Cambodia Investment and Trade 2002

Conference organized by
US ASEAN Business Council (Washington D.C., USA)
and Dataconsult Ltd (Bangkok, Thailand)

Investment: The investors' viewpoint

Remarks made by Robert P. Hagemann
IMF Resident Representative in Cambodia

Phnom Penh, May 15, 2002

Excellencies,

Ladies and Gentlemen,

I'm delighted to have the opportunity to participate in this conference, notably on this particular panel. Interestingly, the panel is entitled Investors' Viewpoint. I am not an investor, but rather an economist by training and an international civil servant by employment. But my viewpoint and that of the International Monetary Fund are not fundamentally different from that of an investment community, taken as a whole.

I obviously cannot share with you any experiences as an investor. But I will take a few moments to describe what I think are the ingredients of an investment-favoring environment, be it investment from abroad (otherwise known as foreign direct investment (FDI)), or home-grown investment, relating these to Cambodia and its reform agenda.

As we all know, investment is undertaken in a context of uncertainty. In an already uncertain world, the government has a responsibility to avoid adding to those inherent risks. To this end, the government plays a very important role, especially in a country recovering from years of internal strife and devastation. Probably the most important precondition for favoring investment is macroeconomic stability, for which the government has the major responsibility. Relatedly, investors require broad policy stability; they need to know that the policy levers over which the authorities have control—monetary policy, tax and public spending decisions, import and export policies, regulation, etc.—will not be pulled and pushed without proper and sufficiently advanced warning. Investors also require certainty about their legal rights and obligations, and confidence in the impartiality of the judiciary when contract or other disputes require recourse to the judicial system.

I would contend that these are preconditions; without macroeconomic and policy stability, a well-defined legal framework, and an impartial judiciary, investment will always be anemic, well below levels it could otherwise reach. I think that it is fair to say that the Cambodian authorities have been very successful in recent years in securing and maintaining macroeconomic stability. In isolation, macro stability has surely been a positive force in attracting foreign investment, other things being equal. But other things are not equal, and progress on legal and judicial reform has been slower than envisaged, certainly slower than necessary to make Cambodia an attractive destination for FDI. It is my conviction that failing significant and rapid progress in these areas, there is unlikely to be the surge that is needed in FDI.

As the Prime Minister said this morning, changes to the Law on Investment (LOI) are designed to improve the investment climate. First, the changes aim at reducing uncertainty for potential investors by providing a three-year tax holiday for all qualifying investments as per the published schedules. Removing the discretionary element in investment approvals can be only a good thing. Witness, for instance, that between 1996 and 2000, only three firms were granted a zero profit tax concession, not a very impressive track record for what some claim cannot and should not be changed lest Cambodia be prepared to lose huge amounts of FDI.

Second, the changes reflect a need to balance investment promotion against revenue mobilization. But this has to be viewed in a broader context. Not only do the revenue increases implied by reforms to the LOI need to be judged against other aspects of the reforms which lower investment costs in Cambodia, but they have to be judged in their broader context. With respect to the former, reduced uncertainty about approval and "one-stop shopping" hold the promise of reducing the scope for facilitation payments and lowering costs by accelerating dramatically the approval process. Whether or not these offset the higher taxation envisaged in the LOI is perhaps an open question. But they are unambiguously good things to do. And here I would like to make a clear statement. I often hear that tax rates have to be lower because hidden costs of doing business are so high. Well, I, for one, believe that one should address a problem directly. Using the tax system to offset hidden costs in no way addresses the problem and, indeed, perpetuates it by deflecting attention.

This brings me to the broader context that I mentioned a moment ago. There are obstacles to investment in Cambodia, and challenges for everyone, and these are interlinked and interconnected in ways that make the sequencing of reforms a real challenge. Reasonable people can disagree on where to break into this very vicious circle. I think the government's approach is broadly the right one, even if more rapid progress in some areas would accelerate the improvement in the investment environment. I think we can all agree that:

• Hidden costs need to be lowered. This requires systemic reforms and, in particular, a better paid and competent civil service. This requires not just political will but financial resources.
• Operating costs need to be reduced. This requires, inter alia, improved infrastructure; roads and bridges have to be paid for.

We unfortunately can't "have our proverbial cake and eat it too," or, for the francophones in the audience, "nous ne pouvons pas avoir le beurre et l'argent du beurre." If you want a more transparent and motivated public sector, it has to be paid for. If you want improved roads to reduce transportation costs, this has to be paid for too. This seems to me to be pretty straightforward. So, yes, in my opinion, the government will be making continued efforts to improve its revenue performance so as to be able to meet the large expenditure needs of the country.

I know many here think that revenue improvements are centered solely on the so-called "legitimate private sector". But this is not correct. The government has a very specific action plan for broadening the revenue base by extending the collection reach to the less formal sector that presently falls under the estimated regime.

Of course, we all know that smuggling is a major impediment to investment, in at least two ways. First, it causes a loss of revenue, such that other taxes have to remain higher than otherwise and/or the government must cut back on spending. The foregone revenue could help reduce poverty and improve the nation's infrastructure. Second, smuggled goods erode the market share of legitimate producers, with clearly adverse impacts on investor attitudes. Thus, it is critical and urgent that anti-smuggling efforts be effectively reinforced. Of course, one of the most effective means of reducing smuggling is to lower tariffs, as will unavoidably be done in the context of Cambodia's ASEAN membership. Obviously, we have to be vigilant as to the revenue implications of this tariff restructuring, and on this score, I would point once again to the need to broaden the domestic tax base to offset revenue losses from lowering tariffs.

But taxation is simply not the deterrent to investment in Cambodia. I think reasonable people would welcome paying taxes if they saw what they get for their money. The problem in Cambodia is that a huge share of taxation never makes it into the public coffers. We can point to other significant obstacles to investment in Cambodia, many of which can only be fixed once there is a broad-based shared vision of what is needed to rebuild this magnificent nation.

• There is a pervasive lack of transparency. Transparency is fundamental in a market economy to enable investors to assess the true total cost of operations and rate of return on investment. Transparency keeps everyone honest.
• The human capital base is very slim, due in large part to Cambodia's recent tragic history, but due also to the lack of financial resources in the public sector. It is a very broadly shared view among economists and policymakers that education is a key ingredient to sustainable growth and, thus, to durable poverty reduction.
• The health care system in Cambodia needs to be improved. Clearly, a healthy population is a more productive population. Moreover, the absence of an adequate health care system makes it difficult for foreign investors to establish complete health care plans and to provide the support most family units seek in a secure environment.

These, then, are just few thoughts on what I think are obstacles to investment in Cambodia. Improving the environment requires that everyone contribute to improving institutions and relationships, to accelerating reforms.