The South Asia Channel

Afghanistan's Troubled Economy

Afghanistan's presidential elections were greeted with much euphoria earlier this year. While some argued that the vote symbolized a loss for the Taliban, others declared that it showed Afghans were confidant "in their ability to determine their political future" and Afghanistan's state institutions were working. This optimism quickly dissipated as the run-off led to political deadlock over claims of election fraud rather than a smooth transfer of power. The real story missed amidst the buzz, however, was that Afghans were hardly confidant about the political situation into the lead-up to the elections. In fact, the decisions of Afghan businesses and consumers illustrated a pessimistic outlook throughout 2013 due to nervousness over the transition. Now, the new Business Tendency Survey Report, released by the Afghanistan Chamber of Commerce and Industries (ACCI) in August, points to a clear worsening of the situation: business conditions have deteriorated rapidly, orders are contracting, firms are closing shop, and layoffs are becoming more widespread.

The report, based on interviews conducted in July 2014 with managers from 541 Afghan firms, covered the manufacturing, services, trade, and construction sectors across the Kabul, Balkh, Kandahar, Nangarhar, and Herat regions.

The survey's headline finding is that the overall business climate has worsened considerably since March: Almost three-fifths of all firms complained of deteriorating conditions. The more troubling revelation is that the degradation is widespread, and not concentrated in any particular region or sector. 

Furthermore, new orders have contracted for a second straight quarter, as firms with declines outweigh those with gains by ten-to-one. Worse yet, this caught companies by surprise, which despite the weakening, were generally optimistic in March and did not foresee shrinkage three months out. This development at least partly reflects a continued slowdown in private consumption that emerged in 2013, as Afghans become more inclined to cut expenditures and save in the face of an uncertain political and deteriorating economic environment.

The most prominent indicator of rapidly declining confidence was business contraction, with many companies interviewed in March now having closed shop entirely or downsized significantly. This retreat was reflected in the unprecedented level of layoffs recorded by ACCI: one-in-ten managers reported cutting workforce size in the last three months, and that too in a season traditionally known for more hiring. 

This is an exacerbation of the pullback that began in 2013. As the World Bank observed, new firm registrations fell by 38 percent between 2012 and 2013, reaching the lowest levels seen since 2008. Foreign and local fixed investment also slowed last year, while real estate prices plunged. Moreover, according the World Bank 2014 Enterprise Survey, employment growth dropped to 4.9 percent, almost one-third of the 2008 rate. 

Domestic private investment fell to 3.6 percent in 2013, slowing considerably from an average of 9 percent between 2006 and 2011. Not only have Afghans become weary of investing locally, but there is also evidence that the pace of capital flight has also been accelerating since last year. According to the Soufan Group's January 2014 Intelbrief, Afghan elites lack confidence in the state's ability to provide effective security once foreign forces leave, and they are increasingly shifting assets and investments to safer destinations like the UAE. As one tribal leader in Kandahar told the International Crisis Group in 2013, "some people are worried about a 1992 scenario, so they are sending money to Dubai."

Real estate and construction -- two sectors already suffering from Afghanistan's drastic slowdown -- are affected heavily from this exfiltration of capital, since investment is often pulled from those markets. It is little surprise, then, that almost 70 percent of construction firms polled by ACCI complained of worsening business conditions.

While businesses struggle to cope with the political instability and threat of rising insecurity, Afghanistan's farmers have been hedging their bets by ratcheting up poppy cultivation since last year: According to both, the UNODC and U.S. State Department, output rose from 2012 to 2013, reaching an estimated 5,500 metric tons. Based on U.N. estimates, this was nearly a 50 percent increase since 2012. In addition to output, farmland used for growing poppy expanded as well. According to U.N. estimates, there was 36 percent one-year increase in areas used for poppy cultivation in 2013. It is estimated that this year's production will stay on par with 2013 levels, if not exceed it.

As predicted by the World Bank in 2012, the transition will have an adverse impact on Afghanistan for a variety of economic and fiscal reasons, but in addition to that, the lack of confidence in the state's ability to provide security and stability will remain a major non-economic hindrance to growth. The latest ACCI poll illustrated exactly that, where despite views being divided on whether security had improved or worsened since March, lack of security (cited by 53 percent of firms) was still ranked as the single biggest obstacle for businesses' growth. As observed from macro trends, the non-economic hindrance is having serious repercussions. Prior to the elections there were clear signs of declining confidence among businesses and consumers with expansion slowing, investment falling, opium production rising, and food inflation surging as retailers hiked prices. In 2014 many of these trends have worsened.

Afghanistan's heavy reliance on foreign aid made a slowdown in aftermath of the transition an eventuality. With the fall in grants, not to mention the absence of consumption generated by the foreign presence, the high growth seen in recent years is unsustainable. But the slide can be arrested and more sustainable levels of growth achieved, provided there is political and policy stability and the government can credibly ensure security against the Taliban as well as other factions jockeying for control as foreign forces depart. Without a secure political environment, stabilizing the economy will be nearly impossible. This itself can exacerbate the security problem by creating more grievances against the government and reducing its legitimacy, while also heightening demand for illicit activities. The latter is already being observed.  

A stable economy is vital to a secure Afghanistan. Presently, however, it's showing clear signs of hurt due to growing pessimism amidst political uncertainty and the impending transition. With the National Intelligence Estimate forecast last year of a deteriorating security situation after 2014, and an independent assessment by the Center for Naval Analysis confirming the Taliban's greater ability to create instability, Afghanistan's economic future appears grim as well. 

Shehzad H. Qazi is a pollster working in emerging and frontier markets and a fellow at the Institute of Social Policy and Understanding. Follow him on Twitter: @shehzadhqazi. 

Erika Schaefer is a graduate student at New York University's Department of International Relations. Follow her on Twitter: @schaefererika.