Catalog

B. Recent Economic Developments

3. Foreign aid, pledged contingent upon reform progress, especially in forestry and demobilization, is critical if Cambodia is to regain the development momentum of the mid-1990s and broaden its coverage. The transition to a market economy began in the late 1980s but became a comprehensive reform agenda only after the 1993 UN-sponsored elections. The economy stabilized in 1993 through mid-1997, a substantial reduction in inflation being a noteworthy achievement. The Government introduced several structural reforms including a two-tier banking system, liberalization of all aspects of the external sector (trade, investment, and exchange rates), privatization of State-owned enterprises, and increased competition, particularly in transportation and agriculture. The rebuilding of government institutions started, particularly with assistance from the Asian Development Bank (ADB), in the area of statistics which was virtually nonexistent in 1992. Cambodian annual real gross domestic product (GDP) growth averaged 4.0 percent from 1994 through 1998.

4. Slow progress in improving governance, combined with increased political instability surrounding the mid-1997 Khmer Rouge defections and subsequent administrative reorganization, led to a marked increase in corruption and violence in 1997 and 1998. The most visible indication was a deterioration of forestry management that triggered the suspension of the International Monetary Fund (IMF) Enhanced Structural Adjustment Facility (ESAF) program. During that time of instability, which coincided with the regional financial crisis, foreign investment dropped, timber prices plunged, tourism arrivals plummeted, private consumption fell, and new commitments of international assistance virtually stopped. During the same period, drought limited the Cambodian rice crop and increased the regional price of rice as crop failures in Indonesia and the Philippines increased import demand from those countries. The resulting slowdown of economic growth and increased cost of living reduced the real incomes of both urban and rural poor and strained the fiscal budget, which was bolstered by central bank financing in 1998 for the first time in several years.

5. With renewed stability, the economy recovered from 1.3 percent real GDP growth in 1998 to about 5 percent in 1999. Economic events in 1999 included the imposition of quotas on garment exports to the United States (US) in early 1999, and progress on reform, culminating in a new agreement with IMF. The quotas, imposed based on the US view that Cambodia should improve labor conditions in the garment factories, may affect industrial growth and foreign direct investment (FDI) in the medium term.² A major fiscal reform in 1999 was the successful introduction of a value-added tax (VAT), which contributed to an increase in fiscal revenues from 9.2 percent of GDP in 1998 to 11.6 percent in 1999. This, along with reform progress in other areas such as forestry, led to a three-year $81.6 million ESAF (now Poverty Reduction and Growth Facility [PRGF]) in October 1999.

6. Although macroeconomic conditions in Cambodia are improving with the formation of the new Government, the population is still extremely vulnerable to economic downturns and weather conditions. To achieve sustained poverty-reducing economic growth, the Government's development program will refocus on development of the rural areas. Success will depend on the ability of the Government to maximize investment efforts by making efficient use of foreign assistance, by attracting private investment funds, and by mobilizing domestic savings. Key areas in which major government efforts are required are in agriculture and rural development, natural resource management, basic health and education provision, and physical infrastructure investment. Improved governance must accompany these efforts.

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1. French acronym for National United Front for an Independent, Neutral, Peaceful, and Cooperative Cambodia.
2. The now dominant garment sector grew rapidly after Cambodia was granted preferential access to the US market in 1997. Other factors that may slow growth in this sector are tighter labor standards, tighter customs supervision, and loss of competitiveness because many regional currencies depreciated relatively more against the dollar than did the Cambodian riel during the regional financial crisis.

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