Cambodia
Ex Post Assessment of Longer-Term Program Engagement

This Ex Post Assessment of Longer-Term Program Engagement for Cambodia reports its progress in implementing its economic stabilization, reconstruction, and reform programs. Prior to the normalization of relations with the IMF, Cambodia faced waves of rapid inflation and exchange rate depreciation, reflecting the government’s recurrent resort to money creation to finance the fiscal deficit as external assistance withered. With monetary instability and negative real interest rates, financial intermediation levels and confidence remain low.

Abstract

This Ex Post Assessment of Longer-Term Program Engagement for Cambodia reports its progress in implementing its economic stabilization, reconstruction, and reform programs. Prior to the normalization of relations with the IMF, Cambodia faced waves of rapid inflation and exchange rate depreciation, reflecting the government’s recurrent resort to money creation to finance the fiscal deficit as external assistance withered. With monetary instability and negative real interest rates, financial intermediation levels and confidence remain low.

I. Introduction

1. This paper assesses Cambodia’s progress in implementing its economic stabilization, reconstruction, and reform programs supported by the Fund during 1993–2003 and draws lessons for future Fund involvement. Cambodia has had three Fund arrangements since 1993. A Systemic Transformation Facility (STF) arrangement was approved in mid-1993 in support of a program for 1993–94. The STF built upon a stabilization program supported by an informal monitoring arrangement adopted in October 1992, which provided a framework for the clearance of arrears to the Fund. Cambodia drew only the first of the two STF tranches and immediately formulated a medium-term adjustment program that was supported by a three-year Enhanced Structural Adjustment Facility arrangement (ESAF-I) in early 1994. The mid-term review of the second annual program under ESAF-I could not be completed due to governance problems in forestry management and revenue collection. Despite repeated efforts to bring the program back on track amidst a progressively deteriorating political situation, ESAF-I expired. With the return of political stability after the 1998 general elections and a renewed impetus for reform, Cambodia entered into a three-year ESAF/Poverty Reduction and Growth Facility arrangement (ESAF-II/PRGF) in 1999, and completed all six reviews with only some delays in the structural reforms area (Box 1).

uA01fig01

Oustanding Fund Credit and Disbursements

(In million SDR)

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

Source: IMF Finance Department.

2. The Fund-supported programs were aimed at addressing two very different problems. The programs under STF and ESAF-I were geared to address problems typical of a postconflict-cum-transition to a market economy. Policies focused on rehabilitation, reconstruction, restoring price stability, and basic institutional development. ESAF-I was expected to initiate several structural reforms mainly supportive of growth, governance, and institutional development, but they stalled somewhat as the program went off-track. The program under ESAF-II/PRGF arrangement aimed at consolidating stability and developing a solid basis for high and sustained growth to address deeply rooted poverty, including by adopting the PRSP framework. However, it was not until the last part of ESAF-II/PRGF that a comprehensive National Poverty Reduction Strategy (NPRS) was developed, and the process of making it operational is still in its initial stages (Box 2).

II. Background and Initial Conditions

3. Cambodia’s needs for reconstruction and development resulted from several years of civil strife. During the Khmer Rouge regime of 1975–79, the population was decimated, its economy was reverted to an agrarian barter system, the industrial base and infrastructure were destroyed, social services ceased, and the banking system and domestic currency were abolished.2 Rebuilding began after 1979, initially within the framework of a centrally planned economy and a monobank system, supported by Soviet Union and CMEA assistance. Market-oriented reforms were introduced starting in 1985–86, including liberalization of prices, privatization of certain state enterprises, and the formal adoption of a two-tier banking system. However, the economic situation remained difficult given the withdrawal of external assistance and continued civil conflict. The Paris Peace Accord of 1991 and the subsequent establishment of the United Nations Transitional Authority of Cambodia (UNTAC) finally paved the way for Cambodia’s renewed access to international financial assistance, including from the Fund.

4. Prior to the normalization of relations with the Fund, Cambodia faced waves of rapid inflation and exchange rate depreciation, reflecting the government’s recurrent resort to money creation to finance the fiscal deficit as external assistance withered. With monetary instability and negative real interest rates, financial intermediation levels and confidence remained very low.

5. The informal monitoring arrangement covering the period 1992–93 anchored the restoration of monetary stability on the strict control of the domestic deficit financing. It also called for the establishment of positive real interest rates for domestic currency bank deposits, and a limit on the spread between the official exchange rate and the parallel market rate, as a step prior to the adoption of a unified flexible exchange rate regime. As fiscal performance improved, money growth dropped sharply, inflation plummeted, and the depreciation of the riel slowed. Temporary setbacks in early 1993 were mainly due to heightened uncertainty surrounding elections and rumors that a new government would again de-monetize the economy.

III. Experience Under the STF, ESAF-I, and ESAF-II/PRGF

A. Macroeconomic Performance

6. Macroeconomic performance was characterized by a quick return to price stability, while growth remained volatile and narrowly based, and poverty pervasive.

  • Inflation dropped to single digit levels in the mid-1990s and remained moderate throughout the period under review, peaking at 13¼ percent in 1998 in the wake of the Asian financial crisis (Figure 1).

  • Following massive devaluations of the riel up to mid-1993, the exchange rate was unified under a market-based regime and remained relatively stable thereafter; official reserves grew steadily reflecting an increased demand for domestic currency (Figure 2). However, significant foreign currency inflows and lingering fears of de-monetization boosted dollarization, particularly in urban areas.

  • Real GDP growth was on average robust, but it was narrowly based and volatile reflecting the vagaries of the political cycle. Growth in the urban areas was driven mainly by the garment sector. This sector gained preferential access to the quota-protected EU and US markets in the mid-1990s.3 It immediately attracted sizable inflows of foreign direct investment, which eventually led to a surge in garment exports. However, the sector’s backward linkages to the rest of the economy remained minimal, as most nonlabor inputs were imported and profits remitted abroad.

  • Growth in rural areas, home to more than 80 percent of the population, remained dependent on agricultural output which continued to suffer from a lack of investment in technology, infrastructure and diversified crops, a shortage of land amid a rapidly growing population, and natural disasters such as the repeated floods in 2000–02.

  • Against this background, poverty remained high and pervasive, particularly in rural areas where the majority of the poor are located (Annex II).

Figure 1.
Figure 1.

Cambodia: Selected Economic Indicators GDP Growth and Political Cycle

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

Sources: Cambodian authorities; and IMF Staff estimates.
Figure 2.
Figure 2.

Cambodia: External Sector Indicators

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

Sources: Cambodian authorities; and IMF Staff estimates.
uA01fig02

Overall GDP and Agricultural Output

(Annual percent change)

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

Source: National Institute of Statistics; and Fund staff estimates.

7. Important progress was made in building central institutions of macroeconomic management, restructuring the financial sector, and integrating Cambodia into the world economy, but there was slow progress in other critical structural areas.

  • Fiscal management and control at the central government level was improved through a number of legal and administrative reforms, and the role of the central bank was strengthened as part of the efforts to build a two-tier banking system.

  • Privatization of state-owned enterprises (SOEs), which had begun under the market-oriented reforms in the late 1980s, was largely completed by 1996.

  • The trade regime was liberalized as Cambodia joined ASEAN and prepared for WTO membership. Accession preparations also provided impetus to legal reforms, in particular the commercial law, civil and criminal codes, intellectual property rights, customs laws, and trade-related investment measures.

  • However, the civil service remained weak and ineffective, and corruption pervasive, impeding basic functioning of the public administration, highlighting the need for further institution-building and reform.

B. Main Factors Contributing to Macroeconomic Performance

Fiscal policy

8. Fiscal policy played a key role in achieving stability, but recurrent pressures on revenues made it difficult to attend in full priority needs (Figure 3). In line with the various programs’ targets, the current fiscal deficit shifted gradually from a deficit into a moderate surplus starting in 1998, before it declined to near balance in 2003 owing to a contraction in tourism-related receipts and increased smuggling. Overall fiscal deficits before grants, which were just indicative targets under all programs, were broadly consistent with available foreign financing and zero recourse to domestic bank credit.4

Figure 3.
Figure 3.

Cambodia: Fiscal Indicators

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

Sources: Cambodian authorities; and IMF Staff estimates.1/ Includes domestic arrears.

9. Fiscal revenues rose sharply in the early 1990s but have since increased only moderately and usually below target,5 despite continued efforts to reform the tax system and strengthen revenue administration (Box 3). While the resulting tax structure was more efficient, equitable, and elastic than the one in the early 1990s, the recurrent revenue shortfalls resulted from the interplay of several factors, including lack of ownership, frail political will, corruption, and fundamental weaknesses in revenue administration. In particular:

  • Tax revenue mobilization was seriously undermined by delays in the implementation and enforcement of measures owing mostly to political pressures, and a serious erosion of the tax base due to ad-hoc extensions of tax and customs exemptions and holidays.

  • Nontax revenue collections were adversely affected by the lack of transparency, control and accountability of government contracts for the provision of services (including telecommunications and civil aviation),6 and the income foregone from the forestry sector owing to a lack of an effective forestry management system and substantial illegal logging.

  • The problems affecting revenue administration, which were no different from the rest of the administration, ranged from low wages, acute shortage of qualified personnel, widespread absenteeism, and corruption, to inadequate resources and facilities. The customs administration had to confront, in addition, porous borders and smuggling, and outdated legislation.

10. To meet the current balance and domestic financing targets given the recurrent shortfall in revenues, expenditures were compressed below target, usually without clearly defined criteria, and payments arrears arose.

  • In general, current expenditures, the wage bill, and operating expenditures had to be kept below target during the review period.7 However, starting in 1998, the government was in a position to counter the compression of priority expenditures, mainly using the space created by declining defense and security expenses and, to a lesser extent, by the continued nonpayment of debt service on the portion of external debt with the United States and Russia.8 The level of social expenditures which was only 1½ percent of GDP in 1998 (a third of the average level for low-income countries), rose steadily to nearly 3 percent of GDP by 2001.9

  • Expenditure arrears problems have arisen on several occasions during the review period but adequate information was seldom available. With recent improvements in public accounting, partial information became available and the issue became central to program discussions in 2001. Since then, recorded arrears have risen rapidly to about 4¾ percent at end 2003,10 reflecting spending pressures associated to the pre-2003 election period. Until 2003, budgets did not contain special allocations to pay for arrears and, as a result, the government resorted to partial and not too transparent solutions, such as offsetting arrears against the suppliers’ tax liabilities. This in turn contributed to reduce revenue collections, forcing a new cycle of expenditure compression and further arrears build-up.

11. Capital expenditures—mostly financed from donor funds—remained high over the review period. While justified on grounds that there was great need for reconstruction and rehabilitation, it is not clear whether the mostly aid-funded development program was aligned with the government’s priorities, what were the selection process or criteria applied in choosing investment projects, and what efforts were being done to enhance the government’s project implementation capacity (see below). Moreover, none of the programs contained an explicit analysis of: (i) the medium-term implications of development expenditures on the current budget, or (ii) the quasi-fiscal development expenditures financed outside the budget that would eventually become a responsibility of the budget.

Deficit Financing, External Financial Assistance and Debt Management

12. Deficits were financed primarily from external sources during the review period, although only about half of all external financing was channeled through the budget. Between 1993 and 2003, Cambodia received about US$5 billion in external assistance, equivalent to an average of about 13 percent of GDP annually.11 Of this, budgetary assistance averaged about 6 percent of GDP annually, with an average of 1 percent of GDP annually for budgetary support and the rest for project support. As the current balance improved, general budgetary support declined steadily to negligible magnitudes by 2000–03, while project support rose to absorb virtually all assistance. Although Fund financial support was relatively small, large increases in external financial assistance were generally preceded by the approval of Fund programs.

13. External financial assistance to Cambodia was significantly higher than to other low income countries,12 but available information does not allow for a comprehensive analysis of its effectiveness and alignment with the development priorities of the country.

  • Based on a functional classification, about 40 percent of total financial assistance ($2 billion) was spent on free-standing technical cooperation (reportedly mostly to pay foreign experts), and another 40 percent was allocated to investment projects. Despite this distribution, Cambodia’s administrative capacity remained weak and infrastructure rehabilitation and development limited, particularly in rural areas, giving rise to questions about effective knowledge transfer and project selection procedures.

  • Based on an economic classification of aid flows, most of the aid was channeled to education, health, institution building and infrastructure. However, only about 8 percent of total financial assistance was directly allocated to agriculture and rural development, even though 80 percent of Cambodia’s poor live in rural areas.

14. About 80 percent of total external financial support was in the form of grants, although the composition changed toward loans in recent years. It is estimated that between 1999 and 2003 Cambodia borrowed about $600 million on concessional terms mainly from the World Bank and AsDB. This brought Cambodia’s external public debt to about 70 percent of GDP at end-2003, two-thirds of which is in arrears mainly to Russia, but also to the United States, and the rest mostly to multilaterals.

15. Rising debt levels and the overall slow progress in ensuring fiscal sustainability highlight the need for a debt management strategy. Although all programs called for an orderly resolution of the public debt with the United States and Russia, concerns on debt sustainability were given more prominence during ESAF-II/PRGF when it was concluded that debt would be manageable only if Cambodia were granted rescheduling terms similar to those obtained under the Paris Club Agreement of 1995 (i.e., Naples terms). However, the difficulties encountered in raising revenues and the various priority expenditures competing for any additional revenues have limited further Cambodia’s ability to repay debt. In this context, the rescheduling terms required to achieving debt sustainability will need to be defined as part of a comprehensive medium-term plan for fiscal sustainability (Box 4).

Monetary and exchange rate policy

16. Encouraged by the initial success in restoring stability, the programs under review continued to prescribe monetary restraint and exchange rate flexibility.13

  • With tight limits on bank financing of the deficit and zero net credit to state-owned enterprises, private sector credit and a build-up in official reserves became the major sources of liquidity expansion. Monetary policy had to rely on bank-specific credit targets in the absence of indirect policy instruments. Reserve requirements and refinancing facilities for commercial banks were adopted at the outset of ESAF-I, but they remained largely ineffective. Moreover, the absence of government securities limited the use of the refinancing facility.14

  • Following the effective unification of the official and parallel market rates from the mid-1990s, official intervention, in particular under the second ESAF-II/PRGF, was geared toward building-up international reserves.15 During this period, the NBC also intervened occasionally to resist disruptive downward pressures to avoid adverse inflationary pressures.

  • The tight domestic credit stance and official intervention contributed to stabilize the riel and lower inflation

17. Notwithstanding, the low inflation and stable riel exchange rate, dollarization rose significantly, limiting the role of the exchange rate as a shock absorber in the short-term and of monetary policy as a countercyclical tool. Dollarization was particularly acute in urban areas,16 while demand for riel continued to rise steadily mainly in 17 the rural areas and for transaction purposes.

Institutional development and structural reform

18. Efforts were devoted early on to building the central institutions of macroeconomic management, in particular the central bank and the ministry of finance. Strengthening the role and building the capacity of the central bank was at the center of the financial sector reform (see below). The key fiscal institutional measures included the introduction of an organic budget law (1993); and steps to increase fiscal transparency, including by assigning financial controllers to each ministry, defining procurement procedures, and implementing a cash budget management system. Notwithstanding these measures, fiscal management continued to suffer from fundamental shortcomings, in particular a fragmented budget department, a proliferation of government accounts in the NBC, and poor budget execution.

19. Progress in structural reform has been mixed.

  • In the fiscal area, some progress was made in privatizing the state owned enterprises (SOEs) and reforming the management of the forestry sector. However, divestiture of seven major rubber plantations and the Foreign Trade Bank were delayed, and there was little progress in privatizing small enterprises. Despite important progress, the management of forestry resources did not reach the desired efficiency level, illegal logging continued, and the sector’s contribution to the budget was well below its notional fiscal incidence.18

  • In the financial area, reforms were successful in setting up the basis for a two-tier banking system, strengthening the soundness of the banking sector, and subjecting banks to a comprehensive regulatory and supervisory regime. Key bank soundness indicators improved visibly.19 However, financial intermediation remained very limited by international standards, particularly in rural areas, where the absence of credit has been considered a key constraint in raising farm output and incomes.20

  • In contrast, only limited progress was achieved in improving governance, civil service reform, and demobilization.

  • Governance problems and corruption have been pervasive throughout the period under review, with mixed progress in certain areas (see Annex III). Evidence of weak governance ranged from ad-hoc exemptions of tax and customs laws to ineffective forestry management. Since the adoption of a more systematic Governance Action Plan in 2001, progress was made by: (1) improving forestry management; (2) introducing competitive bidding for government contracts at line ministries; and (3) establishing a National Audit Authority (NAA). Further progress depends on measures in a number of other critical areas, in particular civil service reform and legal reform (including the adoption of civil and penal codes, and an anti-corruption law).

  • On civil service reform, new rules for recruitment were implemented, a census carried out, and ghost workers eliminated. However, Cambodia’s civil service remunerations remained low compared with other sectors; there was an acute shortage of qualified personnel, and widespread absenteeism. In 2002, the government committed to develop a pay and employment program.21 The World Bank provided full funding for the program but so far progress has been minimal.

  • The postconflict demobilization program was beset by problems, including a large number of ghost soldiers and dependents. As these problems were addressed, related budgetary expenditures started to decline, although they remained high by international standards.22 A renewed effort started beginning in 2000. However, it has been suspended since early 2003, partly because of the elections, and partly because of evidence of misprocurement on a contract.

C. Collaboration with the World Bank and Technical Assistance

20. Fund-Bank collaboration regarding policy advice was generally close. The Bank took the lead in the areas of public sector reform (civil service reform and military demobilization), forestry management, legal reform, governance, and since 2002 on public expenditure management. Specific recommendations in each of these areas deemed to be critical for macro-stability became structural performance criteria or benchmarks. Bank structural conditionality was complementary to that in Fund-supported programs. In general, the division of responsibilities between the Fund and the Bank was broadly clear and the policy advice consistent, except for some contradictory advice in the fiscal institutional area that arose as a result of Integrated Fiduciary Assessment and Public Expenditure Review (IPAFER) findings. The issue was resolved by further enhancing communication through sharing of work plans and terms of reference, and agreeing to work together to provide support in this area.

21. Coordination of the wide-ranging technical assistance provided during the review period was complex as it involved several key multilateral agencies (Annex IV). Under the STF and ESAF-I, the UNDP, AsDB, World Bank, and IMF jointly provided technical assistance to build the central institutions of macroeconomic management. During ESAF-II/PRGF, the technical assistance and cooperation action plan (TCAP) coordinated TA activities of the Fund, UNDP and AsDB, regarding fiscal management and financial sector reform. The World Bank did not participate directly in TCAP but continued to provide complementary TA on public expenditure management, civil service reform, governance, and poverty reduction. Following some complaints by the authorities that they were becoming overwhelmed by the amount (and occasional duplication) of TA being offered to them, since the 2000 CG meeting, all TA programs have been discussed with an official high-level committee. This move has also served to meet donors’ calls for greater accountability, and enhanced coordination to ensure ownership and adequate prioritization.

IV. Evaluation of Program Conditionality and Compliance

A. Program Goals and Achievements

22. The macro-economic objectives of the programs were broadly met, but the foundations for sustainable growth and poverty reduction remain fragile. Inflation was reined in and kept low, the external position strengthened, and growth was on average robust. There was also important progress in setting up key economic institutions and advancing structural reforms in certain areas, especially the financial sector and privatization of SOEs. However, growth has remained narrowly based and subject to the political cycle, and private investment has been subdued since 1998. Moreover, the task of building up a government that effectively controls public revenues and provides adequate social service delivery has proven to take longer than envisaged. Altogether, the programs have had little impact on reducing poverty, particularly in the rural areas, where it remains widespread and high.

B. Quantitative Performance Criteria and Benchmarks

23. Cambodia complied with most of the quantitative performance criteria and benchmarks set for the STF, the first two reviews of ESAF-I, and all of the reviews under ESAF-II/PRGF (Table 1).23 Notwithstanding formal compliance in all the reviews completed by the Board, there were persistent fiscal pressures resulting from chronic revenue underperformance and difficulties in compressing non-priority expenditures, in particular military outlays until the beginning of the ESAF-II/PRGF and the World Bank SAC. The collapse of ESAF-I was in part caused by the government’s decision not to introduce the program’s measures to stop a significant erosion of the revenue due to illegal logging activities. Similarly, the targeted increase in fiscal revenues under ESAF-II/PRGF was not achieved, limiting the availability of funds for social expenditures, giving rise to the accumulation of expenditure arrears in critical areas, and ultimately compromising fiscal sustainability. In retrospect, direct conditionality on revenues, a closer monitoring of the stock of arrears and a plan for their repayment, and some additional conditionality to protect priority expenditures could have strengthened the program’s architecture. However, compliance still would have depended on the government’s will to take the necessary steps.

Table 1.

Cambodia: Quantitative Performance Criteria and Benchmarks Under Fund Programs, 1993–2002

article image
Sources: Various IMF staff reports.

The Systemic Transformation Facility (STF) was approved in October 1993 and contained quantitative benchmarks from September 1993 to June 1994.

The first annual arrangement under the Enhanced Structural Adjustment Facility (ESAF) was approved in May 1994, setting quantitative performance criteria for September 1994, as well as indicative targets for December 1994 and March 1995. The 2nd annual arrangement was approved September 1995. The mid-term review was never completed and a 3rd annual arrangement never approved, reflecting lack of progress on forestry policy and revenue collection.

The Poverty Reduction and Growth Facility (PRGF), initially ESAF, was approved in October 1999, setting performance criteria for March 2000. The first review was completed in September 2000, setting performance criteria for September 2000. The 2nd review was completed in January 2001, setting performance criteria for March 2001. The 3rd review was completed in July 2001, setting performance criteria for September 2001. The 4th review was completed in February 2002, setting performance criteria for March 2002. The 5th review was completed in July 2002, setting performance criteria for September 2002. The 6th review was completed in February 2003. There was a continuous performance criterion on the non-accumulation of external arrears, which was met throughout.

Observance of December1995 performance criteria was not formally reported, as the mid-term review for the 2nd annual arrangement was never completed. The staff report for the 1996 Article IV consultation indicated that the main macroeconomic targets for 1995 were met.

About US$30 million in nonconcessional debt was contracted in 1994 to finance the purchase and repair of military hardware.

C. Structural Performance Criteria and Benchmarks

24. Structural conditionality generally covered a wide range of areas reflecting Cambodia’s comprehensive needs, but it was streamlined over time. The core conditions related to fiscal management and financial sector reform, whereas conditions in other areas of macroeconomic relevance were applied to trade reform, civil service reform, public enterprise reform, and environmental management (Table 2). Altogether, a total of 113 prior actions, performance criteria and structural benchmarks were introduced, most of them under ESAF-II/PRGF reflecting the completion of all 6 reviews. However, the average number of conditions per review declined from 20 under ESAF-I to 12 under ESAF-II/PRGF, reflecting efforts at streamlining, and the concurrence of conditionality under the World Bank lending operations. Structural performance criteria were used sparingly.

Table 2.

Cambodia: Structural Conditionality in Fund Programs, 1993–2003

article image
Sources: Various IMF staff reports.

25. Compliance with structural conditionality was mixed, and experience showed that there was a trade-off between streamlining conditionality and retaining as conditions certain elements of key structural reform actions critical for sustaining stability and promoting growth (Table 3 and Annex V). Compliance tended to be better in the areas of fiscal management and financial sector reform, which, as the Fund’s core areas of expertise, were also best covered by technical assistance provided or coordinated by the Fund.24 By contrast, 80 percent of structural benchmarks in civil service reform under ESAF-II/PRGF were not met, and compliance with conditionality on forestry remained a problem, even after causing the halt of the program supported by ESAF-I. It should be noted, however, that in the attempt to streamline conditionality in 2001, the only structural performance criterion on forestry concessions under ESAF-II/PRGF was converted into a benchmark, on the understanding that conditionality would be better covered under the World Bank operations. In the event, Cambodia complied with Bank conditionality on forestry only after the ESAF-II/PRGF had expired, diluting the sector’s expected contribution to the program.

Table 3.

Cambodia: Percent of Structural Conditionality Met Under Fund Programs, 1993–2003 1/

article image
Sources: Various IMF staff reports.

Met or met with minor delays. Excludes prior actions.

uA01fig03

Structural conditions under Fund programs, 1993–2003

(Average number of conditions per review)

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

uA01fig04

Fund Technical Assistance, 1993–2003

(In person months)

Citation: IMF Staff Country Reports 2004, 324; 10.5089/9781451821697.002.A001

D. Prior Actions

26. Prior actions increased between ESAF-I and ESAF-II/PRGF, but their impact was generally transitory. Prior actions appropriately signaled a renewed government commitment at the outset of a program, or the intention to take decisive actions to address program slippages. Most of the increase in prior actions was in the fiscal area (from one in ESAF-I to nine in ESAF-II/PRGF) and geared at enhancing revenue, including from logging activities. However, revenue shortfalls ensued shortly after the period covered by the prior actions. ESAF-II/PRGF also made extensive use of prior actions in financial sector reform (none under the predecessor arrangement), but mostly to redress slippages with respect to structural benchmarks during the program. Most of the key prior actions concerning forestry (environmental) management and civil service reform sought to redress problems that had arisen under the predecessor ESAF arrangement.

V. Lessons for Policy and Program Design

A. Why was a Long-Term Engagement Needed for Cambodia?

27. Cambodia’s prolonged use of Fund resources reflected mainly the changing role of the Fund in support of low income countries and, to a lesser extent, factors affecting the implementation of the programs. As noted above, Fund-supported programs under review evolved from dealing with a postconflict-cum-transition to a market economy to establishing the foundation for high and sustained growth and reducing poverty. It follows, that long-term Fund engagement was largely unavoidable, if only because of the changing nature of the problems to be addressed. On the other hand, while recognizing that Cambodia’s program implementation capacity improved during ESAF-II/PRGF, it will take significant efforts and political determination to achieve fiscal sustainability, enhance governance, and ensure a timely and successful implementation of the remaining vast development and poverty reduction agenda.

B. Lessons for Policy Design

28. Fiscal policy progressively assumed broader and higher responsibilities for achieving the programs’ objectives, without a clear and sustained resolution of key weaknesses.

  • Revenue mobilization received great attention in the design of policy, but key expenditure priorities should have been sheltered more effectively from compression in case of revenue shortfalls.

  • The tax structure appears to be broadly adequate, and the problems in mobilizing revenue reside more on compliance and a self-inflicted reduction in the tax base. Thus, future revenue-enhancing efforts will require strong political support and should focus on enhancing governance and transparency both in the revenue collecting bodies, and in the decision-making process related to the extension of exemptions and tax holidays, and the concession of contracts.

  • The management of expenditures still leaves much to be desired, as evidenced by the rising arrears and the inappropriate practice of offsetting them against tax liabilities being used. Also, the medium term expenditure framework should be enhanced to incorporate the medium term implications on current expenditure of the high level of aid-financed development expenditures.

  • A short term deficit financing strategy needs to be developed to support the day to day management of expenditure. Also, efforts to normalize relations with foreign creditors should continue to seek the most favorable terms within a medium-term fiscal sustainability context which clearly assigns expenditure priorities and is based on a realistic revenue projection.

  • Progress in recent years in raising outlays for social priority expenditures (health, education, and rural development) has been supported by the PRSP process. Implementation of poverty-reducing expenditures through the medium-term expenditure framework (MET) and budget will need to be strongly backed by adequate costing of measures and a transparent and consultative mechanism to adjust social spending priorities annually in line with needs and available funds.

  • The absence of what is called a combined-sources development expenditure plan is conspicuous and needs to be addressed together with the donor community. To this end, it is of utmost importance to collect information on the type of quasi-public investments being supported outside the budget, which eventually could revert to the government.

29. Reliance on a flexible exchange rate and a firm control over domestic credit should continue, while steps are taken to promote de-dollarization.

  • While acknowledging the limitations imposed by dollarization on the short-term impact of changes in the exchange rate, official intervention in the foreign exchange market should be limited to smoothing fluctuations. The authorities should not resist pressures on the exchange rate that reflect fundamental changes in underlying market conditions.

  • De-dollarization will require, besides maintaining political stability as the ultimate anchor of confidence in the riel, steps to (i) address the lingering trauma of demonetization, including by requiring that all government domestic transactions be paid in local currency; and (ii) promote the supply of basic banking services to the rural areas, by offering high-yield riel denominated deposits and facilitating access to credit. It will also be important to research further what other factors influence Cambodian investors to hold most of their financial portfolios in foreign currency.25

30. The pursuit of a flexible exchange rate combined with progress toward de-dollarization would allow monetary policy to be conducted independently. As such, monetary policy could, over time, complement fiscal policy in addressing unanticipated short-term shocks. Meanwhile, the fact that there is a growing demand for riel makes it important to continue enhancing NBC’s capacity to design and conduct monetary policy.26

31. Institutional and structural reforms need to regain momentum and focus, including on addressing more directly poverty reduction.

  • On the institutional side, limited progress in strengthening budgetary processes, reforming the civil service and combating corruption, has consistently undermined macroeconomic policy implementation and social service delivery.

  • Although plans have been formulated and regulations drafted in all these key areas and significant technical assistance has been provided, implementation of reforms has met with delays. Besides the issue of political will this points to the need to break down reform plans into more manageable and effective steps, and place greater emphasis on knowledge transfer.

  • The experience in reforming the financial sector suggests that a sound banking system in itself is not sufficient to promote financial intermediation and growth. Attention needs to be given now to overcoming the impediments to financial market development, including further development and enforcement of an adequate legal framework.

  • Lack of progress in agricultural and rural development has hampered efforts at poverty reduction. Further structural reforms are needed to promote agricultural growth and productivity, and lift living standards of the rural population accounting for 90 percent of Cambodia’s poor.

  • Private sector-led growth and investment has been robust, but limited mainly to the export-oriented textile sector, reflecting Cambodia’s privileged access to industrial countries’ markets. Such dependence has turned attention away from structural impediments to broad-based growth, including weaknesses in governance, inadequate and poorly enforced legal framework, and a limited supply of skilled workers.

C. Lessons for Bank-Fund Collaboration and Technical Assistance

32. Intense Bank-Fund collaboration will continue to be necessary. The success of any future program will depend on substantive inputs from other multilateral donors, in particular the Bank. Given that both the Fund and the Bank’s involvement in TA is expected to become more selective, with emphasis on the transfer of know-how, collaboration will need to be strengthened. In particular, efforts to expedite the preparation of specific action plans are needed in the areas of governance, civil service reform, and fiscal management.

33. Looking ahead, several areas are in need of immediate assistance. In the area of governance, plans for sustainable forestry have not been finalized, monitoring of logging activities remains ineffective, and there is a need for the adoption and enforcement of an anti-corruption law. In the fiscal area, a fundamental strengthening of revenue collecting agencies and a review of the government contract concessions to the private sector is urgent. The medium-term expenditure framework under development needs to include a comprehensive and explicit review of the current expenditure implications of all government- and donor-financed investment projects. In the area of civil service reform, there is an urgent need to address wage issues and staffing of at least certain key agencies.

VI. Strategy for Future Fund Relations with Cambodia

A. Policy Challenges

34. Cambodia’s policy strategy during the 1990s adapted well to the changing circumstances and progressively more complex challenges. Having made progress in addressing the postconflict and transition to market problems, the government’s policies were appropriately redirected toward promoting high growth and reducing poverty in the latter part of the 1990s. However, the government’s comprehensive poverty reduction agenda took longer to be completed and to become operational, and, as a result, little inroads were made in the period under review as regards poverty reduction, particularly in rural areas.

35. Against this background, the main policy challenges to achieve the desired reduction in poverty continue to be: (i) improving governance and eliminating corruption; (ii) creating the conditions for a revival of investment, with a view to broaden the growth base (particularly agriculture and tourism), and diversify exports; (iii) building up human capital to meet future private sector needs; (iv) raising the efficiency of the delivery of public services and improving the provision of public goods, including basic infrastructure; (v) developing further a stable and predictable legal framework and a strong judiciary system; and (vi) keeping the trust of donors.

B. Rationale for Continued Fund Involvement and Exit Prospects

36. Cambodia’s vast development and poverty reduction agenda is yet to be implemented and will continue requiring internationally concerted financial assistance. Financing requirements are likely to be high (NPRS estimates are in the order of $200 million per year over the next five years).

37. The Fund is likely to be asked both by the authorities and the donor community to continue to provide policy advice, technical assistance, and financial support to Cambodia. The first two roles are clear, although lessons indicate that there is need to focus on the promotion of ownership of the policy measures and on building up an indigenous expertise. Whether and for how long the Fund should continue to assume a catalytic financial role is less clear. Cambodia is likely to require two types of financial involvement from the Fund: (i) to catalyze support for implementing the unfinished poverty reduction agenda; and (ii) to help confront the likely adverse impact of the imminent elimination of the garment quotas. Both types of needs could be met by seeking understandings on a medium-term strategy that could be supported by a successor arrangement, with access to be determined by the strength of the program, taking into account public debt dynamics. It should be expected, however, that a steadfast implementation of a sound policy strategy should help reduce external financial requirements steadily over time, and provide the required policy flexibility to address future shocks without resorting to short-term financing.

38. It is difficult at this juncture to believe that Cambodia will be a candidate for early graduation from using Fund resources any time soon. However, such a question should be raised at the time of approval of each yearly program, since proximity to achieving the MDGs, reducing reliance on concessional external financial resources, and increasing policy flexibility should be key tests of progress under a program.

C. Suggested Key Features of a Successor Arrangement

39. Goals: Consistent with the Government’s National Poverty Reduction Strategy and the Development Plan, any future Fund-supported program should aim at maintaining macroeconomic stability and placing the economy on a path of high and sustained growth, led by the private sector, with a view to foster Cambodia’s human development, including through the reduction of the prevailing high degree of poverty.

40. Policy strategy: The set of economic and structural reform policies should be broad enough to help the authorities not only to set the course for high, private sector-led growth and export diversification, but also to gain policy flexibility to addressing imbalances and countering shocks to maintain stability. The success of a future policy framework should not depend on the strength of fiscal policy alone.

41. Having said this, fiscal policy should continue to be at the center of the economic policy strategy. The emphasis should be on:

  • Strengthening revenue performance, including through further efforts to expand the tax base, a decisive attack on tax evasion and smuggling; and a thorough revision of tax incentives and government concessions. Ensuring a strict control of expenditures, a timely execution of the budget to avoid accumulation of arrears, and a reduction in the scope for corruption, including by upgrading the quality and pay of public servants.

  • Aligning donors’ assistance priorities with those of the government, enhancing the medium term expenditure framework to anticipate future operating costs of aid-financed projects, and initiating the development of a combined sources budget.

  • Developing a deficit financing strategy, including a definitive normalization of outstanding external debts on terms consistent with fiscal sustainability, and the development of the securities market.

  • Program fiscal conditionality should target the primary deficit (not the current balance), and have an indicative path for the overall deficit consistent with a sustainable path for the public debt. Revenues could be subject to a floor target, with accompanying contingent measures to enhance revenues and reduce expenditures on low-priority expenditures to offset any shortfalls. Alternatively, revenues could be projected conservatively, and a mechanism established to increase expenditures as additional revenues become available. Agreements should also be reached on the definition, measurement, and timetable for the elimination of expenditure arrears.

42. Maintaining a flexible exchange rate policy should be another key element of the program. To enhance the role of the exchange rate as shock absorber, steps to broaden the use of the riel as the sole legal tender should be included, provided they do not entail distortionary administrative measures. The program should also contain steps to enhance the NBC’s capacity to design and implement monetary policy, as its role should be expected to grow over time with progress in de-dollarizing the economy.

43. Targeted efforts at public administration reform are urgently needed, even if a comprehensive strategy will take longer to be finalized. Given the slow progress to date and pervasive weaknesses in governance, key steps should include:

  • Providing revenue collecting agencies with effective, well-paid, and accountable staff, while continuing to streamline the rest of the civil service.27

  • Strengthening considerably the Treasury by accelerating the adoption of an integrated cash management system and budget accounting policies in line with best practices.

44. Other structural reforms need to be focused on promoting broad-based private sector-led growth and reducing poverty. In particular:

  • Addressing the impediments to agricultural growth by strengthening land titling procedures, ownership transfer and property rights, auditing existing land concessions and upgrading access to markets and infrastructure facilities.

  • Promoting financial market development by strengthening the legal framework for contract enforcement and collateral-based borrowing, upgrading corporate accounting and disclosure standards to ensure reliable borrower information, and promoting the development of banking services in rural areas.

  • Creating an environment conducive to broad-based private sector investment and growth by strengthening the legal framework and liberalizing further labor market regulations consistent with WTO accession commitments, and by combating corruption.

D. Risks

45. The main risks to the success of a medium-term program would be:

  • Lack of political cohesion could undermine the commitment and resolve to pursue further reforms, and perpetuate the adverse influence of the political situation on the overall economic conditions and outlook.

  • Insufficient progress in improving fiscal management, strengthening fiscal institutions, and enhancing accountability, transparency and governance, coupled with a continued lack of policy options to address shocks.

  • Complacency in addressing governance issues, compounded with delays in implementing the legal and judicial reforms.

  • A larger and more disruptive-than-anticipated adverse impact of the removal of the garment quotas.

Cambodia: Fund-Supported Programs, 1993–2003

Systemic Transformation Facility (STF), 1993–94: The STF was preceded by a year-long informal monitoring arrangement with Fund staff and by an Article IV consultation in May 1993, the first in 20 years. The STF (with a single purchase of SDR 6.25 million) was approved in October 1993, immediately following the clearance of about SDR 37 million in arrears to the Fund. The authorities’ program was fairly successful in restoring macroeconomic stability in the second half of 1993, reflecting tighter fiscal and monetary policies, renewed access to donor support, and the confidence boost resulting from a successful political transition. The authorities also unified the exchange rate and implemented some institutional reforms, including the adoption of an organic budget law. All quantitative and structural benchmarks were observed.

Enhanced Structural Adjustment Facility (ESAF), 1994–97: The three-year arrangement under the EASF was approved in May 1994, in an amount of SDR 84 million (129 percent of quota). The authorities’ aim was to consolidate macroeconomic stability and begin the process of long-term reconstruction, supported by tight financial policies, aid-financed public investment, institution building, and growth-oriented structural reforms. During the program period, Cambodia experienced robust GDP growth, low inflation and strong export growth. There were, however, persistent fiscal pressures resulting from low revenues and large military outlays. Performance under the program deteriorated after the approval of the second annual arrangement in September 1995 and no further disbursements were made until the arrangement expired in August 1997, largely as a result of difficulties in implementing agreed forestry policies.

Poverty Reduction and Growth Facility (PRGF), 1999–2003: After a period of somewhat weaker economic performance in 1997 and 1998, reflecting political instability and spillovers from the Asian crisis, the economy returned to strong growth in 1999. The three-year arrangement under the PRGF (initially ESAF) was approved in October 1999, with total access of SDR 58.5 million (67 percent of quota). The program’s main focus was on fiscal reform, in particular efforts to increase revenues; reduce military spending; reform public administration; and provide additional funds for social services and public investment. The authorities also aimed to improve forestry management, building on efforts made in the first half of 1999 (prior actions), advance structural reforms to support private growth and poverty reduction. Macroeconomic performance under the program was generally positive, with sustained high GDP and export growth, low inflation, and a rebuilding in international reserves. All quantitative performance criteria and all but one structural performance criteria were met, and all six reviews were completed with only minor delays. However, the targeted increase in fiscal revenues was not achieved, forestry management remained problematic, and poverty remained pervasive.

Cambodia: The Role of Poverty Reduction Strategies

Cambodia developed a comprehensive strategy directly aimed at poverty reduction only during the latter part of the period under review. Under ESAF-I, the government’s approach to poverty alleviation was only indirect and consisted of establishing an environment conducive to rapid economic growth. Under ESAF-II/PRGF, a similar approach was initially set out in an overall structural reform strategy (Medium-Term Economic and Financial Policy Framework Paper, EBD/99/119). A more direct approach to poverty reduction only came with the Interim Poverty Reduction Strategy Paper that was finalized in late 2000. In December 2002, a full PRSP was completed, as Cambodia’s National Poverty Reduction Strategy (NPRS). It is based on the five-year Socio-Economic Development Plan for 2001–2005.

The PRSP commits the government to the Millennium Development Goals by 2015, in particular: (1) halving the proportion of people under the $1 poverty line, (2) halving the number of people suffering from hunger, (3) achieving primary education for all, and (4) reduce by two thirds from the 1990 level the child mortality rate.

To achieve these goals, the government has set out the following priorities: (1) maintaining macroeconomic stability, (2) rural sector development, (3) facilitating private sector job growth and promoting exports, (4) achieving education for all and improving health services, and (5) strengthening institutions and improving governance.

The PRSP has benefited from extensive and open participation, but a number of key challenges have been noted in the 2003 Joint Staff Assessment (EBD/03/8) for its successful implementation. These include:

  • Improving costing and prioritization of key measures with a clear link to the annual budget and a medium-term expenditure framework;

  • Improving governance and combating corruption;

  • Building capacity for poverty monitoring as well as evaluation of projects;

  • Further developing pro-poor and infrastructure development strategies.

Cambodia: Measures to Increase and Restructure Revenues, 1993–2002

Tax Measures

  • Trade: Switching from specific to ad valorem tax rates for the consumption tax on imports (1993); rationalizing the tariff structure (1993); imposing a tax on car imports; imposing a 10 percent export tax on rubber (1995); tariff bands reduced from 12 to 4, lowering the maximum tariff to 35 percent, and adjusting excises (2001); reducing ad hoc tax and customs exemptions.

  • Consumption: Increasing petroleum duties from 8–10 percent to 20 percent (1993), and from 20 percent to 35 percent (1994); increasing the turnover tax from 1–2 percent to 4 percent (1996); imposing an export tax at 10 percent, and a reforestation tax.

  • Services: 10 percent hotel room tax extended to other hotel services; tax on rents extended to domestic residents; 10 percent tax on entertainment services (2001).

  • VAT: Introduced in connection with the Law on Taxation. Coverage expanded to include more firms in 2001, and diesel purchases treated as final sales starting 2001.

  • Excises: Introducing 10 percent excise on selected goods (1995); excise on gasoline increased to 20 percent (1996) and further in 2002, with an increase for beer.

  • Income: Wage tax imposed on monthly salaries exceeding US$200 at rates of 10–40 percent. Law on Investment amended (2003) to eliminate certain exemptions and make procedures more transparent.

Nontax measures

Imposing a tax on construction permits (1993), introducing permit fees for casinos, increasing fees and royalty payments from tourist service providers, implementing the timber royalty US$14/m3 to US$54/m3 (1999), introducing a system of stamps for taxing cigarettes (2001).

Administrative measures

Improving the capacity for tax auditing and to collect tax arrears, establishing a large tax payers unit, clarification of customs codes and legislation, simplification of customs procedures, automation of duty calculation, regular rotation and professional training of customs officers, strengthening incentives and discipline for tax and customs officers, implementing preshipment inspection. The authorities also made great efforts to collect revenue from the telecommunications and civil aviation companies and urged line ministries to transfer revenue to the Treasury.

The above changes helped make the tax system more neutral, efficient, and equitable, revenue productive, elastic, and less dependent on trade taxes. By 2002, trade taxes only represented about 35 percent of tax revenues while indirect and direct taxes accounted for 55 percent and 10 percent, respectively. Still, Cambodia’s tax structure relies more on trade taxes than a group of selected Southeast Asian countries, with the average trade tax ratio of 2¾ percent of GDP over the review period more than twice that of Lao PDR and 1 percentage point of GDP higher than that of Thailand. On the other hand—reflecting generous investment tax concessions and low salaries for civil servants—the share of direct taxes is about 3 to 7 times lower than that for Lao PDR, Thailand, and Vietnam. Similarly, the share of excises in total taxes is significantly less than in all these other countries. In addition, the continued widespread use of tax holidays and other tax exemptions has narrowed the income tax base.

Cambodia: Debt and Fiscal Sustainability

The level of external public debt has remained high, totaling US$3 billion at end-2003, or about 70 percent of GDP and almost 700 percent of revenues (excluding grants). Two-thirds of this debt continues to be in arrears (mainly to Russia, but also to the United States), despite repeated efforts at regularization. The remainder is owed mainly to multilateral institutions, whose claims on Cambodia have risen by almost US$600 million since end-1999. Domestic public debt accounts only for only about 5 percent of total public debt at end-2003.

Progress toward public external debt sustainability will not only depend on the rescheduling of arrears, but also on overall fiscal sustainability. Critical considerations include:

  • Liquidity: If a debt restructuring agreement on Naples terms is reached with Russia and the United States, Cambodia’s scheduled debt service would decrease on an accrual basis, but increase on a cash basis by about 5–10 percent of projected revenues (excluding grants), implying a significant additional demand on public resources.

  • Debt overhang: Even after the assumed upfront 70 percent discount on Russian debt and concessional rescheduling, external debt would still be equivalent to about 350 percent of 2004 revenues (excluding grants), provided revenue targets for the year are met. In net present value terms, public external debt would be equivalent to about 70 percent of exports (net of re-exports and garment imports), and not much below the HIPC threshold of 250 percent of revenues. Concerns about fiscal sustainability may thus persist and possibly deter private capital, which would be needed for reducing Cambodia’s reliance on international aid over the long term.

  • Vulnerability to shocks: A real exchange rate depreciation, a decline in revenues, or a decline in GDP could severely worsen the NPV of debt-to-revenues ratio and exacerbate liquidity problems. For instance, a 30 percent real depreciation would increase the NPV of debt after restructuring to more than 300 percent of government revenues.

  • Dependence on foreign project financing: Continued heavy reliance on multilateral loans implies that debt ratios would remain high, even if bilateral debt were to be gradually amortized. This concern is highlighted by the external financing requirement under the NPRS with projected loan disbursements averaging US$ 200 million annually over the next five years.

Against this background, the need for reducing the public external debt burden should be considered in the context of a comprehensive assessment of the factors affecting fiscal sustainability. This would include possible future economic shocks, increases in social-priority outlays and implementation of non-priority expenditure cuts as well as revenue-enhancing measures. In the absence of a credible medium-term fiscal plan, it is not clear what debt rescheduling terms would be appropriate for Cambodia.

Cambodia: Ex Post Assessment of Longer-Term Program Engagement
Author: International Monetary Fund