Cambodia: Staff Report for the 2004 Article IV Consultation
Author: International Monetary Fund
Publication Date:
22 Oct 2004
eISBN:
9781451821741
Language:
English
Keywords:
ISCR; CR; IMF executive board reviews progress report; government; Cambodia's NPRS.; reform agenda; poverty reduction strategy paper; U.S. dollar; private sector; broad money; government capacity; fiscal policy; Exports
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Cambodia’s 2004 Article IV Consultation reports that the macroeconomic performance has been generally good, reflecting both favorable external developments and prudent fiscal policy. Exports soared following a bilateral trade agreement with the United States, and large aid inflows helped finance domestic investment and spurred construction activities. Prudent fiscal policy has been the key to ensuring price stability. Overall GDP growth has been robust mainly because of a strong rebound in agricultural production.

Abstract

Cambodia’s 2004 Article IV Consultation reports that the macroeconomic performance has been generally good, reflecting both favorable external developments and prudent fiscal policy. Exports soared following a bilateral trade agreement with the United States, and large aid inflows helped finance domestic investment and spurred construction activities. Prudent fiscal policy has been the key to ensuring price stability. Overall GDP growth has been robust mainly because of a strong rebound in agricultural production.

I. Background

1. Economic growth in the 1990s was robust, albeit from an exceptionally low base given the damage from the 20-year civil war. UN-sponsored elections in 1993 yielded a coalition government but internal tensions persisted, undermining the rebuilding process. Elections in 1998 produced a more durable coalition government that oversaw a period of generally positive economic performance. More recently, tensions between the former coalition partners in the wake of the July 2003 elections delayed the formation of a new government with sufficient parliamentary support until mid-July 2004.1 Economic reforms largely came to a halt during the eleven-month stalemate.

2. Large aid inflows and the boom in the garment and tourism sectors have helped Cambodia develop a formal sector around the main urban areas. The rural areas, however, where most of the poor live as subsistence farmers with highly volatile incomes, were left behind. The average household expenditure in the rural area has declined from 33 percent of that in Phnom Penh in 1993/94 to 28 percent in 1999, and is estimated to have declined further to about 25 percent in 2002. Moreover, the minimum wage, which is high relative to average wages and increasingly being applied to all industries in the formal sector, reduced employment opportunities for the growing labor force.

A01ufig01

Contribution to GDP growth

(Annual growth rates in percent)

Citation: IMF Staff Country Reports 2004, 328; 10.5089/9781451821741.002.A001

3. Accordingly, only limited progress has been made in alleviating poverty since the beginning of reconstruction efforts. Cambodia remains one of the poorest countries in the region with 36 percent of the population in poverty as of 1999. Moreover, Cambodia is seriously off-track from the MDGs in several aspects (Box 1).

4. Cambodia’s development program was supported by a three-year PRGF arrangement for SDR 58.5 million (67 percent of quota), approved on October 22, 1999. The sixth and final review was completed in February 2003, after which a disbursement of SDR 8.4 million raised total Fund credit and loans outstanding to Cambodia to SDR 70 million (80 percent of quota). The National Poverty Reduction Strategy Paper (NPRS), together with a Fund-Bank joint staff assessment, was also endorsed by the Fund and Bank Boards in February 2003. The National Bank of Cambodia (NBC) prepares its audited financial statements in accordance with International Financial Reporting Standards, as required under the Fund’s safeguards policy. An IMF safeguards assessment mission in January 2004 found that progress has been made and proposed measures to strengthen the remaining weaknesses of NBC’s control framework.

Poverty in Cambodia

Cambodia is one of the poorest countries in the world, with a per capita gross national income less than half of the East Asia and Pacific average. Based on the World Bank Atlas Method, Cambodia’s per capita gross national income is US$300, the lowest in the East Asia region with the exception of Myanmar. It has some of the worst human development indicators in the world, ranking 130th out of 173 countries, with a national poverty level of 36 percent. The population is deprived of basic physical and institutional infrastructure as a result of decades of political and social instability until the early 1990s.

Despite steady growth during the last decade, poverty and inequality have remained stubbornly high. Thirty-six percent of the population had incomes below the poverty line of $0.40-0.63 per day in 1999, only marginally below the 39 percent in 1994.1 In addition, the GINI index of 40 percent implies a high level of inequality. The 20 percent of households with the lowest (per capita) income only receive 7.5 percent of the total income, while the highest quintile receives 46 percent of total income.

Poverty Indicators

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Source: World Development Indicators, 2004.

Cambodia is off-track in pursuing the Millennium Development Goals:

  • Food security is lagging. At 36 percent, the proportion of people suffering from hunger is far from the 2015 target of 19.5 percent. Poverty is worse in rural areas. The high proportion of under-weight children under age 5 persists owing to inadequate food intake, lack of health care, and poor sanitation.

  • Child mortality has increased over the past ten years, particularly post-neonatal mortality. The main causes have been diarrheal diseases, acute respiratory infections, and vaccine-preventable diseases, particularly measles where the coverage rate of immunization is only 59 percent, well-below the 2015 target of 90 percent. Despite progress, the maternal mortality rate remains extremely high at around 437 per 100,000 live births.

  • Cambodia could achieve primary education for all by 2015, but is unlikely to reach its secondary education and gender equality targets. At 20.3 percent in 2001, the youth illiteracy rate was much higher than the 3 percent average in East Asia and the Pacific.

Rural Social Conditions, 2001

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Source: World Development Indicators, 2004.

Health and sanitary conditions are very poor: only 30 percent of the population has access to safe drinking water and only 17 percent has access to sanitation facilities. The conditions are especially poor in rural areas where only 10 percent has access to sanitation. More resources are needed to improve basic household amenities, especially in remote areas. Given the rural concentration of the poor, meaningful poverty reduction will require more broad-based growth based on agriculture diversification and higher agricultural productivity.

Cambodia: Selected Poverty Indicators

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Source: World Development Indicators, 2003; Human Development Report, 2004; United Nations Development Goals (Cambodia 2001); and IMF staff estimates.

The poverty headcount ratio is the proportion of population below the poverty line.

Preferably by 2005.

A value of the GINI index of 100 denotes perfect distribution or equality.

1 Using the poverty line of US$1 per day (based on purchasing power parity exchange rates), the poverty headcount ratio for 1999 was 41.5.

5. During the 2002 Article IV Consultation, Directors welcomed progress under the PRGF. However, they noted the widespread poverty, narrow production base, low revenue to GDP, and pervasive governance concerns. They underscored the need to strengthen government capacity and promote broad-based economic growth through investment and a vibrant private sector. The accompanying Ex-post Assessment report provides a detailed account of the Fund’s contribution to Cambodia’s recent economic growth.

II. Recent Economic Developments and Prospects for 2004

6. Macroeconomic performance in the past few years was generally good. With the advent of political stability in 1999, private sector activities, reportedly also in the informal sector, flourished in urban areas. Annual real GDP growth averaged 6-7 percent, reflecting both favorable external developments and prudent macroeconomic policies (Table 1). In particular:

  • Exports soared following a bilateral trade agreement with the united States that effectively reduced the average U.S. tariff rate for garments produced in Cambodia from 50-70 percent to 10-20 percent. The 1996 trade agreement attracted a large number of foreign investors, which contributed to a sharp increase in garment exports to the U.S. from nearly zero in 1995 to $500 million in 1999 and to more than $1 billion in 2003, which is about 70 percent of total garment exports (Table 2). The benefit to the domestic economy, however, was limited as almost all non-labor inputs were imported.

  • Large aid inflows, which averaged 12 percent of GDP, helped finance domestic investment and fueled construction activities. About half of the inflows were grants in the form of donor-financed projects and technical assistance, all of which were outside the budget. Aid inflows were used to improve health and education, rebuild physical infrastructure, and strengthen economic and social institutions.

  • Prudent fiscal policy has been key to ensuring price stability in Cambodia’s highly dollarized economy. As much as 95 percent of total liquidity, including estimated U.S. dollars in circulation, is in dollars. With few monetary policy instruments, the task of ensuring that aggregate demand does not become a source of inflation necessarily falls to fiscal policy. This task has been made easier in recent years because of low inflation in U.S. dollar terms in trading partners.

Table 1.

Cambodia: Selected Economic Indicators, 1999–2004

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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.

Includes net lending, and compensation payments to Thailand in 2003.

Includes funds in transit and payment orders in excess of cash released.

The financing gap is expected to be closed either by a PRGF and World Bank’s PRSC or by lower reserve accumulation.

A Paris Club rescheduling under Naples terms (67 percent NPV reduction) is assumed in 2004.

Table 2.

Cambodia: Balance of Payments, 2000-09

(In millions of U.S. dollars)

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

Assumes conclusion of debt rescheduling agreement with the Russian Federation and the United States in mid-2004.

The financing gap is expected to be closed either by a PRGF and World Bank’s PRSC, or by lower reserve accumulation.

A01ufig02

Total Garment Exports, Imports, and FDI

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2004, 328; 10.5089/9781451821741.002.A001

A01ufig03

Uses of Aid Flows

(average 1999-2003)

Citation: IMF Staff Country Reports 2004, 328; 10.5089/9781451821741.002.A001

7. Fiscal revenue improved from 8.1 percent of GDP in 1998 to 11.2 percent in 2002 owing in part to strengthened tax and customs administration. The latter was supported by an extensive technical assistance program under the Technical Cooperation Action Plan (TCAP). Nevertheless, total revenue remains low—about 11 percent of GDP compared with an average of 16 percent of GDP in neighboring low-income countries—severely constraining priority spending. For example, civil service wages remain well below private sector wages, and roads and other public facilities are poorly maintained. Although recourse to domestic bank financing of the fiscal deficit was largely averted, arrears to domestic suppliers have accumulated.

A01ufig04

Contribution to Changes in Central Government Tax Revenue

(% of total tax revenue)

Citation: IMF Staff Country Reports 2004, 328; 10.5089/9781451821741.002.A001

8. More recently, nonagricultural growth slowed to 3.2 percent in 2003 due to the SARS-related drop in tourism and election-related uncertainties. However, overall GDP still grew by 5.2 percent, mainly because a lower Mekong river level—due to lower rain fall—exposed a larger area of arable land that allowed a strong rebound in agricultural production. Revenue collection was disappointing, partly reflecting low nonagricultural growth, but more importantly due to greater tax evasion and smuggling by importers.2 Election-related spending during the year helped to boost consumption, which, however, required a sharp curtailment of non-priority expenditure toward the end of the year, especially given the poor revenue collection. The external current account deficit (excluding official transfers) widened by 1¼ percent to 10¼ percent of GDP due to buoyant merchandise imports, lower tourism receipts, and higher petroleum prices. The vulnerability of the deposit base of the banking system was apparent during the July elections when foreign currency deposits declined by 20 percent in a matter of 1-2 weeks. They recovered, however, later in the year (Table 3).

Table 3.

Cambodia: Monetary Survey, 2000-04

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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.

9. Only modest progress on structural reforms has been made since 1999. Basic institutions were set up and various laws ranging from commercial contracts to accounting were adopted. A Financial Institutions Law was passed that provided the legal basis for successful bank re-licensing. However, progress has been particularly slow in civil service and judicial reform due to political resistance. The pace of structural reforms slowed across all sectors in the run-up to, and aftermath of, the July 2003 election. The 2004 budget and a range of legislation needed to complete WTO accession still await approval by the National Assembly.

10. More importantly, the reconstruction efforts have not yet been able to establish a strong foundation for sustainable growth, even in urban areas. In particular, structural weaknesses, complicated by deeply rooted governance problems, remain in the following three inter-related areas:

  • An underlying deterioration of competitiveness has been masked by favorable external developments. Poor public administration and weak governance—partly due to slow progress in legal and judicial reform—have exacerbated uncertainty in the business environment and allowed the rich to set their own rules. In addition, embryonic and poorly maintained infrastructure and high wages have kept operating costs high (Box 2).3

  • Agricultural development has stagnated due to limited access to arable land and markets (Box 3). Slow growth in agriculture has pushed Cambodia further away from meeting the MDGs and reduced its capacity to absorb the growing number of entrants to the labor market over the medium term.

  • Government capacity remains severely constrained by lack of human capital and entrenched governance problems. The quality of the civil service remains poor, and fiscal revenue, currently at 10.4 percent of GDP, is hardly enough to meet basic priority spending needs (Table 4).

Table 4a.

Cambodia: General Government Operations, 2000-04

(In billion of riels)

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For 2003 and 2004, data include compensation payments to Thailand.

Includes CR 137 billion from bilateral donors for 2002, CR 92 billion for 2003, and CR 116 billion for 2004.

Cash payments on expenditure committed in the previous year (-); or expenditure committed but for which cash has not yet been disbursed (+).

Includes CR 28 billion of early repayment by the water supply company on onlent World Bank loan, and CR 16 billion loan by the electricity company.

Includes $2.8 million repayment to IDA in 2003.

Includes funds in transit and payment orders in excess of cash released.

Table 4b.

Cambodia: General Government Operations, 2000-04

(In percent of GDP)

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For 2003 and 2004, data include compensation payments to Thailand.

Includes CR 137 billion from bilateral donors for 2002, CR 92 billion for 2003, and CR 116 billion for 2004.

Cash payments on expenditure committed in the previous year (-); or expenditure committed but for which cash has not yet been disbursed (+).

Includes CR 28 billion of early repayment by the water supply company on onlent World Bank loan, and CR 16 billion loan by the electricity company.

Includes $2.8 million repayment to IDA in 2003.

Includes funds in transit and payment orders in excess of cash released.

Competitiveness

Cambodia’s garment exports have risen rapidly since the late 1990s, mainly reflecting two factors. The first is the 1996 bilateral trade agreement with the United States that substantially reduced the effective tariff rate on garments produced in Cambodia. The second factor is the large economic rent for Cambodian exporters to the U.S. market reflecting the U.S. quotas imposed on Chinese garment exporters. The underlying weaknesses of Cambodia’s competitiveness can be gleaned from two key observations.

Main Categories of Garment Exports to the U.S. Subject to U.S. Quota, 2003

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Sources: Ministry of Commerce of Cambodia and U.S. Department of Commerce, Office of Textiles and Apparel.

  • Cambodia is unable to fully utilize its allocated quota. Most of Cambodia’s garment exports are in categories that are subject to U.S. quotas on imports from China. However, Cambodia’s garment exports are below their quota in the U.S. market, and almost negligible in non-U.S. markets such as in Japan, while Chinese products dominate the market in the same categories.

  • Non-garment exports have remained flat in U.S. dollar terms. The business community estimates that a 15-30 percent cost reduction is required for Cambodia to remain competitive relative to China. Recent proposals to move garment manufacturers to export processing zones will have limited impact since Cambodia already provides extensive tax incentives.

There are many reasons for Cambodia’s weak competitiveness.

Competitiveness is impeded by poor infrastructure, corruption, and red tape. According to the World Bank’s recent Investment Climate Survey and Value Chain Analysis, the average cost of starting a business is estimated to be as high as 553 percent of per capita income, compared with 30 percent in Vietnam and 7 percent in Thailand. The “bribe tax” is estimated at 5¼ percent of sales in manufacturing, more than double the rate in Bangladesh, Pakistan, and China. Moreover, it takes an average of 18 days to obtain export customs clearance in Cambodia, compared with 11 days in India and 7 in China.

A01ufig05

Cambodia: Exports by Category of Goods

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2004, 328; 10.5089/9781451821741.002.A001

High labor cost has been another factor. At a minimum wage of $45 a month and an average of $61 a month in the garment sector, Cambodia’s wages are higher than in several neighboring countries, including Vietnam, India, and Sri Lanka. Moreover, foreign investors are subject to a 100 percent wage premium for night shifts, are restricted from operating on weekends or any of the 22 national holidays to meet temporary demand surges, and face frequent labor strikes.

Impediments to Agricultural Growth

About 80 percent of the poor depend on agriculture for their livelihood. Agriculture contributes 40 percent to GDP and accounts for 70 percent of employment. During 1994-2003, the sector grew at an annual average of less than 4 percent, contributing very little to employment growth. The average rice yield, estimated at 2.1 tons per hectare in 2001, is the lowest in Southeast Asia, reflecting in part low labor productivity. For example, a worker in Cambodia produces 44 kg of rice compared with 62 kg in Thailand.

GDP Growth

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Sources: NPC Statistics, MOP: A Poverty Profle of Cambodia 1999, and Cambodia Socio-Economic Survey 1999.

Average annual growth rates.

Pro-poor growth will depend on addressing key constraints faced by the rural economy in agriculture:

Lack of access to arable land

  • Lack of land availability. Only 1 percent of land area is used for permanent cropland and only 7 percent of this is irrigated. Cultivated land rose gradually from 1.4 million hectares in the mid-1980s to about 2.4 million hectares in the late 1990s, and has not increased since. Furthermore, most of the new land from de-mining (0.1 million hectares) and forest clearance (2.5 million hectares) has reportedly been allocated to the rich, who do not use the land for cultivation. This is partly corroborated by NGO reports that claim the government has approved 0.8 million hectares as land concessions in the past few years. However, official data show no expansion in cultivated land.

  • Lack of property rights. Only 10 percent of farmers have formal title to their farming land. With no property rights, most farmers are hesitant to engage in long-term investment and have no access to collateralized lending.

Limited access to economic opportunities

  • Inadequate rural roads and poor road maintenance impede commercialization. Of the 12,323 km of the existing road network, only 16.20 percent is paved. In comparison, Thailand has 98 percent of its road network paved, Malaysia 76 percent, and Vietnam 25 percent. There are no secondary roads and tertiary roads often feed directly into the primary network. Moreover, the rail system is in need of major rehabilitation.

  • Weak marketing systems. Only small scale informal trading of surplus rice occurs with Vietnam and Thailand. Cambodian farmers have weak bargaining power due to limited information on market prices. In addition, lack of warehouses contributes to huge price swings between post- and pre-harvest seasons (close to 100 percent sometimes), damaging poor farmers. The absence of agricultural associations and cooperatives also slows agricultural development.

  • Lack of modern farming techniques and advanced technology. Farmers use traditional seeds that produce low crop yields. Moreover, even though good quality fertilizers are imported from Thailand, these are diluted by middleman before reaching the farmers.

  • Limited access to formal financial services. The state-owned Rural Development Bank acts as a wholesale bank, mainly in lending to NGO microfinance institutions. So far six micro-finance institutions have been licensed and the largest (Acleda) has recently obtained a commercial bank license. None of the other commercial banks lend to farm households. It is estimated that only 15 percent of the rural population has access to financial institutions. As a result, farmers are under-capitalized and have no means of adopting new technology, improving seeds, or using fertilizers.

  • Barriers to public health. Due in large part to the low pay of public sector health workers, the public must pay fees to obtain free public health services. This limits farmers access to health care and their ability to earn income.

Limited access to forestry and fisheries

Forest and fisheries resources, which were previously a source of supplementary food and income to farmers, have become increasingly difficult to access. Recent changes in natural resource management policies have left vast areas of the country (30 to 40 percent of total area) with unclear management arrangements.

A01ufig06

Actual Social Spending and NPRS Target

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 328; 10.5089/9781451821741.002.A001

11. The outlook for economic growth in 2004 is tinted by weaker prospects for agricultural production. The Avian flu earlier in the year, the smaller fish catch due to the lower Mekong river level, and agricultural production that is unlikely to be much higher than last year’s bumper crop indicate weaker output growth. While non-agricultural growth is expected to rebound strongly due to a recovery in tourism, overall GDP would most likely increase by 4-4½ percent. The impact of still-high petroleum product prices is expected to widen the external current account deficit by another ½ percent of GDP. Inflation is also likely to inch up reflecting price developments in trading partner countries.

III. Medium-term Prospects and Challenges

12. Urgent reform in the agricultural sector is essential to achieve the NPRS objective of reducing poverty. As a small open economy with ample unused arable land and a large unskilled labor force, agriculture is widely recognized to be Cambodia’s comparative advantage. Promoting agriculture is the best strategy to secure a key source of growth that could help absorb a part of the expected increase in the labor force, address poverty more directly, and provide a more rapid expansion of d