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Public Information Notice (PIN) No. 03/21
February 28, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2002 Article IV Consultation with Cambodia

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On February 20, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Cambodia.1

Background

Since late 1998, the newly formed coalition government embarked on a comprehensive economic reform, which was supported by significant inflows of aid and a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) approved in October 1999. Recognizing that rapid growth was key to reduce widespread poverty in Cambodia, the authorities' strategy focused on providing a conducive environment for private sector development through maintaining macroeconomic stability, rebuilding institutions, and addressing governance problems.

The reform strategy has been broadly successful, especially on the macroeconomic front. Real GDP growth averaged 7 percent during 1999-2001, although it is expected to have slowed to 4½ percent in 2002, owing to adverse weather conditions. Inflation has been contained well below 5 percent since 1999, underpinned by fiscal discipline that was backed up by a strengthening of fiscal revenue from 8.3 percent of GDP in 1998 to 11.7 percent of GDP in 2001. At the same time, defense and security spending was reduced by one percentage point of GDP, helping the government to increase social spending. Revenue performance in 2002, however, suffered from a drop in trade taxes, an erosion of the tax base owing to clearing a backlog of applications for tax exemptions and recently signed public contracts that have reduced transfers to the Treasury. The 2002 revenue shortfall was met through a compression of nonwage expenditure and larger-than-expected foreign financing. Financial deepening continued, but private credit expansion remained weak. The exchange rate against the U.S. dollar has remained broadly stable since 1999. International reserves have risen steadily from US$390 million at end-1998 to about US$665 million at end-2002 (equivalent to 3½ months of imports). Efforts are being made to reach a resolution of outstanding debt issues with the United States and the Russian Federation. Finally, program objectives in 2002 under the PRGF have been broadly achieved.

Cambodia has also made progress in implementing key structural reforms, although slippages have occurred in several areas. The capacity of fiscal departments has been strengthened and bank relicensing was successfully completed. The first phase of the military demobilization program was completed in late 2002. Trade liberalization has proceeded smoothly in the context of the ASEAN Free Trade Area and in preparation for World Trade Organization (WTO) membership. However, further implementation of civil service reform has been postponed until after the national elections. Moreover, while Illegal logging has been curtailed and several forestry concessions were cancelled, there is still no effective system in place for monitoring logging activity and sustainable logging plans have yet to be worked out. The recent suspension of donor support to the Forest Crime Monitoring Unit and the government's announcement to terminate the activities of a foreign non-governmental organization (NGO) as an independent monitor have given rise for concern among donors. Cambodia lacks an adequate legal and judiciary framework for enforcing the rule of law, and recently adopted laws (e.g., Land Law and Forest Law) still remain to be implemented.

Notwithstanding recent achievements, the foundations for growth remain weak. Growth has been narrowly based on the garment sector and agricultural production has grown very slowly as the irrigation system is under-developed. Moreover, the high factor cost of production in Cambodia makes attracting foreign investment difficult. Furthermore, the slippages in structural reform, together with a weak government capacity, continue to hamper creation of an environment conducive to private sector activity.

Executive Board Assessment

Executive Directors welcomed the maintenance of macroeconomic stability and the restoration of growth over the last few years, which were supported by donors through financial and technical assistance, and favorable external factors that facilitated a rapid expansion of exports. Notwithstanding these developments, however, Directors noted that poverty is still widespread and—with a narrow production base, continuing governance concerns, and a still low revenue-to-GDP ratio—the foundations for sustained growth in the future remain weak. Going forward, the main challenges facing the country will therefore be to rationalize expenditures and boost revenues, broaden the production base, and strengthen progress on key structural issues, particularly governance, fiscal reform, and forestry.

To reduce poverty, Directors stressed the importance of promoting broad-based economic growth through foreign investment and the encouragement of private sector activity. In this regard, they noted that removing impediments to business activity is essential. In particular, complaints by foreign and domestic investors about the burden of informal facilitation fees and uncertainties in the regulatory framework and labor market rigidities need to be addressed with urgency. Poverty alleviation efforts would also need to focus on strengthening productivity in the agricultural sector, as most of the poor live in rural areas.

In the period ahead, Directors underscored the need for a major strengthening of government capacity, which will require rebuilding official institutions and an upgrading of the civil service in close consultation with the World Bank and other donors. In addition, Directors considered the current system of investment incentives, which provides for large exemptions, difficult to administer, and recommended replacing the system with a simple and transparent regime with low tax rates.

Directors welcomed the progress made in increasing fiscal revenue in recent years, but noted that a further increase in the tax ratio is required to provide resources for strengthening government capacity and spending on social services and infrastructure. In this regard, they urged the authorities to make effective use of technical assistance to further improve tax and customs administration and to prevent further erosion of the revenue base. Moreover, greater efforts should be made to ensure that appropriate fees from government contracts with service providers are transferred to the Treasury.

Directors commended the authorities for their initial efforts in redirecting expenditure from defense to priority sectors and encouraged the authorities to press ahead with these efforts, with more emphasis on health, education, and the agricultural sector. They also encouraged the authorities to enhance coordination among government agencies in order to strengthen budget and cash management.

Directors underscored the urgent need to improve governance during the next phase of reform, and welcomed the preparation of the Second Governance Action Plan, which is focused on corruption and social issues. In this connection, Directors urged the adoption of the Anti-Corruption Law as soon as possible and further progress in establishing a modern legal and judiciary system. Directors also highlighted the importance of effective monitoring of logging activities to ensure the sustainability of natural resources, and stressed that progress in this area would be an important indicator of the government's commitment to enhanced governance. Directors also underscored the importance of approving a medium-term plan for sustainable forestry management in a fully transparent manner.

Directors welcomed completion of the process of relicensing commercial banks, which has helped to restore banking sector soundness. In this connection, they urged the authorities to follow through on their plans to privatize the Foreign Trade Bank and stressed the importance of strengthening banks' lending activity. To reduce lending risks faced by banks, the regulatory framework, including laws related to the provision of collateral and the protection of creditors' rights, should be further enhanced. Directors encouraged the authorities to develop mechanisms to allow micro-finance institutions to play a larger role, in particular, in providing credit to rural areas. Incentives and appropriate policies to encourage de-dollarization were also seen as important steps to be taken.

Directors recommended the maintenance of a flexible exchange rate regime and noted the progress made in establishing a liberal trading system. In particular, Directors commended the authorities' efforts to pursue membership in the WTO, including the drafting of several commercial laws that would facilitate creation of a transparent trading environment.

Directors commended the authorities for completing a fully participatory National Poverty Reduction Strategy (NPRS). They encouraged the authorities to update the NPRS on a continuous basis in light of the recommendations in the Joint Staff Assessment and as new information becomes available.

Directors welcomed the authorities' efforts to search for and block the assets of terrorists, and urged continued attention to this issue.

While recognizing recent efforts to upgrade economic statistics, within the framework of the Technical Cooperation Action Plan for Cambodia, Directors indicated the need for further improvements in data compilation to enhance economic analysis and program monitoring.



Cambodia: Selected Economic Indicators, 1998-2002


 

1998

1999

2000

2001

2002

         

Est


 

(Annual percent change)

Output and prices

 

Real GDP

2.1

6.9

7.7

6.3

4.5

GDP deflator

13.8

3.7

-4.6

-2.9

3.0

Consumer prices (end-period)

13.3

-0.5

-0.8

0.7

3.7

 

(In percent of GDP)

General government

 

Total revenue

8.3

10.6

11.2

11.7

12.1

Total expenditure

13.8

14.7

16.4

17.7

18.9

Of which: current expenditure

8.3

8.9

9.5

10.4

11.1

Current fiscal balance

-0.3

1.6

1.5

1.2

0.9

Overall fiscal balance (excluding grants)

-5.5

-4.0

-5.2

-6.0

-6.8

 

(Annual percent change)

Money and credit (end of period)

         

Broad money

15.7

17.3

26.9

20.4

26.8

Private sector credit

2.8

16.5

17.7

4.2

3.4

 

(In millions of U.S. dollars; unless otherwise indicated)

External sector 1/

 

Current account balance (excluding official transfers)

-261

-295

-412

-456

-391

(In percent of GDP)

-8.7

-8.9

-12.3

-13.4

-10.7

Domestic exports

685

921

1,206

1,295

1,434

Retained imports

-954

-1,219

-1664

-1,777

-1,880

Gross official reserves

390

422

485

550

642

(In months of imports of goods and services)

3.6

3.2

2.8

2.9

3.3

External debt stock (in percent of GDP) 2/

67.9

68.7

67.6

66.2

65.6

Exchange rate (end of period; riels per U.S. dollar)

3,780

3,775

3,910

3,900

3,935


Sources: Data provided by the Cambodian authorities; and IMF staff estimates and projections.

1/ Data for 2002 are projections based on information through mid-November.

2/ Including debt owed to the former Council of Mutual Economic Assistance.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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