Cambodia: Staff Report for the 2002 Article IV Consultation and Sixth Review Under the Poverty Reduction and Growth Facility

This paper examines Cambodia’s 2002 Article IV Consultation and Sixth Review Under the Poverty Reduction and Growth Facility (PRGF). Supported by inflows of development aid, economic activity regained vitality in 1999. The government’s macroeconomic strategy, which was supported by a PRGF arrangement, yielded positive results. Economic performance in 2002 was broadly satisfactory. Real GDP is estimated to have slowed to 4½ percent owing to adverse weather conditions. All end-September quantitative performance criteria and the structural performance criterion for end-October were observed. Progress in structural reforms has been broadly satisfactory, albeit with some delays.


This paper examines Cambodia’s 2002 Article IV Consultation and Sixth Review Under the Poverty Reduction and Growth Facility (PRGF). Supported by inflows of development aid, economic activity regained vitality in 1999. The government’s macroeconomic strategy, which was supported by a PRGF arrangement, yielded positive results. Economic performance in 2002 was broadly satisfactory. Real GDP is estimated to have slowed to 4½ percent owing to adverse weather conditions. All end-September quantitative performance criteria and the structural performance criterion for end-October were observed. Progress in structural reforms has been broadly satisfactory, albeit with some delays.

I. Introduction

1. A coalition government, formed in 1993 following UN-sponsored free elections, provided a brief period of economic stability for the first time in more than three decades. But with growing tension among the ruling parties and poor governance, economic performance deteriorated in the second half of the 1990s. As a result, the mid-term review of the second annual PRGF arrangement (1994-97) was not completed, and the Fund’s resident representative office was closed in October 1997, owing to governance issues relating to illegal logging. Political stability was regained in late 1998 when a new coalition government was formed, headed by Prime Minister Hun Sen (Cambodian People’s Party (CPP)). Cambodia’s first-ever commune elections were held in February 2002, where the CPP gained a significant majority. National elections are slated for July 2003.

2. A three-year PRGF arrangement for SDR 58.5 million (67 percent of quota) was approved by the Executive Board on October 22,1999. The fifth review was concluded on July 22, 2002. An Interim Poverty Reduction Strategy Paper (I-PRSP) was endorsed by the World Bank and Fund Executive Boards in January 2001. As of November 30, 2002, total Fund credit and loans outstanding to Cambodia amounted to SDR 71 million (81 percent of quota). Upon completion of the current (and final) review, a disbursement of SDR 8.4 million would become available. In accordance with the Fund’s safeguards policy, the National Bank of Cambodia (NBC) published in September 2002 its audited financial statements and related audit opinion for 2001, as it did with its 2000 accounts.

3. In concluding the 2001 Article IV consultation (together with the fourth PRGF review) on February 6, 2002, Directors commended the authorities for the maintenance of macroeconomic stability, but stressed the need to press ahead with the reform program, particularly in view of an uncertain global economic environment. They emphasized the importance of stronger tax administration and expenditure management, bank restructuring, forestry policy, and civil service reform. These recommendations, which overlapped with program conditionality under the PRGF arrangement, were broadly observed (Box 1 and Annex I). With support provided under the Technical Cooperation Action Plan (TCAP), some progress was made in strengthening the capacity of various departments of the Ministry of Economy and Finance (MEF), although the remaining agenda is still large (Annex II). In the area of bank restructuring, significant progress was made.

II. Stocktaking of Performance since 1998

4. A decade long civil war in Cambodia and political upheaval destroyed the basic building blocks of the economy. Physical infrastructure was severely damaged by the civil war.1 Government capacity was diminished and remains very limited owing to the lack of adequate institutions, the low skills of civil servants, and financing constraints. In addition, the business environment is unpredictable given the weak legal framework and uneven application of the law, and corruption is pervasive, Reflecting the early stage of economic rehabilitation, poverty in Cambodia continues to be widespread, with 36 percent of the population (1999) by one measure living below the poverty line of half a dollar a day (see page 49 of the Second Socio-Economic Development Plan (SEDP-II)).2

Cambodia: Structural Conditionality

1. Evolution of coverage under the PRGF-supported program

The structural conditions under the PRGF-supported program during 1999-2002 have focused on: (i) improving tax and customs administration and public sector accounting and expenditure management; (ii) reforming management of forestry resources; (iii) completing the bank restructuring program, including reforming the state-owned Foreign Trade Bank (FTB), and developing a modern payments system; (iv) promoting trade reform; and (v) establishing sound governance. These reforms are viewed as essential for maintaining financial stability and enhancing prospects for sustained growth and poverty reduction.

Consistent with the guidelines for streamlining conditionally, structural conditions since the fourth review have been designed to focus on those measures most critical to the near-term macroeconomic outlook, and to avoid duplication with the World Bank. As a result, the restructuring of forestry concessions was retained for the fourth review as a structural benchmark, owing to the declining share of forestry in overall government revenue. Structural benchmarks on formulating a strategy for civil service reform and preparing for the full implementation of the military demobilization program, where the World Bank is taking the lead, were included owing to their importance for the medium-term macroeconomic objectives.

2. Status of structural conditionality from earlier programs

Since the inception of the PRGF-supported program in October 1999, all structural performance criteria have been observed, with the exception of one structural performance criterion on the completion of an unqualified audit for the FTB. A waiver was granted at the time of the fifth review on the grounds that the audit was qualified because of provisions made in 2001 for losses that should have been recorded in earlier years.

There have been significant delays in the implementation of some structural benchmarks. Some of these delays were relatively minor, reflecting time needed to design reforms in the context of a very heavy agenda. The main areas that experienced considerable delays were military demobilization program, civil service reform, revisions to the Law on Investment, and the privatization of the FTB. Nevertheless, delayed reforms subsequently have moved forward or have been completed. The preparation of two pieces of legislation on secure transactions and insolvency were excluded from the formal structural conditionality at the time of the fourth review because they were not critical to the short-term macroeconomic outlook. However, completion of this legislation is under way with donor support, as a requirement for Cambodia’s membership application to the World Trade Organization (WTO).

3. Structural areas covered by the World Bank and the Asian Development Bank (AsDB)

The current World Bank SAC program, approved in February 2000, aims at improving natural resource and public sector management, as well as enhancing governance and fighting corruption. It has conditionality in the areas of forestry policy, the pilot military demobilization program, public expenditure management, and the investment regime. Due to lack of progress in forestry issues, the release of the second tranche is being delayed. The World Bank is also supporting the full military demobilization program through a demobilization and reintegration project approved by the World Bank’s Board in August 2001, and forestry policy through a Learning and Innovation Loan (LIL) approved in June 2000. Civil service reform and the Governance Action Plan are being addressed through an Economic and Public Sector Capacity Building project, and a Policy and Human Resource Development Grant. In support of the full PRSP, an updated Country Assistance Strategy and a Poverty Reduction Support Credit (PRSC) are expected to be in place in 2003. The World Bank also has a Legal and Judicial Reform Project and a Land Management Project.

Other priority areas with active involvement of the AsDB and other donors include natural resource management, land reform, public sector management, financial reform, and legal and judicial reform. Public expenditure management is an overlapping area of assistance involving the Bank, AsDB, WHO, bilateral donors, and the Fund, and has required careful coordination to ensure that assistance is complementary.

5. The authorities have long regarded raising real GDP growth as crucial for reducing poverty. Accordingly, since 1999, they have focused on maintaining macroeconomic stability, rebuilding institutions and addressing governance/corruption problems to reduce the impediments to economic development. With PRGF support, the authorities’ strategy was aimed at: (i) strengthening revenue and implementing administrative reforms to improve social services and support an increase in public investment, while reducing military spending; (ii) improving bank soundness and financial intermediation; (iii) strengthening natural resource management, particularly forestry, to preserve valuable long-term sources of growth; and (iv) building a modern legal and judiciary framework and economic institutions.

6. This reform strategy has been broadly successful, especially on the macroeconomic front. With the booming garment sector and tourist-related activities, real GDP growth averaged 7 percent during 1999-2001. This compares with 3 percent growth during 1997-98 when political instability depressed economic activity. Growth in 2002 is expected to have slowed to 4½ percent due to the impact of a drought followed by flooding on agricultural output (Table 1). The rebound of garment exports after an initial slowdown in early 2002 (related to quota reallocation and worker strikes) helped to reduce the external current account deficit to about 10¾ percent of GDP (Table 2). Inflation has remained well below 5 percent since 1999, largely owing to the maintenance of fiscal discipline. Financial deepening has continued (Tables 3 and 4), partly facilitated by regained public confidence in the banking system, following the successful completion of bank relicensing in March 2002. Nevertheless, private credit expansion remains weak as banks regard lending to local businesses as high credit risk.3 Increased demand for local currency helped boost international reserves. The exchange rate against the U.S. dollar has remained broadly stable during 1999-02, while gross international reserves rose from US$390 million at end-1998 to about US$665 million at end-December 2002 (equivalent to 3½ months of imports).

Table 1.

Cambodia: Selected Economic Indicators, 1998–2003

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

Contributions to 12-month percent change of broad money.

Ratio of nominal GDP to average stock of broad money.

Excludes cash adjustments in 2003.

Includes disbursements for the financing gap the 2003.

Includes expenditure committed but not yet allocated to the accounts of the government agencies that execute the budget, and exchange rate adjustments.

Excludes re-exports.

Projection based on data available through mid-November. Actual gross and net international reserves at end-December 2002 were US$ 665 and US$ 569 million, respectively.

A Paris Club rescheduling under Naples terms (67 percent NPV reduction) is assumed in mid 2003.

Table 2.

Cambodia: Balance of Payment, 2000-2007

(In millions of U.S, dollars)

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

Includes estimates for unrecorded trade, such as forestry exports and unrecorded petroleum imports. Data on exports and imports have been revised from earlier estimates based on improved statistics.

Assumes a Paris Club rescheduling under Naples terms (67 percent NPV reduction) in mid-2003. Bilateral rescheduling agreements were reached in principle with the Czech and Slovak Republies in 2001.

Includes $117 million associated. with the return of Cambodian gold holdings by the BIS in 1998.

Imports excluding imports for re-export and imports for the garment sector.

Ratio of debt service to domestic exports of goods and services.

Table 3.

Cambodia: Monetary Survey, 2000-2003

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Source: Data provided by the Cambodian authorities; and Fund staff projections.

Nominal GDP divided “by the average stock: of broad money.

Table 4.

Cambodia: Summary Accounts of the National Bank of Cambodia, 2000-2003

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

7. The authorities’ reform efforts have been also supported by favorable external developments and significant aid inflows. Merchandise exports rose from only 29 percent of GDP in 1998 to about 40 percent of GDP in 2002, essentially reflecting an increase in garment exports to the United States under the Normal Trade Relations (NTR) status that was granted in 1996. Indeed, NTR status appears to have allowed Cambodia to expand its exports in an increasingly competitive environment (Box 2). Cambodia’s historic heritage also attracted visitors during this period, and tourism receipts rose from US$66 million to US$294 million during the same period (equivalent to about 8 percent of GDP in 2002). Aid inflows (grants and highly concessional loans) amounted annually to about 12-13 percent of GDP during 1999-2001. These inflows were predominantly used to rebuild infrastructure and support budgetary outlays.4 Foreign direct investment inflows, however, have remained at around $100 million in recent years, well below the peak of $300 million in 1996, when foreign garment producers rushed into Cambodia to take advantage of the NTR status with the United States.

Cambodia: Competitiveness

Competitiveness is a concern both with respect to the garment and the non-garment sectors.

The garment sector is heavily affected by external factors, in particular U.S. textile and apparel quota policy. The dramatic increase in garment exports from US$ lmillion in 1996 to US$516 million in 1999 was made possible by the United States granting Cambodia quota-free status for garment beginning in 1996, together with Normal Trade Relations (NTR) status. Accordingly, the average US tariff rate for garments produced in Cambodia was reduced from 50-70 percent to 10-20 percent. Foreign garment producers, who faced quota restrictions in their home countries, were attracted to Cambodia. In 1999, the U.S. imposed quotas on 13 categories of textile and apparels under the US-Cambodia textile agreement, with the average tariff rate kept unchanged. Since then, garment exports subject to quota have been limited to an annual quota increase of about 15 percent. The increase hinges on adherence to fair labor laws and regulations.

Exports of textile and apparel outside the quota categories increased by about 120 percent on average per year during 1999-2001, but have slowed markedly since early 2002. The sharp decline reflects strengthened export competition from other countries, including Vietnam (when its bilateral trade agreement with the United States came into effect), China, and Mexico. U.S. textile and apparel quota policy has protected Cambodia’s garment sector from its competitors, and there is a significant risk that Cambodia’s garment exports could drop sharply once the quota on textile and apparels are phased out in 2005 for all WTO members.

Non-garment exports have declined since 1999. Excluding exports of log and timber, which have declined sharply since 1999 due to the forestry reform program, non-garment exports rose only marginally by 3 percent, highlighting a serious competitiveness problem for the reasons noted below and difficulties in accessing the global market.


Cambodia: Exports by Category of Goods, 1996-2002

In millions of US dollars

Citation: IMF Staff Country Reports 2003, 058; 10.5089/9781451821680.002.A001

Cambodia’s business community noted that they needed to cut their costs by about 15-20 percent to compete with China. Cambodia also needs to finalize it’s accession to the WTO. Since Cambodia is highly dollarized, there is little scope for cost reduction through the exchange rate policy. Key domestic cost components include:

Wages: At a minimum wage of US$45 per month and an average of USS61 per month in the garment sector, for example, Cambodia’s wages are higher than in several neighboring countries including Vietnam, India, and Sri Lanka. Moreover, Cambodia has generous labor benefits, such as 100 percent supplementary pay for overtime, long annual leaves, and about 26 paid official holidays per year.

Operating expenses: (i) Electricity: Although international comparison is difficult, Cambodia’s electricity tariff is regarded as relatively high: the tariff for commercial and industrial consumers ranges from USS0.12 to US$0.16 per kilowatt hour, while electricity tariffs for other ASEAN countries, such as Thailand, Malaysia, the Lao P.D.R., and Vietnam, range from US$0.04/kWh to US$0.08/kWh. (ii) Roads: Paved roads account for only 16.2 percent of the total road network in Cambodia, compared with 22.4 percent in China with a huge land mass, 97.5 percent in Thailand, and 25.1 percent in Vietnam. (iii) Telecommunications: Cambodia has just 2 telephone mainlines per 1000 people, while China has 112, Lao has 8, Thailand has 92, and Vietnam has 32.

Facilitation fees: Since most investors receive various tax breaks, complaints have focused on the informal facilitation fees and the unpredictability of the regulatory environment.


Cambodia: Sources and Uses of Grants and Loans, 1996-2001

(In percent of total)

Citation: IMF Staff Country Reports 2003, 058; 10.5089/9781451821680.002.A001

Source: Data provided by the Cambodian authorities.

8. Government revenue strengthened from 8.3 percent of GDP in 1998 to 11.7 percent of GDP in 2001, contributing to the maintenance of the current budget surplus at above 1¼ percent of GDP. Over the same period, defense spending declined by one percentage point of GDP, enabling the government to reallocate more resources to social spending. In 2002, however, with a projected revenue shortfall of 1¼ percent of GDP relative to the budget target, the current fiscal surplus (excluding grants) is estimated to have fallen below 1 percent of GDP (Table 5). Weak revenue performance reflected a drop in trade taxes in spite of recent efforts to strengthen customs administration and increases in excises on beer and selected petroleum products. Moreover, there has been an erosion of the tax base arising from widespread tax exemptions and the signing of contracts with private firms (to provide certain government services), which reduced transfers to the Treasury (Box 3). Nonwage current expenditure was accordingly compressed. There was no recourse to domestic bank financing of the budget last year because larger-than-expected foreign financing, i.e., bilateral project loans equivalent to about 1 percentage points of GDP, more than fully offset the shortfall in revenue and foreign budgetary support.

Table 5.

Cambodia: General Government Operations, 2001-2003

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

Cash basis.

Projections for 2002 and 2003 include CR 100 billion and CR 75 billion from bilaterals. respectively.

Reflects the rash impact of expenditure commmited at end-2001.

Includes expenditure commited not yet allo rated to the acccounts of the government agencies that execute the budget.