EXECUTIVE SUMMARY
i. Afghanistan's reconstruction has
made considerable progress during the past four years. Led by the Government
with international support but relying most on the energy and initiative
of the Afghan people, reconstruction has resulted in solid achievements
- rapid economic growth, unprecedented primary school enrollments including
for girls, great expansion of immunization, rehabilitation of major highways,
a new and stable currency, promulgation of a new Constitution, Presidential
and Parliamentary elections, return of refugees, and demobilization of
militias. Public Finance Management (PFM) has made a major contribution
to these successes. Yet the challenges remain enormous.
ii. The main objective of the Afghanistan PFM Review, conducted by the World Bank and partner agencies in close cooperation with the Government of Afghanistan, is to consolidate, deepen, and present in an accessible, action-oriented form the knowledge base on Afghanistan's public finance system, review recent progress, analyze key challenges, and put forward options and recommendations for moving forward. This main report is supplemented by four additional volumes, covering PFM performance and procurement (Volume II); key cross-cutting issues (Volume III); selected sector studies (Volume IV); and security sector expenditures (Volume V).
PUBLIC FINANCE MANAGEMENT AND AFGHANISTAN'S DEVELOPMENT
iii. Fiscal structure and trends. Afghanistan has an unusual fiscal structure reflecting its historical legacy (e.g. traditionally low revenue mobilization), the long period of conflict (e.g. civil service wages greatly eroded and compressed by hyperinflation), and current reconstruction activities (very high spending) and priorities (e.g. massive expenditures on security). More specifically:
- Public expenditures are extraordinarily high; total budgetary expenditures in 2004/05 were equivalent to 57% of GDP (excluding the drug economy).
- This is accounted for by extremely high development spending; unlike in most countries, the development budget ($2.8 billion in 2004/05) dwarfs the operating budget ($0.6 billion).
- Operating expenditures (9% of GDP in 2004/05) are well within international patterns.
- There are however large recurrent expenditures in the development budget, including health services, technical assistance, salary payments, and grants, among others.
- There is substantial underspending on non-wage operation and maintenance (O&M).
- Most spending (three quarters in 2004/05) occurs outside Government channels and oversight through the External Budget (as opposed to the Government-controlled Core Budget).
- The security sector (39% of total expenditures in 2004/05) is a major driver of spending.
- A disproportionate share of public spending occurs in Kabul (e.g. 70% of non-wage O&M).
- Domestic revenues (5% of GDP) are very low (likely the lowest ratio in the world for a sizable country) and pay for only about 8% of total expenditures.
- The fiscal deficit is extremely high and entirely financed by aid, mostly grants.
iv. Turning to fiscal trends since 2001/02, (i) budgetary expenditures have increased sharply during 2002/03 to 2004/05, with operating expenditures almost doubling and development spending growing even faster; (ii) revenues also have risen rapidly, more than doubling during the same period; (iii) since revenues started out from a much lower base, the absolute gap between recurrent spending and revenues more than tripled; (iv) this means that external financing of recurrent expenditures has been a fast-growing component of the budget; (v) the budget deficit (before grants) has increased sharply, reflecting large inflows of external assistance predominantly on a grant basis; and finally, (vi) actual development expenditures (in both core and external budgets) have fallen far short of budget targets (reflecting past inclusion of unfunded projects in the development budget, confusion in some cases between commitments and disbursements, overly optimistic projections of disbursements, insufficient project screening, large contingencies in the original budget, and implementation constraints).
v. Contribution of PFM to Afghanistan's development. Public finance has played and will continue to play a critical role contributing to economic stability, state-building, growth, and poverty reduction, including in particular enabling Government to perform effectively and deliver public services to the Afghan people (Chapter 1). To support these objectives, public finances must be: (i) affordable; (ii) well-prioritized in accordance with the national strategy; (iii) efficient in terms of value for money and service delivery; and (iv) fair, accountable, and transparently reported to the Afghan public, private business, and other stakeholders. On the negative side, weaknesses in public finance can enormously harm development. Poor fiscal management can result in hyperinflation (as occurred in Afghanistan in the 1990s). Failure to prioritize spending among programs or problems in budget execution (payments, procurement, accounting, etc.) can result in waste of resources and poor value for money. And lack of accountability and transparency can result in corruption and loss of public support. This is an area of serious concern for many Afghans; there are widespread allegations of various kinds of corruption, including massive corruption associated with the drug industry as well as petty corruption.
vi. Facing a difficult post-conflict situation, Afghanistan has achieved remarkable progress on the fiscal front. Despite pressures, fiscal discipline has been strictly enforced and maintained, notably through control over the Government wage bill. This has been the essential ingredient of macroeconomic stability. Domestic revenues have increased substantially, growing at an average annual rate of 60% per year during 2002/03-2004/05 and rising from 3.2% of GDP to 4.5% in this period. Major efforts have been made to improve the budget process, and it has come a long way since the first post-Taliban budget of 2002/03. Budget execution also has greatly improved in many respects - not least, most civil servants are now being paid, on time. Finally, the Government has made a strong commitment to financial transparency and accountability, resulting in improving fiduciary performance. There have also been institutional improvements and capacity development, especially in the Ministry of Finance (MoF). These achievements have provided confidence to donors resulting in mobilization of high levels of external support for the national budget, mainly through the Afghanistan Reconstruction Trust Fund (ARTF) which finances most of the civilian recurrent budget. These achievements are commendable compared to experience in other post-conflict countries. However, improvements have been to a large extent dependent on external capacity brought in on an "emergency" basis to get things going. The shift from this situation to sustainable core Government capacity for key public finance functions has barely begun for the most part, and there are also daunting weaknesses in PFM capacity in the line ministries.
vii. PFM performance measurement framework and assessment. As discussed in Chapter 2, a PFM performance rating system has been recently developed by the Public Expenditure and Financial Accountability (PEFA) multi-agency partnership program (including the World Bank, IMF, EC, and a number of other agencies). It is intended to provide an objective, internationally comparable framework for assessing the performance of a country's PFM system. This does not attempt to measure fiscal outcomes, the substantive appropriateness of public expenditure policies and decisions, or the actual impacts and value for money achieved through public expenditures. The PFM performance measurement framework instead should be seen as assessing the PFM system, which is a crucial enabling factor for achieving broader development goals and substantive outcomes. Structured around six core dimensions of PFM performance (budget credibility; comprehensiveness and transparency; policy-based budgeting; predictability and control in budget execution; accounting, recording, and reporting; and external scrutiny and audit), the framework includes 28 high-level PFM performance indicators and three indicators of donors' performance. The performance of Afghanistan's PFM system against this framework as of June 2005 has been assessed as part of the PFM Review (see Table 2.1).
viii. This assessment generally portrays a public sector where financial resources are, by and large, being used for their intended purposes as authorized by a budget which is processed with transparency and has contributed to aggregate fiscal discipline. The expenditures and financial position of the Government are reported regularly in an understandable format. Performance regarding the allocation of spending across programs and agencies and the efficiency of operations is not as good, however. Given that the starting point in 2001 was extremely weak, this is overall a remarkable achievement - yet pointing to the need for further progress. Using these ratings as a baseline, future progress in improving the performance of the PFM system can be monitored. However, measurable progress in terms of changes in ratings is more likely to occur over periods of a year or longer than on a short-term basis. Moreover, since the ratings assess the system's current performance with external support (both advisory and operational), questions arise about sustainability. Further improvements in many cases may be manifested not in higher ratings but rather in maintenance of current ratings based on sustainable national capacity and with declining levels of external support. The ratings also provide an assessment for the donor community of the potential capacity of Government systems (currently supported by external assistance) to implement the operations which are now occurring outside Government systems.
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