Afghanistan has a far bigger international profile than a country of 28 million people with an economy of just over $5bn should normally get. The problem is, it has come to prominence for all the reasons that frighten investors off.

The Afghanistan Investment Support Agency (AISA) is the government agency tasked with promoting the country to investors. Once investors are in the country, AISA is their single point of contact with the government, providing assistance with registration, licensing, leasing of land, and tax and customs compliance. Amid criticism and concern at government’s general lack of capacity and effectiveness, AISA is by all reckoning a stand-out exception: a competent and highly motivated agency that moves mountains for investors.

Still, while foreign donor aid and technical assistance are motivated by one set of imperatives, the flow of private capital is ultimately determined by the extent to which project returns justify the risks. And in Afghanistan the risks are considerable, including a precarious security environment; an uncertain pace and direction to government reform; poor infrastructure; and a weak skills base.

Economic boom

Shakib Noori, investment manager at AISA, hits back hard. Albeit off a small base, the economy is booming, with growth averaging 20% over the last three years. Moreover, the expansion has been broad-based, with the contribution of the construction, manufacturing, telecommunications and trade sectors all rising sharply.

Indeed, since 2001/2002, average per capita incomes have almost doubled and though the rise in household incomes has been uneven across the country, Afghans everywhere are enjoying rising disposable incomes.

Mr Noori points out that this has not been at the cost of prudent monetary and fiscal policy, with key indicators such as inflation and public debt remaining healthy.

It makes for a compelling set of investment opportunities, says Mr Noori, noting that the boom time is underwritten by the international community, which has committed $8.2bn until March 2007.

Without dismissing the obstacles faced by investors, Mr Noori is at pains to point out just how much the government is committed to making the private sector the engine of growth. He highlights a number of concrete measures it has implemented to improve the investment environment, including:

• a modern investment law, which is in the process of being revised;

• the establishment of AISA to assist investors to set up in the country and bypass bureaucracy;

• financial sector reforms that have seen foreign banks open for business and strengthened the overall financial system;

• investment insurance guarantees, protecting against political risk;

• the establishment of a number of fully serviced industrial estates, offering a viable, cost-effective solution to the country’s infrastructure gaps;

• an improvement in infrastructure, specifically with respect to telecommunications, roads and bridges, and water supply;

• trade reform that streamlined customs administration and reduced tariffs;

• preferential trade pacts with the US, the EU, Canada, Japan, India and Iran;

• transit agreements with Iran, India, Pakistan, Uzbekistan and Turkey.

Significantly, the government has made political progress that few thought possible, culminating in the successful presidential elections late last year and to be followed by parliamentary elections in September this year. The promise of political stability and a more secure operating environment for companies signals that the environment is ripe for forward-looking investments, says Mr Noori.

Afghanistan offers two attractive demand dynamics. First, the rapidly growing economy is bolstering demand for products and services among Afghanistan’s young population – a relatively small consumer market but one that has been under-served in the past. Vigorous growth and massive infrastructure rehabilitation is also stimulating demand for capital goods, such as machinery.

According to the most recent government figures, Afghanistan’s imports totalled $2.1bn or 47% of GDP in 2003/2004. Simply stated, the country has a near non-existent capability to meet domestic demand from domestic production, creating an instant and growing import-substitution opportunity across nearly all product groups.

In contrast, exports in 2003/2004 amounted to just $144m, meaning a massive and unsustainable trade deficit of 43% of GDP. Though this is funded currently by foreign donor assistance coming through on the capital account, the government is acutely aware of the need to grow exports and cut imports by stimulating domestic production.

Finance minister Anwar-ul-Haq Ahady told fDi magazine that it would be the government’s guiding principle to levy the lowest net tax rates on companies (including incentives and allowances) compared with the rest of the region, translating into generous tax regimes for manufacturing firms.

Regional player

In support of export development, Afghanistan benefits from a strategic location – and herein lies the country’s second demand dynamic, namely regional markets.

For centuries Afghanistan has been the hub connecting Asia, Europe and the Middle East. The country is ideally situated to function as a strategic gateway, serving landlocked countries to the north and the Iranian and Pakistani seaports to the south. For the central Asian republics and the Russian industrial centres of western Siberia, Afghanistan is potentially the shortest route to the open sea. Sharing borders with six neighbours – Iran, Turkmenistan, Uzbekistan, Tajikistan, China and Pakistan, Afghanistan is considered a “land bridge”, linking the region into an extended market of more than two billion consumers.

To this end, the construction of the ring road linking the country’s biggest cities and the negotiation of trade and transit deals has been important.

Target sectors

So far, investors from 25 countries have set up Afghan operations. Multinationals that invested in Afghanistan are in the transport and logistics sector (DHL), food processing (Coca Cola), banking (Standard Chartered Bank, National Bank of Pakistan, Habib Bank, and National Bank of Punjab), tourism (Serena Hotels and Hyatt Hotels), and trade (Toyota Motors and Alcatel Trade International). The total value of investment is approaching $1bn.

In April, the World Bank’s Multilateral Investment Guarantee Agency (MIGA) published the results of a foreign investment benchmarking study. It assessed four sectors – transport and logistics; food and beverage processing; carpets and textiles; and mining – based on an initial sense of their viability for attracting investment. The objective of the study was to look at Afghanistan’s overall competitiveness in each of these sectors, particularly regarding their attractiveness to foreign investors.

In the transport and logistics sector, the study found low levels of competition, a consequence of low investment shaped by the country’s turbulent past. However, demand from the foreign aid community, government and the private sector was likely to remain strong for the foreseeable future. The net result is high profit margins – respondents to the survey reported investment of thousands or tens of thousands of dollars yielding profits of hundreds of billions.

First-movers

Though margins are expected to narrow as competition picks up, prevailing conditions underscore the benefit of ‘first-mover’ advantage, an opportunity available across many sectors in Afghanistan’s very under-developed economy.

The study found particularly high potential for first-mover advantage in the food and beverage processing sector, where almost all goods are imported. The study also noted Afghanistan’s brand name for traditional products such as dried fruits, for which it is historically well known. Added to this, it benefits from close proximity to raw materials and access to the growing markets of India, Pakistan and China.

In the carpet and textiles sector, the study found that the combination of Afghanistan’s skills and reputation for quality, plus preferential trade access to the US and the EU, was a compelling advantage.

In the mining sector the study observed considerable growth potential given how under-developed the sector presently is, with few resources being commercially exploited. Strong demand, in the form of construction materials or coal for energy, offer opportunities, with lower costs of transport and distribution compared to imported materials.

Far from glossing over the numerous challenges confronting investors, the study admits that investing in Afghanistan will be tough. The report also highlights the improving climate for investment, particularly impressive considering the state of the country in 2001.

This, the report concludes, bodes well for the future: “Most important from the investor’s point of view should not so much be the current situation, which has already significantly improved from recent years, but rather the dynamic movement of the country’s economic and security realities, and the future opportunities created for business.

“Investors entering Afghanistan now will benefit from being first-movers in a virgin market that is highly pro-business.”

INVESTMENT LAW

Afghanistan’s weak legal and regulatory infrastructure is, for the moment, an unavoidable and problematic feature of the investment environment. The legislative backlog is long and basic commercial laws are not in place.

In 2002, Afghanistan adopted a new investment law opening the country up to foreign investment. All sectors of the economy were declared open to foreign investors, with the law permitting 100% foreign ownership. There is also no restriction on the transfer of capital and profits in and out of the country.

The law is straightforward to the point of being limited. The actual legislation is contained in just six pages, sparking concerns that its ultimate effectiveness will depend on numerous complicated amendments. A revised version of the law has been drafted but is sitting in the legislative gridlock. The current law prohibits foreigners owning land, for instance; the draft revised law includes long-term leasing clauses.

As the law stands, investments in the construction of pipelines, telecommunications infrastructure, oil and gas, mines and minerals, and heavy industries are not covered by the current legislation. Investments in these sectors will be regulated under separate, yet-to-be enacted laws.

Regarding tax, the government has adopted a simplified, business-friendly approach. The central features are a 20% flat rate tax on corporate profits, unlimited loss carry forward and provisions for accelerated depreciation.

For imports, the government has introduced a simplified tariff scheme with rates ranging from 2.5% to 16%. A tariff of 4% is levied on the import of capital goods. As for exports, Afghanistan enjoys full duty-free access to the EU under the ‘everything but arms’ programme. It also enjoys preferential treatment under the trade systems of all other major industrialised countries. Afghanistan has been granted observer status at the WTO and all trade-related regulations are already enacted with a view to full WTO accession in the future.