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Cambodia: Staff Report for the 2013 Article IV Consultation

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2014
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Outlook and Risk

1. Political Context. The Cambodia People’s Party (CPP) won the July election but the opposition Cambodia National Rescue Party (CNRP) refused to join the National Assembly citing voting irregularities and has been organizing mass demonstrations. In September, the Assembly has approved a new five-year term for Prime Minister Hun Sen and his new Cabinet.

2. Growth. Economic activity remains strong driven by robust exports, with garment exports helped by preferential access to European Union (EU), and tourism with more diversified destinations. (Figure 1, Table 1). Real estate and construction also expanded rapidly supported by fast credit growth. Foreign direct investment (FDI) remained strong partly driven by factories relocating from China and Vietnam. Despite these indicators, growth is expected to stay at 7 percent in 2013 due to the sluggish global recovery, recent floods, and a slowdown in activity during the election period. Growth is projected to pick up to 7¼ percent in 2014 in line with the global recovery and to 7½ percent in the medium term with improvements in infrastructure, competitiveness, and investment climate (Table 2).

Figure 1.Cambodia: Strong Growth with Downside Risks

Sources: Cambodian authorities; IMF’s World Economic Outlook; and IMF staff estimates.

Table 1.Cambodia: Selected Economic Indicators, 2010–14
20102011201220132014
Est.Proj.
Output and prices (annual percent change)
GDP in constant prices6.17.17.37.07.2
(Excluding agriculture)6.98.68.48.68.3
Real agricultural output4.03.14.32.44.0
GDP deflator3.03.41.33.13.1
Inflation (end-year)3.14.92.54.13.0
(Annual average)4.05.52.92.93.4
Saving and investment balance (in percent of GDP)
Gross national saving13.413.914.814.913.1
Government saving0.51.01.72.22.2
Private saving12.912.913.112.710.9
Gross fixed investment17.322.023.523.521.5
Government investment9.68.79.08.88.1
Private investment 1/7.713.314.514.713.4
Money and credit (annual percent change, unless otherwise indicated)
Broad money20.021.420.917.723.7
Net credit to the government 2/0.80.0−1.5−3.6−2.6
Private sector credit23.431.228.028.024.0
Velocity of money 3/2.62.42.22.12.1
Public finance (in percent of GDP)
Revenue17.015.616.917.117.4
Domestic revenue12.112.314.113.914.5
Of which: Tax revenue10.110.111.311.712.2
Grants4.93.22.83.22.9
Expenditure19.919.620.720.120.2
Expense10.811.312.011.612.4
Net acquisition of nonfinancial assets9.18.38.78.57.8
Net lending (+)/borrowing(-)−2.8−4.1−3.8−3.0−2.8
Net acquisition of financial assets−0.30.00.60.40.1
Net incurrence of liabilities 4/2.64.14.43.42.9
Of which: Domestic financing0.90.7−0.4−0.4−0.1
Balance of payments (in millions of dollars, unless otherwise indicated)
Exports, f.o.b.3,8845,2196,0166,9928,002
(Annual percent change)29.734.415.316.214.4
Imports, f.o.b. 5/−5,466−7,260−8,426−9,789−11,135
(Annual percent change)21.732.816.116.213.7
Current account (including official transfers)−441−1,040−1,233−1,339−1,430
(In percent of GDP)−3.9−8.1−8.7−8.6−8.4
Gross official reserves 6/2,6533,0323,4633,8244,327
(In months of prospective imports)3.73.63.63.63.7
(In percent of foreign currency deposits)67.964.058.255.450.7
External debt (in millions of dollars, unless otherwise indicated)
Public external debt 7/3,3373,8414,4865,0525,559
(In percent of GDP)28.729.731.632.833.1
Public debt service778889115147
(In percent of exports of goods and services)1.41.21.01.11.3
Memorandum items:
Nominal GDP (in billions of riels)47,10252,15456,71162,55969,195
(In millions of U.S. dollars)11,25512,89014,118
Exchange rate (riels per dollar; period average)4,1854,0464,017
Sources: Cambodian authorities; and IMF staff estimates and projections.

From 2011, includes FDI related to public-private power sector projects.

Net credit to the government refers to its contribution to broad money growth.

Ratio of nominal GDP to the average stock of broad money.

Includes statistical discrepancy.

From 2011, includes imports related to public-private power sector projects.

Excludes unrestricted foreign currency deposits held as reserves at the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

Sources: Cambodian authorities; and IMF staff estimates and projections.

From 2011, includes FDI related to public-private power sector projects.

Net credit to the government refers to its contribution to broad money growth.

Ratio of nominal GDP to the average stock of broad money.

Includes statistical discrepancy.

From 2011, includes imports related to public-private power sector projects.

Excludes unrestricted foreign currency deposits held as reserves at the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

Table 2.Cambodia: Medium-Term Macroeconomic Framework, 2010–18
201020112012201320142015201620172018
Est.Proj.
Output and prices (percent change)
GDP at constant prices6.17.17.37.07.27.37.37.57.5
GDP deflator3.03.41.33.13.13.13.02.92.8
Consumer prices (end-year)3.14.92.54.13.03.03.03.03.0
Saving and investment balance (in percent of GDP)
Gross national saving13.413.914.814.913.114.615.415.916.7
Government saving0.51.01.72.22.22.63.13.64.1
Private saving12.912.913.112.710.911.912.312.312.6
Gross fixed investment17.322.023.523.521.522.022.022.022.2
Government investment9.68.79.08.88.17.87.47.57.4
Private investment 1/7.713.314.514.713.414.214.614.514.8
Public finance (in percent of GDP)
Revenue17.015.616.917.117.418.018.218.618.9
Domestic revenue12.112.314.113.914.515.015.516.016.5
Of which: Tax revenue10.110.111.311.712.212.713.213.714.2
Grants4.93.22.83.22.92.92.72.62.4
Total expenditure19.919.620.720.120.219.719.319.419.3
Expense10.811.312.011.612.412.412.412.412.4
Net acquisition of nonfinancial assets9.18.38.78.57.87.37.07.07.0
Of which: Domestically-financed1.91.81.61.81.92.12.32.73.0
Net lending (+)/borrowing(-)−2.8−4.1−3.8−3.0−2.8−1.7−1.1−0.8−0.4
Net lending (+)/borrowing(-) excluding grants−7.8−7.3−6.6−6.1−5.7−4.7−3.9−3.4−2.8
Net acquisition of financial assets−0.30.00.60.40.10.40.50.60.7
Net incurrence of liabilities2.64.14.43.42.92.21.61.41.1
Domestic financing, net0.90.7−0.4−0.4−0.1−0.4−0.5−0.6−0.7
Government deposits5.14.64.94.74.74.84.95.25.5
Balance of payments (in percent of GDP, unless otherwise indicated)
Exports (percent change) 2/29.734.415.316.214.413.012.211.711.2
Imports (percent change) 3/22.733.916.416.514.010.39.910.310.2
Current account balance (including transfers)−3.9−8.1−8.7−8.6−8.4−7.4−6.6−6.1−5.5
(Excluding transfers)−10.7−11.9−12.1−11.7−11.3−10.0−9.0−8.2−7.5
Foreign direct investment 4/6.811.511.310.48.68.17.97.97.4
Other flows 5/−1.6−1.10.10.52.71.91.41.31.0
Overall balance1.32.42.62.22.92.62.73.12.9
Gross official reserves (in millions of U.S. dollars) 6/2,6533,0323,4633,8244,3274,8205,3826,0696,781
(In months of next year’s imports)3.73.63.63.63.73.73.83.93.9
Public external debt (in millions of U.S. dollars) 7/3,3373,8414,4865,0525,5595,9496,3116,6246,929
(In percent of GDP)28.729.731.632.833.132.331.430.128.8
Public external debt service (in millions of U.S. dollars) 8/778889115147162215228213
(In percent of exports of goods and services)1.41.21.01.11.31.31.51.51.2
Sources: Cambodian authorities; and IMF staff estimates and projections.

Includes nonbudgetary, grant-financed investment, and, from 2011, public-private partnerships in the power sector projects.

Excludes re-exported goods.

Excludes imported goods for re-export; from 2011, includes imports related to public-private power sector projects.

From 2011, includes FDI related to public-private power sector projects.

Net official disbursements, exceptional financing, and official transfers.

Excludes unrestricted foreign currency deposits held as reserves at the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

Cash basis, excluding the accumulation of arrears on debt owed to the Russian Federation and the United States.

Sources: Cambodian authorities; and IMF staff estimates and projections.

Includes nonbudgetary, grant-financed investment, and, from 2011, public-private partnerships in the power sector projects.

Excludes re-exported goods.

Excludes imported goods for re-export; from 2011, includes imports related to public-private power sector projects.

From 2011, includes FDI related to public-private power sector projects.

Net official disbursements, exceptional financing, and official transfers.

Excludes unrestricted foreign currency deposits held as reserves at the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

Cash basis, excluding the accumulation of arrears on debt owed to the Russian Federation and the United States.

3. Inflation and credit. Inflation is projected to stay around 3–4 percent during 2013–14 owing to projected stable commodity prices, once the impact of the recent floods on food prices subsides. Private sector credit has been growing by about 30 percent (y/y) on average in the last three years nearly doubling credit-to-GDP ratio to over 40 percent. While part of this is due to new banks entering the market, which increased bank flows from abroad, heightened competition in the system also contributed to rapid credit growth. In the process, lending rates and interest rate spreads have declined.

4. External stability. Despite robust exports and tourism, the current account deficit including official transfers is expected to stay flat at around 8½ percent of GDP in 2013 due to strong but moderating imports, and remains fully financed by FDI and official loan flows (Figure 2). The deficit is projected to decline to 5½ percent of GDP over the medium term with improved competitiveness and diversification of exports, and lower imports after the completion of large power projects (Table 3). Gross official reserves stood at US$3.6 billion in November, about 3½ months of prospective imports. Although this reserve coverage appears to be adequate considering the long–term nature of Cambodia’s external debt, the high degree of dollarization (foreign currency deposits are more than 1½ times of gross official reserves) suggests that a higher level of reserves—than that suggested by the reserve adequacy estimates—may be warranted. Consistent with this stable external position, the real effective exchange rate has remained broadly flat since 2008 and in line with fundamentals, suggesting little evidence of a fundamental misalignment.1

Figure 2.Cambodia: Stable External Position

Sources: Cambodian authorities; Eurostat, IMF’s World Economic Outlook database, and IMF staff estimates.

Table 3.Cambodia: Balance of Payments, 2010–18(In millions of U.S. dollars, unless otherwise indicated)
201020112012201320142015201620172018
Est.Proj.
Current account (including official transfers)−441−1,040−1,233−1,339−1,430−1,373−1,340−1,340−1,338
(Excluding official transfers)−1,203−1,533−1,708−1,814−1,905−1,848−1,815−1,815−1,813
Trade balance−1,582−2,040−2,410−2,797−3,132−3,227−3,326−3,515−3,743
Exports, f.o.b.3,8845,2196,0166,9928,0029,04110,14111,32812,592
Of which: Garments2,9953,9014,2744,9105,5576,2016,8417,4878,137
Imports, f.o.b. 1/−5,466−7,260−8,426−9,789−11,135−12,269−13,466−14,843−16,335
Of which: Garments-related−1,359−1,757−2,177−2,455−2,945−3,287−3,626−3,968−4,313
Petroleum−485−999−1,147−1,312−1,375−1,450−1,546−1,673−1,817
Services and income (net)1681944176728891,0091,1071,2581,446
Services (net)6978891,1581,3991,6801,8611,9712,1012,229
Of which: Tourism (credit)1,1801,6161,9572,2112,5092,7112,8983,1213,342
Income (net)−530−696−741−727−791−852−864−843−783
Private transfers (net)212313285311339370404442484
Official transfers (net)762493475475475475475475475
Capital and financial account5841,3451,6061,6831,9171,8541,8902,0162,038
Medium- and long-term loans (net)393487648534459353292279243
Disbursements436536694607556462450448447
Amortization−43−49−46−73−97−109−158−170−204
Foreign direct investment 2/7621,4841,5981,6111,4591,5001,5981,7371,795
Net foreign assets of deposit money banks 3/−41540−330−36600000
Unrestricted foreign currency deposit at NBC−243127−256−28900000
Commercial banks−173−87−73−7700000
Other short-term flows and errors and omissions−155−666−310−9600000
Overall balance143305373345487481550676700
Financing−143−305−373−345−487−481−550−676−700
Change in gross official reserves 4/−161−321−388−361−504−493−562−687−712
Use of IMF credit000000000
Debt restructuring000000000
Accumulation of arrears181615161612121212
Memorandum items:
Current account balance (in percent of GDP)
Excluding official transfers−10.7−11.9−12.1−11.7−11.3−10.0−9.0−8.2−7.5
Including official transfers−3.9−8.1−8.7−8.6−8.4−7.4−6.6−6.1−5.5
Trade balance (in percent of GDP)−14.1−15.8−17.1−18.0−18.5−17.4−16.5−15.9−15.5
Gross official reserves 5/2,6533,0323,4633,8244,3274,8205,3826,0696,781
(In months of next year’s imports)3.73.63.63.63.73.73.83.93.9
Sources: Cambodian authorities; and IMF staff estimates and projections.

From 2011, includes imports related to public-private power sector projects.

From 2011, includes FDI related to public-private power sector projects.

Includes unrestricted foreign currency deposits (FCDs) held as reserves at the National Bank of Cambodia (NBC).

Excludes changes in unrestricted FCDs held as reserves at the NBC, and changes in gold holdings and valuation.

Excludes unrestricted FCDs held at the NBC; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

Sources: Cambodian authorities; and IMF staff estimates and projections.

From 2011, includes imports related to public-private power sector projects.

From 2011, includes FDI related to public-private power sector projects.

Includes unrestricted foreign currency deposits (FCDs) held as reserves at the National Bank of Cambodia (NBC).

Excludes changes in unrestricted FCDs held as reserves at the NBC, and changes in gold holdings and valuation.

Excludes unrestricted FCDs held at the NBC; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

5. Risks and spillovers. The outlook is subject to downside risks. Slow European growth could affect garment exports, although the impact is likely to be limited as reallocating factories from the region, such as China and Vietnam, brought their supply contracts to benefit from Cambodia’s lower production costs and preferential access to the EU market. Cambodia’s direct exposure to international capital markets remains limited, but U.S. tapering as well as slower growth in China may have significant spillovers to the region, and affect Cambodia’s FDI and tourism. The potential increase in dollar funding costs in the post-tapering period could also lead to a stop in foreign bank financing from the region. In light of the fragile confidence in the banking sector following large deposit withdrawals during the election, renewed pressure on deposits could undermine financial stability. On the domestic front, further extreme weather conditions could affect the rural poor especially hard, and dent exports and tourism, while prolonged labor disputes could disrupt garment production. On the positive side, improving power and rural infrastructure as well as more diversified FDI and a renewed reform momentum after the elections could provide a boost to exports and growth.

Cambodia: Risk Assessment Matrix (RAM)1/
LikelihoodPotential Impact
Protracted economic and financial volatility, especially for emerging markets
HighMedium
Exit from unconventional monetary policy could trigger capital outflows from emerging markets. The potential increase in dollar funding costs could lead to a stop in foreign bank financing.The direct impact is limited because of Cambodia’s small exposure to the international capital markets, and most capital inflows to Cambodia are FDI-related. However, should the volatility affect the countries in the region, tourism and FDI could be affected.
Global oil price shock
LowMedium
Continued geopolitical events in the Middle East could raise global fuel prices.With no fuel subsidy, any increase in world oil prices would create domestic inflationary pressure.
Protracted period of slower European growth
HighMedium
Slow growth in Europe could reduce Cambodia’s garment exports.The impact would be mitigated by continued utilization of preferential trade access to the E.U. market.
Labor market instability
MediumHigh
Continued incidences of labor strikes could disrupt garment production.Labor market instability could create a drag on exports and growth, and if prolonged, could weaken Cambodia’s competitiveness.
Extreme weather
MediumHigh
Extreme weather conditions (drought or flood) could lower agricultural production.Extreme weather shocks would adversely affect growth and have serious welfare implications on farmers and rural population.
Fiscal risks
MediumMedium
Slow progress in fiscal refroms could hamper fiscal consolidation.Limited progress in mobilizing revenue and pressures to increase spending would hamper the efforts to rebuild fiscal space and jeopardize fiscal sustainability.
Financial sector risk
MediumHigh
Continued rapid credit growth and proliferation of real estate financing could jeopardize macroeconomic and financial stability.Excessive risk taking by banks to compete for market share amid a growing role of foreign financing could result in a deterioration of asset quality, increase in financial sector vulnerabilities and liquidity risks, and a decline in confidence during a downturn. High degree of dollarization limits the lender-of-last resort capacity of the central bank.

It shows events that could materially alter the baseline path. The RAM reflects staff’s views on the source of risks and overall level of concerns as of the time of discussions with the authorities.

It shows events that could materially alter the baseline path. The RAM reflects staff’s views on the source of risks and overall level of concerns as of the time of discussions with the authorities.

6. Policy response and the authorities’ views. Should downside risks materialize, the policy space to support growth is limited as fiscal consolidation has been slower than expected since 2010. In case of adverse shocks, this limited room for additional spending should be allocated to high impact expenditures on development priorities in education, health, and infrastructure. At the same time, high dollarization limits effectiveness of monetary policy and the declining reserve coverage in terms of foreign currency deposits highlights the limitations on the National Bank of Cambodia’s (NBC) lender of last resort capacity to respond to shocks. This limited policy space underscores the need for vigilance in containing financial sector risks before they materialize. However, should risks to the financial sector materialize NBC should use its available lender of last resort capacity, while expediting the implementation of the crisis management framework, including by enhancing bank resolution powers. The authorities broadly agreed with staff views on the exchange rate assessment, outlook, risks and the limited policy space. However, they remained cautiously optimistic that the floods’ impact would be less than projected and expected GDP growth to exceed 7 percent in 2013. They also viewed external factors posing less risk to growth than domestic factors, such as prolonged labor disputes.

Policy Discussions

A. Maintaining the Momentum of Fiscal Consolidation

7. Context. Buoyant domestic demand and revenue collection efforts improved the fiscal position (Figure 3, Tables 45) making the 2013 budget revenue targets reachable. Domestically–funded spending is also expected to remain within the budget envelope as the increase in civil service salaries in September 2013 (the lowest salaries were increased up to the minimum wage of US$80 per month) had a limited fiscal impact (0.1 percent of GDP). Meanwhile, delays in donors’ reporting of foreign–funded spending continue to hamper the timely monitoring of capital expenditure. The fiscal deficit, excluding grants, in 2013 is expected to narrow further by about ½ percentage points (ppt) of GDP. Despite this progress, the stock of government deposits in terms of GDP is projected to decline slightly to around 4¾ percent.

Figure 3.Cambodia: Maintaining the Momentum of Fiscal Consolidation

Sources: Cambodian authorities; IMF’s Government Finance Statistics and World Economic Outlook; Globalintegrity.com; and IMF staff estimates.

Table 4.Cambodia: General Government Operations, 2010-14 (GFSM 2001)
20102011201220132014
BudgetActualBudget1/ActualBudgetJan-Aug

Est.
Est.BudgetJan-Aug

Prel. Est.
Proj.Proj.
(In billions of riels)
Revenue6,8078,0238,0648,1148,9006,1659,59010,5666,69410,70012,069
Of which: Nongrant5,5375,6986,3726,4367,2805,1118,0178,5845,5218,71810,067
Tax4,8244,7515,4625,2896,2634,1906,4247,3014,6537,3098,440
Income, profits, and capital gains9688001,0449601,2789391,2761,5621,1171,5501,780
Good and services2,7442,7923,1923,1233,6242,3963,8154,2042,6054,2054,910
International trade and transactions1,1121,1591,2261,2061,3618551,3331,5359321,5541,750
Grants1,2702,3251,6921,6781,6201,0541,5721,9821,1731,9822,002
Other revenues 2/7139479101,1471,0179211,5931,2838671,4091,627
Total expenditure8,1149,3639,54310,23610,4316,52911,74011,6616,83612,55713,993
Expense5,1675,0685,8515,8886,5183,9456,8187,3654,1057,2598,570
Compensation of employees2,1462,1352,3792,2902,7351,6952,6603,0921,8453,1493,829
Purchase of goods and services1,5941,7421,9541,9622,0451,1122,3102,2341,1682,2342,506
Interest120143140160171107305256125256282
Expense not elsewhere classified1,3071,0501,3791,4761,5661,0311,5431,7849671,6201,953
Net acquisition of nonfinancial assets2,9474,2953,6924,3483,9132,5844,9224,2962,7325,2995,423
Of which: Externally-financed2,0003,4202,6003,4032,8602,1384,0233,1462,2334,1494,096
Net lending (+)/borrowing(-)−1,307−1,340−1,479−2,122−1,531−364−2,150−1,095−143−1,858−1,924
Net acquisition of financial assets−195−125−498−3−52129236311396251100
Net incurrence of liabilities3/1,1121,2159812,1191,0106562,5141,1065382,1092,024
Of which: External8809248601,7791,0101,0682,3501,1061,1192,1092,024
(In percent of GDP)
Revenue14.517.015.515.615.710.916.916.910.717.117.4
Of which: Nongrant11.812.112.212.312.89.014.113.78.813.914.5
Tax10.210.110.510.111.07.411.311.77.411.712.2
Income, profits, and capital gains tax2.11.72.01.82.31.72.32.51.82.52.6
Good and services tax5.85.96.16.06.44.26.76.74.26.77.1
International trade and transactions tax2.42.52.42.32.41.52.42.51.52.52.5
Grants2.74.93.23.22.91.92.83.21.93.22.9
Other revenues 2/1.52.01.72.21.81.62.82.11.42.32.4
Total expenditure17.219.918.319.618.411.520.718.610.920.120.2
Expense11.010.811.211.311.57.012.011.86.611.612.4
Compensation of employees4.64.54.64.44.83.04.74.92.95.05.5
Purchase of goods and services3.43.73.73.83.62.04.13.61.93.63.6
Interest0.30.30.30.30.30.20.50.40.20.40.4
Expense not elsewhere classified2.82.22.62.82.81.82.72.91.52.62.8
Net acquisition of nonfinancial assets6.39.17.18.36.94.68.76.94.48.57.8
Of which: Externally-financed4.27.35.06.55.03.87.15.03.66.65.9
Net lending (+)/borrowing(-)−2.8−2.8−2.8−4.1−2.7−0.6−3.8−1.7−0.2−3.0−2.8
Net acquisition of financial assets−0.4−0.3−1.00.0−0.90.50.60.00.60.40.1
Net incurrence of liabilities 3/2.42.61.94.11.81.24.41.80.93.42.9
Of which: External1.92.01.63.41.81.94.11.81.83.42.9
Memorandum items:
Priority sector spending 4/3.03.73.83.84.22.44.04.22.44.24.2
Net lending (+)/borrowing(-) excluding grant−5.5−7.8−6.1−7.3−5.6−2.5−6.6−4.9−2.1−6.1−5.7
Domestic financing 5/0.90.91.20.70.9−1.2−0.40.0−1.6−0.4−0.1
Government deposits5.14.64.74.95.04.74.7
GDP (in billions of riels)47,10247,10252,15452,15456,71156,71156,71162,55962,55962,55969,195
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Includes supplementary budget.

Includes provincial tax and nontax revenue.

Includes statistical discrepancy.

Current spending by the ministries of public health; education, youth and sport; agriculture, forestry and fishery; rural development; women’s affairs; justice; urbanization and construction; labor and vocational training.

The figure is different from the domestic financing figure in Table 5 (GFSM 1986) because of differences in classification, in particular for capital revenue.

Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Includes supplementary budget.

Includes provincial tax and nontax revenue.

Includes statistical discrepancy.

Current spending by the ministries of public health; education, youth and sport; agriculture, forestry and fishery; rural development; women’s affairs; justice; urbanization and construction; labor and vocational training.

The figure is different from the domestic financing figure in Table 5 (GFSM 1986) because of differences in classification, in particular for capital revenue.

Table 5.Cambodia: General Government Operations, 2010–14 (GFSM 1986)
20102011201220132014
BudgetActualBudget 1/Est.BudgetJan-Aug

Est.
Est.BudgetJan-Aug.

Prel. est.
Proj.Budget Prel.Proj.
(In billions of riels)
Total revenue5,8386,1606,7526,8227,6125,3618,5968,9365,6229,07010,34510,427
Tax revenue4,7634,7955,4875,4766,2914,3446,6747,4864,8347,5268,5768,616
Direct taxes9688001,0449601,2789391,2761,5621,1171,5501,7761,780
Indirect taxes3,6643,7454,2044,1324,7743,1044,9325,5153,3945,4786,2566,236
Of which: Trade taxes1,0221,0631,1361,0931,2417811,2181,4258541,4381,6211,619
Provincial taxes131249240385240301465409324498544601
Nontax revenue7749048859599897671,3441,0996861,1921,4301,451
Capital revenue 2/30046138038633225057935299352339359
Total expenditure8,3669,70310,09710,74410,7906,61412,17612,0526,95812,94913,65414,202
Current expenditure5,2455,1645,9125,9976,6033,9766,9467,4504,1467,3448,6588,570
Wages2,0922,0832,3162,2332,6731,6592,5983,0291,8053,0863,7823,782
Nonwage2,8822,9193,3643,5213,6282,1694,0394,1332,2013,9704,4444,400
Provincial expenditure271161232243302148308287140287432388
Capital expenditure3,1214,5313,9554,5484,0802,5955,1224,4812,7615,4844,9965,632
Locally financed1,1211,1111,3551,1451,2204571,1001,3355281,3351,5361,536
Externally financed2,0003,4202,6003,4032,8602,1384,0233,1462,2334,1493,4604,096
Net lending08230198107431071225112200
Overall balance−2,529−3,543−3,344−3,922−3,178−1,253−3,579−3,116−1,336−3,879−3,309−3,775
Financing2,5293,5433,3443,9223,1781,2533,5793,1161,3363,8793,3093,775
Foreign (net)2,1503,2492,5523,4572,6302,1223,9233,0882,2924,0913,3894,025
Grants1,2702,3251,6921,6781,6201,0541,5721,9821,1731,9821,6702,002
Loans1,0301,0641,0401,9431,2601,1832,5411,3861,2652,3892,0502,355
Amortization−150−140−180−164−250−115−190−280−146−280−331−331
Domestic (net) 3/379295792465548−869−34428−956−212−80−250
(In percent of GDP)
Total revenue12.413.112.913.113.49.515.214.39.014.515.015.1
Of which: Central government12.112.512.412.313.08.914.313.68.413.714.114.2
Tax revenue10.110.210.510.511.17.711.812.07.712.012.412.5
Direct taxes2.11.72.01.82.31.72.32.51.82.52.62.6
Indirect taxes7.88.08.17.98.45.58.78.85.48.89.09.0
Of which: Trade taxes2.22.32.22.12.21.42.12.31.42.32.32.3
Nontax revenue1.61.91.71.81.71.42.41.81.11.92.12.1
Capital revenue 2/0.61.00.70.70.60.41.00.60.20.60.50.5
Total expenditure and net lending17.820.619.420.619.011.721.519.311.120.719.720.5
Current expenditure11.111.011.311.511.67.012.211.96.611.712.512.4
Wages4.44.44.44.34.72.94.64.82.94.95.55.5
Nonwage6.16.26.56.86.43.87.16.63.56.36.46.4
Provincial expenditure0.60.30.40.50.50.30.50.50.20.50.60.6
Capital expenditure6.69.67.68.77.24.69.07.24.48.87.28.1
Locally financed2.42.42.62.22.20.81.92.10.82.12.22.2
Externally financed4.27.35.06.55.03.87.15.03.66.65.05.9
Net lending0.00.00.40.40.20.10.20.20.10.20.00.0
Overall balance−5.4−7.5−6.4−7.5−5.6−2.2−6.3−5.0−2.1−6.2−4.8−5.5
Financing5.47.56.47.55.62.26.35.02.16.24.85.5
Foreign (net)4.66.94.96.64.63.76.94.93.76.54.95.8
Grants2.74.93.23.22.91.92.83.21.93.22.42.9
Loans2.22.32.03.72.22.14.52.22.03.83.03.4
Amortization−0.3−0.3−0.3−0.3−0.4−0.2−0.3−0.4−0.2−0.4−0.5−0.5
Domestic (net) 3/0.80.61.50.91.0−1.5−0.60.0−1.5−0.3−0.1−0.4
Memorandum item:
GDP (in billions of riels)47,10247,10252,15452,15456,71156,71156,71162,55962,55962,55969,19569,195
Government deposits (percent of GDP)5.14.64.74.95.04.74.7
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Includes supplementary budget.

Includes privatization proceeds.

Includes statistical discrepancy. The figure is different from the domestic financing figure in Table 4 (GFSM 2001) because of differences in classification, in particular for capital revenue.

Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Includes supplementary budget.

Includes privatization proceeds.

Includes statistical discrepancy. The figure is different from the domestic financing figure in Table 4 (GFSM 2001) because of differences in classification, in particular for capital revenue.

8. The 2014 Budget. The budget envisages an additional 25 percent increase in wage bill, particularly for low salary bands, to promote human resource development in public administration and improve public services in line with the authorities’ priorities in the Rectangular Strategy Phase Three (RSIII). To finance the increasing wage bill, the targets for tax and nontax revenues are raised (¾ ppt of GDP higher than the 2013 budget target) and other spending kept broadly constant in terms of GDP, while creating some savings to replenish government deposits.

  • Plans to further reduce the wage gap should be part of a broader civil service reform to avoid jeopardizing fiscal consolidation. The large fiscal cost (½ percent of GDP) would increase Cambodia’s wage bill to 5½ percent of GDP in 2014, beyond those of the peers as a share of domestic revenue and current expenditure. Therefore, further salary increases should target containing the wage bill to around 5 percent of GDP over the medium term by expediting civil service reforms to improve productivity of the civil service. The authorities acknowledged these challenges and have established two working groups for wage and civil service reforms to contain the wage bill while improving the capacity and accountability of the civil servants.
  • Targeting an increase in government deposits despite spending pressures is well placed, but there is room to increase the envisaged savings (Riel 80 billion) further. Since government savings provide the only fiscal buffer against adverse shocks, striving to maintain the stock of government deposits at least broadly constant in terms of GDP remains appropriate. This would require additional savings of about Riel 170 billion (less than ¼ ppt of GDP) which could be achieved by stepping up revenue collection efforts to exceed the target and improving spending efficiency. The authorities shared the staff’s views and reaffirmed their commitment to rebuilding fiscal buffers. They concurred there is room for additional revenue, for example by increasing excise taxes and expanding their base, rationalizing vehicle tax, collecting more tax debt, expanding the tax net, and strengthening customs administration, including by combating smuggling.

9. Revenue Mobilization Strategy (RMS). The government’s commitment to continue raising domestic revenue by ½ ppt of GDP annually over the medium term would help safeguard fiscal sustainability. With overall current spending kept broadly constant in terms of GDP, the fiscal deficit (excluding grants) could be reduced by about 3 ppt of GDP from 2013 to 2018, while providing resources for currently donor supported development spending, including in health and education, in light of the expected decline in grants. In the process government deposits can be replenished to about 5½ percent of GDP by 2018, while limiting public external debt to less than 30 percent of GDP to strengthen Cambodia’s ability to absorb future shocks.2 In this regard, it is essential to adopt the RMS in 2014, which is based on a three-pronged approach: (i) improving revenue administration, (ii) implementing fair and efficient tax policies, and (iii) strengthening governance. The authorities agreed with staff’s recommendations and indicated their near term priorities to reform excise taxes and the VAT, expand the base of the formal (nonestimated) tax regime, and rationalize exemptions and tax holidays. In this context, the plans to set up taxpayer services, modernize IT systems, strengthen capacity of tax officers, and improve governance could start a virtuous cycle. In the medium term, the introduction of income tax, expansion of property tax base, and better administration of nontax revenues would further improve fiscal performance.

10. Safeguarding fiscal space. Careful management of contingent liabilities related to public private partnerships (PPP) remains critical to contain fiscal risks. The authorities have made progress in collecting more information about the PPP projects with technical assistance (TA) from the World Bank. The latest estimate shows that the size of investment projects was around 25 percent of GDP in 2012, lower than previously estimated. The work on estimating the related contingent liabilities is still ongoing. Meanwhile, the Ministry of Economy and Finance (MEF) has established an investment department as a central PPP-monitoring unit and a debt management department to manage contingent liabilities and the associated risks. The authorities concurred that these risks need to be better managed and indicated their plans to continue strengthening the institutional capacity, including by seeking further TA. They also noted plans to adopt a ceiling on PPP guarantees and list all contingent liabilities and guarantees in annual budget laws to help improve fiscal transparency.

11. Public Finance Management (PFM). The adoption of a new chart of accounts with improved budget classifications in 2015 should pave the way for the implementation of the Financial Management Information Systems (FMIS) that is being prepared. In the meantime, expediting the development of an effective internal audit mechanism remains important for successful implementation of FMIS, planned roll out of program budgeting and the relocation of decision making and accountability to ten line ministries. In addition, strengthening donor coordination for timely reporting of donor support would help improve planning and monitoring of capital spending. The authorities broadly agreed with these priorities, requested continued TA support for successful implementation of PFM reforms and noted plans to fully implement program budgeting starting with the education sector to improve spending efficiency.

12. Arrears. The authorities noted that they have been pursuing discussions with the Russian Federation and the U.S. to resolve Cambodia’s debt arrears and would prefer to use most of the debt forgiveness toward development goals. However, an agreement has not been reached.

B. Improving Monetary Policy Effectiveness and Containing Macro Financial Risks

13. Context. The only monetary policy tool is the reserve requirements, which have been raised in September 2012 by ½ ppt to 12½ percent on foreign currency deposits. However, bank funding from abroad is not subject to any prudential limits, escapes monetary control, and could stop with tapering in the U.S., leading to volatile liquidity and credit conditions. Large deposit withdrawals during the election (10 percent of total deposits), which highlight the fragile confidence in the banking sector, reduced banks’ excess reserves substantially (Table 6), but these deposits started to return to the banking system in October. Furthermore, the high degree of dollarization and the absence of an interbank market, which contribute to high precautionary excess reserves, limit the NBC’s control over monetary conditions and its lender-of-last resort capacity. Although recent financial soundness indicators (Table 7) do not reveal any immediate concern, Cambodia’s banking sector is facing old and new risks from a crowded banking system, rapid credit growth, increasing foreign bank funding, greater real estate exposure, and stretched supervisory capacity (Figure 4 and Box 1). Therefore, discussions focused on containing these macro financial risks and developing the interbank and the foreign exchange markets to improve monetary control. Continuing with the implementation of the recommendations of the 2010 FSAP (Table 8) and ongoing TAs remains essential, as well as strengthening the Anti Money Laundering/Combating the Financing of Terrorism (AML/CFT) regime to safeguard financial stability.

Figure 4.Cambodia: Rapid Credit Growth and New Challenges

Sources: Cambodian authorities; and IMF staff estimates.

Table 6.Cambodia: Monetary Survey, 2010–14
20102011201220132014
MarJunSepDecMarJunSepDec

Proj.
Dec

Proj.
(In billions of riels)
Net foreign assets17,05418,42619,39020,71720,48321,26522,54921,77318,72121,85424,324
National Bank of Cambodia14,98216,01017,12717,67518,22618,58320,02619,01916,86819,72122,311
Foreign assets15,41016,43517,55118,09818,65319,00320,43719,43817,29520,14222,731
Foreign liabilities428425424423427421410418427421421
Deposit money banks2,0722,4162,2633,0422,2572,6822,5232,7541,8522,1332,013
Foreign assets3,8644,7145,8197,3197,1038,7218,3898,3178,4448,1878,539
Foreign liabilities1,7922,2983,5564,2774,8466,0385,8665,5636,5926,0546,526
Net domestic assets2,4235,2155,4735,9356,3817,3277,9329,88610,63511,78717,279
Domestic credit10,85014,89815,50917,04418,17819,31220,21822,14823,64624,92431,369
Government (net)−2,127−2,123−2,542−2,400−2,441−2,486−2,992−3,013−2,808−2,977−3,227
Private sector12,97517,02118,05119,44020,61521,79323,19925,14626,44527,89534,590
Other items (net)−8,428−9,684−10,035−11,110−11,797−11,985−12,286−12,262−13,011−13,137−14,090
Broad money19,47723,64024,86426,65226,86428,59230,48131,65929,35633,64141,603
Narrow money3,2213,9563,9853,8723,8184,0464,5014,5864,7214,7135,456
Currency in circulation3,0993,7723,8113,6323,5913,7564,2234,2374,3194,3194,967
Demand deposits122185174240227290278349402394490
Quasi-money16,25619,68420,87922,78023,04624,54625,98027,07324,63528,92836,147
Time deposits4085578966256837806717459118971,031
Foreign currency deposits15,84819,12719,98322,15522,36323,76625,30926,32823,72328,03135,116
(12-month percentage change)
Net foreign assets16.28.011.411.612.415.416.35.1−8.62.811.3
Private sector credit23.431.232.931.130.028.028.529.428.328.024.0
Broad money20.021.422.621.118.720.922.618.89.317.723.7
Of which: Currency in circulation3.221.712.78.81.7−0.410.816.720.315.015.0
Foreign currency deposits24.320.721.922.821.124.326.718.86.117.925.3
(Contribution to year-on-year growth of broad money, in percentage points)
Net foreign assets14.77.04.19.78.712.012.74.0−9.52.17.3
Net domestic assets5.314.31.33.35.28.99.914.812.315.616.3
Domestic credit 1/15.920.83.09.814.518.718.919.116.119.619.2
Government (net)0.80.0−2.1−1.3−1.4−1.5−1.8−2.3−1.2−1.7−0.7
Private sector15.220.85.111.015.920.220.721.417.321.319.9
Other items (net)−10.6−6.4−1.7−6.5−9.3−9.7−9.1−4.3−3.8−4.0−2.8
Memorandum items:
Foreign currency deposits (in millions of U.S. dollars)3,9104,7365,0025,5465,5985,9496,3166,5705,9206,9958,536
(In percent of broad money)81.480.980.483.183.283.183.083.280.883.384.4
Riel component of broad money3,6294,5134,8814,4974,5014,8265,1725,3315,6325,6106,488
(In percent of broad money)18.619.119.616.916.816.917.016.819.216.715.6
Credit to the private sector (in millions of U.S. dollars)3,2014,2144,5184,8665,1605,4555,7896,2756,6006,9618,409
(In percent of GDP)24.832.631.834.336.438.437.140.242.344.659.2
Foreign Currency Loans12,53016,58317,86919,25220,42321,60922,95924,90226,20127,64734,282
Loan-to-deposit ratio (in percent) 2/79.186.789.486.991.390.990.794.6110.498.697.6
Velocity 3/2.62.42.32.22.22.22.12.02.12.12.1
Money multiplier (broad money/reserve money)1.92.12.12.12.12.22.12.32.52.42.5
Reserve money (12-month percent change)17.27.715.515.617.719.022.811.5−6.37.616.0
Sources: Cambodian authorities; and IMF staff estimates and projections.

Revisions of monetary survey to exclude banks’ credits to nonresident.

Foreign currency loans and deposits only.

The ratio of nominal GDP to the year-to-date average stock of broad money.

Sources: Cambodian authorities; and IMF staff estimates and projections.

Revisions of monetary survey to exclude banks’ credits to nonresident.

Foreign currency loans and deposits only.

The ratio of nominal GDP to the year-to-date average stock of broad money.

Table 7.Cambodia: Core Financial Soundness Indicators (FSIs), 2008–13(In percent)
200820092010201120122013
MarJunSepDecMarJunSepDecMarJun
Capital-based FSIs
Regulatory capital to risk-weighted assets27.632.331.431.229.027.526.229.128.827.225.025.625.6
Regulatory tier 1 capital to risk-weighted assets27.733.032.129.527.726.326.329.328.927.325.326.125.7
Nonperforming loans net of provisions to capital5.95.33.83.94.65.43.33.83.54.33.53.43.6
Return on equity 1/12.44.96.59.09.610.59.711.211.010.510.212.911.6
Net open position in foreign exchange to capital0.91.42.33.13.03.93.92.93.41.82.01.61.2
Asset-based FSIs
Nonperforming loans to total gross loans2.93.92.92.93.03.02.12.42.22.52.01.92.1
Return on assets 1/2.71.01.31.91.82.01.82.32.11.91.72.32.1
Liquid assets to total assets14.219.418.017.917.919.016.217.217.516.115.416.216.0
Liquid assets to short-term liabilities30.626.825.225.225.327.023.024.324.422.521.222.422.2
Sectoral distribution of loans to total gross loans
Residents94.495.091.891.090.891.192.388.385.787.184.086.687.2
Deposit-takers3.86.54.43.94.74.97.78.17.98.47.78.17.9
Central bank0.00.00.00.00.00.00.00.00.00.00.00.00.0
Other financial corporations0.00.00.00.00.00.00.00.00.00.00.00.00.0
General government0.00.00.00.00.00.00.00.00.00.00.00.00.0
Nonfinancial corporations70.671.172.372.271.371.169.565.863.864.162.063.863.8
Other domestic sectors20.117.515.114.914.815.115.114.414.014.614.314.715.6
Nonresidents5.65.08.29.09.28.97.711.714.312.916.013.512.8
Income- and expense-based FSIs
Interest margin to gross income48.360.862.267.765.363.664.363.165.666.766.669.968.2
Noninterest expenses to gross income64.264.263.256.857.956.157.553.954.753.653.949.551.1
Source: National Bank of Cambodia.

Annualized.

Source: National Bank of Cambodia.

Annualized.

Table 8.Cambodia: Key 2010 FSAP Recommendations of High Priority
RecommendationTimeframe 1/Status
General Stability
· Improve the quality of data to enable an appropriate assessment of risks, and to enhance the reliability of stress tests, including through strengthening supervision; and collecting additional credit-related information.Short termIn process
· Ensure that banks retain an appropriate level of liquid assets to be able to meet short-term obligations by enforcing existing regulations.Short termIn process
· Upgrade law to formalize delineation of responsibilities among supervisors, and establish procedures, through MOUs, for practical information exchange, coordination and accountability among domestic supervisors (NBC, MEF, SECC), and with foreign supervisors.Short termInitiated but not concluded
· Upgrade both the number and capacity of staff in the areas of banking, insurance, securities and payment system supervision; develop training programs for financial institutions on accounting, corporate governance, risk management, and for the external audit profession.Medium termIn process
· Develop and implement a strategic plan to address the conflicts and overlaps in the financial sector legal and regulatory framework.Medium termIn process
Supervision and Regulation
Banking
· Develop supervisory strategy to deal with banks that cannot meet the new capital requirement.Short termDone
· Conduct comprehensive upgrades to the legal framework.Short termIn process
· Reprioritize the work performed by the staff to facilitate forward-looking, risk-based supervision.Short termIn process
· Impose a moratorium on new bank licenses as long as supervisory capacity and resources remain inadequate.Short termUnder NBC review
Nonbank Financial Sector
· Revise capital regulations in concert with liability, investment and accounting rules to better reflect the risks in a growing insurance market.Short termDone
· Enhance powers for intervention, corrective measures and enforcement.Short termIn process
· Conduct a readiness study prior to the launch of the stock exchange.Short termDone
Access to Finance
· Enhance supervisory practices to keep pace with the development of microfinance deposit-taking institutions, and impose a moratorium as long as supervisory capacity and resources remain inadequate.Medium termIn process
Crisis Management Framework
· Revise PCA framework by developing additional triggers for asset quality, liquidity, and earlier intervention based on the solvency ratio.Medium termIn preparation
· Introduce regulation allowing banks to use their fixed deposits at the NBC and any issue of government (including government bodies) or government-guaranteed securities as eligible collateral for interbank and NBC repos.Short termDone
· Develop a crisis management framework.Medium termIn preparation
Transparency of Monetary and Financial Policies
· Introduce due process for the dismissal of NBC Board members and the Governor by specifying the legal grounds for doing so, and defining an appeal process.Medium termIn preparation
· Amend the law to reduce the government’s representation on the Board of the NBC; and to reflect the practice of appointing two Deputy Governors.Short termIn preparation
Corporate governance of banks
· Draft and/or implement banking regulations on internal audit and controls, risk management, and compliance functions at banks.Short–termDone
AML/CFT
· Introduce new measures for conducting overall AML/CFT risk assessments and risk profiling of financial institutions.Short–termIn preparation

Short term: up to one year; medium term: one to three years.

Short term: up to one year; medium term: one to three years.

14. Multi-pronged approach. Although low inflation and below potential growth do not point to an immediate need to tighten monetary policy—via higher reserve requirements—especially in light of the continued fiscal consolidation and recent deposit withdrawals, steps on multiple fronts are needed to contain macro financial risks and safeguard financial stability.

  • More targeted supervision of liquidity risks would improve the resilience of the system against potential deposit withdrawals or sudden reversal of foreign funding, especially in the absence of a formal interbank market. The broad definition of the liquid asset ratio (LAR) overstates true liquidity conditions, as the recent experience highlighted, and calls for better monitoring of truly useable liquidity buffers.3 This should be complemented with contingency plans by banks and the NBC to address potential liquidity pressures, including by expediting the planned revision of standing facilities4 and improving liquidity forecasting in line with recent MCM TA. In this context, the recent swap agreement with the Bank of International Settlements would provide more room (US$200 million) to respond to liquidity shocks.
  • Fully enforcing the reserve requirements to include bank funding from abroad in the reserve base would help contain credit growth and improve monetary control. This should be accompanied by close monitoring of maturity mismatches for early signs of increasing rollover risks. Should expansion of required reserve base prove insufficient to contain credit growth, consideration should be given to introducing LTD ratio limits as well as higher risk provisioning for new loans, especially for high risk sectors.
  • Better monitoring of real estate sector developments is needed, including by strengthening reporting requirements for all construction activity and real estate sales. Should recent price and activity trends intensify, the NBC could introduce LTV limits, especially in fast growing segments of the real estate market. The proliferation of shadow banking activities by real estate developers calls for strengthening their regulation, including for licensing and reporting of funding sources.

Box1.Financial Sector Developments and Risks

Cambodia has witnessed a fast paced financial deepening in recent years. Credit-to-GDP ratio has nearly doubled in the last three years, surpassing peers and diverging from past trends of sustainable financial deepening. In addition, intensifying competition for market share has increased banks’ risk appetite, especially for smaller and mid-sized banks which expanded faster from a relatively small base, potentially deteriorating quality of loan portfolios. Despite fast credit growth, financial access remains limited to about 12 percent of the population suggesting more exposure to a relatively small group of creditors, intensifying concentration risks.

Entry of new banks has accelerated credit expansion. Foreign banks that started operations since 2011 contributed to more than one-third of total new lending in 2012, often with funding from abroad, which tripled in 2012 and unlike domestic liabilities is not subject to reserve requirements, the only monetary policy tool.

Rapid credit growth amid a shifting funding structure compounds potential liquidity risks. Domestic deposit growth has not kept pace with credit growth. As a result, excess reserves as a share of deposits have gradually declined from their peak of 30 percent (mid-2010) to around 10 percent in recent months, notwithstanding the dip due to recent deposit withdrawals. In the process, the loan-to-deposit (LTD) ratio trended upwards to over 100 percent, a level considered high even by emerging market standards.

Fast expansion of the real estate sector point to emerging financial stability risks. Although the lack of reliable housing price data constraints a complete analysis, land prices have increased by over 10 percent (yoy) and loans to construction and real estate grew by over 44 percent (yoy) in September; imports of construction materials surged and construction approvals for residential units alone quadrupled in 2012, and loan-to-value ratios (LTV) are showing an upward drift from 60–70.

Proliferation of real estate financing from the shadow banking system adds to overall risks. Some real estate developers are reportedly offering real estate loans at competitive interest rates, effectively competing with banks. However, their funding sources remain largely obscure and beyond regulatory and supervisory oversight. Although the younger demographics and a rising middle class would support some demand growth, supply lags and exuberance often lead to the overshooting of construction booms, as experienced by many economies.

The authorities broadly agreed with staff’s assessment and indicated their plans to revisit the definition of LAR. They also noted that large excess reserves reflected precautionary motives by banks and proved useful during the deposit withdrawals. However, they preferred continued monitoring of foreign bank flows and credit growth before taking further measures, including enforcing reserve requirements on foreign funding and requested TA in macroprudential measures, such as LTDs and LTVs. They shared concerns regarding weaknesses in monitoring real estate developments, which requires coordination among several agencies (e.g. MEF and Ministry of Land) to support NBC’s efforts to improve real estate data collection.

15. Interbank and foreign exchange markets. The introduction of negotiable certificates of deposit (NCDs) by the NBC both in U.S. dollar (USD) and Khmer Riel (KHR) is a first step toward developing the interbank market and laying the groundwork for market-based monetary policy operations.5 Subscriptions have been limited so far, partly due to deposit withdrawals and reportedly unattractive pricing. Further consultations with the banking community would be needed to improve their attractiveness, including by differentiating their pricing from that of NBC’s deposit facility. Although exchange rate stability has been a hallmark for sustaining demand for domestic currency, going forward, the development of money and foreign exchange markets should allow for more exchange rate flexibility. In this regard, encouraging state-owned enterprises to source their foreign currency from commercial banks instead of the NBC would also help catalyze market development. Finally, the NBC is preparing to conduct a dollarization survey to help formulate policies to promote the use of local currency. The authorities noted that the NCDs would require time to be widely adopted by the banking sector. They also emphasized the importance of exchange rate stability for maintaining the demand for domestic currency, and considered establishment of interbank and foreign exchange markets as a prerequisite to more effectively address dollarization in the medium term.

16. Risk-based supervision. bold NBC’s on-site supervision is increasingly relying on risk-based targeted inspections rather than full-scale examinations.6 In view of the limited supervisory resources, focusing on emerging risks and strengthening internal training would improve supervisory effectiveness. In this regard, stepping up efforts in monitoring LTV ratios, underwriting and valuation standards for real estate and construction loans would be important, as well as concentration, related party and credit risks, to preempt excessive risk taking. Improving the quality of off-site supervision by enhancing the analytical skills and improving data quality will also be vital in strengthening banking supervision. The emergence of nonresident loans and deposits also warrants close monitoring, including for AML/CFT purposes. In March 2013, the authorities adopted the AML/CFT national strategy, which sets out a 5-year action plan to address the deficiencies identified by the Financial Action Task Force (FATF).

17. Supervisory capacity. Despite continued improvement through recruitment, training, and TA, rapid expansion of the banking system, including through three new bank licenses in 2012, and the transition to risk-based supervision has continued to put additional burden on the already stretched supervisory capacity. In this context, the 2010 FSAP recommendation of imposing moratorium on new bank licensing remains appropriate. The authorities indicated that implementing a formal moratorium may signal a closed-door policy to investors, but they recognized the capacity constraints and reiterated their commitment to maintain a tight stance on new bank licensing and encourage potential applicants to merge with existing banks.

18. Crisis prevention and management. Strengthening the financial crisis management framework is critical in managing systemic risks and minimizing potential fiscal costs. In February, the NBC, the MEF, and the Securities Exchange Commission of Cambodia (SECC) signed a Memorandum of Understanding (MoU) on establishing a policy level Working Group (WG), which also led to the formation of a technical Core Team (CT). Going forward a two track and time-bound approach should target strengthening coordination for crisis prevention and signing of a second MoU on crisis resolution: while the CT explores the types of risk-appropriate joint vulnerability exercises and the information sharing needs, the WG should focus on identifying and clarifying the responsibilities of respective agencies in preventing and resolving crisis. In return, these deliberations should inform the role of respective agencies in the joint vulnerability exercises, identify further areas for analysis, and help develop contingency plans. In parallel, the NBC should expedite improvements to the Prompt Corrective Action framework in line with FSAP recommendations. The authorities agreed with the urgent need to establish a crisis management framework and reiterated their commitment to move forward with the process. As a first step, with TA support from the World Bank, they plan to discuss a draft memorandum on crisis management among the agencies.

C. Promoting Competitiveness and Inclusive Growth

19. Context. Cambodia has made good progress in achieving the Millennium Development Goals (Table 9). Rapid growth in the past decade contributed to a substantial decline in poverty from about 50 percent in 2007 to around 21 percent in 2011. However, a large segment of the population continues to live near the poverty line and growth continues to rely on a narrow economic base, contributing to economic vulnerability. Efforts to increase value-added and diversify the economy remain constrained by low education levels and skill shortages, as well as infrastructure bottlenecks and weaknesses in business climate. On the other hand, the relatively open trade and investment regime and proximity to other ASEAN countries point to a high potential in terms of trade and inward investment. Early signs of manufacturing diversification are evident in recent FDI trends, which is likely to be reinforced with the implementation of Asian Economic Community in 2015 and supported by increased electricity supply and multinational firms’ efforts to diversify their supply chains. Against this background, the authorities noted that promoting competitiveness and improving human capital as well as further reducing poverty and inequality remain the top priorities in their recently adopted RS III to sustain inclusive growth.7

Table 9.Cambodia: Millennium Development Goals (MDG) Indicators
199019952000200520092010201120122015

MDG

Target
Goal 1: Eradicate extreme poverty and hunger
Percentage share of income or consumption held by poorest 20 percent8.5811
Population below minimum level of dietary energy consumption (percent)3321
Poverty gap ratio at $1 a day (incidence x depth of poverty)
Poverty headcount ratio at $1.25 per day (PPP, percent of population)49401920
Poverty headcount ratio at national poverty line (percent of population)53242221
Prevalence of underweight in children (under five years of age)4340282926
Goal 2: Achieve universal primary education
Net primary enrollment (percent of relevant age group)6787909698100
Primary completion rate, total (percent of relevant age group)424785848790100
Proportion of pupils starting grade 1 who reach grade 5635585100
Youth literacy rate (percent of ages 15–24)7376798387100
Goal 3: Promote gender equality and empower women
Proportion of seats held by women in national parliament (percent)8102121202030
Ratio of girls to boys in primary and secondary education (percent)7382100
Ratio of young literate females to males (percent ages 15–24)8184899097100
Share of women employed in the nonagricultural sector (percent)41
Goal 4: Reduce child mortality
Immunization, measles (percent of children ages 12–23 months)3462657992939390
Infant mortality rate (per 1,000 live births)8787807342393650
Under five mortality rate (per 1,000)1191191079650464338
Goal 5: Improve maternal health
Births attended by skilled health staff (percent of total)32447180
Maternal mortality ratio (modeled estimate, per 100,000 live births)450540206250
Goal 6: Combat HIV/AIDS, malaria, and other diseases
Incidence of tuberculosis (per 100,000 people)585557530505451437424
Prevalence of HIV, total (percent of population 15–49)2111
Goal 7: Ensure environmental sustainability
Access to an improved water source (percent of population)01938636567
Access to improved sanitation (percent of population)0816303233
Nationally protected areas (percent of total land area)242626
Goal 8: Develop a global partnership for development
Aid per capita (current U.S. dollars)4503139515154
Fixed line and mobile phone subscribers (per 100 people)00184560100136
Internet users (per 1,000 people)0031135
Personal computers (per 1,000 people)013
Total debt service (percent of exports of goods and services)111111
Goal 9: De–mining, UXO and assistance
Annual numbers of civilian casualties recorded1,6917972442862402400
Percentage of suspected contaminated areas cleared105053595656100
Other
Fertility rate, total (births per woman)6543333
GNI per capita, Atlas method (current U.S. dollars)280280450690740800880
GNI, Atlas method (current, in billions of U.S. dollars)3.23.66.210111213
Gross capital formation (percent of GDP)8151818211717
Life expectancy at birth, total (years)5058626363
Literacy rate, adult total (percent of people ages 15 and above)62646874
Population, total (millions)1011131414141515
Trade (percent of GDP)1978112137105114114
Sources: World Bank database, World Development Indicators, and Poverty Assessment (2009); UN Human Development Indicators. Report (2003); Cambodia MDG 2011 update; UN MDG Indicators 2011 (http://mdgs.un.org); and IMF staff estimates.
Sources: World Bank database, World Development Indicators, and Poverty Assessment (2009); UN Human Development Indicators. Report (2003); Cambodia MDG 2011 update; UN MDG Indicators 2011 (http://mdgs.un.org); and IMF staff estimates.

20. Promoting competitiveness. Cambodia’s competitiveness has improved over time, but it remains concentrated around low value-added garment and agricultural products due to relatively low wages and productivity (Box 2). Going forward, this alone would not be sufficient to sustain growth. In order to accelerate diversification and improve competitiveness, continued improvements in human capital, including through education and training, infrastructure, and the business climate are needed. In this regard, the reform agenda by the Ministry of Commerce to reduce the regulatory burden for businesses while improving governance and accountability of government agencies (including by strengthening the anti-corruption and AML frameworks) would ease constraints on doing business. Increasing agricultural productivity and further improving rural infrastructure will also help increase competitiveness in agriculture.

21. Improving human capital. Cambodia has made substantial progress in education access, but there is room to improve education outcomes, which is essential to move up the value-added chain and make growth more inclusive (Box 3). The increase in education spending in the 2014 budget, partly reflecting higher teacher salaries will help contribute to human capital development. Nonetheless, Cambodia’s public spending on education is low relative to peers, but the room to increase spending by relying solely on budgetary resources is limited. Therefore, the near term priority should be improving efficiency and reallocating spending within the budget envelope. A new initiative, such as establishing a national training fund, could be considered over the medium term, but this would require successful implementation of public finance reforms, particularly by improving tax administration and spending efficiency.

22. Data statistics. Improving the quality and timeliness of economic and financial data would facilitate better formulation of macroeconomic policies and informed decisions by the private sector. In view of the increasing foreign funding of the private sector, including through the banking system, the authorities should start collecting data on private sector debt to monitor and address the associated risks.

Box 2.Cambodia’s Export Competitiveness and the Implications of AEC 2015

Cambodia’s export-led growth model presents an opportunity to benefit from the ASEAN Economic Community (AEC) if exports can be diversified. Exports contributed on average more than 50 percent to Cambodia’s GDP growth over the past decade and are expected to remain the key driver of growth going forward. While the United States and the European Union (EU) are the primary destinations for Cambodia’s main export item, garments, total exports to ASEAN have also grown substantially over the last decade accounting for 12 percent of the country’s total exports at end-2012. Rubber and woods are the main export products to ASEAN, and represent ½ and about 3 percent of the region’s total imports of these commodities, respectively. Although, the elimination of tariffs and nontariff barriers by 2015 could help enlarge Cambodia’s markets for these products initially, the existing trade structure points to the need to diversify exports for further trade expansion.

Cambodia’s comparative advantage is concentrated in a few types of products, most of which have low value-added. Compared to the rest of ASEAN, Cambodia’s exports is the second least diversified, only after Brunei. Based on revealed comparative advantage indices, Cambodia has strong comparative advantage in world markets in ready-to-wear garments, wood, and footwear, mainly due to its relatively low wages. These products constitute only a small share of ASEAN’s imports limiting the benefits from market expansion, while recently increasing market share in vegetables and rubbers point to better prospects in regional markets. The product space analysis also indicates that Cambodia’s opportunity to expand its currently competitive export products into new clusters remains a challenge as garments and vegetables do not have close connectivity with other higher income-potential products.

However, AEC could become a catalyst in diversifying Cambodia’s production and moving toward a higher income potential export base. Cambodia’s central location within ASEAN could help attract FDI in more diversified manufacturing to have tariff-free access to regional markets as well as to Everything but Arms initiative of the EU, while benefiting from low wage advantage. The ongoing diversification of regional supply chains could also help increase FDI in search for tariff-free access to a larger ASEAN market. Early signs of this trend have already emerged with rapid growth of FDI in nongarment sectors.

Contribution to FDI growth by Sector, 2011-12*

(In percent)

* The data is FDI flows by approval and excludes large power plant projects.

Sources: Data provided by the authorities.

Addressing infrastructure bottlenecks and labor skill gaps while improving the business climate are essential to realize the potential benefits from AEC 2015. While macroeconomic and financial stability remain essential to reap the benefits from larger regional markets, leveraging Cambodia’s central location within ASEAN would require improving transportation infrastructure, power supply and trade facilitation. Although the free movement of skilled labor may in the short term address skill gaps— often cited as an impediment for industrial diversification— it also poses risks of losing already scarce skilled labor to more attractive labor markets in the region, highlighting the need for continuous improvements in human capital through education and training. Improving the business climate, including by reducing impediments for doing business would also help make Cambodia a more attractive destination for investment to benefit from market expansion.

Box 3.Cambodia: Fiscal Policies for Human Capital Development

Cambodia has made substantial progress in improving education, but there is scope to catch up with peers. Despite increasing school enrollment and literacy rates and declining pupil teacher ratios in the last decade, further efforts are needed to improve education outcomes. Business surveys indicate that skill shortages and mismatches continue to hamper industrial upgrading, private investment, and economic diversification. Cambodia’s public spending on education, including grants, has been broadly constant at about 2½ of GDP for the past five years, lower than in peers.

Raising labor productivity and providing adequate resources for education within a limited fiscal space pose challenges. Cambodia has relied on low skilled manufacturing and services to support its growth. As the country develops toward an emerging market economy, it will have to rely on more sophisticated production processes and high-skilled labor force to sustain its rapid growth and compete in global markets. However, the room to increase education spending by relying solely on budgetary resources is limited. Over the medium term the challenge is to balance the need to rebuild fiscal buffers to maintain fiscal sustainability, while providing room for more spending on education and maintaining adequate capital spending as grants decline.

Selected Asia: Education Indicators

Source: World Bank’s World Development Indicators.

Public Spending on Education, 2009–11

Source: World Bank’s World Development Indicators.

Given the budgetary constraints, the near-term priority would be reallocating resources within the budget envelope, improving spending efficiency, and securing more donor support for education. For example, the World Bank public expenditure review (2011) indicates that improving efficiency in health spending could generate some savings that can be used for other priority spending. Improving education quality without relying on additional resources, such as targeted programs to reduce dropout rates, strengthening program budgeting for education, and providing schools with greater autonomy to manage spending while holding them accountable for outcomes, would play an important role. Cambodia’s spending efficiency for primary school enrollment is broadly comparable to its peers, but the scores for secondary school enrollment are lower, suggesting that any efforts to raise spending efficiency in secondary education could improve education outcomes as well.1

Over the medium term, new initiatives such as establishing a national training fund (NTF) could be considered to provide additional resources for training and skill development. NTFs in many countries are financed by enterprises, such as through taxes earmarked for training, although some may also be financed by public subsidies or donors. The earmarked-taxes are commonly based on payroll, and may include incentive schemes such as cost reimbursement, grants, and tax exemption or rebate, if firms provide training. In this context, the NTF requires sufficient administrative capacity and sound tax administration. In addition, the NTF is not a substitute for formal education and should not crowd out resources allocated to formal education or generate disincentives to formal education.

Successful implementation of public finance reform program would play a critical role in supporting human capital development. This would include enhancing revenue administration to provide more fiscal space, reallocating spending within budget envelope to human capital development, improving spending efficiency and effectiveness, and preparing the capacity to establish a training fund over the medium term.

1/ Herrera and Pang (2005) World Bank Policy Research Working Paper 3645.

Staff Appraisal

23. Economic setting. Economic activity remains strong driven by robust exports, tourism, and construction despite recent floods and some slowdown during the election. Growth is projected to pick up to 7¼ percent in 2014 and reach 7½ percent over the medium term along with global recovery, improvements in infrastructure, competitiveness, and investment climate. Inflation is expected to remain low in 2013–14 due to stable food and fuel prices. The external position is stable notwithstanding a declining reserve coverage of foreign currency deposits, and the real effective exchange rate appears to be in line with fundamentals.

24. Risks and policy response. The U.S. tapering and slow European growth could expose Cambodia’s favorable outlook to downside risks. On the domestic side, rapid credit growth and emerging risks in a fast changing financial landscape could undermine financial stability; extreme weather conditions could affect agriculture and growth, and labor market instability could disrupt garment production and exports. Should these downside risks materialize, low fiscal buffers would require any additional expenditure to be allocated to high-impact development spending.

25. Past recommendations. The progress made by the authorities in implementing past Article IV recommendations is welcome. They have improved revenue collection, formulated a revenue mobilization strategy, and strengthened public financial management, including improving the monitoring of contingent liabilities. They have also introduced NCDs to help develop the interbank market, improved financial supervisory capacity, and established an initial MoU to establish a financial crisis management framework. Continuous progress in many of these areas remains necessary and is reflected in the priorities of this Article IV consultation.

26. Fiscal policy. The strong fiscal performance has continued, driven by substantial improvement in revenue collection and prudent spending. Fiscal consolidation should continue to rebuild government deposits—the only fiscal buffers—in view of the expected decline in grants, to maintain long-term fiscal and debt sustainability, including by making the planned wage increases in 2014 a part of a broader civil service reform. Successful implementation of revenue mobilization strategy and careful management of contingent liabilities are needed to rebuild and safeguard the fiscal space. Continuing with public financial management reforms remains important to improve fiscal accountability and transparency.

27. Macro financial policies. Rapid credit growth, increasing foreign bank financing and the buoyancy of the real estate and construction sectors pose substantial macro financial risks especially in light of high dollarization, which limits monetary policy effectiveness and lender-of-last resort capacity. Steps on multiple fronts are required to contain credit growth and safeguard financial stability. Strengthening liquidity supervision and redefining the LAR to better capture banks’ true liquidity conditions will improve their resilience to shocks. Fully enforcing the reserve requirements to include foreign funds in the reserve base would help contain credit growth. Should this fail to slow credit growth macro prudential measures such as LTVs and LTDs could be considered. Better monitoring of real estate developments, by collecting more data including on developer financing, is also needed to contain risks. Finally, the introduction of NCDs is a welcome first step toward market-based monetary operations. Going forward establishing an interbank and foreign exchange market would be needed to begin addressing dollarization, including by allowing more exchange rate flexibility.

28. Financial supervision. The transition to risk-based supervision and the rapid expansion of the banking system continued to put additional burden on the supervisory capacity, and in this context, the 2010 FSAP recommendation of imposing a moratorium on new bank licenses remains appropriate. In view of the limited resources, focusing on key emerging risks would improve the supervisory effectiveness. Strengthening the financial crisis management framework is critical in managing systemic risks and minimizing potential fiscal costs. The signing of an initial MoU between supervisory agencies is welcome, and should be used to enhance cooperation at the policy and technical levels, and expedite preparation of a second MoU on crisis resolution.

29. Diversification and inclusive growth. Cambodia has made good progress in achieving the Millennium Development Goals and reduced poverty substantially. Continued improvements in human capital, including through education and training, infrastructure, and business climate are needed to promote inclusive and sustainable growth and further reduce poverty and income inequality. Plans to reduce regulatory impediments to doing business are welcome, while improving education outcomes to catch up with peers would take longer term efforts. Given the budgetary constraints, the near term priority would be improving efficiency and reallocating spending within the budget envelope. New initiatives, such as establishing a national training fund, could be considered over the medium term following the successful implementation of PFM reforms.

30. Arrears. Good faith efforts to resolve external arrears are welcome and should continue.

31. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

1The exchange rate regime is classified as other managed. The CGER estimates show that the exchange rate is broadly in line with fundamentals, although being subject to large measurement errors, given weak data, rapid structural change, and high degree of dollarization. The macroeconomic balance approach shows 3 percent overvaluation while the equilibrium real exchange rate approach indicates 10 percent overvaluation. However, the external sustainability approach suggests the exchange rate is broadly in line with the norm. The current account norm is estimated at around 5 percent of GDP over the medium term, broadly in line with projections. The reserve adequacy estimates range from 2 to 10 months of imports depending on the cost of holding reserves.
2The Debt Sustainability Analysis confirms Cambodia’s low risk of debt distress.
3The LAR is defined as the ratio of liquid assets to weighted deposits, where the liquid assets include cash and gold, net deposits with banks and NBC, including required and excess reserves, and net loans within one month of maturity. Some of these assets are not readily available on call.
4With TA support from the World Bank, the NBC is planning to re-launch the existing overdraft facility as a standing facility to meet short term liquidity requirements.
5The maturities range from 2 weeks to one year with interest rates equal to those on NBC’s deposit facilities.
6By October in 2013, the NBC has completed on-site inspection of 13 banks including top five banks; five are rated as “satisfactory”, and eight are “fair” according to a rating scale of good, satisfactory, fair, unsatisfactory and poor.
7The RS III, which serves as a framework for the 2014–18 national development plan, emphasizes four priorities: (1) developing human resources to ensure competitiveness; (2) developing physical infrastructure and improving trade facilitation; (3) promoting agriculture, including crop, livestock, fisheries, and agro-industry, and (4) strengthening governance and capacity of public institutions.

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