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ECONOMICS

Talibellion: The crumbling economy shakes Taliban rule in Afghanistan

The resurgence of the Wilayat Khorasan faction of ISIS, which drew renewed attention worldwide following the March 22 terrorist attack at Crocus City Hall outside of Moscow, did not occur in isolation. ISIS militants are gaining strength at the same time the Taliban’s hold on power in Kabul is weakening. As the Russian Ministry of Foreign Affairs and Ministry of Justice fight to remove the Taliban from Russia's list of terrorist organizations, seeking to establish increasingly closer ties with the group, economic woes in Afghanistan have led to mounting popular resistance against the Taliban domestically.

Experts from The Economist Group believe that, sooner or later, this resistance will pose a challenge to Taliban authority. Despite the Taliban's initial successes — including in making the Afghan currency, the Afghani, the most stable in the world and reversing inflation to deflation — these victories have proven to be short-lived. The impoverished nation has only grown poorer in the two years since the change in power, with widespread unemployment providing fertile ground for terrorist groups to thrive.

Content
  • The currency strengthened in defiance of economic theory

  • Prices are not rising, but it's too early to rejoice

  • No drugs, no budget

  • Taxes: a new hope

  • Precarious situation

The 2021 seizure of power by the Taliban, an organization recognized as a terrorist group in many countries worldwide, dealt a severe blow to Afghanistan's economy. The state became subject to the sanctions previously imposed on the group, complicating external trade and any international interaction with the new regime. The economy collapsed immediately, losing a fifth of its value in 2021, and it has yet to recover from this downturn. Per capita income plummeted by a third over the past two years, leaving Afghanistan as one of the poorest countries in the world, ranking last in the happiness index. Women are being actively pushed out of the labor market, with the proportion of employed women, already small, nearly halving from 11% in 2022 to 6%. In short, the economic and social repercussions of the Taliban's takeover have been devastating for the Afghan population.

The currency strengthened in defiance of economic theory

Despite the country's crisis, Afghanistan's currency emerged as one of the most resilient globally by the end of the third quarter of 2023, as per Bloomberg's assessment. Surprisingly, the Afghani has appreciated nearly 45% against the U.S. dollar since its January 2022 low of 105 Afghanis per dollar, now surpassing its value from before the Taliban's takeover at 71 Afghanis per dollar.

This paradox is striking given the economic downturn and a significant trade deficit, in which imports outpace exports fourfold. Despite some financing from UN aid to offset the deficit, this economic scenario contradicts conventional wisdom. Typically, the demand for foreign currency rises due to the need to purchase goods abroad, leading to its appreciation and the devaluation of the national currency.

Part of this anomaly stems from Afghanistan's inability to print its own currency. Previously, this task was outsourced to foreign firms, but cooperation ceased after the Taliban's ascent. Consequently, the quantity of banknotes in circulation remains stagnant, with occasional inflows offset by the depreciation of older bills. Consequently, sustained demand for currency against a fixed money supply results in a higher exchange rate. To counter this, the Taliban banned the export of cash from the country and restricted the use of foreign currencies — first U.S. dollars and then other popular options like Pakistani rupees and Iranian rials — within its borders.

However, the primary explanation for the currency’s seeming success appears to lie in the fact that the statistics showing massive amounts of import into Afghanistan are more of a facade than a reality. Why would an economy witnessing a 26% decline in industrial production suddenly require a significant surge in imports of resources like metals and chemicals? How could there be a spike in the purchase of high-end goods, ready-made food products, vehicles and spare parts, and even glassware, in a country where two-thirds of households struggle to afford basic necessities like food? Moreover, businesses are barely staying afloat due to low demand. And yet the import of these goods was recorded as nearly doubling in volume over the past two years compared to the average annual figure for 2016-2020, with their cost increasing by 157%.

This situation likely indicates that goods worth over $1 billion were imported into Afghanistan before being illicitly diverted to the markets of another country — most probably Pakistan, according to the World Bank. As the Afghani strengthened, the Pakistani rupee depreciated in tandem. Additionally, in 2022, Pakistan imposed restrictions on imports due to a balance of payments crisis. Consequently, this unleashed an illegal flow of goods from Afghanistan into Pakistan. This illegal trade is not reflected in official export figures, and it severely distorts the economic picture. Simultaneously, by paying for supplies, Pakistan inadvertently creates demand for the Afghani, thus contributing to its appreciation.

However, this situation may soon undergo a transformation. Pakistan is growing increasingly discontented with rampant smuggling and is advocating for a radical solution: relaxing import restrictions. Nonetheless, as of now, controls are being tightened. If Pakistani authorities successfully curtail — or even limit — the scale of smuggling, it will have a substantial negative impact on Afghanistan's revenues and the stability of its currency. This is because Afghanistan relies on import duties for revenue. Consequently, the prices of imported goods, many of which are essential commodities like food, fuel, and medicines, are likely to fluctuate.

Prices are not rising, but it's too early to rejoice

Inflation skyrocketed immediately after the Taliban assumed power, peaking at 18.3% in July 2022. However, soon after, prices in the country began to plummet rapidly, leading to a notable deflation of 9.1% within just a year.

This downward trend is partly attributed to the strengthening of the national currency, resulting in cheaper imported goods. Yet beneath the surface lies a more profound issue: the economy is grappling with adapting to reduced demand. This decline stems from various factors, including depleted household savings, drastic shrinkage of incomes due to the ban on poppy cultivation, and austerity measures reducing government spending.

The drop in prices has provided some relief to the poorest Afghans, enabling an increase in their real incomes. Over the past two years, the percentage of Afghan households unable to meet even basic needs has decreased from 70% to 62%, according to World Bank data.

However, the looming threat of further deflation casts a shadow over economic stability. It exacerbates the real debt burden, erodes purchasing power, and dampens demand. This poses a conundrum: why make purchases today when prices are anticipated to drop tomorrow? Surveys of businesses have already signaled a significant decline in demand, compounded by uncertainties about the future and constraints within the banking system due to sanctions. Consequently, businesses are deferring investments in development, while individuals are curtailing major expenditures. This downturn is resulting in diminishing profits for businesses, stagnant nominal wages for the populace, and dwindling government revenues. The collective outcome is an exacerbation of poverty. Breaking free from this deflationary cycle presents a formidable challenge.

No drugs, no budget

The revenue from drug sales has always been of paramount importance to the country. The United Nations Office on Drugs and Crime estimated that the total volume of Afghanistan's opium economy in 2021, including domestic consumption and exports, amounted to as much as $2.7 billion, equivalent to 15% of the country's GDP. However, in April 2022, the emirate banned opium poppy cultivation.

As a result, 7 million people lost their source of income. For many, it was their only source, according to a study by the Alcis group.

The ban on poppy cultivation not only led to the impoverishment of the population — it also increased inequality. The wealthiest farmers, who had stocks of dried opium paste, benefited from the sharp rise in prices, which reached a historic high after increasing from $106 to approximately $400 per kilogram. Meanwhile, poorer farmers, sharecroppers, and laborers who had previously found seasonal work weeding and harvesting poppy fields, either lost their income entirely or experienced a significant decrease.

The ban undermined sources of income not only for households, but also for the state itself, as it officially collected duties on opium. The state had also previously benefited from taxes on trade and exports.

Taxes: a new hope

Following the Taliban's victory, Afghanistan found itself stripped of significant amounts of foreign aid (although the UN continues to provide occasional humanitarian aid to the population) and borrowing capabilities. Yet the new government has demonstrated a remarkable ability to generate revenue through taxation and customs duties, rivaling its predecessor's efficiency. In fact, certain categories, including customs duties, have seen an increase, even amidst the economic downturn. Before seizing power, the Taliban had already honed its tax collection skills in the years spent gathering levies to fund military endeavors from Afghans living on territories under the group’s control.

The Taliban's YouTube reports also shed light on two additional tax types not accounted for in the Ministry of Finance's statistics: zakat and ushr — Islamic levies on crops and livestock, now mandated nationwide by the regime. According to the acting Minister of Agriculture, these taxes yielded $1 billion in 2022 alone. Although the emirate insists these contributions are voluntary, ordinary citizens claim they are collected as compulsory communal taxes.

Navigating through myriad challenges and constraints, the emirate has had to carefully allocate its resources. Operational expenses, primarily for maintaining the state apparatus, consume a staggering 95% of the entire budget, leaving a mere 5% for development initiatives. This stark contrast to the previous republic's allocation — 66% for administration and 34% for development — underscores the emirate's prioritization. Notably, the lion's share of administrative expenses is directed towards Afghanistan's Ministry of Interior Affairs, absorbing roughly 20% of the national budget. Meanwhile, the country's healthcare system, as noted by the WHO, languishes due to severe underfunding.

Precarious situation

According to the World Bank, Afghanistan’s slight improvement in macroeconomic health over the past two years has come at a steep price: the depletion of all remaining survival strategies and resources among households. Prior to the Taliban's rise to power, roughly half of families hadn't resorted to extreme measures for survival. Now that figure has plummeted to a mere 8%. Among the remaining 92%, many find themselves without any means to weather the ongoing crisis. Savings have been exhausted for 24% of households, while over 30% lack any assets, such as property or capital, that could be liquidated for funds.

The consequences are dire. People are sinking into debt, withdrawing children from school to send them to work, and even resorting to marrying off their daughters at younger ages, often against their will. The Taliban's restrictions on female education beyond primary school and restrictions on their employment outside of a few exceptional sectors such as healthcare only exacerbate the situation. Meanwhile, a surplus of labor resulting from population growth and the forced deportation of Afghans from Pakistan has far outstripped job creation, doubling the country's unemployment rate to leave one in three individuals without work.

Amidst this turmoil, companies are adopting survival strategies of their own: laying off staff, cutting back on investments, and turning to brokers within the informal hawala payment system, particularly for import and export transactions.

These measures are causing widespread concern, as they fuel a downward spiral of deflation, further eroding demand and undermining the overall economy.

This weakening works in favor of the Afghan branch of the Islamic State, known as Wilayah of Khorasan, which claimed credit for the recent terrorist attack outside of Moscow. Back in 2018, after years of conflict, the Taliban declared the near-complete eradication of ISIS in Afghanistan. In response, ISIS leadership pivoted from direct confrontations to targeted and merciless acts of terrorism.

ISIS perceives a robust Afghan government as a barrier to its objectives and employs all available means to topple or weaken the Taliban. While the Taliban initially managed to contain ISIS, their grip on power has necessitated a dispersal of focus amid a myriad of challenges, chief among them the imperative to sustain the country's economy. Notably, one of the Taliban's earliest moves in power was the release of thousands of prisoners, encompassing not only Taliban affiliates but also members of ISIS and Al-Qaeda.

In 2021, ISIS orchestrated a devastating bombing at the nation's primary airport, claiming the lives of 182 individuals, and has since perpetrated multiple attacks.

The current year presents yet another formidable trial for Afghanistan's economy. Experts from The Economist Group anticipate significant deflation, reflecting plummeting food prices and sluggish consumer demand. They predict that comprehensive sanctions will remain in force until at least 2026, positing that the resistance movement will ultimately challenge the Taliban’s hold on power in Kabul.

Hawala (from Arabic حوالة‎, meaning «transfer») is a system based on the mutual offsetting of claims and obligations between brokers. The system originated on the Indian subcontinent long before the emergence of the Western banking system. A user gives funds to a broker, who then sends a message to a colleague in another region, who in turn delivers the money to the recipient.

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