Cambodia
Poverty Reduction Strategy Paper Progress Report

This paper examines Cambodia’s Poverty Reduction Strategy Paper Progress. The Cambodian economy grew by 5.2 percent in 2003 compared with 5.5 percent in 2002, led by continued growth in garments exports, a rebound in overall investments and an upward surge in agricultural production. The drop in foreign direct investment has been more than compensated by domestic private investment and higher consumption induced by higher public spending. Moreover, the weakness in the service sector receipts has been offset by continued strong growth in garments exports.

Abstract

This paper examines Cambodia’s Poverty Reduction Strategy Paper Progress. The Cambodian economy grew by 5.2 percent in 2003 compared with 5.5 percent in 2002, led by continued growth in garments exports, a rebound in overall investments and an upward surge in agricultural production. The drop in foreign direct investment has been more than compensated by domestic private investment and higher consumption induced by higher public spending. Moreover, the weakness in the service sector receipts has been offset by continued strong growth in garments exports.

1. Introduction

Cambodia’s development performance in 2003 built upon progress gained in 1999 - 2002, further demonstrating the nation’s resolute movement towards lasting peace and sustainable development, manifested in robust economic growth, continuing strengthening of Democratic institutions and alleviation of poverty. Cambodia successfully hurdled all 6 PRGF reviews by February 2003, laying the stage for the Royal Government of Cambodia’s vision that: “By the end of the first decade of the 21st century, Cambodia will have fully reclaimed its destiny, stands as a real partner in regional and global affairs and be wel on her way toward being a truly free nation, and above all free from want and poverty.”

In 2003, the Royal Government succeeded in maintaining macroeconomic stability in the face of external and internal disruptions and uncertainty. Improved security and strengthened peace across the entire country have been crucial to social and economic stability and continuing reduction in poverty. As a highlight, in September 2003 Cambodia was approved for membership in the WTO, becoming the first-ever less-developed country to achieve such approval. Indeed, Cambodia is on the correct track in modernizing the economy and liberalizing trade and investment to integrate the country into the regional and world economy.

Cambodia’s national elections were held in July 2003. The elections were conducted in an orderly and peaceful manner and certified so by international observers. This was due to the improved law enforcement capability of the Ministry of Interior and the Royal Cambodian Armed Forces. Despite the successful election, the economic and social fabric of the nation was severely disturbed by events such as the anti-Thai riots in early 2003, the outbreak of SARS soon after and arising from the elections, the uncertainty that has persisted into 2004. These adverse events caused unexpected shortfalls in fiscal revenues with serious repercussions on budget execution in general, and the implementation of NPRS programs and projects in particular. Moreover, due to the delay in forming a new government, progress on some actionable measures has been limited. Despite the political deadlock, the RGC has taken serious strides to prepare the reform programs for the new government.

NPRS Dissemination

The Council for Social Development (CSD) has taken serious strides to disseminate the National Poverty Reduction Strategy (NPRS). The NPRS was publicly launched in March 2003, with participation from the broad range of stakeholders including government officials, members of Parliament, representatives of donors, NGOs, academia/researchers, private sector, trade unions and the media. The NPRS was made available both in Khmer and English. Free copies of the NPRS were distributed to a large number of policymakers, civil servants, provincial and local authorities, commune councils, and representatives of vulnerable groups. Several workshops were organized at the national, provincial and district levels to spread the NPRS and its key messages across to all stakeholders.

The CSD also implemented actions to further discuss NPRS priority activities and strategic actions, so that the actions are linked more closely to the public investment program (PIP).

The First Annual NPRS Report

The coverage of this document, the first Annual NPRS Report, is deliberately selective and thereby limited to only the key, priority areas. Responding to concerns earlier expressed by stakeholders, the Royal Government has: (i) costed and prioritized programs in the annual budget, linking these together within the Medium-Term Expenditure Framework (MTEF); (ii) strengthened budget management; (iii) improved governance and reduced corruption; (iv) called for the building national capacity for poverty monitoring and evaluation of key programs and policies; and (v) focused on elaborating and implementing pro-poor rural and infrastructure development strategies.

The first Annual NPRS Report has also attempted to reconcile the Millennium Development Goals and the NPRS for 2005. Further efforts are necessary both in the UN system and in the Royal Government to merge the MDGs and NPRS targets into a consistent single set that will facilitate policy implementation and monitoring. As the process progresses, future NPRS reports shall be more supportive of the MDGs and also provide a more comprehensive review of Cambodia’s development strengths, weakness, opportunities and threats (SWOT).

The Reform Strategy for 2004-2008

Soon after the July 2003 elections, the RGC drafted a comprehensive reform agenda, which selects from and prioritizes actions arising from the NPRS and the Socio-Economic Development Plan 2001-2005, and has “good governance” as its backbone. In the first of the Council of Ministers’ Meeting for the third mandate of the National Assembly on the 16th of July 2004, Samdech Prime Minister Hun Sen introduced the “Rectangular Strategy” for growth, employment, equity and efficiency. The “Rectangular Strategy” is an integrated structure of interlocking rectangles, as follows:

First, the core of the Rectangular Strategy is good governance focused at four reform areas: (1) anti-corruption, (2) legal and judicial reform, (3) public administration reform including decentralization and deconcentration, and (4) reform of the armed forces, especially demobilization;

Second, the overall environment for the implementation of Rectangular Strategy consists of four elements: (1) peace, political stability and social order; (2) partnership in development with all stakeholders, including the private sector, donor community and civil society; (3) favorable macroeconomic and financial environment; and (4) the integration of Cambodia into the region and the world.

Third, the four strategic “growth rectangles” are: (1) enhancement of agricultural sector; (2) private sector development and employment generation; (3) continued rehabilitation and construction of physical infrastructure; and (4) capacity building and human resource development.

Fourth, each strategic “growth rectangle” has four sides:

  • Rectangle 1: Enhancement of Agricultural Sector which covers: (1) improved productivity and diversification of agriculture; (2) land reform and clearing of mines; (3) fisheries reform; and (4) forestry reform;

  • Rectangle 2: Continued Rehabilitation and Construction of Physical Infrastructure, involving: (1) continued restoration and construction transport infrastructure (inland, marine and air transport); (2) management of water resources and irrigation; (3) development of energy and power grids, and (4) development of Information and Communication Technology;

  • Rectangle 3: Private Sector Development and Employment Generation covers: (1) strengthened private sector and attraction of investments; (2) promotion of SMEs; (3) creation of jobs and ensuring improved working conditions; and (iv) establishment of social safety nets for civil servants, employees and workers; and

  • Rectangle 4: Capacity Building and Human Resource Development, including: (1) enhanced quality of education; (2) improvement of health services; (3) fostering gender equity, and (4) implementation of population policy.

NPRS Report Participatory Process

The Progress Report on the assessment of NPRS implementation has been prepared through a participatory process involving various key units of the Royal Government and its development partners, including the: Supreme National Economic Council (SNEC), Ministry of Economy and Finance (MEF), General Secretariat of the Council for Social Development (GSCSD), line ministries, donors, NGOs both local and international, and representatives of civil society. The SNEC was responsible for the drafting of the report, including the incorporation of comments and contributions from stakeholders. The GSCSD coordinated the process as a whole, linking with all line ministries and updating the NPRS matrices. Multiple consultations were organized with all key and core stakeholder groups, as well as members of the seven sectoral working groups Starting October 2003, the Royal Government invited a broad set of domestic and external stakeholders to be represented on the NPRS Advisory Group, including: NGO Forum, MediCam, CCC, CDRI, CSD, PADEK, University of Cambodia, UNICEF, WHO, UNESCO, WFP, JICA, GTZ, AFD, AUSAID, IMF, UNDP, WB, ADB, FAO, DFID, Sida and the EC. The NPRS Advisory Group met several times during the process of preparation of this report, to constructively read, review, comment upon and contribute to the final report.

The timetable for the preparation of the NPRS Annual Progress Report highlights the participatory nature of its preparation (see Table 1 below). On 27 October 2003, the “zero” draft was circulated for comments to all stakeholders. The first meeting of core group of stakeholders took place on 4 November 2003 to discuss the “zero” draft and revise it into a first draft. The first draft was discussed in a large workshop involving all stakeholders on 4 December 2003. The results of the workshop were the basis of producing a second draft presented to stakeholders on 22 December 2003. On 12 January 2004 the second draft was circulated to the International Financial Institutions. A final draft is scheduled for completion by 27 April 2004. On 30 April, the final version will be submitted for consideration by the Council of Ministers, and when approved, officially shared with the international donor community.

Table 1.1.

Timetable and Preparation of the First Cambodia NPRS Progress Report

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2. Cambodia’s Macroeconomic Framework

Despite some political uncertainty related to the July 2003 elections, economic growth in 2003 turned out better than expected.

2.1. Recent Economic Performance

The Cambodian economy grew by 5.2 percent in 2003 compared to 5.5 percent in 2002, led by continued growth in garments exports, a rebound in overall investments and an upward surge in agricultural production. However, the tourist sector declined by 10 percent due to the combined impact of the anti-Thai disturbance in Phnom Penh early in 2003 and the outbreak of SARS across most of the region. However, the drop in foreign direct investment was more than compensated by domestic private investment and higher consumption induced by higher public spending. Moreover, the weakness in the service sector receipts was offset by continued strong growth in garments exports. Prices held firm, with inflation slight at 1.2 percent (average percentage change in CPI inflation), in sharp contrast to the 12% inflation experienced during the elections of 1998.

Agricultural production grew by 9.2 percent in 2003, led by a 25.3 percent rebound in crops, following negative growth due to floods in 2002. The surge in crop production enabled the country to maintain its self-sufficiency in rice and kept food prices low. Livestock and fisheries grew moderately, while forestry sector continued its planned decline.

Continued strength in garments exports was reflected in a 27 percent increase in 2003 (Table 2.3), underpinning double-digit growth in manufacturing of 12.2 percent. Construction sector negatively decreased to -3 percent compared to 14 percent growth in 2002 due to slowing down in public and private investments.

Table 2.1:

Cambodia - Visitor Arrivals, 1998-2003

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Source: Ministry of Tourism. 2003. Tourism Statistical Report Year Book.
Table 2.2:

Cambodia - Key Macroeconomic Indicators, 2001-2008

(In Percent of GDP, Unless Otherwise Indicated)

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Source: Ministry of Economy and Finance, National Bank of Cambodia, IMF.

Includes net lending and compensation payments to Thailand in 2003;

Net official disbursement, exceptional financing, and official transfers;

Figures include bilateral debt with the Russian Federation and US and reflects impact of completing rescheduling agreements on Naples terms by end-December 2003;

As percent of domestic exports of goods and services. Decline in 2001 of Tonle Sap reflects the tailing off of payments to the Russian Federation;

As percent of domestic exports of goods and services.

Table 2.3:

Cambodia - Trends in Garments Exports

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Source: Ministry of Commerce

The decline in foreign investment approvals was more than offset by strong growth of domestic investments. Investment project approvals in 2003 totaled US$312 million, of which US$139 million were proposed investments in the tourism sector. Proposed investments in manufacturing amounted to US$86 million, including 19 proposals to establish garment factories which are expected to create some 25,000 new jobs. There was a considerable increase in investments undertaken by Cambodian entrepreneurs in 2003, the total of which accounted for 42 percent of all investment projects

The service sector declined, due to the combined effect of anti-Thai disturbances and the outbreak of SARS. Hotels and restaurants sector dropped to the level of -10 percent. Although tourism activity recovered in second half of 2003, overall tourism arrivals in 2003 were almost 11 percent lower than arrivals in 2002, resulting in no growth for services overall.

In 2003, about 40,000 jobs were created in manufacturing, mostly in SMEs, while about 200,000 new workers entered the labor market.1 It is clear that the development of a robust agricultural sector, labor-intensive industries and services are critical to absorbing the labor surplus.

Sustainable future economic growth in Cambodia remains heavily dependent on the ability of the government to diversify the economy and broaden the base for growth. The challenge for Cambodia is to strengthen governance in order to attract more private investments and ensure competitiveness vis-à-vis neighboring countries. In particular, the country’s physical infrastructure framework must be expanded serve the marketing requirements of the rural economy. Social infrastructure like health and education will be further enhanced. Greater domestic investment will also be encouraged, preferably in industries that utilize domestic resources, like small-and-medium enterprises. Regional initiatives to further integrate Cambodia into ASEAN will be accelerated, particularly through the Economic Cooperation Strategy (ECS) partnership scheme with neighboring countries.

Peace, political stability and social order are needy criteria to enhance macroeconomic stability, sustainable development and especially, poverty reduction. Therefore, the Royal Government will continue its work with the direction to implement national security policy by collecting and destroying all kinds of weapons and ammunition; stopping robbery, drugs, mafia and money laundering; cracking down on terrorism and human smuggling to further strengthen peace, political stability and social order for the people to reflect as a step forwards by Cambodia toward development and prosperity with a full pledge to solve all consequences from the genocidal regime and civil war that have destroyed Cambodia in the last three decades. In this sense, the strengthening of peace, political stability and social order will create a real picture for Cambodia to increase trust from investors and tourists as well as facilitating the people to do business as normal and participating in the economic development.

Ensuring appropriate public expenditure to achieve rapid economic growth is crucial for poverty reduction. As set out in the NPRS, the Royal Government aimed to attain inclusive, broad-based economic growth at the rate of 6 to 7 percent per year, and achieved it in 1999-2003. However, current external and internal conditions indicate that a rate of 6 to 7 percent is difficult to achieve in the medium term.

Therefore the Government has revised key macroeconomic targets downward, updating the NPRS on three accounts: (i) economic developments since the NPRS was formulated, for example, the SARS outbreak, the anti-Thai disturbances and uncertain election-period environment. These factors are expected to reduce GDP growth by 1 to 1.5 percent; (ii) revised GDP data through 2002 which now include higher estimates of the size of the informal sector; and (iii) delays in the implementation of structural reforms such as reductions in cost of production and doing business, improvements in quality, increased productivity and improved marketing, social and labor conditions. All in all, the delays mean that Cambodia may only attain the competitiveness status of China only by 2006 - 07.

The revised macroeconomic framework reflects the following: (i) all ratios to GDP are lower as national income has been revised upwards, and (ii) real GDP growth will dip in 2005 as Cambodia will lose the advantages of quota-based garments market share following the phasing out of the quotas. Growth in 2005 will fall to 1.9 percent, and pick up again in 2007-2008 to 5.5 percent and 6 percent respectively once reform programs take effect.

Better performance of the agricultural sector following implementation of market-friendly policies and increased investment is expected to boost rural and agricultural growth, pushing up real GDP growth and substantially contributing to poverty reduction. The contribution to growth of the agriculture sector is also expected to be promoted by recent infrastructure investments and liberalizing policies. Sustained long-term growth is expected to arise from improved agricultural productivity based on intensifying agricultural education and research, advanced technology, agro-industrial development, broadened extension to farmers and increased investments in rural infrastructure. These projections assume the early and determined implementation of key structural reforms. Improvements in competitiveness, by implementing the recommendations of the World Bank’s Investment Climate Assessment, will contain the extent of anticipated disruption among and relocation of garments producers in 2005 and thereafter. Policy reforms will also attract foreign investment into lower-skilled, labor-intensive manufacturing and tourism-related services. More specifically, the Royal Government, with the strong support of the Government of Thailand, has taken major steps to attract garments factories from Thailand and the rest of the region into the Koh Kong Industrial Estate, close to the Southern Thai-Cambodia border.

With implementation of the reform agenda described in the NPRS, real GDP growth could reach 6 to 6½ percent. Such performance will require political and macroeconomic stability to underpin sustained private sector growth and continuing donor support equivalent to about 10 percent of GDP. Over the medium term, domestic savings are expected to improve by about 2 percentage points of GDP, based on increased budget surpluses and more moderate consumption due to the decline in garments export receipts. The savings will help support domestic investment at 17 percent of GDP. Inflation is expected to remain below 5 percent, and international reserves will remain equivalent to about 2 -3 months of imports of goods and services.

The management and prevention of disasters that have destroyed lives and property is an important part of economic and social planning, especially for the efforts to reduce poverty. In this sense, the Royal Government will concentrate its efforts on enhancing mechanism and national programs to manage disasters created by both nature and human in order to reduce the destruction and losses from all of these disasters. To do this, there is a need to enhance transparency and effectiveness in the implementation of this work and the participation from all related institutions in the framework of cooperation and partnership mechanism.

Cambodia is expected to face serious challenges in the coming years, if the government fails to reduce costs of doing business and combat smuggling, which creates a non-level playing field for investors. While garments exports continued to grow in 2002 and 2003, the prospects of further growth is uncertain due to the ending of the current regime of garments quota import into the US market under the WTO Agreement on Textiles and Clothing (ATC). This will require Cambodian garments to be more competitive vis-à-vis other exporters, particularly the large-scale producers such as India or China.

Cambodia will experience painful adjustments in the near future as garments represent 75 percent of all of Cambodia’s exports. Although 16 new factories were established in Cambodia in 2003, some 76 factories employing 21,825 workers closed down due to various reasons, including unstable labor relations. Currently there are 198 garment factories operating in Cambodia. Some 240,000 workers, most of whom are females from poor families in the countryside, are employed in the garments sector.

Figure 2.1:
Figure 2.1:

Trends in Garments Sector Investments in Cambodia

Citation: IMF Staff Country Reports 2004, 333; 10.5089/9781451821802.002.A001

2.2. Overall Growth Outlook for 2004-2008

Growth in 2004 is expected to increase to around 4.3 percent as tourism recovers and garment exports continue to increase, but at a slower rate of 13 percent. Tourism is expected to rebound by at least 17 percent, boosting growth of services by over 6 percent. Manufacturing growth will thus slow to about 8.7 percent. Agriculture production is projected to grow at an unpleasant level of only 0.4 percent, with crops projected to grow on average by 3.2 percent.

The end of the garments quota system will adversely affect growth in 2005-06, with GDP slowing to around 2 to 4 percent. The slowdown is expected to dampen growth in services and construction, but the impact will be somewhat offset by continued strong growth in tourism. Improving performance of the agricultural sector will further offset any manufacturing decline. Logging is expected to resume, but given tight controls for sustainability, forest sector growth will not exceed 4 percent.

Cambodia - Sectoral Growth Outlook, 2004-2008

Garments - a significant decline is expected in 2005, with up to a third of firms closing, with the larger firms absorbing market share. The larger firms enjoy more comfortable margins enabled by economies of scale. Reforms introduced in 2004-2005 are expected to improve competitiveness by reducing operating costs, particularly labor and administrative costs. Cambodia’s good record of adherence to core labor standards is expected to help mitigate any declines. There will be some relocation of garments producers to Cambodia from Thailand which has been “graduated” from GSP trading status. After 2006, and especially for products not directly competing with Chinese products and currently exported to the US outside of the quota system (equivalent to 40 percent of Cambodia’s exports to the US in 2002), further growth is expected in garments exports, with positive spillover effects for investments in other light manufacturing.

Tourism - is expected to grow at around 15 percent annually in the medium term so long as political stability and security is maintained. Cambodia is a unique and relatively new destination, thus continuing to attract broad segments of travelers. Tourism sector will significantly contribute to the poverty reduction because of its potentiality in the increase of national revenue, the creation of employment and the improvement of people’s living standards as well as contributing towards peace, security, cooperation and mutual understanding between people in the region and the world through this sector.

Agriculture - The agriculture sector is envisioned to serve as the backbone of Cambodia’s poverty reduction strategy, given its relatively larger impact on Cambodia’s poor populations which are largely rural based and dependent on agricultural employment. Current investments in rural roads and irrigation infrastructure is expected to improve market access and productivity of commodities in the coming years. The trend will be aided by policies that enhance land rights and expansion in cultivated land. In the immediate future, productivity improvements may be derived from the introduction of improved seed varieties and more diversified crops (particularly vegetables and fruit trees which are currently imported) and recently-opened community fisheries. Rice yields will move up from 2 to 3 tons per hectare, impacting significantly on national incomes and poverty. Moreover, growing value-added along the agricultural production, processing and marketing chain promises great returns in jobs, employment and incomes. These trends are strongly supported by donors, including the Agriculture Sector Development Program financed by the ADB, to be followed in the future by a major policy-based program loan.

Construction - could continue to grow but at half the exceptionally high annual rate of growth in the past 4 years financed by large inflows, reflecting continued donor support and private investment. The decline in investments in the garment sector in 2005-06 will likely be accompanied by slower growth in construction-related activity in those two years.

Growth is expected to be about 5.5 percent in 2007. Gains in competitiveness, stemming from policy reforms in 2004 - 2006 will enable gradual recovery in garments exports and added investments in other manufacturing and service activities. Agricultural growth is expected to continue to improve toward 4 percent average annual growth, built upon productivity gains and with spillover effects for food and beverage sector, trade, and other services.

The projected growth rates will enable per capita GDP in dollar terms to increase by about 12 percent by 2008 relative to 2002. Improved agricultural productivity and rural income opportunities in the short-term will ensure that rural poverty will be reduced even during 2005-06 when overall economic growth is expected to decline. Moreover, the structural and agricultural reforms coming onstream will provide the foundation for sustained, higher growth after 2006.

Culture has played an important role in promoting tourism in Cambodia. The creation of natural recreation areas and tourism sites based on geographical criteria with the abundances of attractiveness from nature and rare culture and with the construction of road network to link all of these areas, such as an airport in Ratanakkiri province, are the priorities for the Royal Government in this sector. On the other hand, based on these advantages, the government set the development of tourism sector in Cambodia as the “Cultural and Natural Tourism”. These potentialities will play a role as an important energy for the economic growth in Cambodia. In this sense, the Royal Government has considered tourism sector as the most prioritized sector among the 6 prioritized sectors in the strategy to promote economic growth to reduce poverty.

To accelerate the reform process, the Ministry of Economy and Finance will act to further strengthen government capacity, improve customs and tax administration, ensure full implementation of existing tax provisions, and review and reassess all sources of non-tax revenue. Following the example set by the Phnom Penh unit, anti-smuggling units will be strengthened in all provinces. Tax administration/enforcement measures will be implemented and strengthened. The tax rolls will be purged of inactive and non-productive filers to enable improved assessment of arrears and the likelihood of collection.

2.3. Ensuring Broad-Based Growth

Despite progress made in recent years, Cambodia’s production base remains narrow, revenue to GDP ratio low, and governance problems pervasive. Moreover, with the phasing out of garment quotas in 2005 for WTO members, Cambodia will need to compete with its neighboring countries on a level playing field. Accordingly, progress in implementing the NPRS, including measures to strengthen government capacity, enhance the business environment, and improve financial intermediation, are crucial to the achievement of sustainable growth. Efforts to ensure broad-based growth and poverty reduction in the rural areas are essential. A more dynamic rural economy will also help respond to the growing number of new entrants into the labor market each year.

The Royal Government recognizes that strong efforts are needed for Cambodia to improve economic infrastructure, deliver basic services, and enhance governance. The impediments of high transaction costs, poor infrastructure and hidden costs need to be addressed. To ensure broad-based growth, the Royal Government will:

  1. Further orient capital outlays toward infrastructure development in rural areas. To do so, a better planning and allocations of capital outlays, including domestic financed investment and donor financed investment outside the budgetary process, as well as establishing a performance-based monitoring mechanism are needed;

  2. Strive to expand rural income opportunities by: (i) establishing clear land use rights by completing land registration and titling, implementing the social land concessions program and enhancing participatory land use planning; (ii) develop a master plan for fisheries development, including a model for sustainable community fisheries; and (iii) develop projects in community forestry and smallholder rubber plantations.

  3. Develop and implement a strategy for promoting sustainable microfinance institutions and SME financing based on sound financial practices; and

2.4. Monetary Developments

Monetary developments in 2003 reflect Cambodia’s efforts to maintain a stable fiscal position despite political uncertainty. Banking liquidity in 2003, as measured by M2, rose 15 percent after having increased by 31 percent in 2002. The major sources of liquidity growth include the increase of 15 percent in residents’ foreign currency deposits and the 18 percent increase in currency held outside banks. Net foreign assets increased moderately while net domestic assets of banks rose significantly. The increase in NDA was due to a surge in credit to the private sector, which grew by 26 percent or US$69 million in 2003.

Monetary stability was temporarily disrupted in April 2003 by the issuance of treasury bills and the injection of riels into the economy pushed down the value of the Cambodian riel against the US Dollar. The riel depreciated slightly by 2 percent against the dollar, but stabilized quickly at 4,000 riels. Monetary stability was quickly restored and overall, the exchange rate remained stable during 2003 at around CR 3,995-CR 4,050 to the dollar. The overall fiscal deficit (excluding grants) increased from 6.6 percent of GDP in 2002 to 7.0 percent of GDP in 2003, as spending accelerated before the July elections. International reserves were maintained at the equivalent of 2.9 months of imports.

2.5. External Sector Outlook

The overall balance of payments deteriorated in 2003, with the current account deficit wider at -10.2 percent of GDP reflecting the impact of higher petroleum prices and lower tourist arrivals and foreign direct investment due to SARS and some political uncertainty. The growing fiscal imbalance was linked to the depreciation by 2 percent of the riel to the US dollar in April - May 2003, with official reserves declining by 10 percent in July 2003 following intervention to support the riel by the National Bank of Cambodia. Improved fiscal control following the July 2003 elections has encouraged the gradual return of foreign currency deposits, resulting in gross official reserves being maintained at almost the same level as in 2002.

The external balance is expected to slightly deteriorate in 2004. Petroleum prices increased to a record high of US$41 a barrel, although tourism growth has resumed. As a result the current account deficit (excluding transfers) increased from 10.2 percent of GDP in 2003 to 10.8 percent of GDP in 2004. However, together with the expected increase in foreign direct investment due to improved political stability, gross international reserves are expected to increase to US$782 million, or 2.8 months of imports, by at the end of 2004.

Agreement on debt rescheduling with the U.S. and Russia may reduce amortization payments, but it could increase interest obligations. Cambodia’s external debt repayment will have significant impact on budget execution and thereby on poverty reduction goals. By 2008, after rescheduling of its pre-1993 obligations, Cambodia’s external debt is estimated to be about 48.9 percent of GDP, and debt service will equal 2.6 percent of exports of goods and services. However, the fiscal burden of the debt is heavy, given the low revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debt management policy and strictly avoid non-concessional financing.

However, even with reforms, the trade balance will continue to deteriorate through 2008 and a sizeable current account deficit will remain. Even as reforms to enhance competitiveness are begun in, garments exports are expected to decline due to the phase-out of quotas in 2005, with recovery attained only by 2007. Once the cost of doing business in Cambodia declines, new export industries will emerge. The current account deficit (excluding transfers) is expected to be contained at around 10 percent of GDP, given the projected strong performance of the tourism industry. Assuming that foreign assistance grows at the same rate as industrial country GDP, and there is at least moderate increase in FDI in the improved business environment, gross international reserves could increase slightly to about 2.7 months of import by 2008.

2.6. Alternative Macroeconomic Scenarios

Potentially higher growth could arise from the discovery of a viable oil field, accompanied by more vigor in reforms to improve the investment environment and enhance agricultural productivity. Such improvements will also enable Cambodia to fully capitalize on economic cooperation agreements with its neighbors.

Slower growth could stem from exogenous shocks or policy failures from sources such as drought or flood that devastates agricultural output. Another SARS outbreak or an episode of global terrorism would hurt tourism. Adverse developments affecting trading partners, such as a global recession or higher oil prices, could lower growth prospects. Finally, continued improvements in China’s competitiveness could make it difficult to expand Cambodia’s exports even with the full and prompt implementation of programmed reforms.

If reforms to improve the environment for private sector growth are delayed, growth is likely to remain below 3 percent. Without reforms to improve competitiveness, garments exports will not recover after 2005, with firms accounting for about 30 percent of output shutting down. Should improvements in private sector environment not be achieved, investments in manufacturing and services will be held back and construction and other economic activity would also slow down to about half of the rate expected in the full-reform scenario.

Should reforms geared toward boosting agricultural productivity are postponed, agricultural growth rates will remain at the average of the last four years. Stagnant agricultural growth will impact unfavorably on the poor. Slower growth of the manufacturing and services will hamper the pace of poverty reduction since urban job creation will also be slow. Moreover, slower agricultural growth will make it impossible to improve conditions for the poor in the rural areas where poverty is most entrenched.

2.7. Fiscal Developments

2.7.1. Budget Execution in 2003

The country’s fiscal position deteriorated in 2003, as revenue performance suffered due to the outbreak of SARS, continuing inefficiencies in revenue collection and election-related uncertainty. Overspending associated with the general elections put significant pressures on the budget. Furthermore, sluggish growth during the first half of 2003, coupled with negative investors’ and consumers’ sentiments associated with the disturbances of late January, slower collection and increased smuggling during the election period, constrained revenue collection. As a result, cash shortages became severe during the first half of 2003. Domestic revenue declined from 11.2 percent of GDP in 2002 to 10.4 percent in 2003. Tax revenue dropped from 7.9 percent to 7.3 percent, while non-tax revenue fell from 3.2 percent to 3.1 percent of GDP.

Financing for the 2003 elections, compensation due to Thai enterprises that suffered loss during the January disturbances, and the continuing financing obligations for the reconstruction of social and economic infrastructures, especially roads, bridges, schools and hospitals have driven up spending. Current expenditures increased from 10.1 percent of GDP in 2002 to 11.0 percent of GDP in 2003. For the first time since 1997, Cambodia experienced a current fiscal deficit of 0.6 percent of GDP, thus exerting pressure on cash management. The figures in Table 2.4 below illustrate the status of budget execution in 2003. The figures show budget commitments, on accrual basis, which means that cash disbursement is lower.

Table 2.4:

Budget Execution in 2003

(in Million Riels)

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Source: Ministry of Economy and Finance

The budget commitments of six ministries and agencies exceeded planned expenditure: The National Electoral Committee overspending was related to the general election, overspending by the MEF was caused by larger spending on roads (economic transfers) and demobilization (social transfers). Overspending by Interior-Administration was due to the issuance of ID cards used for voter registration. Overspending by the Council of Ministers was because of special government spending on inauguration or ground-breaking ceremonies of economic and social infrastructure projects. Overspending by the Ministry of Tourism was related to the organization of ASEAN Tourism Forum, Overspending by the Ministry of Justice was due to the increase in judge’s salaries.

Revenue shortfalls seriously crimped budget execution in 2003. The public health sector continues to be seriously underfinanced. While 86 percent of health spending was committed, disbursement of cash for non-drug expenditures was only 61 percent, affecting day-to-day operations at health facilities, especially at the beginning of the year. Serious delays in fund releases on both O&M and PAP expenditures were encountered in 2003. But this problem would be solved in 2004 when the revenue increased strongly.

PAP implementation has been delayed since 2002. The MOEYS and MOH experienced difficulties in securing PAP funds releases in 2002, due to delays in procurement procedures and difficulties in establishing decentralized management at provincial and district levels. The PAP 2002 for education was delayed until a regulatory framework for proposed spending was agreed upon in October 2002 on the setting of per school and per student allocations and the guidelines on the use of school operating budgets. The implementation of the government decision to re-deploy staff and performance-based incentive payments for school staff in difficult/remote areas was also delayed due to the late approval by the Council of Ministers. Overall, in 2002 only 35 percent of cash was disbursed to implement the PAP programs in health and education.

Because 65 percent of PAP allocations were not released in 2002, disbursement of 2002 PAP continued into 2003. PAP disbursement accelerated in the second half of 2003, reaching 72 percent of the total education and health PAP budget (Table 2.5). However, the education PAP was released slower at 66 percent. While the education Ministry recognizes that overall release rates are somewhat disappointing, overall PAP spending in 2002 has increased substantially compared to PAP 2001. The PAP for health has been implemented in 8 provinces and 15 central agencies supporting rural activities in TB, malaria and HIV/AIDS, and the constraints in cash disbursement has made it difficult to attain the objectives of health service delivery.

Table 2.5:

PAP 2002-2003 for Health and Education

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Source: Ministry of Economy and Finance

PAP Disbursement Problems and Proposed Solutions

The Royal Government established a Task Force on 11 September 2003 to identify causes of low disbursements to the social sectors, especially health and education, and recommend remedies and improvements, identify institutional constraints and propose actions to immediately accelerate disbursements, taking into account overall fiscal constraints.

The Task Force identified the main causes of low disbursements:

  1. Shortfall in cash flows: the Budget System has several basic serious deficiencies which include: (i) Budget formulation: revenue forecasted are too high, and loose expenditure estimates; and (ii) Budget implementation: expenditure commitments not limited to available budget resources, and supplementary expenditure credits are not fully offset or funded.

  2. Rapid increase in the PAP budget for health and education, while revenue declined during 2003.

  3. Large stock of PAP payment arrears carried over from year to year.

  4. Continued worsening in payment arrears, not only in chapter 13, but also chapter 11 budgets of line ministries at all levels (central and sub government levels).

The Task Force proposed the following actions:

  1. Short-term: (i) Both MOH and MOEYS payment arrears to be totally disbursed by end of May 2004, and (ii) earmark one eighth of daily cash revenue collected by NT for the PAP;

  2. Medium-term: (i) Improvements in Public Financial Management, including establishment of a Unified Budget System, and (ii) establishment of an Executive Reform Committee at the MEF.

Agriculture and rural development is seriously under-funded - the allocation of national budgets to the sector is quite small relative to its economic importance and its potential for poverty reduction. Though the share of budget disbursement for the Ministry of Agriculture, Forestry and Fisheries (MAFF), the Ministry of Rural Development (MRD) and Ministry of Water Resources and Meteorology (MOWRAM) has increased from 2.5 percent in 1999 to 4.5 percent in 2003 as a share of the Government budget (from CR 27.47 billion to 78.69 billion in nominal terms), the size of the allocation is low in view of the large share of the population in the sector. In per capita terms, current spending was merely US$1.4.

Wages as a percentage of recurrent expenditures in agriculture has declined from 29 percent in 1999 to 24 percent in 2003. PAP resources do not seem to be directed to high priority services as intended. PAP expenditures on forestry replanting accounted for 28 percent of total PAP spending in 2001 and 54 percent in 2002. Of these funds, MAFF reports that the majority were spent on contract workers and materials. PAP funds were also spent on animal health, community fisheries, and agricultural research (the Cambodian Agriculture Research and Development Institute (CARDI) and the Royal University of Agriculture (RUA), as well as the Institute of Rubber Research (IRR) and animal food for the state zoo.

Spending by program in MAFF appears to have little impact on sector priorities. Forestry accounts for fully 21 percent of total recurrent spending and nearly half of total direct service spending. In comparison, agricultural extension accounts for less than one percent of total recurrent spending. Animal health and agronomy also account for relatively low shares. Furthermore, an analysis of the regional spending pattern shows that the provinces only receive about 39 percent of total MAFF and MOWRAM spending, while the central level consumes the remaining 61 percent. Thus, as part of the agricultural reform, the RGC will take serious action to align the budget to the priorities at the sectoral level, especially more attention will be given to increase extension activities.

Since 1999, the RGC has given high priority to road rehabilitation. Total expenditures on roads have increased significantly in the past several years, and will continue to increase due to resources from the Fund for the Repair and Maintenance of Roads (FRMR). There has been dramatic growth in capital expenditures for both MPWT (nominally up by a factor of four over the five years to 2002, but declined again in 2003) and MRD (up by a factor of ten from 1998-2002, and slightly increased in 2003), though not all MPWT and MRD expenditures are for roads. Between 2002 and 2004, the government allocated around 53 billion CRs (US$13 million) for FRMR, but only 60 billion CRs (US$15 million) in cash were disbursed during 2002-2003 or US$7.5 million a year.

It is estimated that the total annual government expenditure on road rehabilitation and maintenance (excluding expenditures funded from the FRMR) was on the order of 100 Billion CRs, equivalent to about US$ 25 million. Of this some US$19 million (76 percent) was for MPWT’s primary and secondary network and US$6 million (24 percent) for MRD’s tertiary network. Capital expenditures made up about 80 percent of the total MPWT and MRD budget in 2002. Expenditures from the FRMR can potentially add another US$ 8 million equivalent per year. Table 2.6 summarizes budget execution of MPWT and MRD. The investment budget was mainly used for road construction and rehabilitation. In 2003, the budget disbursement for both ministries declined by 20 percent.

Table 2.6.

Current and Capital Expenditures, MPWT and MRD, 1997-2003

(Millions CRs)

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Includes PAP.

Source: The Ministry of Economy and Finance

As a result of high spending and revenue shortfalls as described earlier, the 2003 fiscal deficit (excluding grants) widened to -7.0 percent of GDP. To counter the growing imbalance of the government’s fiscal position, the Ministry of Economy and Finance will take the following actions: (i) strengthening of role of the Cash Management Committee (CMC); (ii) establishing a Taskforce on non-tax revenue collection to ensure full transfer of non-tax revenue to the budget; (iii) improving revenue collection by enhancing customs and tax administration, combating smuggling and recovering arrears; (iv) containing current and capital government spending strictly to the budgeted amount; (v) increasing transparency of signed contracts; and (v) constraining domestically financed capital spending. The immediate policy issues facing the country pertain to effective implementation of PFM reform as outlined in Section 2.7.4.

Attaining fiscal sustainability by narrowing the primary deficit to below 2 percent of GDP is a challenge for the RGC. The government is conscious that both expenditure restraint in non-priority areas and additional revenue efforts are needed, especially if domestic arrears are to be reduced over the medium term. To reduce budget deficit the government will ensure substantial expenditure compression, while increasing revenue to at least 11.9 percent of GDP in 2004. This will require additional tax policy measures equivalent to about 0.8 percent of GDP.

Moreover, further actions will be taken to strengthen government capacity, including through attracting and retaining high quality civil servants. The RGC will implement the economic action agenda in order to broaden the base of economic growth, so that the fruit of growth benefits all social strata of the population. This reform is designed to improve market rules and ensure transparent business environment.

2.7.2. Revised Medium-term Fiscal Framework

The Ministry of Economy and Finance (MEF) has revised the medium-term fiscal framework to reflect the foregoing developments. Following the implementation of the public financial management reforms, domestic revenue is expected to increase moderately within the next five years from 11.9 percent of GDP in 2004 to 13.7 percent by 2008. Determination is required at all levels to combat smuggling and improve governance which in turn will attract investments and create economic opportunities that will expand the tax base. Tax reforms will continue to strengthen compliance and expand the real regime. The private sector will be encouraged to fully comply with its fiscal obligations.

Government’s current expenditure is expected to increase from 10.5 percent of GDP in 2003 to 12.3 percent of GDP in 2008, reflecting Cambodia’s stringent efforts to pay interests, following debt rescheduling with Russia and the US. At the same time, the level of current spending on non-priority sectors should be reduced to allow for the reduction of domestic arrears. As a percentage of GDP, total expenditures are expected to increase moderately from 17.4 percent in 2003 to 18.7 percent in 2008. The planned level of capital expenditures shows the commitment of the RGC to invest in physical infrastructure.

Table 2.7 above provides a review of actual and projected trends in expenditure allocations. Attention is given to the priority social and economic sectors. The priority sectors have received rising budget allocations (as shown in Table. 2.2).

Table 2.7.

Medium Term Budget Framework for Priority Sectors

(As Percent of Current Expenditures)

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Outturn

Current discretionary expenditures equal current expenditure minus spending on debt service and domestic arrears

Source: Ministry of Economy and Finance

2.7.3. Ensuring Medium-Term Fiscal Sustainability

The Royal Government will maintain the level of overall deficit within the range of 5 to 6 percent of GDP in 2004-2008. The deficit will be financed through concessional loans and grants. Fiscal consolidation is to begin with the 2004 budget aiming to reverse the growing imbalance in 2003 arising from low revenue as well as Thai compensation and election-related spending. Substantial expenditure compression will be necessary to make room for priority development spending, and avoid accumulation as well as allow for repayment of domestic arrears. The wage bill will need to be contained below 5 percent of GDP. Other current expenditures will need to be maintained at about 4 percent of GDP (i.e. below the 2002 level), thereby allowing capital spending to meet the infrastructure development needs. In this regard, a consensus will be built to maintain at the same level the budget allocation for the non-priority sectors, including the budget for the Parliament.

2.7.4. The Public Financial Reform Program

In 2003, the Royal Government, World Bank and the Asian Development Bank released the Integrated Fiduciary Assessment and Public Expenditure Review (IFAPER). The IFAPER constitutes a major, participatory exercise on the appraisal and of the status and reform program on public expenditures in Cambodia.

Acting on the recommendations in the IFAPER report, the Royal Government adopted a public financial management (PFM) reform program, whose longer term objective is to incorporate what are generally accepted as the best international standards. The PFM reform program consists of:

First, a prioritized and sequenced strategy and action plan: a concise strategy statement, based on a clearly articulated vision of the PFM system’s key features, and prioritization and sequencing of Government plans and other policy statements/advice to permit development of a rolling, multi-year, costed, annual work program;

Key Features of an Effective PFM System

  1. The PFM legal framework specifies: (i) separate functions for the national government and for each of the lower provincial and local government levels and (ii) the fiscal relationships between the levels;

  2. To ensure that they are affordable, all government policies, programs and projects are formulated, announced and implemented in the context of a fully integrated, unified budget system including a fully integrated single central account.

  3. All government policies and strategies are formulated in a consistent program framework across all sectors.

  4. Medium term budget planning and control ensures that all of the government’s policy and program objectives are clearly stated and affordable into the future beyond the next budget year.

  5. The budget explains clearly the government’s plans to mobilize and use all of its resources, not just its cash, through the budget and the future years.

  6. Budgeting for the government’s human resources is fully integrated into the medium term rolling budget formulation framework.

  7. All post-budget supplementary expenditure credits are fully financed.

  8. The acquisition, deployment, use and disposal of all government assets and resources, including its human resources, are openly competitive, apolitical, nondiscriminatory and transparent

  9. Government responds promptly and publicly to any problems which emerge during the course of budget implementation. Its public explanations are prompt and clear.

  10. There is a computerized, comprehensive and integrated financial and budget management information and accounting system which consolidates financial transaction planning and execution reporting by all finance ministry departments and all line ministries and other budget sector spending agencies.

  11. The PFM system is designed to seek maximum value for money over time from the use of government resources.

  12. The finance ministry sets the standards for, and guides and monitors, financial management in line ministries and other spending agencies. This includes standards for internal audit institutional arrangements and operations.

  13. Government sector institutions and government-owned enterprises provide full annual reports and audited accounts promptly.

  14. There is timely, searching independent external audit which is widely debated.

  15. The PFM system generally and the organic law in particular are designed to promote accountable, ethical behavior and punish misbehavior.

Second, complementary capacity building and organizational change: development of a capacity building strategy to support the PFM reform program by identifying and providing sustainable approaches to systematically address key capacity weaknesses that would need to be overcome for successful implementation, including the issue of providing meaningful incentives for good performance;

Third, performance management/indicators: establishment of a performance management system as a tool for MEF management to handle program formulation, improve transparency and accountability, monitor progress, and enable international comparisons; and

Fourth, coordinated donor support mechanism: development of a coordinated donor mechanism to assist the RGC with implementation of its PFM reform agenda.

The improvement and reform strategy, which the Government has now adopted involves transforming the traditional cash-based budget system into one which provides for the proper management of all government assets and resources. This will involve the eventual introduction of generally accepted standards for accrual accounting.

The strategy will also involve the gradual shift of accountability for the detailed deployment of budget resource inputs from the Ministry of Economy and Finance to program managers in line ministries and other spending agencies. Increasingly over the longer term they will be given sufficient flexibility in the choice and deployment of resources to achieve the Government’s policy and program objectives. They will then be held accountable for the proper guardianship of those resources and for program outputs and outcomes.

All of the Government’s policies and programs will be clearly stated and fully costed through the medium to longer term. This will ensure that the Government’s policy and program objectives are affordable and are fully funded in successive budgets into the future.

The PFM improvement and reform strategy involves the construction of a succession of platforms, each one building on the earlier ones until the last platform is reached. It is envisaged that this will take a number of years to achieve. However, the timetable has to remain flexible because the strategy involves ensuring that each platform is firm enough to sustain the next one before moving on from one platform to the next. In other words, the strategy will be implemented on a rolling basis. The Government is adopting this approach to ensure that the management of public resources is not exposed to any more risk than it is already.

As part of the PFM reform, the RGC in conjunction with WB, ADB, WHO, DFID and UNDP is conducting the Public Expenditure Tracking and Service Delivery Survey (PETS), which would focus on two central themes: (a) improving service delivery and (b) reducing the fiduciary risk to public funds. The objectives of the PETS are to: (i) assist the RGC in identifying problems in the budget system that impede the efficiency and effectiveness of service delivery in health and education, in order to generate proposals for solving them, and (ii) serve as an independent monitoring tool to assist government in improving accountability by disseminating information and engaging service delivery beneficiaries.

This exercise will trace and document the flow of funds, as well as leakage, from the National Treasury (NT), through the provincial treasuries (PTs), to service providers. It will also examine how those resources are combined with other inputs—including human capital—at the facility level to generate health and education services in order to better understand the linkages between expenditure and service delivery. The PETS will assess the public expenditure and financial management (PEFM) practices in place at the national and sub-national levels and analyze to what extent current practices help or hinder budget execution. This work will provide a set of recommendations for removing bottlenecks, strengthening fiduciary accountability, and thereby improving the flow of funds to pro-poor services.

The appeal of the PETS approach is strengthened by the possibility of fostering greater transparency—and thus accountability—in public service delivery. The PETS will generate information of great interest to the intended beneficiaries of government policy. Strengthening citizens’ ability to engage on service delivery issues would increase demand for more effective and efficient service delivery.

The result of the PETS will be used to make a comprehensive evaluation of the budget system and assess the efficiency and effectiveness of the PAP, compared to the other forms of budget arrangements. The PETS result will be used to set the strategy of the PFM system, identify impact for future program, improve the PFM system and review the financing modality of the education policy and education sector management.

Also the RGC is conducting the benefit incidence analysis in the education and the health sectors to assess the pro-poor impact of the public expenditures.

The IFAPER identifies the following reform measures (in some cases, implementation is ongoing):

Later platform objectives will be aimed at intensifying a program to upgrade and strengthen the management capacity and accountability of the RGC’s administration across all ministries and other central government agencies. This will allow an expansion and acceleration in the gradual shift of responsibility for detailed control of budget resource inputs from the center to line ministries while at the same time increasing their accountability for program performance in the achievement of the Government’s economic and social policy objectives. The RGC plans to propose the following short term recommendations for implementation beginning 2004, drawing from the IFAPER:

Platform 1: The first platform objective is designed to make the annual budget more credible and more predictable to budget managers (this provides the basis for accountability by improving budget execution). A major step will be the elimination of the cash shortages which continue to frustrate line ministries’ efforts to execute the Government’s policies and programs and to deliver its services to the community.

  • Post budget execution data (TOFE) on website;

  • Ensure that the Government’s financial statements (MEF’s budget settlement accounts) are audited annually;

  • Undertake the necessary analyses, including the following studies, to prepare the groundwork for an accelerated pay and employment policy:

  • labor market survey, to determine the remuneration needed to be offered functional analyses;

  • remuneration policy study to develop options to accelerate increases in remuneration and introduction of performance-based compensation;

  • a functional review that covers the appropriate institutional arrangements, organization, processes, and staffing of government functions;

  • employment policy study to develop proposals for redeployment and compensated retrenchment.

  • Undertake feasibility study of comprehensive tax administration reform;

  • Develop a plan to reduce spending on low priority sectors and incorporate into the 2005-2007 MTEF;

  • Improve the pro-poor incidence of spending further by making greater use of equity funds to improve coverage in more remote provinces (by helping the poor obtain services in larger provincial or national facilities);

  • Establish the institutional framework for preparation of the MTEF within MEF and the priority sectors;

  • Evaluate the operational efficiency, compliance, and performance of PAP by undertaking a review and tracking survey before further expansion (focusing on education and health);

Thus the first platform is aimed at enhancing the predictability of the budget by limiting expenditure commitments to available budget resources, making the budget more comprehensive, establishing transparent rules for budget release, making greater use of the banking system for Treasury operations, reducing the stock of payment arrears, and making greater use of the treasury single account.

Platform 2: Initial improvements are made in internal control and holding managers accountable (this enables a focus on what is done with resources by providing better data, effective discipline, and greater internal transparency)

  • Strengthen financial planning and expenditure monitoring capacity by issuing guidelines and defining roles and responsibilities of provincial authorities and communities for financial management, procurement and reporting procedures;

  • Set timetable for automation of customs department, including selection of IT system and financing plan;

  • Increase the share of civil administration wage bill as a percentage of recurrent spending, especially in the priority sectors through targeted allowances;

  • Define and apply threshold for National and Provincial Treasury expenditure operations to be executed by check or bank transfer, and use the banking system for all intergovernmental transfers;

  • Review options for execution of PAP through the banking system;

  • Prepare and implement a modified chart of accounts at the National Treasury;

  • Undertake an inventory of all revenue accounts and draw up a schedule for the elimination of revenue retention accounts that have no basis in law;

Platform 3: Improvements are made in linking policy priorities and service delivery targets to budget planning and implementation (this enables greater accountability for performance)

  • Improve the linkages between the planning and financing institution, departments and units in the procedure of allocation the resources to the strategies, plan and projects appropriately priority.

  • Improve the linkages between resource allocations and strategies that have a stronger poverty reduction impact in upper secondary and tertiary education;

  • Cost and operationalize the (Health Sector Strategic Plan) HSSP by linking it to the annual budget and MTEF;

  • Develop a road maintenance program and increase sector funding for routine maintenance, together with oversight and reporting requirements;

  • Strengthen management of the Fund for the Repair and Maintenance of Roads (FRMR) by:

    • establishing a formula-based allocation mechanism for maintenance funds;

    • Providing for regular financial and performance audits of the fund and its contractors, starting with NAA in 2003;

Platform 4: Accountability and review processes for both finance and performance are integrated (this would result in greater external transparency and provide a solid basis for deconcentration)

  • Strengthen project management capacity by developing financial management training manual, training a core group of civil servants, and developing proposals for establishing a unified Project Monitoring Unit (PMU) within the line ministries;

  • Further strengthen financial planning and expenditure monitoring capacity for finance units in MOEYS, schools, districts, and provinces;

  • Develop and arrange financing for a medium-term capacity building program for the National Audit Authority;

  • Develop options for improving the management and control of civil service employment, including means to better control the establishment;

2.7.5. Tax Reform Program

The RGC received extensive technical assistance of tax and customs reform from the IMF through TCAP. The PFM reform agenda will address non-tax revenue mobilization and revenue forecasting, while building on existing reforms in tax and customs. Coordinated and mutually reinforcing reforms to the revenue system are fundamental underpinnings to any PFM reform program. The customs reform program will be discussed as part of the trade facilitation section. Following is the status of tax reform programs and action plan to be undertaken in 2004-2005.

In 2003, the Department of Taxation (DOT) prepared a new organizational structure and drafted a circular (Prakas) for review. Communication strategies and recommendations regarding taxpayer services have been proposed and discussed. DOT also initiated a change process in the Large Taxpayer Unit (LTU) and the Medium Taxpayer Unit (MTU). The use of banking system for tax collection was introduced for large taxpayers. The department is now preparing to use the banking system for medium taxpayers. The DOT also reviewed the policy of tax regime to make it consistent with the Amendment to the Law on Taxation (LOT). An unambiguous depreciation schedule based on the needs of all stakeholders has been established and the method of taxing dividends has been revised as it is a priority with Law on Investment and Amended Law on Investment.

The DOT reviewed the elimination or reduction of the tax exemption provided under the Law on Investment (LOI) and provided recommendations regarding return on investment and risk management. In terms of tax administration, the department accepted the option regarding the lowering of tax bands without changing the exemption level. The DOT started the work on computerization. Computer system support is completed with the integration of the computer system.

The DOT reviewed the regulation to lower the threshold of VAT to service level and removed the threshold on government contracts. This is aimed at transferring more taxpayers from the assessment regime to the real regime. The department decided to propose VAT on all electricity bills and that a VAT exemption should exist on the first 100 kwts per month in order to mitigate the impact on low income families. A joint Tax and Customs committee has been formed to address the smuggling of liquor, cigarettes, milk and other products. The committee has completed reports on Motorcycles and parts.

To strengthen the tax policy analysis capacity of the tax officials, several training courses were provided on the following topics: Industry Audit, Tax Treaty, Collection Enforcement, Revenue Estimation and Forecasting, Risk Assessment and Accounting , as well as Basic Tax Training for 60 new tax officials. Data on filing of tax returns (returns processing) in electronic format has been developed.

To strengthen tax policy and administration in 2004-2005, three areas have been identified to be the priority areas for implementing the tax reform namely (i) Change process, (ii) Tax policy, and (iii) Tax administration:

  • change process includes establishing a formalized and transparent approach to the change process through the use of an Organizational Technology Framework and identifying the essential elements; providing the linkage and balance all the essential elements as they are dependent on each other; establishing the Departmental vision and communicate that vision within and outside the Department; conducting a review of the current Tax Department’s functional roles and responsibilities and provide advice and assistance in the taking of appropriate action to establish formal roles and responsibilities of Headquarters, Regional or Provincial Offices and District Offices, (functional model);

  • tax policy reform involves identify anomalies in the laws and make recommendations for changes based upon the modernization of tax policy and linked to fiscal direction and policy of the central government with regard to tax regime, tax on profits for the estimated regime, tax on salaries, local taxation, value added tax, turnover tax, excise, and tax policy analysis;

  • tax administration reform involves (1) improving headquarters’ management capacity; (2) implementing the real regime in the five main regional offices; (3) establishing a solid management information system with appropriate data to meet the needs of the MEF, head office, and the field or district offices; (4) developing an operational procedures and manuals at all level and performance standards at the divisional and individual staff level;(5) establishing of LTU and MTU in Phnom Penh to improve administration of the largest taxpayers; (6) establishing a monthly statistical reports; (7) ensuring the real regime covers all large and medium sized business; (8) implementing the real regime in all provinces in the medium term; (9) establishing formal audit manuals and procedures and a modern management information system within the audit operation; (10) developing an audit strategy that provides for a broader coverage of taxpayers; (11) utilizes new selection techniques based on risk analysis; (12) and ensuring information on importations from registered/non-registered taxpayers is received from the Customs Department.

2.7.6. Medium Term Budget Framework

Ensuring that budget allocations match with policy statement and poverty reduction strategy is a challenge for Cambodia. In this regard, the RGC recognizes that more needs to be done to get rid of the incremental psychology and to ensure strategic efficiency of the budget. In this regard, the National Assembly and the Senate have an important role to play in linking policies and strategies to the budget.

Table 2.8 shows that the RGC plans to increase between 2004 and 2007 budget for health and education from 227 billion CRs (1.28 percent of GDP) and 354 billion CRs (1.99 percent of GDP) to 313 billion CRs (1.45 percent of GDP) and 469 billion CRs (2.17 percent of GDP) respectively. Allocations for the agricultural sector will increase from 87 billion CRs (0.49 percent) to 146 billion CRs (0.68 percent of GDP). Allocation for the Ministry of Women’s and the Ministry of Social Affairs, Veteran and Youth Rehabilitation will increase from 72 billion CRs (0.41 percent of GDP) to 107 billion CRs (0.50 percent of GDP). The allocations for the Ministry of Justice will increase from 12.6 billion CR (0.07 percent) to 22 billion CRs (0.10 percent of GDP).

Table 2.8.

Budget Allocations for Priority Sectors, 2002-2007

(Baseline And High-case Scenario, in Billion Riels)

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Outturn

Source: Ministry of Economy and Finance

Table 2.9 shows the medium-term investment framework for 2002-2007. Total investment expenditure as share of GDP is expected to be maintained at the level of around 6 to 7 percent of GDP, reflecting the need to further rebuild the country’s social and economic infrastructure. Government’s investment budget covers mostly the construction of rural roads, rural irrigation facilities and provincial roads. Most of capital investment in health, education, agriculture, public works and transport come from ODA.

Table 2.9.

Government Investment Projects, 2002-2007

(in Million US$)

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Outturn

January-October 2003

Source: Ministry of Economy and Finance

Table 2.10 indicates that ODA disbursement in 2002 was US$500 million or 12.5 percent of GDP. Of this 12.5 percent of GDP, only about 6 percent of GPD is considered to be investment-related, thus was already incorporated into the capital expenditure in Table 2.2. The remaining 6.5 percent of GDP consists of emergency relief, technical assistance, NGO activities, which mostly are recurrent spending by nature. Moreover, a large proportion of the technical assistance is spent or transferred back to overseas.

Table 2.10:

Estimated ODA Disbursement and Projection for 2002-2007

(in Million US$)

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Outturn

Source: Ministry of Economy and Finance

3. Brief Overview of NPRS/MDG Implementation in 2003

Although the NPRS Annual report is selective, this section will provide a general overview of NPRS implementation in a general term to enable all stakeholders to make a general assessment on the implementation of poverty reduction action plans. This section will highlight the achievements and shortcomings of NPRS implementation and actions to be taken by the government to ensure effective strategy implementation in the coming years by focusing on the implementation of the governance reform and the overview of NPRS implementation in other sectors and structural reforms.

3.1. Harmonizing NPRS and MDG

To facilitate the implementation and monitoring of the NPRS, it is essential to merge the NPRS and CMDG into a common framework. The RGC has attempted to merge the two frameworks into a common set of indicators as incorporated in Table 3.1, which will be used for monitoring NPRS implementation to check performance against the benchmark set in the NPRS. Indeed, CMDG is the long-term goals, whereas SEDP/NPRS is the medium-term strategy attempting to achieve the set goals. To merge different framework and targets, the RGC will prepare in the future an MDG-friendly NPRS Annual Progress Report instead of preparing two separate reports in order to reduce the burdens of reporting and monitoring activities. Furthermore, the next NPRS and Socio-Economic Development Plan (SEDP) will be combined into one document in order to ensure the coherency of policies and strategies.

Table 3.1.

Merging NPRS/MDG Monitoring Indicators

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