Cambodia
2008 Article IV Consultation: Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion

This staff report for Cambodia’s 2008 Article IV Consultation describes economic developments and policies. Growth is slowing, liquidity is tightening, and, as a result, banks’ balance sheets are coming under strain. Competitiveness has eroded given the recent sharp real appreciation of the Cambodian riel and U.S. dollar. The immediate risks to Cambodia arise from liquidity shortages among banks owing to a sharp slowing in external inflows and deposit growth. Bank lending has moderated, construction activity has slowed, and property prices, after reaching historic peaks, appear to be declining.

Abstract

This staff report for Cambodia’s 2008 Article IV Consultation describes economic developments and policies. Growth is slowing, liquidity is tightening, and, as a result, banks’ balance sheets are coming under strain. Competitiveness has eroded given the recent sharp real appreciation of the Cambodian riel and U.S. dollar. The immediate risks to Cambodia arise from liquidity shortages among banks owing to a sharp slowing in external inflows and deposit growth. Bank lending has moderated, construction activity has slowed, and property prices, after reaching historic peaks, appear to be declining.

I. Macroeconomic and Financial Developments

1. Cambodia’s exceptional growth performance the past five years is coming under increasing strain from the global financial crisis and weakening external demand (Box 1). The economy has been particularly vulnerable to recent shocks given its narrow production base, concentration of exports by product and destination, and dependence on external inflows. As a result, economic activity is slowing in most sectors and liquidity conditions are tightening as funding sources dry up. Rapid credit expansion since 2007 combined with long-standing weaknesses in bank oversight and now falling property prices have heightened credit and solvency risk among a number of banks, including a few systemically important ones.

2. Core macroeconomic developments are summarized as follows:

  • Real GDP growth is projected at 6½ percent in 2008, compared to 10¼ percent in 2007 (Table 1). Garment exports and tourism activity moderated as external demand weakened. Tourism has also been adversely affected by border tensions that emerged between Cambodia and Thailand in mid-2008. Agricultural growth is expected to be below-trend due to adverse weather. New construction activity—strong in the first half of the year—faltered, as foreign direct investment (FDI) slowed and credit growth decelerated.

  • Inflation pressures intensified in the second half of 2007 and first half of 2008 because of rising commodity prices, a weakening in the U.S. dollar against major currencies, and domestic demand pressures. As these factors reverse, headline inflation is expected to be around 15½ percent (y/y) in December 2008, compared to a peak of 26 percent in May 2008.

  • The current account deficit rose sharply in 2008 due to high oil prices and strong non-oil imports. As a share of GDP, the deficit (including transfers) is projected at 12 percent in 2008 compared to about 3½ percent in 2007 (Table 2). Notwithstanding recent developments, the overall external position for 2008 should improve on strong official inflows as well as private inflows earlier in the year, with gross official reserves projected at US$2.0 billion (3.5 months of prospective imports) by year-end, compared to US$1.6 billion (2.5 months) at end-2007.

Table 1.

Cambodia: Selected Economic Indicators, 2005–09

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

CPI is as of November; money and credit is as of end-October; public finance is as of end-October; and gross official reserves are as of December 5, 2008. The exchange rate is the year-to-date average through December 21, 2008.

Contribution to broad money growth.

Ratio of nominal GDP to the average stock of broad money.

In 2006, includes transfer from the IMF of Multilateral Debt Relief Initiative (MDRI) proceeds as capital revenue.

In 2005, includes repayment of arrears.

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

Excludes unrestricted foreign currency deposits held as reserves at NBC and valuation changes.

From 2006, includes the impact of debt forgiveness from the IMF under the MDRI.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

Table 2.

Cambodia: Balance of Payments, 2005–09

(In millions of U.S. dollars, unless otherwise specified)

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

Debt forgiveness from the IMF of debt incurred before 2005 under the MDRI.

Includes unrestricted foreign currency deposits held as reserves at the NBC.

Includes unidentified short-term flows.

Excludes unrestricted foreign currency deposits held as reserves at NBC and valuation changes.

Reflects the impact of MDRI debt forgiveness.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

uA01fig01

Cambodia: Sources of Growth, 2003–09

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.
uA01fig02

Cambodia: Inflation Developments, 2004–08

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Source: Data provided by the Cambodian authorities; and IMF staff estimates.1/ Excludes food, beverages and tobacco, and transportation and communication components of the consumer price index (Phnom Penh, old series).
uA01fig03

Cambodia: Current Account Balance and Financing Flows

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.1/ Excluding official transfers.

Cambodia: Effects of the Global Crisis

  • On the real side, garment export growth has fallen sharply in Cambodia, consistent with weak retail sales in the United States (around three-quarters of the market). Garment sector employment (the largest source of formal employment) is also declining, down 6 percent (y/y) for the year ending July 2008, or to 330,000 workers. Near-term prospects for the sector are poor from both an output and employment perspective, because of demand concentration in the U.S. and competition abroad (see Box 4).

  • Tourist arrivals are also slowing given external conditions, with rising costs and regional instability also factors. Growth was 3 percent (y/y) in the third quarter of 2008, compared to 17 percent in the same quarter last year. As a further indicator, ticket sales at Angkor Wat were up only ½ percent in the first eight months of 2008, compared to 36 percent for the same period in 2007. With the peak travel season now upon Cambodia, hotel operators are reporting a significant drop in forward bookings for this period compared to the previous year. A prolonged downturn could have serious fiscal implications, given the sector’s contribution to domestic revenues, in particular the VAT.

  • Construction approvals were up 38 percent in the first nine months of 2008, compared to 100 percent in the same period last year. Property prices in and around Phnom Penh are reportedly down as much as 25 percent from historic highs in mid-2008, after rising 50–100 percent in the preceding year. Since the global financial crisis hit, a few major urban projects have been scaled back or cancelled outright, as foreign investors (mainly from Korea) reassess their commitments in the face of tighter funding conditions abroad and weaker near-term prospects in Cambodia.

  • However, lower commodity prices have helped bring down inflation and temper the rise in the current account deficit. Since the May 2008 peak, food and fuel prices are responsible for around 80 percent of the decline in headline inflation. In the event world oil prices had stayed at mid-year levels, the oil import bill for Cambodia would likely be around US$210 million (2 percent of GDP) higher in 2008 than currently projected.

uA01fig04

Cambodia: Garment Exports and U.S. Retail Sales Growth, 2006–08

(Seasonally adjusted, 3-month moving average)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Sources: Data provided by the Cambodian authorities; U.S. Federal Reserve Bank; and IMF staff estimates.
uA01fig05

Cambodia: Total Tourist Arrivals and Angkor Wat Revenue, 2006–08

(Year-on-year growth, in percent)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Sources: Data provided by the Cambodian authorities; and IMF staff estimates.1/ Revenue from ticket sales.
uA01fig06

Cambodia: Contribution to Month-on-Month Headline Inflation, 2007–08

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

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

3. The fiscal stance continued to underpin the government’s stabilization efforts in 2008. The overall deficit is expected at around 1¾ percent of GDP, against an official target of 4¼ percent and an outturn of around 3 percent in 2007 (Table 3). Revenue continues to rise (including as a share of GDP), owing to a buoyant domestic economy and improved tax and customs administration, with a pilot of the ASYCUDA system launched and ad hoc tariff exemptions reduced. Current expenditure has been in line with planned allocations, including a mid-year fiscal package.1 Capital expenditure is expected to be slightly higher than budgeted, but precise estimates of actual spending are hampered by weaknesses in recording payment orders and slow progress in budget integration.

Table 3.

Cambodia: General Government Operations, 2005–09

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

Capital revenue includes privatization proceeds.

The full amount of MDRI proceeds (CR 341 billion) was recorded as capital revenue in 2006. In subsequent years, spending under MDRI has been recorded as capital expenditure.

Capital expenditure (externally financed) includes a statistical discrepancy, reflecting the difference between actual and recorded disbursements.

uA01fig07

Cambodia: Gross Official Reserves

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.
uA01fig08

Cambodia: Fiscal Deficit and Financing, 2003–09

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

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

4. Monetary conditions have tightened as external inflows slow and policy measures take hold. Broad money growth is expected to decline from 63 percent at end-2007 to around 5 percent by end-2008 (Table 4). In response to excessively loose conditions in the first half of 2008, the National Bank of Cambodia (NBC) doubled the reserve requirement on foreign currency deposits (FCDs) to 16 percent in June.2 It also placed caps on banks’ lending to the real estate sector. Credit growth, which exceeded 100 percent (y/y) in mid-2008, is expected to fall to around 60 percent by year-end. Despite recent global developments, the riel has remained generally stable against the U.S. dollar since mid-year. Lacking an effective interbank market, the NBC continued to use foreign exchange market intervention to inject riel liquidity necessary to meet transaction demand, with the effect of limiting riel strengthening.

Table 4.

Cambodia: Monetary Survey, 2006–09

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

Foreign currency loans and deposits only.

The ratio of nominal GDP to the year-to-date average stock of broad money.

uA01fig09

Cambodia: Monetary Developments, 2005–08

(Contribution to broad money growth, in percent)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Source: Data provided by Cambodian authorities; and IMF staff estimates1/ Year-on-year percent change.
uA01fig10

Cambodia: Deposit and Credit Growth, 2007–08

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

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

5. As noted, the banking system is under increasing strain. The global financial crisis has exposed vulnerabilities among Cambodia’s banks and is beginning to affect their financial soundness (Box 2 and Table 5). Liquidity shortages have arisen at some banks. In response, banks have been raising deposit rates, drawing excess reserves and, in few cases, borrowing from abroad (mainly from parent institutions).3 At the same time, loan rates have been sticky, suggesting bank spreads are narrowing and profits may be squeezed going forward. The number of banks has also increased rapidly during the past two years—by nearly 50 percent to 28 licensed institutions in late 2008, putting added pressure on the NBC’s supervisory capacity.

uA01fig11

Cambodia: Net U.S. Dollar Purchases, Exchange Rates, and Riel Circulation, 2005–08

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Source: Data provided by the Cambodian authorities; and IMF staff estimates.1/ Official mid-rate.

Cambodia: Global Volatility and Bank Vulnerabilities

The global financial crisis has increased risks and exposed weaknesses in Cambodia’s highly dollarized banking system. Liquidity risk is an upfront concern, compounded by a potentially volatile deposit base. Bank deposit growth (resident and nonresident) has slowed significantly in recent months, turning negative (month-on-month) since September 2008. Large withdrawals have reportedly been made by firms concentrated in the property sector, notably at Korean-owned banks. Combined with rapid credit growth, the loan-to-deposit ratio for commercial and specialized banks breached 100 percent for the first time in October 2008—up from 68 percent one year before. Currently, the nine largest banks control nearly 90 percent of deposits, with six having an average level of deposits in excess of US$10,000. Credit risk may also be increasing as growth slows and property prices decline. Asset quality at some banks has been compromised by poor risk management and weak internal controls. Loan delinquencies appear on the rise, in particular in construction and real estate, and loan recoveries may face difficulties owing to a weak legal system and poor collateral quality. New banks with loans concentrated in the property sector and large banks with weak capital bases are especially vulnerable.

Financial soundness indicators (FSIs) show that banks remain well capitalized, hold sizable liquid assets, and have low nonperforming loans (NPLs), but the picture could be misleading (Table 5). First, rapid credit growth since 2007 may have masked emerging NPL problems. Second, banks’ compliance with prudential regulations remains weak. Mid-year audits by the National Bank of Cambodia revealed NPLs (as a share of loans) higher by two percentage points than previously reported by banks. Third, the FSIs show a move toward more risky lending activities, as suggested by the sharp increase in large exposures in 2008, partly related to real estate, and a continuing rise in consumer loans, mainly mortgage lending. Regarding liquidity, the decline in the liquid asset ratio net of short-term liabilities in 2008 is partly due to the increasing reliance on short-term external financing, mainly by foreign banks from their overseas parents, in light of tighter liquidity conditions.

Sensitivity analysis performed on the nine largest banks reveals the following:

  • Credit risk: Different assumptions were used for the quality of the banks’ loan portfolio, with higher NPLs assumed for real estate and textile sector loans, followed by new loans (see table below). In the most benign scenario (1), average NPLs would increase by about 4 percentage points to 6.5 percent, bringing the risk-weighted capital-asset ratio (RWKA) below the regulatory minimum of 15 percent for four banks. In the most extreme scenario (3)—with average NPLs increasing to 13 percent—six banks fall below the RWKA required minimum, with the capital deficiency equivalent to 1.2 percent of GDP.

Liquidity risk: Different scenarios for a decline in deposits bring the average liquid asset to deposit ratios (LAD) to between 38–45 percent. However, a deposit reduction by 20 percent (Scenario 2) would take the LAD below 15 percent for a few banks (i.e. below required reserves). At a reduction by 25 percent, four banks would see their LAD decline below 20 percent, extremely low for a financial system lacking liquidity instruments and central bank facilities.

Risks may compound if the global financial environment deteriorates further. Deposit growth could slow more. Banks’ access to external financing could also become restrictive, with foreign parents facing their own financial strain. In the event, banks in Cambodia might be unable or reluctant to renew credit lines, which could affect borrowers’ capacity to repay.

Cambodia: Sensitivity Analysis for the Nine Largest Commercial Banks

(Number of banks, unless otherwise specified)

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Source: Cambodian banks’ financial statements; and IMF staff estimates.
Table 5.

Cambodia: Financial Soundness Indicators, 2006–08

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Sources: National Bank of Cambodia; and IMF staff estimates.

Specialized banks are lending institutions that do not take deposits and are subject to lower capital requirements than commercial banks.

Net of gross interbank transactions with resident banks.

Commercial banks only.

II. Outlook and Risks

6. The near-term outlook for Cambodia points to a further slowing in economic activity in 2009, as the impact of negative external shocks becomes more pronounced.

  • Growth is projected at 4.8 percent in 2009. While agricultural output is expected to pick up, garments and tourism would act as a significant drag given weak external conditions. Real estate and construction activity is expected to decelerate further, as investment becomes more constrained by inflows and credit.

  • Inflation should continue to fall, based on the IMF’s latest commodity price outlook and moderating demand pressures. Headline inflation is projected to decline to around 7½ percent (y/y) by end-2009. However, the lagged effects of high inflation in 2008 could still yield upward wage pressures.

  • The current account deficit is expected to decline to around 7 percent of GDP in 2009, but the overall external position will likely deteriorate. Factors that drove the deficit higher in 2008 are expected to reverse and more than offset a sharp drop in export growth. Official inflows should remain strong, but FDI and other private inflows are expected to decline, likely resulting in a moderate deterioration in the overall external position in 2009. Based on this outlook, gross official reserves would fall to around US$1.9 billion (3.1 months of imports) by end-2009.

uA01fig12

Cambodia: Export Developments

(Contribution to growth, in percent)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.
uA01fig13

Cambodia: Import Developments

(Contribution to growth, in percent)

Citation: IMF Staff Country Reports 2009, 047; 10.5089/9781451821864.002.A001

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

7. The balance of risks is clearly to the downside, because of uncertainty about the length and depth of the global recession and its impact on trade and capital flows. Adding to pressures is a recent loss in competitiveness stemming from high domestic inflation coupled with U.S. dollar strength vis-à-vis most major currencies, leading to a sizable real appreciation. In the event of a sharper pullback in external demand or reversal in foreign inflows, with high dollarization, Cambodia could experience a pronounced liquidity contraction and possible large reserve loss, with limited policy options available to cushion the adjustment. A risk scenario such as this would put an even tighter squeeze on private credit availability, increase risks in the banking system, and raise external vulnerability.

8. Medium-term prospects depend on maintaining macroeconomic and financial stability, improving governance and infrastructure, and taking other actions to strengthen competitiveness. Under the current baseline, growth is projected to rise gradually to 7–7½ percent a year (Table 6), driven by FDI-promoted export opportunities, broader tourism development, and higher agricultural yields—each critical to sustained growth and poverty reduction, including meeting the Millennium Development Goals (Table 7).4 The current account deficit would narrow to 5–6 percent of GDP with further export diversification, even accounting for large investment-related imports. Under this scenario, the reserve cover would settle around 2½–3 months of imports. Underpinning stabilization efforts would be modest fiscal consolidation over the medium term, with the overall budget deficit narrowing to less than 2 percent of GDP by 2012.

Table 6.

Cambodia: Medium-Term Macroeconomic Framework, 2006–14

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

Excludes re-exported goods.

Excludes imported goods for re-export.

Net official disbursements, exceptional financing, and official transfers.

From 2006, includes the impact of debt forgiveness from the IMF under the MDRI.

Debt owed to the Russian Federation is valued at 0.6 rubles per U.S. dollar with the standard 70 percent discount.

As a percent of domestic exports of goods and services.

Excludes the accumulation of arrears on debt owed to the Russian Federation and United States.