Cambodia
Recent Economic Developments

This paper discusses major economic developments in Cambodia in 1997. It discusses developments in the real sector and factors accounting for output growth, estimated at 2 percent in 1997, down from 6½ percent in 1996. The paper analyzes developments affecting inflation during the year, examines public finance, and highlights the persistent problems with revenue collection that, together with overspending on the military budget, led to a squeeze in civilian nonwage expenditure. The paper also analyzes monetary and financial sector developments.

Abstract

This paper discusses major economic developments in Cambodia in 1997. It discusses developments in the real sector and factors accounting for output growth, estimated at 2 percent in 1997, down from 6½ percent in 1996. The paper analyzes developments affecting inflation during the year, examines public finance, and highlights the persistent problems with revenue collection that, together with overspending on the military budget, led to a squeeze in civilian nonwage expenditure. The paper also analyzes monetary and financial sector developments.

I. Introduction

1. The Cambodian economy was predominantly a centrally planned economy from the early 1980s until the signing of the 1991 Paris Peace Accord. Although attempts at reform started modestly in 1985, they gathered momentum after 1992, when reform was supported by the Fund, first under the Systemic Transformation Facility and later under the Enhanced Structural Adjustment Facility (ESAF). Progress has been made in moving toward a market economy, with state-owned enterprises now accounting for less that 10 percent of GDP. In 1997 the authorities adopted their first Socio-Economic Development Plan for 1996-2000 with a view to consolidating the progress achieved and remedying persisting major socioeconomic problems. However, with an estimated annual per capita income of about $300 in 1996, Cambodia remains one of the poorest countries in the world.

2. This report briefly discusses major developments in 1997 and updates the statistical tables included in last year’s report on recent economic developments.1 During the first months of 1997, macroeconomic performance was broadly in line with the second-year ESAF program, but the situation deteriorated markedly in the aftermath of Second Prime Minister Hun Sen’s seizure of power in July and the regional financial crisis. The effects of the political crisis seem to have been much stronger than those of the regional financial crisis as they undermined growth and investors’ confidence. Cambodia’s high degree of dollarization mitigated to a large extent the short-term impact of the unfolding regional crisis because the riel depreciated less than other currencies in the region and its limited use minimized the impact of the depreciation on the economy.

3. Chapter II discusses developments in the real sector and factors accounting for output growth, estimated at 2 percent in 1997, down from 6½ percent in 1996. The chapter also analyzes developments affecting inflation during the year. Chapter III deals with public finance and highlights the persistent problems with revenue collection which, together with overspending on the military budget, led to a squeeze in civilian nonwage expenditure. Chapter IV discusses monetary and financial sector developments and notes that, in Cambodia’s highly dollarized economy, monetary policies of the central bank—the National Bank of Cambodia (NBC)—were confined to containing bank financing of the budget. The NBC’s efforts to improve banking regulations and supervision are also discussed. Chapter V focuses on external sector developments that led to a decline in the current account deficit and a deterioration in the external payments position. Chapter VI discusses privatization, an area where only limited progress was achieved. Finally, Chapter VII deals with forestry management. Illegal logging and exports seem to have intensified following the July events.

II. Real sector

A. Growth and Sectoral Performance

4. Cambodia’s real GDP grew at an annual average of about 5½ percent in real terms between 1993 and 1996 (Table 5).2 Growth during this period was led by the manufacturing and service sectors, while agricultural output, on average, lagged behind population growth. Output growth in 1997 slowed sharply to 2 percent, mainly reflecting the adverse impact on private sector activity of the July events and the regional financial crisis.

5. Agriculture output, which accounts for about 43 percent of GDP, grew by 2 percent in 1997 (Table 6). The rice crop, the main agricultural produce and the country’s staple food, remained at about 3½ million metric tons since 1995, when it had recovered from adverse weather conditions (Table 8). The total cultivated area increased from 1.8 million hectares in 1996 to 2.1 million hectares in 1997, as some previously land-mined fields were reclaimed. The average rice yield increased from 1.3 metric tons per hectare in 1992-94 to 1.8 metric tons in 1997, well below the average 2.7 metric tons of yield reached by Cambodia’s neighbors. Exports of rice from border regions increased modestly in 1997.

6. Rubber production, one of Cambodia’s main cash crops, stagnated mainly because of the aging of rubber trees (Table 8). Trees have been replanted since the early 1990s, but results have not yet been visible because of the long period required to produce gum. The 10 percent export tax on rubber was suspended in October 1997 to preserve the sector’s competitiveness in the face of a 27 percent decline in world prices in U.S. dollar terms.3

7. Livestock grew strongly as diseases were less frequent in 1997 than usual. Growth in the fishery sector was affected by the deterioration in the environment. Deforestation-led soil erosion and flooding, as well as the destruction of marshland and forests, have changed the ecosystem in parts of the country, and several fish species have become extinct. The forestry sector represented less than 3 percent of GDP and was on a declining trend as reserves were being depleted and trees had to be cut deeper in the forest. The sector was also hit by falling world prices for tropical timber, in the wake of weakening demand for wood in the United States and Japan, the two main importers.

8. Output of the industry sector, accounting for about 21 percent of GDP in 1997, grew by 3 percent. Following rapid growth during 1994-96, construction activity declined by 1 percent in 1997, mainly because the political uncertainty and the regional financial crisis adversely affected several hotel construction projects. Garment output, most of which was for exports, continued to grow rapidly (Table 1). Relatively low labor costs, the availability of unfulfilled quotas of exports to the European Union (EU), the Most Favored Nation (MFN) status in Europe and the General System of Preferences (GSP) status granted by the United States in 1997 were the main driving forces behind the sector’s rapid development. The sector was only marginally affected by the July events.

Table 1.

Cambodia: Garment Industry, 1994-98

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Source: Ministry of Industry

9. The growth of the service sector, accounting for about 36 percent of GDP, slowed to about 1 percent in 1997. Activity in the transport and communication sector continued to be buoyant. However, growth in the tourism sector came to an abrupt halt in mid-1997 as a result of the deteriorating security situation.4 In July, the monthly tourist arrivals plummeted to about 6,000 from more than 29,000 in March. Tourist arrivals picked up somewhat during the remaining months of 1997, but did not reach the level achieved during the first half of the year (Table 2).

Table 2.

Cambodia: Tourist Arrivals by Months, 1996-97

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Source: Cambodian Ministry of Tourism

B. Aggregate Demand and Inflation in 1997

10. In 1997, the share of private consumption in GDP remained at about 86 percent, while government consumption declined from 10 percent in 1996 to 9 percent mainly as a result of continued cuts in nonwage current expenditure in the face of revenue shortfalls (Table 9). Domestic investment in relation to GDP declined by 4 percentage points to 16½ percent, reflecting the suspension or postponement of many foreign-financed projects in the wake of the mid-year political conflict and the cutting back of government investment. The national saving rate remained fairly constant at 5½ percent of GDP. Thus, the external current account deficit (excluding official transfers) declined by 4 percentage points, but remained high at about 11 percent of GDP.

11. The inflation performance showed a stark contrast between the first and second semesters of 1997 (Tables 10 and 11). During the first half of the year, inflation measured by the consumer price index (CPI) was about 6 percent on a 12-month basis, reflecting the stable exchange rate, restrained financial policies, and the availability of agricultural produce. During the third quarter, inflation jumped to 12 percent on a 12-month basis, owing mainly to the depreciating exchange rate and the political instability, which temporarily led to shortages of some food and nonfood items. However, during the last quarter, consumer prices declined somewhat and year-end inflation was about 9 percent. The U.S. dollar-denominated CPI, which is derived by deflating the official CPI by the parallel market exchange rate of the riel against the U.S. dollar, declined by 15 percent during 1997, suggesting that U.S. dollar-denominated prices of imports from Asian countries declined significantly.5

III. Public Finances

A. Introduction and Background

12. Fiscal policy made a major contribution to maintaining macroeconomic stability during the first years of Cambodia’s transition to a market-based economy, by avoiding bank financing of the budget deficit. Nonetheless, several structural problems remain. One key problem has been the lack of dynamics in revenue generation. The revenue-to-GDP ratio has been hovering around 9 percent since 1993, without a marked tendency to increase. In addition, military and security expenditures have absorbed a large part of current expenditure and tended to exceed their budgetary limits year after year. As a result, there has been no room for salary increases for civil servants, and civilian nonwage spending has been compressed on several occasions, to the point of becoming unsustainable.

13. The 1997 budget aimed at addressing some of the sustainability issues by targeting an increase in total revenue from 9 percent of GDP in 1996 to 9 ½ percent (Table 12).6 The budget also envisaged a significant shift from defense and security outlays to social expenditure, while holding the expenditure-to-GDP ratio unchanged at 16 percent. The overall deficit was targeted at 6 ¼ percent of GDP, to be entirely foreign financed.

14. The execution of the budget met with severe difficulties in 1997, largely repeating the pattern of previous years. These difficulties were exacerbated by the aftermath of the July events. There were significant shortfalls in revenue collection, overspending on the military budget, and a compression of civilian nonwage expenditures. In addition, capital expenditure had to be squeezed in the second half of the year because aid inflows significantly declined. In the event, the government abstained from bank financing of the deficit and, thus, limited the impact of the poor budgetary performance on inflation. No significant steps were undertaken to improve the tax administration. Full implementation of the new Tax Law (adopted in February 1997), an important step in consolidating Cambodia’s tax system and laying the foundations for a modern tax system, was delayed because of technical problems and a lack of consensus in the Council of Ministers.

B. Revenue Performance in 1997

15. Three quarters of the planned one percentage point increase in revenue (as a ratio to GDP) was to be generated by the new Tax Law, and the 1997 budget envisaged total revenue to increase to 9¾ percent of GDP. In the end, revenue only reached 9¼ percent of GDP, with better-than-targeted domestic tax revenue and nontax revenue, offset by low trade tax revenue (Table 13). Without the impact of the depreciation of the riel on some tax and nontax categories and unexpected royalties from an oil exploration contract (yielding about ½ percent of GDP), revenue performance would have been worse.

16. Domestic tax revenue was better than originally budgeted. However, as indicated, this outcome was influenced mainly by the impact of the depreciation of the riel and not by policy actions planned at the beginning of the fiscal year. Several measures included in the new Tax Law (such as the excise tax on hotel services, income tax for employees of NGOs and final withholding tax of 15 percent on salaries of nonresidents) were not introduced (Box l),7 and no major efforts were undertaken to collect tax arrears as planned.8 There was a significant shortfall in trade taxes (of about 1 percent of GDP), despite the depreciation of the riel. The main factors accounting for this shortfall were (i) continued granting of ad hoc exemptions to major importers (garments) and exporters (sawn timber and rubber), (ii) flawed import valuation procedures, and (iii) a temporary drop in imports immediately after the July events.

17. Nontax revenue performed better than planned because of the depreciation of the riel (affecting such categories as timber royalties, building leases, and overflight fees) and of the unexpected royalties from an oil exploration contract. Timber royalties, for the first time in years, exceeded the targets, but this was mainly the result of the riel’s depreciation. Several other revenue categories fell short of their targets because of persistent problems such as ministries not collecting revenues (or arrears) or not transferring revenue to the MEF. No concrete steps were taken to address these problems, which are partly administrative in nature and partly political.

Status of Implementation of 1997 Tax Law

(As of January 1998)

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C. Expenditure Performance in 1997

18. Total expenditure was about 2 percentage points lower than budgeted, mainly reflecting a squeeze in current expenditure in light of the shortfall in revenue and a drop in capital expenditure stemming from slow aid inflows.

Current Expenditure

19. Current expenditure, at 8 ¾ percent of GDP, was nearly ¾ percentage point lower than budgeted, reflecting a slightly higher wage bill, more than offset by lower-than-budgeted civilian nonwage expenditures (Tables 14 and 15). Overspending (by CR 20 billion or about ¼ percent of GDP) on the wage bill was entirely attributable to military spending, reflecting the unanticipated integration of about 20,000 defecting Khmer Rouge soldiers in the Royal Army and the impact of higher rice prices.9

20. Early in the year, when signs of a revenue shortfall started to appear, the MEF began to control nonwage current expenditures in line with the monthly revenue resource envelop. As in the previous year, expenditures were affected by general cuts across the board, specific cuts in some ministries’ budgets, and postponement of payments. In the event, expenditure for civilian operations and maintenance was cut by nearly 1 percent of GDP, while there was some overspending on the military budget. As a result, current expenditure on health and education was, for the second year in a row, lower than budgeted.

Capital Expenditure

21. Capital expenditure was squeezed by more than 1 percent of GDP, to nearly 5½ percent of GDP (Table 16). The shortfall in revenue led to lower locally financed investment, while the slowdown in project loans and grants contributed to a decline in foreign-financed capital spending. In July, Germany and the United States suspended their nonhumanitarian aid programs for the remainder of the year, and there was also a slowdown in aid inflows from some other major bilateral donors such as France, Japan, and the EU. The World Bank and the AsDB, while continuing the financing of ongoing projects, delayed the start of new projects.

D. The Deficit and its Financing

22. Following a small deficit in 1996, the current balance was marginally positive (CR 3 billion), though below the target of CR 15 billion. The overall deficit, at 5¼ percent of GDP, was more than 1 percent of GDP smaller than planned and foreign funding and nonbank financing allowed the government to build up deposits with the banking system. Nonbank financing largely took the form of a build-up of enterprise deposits with the Treasury.

IV. Money and Banking

A. Overview

23. Cambodia is among the most highly dollarized economies in the world and is still largely cash-based. The stock of foreign currency cash holdings is probably significantly larger than measured broad money (including foreign currency deposits). Dollarization is a legacy of the country’s recent history. Money and banks were abolished under the Khmer Rouge regime. In 1980, a monobank system was introduced and the riel was brought back into circulation. However, confidence in the domestic currency remained low throughout the 1980s and early 1990s as a result of political and economic uncertainty. Dollarization was further facilitated by the inflow of foreign exchange, associated with UNCTAD operations and the return of expatriate Cambodians following the formation of a new coalition government in 1993. The main developments in the monetary and financial sector in 1997 were a significant withdrawal of foreign currency deposits, induced by political and economic uncertainty on the one hand and progress in the NBC’s work on bank regulation and supervision on the other.

B. Institutional Changes in the Banking Sector

24. Cambodia’s banking system consists of the NBC, with 20 provincial branches, 22 locally incorporated banks, 7 branches of foreign banks, 1 state-owned bank, and a decentralized system of NGOs engaging in rural financing (Table 18). The major changes in 1997 included the continued reduction of the state’s direct involvement in the financial sector through (i) the conversion of three joint-venture banks (Cambodia Commercial Bank, Cambodia Public Bank, and Canadia Bank) into locally incorporated private banks, and (ii) the liquidation of the state-owned Municipality Bank; its remaining assets and liabilities were absorbed by the NBC. The only remaining state-owned commercial bank is the Foreign Trade Bank. Its privatization was scheduled for 1997, but a delay in the audit has postponed the process until 1998.

25. In early 1998, the government firmed up its plans to establish, with foreign financial assistance, a Rural Development Bank (RDB) as a “frontal institution” that will channel financial flows from bilateral and multilateral donors to grassroot institutions specializing in microfinance and will supervise these institutions. Presently, there are about 60 such grassroot institutions that are left unsupervised and perform financial and social services to the rural communities. So far their work is largely uncoordinated and their operations are not always run smoothly (sometimes funding from headquarters is cut off). The RDB would not be allowed to receive deposits from the public. It is the government’s intention to privatize this financial institution at a later stage.

C. Monetary Aggregates

26. Developments in monetary aggregates in 1997 were characterized by a significant withdrawal of foreign currency deposits (10 percent in U.S. dollar terms), induced by waning confidence in the political and economic situation (Tables 19, 20, and 21). The withdrawal started soon after the first signs of political violence in March and accelerated after the July events. This development came to a halt in the last two months of the year when the political situation stabilized and security improved. As a result, the year-on-year growth rate of broad money dropped from 40 percent at end-1996 to 16 percent at end-1997. The share of foreign currency deposits in broad money remained stable at around 62-63 percent. Measured velocity (at 9.4) declined by 10 percent, compared with a decline of 23 percent the year before, indicating that the processes of monetization and intermediation slowed down in the wake of the political events.10 Part of the withdrawn foreign currency deposits appeared to have stayed in the system as foreign cash in circulation, but another part was most likely transferred to banks abroad.

27. The stock of private sector credit increased by 18 percent (expressed in U.S. dollar terms) during the first half of the year, reflecting buoyant economic growth. During the second half, political and economic uncertainty led to a standstill in credit activity. By December, the stock of private sector credit (in U.S. dollar terms) was 2 percent lower than the end-June stock. Banks also reported problems with customers who were unable to service their loans as business activity slackened significantly. By year-end, this situation started to improve somewhat.

D. Monetary Policy

28. Cambodia’s high degree of dollarization severely limits the NBC’s scope for monetary policy. Because the domestic currency share in the (unmeasurable) stock of total liquidity (including foreign currency cash in circulation) is so small, central bank actions are not effective. The most important central bank measure has been to limit central bank financing of the government deficit, the main source of domestic money creation in Cambodia under the present circumstances. Cooperation between the NBC and the MEF in the past few years has been effective in this regard. As such, domestic currency liquidity expansion has been contained, thereby minimizing pressure on the exchange rate and prices. During 1997, the government was able to build up its deposit base with the NBC by CR 74 billion. The resultant decrease in net claims on government partially offset the increase in the NBC’s net foreign assets, containing the growth in reserve money to 21 percent (year-on-year), about half the growth rate recorded in 1996 (Table 22).

29. Interest rates still do not perform a meaningful role in resource allocation in Cambodia. Commercial bank interest rates remained broadly unchanged during 1997 (Table 23). Riel deposit rates remained in the range of 8-12 percent and U.S. dollar deposit rates in the 3-7 percent range. Lending rates ranged from 12 percent to 18 percent (U.S. dollar loans).

E. Exchange Rate Policy

30. In 1997 Cambodia continued its market-based exchange rate policy. The exchange rate of the riel against the U.S. dollar remained broadly stable around CR 2,750 during the first half of the year. However, during the last six months, the rate depreciated by about 27 percent and reached CR 3,450 at end-December. During the first five months, the NBC conducted 13 foreign exchange auctions for a total of $6.4 million (the total amount sold in the 1996 auctions was $33.6 million). The main purpose of such auctions, as in the past, was to smooth exchange rate fluctuations. During the second half of the year, no further auctions were conducted. Throughout the year, the spread between the official and the market rate was well below 2 percent, and most of the time it was less than 1 percent.11 The NBC intends to reduce the spread further in the course of 1998.

F. Banking Supervision and Regulation

31. The Cambodian banking system expanded rapidly in 1991-94, putting significant strains on the NBC’s regulatory and supervisory capacity. The moratorium on issuing new licenses (June 1994) was intended to give the NBC breathing space to develop its banking control skills. Since then, supported by technical assistance from the Fund and other multilateral organizations, a foundation has been laid to enhance the NBC’s bank supervision capacities.12 The banking supervision department was reorganized in 1995, new reporting forms designed, and a start was made with off-site inspections based on these reporting forms. On-site inspections started in 1996, through an international audit firm. In addition, to enhance transparency and avoid conflict of interest, the NBC began to divest its interests in the five joint-venture banks, a process that was completed in 1997.

32. Progress in bank supervision in 1997 was achieved on several fronts. First, international audit firms conducted on-site inspections in eight banks. These inspections revealed problems in only one bank. This bank has been given six months to formulate and implement a recovery plan. If this strategy fails, the NBC will advise to close this bank. Given the continued limited capacity of the NBC to conduct such inspections independently, it has been agreed that the entire sector will be inspected by international firms by the end of 1999. Second, the NBC strengthened its reporting requirements by asking the commercial banks to submit, on a monthly basis, the list of loans exceeding $100,000 (or CR 300 million), classified according to the loan classification criteria. By now, banks have to submit 14 reports on a monthly basis and a report on nonperforming loans on a quarterly basis. Third, the NBC raised the minimum capital requirement for new banks to $15 million.

33. The new draft Commercial Bank Law, which is expected to provide a much needed transparent framework for banking operations in Cambodia and for bank supervision, has been with the National Assembly for more than a year, awaiting adoption.

34. Effective January 1, 1998, the NBC increased the reserve requirements from 5 percent to 8 percent and the capital guarantee deposit from 5 percent to 10 percent (Table 24).13 Both measures were introduced for prudential reasons, to ensure liquidity and solvency of the banking system.

V. External Sector

A. Overview

35. Cambodia’s economy is open to international trade and financial relations, underpinned by a framework of liberalized exchange, foreign investment, and trade regimes. This outward-oriented policy has served the country well and has attracted foreign direct investment as well as foreign concessional financial assistance which contributed to strengthening the external payments position.

36. External sector developments in 1997 were marked by a sharp turning point in mid-1997. During the first half of the year, significant foreign concessional aid and foreign direct investment entered into the country, with an ensuing deterioration in the trade balance, as exports could not keep pace with rising aid- and investment-related imports. During this period, the overall balance remained positive as the capital account surplus more than offset the current account deficit. In contrast, during the second half, the current account improved mainly because imports declined in response to falling capital inflows, but the overall balance of payments, although in surplus, deteriorated.

37. The current account (excluding official transfers) declined from 15½ percent in 1996 to 11 percent in 1997, reflecting strong export performance in the garment industry and the reduction in aid-related project imports (Table 25). The capital account deteriorated as multilateral disbursements and foreign direct investment contracted sharply as a result of the political crisis in Cambodia and the financial crisis in Asia. Thus, the overall balance of payments recorded a surplus of $29 million in 1997, compared with that of $52 million in 1996. Official foreign reserves increased to a level equivalent to 2½ months of imports of goods and services.

B. Developments in 1997

38. Total exports increased by about 11 percent in 1997, supported by a strong growth in nontraditional exports, whereas traditional exports remained subdued (Table 26). The export share of forestry products declined from 43 percent in 1994 to 14 percent in 1997.14 Illegal cutting and exporting of logs continued on a large scale in spite of the official ban on such exports. The volume of forestry product exports declined in 1997 and stood at about one half of the 1995 level, when the government exported large quantities of illegally felled trees. In addition, the international price for timber fell in 1997, further reducing the value of timber exports. Natural rubber, the second most important traditional export item (representing about 5 percent of total exports in 1997), increased by 13 percent, despite the sharp drop in international prices.15 Cambodia has also steadily increased its rice and fish exports, but the total value of those exports remained marginal.

39. The most significant export development in 1997 was the more-than-doubling of nontraditional exports, representing about 35 percent of total exports. Nontraditional exports included textile and garment products, covered under the MFN and GSP statuses, as well as leather and furniture items. These exports were virtually nonexistent prior to 1995, but sizable foreign direct investment and a propitious international climate boosted them over the last three years.

40. Re-exports continue to represent an important feature of Cambodia’s external trade, although their share in total exports receded from 53 percent in 1993 to 45 percent in 1997. Re-exports continued to stem from differences in tariffs on goods imported by Cambodia and its neighbors.16 These goods included cigarettes, motorcycles, beer, electronic equipment, and nonmonetary gold. Most of these consumer goods were re-exported to Vietnam, while gold went mainly to Thailand.

41. The assessment of import performance is hampered by the large share of tariff-exempt imports for which there are no customs data. Such imports, which were estimated to represent 32 percent of total imports in 1997, included imports procured by government, imports financed by official foreign assistance and foreign direct investment, inputs for the garment industry, and imports for which ad hoc exemptions from inspection were granted. Retained imports, representing 68 percent of total imports, declined by 6 percent in U.S. dollar terms, reflecting the political turmoil and slack in foreign financial inflows (Table 27). In contrast, security-related government imports were estimated to have almost doubled, whereas aid-related imports decreased sharply.

42. The service account continued to be in deficit in 1997, representing about 17 percent of the current account deficit (excluding official transfers). The tourism sector remained the single most important foreign exchange earning service sector, despite a decline from $84 million in 1996 to $73 million in 1997. Both the cut in foreign aid and the departure of roughly half of the expatriate community after July were reflected in the continued decline of technical assistance. Interest payments on foreign debt remained modest given the high degree of concessionality of Cambodia’s external debt.17 Official transfers, mainly in the form of project financing and technical assistance, plummeted to about $171 million in 1997, half the peak level recorded in 1995. Foreign direct investment was almost halved in 1997 as a result of loss in business confidence and the regional financial crisis (Tables 28 and 29).

C. External Debt

43. Cambodia’s external bilateral sovereign debt was rescheduled on Naples terms at the Paris Club on January 26, 1995 for all outstanding obligations prior to December 31, 1985.18 Since then, Cambodia signed bilateral rescheduling agreements with France, Germany, and Japan and has continued discussions, albeit at a very low pace, with the United States with a view to signing a similar agreement. Cambodia also has sizable external debt obligations vis-à-vis four former Council of Mutual Economic Assistance (CMEA) countries. Pending the signing of agreements with the United States and the CMEA countries, Cambodia suspended servicing their claims.

44. At end-1997, Cambodia’s external debt (excluding short-term debt but including obligations to the IMF) amounted to an estimated $2 billion or about 65 percent of GDP (Table 30). Bilateral debt accounted for 86 percent of total debt. The Russian Federation was Cambodia’s main creditor with an estimated $1.3 billion (65 percent of total debt), followed by the U.S.A. with $0.4 billion (17 percent).19 However, the figures quoted for Russia and the U.S.A. are before rescheduling although the principle of such rescheduling has been accepted by both creditors (Box 2). Accordingly, if the most favorable rescheduling assumptions to Cambodia are applied to its external debt and interest payment arrears, the bilateral debt, after rescheduling, could be as low as $0.7 billion and would represent only 46 percent of total debt.20 The World Bank would then become Cambodia’s principal creditor, while the IMF’s share would be less then 8 percent.

D. Trade Regime Developments in 1997

45. Cambodia, surrounded by ASEAN member countries, has a long-term interest in freeing its trade and having unhindered access to ASEAN’s 500 million consumer-strong market. Accordingly, during 1997 Cambodia signed bilateral trade agreements with China, Indonesia, Thailand, and Vietnam and completed the preparatory technical work for its admission to ASEAN. Import tariffs were reduced by about 15 percentage points for a number of consumption and equipment goods. As a result, the average tariff rate was reduced to 18 percent. In 1997, the maximum import tariff rate was 120 percent on luxury cars and the minimum rate was 0.3 percent on unwrought gold and silver. There were four primary tariff bands (7, 15, 35, and 50 percent) within these extremes. There were no state trade monopolies nor import quotas. In preparation for entry into ASEAN, about 100 nontariff barriers were identified; these will be gradually eliminated once Cambodia joins ASEAN. The authorities drew up the required “Inclusion, Temporary Exclusion, Sensitive Products, and General Exception Lists” and the corresponding timetables for the elimination of the first three of them. A new Customs Code is being drafted in order to meet ASEAN requirements, and the government submitted 16 draft pieces of legislation to the National Assembly for ratification during 1997 with a view to harmonizing Cambodian regulations with the obligations of membership in ASEAN. The authorities are also drafting their Foreign Trade Regime of Cambodia report, a prerequisite for joining the World Trade Organization.

46. Notwithstanding the above positive trade policy developments, the Cambodian authorities partially reversed previous progress by curtailing the coverage of the independent Société Générate de Surveillance’s pre-shipment inspections.

Cambodia: External Debt to the United States and CMEA Countries

Cambodia contracted three loans to purchase U.S. agricultural commodities, which remain outstanding since 1973-74. During the civil war, all debt-related documentation in Cambodia was destroyed. As a result, the Cambodian government never serviced these loans. According to the U.S. Department of Agriculture (USDA), the total amount of outstanding loans (including debt service in arrears) stood at $338.5 million on September 30,1997 ($222.4 million for outstanding principal, $81.1 million for unpaid principal, and $35 million for late interest). The Cambodian authorities dispute the total amount of outstanding debt, estimating it at only $184.7 million (compared with the U.S. claim of $222.4 million), based on the fact, that because of the onset of the civil war, some late deliveries of commodities did not take place. Cambodia’s official development assistance debt to the USDA is eligible for rescheduling under the 1995 Paris Club agreement.

The debt rescheduling Agreement between the Soviet Union’s Vneshekonombank and Cambodia’s Foreign Trade Bank of May 18, 1991 and its implementation accord consolidated 15 previous Soviet state credits to Cambodia into one new credit, denominated in rubles in an amount of SUR 796.6 million. The new credit was to be converted subsequently into U.S. dollars at a mutually agreeable conversion rate; it bore no interest; and the repayment schedule and modalities were to be agreed among the parties. Under the so-called zero option, the Russian Federation assumed the former Soviet Union’s claims on Cambodia. Although the 1991 Agreement is considered valid by both countries, several of its operational aspects remain to be negotiated. Russia’s participation as a creditor in the Paris Club since September 1997 paves the way for a bilateral rescheduling agreement between the two countries. In September 1997, Russia provided the Paris Club with a total claim on Cambodia of SUR 832.8 million. The Cambodian authorities dispute this amount and consider their debt to Russia to amount only to SUR 796.6 million, which was the consolidated amount in the 1991 Agreement. Pending the outcome of the various ongoing discussions, Cambodia has suspended the servicing of all debt to Russia.

Cambodia also contracted debts in rubles between 1983 and 1985 with three other CMEA countries, the Czech Republic, Poland, and the Slovak Republic,. The total amount of these debts is SUR 11.1 million. There are currently no bilateral discussions with any of the three countries, and none of them has a creditor status at the Paris Club.

47. Cambodia maintains a liberal exchange system, with no restrictions on the making of international current payments and transactions, and there are no discriminatory current account arrangements or multiple currency practices. A new Foreign Exchange Law was adopted in 1997, formalizing the liberal exchange framework.

VI. Privatization

48. Only limited progress was achieved in privatization in 1997 (Tables 31-36). First, the divestiture of the country’s six major rubber plantations was mired in ongoing discussions within the administration on the legal statute of the future entity or entities in charge of rubber cultivation. Second, about 20 medium-size enterprises were divested during 1997. The corresponding deals involved mostly 50-70-year leases of existing facilities and only one effective sale. Third, with regard to the remaining small enterprises that were to be privatized over a three-year period, virtually no progress was achieved because the 18,000 employees of these enterprises require a $l,000-$3,000 per person severance package.

VII. Forestry Sector and Forestry Policy

A. Background

49. Tropical forest is among Cambodia’s few developmentally significant natural resources. Proper forest management policies are therefore critical for the quality and sustainability of the country’s economic development. In recent years, however, uncontrolled logging has led to rapid deforestation. If the current trend of deforestation is not reversed, the country’s timber resources could be depleted within the next five years with dramatic environmental, social, and economic consequences. Current practices also lead to significant revenue losses for the government as it does not receive compensation for the economic value for its forests.

50. One of the main problems with respect to the forestry sector is that no coherent set of policies has been adopted to address forestry management and impose effective control. More importantly, political commitment to design such policies and implement them consistently has been lacking, an issue that has been compounded by the involvement of the military in illegal logging in major parts of the country. Government policy since 1992 has been going through cycles whereby bans on logging and exports of logs were followed by ad hoc exemptions granted to special interests to export timber. Such exemptions provided incentives for renewed and widespread illegal cutting. Faced with these illegal activities, the government’s next step was to suspend the export ban to facilitate the exports of already felled logs, at which point the cycle resumed (i.e., with the imposition of a new export ban), quite often under international pressure (Table 3).

Table 3.

Cambodia: Official Logging, Exports and Reforestation, 1993-97

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Source: Data provided by Department of Forestry

51. The government’s current medium-term exploitation strategy is based on granting large-scale concessions. However, this strategy suffers from serious weaknesses which risk to accelerate the current pattern of deforestation, including the facts that (i) the economic viability of capital investment associated with the concessions rests on an unsustainable level of logging; (ii) timber royalties are only a fraction of the economic value of the timber; and (iii) the strategy does not contain any incentive to curtail illegal logging. In addition, this strategy has not been applied consistently because of the government’s tendency to grant additional ad hoc logging permissions.

B. Developments in 1997

52. No significant improvements were made in forestry management in 1997, despite some government initiatives. These initiatives were piecemeal and did not address the issues at their roots. Major areas of concern remain the illegal felling and exporting of logs, the uncontrolled granting of concessions, and weak government revenue collection.

53. Illegal logging and exports remain the most important issue. According to several independent sources, there was some improvement in the first months of the year following the imposition of a new export ban on December 31, 1996, the diplomatic initiative to request cooperation from the Thai, Lao, and Vietnamese governments in controlling illegal exports from Cambodia,21 and the issuance of a Joint Order by the Ministry of Agriculture, Forestry, and Fishery (MAFF) and the Ministry of Defense, requesting military commanders to cooperate with forestry officials.22 However, the situation deteriorated rapidly after the July events, with illegal cutting and exports intensifying. The government’s estimate of illegal logging in 1997 is about 51,000 cubic meters, but the volume estimated by independent sources is significantly higher (as much as 50 times higher).

54. The government considers its concession policy, initiated in 1994, as a key element of its medium-term exploitation strategy.23 As of November 1997, negotiations have been or are being conducted with 32 concessions (Box 3). Among these, for only six concessions all legal requirements have been completed, thus allowing normal exploitations.24 For an additional five concessions, not all legal requirements have been completed but permission to collect logs has been granted. All other concessions remain inactive, and the government intends to withdraw some of the concessions from those companies that are not making any progress with respect to the legal requirements.

55. In addition to the general weaknesses inherent in the government’s current concession policy, this policy was not applied consistently in 1997. The government tended to provide logging permissions even when not all legal requirements were fulfilled. More disturbingly, government officials continued to grant annual harvesting licenses without adequate planning or supervision and to give authoritizations for collection of logs outside concession areas without due regard to environmental or economic factors.

56. Government revenue collection from timber remained far below what it potentially could be, thereby depriving the government year after year of major resources needed to promote social and economic development in the country. In 1997, the budget collected CR 37 billion from forestry activities. Of this amount, 78 percent were in the form of royalties, 5 percent were deposits from concession contracts, 5 percent reforestation fees, and 12 percent export service charge. These revenues were in line with the officially reported removals of 441,000 cubic meters at an average royalty of $14 per cubic meter from concessions and $40 per cubic meter from outside concessions.25 However, since actual cutting was much higher, so was potential revenue.26 In addition to the above revenue sources, there was a 5 percent export tax on logs and sawn timber. After the July 1997 events, the government granted ad hoc exemptions with respect to this tax to all sawn timber export companies (an estimated loss for the budget of about $5 million).

Status of Current Forest Concessions

(As of November 1997)

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57. No significant policy initiatives were taken in 1997 to address the problems at their roots and improve governance in forestry management. None of the three key measures relating to forestry, specified in February 1997 as prior actions for a possible third-year ESAF program, were implemented. First, the Prime Ministerial Order, requiring the Finance Minister’s approval of, and financial control over, all contracts involving state assets went through several drafts, but has not yet been implemented due to a lack of political consensus. This Order is seen as a key element for establishing firm control over the management of public resources, of which forests are a main part. Second, a monitoring and control system for logging and log exports has not yet been established and is not expected until late 1998.

58. In November 1997, the Council of Ministers issued a ten-point program to support the government’s forestry policies (Annex I). The program aimed at centralizing and strengthening decision-making regarding forestry management by granting more authority to the National Steering Committee at the Department of Forestry and by reinforcing earlier government declarations. However, no tangible results have been obtained thus far in terms of better control and management because, in practice, no follow-up has been given to most of the proposed measures.

59. Despite a growing awareness in government circles of the need for change in forest policy, much needs to be done to develop a coherent policy framework. Four studies, supported by the World Bank, are currently undertaken and look at key issues such as logging control and logging verification, the legal framework for granting concessions, reform of the forest policies and forest concession management. Based on the recommendations of each of these studies, expected by mid-1998, the government intends to formulate policies which would set the stage for a medium-term policy framework. To arrive at a sustainable level of logging and ensure adequate returns to the country, full political support at the highest levels will be needed.