techniques. Little use is made of pesticides and insecticides or improved seed varieties. Plant pests and diseases often cause very considerable loss, particu- larly of wheat crops. 20. Farm implements are primitive and labor efficiency consequently low. The principal tillage tools are a wooden plcugh with an iron tip, and a spade, used when animal-drawn equipment is not employed. The plough is slow and inefficient. Many irrigation plots are too small for any use of mechanical drawn equipment. Grain is harvested by sickle. There are only a few tractors in all of Afghanistan, although in large areas of the north the physical conditions are rather favorable for mechanized dry farming. 21. Irrigation is vital to growing most crops in Afghanistan. Even in the best agricultural areas, a considerable part, perhaps one-third, of the irrigable land is fallow each year due to shortage of water, and in order to restore soil fertility. In some areas like the Mazar-e Sharif, Jalalabad and Maimaneh oases, the availability of irri- gation water during late summer is the main bottleneck to increasing the area under irrigation. Elsewhere, as in the Kunduz-Khanabad river valleys, scarcity of irrigation water is mostly due to the inefficiency of existing irrigation systems and practices. There are hardly any struc- tures to regulate water flow and distribution nor is there any organized management of distribution. Floods frequently wash away intakes and cause canal breakages. Farmers are compelled to devote a considerable part of their time, up to three months a year, to maintenance works. 22. The use of commercial fertilizers is negligible; little is available in the principal agricultural areas. Very little cattle manure is applied as fertilizer, largely because it has a higher priority as fuel. The common means of improving fertility is to spread virgin soils brought to the fields from uncultivated areas. 23. Production. Foodgrains and fruit for local consumption accounted for almost all farm production until industrial field crops were intro- duced in the thirties to support new textile and sugar factories. Wheat is by far the most important subsistence crop, grown on all irrigated farming areas and by dry farming. Cultivation of barley and maize is also widely dispersed. Rice production is concentrated mainly in Ka"aghan Province (along the lower Khanabad river) and in the Jalalabad oasis. A variety of vegetables and legumes are also grown for local consumption. 24. Not much is known about the trend of production of the main foodgrains, but their output may have grown somewhat in recent years, largely because of favorable weather conditions. The country is probably more or less self-sufficient in foodgrain production in most years. 25. Fruit and nuts have been among Afghanistan's highest value exports in recent years. The native grapes are of high quality and are the most important fruit, marketed both fresh and as raisins. Almonds and pistachio nuts are also valuable exports. Apricots, apples, peaches, plums, pomegranates, citrus and other fruits are also grown. Total fruit output may have increased somewhat over the last few years, partly as a result of more reliable water supplies in the Kandahar oasis with the construction of dams in that area. Cotton is cultivated mainly in the northern provinces of Kataghan and Mazar-e Sharif. During the last two years, a little cotton has been produced in the Helmand Valley, but it is still an open question whether production will be increased or abandoned. Raw cotton production fluctuates around 50,000-55,000 tons. 26. Sugar beet is grown in the vicinity of the sugar refinery at Baghlan in Kataghan Province. Total output (less than [5,000 tons) appears to have been unchanged for at least the last ten years. About 45,000 tons of sugar cane is also produced in the Jalalabad oasis and largely consumed locally as gur. 27. Afghanistan has a substantial livestock population. Cattle are kept primarily for farm work. Fat-tail sheep are kept mainly for production of meat and fat as well as for wool, much of which is exported. Commercially most important are the five to six million karakul sheep found mainly in the northwestern part of Afghanistan. There does not seem to be any clear trend in this number. The ever- increasing shortage of pasture and lack of substantial production of fodder for winter feed limit livestock production more seriously than does the severity of the winter. Due to the weak physical condition of sheep resulting from poor nutrition, snowstorms and disease cause heavy losses in winter - up to 60 percent of a flock. In some areas, the lack of water nearby is said to restrict the use of otherwise good pasturage. 28. Marketing and Processing. A large part of foodgrain produc- tion does not enter commercial channels. Some is marketed from owner- operated medium and large farms, from sharecroppers' rent payments marketed by landlords, and from the share of dry-farm production paid to the Government for rent of the land. 29. Grain marketing is based on traditional systems with a large number of middlemen and often high marketing margins. Prices differ - 8 - widely from year to year, within a year, and from region to region. 30. Most cotton for export or for the textile industry is prccessed by the Combined Cotton Company, a joint Government - BankeMelli enterprise. rhe poor quality of cotton ginning is reported to have caused considerable loss of export value and production difficulty in the domestic textile plants. Some improvement has taken place recently, and the textile mills now consider the quality of cotton lint adequate for their purposes; but raising the commercial grade of cotton by means of improved ginning could, in the opinion of some experts, considerably benefit exports. 31. Most of the fruit crop coming to the market is exported by private firms. The natural quality of the fruit is considered very good, but poor packing and lack of refrigerated trucks and refrigerated warehouse facili- ties causes high losses. Some export of high-priced fruit by air to the USSR and to India has proved profitable. The handling and processing of fruits is still rather primitive. Production of raisins and packing them for export is unsanitary; consequently they cannot be marketed in Western Europe, the U.S.A., or any other country with comparable food inspection standards. 32. Karakul curing facilities appear to be adequate. However, the facilities for sorting, grading and storage as well as for export packing are reported to be unsatisfactory in the principal collection and curing center at Mazar-e Sharif. Karakul handling in other collection and curing centers is probably inferior. 33. Only a small amount of wool (mostly carpet wool of high strength) is properly prepared for export, in plants that are considered generally unsatisfactory. 34. Experimental Stations and Extension Work. Only with development of an effective extension service can Afghanistan hope to improve agri- cultural practices and increase crop production. Yet because properly trained extension workers are almost completely lacking, extension and demonstration work is negligible. Similarly, the existing experimental stations still do ne&ligible amounts of research because of the absence of properly qualified staff. 35. Credit. Little credit is available to farmers. The sugar beet and cotton processing companies extend production credit equivalent to 25 to 30 percent of the value of the crop to be delivered. Some credit at very high interest rates, reportedly 25 to 50 percent per year, is available from merchants handling farm products and from local money lenders. In 1954 an Agricultural Bank was started. During the first five years of operation, it met with difficulties arising mainly from bad loans. Management was changed some three years ago. The bank, whose capital funds had already been fully used up at that time, began to make use of advances from the Central Bank. Loans extended increased from Afs. 35 million in 1959 to 50 million in 1962, consisting mainly of long-term credits (6 to 10 years) for development purposes. There are still major difficulties with supervision and collection, but some progress has been made. However, short-term production credit to farmers - 9 - is totally inadequate for their needs; it is desirable that the Agri- cultural Bank should be used for this purpose, in the richer provinces, as soon as adequate personnel can be found to staff its branches. Price Relationships and Factor Remuneration. 36. If the output of industrial crops, karakul and other export commodities is to be increased, many adjustments will have to be made in price relationships and in the relative remuneration of the various factors of production. In the Afghan economy the high degree of monopoly, the direct control by the Government of a large sector of the economy, and the institutional framework of tenancy and cropsharing give the market mechanism little chance to establish proper price relationships and to set factor remunerations according to their marginal productivity. Furthermore, the multiple exchange rate system has caused further distortions of price relationships. The Government, which is responsible for most price fixing, should correct some of the striking distortions in the price structure if more production is to be expected out of additional capital investment. During last year a few steps have been taken to correct some imbalances, including the badly needed reform of the ex- change rate system. 37. A few months before the decision to proceed with the foreign exchange reform was taken, the Government took an important measure with regard to the price of raw cotton. Until last year, gross revenue from cotton cultivation in Kataghan Province was estimated at about Afs. 1,400 per acre, or only 15 percent higher than that estimated for wheat and actually lower than that for rice. Production costs for cotton, on the other hand, were estimated to be twice as much as for wheat. Naturally, this cost-price relationship inhibited farmers from substituting the badly needed industrial crop for the traditional foodgrain cultivation. The picture was even worse if we consider that productivity in the cotton fields cannot be increased without some additional capital investment, and a higher monetary production cost per unit of land and labor. At the beginning of the 1962 cotton season, the Government announced an increase in the price paid to farmers equivalent to about 19 percent. Although this increase seems to be still inadequate to make cotton as remunerative to them as its main competitors for land and water, rice in the Kataghan Province, and wheat in the Mazar-e Sharif area, the situation looks much better, from the farmers' point of view, than it was. 38. A comparison of prices paid to farmers for four crops in northern Afghanistan with those paid in four other countries is attempted in table 1. Those figures show that the price paid to Afghan farmers for sugar beet is definitely out of line with respect to the price relationships existing in other countries. A correct price should be more than double the present level and should be based on the sugar con- tent of the beets instead of the gross weight as it is now. As to the - 10 - price of raw cotton, a further increase of 20% would be needed to bring it in line with the relation now prevailing with the price of wheat in Iran and much more to adjust the price relationship to that prevailing in Mexico. Table 1 - Estimated Prices Paid to Farmers for Four Crops in Northern Afghanistan in Comparison with those paid in Four Other Countries. (US$ per metric ton) A. Actual Prices Afghanistan Iran Turkey Mexico France Wheat 63 71 56 72 77 Rice (paddy) 50 70 111 - - Raw cotton 100 133 228 180 - Sugar beet 5 14 - - 14 B. Price Relationships (Theat = 100) Rice (paddy) 79 99 198 - - Seed cotton 158 187 407 250 - Sugar beet 8 20 - - 18 Naturally, this comparison would be more meaningful if it could be done on the basis of net returns, but available information does not permit to pursue the analysis further. However, since the cost of production of cotton and sugar beet is much higher than that of wheat, and not lower than that of rice, the result of similar analysis made on the basis of net bene- fits would show an even less favorable picture for the industrial crops. 39. If the Government wants to increase cotton and sugar beet output, the present price relationship between industrial and foodgrain crops has to be further corrected, and the cropsharing arrangements, which are res- ponsible for a lower remuneration of labor in the case of cash crops than in that of foodgrain production, must be changed. Since the traditional tenancy and cropsharing contracts can hardly be altered quickly, this very fact makes more urgent a further upward revision of producers, prices. As to cotton prices this is now easier to make since the price of lint cotton for export will be increased as a result of the exchange reform. However, the upward revision of raw cotton prices would also require some improvements in ginning. Ginning is now done by a number of small plants in the Mazar-e Sharif area, all of which are obsolete and highly inefficient, and in two larger plants in Kunduz and Emam-Sahib, both of which can be improved to produce a better product and lower costs. A program for the - 11 - modernization of ginning plants is contemplated by the Ministry of Commerce as well as a complete reorganization of the Combined Cotton Company. Both are urgently needed and shauId be given full support. As to sugar beet prices, the very sharp increase required will undoubtedly have to be accom- panied by a change in management practice of the Sugar Company. 4O. A similar situation can be found also in the karakul pelt and raw wool industries. The new foreign exchange rate will probably cure some of the most serious imbalances that handicap the growth of production of those commodities. Although necessary, however, this measure will not, in itself, be sufficient to bring about more output in the absence of a serious drive to improve production techniques, marketing practices and processing facilities. Mining bi. All mines are Government property and are administered through the Ministry of Industry and Mines. Mining is still of minor importance. Only two small coal mines (Karkar and Ishpushta) are in operation, producing about 60,000 tons of poor quality coal per year. A much larger deposit, at Darre Suf, located in the mountain area south of Mazar-e Sharif., esti- mated at about 60 million tons, is under test, but no substantial production is scheduled to come from it during the next five years. Other mining activities are limited to the production of some rocksalt and precious stones (lapiz lazuli), the latter in Badakhshan Province. 42. Oil and natural gas may become important in the future. The search for oil was held back in the past mainly by the strong opposition of the USSR to Western contractors exploring the most promising sedimentary basins of the northern plain. Then, several years ago, the Petroleum Research Department of the Ministry of Industry and Mines was established with Soviet aid, and oil exploration begun in the Mazar-e Sharif region. Fairly large natural gas reserves have been located at Khodje-Gogherdak and at Yatin-dag in the Shibergan-Mazar-e Sharif area. Some strikes of oil have also been made, but no definite information is yet available as to their commercial importance. Industry 43. Economic development will inevitably bring about a diversifi- cation of the Afghan economy, until now so heavily dependent on a primitive agriculture. A moderate expansion of industrial investment opportunities is already evident. However, it considerably exceeds the country's ability to mobilize savings to finance them and to provide proper management. There is hardly an entrepreneurial class in the country. The traditional mercantile mentality persists even among people holding highly responsible positions in relatively large-scale private enterprises. 4b. Aside from some basic industries like power and cement, the main - 12 - increase of industrial production will likely be confined to the consumer goods sector for quite some time. The markets for cotton textiles and sugar offer the brightest prospects for increeing domestic industrial production. Metal working is limited to a couple of plants mainly concerned with the production of spare parts, and with the overhauling and servicing of cars and trucks as well as with truck body making. The Government is operating one of these plants, where a small electric furnace has been installed to do simple iron castings. The plant is producing stoves, nails, screws and other hardware; a relatively large furniture building department is also part of it. 45. Some development has already occurred in the last ten years, although industrial production accounts for certainly less than 6 percent of GNP, and the industrial labor force is probably no more than 13,000 people. Production and apparent consumption of some industrial commodities are given in the table below. The main industrial establishments are in the textile sector which employs about half of the total industrial labor force. The Textile Company, a private venture controlled by Bank-e Melli, has two main factories, one the very modern mill at Gulbahar, recently completed with German assistance; the other, a smaller plant at Pulqe Khumri. Other textile factories manufacturing wool, rayon and silk, are only small- scale establishments. Table 2 - Annual Production and Apparent Consumption of Bome Industrial Commodities 1961/62 Apparent Unit Production Imports Consumption Electric power million Kwh 127 - 127 Cotton textiles million meters 27.2 36.6 63.8 Footwear million pairs n.a. 2.7 Sugar thousand tons 5 62 67 Motor vehicles - 1,320 Petroleum products 1/ Gasoline million gallons - 18.9 18.9 Kerosene million gallons - 2,6 2.6 Diesel oil million gallons - 4.2 4.2 Coal thousand tons 66 n.a. Cement thousand tons 40 n.a. Soap million cakes 2.6 n.a. 1/ 1960/61 Source: Ministry of Planning - 13 - 46. Total apparent consumption of cotton textiles of industrial origin in 1961/62 was about 64 million meters. Assuming a population of 8 million, this figure corresponds to an annual consumption of about 8 meters per capita which appears quite low in comparison with per capita consumption of cotton cloth in India (over 14 meters) and in Iran (about 15 meters). This figure is probably underestimated since import statis- tics exclude smuggling which is reported to be still substantial. The importation of 37 million meters of cotton piece goods resulted in a foreign exchange bill of around %5 million equivalent. Internal produc- tion, including the cottage industry output, covered less than half of total requirements, and amounted to some 32-33 million meters. Domestic industrial output is still about 50 percent of the total productive capacity installed in the country. Of this, only about 11 million meters came from the Gulbahar factory, whose capacity is 35 million. Full-scale production from this factory would reduce the present level of imports of cotton textiles by more than half and save about $3 million of foreign exchange per annum, but even with Gulbahar in full production, Afghanistan would still have to import at least 10 million meters every year to satisfy only the present demand. 47. The Textile Company enjoys a full monopolistic position in the country on the production side and is hardly confronted with foreign competition except for high quality products. There is urgent need for reducing its high degree of monopoly, which is most harmful to the economy. As time goes by and production of cotton increases, there will be room in the Afghan economy for a new cotton textile mill and a greater element of competition. 48. Unfortunately for the future of private enterprise in Afghanistan, the Textile Company, the largest single private industrial venture in the country, has little record of efficiency, imagination and capability of coping with modern managerial problems. In particular, the Company's handling of the new mill at Gulb.har has been most unfortunate. Indeed the experience of the Gulbihar textile rill is an example of some of the difficulties of starting large-scale industrial operations in Afghanistan. Part of those difficulties have a political background involving the com- plicated relations between the Government and the Bank-e Melli group. However, the factory management has not been able to solve some problems, like the power shortage (which could be easily managed by arranging the working shift properly), and the marketing problems, which require correct pricing and quality control. Sales have been held back by high prices, which in turn are based on high production costs due mainly to the fact that the plant is operated so much below capacity. Little use has been made by the Afghan management of German technical and managerial assistance for which they actually paid. - 14 - Table 3 Prescnt Situation and Likely Future Development of the Textile Production and Apparent Consumption 1961/62 1967/68 (1 Output of cotton piece- Output of cotton piece- goods (million meters) goods (million meters) Industrial Production: Gulbehar 11.2 35.02 Pul-e Khumri 16.0 20.0 2 Total Industrial Production 27.2 55.0 Cottage Industry Production 5 - 6- 5 - 6 Total Production 32 - 33 60771 Imports 36.6 20 - 25 Total apparent consumption 69 - 70 80 - 85 31 1/ Mission estimate 2/ Full capacity production 5/ Assume 15-20 per cent increase of domestic consumption over 6 years 49. A similar picture is offered by the sugar industry. Domestic production is only about 5,000 tons; apparent consumption runs as high as 60,000 - 65,000 tons per annum. (These figures exclude gur produc- tion). The foreign exchange bill for sugar imports is about .47 million. If more beets and cane can be grown in the country, there is room for over 50,000 tons of additional domestic productive capacity to satisfy only the present demand. The only important sugar mill existing in the country now is the Baghlan factory belonging to the Sugar Company, which is controlled by the Bank-e 24elli. The factory has never operated at more than 60 per cent of capacity, due to insufficient supcly of beets. This is mainly a matter of management since the company owns some land nearby, which is rented to tenants and cultivated in the traditional way. No effort was ever made by the Sugar Company to give the local farmers any production or technical assistance. More recently, a program has been formulated to put the factory on its feet and a new director appointed, but even this program still seems inadequate to solve all problems of sugar production in the area. 50. There are two cement factories in the country, one of 100 tons per day capacity, which went into production in 1959, and a second of 400 tons per day, which has started production in 1962, at half the ultimate rate. Other industrial activities are limited to small-scale - 15 - plants producing chinaware, shoes, woolen textiles, knitted goods, etc. and to a number of_garages. Fruit processing in Afghanistan is not done on an industrial basis, but a relatively large factory is going into produc- tion in the spring of 1963 in Kandahar. Soap and vegetable oil is produced at the ginning plant in Klduz. Power $1. Despite the potentialities for hydro-electric development, electric power production started only recently in Afghanistan. Total installed capacity is about 59 14W, with a firm capacity of about 48 MW, about 80 percent of which is hydro-electric. The rest is mainly diesel, partly standby plants in the major factories, and for supplying provincial cities. $2. Total production of electricity was about 127 million Kwh in 1961/62, as compared to only 27 million six years earlier. In the last few years, a serious power shortage has actually developed. Domestic consumption has grown much more quickly than was expected, particularly in Kabul. In the other main cities, residential use is restricted by the Lack of adequate supply. The quick rise of residential demand has meant that there has not been enough power to meet growing industrial require- ments. This has seriously affected output, particularly of textiles. To meet the situation, the Government is considering a number of projects for hydro-electric development, planning to increase installed capacity many times by the end of the Second Plan. Most of the expansion is to be installed in the Kabul area. Work is in progress in one major hydroplant near Kabul (Naghlu), which is planned for a capacity of 60 W to be installed by 1966 or 1967. Several other hydro projects will probably be started soon: 40 MW of firm capacity for seven months starting in October at Mahipar near Kabul, which will be interconnected with the Sarobi and Naghlu plants; 11 MW (firm power) on the Jalalabad canal, and 14 W (7.5 Mi firm) at the Arghandab dam in the Kandahar Province. However, given the time required to build hydro-electric plants, hardly any large increase in the power supply can be expected before 1966, and only by 1967/68 will the full benefits of the power program be felt by the economy. Thereafter, power supplies will probably be ample for a number of years. 53. As a result of the recent discoveries of natural gas in the Northern Plains, there are thoughts of developing thermal power for the Mazar-e Sharif area. A tentative project for a 24 MW plant is under study. 54. There is little doubt that the rate structure of the national- ized Electric Company has favored residential over industrial uses. A rate of Afs. 1 ($.022) per Kwh is applied to residential uses as well as small industries, regardless of the amount of power required by the indi- vidual users, and a rate of Afs. 0.5 is applied to major industrial plants. In the absence of detailed information on the financial position - 16 - of the Electric Company one cannot judge the level of this rate with respect to production and distribution costs. There appears, however, to be little relationship between the rate charged to different users and what should be the relative cost of producing and distributing power to them. The cost of distribution to small users should be very high, pprticularly in Kabul, due to the low efficiency of the local network. Correcting the present imbalances would therefore require higher rates for residential uses. On the other hand, the rate now charged for major industrial uses appears, prima facie, not to be too high with respect to normal production costs in industry. Handicrafts 55,, Cottage industry is still a larger source of inc)me and employ- ment in Afghanistan than manufacturing. The main products are hand-woven cotton textiles and, more important, carpets and rugs, most of which are sold abroad. In the bazars a variety of other handicraft products are sold, arong them some metal goods, which testify to the high degree of ingenuity and skill of the population. Trade and Commerce 56. Trade and commerce might account for 10 to 15 per cent of Afghan GNP. Trade is only partly private; government influence is strong in this sector too. Exports of Karakul skins,for example, are organized by private merchants, but sales abroad are made under auctions held by agencies of Da Afghanistan Bank. Barter trade with the USSR is government sponsored. Imports of sugar, cigarettes, autonobiles, trucks and petroleum products are organized by the Monopoly Department. All other exports and imports are in the private sector, although some com- modities are subject to licensing. Internal trade, including the retail- ing of some Monopoly items (sugar and cigarettes, for example), is all handled by private merchants. Except for two export companies, The Combined Cotton Co. and the Karakul Co., private trade in Afghanistan is carried on by medium- and small-size personal enterprises. 57. Internal trade flows are very unevenly distributed in the country, due to the particular features of economic geography and popu- lation settlement. The main consumption center is Kabul. The bulk of cereals (wheat, barley and rice), cotton goods and sugar of internal origin, coal, karakul pelts and handicraft products consumed in the capital are imported from the Mazar-e Sharif-Kunduz-Kokcha area. A substantial amount of rice and fruit is shipped to Kabul from the Jalalabad oasis. Trade between the northern area, Jalalabad and Kabul accounts for well over two-thirds of the total internal trade of the country. Most of this is trucked on the existing roads, but camel cara- vans still play an important role. Trade between the southern and western part of the country (mainly the Kandahar oasis) and the capital appears - 17 - to be much less. Fruits and some wool products are the main items. Some meat is shipped to Kabul from Herat. In particularly bad years, wheat must be supplied to Kandahar from the northern region or from the Herat oasis. Trade between the other areas of the country is only minor and consists mainly of high value products such as carpets. 58. Most of the international trpde also flows through the northern area and the Jalalabad oasis. Trade with and through the USSR accounts normally for over half of total external trade in terms of tonnage, and for substantially more than that now that the Pakistani border is closed to Afghan transit trade. Most of the cotton and karakul pelts are shipped abroad throcgh Qizil Qalle and Termez on the USSR border, and all commod- ities connected with the USSR aid program come in through this area. Under normal political conditions, trade with India along the Kabul- Jalalabad-Khyber Pass road would accobnt for one-fourth to one-fifth of total external trade of the country in terms of tonnage. Imports of textiles and tea, and well over half of fruit exports, would flow along this road. Shipments on the southern road through Kandahar became im- portant only after the U.S. aid program started on a large scale. Afghan exports on this road are quite limited (some carpets, part of dry and fresh fruit, and the bulk of ra- wool). Transportation and Communications 59. In the absence of waterways and railways, transport development is based on connecting the major population centers and providing access to other countries by road and airways. Although the Soviet and Pakistani railway systems touch Afghanistan's border in six places, strategic reasons until World War II, and economic considerations since, have prevented railway development. 60. The present road system, consisting mainly of all-weather, gravel roads, was built during the 1930's. It is in rather poor condi- tion because of the lack of maintenance and the need for syphons and bridges. However, the original construction work was surprisingly good, and with the exception of the Northern Road from Kabul to the Soviet border, and of the Kabul-Khyber Pass road, both of which are being reconstructed and largely relocated, the rest of the systems, if properly maintained, would be more or less adequate for the present low volume of traffic. Less than 12,000 motor vehicles (largely trucks) are now operated in the whole country. 61. The main transport problem in Afghanistan today is to provide a politically and economically acceptable alternative to the route through Pakistan for its trade with India and the West. The economic implications of the recurrent crises over the Pushtunistan issue have convinced the Government of Afghanistan to give serious thought to the possible development of a new route for its foreign trade. At present the only route for trade with Europe is through the USSP which has - 18 - facilitated its use by offering attractive rates and expeditious handling of transit trade. The USSR borders on the most productive part of Afghanistan, and trade between them may be expected to grow further. The USSR is now the largest customer for Afghanistan's fruit and cotton as well as the cheapest supplier of petroleum products, vehicles and many other goods. 62. The only existing alternative to the USSR and Pakistan routes is the very long road through Iran leading, via Kandahar, Herat, Mashad and Tehran, to the Khorramshahr port. However, this is a costly one and is definitely not an economic solution in the long run. Consideration has been given to a possible other alternative which would use the Bandar-e Abbas port. If the scheme, however less costly than the Khorramshahr route, could not compete with the Pakistani routes, it would only be economic if there was no prospect of reopening the Pakistani border. 63. Internal air transport is on the whole adequate. Airfields are completed or in advanced stages of construction at all the major popu- lation centers. Two large commercial jet fields are being built, at Kabul and Kandahar, the latter obviously out of all proportion to its potential usefulness, having been originally conceived as an alternative inter- national stop to Tehran and Karachi. Some export freight which formerly went through Pakistan, is now being airlifted to India. For high value items like karakul skins and fresh fruit, air transport has already proved economic and may be expected to be used more extensively even if the trans- port route through Pakistan were reopened. A scheme for shipping meat to the Persian Gulf area by air from the Herat Province is also under study. 64. Telephone communications between cities are poor, but are being improved by the construction of a new channel system which is expected to be put in operation during the next five years. Foreign Trade 65. Information about foreign trade in Afghanistan is still inade- quate. A substantial amount of smuggling, the primitive administration of the Royal Customs and the confusion created by the multiple exchange rate system and by bilateral trade agreements result in poor records of both imports and exports and prevent a correct statement of the amount of foreign trade. More recently the Ministry of Commerce has attempted the revision of previous foreign trade statistics and has been able to provide some data on the trade balance over the last six years. 66. The total value of exports in 1961/62 was estimated at about $51 million, probably no more than 7 percent of GNP. Exports have fluctuated around this level over the last five or six years, and no definite upward trend is apparent. Until the last closing of the border in 1961, about one-fourth of the exports were directed toward India and - 19 - Pakistan and one-fourth toward the Soviet Union and other communist countries. The rest of the world (mainly the USA and Western Europe) bought as much as one-half of Afghan exports. The closing of the Pakistani border has severely affected the trading pattern of the country. While shipments to the USA and Western Europe still account for about one-half of Afghan exports, the share of the Indian Sub-continent has dropped to about one-eighth, while that of the communist bloc has increased to over one-third. 67. Fresh and dried fruits represent over one-fourth of export pro- ceeds, over 70 percent of which normally go to India and Pakistan. Karakul skins also represent over one-fourth of total export earnings. The USA and Western Europe buy almost all of them. The next important export item is carpets, which now account for over 15 percent of total export values and have been growing in a promising way in the last four years. Cotton and wool each account for about 10 percent of export proceeds: most shipments are to communist countries, West Germany being the main exception in the case of cotton. The balance of export earnings is made up by sheep casings, hides and skins, medicinal herbs and a variety of other minor items. 68. Available import statistics are much less reliable than export statistics. The Ministry of Commerce figures show a rise from $42 million in 1956/57 to $67 million in 1961/62 in the total value of imports. However, a large amount of commodities imported under the foreign aid program is not included in those figures. 69. Before the beginning of the First Five-Year Plan, imports into Afghanistan originated almost in equal proportions in the Western World, the Ccmmunist Countries and the Indian Subcontinent. Since then, however, the pattern of imports has changed: the Indian Subcontinent furnishes about one-tenth of Afghan imports, the Western World (including Japan which plays an important role as an exporter to Afghanistan, while importing hardly any Afghan products) accounts for about one-half of the total, and the Communist Bloc for the remaining 40 percent. 70. Imports rot directly related to development projects are mainly textiles (about 20 percent of commercial imports), sugar and tea (20 percent), petroleum products (15 percent), motor vehicles (10 percent), and other miscellaneous manufactures including chemicals and drugs (20 per- cent). Imports of wheat have been about 50,000 tons in 1960/61 and 30,000 tons in 1961/62. - 20 - III. DEVELOPMENT PROSPECTS Recent Development Efforts 71. After a period of little new investment during World War II, the Government began to take a greater direct part in economic development, first using its own resources, then increasingly foreign assistance. A $21 million Export-Import Bank loan for the agricultural development of the Helmand Valley was extended by the USA in 1946 and a $1.5 million wheat loan in 1953. Only in 1954, however, were large-scale commitments undertaken by the Afghan Government, with the Second Helmand Valley loan of $18.5 million from the USA and three loans for silo construction and municipal works from the USSR totaling $5.8 million. A Ministry of Planning was formed with the Prime Minister as its head and a First Five-Year Plan launched in 1956, representing a rather hastily put together aggregation of projects. Thereafter, external assistance became much larger and the contribution of foreign capital to investment in the country went up substantially. 72. Since 19L6, $360-370 million of foreign assistance has been spent in Afghanistan for economic development. More than $100 million has been spent in the Kandahar-Helmand Valley area (including the Kandahar jet air- port and the Kandahar-Spin Baldak road). Finance was obtained for most of these projects from the USA. The investment in dam building and canal construction which increased and stabilized the water supply to fruit pro- duction in the Kandahar oasis has apparently been of some benefit, but the investments made in the Helmand Valley proper have been out of proportion to the economic and agricultural potentialities of the area. Soil conditions are poor, and problems of shallow soils, alkalinity, salinity and waterlogging are severe. Despite the construction of two big dams, on the Kajakai and Argandab Rivers, the river flow below their confluence is far from being under control. The additional investment in flood control, drainage, and land improvement which would be required to achieve any substantial result from the project is quite considerable. Furthermore, great difficulties have been encountered in settling nomads on these previously unpopulated lands, while the recent attempt to introduce industrial crops (mainly cotton) has not yet proved successful. The Government has therefore rightly deleted for the time being the proposal to commit large additional amounts to the development of this part of the country. 73. Of the other $250 million, about half has been spent in road and airport development. The main projects in this field have been the Kabul- USSR border road (Soviet credits) the Kabul-Kyber Pass road and the Kabul- Kandahar road (USA credits). The major commercial airport development has been in Kabul (USSR assistance); minor airfields have been constructed also in the main provincial cities. Over $8 million of US assistance has gone into various education projects, and smaller amounts into a variety of technical assistance programs. Soviet assistance of $14 million financed oil and natural gas exploration in the North. An unknown amount of Soviet aid went in the Jalalabad canal agricultural project, suppliers' credits and local foreign exchange resources have been used for a few industrial projects (the Sarobi power plant, the Gulbehar textile factory, the expansion of the Pul-e Khumri textile plant and a few other small industries, including the Kandahar fruit processing plant). A minor part of the foreign assistance - 21 - went to the industrial sector - two cement factories (Czech assistance) and the Jangalak engineering and furniture plant in Kabul (USSR assistance) - and into municipal developments. These various projects were, on the wholo. sound and will have a beneficial impact on the economy. E,conomic Planning 7, There have been many shortcomings in the planning and execution of the First Plan. But they have to be considered with understanding since economic development is an entirely new experience for the Afghans. Before 1955 few of the elements of a modern economy existed in the country. I.ith the exception of the Helmand Valley Project, which was mainly carried out by U.S. contractors, Afghanistan had never mana,,ed any large-scale invest- ment. Industrial production was very limited. Little effort to change techniques of production in agriculture had ever been made and industrial crops like cotton or sugar beets were still quite new. Furthermore, prac- tically no Afghans were capable of working out the engineering of any proj- ect, or of setting up a modern business organization. Few had received high school educations, and very few had any practical experience in modern business or government administration. The Afghan authorities were quite aware of their inexperience ;sad therefore open to the influence of the many foreign advisors and economic assistance groups acting in Kabul independently from each other. 75. Economic planning in Afghanistan is mainly an effort to coordin- ate the various economic assistance programs sponsored by foreign countries. .That makes it so vague and uncertain is mainly the lack of adequate engin- eerinr,- and financial information on the projects which are included in the investment program. In fact, even the Second Plan is not much more than a set of vaguely related project-ideas. Proper engineering of these projects will not be worked out until the assisting countries which have been asked to finance them mobilize their own technicians to do the job. 76. Those difficulties in planning are compounded by the lack of a clear definition of investment priorities both with regard to sectors of the economy and to areas of the country. The First Plan called for spending one-third of total investment in industry, one-third in agriculture, less than one-fourth in transportation and the rest on education, health and other sectors. In fact, about one-fourth of the investment was spent in industry, only one-eighth in agriculture and almost one-half in transportation. In this respect, the Second Five-Year Plan is not likely to be much more re- liable than the First. However, given the limited resources of Afghanistan and their geographic distribution, it is of the utmost importance that in- vestment be concentrated in the most productive sectors and in one or two of the most naturally favored locations. 77. Improved economic planning in Afghanistan will only come about wqen proper project preparation and evaluation is started in a comprehensive way. The niinistry of Planning needs to ke strengthened with technical personnel and more Afghans with practical background in business adminstration and - 22 - economics. Larger technical staff is required also in the other Ministries dealing with economic affairs. A higher degree of coordination between the various Ministries is necessary. 78. Against all that, however, an important feature should be pointed out to avoid a pessimistic conclusion which would be rather misleading. The Government appears seriously engaged in the effort to bring about economic progress Lo the country: the institutional framework of economic planning, depending directly on the Prime Minister, is sound and capable of insuring thi implementation of policy decisi pns.- Fupthermore the M1inistries of Plan- ning, Agriculture, Industry, Comimerce and Public Works are staffed with a few energetic men who seem very*willing to get projects underway and things done. The many mistakes they happen to make are to be imputed largely to inexperience and lack of trained personnel to help them and would be likely to be cDrrected and overcomp as soon as they gain the know-how necessary for dealing with the new problems. 79. The Government's development effort has succeeded in getting the economy on the move for the first time in modern history. Observers of the Afghan scene are unanimous in recognizing considerable change in the last five years and definite, though slow progress. Although this may justify some optimism concerning future development, it should not give way to any illusions as to the rate at which the country can absorb new ideas or can put them into action. For some time the pace of development may well be lim- ited by these factors and not by the shortage of investment opportunities or the availability of finance. Investment Priorities 80. Education has undoubtedly the highest priority in view of the desperate need for skilled people, both administrative and technical. Al- though the budget for education has been substantial during the First Plan, there hps been a tendency to concentrate most of the higher education activ- ity in Kabul, while the rich northern area has been almost forgotten. Afghan education must be made more functional. This is particularly evident in the need for effectively trained extension workers to help increase agricultural output. The scarcity of educated tedhnical, managerial and administrative personnel is recognized as the main threat to the success of any project, however good it may be on other grounds. First priority should be given to developing agricultural schools, with highly practical curricula, administra- tion and trade schools, and a good deal of teacher training, as well as tech- nical education at University level. 81. Next to education, agriculture and industry are sectors of high priority. The development of Afghan agriculture, in general, is not likely to go very far, given the very severe limitations of climate, soils and water. However, there are a few areas in the country where good investment op- portunities can be found. Since in most of those areas the labor/land ratio is relatively low, the introduction of better techniques and the use of more - 23 - capital per unit of land and labor is necessary to increase production. There are also good opportunities to invest in the domestic production of sote industrial commodities, which are now imported, like cotton textiles and sugar. Mlore investment in the industrial sector will also increase the average ratio of capital to labor in the productive sectors of the economy. By investing in these sectors, Afghenistpn can hope to raise substantially the average productivity of its labor force in a relatively short period of time. Since the present level of wages is very low and richer people are not yet used to excessive consumption, much of the increase in productivity could lead to larger savings, thus providing the increasing amount of local resources for investment required to accelerate the development process. For these reasons, agriculture and industry should have higher priority than indiscriminate investments on infrastructures which have only indirect effects on the economy and are not likely to effect the productivity level for a long time. 82. Efforts to increase agricultural production should be concentrated in the northern areas (the Kunduz and Kokcha river valleys and the Mazar-e Sherif Oasis), as well as the Kpbul Valley and the Jalalabad oasis, where a relative scarcity of labor - which becomes severe during peak harvest season - should encourage the use of more capital-intensive production tech- niques and provide the means of increasing labor and land prcductivity. Most of the improvement will not require large investments in fixed capital, but mainly the rehabilitation and betterment of the existing irrigation fa- cilities, along with the introduction of better farming practices and some mechanization. 83. In fact, the development effort of the Government in agriculture has not followed this pattern during the First Plan. Large sums have been scent in the attempt to increase the cultivable area in the relatively poor lands of the Helmand Valley, while little investment has been made in the better agricultural areas in the northern region. Out of the total devel- opment expenditure in agriculture, too much has gone into fixed capital formation; extension services, fertilizers, mechanized farming, improved seeds, plant pest control, etc., have been almost entirely neglected. 84. Actually the Afghan Government has been aware of this fact in drafting the Second Five-Year Plan and is now concentrating on low-cost, quick-yielding irrigation projects. Some experimental farm work has been started in the Kataghan province and, although nceding a great deal of improvement, has to be recorded as a step in the right direction. Much more should be done, however, in the field of production services to farmers, including the establishment of a properly designed extension service and the introduction of production credit to farmers. 85. There are also a number of small projects related to agricultural development which will be most beneficial to the economy and need to be undertaken as soon as possible. The Government is now contemplating a silo construction program to stock fcodgrains, which appears reasonable. The Ministry of Commerce has worked oct a plan aimed at providing the economy - 24 - with better facilities for marketing and storage of fruits, for collecting, sorting and washing of wool, for curing and sorting hides, skins, and casings, as well as for improving cotton ginning facilities, and sorting and curing of karakul pelts. This program is likely to be most beneficial to Afghan export earnings since it is mostly concerned with increasing and upgrading production of export commodities. The program is made up of a number of small industrial projects, most of which should be in the private sector. For this purpose the possibility of Da Afghanistan Bank under- taking some of the functions of a development bank might be fruitfully explored, 86. Industry and power are key sectors for Afghan economic growth. The present power bottleneck has been given sufficient attention in the Second Five-Year Plan, although procedural delays have already caused the loss of precious time in the case of Mahipar station, and technical compli- cations are likely to delay the implementation of the Naghlu project and possibly result in a reduction of the planned capacity. 87. For the time being, given the social conditions prevailing in the country and the lack of an entrepreneurial class capable of managing indus- trial development, Afghanistan cannot engage in ambitious plans in this sector. However, a reasonable expansion of some industrial activities aimed at import substitution would help the balances of payments position and lay down the basis for further growth. Sizeable investments are justified in industries such as cotton textiles, sugar, leather goods and glass. Manage- ment and technical personnel are, of coursey a great problem which foreign assistance can temporarily help to solve. A small fertilizer factory, fed on natural gas, to produce urea (20,000 tons of N equivalent) is under con- sideration by the Government. This appears to be a sound investment, pro- vided good management is assured. The cost of imported fertilizers in the Northern Plain is very high, due mainly to prohibitive transportation costs, and therefore even a plant of a relatively small scale may prove competi- tive. On the whole, it should be hoped that, once the industrial crop pro- gram has proved manageable, the Government would allow for more investment in industry than now contemplated. 88. Within Afghanistan, the nature of the terrain and the distribution of the population make a road system linking together the few major produc- tion centers a very costly proposition. A major problem of economic plan- ning is to avoid over-investment in road development within the country. Given Afghanistan's limited resources, the high priority of agricultural and industrial investment, and the importance of concentrating development efforts in a few locations, investment in trunk-road construction should be limited as much as possible. On the other handj feeder roads in the main agricultural areas are definitely a much more urgent need and should be undertaken as soon as warranted by agricultural development. 89. Transportation development has received great emphasis in the Second Plan. A great deal of money has already been earmarked, and part -of it spent, for road construction. The Government is planning a high- -way system over 1,500 miles long to connect the major cities, which is - 25 - likely to result in a disproportionate use of available resources. Only the northern part of this system, the U.S. financed Kabul- Khyber Pass road and the USSR financed Kabul-Qizil Qualle road (see map 2), seems to be justified. The new Kabul-Qizil Qualle road, which tunnels through the Hindu Kush range and will be one- third shorter than the old route, links together the rich agri- cultural area north of the Hindu Kush with the Kabul area, and will undoubtedly benefit the economy. The Kabul-Khyber Pass road, relocated through the Kabul river gorges, will offer a quick commu- nication with Peshawar to the Pakistani railway system, which, under normal political circumstances, is badly needed. The present roads in the remaining part of the system would need only good maintenance, some bridges and a number of syphons for the irri- gation ditches to enable them to cope with the present and fore- seeable volume of traffic for a long time. Many of the new road projects under consideration (with the exception of the Pul-e Khumri- Mazar-e Sharif tract) will connect areas and cities which should be considered as far less important for economic development than the areas already connected b y the roads under construction. 90. Nevertheless, a very large amount of money is being earmarked for the complete reconstruction of the Kabul-Kandahar-Herat-Iranian border-USSR border road. A good deal of the project, the US financed Kabul-Kandahar section and the USSR financed tract from the USSR border to Herat and Kandahar, is already under construction. This big program is mainly wanted for admrinistrative reasons, in order to link to Kabul all major population centers of the country which, widely scattered around the Hindu-Kush range as they are, have traditionally been more oriented toward neighboring countries, than toward their own capital. The economic justification of the whole scheme is questionable, since improvement of those roads could have been done in a quicker and much less costly way. Furthermore, the building of those roads involves large expenditures of local currency (quite a scarce factor in the Afghan economy) which the Government could use in a much more productive way otherwise. - 26 - IV. FININCIAL RESOURCES FOR THE STCOND PLAN The Problem of Internal Financial Resources 91. In the Afghan economy, the estimated ratios of domestic savings to total expenditures ( 2-3 percent) appears to be lower than in many other countries with comparable per capita income level. The present level of Government revenues represents only around 6 percent of GNP. Tnis ratio is also still lower in the Afghan economy than in nearby countries with lower per capita income (India 10 percent, Pakistan 8 percent) and substantially less than in other middle eastern countries (Turkey and Egypt 12-13 percent), Uncertain as they may be, these estimates still confirm the general impres- sion that there is much room for raising additional local currency resources for investment purposes, even if the present levels of land, capital and labor productivity do not change. 92. The main cause of the low level of savings in the economy is to be found in the fact that Afghanistan has started the effort to-develop her economy only recently. Before that, the amount of savings sufficient to maintain the static equilibri-un of a subsistence economy was enough. Sim- ilar reasons explain the low ratio of Government revenues to GNP. A serious drive to improve the fiscal administration and to collect more taxes dates back only five or six years. 93. Under present circumstances, the Government will remain for a time the major domestic source of finance for development. Despite the present impossibility of enforcing tax regulations fully, a sizeable in- crease in Government revenue could be achieved provided a big drive is now started to improve administrative efficiency further. 94. Customs revenues can be increased substantially by introducing a realistic assessment of the invoice value of imported merchandise, by better control of foreign trade, and by raising import duties on some consumers' goods. Additional excises could be collected on items now sold at low prices. Land is practically tax exempt; a flat rate equivalent to about $0.12 per acre is usually assessed but seldom collected. There is no reason why a more realistic taxation of land should be put off until a cadastral survey of the whole country is completed. The cattle tax is still low despite the recently approved doubling of rates. Income tax on individuals is rather lenient and evasion reportedly high. Real estate appreciation, which is now beginning to be substantial in the main cities, is hardly taxed. Taxation of real estate would prove a sizeable source of revenue and would also discourage the excessive investment in building which usually follows a rapid acceleration of business activity accompanying large rloverniient investment pro7rp-. 95. In the short run, however, the key problem the Afghan fiscal au- thorities have to face is the effect of the closing of the Pakistani border - 27 - on the size of revenues. The structure of the budget is such that tax ccI1ec tion is heavily dependent on the amourit of foreign trade and oa the degree of control over it. Following the closing of the Pakistani border, the bulk of foreign trade was shifted to areas where the Afghan authorities are much less equipped to control it, and smuggling has substantially increased. There is little doubt that, in order to reestablish the govern- ment revenue at a satisfactory level, either a workable solution must be found to the Afghan-Pakistani political crisis, or a very serious effort must be made gpickly to control smuggling and to set up an efficient custom administration on the USSR border. Financing the First Plan 96. Total development expenditures since the beginning of the First Plan may now be estimated at about Afs. 19.2 billion, including per- haps over Afs. 1 billion of non-capital development expenditures (additional staff and maintenaace of completed projects). The total includes private investment in large and medium-scale industrial enterprises. The budget contribution of the Government can be estimated at Afs. 4.9 billion, and private investment about Afs. 0.4 billion, and deficit financing (net borrowings from Da Afghanistan Bank and decrease in Treasury cash balances) at 2.1 billion. Foreign assistance disbursed during the same period has been $309 million, including over $20 million of commodity aid, equivalent to Afs. 13.9 billion. The total domestic contribution to the Plan has been Afs. 5,3 billion, or about 18 percent of total development outlays (see Table 4). Table 4 - Financing Development Outlays During the Period of the First Plan 1956/57 - 1960/61 and in 1961/62 First Plan 1961/62 1956/57 - 1961/62 Government revenues 8.9 1.8 10.7 Ordinary budget expend- itures 6.3 1.6 7.9 Budget surplus 2.6 .2 2.8 ueficit financing 1/ 1.0 1.1 2.1 Total Government contri- bution to development expenditures 3.6 1.3 4.9 Private investment 2/ .4 - .4 Total domestic contri- bution 4.o 1.3 5.3 Disbursement of foreign aid 10.8 3.1 13.9 Total development outlays 17.7 17 19.2 1/ Borrowings from Da Afghanistan Bank plus decrease in Treasury cash balances 2/ Mission's estimate - 28 - The Government Budget 97. From 1956/57 to 1960/61 total domestic revenues of the Afghan Goverument -ent up from ^fs. 1.5 billion to Afs. 2.3 billion. The high level of revenues in 1960/61 is, however, somewhat inflated by the large amount of back taxes collected in that year, possibly as much as Afs. 200 million. 98. A preliminary estimate of revenue for 1961/62 is only Afs. 1.8 billion. The main shortfall in tax collection has been the drop of about Afs. 250 million in revenue collection of the custom houses, one of the prices paid for the closing of the Pakistani border. The following table shows the Afghan Government revenues by main sources, at the beginning of the First Plan and in 1960/61, along with the estimate for 1961/62. Table 5 - Government Revenues by Source: 1956/57, 1960/61 and 1961/62 (Million Afs.) 1956/57 1960/61 1961/62 (actual) (actual) (estimate) Individual and corporation 218.4 188.0 ) 297.1 income taxes ) Land Pnd livestock taxes 98.4 113.5 ) Customs duties 705.5 850.7 605.3 Sales and license taxes 70.4 261.7 276.0 Sales of property end 77.2 196.9 130.9 investment income Profits of Government monop- 5.8 206.9 391.5 olies Other revenues and back trxes 503.0 [85.8 113.8 Total 1,527.8 2,303.5 1,814.6 Source: Ministry of Planning 99. By far the main sources of Government revenues are import and export duties, and Monopoly Department profits which, combined, accounted for about 55 percent of total revenues in 1961/62. Sales and licenses taxes were only 15 percent, and direct taxation (including the livestock tax) only 19 percent of total revenue in the same year. This budget structure is very inflexible and makes it difficult for the Government to make good any shortfall in revenue collection that may arise from a decline in the volume of foreign trade. 100. Current and development expenditures of the Government (excluding foreign loans and grants) almost doubled over the First Plan period, from - 29 - less than Afs. 1.6 billion to Alfs. 3.1 billion, the latter figure represent- ing some 9-10 percent of GHTP. Total expenditures of the Government, including foreign assistance, also doubled since 1956/57. Despite the increase of ordinary expenditures by over 50 percent in the last six years, the ordinary budget share of total Government expenditures has dropped, since the beginning of the First Plan, from 35 percent to only 27 percent. Development outlays more than doubled over the same period. 101. At the beginning of the First Plan the Government budget was al- most in equilibrium. Actually, slight surpluses arose in 1957/58 and 1958/59. Foreign assistance accounted for about half of Government expen- diture throughout the whole Plan Period. However, the rapid growth of de- velo ;ment expenditures, combined with the steep rise in the ordinary budget since 1959/60, was quicker than the increase in domestic revenues. To cover the deficit, the Afghan Government resorted to extensive borrowings from Da Afghanistan Bank. Deficit financing, which was practically not used during the first three years of the First Plan, became an important source of finvnce later, and accounted for 13 percent of total Government outlays in 1960/61 and for 19 percent of it in 1961/62 (see table 6). Table 6 - Sources of -,inancing Government Expenditures 1956/57, 1960/61 and 1961/62 1956/57 1960/61 / 1961/62 2/ ,illion Percent Hillion Percent Hillion Percent Ifs. of Total !fs. of Total Afs. of Total Expenditures: Ordinary budget 1,088.8 35 1,566.0 25 1,606.0 27 Development ex- penditures 2,001.7 65 4,677.3 75 4,441.1 73 Total 3,090.5 100 6,243.3 100 6,047.1 100 Financed by: Budget revenue 1,527.8 50 2,303.5 37 1,814.6 29 Foreign assist- ance 1,498.5 48 3,127.5 50 3,o91.5 52 Deficit finan- cing 64.2 2 812.3 13 1,141.0 19 Source: Iinistry of Planning 1/ Actuals 2/ Preliminary estimate - 30 - The Effects of the Foreign Exchange Reform on the Government Budget. 102. The foreign exchange refDrm will have a large impact on the Government budget. It will actually result in considerable change in budgetary practices. The total foreign exchange transactions of the Government have been around $h0 million in recent years, of which about 10 million were purchased for payments of debt service at a rate of Afs. 20 = $1.00. About 12 million were purchased to pay for imports of the Monopoly Department and of other Government entities at a rate of Afs. 32.35 = 1.00, and around 18 million were purchased for ordinary expenditures of the Government at a rate of Afs. 28 = $1.00. It is estimated that, as a result of the introduction of the new rate of Afs. 45 = .1.00 for all Government transactions, the total value in local currency of Government's foreign exchange purchases forecast for 1963/64 will increase by over Afs. 700 million. Furthermore, the Government is prepared to waive the present excise on cotton textiles to compensate the manufacturers for the increase in prices of their raw materials which will be brought about by the exchange reform. At present, receipts through that excise are about Afs. 60 million per annum. On the whole, therefore, the Government will have to increase its revenue by over APs. 760 million to make good the cost to the budget of the exchange reform. 103. To do that, the Government plans to collect, during the next budget year, Afs. 360 million from an export duty on karakul pelts, cotton and wool equivalent, on the average, to 22 per cent ad valorem; Afs. 40 million from other minor export duties; Afs. 200 million from increases in the level of import duties and Afs. 250 million from higher revenues of the Monopoly Department, part of which will be accounted for by shifting to consumers the extra cost of imports in terms of local currency. As a result, the Government plans to be able to avoid any net losses to budget on account of the exchange reform and, possibly, to receive, in due course a net benefit from it. Price Stability. 104. Over the three year period from March 1959 to March 1962 the Afghan budget deficit has been as high as Afs. 2,460 million. Net borrowings from Da Afghanistan Bank and decrease in Treasury cash balances totaled about Afs. 2,060 million: the balance was financed by counterpart funds of commodity aid directlj channeled through the budget. Over the same period of time, money supply rose by about Afs. 970 million and foreign exchange reserves (which were mainly used directly by the Government to finance payments on debt service) dropped by about Afs.695 million. Although a detailed statement of the consolidated position of the banking system over the same period cannot be made, the main factors underlying the change in money supply can be summarised as in table 7. - 31 - Table 7 - Increase in Aoney bupply and its Underlying Factors: March 1959 to March 1962 (Afs. million) Increase in money supply 967 Credit extension to Government sector Borrowings from Central Bank 1,856 Decrease in Treasury cash bal- ances 203 2,059 1/ Credit extension to private sector 374 Increase in private time deposits -34 Increase in capital, reserves and undistributed profits 2/ -244 Decrease in foreign exchange reserves -695 Increase in other liabilities (including errors and omissions) 493 Total of above 967 1/ The total budget deficit over the same period hPs been Afs. 2,460 mil- lion which includes a balancing item of Afs. 401 million, equivalent to the part of commodity aid which has been channelled into the economy througn the Government budget. 2/ Private banks only. Source: Da Afghanistan Bank. 105 Between M"Iarch 1962 and November 1962, money supply rose by another Afs. 510 million, so that the total increase over the period since March 1959 has been about Afs. 1,L80 million. One-third of this remarkable in- crease was offset by disbursement of commodity aid not channeled through the Government budget. USSR wheat assistance to Afghanistan over the same period of time has been equivalent to about 9.5 million, and other commodity aid from the same source $2.5 million. Wheat imports from the USA have been much larger. However, part of it was wasted in the Karachi port warehouses in 1962, and some was held in stock by the Government. Only Afs. 86 million equivalent of PL L80 counterpart fund was spent through - 32 - the Government budget and another ifs. 282 million equivalent was spent directly on U.S. sponsored development projects. Perhaps over A fs. 870 million of counterpart funds here been generated in the last three years in the Afghan economy,of which less than half was used to support the budget and the balance spent directly on foreign financed projects. 106. The big rise in the total amount of money supply did not cause any serious price increase so far. There is no properly prepared price index in Afghanistan, but available information on prices of some main commodities, which should weigh heavily in the consumer budget, is suf- ficient to show that few signs of demand-pull inflation were present in the economy over the last eighteen months. Indeed, some prices, like those of wheat and rice, declined. Others, like those of low quality cloths and housing remained more or less stable. Prices of mutton meat and charcoal increased somewhat, and prices of imported commodities, such as cigarettes, or of items usually bought for export, such as carpets, went up substantially, following the depreciation of the free market value of the Afghani. It seems, therefore, that the high propensity of the people to hoard money, the low degree of monetization of the economy, and the con- traction of its barter sector have so far helped the economic systen to absorb the large increases of the money supply without much effect on the price level. 107. The Government has, howjever, recognized that it cannot continue to increase the bank note issue at the present rate without raising serious inflationary pressures in the economy. is a part of the foreign exchange and budgetary reform, decided last December, a ceiling was im- posed on Government net borrowings from the Central Bank at 1fs. 400 million for the next fiscal year. 103. What effects the foreign e-:change reform will have on domestic prices is an important matter, in so far as raising prices of consumer goods might be reflected in wage increases and thus push up the local currency cost of investment. Thile the domestic price of the major ex- port commodities will go up substantially, the price of most imports should not be much affected. The Afghan exchange reform is only a par- tial devaluation. It will affect transactions equivalent to somewhat more than one-helf of total foreign exchange transactions. Host non- Government imports are now made at the free market rate, or at the cross rate of the controlled foreign exchange transactions with India. For those transactions the exchange reform night be equivalent to a slight revaluation as the free market rate will be brought in line with the official rate in due course of time. 109. The exchange reform will increase by about 40 percent the price to exporters of karakul pelts, cotton, wool, and of fruits airlifted to the USSR. Higher prices of some export commodities, such as cotton lint for example,iuould push up somewhat domestic prices of textiles. However, the elimination of the excise on textile goods should be more then enough to - 33 - balance that. Higher monet-ry income in the hands of the producers of the main export items will probably increase demand for some consumer goods,both imported and domestically produced, and cause a rise in prices of those commoditios. The main effect on import prices will be the result of fiscal measures. Prices of Monopoly Department goods will go up, as well as other prices of imported commodities on which higher import duties will be imposed. 110. Some price increases will probably follow the exchange reform as a result of additional dempnd as well es of higher indirect taxes. However, the effect of the price increase on the wage level should be modest. Except for tea and sugar, the consumer's basket of the Afghan 1-borer is still limited to commodities whose prices should be largely unaffected. ,rojection of Internal Financial Resources 111. Early lest year the AfghFn Government produced a forecast of revenues over the next five year period. The Ministry of Planning and the Ministry of Finance are now engaged in revising their forecast to take into account the possible ef'ucts of the exchange reform. The previous forecast set domestic revenues over the next five years at Afs. 14.6 bil- lion and ordinary budget expenditures at Afs. 10.8 billion. The estimate of revenues was likely to be on the high side, particularly in view of the financial implications of the closing of the Pakistani border. The estimate of ordinary expenditures, as usual in underdeveloped countries, was largely overestimated. The surplus of Afs. 3.8 billion would have financed 1.2 billion of debt service leaving aside about 2.6 billion to be used for financing additional investment outlays. 112. A rough estimate of the surplus of Government budget over the next five years, taking into account the likely effects of the foreign exchange reform, is set forth in the following table: - 34 - Table 8 - Surplus over Ordinary Budget Expenditures during First Plan Period and Projection over the Next Five Years (billion Afs.) First Plan Second Plan Actuals As estimated prior Including likely to foreign exchange effects of foreign reform 1/ exchange reform & Domestic revenues 8.9 14.6 17.5 - 18-0 Ordinary budget 63 10.8 12.5 expenditures Debt service 1.2 2.5 Surplus available to finance develop- ment outlays 2.6 2.6 2.O - 3.5 l/ Ministry of Finance estimate, corrected to exclude from domestic revenues the equivalent of Afs. 00 million representing commodity aid counterpart funds. 2/ Mission's estimate 113. The estimate of Afs. 17.5 billion of domestic revenues over the next five years is of course heavily dependent on three factors: the ability of the Afghan Government to control foreign trade; the amount of foreign trade that will materialize over the period, which in turn depends on the political relations between Afghanistan and Pakistan; and, thirdly, on the ability of the Afghan Government administration to adjust itself to the fiscal practices that will follow the exchange reform. It might well be that, even if the total amount of foreign trade assumed in the forecast of revenues materializes, the Government will still not be able to collect the whole of what at present may be forecast, because of the difficulties in adapting the system to new taxes and in enforcing full control over foreign trade. As a result, the net surplus available to finance develop- ment outlays, which could be of the order magnitude of Afs. 3.5 billion if everything goes well, might be much less. On the whole, it would not be realistic, at this stage, to count on a budget contribution to the develop- ment effort of more than Afs. 2 billion, over and above the requirements for financing debt service, now set at about Afs. 2.5 billion. 114. Provided considerable care'is used, the Government might resort to some more deficit financing. The main question connected with using this source of finance is whether the stability of the price level during the - 35 - last two years has been due to a definitive propensity of the people to hoard money or only to a time-lag in consumers' expenditure. If the second is the case, there is little scope for increasing further the money supply over the next five years. If, instead, the Afghan economy has definitely absorbed the large increase of the last fiscal year, additional net Govern- ment borrowings from Da Afghanistan Bank to the amount of some Afs. 1.5 billion over the Second Plan might be possible, without raising inflationary pressures in the economy and causing undesirable strain on the balance of payments. Naturally, no decision can be made on this issue now and the Afghan fiscal authorities will have to watch carefully the future develop- ment of the economy and make decisions as time passes by on the basis of the current situation. 115. The Government is counting on private contributions toward financ- ing the Second Plan equivalent to about Afs. 200 million. This figure is undoubtedly underestimated even with the present Government policy. A few changes in the price system - some of which will be brought about by the foreign exchange reform - and an improvement of the business climate in the country could show surprisingly good results in this field. So far as foreign private capital is concerned, the Afghan Government has recently removed its former opposition to controlling fVreign equity participation in Afghan business. A German private group has already decided to put up the capital necessary for a small woollen textile plant. Inducing further private capital from abroad would be helped by the publication of the Coi-mercial Code in a western language. But even if no inflow of foreign private capital should be forthcoming, it seeis that a contribution to the Second Plan of at least Afs. 0.5 billion may be expected from domestic private resources. 116. As a result, on the basis of fairly conservative assumptions, it seems that, over the next five years, some Afs. 4 billion could be made available from doi,estic sources for development expenditures, in addition to what is required for payments of debt service. This figure would compare with a total domestic contribution to new investment outlays made during the First Plan period equivalent to Afs. 4 billion and to Afs. 5.3 billion over the six years from 1956/57 to 1961/62. However, if the political situation improves and the Pakistani border is reopened, the budget contri- bution might be larger and the total amount of domestic resources available correspondingly increased. - 36 - External Financial Resources 117. Foreign assistance for the Second Plan has not been fully com- mitted yet; however, the carry-over from earlier commitment and an esti- mate of possible new commitments indicate that as much as $390 million could be forthcoming, assuming complete disbursement of commitments made for the First Plan period, and of new commodity aid (including some $30 million of wheat grants), and 70 percent disbursement of new project aid. This estimate seems reasonable in light of recent levels of foreign financed development expenditure, and of the estimated expenditure of foreign exchange from 1956/57 to 1961/62, now set at over $300 million. 118. The USSR has offered to commit a total of $228 mllion, of which $115 million will be on a grant basis, and the balance soft-term loans. This commitment includes $12.0 million of consumer goods loans to be used to generate local currency, of which $2.5 million have already been dis- bursed. 119. West Germany has offered to commit $50 million of long-term loans, 7.5 million of which have been already disbursed to refinance part of the short term supplierst credits used to finance the Gulbahar textile mill. Terms of those commitments will be determined as agreement is reached on specific projects to be financed through the credit line. 120. The USA has not yet made any_specific comimitme.nt for the Second Plan . The carry-over from the First Plan is however going on, though with increasing difficulties due to the closing of the Pakistani border. As to the new aid program, the U.S. Government has only indicated its interest in some major projects, and in some of the small projects that may show quick returns in the form of foreign exchange earnings. 121. The order of magnitude of the USA project assistance might be around $100 illion. Furthermore, the amDunt of commodity aid which the U.S. is prepared to import through the Iranian route may be as high as $5 million per annum, or, say $20-$25 million over the next five years. 122. The U.S. Government has indicated to the Afghan authorities that it is not prepared to import wheat in Afghanistan through other than the Karachi route. However, if the Pakistani border were opened, the amount of PL 480 assistance could be sizeable. A major problem of PL 480 assis- tance to Afghanistan is that imports of wheat have to be done with much care to avoid depressing further the local price level. It seems, therefore, that even the equivalent of 30 million of wheat sales in the Afghan market, assumed in the estimate of total foreign assistance, might be excessive. By and large, the total amount of USA assistance to the Second Plan, as now envisaged, will probably be no more than $150 million. This figure,is, however, very tentative and subject to much change. 123. Some additional credits may be granted by other countries, mainly - 37 -- from the Communist Bloc (Czechoslovakia). Even including possible IDA assistance, however, it is unlikely that other foreign aid for the Second Plan will exceed $20 million. 124, On the whole, it seems that Afghanistan may count on foreign assistance to finance development expenditures under her Second Plan to the amount of Afs. 16.5 - 17.5 billion equivalent. Of this amount, the equivalent of Afs. 1.7 - 2.7 billion might be in the form of commodity aid, depending on the amount of PL 480 wheat that it will be feasible to import into the country. Matching the inflow of foreign capital 126. Under normal circumstances, with the Pakistani border open and the administration fully adapted to the current fiscal policy, the amount of commodity aid that Afghanistan could count on would be a sufficient addition to her domestic resources to make a five-year plan involving foreign project assistance of Afs. 14.8 billion a workable proposition. On the other hand, with the Pakistani border closed, and in view of the difficulties that the Government administration will have to face in adapting itself to the new fiscal measures, the Government vill probably need a larger budget support to be able to absorb all foreign assistance it now has in sight. 127. Past experience shows that the local cost of new projects is slightly higher than 25% of the total cost. This result has been almost uniformly obtained during the First Plan irrespective of the foreign source of project financing. If one could assume that the same proportion will hold over the next five years, a plan involving a foreign exchange component equivalent of Afs. 14.8 billion would have a total size of about Afs. 20 billion and a local currency component of about Afs. 5.2 billion. 128. Against this requirement, domestic resources to the amount of Afs. 4 billion will be available, as estimated in the previous section. Assuming that no grant wheat could be sold in the Afghan market over the next five years, only Afs. 1.7 billion of counterpart funds will be made available to the Government for development expenditure purposes so that total resources in local currency will add up to some Afs. 5.7 billion. Development non-capital expenditures (about Afs. 1 billion during the First Plan period) may grow to Afs. 1.5 - Afs. 2 billion over the next five years leaving aside for new investment Afs. 3.7 - 4.2 billion. These figures show that further budget support equivalent to as much as Afs. 1 billion might be needed over the next five years to enable Afghanistan to absorb the whole amount of foreign aid she now has in sight. However, an improvement of the political situation may well change the whole picture and enable the Government to collect enough revenue to fill the gap. The many uncertainties of the situation make it very hard to forecast future developments but it is likely that the real outcome will lie somewhere between the two extreme alternatives set out in table 9. - 38 - Table 9 - Financing Local Currency Expenditures of Second Plan Investment Programs (a) (Afs. billion) Alternative A Alternative B Domestic resources 400 5.5 Budget surplus 2.0 3.5 Private investment .5 .5 Deficit financing 1.5 1.5 Counterpart of commodity aid 1.7 1.7 Total resources in local currency 7.7 7.2 Development non-capital expenditures 1.5 2.0 Surplus available to finance new investment outlays 4.2 5.2 Foreign "project" assistance 14.8 1408 Local currency required to match the inflow of foreign "project" assis- tance 5.2 5.2 Deficit (-) or surplus of local currency resources - 1.0 - (a) Mission's estimate 1/ Excluding wheat grants - 39 - 128. As to the situation in the short run, however, the shortage of local currency finance will be, no doubt, very severe. This will be the case particularly during the rest of the current and next budget years. while work on big projects in road building started during the First Plan period is going on at full speed. The situation might ease in two years' time when expenditure on those projects will drop off, sizeable expenditure on new large projects will not have begun yet, and the Government adminis- tration will have adapted itself to the new taxation system. The Balance of Payments 129. There is no reliable estimate of the balance of payments position of Afghanistan. A tentative guess, the purpose of which is mainly illus- trative, is attempted below: Table 10. Approximate 1960/61 Balance of Payments Position ($ million) LRaports, f.o.b.: Commercial (including grants-in-aid) -103 Wheat - 4 Total ;107 Exports, f.o.b.: 51 Trade Balance - 56 Net invisibles (excluding foreign grants) - 14 Capital transactions (including errors and omissions) - 8 Deficit of Above - 78 Financed by: Wheat grant 4 Foreign loans 43 Foreign grants 22 Drawings of foreign exchange reserves 9 Source: Missionts estimate: the figures of exports and wheat imports are taken from the Ministry of Commerce estimate of foreign trade; disbursement of foreign loans and grants is a Ministry of Planning estimate, correc- ted to show eeparately wheat imports; net invisibles are assumed of the same order of magnitude estimated by Da Afghanistan Bank for 1959/60; the figures of drawings of foreign exchange reserve has been provided by Da Afghanistan Bank. - 4o - 130. The balance of payments deficit, estimated around $80 million, is a huge one for the Afghan economy. It shows that, without the massive amount of foreign aid which hes been disbursed over most of the First Plan Period, the Afghan Government would not have been in a position to carry on a sizeable development program. 131. The bulk of the inport surplus is, of course, accounted for by capital equipment and technical services related to the development program. Foreign assistance in the form of commodity aid was only a minor part of foreign aid extended to Afghanistan during the First Plan Period, slightly more then I,5 million in 1960/61 and perhaps less than that in 1961/62. The drawing on the country's foreign exchange reserves, which was very substan- tial in recent years, has been required in order to meet the country's foreign debt obligations. Export earnings have been almost enough to pay for consumer goods imports, and other invisibles and capital transactions. 132. Over the next five years a sizeable increase of exports may be reasonably expected. The exchange reform will stimulate production and exports of cotton, karakul pelts and wool. However, the effect of the foreign exchange reform on the country's balance of payments position has probably been over-estimated by the Afghan authorities. The main short-run effect of the reform will be the elimination of much of the smuggling now going on. This will undoubtedly benefit the Government budget, but is un- likely to affect the net balance of payments position too much. 133. In the longer run, production of export commodities will increase as higher prices are paid to producers. Increased production of karakul pelts End wool will probably take place in a relatively short period of time. But this will hardly be the case with cotton output. Since most of the increase in cotton production is expected through increases in produc- tivity, a longer period of time than the Government now forecasts will be needed to achieve this result. 134. At present, the Government forecasts additional export earnings totalling $90-$100 million over the whole Second Plan Period. This fore- cpst depends heavily on additional earnings from cotton exports, and therefore is to be considered rather optimistic. A lower figure of between $60 and $70 million would look more realistic. It has to be emphasized, however, that even this lower estimate would depend entirely on quick and efficient action to carry on the Ministry of Commerce program. 135. There is no way of guessing what the total level of imports over the next five years will be. The primitive structure of the economy and the low standards of consumption prevailing even among relatively wealthy people sugfest that consumer goods imports should not increase too quickly. They will grow somewhat, however, because of higher monetary incomes in the economy originating in the development program as well as in higher in- comes of exporters and producers of export commodities. - 41 - 136. Debt service is a source of major concern in assessing the balance of payments prospects of the country. Afghanistan will have to pay about $55 million in amortization and interest on foreign loans over the next five years. The annual debt service payment is rising quickly and will be very high by the end of the Second Plan and much higher shortly thereafter. The heavy burden imposed by debt service payments over the next five years may easily eat up over 20 per cent of the country's foreign exchange earnings over the same period. There is only little scope for drawing down further the gold and foreign exchange reserves to finance it. 137. According to Da Afghanistan Bank figures, the total amount of foreign exchange reserves (excluding the net position of bilateral accounts) dropped by $9 million during 1960/61, and by about $5.8 million in 1961/62. On top of that, net liabilities on bilateral accounts were $7.5 million on March 21, 1962, and went up to about $10.5 million by December 4, 1962. Afghanistan is now trying to renegotiate her trade deficit with the Communist countries. The total amount of reserves in convertible currencies was only $1.4 million on March 20, 1962. However, holdings of gold and silver, as recorded by Da Afghanistan Bank, were $48.9 million, as shown in the following table: Table 8 - Foreign Exchange Reserve Position ('; million) 1/ 2/ Gold - Silver Foreign Exchange 2 Total March 20, 1961 14.4 7.5 16.1 65.0 1arch 20, 1962 U1.b 7.5 7.1 56.0 March 20, 1963 1.b 7.5 1.3 50.2 1/ Including Afghanistan's capital subscription to IM (A5.6 million) and to IBRD (0.3 million) 2/ Includes small amounts of net assets or lia'ilities on Indian and Pakistan rupee accounts. Source: Da Afghanistan Bank 138. Excluding both the net liabilities on bilateral accounts and the capital subscription to the IMF and IBRD, the present level of gold and foreign exchange reserves would be about 3b million. They would cover about four months of the current level of imports, including foreign assistance, and seven months of the current level of non-development imports. Despite substantial drawings during the last three years, the level of Da Afghanistan Bank net foreign assets has certainly not reached a critical point yet. Nevertheless, the Afghan authorities are rightly concerned about - 42 - future prospects, particularly in view of the uncertainties as to the increase of foreign exchange earnings from exports, and of the heavy debt service payment schedule. They have, therefore, decided to ask for assist- ance from the IMF and are prepared to draw their gold tranche soon after the declaration of the par-value now set for March 22. 139. In conclusion, the balance of payments problem of the Second Plan is basically the question of whether the Government will be able to control the likely increase of imports of consumer goods and possibly curb it to make room for payments of debt service, which might be well needed if, for any reasons, foreign exchange earnings should not grow as much as expected. On the other hand, the amount of commodity aid that will probably be avail- able from foreign countries over the Second Plan period might not be enough to provide the necessary flexibility of the economy, and further drawings on the foreign exchange reserves might be required if revenue collection will be short of expectations and the Government would have to finance development expenditures by borrowing from the Da Afghanistan Bank in excess of what the current situation will permit. 140. With a sound fiscal policy and a successful drive to increase budget revenues, the Government should be able to succeed in balancing export earnings and payments for debt service and consumer goods imports, using commodity aid as an important element of flexibility more than as a steady source of finance. This target would not be too difficult to achieve in the present economic and internal political situation. But there are other aspects in the Afghan context that may make it a difficult job indeed. The limited number of good, efficient personnel available to help the fiscal authorities, the geographical nature of the country, which makes it all the more expensive to enforce a close control over movements across the borders, and the uncertainty over the future relations with Pakistan are some of the factors that may overcome the good will of the Afghan Government and its serious desire to put sound policy decisions into practical action. 141. The future of the balance of payments of Afghanistan, as well as that of the Government budget position, is subject to uncertainties which depend mainly, but not entirely, on the political relations with Pakistan. In recent years the Afghan Government has certainly shown its willingness to find a solution to most of the problems that are in the way of sound economic development and it may be expected that, if the political crisis with Pakistan will come to an end in a reasonable period of time, a Second Plan of the size of what is now envisaged on the basis of the likely avail- ability of foreign assistance will prove manageable. - 43 - Table 1 Summary of Government Finances (million Afs.) Fiscal Years: 1956/57 1957/58 1958/59 1959/60 1960/61 1961/62 eatual 4ctual actual actual actual provisionall actual Revenues 1,528 1,715 1,748 1,601 2,304 1,815 Expenditures 1 1,592 1,387 1,684 2,088 3,115 2,956 ordinary 1,089 1,014 1,264 1,373 1,566 1,606 development 503 374 421 715 1,550 1,350 Surplus or Deficit (-) - 64 327 63 -487 -812 1.,141 1/ Excluding foreign assistance. Source: Ministry of Finance Table 2 Money Supply (milliDn Afs.) 21st of month: 1336 1337 1138 1339 1340 1341 March '58 Harch '59 March '60 March '61 March'62 nov.'62 Banknotes issued/1, 2,259.8 2,339.9 2,339.8 2,399.8 3,009.8 3,9h9.& less: Banknotes in banks 486.1 679.2 647.2 406.9 429.4 810.8 Banknotes outside banks 1,773.7 1,660.7 1,792.6 1,992.9 2,620. 3,139.0 Treasury notes outside banks 4.3 4.3 4.3 4.3 4.3 4.3 Demand deposits of private sector/2 329.8 354.3 316.5 337.5) 590.0 Time deposits of private sector 203.4 123.6 137.8 214.9) Totals: (1) including time deposits 2,198.2 2,284.8 2,451.5 3,177.1 3,733.3 (2) excluding time deposits 1,994.8 2,161.2 2,313.7 2,962.2 3,473.3 Source: Da Afghanistan Bank /1 Revised series, excludes notes ithdrawn from circulation but not yet destroyed. /2 Afghani deposits of resident nationals and resident foreignerso - 45- TPble 3 Foreign Assistance to First Plan (March 1956 to September 1962) ($ million equivalent) U.S.A. Commitments Disbursements Carry-Over ICA loans 10.8 10.8 Eximbank loans 18.5 18.5 - Project grants 1/ 128.6 90.5 38.1 Wheat grants 38.5 31.8 2/ - Total USA 196.4 151.6 33.1 U.S.S.R. Loans for municipal development 1, 2, 3 5.8 5.8 - Economic development loan, 1 100.0 77.0 23.0 Oil exploration 15.0 13.5 1.5 Economic development grants n.a. 23.5 n.a. Wheat grants 9.5 9.5 Consumer good loan 12.0 26$ 9.5 Totpl USSR 160.3 136.8 34-o West Germany Economic development loan, 1 50.0 7.5 42.5 Czechoslovakia Industrial loans 5.0 5.0 GRAND TOTAL 300.9 3/ 1/ September 1956 through September 1962 2/ Part of PL 480 wheat shipments to Afghanistan has been wasted in the Karachi port warehouses during 1961 and 1962 when it could not be forwarded to Kabul as transit through the Pakistani border was stopped. 3/ The total amount of disbursement of foreign assistance as recorded in this teble differs by about $8.7 million from the figure shown in the, Ministry of Planning estimate of foreign loans and grants contribution to the government budget, 4,804.2 million Afs. (equivalent to $240.P million) for the First Plan period and $68.7 million for 1961/62. - 4 6 - Table 4 Estimpted Foreign Assistance to Second Five-Year Plan (eptember 1962 to Harch 1967) ($ million equivalent) Estimated Disbursement Disbursement of Undrawn Total New Commit- of New Balance of Old Disburse- USA 1/ ments Commitments Commitments ment Project grants - - 38.1 38.1 New project credits, say 100.0 70.0 2/ - 70.0 Commodity aid, say 50.0 50.0 - 50.0 Total USA 150.0 120.0 38.1 158.1 USSR Economic development, loan, 1 - - 23.0 23.0 Oil exploration - - 1.5 1.5 Economic development loan, 2 196.0 137.0 2/ - 137.0 Economic development loan, 3 20.0 20.0 - 20.0 Consumers goods loan - - 9.5 9.5 Total USSR 228.0 147.0 3h.0 191.0 West Germany Economic development loan, 1 - - 30.0 2/ 30.0 Others, say 20.0 14.0 2/ -1.0 GRAND TOTAL 440.5 281.0 102.1 393.1 1/ USA commodity aid would include some $25-30 million of wheat grants. Figures still very tentative: no firm commitment has been made. 2/ Assume a disbursement ratio of 70 percent. - 47 - Table 5 Estimated Debt Service (Amortization and Interest)(a) (In thousands of U.S. dollars) Year U.S.A. U.S.S.R. West Germany TOTAL 1962/63 4,022 2,467 337 6,826 1963/64 3,945 2,467 698 19,610 1964/65 3,869 2,217 698 6,780 1965/66 3,791 3,774 2,036 9,601 1966/67 3,713 6,287 2,036 12,036 1967/68 3,637 6,773 3,468 13,878 1968/69 3,560 7,042 4,041 14,643 1969/70 3,481 7,506 4,001 15,028 1970/71 3,404 7,506 4,655 15,565 1971/72 3,327 7,506 4,655 15,488 1972/73 3,248 10,525 4,655 18,428 (a) This table has been prepared on the basis of incomplete information on Afghan foreign debt. Debt servic6 has been calculated on the basis of somewhat arbitrary assumptions. Except for those relating to the U.S., therefore, debt service figures should be considered only an indication of the orders of magnitudes involved. 0 '00 m0 Kundu0 Tash-Ku gan "Cb MAZAR-E- SHAI Bcghlo- HERAT AU NYBER - PAss Gir.shk- Lashkor Gab AFGHANISTAN POPULATION OF CITIES ELEVATIONS IN FEET 0ve 250,000 Gilacter. About 100,000 0ve 15,000 B.1--10-3 0009000-15,000 EXISTING ROADS 5000-9000 Under 5000 FEBRUARY 1962 I¯ 1RD-953 o Sor0kand Stalinobad Highways completed or U. S.R. under construction - All-e.ther roads (gravel) ,-s---Mileage betw,een towons Railways 0 50 015-0 • le. T mez PF.a.od And1h1 akeo 0,A0tl to ~ ~ ~ ~ o Rol.d.S.o SMAAZRA. -E. tondaspoan S Tosh-Ku on undu Bogtooe dnilorne Po Pule-Khumri 0AL K.,hk S-.-Pul s.frrOA to SoottosopZushto N Gutbohar toMehe smOe ABsHAoghlu ss1 KABU -1c Pesh.war C2 to Mulmo Gr,4 AFGHANISTAN QL.OkorG oh ECONOMIC MAP i ofe0.h B.sI CEMENT FACTORIES COTTON GINNING PLANTS $ 40COTTON TEXTILES FACTORIES SPIn BUtd.khm WOIOLEN TEXTILE FACTORIES FRurT PROCESSING PLANTS SUGAR FACTOR.ES POWER PLANTS Outito nnds~:tructed during SedPa MANGULTIVATED AREAS fl Karah, LIKELY OlL-BEARING AREAS NATURAL GAS FIELDS JANUARY 1963 IBRD-95RI N)