What Happened in 2014?

The 2014 crisis, driven by a hemorrhage of government revenue as well as a slowdown in aid disbursements during much of the year, was extremely costly for Afghanistan, resulting in the Treasury running out of cash, its inability to meet contractual obligations, and a build-up of arrears (a serious failing by international standards). These problems necessitated an “emergency” request for over $500 million in aid in late 2014 to ease the fiscal strain.

Spurred by effective leadership in the Ministry of Finance (MoF), selected tax increases, and stronger revenue mobilization efforts, there was a fiscal turnaround during the next three years. By 2017, total revenue slightly exceeded its 2011-12 peak of 11.6 percent of GDP. But this largely represented making up lost ground, meaning that fiscal progress was essentially stalled over this half-decade.

Revenue trends were already deteriorating in 2012 and 2013, but there was a largely revenue-precipitated “perfect storm” in 2014. Revenue fell by 1.6 percent in nominal Afghani value in the first half of the year and collapsed by 8.5 percent for the entire year. All main categories of revenue suffered declines in 2014, and the revenue-to-GDP ratio dropped to 8.7 percent, nearly three percentage points below its peak in 2011-12. Aid disbursements also slowed down. After depleting its deposits at the Central Bank, the government was forced to impose cash controls during the second half of 2014 and, even with a last-minute influx of aid, ran up arrears on contractually obligated payments of around $200 million.

What Went Wrong? 

By far the most important catalyst of the 2014 fiscal crisis was the political uncertainty surrounding the 2014 presidential election and its problematic aftermath. This uncertainty was compounded by the Karzai administration’s refusal to sign a Bilateral Security Agreement with the United States, and the U.S. administration’s announcement (between the first and second rounds of voting in the Afghan presidential election) that the U.S. troop drawdown would be completed by the end of 2016.

The Afghan economy weakened during the run-up to the election, with real GDP growth dropping sharply from near double-digit levels in the previous decade to 3.7 percent in 2013 and only 1.3 percent in 2014—below the rate of population growth and implying negative growth of average per-capita income. This reflected the lingering demand shock of sharply declining international military expenditures in-country resulting from the international troop drawdown, as well as the political uncertainty and increasing insecurity.

However, government revenue declined much more sharply than the slowdown in the economy, as evidenced by the three percent drop in the revenue-to-GDP ratio. Revenue mobilization efforts apparently slackened considerably during 2013 and especially 2014, due to a combination of:

• Shortening time horizons for officials during the election season, which strongly incentivized corruption—to maximize diversion of revenue for individual and group gain in the shrinking time remaining before the change of government.
• Shortening time horizons leading, less nefariously, to officials not trying hard to mobilize revenue.
• Diversion of revenues, especially customs, for election campaign financing and political payoffs—this may have been a significant factor in the second half of 2013 and especially in the first half of 2014, but could not explain the accelerated revenue decline in the second half of 2014 after voting.
• Businesses holding back on tax payments due to the political uncertainty—some even speculated about the possibility of a return of the anarchy and chaos of the 1992 civil war. After all, why pay taxes when there might not be any government left?
• Possible deterioration in day-to-day government management and oversight in the aftermath of the second round of the presidential election, resulting in further weakening of revenue mobilization—for example a new post-election finance minister was appointed only in February 2015.

Aggravating the Afghan government’s cash squeeze in 2014 were shortfalls in aid inflows to the budget during most of the year (only partly made up by emergency assistance provided at the end of the year). In the first half of 2014, civilian aid disbursements to the budget declined by 12.5 percent compared to the first half of 2013, and security support was down 2.7 percent. 

The aid slowdown was due at least in part to the Afghan government not meeting reform benchmarks and thereby losing some aid, and government underspending that triggered lower aid disbursements from the Afghanistan Reconstruction Trust Fund’s incentive scheme. To the extent the slowdown in aid was attributable to such factors, it ultimately reflected an understandable tendency for reforms to slow down or stop during an election year, though the underspending that resulted in less aid represented self-inflicted damage that should have been avoided. A related problem was the far too optimistic budgeting of aid inflows in 2014, on which basis higher expenditures were budgeted, leaving a gap when some of the aid did not materialize. 

However, lower aid disbursements during much of 2014 possibly also may have resulted, in part, from donors holding back some aid during the election period. This could have been because they wanted to wait for the final results of the election, or because they wanted to hold up aid and release it for the new administration as a positive signal.

Avoiding a Repeat of 2014

What are the lessons from the 2014 fiscal crisis? A repeat of this experience during and after the 2019 presidential election would be even more disastrous than what happened in 2014. It seems doubtful the international community would be as pro-active as it was then—either to resolve any disputes after the presidential election or in responding to a request for aid, like in 2014 when donors provided an additional $200 million.

To avoid a repeat of 2014, a timely, clear, and widely accepted outcome of the election would prevent or at least minimize the risk of a fiscal crisis. But aside from that, what can be done? The recommendations below would help prevent another fiscal crisis and mitigate problems that may arise during a period of inevitable uncertainty:

• Insulate the MoF, especially its leadership, from involvement in the 2019 election campaign and campaign financing. Afghanistan’s development partners should strongly reinforce this message.
• Key elements of the reform program also should be insulated, so aid inflows tied to specific reforms do not get slowed down during election season.
• Avoid making frequent changes in MoF senior staffing (especially in the customs and revenue departments) for political reasons, which, based on experience, would weaken revenue mobilization. 
• Revenue targets should be reasonable, and unrealistic talk of enormous increases in total revenues within a few years avoided. But once set, revenue targets should be strictly enforced, and staff should be evaluated on the basis of performance in achieving these targets.
• Closely monitor revenue trends—which if adverse would constitute an early warning sign of fiscal problems—on a bi-weekly basis overseen by the finance minister, with reporting to the cabinet and the president on a regular basis. Moreover, revenue collection at border points should be seen as not only the MoF’s responsibility, but also needs to be supported (and not undermined) by the police, local authorities, and provincial governors.
• Monthly revenue monitoring should be supported and reinforced by international agencies such as the International Monetary Fund and World Bank.
• Apply further safeguards and oversight to customs revenues, which have been a chronic source of revenue shortfalls.
• The MoF should improve internal coordination in short-run budget management. Hold regular cash management meetings chaired by the finance minister to ensure that cash inflows and outflows are managed to avoid a cash crunch.
• While closely monitoring the fiscal situation, donors should not hold up aid to the Afghan government’s discretionary budget in the run-up to, during, or immediately after the 2019 election. Making this kind of aid—most of which goes for salary payments to civilian and uniformed personnel in the Afghan government—conditional on political factors has not worked well in the past and would not work in 2019. 
• Reform targets and especially their timing need to take into consideration the constraints of election season. While the Afghan government will continue to strongly pursue the reform program outlined in the 2016 Afghanistan Peace and Development Framework and its National Priority Programs, some delays in reforms during the months around the election would be understandable in any country.
• Finally, some kind of backstop mechanism is needed to ensure that if the government does face a short-run cash crunch, it does not result in the kinds of expenditure controls, delays in payments, and build-up of arrears that were so problematic in 2014. This could involve an emergency short-run line of credit from the Central Bank, or some other effective mechanism.  

M. Khalid Payenda is deputy finance minister of the Government of the Islamic Republic of Afghanistan, and William A. Byrd is a senior expert at the U.S. Institute of Peace. The views expressed are the authors’ and should not be attributed to the Ministry of Finance, Government of Afghanistan, or to the U.S. Institute of Peace, which does not advocate specific policy positions.