FINANCIAL PROBLEMS IN AFGHANISTAN

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP79T01003A002300180001-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 13
• Document Creation Date: December 12, 2016
• Document Release Date: January 31, 2002
• Sequence Number: 1
• Publication Date: August 1, 1965
• Content Type: BRIEF

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DIRECTORATE OF INTELLIGENCE
Office of -Research and Reports
SECRET dsclassification
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This material contains information affecting
the National Defense of the United States
within. the meaning of the espionage laws,
Title 18, USC, Secs. 793 and 794, the trans-
mission or revelation of which in any manner
to an unauthorized person is prohibited by law.
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FINANCIAL PROBLEMS IN AFGHANISTAN
Increased foreign assistance has, for the present at least, enabled
Afghanistan to overcome an emerging financial crisis. During the past
fiscal year (21 March 1964 - 20 March 1965), * convertible foreign ex-
change reserves declined about 15 percent to $9. 5 million, the annual
budgetary deficit was 100 percent higher than expected, prices of
several key domestic commodities increased rapidly, and the value of
the afghani depreciated steadily. In response to this developing crisis,
the International Monetary Fund (IMF) extended a standby credit of
$6. 75 million; the USSR deferred for 27 years repayments on $16.5 mil-
lion of a 1956 credit; the US extended additional commodity aid of $5 mil-
lion; and West Germany probably will expand its commodity aid program
by $2. 5 million.
The generosity of aid donors assures the government of Afghanistan
temporary relief from the recent large budgetary deficit and the resultant
inflation. It is estimated that the increase in government revenue re-
sulting from foreign aid during Fiscal Year (FY) 1966 will almost cover
the budgetary deficit. In the latest agreement with the IMF, Afghanistan
reluctantly accepted a number of stringent financial reform measures
designed to promote greater monetary stability. Based on Afghanistan's
past record in this respect, however, it is doubtful that these measures
will be effectively implemented and enforced. The easing of financial
pressure resulting from increased aid, along with the government's
desire to avoid the adverse domestic political reactions that normally
accompany tax increases and reduced government expenditures, will
tend to deter the implementation of needed reform measures.
1. Background
Afghanistan's latest financial problems stem from excessive
deficit spending over a 6-year period by the central government.
The FY 1965 deficit, originally projected at 500 million afghanis,
totaled about 1, 000 million afghanis, nearly equaling the 1, 056 mullion
peak of FY 1963 (see Table 1). The FY 1965 deficit was the product
of a continuation of a more rapid increase in expenditures than in
revenues. Military expenditures during FY 1965 increased by nearly
25 percent, and government expenditures increased significantly as
employees received a substantial pay raise. In addition, there was no
Until 1961 the Afghan fiscal year was 1 October - 30 September. In
1961 a fiscal half-year (1 October 1961 - 20 March 1962) was introduced.
Since 1962 the current fiscal year has been in effect.
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perceptible decline in expenditures on economic development. At the
same time, failure to implement minimal tax reforms continued to
retard growth in revenues.
Large-scale deficits of recent years, financed by governmental
borrowing from the central bank, have led to excessive monetary
expansion. Between March 1961 and March 1965 the supply of money
more than doubled, increasing at an average annual rate of about
20 percent, while the rate of growth in production was negligible. 1/
As a result, prices have risen rapidly. During the last 2 years, the
prices of two major food staples, wheat flour and rice, each increased
by more than 60 percent. 2/ In spite of the inflationary trends, there
has been a continued hoarding of local currency. The hoarding and the
substantial increases in imports paid for in hard currency served to
hold prices down somewhat. Current inflationary pressures undoubtedly
would be accelerated in the event of a loss. of confidence in the Afghani
or a cutback in imports.
There has been a steady increase in the free-market foreign
exchange rate as compared to the official rate, reflecting an increased
demand for convertible foreign exchange. * Since the afghani was de-
valued in March 1963, the government has unsuccessfully attempted
to maintain the free rate close to the official rate through open market
sales of foreign exchange. *' Such sales amounted to $9 million during
FY 1964 and $4 million during the first half of FY 1965
Nevertheless, the free rate has continued to
rise, and by June 196-5--it was about 64 percent above the official rate
(see Table 2).
* The free market rate, commonly known as the bazaar rate, is the
rate at which foreign currency is exchanged freely in the open market
and reflects primarily the demand for dollars and pounds sterling,
since Bloc trade is carried out in nonconvertible clearing account
dollars. The other foreign exchange rate maintained in Afghanistan
is the official rate, which is used for government imports and certain
exports -- including the major hard currency exports, karakul and
wool. Since the foreign exchange earnings from official exports of
karakul and wool have to be exchanged at the official rate, the existence
of a free rate that is considerably higher than the official rate tends to
promote illegal exports.
** In these open market transactions the government sells foreign ex-
change through the central bank at a rate that is higher than the official
rate and lower than the free market rate.
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Foreign exchange difficulties during FY 1965 have been further
aggravated by a drop in official exports paid for in hard currency as
a result of bad weather and weak prices in the international market.
Simultaneously, imports paid for in hard currency have increased.
During the first 11 months, of FY 1965, Afghanistan's receipts of
hard currency were only $8. 3 million, :compared with about $17. 5 mil-
lion in each of the 2 previous years, whereas hard currency payments
for imports rose from $38 million in FY 1964 to $45 million in FY
1965. 4/ Since March 1963, despite drawings of $11, 3 million in
foreign exchange from the IMF (excluding the most recent credit),
Afghan convertible foreign exchange reserves have declined from
about $10. 2 million to $9. 5 million in March 1965, with the net gold
and foreign exchange position declining from $45. 2 million to $40. 3
million. 5/
The combination of excessive deficit financing, domestic inflation,
and dwindling foreign exchange reserves has generated considerable
anxiety in the Afghan government. A similar financial crisis con-
tributed to the resignation of Prime Minister Daud in March 1963,
when the present Yusuf government assumed office. At that time
the present government gained temporary respite by the reopening
of the Pakistan-Afghanistan border and the devaluing of the afghani,
but it did not make any significant effort to eliminate budgetary
deficits, the fundamental cause of monetary instability.
Foreign Aid
To overcome the developing financial crisis, Afghanistan had
either to obtain an increase in foreign aid or to draw down its foreign
exchange reserves still further. The USSR responded to Afghan
appeals for increased aid by tentatively agreeing to defer for 27 years
repayments on $16. 5 million of a 1956 credit, but the US and West
Germany withheld additional assistance until Afghanistan agreed to
adopt the financial reforms demanded by the IMF in their proposed
standby credit agreement. After the $6. 75 million IMF standby
agreement was signed in May, the US agreed to provide additional
PL 480 commodity aid of 150, 000 tons of wheat valued at $5 million,
and West Germany probably will extend additional commodity aid
valued at $2. 5 million. 6/ This additional assistance, together with
increased utilization of aid under existing programs, will provide the
equivalent of nearly 900 million afghanis (more than 20 percent of total
domestic revenue projected for FY 1966) and will almost cover the
budgetary deficit.
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3. Prospects
Afghanistan's prospects of attaining long-run internal monetary
stability are not bright. It is doubtful that revenues can be increased
significantly because the fundamental task is the attainment of more
efficient and less corrupt tax administration along with tax increases.
It will be almost impossible to hold expenditures constant, given the
extreme reluctance to cut development spending and the tendency for
ordinary expenditures to increase as more and more development
projects are completed. In addition to the limit on expenditures, it
will be necessary to carry out further financial reforms and to re-
direct investment to projects with more rapid payoffs. Necessary
reforms would include a reduction in development expenditures and
a greater willingness to restrain general governmental expenditures.
Although it is probable that during FY 1966 revenues will be lower
and expenditures higher than projected, the limit on governmental
borrowing from the central bank probably will not be exceeded, and
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as a result inflationary pressures will be somewhat eased. This,
however, will not necessarily be an indication that significant improve-
ment has been made in balancing domestic revenues and expenditures
but rather will be a reflection of the generosity of aid donors. During
FY 1966 the increase in revenue from foreign aid is estimated at nearly
900 million afghanis, compared with a deficit of 1, 0 billion during
FY 1965. As a result, the Afghans could keep domestic revenues at
the FY 1965 level, increase expenditures by 200 million afghanis, and
still adhere to the IMF limit on borrowing from the central bank. This
is similar to the situation in March 1963 and July 1964, when the
Afghan government, faced with serious monetary problems, agreed
to implement IMF fiscal reforms designed to reduce expenditures and
increase revenues, and in return to receive additional foreign aid.. In
each instance, once the pressure was off, the Afghan government failed
to implement completely the reform measures which would have been
accompanied by adverse domestic reactions. Thus it appears that;
current foreign aid will have the effect of alleviating financial problems
during FY 1966 but, by again reducing the pressure on the Afghan
government, may retard the implementation of measures necessary
for long-run monetary equilibrium.
* Excluding the Soviet deferral of loan repayments, which will allow
the Afghans to reduce debt service payments during FY 1966 by
220 million afghanis.
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Afghanistan: Estimated Government Budget
Fiscal Years, 1960-65 J
Million Afghanis
1960
1961
1963
1964
1965
099
2
108
3
1
3,876
4,300
Total expenditures
,
,
Ordinary
1,394
1,558
1,849
2,272
4
6
N.A.
N
A
Development
705
1,550
1,442
0
1,
.
.
714
1
2
303
2,235
3,320
3,300
Total revenues
,
,
of which:
Afghanis generated
4
0
205
625
390
by commodity aid b/
7
3
39
Deficit
-385
-804
-1,056
-556
-1,000
a, 7 Until 19 1 the Afghan fiscal year was 1 October - 30 Septem-
ber. In 1961 a fiscal half-year (1 October - 20 March) was introduced.
Since 1962 the fiscal year has been 21 March - 20 March. The fiscal
half-year is omitted in this table.
b. Excluding all other foreign aid because it cannot be expressed
realistically in afghanis.
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Afghanistan: Official and Bazaar Exchange Rate a/
Fiscal Years, 1962-66
Afghanis Per US $
Bazaar
1962
20
45
1963 /
20
56
1964 b/
45
51
1965
June
45
59
September
45
62
December
45
66
1966
March
45
'75
June
45
74
a. 9
b. As of 20 March.
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.17 August 1965
MEMORANDUM FOR: Chief, Dissemination Control Branch, DD/CR
FROM , Acting Chief, Publications Staff, ORE
SUBJECT Transmittal of Material
It is requested that the attached copies of CIA RR CB
Problems in Af har,istsn u 'ust ],~ 65-45; rinaxic~ial
g ' 5, Secret, be forwarded as fol1owJ3
State, INR Communications Center,
Room 6527, State Dept. Bldg.
Suggested distribution for
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Cairo,. Kabul, Karachi, New Delhi,
and Tehran
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Attachments:
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BY:`9z
Date:,,.,--'e
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