Cambodia: Staff Report For The 2011 Article IV Consultation—Debt Sustainability Analysis1
Author: International Monetary Fund
Publication Date:
27 Feb 2012
eISBN:
9781463939083
Language:
English
Keywords:
ISCR; CR; GDP; real GDP; U.S. dollar; GDP deflator; debt service; interest rate; service-to-revenue ratio; long-term debt; distress rating; Fiscal stance; Depreciation; Public and publicly-guaranteed external debt; Global
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This 2011 Article IV Consultation reports that Cambodia’s high degree of dollarization and largely reduced fiscal space constrain the authorities’ ability to cushion shocks. Macroeconomic stability hinges on prudent fiscal policies. The mission cautioned that fiscal space is limited and that greater consolidation efforts are needed to strengthen revenue administration and prioritize spending. The outlook for external debt sustainability has improved on Cambodia’s prudent track record, but potentially large contingent liabilities from public–private power sector projects need to be carefully managed.

Abstract

This 2011 Article IV Consultation reports that Cambodia’s high degree of dollarization and largely reduced fiscal space constrain the authorities’ ability to cushion shocks. Macroeconomic stability hinges on prudent fiscal policies. The mission cautioned that fiscal space is limited and that greater consolidation efforts are needed to strengthen revenue administration and prioritize spending. The outlook for external debt sustainability has improved on Cambodia’s prudent track record, but potentially large contingent liabilities from public–private power sector projects need to be carefully managed.

1. Cambodia’s DSA indicates that the risk of debt distress is low. Under the baseline macroeconomic outlook (Box 1), including assumptions on growth and fiscal consolidation, external debt burden indicators do not breach the relevant indicative thresholds. These thresholds are higher than in the 2010 DSA, given Cambodia’s recent upgrade as a medium performer based on the World Bank’s CPIA measure of institutional capacity.

2. Staffs have analyzed an additional country-specific alternative scenario of increased bilateral external borrowing. Assuming a doubling of external borrowing from the baseline over 2011–21 on less concessional terms than those from multilateral donors, this scenario indicates that the scope for absorbing risks would be significantly reduced and Cambodia would lose its low debt distress rating.

3. At the end of 2010, Cambodia’s external public and publicly guaranteed (PPG) debt stock was 28 percent of GDP in nominal terms and 20 percent in net present value (NPV) terms. Until 2008, strong economic growth and favorable external conditions contributed to a decline in debt ratios. However, in 2009, the external PPG debt ratios rose, partly reflecting an increase in the overall fiscal deficit against the backdrop of the global recession. For 2011, the debt stock in PV terms as a share of GDP, as a share of exports of goods and nonfactor services, and of government revenues is projected at 20 percent, 39 percent and 154 percent, respectively. The past DSA (2010) baseline macroeconomic scenario broadly matches the macroeconomic developments, with slightly higher-than-projected growth outcome in recent years, but no tangible impact on debt dynamics.

Cambodia: External Public Debt Indicators at end-2010

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Sources: IMF and World Bank.

4. Around half of Cambodia’s external debt is held by multilateral creditors. primarily the AsDB (27 percent) and the World Bank’s IDA (18 percent). China is the largest emerging creditor, accounting for about 66 percent of total bilateral disbursements in 2010. Cambodia remains in arrears to the Russian Federation and the United States. Following a Paris Club agreement in 1995, Cambodia concluded agreements with France, Germany, Italy, and Japan. The status of negotiations of outstanding debt obligations with the Russian Federation and the United States has effectively remained unchanged since the last DSA. Currently, Cambodia is not servicing its debt with either of these creditors, and efforts to conclude agreements with each under the framework of the Paris Club are required. Since prospects for resolution are unclear, the current DSA assumes no restructuring in its baseline, with arrears continuing to build up throughout the projection period.

Cambodia: Stock of Public and Publicly Guaranteed External Debt at End-2010

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Sources: Cambodian authorities; IMF and World Bank estimates.

Cambodia: Macroeconomic Assumptions Underlying the DSA (2011–31)

The Cambodian economy has performed well in 2011 with overall growth at slightly below 6 percent. on the back of robust garment exports, rising tourism income, and a recovering real estate sector. The recent severe flood is a temporary setback, but agricultural activity should revert back to trend by 2012, pushing GDP growth to 6½ percent.

Inflation is projected to average 5.6 percent in 2011, before gradually declining toward 3 percent in the medium term.

The potential growth rate of Cambodia in the medium and longer terms has been upgraded to 7–8 percent, on the assumption that Cambodia will continue implementing necessary reforms in a steadfast and evenhanded manner (for detailed analysis of the drivers of potential growth see Box 3 in the accompanying staff report). There has been some encouraging progress, such as a rising global market share in garment exports, large investments in hydropower projects that soon will substantially lower the cost of electricity in Cambodia which remains three times as high as in neighboring countries, and an emerging diversification of FDI beyond the garment manufacturing sector.

The external current account deficit (including official transfers) is projected to be above 9 percent of GDP during 2011–13, before trending toward 5 percent of GDP in the longer term. A higher current account deficit in the short term reflects high import contents of the build-operate-transfer (BOT) hydropower projects, which are incorporated in the macroeconomic framework from 2011 onward. These imports are fully financed by corresponding FDI flows. As the construction of these power plants is completed, FDI as a share of GDP should stabilize at around 6 percent, while imports of construction materials and petroleum for electricity production should also level off. Official transfers including loans and grants are programmed to continuously decline as a percentage of GDP in line with rising per capita income. With a positive outlook for export competiveness and FDI, and a narrowing current account deficit in the longer term, gross official reserves in months of next year’s imports are expected to gradually rise from 4.3 months in 2011 toward 5 months in the long run.

Projected fiscal consolidation is an important anchor of macroeconomic stability in the medium term and beyond. The overall fiscal deficit in terms of GDP (excluding grants) is expected to narrow from about 6 percent in 2011 to less than 4 percent in 2016, before gradually falling to 2½ percent by 2031. Revenue would be the main driver of consolidation and is expected to rise to over 14 percent of GDP (excluding grants) by 2016 from about 12 percent of GDP in 2011 in line with targets adopted in the PFM reform program. Revenue (excluding grants) is assumed to increase to 16½ percent of GDP over the long term, implying that gaps in the productivity of Cambodia’s tax system vis-à-vis regional peers would gradually be closed. Public expenditure would remain mostly at around 18 percent through the medium term, and kept below 19 percent up to 2031

EXTERNAL DEBT SUSTAINABILITY ANALYSIS

5. All external debt indicators remain below the policy-dependent debt burden thresholds under the baseline scenario, and no thresholds are breached under standardized stress test. The main results of the external DSA are as follows:

  • All debt indicators in the baseline scenario are expected to decline over the 20-year projection period (Table 1a). During the projection period, the PV of the debt-to-GDP ratio decreases from 20 percent in 2011 to about 14 percent in 2031 (compared to an indicative threshold of 40 percent), while the PV of the debt-to-exports ratio decreases from 39 percent in 2011 to 27 percent in 2031 (compared to an indicative threshold of 150 percent). The PV of the-debt-to-revenue ratio declines from 154 percent in 2011 to 80 percent in 2031 (indicative threshold: 250 percent). The debt service-to-exports and debt service-to-revenue ratios stay well below the indicative thresholds throughout the entire projection period due to concessionality of previous debts.

  • The standard stress tests do not reveal any serious vulnerability (Table 1b and Figure 1). A one-time 30 percent depreciation and the shock to exports push the NPV of debt-to-revenue ratio to 212 and 219 percent respectively, highlighting the need for improved revenue performance.

Figure 1.
Figure 1.

Cambodia: Indicators of External Debt Under Alternative Scenarios, 2011–31 1/

Citation: IMF Staff Country Reports 2012, 046; 10.5089/9781463939083.002.A002

Sources: Cambodian authorities; and staff estimates and projections.1/ The most extreme stress test is the bound test that yields the highest ratio in 2021. In figure b. it corresponds to a one-time depreciation shock; in c. to an export shock; in d. to a one-time depreciation shock; in e. and f. to an exports shock.
Figure 2.
Figure 2.

Cambodia: Indicators of Public Debt Under Alternative Scenarios, 2011–31 1/

Citation: IMF Staff Country Reports 2012, 046; 10.5089/9781463939083.002.A002

Sources: Cambodian authorities; and staff estimates and projections.1/ The most extreme stress test is the bound test that yields the highest ratio in the outer years. In figures a., b., and c., they correspond to permanent shock to growth2/ Revenues are defined inclusive of grants.

6. An additional country-specific alternative scenario considers the impact of increased borrowing (Tables 3a and 4a). This scenario illustrates how increased borrowing (US$880 million during 2011–21, about double the amount envisaged under the baseline scenario) under consideration by the authorities can affect debt sustainability.3 The terms for most of this additional borrowing are assumed to be comparable to bilateral loans from emerging donors: 60 percent of the loans are at 2 percent interest rate with grace period and maturity of 7 and 20 years.4 With no information on the nature or the type of projects to be financed in the higher borrowing scenario and the fact the potential growth has already been upgraded since the last DSA to 7–8 percent, the alternative scenario does not assume any “growth dividends.” Limited administrative capacity of the government to manage debt-financed capital investment and challenges in public financial management would further reduce the likelihood of any growth dividend. The main results under this borrowing scenario are as follows:

  • There would be a significant accumulation of external debt, with the total debt stock rising to 38 percent of GDP (NPV of debt-to-GDP at 29 percent) over the medium term.

  • In several bound tests, the indicative thresholds are breached for a prolonged period of time (Figures 3 and 4). The increased borrowing would therefore push the debt distress rating from low to moderate.

  • Moreover, the return to sustainable debt levels would become more difficult if contingent liabilities, which tend to correlate with shocks under the bound tests, were triggered. Given the large exposure to BOT projects as noted in the accompanying staff report, if problems in only 1 out 10 BOT projects arose potentially leading to a total loss of investment costs, an additional 5 percent of GDP would be added to the debt stock. Similarly, based on international experience, a banking crisis for a country with a financial depth as in Cambodia during the DSA projection period could add about 10 percent of GDP to public debt.5

  • Apart from impairing Cambodia’s ability to absorb shocks, the scenario also underscores the need to raise tax revenue as planned. If the revenue-to-GDP ratio stagnates, higher fiscal deficits would push public debt close to the sustainability threshold.

Figure 3.
Figure 3.

Alternative Scenario of Increasing Borrowing Limits, Indicators of External Debt, 2011–31 1/

Citation: IMF Staff Country Reports 2012, 046; 10.5089/9781463939083.002.A002

Sources: Cambodian authorities; and staff estimates and projections.1/ The most extreme stress test is the bound test that yields the highest ratio in 2021. In figure b. it corresponds to a one-time depreciation shock; in c. to an export shock; in d. to a one-time depreciation shock; in e. to an exports shock; and in figure f. to a one-time depreciation shock.
Figure 4.
Figure 4.

Alternative Scenario of Increasing Borrowing Limits, Indicators of Public Debt, 2011–31 1/

Citation: IMF Staff Country Reports 2012, 046; 10.5089/9781463939083.002.A002

Sources: Cambodian authorities; and staff estimates and projections.1/ The most extreme stress test is the bound test that yields the highest ratio in 2021. In figures a. and b., they correspond to permanent shock to growth, and for c. it corresponds to a one time depreciation in 2011.2/ Revenues are defined inclusive of grants.

PUBLIC DEBT SUSTAINABILITY ANALYSIS

7. Given the predominance of external debt, public debt dynamics closely track that of the external debt. Cambodia does not have, and is not expected to have in the foreseeable future, a market for domestic government debt securities.

8. The nominal stock would increase modestly to 29 percent of GDP (21 percent of GDP in NPV terms) by end-2011 and then gradually decline after 2012. reflecting the fiscal consolidation envisaged under the baseline over the medium term (Table 2a). The PV of public debt-to-GDP ratio and the public debt service-to-revenue ratio would decline gradually over the long term to 14 percent and 64 percent respectively. The debt service-to-revenue ratio remains low in most scenarios for the entire projection period under the baseline.

9. Public debt dynamics are adversely affected by a permanent growth shock and accommodative fiscal stance. Under a permanent growth shock, the level of public debt (as a share of GDP) continues to rise to over 35 percent of GDP (in PV terms). If the primary balance remains unchanged at 2011 level, the PV of public debt-to-GDP continues to rise to 28 percent increase by 2025 and then declines gradually (Table 2b).

DEBT MANAGEMENT

10. The authorities are close to finalizing their formal debt strategy. Staffs welcomed the significant progress in designing a public debt strategy and the creation of a high-level (seven-member) government committee on public debt management, chaired by the Minister of Economy and Finance and co-chaired by the Governor of the National Bank of Cambodia. The debt strategy considers alternative borrowing plans and assesses associated risks. The debt unit at the MEF is also building its capacity, including through TA provided by the AsDB, for analyzing contingent liabilities from the BOT projects and the financial sector. The authorities also acknowledge the importance of a comprehensive approach to debt management, a transparent and objective management of investment projects, and the need to maintain concessionality of new borrowing. Once finalized, the debt strategy is expected to be published in early 2012.

VIEWS OF THE AUTHORITIES

11. The authorities were in broad agreement with the DSA. They underscored that government borrowing would be undertaken only for investment in a few critical sectors (e.g., infrastructure such power, roads, ports, irrigation) and that they would strengthen capacity to assess the budgetary, debt, and growth implications of investment projects. They also welcomed suggestions to strengthen monitoring BOT projects with a view to minimizing fiscal risks. Regarding the alternative scenario with higher borrowing, the authorities concurred that elevated borrowing would lead to Cambodia’s losing the low distress rating.

CONCLUSION

12. In the staffs’ view, Cambodia is at low risk of debt distress based on external indicators under the baseline scenario and the higher thresholds as a medium performer. The baseline projections and the associated standard stress tests show limited risk related to external debt given that none of the indicators breaches the indicative debt burden thresholds. However, in view of Cambodia’s low domestic revenue base, risks to total debt and debt service need to be managed through further strengthening revenue efforts over the medium term.

13. The increase in debt ratios under an alternative scenario with a higher borrowing path highlights the need for a prudent borrowing strategy and careful management of public debt. This exercise also underscores the importance of effective management of new debt accumulation and any contingent liabilities from the rapidly growing BOT projects and the financial sector. Increased borrowing will significantly reduce the government’s ability to tackle any future crises within the sustainability thresholds.

14. The staffs encourage the authorities to build on recent steps and move forward as quickly as possible to strengthen debt management capacity. In this regard, it will be important to continue the work under way to develop and implement a comprehensive debt management strategy and to closely monitor the contingent liabilities from the BOT projects and the financial sector.

Table 1a.

Cambodia: External Debt Sustainability Framework, Baseline Scenario, 2008—31 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Cambodian authorities; and staff estimates and projections.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Includes both public and private sector external debt. The years in the table refer to calendar years.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections, also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 1b.

Cambodia: Sensitivity Analysis for Key Indicators of External Debt, 2011—31

(In percent)

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Sources: Cambodian authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), noninterest current account in percent of GDP, and nondebt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline, while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Table 2a.

Cambodia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2008—31

(In percent of GDP, unless otherwise indicated)

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Sources: Cambodian authorities; and staff estimates and projections.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

The public sector debt represents general government gross debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium- and long-term debt.

Table 2b.

Cambodia: Sensitivity Analysis for Key Indicators of Public Debt, 2011—31

(In percent)

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Sources: Cambodian authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Table 3a.

Alternative Scenario of Increasing Borrowing Limits, External Sustainability Framework, 2008—31 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Cambodian authorities; and staff estimates and projections.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Includes both public and private sector external debt. The years in the table refer to calendar years.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections, also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).