Working Group Proposal: ARTF Recurrent Cost Program

1. Working Group Proposal: ARTF Recurrent Cost Program ARTF Donor Meeting 17 December, 2008

2. What has been the process? • Options note discussed Sep 16, ’08 • Recommendation to develop a technical proposal for December ARTF Q’ly meeting • ARTF WG = MoF, Germany, US, Italy, EC, UK, WB, IMF (6 meetings to date) • Understand positions/views • Discussion technical options • Seek resolution

3. The RC Window – background • Established in 2002 to pool funds towards the operating budget • Achievements to date: • Combines financing from 30 donors • Channeled US$1.6 billion for salaries/O&M • Established strong fiduciary controls • Has helped strengthen government’s public financial management • Secured transparency & efficiency on operating budget

4. ARTF in macro-fiscal context • Revenues have increased by 6 times between SY1382 and SY1386 • Nevertheless, fiscal sustainability has not been achieved (revenue/GDP ratio still low) • …and new pressures are emerging on operating expenditures • External budget impact on O&M • ANA & ANP expansion • Pay & grade • With the government facing these difficult challenges, ARTF remains an important source of predictable financing for GoA

5. Why change the approach? • 2002 ARTF Board Document • Principle of phase-out • ARTF Evaluation in Aug 2008 • Programmatic approach, including the merging over time of recurrent & investment cost windows • Strengthened policy dialogue and donor engagement • ARTF Donors • Pressure to shift weight towards investments • Opportunity for a strategic approach with a long term vision - 2020

6. Objectives of ARTF RC Program • Maintains ARTF RC as the main provider of operating budget support for the Government of Afghanistan • Maintains ARTF role as fiduciary agent on operating budget • Strengthens predictability & aid effectiveness • Supports Government reform program • Strengthens ARTF as a platform for policy dialogue • Clearer strategic objectives for ARTF RC

7. Key components of the proposal • Baseline Phase-Out: RC window set to decline at US$25m/year (11 year exit path) • Policy Incentive Scheme: annual contribution linked to achievement of reform commitments • Structural benchmarks • Revenue matching grant scheme • Existing decision-making maintained • MC as executive; Donor Committee as ‘shareholders’ • New program introduced for SY1388 budget • Establish the operational principle early • Review of policy incentive mechanism in SY1389

8. Indicative ARTF RC Profile (ANDS period) SY1387 is preliminary actual. SY1388 is indicative.

9. How does it work? • Schedule (T+1 mechanism) • For predictability of annual budget formulation process: Performance in year T is reflected in incentive for next year (T+1) • Agreement on structural benchmarks • Donor/Government WG meets in November. • Facilitated/advised by Administrator. • Benchmarks approved by ARTF Donor Meeting. • Review of structural benchmarks • Administrator reviews in November. • Informs the Donors. • Advises the MC on T+1 RC allocation “ceiling” (i.e. approved in following March). • Revenue matching grant scheme • review in June of every year (based on previous financial year’s actual revenue performance) and RC ceiling adjusted accordingly

10. Solar Year Baseline ARTF Amount December: Confirm baseline. December: Confirm baseline. Policy-based incentive November:Review past yearperformance. Set benchmarks for next SY. Revenue-based incentive June:Confirm revenue data from previous SY. Management Committee Decisions Approve RC “ceiling”. Raise RC “ceiling”based on revenue review Approve RC “ceiling”. Government actions Approve Budget Approve Budget MTR of Budget Approve Budget Timing

11. Policy Benchmarks: Principles & Themes • Principles: • Support & strengthen MoF’s role as arbiter of budget • Avoid “over-benchmarking” • Avoid overly ambitious policies • Relevant policy areas • Must support an ARTF RC exit strategy (i.e fiscal sustainability & sound country systems) • Multi-year reform efforts • Increasingly cross-government scope

12. Targeted Policy Outcomes

13. Indicative Benchmarks

14. What does this mean for SY1388? • Overall program design approved by the ARTF Donors December 17, 2008 • ARTF Donors to delegate authority to Administrator to agree on benchmarks for SY1388 & finalise revenue scheme • MoF budgets for US$250m ARTF RC in SY1388 • SY1388 development budget to include a contingency line of US$40m • Review by Administrator before end Hoot SY1387 (March 2009) • If benchmarks have been achieved, ARTF Management Committee approves additional $40m for ARTF RC,

15. Key decisions for today • MC declines the baseline of ARTF RC support by US$25 million a year • Institute the annual Policy Incentive Scheme as described • Delegate a small WG, led by the World Bank, to finalize agreement with MoF on benchmarks & revenue design

16. Risks Non-agreement amongst ARTF donors. Too many benchmarks. Benchmarks not met. Ad hoc fiscal pressures emerge. Revenue continues to lag. Increase in bilateral approach Rewards Achieves predictability for donors & government Establishes the right incentives Strengthens ARTF as policy platform Clearer strategic outcomes for ARTF Risks & Rewards