## 1. Growth Drivers

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### Recent economic developments
- Real GDP is projected to grow at 7¼ percent in 2018 due to strong external demand and expansionary fiscal policies.  
- Inflation is expected to remain at around 2½ percent.  
- Broad-based strong performance: garment exports, tourism and the construction sectors growing at robust rates.  
- Current account deficit expected to widen to around 10 percent of GDP in 2018, driven by higher imports including construction materials.  
- Gross international reserves expected to increase to around US$9.6 billion (5 months of prospective imports) at end-2018.  
- Bank credit expected to grow by around 20 percent in 2018; MFI credit expanding at an even higher rate.  
- Credit-to-GDP gap conservatively estimated at close to 10 percentage points.

### Fiscal developments and stance
- 2017 deficit: 1.1 percent of GDP (considerably stronger than the 3.9 percent in the budget law).  
- Tax revenues grew 26 percent in nominal terms in 2017 (revenue overperformance partly due to one-off factors).  
- Wage spending grew to more than 7 percent of GDP as government raised public wages.  
- Fiscal stance turned expansionary in 2018: both current and capital expenditure expected to increase.  
- Tax revenue in 2018 expected to grow by only 0.1 percent of GDP, reflecting VAT exemptions and import tariff reductions for fuel and basic foods.  
- 2018 deficit expected to widen to 2.2 percent of GDP, resulting in lower government deposits.

### External sector assessment
- External position assessed to be moderately weaker than implied by fundamentals and desirable policies.  
- Assessing Reserve Adequacy tool suggests a level of reserves of about 3½ months of prospective imports (below the current level).  
- Reserves appear adequate on traditional metrics, but further accumulation is welcome given the managed exchange rate regime, high dollarization, and elevated financial vulnerabilities.

### Outlook
- Growth expected to remain around 7 percent over the next few years; inflation to remain subdued.  
- Growth projected to moderate towards potential, estimated at around 6 percent, as domestic credit and real-estate cycles moderate amid tighter global financial conditions.  
- Economic activity expected to become driven more by exports and tourism, narrowing the current account deficit.  
- Strong near-term performance provides a window for structural and governance reforms to sustain medium term growth closer to the government’s target of 7 percent.

### Downside risks
- Domestic:
  - Continued strong credit growth, increasing concentration in the real estate sector, unregulated lending by real estate developers, concerns about credit quality, external funding, and growing systemic importance of MFIs—pose risks to financial and macroeconomic stability.  
  - Fiscal spending pressures and potential materialization of contingent liabilities risk eroding policy space.  
  - Large minimum wage increases could further erode competitiveness.
- External:
  - Spillovers from global rise in protectionism or trade sanctions related to political developments could hamper exports and FDI and dent confidence.  
  - Higher U.S. trade tariffs on China could reduce exports, though trade diversion could mitigate effects via garment-related FDI inflows.  
  - Weaker-than-expected growth in China would have significant negative spillovers through FDI, banking, and tourism channels.  
  - A slowdown in advanced economies or stronger-than-expected U.S. dollar could reduce garment exports and tourism.
- Financial conditions:
  - Sharper-than-expected global financial tightening and disruptions in correspondent banking could heighten liquidity risks.

### Authorities’ views
- Broad agreement on outlook and risks; authorities aim to sustain growth at 7 percent.  
- Authorities emphasize large infrastructure projects in the pipeline and efforts to mitigate financial vulnerabilities and monitor global spillovers.

### Safeguarding fiscal sustainability — near-term and medium-term
- Preliminary 2019 budget aims for current spending restraint; targets a budget deficit of 3.3 percent of GDP (about 1.5 percentage points lower than the 2018 budget law).  
- Preliminary budget envisages increased tax revenues partly driven by higher property tax revenues as property prices are reassessed for tax purposes.  
- Small decline in current spending; public wages expected to grow in line with nominal GDP; reallocation toward health and education; capital spending constant as a share of GDP.  
- Medium-term pressures: absent tax reforms, revenue growth expected to slow as past reforms mature; trade taxes projected to decline with import tariff reductions; grants to fall as middle-income status solidifies.  
- Government deposits projected to decline to around 7 percent of GDP, close to estimated floor at 6.5 percent.  
- Public debt currently just over 30 percent of GDP; Cambodia assessed at low risk of debt distress but exposed to contingent liability and shock risks.

### Fiscal policy recommendations (summary of staff recommendations)
- Restrain current spending:
  - Make further wage increases contingent on maintaining adequate fiscal buffers and support them with public administration reforms.  
  - Target pay increases to priority functions and good performers.
- Raise revenues and improve efficiency and progressivity:
  - New Revenue Mobilization Strategy (RMS) should reform tax policies, improve efficiency and equity, and modernize revenue administration.
  - Real-estate taxes: gradually raise the recurrent property tax rate from current 0.1 percent; re-assess property values for tax purposes; introduce regulations for reassessment at least every 5 years; widen base and enhance transparency and compliance.
  - Corporate and personal income taxes: abolish corporate income tax holiday for new investments while maintaining statutory corporate tax rate at 20 percent; reduce withholding tax on repatriated dividends to 10 percent; abolish or reduce customs tariffs on intermediate goods; ensure timely VAT refunds; eliminate patent tax; remove notches in business tax scale; implement simplified tax on micro firms; initiate preparations for a comprehensive personal income tax regime over the medium term.
  - Other tax policies: replace ad valorem by specific excises for tobacco, fuels and beer and adjust with inflation; abolish the lighting tax; consider introducing/raising excises on luxury goods; assess tax implications of e-commerce and prepare reform plan for VAT on e-commerce.
- Introduce a medium-term fiscal framework (MTFF):
  - MTFF should include a debt-based medium-term fiscal ceiling at about 40 percent of GDP.  
  - Integrate MTFF into budget process, develop medium-term budgetary framework using macro-fiscal forecasts, set ministerial ceilings and eradicate dual budgeting.
- Support inclusive growth:
  - Re-orient expenditures toward priority infrastructure investment, health and education while ensuring gains in spending efficiency.  
  - Finance additional infrastructure spending needed to address gaps through a higher real estate tax to boost growth and reduce income inequality.
- Managing public debt and contingent liabilities:
  - Develop public debt management strategy (PDMS) prioritizing concessional and semi-concessional financing; rely on commercial market borrowing only if shocks exceed buffers.  
  - Develop a risk management framework limiting present value of guaranteed payments; strengthen PPP institutional framework with formal gateway process; ensure PPPs subject to same planning process as other public investment projects.  
  - Ensure MEF and NBC jointly monitor contingent liabilities from PPPs and the financial system.
- Fiscal governance improvements:
  - Tax administration: review staff incentive scheme, develop internal audit capacity, review dispute resolution system for independence and publication of outcomes (while maintaining confidentiality), and strengthen planning, performance, HR management and IT systems.
  - Customs administration: rigorously implement the planned Customs Integrity Program; advance automation including the national single window.
  - Tax incentives: introduce a tax expenditure budget; unify granting and administering tax incentives; consolidate legal basis in tax law; MEF to coordinate policy.
  - PFM: enhance monitoring, transparency and audit in public procurement; publish timely procurement information and comprehensive procurement reports; strengthen expenditure controls to reduce payment arrears and inefficiencies; improve fiscal reporting to include ODA-funded and extra-budgetary expenditures; use automation to re-engineer business processes.

### Managing macro-financial risks
- Elevated financial sector vulnerabilities:
  - Bank credit-to-GDP gap expected to remain close to the BIS threshold of 10 percentage points.  
  - Banks’ capital adequacy has increased, but vulnerabilities persist.  
  - Financial institutions continue to draw on external funding—liquidity risks as global financial conditions tighten; average loan-to-deposit ratio around 100 percent in June 2018.  
  - Bank profitability declined as interest margins fell and non-performing loans edged up; true NPL level may be understated.  
  - Risks from increasing household and corporate leverage.  
  - Interest rate cap has increased average loan size and may have pushed some borrowers to the informal sector; MFI credit growth remains high at above 30 percent.
- Real-estate sector risks:
  - Capital flows into construction sector driven by regional investors and strong demand for residential and retail space.  
  - Significant data gaps, including on property prices, complicate risk assessment.  
  - Anecdotal evidence of oversupply dampening prices of high-end apartments, while prices for retail and residential properties remain robust due to segmented markets—affordability of residential housing being eroded.  
  - Credit growth to real-estate sector averaged around 35 percent since 2016, driven by few banks.  
  - Real-estate developers reportedly offering mortgages with looser lending conditions, an unmonitored and unregulated activity.

### Selected quantitative indicators and thresholds
- Real GDP growth projection for 2018: 7¼ percent.  
- Inflation expectation for 2018: around 2½ percent.  
- Current account deficit in 2018: around 10 percent of GDP.  
- Gross international reserves end-2018: around US$9.6 billion (5 months of prospective imports).  
- Bank credit growth expected in 2018: around 20 percent.  
- MFI credit growth: above 30 percent.  
- Credit-to-GDP gap: close to 10 percentage points.  
- 2017 fiscal deficit: 1.1 percent of GDP (budget law: 3.9 percent).  
- Tax revenue growth in 2017: 26 percent (nominal).  
- Wage spending: more than 7 percent of GDP.  
- Expected 2018 tax revenue growth: 0.1 percent of GDP.  
- Expected 2018 deficit: 2.2 percent of GDP.  
- Preliminary 2019 budget deficit target: 3.3 percent of GDP.  
- Current recurrent property tax rate: 0.1 percent.  
- Statutory corporate tax rate (recommended maintained): 20 percent.  
- Recommended withholding tax rate for repatriated dividends: 10 percent.  
- Government deposits projected to decline to around 7 percent of GDP; estimated floor at 6.5 percent.  
- Public debt: just over 30 percent of GDP.  
- Debt-based medium-term fiscal ceiling recommended: about 40 percent of GDP.  
- BIS threshold referenced for credit-to-GDP gap: 10 percentage points.

---

### 16. Policy Recommendations (Financial Stability and Macroprudential Priorities)

### Safeguarding financial stability and macroprudential priorities
- Authorities’ welcome steps:
  - Phased implementation of a capital conservation buffer.  
  - Introduction of a liquidity risk management framework.  
  - Improvements in banks’ loan classification and revisions to provisioning rules, to be implemented by 2019, when all banks should comply with International Financial Reporting Standards.
- Given still elevated risks, additional prompt macroprudential action is needed.
- Moderating the credit cycle — priority targeted measures:
  - Raise risk weights for real-estate related lending commensurate with the banks’ risk profiles.  
  - Raise reserve requirements (RR) on foreign exchange liabilities, including for MFIs’, to increase the liquidity cushion and help promote local currency use.

### Policies to address real-estate sector risks
- Strengthen monitoring and reporting:
  - Strengthen reporting requirements for construction activity and sales.  
  - Monitor and regulate lending by real-estate developers in line with other non-bank credit providers and contain bank exposure.
- Regulatory and licensing measures:
  - Consider tightening new construction project licenses.  
  - Apply stricter monitoring of official bank guarantees.  
  - Raise the minimum capital to be deposited in a local bank by developers.
- Lending standards and valuation:
  - Introduce and enforce an aggregate loan-to-value limit to ensure prudent mortgage lending standards.  
  - Develop guidelines to standardize real-estate valuations industry-wide.  
  - Finalize and publish a real-estate price index.
- Fiscal and restructuring measures:
  - Property tax reform, including a phased increase in recurrent property tax rate, to help stabilize real estate prices over the cycle and improve transparency and governance of real-estate markets.  
  - Review the framework for household and corporate debt restructuring to improve loan recovery rates and minimize balance-sheet disruptions should real-estate sector risks materialize.

### Enhancing regulation and supervision
- Capacity and licensing:
  - Supervisory capacity remains stretched; the NBC should consider limiting new banking licenses until capacity is sufficiently scaled up.
- Regulatory alignment and reporting accuracy:
  - Finalize and implement regulations on related-party lending and large exposures to align with international best practice.  
  - Conduct regular validation exercises to ensure accurate reporting.
- Capital and provisioning:
  - Upgrade capital adequacy regulations for risk weight calculations to ensure adequate capital buffers.  
  - Phase out the MFI interest rate cap, and align MFI sectoral loan classification with that for banks.
- Risk monitoring:
  - Closely monitor unhedged exchange rate risk exposures.

### Crisis management and safety nets
- Introduce a comprehensive crisis management framework:
  - Finalize the establishment of the national Financial Stability Committee to better coordinate policies across government agencies and improve information sharing.  
  - Expedite progress on introducing a deposit insurance scheme and a bank resolution framework to help mitigate liquidity risks and bolster confidence.

### Addressing shortcomings in the AML/CFT regime
- APG 2017 assessment highlighted shortcomings, including AML/CFT supervision and implementation of preventative measures by reporting entities.
- Financial Intelligence Unit (FIU):
  - FIU has recently commenced risk-based AML/CFT supervision of banks and is building capacity.  
  - Supervision of the real estate sector for money laundering risk has not yet taken place.
- Policy priorities:
  - Address shortcomings identified by the APG and demonstrate progress, in line with Fund TA recommendations, to avoid public Financial Action Task Force (FATF) listing.  
  - Take steps to address the possible impact of public listing on correspondent banking relationships, which could constrain private transfers.

### Exchange rate policy and financial development
- Exchange rate regime:
  - Regime is appropriate given the still high level of financial dollarization.
- Measures to increase Riel use:
  - Gradually increase the reserve requirement on foreign exchange liabilities.  
  - Require all future government payment transactions to be based in Riel.  
  - Adopt market-based measures to encourage de-dollarization.
- Financial market development:
  - Continue to develop equity markets and introduce government bond markets; progress has been made in introducing capital markets, including for corporate bonds.
- Financial technology:
  - Rapid growth in financial technology, centered around mobile payments and driven by demand for low-cost payment services, particularly in rural areas.  
  - NBC is exploring use of Distributed Ledger Technology for interbank settlements.  
  - Close monitoring required to ensure regulation keeps up with evolving best international practice.

### Staff appraisal and recommended follow-up (summary)
- Economic outlook and risks:
  - Economic activity projected to remain robust, supported by stronger manufacturing exports, construction and tourism activity.  
  - Growth expected to decline somewhat over the medium term owing to moderation in credit and real estate cycles and challenges in improving economic diversification and competitiveness.
- Fiscal policies:
  - Authorities’ plans for current spending restraint in 2019 are welcome.  
  - Policies could do more to safeguard fiscal sustainability and support inclusion, including shifting tax burden to more progressive direct revenue sources and re-orienting expenditures towards priority infrastructure investment, and health and education spending.
- Macro-financial policies:
  - Further policy measures needed to address elevated financial sector vulnerabilities, including effective implementation of past measures and further targeted prudential measures (e.g., raising risk weights for real-estate lending), introducing a crisis management framework with a deposit insurance scheme, and continued upgrading of regulation and supervision.
- Structural reforms:
  - Accelerate implementation of structural reforms to entrench gains and enhance productivity growth: reduce energy costs and improve reliability, enhance transportation links, address skills gaps via education and vocational training, and enhance social protection policies.
- Governance and corruption:
  - Further strengthen fiscal governance through modernizing revenue administration, public financial management and procurement reforms focused on increasing spending efficiency, improving transparency and reducing opportunities for corruption.
- Recommended follow-up:
  - Next Article IV consultation is recommended to take place on the standard 12-month cycle.

---

### Box 3. Advancing Inclusive Growth through Fiscal Reforms

### Model simulations: headline findings
- An increase in public investment financed by higher taxes can boost output and reduce income inequality.  
- The level of GDP could be raised by up to 2.7 percent.  
- The Gini coefficient could be reduced by up to 0.1 Gini points.  
- GDP is increased most when financing comes from a higher real estate tax, and inequality is reduced most when financed by higher real estate or wage taxation.  
- Output gains are driven by productivity increases from better infrastructure but are partially offset by distortions introduced by higher taxation.

### Infrastructure financing scenarios evaluated
- A permanent increase in quality infrastructure by 0.5 percent of GDP is evaluated under three financing options:
  - A general increase in the real estate tax from 0.1 to around 0.6 percent. A revaluation of property prices and improvements in revenue administration could reduce the necessary rate increase.  
  - An increase in the effective VAT rate of around 0.4 percentage point (e.g. by reducing exemptions).  
  - Raising revenue from wage taxation from its current low level of 1.0 percent of GDP to 1.5 percent.

### Contextual key statistics and constraints
- Infrastructure gaps remain: the share of paved roads was only 10.5 percent in 2015 (World Development Indicators).  
- The latest available Gini coefficient (2012), based on household consumption data, was 29 (Figure 5).

---

### Box 5. Fintech and Financial Inclusion

### Overview and Cambodia context
- FinTech in Cambodia is centered around mobile payments.  
- Mobile financial services have enabled domestic migrant workers to remit money to rural areas, replacing more costly and insecure informal channels.  
- Remittances act to smooth rural consumption, with remittances acting as a form of insurance against shocks, and encourages greater local currency use.  
- Digitalization of government payments could also lead to better targeting, reduction in leakages, and improvements in spending efficiency.

### Access and gaps
- Financial inclusion remains uneven with limited saving services, but very large credit saturation.  
- Regionally, Cambodia has one of the highest rates of borrowing (around 27 percent of the adult population) despite few individuals having access to a formal savings account (around 5 percent).  
- Expanding mobile money services beyond payments to savings and other financial services (including insurance) would further enhance financial inclusion.

### Risks and regulatory needs
- The rapid growth of Fintech introduces new risks.  
- Strong regulation of mobile banking is needed to ensure the nascent industry follows best international practice.  
- Authorities have developed regulations governing the licensing of mobile payment services providers and should continue to strengthen the legal framework, and fully adopt e-KYC and e-commerce consumer protection policies.

---

### Appendix I. Risk Assessment Matrix — Key Risks and Recommendations

- Revenue shortfall: Horizon Medium; Prob.: High; Impact: Medium. Policy: Steadfast implementation of RMS, rationalize non-developmental current expenditure.
- A large correction in real estate prices: Horizon Short-term; Prob.: Medium; Impact: High. Policy: Increase reserve requirements, implement macroprudential measures, strengthen supervision for MFIs, preemptively strengthen crisis management framework.
- FATF listing: Horizon Short-term; Prob.: High; Impact: Medium. Policy: Implement APG recommendations expeditiously to mitigate loss of correspondent banking relationships.
- Extreme weather: Horizon Short-term; Prob.: Medium; Impact: Medium. Policy: Expedite structural reforms, improve infrastructure, increase transfers to rural poor after creating fiscal space.
- Rising protectionism and retreat from multilateralism: Horizon Short-term; Prob.: High; Impact: High. Policy: Expedite structural reforms to accelerate diversification and find new export markets.
- Weaker-than-expected global growth (US, EU, China): Horizon Short-term; Prob.: Medium; Impact: Medium/High. Policy: Expedite structural reforms, ensure adequate emergency liquidity.
- Sharp tightening of global financial conditions and strengthening of the US dollar: Horizon Short-term; Prob.: High; Impact: High. Policy: Build foreign reserve buffers; consider increasing reserve requirements on foreign deposits; expedite crisis management framework.

---

### Appendix IV. External Sector Assessment — Key Findings and Metrics

### External position and vulnerabilities
- External position 2017: moderately weaker than level consistent with medium-term fundamentals and desirable policy settings.  
- Net Foreign Asset (NFA) position: -43 percent of GDP by end-2017.  
- FDI inflows: 12.1 percent of GDP in 2017; about 35 percent of FDI inflows directed to the banking sector; about 35 percent of FDI inflows are Chinese investments.
- Actual CA deficit 2017: 8 percent of GDP; CA norm (model): -5.2 percent of GDP; CA gap: -2.9 percent of GDP (translates into an REER overvaluation of 5.2 percent per the ES model).

### Reserves and reserve adequacy
- International reserves:
  - End-2017: US$8.8 billion.  
  - June 2018: US$9.1 billion.  
  - End-2017 equivalents: about 5 months of prospective imports and 55 percent of broad money.
- ARA tool (Credit-Constrained Economies with fixed exchange rate) suggests optimal level about 3½ months of current imports (below current level).  
- Coverage concern: gross official reserves covered only 60 percent of foreign currency deposits as of end-2017.

### Debt sustainability and projections
- Risk of external debt distress: Low.  
- Overall risk of debt distress: Low.  
- Public and PPG debt-to-GDP ratio projected to rise by more than 10 percentage points during the next decade if medium-term fiscal deficits persist.  
- Public external debt (end-2017): US$6.7 billion (30.3 percent of GDP).  
  - Multilateral: US$1,951.0 million (9.0 percent of GDP).  
  - Bilateral: US$4,717.6 million (21.3 percent of GDP); of which China: US$3,209.6 million (14.5 percent of GDP).
- PV of debt-to-GDP ratio (end-2017): 23.6 percent.
- Contingent liability stress test total default magnitude used: 11.3 percent of GDP (PPP: 6.3 percent of GDP; Financial market: 5 percent of GDP).

### Macro forecasts (selected)
- GDP growth:
  - Projected 2018: 7½ percent.  
  - Expected to decline toward potential of 6 percent over the medium term.
- Inflation:
  - 2017: 2.9 percent.  
  - Projected 2018: 2.5 percent.
- Current account deficit:
  - 2017: 8 percent of GDP.  
  - Outlook: expected to widen in 2018 and narrow over the medium term.
- External debt disbursements projected average 2018–23: 3.9 percent of GDP annually.  
- External debt projected to reach 34.1 percent of GDP by 2023 and stabilize at 38 percent of GDP in 2028.
- Fiscal:
  - Fiscal deficit 2017: narrowed to 1.1 percent of GDP.  
  - Government deposits rose to 12.6 percent of GDP by end-2017.  
  - Fiscal deficit projected 2018: about 2.2 percent of GDP.  
  - Medium-term projection: fiscal deficit projected to widen to 3.7 percent of GDP by 2023 (absent tax policy reforms).

### DSA stress-test results and vulnerabilities
- Under baseline, PV of debt ratios remain below applicable thresholds for the Medium debt-carrying capacity classification.  
- Stress tests: export shock is the most extreme, producing the largest increases in indicators compared to shocks to real growth, fiscal primary balance, exchange rate depreciation, and external flows.  
- PPG debt vulnerable to growth and contingent liabilities shocks: a growth shock in 2019-20 would raise PV of total debt-to-GDP ratio to 45 percent in 2028; contingent liabilities realization could increase debt service-to-revenue ratio from 5 percent in 2018 to 15 in 2021.

### Policy priorities to improve external and debt sustainability
- Maintain adequate fiscal buffers and introduce a debt-based fiscal anchor (recommended debt ceiling at 40 percent of GDP).  
- Diversify export markets and improve productivity and competitiveness (ensure minimum wage growth aligned with productivity, improve infrastructure, improve education).  
- Mobilize fiscal revenue, strengthen Public Investment Management and PPP frameworks, and enhance monitoring of PPP and financial sector risks.  
- Close data gaps, particularly external private debt and PPP stock.

---

### Public Debt Outlook and Conclusion — Selected Projections and Indicators

- Total PPG debt projected to rise from 30.3 percent of GDP in 2017 to 41.4 percent in 2038.  
- PV of total debt-to-GDP ratio expected to increase to 30.2 percent in 2028, remaining below the 55 percent benchmark.  
- Public sector debt (in percent of GDP) selected: 2017: 30.3; 2018: 30.2; 2019: 30.3; 2020: 30.4; 2021: 31.4; 2022: 33.1; 2023: 35.2; 2028: 40.8; 2038: 41.4.  
- Real GDP growth (in percent, selected): 2017: 7.0; 2018: 7.3; 2019: 7.0; 2020: 6.7; 2021: 6.5; 2022: 6.2; 2023: 6.0; 2028: 6.0; 2038: 6.3.
- Policy recommendations reiterated:
  - Establish a fiscal anchor by introducing a debt ceiling at 40 percent of GDP.  
  - Develop a medium-term budgetary framework.  
  - Preserve macroeconomic stability, diversify the economy and exports, improve spending efficiency, implement the Revenue Mobilization Strategy, and strengthen PIM and PPP frameworks.

---

*Source: cr18369*

### 1. Growth Drivers _______________________________________________________________________________ 18

### 1. Growth Drivers _______________________________________________________________________________ 18

### Recent economic developments
- Real GDP is projected to grow at 7¼ percent in 2018 due to strong external demand and expansionary fiscal policies.  
- Inflation is expected to remain at around 2½ percent.  
- Broad-based strong performance: garment exports, tourism and the construction sectors growing at robust rates.  
- Current account deficit expected to widen to around 10 percent of GDP in 2018, driven by higher imports including construction materials.  
- Gross international reserves expected to increase to around US$9.6 billion (5 months of prospective imports) at end-2018.  
- Bank credit expected to grow by around 20 percent in 2018; MFI credit expanding at an even higher rate.  
- Credit-to-GDP gap conservatively estimated at close to 10 percentage points.

### Fiscal developments and stance
- 2017 deficit: 1.1 percent of GDP (considerably stronger than the 3.9 percent in the budget law).  
- Tax revenues grew 26 percent in nominal terms in 2017 (revenue overperformance partly due to one-off factors).  
- Wage spending grew to more than 7 percent of GDP as government raised public wages.  
- Fiscal stance turned expansionary in 2018: both current and capital expenditure expected to increase.  
- Tax revenue in 2018 expected to grow by only 0.1 percent of GDP, reflecting VAT exemptions and import tariff reductions for fuel and basic foods.  
- 2018 deficit expected to widen to 2.2 percent of GDP, resulting in lower government deposits.

### External sector assessment
- External position assessed to be moderately weaker than implied by fundamentals and desirable policies.  
- Assessing Reserve Adequacy tool suggests a level of reserves of about 3½ months of prospective imports (below the current level).  
- Reserves appear adequate on traditional metrics, but further accumulation is welcome given the managed exchange rate regime, high dollarization, and elevated financial vulnerabilities.

### Outlook
- Growth expected to remain around 7 percent over the next few years; inflation to remain subdued.  
- Growth projected to moderate towards potential, estimated at around 6 percent, as domestic credit and real-estate cycles moderate amid tighter global financial conditions.  
- Economic activity expected to become driven more by exports and tourism, narrowing the current account deficit.  
- Strong near-term performance provides a window for structural and governance reforms to sustain medium term growth closer to the government’s target of 7 percent.

### Downside risks
- Domestic:
  - Continued strong credit growth, increasing concentration in the real estate sector, unregulated lending by real estate developers, concerns about credit quality, external funding, and growing systemic importance of MFIs—pose risks to financial and macroeconomic stability.  
  - Fiscal spending pressures and potential materialization of contingent liabilities risk eroding policy space.  
  - Large minimum wage increases could further erode competitiveness.
- External:
  - Spillovers from global rise in protectionism or trade sanctions related to political developments could hamper exports and FDI and dent confidence.  
  - Higher U.S. trade tariffs on China could reduce exports, though trade diversion could mitigate effects via garment-related FDI inflows.  
  - Weaker-than-expected growth in China would have significant negative spillovers through FDI, banking, and tourism channels.  
  - A slowdown in advanced economies or stronger-than-expected U.S. dollar could reduce garment exports and tourism.  
- Financial conditions:
  - Sharper-than-expected global financial tightening and disruptions in correspondent banking could heighten liquidity risks.

### Authorities’ views
- Broad agreement on outlook and risks; authorities aim to sustain growth at 7 percent.  
- Authorities emphasize large infrastructure projects in the pipeline and efforts to mitigate financial vulnerabilities and monitor global spillovers.

### Safeguarding fiscal sustainability — near-term and medium-term
- Preliminary 2019 budget aims for current spending restraint; targets a budget deficit of 3.3 percent of GDP (about 1.5 percentage points lower than the 2018 budget law).  
- Preliminary budget envisages increased tax revenues partly driven by higher property tax revenues as property prices are reassessed for tax purposes.  
- Small decline in current spending; public wages expected to grow in line with nominal GDP; reallocation toward health and education; capital spending constant as a share of GDP.  
- Medium-term pressures: absent tax reforms, revenue growth expected to slow as past reforms mature; trade taxes projected to decline with import tariff reductions; grants to fall as middle-income status solidifies.  
- Government deposits projected to decline to around 7 percent of GDP, close to estimated floor at 6.5 percent.  
- Public debt currently just over 30 percent of GDP; Cambodia assessed at low risk of debt distress but exposed to contingent liability and shock risks.

### Fiscal policy recommendations (summary of staff recommendations)
- Restrain current spending:
  - Make further wage increases contingent on maintaining adequate fiscal buffers and support them with public administration reforms.  
  - Target pay increases to priority functions and good performers.
- Raise revenues and improve efficiency and progressivity:
  - New Revenue Mobilization Strategy (RMS) should reform tax policies, improve efficiency and equity, and modernize revenue administration.
  - Real-estate taxes: gradually raise the recurrent property tax rate from current 0.1 percent; re-assess property values for tax purposes; introduce regulations for reassessment at least every 5 years; widen base and enhance transparency and compliance.
  - Corporate and personal income taxes: abolish corporate income tax holiday for new investments while maintaining statutory corporate tax rate at 20 percent; reduce withholding tax on repatriated dividends to 10 percent; abolish or reduce customs tariffs on intermediate goods; ensure timely VAT refunds; eliminate patent tax; remove notches in business tax scale; implement simplified tax on micro firms; initiate preparations for a comprehensive personal income tax regime over the medium term.
  - Other tax policies: replace ad valorem by specific excises for tobacco, fuels and beer and adjust with inflation; abolish the lighting tax; consider introducing/raising excises on luxury goods; assess tax implications of e-commerce and prepare reform plan for VAT on e-commerce.
- Introduce a medium-term fiscal framework (MTFF):
  - MTFF should include a debt-based medium-term fiscal ceiling at about 40 percent of GDP.  
  - Integrate MTFF into budget process, develop medium-term budgetary framework using macro-fiscal forecasts, set ministerial ceilings and eradicate dual budgeting.
- Support inclusive growth:
  - Re-orient expenditures toward priority infrastructure investment, health and education while ensuring gains in spending efficiency.  
  - Finance additional infrastructure spending needed to address gaps through a higher real estate tax to boost growth and reduce income inequality.
- Managing public debt and contingent liabilities:
  - Develop public debt management strategy (PDMS) prioritizing concessional and semi-concessional financing; rely on commercial market borrowing only if shocks exceed buffers.  
  - Develop a risk management framework limiting present value of guaranteed payments; strengthen PPP institutional framework with formal gateway process; ensure PPPs subject to same planning process as other public investment projects.  
  - Ensure MEF and NBC jointly monitor contingent liabilities from PPPs and the financial system.
- Fiscal governance improvements:
  - Tax administration: review staff incentive scheme, develop internal audit capacity, review dispute resolution system for independence and publication of outcomes (while maintaining confidentiality), and strengthen planning, performance, HR management and IT systems.
  - Customs administration: rigorously implement the planned Customs Integrity Program; advance automation including the national single window.
  - Tax incentives: introduce a tax expenditure budget; unify granting and administering tax incentives; consolidate legal basis in tax law; MEF to coordinate policy.
  - PFM: enhance monitoring, transparency and audit in public procurement; publish timely procurement information and comprehensive procurement reports; strengthen expenditure controls to reduce payment arrears and inefficiencies; improve fiscal reporting to include ODA-funded and extra-budgetary expenditures; use automation to re-engineer business processes.

### Managing macro-financial risks
- Elevated financial sector vulnerabilities:
  - Bank credit-to-GDP gap expected to remain close to the BIS threshold of 10 percentage points.  
  - Banks’ capital adequacy has increased, but vulnerabilities persist.  
  - Financial institutions continue to draw on external funding—liquidity risks as global financial conditions tighten; average loan-to-deposit ratio around 100 percent in June 2018.  
  - Bank profitability declined as interest margins fell and non-performing loans edged up; true NPL level may be understated.  
  - Risks from increasing household and corporate leverage.  
  - Interest rate cap has increased average loan size and may have pushed some borrowers to the informal sector; MFI credit growth remains high at above 30 percent.
- Real-estate sector risks:
  - Capital flows into construction sector driven by regional investors and strong demand for residential and retail space.  
  - Significant data gaps, including on property prices, complicate risk assessment.  
  - Anecdotal evidence of oversupply dampening prices of high-end apartments, while prices for retail and residential properties remain robust due to segmented markets—affordability of residential housing being eroded.  
  - Credit growth to real-estate sector averaged around 35 percent since 2016, driven by few banks.  
  - Real-estate developers reportedly offering mortgages with looser lending conditions, an unmonitored and unregulated activity.

### Selected quantitative indicators and thresholds (as reported)
- Real GDP growth projection for 2018: 7¼ percent.  
- Inflation expectation for 2018: around 2½ percent.  
- Current account deficit in 2018: around 10 percent of GDP.  
- Gross international reserves end-2018: around US$9.6 billion (5 months of prospective imports).  
- Bank credit growth expected in 2018: around 20 percent.  
- MFI credit growth: above 30 percent.  
- Credit-to-GDP gap: close to 10 percentage points.  
- 2017 fiscal deficit: 1.1 percent of GDP (budget law: 3.9 percent).  
- Tax revenue growth in 2017: 26 percent (nominal).  
- Wage spending: more than 7 percent of GDP.  
- Expected 2018 tax revenue growth: 0.1 percent of GDP.  
- Expected 2018 deficit: 2.2 percent of GDP.  
- Preliminary 2019 budget deficit target: 3.3 percent of GDP.  
- Current recurrent property tax rate: 0.1 percent.  
- Statutory corporate tax rate (recommended maintained): 20 percent.  
- Recommended withholding tax rate for repatriated dividends: 10 percent.  
- Government deposits projected to decline to around 7 percent of GDP; estimated floor at 6.5 percent.  
- Public debt: just over 30 percent of GDP.  
- Debt-based medium-term fiscal ceiling recommended: about 40 percent of GDP.  
- BIS threshold referenced for credit-to-GDP gap: 10 percentage points.

*Source: cr18369 - 1. Growth Drivers*

### 16. Policy Recommendations. The authorities are taking welcome steps to safeguard financial

### 16. Policy Recommendations. The authorities are taking welcome steps to safeguard financial

### Safeguarding financial stability and macroprudential priorities
- Authorities’ welcome steps:
  - Phased implementation of a capital conservation buffer.
  - Introduction of a liquidity risk management framework.
  - Improvements in banks’ loan classification and revisions to provisioning rules, to be implemented by 2019, when all banks should comply with International Financial Reporting Standards.
- Given still elevated risks, additional prompt macroprudential action is needed.
- Moderating the credit cycle — priority targeted measures:
  - Raise risk weights for real-estate related lending commensurate with the banks’ risk profiles.
  - Raise reserve requirements (RR) on foreign exchange liabilities, including for MFIs’, to increase the liquidity cushion and help promote local currency use.

### Policies to address real-estate sector risks
- Strengthen monitoring and reporting:
  - Strengthen reporting requirements for construction activity and sales.
  - Monitor and regulate lending by real-estate developers in line with other non-bank credit providers and contain bank exposure.
- Regulatory and licensing measures:
  - Consider tightening new construction project licenses.
  - Apply stricter monitoring of official bank guarantees.
  - Raise the minimum capital to be deposited in a local bank by developers.
- Lending standards and valuation:
  - Introduce and enforce an aggregate loan-to-value limit to ensure prudent mortgage lending standards.
  - Develop guidelines to standardize real-estate valuations industry-wide.
  - Finalize and publish a real-estate price index.
- Fiscal and restructuring measures:
  - Property tax reform, including a phased increase in recurrent property tax rate, to help stabilize real estate prices over the cycle and improve transparency and governance of real-estate markets.
  - Review the framework for household and corporate debt restructuring to improve loan recovery rates and minimize balance-sheet disruptions should real-estate sector risks materialize.

### Enhancing regulation and supervision
- Capacity and licensing:
  - Supervisory capacity remains stretched; the NBC should consider limiting new banking licenses until capacity is sufficiently scaled up.
- Regulatory alignment and reporting accuracy:
  - Finalize and implement regulations on related-party lending and large exposures to align with international best practice.
  - Conduct regular validation exercises to ensure accurate reporting.
- Capital and provisioning:
  - Upgrade capital adequacy regulations for risk weight calculations to ensure adequate capital buffers.
  - Phase out the MFI interest rate cap, and align MFI sectoral loan classification with that for banks.
- Risk monitoring:
  - Closely monitor unhedged exchange rate risk exposures.

### Crisis management and safety nets
- Introduce a comprehensive crisis management framework:
  - Finalize the establishment of the national Financial Stability Committee to better coordinate policies across government agencies and improve information sharing.
  - Expedite progress on introducing a deposit insurance scheme and a bank resolution framework to help mitigate liquidity risks and bolster confidence.

### Addressing shortcomings in the AML/CFT regime
- APG 2017 assessment highlighted shortcomings, including AML/CFT supervision and implementation of preventative measures by reporting entities.
- Financial Intelligence Unit (FIU):
  - FIU has recently commenced risk-based AML/CFT supervision of banks and is building capacity.
  - Supervision of the real estate sector for money laundering risk has not yet taken place.
- Policy priorities:
  - Address shortcomings identified by the APG and demonstrate progress, in line with Fund TA recommendations, to avoid public Financial Action Task Force (FATF) listing.
  - Take steps to address the possible impact of public listing on correspondent banking relationships, which could constrain private transfers.

### Exchange rate policy and financial development
- Exchange rate regime:
  - Regime is appropriate given the still high level of financial dollarization.
- Measures to increase Riel use:
  - Gradually increase the reserve requirement on foreign exchange liabilities.
  - Require all future government payment transactions to be based in Riel.
  - Adopt market-based measures to encourage de-dollarization.
- Financial market development:
  - Continue to develop equity markets and introduce government bond markets; progress has been made in introducing capital markets, including for corporate bonds.
- Financial technology:
  - Rapid growth in financial technology, centered around mobile payments and driven by demand for low-cost payment services, particularly in rural areas.
  - NBC is exploring use of Distributed Ledger Technology for interbank settlements.
  - Close monitoring required to ensure regulation keeps up with evolving best international practice.

### Authorities’ views
- Broad agreement with staff recommendations, including the need to better monitor real estate sector risks.
- Aim to encourage first-time home buyers; authorities stated bank lending standards remained prudent but acknowledged risks from growing mortgage lending and lending by real-estate developers.
- Preparing legislation to improve monitoring and regulation of real-estate sector activity.
- External funding profile:
  - External funding consists mainly of longer-term funding from parent banks (to banks) and from financial institutions with development purposes (to MFIs), thus mitigating liquidity risks.
- AML/CFT and FIU:
  - Authorities emphasized efforts to comply with international standard by building FIU capacity and improving AML/CFT supervision of banks.
- Local currency promotion and financial literacy:
  - NBC has made significant efforts to promote local currency use and financial literacy and will continue to monitor the impact of the interest rate cap on MFIs.

### Reforms to support sustainable development, governance, and structural priorities
- Reforms to promote inclusive growth:
  - Reduce energy costs and improve reliability.
  - Enhance transportation links.
  - Address skills gaps via improving quality of education and promoting technical and vocational training.
  - Shift tax policies toward more progressive revenue sources and increase spending on infrastructure while improving spending efficiency.
- Progress towards SDGs:
  - Expand economic opportunities and sustainable development by improving economic and social infrastructure, particularly in rural areas; improve health and education outcomes and social protection in line with the NSPPF; promote higher productivity in the agricultural sector.
  - Increased use of financial technology, further development of financial infrastructure and improving financial literacy to expand inclusion.
- Improving regulatory environment and rule of law:
  - Reduce cost of setting up and operating businesses to support job creation and SME growth.
  - Timely VAT refunds to relieve SME financing constraints.
  - Finalize a competition law to protect the economy from harmful anti-competitive practices.
  - Strengthen rule of law, complete systematic land registration and introduce a commercial court.
- Strengthening anti-corruption efforts:
  - Improve effectiveness, transparency, and operational independence of anti-corruption institutions; strengthen the anti-corruption framework, including better protecting whistleblowers.
  - Address AML/CFT shortcomings, including by introducing due diligence measures for domestic politically exposed persons.

### Staff appraisal and recommended follow-up
- Economic outlook and risks:
  - Economic activity projected to remain robust, supported by stronger manufacturing exports, construction and tourism activity.
  - Growth expected to decline somewhat over the medium term owing to moderation in credit and real estate cycles and challenges in improving economic diversification and competitiveness.
  - External position assessed to be moderately weaker than the level consistent with fundamentals and desirable policies.
  - Downside risks include elevated financial sector vulnerabilities, tighter global financial conditions, international trade sanctions, and spillovers from global rise in protectionism.
- Fiscal policies:
  - Authorities’ plans for current spending restraint in 2019 are welcome.
  - Policies could do more to safeguard fiscal sustainability and support inclusion, including shifting tax burden to more progressive direct revenue sources and re-orienting expenditures towards priority infrastructure investment, and health and education spending.
  - New Revenue Mobilization Strategy should focus on modernizing revenue administration and policies.
  - Public wage increases should balance pay incentives and fiscal sustainability; institutionalizing a Medium Term Fiscal Framework would help safeguard infrastructure and development spending.
  - Strengthen the PPP framework to better manage fiscal costs and risks.
- Macro-financial policies:
  - Further policy measures needed to address elevated financial sector vulnerabilities, including effective implementation of past measures and further targeted prudential measures (e.g., raising risk weights for real-estate lending), introducing a crisis management framework with a deposit insurance scheme, and continued upgrading of regulation and supervision.
  - Address real-estate sector risks with broad policy response, including strengthening monitoring and regulation and phased increases in property taxes.
  - Address gaps in the AML/CFT regime and take pre-emptive steps to address any impact on correspondent banking relationships from possible FATF public listing.
  - Promote further financial market development and encourage local currency use to increase resilience.
  - Regulate and supervise financial technology to balance financial innovation and financial stability.
- Structural reforms:
  - Accelerate implementation of structural reforms to entrench gains and enhance productivity growth: reduce energy costs and improve reliability, enhance transportation links, address skills gaps via education and vocational training, and enhance social protection policies.
  - Use direct tax revenue gains, including from property taxation, to boost infrastructure spending to support growth and reduce inequality.
  - Enhance the regulatory environment to improve business climate, encourage investment and reduce informality.
- Governance and corruption:
  - Further strengthen fiscal governance through modernizing revenue administration, public financial management and procurement reforms focused on increasing spending efficiency, improving transparency and reducing opportunities for corruption.
  - Continue to improve the anti-corruption framework and institutions and strengthen AML/CFT compliance.
- Recommended follow-up:
  - Next Article IV consultation is recommended to take place on the standard 12-month cycle.

*Italic source: IMF staff summary of Chapter 16 and related sections as provided in the supplied content.*

### Box 3. Advancing Inclusive Growth through Fiscal Reforms

### Box 3. Advancing Inclusive Growth through Fiscal Reforms

### Model simulations: headline findings
- An increase in public investment financed by higher taxes can boost output and reduce income inequality.
- The level of GDP could be raised by up to 2.7 percent.
- The Gini coefficient could be reduced by up to 0.1 Gini points.
- GDP is increased most when financing comes from a higher real estate tax, and inequality is reduced most when financed by higher real estate or wage taxation.
- Output gains are driven by productivity increases from better infrastructure but are partially offset by distortions introduced by higher taxation.

### Infrastructure financing scenarios evaluated
- A permanent increase in quality infrastructure by 0.5 percent of GDP is evaluated under three financing options:
  - A general increase in the real estate tax from 0.1 to around 0.6 percent. A revaluation of property prices and improvements in revenue administration could reduce the necessary rate increase.
  - An increase in the effective VAT rate of around 0.4 percentage point (e.g. by reducing exemptions).
  - Raising revenue from wage taxation from its current low level of 1.0 percent of GDP to 1.5 percent.

### Model, calibration, and scope
- Reforms are evaluated using a calibrated general equilibrium model.
- The model features an urban and a rural sector, an uneven distribution of income, and a government sector.
- The parameters are calibrated to match the Cambodian economy.

### Mechanisms and distributional effects
- Output: Better infrastructure raises productivity across all sectors; the net impact on GDP reflects this productivity gain minus tax-induced distortions.
  - The impact on growth is largest when investment is financed using the property tax, and smallest when financed through the wage tax.
- Inequality: Improvement in income equality is driven by the choice of financing and is largest when financing is done via the property tax.
  - The improvement in income inequality is larger when investment is focused on the poorer rural areas (as opposed to wealthier urban areas).

### Contextual key statistics and constraints
- Infrastructure gaps remain: the share of paved roads was only 10.5 percent in 2015 (World Development Indicators).
- The latest available Gini coefficient (2012), based on household consumption data, was 29 (Figure 5).

*Prepared by Albe Gjonbalaj and Niels-Jakob Hansen.*

### Box 5. Fintech and Financial Inclusion

### Box 5. Fintech and Financial Inclusion

### Overview
- Fintech has encouraged financial inclusion by making financial services more accessible, primarily through an expansion of mobile payment services.
- Regulations need to balance innovation against mitigating new risks.

### Fintech in Cambodia
- FinTech in Cambodia is centered around mobile payments.
- Mobile financial services have enabled domestic migrant workers to remit money to rural areas, replacing more costly and insecure informal channels.
- Remittances act to smooth rural consumption, with remittances acting as a form of insurance against shocks, and encourages greater local currency use.
- Digitalization of government payments could also lead to better targeting, reduction in leakages, and improvements in spending efficiency.

### Access and Gaps in Financial Inclusion
- Financial inclusion remains uneven with limited saving services, but very large credit saturation.
- Regionally, Cambodia has one of the highest rates of borrowing (around 27 percent of the adult population) despite few individuals having access to a formal savings account (around 5 percent).
- Expanding mobile money services beyond payments to savings and other financial services (including insurance) would further enhance financial inclusion.

### Risks and Regulatory Needs
- The rapid growth of Fintech introduces new risks.
- Strong regulation of mobile banking is needed to ensure the nascent industry follows best international practice.
- The authorities oversight framework need consider clarity of the legal and regulatory regime, safeguarding funds, AML/CFT measures, and operational resilience.
- The authorities have developed regulations governing the licensing of mobile payment services providers and should continue to strengthen the legal framework, and fully adopt e-KYC and e-commerce consumer protection policies.

*Prepared by Lisa Uemae and Yong Sarah Zhou.*

### Appendix I. Risk Assessment Matrix

### Appendix I. Risk Assessment Matrix

### Overview of the Risk Assessment Matrix (RAM)
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).  
- The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent).  
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.  
- “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

### Domestic Risks
- Revenue shortfall
  - Horizon: Medium-term
  - Up/Down-side: ↓
  - Prob.: High
  - Impact: Medium
  - Transmission: Fiscal position deteriorates - fiscal deficits widen and government deposits deplete sharply.
  - Policy Recommendations: Steadfast implementation of RMS, while rationalizing non-developmental current expenditure.

- A large correction in real estate prices
  - Horizon: Short-term
  - Up/Down-side: ↓
  - Prob.: Medium
  - Impact: High
  - Transmission: Turning of the credit cycle and fallout from excess household and corporate leverage (incl. in FX) as investors withdraw FX deposits, generating disorderly deleveraging.
  - Policy Recommendations: Increase reserve requirements to slow down credit growth, implement macro prudential measures, strengthen micro-prudential regulation and supervision, ensure adequate emergency liquidity, strengthen supervision and regulation for MFIs. Preemptively strengthen the crisis management framework.

- FATF listing
  - Horizon: Short-term
  - Up/Down-side: ↓
  - Prob.: High
  - Impact: Medium
  - Transmission: Loss of CBRs and deterioration of investors’ confidence, affecting financial sector stability and growth.
  - Policy Recommendations: Expeditiously implement the recommendations issued by the Asia Pacific Group on Money Laundering and take measures to mitigate the risks arising from loss of CBRs.

- Extreme weather
  - Horizon: Short-term
  - Up/Down-side: ↓
  - Prob.: Medium
  - Impact: Medium
  - Transmission: Weaker agricultural production and exports, weaker tourism, and wider income inequality.
  - Policy Recommendations: Expedite structural reforms to accelerate diversification, improve infrastructure, and increase transfers to the rural poor after creating fiscal space.

### External Risks
- Rising protectionism and retreat from multilateralism
  - Horizon: Short-term
  - Up/Down-side: ↓
  - Prob.: High
  - Impact: High
  - Transmission: Weaker garments export growth.
  - Policy Recommendations: Expedite structural reforms to accelerate diversification, by expanding the narrow range of export products, while finding new export markets for existing products.

- Weaker-than-expected global growth (US, EU, China)
  - Horizon: Short-term
  - Up/Down-side: ↓
  - Prob.: Medium
  - Impact: Medium/High
  - Transmission: Lower exports coupled with weaker FDI and banking sector flows.
  - Policy Recommendations: Expedite structural reforms to accelerate diversification. Ensure adequate emergency liquidity.

- International trade sanctions
  - Horizon: Medium-term
  - Up/Down-side: ↓
  - Prob.: Medium
  - Impact: High
  - Transmission: Loss of preferential access to key export markets, leading to a decline of exports and FDI.
  - Policy Recommendations: Expedite structural reforms to accelerate diversification. Ensure adequate emergency liquidity.

- Sharp tightening of global financial conditions and strengthening of the US dollar
  - Horizon: Short-term
  - Up/Down-side: ↓
  - Prob.: High
  - Impact: High
  - Transmission: Higher rates would lead to FX deposit outflows, foreign reserves fall.
  - Policy Recommendations: Build up foreign reserve buffers against external shocks; where appropriate release limited short-term liquidity to troubled banks; expedite work on a crisis management framework; increasing reserve requirements on foreign deposits substantially would create a buffer that could be liberated when foreign deposits flow out in response to external shocks.

- (Related external effect)
  - Horizon: Medium
  - Transmission: Stronger US dollar would lead to weaker exports, tourism receipts, FDI, and bank lending from other partner countries.
  - Policy Recommendations: Maintain macroeconomic stability and develop interbank and foreign exchange markets to enhance monetary policy effectiveness and to reduce dollarization. Expedite structural reforms to boost non-price competitiveness.

*Appendix I. Risk Assessment Matrix — IMF staff views as of the time of discussions with the authorities.*

### Appendix IV. External Sector Assessment

### Appendix IV. External Sector Assessment

### External position and overview
- The external position of Cambodia in 2017 was moderately weaker than the level consistent with medium-term fundamentals and desirable policy settings.
- Policies highlighted to improve the external balance: maintaining adequate fiscal buffers, diversifying export markets, and improving productivity and competitiveness.
- There is room to build reserves given high dollarization and elevated financial vulnerabilities.

### Foreign asset and liability position
- Net Foreign Asset (NFA) position: -43 percent of GDP by end-2017.
- NFA composition: almost entirely FDI liabilities.
- Projection: NFA position is projected to increase over the medium term, in line with continuing FDI inflows.
- External Sustainability (ES) model results:
  - A current account (CA) norm that stabilizes the NFA at its end-2017 level implies 7.8 percent REER overvaluation, using EBA-lite elasticities.
  - Allowing NFA to reach 60 percent over the medium term would imply a smaller overvaluation of 5.1 percent.

### Current account (CA)
- Actual CA deficit: 8 percent of GDP in 2017.
- CA norm (model): -5.2 percent of GDP (the CA level suggested by fundamentals and desirable policy settings).
- CA gap: -2.9 percent of GDP (actual CA of -8.0 percent minus CA norm of -5.2 percent).
- Translation: the CA gap of -2.9 percent of GDP translates into an REER overvaluation of 5.2 percent.
- Model caveat: part of the CA gap reflects the CA model not fully accounting for Cambodia’s very young population (fundamentally lower savings and higher CA deficit). If the model used total instead of old-age dependency ratio, the CA norm would be expected to show a larger deficit, resulting in a smaller CA gap.

### Real effective exchange rate (REER)
- Historical REER appreciation: 4 percent on average every year during the last 10 years (reflecting U.S. dollar appreciation, buoyant growth, and capital inflows).
- 2017 dynamics: weaker U.S. dollar and low relative inflation resulted in a slower rate of REER appreciation.
- 2018 first nine months: REER depreciated by 2 percent on average.
- Outlook: projected strengthening of the U.S. dollar and inflation differential are likely to contribute to resuming REER appreciation.
- EBA-lite REER model: suggests a significantly higher level of overvaluation compared to the CA and ES methods, but results are sensitive to the time period used and may not fit well for countries with rapid structural change like Cambodia.

### Recommended policies (to improve external balance)
- Maintain adequate fiscal buffers.
- Diversify export markets.
- Improve productivity and competitiveness by:
  - Ensuring that minimum wage growth is in line with productivity improvements.
  - Improving infrastructure.
  - Improving education.

### Capital flows and risks
- FDI inflows: 12.1 percent of GDP in 2017.
  - FDI more than financed the CA deficit and contributed to reserves buildup.
  - About 35 percent of FDI inflows directed to the banking sector.
  - About 35 percent of FDI inflows are Chinese investments.
- Risks:
  - FDI inflows may be fueling rapid real-estate and banking sector growth.
  - Cambodia may experience smaller inflows as global financial conditions tighten.

### FX intervention and reserve adequacy
- Exchange rate regime: keeping the Riel broadly stable against the U.S. dollar; appropriate given high dollarization and concentration in U.S. dollar-invoiced exports.
- International reserves:
  - End-2017: US$8.8 billion.
  - June 2018: US$9.1 billion.
  - End-2017 equivalents: about 5 months of prospective imports of goods and services and 55 percent of broad money.
- ARA (Credit-Constrained Economies with fixed exchange rate) tool result: suggests an optimal level of reserves of about 3 ½ months of current imports of goods and services, which is below the current reserve level.
- Coverage concern: gross official reserves covered only 60 percent of foreign currency deposits as of end-2017, which limits the central bank’s lender of last resort capacity and is below regional comparators.
- Policy implications:
  - Continued financial deepening and near full dollarization imply foreign currency deposits are likely to continue to grow.
  - Further accumulation of reserves beyond traditional reserve adequacy metrics, along with measures encouraging use of the Riel, are necessary to enhance resilience against financial sector vulnerabilities and rapid capital flow reversals.

### Regional reserve indicators (2017) — Cambodia vs. regional averages
- Cambodia (2017):
  - Months of prospective imports of G&S: 5
  - Percent of exports of G&S: 54
  - Percent of broad money: 55
  - Percent of GDP: 40
- Regional average (2017):
  - Months of prospective imports of G&S: 6
  - Percent of exports of G&S: 22
  - Percent of broad money: 30
  - Percent of GDP: 29

### Data, statistics, and surveillance notes
- Balance of payments and IIP: compiled by the NBC according to BPM6; data present shortcomings in coverage, accuracy, and timeliness and rely on estimation methods.
- Inward FDI data: present large gaps despite survey improvements.
- Technical assistance and improvements:
  - Enhancement of the International Transactions Reporting System (ITRS).
  - DI (Direct Investment) survey improvements; TA missions in September 2016 and March 2018 and September 2018 assisted with inward FDI compilation and improving coverage/estimation methods for travel, compensation of employees, and workers’ remittances.
- Cambodia participates in the IMF’s e-GDDS; National Summary Data Page launched May 30, 2018.

### Debt Sustainability Analysis (DSA) — key findings
- Framework: revised joint IMF/WB LIC-DSF.
- Risk of external debt distress: Low.
- Overall risk of debt distress: Low.
- Public and PPG debt-to-GDP ratio: projected to rise by more than 10 percentage points during the next decade due to projected large fiscal deficits in the medium term.
- Vulnerabilities: debt sustainability is vulnerable to export and growth shocks and the materialization of contingent liabilities.
- Policy priorities to ensure debt sustainability:
  - Implement reforms to increase resilience to external shocks and encourage export and economic diversification.
  - Mobilize fiscal revenue.
  - Strengthen the Public Investment Management framework (including for PPPs).
  - Enhance monitoring of PPP and financial sector risks.
  - Introduce a debt-based fiscal anchor.

### Public and external debt stocks and composition (end-2017)
- External public debt (including arrears): US$6.7 billion (30.3 percent of GDP).
- Composition of external public debt stock:
  - Multilateral: US$1,951.0 million (9.0 percent of GDP; 29.3 percent of external public debt).
  - Bilateral: US$4,717.6 million (21.3 percent of GDP; 70.7 percent of external public debt).
    - Of which China: US$3,209.6 million (14.5 percent of GDP; 48.1 percent of external public debt).
- PV of debt-to-GDP ratio (end-2017): 23.6 percent.
- Legacy arrears to the Russian Federation and the United States: about 3 percent of GDP (legacy borrowing prior to 1993); assumed no debt restructuring for the DSA.
- Public domestic debt (end-2017): US$2.8 million (negligible).

### Contingent liabilities and PPPs
- Contingent liability stress test includes:
  - PPP: 6.3 percent of GDP.
  - Financial market: 5 percent of GDP.
  - Total default magnitude used in contingent liability stress test: 11.3 percent of GDP.
- PPP stock and framework:
  - PPP stock grew more than twofold between 2010 and 2015 (estimated at 17 percent of GDP in 2015).
  - Authorities established roadmap to have full PPP mechanisms by 2020 and adopted an annual ceiling at 4 percent of GDP.
  - A new PPP law is being drafted with ADB support.

### Macro forecasts (selected)
- GDP growth:
  - Projected 2018: 7½ percent.
  - Expected to decline toward potential of 6 percent over the medium term.
- Inflation:
  - 2017: 2.9 percent.
  - Projected 2018: 2.5 percent.
- Current account deficit:
  - 2017: 8 percent of GDP.
  - Outlook: expected to widen in 2018 (due to increased imports of construction material) and narrow over the medium term as activity becomes more export- and tourism-driven.
- Foreign reserves:
  - End-2017: US$8.8 billion (5.1 months of imports).
- External debt disbursements:
  - Projected average 2018–23: 3.9 percent of GDP annually.
  - External debt projected to reach 34.1 percent of GDP by 2023 and stabilize at 38 percent of GDP in 2028.
- Fiscal:
  - Fiscal deficit 2017: narrowed to 1.1 percent of GDP.
  - Government deposits rose to 12.6 percent of GDP by end-2017.
  - Fiscal deficit projected 2018: about 2.2 percent of GDP.
  - Medium-term projection: fiscal deficit projected to widen to 3.7 percent of GDP by 2023 (absent tax policy reforms).
- Domestic debt issuance:
  - Assumption: government will start issuing long-term domestic bonds in 2021.
  - Projected annual issuance of domestic bonds: from 0.4 percent of GDP in 2021 to 1 percent of GDP in 2038.
  - Domestic PPG debt expected to increase from 0 to 4.1 percent of GDP by 2038.

### DSA scenario and stress-test notes
- Country classification for LIC-DSF: Composite Indicator (CI) places Cambodia in the Medium debt-carrying capacity category (final classification Medium; previous vintage Strong).
- Applicable external debt thresholds for Medium classification:
  - PV of debt-to-exports: 180 percent.
  - PV of debt-to-GDP: 40 percent.
  - Debt service-to-exports: 15 percent.
  - Debt service-to-revenue: 18 percent.
- DSA results:
  - Under baseline, PV of debt ratios remain below thresholds and are projected to remain flat.
  - Debt service-to-exports and debt service-to-revenue ratios remain well below thresholds throughout projection period.
  - Stress tests: export shock is the most extreme, producing the largest increases in indicators compared to shocks to real growth, fiscal primary balance, exchange rate depreciation, and external flows.

*Source: IMF staff estimates and analysis from "Appendix IV. External Sector Assessment" (cr18369).*

### 23.3 percent in 2018 to 36 percent in 2020, but would remain under the 40 percent threshold.

### Public debt outlook and risk assessment

### Baseline projections
- Total PPG debt is projected to rise from 30.3 percent of GDP in 2017 to 41.4 percent in 2038 (Table 2).
- The PV of total debt-to-GDP ratio is expected to increase to 30.2 percent in 2028, as the share of concessional external debt to total debt decreases, but to remain well below the 55 percent benchmark (Figure 2).
- Debt-to-revenue and debt service-to-revenue ratios are also expected to increase over the next decade.
- 23.3 percent in 2018 to 36 percent in 2020, but would remain under the 40 percent threshold.

### Vulnerabilities and stress scenarios
- PPG debt is vulnerable to growth and contingent liabilities shocks.
- A growth shock (calibrated at 1 standard deviation of historical performance) in 2019-20 would lead to a rise of the PV of total debt-to-GDP ratio to 45 percent in 2028.
- The realization of contingent liabilities related to PPPs and financial stress could increase the debt service-to-revenue ratio from 5 percent in 2018 to 15 in 2021.

*Source: cr18369 - 23.3 percent in 2018 to 36 percent in 2020, but would remain under the 40 percent threshold.*

### CONCLUSION

### CONCLUSION

### Overall assessment
- Cambodia remains at low risk of external and overall debt distress.
- The total PPG debt-to-GDP ratio is expected to rise by more than 10 percentage points during the next decade due to projected increasing fiscal deficits between 2018 and 2023.

### Debt projections and key indicators (selected)
- External debt (nominal) (in percent of GDP): 2015: 31.2; 2016: 29.1; 2017: 30.3; 2018: 30.1; 2019: 30.3; 2020: 30.4; 2021: 31.1; 2022: 32.4; 2023: 34.1; 2028: 38.2; 2038: 37.3.
- Public sector debt (in percent of GDP): 2015: 31.2; 2016: 29.1; 2017: 30.3; 2018: 30.2; 2019: 30.3; 2020: 30.4; 2021: 31.4; 2022: 33.1; 2023: 35.2; 2028: 40.8; 2038: 41.4.
- Non-interest current account deficit (in percent of GDP): 2015: 8.4; 2016: 8.1; 2017: 7.7; 2018: 9.8; 2019: 9.6; 2020: 9.1; 2021: 8.1; 2022: 7.7; 2023: 7.0; 2028: 5.6; 2038: 1.9.
- Net FDI (negative = inflow, in percent of GDP): 2015: -9.6; 2016: -12.0; 2017: -12.1; 2018: -12.7; 2019: -12.1; 2020: -11.1; 2021: -10.5; 2022: -9.9; 2023: -9.3; 2028: -7.1; 2038: -2.6.
- PV of PPG external debt-to-GDP ratio (selected): 2023: 23.8; 2028: 24.8; 2038: 27.5.
- PV of PPG external debt-to-exports ratio (selected): 2023: 29.9; 2028: 30.6; 2038: 40.6.
- Gross external financing need (Million of U.S. dollars, selected): 2016: -595.4; 2017: -751.9; 2018: -444.1; 2019: -359.9; 2020: -219.4; 2021: -351.3; 2022: -289.9; 2023: -380.0; 2028: -106.5; 2038: 1532.8.
- Real GDP growth (in percent, selected): 2015: 7.0; 2016: 6.9; 2017: 7.0; 2018: 7.3; 2019: 7.0; 2020: 6.7; 2021: 6.5; 2022: 6.2; 2023: 6.0; 2028: 6.0; 2038: 6.3.

### Risks and stress-test findings
- Baseline projections and standard stress tests show increasing risks to the external and public debt outlooks.
- Stress tests indicate vulnerability of Cambodia’s debt sustainability to shocks to:
  - exports,
  - economic growth,
  - contingent liabilities.
- The most extreme stress scenarios for several indicators are driven by export shocks (as indicated in the stress-test figures).

### Policy recommendations
- Establish a fiscal anchor by introducing a debt ceiling at 40 percent of GDP.
- Develop a medium-term budgetary framework.
- Preserve macroeconomic stability and diversify the economy and exports to increase resilience to external shocks.
- Improve spending efficiency and successfully implement the revenue mobilization strategy.
- Further efforts to implement sound PIM and PPP frameworks and strengthen analysis of PPP risks are needed.
- Focus on closing data gaps, in particular regarding external private debt and the PPP stock.

*Source: IMF staff estimates and projections (CONCLUSION, Cambodia Debt Sustainability Analysis).*

### 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the

### Statement by the Staff Representative on Cambodia — November 28, 2018

### Recent economic development and outlook
- Following more than two decades of strong economic growth, the Cambodian government has attained lower middle-income status.
- Average growth during 1995–2017: 7.7 percent.
- Growth in 2017: 6.9 percent.
- Projected growth in 2018: 7.25 percent.
- Growth drivers: garment exports, tourism and construction; support from strong external demand and expansionary fiscal policies.
- Authorities estimate foreign reserves to reach USD9.6 billion by the end of 2018, equivalent to around 5 months of prospective imports as estimated by the staff.
- Authorities expect large FDI inflows and increasing public investment in infrastructure to help expand production capacity over the medium term.
- Authorities and staff share concerns about vulnerabilities from:
  - erosion of export competitiveness due to rising real wages;
  - buildup of vulnerabilities from a prolonged real estate and construction boom;
  - escalating trade protectionism and tensions.

### Fiscal policies and 2019 Budget Law
- Final 2019 budget law was approved by the National Assembly; preliminary budget used in staff projections.
- Final 2019 budget includes additional spending (including on establishing an SME bank), with current expenditures around 0.3 percent of GDP higher than envisaged in staff projections based on the preliminary budget.
- Final budget projects a fiscal deficit of 3.7 percent in 2019 compared with a staff projection of 3.3 percent of GDP in the staff report.
- Staff view: upward revision does not alter macroeconomic outlook but underscores need to restrain current spending and raise revenues to address medium-term fiscal pressures.
- Authorities report tax revenue growth of an impressive 26 percentage points, which neutralized the effects of the 2017 public wage bill increase on the fiscal deficit.
- After expansionary budget policy between 2017–2018, the 2019 Budget Law is geared towards consolidation by restraining current spending.
- Authorities expect revenue to pick up from 2019 onwards due to adoption of the Revenue Mobilization Strategy II (RMS II).
- Authorities appreciate IMF technical assistance in developing the Medium-Term Fiscal Framework (MTFF) and the RMS II.
- Public debt assessment: public debt is low at just over 30 percent of GDP; Cambodia expected to remain at low risk of debt distress.
- Fiscal risk management priorities:
  - monitor and manage contingent liabilities, including from increasing Public–Private Partnerships (PPP) projects;
  - limit public guarantees and strengthen institutional framework for PPPs;
  - modernize tax collection system and customs administration;
  - public financial management and procurement reforms to increase spending efficiency and improve fiscal transparency.

### Monetary policy
- Authorities pursued an expansionary monetary policy while maintaining low inflation.
- Authorities expect M2 growth to remain robust in 2018 and stay around 19 percent in the medium term.
- Expansion expected to be driven mainly by rising foreign currency deposits, boosted by improved confidence and developments in equity, interbank, government and corporate bond, and foreign exchange markets.
- National Bank of Cambodia (NBC) efforts:
  - promote use of local currency to enable more flexible and effective monetary policy framework and increase resilience;
  - regain monetary policy independence, including short-term interest rate targeting and expansion of the use of local currency;
  - explore financial technology, such as mobile payments, to provide low-cost payment services.

### Financial sector
- Cambodian banking sector remains sound and profitable with adequate capital buffers as reflected by core financial soundness indicators.
- Authorities mindful of elevated financial sector vulnerabilities from high credit growth and risks in construction and real estate sector.
- Macroprudential measures adopted by NBC:
  - capital conservation buffer to be implemented in phases;
  - liquidity management framework;
  - improvements in banks’ loan classification and provisioning rules.
- Authorities expediting data collection on real estate sector to better manage credit risk.
- Further targeted prudential measures under consideration (as suggested by staff), including:
  - raising risk weights for real-estate lending to reduce scope for speculative activities;
  - introduction of a crisis management framework with a deposit insurance scheme;
  - continued upgrading in regulation and supervision, including for non-bank financial institutions.
- Commitment to comply with international standards, including addressing shortcomings in the Anti-Money Laundering/Counter Financing of Terrorism (AML/CFT) regime and building the Financial Intelligence Unit’s (FIU) capacity.

### Structural reforms and governance
- Authorities emphasize addressing structural constraints to potential growth to maintain strong growth.
- Key priorities:
  - invest more in education and skills training;
  - address constraints facing small and medium enterprises (SMEs) to support economic diversification and promote job growth;
  - improve business climate, increase competitiveness and encourage diversification through lower energy costs, better human capital and infrastructure;
  - strengthen the rule of law and enhance state capacity to efficiently provide public goods and services;
  - improve governance and address corruption.
- Government target: achieve 7 percent growth over the medium-term.
- Authorities consider investing in the Cambodian people their top priority.

### Conclusion
- Authorities will continue to implement the reform agenda to take full advantage of the country’s growth prospects.
- Commitments include implementing structural reform measures and policies to improve the investment climate and sustain economic growth, while providing buffers against external and domestic shocks.
- Emphasis on making growth more inclusive through fiscal prudence, well-grounded monetary management and financial stability, improved competitiveness of SMEs, and confidence in the banking system.

*Source: Statement by the Staff Representative on Cambodia, November 28, 2018.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18369.pdf_