Thu, Sep 9, 2021

Afghanistan’s economy under the Taliban: the challenges ahead

Blog Post by Inbar Pe'er

Afghanistan Economy & Business Financial Regulation Macroeconomics

In August 2021, Afghanistan succumbed to the Taliban at lightning speed. However, the new regime will soon be overrun by another foe: an economic crisis. In response to the Taliban takeover, the United States froze $9.5 billion in foreign reserves, Germany suspended $300 million in aid, and the International Monetary Fund (IMF) suspended $440 million in special drawing rights (SDR) allocation. The sum of this foreign aid made up 40% of Afghanistan’s gross domestic product (GDP). To make matters worse, the new government must also swim through a sea of pre-existing sanctions tied to the Taliban since 2001. The Taliban’s takeover was a challenge that pales in comparison to their next mission: governing during an economic crisis.

It is unclear whether the Taliban are up for the task. Afghanistan’s economy has transformed in the twenty years since the previous Taliban regime. According to the World Bank, Afghanistan’s GDP has almost quintupled between 2002 and 2020, jumping from $4 billion to $19.8 billion. This growth was driven by the influx of foreign aid into a highly centralized government. The international community flooded the weak, corrupt system with funds — both keeping the Afghan government afloat and preventing it from being held accountable to Afghan citizens. The Taliban takeover has cut off the flow of international aid and left the dysfunctional economy exposed.

Financial meltdown and the Taliban takeover

However, Afghanistan’s financial struggles began long before the Taliban’s takeover. The spectacular implosion of the Afghan government in August 2021 stemmed in part from pre-existing structural issues. The government of Afghanistan has long suffered from widespread corruption, exacerbated by its highly centralized fiscal system. Afghanistan’s 2004 constitution gave the president significant control over the country’s finances while virtually excluding local representatives from the budgeting process. Consequently, the budget was often unrepresentative of local needs and preferences, leading the Afghan people to believe it did not represent their will.

The implications of those frustrations became clear when the Afghan people’s dissatisfaction with their exclusion from the budgeting process contributed to a fiscal crisis on January 16, 2021. Barred from making decisions around the country’s budget until it was required for final approval, the Wolesi Jirga — the lower house of the Afghan National Assembly — rejected the Afghan government’s proposed national budget. It justified the rejection on the grounds that there was an unacceptable increase of the president’s already unchecked fiscal authority, and on the basis that the budget massively misappropriated funds.

Leading up to the Taliban blitz, this fiscal crisis left the government unable to pay its soldiers. Consequently, government forces went unpaid from December 2020. Jonathan Schroden, who served as an advisor to U.S. central command and the U.S. – led international force in Afghanistan, said the Afghan army was as much a “jobs program” as a fighting force “because it’s the source of a paycheck in a country where paychecks are hard to come by.” Given the choice between the Ghani government and the Taliban — who were capable of supplying funds where the government could not — many soldiers accepted the latter.

Indeed, the collapse of Afghanistan’s military started with a series of deals brokered in rural villages in which Taliban leaders offered compensation to government forces in exchange for surrender. In Afghanistan, troops are often loyal first to their village and family and secondarily to the central government. Purchasing loyalty is made easier in this context, but it is made all the more effortless when Afghanistan’s military leaders live luxurious lifestyles without paying their troops. Even without financial incentives from the Taliban, uncompensated soldiers were uncommitted to an Afghan government that seemed unconcerned with and incapable of providing for them.

Turbulent Tides

The previous regime’s foreign aid enabled corruption played a role in the Taliban takeover. But now, the Taliban has inherited the very predicament that buttressed its victory — and then some. There are two troubling macro-economic trends that the new government will have to manage if it wants to stave off a disastrous humanitarian crisis.

Currency crash

First, Afghanistan’s currency will decline and cause widespread inflation. As banks reopen, Afghans are rushing to convert afghanis into U.S. dollars, driving the value of the afghani down and pushing up prices of goods. Already, food prices have almost doubled and fuel prices have increased by 75 percent. Without the usual shipments of American dollars, Afghanistan’s banks may be emptied of cash in as little as three weeks.

The Taliban are unlikely to rely on the previous administration’s tactics to secure its citizens’ confidence and prevent a run on the banks. For example, under the previous administration, Afghanistan’s central bank would auction off $20 million U.S. dollars in cash on a weekly basis to prove the afghani’s stable worth relative to the dollar to the public. The Taliban will struggle to replicate such shrewd moves, due in part to their choice of personnel. The Islamist movement appointed senior member Mohammad Idris as the new acting governor of the central bank. Idris has no experience in finance or banking, which does not bode well for Afghanistan’s future financial policy.

Rather than relying on inexperienced appointees, the Taliban need financial and economic expertise to operate Afghanistan’s central banking system during the incoming crisis. They would be wise to listen to the advice of former Afghan finance minister, Omar Zakhilwal, who suggested appointing existing experienced civil servants to replace senior economic officials who fled the country. In the short term, such a move would help Afghanistan ward off an economic catastrophe. It could also indicate that the government is more responsive and inclusive than the previous regime, garnering long-term credibility.

With an inflationary spiral already set in motion, a crucial question remains. Has the Taliban changed the way they think about monetary policy? The answer will be as important to the regime’s survival as its supposed shift on women’s rights. Some early signs — such as their appointment for central bank governor — spell impending doom. Other indicators are more promising: Afghanistan’s banks have reopened as of August 25th, a Taliban spokesman proclaimed that all banking employees ought to return to their jobs, and Idris has placed a cash-withdrawal restriction on commercial banks. Moreover, the Taliban have promised that the Ministry of Finance would pay all of Afghanistan’s civil servants and met with bankers across Afghanistan to listen to their concerns. These indicators are promising because they demonstrate a Taliban willingness to work with experienced bankers and enact necessary monetary policy.

Spending Slump

Second, aggregate income will likely plummet due to decreased government revenue. 75% of public spending was previously funded by international grants. As this aid is revoked, government services will inevitably be cut, public employees will be laid off, and wages will fall. While the Taliban funded its insurgency operation from illegal mining and opium production, these revenue sources are not enough to operate a fully functional government. To circumvent the crisis, the new Taliban government must quickly determine additional sources of funding.

The ability for regimes to survive under heavy sanctions and Western financial freezes is not without precedent — consider Iran, where the current regime has survived crippling sanctions for over four decades. In Afghanistan’s case, there has also been speculation about China filling the void left by the U.S. withdrawal and investing in the region. But Chinese investments are far from guaranteed. China has been burned by similar situations in the past and is unlikely to increase its investment until the Taliban proves itself stable. Moreover, even if China, Russia, and Pakistan all invest large sums, their investment would not replace the combined financial firepower of the main bilateral and multilateral international actors including the U.S., E.U., and  IMF. Gaining access to these revenue sources will require a long negotiation process the Taliban and the people of Afghanistan cannot afford.

Still, the financial pressure exerted by the West may not levy the pressure it is intended to. The Taliban have already proved themselves to be expert tax collectors by raising far more than the Afghan government in areas under their control. Their ability to effectively enforce rules and regulations allows them to tap into Afghanistan’s illicit economy, which “accounts for a significant share of production, exports, and employment,” according to the World Bank. Indeed, some analysts have suggested that Taliban control of trade routes serving as strategic choke points for the flow of goods across South Asia will provide the group with sufficient revenue. In Nimruz province, for example, the Taliban’s collection of fees to allow safe passage of goods raised $235 million annually, as compared to the $20 million a year the province received in foreign aid. Nimruz is just the tip of the iceberg. When provinces are examined in depth, potential profit from undeclared trade dwarfs international aid. Given the paucity of data, it is unclear whether trends observed on a provincial level can be magnified. Still, the Taliban’s track record suggests that they will likely pursue this source of revenue. With strong economic pressure for bordering countries to reopen lucrative commercial traffic, they may be in luck.

Deriving funding from an informal economy is not a sustainable government practice. But neither was the previous administration’s corruption and reliance on foreign aid. The Taliban may actually benefit from its less technocratic approach to the economy because it could become more responsive to individual provinces. If the Taliban is financially reliant on its control over land, it might be forced to maintain the support of local tribes instead of alienating them from the governing process. If the Taliban can weather the brewing economic storm by strengthening relationships with individual provinces, it might also break the cycle of over-centralization that has been a key feature of Afghan regimes since the 1880s.

Afghanistan’s future remains unclear, but one thing is certain: money matters. The Taliban have proven they understand this simple truth. If their past is any indication of the future, the Taliban will find funds. But their ability to properly manage monetary policy remains to be seen. If they don’t, they’ll surely lose the economic war — and the people of Afghanistan along with it.

Inbar Pe’er is a consultant to the Atlantic Council’s GeoEconomics Center. She is also a program coordinator at the Saltzman Institute of War and Peace Studies at the School of International and Public Affairs at Columbia University.

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