Natural Resources Revenue Sharing in Afghanistan

A Survey of social demands and expectations

With a Proposed

Procedure for Distribution of the 5% of the Natural Resources Revenues for Provincial Development

By Dr. Mohammad Qasim Wafayezada

Executive Summary

Afghanistan is a resource rich country with reserves estimated to worth around 3 trillion USD which almost have remained untapped. Facing a wind-down in international aid and assistance, Afghanistan is prompt to invest in its extractive industry to cover the state expenses and budget deficits and to fund its development projects to alleviate poverty in the country.

However, with the new amendment in the Minerals Law, a sound and reasonable legal framework has been laid down that would regulate the extractive industry; the sector requires more regulations to clarify all areas of activity and investment. One of the issues that deserve a good deal of attention is the re-distribution of revenues generated in the extractive sector. The Law, provides for two main mechanisms that would benefit the local communities and revenue generating regions. First, investment in development projects based on the Community Development Agreements to be carried out by the extractor company under supervision of the government, and second, allocation of 5% of revenues to the producing areas. But since the introduction of the Law in 2012, there has been a regulatory vacuum to enable the government to bring this provision of the Law into practice.

Therefore, the current study explores the allocation and distribution mechanisms for spending the 5% of the mining revenues based on literature review and focus groups deliberations and a survey of local communities. A proposed procedure/regulation for distribution of the 5% of the mining revenue was drafted based on the findings of the study (Please see Annex 1). Generally, the findings of the study highlight the following issues:

1. Perceptions of governance and management of the mining sector

Given the concerns over the potentials for horizontal conflicts emanating from geographical/natural distribution of resources across the country, it is important to understand if the people thinks the natural resources are used properly as a national wealth as defined in the Constitution. In both surveys of the focus groups and individual residents of the mining areas, the absolute majority believed that there was corruption in the mining sector with 95.2% in the individual survey and 82.4% in the focus groups survey. Moreover, 81% of the participants in the individual survey and 76.5% of the focus groups expressed concerns over lack of political will for sound management of the mining sector which has been the main hope for economic development of Afghanistan after years of war and violent conflicts. They also doubted the capability of the government to administer the mining sector and exploitation of the natural resources effectively as 91.4% in the individuals’ survey and 94.1% of the focus groups stated that there was no such capability within the government. Hence, 94.3% of the individuals and 94.1% of the focus groups didn’t think that mines are used properly in a way it should.

2. Priority areas for development

In the focus group’s deliberations on development priorities, road, school and water system came at the top with 20.41%, 18.37% and 12.24% respectively. However, the priorities stated by the individuals are slightly different in prioritization not in essence, where schools ranks first with 20.63% and agricultural machinery comes second with 18.10%, followed by roads with 15.57%.

3. Criteria for allocation of the 5% mining revenues

From the three mechanism of allocation and revenue distribution including, 1) a derivative option, based on the income of their province form mines/their share in the overall revenues of the state from mining of natural resources, 2) using a more indicator based approach (e.g. based on the size of the population), 3) redistribution of the 5% in accordance with the poverty index and the need for development of infrastructures in their province, the population-based choice was almost rejected with 3.8% ratio. Most of the participants opted for the derivative choice with 64.8% and another 28.6% chose the distribution mechanism based on poverty index and the extension of necessity for infrastructure development in their region.

4. Determining percentages for distribution of the 5% mining revenues

Among the criteria for distribution of the mining revenues, population and poverty index had the highest vote to be considered in sharing the 5% allocated revenues. But for determining percentages to mining areas, neighbouring areas and the whole province, the members of focus groups had different opinions though with a narrow margin which was unified after discussions in a defined percentage representing the view of the focus group.

Under the local development model the percentage of share from the 5% of the mining revenue was 45.45% for the communities in the mining areas, 24.09% for the neighbouring areas, and 30.45% of the allocated revenue from the natural resources to the rest of the producing province including its related districts and municipalities. While, the weighted percentage for communities in the mining areas deemed to be directly affected was 45.74%, and a share of 16.67% for the neighbouring areas that are also assumed to be affected by the mining activities. The weighted percentage shows 12.06% of revenues to be allocated for the citizens who are somehow affected. Regarding the producing district and the overall regions of the producing province the focus groups gave a share of 11.77% and 13.76% respectively.

5. Channels of distribution

Both the focus groups and other participants of the study tended to prefer mostly the Citizen Charter as a preferred channel for execution of the allocated portion of the revenue, as it has proved to have the merits of responding to the local needs for development as well as the required efficiency in execution of the project. In addition, people feel more familiar with this mechanism and since they are involved in monitoring and supervision of the implementation process, they think of the Citizen Charter as preferable option for channelling the 5% revenue of mining for provincial development. In the focus groups’ discussions, Citizen Charter with 64.71% stood at the top, while NGOs with 23.53% and Private Mining Companies with 11.76% came second and third respectively.

6. Monitoring and supervision  

Both in the focus group deliberations and the individual surveys, more localized supervisory mechanism was preferred. At the focus group deliberations, a combined mechanism of supervision that excluded the village council was rejected at the first place. Hence the remaining three options of supervision by the village council, a combined mechanism of supervision by district council and village council, and the third party was discussed. The result shows that within and across the focus groups, village councils are perceived to be the most effective and reliable bodies of supervision with 64.71%, while the combined mechanism of supervision by district and village council receive less support with 23.53%  and lastly the supervision by a third party got only 11.76%.

7. Recommendations

In addition to the procedure/regulation attached in Annex 1, the findings of this study suggest the following policy recommendations:

• A regulated and gradual decentralization of the fiscal and budgeting system is required in order to open space and give way to local governments and local initiatives. This would enable the central government to cope more effectively with the potential future challenges that may arise when natural resources revenues increase and become more important in Afghanistan’s economy, by sharing the burden with the sub-national administrations.
• A provincial development fund code should be established and activated by the Ministry of Finance by the new fiscal year 2019, so that the allocated 5% of revenues can be collected and disbursed for development projects in the producing provinces.
• The amended draft of the Minerals Law that provides a better and clear regulatory framework for the mining of Mineral resources in Afghanistan and includes recommendations from civil society and transparency advocates should be processed promptly to fill the existing vacuum and regulatory deficiencies.
• In addition, a procedure for allocation and execution of the provincial development fund is required. This procedure must consider the local demands and civil society recommendations and balance it with administrative requirements through a fair formula of distribution and defining of a transparent mechanism of implementation.
• In complete compliance to the EITI standards and requirements, Afghanistan needs to take preventive measures on the possible impact of the mining on its environment and society. 

Natural Resources Revenue Sharing in Afghanistan

Introduction

Mining sector plays an important role in the economic development of every country. For Afghanistan, after four decades of war and violent conflicts that brought immense destruction, the mining sector is seen as a vital source of revenue generation to rebuild its economy. Based on the geological surveys, Afghanistan’s underground resources are estimated to worth between one to three trillion USD, which is almost completely untapped.  The sheer size of the deposits – including copper, gold, iron and cobalt as well as vast amounts of lithium, holds out the possibility that Afghanistan, ravaged by decades of conflict, might become one of the most important and lucrative centers of mining in the world. As the Independent wrote based on some official memos in Pentagon, Afghanistan could become the "Saudi Arabia of lithium." Only the lithium reserves discovered in Ghazni province “shows the potential to compete with Bolivia, which, until now, held half the known world reserves”.

Given the dire economic situation in the country and the rich mineral resources, it is truly said that Afghans are poor nation living over rich natural resources.

To change this bitter situation, Afghanistan need to invest in its extractive industry in order to generate sufficient revenue required for post-war reconstruction and poverty reduction. Today, the government is able to collect annually around two billion dollars of revenue that constitutes 33% of the national budget.  Most of these revenues come from custom tariffs and indirect taxes. Only around 90 million USD of the total revenue comes from extractive industry and mining sector.  Given the shrinking amount of international aid to Afghanistan which is scheduled to end by 2024, Afghanistan has to rely on its rich natural resources in order to cover the state expenses including provision of public services and as well as its defence budget.  

However, the importance of underground riches for an economic take-off of Afghanistan has been in focus for both, the Afghan government and the international community, little has been done in this regard. Insecurity and instability perhaps stands at the top as the main challenge. Two major contracts for extraction of Hajigag ore mine and Ainak copper mine have not been implemented for years since its conclusion and signature. Both were expected to generate around one billion revenue to the government in royalties and taxes.  Transparency is another major issue that surrounds mining sector in Afghanistan. Hundreds of contracts awarded to small domestic companies lack transparency with no environmental and social considerations in the extraction process.

Mining, economic growth and poverty reduction

Mining can positively contribute to poverty reduction and economic growth. Lucrative minerals and natural resources can provide poor countries with large revenue streams that can be used to alleviate poverty and channelled for economic development. However, natural resources are volatile and exhaustible and therefore there is a risk of getting dependent on such revenues in the absence of strong trading economy and industrial production. The experience from many resource rich countries shows that there are several challenges for these countries to rise from poverty to affluence using their revenues from natural resources.  If natural resources’ revenues are not well managed, this natural fortune may turn into a curse and such countries fall into a so-called ‘resource curse trap’, a complex phenomenon in which, through several economic and political economy transmission mechanisms, mining revenues can be translated into economic stagnation and may even upset the social order and cause horizontal conflicts.  

Exploitation of natural resources is a potential source of conflict between the governments, the people of the producing areas and non-producing areas who see the resources to be the national wealth and expects to benefit from it. Many of horizontal conflicts are caused by discovery and extraction of natural resources such as the one between Aceh and the Indonesian government over the oil and gas reserves.  Therefore, addressing the possible grievances that may arise over redistribution of wealth extracted from the natural resources as well as intergovernmental sharing is important and needs a solution when natural resources are discovered and exploited.

The next challenge is channelling of the revenues into the financial system to avoid inflation and rising rates of commodity. In addition, there should be sufficient capacity within the financial and fiscal system and clearly defined objectives for infrastructure development to translate the resources revenue and income into development and growth. Otherwise, given the volatility of such revenues, it may exert adverse effect on the overall economy of a country. Studies of per capita economic growth and natural resource abundance show that an increase of about 10 percentage points in the natural capital share from one country to another is associated with a decrease in per capita growth by one percentage point per year on average.”  Moreover, ‘Dutch disease’—which refers to absorption of revenue windfalls through higher prices rather than more projects and services— also may cause counterintuitive results.

The most important issue for all resource rich countries to consider is that natural resources revenues are non-renewable, temporary and exhaustible. Therefore, the revenue from mining of natural resources should be considered as consumption of selling of an existing asset rather than additional income. Natural resources, as the gift of nature, provide a temporary stimulus for economic growth and therefore needs to be used properly for development of infrastructures and other key drivers of economic growth that would enable the economy for a takeoff based on an increased level of production and trade. In other words, the revenues from the natural resources should be transformed into capital and capacity in order to avoid stagnation and relapse to poverty.

Another issue that has been a major concern in war-torn countries is the exploitation of natural resources by armed insurgents to finance the insurgency against the government. The insurgents’ access to mines and natural resources on the one hand prolong the conflict and present obstacles to peace building efforts , and on the other it may cause development of political economy of war intertwined with illicit trade of minerals and precious metals or other types of resources. For instance in Afghanistan, the revenue from gold mines, lapis lazuli, and semi-precious minerals has been one of the major sources for financing the anti-government militia groups.  Global Witness has found that the Taliban and other armed groups are earning up to 20 million dollars per year from Afghanistan’s lapis mines.  Recently, control of the Taliban insurgency over coal mines in areas such as Baghlan province is another example of extraction for financing the war.  Therefore, effective governance of natural resources extraction and exploitation and sound management of its revenues is important to make effective use of the ‘gift of the nature’.

Approaches to natural resources revenue distribution

Redistribution of the natural resources revenues has been a big challenge for almost all resource rich countries. On the hand, national governments use natural resources revenues to finance development projects and in best cases with due consideration of macro-economic management objectives, it is integrated into the overall fiscal framework to cover budget deficits. On the other hand, to address claims from resource rich regions, governments are to allocate and distribute the revenues from mining to sub-national governments. In addition, they should consider the non-producing areas that also claim a share in the mining revenues as ‘national wealth’, specially the least developed areas that requires more dedicated planning and sets of action. To overcome such challenges, governments have adopted different approaches to re-distribution of mining revenues that can be categorized generally in two vertical and horizontal systems.

Vertical and horizontal distribution systems

Regarding vertical distribution of natural resource revenues, which refers to distribution from national government to subnational governments, there are three criteria commonly taken into consideration when deciding the share of extractive industry revenues that corresponds to subnational governments: a) matching (administrative) responsibilities to the level of fiscal transfers, b) ensuring a political equilibrium between the centre and the periphery, and c) managing volatile revenues.

Determining revenue distribution mechanism varies first according to the fiscal and budgeting system of every country. Countries with more centralized budget system adopt different methods of revenue sharing than those with more decentralized systems. In centralized and unitary system the revenues from overall sectors throughout the country are collected to the central treasury and then redistributed based on certain criteria or formula. Therefore, any revenue sharing method must go through a complex centralized system, with less room for local planning and initiatives. Many national governments such as in Afghanistan, Algeria, Myanmar and Saudi Arabia collect the vast majority of resource revenues and manage subnational authorities directly and there is a minimal degree of resource revenue sharing.  In this system, as an EITI report highlights, the subnational governments have two types of access to resource revenues, 1) local payments, in which legislation assigns specific collection responsibilities to subnational governments, and 2) transfers, in which intergovernmental revenue-sharing arrangements entitle subnational governments to a share of resource-revenue collected by the national/ federal government.  

Figure 1 Vertical and horizontal re-distribution of natural resource revenues

In fiscally decentralized systems, such as Bolivia, Indonesia, Peru and the Philippines, most resource revenues are collected by the national government, but there are significant transfers of resource revenues to subnational governments. In the Philippines, for example, 40 percent of all mining revenues collected by the national government have been allocated to the local and subnational governments.   Some studies show that political institutions also matter. For example Brosio and Singh in their study of African states found that, following the return of their countries to democracy, the constitutions tend to replace a previous totally centralized system of allocation of natural resource revenues with a decentralized one. This is the case of Iraq and the Democratic Republic of Congo and could possibly also be that of Libya.

Another system is the horizontal distribution that refers to distribution of natural resources revenues across subnational governments. In horizontal system an important discussion on allocation of non-renewable resource revenues across different subnational jurisdictions is whether to redistribute revenues solely to territories that host extractive activities or not, and whether the central government should reallocate revenues through discretionary or institutionalized rules, such as the adoption of a proportionality formula. The existing literature has identified three types of mechanisms: a) direct allocation from the central government; b) formula-based participation, and c) devolution. In practice, countries combine two or more criteria when adopting reallocation formulas.  

In addition to the difference in the fiscal system of every country and who is entitled to collect the natural resource revenues, under both horizontal and vertical sharing systems, there is no uniform method for revenue distribution. The regulatory framework in each country dictates different methods of revenue sharing and the percentages that should go to the central government and that of the local governments varies significantly from one country to another.

Derivation and indicator-based sharing systems

UNDP’s report introduces two types of natural resources revenue sharing, 1) derivation of percentage option and 2) indictor based system, each varying according to the government objectives for setting the revenue sharing. Local development, reduction of income inequalities, compensating to producing regions, and conflict prevention are namely the most optimum objectives that may induce and affect a revenue sharing formula. In the derivation based formula, certain percentage is determined for producing/non producing regions, or directly affected and indirectly affected communities and land owners. In some cases equal shares is preferred for all regions in distribution of the revenues from natural resources as a national wealth. However, certain countries consider only the producing regions for allocating a share in the revenues, some other countries such as Nigeria, Bolivia, Mexico and Indonesia includes non-producing regions as well.

In indicator based formula, population, access to education, health services, wage level, poverty index and availability of infrastructure or presence of mining sites are the main indicators for sharing the revenues. If the objective of the national government is prevention of conflict, they may seek a fair formula based on a national consensus.

For example in Uganda taking into account the interest of the individual landowners, local governments and the government, according to the Mining Act of 2003 the central government is entitled to 80 percent of the mining royalties, the local government of the producing areas are entitled to 17 percent and the owner of the land gets 3 percent.  In Democratic Republic of Congo, the mining law of 2002 sets the sharing rates for natural resource revenues: 60 per cent to the national government and 40 per cent goes to the provinces, from which 10 per cent is allocated to their local communities. In Ghana, a Mineral Development Fund was established in 1993 which receives 20% of the mining royalty payments. Half of the fund is distributed in the mining areas for projects to mitigate the effects of mining: 25% via the district assemblies and the rest to local communities. In Chad, based on the 1999 Petroleum Revenue Management Law, Eastern Logone, the country’s oil-producing region, receives 4.5 percent of the royalties. According to the application decree of the mining code of 2002 of Cameron, royalties on minerals (an ad valorem tax) is distributed with 75 percent to central government 25 percent to riparian local councils and communities. But in other areas of resource revenues, the formula is different. For example, according to the 1999 Law of Forestry, royalties on forests are shared 50 percent to central and 50 percent to local governments.  

Some countries such as Nigeria specifies a derivation based formula for revenue distribution as stipulated in the Section 162.2 of the Constitution: “The principle of derivation shall be constantly reflected in any approved formula, as being not less that 13 per cent of the revenue accruing to the Federation Account directly from any natural resources.”

In Mongolia, according to the new law that came into effect in 2016, preferring a more indicator based formula, 65 percent of mining royalties will go to the central government, 5 percent will continue going to the General Local Development Fund and then redistributed according to the formula, and 30 percent will go directly to mining aimags, of which one third is reallocated to the soums. In addition, 50 percent of license fees will go directly to the mining aimag’s local development fund, of which 50 percent is sent to the soums.  

Bolivian case shows a more comprehensive natural resource revenue sharing system. The 2005 Hydrocarbon Law, adopted based on the Law of the National Referendum of July, 18 2004, established the quantitative levels at which royalties and taxes are imposed and shared. Overall, the law establishes a 50% tax on oil and gas production. This consists of an 11% share of producing region, a 1% compensatory share of national production to the least developed regions of the country (Beni and Pando) and a 6% share of national production to the national treasury. In addition, the law establishes a direct tax on hydrocarbons (IDH –impuesto directo a las hidrocarburos) of 32% of which 4% goes to producing regions according to their share of production and 2% to non-producing regions. The remaining allocation is decided by the executive branch in support of the national treasury, indigenous communities, peasant communities, municipalities, public universities, the armed forces, the national police, and others. The law furthermore stipulates that beneficiaries of the IDH will allocate resources for the education and health sector, roads, productive development, and anything which contributes to job creation.

Furthermore, the IDH is allocated as follows: 30.5% to municipal governments, 27.3% to the Renta Dignidad (a non-contributory old-age pension scheme), 10% to subnational governments, 5.8% to public universities, 1.8% to the Fondo Nacional de Desarrollo Regional and 1.4% to the Fondo Indígena (Indigenous Development Fund). The remaining 23.2% goes to the national treasury.  

However some has argued that since resource wealth distorts incentives, generates rent-seeking behaviour, and undermines democratic accountability; therefore governments in resource-rich countries cannot be trusted to spend their resource revenues wisely and equitably using existing institutions and systems. This has prompted calls for the direct distribution of natural resource income to the population instead of channelling it through the budget. 

A common and rather popular approach has been providing the dividend to all citizens. Other approaches are based on the objective of influencing individual behaviours such as by providing dividends only to adults in order to ameliorate incentives to increase fertility, and to discriminate among the population for social or development goals, either by targeting certain segments of the population or by imposing behavioural conditions.

But since in this method the state is left without adequate resources to carry out its core activities, usually the governments using this system distribute a portion of the revenues to the population in cash or compensate them with some poverty alleviating measures such as subsidizing primary foodstuff. However, this method has been argued by some scholars as having positive impact on escaping the “resource curse”, yet it is not common method for resource rich countries.

Determining revenue streams for sharing with sub-national governments

Three resource revenue sharing systems can be generally identified: (1) countries that treat natural resource revenues in the same way as non-resource revenues for distribution purposes; (2) countries that treat natural resource revenues differently from non-resource revenues and distribute them based on derivation; and (3) countries that treat natural resource revenues differently from non-resource revenues and distribute them based on indicators.  

The revenues from extractive industry includes, royalties, signature bonuses, profit taxes, property taxes, goods and service taxes, taxes on use of goods, border taxes, dividends from government equity, production entitlements, fines and penalties.  Globally, royalties and property taxes are more likely to be shared than profits taxes, goods and service taxes or dividends from government equity. For example, Ghana and China shares only revenues from royalties. The Oil and Gas Revenue Management Policy of Uganda also set its goals as defining a mechanism for the sharing of royalty revenues with the local governments within the oil producing region.  The main advantage of royalties, and the reason for their popularity, is early timing of payments – as soon as the production starts – and simplicity of administration.

Community Development Agreements

Another mechanism, in addition to revenue sharing system, for mitigation of negative impacts of mining on the local community is the so-called Community Development Agreements (CDA), in which the winner company for extraction of a mining site enters an agreement with the local community on a sort of development or compensatory investment.

Community Development Agreements (CDAs) have the potential to facilitate the delivery of tangible benefits from large-scale investment projects, such as mines or forestry concessions, to affected persons and communities. To be effective, however, CDAs must be adapted to the local context, meaning that no single model agreement or process will be appropriate in every situation.  CDAs are becoming more and more common, and stand as an important opportunity for ensuring the self- determined development of local communities.

The full report (PDF) can be found here.