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p. 5 of 11 BACK | NEXT Executive Summary I. Recent Economic Developments A. Growth, Employment, Savings, and Investment B. Fiscal Developments C. Monetary Developments and Prices D. External Trade and Balance of Payments II. Short and Medium-Term Economic Prospects and Policy Issues Appendix

Country Economic Review - Cambodia : I. Recent Economic Developments

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C. Monetary Developments and Prices

37. Phnom Penh experienced offsetting inflationary and deflationary pressures, as measured by the consumer price index (CPI), through the first nine months of 2000 after average inflation decelerated in 1999 to 4.0 percent from 14.8 percent in 1998 (Table 9, Appendix Table A5)¹². Three sets of factors influenced this outcome including relative price movements, exchange rate behavior, and monetary developments.

1. Relative Price Movements

38. The decrease in food prices, rise in housing costs, and rise in world oil prices were significant relative price movements that affected the price level in Phnom Penh in 2000. World rice prices, which strongly influence rice prices in Phnom Penh, are currently low because of large world surpluses. Thus, despite flooding, local rice prices were 7.5 percent lower in September 2000 than in September 1999. Indeed, prices fell for most major categories in the food subgroup, which carries a 46.3 percent weight in the CPI, including cereals, meat and poultry, and fish.

39. Housing costs, which carry a 19.5 percent CPI weight, rose because of strong demand in Phnom Penh. This is thought to be a result of political stability. The rise in world oil prices contributed to increasing costs for transport, although this effect was mitigated by the introduction of new port services in Sihanoukville, which significantly reduced the cost of fuel delivery. Initially, falling food prices together with falling prices in clothing and footwear, medical care, and recreation and education, dominated until September 2000, when food prices began to rise and fuel price increases began to accelerate¹³ Thus, in September, the price level was virtually the same as a year earlier, although food was relatively cheaper with transportation and housing relatively more expensive. These trends, particularly the effects of world prices and increased political stability, are likely to be similar in other areas of Cambodia, except in isolated communities, which may be more of a problem than usual in 2000 because of the prolonged flooding.

2. Exchange Rate Movements

40. Very low inflation through the first nine months of 2000 is related to very low depreciation. Heavy dollarization of the Cambodian economy means that many prices are quoted in dollars and must be converted to riel prior to CPI calculation. The riel depreciated against the dollar by 6.6 percent in 1996, 11.7 percent in 1997, 20.7 percent in 1998, 1.2 percent in 1999, and 1.0 percent in the first nine months of 2000 (Appendix, Table A6)¹⁴. Thus, changes in the inflation rate track changes in the exchange rate. The exchange rate depreciated relatively rapidly in the second half of 1997 and in 1998 as a consequence of political instability and the regional financial crisis. However, in 1999 and 2000, with improvements in political and regional economic conditions, exchange rate depreciation slowed significantly. Moreover, to a certain extent, the depreciation against the dollar reflects regional trends. The riel depreciated by about 30.0 percent against the dollar from end-1996 through end-July 2000, but appreciated by about 7.0 percent against the Thai baht, and depreciated by only about 13.0 percent against the Singapore dollar during the same period.

3. Monetary Developments

41. In Cambodia, the link between price movements and monetary developments is relatively weak because of low levels of monetization (the extent to which money is used in economic activity, as measured, for example, by the ratio of liquidity or broad money to nominal GDP) and high levels of dollarization. The main monetary policy tool of NBC is to avoid financing fiscal deficits, which it has done since 1998. After three years of relatively modest growth, total liquidity is expanding more rapidly in 2000, having grown by over 24.0 percent through September 2000 (Table 10, Appendix, Table A7). This was the combined result of a recovery of currency in circulation from the contraction in 1999, and accelerated expansion of foreign currency deposits as confidence in the economy strengthened. However, falling velocity—the ratio of nominal GDP to average stock of broad money—limited the inflationary impact of increased money supply growth.

42. Foreign currency deposits continue to dominate total liquidity increasing from 61.0 percent of total liquidity in 1995 to 68.0 percent in August 2000. Riel deposits (demand, time, and savings) account for less than 4.0 percent of total liquidity, while currency in circulation accounts for 27.7 percent. The liquidity to nominal GDP ratio was 12.5 percent in 1999 as compared with about 30.0 percent for Viet Nam and about 90.0 percent for Thailand, indicating a fairly low level of monetization of the economy. However, this measure of liquidity does not include the value of dollars in circulation, which is probably much larger than the value of riels in circulation.

43. The rapid increase in foreign currency deposits in 1999 and 2000 reflects both strong export growth and improved confidence in macroeconomic management and political stability. On the asset side, net foreign assets are increasing at a similar rate. Surprisingly, even as domestic credit edges up, net domestic assets continue to become more negative as capital and reserves of commercial banks continue to build rapidly. These are counted as negative assets since they are, in effect, liabilities to shareholders.

44. A healthy sign of economic recovery is the accelerated growth of credit to the private sector, which grew by 22.1 percent through September 2000, at the same time that net credit to the Government continued to fall after the buildup in 1998. Thus, the composition of domestic credit shifted between December 1998 and September 2000, with the share of net claims on the Government and state enterprises falling from 22.0 percent to 1.1 percent while the private sector share rose from 78.0 percent to 98.9 percent. As the Government disburses accumulated deposited revenues while implementing the last quarter of the 2000 budget, net claims on the Government are expected to rise. Yet, the trend to a reduced public sector presence in domestic credit markets is clear.

45. By sector, the largest share of the KR857 billion credit extended by commercial banks through June 2000 was for services and personal consumption (27.1 percent), followed by wholesale and retail trade (24.6 percent), and manufacturing (19.4 percent). All sectors experienced an increase in credit except agriculture, which accounted for only 3.5 percent of credit extended by commercial banks through June 2000¹⁵

46. The expansion of deposits and credit is accompanied by increases in real interest rates. The interest rate on 12-month dollar deposits fell from 6.48 percent in January 1999 to 5.90 percent in July 2000. Over the same period, the annual inflation rate fell from plus 9.0 percent to minus 2.7 percent, indicating that the real interest rate shifted from being negative to substantially positive. The interest rate on 12-month dollar loans rose from 17.11 percent in January 1999 to 18.49 percent in July 2000. Thus the spread between deposit and lending rates rose from 10.63 percent to 12.59 percent, perhaps reflecting an increase in demand for credit. However, this spread was still below the 14.5 percent spread prevailing in August 1998, possibly because increased political stability has reduced perceived risk. Although credit and lending activities in riels are relatively small as compared with banking in dollars, real interest rates on riel deposits and loans have been rising as well.

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