Despite Daunting Economic Headwinds, Afghan Private Sector Shows Signs of Life

But the broader headwinds facing the macro-economy remain formidable. The continuing impacts of the shocks stemming from the August 2021 Taliban takeover — most notably the abrupt cut-off of development aid and security assistance — have been compounded by the Taliban’s rigorously enforced ban on poppy cultivation, declining humanitarian aid, and compulsory return of many Afghans from Pakistan.

Business Activities in Afghanistan

The stirring of the Afghan private sector was evident at a private sector conference in Istanbul on March 4, organized by the Afghan-American Chamber of Commerce and joined by USIP, and at individual meetings with Afghan business leaders there and subsequently in Dubai.

• The Taliban are reporting new business creation in Helmand, where some 67 manufacturing firms — mostly in agro-processing — are said to have started operations in the past three years, along with similar reports from some other provinces. At a broader level, the number of private enterprises surveyed by the World Bank that reported being fully operational rose from 28 percent in May-June 2022 to 57 percent in March 2023, with 31 percent of firms in the subsample that responded to both surveys reporting their operating status had improved versus 16 percent reporting a decline.
• The sole remaining Afghan private airline, Kam Air, has an expanding fleet of 12 aircraft with commercial flights operating among four Afghan cities and between Afghanistan and Dubai, Istanbul, Delhi and other regional cities. Several foreign airlines have resumed scheduled international flights to Kabul.
• The Taliban retendered and awarded to a Chinese company the major Amu Darya oilfields project, with production reported to have started up. There are also reports that small-scale oil refineries are back in operation, using locally extracted crude oil purchased by the Taliban and then auctioned to refiners.
• The Taliban have contracted three sizable cement projects, two with Afghan companies and one with a Qatari investor, with a reported total investment of $450 million. This presages significant progress toward self-sufficiency in a sector where it eminently makes sense given Afghanistan’s resource base and the high cost of transporting cement long distances from neighboring countries. The contrast with the previous government, which could not get major cement investments going due to a variety of reasons, one being corruption, is striking.
• Numerous mining contracts have been issued, though many of them may be simply validating and taxing ongoing activities while the prognosis for large new projects is uncertain. There is clearly considerable ongoing activity in smaller-scale extraction of resources such as coal, talc, chromite, dimension stones, gemstones and lithium, the latter including at least for a time involvement of Chinese entrepreneurs.

On the international side, some larger Chinese companies appear to be expressing interest in the mining sector and infrastructure, and there are even a few U.S. and European businesses operating in Afghanistan. For example, a California-based telecom services company is actively supporting a major Afghan mobile phone company.

The World Bank’s Approach 3.0, announced in February, modestly expands the Bank’s engagement with Afghanistan, while maintaining its “principled approach” embodied in Approach 2.0, which is intended to ensure participation of women and girls in bank-financed projects. Approach 3.0 authorizes: (1) resumption of World Bank International Development Association (IDA) grants to Afghanistan, which had been stopped since August 2021, to complement continuing funding by the Afghanistan Resilience Trust Fund (ARTF); (2) completion of the $1.2 billion CASA-1000 project to transmit electricity from the Kyrgyz Republic and Tajikistan through Afghanistan to Pakistan; (3) bank staff to engage in technical meetings with senior Taliban officials; and (4) financing of small and medium-sized private Afghan businesses by the World Bank, including a recently approved microfinance project, and its private sector arm, the International Finance Corporation (IFC).

Afghan Economic Doldrums

Despite these positive signals, private sector activity along with Taliban business promotion is running up against the formidable challenges faced by the Afghan economy as a whole, enumerated above: plummeting humanitarian aid, the Taliban’s opium ban and the last year’s forced repatriation of Afghans from Pakistan (which appears to be resuming after a pause). These new shocks are reverberating atop those stemming from the August 2021 Taliban takeover — loss of more than $8 billion a year of civilian and security aid, the run on Afghan banks, freezing of some $9 billion of Afghan central bank assets in the U.S. and elsewhere and the stoppage of financial transactions with foreign banks, among other things.

The impact of all these shocks on aggregate demand in the economy, and on Afghans’ incomes, has been dramatic. GDP declined by more than a quarter in 2021 and 2022 and there is no sign of significant recovery in 2023, nor on the horizon in 2024 and beyond. According to the World Bank’s Afghanistan Welfare Monitoring Survey, the unemployment rate among surveyed households was close to 20 percent as of April-June 2023, and there is no reason to believe that more recent trends will be any better.

A striking symptom of low demand and lack of purchasing power in the country is the ongoing economy-wide price deflation. Headline inflation (year-on-year) started to decline in mid-2022, went below zero about a third of the way through 2023, and since then has been negative — reaching nearly minus 10 percent as of February 2024. These kinds of price declines are only seen in countries facing a deep economic recession, such as the U.S. Great Depression in the early 1930s when prices declined by 25 percent between 1929 and 1933. Mirroring these price declines is the appreciation of the exchange rate of the afghani by 20 percent vis-à-vis the U.S. dollar, which discourages exports and encourages imports — the opposite of what is needed given Afghanistan’s large trade deficit which calls for higher exports and lower imports.

What To Do?

Afghanistan’s economy will remain weak for the foreseeable future despite private sector activity and business interest in some projects. It would require major, unlikely actions to change this bleak picture.

On the Taliban side, reversing or at least mitigating their restrictions against female education and women working would, in addition to its direct benefits for Afghanistan’s economy and development, help loosen restrictions affecting international financial transactions and economic relations. And at least a de facto relaxation of the Taliban’s problematic, unsustainable opium poppy cultivation ban would restore part of the more than $1 billion a year in rural small farmers’ and wage laborers’ incomes that have been lost. Unfortunately, major changes like these do not appear to be on the cards.

Short of such game-changers, the Taliban administration should reverse recent price deflation and ensure that the Afghani exchange rate is not too strong. Reducing the amounts of U.S. dollars sold by the Central Bank at foreign currency auctions, and moderately increasing the printing and circulation of afghani banknotes, is the correct macro policy stance and would at least stop worsening the recession.

Second, avoid overtaxing the private sector. The regime has been successful in mobilizing tax revenue, especially customs receipts. However, actually collecting all the taxes on the books, which the previous government did not exploit due to lax effort and widespread corruption, would impose too heavy a burden on the private sector and further dampen economic activity. The Taliban should review of the existing panoply of taxes, simplify by abolishing duplicate and excessive taxes, and not impose new levies.

What can foreign donors and international agencies do? Absent unlikely changes in policies such as formal recognition of the Taliban government or the outright removal of sanctions, international actors can mitigate the economic headwinds by:

• Slowing and making more predictable the inevitable decline in humanitarian aid while increasing basic development assistance to the maximum extent possible (including newly authorized World Bank assistance under Approach 3.0);
• Maximizing the effectiveness of aid and its benefits for the economy and private sector by prioritizing local procurement from Afghan companies while moving away from importing goods that can be produced in Afghanistan and aid agencies importing goods on their own account;
• Reducing over time the U.N. humanitarian cash shipments, which are high-cost, risky, and optics-wise problematic, and gradually replacing them with a combination of normal banking transactions, swap arrangements, and use of digital currency and e-money;
• Exploiting the authorization for the World Bank and IFC to provide financing directly to Afghan private businesses, and encouraging other aid agencies to do the same (funding well-vetted Afghan private companies is no more risky and probably less risky than other forms of aid);
• Engaging with Taliban officials on technical macroeconomic policy issues by the World Bank (permitted under Approach 3.0) — in particular to encourage the authorities to shift to more expansionary monetary and exchange rate policies; and
• Getting international authorization and facilitation — if necessary — to arrange manufacture and circulation of more afghani banknotes to increase the money supply moderately.

Regional countries should facilitate — not block — trade between Afghanistan and its neighbors. Border closures should be avoided and not used for political leverage. Business travel and contacts should be encouraged, building on earlier initiatives. Large-scale deportations of Afghans by neighboring countries need to stop. Beyond their humanitarian consequences, they are economically harmful — especially for Afghanistan but also for neighboring economies, which make use of Afghan labor, and potentially damaging as well for regional security.

From a longer-term perspective, Afghanistan will need to make more and better use of its water resources, for both irrigation and hydroelectric power, which in turn will support the private sector in agriculture, agri-business and other activities. This will require cooperation by regional countries and receptivity to fair water sharing agreements and mutually beneficial water conservancy projects, which can regulate water flows as well as provide electricity to multiple countries.

What can Afghan businesses do? Though the Afghan private sector can sometimes be effective in pursuing narrow commercial issues such as tax relief, it seems unable to engage in effective collective action in furtherance of broader economic goals, let alone to pursue changes in social policies.

Sizable businesses with ongoing activities in Afghanistan should strive to stay in operation, even if there are no prospects for expansion in the short run. They should proactively seek, as appropriate, contracts with the aid community to provide imported and, increasingly, domestically produced goods and services, which will foster private sector development and improve aid effectiveness.

Sizable and successful Afghan businesses based in neighboring countries should not lose interest in Afghanistan, and they may be able to support exports of Afghan agricultural and processed goods and enhancing their value chains, as well as investing in import substitution.

The large amounts of Afghan expatriate financial capital in nearby countries may become available to augment the leverage of IFC and other international financing, which is now authorized and hopefully will materialize in the future.

There are no “silver bullets” that will revive Afghanistan’s economy, let alone stimulate the robust economic growth that is essential for national development. But taken together, the above actions by the key stakeholders will make a difference. They can mitigate the weakness of the country’s economy and help promote critically needed economic stability.