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2011 Investment Climate Statement - Afghanistan


2011 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
March 2011
Report
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Overview of Foreign Investment Climate

The Government of the Islamic Republic of Afghanistan (GIRoA) recognizes that the development of a vibrant private sector is crucial to the reconstruction of an economy ravaged by decades of conflict and mismanagement. As such, it has taken concrete steps toward fostering a business-friendly environment for both foreign and domestic investment. Security threats sometimes limit investors' opportunities to develop businesses in some regions, and certain sectors (such as mining and hydrocarbons) still lack a regulatory environment that fully supports investment. In the face of these challenges, Afghanistan's investment climate has shown surprising levels of dynamism in recent years. The following chart summarizes well-regarded indexes and rankings (MCC refers to the Millennium Challenge Corporation):

Measure

Year

Index or Rank

TI Corruption Index

2010

176/178

Heritage Economic Freedom

2010

N/A (not ranked)

World Bank Doing Business

2011

167/183

MCC Gov't Effectiveness

2010

-0.52 (23%)

MCC Rule of Law

2010

-1.12 (2%)

MCC Control of Corruption

2010

-0.86 (5%)

MCC Fiscal Policy

2010

-2.8 (34%)

MCC Trade Policy

2010

69.6 (62%)

MCC Regulatory Quality

2010

-0.95 (8%)

MCC Business Start Up

2010

0.965 (83%)

MCC Land Rights Access

2010

0.383 (5%)

MCC Natural Resource Mgmt

2010

22.55 (0%)

Openness to Foreign Investment

Official support for open markets and private sector participation is stated in the Afghanistan National Development Strategy (ANDS), which President Karzai and the international donor community endorsed in June 2008. The Law on Private Investment of Afghanistan of 2005 specifically prohibits discrimination against foreign investors, as does the Constitution. According to the Afghan Investment Support Agency (AISA), discussions are underway to improve regulations under the law; these will be submitted to the Parliament and President for promulgation once completed. Investment in certain sectors, such as non-banking financial activities, insurance, natural resources, and infrastructure (defined to include power, water, sewage, waste-treatment, airports, telecommunications, and health and education facilities) is subject to special consideration by the High Commission on Investment (HCI), in consultation with relevant government ministries. The HCI is the Government’s focal point for investment policy-making and is composed of the Ministers of Commerce, Agriculture, Foreign Affairs, Finance, the Afghan Investment Support Agency (AISA), and Da Afghanistan (Central) Bank.

Investments can be 100 percent foreign-owned. Under the Afghan Constitution and the Private Investment Law, foreigners may not own real estate, but they may lease it for periods up to 50 years for arable land or longer for non-arable land. Some leases have been negotiated with an automatic renewal clause for terms of up to 99 years. Many businesses cite access to land as one of the biggest impediments to investment in Afghanistan. Foreign investors are not required to secure an Afghan partner, but due to the restriction on land ownership, they almost always choose to work with one. Private investors have the right to transfer their capital and profits out of Afghanistan, including for debt service for off-shore loans.

The government has adopted economic reform programs and these rely heavily on foreign experts who base their initiatives on international best practices. The government has also adopted progressive policies to foster trade and investment, including currency reform, rationalized customs tariffs, and a simplified tax code. It has also set up structures to help promote investment and investment-friendly policies. AISA, a quasi-government agency under the Ministry of Commerce, operates a streamlined business registration process ("one-stop shop") and conducts a host of business and investment promotion and facilitation activities.

The Afghanistan Chamber of Commerce and Industries (ACCI), which engages actively in the process of establishing a legal framework for private business in Afghanistan, represents the business community to leading government officials, and provides services to members. ACCI took its current form as a private chamber of commerce in 2008, and since that time, ACCI has elected its leadership and established offices in 21 provinces of Afghanistan. ACCI also has affiliations and partnership agreements with investors and associations in the United States, Tajikistan, Iran, Pakistan, the United Arab Emirates, Italy, and many other countries. ACCI works with Parliament, the Office of the President, and the Ministries of Finance, Commerce, Interior, Transport, Justice (among others) to bring about reform and encourage investment in Afghanistan.

Afghanistan's legal system is only just beginning to rebuild itself. Much of the framework necessary for encouraging and protecting private investment is not yet in place, and the existence of three overlapping systems (the Sharia-Islamic Law, the Shura-traditional law and practice, and the formal legal system instituted under the 2004 Constitution) can be confusing to both investors and legal professionals. Major commercial laws currently in effect cover partnerships, corporations, arbitration, mediation, copyrights, and patents. A new telecommunications law (replacing the previous law enacted by decree) has been approved by the Parliament and Presidential signature is pending. A related ICT Law (Information & Communications Technology) is under consideration that will update the legal framework for ICT. Parliament also passed a Labor Law in 2008. Laws modernizing legislation on trademarks, transportation, agency, and competition await the President's signature. Anti-hoarding and contract laws are under consideration. Accounting and standards regimes have yet to be set up.

Although most senior Afghan government officials express strong commitment to a market economy and foreign investment, many businesses maintain that this attitude is not always reflected in practice. Many government officials -- some of whom demand bribes, levy unofficial taxes, and inflict bureaucratic delays -- are out of step with official government policy. Commercial regulatory bodies are often understaffed.

While not sanctioned by law or official policy, small groups of businessmen, many of whom are alleged to have connections with current or former warlords and militias, dominate the trading market in many areas. These individuals, because of their wealth and insider access to land, credit and contacts, and their ability to manipulate prices, enjoy excessive advantages that result in a non-competitive environment in some fields, notably gem-mining, fuel transport, and construction. In addition, some industries, including money changing and carpet production, have well-organized guilds which protect existing firms and prevent newcomers from establishing themselves.

The World Bank’s 2011 Doing Business Report ranks Afghanistan at 167th out of 183 economies for the ease of doing business overall. This ranking reflects the reality that the legal and regulatory frameworks and enforcement mechanisms are in a nascent stage. USAID, through its Economic Growth and Governance Initiative (EGGI), has launched a “Doing Business Indicators (DBI) Project focused on improving the business-enabling environment in Afghanistan. Five working groups to be facilitated by USAID will be created to study and make recommendations for improving Afghanistan’s rating on the following selected World Bank index indicators: 1) Starting a business; 2) Registering property; 3) Protecting investors; 4) Trading across borders; and 5) Closing a business.

Conversion and Transfer Policies

There are no restrictions on converting, remitting, or transferring funds associated with investment, such as dividends, return on capital, interest and principal on private foreign debt, lease payments, and royalties and management fees, into a freely usable currency and at a legal market clearing rate. Afghanistan does not maintain a dual exchange-rate regime, currency controls, capital controls, or any other restrictions on the free flow of funds abroad.

However, in practice, particularly in the provinces, many banks may not have the capacity to deal with foreign exchange. The large, informal foreign-exchange markets in major cities and provinces such as Kabul, Mazar-e Sharif, Jalalabad, Kandahar, and Herat, where U.S. dollars, British pounds, and Euros are readily available, are slowly starting to become formal markets. As of October 2010, Da Afghanistan Bank had issued 209 licenses for money service providers (MSPs) and 271 licenses for money exchange dealers in Kabul. It has licensed 88 MSPs and 396 money exchange dealers in the provinces. Despite these licensed service providers and exchange dealers, there are thousands of unlicensed money changers that continue to practice their trade. Non-official money service providers (i.e. hawaladars, many of whom also often perform currency exchange) often cite the lack of enforcement in the currency exchange area and the resulting competitive disadvantage to licensed exchangers as a reason not to get MSP licenses. U.S. investors should only use licensed hawaladar money service providers, who are listed on the website of Da Afghanistan Bank.

The only requirements placed on the outflow of funds are to prevent money laundering (and the financing of terrorism). The transport of more than AFS 1,000,000 or equivalent in cash across the border of Afghanistan into another country must be reported in advance to Afghan Customs.

Expropriation and Compensation

The Private Investment Law states, "The State can expropriate an investment or assets only for the purposes of public interest and on a non-discriminatory basis." It further states that the "State shall provide prompt, adequate and effective compensation in conformity with the principles of international law, equivalent to the fair market value." The State may confiscate private property in order to settle bad commercial debts. The law allows a majority investor to challenge the expropriation, but this right does not extend to minority shareholders. There have been no reports of State expropriation of foreign assets, "creeping" or otherwise.

Dispute Settlement

While a commercial court system exists, the lack of a law on Commercial Agency is a significant impediment to the arbitration of commercial matters. In addition, there is a shortage of qualified legal practitioners, and corruption in the judicial system is endemic.

The enactment in January 2007 of Arbitration and Mediation laws established the foundation for an alternative dispute settlement system. Afghanistan is a party to the Convention on the Settlement of Investment Disputes Between States and Nationals of Other States and the New York Convention of 1958 on the Recognition and Enforcement of Foreign Arbitral Awards. The Private Investment Law provides for dispute resolution under these mechanisms, under United Nations Commission on International Trade Law (UNCITRAL) rules, or under any mechanism that the investor has specified in a contract with another investor. The international donor community is supporting the development of an Afghanistan Center for Dispute Resolution.

Under these conditions, the legal system plays a limited role in adjudicating commercial disputes and most businesses use informal mechanisms to resolve disputes and enforce property rights. AISA, for example, has some capability to assist investors in the mediation of certain disputes.

Investment disputes are common in the areas of land titling and contracts. The lack of a comprehensive land titling database means that several individuals may hold deeds to the same property. Real estate agents are not reliable. Those foreign investors seeking to work with Afghan citizens to purchase property are advised to conduct extensive and painstaking due diligence. The Embassy maintains a list of legal advisors that businesses may consult.

Performance Requirements and Incentives

Afghanistan has no formal regulations or laws governing performance requirements. There are no separate investment incentives or special treatment accorded to foreign investors. There are no government-imposed conditions on investment, beyond the procedures required for establishing or acquiring a business. The government does not impose offset requirements on its procurements.

The government does not apply discriminatory or excessively onerous visa, residence or work permit requirements for foreigners, but bureaucratic processing of visas can be time-consuming and there have been reports of bribes being solicited for faster processing. There are no discriminatory or preferential export and import policies affecting foreign investors. As noted above, the HIC may choose to apply terms that are different from those generally applied to investments for certain restricted sectors.

Right to Private Ownership and Establishment

Under the Private Investment Law, foreign and domestic private entities have equal standing and may establish and own business enterprises, engage in all forms of remunerative activity and freely acquire and dispose of interests in business enterprises.

Protection of Property Rights

Property rights protection is weak due to a lack of property registries or a comprehensive land titling database, disputed land titles, incapacity of commercial courts, and widespread corruption. The acquisition of a clear land title to purchase real estate or a registered leasehold interest is complicated and cumbersome. The World Bank estimated in its 2011 "Doing Business Report" that it takes an average of 250 days and entails legal fees of five percent of property value to register property. According to Da Afghanistan Bank and ACCI, there is no law in force that deals specifically with bankruptcy, although the subject is discussed in some of the articles of the Banking Law. The Corporation Limited Company Law, Mediation Law and Partnership Law also discuss bankruptcy. The Law on Mortgage and Secured Transactions was approved by Parliament and signed by the President in 2009.

While Afghanistan has laws on Patents and Copyright, there is no enforcement. A Law on Trademarks is awaiting Presidential signature. Afghanistan is not a member of the WTO Trade Related Intellectual Property Rights (TRIPS) Agreement or the World Intellectual Property Organization (WIPO) Internet Treaties. Pirated DVDs and software are sold throughout the country. Counterfeit pharmaceuticals and building materials are common.

Transparency of the Regulatory System

In general, the Afghan government promotes transparent policies and effective laws to foster competition, establish "clear rules of the game" and promote, rather than hinder, foreign investment. The inadequacy of the regulatory system, and corruption among those working-level officials who administer it, are larger obstacles to investors than the transparency of the regulations.

Procedures for obtaining a business license were streamlined in 2003 with the establishment of AISA, which serves as a "one-stop shop" for investors, and which has greatly facilitated the process of establishing a business. Afghanistan now ranks an impressive 25th out of 183 economies in ease of registering a business, according to the World Bank's 2011 "Doing Business Report." There are no informal regulatory processes managed by non-governmental organizations or private sector associations. Parliament must approve all legislation, except that when Parliament is in recess, the President can issue decrees that have the force of law. However, in these cases, Parliament has the right to review and amend the decrees.

Efficient Capital Markets and Portfolio Investment

Finance is Afghanistan's second largest service industry (behind telecommunications) and an important driver of private investment and economic growth. The sector has grown rapidly since the end of Taliban rule. Today, 17 commercial banks operate in Afghanistan, with total assets of $4.1 billion (compared to assets of less than $300 million in 2004). However, despite the boom in banking, most Afghans remain "unbanked," with only 5 percent currently holding deposits. Moreover, many Afghans continue to rely on money service providers (or hawalas) to access finance and transfer money, due to unfamiliarity with a functioning banking system and limited access to banks in rural areas. Banking remains highly centralized, with more than 75% of total loans made in Kabul Province. Bank lending is also undermined by a deficient legal and regulatory infrastructure that impedes the enforcement of property rights and development of collateral. The difficulty of accessing credit through banks and other formal financial institutions makes existing firms dependent on family funds and retained earnings, limits opportunities for entrepreneurialism, and reinforces dependence on the informal credit market.

The recent exposure of massive fraud at the country’s largest bank, Kabul Bank, laid bare the underlying weaknesses in banking regulation and supervision. Despite receiving significant technical assistance, Da Afghanistan Bank has been unable to match the pace of the banking sector’s growth with requisite improvements in monitoring and supervision. These weaknesses have been compounded by a lack of political willingness in the Afghan government more broadly to enforce laws against well-connected wrongdoers in the financial sector.

Credit to the private sector stands at less than ten percent of GDP, significantly lower than other countries in the region. Afghanistan ranks 128th out of 183 countries for ease of obtaining credit in the World Bank's 2011 "Doing Business Report." In response to this situation, investment funds, leasing, micro-financing, and SME-financing companies have begun to enter the market.

Competition from State-Owned Enterprises

In principle, government policies and regulations apply the standard of competitive equality to private enterprises in competition with public enterprises with respect to access to markets, credit and other business operations. However, working-level government officials have in some instances exhibited anti-competitive and protectionist bias in some sectors in which state-owned enterprises (SOEs) are active.

Under Presidential Decree No. 103 (December 2005), the Ministry of Finance has sole responsibility for assessing the economic viability of State-owned enterprises (SOEs). Since passage of the Decree, the Ministry of Finance has determined that eight of 64 enterprises should remain state-owned for the time being, while the other 56 should be divested-either through privatization, liquidation, corporatization or other mechanisms. The Afghan government has identified for divestment more than 1,400 SOE land parcels/buildings, from 44 SOEs evaluated. The Afghan government has approved 29 SOE liquidations, restructuring, and corporatization proposals. As of December 2010, 118 successful public auctions have taken place with assets worth $12,607,075 devolving to the private sector. Foreign and domestic investors enjoy equal treatment under ongoing privatization programs.

Corporate Social Responsibility

The Afghan government is working with large companies and foreign investors to encourage corporate social responsibility (CSR). Large mining contracts include stipulations for environmental protection and community inclusion. Afghanistan law prohibits mining that would result in the destruction of antiquities unless the mining company has prior approval from the Ministry of Information and Culture. Two competing cell-phone providers in the country have well-developed CSR outreach programs that include health, education, job creation, environmental protection, and outreach to refugees. Some Afghan charities are also benefiting from CSR funds from companies outside of the country (for example, a Japanese cosmetic company contributed CSR funds to UNIFEM (the United Nations Development Fund for Women) Afghanistan, and a European trade organization donated a factory to make medicines in Afghanistan.) The newly-formed American Chamber of Commerce in Afghanistan (AmCham Afghanistan) has identified CSR as one of its core areas of focus.

Political Violence

Afghanistan is struggling toward political stability, but anti-government violence has constrained economic activity. The parliamentary elections of September 18, 2010, were marred by violence, voter intimidation, and fraud. The new parliament is expected to convene in late January 2011. The government is taking steps to extend its reach in the provinces, but the risk of violence continues to be high in many areas, and security remains a primary concern for most investors. Foreign firms operating in country report spending a significant percentage of their revenues on security infrastructure and operating expenses. The U.S. Department of State continues to warn Americans against travel to Afghanistan. U.S. citizens should review the Consular Information Sheet and Travel Warning for Afghanistan for the most up-to-date information on the security situation and possible threats.

Corruption

Corruption is pervasive in Afghanistan. In 2010, the country ranked 176th out of 178 countries in Transparency International's Corruption Perception Index. Based on the Penal Code, corruption is a serious criminal act; articles 260 to 267 state that anyone accepting or giving a bribe can be charged with criminal acts. While these anti-corruption laws exist, enforcement has been very limited. Afghan President Hamid Karzai created the High Office of Oversight for the Implementation of Anti-Corruption Strategy ("HOO") to coordinate anti-corruption measures for the government; this office does not control penalties, however.

Afghanistan acceded to the United Nations Convention against Corruption in August 2008 but is not a party to the OECD Convention on Combating Bribery of Foreign Public Officials.

U.S. firms identify corruption as one of the biggest obstacles to foreign direct investment and routinely report being asked for a bribe, called "sherini" or "baksheesh." Although official working-level government salaries have recently risen, many officials take small bribes for government services. U.S. companies are expected to comply with the Foreign Corrupt Practices Act, which prohibits the bribery of foreign officials.

Bilateral Investment Agreements

Afghanistan has Bilateral Investment Treaties (BITs) with Turkey and Germany. Afghanistan acceded to the South Asia Free Trade Area (SAFTA) in August 2008, but needs to bring its terms into force through ratification by Parliament or Presidential decree. Most products originating in Afghanistan can be imported into the U.S. duty-free under the Generalized System of Preferences (GSP) Program, and EU tariffs on Afghan products are also very low. Afghanistan is a member of the South Asian Association for Regional Cooperation (SAARC) and Central Asian Regional Economic Cooperation (CAREC).

The Afghanistan Pakistan Transit Trade Agreement (APTTA) was signed in Kabul by the two countries’ respective Ministers of Commerce in October 2010. Once fully ratified, APTTA should cut down on transportation costs and promote trade within the region.

Afghanistan signed a Trade and Investment Framework Agreement (TIFA) with the United States in 2004, but a BIT has not been negotiated. There is no Bilateral Taxation Treaty with the United States.

Overseas Private Investment Corporation and Other Insurance Programs

The Overseas Private Investment Corporation (OPIC) has an active and expanding portfolio of political risk insurance and provides both direct and indirect financial support to private business investments in country. OPIC makes direct loans of up to 60% of long-term investments that are at least 25% owned by a U.S. investor. OPIC provides political risk insurance coverage for the U.S. equity component, as well as reinsurance support for insurance that is written in-country.

Afghanistan is a member of the Multilateral Investment Guarantee Agency (MIGA).

Labor

There is a critical shortage of skilled labor in Afghanistan. Only 28 percent of the population over the age of 15 can read and write. Decades of war, a low level of education and lack of training facilities have resulted in a serious scarcity of skilled technicians, qualified managers and educated professionals.

U.S. companies that establish training programs for their employees should expect significant returns in enhanced productivity, but there is a risk of high turnover as skilled employees chase higher paying opportunities.

Labor-management relations are undeveloped. While there are major and smaller trade union organizations in the country, there is little knowledge or practice of collective bargaining.

The new Labor Law, which was intended to be in accordance with International Labor Organization (ILO) standards, went into effect in 2009. The law bans forced labor and child labor. It sets terms for working hours, overtime and leave, and calls for employers to provide a wide array of benefits, but there is little awareness of its provisions in either the government or the private sector. There are no implementing regulations, and the Ministry of Labor, Social Affairs, Martyrs and Disabled lacks the capacity to enforce the law. Private sector employers report they have not been affected by the law.

A regulation pertaining to foreign workers was published in 2005. While allowing for the employment of foreign workers, it requires that priority be given to Afghan workers when they are equally qualified.

Foreign-Trade Zones/Free Ports

Afghanistan has no duty-free import zones or ports. However, Afghanistan is considering the establishment of Trade Facilitation Zones and/or Export Processing Zones to enhance export potential. Legislation currently under consideration in the U.S. Congress would establish special import-tax status for certain categories of goods made in Reconstruction Opportunity Zones (ROZs).

Foreign Direct Investment Statistics

Comprehensive foreign direct investment (FDI) statistics for Afghanistan are unavailable. Available figures are not reliable because of inconsistencies in data collection. The United Nations Conference on Trade and Development (UNCTAD) 2010 World Investment Report estimates FDI flow into Afghanistan in 2009 at USD 185 million and total FDI stocks at USD 1.55 billion, representing 10.3% of GDP. According to a 2008 report by AISA, the top FDI destination sectors were, in descending order, services, construction, agriculture, and miscellaneous "industry." The four largest investors were Turkey, the United Arab Emirates, Canada, and the United States. AISA's data track approved, rather than actual, investment.



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