the world bank...the world bank 2019 incentive program development policy operation (p168446)...

The World Bank 2019 Incentive Program Development Policy Operation (P168446)

Document of

The World Bank

FOR OFFICIAL USE ONLY Report No: PGD85

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT FOR A

PROPOSED IDA GRANT

IN THE AMOUNT OF SDR 72.2 MILLION (EQUIVALENT TO US$100 MILLION)

AND

A PROPOSED AFGHANISTAN RECONSTRUCTION TRUST FUND GRANT IN THE AMOUNT OF US$300 MILLION TO THE

ISLAMIC REPUBLIC OF AFGHANISTAN FOR THE

2019 INCENTIVE PROGRAM DEVELOPMENT POLICY OPERATION MAY 23, 2019

Macroeconomics, Trade And Investment Global Practice South Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official

duties. Its contents may not otherwise be disclosed without World Bank authorization.

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Islamic Republic of Afghanistan

GOVERNMENT FISCAL YEAR

December 22 – December 21

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of May, 2019)

Currency Unit

US$1.00 = AF77.57

ABBREVIATIONS AND ACRONYMS AF Afghanis (Currency)

ACGF Afghan Credit Guarantee Foundation

AFMIS Afghanistan Financial Management Information System

ALCS Afghanistan Living Conditions Survey

AML/CFT Anti‐Money Laundering and Countering Financing of Terrorism

ANPDF Afghanistan National Peace and Development Policy Framework

ARD Afghanistan Revenue Department

ARTF Afghanistan Reconstruction Trust Fund

ARTF IP Afghanistan Reconstruction Trust Fund Incentive Program

ASA Advisory Services and Analytics

BRT Business Receipts Tax

CPF Country Partnership Framework

CSO Civil Society Organization

DAB Da Afghanistan Bank

DABS National Electricity Utility of Afghanistan

DPF Development Policy Financing

DPG Development Policy Grant

ECF Extended Credit Facility

FPIP Fiscal Performance Improvement Plan

FSP Fiscal Performance Improvement Plan Support Program

GDP Gross Domestic Product

GoIRA Government of Islamic Republic of Afghanistan

HIPC Heavily Indebted Poor Countries

HRM Human Resource Management

ICT Information and Communication Technologies

IDA International Development Association

IDP Internally Displaced People

IFC International Finance Corporation

IMF International Monetary Fund

IP‐DPG Incentive Program Development Policy Grant

IPM Integrated Pest Management

LIS Land Information System

LTO Large Taxpayer Office

MAIL Ministry of Agriculture, Irrigation and Livestock

MCIT Ministry of Communication and Information Technology

MEW Ministry of Energy and Water

MOE Ministry of Education

MOF Ministry of Finance

MOJ Ministry of Justice

MTO Medium Taxpayer Office

MTEF Medium‐Term Expenditure Framework

MUDL Ministry of Urban Development and Land

NATO North Atlantic Treaty Organization

NEPA National Environment Protection Agency

NRVA National Risk and Vulnerability Assessment

NTA National Technical Assistants

O&M Operations and Maintenance

PCR Public Credit Registry

PEFA Public Expenditure and Financial Accountability

PFM Public Financial Management

PFMR Public Financial Management Reform

PFMRII Second Public Financial Management Reform Project II

PIM Public Investment Management

PMP Pest Management Plan

PPA Power Purchase Agreement

PV Present Value

RCW Recurrent Cost Window

SDR Special Drawing Rights

SESA Strategic Environmental and Social Assessment

SIA Strategic Impact Assessment

SIGTAS Standard Integrated Tax Administration System

SME Small and Medium Enterprises

SMG Senior Management Group

TDRB Tax Dispute Resolution Board

UNAMA United Nations Assistance Mission in Afghanistan

UNDP United Nations Development Programme

USAID United States Agency for International Development

USIP United States Institute of Peace

VAT Value Added Tax

.

Regional Vice President: Hartwig Schafer

Country Director: Shubham Chaudhuri

Senior Practice Director (s): Lalita M. Moorty

Practice Manager (s): Maria Manuela Do Rosario Francisco

Task Team Leader (s): Tobias Akhtar Haque, Saurabh Shome


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ISLAMIC REPUBLIC OF AFGHANISTAN

2019 INCENTIVE PROGRAM DEVELOPMENT POLICY OPERATION

TABLE OF CONTENTS

SUMMARY OF PROPOSED FINANCING AND PROGRAM ........................................................................ 3

1. INTRODUCTION AND COUNTRY CONTEXT .................................................................................... 5

2. MACROECONOMIC POLICY FRAMEWORK ..................................................................................... 7

2.1. RECENT ECONOMIC DEVELOPMENTS ............................................................................................ 8

2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ......................................................... 12

2.3. IMF RELATIONS ............................................................................................................................ 14

3. GOVERNMENT PROGRAM .......................................................................................................... 14

4. PROPOSED OPERATION .............................................................................................................. 15

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION .......................................... 15

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS .................................................. 16

4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY .......................................... 32

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS ............................... 32

5. OTHER DESIGN AND APPRAISAL ISSUES...................................................................................... 33

5.1. POVERTY AND SOCIAL IMPACT .................................................................................................... 33

5.2. ENVIRONMENTAL ASPECTS ......................................................................................................... 35

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS .......................................................................... 36

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY .................................................................. 39

6. SUMMARY OF RISKS AND MITIGATION ...................................................................................... 40

ANNEX 1: POLICY AND RESULTS MATRIX ............................................................................................ 44

ANNEX 2: FUND RELATIONS ANNEX .................................................................................................... 47

ANNEX 3: LETTER OF DEVELOPMENT POLICY ...................................................................................... 50

ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE .................................................. 54

The Incentive Program Development Policy Grant was prepared by a team comprising: Tobias Haque (TTL, Senior Economist, GMTSA), Saurabh Shome (Co‐TTL, Economist, GMTSA), Tae Hyun Lee (TTL, Lead Economist, GMTSA), Bernard Haven (Public Sector Specialist, GGOAP), Habiburahman Sahibzada (Economist, GMTSA), Murtaza Muzaffari (Economist, GMTSA), Shankar Narayanan (Senior Social Development Specialist, GSU21), Enrique Pantoja (Operations Advisor, OPSIL), Mohammad Yasin Noori (Senior Social Development Specialist, GSU06), Christina Wieser (Poverty Economist, GPV06), Nandini Krishnan (Senior Poverty Economist GPV06), Mohammad Sulaiman Akbari (Private Sector Specialist, GTC06), Yousif El Fadil (Senior Public Sector Specialist, GG024), Atiqullah Ahmadzai (Senior Public Sector Specialist, GGOAP), Ahmed Rostom (Senior Financial Sector Specialist, GFM06), Syed Waseem Kazmi (Senior Financial Management Specialist, GGO24), Marcelo Acerbi (Senior Environment Specialist, GEN06), Hisham Osman (Young Professional, GENMS), Mohammad Arif Rasuli (Senior Environment Specialist, GEN06), Fanny Missfeldt‐Ringius (Lead Energy Specialist, GEE06), Abdul Hamid Quraishi (Operations Officer, GEE06), Mir Ahmad (Water Resources Management Specialist, GWA06), Sana Agha Al Nimer (Senior Water Specialist, GWA06), Christina Leb (Senior Counsel, LEGEN), Ria Dharmawan (Counsel, LEGES), Ahmad Shakeeb Safai (Consultant, SACKB), Jane Ebinger (Program Leader, SACKB), Guillemette Sidonie Jaffrin (Program Leader, SACKB), Janmejay Singh (Lead Social Development Specialist, GSU06), Yasuhiko Matsuda (Program Leader, SACKB), Wezi Marianne Msisha (Senior Operations Officer, SACKB), Muhammad Wali Ahmadzai (Operations Officer, SACKB), Jose Janeiro (Senior Finance Officer, WFACS), and Anastassia Alexandrova (Senior Country Officer, SACKB). Overall guidance was provided by Manuela Francisco (Practice Manager, GMF06), Abdoulaye Seck (Operations Manager, SACKB), and Shubham Chaudhuri (Country Director, SACKB). Geoff Handley (Senior Public Sector Specialist, GGOAE) served as peer reviewer.


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SUMMARY OF PROPOSED FINANCING AND PROGRAM

BASIC INFORMATION

Project ID Programmatic

P168446 No

Proposed Development Objective(s)

Program Development Objectives are: (i) strengthening the policy framework to support state effectiveness, private investment, and social inclusion; and (ii) improving the policy and institutional framework for public financial management

Organizations

Borrower: ISLAMIC REPUBLIC OF AFGHANISTAN

Implementing Agency: MINISTRY OF FINANCE

PROJECT FINANCING DATA (US$, Millions) SUMMARY

Total Financing 400.00 DETAILS

International Development Association (IDA) 100.00

IDA Grant 100.00

Trust Funds 300.00

Afghanistan Reconstruction Trust Fund 300.00

INSTITUTIONAL DATA

Climate Change and Disaster Screening

This operation has been screened for short and long‐term climate change and disaster risks

Overall Risk Rating

High


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. Results

Indicator Name Baseline (end 2018)

Target (end 2020)

Proportion of customs duties (as a share of total payments by volume throughout the fiscal year) transferred to DAB via electronic payment from commercial banks

2% 60%

Average monthly number of transactions through the APS 3,534 100,000

Proportion of total civil servant appointments (2018‐2020) made in compliance with the new competitive recruitment processes

0% 80%

Proportion of female civil servants in total and at Senior Management Group level (grade levels one and two)

22% (all) 6% (G1&2)

26% (all) 9% (G1&2)

Credit registry coverage as a proportion of adult population (15‐64) 1.3% 2.0%

Proportion of women included on the credit register 2.3% 4.0%

Time taken to acquire an electricity connection for commercial customers 114 days 80 days

Cost of acquiring an electricity connection for commercial customers 2,448% of income per

capita

1,500% of income per

capita

Number of international PPAs reviewed by dedicated multi‐disciplinary team within DABS 0 3

Number of municipal districts in which an administrative land system is operating 0 1

Responsibility for the design, construction, and management of irrigation canals for agriculture from the source to the farm is allocated to MAIL

No Yes

Proportion of new projects of over US$7.5 million approved for implementation in the discretionary development budget that have undergone economic and gender analysis.

0% (2019 budget)

50% (2020 budget)

Proportion of active LTO filing firms utilizing fast‐track filing. 9.7% 60%

Number of cases submitted for ruling by the Tax Dispute Resolution Board 0 10

VAT business processes approved and communications material released based on regulations, including procedures for exemptions

No Yes

The budget is developed through application of the new O&M norms for four pilot ministries(as reflected in budget working papers)

No (2019 budget)

Yes (2020 budget)

Number of downloads of new revenue performance reports 0 500

Proportion of treasury salary payments made within ten days of submission of monthly claims by line ministries

100% 100%

.


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IDA PROGRAM DOCUMENT FOR A PROPOSED GRANT TO THE ISLAMIC REPUBLIC OF AFGHANISTAN

1. INTRODUCTION AND COUNTRY CONTEXT

1. The proposed 2019 Incentive Program Development Policy Grant (IP‐DPG) Operation supports continued progress with key reforms under the Afghanistan National Peace and Development Framework (ANPDF). Reforms supported by the operation are organized under two pillars: i) strengthening the policy framework to support state effectiveness, private investment, and social inclusion; and (ii) improving the policy and institutional framework for public financial management. The proposed operation will be supported by an IDA grant of SDR 72.2 million (US$100 million equivalent) and a US$300 million grant from the Afghanistan Reconstruction Trust Fund (ARTF) and is the second of three planned stand‐alone operations aligned with Government’s current three‐year program of policy reforms. World Bank Board approval is sought for IDA financing in support of the program. The ARTF Management Committee will approve the ARTF grant financing in support of the program. 2. Despite progress, Afghanistan remains a poor fragile state. Substantial progress has been achieved through reconstruction efforts in Afghanistan since 2001, with gains including: i) re‐establishment of basic public finances, with revenues now equal to 13.4 percent of GDP; and ii) massive expansion in access to services, with accompanying improvements in social outcomes, including reductions in maternal and infant mortality, improved education access, and increases in life expectancy. Many challenges remain, however, and progress has slowed since 2012 due to deteriorating security and political and governance challenges. Gross Domestic Product (GDP) per‐capita is among the lowest in the world, poverty is deep and widespread, and Afghanistan continues to perform poorly against many social indicators. Afghanistan remains heavily reliant on aid, which finances more than 75 percent of total public spending. The security situation remains dire, with insurgents controlling a significant number of districts, and civilian casualties from terrorist attacks at record levels.

3. Afghanistan faces important challenges and opportunities in 2019. Afghanistan’s economy is estimated to have grown by just 1.8 percent in 2018, reflecting the impacts of severe drought and declining confidence.1 The security situation remains volatile and the duration and extent of external security assistance remains uncertain. Parliamentary elections were held in November 2018, and Presidential elections are scheduled for September 2019. Presidential elections in Afghanistan have been associated with extended periods of political instability, weakening governance, and sharp declines in revenue. During the last Presidential election in 2014, revenues declined from 11.3 percent of GDP to 8.4 percent of GDP, with large declines in both economic activity and compliance, especially at customs points, driving a fiscal crisis. The crisis was managed though the implementation of expenditure controls and emergency revenue measures but with substantial cost to investment confidence. Election related risks are not confined to the campaign period, as likely subsequent run‐off elections and the formation of any government may involve contestation, disputes, delays, and disruption to policy processes.2 Ongoing negotiations present the possibility of a peace deal with the Taliban, with the potential for significant

1 GDP growth for 2018 is a World Bank staff preliminary estimate and subject to revision upon planned upcoming release of new national account data using a revised methodology. 2 If no presidential candidate secures more than 50 percent of votes cast in the initial ballot, the Constitution requires a second run‐off election between the two leading contenders.


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improvements in the security situation, service delivery, and investor confidence. A political settlement may generate opportunities for: i) improvements in service access and quality; ii) increased private investment, including in key potential growth sectors, including extractives; and iii) a substantial reduction in security‐related fiscal costs, freeing up resources for investment in infrastructure and social services; and iv) enhanced regional integration through development of trade and connective links with a dynamic and rapidly growing region. Realization of these benefits will, however, depend heavily on the content and timing of any political settlement, and the extent to which it leads to a substantial and sustained reduction in violence. 4. The proposed operation seeks to support policy continuity and macroeconomic stability through this period of heightened uncertainty. Policy reforms supported by the operation are intended to help manage risks through: i) maintaining momentum on core reforms to support self‐reliance and economic development; ii) ensuring continued availability of resources for core government functions through revenue and expenditure reforms; and iii) supporting increased transparency in revenue performance and cash management to enhance accountability to citizens, inform policy dialogue with development partners, and provide early warning to government and the international community in the case of economic disruption.

5. Afghanistan, with its consistently high rankings on the Global Climate Risk Index, is among the most vulnerable countries to the effects of natural hazards and climate change. Climate Change poses a significant threat to Afghanistan’s natural resources, in particular the agriculture sector, on which the majority of Afghans depend for their livelihoods. While floods are the most frequent natural hazard in Afghanistan, droughts cause an average of US$280 million in economic damages to agriculture each year with the potential for an extreme drought event to result in economic losses of up to US$3 billion. Climate change is also expected to increase the frequency of heavy precipitation events, as well as contribute to earlier spring snowmelt, reducing the availability of water over the summer months and making efficient irrigation system even more critical for agricultural productivity.3

6. The World Bank, as the administrator of the Afghanistan Reconstruction Trust Fund (ARTF), has been providing recurrent cost support to Government since 2002. Government remains heavily reliant on grants to finance its operations. Resources provided to meet recurrent costs have accounted for around 20 percent of non‐security recurrent expenditures, and between US$250 million and US$350 million per year since 2013. In 2018, recurrent cost support was provided through a Development Policy Financing operation for the first time, with the first of a non‐programmatic series of three development policy operations approved by the Board in June 2018. The proposed operation builds on the gains achieved under the 2018 IP‐DPG, including legislative changes to enable vital civil service reforms, improvements to the business regulatory environment, adoption of policies to guide water and irrigation management, and vital public financial management and tax administration reforms.

7. The proposed operation has a similar design to the 2018 IP‐DPG operation. The 2018 IP‐DPG supported key reforms aligned with Government’s reform program. Innovative use of decrementing tranches associated with Tranche Release Conditions (to be met after Board approval) proved successful in motivating continued reform progress throughout the year and catalyzing coordination of donor support around supported reforms. All Tranche Release Conditions were met by the specified completion

3 Afghanistan Disaster Risk Profile, World Bank, 2017


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date and the full allocated ARTF financing amount was disbursed. Innovative design elements from the 2018 IP‐DPG are retained under the proposed operation. The operation will be composed of 11 tranches. The first tranche of US$100 million of IDA resources is associated with three prior actions. The tranche associated with the three prior actions will be released immediately and in full after the effectiveness conditions are met. Ten tranches of US$30 million each of ARTF resources are associated with tranche release conditions that are expected to be fulfilled by a specified Completion Date (November 15, 2019). Disbursement amounts associated with tranche release conditions will be timing dependent. Tranches will be released in full if Tranche Release Conditions are met by the Completion Date. Traches will decrement in amount (at the rate of ten percent per month) if fulfilment of the tranche release conditions extends past the targeted Completion Date, providing continued incentives for the fulfilment of agreed reforms by Government. At the request of Government and ARTF Partners, the program has been broadened slightly to include additional policy areas reflecting: i) increased resources being allocated through the Development Policy Operation relative to the 2018 operation (US$400 million compared to US$300 million in 2018); and ii) the need for the inclusion of policy actions to help manage elevated fiscal risks over the period of presidential elections. 8. The overall risk rating for the operation is high. Political and governance risks arise from overall weak governance and uncertainties associated with the upcoming presidential elections. Macroeconomic risks arise from heavy aid dependence and potential deterioration of revenue performance over the election period. Overall institutional capacity for implementation and sustainability is weak and may further deteriorate in the context of election‐related personnel changes at senior levels of government. Security risks are high, given the active‐conflict environment.

2. MACROECONOMIC POLICY FRAMEWORK

9. Afghanistan remains an undiversified economy, heavily dependent on aid. The private sector is extremely narrow, with employment concentrated in low‐productivity agriculture (44 percent of the total workforce works in agriculture and 60 percent of households derive some income from agriculture). Investment since 2001 has focused around the aid‐driven contract economy. Private sector development and diversification is constrained by political instability, weak institutions, inadequate infrastructure, widespread corruption, and a difficult business environment (despite substantial improvements during 2018, Afghanistan was ranked 167th of 190 countries in the 2019 Doing Business Survey). In the absence of a strong domestic private sector, foreign grants currently finance more than 52 percent of the budget and substantial off‐budget security needs. Aid flows to Afghanistan were equal to around 45 percent of GDP in 2018, financing a large share of both total civilian and security expenditures. Security expenditures (national security and police) are high at around 29 percent of GDP in 2018, compared to the low‐income country average of around 3 percent of GDP.4 Illicit activity remains central to the Afghan economy.5 The opium economy is driven by weak rule of law, easy access to key trade routes, and absence of alternative livelihood generating activities. The major role of illicit activity in the Afghan economy, including opium

4 This includes off‐budget security costs. 5 Total opium production in 2018 was around US$0.6 billion, almost all of which is exported. This compares with total formal exports of around US$0.9 billion. Poppy production decreased substantially in 2019, despite reduced eradication efforts, with drought negatively impacting yields and the area of land under poppy cultivation. Declining production may also have been driven by falling prices. Opium prices have collapsed in response to very strong production over recent years, with potentially significant impacts on livelihoods in poppy‐cultivating regions.


Page 8

production and smuggling, weakens overall governance and deprives government of much‐needed revenues. 10. Following a sustained period of impressive development progress after the fall of the Taliban, Afghanistan has faced intensifying and interlinked economic, security, and political challenges. With an influx of aid since 2002, Afghanistan sustained rapid economic growth and improvements against important social indicators for more than a decade. Annual growth averaged 9.4 percent between 2003 and 2012. Since 2012, however, a range of factors have slowed economic and social progress. Aid flows decreased from around 75 percent of GDP in 2012 to 45 percent of GDP in 2018 (with the number of North Atlantic Treaty Organization (NATO) troops declining from more than 130,000 in 2011, to around 15,000 by end‐2014). Reduced aid and security presence led to a rapid weakening of demand, especially in construction and other service sectors, with follow‐on impacts across the economy. The security situation deteriorated, with increased activity by anti‐government forces leading to a large increase in civilian casualties from around 6,000 in 2009 to more than 10,000 in 2018 (civilian deaths reached a record high of 3,804).6

11. Increasing displacement threatens a humanitarian crisis in a context where poverty remains stubbornly high and inequality is growing. Afghanistan currently faces a humanitarian crisis arising from large numbers of returning migrants (more than 2 million since 2015) and a large and growing internally displaced population (1.7 million). Internal displacement and the returnee population represent both a risk and an opportunity to the economy. Successful integration into productive employment of generally better‐educated returnees could provide a boost to productivity and growth. On the other hand, concentration of returnees and the displaced in urban centers risks overwhelming services and generating large humanitarian needs. Over recent years, the rate of economic growth has lagged population growth. The poverty rate increased sharply from 38 percent in 2011/12 to 55 percent in 2016/17, with poverty increasing in both urban and rural areas.

2.1. RECENT ECONOMIC DEVELOPMENTS

12. Afghanistan is facing strong economic headwinds. From a low of 1.5 percent in 2015, growth gradually accelerated over subsequent years, increasing to 2.3 percent in 2016 and 2.7 percent in 2017, driven by sound macroeconomic management, reform progress, and a slight recovery of business confidence. In 2018, however, growth is estimated to have slowed to around 1.8 percent, reflecting negative impacts of drought on wheat and grain production and weakening confidence in the context of mounting insecurity, questions regarding the duration of international security assistance, and upcoming elections. Agricultural production expanded by only around 1 percent due to severe drought conditions. Services and industry grew by around 1.8 percent and 2.5 percent respectively in the context of weak confidence. 13. Inflation has slowed. Inflation slowed significantly from around 5 percent in 2017 to just 0.6 percent in 2018, reflecting overall weak demand and weakening food prices in the context of strong domestic fruit and vegetable production. The impacts of drought on domestic grain prices were

6 UNAMA Protection of Civilians in Armed Conflict Report, October 2018.


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moderated by strong production in neighboring countries, which allowed for increased imports at a stable international price. Inflationary pressures are strongly linked to import prices. 14. The trade deficit remains large. Exports (primarily dried fruits, nuts, and textiles) grew rapidly during 2017 (28 percent), due to the establishment of subsidized ‘air corridors’ and the resolution of disruptions at the border with Pakistan, but the pace of growth slowed to 5 percent in 2018 due to the impacts of drought. Exports remain limited at around seven percent of GDP in 2018. Imports are approximately 43 percent of GDP. Despite the large trade deficit, aid inflows have allowed the current account to remain in surplus (0.6 percent of GDP in 2018) and foreign exchange reserves to remain at comfortable levels (close to one year of prospective imports). The Afghani depreciated by around 9 percent against the US dollar during 2018 (end period) driven mostly by general strengthening of the US dollar. The Afghani appreciated against other main trading currencies, including the Pakistani rupee, with little overall change in the real effective exchange rate.

15. Da Afghanistan Bank (DAB) follows a monetary aggregate regime and targets price stability, but transmission channels are weak. The main monetary policy instruments are capital notes and foreign exchange auctions. A limited policy toolkit together with an underdeveloped financial sector has undermined effectiveness of monetary policy. Confidence in the banking sector is yet to fully recover from the Kabul Bank crisis of 2010, during which massive fraud led to a run on Afghanistan’s largest bank, necessitating a government bail‐out and undermining confidence in the sector. Credit to the private sector was equal to only around 3.4 percent of GDP in 2018 and declined by around 4 percent during 2018. Profitability of private banks remains marginal. Average return on assets across the banking sector has been around 0.002 percent on average since 2011. Non‐performing loans were equal to 11.3 percent of total gross loans at end of Q2, 2018 (substantially down from 17.9 percent at end‐Q2 2017). The economy remains heavily dollarized. To facilitate interbank lending, the interest rate on capital notes was progressively lowered from 3.8 percent in 2017 to 0.15 percent in September 2018, but this has been ineffective in reducing capital note holdings in the banking system, which remain close to 2017 levels. Regulatory reforms supported by the proposed operation will expand the range of assets that can be recognized as collateral, providing impetus for an expansion of credit to the private sector. There is limited coordination between monetary and fiscal policy. DAB remains committed to exchange rate flexibility, with limited interventions to smooth volatility. In the context of increased recent volatility, DAB increased US dollar sales from US$1.9 billion in 2017 to US$2.4 billion in 2018. 16. Revenues reached historically high levels, but fiscal pressures are daunting. Reforms over recent years have seen revenues increase to 13.4 percent of GDP in 2018, after falling to 8.5 percent of GDP in 2014.7 But, with Afghan security forces taking on greater responsibilities with the draw‐down of international forces, on‐budget security expenditure remains a large share of total expenditure, and domestic revenues finance only 46 percent of civilian expenditures. Capital expenditures increased significantly in 2018, exceeding budgeted levels by around 25 percent, driven by improved execution of

7 In 2015, a 10 percent telecom services fee was introduced and a Functional Review of the ARD was completed. Risk‐based audit and the Standard Integrated Tax Administration System (SIGTAS) IT system were progressively implemented in all major provinces during 2017. A revised Income Tax Law was submitted to the National Assembly in late 2017, reflecting tax policy recommendations from the World Bank and the International Monetary Fund (IMF). Risk‐based compliance measures have been introduced in customs leading to a substantial reduction in misdeclarations. Efforts to recover arrears including through the introduction of amnesty schemes were intensified in 2018 leading to significant recoveries.


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donor‐managed on‐budget projects. Despite pressures, the Government has run a largely balanced budget (including on‐budget grants). The 2018 outturn saw a small surplus with over‐performance against own‐revenue targets offsetting a short‐fall in budgeted grants. Security accounted for around 34 percent of budget expenditure in 2018. Education and agriculture only accounted for 12 percent and 7 percent of total expenditures, respectively. Health only received 3.9 percent of the total budget.


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Table 1: Selected Economic Indicators

2016 2017 2018e 2019p 2020p 2021p 2022p

Real Economy

Nominal GDP (billion Af) /1 1,314 1,376 1,411 1,486 1,604 1,738 1,892

Nominal GDP (billion US$ ) /1 19.4 20.2 18.7 18.7 19.2 19.8 20.6

GDP per capita (US$ ) 559 568 513 503 505 510 515

Population (million) 34.7 35.5 36.4 37.2 38.1 38.9 39.9

Real GDP growth /1 2.3 2.7 1.8 2.3 3.0 3.3 3.9

Prices

CPI inflation (period average) 4.4 5.0 0.6 3.1 5.0 5.0 5.0

Fiscal

Total Revenue and Grants 53.2 53.0 58.8 55.1 53.4 51.7 49.9

Domestic revenues 11.2 12.3 13.4 12.7 13.3 13.9 14.0

Grants 42.0 40.7 45.3 42.4 40.1 37.8 35.9

Security grants 21.8 23.1 24.8 23.4 22.1 20.8 19.7

On‐budget 7.3 5.7 5.0 5.1 5.1 4.8 4.7

Off‐budget 14.6 17.4 19.8 18.3 17.0 16.0 15.0

Civilian grants 20.1 17.6 20.6 19.0 18.0 17.0 16.1

On‐budget 8.5 7.4 9.6 8.3 8.2 8.2 8.3

Off‐budget 11.7 10.2 11.0 10.7 9.8 8.8 7.9

Total expenditures 53.2 53.6 58.1 55.8 53.9 52.6 50.7

Security spending 25.7 27.2 29.2 28.1 27.0 26.6 26.2

On‐budget security 11.1 9.7 9.4 9.8 10.0 10.6 11.2

Off‐budget security 14.6 17.4 19.8 18.3 17.0 16.0 15.0

Civilian spending 27.5 26.4 28.9 27.7 26.9 26.0 24.5

On‐budget civilian 15.9 16.2 18.0 17.0 17.1 17.2 16.6

Off‐budget civilian 11.7 10.2 11.0 10.7 9.8 8.8 7.9

Budget balance 0.0 ‐0.6 0.7 ‐0.7 ‐0.5 ‐0.9 ‐0.8

Budget balance excl. grants ‐15.8 ‐13.6 ‐13.9 ‐14.1 ‐13.8 ‐13.9 ‐13.8

External Sector

Exports of goods (million US$ ) /2 614 784 825 908 1,016 1,169 1,286

Imports of goods (million US$ ) /3 6,636 7,355 7,407 7,481 7,556 7,631 7,708

Merchandise trade balance ‐31.1 ‐32.5 ‐35.3 ‐35.2 ‐34.0 ‐32.6 ‐31.2

Net current transfers 39.0 39.1 42.3 39.7 37.8 35.9 34.4

Current account balance 7.1 1.6 0.6 ‐1.1 ‐1.5 ‐1.4 ‐1.9

Gross foreign exchange reserves (million. US$ ) 7,330 8,129 8,322 7,958 6,765 6,295 5,557

(months of imports of goods and services) 10.2 10.8 11.1 10.4 8.7 7.9 6.9

External debt 6.1 5.9 6.6 6.9 6.9 6.9 6.9

Exchange rate (AFN/USD, period average) 67.9 68.1 .. .. .. .. ..

Monetary

Broad money (M2) 34.6 34.4 34.4 36.2 38.0 39.9 41.9

Total deposits 19.7 19.2 19.3 20.2 20.6 21.0 21.2

Credit to private sector, commercial banks 3.6 3.4 3.5 3.7 3.8 3.8 3.9

1/ National Accounts data exclude opium value added.

2/ Exclude sales of goods to nonresidents in the country.

3/ Include estimated unofficial trade or smuggling.

Sources: World Bank staff estimates, DAB, MoF, IMF

% of GDP (unless otherwise noted)


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Table 2: Central Government Budgeted Operations

2016 2017 2018e 2019e 2020p 2021p 2022p

Total revenues 26.9 25.3 28.0 26.0 26.6 26.9 27.0

Domestic revenues 11.2 12.3 13.4 12.7 13.3 13.9 14.0

Direct taxes 5.0 5.5 5.9 6.0 6.2 6.3 6.4

Indirect taxes 2.2 2.6 2.5 2.5 2.9 3.2 3.2

Nontax revenues 4.0 4.2 5.0 4.1 4.3 4.4 4.4

Donor grants 15.8 13.0 14.6 13.4 13.3 13.0 13.0

Security 7.3 5.7 5.0 5.1 5.1 4.8 4.7

Civilian 8.5 7.4 9.6 8.3 8.2 8.2 8.3

Total expenditures 27.0 25.9 27.3 26.8 27.1 27.8 27.8

Recurrent expenditures 19.8 18.4 18.4 18.7 19.0 19.8 20.3

Security 11.1 9.7 9.4 9.8 10.0 10.6 11.2

Civilian 8.7 8.7 9.0 8.9 9.0 9.2 9.1

Wages and salaries 4.5 4.6 4.8 4.8 4.9 5.0 5.0

Operations and maintenance 2.3 2.1 1.8 1.8 1.8 1.9 1.8

Social transfers 1.7 1.7 2.0 2.0 1.9 1.9 1.8

Interest payment 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Other 0.2 0.2 0.2 0.2 0.2 0.2 0.2

Development expenditures 7.2 7.5 9.0 8.0 8.1 8.0 7.6

Discretionary 2.3 3.0 3.8 3.8 3.9 3.9 3.8

Non‐dscretionary 4.9 4.4 5.2 4.2 4.2 4.1 3.8

Overall balance 0.0 ‐0.6 0.7 ‐0.7 ‐0.5 ‐0.9 ‐0.8

Overall balance excluding grants ‐15.8 ‐13.6 ‐13.9 ‐14.1 ‐13.8 ‐13.9 ‐13.8

Financing 0.0 0.6 ‐0.7 0.7 0.5 0.9 0.8

Borrowing 0.3 0.2 0.2 0.1 0.1 0.2 0.3

Change in Government Deposits and others 1/ ‐0.3 0.4 ‐0.9 0.6 0.4 0.7 0.5

Memo items

Nominal GDP (billion Af) 1,314 1,376 1,411 1,486 1,604 1,738 1,892

Nominal GDP (billion US$) 19.4 20.2 18.7 18.7 19.2 19.8 20.6

1/ Others include sale of non‐financial assets, credit from DAB, and expenditure discrepancy

Sources: World Bank staff estimates, IMF, MoF

In percent GDP, unless otherwise indicated


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Table 3: Balance of Payments Financing Requirements and Sources

2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

17. The growth outlook is expected to modestly improve: The outlook is based on assumptions of: i) continuing conflict and insecurity at current levels; ii) steady progress with implementation of business environment and institutional reforms; iii) gradually declining grant assistance; and iv) completion of the 2019 Presidential elections without major political contestations. Growth is projected to accelerate to around 2.3 percent in 2019, increasing slightly to 3.0 percent in 2020. Improved growth in 2019 reflects the easing of drought conditions, with prospects remaining constrained by political and security conditions. Slightly stronger growth in out‐years is predicated on improvements in security (following the completion of the election process) and reform progress against a backdrop of declining aid levels. Based on historical experience, rapid population growth in the context of unevenly distributed and gradual economic growth is expected to drive further increases in poverty. 18. Prices are expected to remain stable and the current account to move into a slight deficit. Inflation is expected to accelerate to around three percent in 2019 with recovery in aggregate demand and increased prices for food imports. With declining grants, the current account surplus is expected to turn into a deficit over the medium‐term. Credit to the private sector is expected to grow modestly. Impacts of slow growth and weak confidence will continue to constrain credit growth, despite efforts to support financial inclusion and improve financial sector corporate governance. The monetary policy stance is expected to remain unchanged. 19. Afghanistan faces a difficult fiscal adjustment as aid levels decline and increasing responsibility for security is transferred to government. The future trajectory of international grant assistance is subject to high uncertainty, with current pledges from major donors due to expire in 2020. Assuming a mid‐case scenario of gradual grant decline (around two percentage points of GDP per year over the period), a small budget deficit is expected in 2019. The deficit will be financed from cash reserves, which remain

2018e 2019p 2020p 2021p 2022p

External Financing Requirements 8,361 8,159 8,023 7,787 7,774

Current account deficit (excl. grant inflows) 8,340 8,138 8,007 7,777 7,766

Amortization 21 21 16 10 8

Official Loans 21 21 16 10 8

Financing Sources 8,361 8,159 8,023 7,787 7,774

A. Official Grant Inflows 8,456 7,934 7,709 7,506 7,377

B. Capital and Financial Inflows 98 (139) (880) (189) (341)

Net FDI and Portfolio investment 115 71 70 71 74

Other inflows 1/ (17) (210) (950) (260) (415)

C. Changes in Reserves (+ means drawing) (193) 364 1,193 470 738

Foreign exchange reserves (end‐of‐year) 8,322 7,958 6,765 6,295 5,557

( Reserves in months of imports) 11 10 9 8 7

1/ Other inflows include loans, other investments, and errors and omissions.

Sources: World Bank staff estimates, IMF


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comfortable. On‐budget Government expenditures are expected to decline slightly from 27.3 percent of GDP in 2018 to 26.8 percent of GDP in 2019. On‐budget security expenditure is expected to grow as responsibilities are transferred to Afghan forces. Increasing security expenditures will crowd out non‐security expenditures posing daunting challenges to maintaining current service levels to a growing population, providing essential infrastructure, and undertaking necessary maintenance of aid‐financed assets recently transferred to government ownership. Improvements in policies guiding operations and maintenance expenditures and public investment management, supported by the proposed operation, will help to contain and maximize efficiency of non‐security expenditures. Domestic revenue is expected to decline slightly as a share of GDP in 2019, reflecting high one‐off collections in 2018 resulting from arrears collection through an amnesty program. Implementation of a value‐added tax (VAT) and progress towards implementation of electronic filing and payment systems, as supported by the proposed operation, will support enhanced revenue performance over the medium‐term. Fiscal sustainability analysis undertaken by the World Bank suggests that non‐security aid commitments will be sufficient to finance existing service levels and some key infrastructure investments, but only if these resources are tightly aligned with government priorities and with a growing proportion delivered through the budget. At current expected aid levels there is very limited fiscal space over coming years for programs to stimulate aggregate demand and spur increased growth. 20. Realization of a political settlement with the Taliban may lead to substantially improved growth prospects. A political settlement could support a significant acceleration in development progress, including through: i) improved access to services; ii) repatriation of overseas capital; iii) return migration of skilled workers; iv) improvements in investor confidence; and iv) a reduced fiscal burden from security sector expenditure needs. Realization of such benefits, however, will depend heavily on the nature of any peace deal and the extent to which it leads to a significant improvement in the security environment. 21. Afghanistan is at high risk of debt distress under the World Bank/IMF Debt Sustainability Framework. The most recent World Bank/IMF debt sustainability analysis (December, 2018) finds Afghanistan at high risk of debt distress despite very low levels of public debt (6.6 percent of GDP), nearly all of which is highly concessional external debt to multilaterals. The “high” risk rating is driven by a gradual decline in grants under the ‘baseline’ scenario, with grant flows decreasing by around one percentage point of GDP per year beyond the period for which grant support has been firmly committed, and remaining financing needs met through new borrowing with a grant element of around 35 percent. Resulting debt accumulation leads to a significant and sustained breaches of the present value of debt‐to‐exports ratio (around 170 percent by the end of the projection period). While there are no breaches of liquidity indicators under the baseline scenario, Afghanistan experiences large and sustained breaches of the debt‐service‐to‐exports and PV of debt‐to‐exports thresholds under the standard export shock stress test. The analysis shows that Afghanistan’s external debt sustainability remains subject to substantial downside risks, including aid shortfalls, the fragile security situation, political uncertainty, domestic revenue shortfalls, and exchange rate depreciation.


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22. Afghanistan’s macroeconomic framework is adequate for the operation but exposed to substantial downside risks. Fiscal policy is adequate, even though under any scenario Afghanistan will rely on elevated levels of external assistance until at least 2030. Current domestic revenues are insufficient to finance even current on‐budget civilian expenditures. Monetary policy is adequate to ensure price stability. Main macroeconomic risks include: i) a premature withdrawal of aid, which would undermine fiscal sustainability and investor confidence; ii) further deterioration in the security environment, which would undermine confidence and further slow growth; iii) political instability which would have highly unpredictable impacts on the security situation, business confidence, and external support; and iv) regional economic or political developments that may see renewed flows of returning refugees and disrupted remittance flows. On the other hand, implementation of a peace agreement with the Taliban may see increased investor confidence, repatriation of off‐shore capital, and a return of skilled migrants, supporting private sector development, accelerated growth and stronger government revenues.

2.3. IMF RELATIONS

23. Afghanistan’s macroeconomic policies and reform are supported by an Extended Credit Facility (ECF) arrangement with the IMF. The IMF Executive Board approved a US$44.9 million three‐year ECF program for Afghanistan in July 2016. It supports: i) macroeconomic and structural reforms and catalyzes donor support. The program includes structural reforms for institution building, fiscal and financial reforms, and measures to combat corruption for scaled‐up private sector investment; and ii) policies to preserve macroeconomic stability. The fourth program review was undertaken by the IMF Board in December 2018 and concluded that the program was on track. All performance criteria were met, six of seven structural benchmarks were completed, and the remaining benchmark fulfilled with delay. In December 2018, the IMF Board approved an extension of the program to end‐2019 at the request of Government in order to provide sufficient time for the completion of additional reforms and uninterrupted engagement with the IMF through the election year. The IMF and the World Bank have been closely collaborating on supporting key economic reform programs, including regular participation of the World Bank in semiannual ECF review missions.

Figure 1: PV of debt‐to‐exports ratio Figure 2: Debt service‐to‐exports ratio


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3. GOVERNMENT PROGRAM

24. Government strategy is outlined in the Afghanistan National Peace and Development Framework (ANPDF), while Public Financial Management (PFM) reform priorities are presented in the Fiscal Performance Improvement Plan (FPIP). The main priorities identified in the ANPDF are: i) improving governance and state effectiveness through public sector reform, rooting out corruption and strengthening subnational governance; ii) building social capital and nation building through reforming the justice sector and building national identity; iii) economic growth and job creation through agriculture development, private sector–growth, and mineral and resource development; and iv) poverty reduction and social inclusion through improving the quality of health and education programs. Government’s public finance reform strategy is presented in the Fiscal Performance Improvement Plan (FPIP). The FPIP was developed as a five‐year rolling roadmap for PFM reform, with the first five‐year rolling plan approved in February 2016, with an objective to deliver: (i) more efficient and effective public services; (ii) significantly improved fiscal discipline; and (iii) more strategic use of fiscal policy as a tool for development. To this end, the FPIP targets three key PFM reform areas, including: (i) improving investment performance through strengthened macro‐fiscal planning and policy coordination; (ii) ensuring a more accurate, transparent and accountable budget through improving budget preparation and reporting, treasury and procurement functions, and revenue and customs management; and (iii) building capacity to manage reforms in the areas of HR, administration, finance, IT and communications.

4. PROPOSED OPERATION

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

25. The proposed IP DPG operation will support selective reform areas of the two flagship reform programs of the Government: the ANPDF and the FPIP. This DPG aims to support the Government in improving economic and fiscal self‐reliance by supporting: (i) select reform areas of the ANPDF; and (ii) key PFM reforms pursued under the FPIP. Policy actions supported by the operation are part of Government’s 3‐year Incentive Program Reform Plan, included as Annex 5, which provides a roadmap for sequential policy reforms and implementation steps in relevant policy areas. The proposed operation seeks to ensure policy continuity through a period of heightened political uncertainty by: maintaining momentum on core reforms; ensuring continued availability of resources for core government functions; and supporting increased transparency in areas vital for management of short‐term fiscal risks. 26. The proposed operation is broadly consistent with the design of the 2018 IP‐DPG. The operation will be composed of 11 tranches. The first tranche of US$100 million of IDA resources is associated with three prior actions. Ten tranches of US$30 million each of ARTF resources are associated with tranche release conditions that are expected to be fulfilled by a specified Completion Date (November 15, 2019). ARTF‐financed tranches will decrement in amount if fulfilment of the tranche release conditions extends past the targeted Completion Date. World Bank Board approval is sought for the utilization of IDA resources associated with prior actions. The ARTF Management Committee will approve ARTF resources in support of tranche release conditions.


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27. Proof of concept for design of the proposed operation has been demonstrated by the success of the 2018 IP‐DPG. All tranche release conditions were met under the 2018 IP DPG and all ARTF‐financed tranches were fully disbursed. The use of tranche release conditions provided sufficient lead times and strong incentives for timely implementation of reforms. By allowing decrementing disbursements for delayed completion of reform actions for a limited period, the risk of disrupting the budget was reduced. The utilization of a similar operation design structured around a similar program of reforms reflects the success of the previous operation in both supporting a program of significant structural and public finance reforms and ensuring a relatively reliable and timely source of financing to meet recurrent expenditure needs.

Box 1: The Afghanistan Reconstruction Trust Fund The World Bank administers the Afghanistan Reconstruction Trust Fund (ARTF), which was established in 2002 to provide a coordinated financing mechanism for the Government of Afghanistan's budget and priority national investment projects. More than US$11.3 billion has been mobilized through the ARTF from 34 development partners. The World Bank as Administrator jointly chairs with the Minister of Finance the ARTF’s highest governance body‐ the Steering Committee, which endorses the ARTF’s overall strategic directions, and financing programs. The Administrator also chairs the ARTF Management Committee, which is responsible for approval of financing allocations to individual ARTF programs, in line with the Steering Committee endorsements. Alongside investment project financing, the ARTF has provided support to Government’s recurrent costs of between US$250‐$350 million per year. This support was periodically complemented by budget support through several World Bank Development Policy Grants. In 2018, Government, the World Bank, and ARTF partners agreed that both World Bank and ARTF recurrent cost support should be channeled through a World Bank Development Policy Grant instrument. This decisions reflected a desire to: i) provide the transparency and monitoring arrangements that are associated with standard World Bank program preparation, oversight, and review practices; ii) satisfy Government’s objective for increased alignment of donor budget support by allowing IDA and ARTF resources to be mobilized through a single operation; and iii) provide all recurrent cost support conditional on structural reform progress, reflecting Government’s increased capacity to drive a reform agenda. The Ministry of Finance is the main implementation partner for the IP DPG and will coordinate cooperation with participating Ministries. The World Bank, in collaboration with ARTF partners, will provide technical support to the implementation of reforms under the IP DPG. An independent, Third Party Monitoring Agent audits expenditures financed through the ARTF Recurrent Cost Window (RCW) and IP to ensure that resources disbursed do not exceed the level of “eligible expenditures” against which compliance with appropriate fiduciary procedures and controls has been assured through audit of a representative sample of expenditure transactions. External review and validation is an important part of the accountability framework of the ARTF. The ARTF has controls in place to: 1) monitor the entire civilian operating budget to ensure funds are used in accordance with government rules and the legal agreement between the World Bank and the government; and 2) carry out asset verification, quality assurance, and data mapping of investment projects (by using, among other methods, smart phones, citizen monitoring, satellite imagery and innovative technology). The World Bank constantly works with ARTF partners to strengthen monitoring of ARTF program implementation.

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS


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Pillar I: Strengthen the Policy Framework to Support State Effectiveness, Private Investment, and Social Inclusion

Policy Action #1 (Tranche Release Condition): To develop a regulatory framework for e‐money and digital payments: i) DAB issues a circular to operating banks and MOF issues a circular to tax and customs directorates and provincial offices allowing for electronic payment of customs and tax dues; and ii) DAB issues a circular requiring participation of all mobile money providers, payment card issuers, and acquiring banks in Afghanistan Payment System to enable interoperability.

28. Development of e‐money and digital payments is a priority for Afghanistan. Afghanistan is among the countries with lowest financial inclusion as defined by number of transaction accounts. Progress towards broad access to e‐money and digital payments has great potential as a means of improving access to financial services in a country where the population remains predominantly rural and often remote. While basic regulations that enable the implementation of electronic payments have already been put in place (Electronic Money Institutions Regulation, Regulation on Domestic Payment Operations in Afghanistan, Regulation on Electronic Fund Transfers) important regulatory constraints remain. 29. Firstly, the current regulatory framework does not allow for the use of e‐money and digital payment for paying taxes and customs duties. Most large customs and tax payments are currently cash based and take place at DAB branches in Kabul and provinces. This model imposes heavy transaction costs and poses large security and financial integrity risks. The inability to pay taxes and customs duties digitally also weakens incentives for use of e‐money systems, forcing businesses to hold and transact cash.

30. Secondly, there is limited interoperability between payment service providers. Without a critical mass of providers being connected to the system the Afghanistan Payment System (APS), a switch for card and mobile wallet transactions, has had limited impact. The overall payment system remains fragmented, with customers reliant on a fragmented and limited network of ATMs and bank branches. Lack of interoperability is constraining: (i) adoption and usage of digital financial services by end‐beneficiaries; and (ii) feasibility of new players entering the market to help in the delivery of government‐to‐person payments.

31. As a tranche release condition for the proposed operation, regulatory reforms will be pursued that both enable digital payments of taxes and customs duties and strengthen interoperability of the payment system. These regulatory reforms will include: i) the issuance of a DAB circular to operating banks and a MOF circular to tax and customs directorates and provincial offices allowing for electronic payment of customs and tax dues; and ii) issuance of a DAB circular requiring participation of all mobile money providers, payment card issuers, and acquiring banks in a regulated payment system (APS) to enable interoperability.

32. Allowing for digital payment of taxes and customs duties will lead directly to increased efficiency and transparency in government finances, reducing opportunities for corruption and leakage. Mandating interoperability of banks and mobile network operators will also support expansion in financial inclusion, higher levels of consumer protection, and strengthened DAB’s powers of oversight over


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payment service providers. Supported policy reforms are expected to lead to the following results: i) the proportion of customs duties received by DAB via electronic transfers from commercial banks increases from two percent to 60 percent; and ii) average number of transactions through the APS increases from 3,534 to 100,000. The results indicator focusses on customs payments to the large share of total revenues collected at customs points and current delays imposed by the current cash‐based system.

Policy Action #2 (Prior Action): To support implementation of its Civil Servants Law, the Recipient’s: (i) Cabinet has approved (A) the Civil Service Pay Management Policy, (B) the Policy for Increasing Women’s Participation in Civil Service, as well as (C) the Customs Cadre Regulation and the Procurement Cadre Regulation; and (ii) Independent Administrative Reform and Civil Service Commission has approved the Procedure on Civil Servants' Recruitment through Mass Competitive Exam.

33. Efficiency and effectiveness of Afghanistan’s civil service is vital for development. There are approximately 400,000 civil servants in Afghanistan. While the civil service has grown significantly, most growth has come from much‐needed teacher recruitment, with teachers now accounting for around 66 percent of total public servants. Around 75 percent of civil servants are in provinces. Even though public service salaries are, on average, significantly higher than private sector salaries, there is substantial variation across the pay scale. Low rates of base pay have limited the applicant pool for some key skilled civil servant positions and around 30 percent of household members in households headed by a public servant are living below the poverty line. Expenditures on civil servant remuneration are relatively high but stable as a share of GDP (around 12 percent). With a large share of public resources devoted to civil service salaries and the civil service accounting for a significant share of formal‐sector employment (especially for those with higher skills and for women), efficiency and effectiveness in the public sector is vital for development. 34. Afghanistan continues to face major constraints in the capacity of its civil service. Firstly, pay policy is weak and the control system is excessively rigid. There is limited flexibility in civil service pay with no ability to adjust salary levels to special circumstances or to reflect the scarcity of skills. The core salary scale has never been adjusted and base pay has therefore eroded with inflation. Declining base pay has led to a proliferation of special allowances, overtime and other ad hoc arrangements, undermining the consistency and coherence of remuneration. There is currently no central entity responsible and empowered to regularly review salaries and propose changes within fiscal constraints. Secondly, women remain heavily under‐represented in the civil service. Women account for approximately 21.9 percent of the civil service and only less than 6 percent of Senior Management Group (SMG) positions.8 This reflects both active discrimination against women and the existence of important structural barriers, such as a lack of experienced women candidates and working conditions unconducive to women. Thirdly, civil service capacity is weakened by poor recruitment processes that remain convoluted and vulnerable to political interference. Recruitment of teachers and entry into the civil service is subject to high levels of discretion and processes are non‐transparent and non‐standardized. 35. To begin to address these issues, Government passed important revisions to its Civil Servants Law in 2018. Supported by the 2018 IP‐DPG, revisions to the law introduced a cadre system for civil service management, through which Government can recruit professional staff in batches at entry and provide

8 SMGs include all Director General (Grade 1) and Director (Grade 2) positions. Deputy Ministers are also to be integrated into the civil service

within the SMG cohort.


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batch recruits with system training and experience through job rotation. The law also includes specific provisions to: i) establish a career track for specialist staff; ii) introduce merit‐based and tailored recruitment; iii) enable positive gender discrimination within civil service appointments; and iv) enable transfers, sanctions, transparent grievance redress and civil service renewal.

36. As a prior action for the proposed operation, policies, regulations, and procedures have been adopted to support effective implementation of the new law. Firstly, a new Civil Service Pay Policy has been approved by Cabinet, providing principles to guide the management of the civilian wage bill. The new pay policy: i) ensures that pay decisions are grounded in an indicative costing methodology; ii) rationalizes the pay scale; and iii) ensures that pay is commensurate with verified competencies. Secondly, a policy to increase women’s inclusion has been approved by Cabinet, which specifies quantitative targets for women’s representation and a clear pathway to increasing women’s participation in the civil service. Specified mechanisms include advertising women‐only positions, increasing targeted outreach to potential women candidates, and enhancing enforcement of the anti‐harassment policy. Thirdly, to enable the implementation of the cadre system, cadre regulations have been approved by Cabinet for customs officer and procurement specialist cadres. These regulations establish a salary structure and competency framework for cadres, allowing recognition of specialist skills and establishing a career path, addressing attrition and reducing reliance on contracted external assistance in these areas over time. Regulations also allow transfer and rotation within cadres and establish cadre‐specific allowances. Finally, Cabinet has approved a mass recruitment general procedure. This procedure will improve recruitment of teachers and overall entry into the civil service by narrowing discretion in the testing and scoring of applicants, therefore supporting equal opportunities and minimizing opportunities for political interference. 37. Approval of policies, regulations, and procedures to support implementation of the new Civil Servants Law is expected to lead to strengthened civil service capacity. This will be achieved through: i) a more rational pay and remuneration structure; ii) reduced political interference in hiring; iii) increased representation of women; and iv) improved retention of specialized staff through the introduction of cadres in customs specializations. Supported policy reforms are expected to lead to the following results: i) the proportion of new civil service appointments in compliance with the new competitive recruitment process will increase from zero to 80 percent; and ii) the proportion of women in civil service positions in total and at grade levels one and two will increase from 22 percent to 26 percent and from six percent to nine percent, respectively.

Policy Action #3 (Prior Action): To support private sector development through improved access to credit DAB has: (i) issued a circular altering collateral requirements to allow inclusion of risk guarantees from Afghan Credit Guarantee Foundation; and (ii) entered into a memorandum of understanding with DABS to allow data sharing to provide operating banks with additional information in evaluating creditworthiness of potential borrowers through the Recipient’s public credit registry. 38. The Afghan financial sector remains underdeveloped, offers limited financial instruments, and lacks adequate risk management. There is little informational base to support financing decisions. Reflecting these realities, access to finance is a major constraint to business activity, with access to finance cited as the third‐greatest constraint in business surveys. Only five percent of firms have access to a line of credit. Access to credit is particularly constrained for the small‐ and medium‐enterprise sector, which


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accounts for the overwhelming majority of firms and around 80 percent of private sector employment. Access to credit is constrained by collateral requirements of the Central Bank, which recognize only land property as collateral. Even use of land property is subject to many challenges around property valuation, repossession, and resale. Narrowness of collateral requirements has depressed bank lending. 39. Access to credit is also constrained by limited coverage of the Public Credit Registry. While there is an existing Public Credit Registry (PCR), its coverage is extremely narrow, with membership equal to only around 0.3 percent of the adult population. The PCR currently covers around 120 thousand records for banking sector clients. The central infrastructure is managed by DAB and connected to 15 commercial banks, four microfinance institutions as well as the MoF Revenue’s department. Expanding coverage of the PCR requires integration with other data sources. This is fundamental to sound financial market development, with the Financial Supervision Department of DAB mandating all commercial banks to make an inquiry to the PCR and obtain a credit report before issuing a loan.

40. A major source of credit to the small and medium enterprise (SME) sector in Afghanistan is the ACGF. The ACGF provides credit guarantees and technical assistance to financial institutions that extend credit to Afghan SMEs. As of September 2018, the ACGF had provided 5,000 guarantees, worth US$212 million. The current outstanding guarantee portfolio covers close to 500 loans, with a value of US$26.7 million (0.1 percent of GDP). ACGF currently supports more than 70% of SME financing in Afghanistan.

41. As a prior action for the proposed operation, DAB has issued a regulation allowing the recognition of risk guarantees from ACGF as collateral and taken important measures to expand the coverage of the credit registry. Recognizing risk guarantees provided by ACGF as collateral will substantially expand options for accessing credit. As ACGF guarantees become recognized as eligible collateral, financial institutions will be able to reduce their loan loss provisioning and/or accept lower levels of collateral (the current practice is to request up to 200 percent collateral ‐as a percentage of loan value, compared with the minimum 120 percent required by DAB). To expand the coverage of the credit registry, DAB and DABS (the electricity utility) will sign a Memorandum of Understanding. Through sharing of data with DABS, the informational base of the PCR will be extended to cover the credit history of the DABs Brishna (electricity utilities company) clients. This will provide operating banks with additional critical information for use in evaluating creditworthiness of potential borrowers and the credit circumstances of consumers. This information flow will enable the banking sector to function more efficiently and at lower cost.

42. Including of ACGF guarantees in collateral will support expansion of credit to the SME sector, increasing the lending volume to entrepreneurs and the private sector. Expanding the coverage of PCR will improve the efficiency of the financial sector through a smooth flow of credit information and strengthening the foundations for credit decisions. This should lead to reduced delinquencies and improved loan portfolio quality for operating banks in Afghanistan. Supported policy reforms are expected to lead to the following results: i) credit registry coverage as a proportion of the adult population increases from 1.3 to 2.0 percent; and ii) proportion of women included on the credit registry increases from 2.3 percent to 4 percent. The target of two percent coverage remains modest relative to average credit registry coverage of around 4.8 percent for South Asia, reflecting current underdevelopment of the financial sector.


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Policy action #4 (Tranche Release Condition): To reduce the costs and time requirements of accessing electricity, DABS’ Senior Management Group: i) approves simplified subscription procedures for commercial and industrial customers; ii) establishes a fast‐track center for large customers in Kabul; and ii) approves a formal written procedure to regularly review and manage domestic and international power purchase agreements (PPA) including through the establishment of a multi‐disciplinary team with the mandate of managing such contracts. 43. The high cost of accessing electricity is a key constraint to economic growth and investment in Afghanistan. Afghanistan is ranked 168th globally in the Doing Business rankings for ‘getting electricity’. Accessing electricity requires six procedures and costs around 24 times annual income per capita. Depending on the location of the consumer and availability of the capacity in the grid and local transformers, commercial and industrial consumers can be asked by DABS to pay for the cost transformers and build their own transformer towers/house. Electricity is extremely unreliable, with Afghanistan scoring zero against the reliability of supply and transparency of tariff index. Reliability is undermined by inadequate and poorly‐maintained infrastructure and insufficient generation capacity, which is – itself – driven by the poor financial health of the national energy utility. A particular issue for DABS’ long‐term financial sustainability is heavy reliance on imported electricity under international supply contracts that are often unfavorable to the utility and have not been subject to thorough economic assessment or regular review. Supported by the 2018 IP‐DPG, DABS recently signed a partnership agreement with the MOF. Under this agreement, DABS debt to the MOF will be gradually reduced to sustainable levels conditional upon meeting a range of performance and management improvement benchmarks. 44. As a tranche release condition for the proposed operation, DABS will undertake a range of reforms to reduce the costs and time requirements for accessing electricity, while improving its capacity to access imported electricity at lower costs. To reduce the time and costs associated with accessing electricity, the DABS’ Senior Management Group will: i) approve simplified subscription procedures for commercial and industrial customers, substantially reducing the number of steps involved in acquiring an electricity connection; and ii) establish a fast‐track center in Kabul where large customers will be able to access all electricity services, reducing wait times and opportunities for corruption. To improve financial sustainability and manage the costs of imported electricity faced by the utility, DABS’ Senior Management Group will also approve a formal written procedure to regularly review and manage domestic and international PPAs including through the establishment of a multi‐disciplinary team with the mandate of managing such contracts. The new procedures and capacity are expected to lead to lower imported energy prices by ensuring that contracts are subject to regular expert review and – where appropriate – are renegotiated and revised. 45. Supported reforms will reduce the time and costs associated with accessing electricity. Supported policy reforms are expected to lead to the following results: i) the time taken to access an electricity connection for commercial customers will decline from 114 to 80 days; ii) the cost of acquiring an electricity connection for commercial customers will decline from 2,448 percent of income per capita to less than 1,500 percent; and iii) the number of international PPAs reviewed by a dedicated multidisciplinary team within DABS increases from zero to three.

Policy Action #5 (Tranche Release Condition): To improve land administration, the Supreme Court and MUDL sign a protocol transferring responsibility for deed registration to Ministry of Urban Development and Land (MUDL) in Herat city.


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46. Afghanistan currently has a deed‐based land registration system. Under this system, land management is the responsibility of the courts. Land information is scattered across various registries with different ministries and agencies. Most registry books are not interlinked, causing overlaps and outdated or missing records. Land transactions must be pursued through the court system, generating substantial delays and generating opportunities for corruption. This situation has resulted in low formal land registration in Afghanistan, with only 30 percent of urban properties and 10 percent of rural properties formally registered. The time taken to register property in Afghanistan is 250 days, well above the South Asian average of 114 days, with access to land commonly cited as a major constraint by investors. Uncertainty of tenure is a major constraint to agricultural development, with disproportionate negative impacts on the poor (who depend heavily on agricultural livelihoods). Weaknesses in land management also impose high social costs, with weaknesses and ambiguity in land property rights contributing to widespread problems of land‐grabbing and land‐related contestation and conflict.9 47. The WBG has been working in close partnership with Government to improve land governance in Afghanistan for over a decade. The World Bank has provided technical assistance to the land management agency and supported policy reforms under previous Development Policy Operations and investment projects. The Government has been working with the World Bank and other development partners since 2007 to: i) strengthen the institutional framework for land management; ii) build institutional capacity for land management through international technical assistance support; and iii) strengthen the legal framework for land management. Under recent institutional changes, the Government’s land agency (previously known as ARAZI) has been transformed into the Deputy Ministry of Land within a new Ministry of Urban Development and Land (MUDL). It has maintained its mandate as the land authority in Afghanistan, underpinned by the new Land Management Law and Land Acquisition Law. Absorption of the land agency into MUDL continues a positive ongoing process of consolidation of agencies with responsibilities for land management.

48. In line with the Land Management Law, the Government is now working to transform the court‐based deed registration system into an administrative function and to gradually move away from a deed registration to title registration system based on a centralized Land Information System (LIS). The new Land Management Law provides MUDL with the mandate to assume the functions of the courts in administration of formal deeds, which includes the issuance, indexing and archiving of new deeds and administration of the deeds archives, which are nearly a century old. MUDL will also manage the LIS. Implementation will be phased, beginning with the transferring of the deed registration responsibility from the court to MUDL in a single municipal district, which will be integrated over time into the LIS. As MUDL takes over deed registration in agreed areas, it will improve registration services while the deed system is replaced with a title registration system over time. Under the new Afghanistan Land Administration System Project, the LIS will be functioning in Heart and Kabul at the end of implementation. The pace and extent of roll‐out to other areas in the country will be informed by the pace with which enabling institutional and technological platforms can be established and the presence of the necessary underpinning governance and security environment. Nationwide roll‐out is therefore viewed as a long‐term objective.

9 Survey evidence suggests increasing concern regarding land disputes since 2002, with 50 percent of respondents to one survey citing land disputes as a major source of insecurity. Almost 240,000 hectares of state lands have been expropriated by political and economic elites since the fall of the Taliban.


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49. The implementation of an administrative system is expected to reduce opportunities for predation and corruption. The use of a centralized administrative system based on modern processes and electronic systems (including a land registration database to be established at MUDL) allows for strengthened centralized verification and reduces the discretion of decentralized actors within the court system. The use of a centralized and electronic system is expected to substantially reduce scope for corruption while reducing administrative costs. A grievance mechanism is being established, with World Bank support, through which any abuses of the new system can be reported and addressed. 50. As a tranche release condition for the proposed operation, the Supreme Court and MUDL will sign a protocol transferring responsibility for deed registration to MUDL in Herat city. The Protocol will (i) confirm the delegation of authority and responsibilities of registration of land and properties and execution of deeds to MUDL; (ii) establish cooperation between the Supreme Court and MUDL in the gradual transfer of these responsibilities, including access to the relevant archives; and (iii) confirm responsibility of MUDL, along with relevant government agencies, particularly the MOF to provide facilities, human resources, safe archives and all other requirements for the implementation of the protocol. 51. Transition to an administrative system will lead to reduced compliance costs and greater certainty of property rights, facilitating, over time, increased investment and land productivity. Supported policy reforms are expected to lead to an increase in the number of municipal districts in which an administrative land system is operating and land transactions are recorded on the Land Information System from zero to at least one.

Policy Action #6 (Prior Action): To improve management of water resources Cabinet has approved and submitted to the National Assembly a revised water law which includes: i) clarification of MEW and MAIL mandates; ii) recognition of traditional water use rights; and iii) provisions governing dam safety, pollution, and groundwater.

52. Water scarcity and security has been a major constraint to agriculture in Afghanistan. Agriculture accounts for about one fourth of GDP. Agro‐processing accounts for roughly 90 percent of total manufacturing and employs 60 percent of the total labor force.10 Over 80 percent of the population and 90 percent of the poor are engaged in agriculture for livelihoods. Agricultural production is heavily impacted by water availability, and periods of drought are expected to become worse with climate change. Adequate water and irrigation management is critical to address the mismatch in the timing of water supply (from mainly melted snow) and demand (crop production). About 80 percent of agriculture production in the country comes from irrigated agriculture. Lack of irrigated land has been a significant challenge with only 2.45 million hectares (ha) currently under irrigation out of a total 4.4 million ha of potentially irrigable land. 53. Water resources and irrigation management are negatively impacted by gaps in the regulatory framework. The current Water Law, adopted in 2009, has major deficiencies, including: i) lack of recognition of the traditional water rights which have been implicitly endowed to community‐based irrigation entities, called Mirab; ii) lack of regulatory framework for the concession of water use rights;

10 World Bank (2014), “Islamic Republic of Afghanistan: Revitalizing Agriculture for Economic Growth, Job Creation and Food Security”


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and iii) absence of the provisions on dam safety, pollution, and groundwater. Most significantly, the Water Law contains significant references to irrigation but does not provide clarity on the roles and responsibilities of Ministry of Energy and Water (MEW) and Ministry of Agriculture and Land (MAIL). Lack of clarity in relation to responsibility for construction and maintenance of irrigation schemes has significantly undermined the expansion of the irrigation network and – therefore – agricultural production and productivity. An efficient irrigation network will only become more important to the agricultural sector as climate change impacts water availability. The Water Law also does not address in sufficient detail: elements of the water rights regime; aspects of water related disaster management, monitoring and data (including public access); protected areas and wetlands; international watercourses; and provisions on inspection, enforcement, and offences. Addressing all these issues is vital for management of current and future impacts of climate change. 54. As a prior action for the proposed operation, Cabinet has approved and submitted to the National Assembly a revised Water Law. The revised law addresses crucial gaps in the existing legal framework as specified above. Specifically, the revised law will include provisions: i) clarifying the respective mandates of MEW and MAIL; ii) allowing for recognition of traditional water use rights; and iii) establishing a legal framework to govern dam safety, pollution, and groundwater. The new law complements and supports implementation of the new irrigation and dryland agriculture policies that were supported under the 2018 IP‐DPG. The new law also includes measures to recognize traditional water management systems, including protecting allocation of water for farm irrigation under customary systems, and preventing disruption by new water rights allocations of downstream traditional users.

55. Adoption of the amended Water Law is expected to support improved agricultural production and productivity and enhance resilience to weather related shocks, including those resulting from climate change. Supported policy reforms are expected to lead to the following result: Responsibility for the design, construction, and management of irrigation canals for agriculture from the source to the farm is allocated to MAIL (y/n). Pillar II: Improve the Policy and Institutional Framework for Improved Public Financial Management

Policy actions #7 (Tranche Release Condition): To improve public investment management the circular for the 2020 budget: i) includes detailed guidelines on financial, economic, and gender analysis; and ii) specifies that no new project proposal of greater than USD 7.5 million will be approved for further appraisal through the discretionary budget for 2020 without strategic fit analysis and no new project of greater than US$7.5 million will be approved for implementation without project appraisal including financial, economic, and gender analysis.

56. Improved public investment management is vital for Afghanistan. With expected reductions in grant support, Afghanistan will face increased pressure on fiscal resources over coming years. With a shrinking resource envelope, optimizing public expenditure towards the greatest development needs remains a key challenge. Existing budget systems relating to project selection are inadequate to meet these challenges. Within the government discretionary development budget (around US$700 million in 2018), projects are selected for implementation without robust checks for alignment with policy priorities


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or adequate project appraisals.11 Political considerations have historically dominated project selection, undermining both project quality and policy alignment. Lack of thorough project appraisals has led to major problems with budget execution, with projects often encountering delays and avoidable cost overruns. 57. To improve the quality of development project expenditure and the alignment of public resource use with policy priorities, the government is pursuing an ambitious program of Public Investment Management reform. In 2018, supported by the previous IP‐DPG, MOF standardized project concept notes for new project proposals to enable better alignment via a process of strategic fit screening. MOF also implemented a review of existing development projects, rationalizing the project pipeline.

58. As a tranche release condition for the proposed operation, MOF will further strengthen project selection processes and criteria. The budget circular for the 2020 budget will contain guidelines for financial and economic analysis. These guidelines will provide a framework for standardized assessment of projects, which can be applied by ministries. Economic analysis guidelines will also provide guidance on gender analysis of projects. The budget circular for the 2020 budget will mandate that no large project will be cleared for further appraisal without first undergoing strategic fit analysis and obtaining clearance to proceed for further preparation. The budget circular will further mandate that no large new project will proceed to implementation under the national development budget without first undergoing appraisal including an economic analysis. Large projects are defined as those with a total budget of more than US$7.5 million and account for around 40 percent of the total number of projects in the current pipeline and more than 90 percent of the pipeline by total value.

59. Developing clear guidelines for project analysis and mandating the application of these guidelines through the budget process will enhance the alignment of development projects with the ANPDF and national priority programs and improve the efficiency and effectiveness of development expenditure. Supported policy reforms are expected to lead to the following results: at least 50 percent of all new projects over US$7.5 million included in the discretionary development budget will have undergone economic and gender analysis.

Policy Action #8 (Tranche Release Condition): To improve tax administration, MOF issues a circular to make fast‐track tax filing mandatory for banking and telecommunication sectors in the large taxpayer office (LTO) and available for optional use in the medium taxpayer office (MTO). 60. Authorities are committed to raising additional domestic revenues and improving the business climate in Afghanistan. Improving the ease of filing and payment of taxes is central to both objectives. While tax rates in Afghanistan are low compared to the rest of South Asia, tax administration is a challenge. Afghanistan is ranked 177th in the Doing Business survey on the paying taxes measure. Interviews with taxpayers and their representatives suggests that filing, payment, and post‐filing compliance procedures remain difficult and time‐consuming. 61. The current paper‐based process of filing tax returns is a key constraint to improved tax administration. Tax filing is currently heavily reliant on paper‐based processes which are time‐consuming

11 The development budget is divided between a ‘non‐discretionary’ development budget comprising on‐budget donor projects and the ‘discretionary’ development budget comprising government‐managed projects.


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and vulnerable to calculation and transcription errors (often resulting in penalties for taxpayers). As a solution that is feasible within the existing legal framework the Afghanistan Revenue Department (ARD) is introducing “Fast Track Filing” as a hybrid system. All steps are electronic, except a final printed submission form that also serves as a receipt for the taxpayer. This receipt is submitted when the taxpayer makes a payment at Da Afghanistan Bank (DAB).

62. As a tranche release condition for the proposed operation, fast‐track filing will be made mandatory for large taxpayers in the telecommunications and banking sectors and offered optionally to all large and medium taxpayers. This will deliver immediate reductions in compliance costs. Further, roll‐out of electronic filing to large taxpayers will greatly facilitate the introduction of the VAT in 2020.12 All VAT registrants in the initial phase of VAT implementation are located in the LTO, as the LTO and VAT turnover threshold are harmonized. This will allow the VAT implementation to exclusively make use of electronic filing systems, ‘leapfrogging’ the use of paper‐based processes and forms. Expanding the optional use of this system to the MTO will offer improved taxpayer services to a large group of clients and will continue to improve the business climate in Afghanistan. The ARD anticipates that most LTO clients will voluntarily adopt electronic filing in the current year, with mandatory use for all LTO clients to be introduced in the subsequent fiscal year.

63. Increased use of electronic systems will reduce compliance costs for tax‐payers, reduce administrative costs for ARD, and reduce opportunities for petty corruption. Supported policy reforms are expected to lead to the following results: the proportion of active large taxpayers utilizing fast‐track filing will increase from 9.7 percent to 60 percent (telecommunication and banking sector firms account for around 12 percent of total LTO firms, but a large proportion of firms beyond these sectors are also expected to voluntarily utilize fast‐track filing).

Policy Action #9 (Tranche Release Condition): To improve tax administration, a Tax Dispute Resolution Board is equipped with five board members and a secretariat. 64. The absence of a dispute resolution mechanism impedes tax administration. Taxpayers in Afghanistan currently only have recourse to the Objections Department of the ARD or the court system when attempting to resolve tax disputes. Many in the business community perceive the Objections Department as lacking in neutrality, while cases are often also subject to delay and petty corruption. The court system is an inadequate alternative, as the courts can only rule on matters of law, while the costs and time requirements for resolving disputes through this channel are extremely high. Lack of confidence in the tax system is major constraint to formalization (approximately 80 percent of firms operate informally). For large firms, exposure to perceived corruption and predation through the tax system without easy recourse to mechanisms for resolving disputes constrains confidence and investment.

65. Government is committed to improving dispute resolution mechanisms. An additional mechanism for dispute resolution is called for in the 2015 Tax Administration Law – the Tax Disputes Resolution Board (TDRB). The TDRB will exist outside the administrative structure of the ARD, governed by board members, providing the opportunity for independent review of taxpayer disputes. The TDRB will have five members including an economic specialist, a legal specialist, an accounting specialist, a tax

12 There are around 270 large taxpayers in Afghanistan which account for a large proportion of total direct tax revenues.


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specialist and a representative of the private sector. The legal procedures for mobilizing the TDRB have been completed, and the role and legal mandate of the TDRB is now clear. The remaining task is the appointment of board members and the establishment of the TDRB secretariat to support the function of the board. In short, the TDRB should now be operationalized.

66. As a tranche release condition for the proposed operation, the TDRB will be operationalized. Board members will be selected and appointed, following the legal framework outlined in the Tax Administration Law (2015). The board members should be proposed by the Minister of Finance and approved by the Council of Ministers for five‐year terms. A secretariat will be required to support the work of the TDRD with its functions including receiving dispute documentation from taxpayers, scheduling meetings, recording and communicating decisions.

67. The establishment of a TDRB is expected to lead to increased private sector confidence in the tax system and therefore increased voluntary compliance and potentially marginal increases in investment, both leading to positive impacts on revenues. Supported policy reforms are expected to lead to the following results: number of cases submitted for ruling by the Tax Dispute Resolution Board increases from zero to ten (this target reflects an estimate of demand for second‐level dispute resolution based on current first‐level objections of around 50 per year).

Policy Action #10 (Tranche Release Condition): To improve tax policy Cabinet approves VAT regulations including proposed exemptions by harmonized system (HS) code and refund procedures.

68. To support Afghanistan’s self‐reliance agenda, a Value‐Added Tax (VAT) is planned for implementation by the end of 2020. Afghanistan is currently heavily reliant on customs revenues, which account for around 19 percent of total revenues. Customs revenues are expected to decline in the context of Afghanistan’s accession to the World Trade Organization (WTO). Afghanistan also currently operates a highly distortionary cascading turnover tax (the Business Receipts Tax, BRT) which is considered a significant constraint to private sector development. To replace both the BRT and revenues lost from declines in tariff rates, authorities are targeting implementation of a 10 percent VAT. VAT implementation is the cornerstone of government’s revenue strategy and is expected to deliver an overall revenue increase equal to two percent of GDP over the medium‐term. 69. A simple VAT system is being introduced, focused on large taxpayers. Generally, VAT will be charged on all imports and on the supply of taxable goods and services in Afghanistan made by VAT registered taxpayers. Due to a high VAT registration threshold, the number of taxpayers required to register for VAT is expected to be approximately 500 of the largest businesses in Afghanistan. Taxpayers who are registered for VAT will not be subject to domestic BRT. Taxpayers who are not registered for VAT will continue to be liable for domestic BRT if they meet the BRT legislative requirements. The vast majority of VAT revenue will be collected from VAT on imports. The ARD will administer the VAT charged and collected by VAT registered taxpayers on domestic economic activity. Administrative activities will include registration, assessments, payments/refunds, taxpayer service, audit and enforcement.

70. Two issues are particularly important in the VAT regulations – exemptions and refunds. The VAT law notes that the list of HS codes for exempt products will be specified in the regulations within a


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grouping of food and non‐food items used by low income households. Determining this list of HS codes will require analyzing household survey data on consumption patterns of low‐income households, while also considering revenue losses, to inform the selection of exempt products. Secondly, refund procedures and modalities must be clearly analyzed and agreed to facilitate refunds of VAT on zero‐rated products.

71. As a tranche release conditions for the proposed operation, Cabinet will approve VAT regulations, including proposed exemptions by HS code and refund procedures. While the VAT legislation has already been completed and approved, regulations are incomplete. It will be important for regulations to be completed in 2019 to inform operational preparations in 2020 for the launch of VAT by December 2020.

72. Completion of the VAT regulations will enable the ARD and Afghanistan Customs Department (ACD) to continue preparations for operationalization of the VAT by the end of 2020, supporting a broadening of the tax base, a reduction in reliance on distortionary turnover taxes, and improved overall revenue performance. Supported policy reforms are expected to lead to the following results: VAT business processes approved and communications material released based on regulations, including procedures for exemptions. Policy Action #11 (Tranche Release Condition): To improve the quality of public expenditure, the budget circular mandates the use of revised norms for vehicles and buildings in at least four pilot ministries in preparing the 2020 budget. 73. Afghanistan faces major challenges in ensuring adequate and efficient O&M expenditures. The infrastructure base has grown rapidly since 2001, with heavy investment in new infrastructure by Government and development partners. As responsibility for maintaining new infrastructure has been transferred to government, pressure on available resources for O&M has dramatically increased. These pressures are likely to become more severe over coming years, as Government deals with expected declined in grant inflows and pressures for new spending to expand services and consolidate any potential peace agreement with the Taliban. Current systems and processes are inadequate to effectively manage these challenges. The incremental budgeting approach, a highly centralized budget system, and absence of effective monitoring impedes prioritization and accountability over O&M expenditures. 74. Government has recognized the importance of enhancing O&M. In November 2019 and supported by the 2018 IP‐DPG, GoIRA approved an ambitious new O&M policy to ensure sufficient O&M allocations and improve the efficiency and effectiveness of O&M expenditures. Key elements of the new policy include: i) setting realistic targets for service delivery levels taking into account the available budgetary resources (budget ceilings); ii) establishing norms for the O&M costs for each main line of service delivery (object codes); iii) aligning budget allocation process with pre‐agreed norms for each line of service delivery; iv) establishing an asset management information system; and v) development of robust procedures for identification, appraisal and approval of proposed capital investments (including donor funded projects) which incorporate full estimates of recurrent O&M costs associated with utilization and maintenance of new assets. Under the policy, the ongoing costs of existing asset portfolios will also be recorded and used to inform medium‐term expenditure profiles under the medium‐term fiscal framework.


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75. The new policy is now being rolled out progressively across Government. The MoF is now working to prepare standard norms and cost schedules for budgeting, a national asset registry, and detailed codes for proper budgeting and monitoring of O&M expenditure. The policy is being piloted in four‐line ministries and an amount of AFN 2 billion has been kept in the 2019 (FY 1398) budget to be allocated to the pilot ministries as per the O&M policy.

76. As a tranche release condition for the proposed operation, MoF will take major steps towards implementation of the new O&M policy. Specifically, MOF will develop revised norms for vehicles and buildings and issue a circular mandating their use by at least four pilot line ministries in preparing the 2020 (FY 1399) budget. Through the mid‐year budget review, the Ministry of Finance will also allocate the already‐appropriated AFN 2 billion O&M contingency to costs incurred through rolling out the O&M policy in pilot ministries.

77. Roll‐out of the new O&M policy is expected to lead to improved quality and efficiency of O&M expenditure through an evidence‐based and consistent approach. Increased confidence in the quality of O&M expenditures is expected to lead, over time, to increased O&M budget allocations, progressing towards levels required to maintain the existing asset base. Supported policy reforms are expected to lead to the following results: clear guidance available to line ministries to guide O&M expenditures on vehicles and buildings (y/n).

Policy Action #12 (Tranche Release Condition): To strengthen transparency, MOF publishes fortnightly revenue reports on its website that: i) provide full disaggregated tax, customs, and non‐tax performance data at the level of collection points; and ii) track progress against government revenue targets. Policy Action #13 (Tranche Release Condition): To improve accountability and quality of cash management, the cash management committee meets at least every 21 days and publishes minutes of decisions taken at those meetings on its website within 7 days of the meeting.

78. Afghanistan is entering a period of elevated macro‐fiscal risks. Elections in Afghanistan have historically been associated with deteriorations in revenue performance and governance, posing important fiscal and macroeconomic risks. Government and the international community are committed to managing such risks during 2019. 79. Government is now seeking to ensure full transparency in revenue performance and expenditure management decision‐making. This is expected to both improve accountability on policy‐makers to citizens and the international community and ensure that development partners have full and up‐to‐date information on short‐term developments that are impacting the revenue and cash position in order to inform any response to fiscal disruptions on behalf of the international community. Data on revenue performance is not currently published throughout the year. While a cash management committee exists within the Ministry of Finance, it does not sit regularly throughout the year and its procedures and decisions are not made public. 80. As a tranche release condition for the proposed operation, MOF will publish fortnightly revenue reports on its website. These reports will provide full disaggregated tax, customs, and non‐tax revenue


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performance data at the level of collection points and track progress against government revenue targets. Through the inclusion of data at the level of collection points, this data will provide an early warning of compliance problems allowing for early remedial action. Close overall tracking of revenue performance against targets will also support the international community in understanding the overall fiscal situation and emerging fiscal risks and planning and phasing any necessary support through budget support and other programs. Reporting in compliance with this tranche release condition will begin in June 2019 (when risks related to the September Presidential elections are expected to intensify) and continue indefinitely. Verification will take place in mid‐November 2019, ensuring continuous publication over the elections and the subsequent period of government formation.

81. As a tranche release condition for the proposed operation, MOF’s cash management committee will also hold regular meetings and publish regular reports summarizing the cash situation and key decisions. In the event that macro‐fiscal risks are realized and revenues fall short of budgeted levels, allocation and prioritization of public resources will be governed, de facto, through cash rationing rather than the annual budget. With no recourse to borrowing, cash management decisions will determine to a large extent how scarce resources are utilized and the alignment of expenditures with core government functions and service‐delivery needs. Transparency over cash management decisions will be important to ensure the availability of accurate information on resource allocation decisions to the public and agencies of the international community that fund a large proportion of annual recurrent and development expenditures.

82. Supported reforms will lead to increased transparency of revenue and cash management. Increased transparency with regards to revenue performance is expected to strengthen overall accountability to the public, ensuring that sufficient efforts are taken to maintain revenue collection and provide the international community with information to inform an appropriate response in the context of an unexpected revenue decline. Reflecting the need for wide dissemination of the revenue reports, the results indicator is: number of downloads of the new revenue performance report increases from zero to 500. Increased transparency with regards to cash management decisions will help ensure that available cash resources are utilized to meet basic social service needs and finance core operations of government, rather than being directed to lower‐priority projects for political purposes. Improved cash management should mitigate against potentially destabilizing and disruptive interruptions to salary payments. The results indicator is: share of treasury civil service salary payments made within ten days of monthly claims by line ministries remains at 100 percent. This result indicator captures avoidance of disruption to salary payments and associated risks to public order and service delivery.

Table 4: Development Policy Financing (DPF) Prior Actions, Analytical Underpinnings, and Complementary Support Programs

Policy Actions Analytical Underpinning Parallel Support

Program

Pillar I: Strengthen the policy framework to support state effectiveness, private investment, and social inclusion To develop a regulatory framework for e‐money and digital payments: i) DAB issues a circular to operating banks and MOF issues a circular to tax

WB (2018) “Developing Afghanistan’s Mobile Money and Financial Technology” ‐

Payments Automation and Integration of


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and customs directorates and provincial offices allowing for electronic payment of customs and tax dues; and ii) DAB issues a circular requiring participation of all mobile money providers, payment card issuers, and acquiring banks in Afghanistan Payment System to enable interoperability.

Highlighted potential for e‐money to address financial inclusion in Afghanistan, emphasized the importance of interoperability as an enabling condition.

Salaries in Afghanistan (PAISA) (P168266) (Pipeline)

To support implementation of its Civil Servants Law, the Recipient’s: (i) Cabinet has approved (A) the Civil Service Pay Management Policy, (B) the Policy for Increasing Women’s Participation in Civil Service, as well as (C) the Customs Cadre Regulation and the Procurement Cadre Regulation; and (ii) Independent Administrative Reform and Civil Service Commission has approved the Procedure on Civil Servants' Recruitment through Mass Competitive Exam.

WB (2018) “Discussion Note: New Civil Service Program.” WB (2016‐17), “Wage Bill Analysis and Modeling”, WB (on‐going), “Assessment of Human Resource Management Information System” WB (2017‐), “Functional Reviews” – Highlighted reliance on unsustainable NTA positions, highlighted the need for remuneration and hiring policies that enabled retainment of skilled staff within the core civil service structure.

WB, Tackling Afghanistan’s Government HRM and Institutional Reforms (TAGHIR) Project

To support private sector development through improved access to credit DAB has: (i) issued a circular altering collateral requirements to allow inclusion of risk guarantees from Afghan Credit Guarantee Foundation; and (ii) entered into a memorandum of understanding with DABS to allow data sharing to provide operating banks with additional information in evaluating creditworthiness of potential borrowers through the Recipient’s public credit registry.

WBG (2018) Doing Business Reform Memorandum – Highlighted constraints to accessing finance associated with collateral requirements and limited coverage of the PCR.

USAID funded Trust Fund ‐ Investment Climate Program Afghanistan

To reduce the costs and time requirements of accessing electricity, DABS’ Senior Management Group: i) approves simplified subscription procedures for commercial and industrial customers; ii) establishes a fast‐track center for large customers in Kabul; and ii) approves a formal written procedure to regularly review and manage domestic and international power purchase agreements (PPA) including through the establishment of a multi‐disciplinary team with the mandate of managing such contracts.

WB (2017), “Financial Evaluation of DA AFGHANISTAN BRESHNA SHERKAT‐DABS” – Highlighted requirements for financial sustainability at DABS, including potential savings from review of international PPAs.

“DABS Planning and Capacity Support Project”, and “Afghanistan Energy Study”

To improve land administration, the Supreme Court and MUDL sign a protocol transferring responsibility for deed registration to MUDL in at least one province.

World Bank (2013) Land Governance Assessment Framework Afghanistan: Final report. – Highlighted shortcomings of the current court‐based system of land management.

Afghan Land Administration System Project (P164762)

To improve management of water resources Cabinet has approved and submitted to the National

WB (2018) Climate Change Impacts on Hydrology and

On‐going technical assistance under On


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Assembly a revised water law which includes: i) clarification of MEW and MAIL mandates; ii) recognition of traditional water use rights; and iii) provisions governing dam safety, pollution, and groundwater.

Agriculture (P162117) – Highlighted the need for improved irrigation coverage to manage climate and natural disaster risks.

Farm Water Management Project (P152870)

Pillar II: Strengthen the policy framework for an improved public finance system

To improve public investment management the circular for the 2020 budget: i) includes detailed guidelines on financial, economic, and gender analysis; and ii) specifies that no new project proposal of greater than USD 7.5 million will be approved for further appraisal through the discretionary budget for 2020 without strategic fit analysis and no new project of greater than US$7.5 million will be approved for implementation without project appraisal including financial, economic, and gender analysis.

WB (2017), “Afghanistan: Developing an Efficient PIM System”, WB (2017), “PIM Conceptual Framework in Afghanistan”, WB, (forthcoming), “Assessment on Afghanistan’s PIM system” – Highlighted weaknesses in the current PIM framework and the need for improved economic analysis in project selection.

WB Fiscal Performance Improvement Plan Support Project (FSP): IPF TA support WB FPIP Advisory Facility: Programmatic Analytical Services and Advisory

To improve tax administration, MOF issues a circular to make fast‐track tax filing mandatory for banking and telecommunication sectors in the large taxpayer office (LTO) and available for optional use in the medium taxpayer office (MTO).

WB (2015) “ARD Functional Review”, WB (2016) “LTO Business Process Mapping” ARD (2016) “ARD Tax Administration: Re‐Organization and Modernization Proposal 2016‐2021” – Highlighted the need for streamlined processes in paying taxes and additional dispute resolution mechanisms.

WB FSP: IPF TA support WB FPIP Advisory Facility: Programmatic ASA

To improve tax administration, a Tax Dispute Resolution Board is equipped with five board members and a secretariat.

To strengthen tax policy, Cabinet approves VAT regulations, including proposed exemptions by HS code and refund procedures.

WB (2018) VAT Implementation Plan – Provides a detailed roadmap for VAT implementation, including the role of vital supporting regulations.


To underpin implementation of the new O&M policy, a MOF circular mandates the use of revised norms for civilian vehicles and buildings in at least the four pilot ministries in preparing the 2020 budget.

WB (2018), “Public Expenditure and Financial Accountability (PEFA) Assessment” – Highlights current weaknesses in O&M policy and associated inefficiencies in public resource sue.


To improve transparency, MOF publishes fortnightly revenue reports on its website that: i) provide full disaggregated tax, customs, and non‐tax revenue performance data at the level of collection points; and ii) track progress against government revenue targets.

USIP 2018 “How Afghanistan can avoid another fiscal crisis” – Highlights the need for improved transparency on revenue and cash management to help manage election‐related risks.


To improve accountability and quality of cash‐management, the cash management committee meets at least every 21 days and publishes minutes of decisions taken at those meetings on its website within 7 days of the meeting.



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4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY

83. The proposed operation is fully consistent with the priorities and approach established in the World Bank Group’s Afghanistan Country Partnership Framework (CPF) (FY2017‐FY2020).13 Building on a Systematic Country Diagnostic completed in 2016, the CPF is structured around three pillars: i) building strong and accountable institutions; ii) supporting inclusive growth; and iii) social inclusion. Reforms supported under both pillars of the proposed operation directly contribute to all three pillars of the CPF, through an emphasis on institutional, legal, and regulatory reforms that both expand access to economic opportunities to disadvantaged groups and support private sector development. Actions to improve the business environment are also complementary to ongoing IFC and MIGA activities intended to mitigate risks faced by private sector investors in fragile contexts through risk sharing and guarantee facilities.

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS

84. Reforms supported by the operation have benefited from wide consultation undertaken by government. Reforms supported by the operation are aligned with the ANPDF, which was developed through extensive consultations with civil society and the private sector. Private sector reforms, including financial inclusion measures, tax administration, and energy were subject to extensive private sector consultations through the Private Sector Executive Committee, co‐chaired by the Ministry of Commerce and Industry (MOCI), Office of the Chief Executive, and the World Bank. Land actions were subject to extensive community consultation through reviews of the Land Management Law, led by MUDL. In revising the Civil Servants Law, the Independent Administration Reform and Civil Services Commission (IARCSC) carried out extensive upfront consultations across Government, including within the relevant Development Council “the High Council for Good Governance and Administrative Reforms” ‐ including the Administrative Office of the President (AOP), MOF, Ministry of Economy, Ministry of Labor and Social Affairs, and with the Ministry of Justice (MOJ). Since December 2017, the more than 18 government ministries and agencies concerned with water management have been involved in the process of revising the 2009 Water Law to address the current regulatory gaps. Under a first committee, established under the Technical Secretariat of the Supreme Council of Land, Water and Environment, a technical review of the Water Law was carried out. In April/May 2018 a second committee was established by decree of the President and under the chairmanship of MOF and secretariat of MOJ for the legal drafting process. Both committees have comprehensive membership of all ministries and government agencies concerned (all ministries represented in both committees). 85. This operation has been developed in close collaboration with development partners, particularly through the ARTF donor group. Donor aid coordination in Afghanistan is strong and frequent. Policy reforms and technical assistance efforts are coordinated through different donor‐government platforms, among others the Joint Coordination Monitoring Board, heads of agency meetings, the ARTF Strategy Working Group and other technical working groups. During the preparation phase of this operation, discussions have been held with the IMF and all ARTF development partners, including multilaterals such as European Union (EU) and Asian Development Bank (ADB) as well as bilateral partners

13 Report No. 109589‐AF, discussed by the Board on October 27, 2016


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participating in the ARTF. Overall strategic coordination on outcomes and reform priorities has been supported through the ARTF Incentive Program technical working group, which is monitoring implementation of the Incentive Program policy actions. The World Bank team has been also closely cooperating with the IMF, including regular participation in IMF ECF quarterly reviews and day‐to‐day collaboration on macro‐monitoring and assessment.

5. OTHER DESIGN AND APPRAISAL ISSUES

5.1. POVERTY AND SOCIAL IMPACT

86. Assessment of the policy and institutional reforms supported by the operation suggest significant positive or neutral poverty and social effects over the longer‐term. 87. The development of a regulatory framework for e‐money and digital payments is expected to have positive poverty effects if the policy is implemented according to plan, and if concerted effort is made to extend benefits to women. The establishment of systems that support e‐money and e‐payments should have positive poverty impacts by supporting financial inclusion, facilitating access to bank accounts, and thereby increasing options for saving and borrowing. This may have significant benefits for the poor over time, with low levels of current financial inclusion driving heavy reliance on harmful coping mechanisms in the context of economic shocks. While access to the internet is limited in Afghanistan14, almost three quarters of the poor have access to a mobile phone, suggesting broad access to benefits of e‐money and electronic payment systems as systems mature.15 About 11 percent of the employed Afghans work as salaried employees in the public sector and could therefore benefit from a move to e‐payments for public sector salaries through reduced transaction costs and reliance on payment agents who often charge significant commissions. Though civil servants have a higher representation in the top two quintiles, seven percent of the employed of the bottom three quintiles are civil servants and could benefit from the recommended reforms. Women are less likely to have access to the banking sector, internet or mobile phones and focused effort will be essential to ensure female civil servants can access e‐payments and women can access services such as e‐banking. Utilization of electronic systems for the payment of taxes may ease women’s participation in the formal business sector, especially in the context of cultural constraints to women traveling and queueing in some areas. 88. Policies, procedures, and regulation to implement the Civil Servants Law are not likely to have any adverse poverty or social impacts. Merit‐based and inclusive recruitment practices have the potential to increase the productivity and efficiency of government services and increase transparency and accountability which may have positive but certainly not negative spillover effects for the broader population. Supported policies, procedures, and regulations are not associated with public sector redundancies or reductions in civil service pay.

14 Only 10 percent of households have at least one household member who used the internet in the past 12 months (27 percent in urban and five percent in rural areas) and on average, only 11 out of 100 Afghans use the internet (ALCS, 2016‐17). 15 About 80 percent of households have at least access to one mobile phone (96 percent in urban and 75 percent in rural areas) (ALCS 2016‐17).


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89. Several policy actions supported by the proposed operation are expected to have indirect positive poverty effects through facilitating investment and private sector development. Afghanistan’s private sector primarily consists of small and micro enterprises and most Afghans work as own account workers, the majority of which are in the informal sector. Business environment reforms to strengthen access to credit are expected to support entrepreneurship and investment of small and micro enterprises. Easier access to credit under fair and transparent procedures, with limited collateral requirements, can strengthen small private sector operators, which comprise the bulk of the sector, to invest, facilitating private sector development. To the extent that improvements in the business environment lead to increased productivity, employment growth, and increased wages, overall poverty effects are expected to be positive.

90. Measures to reduce the cost of accessing electricity for commercial customers are unlikely to have any adverse poverty and social impacts. Energy sector reforms do not involve any changes in tariffs for residential users. Reducing the cost of accessing electricity for commercial customers should lead to lower input costs and easier access, which may facilitate private sector investment. Lower costs of electricity for commercial customers may even benefit end‐users if these cost savings translate into lower prices for end‐products and services.

91. The transfer of responsibility for deeds registration to MUDL is likely to have positive effects subject to MUDL’s implementation capacity. The creation of a government‐maintained register and deeds registration system may have significant benefits for the poor if it is effectively implemented. An administrative land system will, over time, strengthen property rights facilitating tenure security, access to credit, and investment. The transfer to an administrative system may bring particular benefits to women, with measures in place to ensure that women’s land rights can be more‐effectively recorded and enforced than under the court‐based system. Risks, however, also exist and need to be managed. Firstly, formal titling processes may enable expropriation, with state institutions and vested interests being empowered to distribute land rights to special interests. Secondly, formal land titling processes may fuel corruption, if governance is weak within new institutions established to manage disputes. Thirdly, new processes may lead to frustration if processes for issuing rights are slow or viewed as unfair. Several factors mitigate these risks. Firstly, processes are in place to control land grabbing. MUDL has detailed information on instances of land grabbing, and the practice has been criminalized through recent legislative reforms. Secondly, the transfer to an administrative system is being piloted in urban centers where government administrative reach and oversight arrangements are strongest. Thirdly, the land authority – MUDL – is a relatively high capacity agency with established administrative dispute resolution processes. Finally, the World Bank has a long history of engagement in land in Afghanistan, beginning with providing technical assistance to the development of a Land Policy in 2008, sustained technical support to MUDL, and most recently supporting substantial revisions to key land laws (the Land Acquisition Act and the Land Administration Act) through a Development Policy Grant in 2017. The current Afghanistan Land Administration System Project (ALASP) includes specific risk mitigation measures to deal with the gradual transformation from a deed‐based to a title based administrative system, including: i) attention to governance with oversight from multiple authorities, including the High Council on Land and Water; ii) monitoring of fiduciary and land data; iii) substantial technical support for the development of policy, legislative, and regulatory instruments; iv) improved access to information, within necessary confidentiality standards; v) inclusion of community participation in systematic processes for land survey and regularization; and vi) establishment of an institutional grievance redress mechanism.


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92. Revisions to the water law are expected to have positive poverty impacts in the medium‐ to long‐term. Clarifying the institutional mandates of MEW and MAIL is likely to ease a significant constraint to the expansion of irrigation networks. The expansion of the irrigation network coverage is expected to have positive poverty effects through two main channels. First, even for households with access to irrigation, levels of irrigation are often not sufficient for the harvest in the previous year. About 56 percent of poor Afghan household have access to irrigated land, the majority of which (62 percent) depends on irrigation via a river, canal, or dam and 11 percent depend on irrigation through a deep well pump. However, even of households with access to irrigated land, only 59 percent indicate that they had sufficient irrigation in the previous year. Second, households who did not cultivate irrigated land indicate a severe lack of water. 44 percent of poor households who did not cultivate irrigated land indicated a lack of water. Better access to irrigation would allow poor households in rural areas, which heavily rely on agriculture as their main livelihood to improve their productivity and generate higher yields. Improved irrigation coverage is also expected to support resilience to climate change and other weather‐related shocks. Natural disasters, including drought and water shortages, are currently the most‐common negative shock impacting poor households in Afghanistan, with survey data suggesting that harmful coping strategies are common, including reducing investment in education and sale of assets. Ownership of irrigation networks is currently deconcentrated in Afghanistan, with benefits expected to accrue to a large number of households rather than being monopolized by local elites. While it is possible that expansion of irrigation systems may facilitate opium production on some land, there is no evidence that irrigation expansion has previously led to increased opium cultivation. Most opium farming takes place on unirrigated land and evidence suggests that improving alternative livelihoods is the most appropriate approach to dis‐incentivizing opium farming. Increased returns to licit agriculture through irrigation should weaken incentives for opium production, while loss of assets and low incomes have been shown to drive household participation in the opium economy. Recognition of traditional water rights management mechanisms within the new law is expected to strengthen local governance of water resources, potentially averting conflict pressures and helping to ensure effective mediation of contestation over water resources.

93. Improvements in the policy and institutional framework for public financial management are unlikely to have adverse or positive effects on poverty. Strengthening public finance systems and processes will likely have positive benefits through increased efficiency and effectiveness in public‐sector spending. Detailed guidelines on financial and economic analysis and analysis of strategic fit are likely to ensure that projects funded through the budget are aligned with government’s pro‐poor priorities and that projects are well‐designed and viable. Greater transparency and accountability for public funds is likely to have indirect positive impacts through more effective and efficient use of scarce public resources. The reforms relating to: i) fast‐tracking of tax filing for banking and telecommunication sectors; and ii) establishment of the TDRB are unlikely to have adverse impacts on poverty. These measures will primarily reduce the transaction costs associated with paying taxes. They do not involve any changes in tax policy or changes in tax rates.

94. Development of regulations for implementation of VAT has been informed by preliminary poverty analysis supported by the World Bank. Under the proposed VAT, zero‐rated items currently protect 40 percent of the budget of the poor. The removal of the BRT on commonly consumed imported food items such as wheat and rice (which together account for 27 percent of the budget of the average


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Afghan household) is expected to further reduce prices faced by end‐consumers. Based on current evidence, replacement of the Business Receipt Tax by the VAT will lead to a 4 percent reduction in the cost of basic food items, which will be VAT‐exempt. Household survey data does not generally disaggregate imported consumption, and more analysis will be undertaken to estimate the distributional and poverty implications of the proposed replacement of the BRT with the VAT, once final exemptions are set.

5.2. ENVIRONMENTAL ASPECTS

95. Overall, the prior actions supported by the DPG will not have significant effects on the environment, forests and natural resources. Some positive effects are possible from supported policy actions. Simplified subscription to the public electricity network (PA#4) will help to reduce reliance on fuel generators which will reduce health risks related to air pollution. The new Water law (PA#6) will address water pollution and mainstream integrated water resources management. The law is expected make irrigation systems more efficient and resilient to climate change impacts. The law is comprehensive and includes specific measures to address the externalities of irrigation expansion and support more efficient irrigation systems through better defined institutional roles and responsibilities. 96. Some actions may have negative effects if mitigation measures are not implemented. Government’s overall land reform agenda will create greater certainty of land property rights, generating incentives for improved land management and sustainable use. Certainty of property rights may lead to increased investment and production of negative environmental externalities, however, potentially causing pollution and degradation of natural resources. The specific action supported by the operation (PA#5), however, will focus on Herat City of Herat Province and – given that this is an urban area – only minimal effects on forests and natural resources are expected. Support to private sector development through improved access to credit (PA# 3) and PIM reform (PA#7) could potentially have negative effects (i.e. unsustainable agricultural practices or large infrastructure investments with significant environmental effects) if the country environmental assessment process is not conducted adequately and if mitigation plans are not implemented and enforced.

97. Potential negative environmental effects can be mitigated if the existing management tools in the country system are implemented. The Government has a basic legal and regulatory system in place to manage these effects. This includes the Environmental Law 2007, the revised Water Law 2019 and the Forest Law 2013, amongst others. New Environment and Social Impact Assessment regulations have been passed recently to mitigate potential environmental downstream effects of public or private sector investments. The existing country framework mandates investments in the areas of infrastructure and mining projects to go through the Afghan ESIA regulation, guidelines, and policy. Complex projects require full ESIA studies and approval by the NEPA, and for less complex projects, an Initial Environmental Assessment is required. Therefore, all projects falling under new PIM reforms (PA#7) will have to be prepared in compliance with the environmental assessment process in Afghanistan, including mandated environmental management plans when relevant. Regarding the mitigation of potential effects related to land management (PA#5), the recently approved Land Administration System Project (P164762) will support strengthening systems for environmental protection, including through introducing requirements for Environmental and Social Impact Assessment and public consultations for land use change. Based on these public consultations’ feedback, MUDL will develop Environmental Safeguard Management Plans to


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mitigate/ mange the impact due to this land use change. Land use change can be affected only after successfully implementing the management plans. 98. Capacity building and technical assistance is needed to enable the government to properly implement the existing environmental management system in the country. Civil service reforms (PA#2) will ultimately support increased capacity and professionalization of the public sector, including within environment‐related agencies. More directly, the Bank is: i) supporting NEPA to develop a medium‐term capacity strengthening plan; ii) supporting MUDL to develop a medium‐term capacity strengthening plan; and iii) strengthening field‐based supervision and risk‐management. The Bank executed Anti‐Corruption and Results Monitoring Action Program (P165998) includes specific activities to strengthen the overall capacity of NEPA to implement environmental policies, strategies and implementation procedures, including on climate change, and to strengthen the knowledge and the capacity in key development sectors to comply with best practice international environmental management standards. The Bank is also working with the government to increase resilience to climate change through a programmatic approach to natural resource management and landscape management (P167603 – Strengthening Climate Resilience). Finally, to improve sectoral capacity, the Bank has been engaged with water organizations such as MAIL and MEW to enhance their capacity through different activities such as “Policy advice on water resources management (P167059)” and “Climate change impact analysis on hydrology and agriculture in Afghanistan (P160070)”.

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS

99. Afghanistan is a unitary government and has a centralized PFM architecture. The Public Finance and Expenditure Management Law 2005 (PFEML), sets out the responsibilities, authorities and obligations related to the management of public finance in the country. MOF has a dominant role in preparing and managing the annual government budget. It is also responsible for treasury functions, government financial reporting as well as tax policy and administration. At the provincial level, Mustofiasts as MOF representatives, perform treasury functions. The central line ministries have the mandate of country wide public service delivery. Accordingly, they prepare and execute their annual budgets. The central line ministries are also responsible for maintaining an internal audit function as required by the Public Finance and Expenditure Management Law. The Supreme Audit Office Law 2013 requires the Auditor General to conduct annual audit of the government accounts. 100. The PEFA assessment ‐ July 2018 ‐ noted that the government maintained aggregate fiscal discipline by controlling expenditure within available resources, but budget credibility remains low and the overall control environment is weak. MOF uses the Afghanistan Financial Management Information System (AFMIS) to manage budget execution, including control over spending. The expenditure authorities are centralized, which creates spending rigidities and hampers innovations in service delivery. The service delivery units have virtually no role in budget planning and execution. Over the last three fiscal years (2014‐2017), approximately half of the development budget remained unspent, but execution rates improved dramatically in 2018 (reaching 90 percent). Although the prescribed internal control framework is reasonably detailed, compliance is varied. The control systems for payroll are insufficient and represent a major weakness for a significant proportion of expenditure. The asset and liability management and monitoring of fiscal risks displayed considerable gaps.


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101. The budget allocation mechanism is largely incremental and impedes the linkages between the budget and policy priorities. Owing to the lack of required financing and uninformed budget allocation decisions, the social sector strategies have not been adequately funded. Historically weak budget expenditure execution has been driven by poor project selection and inadequacies in the entire public investment management cycle—project preparation, project appraisal, execution and monitoring and evaluation. The budget documents lack the required performance information. The Chart of Accounts does not facilitate information availability to the service delivery units; and there are no performance plans for service delivery. Consequently, the performance orientation of the entire budget formulation and execution process is undermined. 102. Government exerts strong leadership and ownership over the PFM reform process. The recent emphasis on revenue reforms has reflected the urgent need to raise domestic revenues in the context the 2014 transition and the prospect of declining international aid support. Similarly, a focus on strengthening procurement processes and addressing corruption were vital to improve the integrity of the PFM system and to provide development partners with sufficient confidence to continue using country systems. The current FPIP approach has full buy‐in across Government, including the President. Commitment to PFM reform is stated in the current national development plan, the Afghanistan National Peace and Development Framework (ANPDF). Government has consistently emphasized the importance of PFM reform to increase confidence in government systems, bring a greater share of aid on‐budget, and – eventually – underpin self‐reliance through effective revenue mobilization and efficient utilization of public resources.

103. PFM systems have displayed the ability to track and report expenditure within budget which has contributed to aggregate fiscal discipline. The revenues, expenditures and financial position of the Government are reported periodically in an understandable format and the Parliament reviews the fiscal reports of the executive and the audit reports. Budget documents are publicly available once approved by Parliament. The Government’s commitment and efforts to implement PFM reforms is improving PFM performance including budget reliability, cash management, and avoidance of arrears.

104. The fiduciary risk is substantial, mostly due the volatile and fragile country environment but also due to some instances of ineligible expenditure and concerns related to capacity challenges. The fiduciary risks are mitigated by the self‐reinforcing actions committed to under the FPIP and the World Bank‐financed FPIP Support Program. The actions include (i) strengthening the budget in driving effective delivery of key priority outcomes; (ii) improving budget execution, and (iii) strengthening accountability and transparency. 105. The operation design allows for additional fiduciary protections through the ARTF Monitoring Agent mechanism. ARTF resources associated with tranche release conditions remain subject to ARTF fiduciary controls. Total ARTF disbursements under the program will be the lesser of: i) the value of tranches, after decrementing, associated with all tranche release conditions; or ii) total eligible expenditures estimated by the Monitoring Agent. If assessed eligible expenditures verified by the Monitoring Agent fall below the level of planned disbursements under the program, ARTF funds will not be available for withdrawal. This creates strong incentives to maintain and strengthen fiduciary performance while providing assurance to ARTF partners.


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106. The IMF completed its most recent safeguards assessment of DAB in December 2017. It found that DAB had strengthened some elements of its safeguards framework since the previous assessment (2008), but an effective internal audit mechanism had not been established. The assessment made recommendations to address the risks emerging from the Kabul Bank fraud, including related to central bank autonomy and recapitalization. Since that time, some of the 2011 safeguards recommendations have been implemented, albeit with delay. Amending the law has been difficult, however, and the recommendation concerning the DAB’s legal structure remains outstanding. DAB has continued to publish on its website DAB’s financial statements audited by an international audit firm.

107. Funds flow and disbursement arrangements. A foreign currency account in dollars will be established at DAB and will form part of the country’s official foreign exchange reserves. Upon notification by IDA of grant effectiveness, and with the submission by the recipient of a withdrawal application, the proceeds of the grant will be deposited by IDA into the Government dollar account in DAB. Upon receipt of funds from IDA, an amount equivalent to the grant proceeds will be credited to Government’s Treasury Single Account in Afghanis and will become a part of the government’s budget resources. The ARTF grant will be disbursed based on compliance/fulfillment of the tranche release conditions. The Bank will verify fulfillment of each of the tranche release conditions and if satisfied will approve the tranche releases (conditional upon sufficient eligible expenditures as verified by the Monitoring Agent). Subsequently, the recipient can submit withdrawal application equivalent to the amount of tranche releases and the ARTF grant will be deposited into the Government dollar account in DAB. Upon receipt of funds from ARTF, an amount equivalent to the grant proceeds will be credited to Government’s Treasury Single Account in Afghanis and will become a part of the government’s budget resources. The receipt of the IDA and ARTF grants would be promptly accounted for in the government’s budget system; transactions and balances of the government account will be fully incorporated into the government’s accounting records and financial statements, via the AFMIS.16 108. Disbursement will be phased against completion of policy actions. Disbursement of the operation’s first tranche (associated with four prior actions) will take place following effectiveness. Disbursement of the subsequent ten tranches (associated with the ten tranche release conditions) will take place following the completion of tranche release conditions. Disbursements against tranche release conditions completed prior to the completion date are scheduled for July 15 and August 30. The final completion date is 15 November 2019. Additional disbursements may occur to June 2020 if completion of some tranche release conditions is delayed beyond the 15 November completion date. Disbursed amounts against tranche release conditions that are not completed by the 15 November completion date will be discounted at the rate of ten percent per month. 109. The proceeds of the grant cannot be used for ineligible expenditures (i.e., to finance goods and services from IDA’s standard negative list as reflected in the financing and grant agreements). If the proceeds of the IDA and ARTF grant are used for ineligible expenditures, the Bank will require the Government to refund the amount directly to IDA or ARTF. Amounts refunded to IDA or ARTF shall be cancelled.

16 The full US$300 million of ARTF resources is not currently available in the ARTF. The initial Grant Agreement for the ARTF therefore reflects an amount of $60 million for the first two ARTF withdrawal tranches. Once further funding becomes available in the ARTF, the Grant Agreement will be amended to reflect the full US$300 million amount and the remaining withdrawal tranches.


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110. Within 30 days of receipt of the IDA and ARTF grants, the government will provide to the Bank: (a) a written confirmation that this transfer has been completed; (b) any other relevant information relating to these matters, including the exchange rate of the conversion from US dollars to Afghanis; and (c) any other information that the Bank may reasonably request. Disbursements will not be linked to specific purchases and no procurement requirements will be necessary.

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY

111. The Ministry of Finance is the delegated implementing agency and will be responsible for the overall monitoring and evaluation of the program. MOF has previous experience with monitoring results of World Bank Development Policy Operations and will work closely with specific agencies with key policy responsibilities under the program, including: MUDL, MOF, DABS, DAB, and MEW. Results indicators for the program have been selected based on data availability and generally rely on currently‐available data sources. Tracking the results indicator related to registration of land under the new legislative framework will depend upon the establishment of new systems within MUDL, to which the World Bank is planning a program of dedicated technical assistance support. 112. Performance of the operation will be assessed in terms of progress with the overall Government program, which is supported by both IDA and ARTF grants. Accordingly, the operation’s performance will be assessed against the full range of results indicators, including those associated with both prior actions and tranche release conditions. 113. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a World Bank Development Policy Operation may submit complaints to the responsible country authorities, appropriate local/national grievance redress mechanisms, or the WB’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Affected communities and individuals may submit their complaint to the WB’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non‐compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org.

6. SUMMARY OF RISKS AND MITIGATION

114. The overall risk rating for the operation is high. Risks in four areas are most pronounced and could potentially jeopardize the achievement of program outcomes. These risk areas, discussed below, are: i) political and governance risks; ii) macroeconomic risks; iii) institutional capacity for implementation and sustainability risks; and iv) security risks.


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115. Political and governance risks are high. The proposed operation (June 2019 – May 2020) will span presidential elections. Election outcomes and the potential political instability associated with elections present important risks to the operation. Firstly, political commitment to the current reform program cannot be assured given the potential for a change of executive. Scope to manage this risk through consultation with opposition candidates is constrained by a political process in which outcomes are unpredictable and subject to complex processes of alliance formation, which often involve last‐minute changes in policy positions. Candidates’ previous performance in Presidential elections is not a good indicator of likely success. While policy actions supported by the operations are not highly politicized, the overall program may not reflect the priorities of an incoming President. Secondly, elections themselves may lead to periods of political instability with negative impacts on administrative capacity to complete policy actions. The outcome of the 2014 Presidential election was contested amid widespread electoral fraud accusations. Competing claims of victory were only peacefully resolved through international brokering of a power‐sharing agreement. The process of negotiating the power‐sharing agreement and subsequent political competition over key Cabinet roles and administrative appointments between the President and newly‐created Chief Executive role disrupted government business for several years. Similar outcomes surrounding the elections would likely weaken the capacity of government to complete administrative procedures and approval processes, hence the reform schedules agreed with the current administration. While progress has been made, electoral institutions are still too weak to foreclose the possibility of widespread electoral fraud accusations and subsequent disruptive contestation over electoral outcomes, potentially including violence. This risk is partly mitigated through the use of a single operation, allowing for policy actions under planned future operations to be adjusted in response to changing government policies or priorities. 116. Macroeconomic risks are high. Afghanistan’s macroeconomic outlook is subject to substantial downside risks. Previous experience suggests that elections and associated political instability can have major negative impacts on growth, investment, and revenues: Revenues fell from 11.6 percent of GDP in 2013 to 8.4 percent of GDP in 2014 due to the combined impacts of withdrawal of international security forces and political instability following the elections. To the extent that the program provides more flexible and dependable budget support assistance, it helps to mitigate risks associated with aid dependency. However, if political instability undermines the progress of implementation of reforms, it is possible that associated reductions in budget support could pro‐cyclically contribute to fiscal management challenges. Macroeconomic risks are further exacerbated by weaknesses in the financial sector including potential fiscal risks arising from state‐owned banks. Financial sector risks are partly mitigated through ongoing World Bank technical assistance to reform state‐owned banks. Risks are also partly mitigated by Government’s previously demonstrated capacity to maintain overall macroeconomic stability in the context of revenue declines, through effective expenditure control and maintenance of the monetary policy framework. 117. Risks associated with institutional capacity for implementation and sustainability are high. The public sector in Afghanistan is characterized by highly uneven and thinly spread technical capacity. The context of long‐term aid dependency had left some agencies and reform processes heavily dependent on international technical assistance, and vulnerable to associated delays, discontinuities, and coordination problems. Coordination problems and capacity constraints have been exacerbated by parallel bureaucracy and contestation over appointments under the National Unity Government. These issues are being exacerbated in the lead‐up to elections, with politically‐motivated changes in leadership positions


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across key government agencies, including the Ministry of Finance. Lack of capacity is a particular constraint in the Ministry of Justice, which has important implications for policy actions requiring the issuance of new laws. To mitigate these risks, all policy reforms are being supported by technical assistance from the World Bank Group or other development partners. In addition, Bank experts will conduct close supervision and monitoring of the results.

118. Security risks are high. Continued insurgent activity represents another source of risk to achievement of program outcomes. Deterioration in the security situation could divert government capacity and policy attention from supported reforms, impede the provision of technical assistance, disrupt monitoring arrangements, or undermine the expected impact of supported reforms. These risks are somewhat mitigated through the program’s focus on policy actions that should show positive impact even in the context of ongoing conflict. Previous experience has shown that the Bank can successfully monitor and support implementation of reform programs even in a difficult security environment.

119. Environmental and social risks are high. While positive social outcomes are expected from the transition to an administrative system of land management and the implementation of a revised Water Law, social risks associated with these policy actions are high. Previous experience with land reforms in fragile states has highlighted how institutional reforms can be coopted by elites and benefits monopolized. Expansion in irrigation systems may be utilized to support illicit production of opium in some areas. Social risks are mitigated in areas under Government control by: i) relatively strong capacity in MUDL; ii) substantive World Bank technical assistance engagements in both land and water management; iii) evidence that expansion of irrigation networks is likely to support substitution of agricultural activity away from, rather than towards, opium production; and iv) the focus of land reforms on urban areas where implementation capacity is relatively strong and government control is assured. Risks cannot be mitigated in areas beyond Government control given that: i) it is not known how or whether new institutional mechanisms or infrastructure would be utilized by anti‐government elements; and ii) Government and the World Bank are unlikely to be able to effectively implement mitigation measures in areas beyond Government control. 120. In addition, risks in several areas are rated substantial, including:

121. Sector strategies and policies risks. Sector strategy and policy risks are substantial due to the inherent complexity of land and water management reform in fragile state contexts. This risk is mitigated by: i) the provision of World Bank technical assistance support to MUDL and MEW; ii) recent improvements in administrative arrangements and the legislative framework for managing risks of land‐grabbing, including the establishment of a database of grabbed lands and new legal provisions criminalizing the practice; and iii) relatively strong capacity at MUDL and the existence of an administrative dispute resolution process at the agency.

122. Fiduciary risks. Fiduciary risks are substantial despite good progress in most phases of budget operations. Previous DPF and investment operations (e.g., Public Financial Management Reform Project II) have helped to put in place adequate processes and practices for financial management, procurement and control. However, fiduciary risks remain substantial due to low compliance with PFM rules and limited internal and external controls. For the most part risk mitigation relies on the self‐reinforcing actions committed to under the Government’s FPIP, the ARTF Incentive Program and the proposed IP DPG, the


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IMF ECF and the FSP. The FSP, in particular, is heavily focused on the timely implementation of PFM measures across the whole range of the PFM cycle in parallel with the PFM reforms supported by the proposed IP‐DPG. 123. Stakeholder risks. Vested interests negatively affected by the provisions of various reforms could exercise undue influence on decision‐makers in the government and parliament, undermining the effective implementation of the reforms. The intent and likely outcomes of reforms in land and water sectors may also be subject to misunderstanding and communication. Through a range of technical assistance activities and its broader engagement, and throughout the implementation of the reforms, the World Bank will continue conducting informed discussions on these issues, carrying out adequate consultations with the affected social groups, the private sector and civil society, and in identifying risks and mitigation measures. This will also involve assistance with media strategies and campaigns to ensure that Afghan citizens and investors are made aware of the rights extended to them through the changes in the different legislation.

124. Technical design risks. Innovative design elements proved successful in implementing the 2018 IP‐DPG, and the program represents a simple mechanism for the provision of recurrent cost support. However, there remains scope for misunderstandings and dissatisfaction regarding decision‐making processes around selection, monitoring, and verifying completion of policy actions which may manifest if the revised operation design leads to non‐disbursement of an important source of recurrent cost financing during a sensitive political period or amidst a negative economic shock. This risk can be partly mitigated through regular consultation with Government and the IP ARTF working group.


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Table 5: Summary Risk Ratings

Risk Categories Rating

1. Political and Governance High

2. Macroeconomic High

3. Sector Strategies and Policies Substantial

4. Technical Design of Project or Program Substantial

5. Institutional Capacity for Implementation and Sustainability High

6. Fiduciary Substantial

7. Environment and Social High

8. Stakeholders Substantial

9. Other High

Overall High

.


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ANNEX 1: POLICY AND RESULTS MATRIX

Policy Action Type Financing Results Indicator Baseline

(End‐2018) Target (End‐2020)

Pillar 1: Strengthening the policy framework to support state effectiveness, private investment, and social inclusion

1) To develop a regulatory framework for e‐money and digital payments: i) DAB issues a circular to operating banks and MOF issues a circular to tax and customs directorates and provincial offices allowing for electronic payment of customs and tax dues; and ii) DAB issues a circular requiring participation of all mobile money providers, payment card issuers, and acquiring banks in Afghanistan Payment System to enable interoperability.

Tranche release condition

ARTF Proportion of customs duties (as

a share of total payments by

volume throughout the fiscal

year) transferred to DAB via

electronic payment from

commercial banks

2% 60%

Average monthly number of

transactions through the APS

3,534 100,000

2) To support implementation of its Civil Servants Law, the Recipient’s: (i)Cabinet has approved (A) the Civil Service Pay Management Policy, (B) the Policy for Increasing Women’s Participation in Civil Service, as well as (C) the Customs Cadre Regulation and the Procurement Cadre Regulation; and (ii) Independent Administrative Reform and Civil Service Commission has approved the Procedure on Civil Servants' Recruitment through Mass Competitive Exam.

Prior action

IDA Proportion of total civil servant

appointments (2018‐2020) made

in compliance with the new

competitive recruitment

processes

0% 80%

Proportion of female civil

servants in total and at Senior

Management Group level (grade

levels one and two)

22% (all)

6% (G1&2)

26% (all)

9% (G1&2)

3) To support private sector development through improved access to credit DAB has: (i) issued a circular altering collateral requirements to allow inclusion of risk guarantees from Afghan Credit Guarantee Foundation; and (ii) entered into a memorandum of understanding with DABS to allow data sharing to provide operating banks with additional information in evaluating

Prior action

IDA Credit registry coverage as a

proportion of adult population

(15‐64)

1.3% 2.0%

Proportion of women included

on the credit register 2.3% 4.0%


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creditworthiness of potential borrowers through the Recipient’s public credit registry.

4) To reduce the costs and time requirements of accessing electricity, DABS’ Senior Management Group: i) approves simplified subscription procedures for commercial and industrial customers; ii) establishes a fast‐track center for large customers in Kabul; and iii) approves a formal written procedure to regularly review and manage domestic and international power purchase agreements (PPA) including through the establishment of a multi‐disciplinary team with the mandate of managing such contracts.

Tranche Release Condition

ARTF Time taken to acquire an electricity connection for commercial customers

114 days 80 days

Cost of acquiring an electricity connection for commercial customers

2,448 percent of income per capita

1,500 percent of income per capita

Number of international PPAs reviewed by dedicated multi‐disciplinary team within DABS

0 3

5) To improve land administration the Supreme Court and MUDL sign a protocol transferring responsibility for deed registration to MUDL in Herat city.


ARTF Number of municipal districts in which an administrative land system is operating and land transactions are recorded within the Land Information System.

0 1

6) To improve management of water resources Cabinet has approved and submitted to the National Assembly a revised water law which includes: i) clarification of MEW and MAIL mandates; ii) recognition of traditional water use rights; and iii) provisions governing dam safety, pollution, and groundwater.

Prior Action

IDA Responsibility for the design, construction, and management of irrigation canals for agriculture from the source to the farm is allocated to MAIL.

NO YES

Pillar 2: Improving the policy and institutional framework for public financial management

7) To improve public investment management the circular for the 2020 budget: i) includes detailed guidelines on financial, economic, and gender analysis; and ii) specifies that no new project proposal of greater than USD 7.5 million will be approved for further appraisal through the discretionary budget for 2020 without strategic fit


ARTF Proportion of new projects of over USD 7.5 million approved for implementation in the discretionary development budget that have undergone economic and gender analysis.

0% (2019 budget)

50% (2020 budget)


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analysis and no new project of greater than US$7.5 million will be approved for implementation without project appraisal including financial, economic, and gender analysis.

8) To improve tax administration, MOF issues a circular to make fast‐track tax filing mandatory for banking and telecommunication sectors in the large taxpayer office (LTO) and available for optional use in the medium taxpayer office (MTO).


ARTF Proportion of active LTO firms utilizing fast‐track filing.

9.7% 60%

9) To improve tax administration, a Tax Dispute Resolution Board is equipped with five board members and a secretariat.


ARTF Number of cases submitted for ruling by the Tax Dispute Resolution Board

0 10

10) To strengthen tax policy Cabinet approves VAT regulations, including proposed exemptions by HS code and refund procedures.


ARTF VAT business processes approved and communications material released based on regulations, including procedures for exemptions

NO YES

11) To underpin implementation of the new O&M policy, a MOF circular mandates the use of revised norms for civilian vehicles and buildings in at least the four pilot ministries in preparing the 2020 budget.


ARTF The budget is developed through application of the new O&M norms for four pilot ministries (as reflected in budget working papers)

No (2019 budget)

Yes (2020 budget)

12) To improve transparency MOF publishes fortnightly revenue reports on its website that: i) provide full disaggregated tax and customs performance data at the level of collection points; and ii) track progress against government revenue targets.


ARTF Number of downloads of new revenue performance reports

0 500

13) To improve accountability and quality of cash‐management, the cash management committee meets at least every 21 days and publishes minutes of decisions taken at those meetings on its website within 7 days of the meeting.


ARTF Proportion of Treasury salary payments made within 10 days of submission of monthly claims by line ministries.

100 percent

100 percent


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ANNEX 2: FUND RELATIONS ANNEX


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ANNEX 3: LETTER OF DEVELOPMENT POLICY


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ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE

Prior actions/Tranche release conditions Significant positive or negative environment effects

Significant poverty, social or distributional effects positive or

negative

1. To develop a regulatory framework for e‐money and digital payments: i) DAB issues a circular to operating banks and MOF issues a circular to tax and customs directorates and provincial offices allowing for electronic payment of customs and tax dues; and ii) DAB issues a circular requiring participation of all mobile money providers, payment card issuers, and acquiring banks in Afghanistan Payment System to enable interoperability.

No significant positive or negative environment effects

Positive poverty effects through expanded financial inclusion

2. To support implementation of its Civil Servants Law, the Recipient’s: (i) Cabinet has approved (A) the Civil Service Pay Management Policy, (B) the Policy for Increasing Women’s Participation in Civil Service, as well as (C) the Customs Cadre Regulation and the Procurement Cadre Regulation; and (ii) Independent Administrative Reform and Civil Service Commission has approved the Procedure on Civil Servants' Recruitment through Mass Competitive Exam.

No significant positive or negative environment effects

No significant positive or negative poverty or social effects


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3. To support private sector development through improved access to credit DAB has: (i) issued a circular altering collateral requirements to allow inclusion of risk guarantees from Afghan Credit Guarantee Foundation; and (ii) entered into a memorandum of understanding with DABS to allow data sharing to provide operating banks with additional information in evaluating creditworthiness of potential borrowers through the Recipient’s public credit registry.

Some negative environment effects


4. To reduce the costs of accessing electricity DABS’ Senior Management Group: i) approves simplified subscription procedures for commercial and industrial customers; ii) establishes a fast‐track center for large customers in Kabul; and ii) approves a business process to regularly review and manage domestic and international power purchase agreements (PPA) including through the establishment of a multi‐disciplinary team with the mandate of managing such contracts.

Some positive environment effects No significant positive or negative poverty or social effects

5. To improve land administration, the Supreme Court and MUDL sign a protocol transferring responsibility for deed registration to MUDL in Herat city.

Some positive and negative environment effects

Positive poverty effects through strengthened land tenure and agricultural production.

6. To improve management of water resources Cabinet has approved and submitted to the National Assembly a revised water law which includes: i) clarification of MEW and MAIL mandates; ii) recognition of traditional water use rights; and iii) provisions governing dam safety, pollution, and groundwater.

Some positive environment effects Positive poverty effects through improved access to water and mitigating the impacts of climate change.


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7. To improve public investment management the circular for the 2020 budget: i) includes detailed guidelines on financial, economic, and gender analysis; and ii) specifies that no new project proposal of greater than USD 7.5 million will be approved for further appraisal through the discretionary budget for 2020 without strategic fit analysis and no new project of greater than US$7.5 million will be approved for implementation without project appraisal including financial, economic,

Some negative environment effects.


8. To improve tax administration, MOF issues a circular to make fast‐track tax filing mandatory for banking and telecommunication sectors in the large taxpayer office (LTO) and available for optional use in the medium taxpayer

No significant environment effects. No significant positive or negative poverty or social effects

9. To improve tax administration, a Tax Dispute Resolution Board is equipped with five board members and a secretariat.


10. To strengthen tax policy MoF submits VAT regulations to Cabinet for approval, including proposed exemptions by HS code and refund procedures.


11. To underpin implementation of the new O&M policy: i) a MOF circular mandates the use of revised norms for civilian vehicles and buildings in at least the four pilot ministries in preparing the 2020 budget.


12. To improve transparency MOF publishes fortnightly revenue reports on its website that: i) provide full disaggregated tax and customs performance data at the level of collection points; and ii) track progress against government revenue targets.



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13. To improve accountability and quality of cash‐management, the cash management committee meets at least every 21 days and publishes minutes of decisions taken at those meetings on its website within 7 days of the meeting.



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ANNEX 5: GOVERNMENT THREE‐YEAR REFORM MATRIX

2018 Reform Actions 2019 Reform Actions 2020 Reform Actions Medium-Term Results Indicator

Baseline (end-2017)

Target (end-2021)

Pillar 1: Strengthening the policy framework to support state effectiveness, private investment, and social inclusion

E‐Payments and M

obile

Money

1. Tranche Release Condition: The President issues a decree formalizing and defining Asan Khedmat (AK) responsibilities for integrating national IT infrastructure necessary to roll out the E-money and digital payment system.

1. Tranche Release Condition: To develop a regulatory framework for e-money and digital payments: i) DAB issues a circular to operating banks and MOF issues a circular to tax and customs directorates and provincial offices allowing for electronic payment of customs and tax dues; and ii) DAB issues a circular requiring participation of all mobile money providers, payment card issuers, and acquiring banks in a regulated payment system (APS) to enable interoperability. To develop a regulatory framework for e-money and digital payments: i) DAB and MOF issue a joint regulation allowing for electronic payment of customs and tax dues; and ii) DAB issues regulations requiring participation of all mobile money providers, payment card issuers, and acquiring banks in a regulated payment system (APS) to enable interoperability.

1. To further develop a regulatory framework for e-money and digital payments: i) DAB issues regulations requiring participation of all commercial banks in the Automated Transfer System (ATS); and ii) Cabinet approves the e-governance law, allowing for recognition of e-signatures in online communications and transactions.

Percentage share (by volume) of customs and tax dues settled through electronic payments

0% 20%

Civil service

reform

2. Prior Action: The Recipient’s Cabinet has approved and submitted to the National Assembly an amendment of the Civil Servants Law that: (i) establishes a career track for

2. Prior Action: To support implementation of its Civil Servants Law, the Recipient’s: (i) Cabinet has approved (A) the Civil Service Pay Management Policy, (B) the Policy for Increasing Women’s Participation in Civil

2. Cabinet approves revisions to Establishment (Tashkeelat) Management procedures requiring that revisions to the tashkeel are based on links to government policy priorities, are informed by the use of multi-year

Number of civil servant positions competitively selected in line with new recruitment process

0 500


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specialist staff; (ii) enables positive gender discrimination within civil service appointments; (iii) introduces merit-based and tailored recruitment into the civil service; (iv) establishes Deputy Minister positions within the civil service framework; and (v) enables transfers, sanctions, transparent grievance redress, and civil service renewal.

Service, as well as (C) the Customs Cadre Regulation and the Procurement Cadre Regulation; and (ii) Independent Administrative Reform and Civil Service Commission has approved the Procedure on Civil Servants' Recruitment through Mass Competitive Exam.

costings, and achieve equity between provincial, central, and district staff.

Proportion of female civil servants competitively recruited for civil servant positions.

0% 30%

Proportion of cadre recruitment in common function and select technical areas

0% 50%

Business environmen

t reform

3. Prior Action: Cabinet has approved and submitted to the National Assembly an insolvency law which adequately addresses insolvency proceedings, reorganization provisions for insolvent companies, creditor rights, and treatment of insolvency in viable businesses.

3. Tranche Release Condition: To support private sector development through improved access to credit DAB has: i) issued a regulation altering collateral requirements to allow inclusion of risk guarantees from Afghan Credit Guarantee Foundation (ACGF); and ii) entered into a Memorandum of Understanding with DABS Brishna to allow data sharing to provide operating banks with additional information in evaluating creditworthiness of potential borrowers through the Public Credit Registry.

3. Cabinet approves introduction of a simple one-step, online business registration process through MoCI.

Distance to Frontier score against starting a business as measured by the Doing Business Survey

DB2018 Resolving Insolvency DTF: 23.62 Ease of Doing Business DTF: 36.19

DB2021 Resolving Insolvency DTF: 33.32 Ease of Doing Business DTF: 40

Power

utility

f

4. Tranche Release Condition: DABS and MoF sign a Partnership Agreement to improve DABS’

4. Tranche Release Condition: To reduce the costs of accessing electricity DABS’ Senior Management Group: i) approves

4. DABS develops and adopts a new mechanism to address exchange rate risks.

DABS working ratio

108 (in Afghan FY 2016)

100 (in FY2020)


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performance over 2018-2020, including: i) a number of annual performance targets to be met by DABS; and ii) restructuring of DABS debt to MOF, conditional on performance improvements.

simplified subscription procedures for commercial and industrial customers; ii) establishes a fast-track center for large customers in Kabul; and ii) approves a business process to regularly review and manage domestic and international power purchase agreements (PPA) including through the establishment of a multi-disciplinary team with the mandate of managing such contracts.

Number of new electricity connections to industrial customers provided through the simplified procedure

0 100

Commercial losses as % generation

23% [TBD]

Land gove

rnan

ce

5. Prior Action: The Recipient’s Cabinet has issued and published the Regulation on Managing Affairs of Informal Urban Properties allowing for the distribution of Property Documents to occupants of informal settlements in urban areas.

5. Tranche Release Condition: To improve land administration the Supreme Court and MUDL sign a protocol transferring responsibility for deed registration to MUDL in Herat city.

5. MUDL takes additional vital steps towards transition to an administrative land system, including: i) approving new and standardized cadastral surveying procedures; ii) establishing an electronic land administration system, including gender-disaggregated data on land holdings.

Number of property documents issued to informal occupants of state land

0 1,000

Number of property documents recognizing women as part or whole owners

0 20% of total number of property documents issued

Gender disaggregated records of land ownership are available under the MUDL digital registration system.

Not available

Available in ARAZI digital registration system

Water

productivity an

d

l

6. Tranche Release Condition: The Recipient’s Cabinet approves an Irrigation Policy and a Dry Lands Agriculture Policy to increase the resilience of

6. Prior Action: To improve management of water resources Cabinet has approved and submitted to the National Assembly a revised water law which includes: i) clarification of

6. Cabinet approves vital regulations and implementation plans to guide irrigation expansion and management under the Irrigation Policy, Drylands, Agriculture Policy, and Water Law.

Rainfed wheat productivity

1.03 t/ha 1.12 t/ha


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agriculture-based livelihood activities against climate change and strengthen management of water rights.

MEW and MAIL mandates; ii) recognition of traditional water use rights; and iii) provisions governing dam safety, pollution, and groundwater.

Irrigated wheat productivity

2.49 t/ha

2.95 t/ha

Pillar 2: Strengthen the policy and institutional framework for public financial management

Improved planning an

d appraisal of projects

7. Tranche Release Condition: MoF issues a revised Budget Circular 1 that: (i) clearly defines the time-bound process and requirements for project proposal submission from ministries and agencies, including the submission of project concept notes according to the standard template and guidelines provided by the MoF; (ii) requires all projects proposals to include cost estimates for operating and capital expenses needed for the project life cycle.

7. Tranche Release Condition: To improve public investment management the circular for the 2020 budget: i) includes detailed guidelines on financial, economic, and gender analysis; and ii) specifies that no new project proposal of greater than USD 7.5 million will be approved for further appraisal through the discretionary budget for 2020 without strategic fit analysis and no new project will be approved for implementation without project appraisal including financial, economic, and gender analysis.

7. The five largest civilian development spending ministries apply simplified or full appraisal to 75 percent of projects included in the budget submitted to Parliament.

Ratio of the value of projects that have undergone the new PIM process to the total value of projects in the development budget submitted to Parliament.

0% of projects

At least 95% of projects

Improving Ta

x Administration

8. Tranche Release Condition: ARD rolls out an electronic taxpayer management system by making fast-track tax filing available (but optional) in LTO.

8. Tranche Release Condition: To improve tax administration, MOF issues a circular to make fast-track tax filing mandatory for banking and telecommunication sectors in the large taxpayer office (LTO) and available for optional use in the medium taxpayer office (MTO).

8. ARD fully rolls out electronic taxpayer management system: fast-track filing mandatory in MTO and available for optional use in STO.

Domestic revenue collected by ARD MTO and LTO.

AFN 38.6 billion

AFN 59.5 billion

Proportion of LTO and MTO clients with access to fast-track filing.

2% 100%


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9. Tranche Release Condition: ARD reviews and revises LTO and MTO client lists to ensure correct categorization of tax-payers and risk-commensurate compliance and enforcement efforts.

9. Tranche Release Condition: To improve tax administration, a Tax Dispute Resolution Board is equipped with five board members and a secretariat.

9. ARD implements a function-based organizational structure (including the NLTO).

LTO share of domestic tax collection.

27% 45%

LTO/MTO Cases resolved by the Tax Disputes Resolution Board per year

0 case 20 cases

10. Tranche Release Condition: To strengthen tax policy Cabinet approves VAT regulations, including proposed exemptions by HS code and refund procedures.

Strengthened

exp

enditure

control

10. Tranche Release Condition: Cabinet approves a revised O&M Policy to: (i) improve O&M expenditure management; and (ii) mandate piloting of the revised O&M Policy by four line-ministries in preparing their 2019 budget.

11. Tranche Release Condition: To underpin implementation of the new O&M policy: i) a MOF circular mandates the use of revised norms for civilian vehicles and buildings in at least the four pilot ministries in preparing the 2020 budget; and ii) the O&M budget contingency included in the 2019 budget is allocated through the mid-term budget review towards costs associated with O&M policy implementation in pilot ministries.

10. SAO conducts performance/special audit of the piloting of O&M policy

O&M budget allocation based on standard norms for O&M costing and allocation

Existing O&M policy does not specify norms for O&M budget and incremental budgeting is used.

All ministries apply the standard norms and guidelines for O&M costing and allocation.

Fiscal risk monitoring 12. Tranche Release Condition:

To improve transparency MOF publishes fortnightly revenue reports on its website that: i) provide full disaggregated tax and customs performance data at the level of collection points; and ii) track progress against government revenue targets.


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Fiscal risk monitoring 13. Tranche Release Condition:

To improve accountability and quality of cash-management, the cash management committee meets at least every 21 days and publishes minutes of decisions taken at those meetings on its website within 7 days of the meeting.