1. The Cambodian authorities would like to express their sincere appreciation to the IMF mission team for the constructive and candid policy discussions, which centered on policies towards strong, inclusive and sustainable growth. The authorities welcome staff’ acknowledgement of Cambodia’s robust economic growth and broadly share staff’s view on near-term risks and medium-term challenges. They are also in broad agreement with staff’s recommendations and will take these into consideration when formulating future policies.
Recent Developments and Outlook
2. The Cambodian economy continues to perform well with 7 percent growth in 2016. Indeed, Cambodia has registered an annual average growth of more than 7 percent over the past 20 years and is regarded as one of the world’s fastest growing economies. More importantly, this growth momentum is expected to remain robust on the back of strong exports and services, as well as real estate and construction activities. The economy is expected to continue to grow around 7 percent in 2017 and 2018.
3. Notwithstanding the recent pickup in headline inflation, the authorities expect headline inflation to decline to around 3 percent in 2018 due to a slowdown in food price increases, owing partly to the authorities’ efforts to improve agricultural productivity and market access, and a deceleration in oil price increases. Credit growth has moderated to around 15 percent in the first half of 2017, following the introduction of policy measures, and is projected to continue to slow to 13 percent in 2018 from an average of 30 percent over the past five years. The authorities are mindful of the impact of these measures on growth and will continue to assess their impact before introducing further measures. The external position has also continued to improve with the current account deficit expected to narrow further to 8.3 percent of GDP in 2017. While gross official reserves continue to increase and cover almost 6 months’ worth of imports of goods and services at end-June 2017, the authorities see merit in staff’s recommendation to further build up the reserves buffer.
4. Despite the overall outlook remaining positive, the Cambodian economy still faces downside risks, particularly on the external front. The authorities share the view of staff that a growth slowdown in advanced economies, appreciation of the US dollar, or rise in protectionism could have an adverse impact on the Cambodian economy. Against this background, the authorities remain vigilant and are committed to undertaking measures and reforms to maintain economic and financial stability while ensuring sustainable growth.
5. The authorities welcome staff’s acknowledgement of sustained financial deepening, which has been a result of strong credit growth over the past years. While the banking sector has been profitable, with adequate capital buffers and provisions, as reflected by the core financial soundness indicators, the authorities are mindful of a potential pocket of vulnerability arising from high credit growth and the concentration of loans associated with the real estate and construction sectors. As such, the Real Estate Data Collection and Coordination Working Group was established in January 2017 to collect and analyze data as well as monitor potential risks in the real estate sector in order to formulate well-targeted preemptive measures. The National Bank of Cambodia (NBC) has also introduced several policy measures to enhance the resilience of the financial system and rein in credit growth, including the phased implementation of the liquidity coverage ratio and bank-specific prudential measures such as higher minimum capital requirements for riskier and more systemically important banks. While these measures have helped bring down credit growth, the authorities will continue to closely monitor developments and remain committed to implementing prudent policies to stabilize credit growth and maintain a strong financial system.
6. The authorities agree with staff that Microfinancial Institutions (MFIs) have played an important role in financial inclusion in Cambodia and some deposit-taking MFIs (MDIs) are becoming more systemically important. The authorities have introduced an interest rate cap on lending by MFIs, MDIs and Rural Credit Operators to improve credit culture and operational efficiency of these financial institutions while protecting customers from excessive interest rate charged by institutions. More importantly, the authorities continue to step up efforts to enhance the supervision framework for banks and financial institutions. The authorities remain committed to a risk-based approach that is consistent with the FSAP recommendations. The NBC is in the process of strengthening regulations including the liquidity risk management framework, capital buffer and external audit requirements for banks and financial institutions. The authorities recognize the important role of the Fund in helping the Cambodian authorities strengthen financial system resilience, and look forward to continued close collaboration to further improve data collection and enhance the crisis resolution framework for the financial sector, in particular, the establishment of the financial stability committee.
7. The authorities concur with staff that a stable exchange rate against the US dollar remains appropriate, given high dollarization, as this continues to serve as an important nominal anchor. The authorities are aware that a high degree of dollarization limits the NBC’s ability to implement monetary policy effectively. The authorities are therefore fully committed to developing the interbank and money markets as well as foreign exchange markets to promote greater use of the local currency (Khmer Riel) in order to allow for a more effective and flexible monetary framework. In this regard, the National Policy, which will serve as a comprehensive roadmap to promote the greater use of the Riel, has been developed and is being reviewed by the Economic and Financial Policy Committee before submission to the Cabinet for approval.
8. Meanwhile, the authorities have undertaken a number of important steps to promote the use of the Riel. The NBC established in October 2016 the Liquidity-Providing Collateralized Operation (LPCO) to provide Riel liquidity to banks and financial institutions against negotiable certificate of deposits (NCDs). LPCOs have been issued on a regular basis to help facilitate banks’ liquidity management and market-based monetary policy operations. In addition, the NBC implemented in December 2016, a measure requiring banks and financial institutions to lend at least 10 percent in Riel. This has resulted in an increase in lending in Riel by banks and financial institutions.
9. The authorities agree that the reserve requirement is an important instrument of monetary and prudential policy. While the authorities have already re-imposed the reserve requirement on banks’ foreign borrowing in 2015, in line with the Fund’s past recommendation, they believe that staff’s recommendation to increase the reserve requirement on foreign exchange liabilities should be undertaken on a gradual and well-sequenced basis, given other regulations in the pipeline.
10. The authorities underscore the important role of fiscal policy in promoting economic growth and development as well as in ensuring the success of their reform agenda. Tax revenue is projected to continue to perform well as a result of the Revenue Mobilization Strategy (RMS), and exceed the Budget Law for fiscal year 2017. Nevertheless, the fiscal deficit is expected to widen due to higher capital spending and increases in public sector wages, as planned.
11. To strengthen fiscal buffers, the authorities are determined to prioritize expenditure and further enhance revenue mobilization. On the expenditure side, the authorities agree on the importance of developing a medium term fiscal framework (MTFF) to improve expenditure allocation efficiency. Education, health and infrastructure will remain expenditure priorities while ensuring social protection. In addition, public sector wage increases will continue to be cautiously implemented and linked with public administration reform progress, in due recognition of its impact on fiscal sustainability and spending priorities. The authorities are in the process of drafting a new public-private partnership (PPP) law with a view to developing a well-designed PPP framework, while a few PPP projects will be implemented on a pilot basis in line with international best practices. On the revenue side, the authorities note the need to rationalize investment incentives and review other tax policies over the medium term and are committed to strengthening the implementation of the RMS. More importantly, the RMS II (2019 – 2023) is being developed to further enhance revenue mobilization and improve efficiency. In this regard, the authorities welcome the Fund’s technical assistance to develop the MTFF and the RMS II, which will be crucial to ensure medium term fiscal sustainability.
12. The authorities note positively from the Debt Sustainability Analysis that Cambodia’s risk of debt distress remains low. The authorities remain committed to maintaining the debt-to-GDP ratio at a sustainable level over the medium term to ensure debt sustainability in acknowledging that access to concessional loans will diminish given Cambodia’s lower middle income status.
Continuing the Reform Agenda
13. The authorities are aware that the Cambodian economy is at an important juncture after sustaining high growth over the last two decades, and requires comprehensive structural reforms to ensure sustainable economic growth with an equitable distribution of wealth. In this connection, the authorities are committed to promoting sustainable and inclusive high economic growth through economic diversification, strengthening competitiveness and promoting productivity through the steadfast implementation of Industrial Development Policy. The completion of hydropower projects will result in more affordable electricity and contribute to enhancing Cambodia’s business climate and competitiveness. At the same time, the authorities will continue to focus on infrastructure projects including roads and irrigation, that would play a vital role in addressing structural bottlenecks and further promoting rural development. More importantly, the authorities are also focusing on developing human capital through education reform, especially technical and vocational training, which in turn will strengthen productivity and further promote inclusive growth.
14. The Cambodian authorities are committed to preserving macroeconomic and financial stability, promoting sustainable and inclusive growth and stand ready to implement any measures deemed appropriate. While significant progress has been made to advance the Cambodia’s economic growth and development, the authorities will continue their efforts to further improve the macroeconomic and financial sector regulatory frameworks in line with the Fund’s policy recommendations. Finally, the authorities would like to express their appreciation to the Fund for its continuing support through policy advice and technical assistance and look forward to continued support from the Fund.