FY1398 Budget AFGHANISTAN DEVELOPMENT BRIEF Highlights of Afghanistan Fiscal Year 1398 Budget December 2018 Topic: FY 1398 Budget The budget for Fiscal Year 1398 was approved by parliament on 1st January 2019. It provides a consolidated medium-term fiscal outlook with lower fiscal deficits for budget year amid drastic decreases in aid and increasing government responsibility for security spending over the medium-term. In this note we provide an assessment of the technical aspects of budget and discuss the implications of the medium-term fiscal framework. The budget document is technically sound and includes some significant improvements in compliance with international best practices. The medium-term fiscal implications of the budget are concerning, however, with declining aid leaving little fiscal space for development and O&M spending over the medium term as security expenditures rapidly increase. Budget aggregates The 1398 fiscal Overall revenues and expenditures are budgeted to decline by 3 percent for FY 1398 deficit is reduced from previous compared to previous year. Total expenditures are estimated at Afs11 399.4 billion budgeted deficits (25.5 percent of GDP), of which 47 percent is financed from domestic revenues and about 50 percent is financed through aid. The total fiscal deficit is budgeted at Afs 12.4 billion compared to Afs 16.1 billion in the previous year, with financing sources not yet identified. Domestic revenue collection is expected to increase by 8 percent, while grants are expected to decline by 11 percent in 2019 and much more over the medium term. The decrease in expenditures mainly comes from drastic reductions in pension and contingency funds as well as lower budgeting for development projects to reflect expected improvements in execution and the exclusion of poorly performing projects. Revenues by source and expenditures by type are shown in Figure 1. Figure 1: Fiscal Year 1398 Budget (in billion Afs) Revenues Tax, 127 Other Revenues, 60 Grants, 199 Deficit, 12 Expenditures Development, 124 Operating, 275 1 Afs refers to the currency of Afghanistan named afghani. Afghanistan Development Brief FY1398 Budget Several improvements have been made to presentation and content of the FY1398 budget The presentation of the budget is better aligned with international norms and standards, contingent liabilities are identified, the contingency fund allocations have been reduced. Gender issues are given some visibility, and the budget is anchored within realistic macroeconomic forecasts for the budget year. The budget is The forecast economic growth rate of 3 percent during 2019 appears to be slightly anchored in reasonable optimistic considering the upcoming elections and lower agriculture growth in 2018 forecasts for 2019 due to severe drought. The government expects to collect 8 percent higher revenues in 2019, which represents a realistic target and a slowdown from recent expenditure growth rates. Overall budget expenditures are in line with total expenditure in FY 1397. Development Development projects have been reviewed for execution performance. Projects with projects have been reviewed persistently low rates of execution have been removed from the budget, freeing up fiscal space for other needs. This can be expected to help with further improvements in budget execution throughout the fiscal year. Presentation of the The budget is presented based on Classification of the Functions of Government budget is aligned with international (COFOG). Developed by OECD and adopted by UN Statistical Division, the COFOG standards classification of the budget brings important advantages, including: i) facilitating international comparisons; and ii) linking expenditures to specific policy goals. Contingent The budget document also includes an assessment of contingent liabilities and risks liabilities and fiscal risks are facing the government in next fiscal year and over the medium term. The contingent identified liabilities include risks arising from deteriorating security situation, climate change, direct and indirect guarantees from PPP projects and SoEs, and social spending such as on pension and refugee repatriation. In future years, budget documentation could be improved by quantifying and including measures to mitigate these risks. Contingency Contingency fund allocations are reduced from previous years. While inclusion of allocations have been reduced from some contingency funding is consistent with international good practice, previous years expenditures from this fund have previously been used for a variety of purposes inconsistent with the objectives of a contingency allocation. This has undermined overall budget realism. A reduced contingency allocation is an important step towards budget credibility, but it will also be important to ensure that budgeted contingency resources are used only for genuinely unforeseeable needs. The budget Building on the previous budget reforms, the budget includes medium-term includes forward estimates estimates at a disaggregated level. This ensures that the budget documents provide a realistic assessment of medium-term expenditure needs and pressures, facilitating medium-term fiscal and policy planning. Afghanistan Development Brief FY1398 Budget Budget formation Throughout the budget process, budget hearings included discussion of the gender was informed by gender aspects of ministry budget initiatives. The budget document also discusses plans to considerations further mainstream gender, including through protecting expenditures on projects and programs that benefit women and promoting equal access of men and women to government services. Medium-term implications of the 1398 budget While the budget document is technically strong, the medium-term framework it presents is worrisome. Within the medium-term fiscal framework presented in the budget document, increasing government responsibility for security spending squeezes out resources available for development spending and service delivery. Medium-term Medium-term revenue forecasts included in the budget are optimistic and predicated revenue estimates are optimistic. on optimistic growth projections. Over the medium term, domestic revenues are expected to increase at an average rate of 11 percent. This may be difficult to achieve given the expectation of political disruptions through the elections. Even under these optimistic revenue scenarios, the medium-term framework includes some problematic trends. The budget will be Firstly, security expenditures are expected to absorb an increasing share of available increasingly skewed towards revenues. As security sector grants decline, government will have to finance security the security sector needs, including personnel costs from its own resources. As of 2018, only about sector… 23 percent of domestic revenues are utilized to finance security spending. Over the medium-term, this ratio is expected to increase to 60 percent by 2021. ..and security With security sector personnel costs, accounting for a larger share of the budget, personnel costs will squeeze out resources available for development projects and O&M expenditures decline. The development and medium-term fiscal framework includes gradual declines in government spending on O&M spending goods and services and development projects while wages and salaries are expected to increase at an average rate of 6 percent over the medium term. Figure 2: Medium term revenues Figure 3: Domestic revenues financing security (in billion Afs) (in billion Afs) 450 400 300 80% 350 300 60% 200 250 40% 200 150 100 20% 100 50 0 0% 0 2018 2019 2020 2021 2022 2018 2019 2020 2021 2022 Government own revenues Development Grants Security Grants Government-financed security spending Domestic Revenues Revenues Government-financed security as a share of own revenues Afghanistan Development Brief FY1398 Budget Budgeted deficits Finally, the medium-term fiscal framework suggests higher fiscal deficits following are unsustainable over the medium- 2019. Deficits included in the budget framework reach an unsustainable level of 4 term. percent of GDP by 2022. It is not clear how these deficits could be financed, given limited access to either private or official debt financing, and government policies to avoid contracting of substantial non-concessional debt. Figure 4: Overall expenditures (in billion Afs) 500 400 300 200 100 0 2018 2019 2020 2021 2022 Development Security Others Total Expenditures Figure 5: Disaggregated expenditures (in billion Afs) 500 400 300 200 100 0 2018 2019 2020 2021 2022 Others Goods & Services Development Wages & Salaries Total Expenditures Conclusions The 1398 budget is a technically strong document. It includes several important improvements over previous budget documents, which help to faciltiate fiscal Afghanistan Development Brief FY1398 Budget transparency and support better links between public expenditure and policy priorities. Despite technical improvements, the budget document also paints a daunting picture of the fiscal challenges currently facing Afghanistan. The medium-term fiscal framework included in the budget clearly shows that reductions of international grant support over coming years will: i) place pressure on development expenditures; ii) lead to a reorientation of revenue-financed expenditure towards security sector needs; and iii) generate a potentially signficant gap between expenditure needs and available resources. Government should continue recent progress with improving public financial management systems, including through the annual budget process, to ensure pressures associated with declining grant support are managed as best possible. Ultimately, however, without continued and extended grant support or a radical change in the current security situation, development and service delivery needs are likely to go increasingly unmet as government takes on greater responsibiltiy for financing the security sector. Afghanistan Development Brief FY1398 Budget Table 1: FY 1397 budget execution performance FY 1397 Budget Execution against Actual Approved Reported in FY Expenditure Approved Reported 1398 MYR MYR Budget 1398 Budget Budget Budget Overall Budget 377 407 413 388 103% 95% 94% Operating 266 284 280 260 98% 92% 93% Development 111 123 133 128 115% 104% 96% Discretionary 52 58 58 53 103% 93% 93% Non-Discretionary 59 65 75 74 126% 114% 99% Note: in billion Afs unless otherwise stated Source: Approved budget documents and budget execution report as of end December 2018 Table 2: FY 1397 budget execution performance by sectors Operating Development Overall Budget Expenditure Execution Budget Expenditure Execution Execution Security 155,517 138,315 89% 3,251 2,913 90% 89% Governance and Rule of Law 25,187 24,495 97% 10,054 9,323 93% 96% Infrastructure 7,255 6,964 96% 57,118 55,564 97% 97% Education 43,200 42,045 97% 6,672 5,775 87% 96% Health 4,605 4,318 94% 18,352 17,150 93% 94% Agriculture and Rural Development 3,111 2,954 95% 30,330 28,729 95% 95% Social Protection 31,608 30,431 96% 1,403 1,274 91% 96% Economic 11,130 10,958 98% 134,323 127,526 95% 95% Note: in million Afs unless otherwise stated Source: Budget execution report as of end December 2018 Afghanistan Development Brief