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Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Cambodia

Despite some signs of economic slowdown, the economy continued to register strong growth in 2001. Exports, particularly garments, increased rapidly and made a major contribution to economic expansion. Fiscal and monetary policies have been well managed, and both prices and the exchange rate remained stable. One of the Government’s main challenges is to convert strong macroeconomic performance into increased poverty reduction.

Macronomic Assessment

Despite severe flooding that hit the country in the last quarter of 2000, Cambodia saw reasonably strong economic expansion in 2001, when GDP was estimated to have risen by 5.3%. This was slightly below the rate in 2000, and below the Government’s target of 6.1%, but still a strong performance given the global slowdown. In 2000, the industry sector (and in particular the garments subsector) led economic growth because agriculture suffered from the flooding, and growth in services was muted.

In 2001, economic developments were more balanced (Figure 2.6). The agriculture sector, accounting for 32% of the economy, expanded by 5%, despite localized flooding along the Mekong River and droughts in the north and northwest. Growth in industry, recently dominated by garments, slowed to a rate of 12%. The services sector registered an increase of 1.9%, with tourism continuing to play an important role. The annual growth rate in 2000–2001, above the 4% average in the previous 4 years, is laudable. Nevertheless, per capita incomes are still only rising by around 2% a year. The rate of expansion in the agriculture sector is of particular concern, given that over 80% of the population live in rural areas and depend largely on agriculture for their livelihoods. Labor market statistics collected by the Cambodia Development Research Institute show that wages for unskilled workers in Phnom Penh were stagnant or declining in 2001, highlighting the difficulty that the labor market faces in absorbing new entrants.

For the third year in a row, prices were stable. Before 1999, Cambodia suffered from inflation that was often in double digits. With low inflation, the exchange rate against the dollar has been stable.

The fiscal deficit remained largely unchanged in 2001, at 5.6% of GDP. Revenues accounted for 11.5% of GDP and total expenditures for 17.1%. Virtually the entire deficit is financed through grants and concessional lending.

Cambodia’s trade deficit continued to narrow, to an estimated $225 million in 2001 from $263 million in 2000. Total exports grew to $1.35 billion from $1.26 billion over this period. While this growth rate is less than in 2000, it still reflects healthy external demand for Cambodian exports, led by strong growth in garments. The current account deficit of 6.6% of GDP is financed through official transfers and capital inflows in the form of concessional loans and FDI. FDI was estimated to be $120 million in 2001.

Policy Developments

Public finances are weak as the Government makes the transition between taxes on international trade to broader measures such as VAT. Concessional loans and grants are widely used to finance the capital needs of the country, which are extensive given two decades of war and neglect by the international community. The Government is committed to maintaining fiscal stability with both revenues and expenditures scheduled to increase gradually as a proportion of GDP. It is also taking further steps to reorient spending toward the priority sectors of health, education, agriculture, and rural infrastructure, while reducing the share of expenditures on the military. By 2003, revenues should increase to around 13% of GDP with expenditures expected to rise to 17%. The share of recurrent expenditures in the budget is also expected to grow. Cambodia has a relatively liberal trade policy and is open to both imports and exports. The Government is also taking steps to align its trade policies with those of the ASEAN free trade area and WTO.

The dollar circulates widely and is freely used for many domestic transactions, while the financial system remains quite weak, together limiting the capacity of monetary policy to influence the real economy. The central bank may keep its conservative stance with continued careful management of the money supply. It is likely to intervene in a limited fashion to maintain stability and liquidity in the foreign exchange market. One key development is finance sector reform. The Government, with the support of ADB, prepared a finance sector blueprint that serves as a guide for medium-term reform in the sector. In January 2001, a number of unviable banks were closed and warnings issued to other banks. Further reforms in the medium term include the establishment of interbank payment systems and improved supervision of banks.

Cambodia is still recovering from more than 20 years of war and international isolation. It has made significant progress in improving the quality of life of the population in the past decade. For example, primary-school enrollment rates are now much higher at around 78%, and the population’s health has improved. However, the Government—together with donors—needs to do more. Some indicators are still among the worst in Asia. For example, the infant mortality rate was estimated to be 95 per 1,000 live births in 2000. An estimated 36% of the population still live below the poverty line. Poverty remains concentrated in rural areas, where an estimated 90% of poor people live. Economic expansion in recent years has centered on rapid growth in textile production and exports, mainly in urban areas. For the benefits of this growth to reach the rural poor, significant investment is necessary to restore the physical infrastructure and to improve the quality and quantity of the country’s human capital.

Outlook for 2002–2003

The outlook for 2002–2003 is positive, with the economy expected to grow at about the same pace as in 2000–2001. In 2002, growth is forecast at 4.5%, a decline from current levels, but in 2003 it will likely pick up to 6.1%, in line with the Government’s targets. Garments and tourism will continue to be the most dynamic areas. Exports will benefit from increased external demand in 2002–2003, as growth in the world economy strengthens. Nevertheless, the country will face growing competition in external markets, particularly in garments. Although the domestic cost of labor is quite low, exporters are often at a disadvantage due to the high costs of doing business, the country’s poor infrastructure, and the strong dollar (since most costs are denominated in dollars).

Tourism will make an increasingly important contribution to the economy and the current account. The recent opening of Siem Reap airport to international flights has boosted the flow of visitors to the country. Additional investment is needed, however, to ensure that Siem Reap has sufficient public infrastructure to meet growing demand.

Inflation will remain subdued, given the central bank’s recent history of responsible monetary management. Although increased demand should lead to some upward pressure on prices, the outlook is for inflation to remain below 5% in 2002–2003. The exchange rate will depreciate in line with the increase in inflation. Continued reforms in the finance sector will help improve the investment climate and lead to gradually higher savings and investment rates.

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