Consultative Group Meeting on Cambodia -- Statement by Representative of the IMF, Mr. Thomas Rumbaugh, on Behalf of the Fiscal Reform Working Group

June 13, 2001

Statement by Mr. Thomas Rumbaugh
IMF Representative, on Behalf of the Fiscal Reform Working Group
Tokyo, June 12-13, 2001

Mr. Chairman, Excellencies, and Distinguished Delegates

1. It is a pleasure to attend this fifth Consultative Group Meeting and discuss progress and prospects under Cambodia's reform program. This meeting is being convened against the background of encouraging progress in implementing economic reforms in the context of the strategy set out in the Interim Poverty Reduction Strategy Paper (I-PRSP) and the Second Socio-Economic Development Plan (SEDP II, 2001-03). Progress in implementing reforms is clearly presented in the documentation provided by the government for this meeting. Addressing existing shortcomings and sustaining the reform effort are now the key challenges.

2. The government's program has received full support from the IMF through an arrangement under the Poverty Reduction and Growth Facility (PRGF) approved in October 1999. A favorable track record has been set under the program, as the IMF's Executive Board has already completed two semi-annual reviews of Cambodia's performance. A third review is expected to take place in late July, assuming that a few remaining outstanding issues are resolved. The PRGF-supported program is aimed at fostering sustained economic growth, reducing poverty, and creating employment opportunities. Maintaining a sound macroeconomic environment and timely implementation of broad-based structural reforms are crucial for achieving these objectives. Accordingly, the government's program is centered on a major increase in revenue collection, a shift in public expenditure away from defense, a sustainable forestry policy, strengthened governance, and private sector development.

Progress in program implementation

3. Macroeconomic performance to date has been fully in line with expectations under the program. Despite severe flooding in the second half of last year, real GDP growth is now estimated at about 5 percent in 2000, reflecting a quick recovery in the rice harvest from the flooding, and buoyant activity in the garment and tourism sectors. The year-on-year inflation rate was about minus 1 percent, reflecting the implementation of prudent fiscal and monetary policies, and timely flood-related assistance by the government and donors that prevented food price increases. The budgetary outturn strengthened, while the exchange rate depreciated only slightly against the U.S. dollar. All quantitative and structural performance criteria under the PRGF-supported program through March 2001 were observed. These positive macroeconomic developments have continued into 2001, and developments so far suggest that the targets of 6 percent economic growth and an inflation rate below 5 percent remain achievable.

4. Fiscal performance has improved, but the projected increase in social sector spending has experienced some delays. Despite the unexpected burden of large flood relief outlays in late 2000, the current budget surplus was maintained at about 1½ percent of GDP and the overall deficit was contained at about 5½ percent of GDP and fully covered through concessional external assistance. The 2001 budget targets an increase in revenue to 12 percent of GDP and further improvements in the composition of expenditure, with social sector spending projected to reach 3 percent of GDP. Overall revenue has been broadly in line with program targets, largely due to improvements in collections of VAT and direct taxes, but persistent shortfalls in trade tax and nontax revenue will continue to pose challenges for further increases in revenue in the future.

5. The external position in 2000 was strengthened by buoyant garment exports and tourism related inflows. The external current account deficit (excluding grants) remained broadly stable at about 10 percent of GDP, and gross official reserves increased in line with the program target. The recent decision of the government to implement tariff restructuring is a welcome step in trade liberalization in the context of Cambodia's commitments under ASEAN, and helps to pave the way for its eventual accession to the WTO.

6. Significant structural reforms have been initiated, but there have also been delays in several priority areas. The key achievements include implementing bank restructuring, computerizing the civil service payroll, establishing the Forest Crime Monitoring Unit (FCMU), beginning the restructuring of forestry concessions, and adopting a comprehensive Governance Action Plan (GAP). However, delays have been experienced in completing the pilot military demobilization program, initiating the full demobilization program, finalizing an appropriate strategy for civil service reform, and establishing the National Audit Authority (NAA). These delays remain matters of concern. Moreover, some important structural initiatives such as the FCMU and the pre-shipment inspection program for imports are not working to their full potential.

Improving reform momentum

7. It is critical for the government to press ahead with the agreed reform agenda and address areas where there have been slippages. As appropriately noted in the government's mid-term review report, it will take another three years of strict implementation of the reform program to put Cambodia firmly on the track of sustainable growth and poverty reduction. Given the timing of commune elections in 2002 and national elections in 2003, to achieve these objectives it will be crucial to avoid backtracking and to make up for the delays already experienced. The government's commitment to follow through on the governance actions identified in the GAP, including the establishment of a fully independent NAA, will contribute to strengthening revenue and expenditure management and control, and the quality of public service delivery.

8. Further progress is needed in developing a full Poverty Reduction Strategy. Building on the I-PRSP, it is essential to ensure that the full PRSP is consistent with the information and analysis contained in the SEDP II. Important elements that will need to be further developed include prioritizing policies, fully costing envisaged programs to ensure they can be financed, establishing systems for monitoring outcomes, and ensuring an effective participatory process. In this regard, the government should take the time needed to prepare a quality PRSP, but should adopt clear milestones against which progress can be assessed through regular progress reports.

9. Fiscal reform continues to be the cornerstone of the reform program. Strengthening the fiscal position and achieving poverty reduction objectives will depend critically on improving revenue performance, and on the flow and efficiency of government spending for the priority social sectors. Raising revenue is central to the poverty reduction and growth objectives outlined in the I-PRSP and SEDP II, and will require a substantial agenda of actions by the government in the period ahead. Sustained actions to improve customs and tax administration will be particularly important. In the area of customs, reducing pervasive smuggling and improving the effectiveness of the pre-shipment inspection program will be crucial. On tax administration, stronger administration of the VAT and establishment of a large taxpayers unit will be important. Securing revenue from the leasing of state assets and telecommunication services has been an ongoing problem that also must be addressed, including through the establishment of an appropriate legal framework. Better control and monitoring over the use, renting, or sale of state assets, in particular, is central to improving financial performance, as well as overall governance. Finally, adopting the proposed amendments to the Law on Investment will improve transparency, and support efficient revenue administration, while maintaining attractive investment incentives for both domestic and foreign investors.

10. Redirecting expenditure toward priority social sectors and improving public administration are crucial for supporting the poverty reduction strategy. Meeting these goals critically hinges on the success of the large-scale demobilization program being supported by donors, and we encourage the government to take all necessary steps to prepare for the implementation of the program without further delay. We welcome the progress made toward completing the full computerization of the civil service payroll and the removal of irregular cases, as well as the progress that has been made in preparing a realistic reform strategy. However, further adjustments in the strategy are needed to ensure that it provides adequate incentives for performance and that this strategy is set within fiscal constraints. Prompt finalization of the strategy, in consultation with development partners, is urgently needed to begin implementation in 2002 as envisaged. Further efforts are also needed to ensure the timely release of the budgetary provisions to the priority social sectors under the Priority Action Program (PAP). Effective implementation of the PAP initiative is essential for the credibility of the public expenditure reform program, which will need to be broadened in the future and incorporated into a full medium-term expenditure framework.

11. Substantial progress has been made in bank restructuring since the promulgation of the Financial Institutions Law in November 1999. Actions have been taken to liquidate nonviable banks and restructure potentially viable banks under the terms set forth in Memoranda of Understanding (MOUs). However, further actions are urgently needed to establish a commercial culture in the Foreign Trade Bank (FTB) and prepare for its future privatization. Immediate priority should be given to the prompt recapitalization of the bank and the appointment of additional Board members with adequate commercial banking experience. Finally, we welcome the recent completion of the first independent external audit of the National Bank of Cambodia as an important indication of the government's commitment to establishing a foundation of good governance in the financial sector.

12. The governance framework for forestry is being upgraded, and this effort needs to be strengthened. We welcome the recent progress in completing a new Forestry Law after considerable delays. An important priority for the future is to follow through with the timely completion of the restructuring of forestry concessions, and improve the effectiveness of the FCMU by following up on the cases entered into the forestry crime tracking system. Coordination among government ministries and the independent monitor needs to be improved as well.

Medium-term outlook

13. Sustained implementation of the government's commitments is a prerequisite for achieving the medium-term objectives set forth under the PRGF-supported program. The objectives established under the program continue to be appropriate. These call for sustained economic growth averaging 6 percent per annum, while containing inflation to below 4 percent and the external current account deficit to 9-10 percent of GDP (2-3 percent of GDP including grants). Gross international reserves are targeted to reach about 4 months of imports of goods and services. This macroeconomic environment, in tandem with broad-based structural reform, would set the conditions for achieving growth with equity, while alleviating poverty.

14. Medium-term external viability would still hinge upon timely implementation of policies and continued donor support and debt relief. To that end, efforts to resolve outstanding external debt issues need to be intensified and debt management further strengthened to strictly avoid any borrowing on nonconcessional terms, as required under the IMF-supported program. On the assumption of favorable debt rescheduling terms, the external debt stock would be contained below 35 percent of GDP over the medium term.

IMF support for Cambodia

15. In closing, Mr. Chairman, it should be noted that, notwithstanding commendable progress in key reform areas, Cambodia's economic position remains fragile. It will be a considerable challenge to address existing shortcomings, and to implement the necessary reforms for establishing a sound financial and governance environment. The IMF is prepared to continue providing financial and technical assistance in support of strong efforts to ensure macroeconomic stability, and to continue to build the basis for growth and poverty reduction. With confirmation of the authorities' commitment to address the aforementioned key priority areas, Cambodia will deserve the full support and continued financial and technical assistance of the donor community.