KEY TAKEAWAYS
KEY TAKEAWAYS
Afghanistan’s precarious economy is facing a new set of multidimensional risks as humanitarian aid — delivered in massive shipments of U.S. cash dollars — shrinks rapidly amid competing demands from other crises around the world. The dollar inflows, moved under U.N. auspices, have helped stabilize the Afghan economy, cover its mammoth trade deficit, and inject monetary liquidity into commerce. With much smaller cash infusions, in line with a general reduction in aid, the suffering of Afghanistan’s poverty-stricken population is likely to increase.
Minimizing the potential economic damage will demand sound macroeconomic management by the Taliban regime. Among other measures, the country’s economic policymakers will need to organize a gradual depreciation of the excessively strong exchange rate and ensure that there are adequate amounts of Afghani currency notes in circulation.
Despite strongly disapproving of the Taliban's destructive policies on gender, other countries and international agencies can play a supportive role by facilitating production of more Afghani banknotes as needed and allowing investment income from the Afghan Fund in Switzerland (comprising part of Afghanistan's frozen foreign exchange reserves) to be used for macroeconomic stabilization. This can be done without turning any funds directly over to the Taliban.
Other countries and international agencies can play a supportive role … without turning any funds directly over to the Taliban.
How did Afghanistan arrive at this point?
After the severe economic shock that accompanied the final withdrawal of U.S. troops and the Taliban’s takeover in August 2021, international humanitarian aid ramped up and helped stem a months-long economic freefall. Humanitarian aid funding totaled $3.8 billion in 2022.
With normal international financial transactions blocked and some $9 billion of Afghan central bank reserves frozen after the American pullout, much of the aid had to be delivered in shipments of U.S. cash to a private Afghan bank. The bank, in turn, made the funds available to U.N. and other aid agencies to run their programs, pay salaries and distribute assistance. The cash shipments totaled $1.8 billion from December 2021 through 2022.
From a macroeconomic perspective, the deliveries replaced pre-2021 Afghan central bank (Da Afghanistan Bank, or DAB) imports of U.S. cash of a similar size. But serious technical and programmatic problems are associated with the cash shipments, including high costs from fees and overhead charged at each stage and risks that include potential security failures.
Previous advocacy for a gradual, pre-programmed reduction in humanitarian aid was belied by a sharp drop in assistance after 2022. Funding fell by half in 2023 to $1.9 billion and remains low this year, having reached only $1.2 billion by mid-November. By all indications, the U.N. cash shipments remained high last year, reflecting the pipeline of undisbursed assistance and the lag time between funding commitments for aid and actual delivery. But their level is falling now, probably by at least half in line with the decline in overall aid.
Various observers as well as this author have expressed concerns that the waning of cash injections, which have financed part of Afghanistan’s large official trade deficit, will destabilize the economy. The balance of payments issue is only part of the story, however; U.N. cash shipments also play an important monetary role.
Key features of the situation:
These economic characteristics leave U.S. cash comprising a core part of Afghanistan’s money supply and providing the liquidity needed to lubricate business and personal transactions. Indeed, the injections of U.N. cash shipments are akin to a central bank augmenting the money supply. Especially in the kind of recessionary situation Afghanistan finds itself, a too-constrained money supply is likely to exacerbate the economic downturn and may result in harmful deflation (i.e. price declines), which Afghanistan has been experiencing.
The U.N. cash shipments also have supported the exchange rate. In particular, DAB from time to time conducts foreign currency auctions — selling U.S. dollars that have accrued to it indirectly from the U.N. shipments — in exchange for Afghani currency. By injecting dollars and removing Afghanis from circulation, these auctions strengthen the exchange rate (the Afghani appreciated by some 25 percent against the U.S. dollar in the three years since the Taliban takeover, with some further appreciation since then).
The normal policy response to the balance of payments shock from declining humanitarian aid and U.N. cash shipments would be a gradual depreciation of the Afghani currency. That would help balance the demand and supply of foreign exchange while potentially stimulating exports and curbing imports by making both more expensive when valued in domestic currency.
A managed depreciation could be brought about by reducing the amounts and/or frequency of DAB’s foreign currency auctions. If that results in excess dollars, accumulating them as in-country dollar reserves in DAB would be beneficial for macroeconomic management in the future. However, this will be challenging to manage if DAB does not have U.S. dollars in vault to flexibly deploy in foreign currency auctions to ensure a steady, gradual depreciation.
It is crazy to let the vagaries of humanitarian aid and the ups and downs of the U.N. cash shipments serve as a de facto instrument of monetary policy. The shipments fluctuate from month-to-month depending on program needs, and strong seasonal elements such as preparing for winterization are also involved, so they may have little relationship with the liquidity needs of the economy.
It is crazy to let the vagaries of humanitarian aid and the ups and downs of the U.N. cash shipments serve as a de facto instrument of monetary policy.
The desirable direction over the medium term is to move away from both dollarization and the cash-based economy, which will obviate the need for sizable inflows of U.S. cash.
In the short run, DAB could encourage or pressure the U.N. and other agencies operating in Afghanistan to use only Afghani currency in transactions, not U.S. dollars. Most expenses such as cash aid and staff salaries are paid in small amounts, so using Afghanis would be appropriate.
Withdrawing cash dollars from deposit accounts and then turning them over to the informal hawala money exchanges to convert into Afghanis or for other purposes is unnecessary and harmful. So, when cash withdrawals are made from private bank deposits created by the U.N. cash shipments, they should be in the form of Afghanis converted at the market exchange rate. Making payments through electronic transfers or digital currency transactions should be encouraged wherever possible. Similarly, if U.N. or other agencies transfer funds electronically to Afghan banks, any cash withdrawals of those funds should be in Afghani currency, not in cash dollars.
These measures would require DAB to have sufficient Afghani currency in its vault. Printing banknotes faced difficulties earlier, and if there are still shortages of Afghani notes, more should be printed. Any obstacles emanating from the international side that hinder printing of more Afghani banknotes, such those related to sanctions, need to be urgently addressed.
Another attractive option is to begin to deploy the investment earnings of the Afghan Fund in Switzerland — cumulatively approaching $400 million and accruing about $150 million annually — to support exchange rate stability. This would be a normal, well-justified use of the foreign exchange reserves for the benefit of the Afghan people by helping with macroeconomic stabilization. The Afghan Fund’s board of directors should make a decision to move in this direction, and then commission technical work to determine specifically how this can be done.
The Afghan Fund needs to avoid providing any financial resources directly to the DAB, which some board members would likely find objectionable. Moreover, such an action might well provide ammunition for U.S. plaintiffs seeking access to the other $3.5 billion of Afghanistan’s foreign exchange reserves that remain frozen in the United States, protected so far from the litigants. Workarounds could be explored, such as commissioning a reputable third-party entity to conduct foreign currency auctions using some of the foreign exchange belonging to the Afghan Fund. The fund could also consider ways to facilitate international financial transactions and trade. Both of these options would be fully consistent with the goals of the fund.