Regions and Countries

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p. 9 of 11 BACK | NEXT Executive Summary I. Recent Economic Developments II. Short and Medium-Term Economic Prospects and Policy Issues A. Growth and Investment B. Macroeconomic Management C. Risks and Uncertainties Appendix

Country Economic Review - Cambodia : II. Short and Medium-Term Economic Prospects and Policy Issues

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B. Macroeconomic Management

1. Public Finance

62. To achieve long-term growth of 7.0 percent per annum, Cambodia must increase public investment from current levels of about 5.5 percent of GDP, and improve its efficiency. Revenue enhancement from the current level of about 12.0 percent in 2000 is vital. This is a major goal of the current reform effort being assisted under the 1999 International Monetary Fund Poverty Reduction and Growth Facility. Planned reforms during 2001 and 2002 include (i) broadening of the revenue base by extending VAT coverage; and (ii) strengthening revenue administration, particularly in customs, non-tax revenues, and arrears collection. In the context of continued reform of the forestry concession system, the Government is reviewing the royalty system to ensure its fairness and consistency with sustainable forestry management.

63. With planned reforms, revenues are projected to approach 14.0 percent of GDP over the next few years as compared with the average of about 18.0 percent for MHD countries. Thus, Cambodia will need to attract large amounts of official development assistance (ODA) to significantly boost public investment in the medium term. Cambodia already receives large amounts of ODA—averaging about 10.0 percent of GDP over the last five years and over $20 per capita—in comparison with MHD countries for which the average level of ODA is 3.4 percent of GDP and just over $6 per capita. A large portion of ODA to Cambodia, over 80.0 percent in 1999, is through official transfers. The Government does not manage some of these transfers, and a portion is devoted to current expenditures rather than investment.

64. External debt service is relatively minor, currently under 2.0 percent of exports of goods and services, and likely to remain under 5.0 percent after rescheduling of debt to the US and the Russian Federation, as compared with an average of about 19.0 percent for MHD countries. This implies that judicious expansion of the use of official loans, on concessional terms, to expand public investment is possible provided that (i) efforts to enhance revenue mobilization continue, and (ii) the Government’s ability to efficiently absorb and manage additional loan-financed projects improves.

65. Public expenditure management is still very weak. With a development goal of reducing poverty, the Government is working to redirect funds away from defense and security to socioeconomic development. A demobilization program, to reduce the size of the military by over 30,000 soldiers by the end of 2002, is currently under way. In a pilot project, the Government demobilized 1,500 soldiers in May 2000. Lessons learned from that exercise will be used to improve the efficiency of full-scale demobilization once external funding for the $45 million program is secured.

66. In addition to increasing the proportion of expenditures devoted to socioeconomic development, Government is working to improve budget planning, execution, and transparency. Among planned reforms for 2001-2002 is the development and use of a medium-term expenditure framework to improve the linkage of recurrent expenditures to the Public Investment Program. Priority action plans are being implemented to improve budget execution in health, education, and rural development, which has traditionally been difficult, in part because of the decentralized nature of spending in these areas. These budget reforms will eventually be introduced in all sectors. Finally, the Government is moving to increase the transparency of public finance through the establishment of an independent national auditor general.

67. Public investment is dominated by aid financing. Many aid activities are carried out by aid agencies independently of the Government, and the Government has very little control over these flows. To identify priority areas for public investment, the Government is preparing a five-year plan, covering 2001-2005, to guide socioeconomic development and poverty reduction. This plan will attempt to balance the needs for continued infrastructure investments with those for increased social service provision.

2. Money and Banking

68. NBC’s primary goals are to maintain macroeconomic stability, reduce reliance on the dollar as a medium of exchange, and facilitate expanded domestic saving and investment through improved banking supervision. To contain inflation and maintain exchange rate stability, NBC has a managed but flexible exchange rate policy. The spread or premium between the official exchange rate and the unofficial parallel market exchange rate is kept to 1.0 percent by adjusting the official exchange rate each morning according to the movements in the previous day’s closing parallel market rate. Moreover, to accumulate and conserve official reserves, NBC intervenes in the exchange rate market only to avoid rapid appreciation by buying excess dollars when conditions warrant this intervention. Although the Government has been able to keep inflation low and exchange rate depreciation relatively modest over the last two years, dedollarization (the gradual elimination of the dollar as a medium of exchange) remains a long-term goal.

69. Foreign currency deposits continue to dominate broad money supply. While dollarization inhibits the use of monetary policy to stabilize the economy, it does not prevent the expansion of banking services, a critical need in a country that suffers from such a low level of monetization. Banking reform is a major effort under the Poverty Reduction and Growth Facility program. In late 2000, NBC was in the process of reviewing the relicensing applications of all banks as required under the 1999 Financial Institutions Law and classifying them as (i) viable and eligible for immediate relicensing, (ii) potentially viable but requiring a restructuring plan, and (iii) nonviable requiring liquidation. The classification process should be completed by end-2000. Once the relicensing process is complete, banks should significantly improve their performance. In 2000, total commercial bank loans are projected at only about 7.0 percent of GDP, although credit extension to the private sector appears to be growing.

3. External Sector

70. Key Government policy objectives in the external sector are (i) to liberalize trade in conjunction with requirements under current ASEAN membership (particularly the ASEAN Free Trade Agreement) and proposed World Trade Organization membership; (ii) to negotiate rescheduling agreements on bilateral debt with the Russian Federation and the US; and (iii) to increase the level, broaden the base, and enhance the quality of FDI projects. By 2002, the Government plans to reduce the maximum tariff rate from 120.0 percent to 30.0 percent, reduce the number of tariff bands from 12 to 4, and reduce the unweighted average tariff from about 17.0 to about 13.0 percent. Cambodia’s average common effective preferential trading tariff on goods included under the ASEAN Free Trade Agreement will fall from 10.4 percent in 2000 to 8.93 percent in 2002. The Government is working to gain approval of membership in the World Trade Organization in 2001. Debt rescheduling negotiations are ongoing and may be completed in 2001.

71. Attracting sufficient levels of FDI is critical to achieving the high rates of growth and employment generation needed to significantly reduce absolute poverty from the current level of over 35.0 percent. Cambodia’s investment regime is open and liberal, with no significant legal barriers to FDI except in certain areas such as printing, radio, and television, and the prohibition against owning land. However, corruption, inadequate physical and financial infrastructure, low labor productivity, and weak legal institutions tend to offset investment incentives such as tax exemptions for up to eight years and import duty exemptions on investment goods and materials. Nevertheless, where significant opportunities exist, such as in tourism and garments, Cambodia is able to attract foreign investors. The ability to continue attracting foreign and domestic private investment in a sustained way is ultimately a matter of expectations about future opportunities. With real reform progress and macroeconomic stability, investors should be able to find and exploit sufficient opportunities in Cambodia to sustain high levels of growth.

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