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Regions and Countries Country Assistance Plans Document
Country Assistance Plans - Cambodia : I. Country Performance Assessment
A. Economic Performance Assessment1. With the formation of a coalition Government in late 1998, headed by Prime Minister Samdech Hun Sen, a new promise of peace, stability, and unity emerged. The new administration made poverty-reducing economic development its first priority and launched a comprehensive reform program, with emphasis placed on strengthening fiscal revenue collection, civil service reform, demobilization of soldiers, and improving forest resource management. Progress in moving this large agenda forward was indicated by the October 1999 International Monetary Fund (IMF) approval of a three-year $81.6 million Enhanced Structural Adjustment Facility (now called the Poverty Reduction and Growth Facility [PRGF]) which stresses fiscal reform, particularly revenue mobilization. 2. Improvements in both political conditions and weather conditions contributed to stronger 1999 economic performance as tourism rebounded and a good 1999-2000 wet season rice crop was harvested. Real gross domestic product (GDP) growth accelerated to 5.0 percent in 1999 as compared to 1.8 percent in 1998 (Appendix 1). Investment increased in 1999, but investment approvals declined, in part because of revisions to the Investment Law to require larger deposits with applications for investment incentive benefits and in part because of the imposition of United States (US) textile quotas. The fiscal deficit narrowed from 5.9 percent in 1998 to 4.0 percent in 1999 because of improved revenue mobilization. Inflation fell to 4.0 percent in 1999 from 14.8 percent in 1998 and the value of the riel against the dollar remained relatively stable at about KR3815 per US dollar in 1999 after two consecutive years of depreciation. With the current account deficit widening only slightly and stronger foreign inflows, gross official reserves improved marginally from 3.7 months of imports to 3.8 months. 3. Industry was the main engine of real GDP growth in 1999, increasing its share of GDP by 1.1 percent to 19.5 percent, as the textile industry continued to expand and construction experienced a strong rebound after two years of contraction. The textile industry is now a major source of employment (there were about 180 factories employing over 100,000 workers in 1999) and foreign exchange earnings (garment export earnings increased by 60.0 percent to $606 million in 1999). Real value added in services, which accounted for 36.0 percent of GDP in 1999, also rebounded after two consecutive years of contraction as both tourism and domestic consumption strengthened. In agriculture, at 40.1 percent of GDP, strong performance in crops and fisheries was somewhat offset by a sharp contraction in real value added in forestry as illegal logging was curtailed. 4. Fiscal performance improved markedly in 1999. The introduction of a value-added tax (VAT) in 1999 contributed to a substantial boost in revenues from 8.9 percent of GDP in 1998 to 11.5 percent in 1999. Nontax revenues climbed from 2.1 percent of GDP to 3.1 percent, in part because of high one-time revenues from the first year of garment quota auctions. Reliance on trade taxes was reduced from 40.0 percent of revenues in 1998 to 33.0 percent in 1999. Yet, direct taxes account for less than 7.0 percent of revenues, which are still dominated by trade and indirect taxes collected at the borders. 5. Expenditures increased from 14.8 percent of GDP in 1998 to 15.5 percent in 1999 primarily because of an increase in externally financed capital expenditures as aid programs gradually returned to normal after the 1997 disruptions. Current expenditures remained roughly constant at 9.6 percent of GDP but with a shift in composition. Current spending on defense fell from 33.4 percent of total current spending in 1998 to 30.6 percent in 1999. At the same time, current spending on social administration increased from 21.8 percent of total current spending in 1998 to 27.4 percent in 1999. With current expenditures contained and stronger revenues, public savings increased from –0.3 percent of GDP in 1998 to 1.8 percent in 1999. The fiscal deficit was entirely financed by foreign funds and there was a reduction in the National Bank of Cambodia’s net claims on the Government. 6. The drop in the average annual inflation rate from 14.8 percent in 1998 to 4.0 percent in 1999 was reflected in a slowing of the rate of inflation across all categories of consumer goods and can be traced in part to a generally stable exchange rate. The Cambodian riel depreciated only by about 1.0 percent against the US dollar in 1999 (using the average of the midpoint value of the buying and selling rates of the official exchange rate) as compared to about a 21.0 percent depreciation in 1998. The food, beverage, and tobacco group, which has a 50.0 percent weight in the consumer basket (the Consumer Price Index is measured in Phnom Penh only), experienced average annual inflation of 7.6 percent, down from 14.1 percent inflation in 1998 as a result of improved weather conditions. 7. Dollarization of the Cambodian economy and a related lack of monetary instruments limit the influence of monetary policy on economic activity. Excessive monetary expansion rapidly translates into inflation and exchange rate depreciation. The Government is thus committed to a conservative monetary policy, containing broad money (M2) growth below 18.0 percent in each of the last three years. The Government is maintaining a flexible exchange rate system, keeping the spread between the official exchange rate and the parallel exchange rate below 1.0 percent throughout 1999. The National Bank of Cambodia is focussing on improving regulation and supervision of the banking sector. Currently, all banks are being evaluated for re-licensing under the 1999 Law on Banking and Financial Institutions. 8. As economic recovery took hold in 1999, import growth outstripped strong export growth (primarily in garments) to widen the trade deficit from 5.7 percent of GDP to 6.6 percent of GDP. With the recovery in tourism, the deficit on the balance of services narrowed from 2.4 percent of GDP in 1998 to 1.7 percent in 1999. Overall, the current account deficit (excluding official transfers) rose from 7.0 percent of GDP in 1998 to 7.3 percent in 1999. With modest improvements in official development assistance and foreign direct investment, and a reduction in the size of errors and omissions, the overall balance of payments surplus increased from 0.6 percent of GDP in 1998 to 1.8 percent in 1999. As a result, gross official reserves increased to $422 million or 3.8 months of imports. 9. The year 1999 was a transition year of economic reform and recovery. However, the road ahead is daunting. Growing at 2.5 percent annually, the Cambodian population will reach about 13.5 million by the end of 2005, adding about 165,000 workers to the labor force each year. To reduce poverty, Cambodia must simultaneously absorb these additional workers while increasing labor productivity, particularly in agriculture. The former will require continued growth in nonagricultural enterprises such as light manufacturing—despite recent quotas imposed on garment exports to the US—and tourism. The latter will require substantial—primarily aid financed—public investment in the rural economy. If Cambodia can maintain the momentum of economic reforms initiated in 1999, public investment funds should continue to be available in sufficient supply while private investment should slowly increase. Thus, economic growth in the target range of 6.0-7.0 percent annually should be achievable over the medium term.
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