1. On behalf of the Cambodian authorities, we would like to thank the IMF mission and the FSAP team for visiting Phnom Penh and engaging in the fruitful dialogue with the authorities during a crucial time when the country has been undergoing reforms to underpin macroeconomic stability after the crisis. The authorities also wish to thank staff for their thoughtful recommendations. The exchange of views during the mission was candid. The authorities are in broad agreement with the general thrusts of staff’s assessment and policy recommendations.
Recent Economic Developments and Outlook
2. Having been hit hard by the external sector last year, Cambodia’s macroeconomic performance and outlook has regained strength as the recovery has picked up quickly since the last quarter of 2009 owing to the authorities’ prompt policy response to boost the economic activities. The recovery is supported by strong rebound in garment exports, tourism and to a lesser extent agriculture. The authorities are in broad agreement with staff’s growth projection for this year within the range of 4.5 – 5 percent. The growth will soar close to its pre-crisis level in the medium term. The strong rebound in the garment sector reflects the improved productivity in terms of quantity and quality, the lower domestic production costs, and the increase in offshore demand for Cambodia’s product. The number of tourist arrivals, especially by air, is increasing owing to the government’s policies to promote tourism and the strength of regional economies. Agriculture is expected to grow at a moderate rate due to late rain. The authorities share staff’s view that downside risks remain on the fragile global recovery.
3. The external position has deteriorated somewhat due to stronger rebound of imports to support the reviving domestic demand. The current account deficit (including official transfers) is projected to increase to 7 percent of GDP in 2010 from 5.2 percent the previous year. This was mainly due to the increase in trade deficit to 18 percent of GDP. Exchange rates remain relatively stable. The inflation pressure has eased markedly. The following low growth of domestic retail oil prices and the earlier anticipation of good harvest in the second half of the year have also helped ease the pressure on inflation. The authorities agree with staff that the inflation will remain below 5 percent at the end of this year. Renewed increase in food and commodities prices in the international market following natural calamities experienced in the region and in the country would be a near term risk to price stability and economic developments.
4. On the fiscal sector, the stimulus package had helped boost the economy. Prudent fiscal policy also serves the country well in sustaining fiscal credibility. The overall performance this year has been strong with the expectation of meeting the expenditure and revenue targets envisaged in the 2010 Budget Law. Going forward, given the limited room for fiscal maneuver, the authorities agree with staff to continue implementing fiscal consolidation in order to strengthen fiscal sustainability. While believing that much of the necessary consolidation will have to come mainly from the revenue side, the authorities view that it is difficult to cut expenditures especially those related to social spending and public investment projects already in the pipeline.
5. On the revenue side, collection is expected to exceed the target. However, the authorities recognize that realizing the full potential of revenue collection from a narrow base is challenging and required years of reforms. They are requesting technical assistance from the Fund for improvement in this area. They are committed to improve revenue collection through: 1) improvement of tax administration and enlargement of the tax base, 2) closer coordination and data sharing among revenue agencies, and 3) enforcement of the newly enacted Anti-Corruption Law. On the expenditure side, the authorities are committed to prudent fiscal expenditure to strengthen fiscal management and credibility. The planned cuts in wage bill are on track with the budget. In the medium term, the current expenditure will be kept at the same rate as a percentage of GDP. Expenses related to agriculture, education, and health will be increased by about 10 percent each. The capital expenditure will also increase by about 15 percent in 2011, with expected funding comes primarily from external sources.
6. In the authorities’ view, long-term fiscal consolidation efforts require long-term commitment toward improving revenue collection, prudent expenditure and cautious borrowing. Great care will be given to new concessional borrowings to finance necessary infrastructure and growth-enhancing projects, with the objectives to progress toward achieving the MDGs by 2015. Assistance and grant from development partners will help contribute significantly to these objectives.
Monetary and exchange rate policies
7. The characteristic of the economy this year is shown by slowly depreciating exchange rates, smoothly declining interest rates in the credit market, and easing inflationary pressure. The authorities believe that in a highly dollarized economy like Cambodia, exchange rate stability serves the country well and help anchor inflation expectation. Since May this year the National Bank of Cambodia (NBC) has injected over US$ 40 million into the economy to stabilize the foreign exchange market. The depreciation of the riel was a result of the increased government’s spending in local currency associated with the stimulus package implemented since last year.
8. The monetary policy easing had been withdrawn and policies going forward will remain unchanged although closer attention is paid to the credit quality and the banking system liquidity overhang. The NBC are monitoring the system liquidity on a daily basis to avoid undue pressures on inflation and the exchange rate. They plan to set up less-costly money market instruments such as certificate of deposits and monetary stabilization bonds to promote interbank markets and improve the efficiency of monetary policy. They reiterate their stand to leave the reserve requirement ratio unchanged at 12 percent on foreign currency denominated deposits and 8 percent for domestic currency denominated deposits. As deposit increases, broad money and credit to the private sector are expected to increase at a similar annualized rate of over 20 percent. The foreign exchange reserve has also increased to a more comfortable level.
Financial and banking issues
9. The financial sector is growing rapidly. The banking sector total assets currently stand at about half of the size of GDP. Cambodia is expected to set up its money and capital markets in the near future, as outlined in the Financial Sector Development Strategy 2006-2015. However, much of the prerequisite works remain to be done for the groundbreaking. The requested FSAP diagnostic on the financial system earlier in the year has produced welcoming results. The authorities are committed to implementing the FSAP recommendations as highlighted in the FSSA report. Preparation is under way with assistance from the MCM to lay out a plan to implement the FSAP recommendations with short-term priority given to enhancing capacity in bank supervision, strengthening liquidity forecasting and monitoring framework, and preparing legal base for harmonizing coordination among supervisory agencies, and with medium-term priority given to developing crisis management framework and improving laws and regulations. These developments present serious challenges to the authorities’ limited capacity and they have requested the Fund’s technical assistances in these areas.
10. The banking system remains sound as banks are adequately capitalized. Customer confidence in the system remains strong despite sudden withdrawals by depositors following the unrest at the border last year. The run on deposits only occurred at a few branches located near the border and on a very small scale. The effect on customer confidence was very minimal as deposits kept increasing afterwards. During the crisis, non-performing loans (NPLs) were rising and banks’ balance sheet provisions were made appropriately. However, as the economy started to recover, business profits have resumed, NPLs have fallen, and banks’ capital adequacy ratios have remained well above regulatory threshold. The stress test result conducted by the FSAP team was very helpful. The NBC will monitor closely the level of NPLs and ensure that the unlikely breaking-point NPL ratio for each bank will not materialize.
11. The NBC’s efforts to reform the banking sector, especially the current recapitalization reform, have made remarkable results. So far, over 90% of banks are well recapitalized. The authorities are enforcing the remainder to fully comply with the regulation. On the AML/CFT, the AML/CFT Law was promulgated in 2008 and the Financial Intelligence Unit (FIU) was formed and housed under the central bank umbrella with the Board of Directors consisting of representatives from the Council of Minister, the Ministry of Justice, the Ministry of Interior, the Ministry of Economy and Finance and the NBC. The body is responsible for receiving, analyzing, and disseminating reports on suspicious transactions and other information regarding AML/CFT.
12. The authorities have stepped up efforts to improve business climate and create an environment conducive to promote private sector-led growth. They have put in place measures to develop agriculture, agro-processing industry and SMEs and to diversify export base. One of the main challenges to the initiatives is the lack of capital investment. They invite the private sector to help contribute in this area. Cambodia also faces other challenges such as the lack of skilled workforces (especially middle management level) and institutional capacity, and the need for improved competitiveness, trade facilitation, border efficiency and infrastructure development. They have expressed commitment to overcome these challenges. They welcome participation from all development partners and private sector in this regard.
13. One of the good news is that domestic hydro energy production will come on stream by 2012. This will help reduce the production costs and improve Cambodia’s price competitiveness. However, in terms of human resources, the objective is to produce the right people for the right jobs for the economy. To produce skilled workforces, vocational trainings are needed. We also need to strengthen institutional capacity. These objectives however will not be realized without assistance from development partners. The authorities are committed to improving trade facilitation and border efficiency. Further efforts are needed to develop infrastructure especially in the rural areas. A new Anti-corruption Law has been passed by the National Assembly and an Anti-Corruption Body has been set up to implement and enforce the Law.
14. The authorities have learned from the recent crisis experience and transformed it to an opportunity to identify their own weaknesses and to take steps to scale up reforms aimed at addressing those weaknesses and develop a framework for sustainable medium-to long-term growth. However, due to the country’s limited resources and policy spaces at the current juncture, joint participations among all stakeholders including the government, private sector and development partners are much needed. The authorities would like to underscore their commitment to reforms supported by technical assistance from all development partners including the Fund and the Bank.