An IMF team from the Asia-Pacific Department visited Phnom Penh during 1-16 June 2005 to continue discussions with the Royal Government of Cambodia (RGC) and the National Bank of Cambodia on an economic and structural program that could be supported by a new PRGF arrangement. ¹ A first round of discussions were held in December 2004, during which a preliminary shared assessment of the medium-term outlook was undertaken, and extensive dialogue took place regarding a wide range of policy initiatives. Most of these are already spelled out in various RGC policy documents (e.g. the Rectangular Strategy, the National Poverty Reduction Strategy Paper, the government's twelve point action plan to improve the investment climate, trade facilitation and SME activity, the 2004 CG joint monitoring indicators, etc.). During the June mission, IMF staff revisited the short-term and medium-term economic outlook on the basis of recently available data, and completed discussions with the authorities on key reform issues. IMF staff and the RGC reached agreement, ad referendum, ² on an economic and structural reform program. It is hoped that the Executive Board of the IMF will consider the RGC's proposed program in late September or early October 2005.

Macroeconomic performance and outlook

Macroeconomic performance has been significantly stronger than previously measured and forecast. The National Institute of Statistics (NIS) recently revised historical GDP upward, reflecting improved compilation methods and source data, and broader coverage of economic activities, especially those in the informal sector. ³ For 2003 and 2004, real GDP growth has been revised up to 7 and 7 ¾ percent (attached table), respectively, compared to 5 ¼ and 6 percent previously reported following the December 2004 mission. The IMF mission raised its growth projection for 2005 to 6 ¼ percent, up from a projected 2 ¼ percent as of last December. The higher estimated and projected growth rates can be traced mostly to more buoyant activity in the garment manufacturing and construction sectors. Growth in garments is now expected to average 10 percent during 2005-06 following the recent announcement of possible safeguard measures by the United States against China, and the latter's agreement to voluntary restraint of exports to the EU. In addition, domestic activity indicators, notably construction and tourism, remain strong. Notwithstanding the brighter outlook for garment exports, gross international reserves are projected to decline slightly, to 2 ½ months of imports, due to the rising cost of petroleum imports.

Budgetary performance improved somewhat in 2004. Total revenue rose by 1 percentage point of GDP to 11.3 percent of GDP, although this was partly due to one-off revenue collected from tax arrears. Non-tax revenue performance remains especially poor. Thus, additional efforts are needed in the period ahead to ensure the durability of enhanced overall revenue performance. Expenditure execution was also weak, but the accumulation of arrears was avoided. An unusually large bunching of spending at the end of the year (37 percent of current spending was recorded in December 2004) was partly attributable to the delayed passage of the budget until late in the fiscal year. Revenue is expected to remain at around 11 ¼ percent of GDP in 2005, and the overall deficit should rise slightly to 5 ½: percent of GDP.

Against a backdrop of better garments exports than previously projected, the deficit of the current account (including official transfers) of the balance of payments is projected to be slightly lower (4.8 percent pf GDP) than previously projected (6.1 percent of GDP). The improvement to the outlook would have been greater but for the sustained upward pressure on the nominal value of imports of higher oil prices. Gross international reserves, which reached $809 million by end-2004 (compared to $770 million previously estimated), are projected to continue to rise during 2005.

Broad features of the future economic program The RGC's economic and structural reform program to be eventually submitted to the IMF's Executive Board aims to promote more diverse sustainable pro-poor growth to help accelerate progress toward achieving the Cambodia Millennium Development Goals. The government's program has several pillars to help implement the Rectangular Strategy. First, the government will aim to maintain macroeconomic stability through cautious fiscal and financial policies. Second, structural reforms will be pursued to strengthen institutions with macroeconomic and financial responsibilities, especially public financial management (e.g., budget formulation, treasury operations, and tax and customs revenue administration) and operations of the monetary authorities (e.g., prudential supervision). The government's program will also aim to promote private sector development through policies to reduce uncertainties and unnecessary burdens (i.e., red tape, unofficial payments, etc.) on private sector actors rather than through the granting of additional tax incentives, given the generosity of such incentives at present. Promoting private sector activity will also be pursued by making serious progress toward improving the legal and judicial system, enhancing the quantity and quality of infrastructure, and improving governance. A key means of achieving this will be insistence on using credible competitive bidding procedures in the granting of government procurement contracts, asset sales, and concessions agreements. Third, the government's program is designed to help promote more rapid rural development and faster agricultural growth, given the prevalence of the poor among the rural population. Substantial improvements in the management of public lands and property will be key to achieving this objective of the program.

The RGC's economic and structural reform program that could be supported by a PRGF arrangement has been carefully aligned with the government's strategies in various areas in which donors have been making efforts to harmonize policies and approaches to providing official development assistance. Moreover, the program's milestones reflect and are consistent with the commitments made at the last Consultative Group meeting held in Phnom Penh in December 2004.

¹The Poverty Reduction and Growth Facility (PRGF) is the IMF's concessional lending facility for low-income countries.
²A PRGF arrangement requires approval by the Executive Board of the IMF of the economic and structural reform program agreed with the authorities.
³See National Accounts of Cambodia 1993-2004, Bulletin No. 9 (June 2005) for a full explanation of the changes to the national accounts. .