U.S.-AFGHANISTAN STRATEGIC PARTNERSHIP

UNCLAS SECTION 01 OF 08 KABUL 000775

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR SCA/FO DAS GASTRIGHT, SCA/RA, SCA/PB AND SCA/A
CENTCOM FOR CG CFC-A
NSC FOR AHARRIMAN
AID FOR ANE/AA MWARD AND SKEYVANSHAD
TREASURY PASS TO LMCDONALD, ABAUKOL, AND JCIORCIARI
OSD FOR BRZEZINSKI

E.O. 12958 N/A
TAGS: ECON ETRD EFIN EINV PREL AF
SUBJECT: U.S.-AFGHANISTAN STRATEGIC PARTNERSHIP
PROSPERITY WORKING GROUP, FEBRUARY 21, 2007

Ref: Kabul 692

SUMMARY


1. (SBU) In the second meeting of the Afghan-U.S.
Strategic Partnership Prosperity Working Group, Afghan
and USG dels reaffirmed their commitment to a long-term
economic partnership and advanced preparations for the
March 13-14 Strategic Partnership plenary in Kabul to be
co-led by Under Secretaries Burns and Edelman. Both
delegations noted that the meeting provided an excellent
forum for reviewing joint efforts towards achieving
Afghanistan Compact goals. The Afghans made a strong
pitch for donor assistance in urgently enhancing Kabul?s
electricity before the 2009 general elections. USDEL
stressed its strong commitment to supporting GOA efforts
in the energy sector and indicated its willingness to
look at funding additional power generation capacity for
Kabul, based on GOA acceptance of key conditionalities
(action cable on Kabul electricity follow up has been
transmitted reftel). USdel identified an imperative to
provide budget support for road maintenance. Both sides
agreed that airport planning, operations, and management
need urgent attention.


2. (SBU) The Afghans highlighted their concern about the
surging recurrent cost obligations from donor spending
and ANA/ANP expansion and pay increases. Revenue is not
growing as quickly. USdel stressed the need for fiscal
discipline and revenue enhancement through improving tax
administration and enacting new taxes. The Border
Management Initiative could have a large positive impact
on customs collections, but the GOA needs to push forward
on creation of a Border Management Commission and ensure
participation of all ministries with a stake in the
issue. USdel agreed to share with the GOA an analysis of
customs revenue losses. On development budget execution,
the Finance Ministry advised it is moving forward with
program budgeting and provincial budgeting initiatives to
create greater flexibility and more effective development
project implementation at the province and district
levels. USdel noted its willingness to put more
resources through the GOA development budget in line with
GOA capacity to absorb and manage such funds. US
delegation head Ward proposed that our teams discuss two
possible pilot projects involving capacity building and
concomitant channeling of direct support to the Afghan
core budget.


3. (SBU) USdel praised GOA for enacting four commercial
laws in January and encouraged the Afghans to move nine
other laws to enactment by the end of the year. USdel
acknowledged capacity constraints at the Justice Ministry
and pledged assistance to alleviate this bottleneck in
the legislative process. USdel announced USAID?s
sponsorship of the first Agricultural Trade Fair,
scheduled for April. After a discussion of regulatory
bottlenecks for exports, the GOA undertook to announce at
the trade fair a specific plan to reduce red tape
hampering Afghan exports. In the discussion of
Reconstruction Opportunity Zones, the Afghans promised to
provide a paper on suitable products and locations and a
broader concept paper. On Afghan-Pakistan transit trade,
the GoA advised that it offered to host the Joint
Economic Commission in Kabul on March 14-15, but Pakistan
had not yet responded. The Afghans also indicated that
Pakistan had offered to host the next Regional Economic
Cooperation Conference (RECC). The illicit finance
discussion highlighted the importance of increasing the
registration of hawaladars and beginning enforcement of
U.N. terrorist lists. The GOA committed to brief

KABUL 00000775 002 OF 008


Strategic Partnership principals on a draft plan to shut
down unregistered hawaladars. The two delegations
recognized that access to credit is crucial for economic
growth, but that the high risk environment, including a
recent wave of bank robberies, is constraining the growth
of the financial sector. USAID discussed how its new
ARIES project would be addressing some of these
constraints while providing significant levels of credit.
The GOA agreed to take strong steps to improve the
security of financial institutions and their assets.
Concluding the session, both sides agreed to name focal
points and hold regular quarterly meetings at the working
level in Kabul.
END SUMMARY.

PROGRESS SINCE MARCH 2006 STRATEGIC PARTNERSHIP TALKS:


4. (SBU) U.S. and Afghan inter-agency delegations held
their second Strategic Partnership Prosperity Working
Group session in Kabul on February 21, 2007. USDEL was
led by USAID Acting Assistant Administrator for Asia and
the Near East Mark Ward. He was joined from Washington
by State Department South Central Asia Bureau DAS John
Gastright, NSC Senior Director Tony Harriman, Treasury
South Asia Director Andrew Baukol, USTR Director Robert
Gerber, and EB Economic Officer Marybeth Goodman, and
supported by embassy staff. The Afghan side was led by
Deputy Finance Minister Wahedullah Shahrani. Their
delegation also included Central Bank Governor Norullah
Delawarie and the head of the bank?s Financial
Information Unit; Afghan National Development Strategy
Director Adib Farhady; and Deputy Minister-level
representatives from the Ministries of Commerce and
Industry (MoCI),Water and Energy (MoEW),Agriculture
(MoA),Ministry of Rural Reconstruction and Development
(MRRD),Ministry of Urban Development (MoUD),Ministry of
Mines (MoM),and the Ministry of Women?s Affairs.


5. (SBU) Also on the Afghan side was Afghan International
Chamber of Commerce CEO Hamidullah Farooqi, representing
the private sector; a representative of the Civil Service
Commission; and the chief of the Ministry of Interior?s
Criminal Investigation Unit. During introductory remarks,
both sides reaffirmed their commitment to a long-term
partnership between Afghanistan and the United States.
They stated that, while significant progress has been
made (growth of national income, infrastructure
improvements, private sector development, etc),much
remains to be done in key areas (investment climate,
budget, revenue generation, etc). DM Shahrani expressed
appreciation to the United States as Afghanistan?s most
significant international partner. Both delegations
noted that the Prosperity Working Group provided a useful
forum for reviewing joint efforts to achieve Afghanistan
Compact benchmarks.

LEGAL AND REGULATORY FRAMEWORK


6. (SBU) ECON Counselor stated that a functioning
commercial legal and regulatory framework was critical to
investment and job creation and, while commending the
recent passage of four commercial laws (arbitration,
mediation, corporations, and partnerships),urged
continued priority action in this area. DM Shahrani
pledged to meet the Afghanistan Compact benchmark by
presenting to Parliament by the end of 2007 six
additional commercial laws (agencies, contracts,
copyrights, patents, standards, and trademarks) and three
financial laws (negotiable instruments, secured
transactions, and mortgages). These are among a group of
20 priority laws that the government has notified to the

KABUL 00000775 003 OF 008


JCMB. Accepting the GOA?s assertion of capacity
constraints at the Taqneen (the Justice Ministry?s
legislative review department),USDel head Mark Ward
offered to increase the existing support to build
capacity at the Taqneen to facilitate the movement of
priority laws. USDEL noted that to meet its Afghanistan
Compact benchmark, the GOA also needs to begin working on
the drafting and adoption of regulations and procedures
to implement these new laws. DM Shahrani advised that
draft regulations must be approved by the cabinet, but
procedures may be approved by the responsible ministry.
Mark Ward advised that a USAID-funded study on the
commercial legal framework should be ready within a
month.

RURAL DEVELOPMENT/EMPLOYMENT/AGRICULTURE


7. (SBU) The Deputy Minister of Reconstruction and Rural
Development (MRRD) briefed that the National Solidarity
Program (NSP),the flagship of the five ongoing programs
under MRRD, has extended the presence of the GOA to
approximately 65% of rural communities. The second phase
of this program has begun and MRRD hopes to increase
coverage to 100% within three years at cost of $525M.
Both sides encouraged the ministries to work through the
Community Development Councils, and to engage the private
sector at the community level. AIDOFF enumerated USAID
assistance to agriculture, stressing its focus on
supporting the growth of commercial agriculture and
agribusiness. He announced the first Agriculture Trade
Fair, to be held in Kabul on April 21-23. He stressed
that new USAID programs would be able to support the
emerging GOA integrated approach to rural development.
The Deputy Minister of Urban Development urged parallel
attention to the urban poor and offered to provide
documents; Mark Ward requested that the Deputy Minister
provide a paper identifying his proposals.

EXPORT DEVELOPMENT


8. (SBU) AIDOFF stated that while Afghanistan used to be
a significant exporter of numerous products, its economy
is now almost completely dependent on imports. In
sectors where it still exports, almost all value-adding
takes outside the country. AIDOFF indicated that we
believe that, while volume and quality of goods produced
in Afghanistan are an issue, the larger problem is
regulatory and procedural impediments that increase the
risk and cost of exporting. It takes 66 days and
approval of seven documents to export a product from
Afghanistan. The World Bank recently ranked Afghanistan
as 152nd of 175 countries for ease of cross-border trade.
DM Shahrani responded that the GoA needs to simplify its
procedures and address corruption. DM Reza (Ministry of
Commerce and Industry - MoCI) added that there needs to
be a clear division of responsibilities between MOCI and
Ministry of Finance. The parties agreed to use USAID
programs on commercial legal framework and economic
governance to support GOA objectives. In addition, DM
Shahrani stated that the GOA would present a detailed and
specific plan to reduce regulatory impediments and costs
for export at the Agriculture Trade Fair on April 21-23.
The USG requested a draft at the Principals? meeting in
one month.

RECONSTRUCTION OPPORTUNITY ZONES


9. (SBU) ECONOFF advised that President Bush proposed the
ROZ concept in 2006 as an attempt to promote private
sector development and job creation through duty-free
imports to the US. With USG support, an Afghan

KABUL 00000775 004 OF 008


delegation recently visited Jordan to observe its
successful Qualified Industrial Zone program. The USG
will prepare necessary legislation and consult with
Congress. Simultaneously, the MOCI will prepare (1) a
short paper on suitable products and locations
(subsequently provided on 2/23/07),and (2) an ROZ
concept paper. Both sides emphasized the need for
development of supporting initiatives (trade
facilitation, labor rights, infrastructure, matchmaking
services, etc.) to make this program work. DM Shahrani
stated that he had received assurance in Washington in
March 2006 that this program could cover all of
Afghanistan?s borders, including borders with northern
neighbors.

REGIONAL TRADE INTEGRATION


10. (SBU) DM Reza (MOCI) advised that it is prepared to
table a revised text for a bilateral transit trade
agreement with Pakistan at next Afghanistan-Pakistan
Joint Economic Committee meeting. He stated that the GOA
has proposed that the JEC meet in Kabul on March 14-15;
however, Pakistan has not yet accepted the dates. USTR
Director indicated that USG will raise transit trade with
the GOP and encourage flexibility in the negotiations.
He also praised Afghanistan?s leadership on regional
trade policies in the context of the Regional Economic
Cooperation Conference at New Delhi in November. DM Reza
noted that Pakistan has agreed to host the next Regional
Economic Cooperation Conference.

BUSINESS BUILDING BRIDGES


11. (SBU) When dates and delegation composition are
finalized, the Embassy will contact the GOA to begin
arrangements for the visit.

STRONGER CONTROLS AGAINST ILLICIT FINANCE


12. (SBU) The Central Bank?s Financial Intelligence Unit
(FIU) Director said that since 2006, the FIU has been
receiving monthly reports and suspicious transaction
reports from the 14 commercial banks. The Central Bank
has begun registering hawaladars and requiring travelers
at Kabul International Airport to provide a declaration
of cash being carried. Currently, only 30 of
approximately 280 hawaladars in Kabul are registered. A
January raid of an unlicensed hawaladar induced a brief
upsurge in registration. The Central Bank will increase
registration of hawaladars, spread implementation of
border cash controls, and report on progress to next
Strategic Partnership Prosperity Working Group meeting.
USDel Lead Mark Ward requested that the GOA provide a
draft plan to shut down illegal hawaladars at the
upcoming plenary session. Deputy ECON Counselor stressed
the importance of working with banks to identify and
freeze accounts of entities on the UNSCR 1267 terrorist
list. Embassy Treasury Attache advised that it will
continue to sustain technical assistance to the FIU and
Bank Supervision Department.

INCREASING ACCESS TO CREDIT


13. (SBU) AIDOFF stated that access to credit on a
commercial basis is a major impediment to investment and
job creation in Afghanistan. Banks that are willing to
make loans are charging prohibitive interest rates (20%),
while the banks that maintain lower rates lend only on a
very narrow relational basis. Various credit and
microfinance programs have provided some assistance but
cannot substitute for a functional banking sector.

KABUL 00000775 005 OF 008


AIDOFF made clear that perceptions of high risk are the
foundation for high interest rates. To address
institutional sources of risk, AIDOFF identified four
priority reforms of (1) legal and regulatory framework
for recovery of assets, (2) credit information system,
(3) international reporting, accounting, and auditing
standards, and (4) better training for banks that would
have a positive impact on the market. Deputy ECON
Counselor noted that risk from crime is a growing
concern; there have been six major bank robberies (cash
in transit) in Kabul in six months. Further thefts could
lead insurers to cancel policies and force banks to
depart the country (one insurer has declined to renew one
bank?s policy). To address the risk associated with
theft, the GOA agreed to take strong steps to insure the
security of financial institutions and their assets.

ROADS AND AIRPORTS


14. (SBU) Some 1600 km of the 2500 km ring road has been
completed. Donors and the GoA have spent some $1.5
billion on this road and border connector roads, and are
adding another 1,000 km of roads each year, including
secondary and tertiary roads. To protect this
investment, Deputy Minister of Public Works Rasooli
stressed that the GoA will have to spend $30 million per
year on maintenance. By 2017, the ministry estimates
that road maintenance costs will rise to $50-80 million.
USAID's Mark Ward said that USAID?s original road
construction plan included funding for maintenance for
several years, but that this money had been diverted to
build roads in response to urgent needs, including the
insurgency. Ward suggested linking the labor-intensive
road maintenance with counter-narcotics resources,
because road repairs would employ young men and provide
income in rural areas. Ward discouraged the GoA from
expecting US help in building the 800 km east-west road
directly from Herat to Kabul via Ghor and Bamyan
provinces, estimated to cost some $500 million. Rasooli
said the GoA is seeking donors for this new road to
handle some of the high volume of truck traffic on the
Kabul-Kandahar-Herat segments of the ring road. Truck
traffic between Kabul and Kandahar is said to be
averaging 12,000 trucks per day. The road was designed
to handle only 7,000 per day.


15. (SBU) On civil aviation, Deputy Minister of
Transportation Alami briefed that Japan will spend $27
million and the GOA $8 million to construct a new
international terminal for Kabul International Airport.
The project will be completed in 2-3 years. In addition,
the ADB has provided $35 million for rehabilitation of 7
regional airports. The FAA advisor to the GOA added that
there was a pressing need for capacity building in the
Ministry. He referred to budget coordination problems
but said that the dialogue between the Ministries of
Transportation and Finance had improved in recent months.
One of the challenges he highlighted was the transition
over time of the management of airports and airspace from
ISAF to the civilian authorities.

POWER SUPPLY


16. (SBU) The Afghan delegation made a strong pitch for
donor assistance in enhancing the supply of power to
Kabul. Deputy Minister of Energy and Water Mir Sediq
noted that the Energy Sector Master Plan for Kabul
envisions a demand of 950 MW. Currently, he said
Afghanistan has an immediate need for over 300 MW to
provide lighting alone to those already on the grid.
Sediq pleaded for donor assistance in standing up 200 MW

KABUL 00000775 006 OF 008


of new power immediately. In this connection, he drew
attention to the high diesel requirements ? 310,000
liters per day -- of the old generators at the North West
Kabul Power plant. Shahrani said that $34 million had
been included in the budget for this diesel fuel, with
the remainder to come from the national power company?s
tariff collections, but noted that fuel costs will remain
a challenge for the budget. ANDS official Farhadi
underscored the political imperative of increasing the
power supply in Kabul in the near term, particularly in
light of the election timetable for 2009.


17. (SBU) Sediq pointed to some missing pieces in NEPS,
including funding for a dispatch center and for some
substations. He highlighted the urgency of upgrading the
distribution network in Kabul. He also mentioned the
proposed Sheberghan gas fire power plant as an important
project on the horizon and he urged greater attention to
renewable energy by the GOA and the donor community.
Shahrani provided a brief read-out of the
commercialization of the public utility Da Afghanistan
Breshna Moassessa (DABM),emphasizing the need to set
strong benchmarks, reduce leakages and put in place a
modern management system and a trained work force. Sediq
reminded Shahrani that progress on DABM commercialization
was being delayed by the failure of the Finance Ministry
to approve some rules and procedures for privatization of
state-owned enterprises. DM Shahrani promised to sort
things out.


18. (SBU) USAID Mission Director Waskin reiterated the
strong USG commitment to supporting GOA efforts in the
energy sector. He congratulated the GOA on the formation
of the Inter-Ministerial Commission on Energy (ICE) as a
coordinating agency and on its decision to raise power
tariffs, which underscores the importance of cost
recovery. Acknowledging the urgent need that the GOA has
identified for additional power in Kabul, Waskin signaled
USG willingness to assist with funding and technical
assistance if the GOA would step up to the table with
certain commitments:
-- identify GOA funds quickly to contribute to the
capital costs for additional generator sets for Kabul;
-- budget for fuel costs and operations and maintenance
for the additional generation equipment;
-- accelerate DABM commercialization, including
outsourcing of metering, billing and collection in Kabul;
-- appoint a NEPS coordinator; and
-- work with USG support to establish a legal and
regulatory framework to attract Independent Power
Producers.


19. (SBU) Sharani asked for U.S. assistance in exploring
technical and financing options for enhancing Kabul
power. USAID Director Waskin reported that USAID had
already tasked its contractor Black and Veatch to look at
technical options for increased generating capacity for
the city.

BUDGET EXECUTION, FLEXIBILITY, AND SUSTAINABILITY


20. (SBU) DM Shahrani outlined the fiscal pressures GOA
is experiencing due to increasing security (e.g., ANA and
ANP) and some non-security (e.g., teachers) expenditures.
The IMF agreement allows for increased security
expenditures (beyond the 1386 operational budget envelope
agreed with the IMF) only if they are donor funded or
revenues are increased proportionately. He noted the
significant expenditures paid through the external budget
that GOA will eventually have to pick up (e.g., U.S.
funding of the National Directorate of Security is

KABUL 00000775 007 OF 008


scheduled to end in September 2008). Fuel for Kabul
power is another area of budgetary pressure. Only $34
million is included in the 1386 budget, but the IMF
agreed that if MOD fails to meet its ANA recruitment
targets, unspent funds from the ANA salary budget could
be used to pay for fuel for electricity generation.


21. (SBU) MOF Director General for Budget Mastoor
described their work earlier in the 1386 budget process
with line ministries, provincial level governments, and
international donors (through the ANDS working and
consultative groups) to prepare a more professional and
rationalized budget for 1386. The budget also
establishes a better link with the ANDS process; the MOF
budget department has been reorganized along ANDS
sectoral lines. Two useful pilot projects were created
to develop and improve provincial and programmatic
budgeting. In 1386, the provincial budgeting program
will be extended from three provinces to ten. Dr.
Mastoor referenced the new budget mechanism to provide
flexibility in implementation of the development budget.
The goal is to make the process among ministries more
competitive and reduce the type of project ?wish lists?
that have been produced by ministries in the past.


22. (SBU) In the discussion on improved development
budget execution and expenditure management, USAID
Program Officer highlighted USAID?s Afghan?s Building
Capacity program and the plans to target specific
ministries for capacity building. Consistent with
USAID?s aid effectiveness policy statement from the
London Conference, AID noted it will put more resources
through the GOA budget and national programs in line with
GOA capacity to absorb and manage such funds. By the
time of plenary, USDel Head Mark Ward agreed the US and
GOA should identify ministries as part of a pilot that in
addition to capacity building would involve the direct
disbursement of USAID funds into the GoA core development
budget for agreed purposes.


23. (SBU) US Treasury Official Andrew Baukol led the
exchange on fiscal discipline and managing recurrent
costs, and increasing budget flexibility to meet
unexpected future needs. He commended GOA for making the
budget process more professional. He noted the medium-
term sustainability challenge which the U.S. is trying to
help GOA meet by providing earlier notice about US funded
programs that GOA will have to cover. He emphasized the
importance of civil service reform and the good balancing
act GOA has done under the IMF program constraints.
Deputy Minister Shahrani said he is determined not to
seek a waiver to the Compact benchmark on GOA funding 58%
of recurrent costs with revenues by 2010-11.


24. (SBU) The session on revenue generation focused on
the Border Management Initiative (BMI),and improving the
tax regime to meet Afghan Compact revenue targets. The
Embassy?s Afghanistan Reconstruction Group (Ed Smith)
emphasized the cross-cutting nature of BMI and the need
for the Ministries of Interior and Commerce to be more
active participants. The U.S. will work with the MOF to
accelerate the BMI work and push for a GOA inter-
ministerial Border Management Commission. The MOF
Director General for Customs Ahmad agreed that BMI could
help customs expand revenue collection, but described the
substantial challenges. There are at least 74 illegal
border points, while BMI intends to support 14 official
border crossings. When the customs collection capacity
has increased (e.g., Herat),traders and importers go to
less developed crossings (e.g., Farah).


KABUL 00000775 008 OF 008



25. (SBU) Deputy Minister Shahrani said the revenue goal
for 1386 is $715 million, which is also in the IMF
agreement, but this is not an increase that is
proportionate with increasing expenditures. The Director
General for Customs suggested that revenue goals should
be given to line ministries, not only MOF. Shahrani
asked the US to help calculate how much potential customs
revenue GOA loses each year, which would assist them in
reducing leakages. We agreed to help in this area.
Director General for Revenue Jalali outlined his efforts
on non-customs revenues, adding that they have drafted a
tax policy paper on which they would welcome comments.
MOF has created a large taxpayers office and is expanding
this into the provinces. There are currently four major
taxes (business receipts tax, wage withholding tax, sales
withholding tax, and corporate income tax). Baukol
discussed the 3 main ways for GOA to boost revenues:
customs, tax administration, and tax policy. The latter
may be the best option given the GOA?s limited capacity.
The elimination of nuisance taxes is a good step, and the
creation of a generalized consumption tax will be
important for the medium term. Jalali replied that they
plan to present to Parliament a broad-based consumption
tax by the end of 1387. Shahrani said he supports an
aggressive approach to tax reforms, but not necessarily
new taxes.


26. (SBU) During concluding remarks, both sides agreed
to a robust follow-up mechanism, including naming focal
points and holding regular quarterly working group
meetings at the in Kabul.


27. (SBU) COMMENT: The Economic Working Group was
notable for its constructive and open discussion of
concrete issues and projects, as well as the impressive
preparation on the Afghan side led by the Finance
Ministry. Key issues requiring further attention during
the March 13-14 Strategic Partnership plenary include USG
responsiveness on Kabul electricity needs; efforts to
strengthen Afghan customs and revenue generation
including by bolstering the Border Management Initiative;
and further impetus to building capacity in the Afghan
government in project development, budgeting, and
legislative work.

NEUMANN