Statement at Donor Meeting

Cambodia Consultative Group Meeting Statement by Representative of the IMF at the Consultative Group Meeting on behalf of the Fiscal Reform Working Group

June 20, 2002

Mr. Chairman, Excellencies, and Distinguished Delegates,

1. It is a pleasure to attend this Consultative Group Meeting and discuss progress and prospects under Cambodia's reform program. During the last 3 years, economic growth and macroeconomic stability were restored, and initial progress was made across a very broad range of structural reforms. These achievements are clearly presented in the documentation provided by the government for this meeting. The return of peace since late 1998, together with credible efforts by the government, have made these results possible. However, reform efforts need to be strengthened to sustain growth and to ensure that this growth leads to lasting poverty reduction. This meeting provides an appropriate opportunity for a candid assessment of the government's accomplishments, and the areas where performance needs to be considerably strengthened.

2. The Government's program has received the support of the IMF through an arrangement under the Poverty Reduction and Growth Facility (PRGF) approved in October 1999. Reflecting the progress achieved thus far, four semi-annual program reviews have been completed broadly on schedule and completion of the fifth review is expected in late July. The Government's program, as reflected in the I-PRSP and SEDP-II, is centered on improving revenue collection, shifting public expenditure away from defense, creating a sustainable forestry policy, strengthening governance, and improving the environment for private sector activity. Progress has been made in all of these areas, but efforts need to be continued and reinforced in several important respects. Above all, there is no substitute for government ownership and commitment, and it is this—supported by donor assistance—which will ultimately determine the success of the government's program.

Progress in program implementation

3. Macroeconomic performance has been positive and in line with program targets. Over the last 3 years, revised national accounts estimates place economic growth at an average annual rate of 7 percent. Inflation, at an annual rate of about 3 percent, has remained well under control reflecting the implementation of prudent fiscal and monetary policies. Budgetary performance has improved, the exchange rate has been stable, and international reserves increased. All quantitative performance criteria under the PRGF—supported program through March 2002 have been observed. Structural benchmarks and performance criteria under the program have also largely been adhered to, although there have been several delays in meeting certain conditions. Looking ahead, the macroeconomic outlook for 2002 remains favorable. While the growth in garment production has leveled off—at a much lower rate than in the past—tourist arrivals continue to increase. This, together with an expected increase in production, should lead to economic growth in 2002 on the order of 5 percent with continued low inflation.

4. Fiscal performance has improved in recent years, but the job is far from finished. Despite the extraordinary burdens of flood relief and election expenses in the last two years, a current budget surplus of 1-1½ percent of GDP has been maintained. The overall deficit has been contained at about 6 percent of GDP and fully covered through concessional external assistance. Revenue has increased from 8 percent of GDP in 1998 to nearly 12 percent of GDP in 2001 and social sector spending has improved. The 2002 budget targets an additional increase in revenue to 12¾ percent of GDP and further improvements in the composition of expenditure with social sector spending projected to reach 3½ percent of GDP—well in excess of defense spending for the first time in recent history.

5. Significant structural reforms have been initiated, but there have also been delays in several priority areas. Key achievements include the completion of a bank relicensing program; improvements in expenditure management, as well as in tax and customs administration; the launching of the military demobilization program; the computerization of the civil service payroll and the start of civil service reform; the establishment of the National Audit Authority; initial reforms in forestry policy; and progress in meeting the accession requirements for WTO membership. This list reveals the comprehensiveness of the government's program. At the same time, the number of areas where efforts need to continue also indicates the fragility of the reform momentum.

Priorities for Strengthening Performance

6. Given progress so far in improving the structure of public finances, it is now time to further upgrade the efficiency of the budget. This will need to involve further improvements in tax and customs administration and overall expenditure management. Strong attention needs to be given to further improving financial transparency and accountability. The development and dissemination of the government's Governance Action Plan was a watershed event, but this is now the time to shift this work from "planning" to more "action". In this regard, the National Audit Authority must be able to carry out its mandate with full independence, and we look forward to its first report to the National Assembly later this year on the implementation of the 2001 budget.

7. Despite recent gains, Cambodia's revenue performance still lags behind that of comparable countries. The government's development strategy underlying SEDP-II and the forthcoming PRSP will entail substantial expenditure commitments which, in turn, are predicated on further improvements in revenue. The current approach is to improve administration and broaden the tax base with limited increases in tax rates. This is appropriate, but requires strong government commitment to reduce illegal activities that lead to revenue loss (such as smuggling), collect existing tax arrears, and bring all parties into compliance with their tax obligations under the law. To succeed in this effort, there is an urgent need for much greater transparency over the financial terms governing the use of state assets. Indeed, the transparency surrounding the review of the government contract for the entrance fees for the Angkor temple complex was helpful in achieving more appropriate revenue for the government. This transparency needs to be extended to cover telecommunications, service contracts for the administration of airports, and many other leases of state assets.

8. Advancing reforms in expenditure management will also contribute to establishing policy credibility. Based on recent improvements in cash management, budget and treasury reforms need to be directed at limiting the issuance of government payment orders to projected cash availability. This will ensure that the government can meet payment commitments in a timely fashion, and will help support a more rigorous application of the established guidelines on procurement policy, a critical guarantee for the efficient use of public funds. In addition, successful implementation of the military demobilization program and administrative reform will continue to be important for achieving fiscal objectives.

9. There is also a need for the government to press ahead with other aspects of the structural reform agenda. The bank relicensing program has been completed, but further improvements in bank supervision and the restructuring of the Foreign Trade Bank are needed to support a larger and more effective role for the financial system. Forestry policy will be discussed during another session, but we have always emphasized the importance of forestry being based on sustainable policy and appropriate transfer of revenue to the budget. There is a clear need for the government to re-establish its credibility in this area, including through a full report on the transfer of forestry revenue to the budget during 2001-02. More generally, the transparent pricing and transfer of revenue derived from natural resources will become an even more important issue in the future in view of on-going discussions on oil and gas exploration.

10. Efforts to develop a national poverty reduction strategy should continue and be fully integrated with improvements in trade facilitation identified in the Integrated Framework (IF) exercise. There is a good opportunity in the coming months to link government initiatives related to the IF study and WTO accession to other aspects of the reform program to enhance the impact of trade and growth in reducing poverty. Building on the I-PRSP and SEDP-II, the full PRSP is being developed through a broadly participatory process. It will also need to prioritize and fully cost reforms in the context of ongoing work to develop a comprehensive medium-term expenditure framework.

Medium-term outlook

11. The medium-term macroeconomic objectives which underpin the poverty reduction strategy 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 8-9 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. To sustain growth over the medium term, existing constraints will need to be addressed, especially with regard to improving infrastructure, raising agricultural productivity, and promoting trade. As has been noted repeatedly, consistent implementation of the Government's commitments is a prerequisite for achieving the medium-term objectives. Provided that strong implementation is maintained, donor support of about $1.4 billion over the next three years would be needed to finance this agenda.

12. In addition to donor support, medium-term external viability will depend on successfully concluding pending rescheduling agreements with Cambodia's bilateral creditors on concessional terms. In view of the prospect for increased debt servicing costs, it will continue to be critical to strengthen debt management and strictly avoid any borrowing on nonconcessional terms. On the assumption of favorable debt rescheduling terms, the external debt stock would be contained below 40 percent of GDP over the medium term.

IMF support for Cambodia

13. In closing, Mr. Chairman, it should be noted that, notwithstanding the progress that has been made, Cambodia's economic position continues to be fragile. It will be a considerable challenge to strengthen government performance in the required areas, but it is a challenge that must be faced to accelerate poverty reduction. There is still a great deal to be done to establish a sound financial and governance environment. The IMF is prepared to continue with financial and technical assistance provided that strong efforts to advance this agenda continue. With confirmation of the authorities' commitment, the Government of Cambodia will deserve the full support of the donor community.