Cambodia: Staff Report for the 2015 Article IV Consultation-Debt Sustainability Analysis

Context. Economic activity remained strong driven by garments exports, real estate, and construction. Inflation decelerated strongly in late 2014 due to the sharp decline in oil prices and REER appreciation. While the outlook remains broadly positive, it is subject to substantial domestic risks as a result of rapid credit growth. External risks include weaker-than-expected growth in the EU and China and continued appreciation of the U.S. dollar. Safeguarding macro and financial stability. Rapid credit growth, increasingly financed by bank flows from abroad, and with greater exposure to the real estate and construction sectors, poses significant macro financial risks. Raising reserve requirements and introducing well-designed macroprudential policies would help to moderate the pace of credit growth. Better monitoring of real estate developments is needed to contain risks. Further strengthening banking supervision and the regulatory framework, and completing a broader crisis management framework would support macro-financial stability. Securing a strong fiscal buffer while meeting development needs. Deficits have been reduced on strong revenue performance. Continued fiscal consolidation is necessary to maintain adequate government deposits in view of spending pressures from a higher wage bill and an expected fall in official assistance. Steadfast implementation of the Revenue Mobilization Strategy is needed to safeguard fiscal space, and provide resources for development. Future public wage increases should be contingent on fiscal performance, and be accompanied by broad civil service reform. Promoting competitiveness, diversification, and inclusiveness. The changing patterns of China's trade and further regional integration through the ASEAN Economic Community provide opportunities for economic diversification. Greater investment in human capital and improving the business climate will help sustain robust growth and enhance competitiveness, foster economic diversification, and inclusiveness.

Abstract

Context. Economic activity remained strong driven by garments exports, real estate, and construction. Inflation decelerated strongly in late 2014 due to the sharp decline in oil prices and REER appreciation. While the outlook remains broadly positive, it is subject to substantial domestic risks as a result of rapid credit growth. External risks include weaker-than-expected growth in the EU and China and continued appreciation of the U.S. dollar. Safeguarding macro and financial stability. Rapid credit growth, increasingly financed by bank flows from abroad, and with greater exposure to the real estate and construction sectors, poses significant macro financial risks. Raising reserve requirements and introducing well-designed macroprudential policies would help to moderate the pace of credit growth. Better monitoring of real estate developments is needed to contain risks. Further strengthening banking supervision and the regulatory framework, and completing a broader crisis management framework would support macro-financial stability. Securing a strong fiscal buffer while meeting development needs. Deficits have been reduced on strong revenue performance. Continued fiscal consolidation is necessary to maintain adequate government deposits in view of spending pressures from a higher wage bill and an expected fall in official assistance. Steadfast implementation of the Revenue Mobilization Strategy is needed to safeguard fiscal space, and provide resources for development. Future public wage increases should be contingent on fiscal performance, and be accompanied by broad civil service reform. Promoting competitiveness, diversification, and inclusiveness. The changing patterns of China's trade and further regional integration through the ASEAN Economic Community provide opportunities for economic diversification. Greater investment in human capital and improving the business climate will help sustain robust growth and enhance competitiveness, foster economic diversification, and inclusiveness.

This Debt Sustainability Analysis (DSA) shows that Cambodia’s debt distress rating remains low with all debt burden indicators projected to remain below the respective thresholds. In line with last year’s DSA, the results also indicate that debt sustainability continues to be vulnerable to growth, exports, fiscal shocks, and the materialization of contingent liabilities, calling for continued structural reforms to increase the economy’s resilience against external shocks, and to mobilize fiscal revenues.

1. This DSA continues to assess the risk of debt distress as low. The indicative debt distress thresholds remain unchanged from the 2013 Article IV DSA. Under the baseline scenario, the external and the public debt distress indicators never breach the policy-dependent indicative thresholds, and the PV of external debt follows a downward trend in the medium term. Downside risks to the baseline scenario include external arrears, and the materialization of contingent liabilities. The macroeconomic assumptions underlying the baseline scenario remain broadly similar to last year’s DSA, with Cambodia assumed to issue domestic debt (e.g., government bonds) over the long term. The debt-to-GDP ratio at end-2014 was slightly higher than the previous estimate due to larger disbursement of bilateral debts, especially from China.1 Cambodia’s Country Policy and Institutional Assessment (CPIA) rating remained unchanged at “medium performer.”

Cambodia’s Public Debt

2. At end-2014, the stock of Cambodia’s external public debt, including arrears, stood at around US$5.5 billion or 33 percent of GDP (23.3 percent in NPV terms). The debt-to-GDP ratio has been steadily increasing since 2008, when it was 27 percent of GDP. Since 2010, the increase in external debt has been driven largely by disbursement of bilateral loans. The corresponding net present value (PV) of the external debt is 23.3 percent of GDP at end 2014, a significant increase from 19.0 percent of GDP at end-2012, primarily because the amortization schedule of existing debt assumes larger principal repayments in more recent years compared to the last DSA.

Cambodia: External Public Debt

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Sources: Cambodia authorities; and World Bank estimates.

3. With greater disbursement of bilateral debt over the past five years, the share of multilateral creditor debt has continued to decline. The share of bilateral debt, including arrears, in total external public debt has increased from 50 percent in 2009 to 69 percent in 2014. China remains the largest bilateral creditor, contributing to 62 percent of the total bilateral debt stock and about 90 percent of bilateral debt disbursement during the past three years. Cambodia remains in arrears to the Russian Federation and the U.S. (nearly 15 percent of total debt or 5 percent of GDP), and the status of negotiations of these arrears has remained unchanged since the last DSA. Cambodia is not servicing its debt with these two creditors. The Cambodian authorities have been in contact with the Russian and U.S. authorities at least on an annual basis, but further efforts are needed to conclude agreements under the Paris Club framework. Since prospects for resolution remain unclear, this DSA continues to assume no debt restructuring, with arrears continuing to build up over the projection period.

4. The negligible level of domestic debt remains unchanged. Cambodia has virtually no domestic public debt at present. There is a small amount of bonds (US$4 million) issued in the early 2000s and some old claims on the government (the total equal to half percent of GDP, with no interest) that were carried over from the 1990s and remain to be recorded in the monetary survey.

5. While the authorities have made progress on the monitoring of contingent liabilities and debt management, the fiscal risks from contingent liabilities need continuous monitoring. The development of the debt management strategy and its submission to the parliament in conjunction with the budget and the establishment of the public private partnership (PPP) unit in the MEF to monitor future PPP approvals are welcome. Progress in measuring already assumed contingent liabilities is underway and receives technical assistance from the World Bank. Further strengthening the capacity of the MEF to deal with PPPs contracts, particularly on legal issues, would be recommended. Other recommendations include the adoption of an annual ceiling on PPP guarantees and the listing of all contingent liabilities in the annual budget law to enhance fiscal transparency. Although debt remains sustainable with a low risk of distress, closer monitoring of fiscal risks from contingent liabilities and further strengthening of capacity to analyze these risks is needed to safeguard the fiscal space.

Macroeconomic Framework

6. The macroeconomic framework underlying the baseline scenario remains broadly in line with the previous DSA.

  • Growth and inflation: Economic activity remains strong driven by robust exports, real estate, and construction. GDP growth is expected at 7.0 percent in 2015 and is projected to gradually increase to 7.3 percent by 2018 assuming continued improvements in business climate, physical infrastructure, and human capital. Over the long term, growth is projected to moderate to 7 percent. Inflation dropped to 1.1 percent in 2014 led by lower energy and commodity prices. In the medium term, it is expected to average 3 percent, in line with the authorities’ informal target and partner countries’ medium-term inflation.

  • External stability: Despite lower garment export and tourism receipts, the current account deficit, including official transfers, is expected to stay flat at around 12 percent of GDP in 2014, partially due to the moderation in imports related to near completion of large power projects and lower garment materials imports, and to remain fully financed by FDI and official loans. For the medium-term, the current account deficit is projected to decline to 7 percent of GDP, as a result of further moderation in imports after the completion of large power generation projects and improved competitiveness and diversification spurred by the participation in the ASEAN Economic Community (AEC), which should support robust export growth. Gross official reserves are projected to remain at around 4 months of prospective imports through 2020. External debt disbursement is projected to average about US$550 million annually during 2015–20 (about 2½ percent of GDP on average), and with this, the debt to GDP ratio is projected to gradually decline to 30 percent by 2020.

  • Fiscal sustainability: Buoyant revenue collection efforts have improved revenue performance significantly in 2014 and stringent procurement measures have slowed the execution of non-wage current expenditure and locally financed capital expenditure, more than offsetting the continuous increase in the wage expenditure. As a result, the 2014 fiscal deficit narrowed to 1.3 percent of GDP (GFS 2001), compared to 3.1 percent implied by the budget, and government deposits are expected to increase temporarily to 7.1 percent of GDP, before declining to around 4 percent of GDP in the medium term. Effective implementation of the list of tax administration measures contained in the Revenue Mobilization Strategy (RMS) should continue to generate revenue gains, raising domestic revenue by ½ percent of GDP on average over the medium term, in line with the authorities’ goal under the Public Financial Management Reform Program. Budget pressure in recent years eased due to strong revenue collection, but large wage increases have limited space to enhance growth critical social and infrastructure spending. In this context, it is important to ensure that the domestic revenue expansion is used most efficiently and effectively. Medium-term fiscal consolidation is therefore anchored to safeguarding government deposits and ensuring long-term fiscal debt sustainability, while striking a careful balance to provide resources for Cambodia’s vast development needs against rising wage pressures and an expected gradual decline of concessional external funds. In view of this, domestically funded capital spending is projected to increase from 1.8 percent GDP in 2014 to 3.4 percent in 2020 to cushion the decline in externally funded capital spending, thereby ensuring that the overall capital spending is maintained at around 8 percent of GDP. With continued efforts to increase efficiency of public investment program and by containing the nonwage current spending in terms of GDP, the fiscal deficit, excluding grants, is projected to decline from about 6 percent of GDP in 2013 to 4.6 percent in 2020. Compared to the 2013 DSA, loans from the non-Paris Club official bilateral donors are assumed to be on less concessional terms. This difference in the loan terms increases external debt by 3 percent of GDP by 2033.

  • Domestic debt: As Cambodia’s financial sector continues to develop, it is expected that the government will start issuing domestic government bonds to provide additional fiscal financing. By issuing debt starting from ¼ ppt of GDP annually in 2021 and gradually increasing to about ½ ppt of GDP in 2035, the total stock of domestic debt would reach about 3.7 percent of GDP by 2035. This remains low compared to the average domestic debt in low-income countries (LICs) of about 15 percent of GDP. However, this conservative estimate is in line with the authorities’ intention of not issuing domestic debt over the medium term and to focus more on mobilizing domestic revenue and raising government deposits (i.e., savings, not borrowings).

External and Public Debt Sustainability

7. Under the baseline scenario, the external DSA shows that Cambodia’s risk of debt distress is low (Figure 1, Tables 1a and 1b). The PV of debt-to-GDP, debt-to-exports, and debt-to-revenue ratios never breach their respective policy-dependent indicative thresholds and are projected to decline over the projection period. Moreover, the debt service-to-exports and debt service-to-revenue ratios remain well below the thresholds throughout the projection period, partly due to the concessional nature of the debt.

Figure 1.
Figure 1.

Cambodia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2015-2035 1/

Citation: IMF Staff Country Reports 2015, 307; 10.5089/9781513520254.002.A003

Sources: Cambodia authorities; and IMF staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a Exports shock; in c. to a Exports shock; in d. to a Exports shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock.
Table 1a.

Cambodia: External Debt Sustainability Framework, Baseline Scenario, 2012–2035 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Cambodian authorities; and IMF staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - p(1+g)]/(1+g+p+gp) 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.

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

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 Public and Publicly Guaranteed External Debt, 2015–2035

(In percent)

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Sources: Cambodia authorities; and IMF staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt 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.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 1c.

Cambodia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2015-2035 (continued)

(In percent)

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Sources: Cambodia authorities; and IMF staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt 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.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

8. Even though standard debt stress tests do not indicate any major vulnerability, they highlight that large exchange rate or export shocks could potentially have a major impact on the debt dynamics. Change in export value growth remains the most important risk to sustainability. As shown in Figure 1, this shock would bring the PV of debt-to-GDP to 36 percent, just 4 percent under the indicative threshold. Similarly, a large one-off depreciation would bring the PV of debt-to-GDP to about 35 percent. While this highlights the importance of continuous monitoring of debt dynamics, the PV of external debt declines over the projection period and does not currently indicate any major vulnerability.

9. Given the minor role played by domestic debt, the public sector DSA closely tracks the external debt sustainability (Figure 2 and Tables 2a and 2b). In particular, the PV of public debt-to-GDP and the public debt service-to-revenue ratios would decline gradually over time, and the debt service-to-revenue ratio would remain low in most scenarios for the entire projection period. It is assumed that, with the development of the domestic bond market, the domestic financing sources will increase after 2020 and the domestic debt will reach about 3.7 percent of GDP over the long run.

Figure 2.
Figure 2.

Cambodia: Indicators of Public Debt Under Alternative Scenarios, 2015-2035 1/

Citation: IMF Staff Country Reports 2015, 307; 10.5089/9781513520254.002.A003

Sources: Cambodia authorities; and IMF staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025.2/ Revenues are defined inclusive of grants.
Table 2a.

Cambodia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2012–2035

(In percent of GDP, unless otherwise indicated)

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Sources: Cambodian authorities; and IMF staff estimates and projections.

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

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.

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

Table 2b.

Cambodia: Sensitivity Analysis for Key Indicators of Public Debt 2015-2035

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Sources: Cambodia authorities; and IMF 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.