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p. 22 of 69 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia Cambodia Indonesia Lao People's Democratic Republic Malaysia Myanmar Philippines Singapore Thailand Viet Nam South Asia Central Asia The Pacific III. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Cambodia

Growth slowed in 2003, but is set to pick up in 2004. The Government has made advances in rebuilding institutions and creating conditions for economic stability, though further progress is needed to reduce poverty. The private sector could play a much bigger role if infrastructure, financial, and governance weaknesses are overcome.

Economic Assessment

Growth in GDP eased to 5.0% in 2003 from 5.5% in 2002, the fourth consecutive year of slowdown (Figure 2.6). Domestic political uncertainties-including anti-Thai disturbances and the fact that Cambodian elections held in July 2003 have, as of early April 2004, yet to result in the formation of a new government-hurt investment and consumption, and delayed official transfers. Tourism was hit by the domestic political uncertainties and SARS.

Underpinning growth in 2003 was a recovery in agriculture following a drought-induced decline in 2002, and robust growth in the export-oriented garment sector. However, services sector activity weakened due to declines in the hotels, restaurants, and real estate subsectors as a result of lower tourist arrivals and the political deadlock after the elections.

Preliminary data for 2003 indicate that the fiscal deficit narrowed to 6.1% of GDP from 6.6% in 2002. Although revenues came in below target, so did overall spending because current expenditures fell short of budgeted levels. Spending on economic and social transfers was higher than budgeted, while defense-related outlays were lower. The fiscal deficit was financed mainly by grants and concessional loans.

Inflation subsided from 3.3% in 2002 to 1.2% in 2003, reflecting the fiscal stance, relative exchange rate stability, and stable food prices following a rise in rice production after the drought of 2002. The riel depreciated by 1.6% against the dollar to KR3,973/$1, and the spread between the official and market exchange rates remained at 1%.

During 2003, merchandise exports are estimated to have increased by 14.4% to $2.0 billion, with strong growth in garments and natural rubber. The country’s garment exports were granted special access privileges by the US and EU in the late 1990s, resulting in rapid growth that continued into 2003, especially to the US. The garment industry currently employs about 230,000 workers and generates more than 10% of GDP and over 80% of total exports.

Imports also increased, by a robust 12.5% to $2.6 billion, with a particularly large rise in transport equipment and, to a lesser extent, machinery and other equipment. Reflecting a higher base, the growth in imports offset the increase in exports, and led to a widening of the trade deficit to $599 million from $563 million in 2002. The current account deficit also widened, to 3.9% of GDP in 2003 from 1.6% in 2002, due to the wider trade deficit and a narrower services surplus as receipts from tourism moderated. The deficit was financed through official transfers and capital inflows, including about $130 million of FDI. Foreign exchange reserves at $737 million were sufficient to cover 3.4 months of imports.

Policy Developments

Given nearly three decades of conflict and a volatile political environment, most institutions were barely functioning when the Government began its first mandate in 1993. Since then, Cambodia has made important progress in rebuilding institutions, ensuring peace and security, and creating a stable macroeconomic environment. The country is now at a crossroads in its governance agenda and further progress in strengthening institutions is needed to guarantee sustainable economic growth and poverty reduction.

Central to strengthening governance is improving public administration at the central and local levels. A first phase that involved registration of civil servants and new career path and remuneration systems was completed in 2003; a second phase was started, under which the remuneration and classification systems are being overhauled and performance-based allowances are being introduced in priority sectors (i.e., education, health, agriculture, and rural development).

Public sector financial management is an important priority in governance, particularly given the need to increase revenues and improve the impact of government expenditures. The alignment of fiscal resources with development objectives in the past 2 years has resulted in an increase in budget allocations for the priority sectors and a reduction in defense spending. The revenue-to-GDP ratio, however, remains very low, and constrains spending on development. Increased revenue mobilization through tax and nontax collection and customs reforms is crucial.

Corruption has been a concern and is a serious impediment to private sector development. The Government adopted the Anticorruption Action Plan for Asia-Pacific-a program to combat corruption and bribery launched in 2001 by several countries and supported by international organizations-and submitted an Anticorruption Law to the National Assembly. In addition, both the National Audit Authority and the National Assembly’s Finance and Banking Committee are being strengthened. These developments are expected to enhance accountability and thereby reduce the fiduciary risk of public funds. The challenge, however, is to implement the reform measures effectively.

In the agriculture sector, while donors are supporting privatization of SOEs as well as commercialization and diversification of the sector, there is a need to expedite the implementation of existing policy reforms, including the land titling system and social land concession policies, which will provide formal land rights to the poor. Natural resource management is another key area of governance. More equitable access and sustainable natural resource management are essential for sustainable economic growth and poverty reduction.

Notwithstanding efforts to improve governance, the outstanding reform agenda is still very long. Cambodia’s incidence of poverty remains high, with 35-40% of the population living below the poverty line, and social indicators are among the lowest in the world. A reduction in the incidence of poverty requires a significant increase in economic growth, employment creation, and an increase in real wages. There is then a need for significantly higher rates of productivity and investment, and to nurture new sources of growth, particularly in the tradable goods and services sectors. The existing sources of growth remain narrowly based on garments and tourism, and prospects for the garment industry are uncertain with the phaseout of the Multifibre Arrangement (MFA) in 2005.

While there is a continued requirement for public investment, given increased fiscal pressures the private sector should be encouraged to play a considerably larger role in economic development. Private investment is, however, constrained by infrastructure bottlenecks, a weak financial system, shortage of skilled labor, and governance issues. These aspects need to be addressed if the country is to maximize benefits from its accession to WTO in September 2003.

Outlook for 2004-2005

Assuming a speedy resolution of the political deadlock over forming a new government, economic growth is expected to improve to 5.4% in 2004, led by export-oriented manufacturing (primarily garments) and an upturn in tourism and construction. The garment industry and tourism will benefit from a stronger global economy.

A forecast increase in global rice prices is likely to lead to relatively robust agricultural growth, which will increase rural incomes and domestic consumption demand. Given the Government’s commitment to improving the effectiveness of its expenditures, spending on the priority sectors is expected to rise, while spending for military purposes is projected to decline further.

Overall, the budget deficit should narrow because of a stronger revenue mobilization effort. Improved public financial management and renewed emphasis on structural reforms will help the investment climate, as will membership of WTO. Efforts to integrate more closely with other countries in the Mekong region are also likely to promote trade and tourism.

GDP growth is expected to remain at 5.4% in 2005. Although the phasing out of the MFA is likely to dampen growth, tourism is forecast to pick up further, as long as peace and order are maintained. Agriculture is also expected to grow faster with new irrigation projects coming into operation and as implementation of land ownership reforms gathers pace. Overall private economic activity will also be helped by progress in implementing structural reforms.

Inflation is likely to rise moderately over 2004-2005, due to a recovery in domestic demand, an expected upturn in global rice prices, and a likely modest depreciation of the riel as the current account deficit widens. This deficit is estimated at 4.3% of GDP in 2004, pushed by a wider trade gap. Exports are likely to rise on the back of stronger world trade growth and a US decision to increase its quota for Cambodian garments in 2004, but imports will likely rise even faster in absolute term because of the import-dependent nature of manufactured exports and a likely increase in capital goods as investment picks up.

In 2005, the current account deficit is expected to widen further when garment exports are affected by the phasing out of the MFA. Gross international reserves, however, are likely to remain at over 3 months of imports because of increased inflows of official transfers and FDI.

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