The development and progress of any country are majorly dependent on the economic infrastructures of that country. Due to security issues and political unrest in Afghanistan, the country has been experiencing a lot of economic instability. Despite the high potential the country has regarding natural resources, the unstable security issue in Afghanistan has hindered investors, especially international investors from investing in the country (Rumi consultancy & World Bank, 2015). Out of this urgent security concern, intra-structure development has been microscopic. The political unrest, insecurity threat and lack of social infrastructure systems have all contributed to the inadequate and unfavorable business environment experienced in the country thereby negatively affecting the economy. To properly develop and strengthen its economy, Afghanistan needs to restructure its development strategies towards a capitalistic structure. Strong laws to govern society and businesses should be formulated. These laws should correspond to every need and aspect of the economy, from protecting investors to checking things like nature of completions within the economy. This paper is going to analyze the economic climate of Afghanistan and explain some of the monetary instruments used by the central bank of Afghanistan to maintain stable prices and check exchange volatility.
Afghanistan’s Economic Background
Even though the Taliban regime was removed and the subsequent election of the government of National Unity, Afghanistan has started to reform and adjust its economic climate though it has continued to be a weak state. This country is landlocked and is highly dependent on foreign aid. Most of its people face fundamental challenges such as access to clean water, food and medical services. In fact, the living standard of people in Afghanistan is ranked among one of the worlds lowest. Afghanistan has a population of 31.3 million people and has a GDP of 60.6 billion. The country’s growth rate this year has been at 1.5% with and an inflation rate of 4.6%. Unemployment is at 9.1 %. Out of the country cultivation of opium, there is a high dependency on proceeds from drug trafficking. The judicial system of the country is weak, leading to massive corruption in the government.
Delegate your assignment to our experts and they will do the rest.
The economic climate of Afghanistan has severely been affected by the political and security challenges it’s currently facing. Confidence level on the state both from local and international investors has also deteriorated. The cause of this deterioration has been due to the government’s incapacity to deliver vital services on a reliable basis. Also, the country’s agricultural sector is heavily dependent on opium poppies, a product which draws a lot of conflict in the international market. All tax collected by the government, income, corporate tax and sales tax amongst others contribute only 7% of the country’s GDP. As such, Afghanistan’s government generates very little revenue hence relies heavily on foreign help (Heritage Foundation, 2016). With limited financial muscle and social challenges, development initiatives have been limited leading to slow economic growth rate.
The private sector has also been restricted in several aspects. The country has a very rigorous and complex customs system which has severely affected importation and exportation of goods in and out of the country. Very little has been done to lure foreign investors to the country as both foreign and local investors are subjected to similar laws. Bureaucratic impediments have also hindered the private sector from establishing businesses. The country’s labor market is also poorly developed providing a very little supply of technocrats and skilled labor to the economy. Another key factor which has hindered economic development especially the one driven by the private sector is the poorly developed financial sector coupled with the limited access to financial products. This challenge of access to financial products has been expounded by the fact that most members of the public do not trust the banking system in the country (Heritage Foundation, 2016). The economy of Afghanistan is quite vulnerable and with its poorly developed financial system, the government has a small influence on the monetary policy of its country.
Monetary policy in Afghanistan
Monetary policy in Afghanistan is formulated and implemented by Da Afghanistan Bank, which is the central bank of Afghanistan. Through the monetary policy department, the bank monitors the exchange rate behavior and intervenes whenever necessary to maintain domestic price stability and check exchange rate volatility. Because the Afghanistan’s economy is weak and open with a long lasting trade discrepancy, exchange rate volatility usually has an enormous impact on the stability of the country’s domestic price. To check its monetary policy, the central bank of Afghanistan has set a ceiling on the reserve money and currency in circulation growth. The bank’s Monetary Policy Department has also set a floor on the net international reserve (Da Afghanistan Bank, 2016). Reserve money under the country’s monetary policy framework is the leading indicator of liquidity in the country. This indicator is usually crucial in estimating the expected growth rate, the rate of inflation in the country and the changes in Afghan currency. Since the banking sector in the country has been expanding hence more money is being created; Da Afghanistan Bank sets the Reserve Money as the primary operational aim or target while the currency in circulation is set as a dormant target.
Monetary Tools in Afghanistan
The monetary tools used by several economies are reserve requirements, discount rate, and open market operations. These devices are frequently used to control the money flowing within the banking system. The discount rate is the interest rate the Reserve bank or central bank extends to commercial banks. This rate is commonly used to control the amount of liquidity in the economy (Federal Reserve Education organization, 2016). To increase the amount of liquidity in the economy, the central bank usually lowers its interest rate encouraging lending and spending. To mop up liquidity from the economy, the central bank usually raises the interest rate which discourages spending and borrowing by businesses and consumers. Reserve requirements involve controlling of the proportion of deposits in cash banks should have at any given time. When the central bank reduces the reserve requirements of commercial banks, this usually leads to an increase in liquidity in the market. Increase or reserve requirement has the opposite effect of reducing liquidity in the market. The last monetary and the most commonly used tool is the open market operations. This tool involves the buying and selling of the countries securities and foreign exchange. Compared to the other two devices which are controlled by the central bank, the open market operation is determined by the forces of the market. (Federal Reserve Bank of St. Louis, 2016). Open market operations typically influence the supply of bank reserve along with reserve requirements.
The two most significant monetary tools used by Da Afghanistan Bank are the foreign exchange auction and the sale of capital notes. These are reserve requirement and open market operations.
Foreign Exchange Auction
It is one of the primary monetary tools used by the central bank of Afghanistan to intervene into the market. Foreign exchange auction, according to its regulation is frequently carried out twice per week. The process is usually done through an open auction with commercial banks and foreign exchange dealers as its participants. The sale is usually carried out so that the central bank can maintain its target of foreign currency in circulation within its economy. Since a lot of foreign exchange comes into the country through donation and trade lack of foreign currency auction will see the amount of foreign money in the economy surpassing the central bank’s target. Such an increase will lead to an increase in inflation of commodity prices, and the national currency will lose its value against foreign currencies. People’s purchasing power will diminish, confidence in the local currency decreased and lastly the county’s economic welfare will be negatively impacted. Also, people will prefer to maintain their currency in foreign money, converting both their non-liquid and liquid assets to foreign currency (Da Afghanistan Bank, 2016).
Capita Notes Auction
The other monetary tool used by Da Afghanistan Bank the capital notes auction. Capital notes are unsecured and risky loans which are short term and have a high-interest rate. In Afghanistan, the central bank sells capital notes to commercial banks once per week. There are three types of capital notes sold to the commercial banks by the central bank. These include the 28 day, 182 day and 364-day capital notes. Some notes have a lower maturity date of even seven days. The capital notes are important in managing liquidity within the economy and help reduce dependency by commercial banks on foreign currency. To further boost this sector, the government of Afghanistan is considering opening a secondary market for capital notes to increase investments on the same.
The level of International net reserves in the country is another measure used by the central bank to evaluate the effectiveness of its monetary policy. International net reserves are usually determined by considering the amount of foreign exchange flowing into the country compared to the projected foreign currency auction. High level of foreign currency in the country is admired since it increased confidence in the economy and also strengthens the value of the domestic currency. Despite the fact that this indicator or tool has always been a good measure of economic good being, high levels of foreign exchange in a country have direct consequences on implementation of monetary policy. A large amount of foreign exchange in a country also affects other indicators such as exchange rate of a county’s currency, its inflation index and maintenance of the balance of trade.
Apart from formulating and implementing the monetary policy the monetary policy department performs other duties which help a country maintain stable prices and avoid exchange rate volatility. These include collection and reviewing of data and the necessary financial indicators. They provide crucial information on the changes in the market conditions and trends. It helps identify any impending problem and come up with suggestions on how to handle the problem. The monetary policy department in Afghanistan is divided into four major sectors: monetary sector, fiscal sector, real sector and external sector.
The monetary sector is accountable for collection and compilation of raw data, reviewing them and making any necessary calculation. The reports generated from these data are usually used in the subsequent decision-making processes. The real sector, on the other hand, is responsible for analysis of macroeconomic variables. The department works on things such as determination of GDP, Inflation Index, and Consumer price index amongst other macroeconomic indicators. External sector collects data on external matters such as foreign trade and the business transaction between Afghanistan and other countries. The segment provides crucial information for central government and other monetary organizations. Information from this sector includes the country’s position of foreign reserves plus the liability the country could be having. The fiscal sector is the bridge between Ministry of Finance and the Monetary Policy Department. This industry collects data on government revenues, expenditures and other sources of government budget (Da Afghanistan Bank, 2016).
To maintain stable prices and avoid exchange rate volatility, other than the monetary the central bank of Afghanistan should also consider enhancing its revenue collection or generation efforts. The central bank should also consider ways of how to consolidate its expenditure efforts and come with ways of seeking additional financial assistance. All these are viable options in improving the economic environment of the country which will consequently protect it against several external situations which might weaken the economy.
Conclusion
Due to the poorly developed banking and financial sector of Afghanistan, there very few direct monetary tools which the central bank can use to safeguard its economy. The primary monetary tool used in the country is the open market operation which involves capital notes and foreign exchange auctions. Reserve requirements and discount rates are other tools which can be used to analyze monetary policy, maintain stable prices and avoid exchange rate volatility. A lot needs to be done in the country regarding handling the several economic challenges which the country is facing. These challenges include the security and political instability coupled with the various institutional challenges. The judiciary system should be reformed to check corruption; better regulation implemented to build confidence in the county’s banking sector. The county has a lot of potential and with sound governance; the country can turn around its economic challenges.
References
Da Afghanistan Bank (2016). Monetary policy. Retrieved from http://dab.gov.af/en/page/about-the-bank/departments/11010
Federal Reserve Bank of St. Louis (2016). How monetary policy works. Retrieved from https://www.stlouisfed.org/in-plain-english/how-monetary-policy-works
Federal Reserve Education organization (2016). Monetary policy basic. Retrieved from https://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy
Heritage foundation (2016). Afghanistan. Retrieved from http://www.heritage.org/index/country/afghanistan
Rumi consultancy & World Bank (2015). Afghanistan Economic Update: Fiscal Stability is Critical to Steer Afghanistan’s Economy Back to Recovery and Growth. Retrieved from http://www.worldbank.org/en/news/feature/2015/05/02/increasing-fiscal-stresses-against-the-backdrop-of-a-slowing-economy-and-a-deteriorating-security-environment-demand-solid-reforms-to-restore-fiscal-stability-and-reinstate-investor-and-consumer-confidence
