1. On behalf of the Cambodian authorities, we would like to express our gratitude to the IMF mission team for the constructive discussions and exchange of views on macroeconomic developments and policy recommendations for the Cambodian economy. In particular, the authorities appreciate the discussions on the need for reinforcing fiscal buffers, strengthening monetary policy instruments and the transmission mechanism, as well as enhancing supervisory practices, which would all contribute towards a more sustainable economic growth for Cambodia. The authorities are in broad agreement with staff’s assessment and would take staff’s policy recommendations into consideration when formulating future policies.
Recent Economic Development and Outlook
2. Cambodia has achieved a remarkable average annual growth rate of 7.7 percent in the last two decades. The 2014 World Bank Economic Update acknowledged that “Cambodia has joined the Olympians of growth” and is the sixth fastest growing economy in the world. Cambodia is also one of the largest recipients of foreign direct investment (FDI) and a top exporter of textiles. This strong growth has been accompanied by a significant decline in poverty from around 53 percent in 2004 to 18 percent of population in 2013. Cambodia is also one of a few countries that have outperformed the United Nations’ Millennium Development Goals (MDGs) on poverty reduction and other social indicators before its 2015 deadline. The authorities are determined to transform Cambodia from a low income country to a low-middle income country by 2016 and a middle income country by 2030.
3. In recent years, Cambodia’s economic growth has been one of the fastest among Asia’s developing economies. After recording an annual average growth rate of 7.2 percent over the last five years, the growth momentum is expected to remain strong at 7 percent and 7.3 percent in 2015 and 2016, respectively. This solid growth will continue to be underpinned by strong exports and tourism, as well as robust real estate and construction activities. Strong FDI flows are also expected to be sustained. The return of domestic political stability after a year-long political deadlock and the easing of labor tensions following the 2014 minimum wage increase are also expected to support growth.
4. Headline inflation is low and has decelerated by nearly half of what it was in 2014, from 3.9 percent to 2.6 percent in 2015, due mainly to the sharp decline of global oil prices and appreciation of the real effective exchange rate (REER). Over the medium-term, headline inflation is projected to average around 3 percent.
5. On the external front, the current account deficit is expected to gradually narrow, falling to 10 percent of GDP in 2015 from 12 percent of GDP in 2014, mainly due to the decline in oil prices. Despite the US dollar appreciation, the REER has remained relatively stable and as assessed by staff, is in line with fundamentals. Gross official reserves remain ample at to US$4.7 billion at end-August 2015, covering four months of prospective imports. Although this level of reserves is considered sufficient, the authorities agree on the merits of building more reserves buffer. The authorities also share a similar assessment on the impact of recent oil price developments on the current account and the slowdown in garment exports. However, over the medium-term, the authorities are optimistic on sustained FDI flows and are committed to prioritizing public investment, diversifying the economy through structural reform, enhancing the business environment and competitiveness, and fostering a more inclusive growth.
6. The authorities share the staff’s view that the outlook is broadly positive but subject to downside risks, particularly on the external front. The slow recovery in Europe and the appreciation of the US dollar have contributed to a moderate growth in the tourism sector and stronger competition in garment exports, while the weaker-than-expected growth in China has created spillovers through FDI, banking and tourism channels. These developments warrant further reforms to ensure economic diversification and macro-financial stability.
7. The stable exchange rate against the US dollar continues to serve as an important nominal anchor, keeping inflation low and stable. Nevertheless, the authorities are fully committed to developing the interbank and money markets as well as foreign exchange markets to promote the use of the local currency (Khmer Riel) and allow for a more effective and flexible monetary framework. In managing dollarization, the National Bank of Cambodia (NBC) and the authorities have recently developed policies and action plans to support market-based monetary policy, promote the greater use of the local currency, and reduce dollarization in the long term.
8. The authorities have tightened monetary policy by increasing the reserve requirements (RR) by 50 basis points to 12.5 percent in 2012. In 2013, in line with the Fund’s past recommendations, the NBC issued negotiable certificate of deposits (NCDs), both in US dollar and Khmer Riel (KHR), to help develop the interbank market. This has also helped to facilitate banks’ liquidity management and market-based monetary policy operations. In addition, the expansion of reserve requirements to cover banks’ foreign borrowing was instituted in March 2015, in line with the Fund’s recommendation.
9. The authorities concurred that Cambodia has experienced an increase in financial deepening, with credit growing more rapidly than in peer Asian economies during their take-off period. Credit growth remains in line with Cambodia’s level of development and the required diversification of the economic base. Moreover, despite the strong credit growth, it is important to note that the core financial soundness indicators are healthy and credit quality remains sound. Credit has also been to a large extent directed to productive sectors to support the country’s development and facilitate economic growth. Nevertheless, the authorities recognize that this rapid credit growth and the growing exposure to real estate and construction sectors represent a potential pocket of vulnerability to financial stability. Mindful of these risks, the authorities have introduced several measures to reign in credit growth, including increasing in the reserve requirements. Going forward, the authorities will continue to closely monitor the developments on this front and remain committed to implement prudent policies to stabilize credit growth and maintain a strong financial system. The authorities are, however, mindful of the impact of these measures on growth.
10. The supervision framework has been strengthened and data collection has improved in recent years, with technical assistance from the Fund. The authorities are aware that Micro-finance institutions (MFIs) are becoming more systemic and have stepped-up efforts to enhance the supervision framework for MFIs and stand ready to implement prudential measures if necessary. In strengthening the supervision and regulation of MFIs, the NBC remains committed to a risk-based approach that is consistent with the FSAP recommendations. The recent revision of the liquidity ratio requirements also remain in line with the recent Fund technical assistance advice and previous Article IV recommendations. In strengthening collaboration and crisis management frameworks, a Memorandum of Understanding (MoU) on establishing information sharing was signed between the Ministry of Finance, the NBC and Securities Exchange Commission of Cambodia (SECC) in 2014. The NBC continues to provide internal and external training for its staff in order to enhance capacity and quality of bank supervision. However, given its limited capacity, the NBC welcomes further technical assistance from the Fund to strengthen capacity building.
11. Overall, the NBC continues to closely monitor the financial system for any signs of emerging risks that may arise from the rapid credit growth and stands ready to strengthen the prudential and supervisory measures on banks, MFIs and other credit intermediaries. The authorities recognize the importance of safeguarding the financial system from the potential impact of slower global growth and are committed to working closely with the Fund on identifying risks, improving data collection and enhancing the crisis resolution frameworks for the financial sector.
12. The fiscal deficit has been reduced to 1.3 percent of GDP in 2014 from 2.1 percent in 2013, supported by stronger revenues and lower capital spending. Tax revenues have increased robustly by 2.2 percentage points of GDP to 13.9 percent in 2014, due mainly to the authorities’ recent adoption and enforcement of the Revenue Mobilization Strategy (RMS) as well as improved tax and customs administration. Further, in order to strengthen fiscal buffers, the authorities are determined to prioritize expenditure and strengthen revenue mobilization and governance.
13. In the near term, the budget deficit is projected to moderate further, consistent with the economy’s cyclical position. The authorities have committed to the wage bill increase equivalent to 0.7 percent of GDP by 2016, to be supported by the higher-than-expected revenues collection and expenditure prioritization. Nevertheless, the authorities aim to limit the wage bill to less than 50 percent of current expenditure in order to allow for more capital expenditure for infrastructure investment. The authorities will also expedite civil service reforms in order to increase efficiency and productivity.
14. The authorities have been continuously working on improving the monitoring of contingent liabilities. In addition, the debt management committee has recently revised the debt policy framework, which now includes a ceiling on government guarantees at 4 percent of GDP. The authorities have also designated a contingency fund account for contingent liabilities related to enterprises in the power sector. The authorities remain strongly committed to the implementation of the RMS, and recognize the need to rationalize investment incentives and review other tax policies over the medium term.
15. The Debt Sustainability Analysis indicates that Cambodia’s risk of debt distress is low, while public debt continues to decline. The authorities remain committed to reducing the fiscal deficit and maintaining the debt-to-GDP ratio below 30 percent over the medium term to ensure debt sustainability and to secure stronger fiscal buffer over the longer term.
Continuing the Reform Agenda
16. Cambodia’s strong growth performance has significantly improved income distribution and the consumption-spending by the bottom income quartile continues to increase. In addressing structural bottlenecks, the authorities remain committed to implementing public investments on roads, railways, bridges and irrigation to further promote rural and inclusive growth. Public investment in these infrastructure projects will also help crowd in private investment. The recent completion of the 1,300 megawatt hydropower projects will provide affordable electricity to the general population and enhance Cambodia’s business climate and competitiveness. Encourage by the improvements in maternal health, early childcare and primary education in the rural areas, the authorities will continue to prioritize the development of education and healthcare, especially in the rural areas.
17. Over the medium term, robust economic growth supported by exports, tourism and construction activities have worked in favor for Cambodia’s economic prospect. However, lingering global uncertainty and the planned slowdown in China’s economic growth could pose downside risks to Cambodia’s growth outlook. The authorities are committed to preserve macroeconomic and financial stability in order to ensure sustainable growth and stand ready to implement any available measures as deemed appropriate.
18. Finally, the authorities would like to express their appreciation to the Fund for its continuing support in providing high-quality technical assistance which has resulted in a broad base strengthening in capacity across the Cambodian government. The authorities will continue its efforts to further improve the macroeconomic framework in line with the Fund’s policy recommendations and look forward to continuing support from the Fund.