1. The Cambodian authorities would like to express their gratitude for the constructive discussions and exchange of views with staff on macroeconomic developments and policy recommendations during the 2016 Article IV consultation. The authorities appreciated the discussions on the need to effectively contain growing macro-financial risks, maintain fiscal sustainability, and enhance their financial sector and structural reform agendas for more sustainable and inclusive growth. The authorities broadly agree with staff’s assessment and would take staff’s recommendations into consideration when formulating future policies.
Recent Economic Development and Outlook
2. Cambodia’s economy remains strong, with growth projected to be around 7.0 percent in 2016 and 2017, among the highest in Asia. Rapid economic growth has been supported by significant increase in integration with the global economy and more importantly, has been accompanied by an impressive decline in poverty from 50 percent in 2005 to 18 percent in 2012 and improved income distribution. Cambodia has successfully transitioned to a lower-middle income status this year. This growth momentum is expected to remain robust, underpinned by strong garments exports, as well as real estate and construction activities. Cambodia’s transformation is guided by the Royal Government of Cambodia’s Rectangular Strategy Phase III (RS III) and the National Strategic Development Plan 2014-2018, the implementation of which is on track.
3. Headline inflation picked up to 3.2 percent at end-2016 from 2.6 percent in 2015, due to higher food and oil prices. Nonetheless, headline inflation is projected to remain low and average around 3 percent over the medium term.
4. Credit growth remains high, but has moderated from 34 percent in 2014 to 30 percent in 2015, and is projected to continue slowing to around 25 percent in 2016 and 2017. The authorities share staff’s views on the need to moderate the pace of credit growth to preserve financial stability while at the same time are mindful of the need to support growth. In this regard, the authorities are strengthening the financial regulatory framework, including the macro-prudential policy and crisis management frameworks. The National Bank of Cambodia (NBC) has recently introduced a Basel III-compliant liquidity coverage ratio to strengthen liquidity regulations and align them with international standards.
5. On the external front, the authorities expect the current account deficit to narrow to 9.7 percent in 2016 from 10.6 percent of GDP in 2015, due to reduced imports following the completion of major hydropower projects, low commodity prices and increasing remittances. Over the medium-term, the current account deficit is projected to narrow further to around 8 percent of GDP, supported by the completion of several hydropower projects, and increased export and tourism receipts. Gross official reserves have increased to US$8 billion at end-August, covering 4.6 months of total imports. The authorities are encouraged by sustained FDI inflows and are committed to implement reforms to further enhance the business environment and prioritize public investments in agriculture and transportation infrastructure to promote economic diversification.
6. The authorities’ welcome staff’s assessment that the growth outlook is broadly positive but agree that it is subject to downside risks, particularly arising from the rapid credit growth and the uncertain external environment. China’s rebalancing, which is expected to result in lower growth in the near-term, appreciation of the US dollar, weaker growth in Europe and a sharper-than-anticipated tightening in global financial conditions could impact the economy and the financial system. The authorities remain vigilant of the downside risks and continue to undertake measures and reforms to enhance macro-financial stability and ensure sustainable growth.
7. Fiscal deficit is projected to widen to 2.6 percent of GDP in 2016 from 1.6 percent of GDP in 2015, due to higher capital spending and public sector wage bill. Tax revenue performance remains strong, and is projected to increase to 14.9 percent of GDP in 2016 from 14.6 percent in 2015. This is supported by the authorities’ efforts in strengthening enforcement of the Revenue Mobilization Strategy (RMS), which resulted in improvement of tax and customs administration.
8. Over the medium term, the authorities are determined to prioritize expenditure and further strengthen revenue mobilization and governance. They remain strongly committed to the implementation of the RMS and recognize the need to rationalize investment incentives and will further review other tax policies. On expenditures, the authorities are reviewing the public expenditure framework and agree on the importance of developing a medium term fiscal framework to improve expenditure allocation efficiency. Meanwhile, the wage bill increases are being implemented cautiously to allow for capital expenditure for infrastructure investment.
9. The authorities have been continuously working on improving the monitoring of contingent liabilities, particularly from public-private partnerships. In connection with this, the authorities have designated a contingency fund account for contingent liabilities related to enterprises in the power sector.
10. While public debt has increased moderately, staff’s Debt Sustainability Analysis indicates that Cambodia’s risk of debt distress remains low. The authorities are open to developing the bond market, and are committed to maintaining adequate government deposits, in order to ensure debt sustainability and secure stronger fiscal buffers, as well as to ensure macroeconomic stability over the longer term.
11. Cambodia’s monetary system is characterized by a high degree of dollarization and cash-based economy that limits the NBC’s ability to implement monetary policy effectively. The stabilization of the exchange rate against the US dollar continues to serve as an important nominal anchor to help keep inflation low and stable. At the same time, the NBC is fully committed to developing the interbank and money markets as well as the foreign exchange market to promote the use of the local currency (Khmer Riel) in order to allow for a more effective and flexible monetary policy framework. With regards to de-dollarization, policies and action plans are being developed to promote greater use of the local currency, and reduce dollarization in the long term.
12. The reserve requirement ratio remains an important instrument of monetary and prudential policy. It has been kept unchanged since the end of 2012 with the ratios of 12.5 percent for the foreign currency deposits and 8 percent for the local currency. Since 2013, in line with the Fund’s past recommendations, the NBC issued negotiable certificate of deposits (NCDs), both in US dollar and Khmer Riel, to help develop the interbank market. This has also helped facilitate banks’ liquidity management and market-based monetary policy operations. In addition, reserve requirement on banks’ foreign borrowing was re-imposed in March 2015 in order to better manage short-term capital inflows to the banking system.
13. Cambodia has experienced a significant increase in financial deepening, with credit growth averaging nearly 30 percent (year on year) over the past three years. Despite the strong credit growth, core financial soundness indicators remain healthy with adequate capitalization levels and high profitability, while credit quality remains sound. The distribution of credit has been to a large extent, directed to productive sectors but the authorities recognize growing exposure to the real estate and construction sectors which represent potential pockets of vulnerabilities to financial stability.
14. Mindful of the risks, efforts are on-going to strengthen the financial regulatory and supervision frameworks, and recently, several pre-emptive measures were introduced to enhance the resilience of the financial system and rein in credit growth, including the re-introduction of the reserve requirement on bank borrowing from non-residents, raising the minimum registered capital of banking and financial institutions, and implementing a Basel-III compliant liquidity coverage ratio. The NBC is also working on strengthening regulations on asset classification and provisioning, and plans to upgrade solvency regulation. The NBC is also considering imposing prudential measures on institutions deemed to be engaged in excessive risk-takin. Going forward, the authorities will continue to closely monitor developments on this front and take necessary prudential actions to curb credit growth and maintain a sound financial system. The authorities are, however, mindful of the impact of these measures on growth.
15. The authorities are keenly aware that the microfinance sector is becoming more systemically important and have stepped-up efforts to enhance the supervisory framework for microfinance institutions. The NBC remains committed to a risk-based supervisory approach that is consistent with the FSAP recommendations. To help enhance the crisis management framework, the MoU on establishing information sharing was signed between the Ministry of Economy and Finance, the NBC, and Securities Exchange Commission of Cambodia (SECC) in 2014. The authorities have also continued to build capacity for their staff, and welcome further technical assistance from the Fund in this area. The authorities are committed to working closely with the Fund on identifying risks, improving data collection and enhancing the crisis resolution framework for the financial sector.
Continuing the Reform Agenda
16. In addressing structural bottlenecks, the authorities remain focused on public investments in roads, railways, bridges and irrigation to further promote rural development and enhance inclusive growth. Public investment in these infrastructure projects will help crowd in private investment. Over the near term, the completion of several hydropower projects will provide affordable electricity to the general population and contribute to enhancing Cambodia’s business climate and competitiveness. Building on the improvements in maternal health, early childcare and primary education programs in the rural areas, the authorities will continue to remain actively engaged in the improvement and prioritization of education and healthcare development. Moreover, the authorities are working on promoting technical and vocational training, in order to address skill mismatches, which in turn will strengthen productivity and further promote inclusive growth.
17. Overall, the Cambodian authorities are committed to preserving macroeconomic and financial stability, promoting sustainable and inclusive growth, and stand ready to implement any measures deemed appropriate. The authorities are highly appreciative of the Fund’s continued support in providing high-quality policy advice and technical assistance, particularly in fiscal, monetary and financial sector policies. Going forward, the authorities will continue to further improve their macroeconomic policy and financial sector regulatory frameworks in line with the Fund’s policy recommendations.