The Central Bank of Afghanistan, Da Afghanistan Bank, is the highest public institution in the country in whose hands the powers for management of Afghanistan's economy are vested. As any other Central Bank, Da Afghanistan Bank is responsible for a wide array of crucial issues related to the economy of Afghanistan and the standard of living of its people. Setting the course and contours of a country's monetary policies is the exclusive realm of a country's Central Bank.
In the case of Da Afghanistan Bank too, decisions such as how much money should be printed and allowed in circulation are made by the Bank and its board of directors a as well as the executive board. The Bank also has the responsibility of managing the liquidity, or, in other words, the total amount of banknotes and coins that is in circulation in Afghanistan.
When the amount of physical money, which consists of banknotes and coins, exceeds the amount needed by the economy as a whole, Da Afghanistan Bank absorbs the excess money in the system in a variety of ways to prevent rise in prices and discomfort to common people.
Absorbing of excess money in the system by Da Afghanistan Bank, takes place in a number of ways. In one method, Da Afghanistan Bank, on a regular basis, requires all the commercial banks in Afghanistan to deposit a certain percentage of their physical money with Da Afghanistan Bank so that this money does not enter the economy. For example, until last year, Da Afghanistan Bank required all the banks to deposit 8% of their physical money with the Central Bank. This rate is decided upon by the Central Bank according to the economic, fiscal and monetary requirements of the time.
In another method to absorb excess of money and keep the prices of commodities, goods and services stable, Da Afghanistan Bank offers interest to banks in return for them keeping their money with the Central Bank.
Another policy of choice by Da Afghanistan Bank is bi-weekly auctioning of foreign currency including U.S. dollars to commercial banks. Every two weeks, the Central Bank places tens of millions of dollars on sale in Kabul.
Interested banks submit their bids and the winner of the tender process gets to buy the foreign currency. This policy instrument of Da Afghanistan Bank is perhaps its most important. If the Central Bank does not auction U.S. dollars on a regular basis, the exchange rate of Afghani against other currencies would go up to dangerous levels. For example, if Da Afghanistan Bank stops its bi-weekly auctioning of U.S. dollars, then, in a matter of weeks, one dollar would come to equal hundreds of Afghanis. This would be an economic disaster, sending the people to the bottom of poverty and hunger.
Da Afghanistan Bank also supervises the growth and consolidation of Afghanistan's financial and banking system. In the plan and policy announcements by the Bank, this has come to be upheld as one of the most important areas of focus by the Central Bank in coming years.
The Kabul Bank debacle has been in part a failure of the Central Bank to provide the needed oversight and regulation. With the economy of Afghanistan slowly expanding, it is expected that the banking sector of Afghanistan be further expanded, strengthened, and the required oversight provided. In absence of effective regulation, a repeat of Kabul Bank would be likely. That, in turn, would further erode the confidence of Afghanistan's international partners in helping Afghanistan develop its economy and financial system.
One of the most important areas of responsibility of Da Afghanistan Bank is management of inflation in the economy and maintenance of price stability. Price levels of commodities, goods and services in the economy need to be moderated since they directly affect the livelihoods of people and can have adverse impacts on the economy as a whole.
High inflation rates, meaning rapid rise in prices of consumer and industrial goods, commodities and services can restrain the pace at which the economy as a whole grows. Since economic growth is high on the national agenda of Afghanistan, adoption of sound monetary policies by the country's Central Bank is of paramount importance.
A steep rise in inflation rate would consequently mean that many of the gains made over the past one decade in poverty reduction would be lost as a result of the unbearably high prices. Hundreds of thousands of families across Afghanistan, who have been able to enjoy a relatively better standard of living in recent years, are, therefore, would be at the risk of losing a significant part of their real income in the event of the inflation rates spiraling out of control.
One example is the year 2008, when a combination of skyrocketing pieces in international food markets coupled with supply chain bottlenecks led to very high inflation rate of 28% and above at conservative estimates. Some sources put the inflation rate at near 40% and above.
These external shocks, however, are outside the power of the Central Bank to influence and prevent their negative impacts. Rising international prices of oil, subdued for now as a result of world-wide economic slowdown, is a real threat to Afghanistan's economy. The policy toolbox of Da Afghanistan Bank should be employed to mitigate the impact of these external shocks on Afghanistan's economy.
Another factor that perhaps constitutes the gravest threat to the economy of Afghanistan in the medium to long term and requires action by Da Afghanistan Bank is Afghanistan's widening trade deficit i.e. the difference between the imports and exports.
Generally and as a rule, high imports and less export puts under pressure the country's exchange rate. In other words, importing excessively without a corresponding volume of exports can lead to decrease in the country's exchange rate value.
According to Da Afghanistan Bank, at the end of 2010, the country's imports of merchandise and other goods and services stood at $1031.9 million while the country's exports was a mere $127.29 million.
In normal circumstances, such a foreign trade and balance of payments situation should have made the Afghani's exchange rate go down to historic lows. Surprisingly we see that Afghani's exchange rate is still robust trading at 1/48 against the US dollar. This is, in part, due to the policy interventions by Da Afghanistan Bank and the incoming aid funds denominated in U.S. dollar.
Maintaining economic stability including price stability, creation of a stable investment climate for domestic and foreign investors, development of the country's private sector and inclusive economic growth are the goals that every developing country strives to achieve. For Afghanistan and Da Afghanistan Bank, these sets of overarching goals constitute their strategic framework for action.