Will China invest in the new Afghanistan?

On the 15 of August 2021, the Islamic fundamentalist and military group “Taliban” commenced its final surge into Kabul, succeeding a withdrawal of US troops stationed since the inception of the US-Afghan war in 2001. This put an end to the rule of the Islamic republic of Afghanistan and kicked off the de facto reinstatement of the Islamic Emirate of Afghanistan (Brader, 2021).

Under allegations of Taliban human rights violations, and a fear of condoning the proliferation of terrorism, international acceptance of the new government is low. Of the US-held Afghan central bank’s foreign assets, 78% have been frozen (Turak, 2021). The loss of access to foreign currency is detrimental to the heavily import dependent economy. Furthermore, a sudden drop in the foreign aid it is so dependent on (total aid: 42.9% of GDP. Remittances: 4% of GDP. Proportion of outside government funding: 80%) will cause a liquidity crisis (Turak, 2021). With over $12 bn in international financing pulled out of the country, prospects over China filling this vacuum emerge, but short-term vulnerabilities and security risks cause a hold-off on investment.

Even despite a large repository of $1 trillion of untapped minerals (lithium & gold; resources China is in desperate need of for electric vehicles) in Afghanistan, low investment is likely to persist beyond the short term (Turak, 2021). One reason is that the country’s geography and historical legacies are barriers to development. Diamon’s thesis of endowments as primary determinant for economic potential holds true here (Acemoglu, 2013); Afghanistan is landlocked and internally obstructed to trade and cultivation by vast mountain ranges. Highly variable weather conditions limit agricultural potential. Basic Infrastructure is still lacking in many regions (CountryReports, 2021). Furthermore, the cultural landscape which ultimately shapes the political and economic institutional environment (Roland, 2014) is fractured by ethnic groups, all aspiring representation on the country level. Unfortunately, the US’s nation-building attempts resurrected regulatory institutions from the soviet occupation era such as the 1964 constitution (Turak, 2021). The resulting exclusive, centralized structure disallows local involvement of the heterogenous cultural factions (non-existent sub-national elected officials) causing divides on the acceptance and enforcement of laws. The ensuing issues of legitimacy have strengthened the rise of the Taliban in August, but centralization remains in place today. Centralization in it of itself is not the core issue here, legitimacy and extractive political institutions are (Acemoglu, 2013). Some ethnic tensions arise for instance on relations with China on the treatment of Uyghurs but find no representation in policy, casting doubt on the nation’s long-term political stability (Turak, 2021). A general lack of state capacity and rule of law is engrained through corruption and a lack of accountability (WJR, 2020). These issues culminate in insufficient financial and institutional quality, lacking macroeconomic policy and reduced trade openness, all of which are necessary prerequisites for the potential “collateral benefits” of financial inflows. At sub-standard thresholds of development, inflows may add volatility of incomes and consumption (Kose, 2009).

Capital inflows into Afghanistan are certainly not a priority for China and only justifiable for non-financial long-term objectives. At current trade levels of 1.3% of Afghan imports and 8.7% of exports to China, integration into BRI supply chains may introduce more negative volatility than gains for both parties (OEC, 2021 & World Bank, 2019). Holding off on Afghanistan until institutions are stabilized and pursuing the planned CPEC&CCWEC corridors around the country with the intention of later integration seems much more reasonable from the Chinese perspective. However, just like China pursued lending with its African ‘debt-trap’ covenants, similar practices in Afghanistan could help it secure resources and militaristic posts. China will make sure to be the first to claim these dormant assets. Unfortunately, this extractive pursuit makes the potential for voluntary Afghan institutional anchoring and consequent Afghan institutional discipline to China unlikely and the fragile status-quo could be exacerbated. On the other hand, self-sustaining finance of Afghanistan at former levels is considered impossible (Turak, 2021), even if much of the illicit trades (e.g., opium) are revived. Falling prey to the debt trap is thus not all too unlikely.

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