May 29, 2006	Monday	Jumadi-ul-Awwal 1, 1427

Afghanistan

ACCORDING to western economists, Afghanistan’s economic outlook has improved significantly since the fall of the Taliban regime in 2001 because of the infusion of over $8 billion in international assistance, recovery of the agricultural sector and growth of the service sector, and the re-establishment of market institutions. However, real GDP growth is estimated to have slowed in the last fiscal year primarily because adverse weather conditions, decline in agricultural production, but is expected to rebound over 2005-06 because of foreign donor reconstruction and service sector growth.

The real GDP is estimated to have grown by 14 per cent in 2005/06, as agricultural output recovered on account of better precipitation, while momentum in the reconstruction effort sustained activity in manufacturing, construction, and services. Inflation continued to decline, to 12.6 per cent in February 2006, owing primarily to a slowdown in food prices, which was partly offset by an acceleration of rents and petroleum product prices. Looking ahead, Afghanistan’s medium-term growth prospects appear favourable. According to the IMF staff latest assessment, sustained reforms aimed at improving the investment climate should facilitate growth at an average of 10 per cent a year over the medium term. While agricultural growth would return to trend, telecommunications, transport, and trade would provide further impetus for growth.

Construction activity would increase steadily, though at a slower pace than in recent years. Per capita income would rise to more than $400 by 2008/09, from $299 in 2005/06. Assuming the pursuit of sound monetary and fiscal polices, inflation would decline further to 9 per cent by end-2006/07, and to five per cent a year thereafter. While revenue is projected to increase to six per cent of the GDP in 2006/07 from 5.5 per cent in 2005/06, the authorities must accelerate the reform programme to reach the “Compact” target of over eight per cent by 2010/11.

Limited basic infrastructure, weak capacity, red tape, the prevalence of drug-related activities, lingering insecurity, a weak and ineffective court system, the lack of enforcement powers to implement reforms, and limited transparency remain powerful deterrents to investment, sustainable growth, and improvements in the welfare of the population.

Agriculture: In view of the recovery in agricultural output, as well as continued sustained activity in construction, telecommunications, and transport, the real GDP growth projection of 13.6 per cent for 2005/06 remained unchanged. In 2006/07, as agricultural growth returns to its trend, economic growth is likely to moderate somewhat, to a projected 10.9 per cent. On account of the expected slowdown in rents and food prices and of the tightening of the monetary stance, inflation is expected to decline further, to 10 per cent year-on-year at end-2005/06 and 8 per cent year-on-year at end 2006/07.

Monetary policy will continue to be guided by the 2005/06 monetary programme agreed on at the time of the third review. It provides for a further tightening of the monetary stance during the remainder of the year, to bring inflation fewer than 10 per cent. The monetary programme will remain flexible to be able to accommodate unanticipated shifts in the demand for currency. International reserves are expected to increase further, to about $1.7 billion at end-2005/06, equivalent to 4.8 months of 2006/07 imports.

Budget: The budget will continue to be funded by domestic revenues and foreign grants. For 2005/06, it is estimated to be equivalent to 44 per cent of the GDP, compared with estimated disbursements of 35 per cent of GDP in 2004/05. Nonetheless, part of the external budget (equivalent to 21 per cent of the GDP) is unfunded and projects will not commence until the funding is secured.

Increasing domestic revenues over the medium term is of critical importance. The authorities concurred that the revenue target for 2005/06, which is slightly higher than the budget projection but, at 5.2 per cent of the GDP, is still one of the lowest in the world, is achievable provided that customs and tax administration reform programs are well implemented. The proposed tightening of expenditure controls, combined with a strong revenue effort, should help contain the operating deficit, excluding grants, to no more than three per cent of the GDP for 2006/07.

The government estimates that sustained growth of nine per cent annually of GDP is required to provide citizens with a tangible sense of improvement in living conditions, and compensate for the contraction caused by the elimination of the narcotics sector. Projected growth in FY2006 at 11.7 per cent and FY2007 at 10.6 per cent should exceed this minimum.

Current account: The current account deficit is projected to improve gradually from 39.9 per cent of GDP in 2006 to 33.8 per cent in 2007 as grant aid tapers down. The deficit increases slightly, reflecting somewhat greater foreign direct investment and public loan inflows. Trade has the potential to become an important driving force. However, formal trade flows with neighbours are relatively small (except for large-scale re-exports to Pakistan and Iran and reconstruction-related imports). With an average tariff of 5.3 per cent, Afghanistan has one of the most liberal trade regimes in the region.

Iran

The economy continues to benefit from the strong oil price and many economic indicators have improved as a result. There has also been a pickup of real GDP growth, fuelled by the higher oil price and government spending. Real GDP is forecast to grow by six per cent in 2005/06, after increasing by 5.6 per cent y/y in the first half of the fiscal year. There was a slowdown in the second quarter, to 4.8 per cent from 6.4 per cent in the previous quarter, owing to the political uncertainty surrounding the presidential election in June. Growth forecast for 2006/07 is around 5.5 per cent.

Inflation: Annual consumer price inflation averaged 11.1 per cent in the second quarter of 2005/06, down markedly 15.9 per cent in the first quarter. This is mostly due to the freeze on the price of subsidies of good and services. However, higher government spending is placing upward pressure on the inflation outlook and prices are forecast to accelerate in 2006/07. The government is unlikely to meet its target of reducing inflation to single digits in the current five-year.

According to a latest assessment, key macroeconomic indicators have improved on the back of favourable external conditions, but substantial structural imbalances exist and economic management has deteriorated. Highlighting the strengthened external position, Iran’s current account surplus increased to $7.1bn in H1 FY2005/06, almost three times the surplus realised over the same period in the previous fiscal year. Foreign exchange reserves increased to $45 billion in March 2006, the healthiest foreign liquidity position since the revolution. Furthermore, oil revenues increased to $ 41.85bn in the first 11 months of 2005/06, up 13.0 per cent from 2004/05.

Increased spending has resulted in the fiscal balance deterioration. The Standard Chartered economic update reveals fiscal deficit of 6.5 per cent of the GDP in 2005/06 and 7.4 per cent in 2007/08. Current spending raised 37 per cent y/y in the first half of fiscal 2005/06 and was almost 25 per cent over budget.

Furthermore, the Iranian fiscal position faces severe problems due to large-scale subsidies. The Majlis’ decision in January to freeze already low petroleum and gasoline prices to 2003 levels, along with some utility prices, will increase the subsidy costs. Subsidies already account for a quarter of total spending. The government has also increased funding to conservative institutions. To finance the sharp rise in subsidy costs, the parliament voted to spend an extra $3bn in 2005/06. Of this, $ 2.6bn will come from the Oil Stabilisation Fund (OSF), which is funded by higher than budgeted oil revenues.

Foreign investment: Meanwhile, Ahmedinejad has repeatedly called for domestic investors to be favoured over foreign ones in the oil sector. Contracts will still be awarded to foreign companies, although at a slower rate.

The value of Iran’s non-oil exports has reportedly surpassed $8.1 billion by the end of the current Iranian calendar year. According to the Commerce Ministry, the volume of goods exported in the current year shows a 24 per cent growth compared to the figure released in the previous year. Some six billion dollars worth of non-oil commodities have been exported to different countries since the start of the year. The increased investment in production facilities has been seen as the most important factor behind the boost in non-oil exports.

Exports: Non-oil export products have been sent to 10 major global markets and equal 63 per cent of the total volume of non-oil exports.

Foreign investment in the oil and gas sector remains vital to upgrading the current facilities and increasing production levels going forward. On a wider level, FDI is crucial in increasing employment opportunities, which remains a key challenge for the economy. However, the appetite of foreign investors will have been diminished by the negative signal sent by the Majlis in 2005 when it decided to reduce the stake of a foreign investor in Iran’s second mobile license to 49 per cent from 70 per cent.

There are also indications that some purchasers of Iranian oil have started looking to reduce imports from Iran and find new suppliers. Both the domestic and the international political environments will continue to place downward pressure on Iran’s economic outlook.