Investment Climate Improving in Afghanistan, but Challenges Remain

Kabul, February 25, 2006—A World Bank report released today says despite encouraging progress, many challenges remain to improve Afghanistan’s investment climate. According to the study, The Investment Climate in Afghanistan: Exploiting Opportunities in an Uncertain Environment, the key challenge is to broaden participation in the market by removing barriers to new investors and creating conditions that will encourage those already in the market to invest more.

Based on a survey of 338 firms in five Afghan cities, the report analyzes challenges for private sector development in Afghanistan. The most serious constraints reported by the surveyed firms are electricity and access to land. Corruption and access to finance were also mentioned as significant.

The report highlights that the Afghan government has taken a number of steps to improve the business environment and attract investment. It has established the Afghanistan Investment Support Agency (AISA) designed specifically to promote and facilitate investment. There has also been significant progress in developing the financial sector, and implementing labor regulation and tax reforms.

"The government has made important strides toward creating an enabling investment climate," said Jean Mazurelle, World Bank Country Manager for Afghanistan. "But much more remains to be done. Private sector activity is still carried out in an environment dominated by informal practices. These arrangements may be useful for many investors in the short run but will have negative effects for longer-term investment growth."

Some 80-90 percent of economic activity is informal and potential investors who do not have established contacts with influential figures find these informal arrangements daunting and are often discouraged from investing, the report argues.

The report recommends four categories of actions for accelerating private sector development:

1. Improve access to inputs: Firms need factors of production, notably finance, land, skilled labor and physical utilities and infrastructure, including power, water, telecoms, roads and ports.
2. Clarify and strengthen property rights by creating a sound legal, judicial, and regulatory framework for investment.
3. Improve the flow of information: When market players lack information about market opportunities and trends, quality of products, availability of resources, and government policies and regulations, they become dependent on informal contacts for information.
4. Improve the provision of business services: The government needs to put in place a policy and regulatory framework to facilitate private investors.

While Afghanistan has witnessed a sharp increase in private sector investment, it is well below its potential, the report says. For example, AISA has registered nearly US$1.3 billion in new investment (excluding telecom firms) over the past two years, but only a fraction of these commitments has actually been disbursed. Additionally, while investment accounts for nearly 22 percent of GDP, the bulk of this investment is public investment financed through international aid.

Nearly 50 percent of the new investment approved by AISA has been in construction and construction materials. "This reflects the massive inflows of external aid and the need to rebuild infrastructure," said Syed Mahmood, World Bank Private Sector Development Specialist and co-author of the report. "In the risky environment of Afghanistan, foreign investors prefer government- and donor-funded reconstruction projects or services through which they can quickly recover their investment, to the longer-term process of building markets for manufactured goods."

Finally, the report emphasizes the need to improve government capacity to analyze private sector issues and formulate and implement private sector development policies and programs. "Enterprises need a variety of business services to help them enter, operate, grow and manage risks," said Samuel Munzele Maimbo, World Bank Senior Financial Sector Specialist and co-author of the report. "These services are best provided by the private sector but the government needs to put in place a policy and regulatory framework to facilitate private entry."

To read more on the World Bank's work in Afghanistan,
please visit: http://www.worldbank.org/af