Information about Asia and the Pacific Asia y el Pacífico

Chapter 1. Introduction: Cambodia Entering a New Phase of Growth

Olaf Unteroberdoerster
Published Date:
February 2014
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Information about Asia and the Pacific Asia y el Pacífico
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Olaf Unteroberdoerster

Cambodia is about to leave behind its post-conflict status. Although the nation’s efforts at rebuilding and recovery were initially beset with internal tensions and civil unrest, its hard-won macroeconomic stability and steady adherence to prudent policies gradually prevailed. This has allowed Cambodia to become one of the world’s fastest-growing economies in the first decade of this century. As a result, progress in reducing poverty has been faster than in most other low-income countries, pushing Cambodia into the top five Millennium Development Goals trailblazers (Leo and Barmeier, 2010). The economic difficulties and policy challenges of the past 30 years of reconstruction—as well as the achievements—have been well documented, including in a 2006 IMF publication, Cambodia: Rebuilding for a Challenging Future (Coe and others, 2006).

This book focuses on the new challenges facing Cambodia’s next generation. Our starting point is a Cambodia entering a new phase of rapid transformation and aspiring to become an emerging market economy. A testament to Cambodia’s newfound vibrancy is its remarkable recovery from the global financial crisis of 2008–09. Since then, its garment exports have risen by more than two-thirds, led by robust retail sales in the United States and improved access to the European Union. Tourist arrivals have continued to grow at a brisk pace, while the recent sharp increase in construction approvals points to a rebound of the battered real estate sector and a return of investor confidence. In addition, early support for farmers’ replanting efforts and improvements in rural infrastructure helped to lessen the severity of the impact of the floods in late 2011, which were the country’s worst floods in a decade.

Yet as policymakers chart a path to enhanced development and shared prosperity, they will need to tackle Cambodia’s main structural vulnerabilities, which were so painfully exposed when growth collapsed during the global crisis:

  • A narrow economic base: Exports have remained narrow-based, with garments and tourism accounting for more than 95 percent of foreign exchange earnings. At the same time, backward linkages of the manufacturing and services sectors to the rural economy—home to about 70 percent of Cambodia’s poor—are still very limited.

  • A dollarized and fragmented financial system: Despite nearly two decades of low inflation, Cambodia’s financial system is highly dollarized, limiting its scope for absorbing external shocks and increasing its banks’ vulnerabilities to solvency and liquidity risks. Moreover, the banking system is both concentrated and fragmented, especially between urban and rural areas, posing risks to stability without adequate benefits for competition and innovation.

  • Limited policy space: The burden of macroeconomic management rests on fiscal policy. However, over the medium term, low fiscal revenues severely constrain the government’s ability to address its development priority needs and raise investment in infrastructure and education, key drivers for future growth.

Part I of this book takes a closer look at these challenges and shows an economy at a crossroads. Chapter 2 offers a growth diagnostic, a framework to analyze the main drivers of Cambodia’s future growth. It makes clear that for Cambodia to achieve a higher development trajectory, productivity growth will need to be unleashed by removing infrastructure bottlenecks, which in turn are holding back private investment, both domestic and foreign.

Chapters 3 and 4 move beyond the real economy and bring into focus the imbalances in Cambodia’s financial development. The first imbalance stems from the fact that Cambodia is Asia’s most dollarized economy. Somewhat paradoxically, growing dollarization in Cambodia has occurred against a backdrop of greater macroeconomic and political stability. The usual motive, currency substitution, does not appear to have been a factor. The dollarization instead reflects Cambodia’s unbalanced and narrow growth so far, driven by its dollarized urban export and tourism sectors. Therefore, more diversified development with greater emphasis on agriculture and rural areas, where the riel is commonly accepted, could over time contribute to a significant decline in dollarization. In addition, Cambodia could try to create stronger incentives for the public use of riels by adapting the policies and experiences of other countries that have successfully dedollarized.

The second financial sector imbalance, examined in Chapter 4, concerns the paradox that Cambodia’s still young financial system is already overbanked—that is, there are too many banks. This conclusion holds whether Cambodia is compared with its developmental peers, its regional neighbors, or even with countries that have much higher income levels and much larger and more well-developed financial systems. However, as the chapter highlights, the proliferation of banks not only stretches scarce supervisory resources but can also harm competition and financial stability, given the banking system’s ownership structure and fragmentation. As a result, the chapter stresses the need for more stringent bank licensing and continued improvements in banking supervision, in both qualitative and quantitative terms.

Chapter 5, which concludes Part I, provides a comprehensive and integrated assessment of Cambodia’s external, financial, and fiscal vulnerabilities. These are all linked to the unique features of Cambodia’s post-conflict reform and growth experience. The vulnerability assessment takes stock not only of Cambodia’s initial structural conditions and policy buffers but also of the vulnerabilities and emerging risks from changes in the external environment and the ongoing transformation in the domestic economy. Particular emphasis is given to the opportunities and challenges arising from the economic rebalancing taking place across Asia, in particular the emerging role of China. The chapter concludes by advocating a virtuous cycle of vulnerability-mitigating macroeconomic policies that could lay the foundations for high and sustained growth.

Part II of the book takes a more detailed look at these policies. Focusing on fiscal and financial sector policies, the common observation throughout this book is that greater policy buffers are needed to cushion adverse shocks in the near term and reduce structural vulnerabilities and constraints to growth over the medium term. First, the government’s new revenue mobilization strategy will play a central role, since it offers the best chance for Cambodia to meet its development needs while safeguarding fiscal sustainability. Second, efforts to enhance the credibility and effectiveness of monetary policy and adopt better safeguards for a rapidly evolving financial system will also help promote economic resilience. While the book argues for such fiscal and financial sector policies, the resulting improvements in macroeconomic management will only enable a virtuous cycle of self-sustaining and inclusive growth if they are combined with steadfast structural reform. In particular, better governance and public service delivery to enhance the effectiveness of high-priority social and infrastructure investments will be critical both for poverty reduction and private-sector-led economic diversification.

The detailed policy challenges and recommendations provided in the chapters are summarized next.

Creating and Safeguarding Fiscal Space

Cambodia currently has limited fiscal space. That is to say, the government has only a limited capacity for responding to adverse macroeconomic shocks and, over the medium term, for providing adequate resources to meet the country’s vast development needs. The fiscal challenges are threefold: Cambodia needs to mobilize more revenue to rebuild fiscal space; it needs to better manage public debt to safeguard this space and ensure fiscal and debt sustainability; and it needs to strengthen public financial management to improve the quality, or effectiveness, of government spending.

In particular, Cambodia’s capacity to collect tax revenue remains weak by international standards, depriving the government of critical resources to fund priority investments in infrastructure and social sectors. Moreover, there are important risks to fiscal sustainability because of the narrow tax base and the high correlation of the country’s revenues with advanced economies’ business cycle. Against this background, this book outlines the rationale for the government’s new strategy to rebuild fiscal space by mobilizing domestic revenue.

A three-pronged approach is essential:

  • improving revenue administration

  • reforming tax policy to broaden the tax base and make revenues more buoyant, and

  • strengthening governance.

Simultaneous implementation in these three reform areas is critical because progress in one area would create positive feedback to the others, making revenue mobilization more effective and self-sustaining. However, while greater revenue mobilization is the key to increasing fiscal space, careful management of fiscal risks and public expenditures is the key to safeguarding it. Therefore, this book also discusses ways to minimize the risks associated with rapidly growing contingent fiscal liabilities and ways to strengthen implementation of Cambodia’s public financial management reform program.

Toward Greater Monetary Independence and Financial Development

In a low-income and heavily dollarized economy such as Cambodia’s, policymakers face the dual challenge of striving to attain monetary policy independence (and dedollarize the economy) while ensuring steady progress in financial market development to support economic growth and broad economic development. The recent launch of the stock exchange and the issuance of negotiable certificates of deposit are two examples that show the dilemma that arises in pursuing these two objectives: Faster financial deepening based on investors’ current currency preferences and market customs could cement the high degree of dollarization. To resolve this dilemma, the book proposes a strategic roadmap, highlighting two of its key elements. The first element is the right sequencing of policies needed to gradually achieve monetary policy independence and, ultimately, to establish a market-based monetary policy instrument in the Cambodian riel, without hindering progress in financial development. The second element is the right design of incentives that not only promote greater use of the riel but also provide a catalyst for a gradual convergence toward a market-based and independent monetary policy framework.

Ensuring a Sound Financial System

Attaining sustainable economic growth in Cambodia also requires a sound financial system. In addition to the stability risks discussed in Part I, the regulatory framework is currently marked by conflicts and overlaps, which interact with uneven implementation and enforcement of recently strengthened regulations. Cambodia’s supervisory capacity is still limited, and a comprehensive crisis management framework is missing. Also missing is an adequate infrastructure to support the Cambodian Stock Exchange, including an adequate liquidity management framework and timely development of a foreign exchange market.

Notwithstanding these challenges, Cambodia has achieved a number of milestones in recent years and has made significant strides in establishing a legal and regulatory framework for financial sector activities. Based on the IMF-World Bank 2010 Financial Sector Assessment Program (FSAP) and relevant follow-up work, Part II of this book reviews in greater detail the milestones achieved in recent years and discusses key recommendations going forward in developing the financial sector. In particular, the analysis explores ways to strengthen the National Bank of Cambodia’s financial supervision function commensurate with the development of a more complex financial system.


Cambodia’s achievements over the last three decades have been remarkable. The nation is now set to join the new generation of Asia’s frontier economies, aptly called Asia’s “flying geese” by the Japanese economist Kaname Akamatsu in describing the rise of Asia’s emerging markets since the middle of the 20th century. But the path to greater and more shared prosperity will require a solid foundation of sound macroeconomic policies. Creating and safeguarding fiscal space, enabling financial deepening while allowing the riel to play a greater role in the economy, and addressing financial stability challenges in a forward-looking manner—all are key elements of a virtuous cycle of sound macroeconomic policies and more resilient growth. Along with integrating its policy approach, Cambodia’s transition to an emerging market economy will require modernizing the role of government and strengthening coordination among relevant government agencies during the formulation and implementation of those policies.


    CoeD. T.I.LeeW. F.AbdelatiD.EastmanR. P.HagemannS.IshikawaA.Lopez-MejiaS.MitraK.NakamuraN.RendakS.Yelten and S.Muñoz2006Cambodia: Rebuilding for a Challenging Future (Washington: International Monetary Fund).

    LeoB. and J.Barmeier2010Who are the MDG Trailblazers? A New MDG Progress Index,Working Paper No. 222 Center for Global DevelopmentWashington.

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