Information about Asia and the Pacific Asia y el Pacífico
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Cambodia

Author(s):
International Monetary Fund
Published Date:
December 2009
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I. Introduction

1. Cambodia’s economy has been buffeted by the global recession, following a decade of high economic growth with significant poverty reduction.

  • Growth averaged 8 percent over the period 2000–09, underpinned by favorable global conditions resulting in new productive opportunities and by generally prudent policies supporting macroeconomic stability. The poverty level fell to 30 percent of households in 2007 compared to about 50 percent in the mid-1990s, but with indications of rising inequality. 1 Measurable progress was made in strengthening public administration and undertaking growth-enhancing structural reforms, in collaboration with development partners.
  • In the wake of the global recession, growth in Cambodia in 2009 has turned negative, as export receipts plunged, the tourism industry suffered, and construction activity contracted. By World Bank estimates, the crisis could lead to some reversal in poverty indicators.2 Growth conditions are only expected to improve modestly in 2010, given uncertain global prospects. The sharp slowdown and now deflated property prices have led to heightened financial risk and weakened banks’ balance sheets. Lower foreign currency inflows and a significant loosening of the fiscal stance are also putting pressure on the external position.

2. Against this backdrop, discussions focused on policies aimed at mitigating the impact of the crisis, while preserving macroeconomic stability. Key issues included balancing well-targeted support against avoiding excessive fiscal expansion, as well as strengthening monetary management, allowing greater exchange rate flexibility, and resolving banking sector weaknesses. The structural reform agenda was also revisited in view of the need to diversify growth and improve competitiveness.

II. Recent Economic Developments and Outlook

3. The global crisis is affecting large segments of Cambodia’s economy and clouding prospects, with growth in 2009 now projected at negative 2¾ percent. This compares with the government’s preliminary estimate of positive 6¾ percent in 2008 and double-digit growth earlier in the decade (Figure 1 and Table 1). While signs of a bottoming out began emerging in mid-2009, three of the four main drivers of growth—garments, tourism, and construction—have registered significant contractions so far this year. Private investment has also been hit, with project implementation slowing, new project approvals down significantly, and some foreign-funded construction activity on hold. In addition, retail trade is faltering, reflecting especially steep declines in automobile and motorcycle imports. Notwithstanding the moderate impact from Typhoon Ketsana, good harvests are expected this year, although rural incomes have been depressed by lower agricultural prices.

Figure 1.Cambodia: Real Sector and Inflation Developments

Table 1.Cambodia: Selected Economic Indicators, 2005–10
20052006200720082009 1/20092010
Est.LatestProj.
Output and prices (annual percent change)
GDP in constant prices13.310.810.26.7-2.74.3
(Excluding agriculture)8.117.312.27.0-5.43.9
Real agricultural output15.75.55.05.75.05.0
GDP deflator6.14.66.521.90.74.8
Inflation (end-year)8.44.214.012.5-2.35.36.0
(Annual average)6.36.17.725.03.0-0.65.5
Saving and investment balance (in percent of GDP)
Gross national saving-2.819.919.09.110.55.8
Government saving1.91.82.92.60.2-0.2
Private saving-4.718.116.26.510.36.0
Gross fixed investment1.020.620.819.516.017.0
Government investment4.95.76.15.87.57.6
Private investment 2/-3.914.814.713.78.59.4
Money and credit (annual percent change, unless otherwise indicated)
Broad money16.138.262.94.812.923.512.9
Net credit to the government 3/-4.9-10.6-12.4-11.10.84.95.6
Private sector credit31.851.676.055.04.13.517.0
Velocity of money 4/5.44.93.93.73.43.43.1
Public finance (in percent of GDP)
Revenue 5/10.311.511.912.07.512.012.4
Of which: Tax revenue7.67.99.59.96.29.810.3
Expenditure12.814.214.714.810.518.819.9
Current expenditure7.98.58.79.06.511.312.3
Capital expenditure 6/4.95.76.15.84.07.57.6
Overall budget balance (excluding grants)-2.5-2.7-2.9-2.8-3.0-6.7-7.4
Foreign financing, net4.94.85.05.32.65.55.8
Domestic financing, net 7/-2.4-2.0-2.2-2.50.41.21.6
Balance of payments (in millions of dollars, unless otherwise indicated)
Exports, f.o.b.2,9103,6944,0894,4333,8924,059
(Annual percent change)12.426.910.78.4-9.6-12.24.3
Imports, f.o.b.-3,904-4,727-5,432-6,679-5,501-6,446
(Annual percent change)19.421.114.922.9-7.3-17.617.2
Current account (including official transfers)-240-47-151-1,175-597-1,319
(In percent of GDP)-3.8-0.6-1.7-10.4-5.5-11.2
Gross official reserves 8/9151,0971,6162,1642,2722,1992,137
(In months of prospective imports)2.02.12.54.03.63.53.1
(In percent of foreign currency deposits)105.085.770.895.279.370.1
External debt (in millions of dollars, unless otherwise indicated)
Public external debt 9/2,1202,2542,5712,7733,1703,531
(In percent of GDP)33.731.029.624.629.230.1
Public debt service (cash basis)282835384761
(In percent of exports of goods and services)0.70.60.60.60.91.1
Memorandum items:
Nominal GDP (in billions of riels)25,75429,84935,04245,58344,69648,843
(In millions of U.S. dollars)6,2867,2648,69111,277
Exchange rate (riels per dollar; period average)4,0974,1094,0324,0424,159
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Data as of the following dates: public finance and monetary (August); exports and imports (August); CPI (September); gross official reserves (September 30); and the exchange rate (as of October 26). Latest trade data based on reported figures from the Customs and Excise Department.

Includes nonbudgetary grant-financed investment.

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 the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

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

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

Data as of the following dates: public finance and monetary (August); exports and imports (August); CPI (September); gross official reserves (September 30); and the exchange rate (as of October 26). Latest trade data based on reported figures from the Customs and Excise Department.

Includes nonbudgetary grant-financed investment.

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 the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

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

Cambodia: Contributions to Real GDP Growth
2005–07200820092010
AverageEst.Proj.
Total GDP11.46.7-2.74.3
Agriculture, fisheries, and forestry8.75.75.05.0
Industry13.14.0-9.53.4
Of which: Garments13.22.2-15.03.0
Construction16.35.8-8.03.0
Services11.19.0-4.73.2
Of which: Tourism15.49.8-10.04.0
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

4. Growth is projected to pick up to 4¼ percent in 2010, but risks are clearly tilted to the downside. Export-related activity is particularly vulnerable given the narrow export base, the high concentration of garments destined for the U.S. market, and continued weak prospects for U.S. retail sales. Any recovery in tourism, especially high-end arrivals, is likely to be muted, based on low forward bookings and threats from H1N1, while a pickup in construction depends on resumption of bank lending and foreign direct investment (FDI) inflows. On the upside, rising productivity in agriculture could lead growth higher.

5. Inflation has declined sharply, mainly due to lower food and fuel prices. Headline inflation is expected be around 5 percent (y/y) by end-2009 (compared to negative 2¼ percent in September 2009), mainly as base effects from sharp declines in commodity prices fall out of the consumer price index (CPI). It should remain in the mid-single digits in 2010, although upside risk remains possibly stemming from a more expansionary fiscal stance, a sharper depreciation of the U.S. dollar vis-à-vis other major currencies, and/or higher oil prices than currently envisaged.

6. The current account deficit (including transfers) is expected to narrow in 2009 to around 5½ percent of GDP (Figure 2 and Table 2) as lower import demand and fuel prices more than offset sharply smaller export and tourism receipts (garments account for 65 percent of merchandise exports). As the recovery starts to kick in, the deficit is projected to widen to more than 11 percent of GDP in 2010, owing principally to sluggish exports trailing rising imports and oil prices. Gross official reserves are expected to stay broadly stable, at around US$2.2 billion (3.5 months of next year’s imports) at end-2009 (including the recent SDR allocation). 3 However, a modest decline is projected for 2010, to around US$2.1 billion by year end, as the widening current account deficit more than offsets an expected pickup in FDI and banking inflows. In the event of an even looser fiscal stance, further pressure could be placed on reserves if the exchange rate is not allowed to adjust.

Figure 2.Cambodia: External Developments

Table 2.Cambodia: Balance of Payments, 2007–14(In millions of U.S. dollars, unless otherwise indicated)
20072008200920102011201220132014
Est.Proj.
Current account (including official transfers)-151-1,175-597-1,319-1,585-1,547-1,455-1,452
(Excluding official transfers)-705-1,733-1,147-1,880-2,157-2,130-2,051-2,059
Trade balance-1,343-2,246-1,608-2,387-2,722-2,902-3,085-3,234
Exports, f.o.b.4,0894,4333,8924,0594,4244,7395,1025,496
Of which: Garments2,8402,8992,4452,5222,7432,9053,0803,263
Imports, f.o.b.-5,432-6,679-5,501-6,446-7,146-7,641-8,187-8,730
Of which: Garments-related-1,326-1,355-1,147-1,160-1,262-1,316-1,374-1,434
Petroleum-1,362-2,075-1,559-2,145-2,374-2,544-2,746-2,963
Services and income (net)261148169147165224405475
Services (net)643616478499535634851954
Of which: Tourism (credit)1,1351,2219981,0901,2121,3401,4721,613
Income (net)-381-468-309-352-370-410-446-479
Private transfers (net)377365292360400548630700
Official transfers (net)554558550561572584595607
Capital and financial account5671,6905751,2401,4451,4141,4841,553
Medium- and long-term loans (net)240223377352342320336337
Disbursements259260413395390373407432
Amortization-19-37-36-42-48-53-71-94
Foreign direct investment 1/8678155937238038949971,115
Net foreign assets of deposit money banks (+ decrease) 2/-384692-71677250200150100
Other short term flows and errors and omissions-156-413218850000
Overall balance416515-23-79-140-13328100
Financing-416-5152379140133-28-100
Change in gross official reserves 3/-436-535361124118-44-117
Use of IMF credit00000000
Debt restructuring00000000
Accumulation of arrears2021191816151616
Memorandum items:
Current account balance (in percent of GDP)
Excluding official transfers-8.1-15.4-10.6-16.0-16.5-14.6-12.8-11.7
Including official transfers-1.7-10.4-5.5-11.2-12.1-10.6-9.1-8.2
Trade balance (in percent of GDP)-15.5-19.9-14.8-20.4-20.8-19.9-19.2-18.4
Exports, f.o.b. (annual percent change)10.78.4-12.24.39.07.17.77.7
Of which: Garments6.62.1-15.73.28.75.96.06.0
Nongarments21.322.8-5.66.29.49.010.310.4
Imports, f.o.b. (annual percent change)14.922.9-17.617.210.96.97.26.6
Of which: Garment-related2.22.2-15.41.28.74.34.44.3
Petroleum21.252.4-24.937.610.77.27.97.9
Nongarment, nonpetroleum imports18.021.2-14.012.411.87.77.66.5
Gross official reserves 4/1,6162,1642,1992,1372,0131,8961,9402,056
(In months of next year’s imports)2.54.03.53.12.72.42.32.3
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Includes some debt creating flows related to power sector projects.

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

Excludes changes in unrestricted FCDs held as reserves at the NBC, and changes in gold holdings and valuation.

Excludes unrestricted FCDs held as reserves at the NBC; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

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

Includes some debt creating flows related to power sector projects.

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

Excludes changes in unrestricted FCDs held as reserves at the NBC, and changes in gold holdings and valuation.

Excludes unrestricted FCDs held as reserves at the NBC; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

7. Cambodia’s slowing economy has also weakened banks’ balance sheets and stalled new lending. While banks reported no direct exposure to toxic assets abroad, liquidity conditions tightened significantly at the onset of the global financial crisis. In addition to heightened liquidity risks, banks began facing greater credit risks, exacerbated by sharply lower property prices, which also called into question the adequacy of real estate as collateral.4 Liquidity conditions began improving in early 2009, following policy action by the National Bank of Cambodia (NBC) and banks’ own drive to build liquid balances (discussed below). As a result, banks’ foreign currency deposits (FCDs) rose by 21 percent in the first eight months of 2009, in part due to high deposit interest rates as some banks sought to reduce loan-to-deposit ratios and others to maintain market share. However, credit growth has fallen sharply, from 55 percent (y/y) in 2008 to 4 percent in August, with banks increasingly risk averse.

8. Moderate growth is expected over the medium term, but the external position would remain relatively weak. In the context of a more subdued global outlook (compared to pre-crisis conditions), growth would stabilize at 6–6½ percent per year over the medium term (Table 3), driven by more supportive services activities, including tourism; a pickup in investment demand—notably in power sector infrastructure; and improved agricultural yields. Garment exports are expected to be muted by the productivity gap with other regional producers, high nonwage costs, and structural changes in the global market (Box 1). Other export sectors—namely in agribusiness and light manufacturing—face similar challenges. On the other hand, capital imports are expected to pick up as FDI resumes and new power generation and transmission projects are developed. Underpinning the medium-term outlook is moderate fiscal adjustment starting in 2010, as needed to ensure stable macroeconomic conditions. Improving growth prospects, reducing inequality, and strengthening the external position will also require a more diverse productive base, strengthened competitiveness, and sounder economic governance. To this end, the pace of implementation of the structural reform agenda will need to be stepped up, especially for those reforms aimed at improving basic infrastructure, enhancing labor skills, and strengthening the business climate.

Table 3.Cambodia: Medium-Term Macroeconomic Framework, 2007–14
20072008200920102011201220132014
Est.Proj.
Output and prices (percent change)
GDP at constant prices10.26.7-2.74.36.86.26.06.2
GDP deflator6.521.90.74.84.44.94.13.5
Consumer prices (end-year)14.012.55.36.04.94.03.43.0
Saving and investment balance (in percent of GDP)
Gross national saving19.09.110.55.86.99.412.414.3
Government saving2.92.60.2-0.21.82.12.42.5
Private saving16.26.510.36.05.17.310.011.7
Gross fixed investment20.819.516.017.019.020.021.522.5
Government investment6.15.87.57.67.06.56.46.3
Private investment 1/14.713.78.59.412.013.515.116.2
Public finance (in percent of GDP) 2/
Revenue11.912.012.013.213.714.014.414.5
Of which: Tax revenue9.59.99.811.111.511.812.212.3
Expenditure14.714.818.819.018.518.018.017.9
Current8.79.011.311.411.511.511.611.6
Capital6.15.87.57.67.06.56.46.3
Current balance2.92.60.21.41.82.12.42.5
Primary balance (including grants)-0.50.4-3.9-3.0-2.1-1.3-1.0-0.9
Overall balance (excluding grants)-2.9-2.8-6.7-5.8-4.8-3.9-3.6-3.4
(Including grants)-0.70.3-4.1-3.2-2.4-1.6-1.3-1.1
External financing, net (including grants)5.05.35.55.85.24.74.64.3
Domestic financing, net-2.2-2.51.20.0-0.5-0.8-1.0-0.9
Balance of payments (in percent of GDP, unless otherwise indicated)
Exports (percent change) 3/9.57.1-13.04.49.47.48.08.1
Imports (percent change) 4/14.324.5-18.017.611.17.17.36.8
Current account balance (including transfers)-1.7-10.4-5.5-11.2-12.1-10.6-9.1-8.2
(Excluding transfers)-8.1-15.4-10.6-16.0-16.5-14.6-12.8-11.7
Foreign direct investment (in millions of U.S. dollars)8678155937238038949971,115
Net official capital flows 5/9.16.98.67.87.06.25.85.4
Overall balance4.84.6-0.2-0.7-1.1-0.90.20.6
Gross official reserves (in millions of U.S. dollars) 6/1,6162,1642,1992,1372,0131,8961,9402,056
(In months of next year’s imports)2.54.03.53.12.72.42.32.3
Public external debt (in millions of U.S. dollars) 7/8/2,5712,7733,1703,5313,8824,2134,5624,914
(In percent of GDP)29.624.629.230.129.728.928.427.9
Public external debt service (in millions of U.S. dollars) 9/353847617385107137
(In percent of exports of goods and services, cash basis)0.60.60.91.11.21.31.51.8
(In percent of exports of goods and services, accrual basis)1.01.01.31.51.51.61.82.0
Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

Includes nonbudgetary grant-financed investment.

For 2010, includes additional revenue and expenditure measures equivalent to overall deficit reduction of 1.6 percent of GDP.

Excludes re-exported goods.

Excludes imported goods for re-export.

Net official disbursements, exceptional financing, and official transfers.

Excludes unrestricted foreign currency deposits held as reserves at the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

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.

Cash basis, excluding the accumulation of arrears on debt owed to the Russian Federation and the United States.

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

Includes nonbudgetary grant-financed investment.

For 2010, includes additional revenue and expenditure measures equivalent to overall deficit reduction of 1.6 percent of GDP.

Excludes re-exported goods.

Excludes imported goods for re-export.

Net official disbursements, exceptional financing, and official transfers.

Excludes unrestricted foreign currency deposits held as reserves at the National Bank of Cambodia; starting in 2009, includes the new SDR allocations made by the IMF of SDR 68.4 million.

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.

Cash basis, excluding the accumulation of arrears on debt owed to the Russian Federation and the United States.

III. Report on Discussions

9. Discussions focused mainly on the following:

  • Fiscal: Ensuring the current fiscal stance, as the main anchor to macroeconomic stability, is appropriately supportive, but does not exert undue external pressures, in light of heightened vulnerabilities;
  • Monetary: Strengthening the monetary policy framework, in the context of helping banks better manage liquidity and eventually facilitating greater use of riels, as a precursor to a more independent policy;
  • Exchange rate: Allowing greater exchange rate flexibility, as necessary, in view of the accommodative fiscal stance and to help facilitate external adjustment; and
  • Banking sector: Reducing risks facing the banking sector to contain potential fiscal costs and improve conditions for banks to resume normal lending activities, in support of economic recovery.

Box 1.Cambodia: Garments Sector—Impact of the Global Slowdown and Prospects

The severe impact of the global slowdown on Cambodia’s garment industry is a major driver of the recent contraction in economic activity.

  • In 2008, the garment sector accounted for about 15 percent of GDP and 65 percent of exports (nearly three-quarters of which were destined for the U.S. market), with total employment of about 350,000—the bulk of the manufacturing workforce. Volume growth averaged 11 percent per year over 2005–08.
  • In contrast, over the first nine months of 2009, export volumes are down about 16 percent compared to the same period in 2008. According to industry representatives, forward orders also are very weak.
  • According to the Garment Manufacturers Association of Cambodia (GMAC), around 40 factories (net) have closed so far this year, with another 25 or so remaining open, but operating under a suspension of activity. Small factories previously carrying out subcontracting of overflow orders have been most affected. Most large factories are operating at 60–70 percent capacity (130 percent previously), with less than 5 percent of factories on a 24-hour shift cycle. As of June, some 40,000 jobs had been lost, with retained workers earning about 20 percent less than in 2008 as a result of reduced overtime.

In contrast to garment exporters in other Asian lower-income economies, Cambodia has not gained U.S. market share, as a sizable fraction of its orders is overflow of large ones received by key buyers. Cambodian garment exports to the United States are down some 23 percent in value terms, in line with trends observed in more mature Asian economies where garments account for a far smaller share of exports. Large garment orders received by producers in major hubs such as Hong Kong Special Administrative Region or Taiwan Province of China (POC) are allocated to factories throughout the region starting with the most cost efficient. Declining orders have left fewer allocated to garment manufactures with relatively high unit costs and compress profit margins for all.

Source of Asian Garment Exports to the United States, August 2009

(Year-to-date percentage change)

Source: Office of Textiles and Apparel (OTEXA), United States Department of Commerce.

Competitiveness in Cambodia is hampered by several factors, mainly lower productivity, unreliable supply and high cost of electricity (about 15 percent of total cost), high transport costs and protracted time to market, and lack of vertical integration—factors that are increasingly important given weak demand. According to the GMAC, total manufacturing cost is about 20 percent higher than in neighboring Vietnam, despite lower hourly wages, with major factors being lower productivity, higher electricity costs (22 cents per kwh versus 7 cents in Vietnam), and less developed infrastructure such as ports and roads (getting a container to port reportedly costs about five times that of Vietnam).

The outlook for Cambodian garment exports is clouded by structural changes in the market, in addition to lagging competitiveness. The global recovery is not expected to be consumer-led, dimming prospects for 2010. Looking ahead, the long-anticipated consolidation of the garment industry as a result of the expiry of quotas and safeguards under China’s WTO accession agreement appears to be in train, while free trade agreements between other low-income country (LIC) producers and the United States are increasingly putting Cambodia at a disadvantage. The United States has granted quota-free, duty-free access through various trade agreements to 30 of 49 non-Asian LICs. In contrast, Cambodia is subject to an average 16 percent tariff on garment imports.

While new bilateral trade agreements could play a key role in expanding markets, negotiations will likely be protracted, whereas conclusion of the Doha Round would permanently reduce tariffs. An ASEAN-USA or ASEAN-EU free trade agreement would benefit Cambodia as Rules of Origin would only require sourcing inputs from ASEAN, while passage of the U.S. Trade Act of 2009 would eliminate tariffs on garments and textiles from 14 LICs, including Cambodia. However, all are currently stalled due to political considerations. Sourcing by Japan has seen a shift away from Chinese garment imports and could reduce Cambodia’s dependence on the U.S. market, but at a mere 1 percent of exports, scope is low.

A. Preserving Macroeconomic Stability in the Wake of the Global Crisis

Fiscal policy

10. Moderate fiscal easing was broadly appropriate in 2009 given weak aggregate demand, but in staff’s view the current stance is overly expansionary, which could undermine stability. The 2009 budget deficit is projected to widen to 6¾ percent of GDP (Figure 3 and Table 4), against an original target of 4¼ percent (and up from 2¾ percent in 2008). Unlike recent budgets, this year’s will likely require domestic financing (i.e., a drawdown in government deposits)—now projected at around 1¼ percent of GDP. Staff observed that revenue targets appear on track owing to strong administrative efforts, notwithstanding automatic stabilizers and selected tax relief (mainly customs exemptions on imported inputs for agriculture and small enterprises). However, expenditure levels have risen sharply, with large increases in wage and defense outlays and locally-financed capital spending.5 Staff cautioned that any large injection of riel liquidity into the economy could put pressure on inflation, the exchange rate, and foreign reserves, absent effective monetary controls. With only a few months left in the current fiscal year, efforts should focus on maintaining strong revenue collection and reducing nonpriority spending, in order to ensure adequate space for high-impact social and infrastructure outlays and limit domestic financing.

Figure 3.Fiscal Developments

Table 4.Cambodia: General Government Operations, 2006–10
20062007200820092010
BudgetEst.BudgetJan.–Aug. Est.Staff Proj.Staff Proj.
(In billions of riels)
Total revenue3,4314,1654,1095,4635,3973,3325,3806,068
Of which: Central government3,2403,9623,9575,1885,1053,1375,1025,760
Tax revenue2,3723,3433,2414,4944,3422,7514,3865,009
Direct taxes331480486654746512751833
Indirect taxes1,9202,6762,6243,4333,3241,4593,3773,889
Of which: Trade taxes6449038581,0871,0325941,0051,144
Provincial taxes121187131259272185258287
Nontax revenue681705710769871449755859
Capital revenue 1/377117157200183132238200
Of which: MDRI capital transfer 2/3410000000
Total expenditure4,2445,1645,6806,7517,4174,6768,3909,697
Current expenditure2,5273,0433,5694,0974,6582,8985,0545,983
Wages9751,0581,2421,4381,7301,2022,1372,366
Nonwage1,3721,7662,1202,3112,5721,5422,5593,246
Of which: Interest payments5070757910054100120
Provincial expenditure180220207347357154357371
Capital expenditure1,7162,1212,1112,6542,7591,7783,3373,713
Locally financed381436709701966677966982
From MDRI capital transfer0221093093126
Externally financed 3/1,3361,6821,4001,9431,7001,1012,2782,605
Current balance5261,0053831,1665551388-115
Overall balance (excluding grants)-813-999-1,571-1,288-2,020-1,344-3,010-3,628
Additional measures802
Overall balance (including additional measures)-813-999-1,571-1,288-2,020-1,344-3,010-2,826
Financing8139991,5711,2882,0201,3443,0103,628
Foreign (net)1,4181,7681,5012,4231,8951,1522,4602,826
Disbursements1,4741,8701,6212,5262,0351,2232,6002,965
Grants7617648831,4051,0786481,1841,260
Loans7121,1067381,1219575741,4161,705
Amortization-55-102-120-102-140-71-140-139
Domestic (net)-606-76970-1,135125192551802
Of which: Bank financing (net)-532-863120-1,171155364581817
(In percent of GDP)
Total revenue11.511.910.912.011.17.512.012.4
Of which: Central government10.911.310.511.410.57.011.411.8
Tax revenue7.99.58.69.99.06.29.810.3
Nontax revenue2.32.01.91.71.81.01.71.8
Capital revenue 1/1.30.30.40.40.40.30.50.4
Total expenditure14.214.715.114.815.310.518.819.9
Current expenditure8.58.79.59.09.66.511.312.3
Of which: Wages3.33.03.33.23.62.74.84.8
Nonwage4.65.05.65.15.33.55.76.6
Capital expenditure 3/5.76.15.65.85.74.07.57.6
Of which: Locally financed1.31.21.91.52.01.52.22.0
Current balance1.82.91.02.61.10.00.2-0.2
Overall balance (excluding grants)-2.7-2.9-4.2-2.8-4.2-3.0-6.7-7.4
Additional measures 4/……1.6
Overall balance (including additional measures)-2.7-2.9-4.2-2.8-4.2-3.0-6.7-5.8
Financing (net)2.72.94.22.84.23.06.77.4
Foreign4.85.04.05.33.92.65.55.8
Disbursements4.95.34.35.54.22.75.86.1
Grants2.52.22.33.12.21.52.62.6
Loans2.43.22.02.52.01.33.23.5
Amortization-0.2-0.3-0.3-0.2-0.3-0.2-0.3-0.3
Domestic-2.0-2.20.2-2.50.30.41.21.6
Of which: Bank financing (net)-1.8-2.50.3-2.60.30.81.31.7
Memorandum items:
Tax Department revenue2.63.12.93.33.52.43.73.9
Customs Department revenue5.06.15.46.15.03.45.65.9
Priority sector spending 5/3.02.83.12.83.11.9
GDP (in billions of riels)29,84935,04237,69445,58348,44644,69644,69648,843
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 the MDRI has been recorded as capital expenditure.

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

Additional measures to reduce the domestic financing requirement to zero in 2010.

Current spending by the ministries of public health; education, youth and sport; agriculture, forestry and fishery; rural development; woman affairs; justice; and urbanization and construction.

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 the MDRI has been recorded as capital expenditure.

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

Additional measures to reduce the domestic financing requirement to zero in 2010.

Current spending by the ministries of public health; education, youth and sport; agriculture, forestry and fishery; rural development; woman affairs; justice; and urbanization and construction.

11. The staff strongly recommended that the 2010 budget target a reduction in the overall deficit and reallocate spending toward priority sectors. Based on preliminary revenue and expenditure plans for 2010, staff noted the budget deficit could rise to 7½ percent of GDP, resulting in a domestic financing requirement of more than 1½ percent of GDP.6 Pressure was seen as emerging from the large carry-over of spending on wages together with unspecified increases in nonwage current expenditure. Staff urged the budget deficit be limited to around 5¾ percent of GDP—still appropriately accommodative in providing adequate space for development objectives, but eliminating the domestic financing requirement and setting the stage for medium-term fiscal consolidation.

12. The authorities noted staff’s concern, indicating that with budget discussions ongoing, scope existed to adopt a more prudent fiscal stance.

  • On the revenue side, the authorities indicated specific revenue measures are being considered, such as raising excises on truck sales and imposing a value-added tax (VAT) on electricity imports.7 They also remain committed to further strengthening tax administration, including customs valuation procedures, anti-smuggling efforts, and tax arrears collection. Staff urged more upfront action be considered in light of fiscal risks, including such measures as increasing the reference price for taxing petroleum products and raising other selected excises (e.g., cigarettes, spirits, and diesel). In addition, staff recommended ad hoc import tariff reductions in 2009, tax holidays, and exemptions, and minimum presumptive taxes be reconsidered.8
  • In expenditure areas, the authorities suggested functional allowances would be reviewed, especially new ones for the military and security forces. Staff noted that containing wage bill growth would be key to ensuring sound fiscal management, urging tighter limits on increases in basic wages and allowances and possible freezes on new hires (focused on nonpriority sectors). These measures would need to be accompanied by comprehensive civil service reform, as part of broader efforts to strengthen public financial management and accountability. The authorities indicated in this context that remedies would be devised to control wage costs, recognizing political constraints but consistent with maintaining budget discipline. Staff also urged tighter limits on nonwage recurrent spending growth, apart from that in priority sectors and operations and maintenance, as well as a phasing out of remaining subsidies to Electricité du Cambodge, facilitated by allowing full cost recovery tariffs.

13. There was broad agreement that sound fiscal management would continue to be underpinned by public financial management (PFM) reforms. Aided by substantial technical assistance from the IMF, World Bank, and other development partners, staff noted the measured progress made under the PFM reform program, but urged in light of current circumstances that efforts be accelerated under the second phase (Box 2). Priorities include improving budget integration, especially as pertains to donor-financed capital spending; fully implementing GFS-consistent budget classification and a new chart of accounts; increasing transparency of governmental transactions (with Extractive Industries Transparency Initiative participation encouraged to promote sound development of the country’s potential oil and mineral wealth); and establishing a Treasury single account. To increase government accountability and transparency, staff also urged publication of more timely and comprehensive information on budget formulation and outturns. The authorities noted challenges in implementing PFM reforms, including adhering to more stringent procurement procedures, strengthening internal coordination in the context of weak capacity, and undertaking politically sensitive measures aimed at enforcing greater budget discipline.

Box 2.Cambodia: Update on Public Financial Management Reform

Cambodia’s Public Financial Management Reform Program (PFMRP) was launched nearly five years ago, with the main objective of bringing the PFM system in line with international standards by 2015. Under a donor-supported framework, the PFMRP adopted a “stage-by-stage” approach, with second stage of implementation beginning in 2009. Four platforms were established in order to prioritize the sequence of reforms.

Under Stage 1, the main focus was on building budget credibility, with recognizable achievements in a number of areas. Key objectives were to make the budget comprehensive, strengthen macro-fiscal forecasting, and streamline spending processes, along with some start-up work on later platforms (namely the government accounting system and medium-term expenditure framework (MTEF)). Major achievements were (i) introducing a new budget calendar (with an earlier start to the annual budget process); facilitating more inputs from line ministries; (ii) adopting Budget Strategic Plans and developing a strategy for introducing an MTEF; (iii) improving cash management—eliminating payment arrears and thus allowing smoother budget implementation; and (iv) extending the use of the banking system for government transactions.

However, in some areas, progress under Stage 1 was slow due to capacity constraints and coordination problems within the Ministry of Economy and Finance (MEF) and other lead agencies. Initial steps have been made to establish a Treasury single account. However, it has yet to become fully operational, with National Treasury automation lagging. Implementation of a new chart of accounts (COA) and budget classification has also been limited. As a result, timely and accurate monitoring of the budget remains a challenge. In particular, the current system of monthly fiscal reporting (TOFE) suffers from occasional delays, incompleteness, and inconsistencies. Finally, the public procurement process remains complicated.

In Stage 2, the focus has shifted to achieving better financial transparency and accountability. Main objectives are to improve the accountability of budget decision makers; implement new budget classification dimensions, bringing the COA in line with the IMF’s Government Finance Statistics and UN’s Classification of the Functions of Government standards; introduce an IT-based Financial Management Information System (FMIS); and further strengthen internal and external audit functions and decentralize service delivery.

While the progress to date is commendable, there is a need to:

  • Strengthen budget integration, especially in donor-financed capital spending. Relevant departments in the MEF, the Ministry of Planning, and the Council for the Development of Cambodia are urged to have regular, frequent, and closer coordination in the areas of budget formulation, execution, and recording. Ultimately, a unified control and monitoring system closely linked to the budget is needed.
  • Improve fiscal monitoring and reporting. Integrating the financial information produced by several agencies using different software systems and accounting codes within a standard framework is a top priority. To accelerate system computerization, strong leadership in preparation for full implementation of the FMIS is needed.
  • Reinforce controls over payroll and procurement. In light of a rapid increase in the wage bill, a more systemic management of payrolls should be set up to guard against the risk of “ghost workers” and prevent the wage bill from crowding out other priority spending. Streamlining the overlapping procurement procedures, including approval processes, and strengthening monitoring through a better regulatory framework are also necessary.

Monetary and exchange rate policy

14. The monetary stance is broadly appropriate, but staff cautioned relatively loose conditions would require closer watch as economic recovery takes hold. There was agreement that a further easing—specifically a reduction in the reserve requirement—was neither warranted based on monetary conditions nor desirable from a prudential perspective.9 Under these conditions and given the anticipated recovery, credit growth is expected to rebound in 2010 to 17 percent (y/y), compared to a projected 3½ percent in 2009 (Figure 4 and Table 5). Staff cautioned that as banks’ excess reserve holdings at the NBC mounted (more than one-third of banks’ total FCDs at end-August), the sizable liquidity overhang could pose macro-financial risks on a couple of fronts. First, a rapid reversal in the deposit buildup (including speculative inflows) could result in a spike in liquidity risk, and second, some banks could attempt to lend their way out of their problems, heightening credit risks. Staff also noted the need to maintain adequate vault cash at the NBC, including at local branches, as a safeguard against liquidity shocks in view of still-elevated risks.

Figure 4.Monetary Developments

Table 5.Cambodia: Monetary Survey, 2006–10
20062007200820092010
Dec.Dec.Dec.Mar.Jun.Jul.Aug.Dec. Proj.Dec. Proj.
(In billions of riels)
Net foreign assets7,22410,73510,34611,22212,61113,10313,34613,25112,684
National Bank of Cambodia5,7298,57910,77611,20212,48812,86312,60812,31411,497
Foreign assets5,7298,57910,77611,20212,48812,86313,02912,73611,918
Foreign liabilities000000421421421
Deposit money banks1,4962,156-431201232397389371,187
Foreign assets1,9213,3112,1102,2632,0782,4912,6532,8182,818
Foreign liabilities4261,1562,5402,2431,9552,2521,9141,8811,631
Net domestic assets-2825761,5131,2661,2491,0081,0701,3973,853
Domestic credit2,6764,5706,9076,7667,2417,2997,4047,83410,393
Government (net)-953-1,816-2,987-3,048-2,889-2,807-2,623-2,406-1,589
Private sector3,6286,3859,8939,81310,13010,10610,02710,24011,981
Other items (net)-2,959-3,994-5,394-5,500-5,992-6,291-6,333-6,437-6,539
Broad money6,94211,31111,85912,48813,86014,11114,41714,64816,537
Narrow money1,6582,0522,4002,5452,6952,7702,7352,8083,453
Currency in circulation1,6001,9902,2952,4652,6042,6592,6372,6853,302
Demand deposits5862105819211298123150
Quasi-money5,2859,2599,4599,94211,16411,34011,68111,84113,084
Time deposits89121185193243282289296384
Foreign currency deposits5,1969,1389,2749,74910,92211,05811,39211,54512,700
(12-month percentage change)
Net foreign assets31.948.6-3.62.811.119.419.828.1-4.3
Private sector credit51.676.055.021.910.06.54.13.517.0
Broad money38.262.94.83.79.111.012.923.512.9
Of which: Currency in circulation24.824.415.36.110.99.716.317.023.0
Foreign currency deposits44.875.91.52.38.310.011.024.510.0
(Contribution to year-on-year growth of broad money, in percentage points)
Net foreign assets34.850.6-3.42.69.916.717.224.5-3.9
Net domestic assets25.812.48.31.1-0.8-5.7-4.3-1.016.8
Domestic credit14.0-17.520.79.35.63.24.07.817.5
Government (net)-10.6-12.4-10.4-5.4-1.7-1.60.84.95.6
Private sector24.639.731.014.67.34.83.12.911.9
Other items (net)-10.7-14.9-12.4-8.2-6.4-8.9-8.3-8.8-0.7
Memorandum items:
Foreign currency deposits (in millions of U.S. dollars)1,2792,2832,2732,3822,6232,6392,7482,7733,050
(In percent of broad money)74.880.878.278.178.878.479.078.876.8
Riel component of broad money1,7462,1732,5842,7382,9383,0523,0253,1033,837
(In percent of broad money)25.219.221.821.921.221.621.021.223.2
Credit to the private sector (in millions of U.S. dollars)8931,5952,4242,3982,4332,4112,4182,4592,877
(In percent of GDP)12.218.221.722.322.722.522.522.924.5
Loan-to-deposit ratio (in percent) 1/67.167.4103.597.690.288.985.876.569.5
Velocity 2/4.93.93.73.73.53.43.43.43.1
Money multiplier (broad money/reserve money)2.12.31.91.91.81.71.81.82.0
Reserve money (12-month percent change)28.348.321.619.127.132.918.430.32.9
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.

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.

15. Progress continues to be made in improving liquidity management, but a number of actions are needed for an operational monetary framework. The conduct of monetary policy is hampered by the lack of market-based instruments, weak interbank activity, and high level of dollarization, which limits the establishment of operating and intermediate targets.10 With Fund technical assistance, the NBC is undertaking higher frequency liquidity monitoring, with weekly indicators now being compiled. Staff welcomed progress toward issuing negotiable U.S. dollar-denominated instruments that could be traded among institutions, as this would help strengthen banks’ liquidity management and deepen interbank activity. To this end, the NBC seeks to finalize regulations on issuing securitized instruments and on a repo master agreement by end-2009. Given the absence of monetary instruments to control riel liquidity, the authorities also expressed interest in issuing riel-based securities. Staff noted that with few banks holding large riel balances, the effectiveness of such instruments might be limited for some time. However, issuance of new dollar-based instruments could provide collateral for more riel transactions between banks and ultimately pave the way for trading local currency securities.

16. Staff noted that maintaining a relatively fixed exchange rate could undermine efforts to strengthen monetary management and heighten vulnerability to shocks. In light of the government’s riel injection and seasonal factors, the NBC took steps to stem downward pressure on the riel at mid year, becoming a net seller of foreign exchange to the market in three consecutive months (July–September) for the first time since mid-2005. Staff noted such intervention was potentially costly in terms of delaying adjustment and reducing reserve coverage—both as a share of imports and deposits. The authorities indicated their action was necessary to address possible overshooting and avoid an inflation spiral, but that as market conditions had now stabilized, they did not anticipate further intervention. Staff continued to urge limiting intervention to smoothing volatility to help protect international reserves, deepen the foreign exchange market, and allow the exchange rate a greater role in facilitating external adjustment. In this context, both the staff and the authorities agreed the new SDR allocation should be retained to build up foreign reserves, given current vulnerabilities.

17. The real effective exchange rate appears to be somewhat overvalued relative to its equilibrium level. However, this assessment is subject to considerable uncertainty.11 Much of the increase in the current account deficit over the near to medium term is accounted for by imports associated with large FDI and donor-related projects, which are fully financed. Nevertheless, a continued strengthening of the exchange rate could weaken export prospects and increase external pressures.

B. Strengthening the Financial Sector

18. While banks’ liquidity has improved, staff noted that bank balance sheets have further weakened and credit risks have risen sharply over the past year. Contributing factors center on weak risk management, earlier supervisory lapses, and excessive credit growth, the effects of which have been exacerbated by the growth slowdown and property price collapse. Nonperforming loans (NPLs) are rising, but the figures officially reported by banks likely fail to capture the true extent of the problem. Sensitivity analysis informed by other countries experiencing similar property cycles to Cambodia points to potentially larger loan losses and capital deficiencies, raising the risk of bank insolvencies (Box 3). Negative interest carry and low demand for credit appears to be squeezing profits, making it difficult for banks to grow out of these problems. Given current circumstances, staff cautioned that sustained competition for deposits as a cushion against liquidity shocks could further undercut banks’ profitability and hamper their ability to write off NPLs. Under such a scenario, banks could face difficulty resuming normal lending activities, with a potential for adverse feedback between weak growth and further credit losses.

19. So far, the NBC has taken measured steps to deal with problem banks, with much more forceful action needed to reduce systemic risks. Since early 2009, the NBC has conducted a set of prioritized onsite inspections (with assistance from the IMF and AsDB), resulting in the issuance of supervisory letters to noncompliant banks and development of corrective action plans to address a range of operational and financial deficiencies. Banks are also being urged to advance compliance with new minimum capital requirements ahead of the end-2010 deadline. In addition, their related party activities are being more closely scrutinized and internal governance is being strengthened, including through the introduction of credit committees and use of more independent directors. Staff urged strict enforcement of newly-introduced loan classification and provisioning standards and recognition of loan losses, with recapitalization where needed, to ensure banks’ solvency and minimize fiscal risks. To these ends, the authorities were urged to develop a comprehensive bank resolution framework, including procedures to assume administrative control of intervened banks, resolve failed institutions, and provide public financial assistance as necessary under a transparent regime. Going forward, the authorities agreed on the need to deal more firmly with troubled banks, as staff cautioned a gradual approach could potentially entail even greater risks for the banking sector and become more costly.

Box 3.Cambodia: Banking Sector Vulnerabilities

Cambodia’s banking sector continues to face heightened risks, despite the slowdown in credit growth and easing of liquidity pressures observed so far in 2009.

Most notably, credit quality has deteriorated significantly, although official reports may belie the true extent of the problem. Banks reported that NPLs rose to 5¼ percent at June 2009 from 3¾ percent in December 2008 (Table 6). However, the actual level of NPLs is likely much higher. In particular, a number of banks continue to report few or no NPLs, suggesting incomplete adherence with the new loan classification and provisioning regulation. Moreover, the evergreening of loans and capitalization of interest still take place to avoid loan loss recognition and provisioning and possible capital writedowns. These practices appear particularly acute for overdraft loans used to finance land purchases during the recent property boom.

Table 6.Cambodia: Financial Soundness Indicators, 2006–09
2006200720082009
Dec.Dec.Mar.JuneSept.Dec.Mar.June
Number of banks2024242528303032
Commercial banks1517172022242426
Of which: State-owned banks11111111
Specialized banks 1/57756666
Bank concentration—number of banks accounting for:
25 percent of banks’ total assets22222222
75 percent of banks’ total assets76676666
Capital adequacy (in percent)
Regulatory capital to risk-weighted assets26.523.624.125.625.627.827.827.8
Capital to assets20.017.017.919.419.522.022.122.1
Nonperforming loans net of provisions to capital19.48.25.55.34.97.59.28.7
Asset quality (in percent)
Nonperforming loans to regulatory total loans9.93.42.52.62.73.75.15.2
Large exposures to capital60.47.353.043.438.742.337.336.5
Sectoral distribution of loans (in percent of total loans)
Real estate8.67.99.47.07.67.57.16.6
Construction7.710.29.17.06.87.97.98.0
Consumer10.219.719.720.321.521.820.419.8
Earnings and profitability (in percent)
Return on assets2.82.84.03.43.12.91.31.3
Return on equity14.216.622.217.615.813.16.15.7
Liquidity (in percent)
Liquid assets ratio 2/41.748.439.737.738.635.937.339.6
Liquid assets to total deposits56.665.655.555.060.959.359.861.0
Liquid assets ratio net of short-term liabilities49.443.533.930.427.824.327.732.8
Loan-to-deposit ratio 3/60.562.776.182.485.594.088.581.4
Foreign exchange exposure (in percent)
Foreign currency loans to total loans97.297.798.098.298.298.097.998.1
Foreign currency deposits to total deposits96.797.697.697.196.996.396.696.6
Memorandum item:
Banks’ assets (in percent of GDP)26.038.438.339.641.137.337.740.5
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.

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.

Sensitivity analysis of the banking system, using a range of NPL ratios that have materialized in other countries experiencing similar property price busts, suggests a potentially large capital deficiency. Using a top-down approach, if average system-wide NPLs were to rise to around 15 percent (Scenario 1) and require full provisioning, the risk-weighted capital to asset (RWKA) ratio would decline to 20 percent. At this level, NPLs would amount to around 37 percent of the banking system’s capital at end-June 2009.

Cambodia: Banking System Sensitivity Analysis 1/
Credit Risk 2/Liquidity Risk 3/
NPLsRWKANPL to CapitalLAD Ratio
Baseline5281339
Scenario 115203728
Scenario 225136124
Scenario 33558618
Assumptions for Risk Scenarios
Assumed NPLs (percent of loans, by sector)Deposit Reduction (percent change)
Real EstateTourismOther
Scenario 130151015
Scenario 240252020
Scenario 350353025
Sources: National Bank of Cambodia (NBC); and IMF staff estimates.

Top-down simulations using consolidated banking system from data provided by the NBC.

Based on end-June 2009 data (baseline). Assumes 100 percent provisioning against assumed NPLs and a 100 percent risk weight for affected assets.

Based on end-September 2009 data (baseline). Liquid assets include vault cash, excess reserves at the NBC, and deposits held abroad.

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

Top-down simulations using consolidated banking system from data provided by the NBC.

Based on end-June 2009 data (baseline). Assumes 100 percent provisioning against assumed NPLs and a 100 percent risk weight for affected assets.

Based on end-September 2009 data (baseline). Liquid assets include vault cash, excess reserves at the NBC, and deposits held abroad.

Even as liquidity pressures ease, risks remain in the current environment. To protect themselves, some banks are self-insuring and reducing loan-deposit ratios by raising new deposits, but at considerable cost, which may eventually undermine stability. Interest rates on six-month term deposits in U.S. dollars averaged over 5 percent throughout 2009, leading to a significant increase in bank deposits. Along with slower lending growth, the loan-deposit ratio declined from over 100 percent in late-2008 to around 80 percent. Banks have placed most new deposits at the NBC as excess reserves, where they are remunerated at most at one-half of SIBOR (close to zero percent), generating a negative interest spread and driving down banking sector profits, with return on equity and return on assets both declining. The profit squeeze has adversely affected banks’ ability to absorb loan losses and resume lending growth. Proper provisioning against NPLs would further reduce profits.

In the event recent deposit inflows were to reverse, banks could come under heightened pressures, requiring close monitoring. Moreover, excessive use of overdrafts represents contingent calls on liquidity (i.e., if customers draw overdrafts down quickly). Staff sensitivity analysis suggests that a 15 percent deposit reduction (Scenario 1 in the text table) would reduce the ratio of liquid assets to deposits (LAD) to around 28 percent, well below the level prevailing during the period of liquidity stress in late 2008. A 20 percent deposit reduction would result in a system-wide LAD ratio of 24 percent, which is very low for a highly dollarized financial system lacking a functioning interbank market and central bank facilities.

The results of these sensitivity analyses are preliminary. The upcoming Financial Sector Assessment Program (FSAP), scheduled for 2010, will examine the soundness of the banking sector in greater depth, including through comprehensive stress tests using both a top-down and bottom-up approach and assess banks’ vulnerabilities to a range of tail risk shocks.

20. Staff noted further capacity building was needed to safeguard the financial system and limit regulatory arbitrage, given growth and diversification of the sector. The NBC’s supervisory and oversight capacity is already stretched by rapid growth in the number of banks and could be further burdened by bank restructurings. The development of a stock market and impending consolidated supervision of securities firms will place additional strains on resources. The recently established Financial Intelligence Unit is still in the process of sourcing much-needed technical resources for processing a large quantity of cash transaction reports. The authorities were urged to increase qualified staff in banking supervision—notably for onsite inspection teams, continuing to concentrate their activities on the larger banks. A temporary moratorium on the granting of new bank licenses was also urged until supervisory capacity could be appropriately expanded. Here, however, the authorities noted the important role that new entrants could play, notably those from abroad, in raising operating standards and reducing risk concentration in the banking system.12 Finally, there was agreement on the need for closer collaboration between the NBC and Securities and Exchange Commission of Cambodia (SECC) to avoid opportunities for regulatory arbitrage, with guidelines for establishing securities firms and broker operations now issued in anticipation of a new stock exchange to be rolled out next year.13

C. Reducing Vulnerabilities and Fostering Competitiveness

21. The resumption of sustained high growth requires more concerted actions aimed at strengthening competitiveness and improving the business climate. The authorities noted that efforts toward full WTO compliance and lowering the cost of doing business were ongoing. However, the number of required laws, amendments, and regulations is extensive, and great care must be taken to address wide-ranging inconsistencies among laws and regulations under various ministries. Given the limited number of staff and capacity, priority has been given to those areas that will most benefit business. At present, focus is on the finalization of the Commercial Contract Law, including the chapter on Commercial Agency, and establishment of the National Arbitration Council, which should be in place by year-end. Moreover, implementation of post-clearance audits and simplified valuation and cargo processing procedures have reduced time required for customs clearance.

22. Cambodia is assessed to be at a moderate risk of debt distress, and rising contingent liabilities warrant increased vigilance. At end-2008, total public debt was equivalent to around 25 percent of GDP, with nearly all external. The joint IMF-World Bank Debt Sustainability Analysis highlights Cambodia’s dependence on nondebt creating flows from abroad and risks posed by higher fiscal deficits (Appendix I). A failure to significantly rein in the deficit or the realization of possible contingent liabilities resulting from dislocations in the banking system, government guarantees on build-operate-transfer schemes, and/or large hydropower-related investments could negatively affect debt sustainability and jeopardize poverty reduction efforts. The staff urged the authorities to thoroughly review existing contracts for potential liabilities, and exercise caution when evaluating new investment projects that carry an explicit or implicit government guarantee.

IV. Staff Appraisal

23. Over the past decade Cambodia has made considerable strides, achieving sustained growth and poverty reduction, aided in part by the global upcycle. Generally prudent policies have supported macroeconomic stability and enhanced credibility, while collaboration with development partners has helped address capacity constraints, which at times has held back reform efforts.

24. However, over the past year, the economy has been buffeted by the global recession, with contracting activity further weakening the banking sector. As the main anchor to stability, a cautious fiscal policy response is required, since excessive spending, larger deficits, and domestic financing could place downward pressure on the exchange rate, raise inflation concerns, and weaken the external position in the context of high dollarization. Given uncertain global prospects, policies should aim to protect vulnerable groups while preserving macroeconomic stability and address the urgent need to strengthen the banking sector.

25. The current fiscal easing appears overly expansionary and insufficiently targeted. Large increases in the wage bill will be difficult to roll back to make space for needed expenditure in priority social sectors as well as operations and maintenance. The domestic financing requirement should be eliminated in 2010 through a combination of revenue and expenditure measures, spending should be re-prioritized, and the deficit placed on a clear consolidation path over the medium term to safeguard debt sustainability in light of potentially rising contingent liabilities. In the absence of policy tightening, the exchange rate would need to be allowed to depreciate to protect international reserves. Continued gains in PFM would improve policy effectiveness, while publication of comprehensive budget data would increase accountability and transparency.

26. The monetary stance is broadly appropriate, but conditions bear close watch in view of the liquidity overhang and recovery prospects. Banks’ excess reserves, fueled by rapid deposit growth but also reflecting weak credit demand, could reverse quickly and/or invite weakened credit standards—each potentially elevating risks. Under current conditions, a reduction in the reserve requirement is neither warranted nor desirable on monetary or prudential grounds in light of relatively loose liquidity conditions and banks’ weak balance sheets. Further efforts to strengthen liquidity monitoring and introduce new tradable instruments should help deepen interbank activity and improve banks’ liquidity management. However, effective monetary controls will require greater confidence in and use of the riel, as well as a more flexible exchange rate arrangement. To this end, exchange market intervention should be limited to smoothing volatility, which would help protect foreign reserves, deepen the foreign exchange market, and facilitate external adjustment.

27. The economic downturn and bursting of the property bubble have weakened banks’ balance sheets and increased credit risks. While the NBC has taken commendable actions, conducting prioritized onsite inspections and issuing supervisory letters to noncompliant banks, NPLs continue to mount and profitability is being squeezed by the combination of high funding costs and few lending opportunities. Strict enforcement of the new asset classification regime, implementation of corrective action plans, and development of a comprehensive bank restructuring framework are critical to strengthening banking system solvency. Supervision capacity, including staffing, should be increased, complemented by a temporary moratorium on new bank licensing, while care should be taken to ensure new securities regulations are consistent with those governing other segments of the financial system.

28. A return to a path of high growth will require strong efforts to diversify the production base, strengthen competitiveness, and improve the business climate, especially in light of the more subdued global outlook and challenges from low-cost regional producers. Reforms should aim at improving basic infrastructure and enhancing labor skills, as well as expanding market access through trade commitments and reducing the cost of doing business, including through streamlining investment approvals and customs procedures.

29. In view of the uncertain external environment, macroeconomic imbalances, and systemic financial risks, staff will continue to monitor developments closely. Given the lack of progress in resolving outstanding arrears to the Russian Federation and the United States remains a major hurdle to formal program engagement, staff urge all parties to demonstrate flexibility. Under any circumstances, the authorities should further carry out their reform efforts, which the IMF will continue to support through intensive technical assistance and policy dialogue.

30. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Table 7.Cambodia: Millennium Development Goals Indicators
1990199520002002200320042005200620072015
MDG Target
Goal 1: Eradicate extreme poverty and hunger
Percentage share of income or consumption held by poorest 20 percent9711
Population below minimum level of dietary energy consumption (percent)3321
Poverty headcount, national (percent of population)473520
Prevalence of underweight in children (under five years of age)4526
Goal 2: Achieve universal primary education
Net primary enrollment (percent of relevant age group)6785939196100
Primary completion rate, total (percent of relevant age group)555554575587100
Proportion of pupils starting grade 1 who reach grade 56361606362100
Youth literacy rate (percent of ages 15–24)7376798083100
Goal 3: Promote gender equality and empower women
Proportion of seats held by women in national parliament (percent)8771010101030
Ratio of girls to boys in primary and secondary education (percent)7382858687908993100
Ratio of young literate females to males (percent ages 15–24)818489909090100
Share of women employed in the nonagricultural sector (percent)4146525353
Goal 4: Reduce child mortality
Immunization, measles (percent of children ages 12–23 months)34626552658079787890
Infant mortality rate (per 1,000 live births)84897867656550
Under 5 mortality rate (per 1,000)11612310485828238
Goal 5: Improve maternal health
Births attended by skilled health staff (percent of total)32444480
Maternal mortality ratio (modeled estimate, per 100,000 live births)450540540250
Goal 6: Combat HIV/AIDS, malaria, and other diseases
Incidence of tuberculosis (per 100,000 people)577549530520515510505500500
Prevalence of HIV, total (percent of population 15–49)3321
Goal 7: Ensure environmental sustainability
Access to an improved water source (percent of population)346565
Access to improved sanitation (percent of population)162828
Nationally protected areas (percent of total land area)1924
Goal 8: Develop a global partnership for development
Aid per capita (current U.S. dollars)45031373835393737
Fixed line and mobile phone subscribers (per 100 people)02134781218
Internet users (per 1,000 people)6303541446670
Personal computers (per 1,000 people)01222
Total debt service (percent of exports of goods and services)12111111
Goal 9: De-mining, UXO, and assistance
Annual numbers of civilian casualties recorded1,6917970
Percentage of suspected contaminated areas cleared1050100
Other
Fertility rate, total (births per woman)64443333
GNI per capita, Atlas method (current U.S. dollars)280280300340380440490540
GNI, Atlas method (current, in billions of U.S. dollars)3.13.64.04.55.36.27.07.9
Gross capital formation (percent of GDP)81517202218202122
Life expectancy at birth, total (years)50545454585959
Literacy rate, adult total (percent of people ages 15 and above)6264686974
Population, total (millions)9.611.212.713.213.413.614.014.213.4
Trade (percent of GDP)1980114127133146137134145
Sources: World Bank database, World Development Indicators, and Poverty Assessment (2006); UN Human Development Indicators Report (2003); Cambodia MDG 2005 update; and IMF staff estimates.
Sources: World Bank database, World Development Indicators, and Poverty Assessment (2006); UN Human Development Indicators Report (2003); Cambodia MDG 2005 update; and IMF staff estimates.
1/Progress toward achieving the Millennium Development Goals (Table 7) remains on track in the areas of expanding primary education, reducing the incidence of communicable diseases, and promoting gender equality, but more efforts are needed to eradicate extreme poverty and reduce maternal mortality (http://www.mdgmonitor.org).
2/The World Bank’s East Asia Update (forthcoming in November 2009) reports that the current crisis could add 1–4 percentage points to the poverty headcount between 2007–10. The crisis’s impact on Cambodia is compounded by high household indebtedness and the lingering wealth effect of soaring food prices in 2007–08. In contrast, strong growth in earlier years is estimated to have contributed to a decline in the poverty headcount by more than 1 percentage point per year during 2004–07.
3/The IMF provided new general and specific SDR allocations to Cambodia totaling SDR 68 million in August and September 2009.
4/No reliable index of property prices exists in Cambodia. However, property prices in Phnom Penh are reportedly down by 50 percent from their mid-2008 peak. Most loans are backed by real estate, while property-related loans account for 20–30 percent of total credit outstanding.
5/On the other hand, externally-financed capital spending was at a slower pace than expected (through August 2009) due to reported delays in project-related procurements, as well as continued problems in the timely recording of donor disbursements.
6/The drawdown in government deposits over 2009 and 2010 would amount to nearly 3 percentage points of GDP, almost half of the accumulated buildup over the preceding years.
7/The authorities’ plan to impose a VAT on electricity consumption starting in mid-2009 has been placed on hold, given risks to revenue collection posed by possibly large rebates to private energy producers and political challenges associated with already high end-use prices of electricity.
8/The tax holiday to the garment sector has been extended by two years to 2011, with the rate on profit taxes capped at 9 percent until then. In addition, monthly prepayments of the tax have been suspended until 2012.
9/In response to tightening liquidity conditions in late 2008, the NBC reduced the reserve requirement on FCDs in February 2009 from 16 percent to 12 percent and introduced a new reserve requirement system helping banks conserve liquid balances. An emergency overdraft facility was also put in place.
10Currently, net domestic assets of the NBC serves as a de facto operating target, in view of the impact of changes in net claims on government by the central bank on riel liquidity and the exchange rate.
11Results of the exchange rate assessment are mixed. The macroeconomic balance approach indicates an overvaluation of around 25 percent, while the equilibrium real exchange rate approach points to an undervaluation of about 2 percent. Neither is statistically significant. Extreme caution is warranted when assessing the equilibrium exchange rate for Cambodia, given structural changes and weaknesses in macroeconomic data.
12Over the past year, an additional 5 bank licenses have been issued, bringing the total number of banks to 32.
13In all, some 30 regulations are under preparation by the SECC.

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