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p. 2 of 8 BACK | NEXT Executive Summary I. Current Development Trends and Issues II. The Government's Development Strategy III. ADB's Development Experience IV. ADB's Strategy V. ADB's Assistance Program VI. Risks and Performance Monitoring and Evaluation Appendixes

Country Strategy and Program 2005-2009: Cambodia

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I. Current Development Trends and Issues

A. Development Context

1. Cambodia is at a crossroads in its development as it moves away from a postconflict situation towards a more normal development paradigm. More than two decades of isolation and conflict that ended in 1991 with the signing of the Paris Peace Agreements devastated much of the country's physical, social, and human capital, forcing Cambodia to start from scratch in rebuilding its infrastructure and institutions.

2. Much has been achieved in recent years. Cambodia has made important progress in ensuring peace and security, rebuilding institutions, establishing a stable macroeconomic environment, and putting in place a liberal investment regime. Notwithstanding these achievements, the development agenda remains daunting. Poverty remains widespread—with 35–40% of the population remaining below the poverty line—and inequality appears to be increasing. Recent economic growth has been narrowly based, and has not led to a significant reduction in poverty. Achieving many of Cambodia’s Millennium Development Goals (MDGs) will be difficult.

3. With peace and macroeconomic stability now more firmly entrenched, the country has the opportunity to make far-reaching economic reforms to achieve sustained socioeconomic development. Within this context, the Government has developed a comprehensive reform agenda to achieve Cambodia’s MDGs. This is set out in the Second Socio-Economic Development Plan (SEDP II), 2001–2005; the National Poverty Reduction Strategy (NPRS) 2003–2005; and the Rectangular Strategy For Growth, Employment, Equity, and Efficiency.

B. Economic Growth

4. Reflecting prudent macroeconomic policies, significant aid inflows and the signing of a bilateral trade agreement with the US in 1996, Cambodia’s gross domestic product (GDP) grew by an average 6.8% per year from 1999 to 2002, compared with 5.6% per year from 1995 to 1998. However, GDP growth has been in decline since its peak of 10.8% in 1999, and the figure for 2003 was 5.2%. Growth in 2003 was held back by both the severe acute respiratory syndrome (SARS) outbreak and anti-Thai riots, which adversely affected tourism. The fact that it took 1 year to form a new government after elections in July 2003 also dampened business confidence. On the positive side, agriculture production staged a strong recovery from a drought-induced decline in 2002, and the export-oriented garment industry expanded strongly. Over the past decade, the industrial sector has been the main engine of growth, with industry'sshare of GDP increasing from 13% in 1992 to 26% in 2003, and that of agriculture falling from 48% to 34% during this period. The manufacturing subsector was the largest contributor to incremental GDP, with garments being the key driver of such growth. Tourism also contributed significantly to growth, while agriculture has grown modestly, lagging behind population growth. The outlook for economic growth in 2004 is clouded somewhat by weaker prospects for agriculture and there are fears of a sharp slowdown in 2005, following the phasing out of the Multi-Fiber Agreement (MFA) at the end of 2004.

5. With Cambodia’s economy remaining highly dollarized, the authorities have had limited scope to employ traditional tools for monetary management. As a result, prudent fiscal policy has been the key to ensuring price stability, and Cambodia has achieved rates of inflation well below 4% since 1999. However, with demand for riel continuing to increase with economic growth, the authorities have recently intervened in foreign exchange markets to stabilize the exchange rate. As a result, it remained broadly stable at about 4,000 riels per US dollar in 2003, with inflation averaging only 1.2%. However, the government’s revenue performance in 2003 deteriorated because of a drop in trade and excise taxes, despite recent efforts at improving tax administration and collection. The fall in revenues widened the overall fiscal deficit to 7% of GDP in 2003 from 6.7% in 2002, and reduced spending in the priority sectors of health, education, rural development, and agriculture. As in recent years, large aid inflows helped finance the deficit. Despite a modest decrease in the trade deficit, the current account deficit (excluding official transfers) widened to 10.2% of GDP in 2003 from 9.0% in 2002, because of a smaller services surplus as receipts from tourism decreased. The deficit was financed through private and official transfers and capital inflows, including about $77 million in foreign direct investment (FDI). Gross foreign exchange reserves were $737 million at the end of 2003 and were sufficient to cover almost 3 months of imports. The total debt at the end of 2003 was estimated to be 70.8% of GDP. Cambodia’s debt to the United States and the Russian Federation is being negotiated and is currently not being serviced. As a result, the debt service ratio relative to exports of goods and services at the end of 2003 was only 2.9%. However, the debt service ratio relative to government revenue was 14.8%, placing Cambodia in the category of debt-stressed countries.

6. Cambodia must resolve several structural constraints to economic growth. The existing sources of growth are narrowly based on garments and tourism. Prospects for garments are, however, uncertain with the phasing out of the MFA. New sources of growth must be tapped to achieve the 6–7% growth target in the Rectangular Strategy and find employment for the estimated 250,000 persons entering the labor market each year. With 90% of the poor living in rural areas, promoting agriculture is the best way of to accelerate growth, absorb a large part of the growing labor force, and address poverty more directly. Agricultural production, however, remains far below its potential because of low productivity and limited access to arable land and markets. New, or diversified, sources of growth would require significantly higher rates of productivity and investment. However, the prospects for a significant increase in public investment are limited because of the very low government revenue base. On the other hand, private investment is hampered by infrastructure bottlenecks (particularly in power and transportation), a weak and shallow financial system, a lack of skilled labor, and weaknesses in governance, ranging from an ineffectual policy and regulatory environment and poor service delivery to bureaucratic inefficiency and endemic corruption. All of these serve to increase transaction costs significantly and to weaken business confidence, productivity, and the competitiveness of the economy. While gains have been made in structural reforms over the last decade–particularly those relating to trade, price and exchange rate liberalization, tax and financial sector reforms, and privatization and leasing of state enterprises–the policy and institutional setting in almost all sectors of the economy merits substantial reform. Progress has been particularly slow in legal and judicial reforms, forcing the private sector to operate under uncertain market rules. A strengthened revenue mobilization effort will also be crucial for the Government if it is to increase social spending and improve the quality of public services. The new Government has moved quickly to address some of these issues, particularly reducing the cost and time associated with import and export procedures and company registration, and in ratifying Cambodia’s accession to the World Trade Organization (WTO). While benefits from membership of WTO due to increased market orientation and access are expected to be wideranging—requiring more than 40 pieces of legislation relating to commercial transactions to be adopted over the coming years—emphasis needs to be placed on proper implementation of the legislation if the benefits are to materialize.

C. Poverty¹

7. Despite data limitations, there is consensus on the principal characteristics of poverty in Cambodia. About 35–40% of the population has expenditure levels below the income poverty line, with 15–20% living in extreme poverty. Poverty in Cambodia is overwhelmingly rural, from a low of 10–15% in Phnom Penh, to 40–45% in rural areas, reaching 70–80% in some areas around the Tonle Sap basin. Despite relatively robust growth over the past decade, official figures indicate that the incidence of poverty has declined only modestly, from 39% in 1994 to 36% in 1999. This is due to a range of factors, including the narrowness of the existing sources of growth, with few if any backward linkages to the domestic economy, the exclusion of the poor from the mainstream economy, the poor quality of and lack of access to social services, unavailability of credit, the lack of equitable access to land, forestry and fisheries resources, and the exclusion of the poor (and particularly of minority groups and women) from the decisionmaking that shapes their lives.

8. Progress in reducing human dimensions of poverty has been mixed. There has been considerable progress towards the universal primary education target, with the net primary school enrollment rate increasing from 76% in 1997 to 87% in 2001. The quality and affordability of education has also improved, but further progress is needed. There is still significant gender inequality in education, with girls currently accounting for only 39% of lower secondary school enrollment and recording higher drop-out rates. The population’s health status is low, with child mortality estimated to be 115 per 1,000 live births. Data from 2000 show a high maternal mortality ratio of 437 per 100,000 live births. Around 85% of deliveries take place at home and skilled personnel attend less than half of all deliveries. There is an unmet demand for family planning services that has led to a population growth rate of about 2.5% per year, aggravating poverty and increasing the pressure on natural resources. Although Cambodia has the highest HIV/AIDS prevalence rate in Asia, it has made substantial progress, with the adult prevalence rate declining from 3.9% in 1997 to 2.6% in 2002.

9. Poverty assessments suggest that income inequality has increased, especially in rural areas. Slow agricultural growth has exacerbated income inequality. Despite Government commitments, inequalities are also evident in the status of minority groups, those displaced by conflict, and women. Poverty assessments also indicate that poverty increases with household size and number of children, and is highest where the household head is engaged in agriculture. While households headed by women are not significantly poorer than others, they are often more vulnerable, have less land and labor resources and thus rely more on risky coping strategies, such as selling assets, or pulling children out of school and sending them to work. Education plays an important role in determining rates of poverty. Poverty rates are similar when the household head has no schooling or primary schooling only, and are significantly lower when the household head has secondary, technical, or higher education.

10. A significant number of people are also chronically vulnerable, moving into and marginally out of poverty as external factors affect their lives. The poor also experience a high degree of food insecurity, even in provinces that enjoy a rice surplus. The ADB-sponsored participatory poverty assessment of 2001 indicated that the poor feel disempowered, and have limited access to land and natural resources, physical infrastructure, and basic social services.² Many also said the erosion of family and community relationships were a major concern and that they lacked confidence in local and provincial administrations. Accidents and illness were repeatedly mentioned as leading causes of vulnerability and poverty. Households spend a large proportion of their income on health care and a single accident or illness can be financially devastating.³

11. Progress Towards Achieving the Cambodia’s Millennium Development Goals. While Cambodia has made some progress towards achieving some of its MDGs, attaining many of the targets will be difficult. Cambodia is likely to meet its MDG target for universal primary education, but meeting the targets for secondary education (including female secondary school enrollment) seems unlikely. There has also been some progress towards achieving healthrelated goals, but at current rates, the increases are probably not sufficient to meet the MDGs. The country is, however, likely to meet its MDG target of reducing the HIV prevalence rate by 2015, although HIV transmission patterns are shifting, with most new infections occurring among married women and their children, a difficult group to target. Continued focus is needed to ensure that the incidence rate declines. Meeting the MDG target of halving the population below the national poverty line by 2015 would require considerably faster economic growth and a more pro-poor orientation to that growth.

D. Political Environment

12. The Paris Peace Agreement of October 1991 initiated the process of recovery and nation building in Cambodia. The first multi-party elections were held in July 1993, with United Nations (UN) involvement. In September 1993, a new constitution was adopted, which established the Royal Government of Cambodia as a multiparty liberal democracy under a constitutional monarchy. Cambodia is a signatory to the Millennium Declaration and is a party to the six main international human rights instruments.

13. Three main political parties have dominated Cambodian politics over the last decade: the Cambodian People’s Party (CPP), FUNCINPEC,⁴ and, more recently, the Sam Rainsy Party (SRP). Since 1993, three other nationwide elections have been organized, including the first commune elections in February 2002.

14. Although the CPP dominated the elections on 27 July 2003, it did not win the two-thirds majority required under the constitution to form a government on its own. A new government was formed on 15 July 2004 after protracted negotiations between the CPP and FUNCINPEC (which at one time also represented the interests of the SRP) on forming a coalition government. During this period, the National Assembly did not meet, and no legislative business was transacted. Apart from the general climate of uncertainty created by this prolonged hiatus, a number of problems affected the activities of all development partners, including:

1. the absence of an authorized budget, which limited the Government’s capacity to borrow, as well as to carry out some policy measures
2. the inability to pass legislation required to meet tranche conditionality under program loans

15. The formation of a new government on 15 July 2004 nevertheless represented a major step forward in the political development of Cambodia. While forming the Government has taken a very long time, it has taken place through a process of dialogue, where all outstanding differences between the political parties were apparently resolved, and without recourse to the violence that characterized previous election outcomes. The new political environment has also been underpinned by the recent abdication of King Sihanouk and the peaceful coronation of his son, Prince Sihamoni. Democracy is also gaining ground in other areas. The commune elections of 2002 represented an important step in a comprehensive program of political, administrative, and financial decentralization. Civil society and NGO groups are participating more in various areas of public concern and a relatively underdeveloped media is beginning to exercise its newly won freedoms. However, civil society organizations face significant challenges in accessing information, engaging in dialogue with the Government, and taking part in participatory processes. The Government’s capacity to engage in policy dialogue with civil society is growing, but participatory mechanisms have yet to become a part of the mainstream of public planning or monitoring processes.

E. Governance and Institutional Capacity⁵

16. Most institutions in Cambodia were barely functioning when the Government began its first mandate in 1993. Although Cambodia has made important progress in rebuilding its institutions, the country continues to operate far below its economic and social potential because of weak governance. Key areas of governance requiring attention include reducing corruption and reforming the legal and judicial system, public financial management (PFM), public administration, and local governance. The government is well aware of these challenges and has proposed reforms in key policy documents, including the Governance Action Plan, SEDP II, NPRS, and the Rectangular Strategy. Despite much effort being devoted to policy formulation, the implementation of reforms has been slow. There is also a need for ordinary citizens to participate more fully in public decision-making to improve accountability and reduce corruption.

17. Legal and Judicial Reform. Strengthening the justice system and the integrity of the courts is key to ensuring effective rule of law. The rule of law plays an important role in empowering the poor, providing effective guarantees to private investors and ensuring impartial dispute resolution. Although the Council of Legal and Judicial Reform has prepared a draft action plan for reform, the failure to enforce existing laws undermines attempts at reform. Legal reform issues include inconsistencies in legislation, limited transparency in legislative processes, weak capacity to draft laws, and lack of participation by stakeholders. Judicial reform issues include weak governance and corruption in the judiciary, the need for reform of the Supreme Council of Magistracy, the small number of trained judges and lawyers, and the low salaries of judges and prosecutors.

18. Public Financial Management. Weaknesses in public expenditure management have resulted in inefficient allocation of limited public resources, reducing their development impact. Public expenditures were 19.4% of GDP in 2003, low by international standards, and the revenue to GDP ratio of 12.0%, with tax revenues accounting for only 8.4% of GDP, is among the lowest in the world. The chronic imbalance between government responsibilities and domestic revenues is an important contributor to weak governance and corruption, manifested in low public sector salaries, underprovision of essential services, informal payments for services, underfunding of operation and maintenance (O&M), and the centralization of authority over the limited revenues.

19. The Government is committed to comprehensive reform of PFM and with donor support aims to

1. improve budget formulation by strengthening the links between policies and budgets and by introducing a medium-term expenditure framework
2. improve budget execution by strengthening cash management and overhauling treasury operations

A public expenditure tracking survey is being initiated for both the education and health sectors to identify bottlenecks and leaks in public finances at national and local levels. The Government will also have to strengthen systems of accountability to reduce the fiduciary risks to public funds.

20. Public Administration Reform. Given the serious problems afflicting the civil service-low pay, absence of clear hiring and promotion policies, and low skills leading to low capacity-comprehensive civil service reform is an important priority if service delivery is to be improved. There is an urgent need to rationalize the civil service, introduce effective performance management, and upgrade salaries of the remaining staff to a living wage. There is also a need to improve the sectoral and geographic deployment of civil servants, as well as to improve coordination across ministries.

21. Corruption. Weak institutions and limited accountability mechanisms are legacies of Cambodia’s recent history and contribute to high levels of corruption. Although difficult to quantify, the evidence suggests that corruption seriously constrains economic growth, private sector development, and poverty reduction. A recent study of the country's competitiveness identified the cost of corruption as the single most important constraint faced by the private sector in doing business in Cambodia.⁶ Other surveys also indicate that corruption is a key concern of households, firms, public officials, nongovernment organizations (NGOs), and academics.⁷

22. Gaps in the legal framework and weak implementation and enforcement of existing regulations and laws have hampered anti-corruption efforts. Although some progress has been made towards establishing a National Audit Authority and introducing procurement procedures in most ministries, the existing draft anti-corruption law needs to be made to comply with international best practice (e.g., as reflected in the UN Convention against Corruption) and enacted.

23. Decentralization.⁸ The Government sees decentralization as crucial to the strengthening of a local voice in government and improving public service delivery. While the holding of commune elections was an important first step, further efforts are needed to expand opportunities for citizens to influence and participate in government. Currently the commune councils control very limited resources, resulting in low levels of implementation of services and investment. They still lack the authority, administrative capacity, and financial resources to accelerate development at their level, and have limited means for dispute resolution. Government policy on deconcentration has not yet been clearly articulated and there is a need for stronger harmonization between decentralization and deconcentration policies. An effort is currently being made to arrive at a comprehensive perspective for decentralization and deconcentration.

F. Gender Assessment⁹

24. Cambodia has among the lowest levels of gender equity in Asia as measured by the gender-related development index (0.557) and the gender empowerment index (0.364).¹⁰ Social attitudes and tradition deem women to be of lower status. The consequences of these traditional attitudes are clearly manifest in the significant gender inequities in educational attainment and levels of literacy, rates of child labor, access to public services, and representation in decision-making positions. Human poverty is greater among Cambodian women than among men across all economic groups.¹¹

25. Women make significant contributions to the national economy and the income and wellbeing of their households. They comprise 54% of the agriculture and fisheries workers and their incomes provide more than half of household expenditures. Within the context of a shift to a market economy and private sector development, women have made significant gains in securing paid employment in recent years. These gains have, however, been limited to the garments industry whose immediate future is uncertain. The garment sector employs relatively well-educated young women and a substantial number of rural households receive regular income transfers from their daughters. Outside agriculture and garments, women are primarily self-employed in small, informal enterprises and comprise 49% of self-employed retail traders. In addition to culturally prescribed notions of "male" and "female" occupations, the lower levels of literacy and education of women make it difficult for them to compete. Lack of access to, or control over, productive resources and services including credit, land and land titles, agricultural inputs and extension services are critical gender issues.

26. Although progress is being made in responding to gender inequities in social sectors, serious gaps remain. In education, while there is increasing gender equity at the primary school level, severe disparities persist at higher levels of schooling, and the female child labor rate of 50% in the 14–17 age group is considerably higher than the male rate of 36%. In health, although progress is being made in rebuilding clinical health services, Cambodia’s maternal mortality ratio remains one of the highest in the region at 437 per 100,000 live births, suggesting the need to pay more attention to reproductive health and to improve access to health information and services.

27. Women are underrepresented in both elected and appointed positions as well as in mid to high levels of the civil service. Only 8.5% of the commune councilors and 12.2% of National Assembly members are women. This underrepresentation of women is directly related to the small number of female candidates in party lists. Cambodia’s nascent legal framework affords many rights to women, yet most are unaware of these rights. General weaknesses in the judicial system, together with their low social status, leave women with little legal protection. As a result, women are highly vulnerable to trafficking, domestic violence, and rape. The legal standing of women in property disputes is also a concern. While some progress in formulating policies promoting gender equality has been achieved, mainstreaming gender continues to be a serious challenge, and the political will to implement such policies remains weak.

G. Private Sector¹²

28. The private sector in Cambodia is dominated by the informal sector, which accounts for over 80% of GDP and close to 90% of employment outside the public sector. Much informal sector activity is concentrated in agriculture. The informal industrial sector accounts for almost half of total industrial output and supplies mainly the domestic market. It has been estimated that more than 90% of enterprises in Cambodia are small (fewer than 100 employees) and operate entirely in the informal sector. Some 7,000 private enterprises registered with the Ministry of Commerce constitute the formal private sector, which has been narrowly focused on garments and tourism. FDI has played an important role in developing the formal private sector and is the main source of exports. However, since the late 1990s FDI has been in decline. The private sector’s efforts to promote growth and employment are constrained by

1. weak governance, including an underdeveloped legal framework and an ineffective regulatory regime, excessive red tape, and widespread corruption
2. a lack of access to, and the high cost of, institutional finance
3. high costs and a lack of infrastructure in such sectors as transport and energy
4. limited human technical and managerial skills
5. limited access to land, information, and competitive markets

29. Surveys of firms reveal that complex registration and licensing procedures and associated formal and informal charges impose significant burdens. Enterprises therefore have an incentive to remain informal to avoid these high costs. The country’s limited tax base means that the tax burden has to be borne by the small number of registered enterprises. Exporters complain that red tape associated with export processing causes significant delays, while smuggling from neighboring countries has a negative impact on domestic manufacturers. Poor transport infrastructure and unofficial tolls, and the high cost of electricity caused by a lack of generating capacity, also increase the cost of doing business in Cambodia. Land tenure issues related to the low level of land titling dissuade investments in agriculture, while a lack of access to credit, especially for small and medium-sized enterprises (SMEs), constrains private sector growth. There is no development strategy for the SME sector, which is characterized by weak entrepreneurial skills and accounting standards. SMEs have limited access to market information and technology.

30. The Rectangular Strategy reiterates that the private sector must be the main engine of growth, employment generation, and poverty reduction. It commits the Government to addressing the deficiencies outlined above. Private sector development has taken on an added sense of urgency with the phasing out of the MFA quota system, the need to raise competitiveness in light of WTO accession, and the high rates of unemployment among new entrants to the labor market. In response, the Government has launched a comprehensive private sector development program with a focus on facilitating trade, developing SMEs, and enhancing private participation in infrastructure provision. A number of reforms have already been introduced to reduce the cost and time of export and import transactions, remove disincentives to SME formalization, and improve transparency in managing private participation in infrastructure projects. Ensuring that key reform measures are actually implemented and are sustainable will be a major challenge.

H. Environment¹³

31. Environmental Management. Cambodia's economy depends heavily on agriculture, fisheries, and natural resources and the unique ecosystem centered on the Tonle Sap basin. Environmental management in Cambodia is weak and the legal framework does not meet the country's environmental needs. Information and guidelines on crucial aspects such as allowable forestry cut, fish yields, and groundwater resources are lacking. Weak stakeholder participation reduces the scope for community-based management. The roles and responsibilities of the environmental agencies at various levels need to be clarified, given that up to 14 agencies are involved in managing the Tonle Sap basin. Management capacities are particularly weak at provincial level. The Government’s key environmental challenges include

1. decreasing forest cover, which reduces biodiversity, causes erosion, accelerates river siltation, and increases flooding
2. untreated wastewater
3. unsustainable irrigation
4. degradation of inland fisheries and coastal resources
5. poor protection of biodiversity and protected areas

32. Over 20% of incomes of poor households are sourced from the commons, mainly fisheries and forestry, and serve as a safety net when other sources fail. Efforts to formalize community access rights to fisheries and forests are in their infancy and there is limited capacity to support community management or to ensure adequate enforcement to exclude large-scale commercial interests. Although private forest concessions that were environmentally unsound or economically unviable have been cancelled, illegal logging continues. The Government has released many private fishing concessions in the Tonle Sap to community groups for them to manage. While this is an important step towards enhancing access of the poor to fisheries resources, further strengthening of the regulatory framework and local capacity is required to ensure that communities enjoy the benefits of sustainable fisheries management.

33. Tonle Sap Basin. Around the Tonle Sap some 1.7 million people depend on fishery-based livelihoods. In the dry season, the Tonle Sap River drains into the Mekong and Bassac Rivers near Phnom Penh. Both these rivers flow into Viet Nam’s Mekong delta. When the Mekong rises with the monsoon rains, the Tonle Sap’s flow reverses to the north-west into the Tonle Sap Lake, raising its level by up to 10 meters and increasing its area from 3,000 square kilometers to 16,000 square kilometers. This unique hydrological cycle generates vast areas of seasonally-flooded forests with intense biodiversity, and provides the people of Cambodia with 40–70% of their protein intake. Despite the natural and ecological wealth of the Tonle Sap basin, it is one of the poorest regions of Cambodia. The population growth rate is rapid, the population young and social indicators low. The competing pressures on natural resources have put the entire basin at risk of overexploitation.

I. Regional Cooperation

34. The Government sees regional and international integration as one of the key pillars of its development agenda. Regional cooperation will provide Cambodia with the economies of scale and opportunities to attract investment, create employment, generate income and reduce poverty. Key to Cambodia's commitment to enhance regional links has been its active role in the Greater Mekong Subregion (GMS) and its membership of the Association of South-East Asian Nations (ASEAN). Cambodia is also pursuing other efforts to harmonize trade and investment policies in the context of ASEAN and the East Asian Free Trade Area.

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