## _cr04328 ## Source details **Canonical URL:** [_cr04328](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04328.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04328.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04328.pdf.json) --- ### Executive summary — macro performance and risks - Macroeconomic performance in the past few years was generally good, reflecting favorable external developments and prudent fiscal policy. - Exports soared following a bilateral trade agreement with the U.S.; large aid inflows averaged 12 percent of GDP and helped finance domestic investment and spurred construction activities. - Cambodia’s economy is highly dollarized (as much as 95 percent of total liquidity, including estimated U.S. dollars in circulation, is in dollars). - Underlying structural weaknesses masked by these favorable developments include: deterioration of competitiveness linked to poor governance and weak legal/judicial reform; rudimentary infrastructure and high wages that keep operating costs high; and slow agricultural growth affecting the poor and MDG progress. - Recent highlights (2003): - Non-agricultural growth: 3.2 percent (slowed due to SARS and election uncertainties). - Overall GDP growth: 5.2 percent (strong rebound in agricultural production). - Revenue collection: some earlier gains lost in the election year. - Reforms pace stalled in run-up to and aftermath of July 2003 elections; 2004 budget law and legislation for WTO accession awaited parliament approval. - Outlook and risks (2004–05): - Growth expected to slow in 2004-05. - Garment industry exposed to direct competition from China following elimination of quota system in January 2005; possible further slowdown to below 2 percent GDP growth. - Tourism expected to rebound; agricultural growth likely lower than exceptionally high 2003. ### Background and political context - Political developments: - UN-sponsored elections in 1993; coalition governments followed by more durable coalition after 1998. - Tensions following July 2003 elections delayed formation of a new government until mid-July 2004; reforms largely halted during the eleven-month stalemate. - Hun Sen’s party solidified seats in July 2003 but required a power-sharing agreement in June 2004 to form a new coalition in mid-July 2004. - Fund engagement: - Three-year PRGF arrangement for SDR 58.5 million approved October 22, 1999. - Sixth and final review completed February 2003; disbursement of SDR 8.4 million raised total Fund credit and loans outstanding to SDR 70 million. - National Poverty Reduction Strategy Paper (NPRS) and Fund-Bank joint staff assessment endorsed February 2003. - IMF safeguards assessment mission in January 2004 found progress and proposed measures to strengthen remaining weaknesses. ### Growth drivers, composition, and aid - Annual real GDP growth averaged 6-7 percent with political stability from 1999. - Garment exports to the U.S.: nearly zero in 1995 → $500 million in 1999 → more than $1 billion in 2003; about 70 percent of total garment exports went to the U.S. in 2003. - Garment export growth benefited little domestically because almost all non-labor inputs were imported. - Aid composition (average 1999-2003): Technical assistance 45%; Investment 39%; Budgetary support 8%; Food aid 7%. - Uses of aid flows (average 1999-2003): Education and health 24%; Infrastructure 23%; Institution building 15%; Agriculture and forestry 8%; Others 30%. ### Fiscal developments and public finances - Fiscal revenue improved from 8.1 percent of GDP in 1998 to 11.2 percent in 2002; revenue remained about 11 percent of GDP compared with an average of 16 percent of GDP in neighboring low-income countries. - Fiscal revenue (selected): 2002 11.2 percent of GDP; 2003 10.4 percent of GDP; 2004 target 11.9 percent of GDP. - Total revenue currently cited as 10.4 percent of GDP in one section and "currently at 11 percent of GDP" in another — revenue remains weak and constrains priority spending. - Government agreed to avoid recourse to domestic bank financing to help contain riel inflation. - Spending and wage policy: - Average civil service salary in 2003: $34 a month; authorities aimed to raise average salary to $80 a month by 2008 while keeping a tight lid on non-wage and non-social spending. ### Structural reform progress and governance - Only modest progress on structural reforms since 1999; basic institutions and various laws (commercial contracts, accounting) adopted; Financial Institutions Law passed. - Progress slow in civil service and judicial reform due to political resistance; reform pace slowed around July 2003 elections. - Institutional and cost impediments to competitiveness: - Average cost of starting a business estimated as high as 553 percent of per capita income. - The “bribe tax” estimated at 5¼ percent of sales in manufacturing. - Average of 18 days to obtain export customs clearance (India 11 days; China 7 days). - Minimum wage of $45 a month and average of $61 a month in the garment sector; foreign investors subject to 100 percent wage premium for night shifts; restrictions on weekend/holiday operations; frequent labor strikes. - Business community estimates a 15–30 percent cost reduction required for Cambodia to remain competitive relative to China. ### Agricultural sector — constraints and social importance - About 80 percent of the poor depend on agriculture. - Agriculture contributes 40 percent to GDP and accounts for 70 percent of employment. - Sector growth during 1994-2003: annual average less than 4 percent. - Average rice yield (estimated): 2.1 tons per hectare in 2001 — the lowest in Southeast Asia. - Labor productivity example: worker in Cambodia produces 44 kg of rice vs 62 kg in Thailand. - Land and infrastructure constraints: - Only 1 percent of land area used for permanent cropland and only 7 percent of this is irrigated. - Cultivated land rose from 1.4 million hectares (mid-1980s) to about 2.4 million hectares (late 1990s), and has not increased since. - New land from de-mining (0.1 million hectares) and forest clearance (2.5 million hectares) reportedly allocated largely to the rich; NGO reports claim 0.8 million hectares approved as land concessions. - Only 10 percent of farmers have formal title to their farming land. - Of the 12,323 km existing road network, only 16.20 percent is paved. - Only 15 percent of the rural population estimated to have access to financial institutions. ### Short-term outlook (2004) and risks - Short-term outlook affected by weaker agricultural prospects (avian flu earlier in the year; smaller fish catch due to lower Mekong river level). - Non-agricultural growth expected to rebound strongly due to recovery in tourism. - Overall GDP most likely to increase by 4-4½ percent in 2004. - High petroleum product prices expected to widen the external current account deficit by another ½ percent of GDP. - Inflation likely to inch up reflecting trading partner price developments. ### Medium-term scenarios — baseline and non-adjustment (selected series) - Baseline scenario (selected annual figures shown): - Real GDP growth (percent change): 2002 5.5; 2003 5.2; 2004 4.3; 2005 1.9; 2006 4.3; 2007 5.5; 2008 5.9; 2009 6.1 - Garment (percent change): 2002 21.0; 2003 15.0; 2004 12.0; 2005 -12.0; 2006 -1.0; 2007 5.8; 2008 7.2; 2009 7.2 - Agriculture (percent change): 2002 -2.7; 2003 9.2; 2004 0.4; 2005 3.2; 2006 3.7; 2007 3.8; 2008 3.9; 2009 4.2 - Government revenue (percent of GDP): 2002 11.2; 2003 10.4; 2004 11.9; 2005 12.3; 2006 12.9; 2007 13.3; 2008 13.6; 2009 14.0 - Garment export (in US$ million): 2002 1,338; 2003 1,607; 2004 1,794; 2005 1,587; 2006 1,590; 2007 1,699; 2008 1,839; 2009 1,991 - Current account balance, excluding official transfers (in US$ million): 2002 -359; 2003 -429; 2004 -489; 2005 -545; 2006 -565; 2007 -567; 2008 -566; 2009 -567 - Gross international reserves (in US$ million): 2002 663; 2003 737; 2004 782; 2005 804; 2006 838; 2007 886; 2008 935; 2009 1,021 - Non-adjustment scenario (selected annual figures shown): - Real GDP growth (percent change): 2002 5.5; 2003 5.2; 2004 4.3; 2005 0.9; 2006 2.7; 2007 3.1; 2008 3.4; 2009 3.7 - Garment (percent change): 2002 21.0; 2003 15.0; 2004 12.0; 2005 -15.0; 2006 -5.0; 2007 -2.0; 2008 0.0; 2009 3.0 - Government revenue (percent of GDP): 2002 11.2; 2003 10.4; 2004 11.1; 2005 10.9; 2006 10.9; 2007 10.9; 2008 11.0; 2009 11.0 - Garment export (in US$ million): 2002 1,338; 2003 1,607; 2004 1,794; 2005 1,579; 2006 1,516; 2007 1,490; 2008 1,495; 2009 1,545 - Current account balance, excluding official transfers (in US$ million): 2002 -359; 2003 -429; 2004 -489; 2005 -621; 2006 -639; 2007 -647; 2008 -599; 2009 -575 - Gross international reserves (in US$ million): 2002 663; 2003 737; 2004 782; 2005 728; 2006 688; 2007 656; 2008 672; 2009 749 ### Debt sustainability — current stock, restructuring assumptions, and sensitivities - Total external public debt: $3.0 billion (71 percent of GDP) at end-2003; $1.9 billion owed to the United States and the Russian Federation. - Domestic public debt: about 5 percent of GDP (all denominated in local currency). - Baseline restructuring assumptions: - Agreement with the U.S. by mid-2004 on terms comparable to 1995 Paris Club (flow rescheduling on Naples terms): 40-year maturity, 16-year grace period, interest rate 3 percent. - Similar terms with Russian Federation after upfront discount of 70 percent. - Projected post-restructuring stocks: - Restructured debt would amount to $1.7 billion at end-2004. - Total stock outstanding at end-2004 would be $2.1 billion (46 percent of GDP), or 29 percent of GDP in NPV terms. - Public debt projections and risks: - Public debt was 75 percent of GDP at end-2003 (in one section); NPV of public debt projected to fall to 16 percent by 2023 under baseline if primary deficit kept to about 2½ percent of GDP over medium term. - NPV of public debt would still represent around 235 percent of total revenue (280 percent excluding grants) after restructuring; significant strengthening of revenue effort needed to reduce this below 200 percent after 2013. - Sensitivity tests: - One-time 30 percent real depreciation in 2004 would increase NPV debt-to-GDP from 34 percent to over 50 percent and NPV debt-to-revenue to more than 300 percent in the medium term. - A 10 percent of GDP increase in debt-creating flows in first projected year would raise NPV debt-to-GDP and debt-to-revenue to 40 percent and 270 percent respectively. - A fall in real GDP growth by two standard deviations would raise NPV debt-to-revenue to about 240 percent. - Conclusion: under baseline, debt expected to be sustainable conditional on successful restructuring, sustained growth (real GDP growth 6 percent; export growth 9 percent), broadly stable foreign aid in nominal U.S. dollars, and budgetary consolidation beginning with 2004 budget. ### Tax administration, revenue measures, and arrears - Computerization of revenue departments expected to reduce paperwork and help reduce corruption. - Measures considered: - Subjecting all telecom charges and airline tickets to a 10 percent excise. - Specific tax on kerosene, bicycles, and air-conditioners at 10 percent. - Full-year revenue impact of these measures could be as high as 0.35 percent of GDP. - Announced increase in ad-valorem tax on beer from 20 percent to 30 percent put on hold. - Arrears: - Mission estimated total domestic arrears at end-2003 around 3 percent of GDP. - Authorities to continue collecting arrears and consider restructuring the Tax Department toward taxpayer services and self-assessment. ### Public expenditure management, procurement, and civil service - PEM reforms large; Treasury reform slowed in 2003 with about two thirds of line ministries not providing timely reports. - Cash Management Committee unable to smooth government spending in 2003, causing late-year bunching. - Foregone revenue from three key contracts estimated as much as $15 million a year. - National Audit Authority to audit operations of contract holders with significant fiscal implications (noncommittal). - Civil service: public employment at some 2½ percent of total population; wage bill less than 4 percent of GDP. - Wage structure highly compressed; authorities reluctant to downsize civil service. - Studies (functional reviews, labor market analyses) expected to be completed to inform comprehensive civil service reform. ### Monetary policy, de-dollarization, and financial sector - NBC to continue intervening in foreign exchange market to stabilize excessive fluctuations; policy to stabilize “riel” inflation at low level by maintaining broadly stable exchange rate. - De-dollarization seen as beneficial long run; concerns over loss of seigniorage, lack of monetary independence, and inability to act as lender of last resort under dollarization. - Financial sector: - Bank restructuring during 2000-02 contributed to financial deepening, but bank loans as percent of GDP remain low. - NBC to monitor credit expansion; legal infrastructure improvements (Negotiable Instruments and Payment Transactions Law; Secured Transaction Law; Insolvency Law; Securities and Exchange Law) expected to facilitate collateral-based lending. - New chart of accounts implementation to improve bank information on borrowers. ### Legal, judicial, and WTO-related reform - Judicial system: civil law basis; 195 judges and prosecutors (“magistrates”); judges perceived to lack independence and expertise for commercial disputes; enforcement unpredictable and costly. - Recent steps: - Judges’ salaries raised in 2003 from $25-30 a month to $200-400 a month. - Royal School of Judges and Prosecutors established; first 55 students enrolled November 2003. - June 2003: Strategy for Legal and Judicial Reform adopted; working groups to produce action plan by mid-2004. - Short-term recommended measures (little or no donor assistance): - Adopt law on status of judges and prosecutors; ensure independence/transparency of Supreme Council of the Magistracy; establish commercial court (law expected to be passed in 2005); pass anti-corruption law with income/assets declaration provisions; publish court decisions and create law repository in Khmer and English. - WTO accession: - Accession requires adoption of 46 pieces of legislation over several years; accession package deadline extended to September 2004 due to political impasse. ### Rural development, aid allocation, and forestry - Mission recommended auditing awarded land concessions and reviewing transfer process of de-mined and de-forested land. - Authorities to consider helping farmers set up associations/cooperatives and promote micro-finance. - AsDB assisting commercialization and diversification; World Bank focusing on land concessions and titling. - Authorities noted weak administrative capacity may have required about 50 percent of all aid flows for technical cooperation; mission recommended reallocation toward agricultural infrastructure. - Forestry: ban on logging remains in place; monitoring weak; plan for community-based forestry being considered. ### Policy priorities and staff recommendations (selected) - Strengthen revenue mobilization: - Additional tax policy measures equivalent to 0.8 percent of annual GDP during second half of 2004 needed to meet 2004 revenue target (inclusive of measures announced last December). - Total cumulative revenue measures equivalent to about 2½ percent of GDP needed over 2004–09 to meet NPRS targets (requirement would rise if foreign financing declines). - Passage of Law on Customs and computerization of revenue departments emphasized. - Public financial management and procurement: - Establish MEF reform committee; National Audit Authority to audit significant contract holders and make reports public. - Civil service reform: - Early completion of delayed studies critical; implement decompression and wage increases consistent with fiscal sustainability. - Judicial and governance reforms: - Accelerate judicial reform, adopt Anti-Corruption Law and Law on the Status of Judges and Prosecutors, and establish commercial court. - Agriculture and land: - Audit economic concessions, review transfers of de-mined and de-forested land, speed up land registration; reallocate aid toward agricultural infrastructure (irrigation, roads). - Exchange rate and de-dollarization: - Maintain broadly stable exchange rate; consider gradual de-dollarization measures (e.g., require government transactions in domestic currency; issue larger denomination note) while avoiding forceful abrupt measures that could trigger capital flight. - Financial sector legal infrastructure: - Early passage of Negotiable Instruments and Payment Transactions Law, Secured Transaction Law, Insolvency Law, Securities and Exchange Law; complete new chart of accounts implementation. ### Article IV recommendation and key macro data (selected) - Next Article IV consultation recommended on the standard 12-month cycle; Executive Board concluded last Article IV consultation on February 20, 2003. - Key macro and external statistics (selected): - Nominal GDP (2002): $3,996 million - Population (2002): 13.5 million - GDP per capita (2002): $296 - Fund Quota: SDR87.5 million - Gross official reserves (selected years, in US$ million): 422; 484; 548; 663; 696; 737; 782 - Public external debt (selected, in US$ million): 2,315; 2,394; 2,489; 2,735; 1,671; 2,981; 2,088 - CPI Inflation (end of period, selected years): -0.5; -0.8; 0.7; 3.7; 3.7; 0.5; 3.2 *Source: Executive Summary and selected sections, IMF staff report (content unit: _cr04328).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Macroeconomic performance and drivers - Macroeconomic performance in the past few years was generally good, reflecting both favorable external developments and prudent fiscal policy. - Exports soared following a bilateral trade agreement with the U.S., and large aid inflows helped finance domestic investment and spurred construction activities. - Prudent fiscal policy has been key to ensuring price stability in Cambodia’s highly dollarized economy (as much as 95 percent of total liquidity, including estimated U.S. dollars in circulation, is in dollars). ### Underlying structural weaknesses - These favorable developments masked underlying structural weaknesses. - Competitiveness has deteriorated on account of poor governance—in part due to lack of progress in legal and judicial reform—which exacerbated uncertainty in the business environment. - Rudimentary infrastructure and high wages have kept operating costs high. - Slow growth in agriculture, where most of the poor make their living, has pushed Cambodia further from meeting the MDGs. ### Recent performance highlights (2003) - Non-agricultural growth slowed to 3.2 percent in 2003 due to the SARS-related drop in tourism and election-related uncertainties. - Overall GDP growth was 5.2 percent in 2003, mainly because of a strong rebound in agricultural production. - Prices remained stable reflecting low trading partner inflation and prudent fiscal policy. - Some earlier gains in fiscal revenue collection were lost in the election year. - The pace of reforms stalled in the run-up to and aftermath of the July 2003 elections; the 2004 budget law and a range of legislation needed to complete WTO accession still awaited parliament approval. ### Outlook and risks (2004–05) - Growth is expected to slow in 2004-05. - While tourism is rebounding, agricultural growth is expected to be lower than the exceptionally high growth of the previous year. - A further slowdown, possibly to below 2 percent GDP growth, is expected as Cambodia’s garment industry will be exposed to direct competition from China following the elimination of the quota system in January 2005. ### Policy priorities and requirements - A refocus of economic policies is needed to achieve the NPRS targets. - In the medium term, improving competitiveness will require a more forceful approach to addressing impediments to private sector activities, particularly the regulatory environment and governance problems. - In the long run, agricultural reforms through improved use of land and a redirection of foreign aid toward promoting agricultural growth will be essential to reduce poverty and generate employment to absorb the growing labor force. - Additional revenue mobilization is necessary to meet social spending needs and maintain fiscal sustainability; total revenue remains about 11 percent of GDP compared with an average of 16 percent of GDP in neighboring low-income countries. - Effective use of revenue and aid resources and improved service delivery hinge on comprehensive civil service reforms. - Legal and judicial reform, which has been on the government’s reform agenda for years, is critical to institute a transparent and accountable economic system. --- ### I. Background ### Political and reform context - Economic growth in the 1990s was robust, albeit from an exceptionally low base given the damage from the 20-year civil war. - UN-sponsored elections in 1993 yielded a coalition government but internal tensions persisted. Elections in 1998 produced a more durable coalition government. Tensions following the July 2003 elections delayed formation of a new government with sufficient parliamentary support until mid-July 2004; economic reforms largely came to a halt during the eleven-month stalemate. - Hun Sen’s party solidified its seats in the July 2003 national elections but not by enough to rule. A power-sharing agreement with one of the main opposition parties in June 2004 paved the way to the formation of a new coalition government in mid-July 2004. ### Structural dualism and labor market - Large aid inflows and the boom in the garment and tourism sectors helped develop a formal sector around main urban areas; rural areas, where most poor live as subsistence farmers with highly volatile incomes, were left behind. - Average household expenditure in rural areas declined from 33 percent of that in Phnom Penh in 1993/94 to 28 percent in 1999, and is estimated to have declined further to about 25 percent in 2002. - The minimum wage, which is high relative to average wages and increasingly being applied to all industries in the formal sector, reduced employment opportunities for the growing labor force. ### Poverty and human development (selected indicators) - Cambodia remained one of the poorest countries in the region with 36 percent of the population in poverty as of 1999. - Using the World Bank Atlas Method, Cambodia’s per capita gross national income is US$300. - GINI index: 40 percent (high inequality). - Rural population: 82.6 percent of total population. - Rural poverty headcount (1999): 39.2 percent; Urban: 17.7 percent. - Access to sanitation facilities (% of population): Rural 10.0; Urban 56.0. - Access to safe drinking water (% of population): Rural 26.0; Urban 54.0. - Food security and health indicators are off-track for MDGs (e.g., proportion of people suffering from hunger 36 percent vs 2015 target 19.5 percent; maternal mortality around 437 per 100,000 live births). ### Fund engagement - Cambodia’s development program was supported by a three-year PRGF arrangement for SDR 58.5 million (67 percent of quota), approved on October 22, 1999. - The sixth and final review was completed in February 2003; a disbursement of SDR 8.4 million raised total Fund credit and loans outstanding to Cambodia to SDR 70 million (80 percent of quota). - The National Poverty Reduction Strategy Paper (NPRS), together with a Fund-Bank joint staff assessment, was endorsed by the Fund and Bank Boards in February 2003. - The National Bank of Cambodia (NBC) prepares audited financial statements in accordance with International Financial Reporting Standards as required under the Fund’s safeguards policy. An IMF safeguards assessment mission in January 2004 found progress and proposed measures to strengthen remaining weaknesses. --- ### II. Recent Economic Developments and Prospects for 2004 ### Growth drivers and composition (late 1990s–2003) - Annual real GDP growth averaged 6-7 percent with the advent of political stability in 1999. - Exports surged after a bilateral trade agreement with the United States reduced average U.S. tariff rates for garments produced in Cambodia from 50-70 percent to 10-20 percent. - Garment exports to the U.S. rose from nearly zero in 1995 to $500 million in 1999 and to more than $1 billion in 2003; about 70 percent of total garment exports went to the U.S. in 2003. - The benefit to the domestic economy was limited because almost all non-labor inputs were imported. ### Aid and public investment - Large aid inflows averaged 12 percent of GDP and helped finance domestic investment and fueled construction activities. - About half of the inflows were grants in the form of donor-financed projects and technical assistance, all of which were outside the budget. - Uses of aid flows (average 1999-2003): Education and health 24%; Infrastructure 23%; Institution building 15%; Agriculture and forestry 8%; Others 30%. ### Fiscal developments - Fiscal revenue improved from 8.1 percent of GDP in 1998 to 11.2 percent in 2002 owing in part to strengthened tax and customs administration supported by the Technical Cooperation Action Plan (TCAP). - Nevertheless, total revenue remains low—about 11 percent of GDP compared with an average of 16 percent of GDP in neighboring low-income countries—severely constraining priority spending. - Civil service wages remain well below private sector wages; roads and other public facilities are poorly maintained. - Arrears to domestic suppliers have accumulated despite largely averting domestic bank financing of the fiscal deficit. ### 2003 developments and vulnerabilities - Nonagricultural growth slowed to 3.2 percent in 2003 due to SARS-related drop in tourism and election-related uncertainties. - Overall GDP growth in 2003 was 5.2 percent due to a strong rebound in agricultural production (lower Mekong river level exposed a larger area of arable land). - Revenue collection was disappointing, partly reflecting low nonagricultural growth and increased tax evasion and smuggling by importers. - Election-related spending boosted consumption but required a sharp curtailment of non-priority expenditure toward the end of the year. - The external current account deficit (excluding official transfers) widened by 1¼ percent to 10¼ percent of GDP due to buoyant merchandise imports, lower tourism receipts, and higher petroleum prices. - The vulnerability of the deposit base of the banking system was apparent during the July elections when foreign currency deposits declined by 20 percent in a matter of 1-2 weeks; they recovered later in the year. --- *Source: _Executive Summary_, IMF staff report (content unit: _cr04328 - Executive Summary).* ### 9. Only modest progress on structural reforms has been made since 1999. Basic ### _cr04328 - 9. Only modest progress on structural reforms has been made since 1999. Basic ### Progress on structural reforms since 1999 - Basic institutions and various laws (commercial contracts, accounting) were adopted. - A Financial Institutions Law was passed providing the legal basis for successful bank re-licensing. - Progress has been particularly slow in civil service and judicial reform due to political resistance. - The pace of structural reforms slowed across all sectors in the run-up to, and aftermath of, the July 2003 election. - The 2004 budget and a range of legislation needed to complete WTO accession still await approval by the National Assembly. ### Structural weaknesses and competitiveness - Reconstruction efforts have not yet established a strong foundation for sustainable growth, even in urban areas. - Three inter-related areas of structural weakness (complicated by deeply rooted governance problems) are highlighted: - An underlying deterioration of competitiveness masked by favorable external developments. - Stagnation of agricultural development due to limited access to arable land and markets. - Severely constrained government capacity due to lack of human capital and entrenched governance problems. - Specific competitiveness observations: - Garment export growth since the late 1990s mainly reflected the 1996 U.S. bilateral trade agreement and large economic rent from U.S. quotas on Chinese exporters. - Cambodia is unable to fully utilize its allocated U.S. quotas; garment exports are below quota in the U.S. market and negligible in non-U.S. markets such as Japan. - Non-garment exports have remained flat in U.S. dollar terms. - The business community estimates that a 15–30 percent cost reduction is required for Cambodia to remain competitive relative to China. - Institutional and cost impediments to competitiveness: - Average cost of starting a business estimated as high as 553 percent of per capita income (compared with 30 percent in Vietnam and 7 percent in Thailand). - The “bribe tax” is estimated at 5¼ percent of sales in manufacturing, more than double the rate in Bangladesh, Pakistan, and China. - Average of 18 days to obtain export customs clearance in Cambodia (compared with 11 days in India and 7 in China). - Minimum wage of $45 a month and an average of $61 a month in the garment sector; foreign investors subject to a 100 percent wage premium for night shifts; restrictions on weekend/holiday operations; frequent labor strikes. ### Garment export details (2003 U.S. market, subject to U.S. quota) - Quota utilization ratio, in percent: 63 93 81 50 65 79 - Exports, in million US$: 1,123 711 386 182 39 40 29 ### Agricultural sector: constraints and social importance - About 80 percent of the poor depend on agriculture for their livelihood. - Agriculture contributes 40 percent to GDP and accounts for 70 percent of employment. - During 1994-2003 the sector grew at an annual average of less than 4 percent. - Average rice yield (estimated): 2.1 tons per hectare in 2001 — the lowest in Southeast Asia. - Labor productivity example: a worker in Cambodia produces 44 kg of rice compared with 62 kg in Thailand. - Key constraints to pro-poor agricultural growth: - Lack of access to arable land: - Only 1 percent of land area is used for permanent cropland and only 7 percent of this is irrigated. - Cultivated land rose from 1.4 million hectares in the mid-1980s to about 2.4 million hectares in the late 1990s, and has not increased since. - New land from de-mining (0.1 million hectares) and forest clearance (2.5 million hectares) has reportedly been allocated largely to the rich; NGO reports claim 0.8 million hectares approved as land concessions. - Only 10 percent of farmers have formal title to their farming land. - Limited access to economic opportunities: - Of the 12,323 km existing road network, only 16.20 percent is paved (Thailand 98 percent, Malaysia 76 percent, Vietnam 25 percent). - No secondary roads; tertiary roads feed directly into primary network; rail system needs major rehabilitation. - Weak marketing systems: small-scale informal trading with Vietnam and Thailand; lack of warehouses causes price swings up to close to 100 percent between post- and pre-harvest seasons. - Absence of agricultural associations and cooperatives. - Limited access to modern farming techniques and quality inputs; dilution of imported fertilizers by middlemen. - Limited access to formal financial services: - State-owned Rural Development Bank acts as a wholesale bank mainly lending to NGO microfinance institutions. - Six micro-finance institutions licensed; the largest (Acleda) has recently obtained a commercial bank license. - None of the other commercial banks lend to farm households. - Only 15 percent of the rural population estimated to have access to financial institutions. - Barriers to public health: fees for “free” public health services due to low pay of public sector health workers. - Limited access to forestry and fisheries: 30 to 40 percent of total area left with unclear management arrangements. ### Growth, poverty, and sector shares (1994-2003; 1999 incidence) - Agriculture: Share in GDP (in 2000) 0.38; Growth 3.8; Poverty incidence (in 1999) 78.9 - Industry: Share in GDP (in 2000) 0.24; Growth 15.0; Poverty incidence (in 1999) 3.8 - Services: Share in GDP (in 2000) 0.35; Growth 4.9; Poverty incidence (in 1999) 11.0 - Total: Share in GDP (in 2000) 1.00; Growth 6.6; Poverty incidence (in 1999) 93.7 - Sources cited: NPC Statistics, MOP: A Poverty Profile of Cambodia 1999, and Cambodia Socio-Economic Survey 1999. ### Government capacity and fiscal position - Government capacity remains severely constrained by lack of human capital and entrenched governance problems. - Fiscal revenue: currently at 10.4 percent of GDP. - Fiscal revenue is hardly enough to meet basic priority spending needs. ### Short-term outlook (2004) and risks - Outlook for 2004 affected by weaker agricultural prospects: - Avian flu earlier in the year. - Smaller fish catch due to lower Mekong river level. - Agricultural production unlikely to be much higher than last year’s bumper crop. - Non-agricultural growth expected to rebound strongly due to recovery in tourism. - Overall GDP most likely to increase by 4-4½ percent. - Impact of high petroleum product prices expected to widen the external current account deficit by another ½ percent of GDP. - Inflation likely to inch up reflecting price developments in trading partner countries. ### Medium-term prospects, quota elimination risk, and scenarios - Urgent agricultural reform essential to achieve NPRS poverty reduction objectives. - Cambodia can no longer rely on the garment sector as engine of growth; elimination of the quota system in January 2005 will expose exporters to direct competition from China (production costs estimated 15 to 30 percent lower in China). - Possible outcomes and risks: - Value of garment exports could decline by 12 percent in 2005, which might reduce GDP growth to below 2 percent. - Depreciation of the exchange rate likely to have only limited impact on competitiveness because most costs, including wages, are denominated in U.S. dollars. - Quota-related safeguards in the U.S. (product specific until 2013; special textiles safeguard until 2008) could buy time but are uncertain. - Baseline scenario (selected annual figures shown): - Real GDP growth (percent change): 2002 5.5, 2003 5.2, 2004 4.3, 2005 1.9, 2006 4.3, 2007 5.5, 2008 5.9, 2009 6.1 - Garment (percent change): 2002 21.0, 2003 15.0, 2004 12.0, 2005 -12.0, 2006 -1.0, 2007 5.8, 2008 7.2, 2009 7.2 - Agriculture (percent change): 2002 -2.7, 2003 9.2, 2004 0.4, 2005 3.2, 2006 3.7, 2007 3.8, 2008 3.9, 2009 4.2 - Government revenue (percent of GDP): 2002 11.2, 2003 10.4, 2004 11.9, 2005 12.3, 2006 12.9, 2007 13.3, 2008 13.6, 2009 14.0 - Garment export (in US$ million): 2002 1,338, 2003 1,607, 2004 1,794, 2005 1,587, 2006 1,590, 2007 1,699, 2008 1,839, 2009 1,991 - Current account balance, excluding official transfers (in US$ million): 2002 -359, 2003 -429, 2004 -489, 2005 -545, 2006 -565, 2007 -567, 2008 -566, 2009 -567 - Gross international reserves (in US$ million): 2002 663, 2003 737, 2004 782, 2005 804, 2006 838, 2007 886, 2008 935, 2009 1,021 - Non-adjustment scenario (selected annual figures shown): - Real GDP growth (percent change): 2002 5.5, 2003 5.2, 2004 4.3, 2005 0.9, 2006 2.7, 2007 3.1, 2008 3.4, 2009 3.7 - Garment (percent change): 2002 21.0, 2003 15.0, 2004 12.0, 2005 -15.0, 2006 -5.0, 2007 -2.0, 2008 0.0, 2009 3.0 - Government revenue (percent of GDP): 2002 11.2, 2003 10.4, 2004 11.1, 2005 10.9, 2006 10.9, 2007 10.9, 2008 11.0, 2009 11.0 - Garment export (in US$ million): 2002 1,338, 2003 1,607, 2004 1,794, 2005 1,579, 2006 1,516, 2007 1,490, 2008 1,495, 2009 1,545 - Current account balance, excluding official transfers (in US$ million): 2002 -359, 2003 -429, 2004 -489, 2005 -621, 2006 -639, 2007 -647, 2008 -599, 2009 -575 - Gross international reserves (in US$ million): 2002 663, 2003 737, 2004 782, 2005 728, 2006 688, 2007 656, 2008 672, 2009 749 - Debt implications: - Public debt was 75 percent of GDP at end-2003. - If Cambodia reaches a debt rescheduling agreement with the Russian Federation and the United States on comparable terms to the 1995 Paris Club agreement, Cambodia’s net present value (NPV) of public debt at the end of 2004 would be reduced to 33 percent of GDP. - The NPV of public debt would still represent around 235 percent of total revenue (280 percent excluding grants); a significant strengthening of the revenue effort would be needed to reduce this below 200 percent after 2013. - In the non-adjustment scenario the NPV of public debt will reach about 230 to 250 percent of fiscal revenue, threatening fiscal sustainability. ### Policy discussions and fiscal measures - Authorities were more sanguine than the mission about prospects, citing efforts to reduce red tape and adherence to core labor standards, and new investment proposals. - The mission argued that additional tax policy measures equivalent to 0.8 percent of annual GDP during the second half of 2004 would be needed to meet the revenue target (inclusive of measures announced last December). - Authorities saw scope for additional revenue from strengthened anti-smuggling efforts but expressed doubts about implementing 0.8 percent of GDP measures in the remainder of 2004. - To meet NPRS targets, total cumulative revenue measures equivalent to about 2½ percent of GDP will be needed over 2004–09; this requirement would rise if foreign financing declines from current levels. - Authorities agreed to avoid recourse to domestic bank financing to help contain riel inflation. - Spending priorities and wage policy: - Continued tight lid on non-wage and non-social spending would allow a modest increase in the wage bill from an average salary of $34 a month in 2003 to $80 a month by 2008. - This would aim to improve the primary balance to a level consistent with a sustainable fiscal path by 2007. - Fiscal pressures noted: - Domestic-financed capital spending will be substantially compressed because of compensation payments to Thailand, higher interest payments following possible closure of debt rescheduling negotiations, and settlement of a portion of the stock of arrears to domestic suppliers. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 19. The authorities agreed that computerization of the revenue departments will ### _cr04328 - 19. The authorities agreed that computerization of the revenue departments will ### Tax administration, revenue measures, and arrears - Computerization of the revenue departments is expected to reduce paperwork and keep track of collections, a key to reducing corruption. - Measures considered: - Subjecting all telecom charges and airline tickets to a 10 percent excise. - Introducing a specific tax on kerosene, bicycles, and air-conditioners at 10 percent. - The full-year revenue impact of these measures could be as high as 0.35 percent of GDP. - The announced increase in the ad-valorem tax on beer from 20 percent to 30 percent has been put on hold. - Enforcement and collection: - Faced with strong resistance, the authorities are not yet fully enforcing these measures. - While comprehensive data are not available, the mission estimated total domestic arrears at end-2003 to be around 3 percent of GDP, including unsettled outstanding operations from previous years and payment orders during 2003 in excess of cash released. - Authorities will continue to collect arrears (receivables) to institute a tax-paying culture. - Authorities were receptive to restructuring the Tax Department to one based on taxpayer services, education, and self-assessment. - Customs reforms: - Passage of the Law on Customs, which the new government should re-submit to parliament without further delays, is considered crucial to strengthen enforcement and reduce smuggling. - Authorities will collaborate with other law enforcement agencies to monitor closely large urban distribution centers where smuggled products are alleged to be sold. ### Public procurement, contracts, and fiscal oversight - The authorities are more cautious in awarding government contracts following experience with Build-Operate-Transfer contracts awarded through direct negotiations that resulted in actual payments to the Treasury well below expectations. - The mission estimated that foregone revenue from three key contracts signed in recent years could be as much as $15 million a year. - Audit and oversight: - Authorities agreed on the need for the National Audit Authority to audit the operations of existing contract holders with significant fiscal implications to verify compliance with contract terms (noncommittal). - Procurement reform: - The World Bank’s proposed overhaul of procurement and concession legislation, stressing competitive bidding, is expected to help address part of the problem in the medium term. - The Ministry of Economy and Finance (MEF) stopped awarding a power project to a private company and asked the IFIs to provide an assessment of the proposal. - The World Bank and the AsDB will identify the least cost national power development plan, against which the current and any future projects can be compared. ### Public expenditure management (PEM) - Reform status and problems: - The public expenditure management reform agenda remains large. - Reform of the Treasury slowed in 2003: about two thirds of line ministries still do not provide timely reports of their transactions to the Treasury. - Foreign currency units within the MEF manage their accounts separately. - Partly reflecting a revenue shortfall, the Cash Management Committee was unable to smooth out the government’s spending commitments during 2003, resulting in yet another late-year bunching of spending and earmarking of next year’s tax receipts. - Social spending and reform coordination: - Disbursements under the Priority Action Plan for social spending had accelerated, and the backlog was expected to be fully cleared by early 2005. - The MEF has established a reform committee to better coordinate and monitor PEM reform; the committee will also serve as counterpart to a donor technical working group under a Sector-Wide-Approach to PEM reform. - Authorities committed to improving the effectiveness of public spending once lessons are learned from the World Bank’s ongoing expenditure tracking study. ### Civil service, wages, and public employment - Studies and facts: - Public employment is at some 2½ percent of the total population, and an associated wage bill of less than 4 percent of GDP are within international norms. - Civil service wages are well below that of the formal private sector, and the wage structure is highly compressed. - Reform stance: - Authorities reluctant to downsize the civil service because of social concerns amid rising unemployment. - Authorities expect to complete key studies, substantially delayed, within the next few months; these studies are critical inputs to a comprehensive civil service reform strategy in consultation with the World Bank. - The studies include functional reviews and labor market analyses to identify adequate remuneration. - The government was less committal on demobilization, which had stalled since the first phase was completed in late 2002. ### Monetary and exchange rate policy - Exchange rate intervention and objectives: - The central bank will continue to intervene in the foreign exchange market to stabilize excessive fluctuation of the exchange rate. - The mission supported the NBC’s policy to stabilize “riel” inflation at a low level by maintaining a broadly stable exchange rate. - At the same time, the authorities should not preclude an exchange rate adjustment if fundamental changes in underlying market conditions exert pressure in the foreign exchange market. - De-dollarization: - The mission agreed with the NBC that Cambodia would benefit from de-dollarizing the economy in the long run. - Concerns with dollarization include loss of seigniorage, lack of monetary policy independence, and the central bank’s inability to act as a lender of last resort, which could threaten financial stability. - The United States now accounts for 25 percent of Cambodia’s gross external trade; this is expected to decline after the elimination of the quota system. - De-dollarization initiatives, such as requiring that all government transactions be conducted in domestic currency, could be considered, but forceful administrative measures or political uncertainty could immediately translate into capital flight due to lack of confidence in riel. ### Financial sector, laws, and credit - Banking and finance: - Commercial banks have played only a limited role in facilitating investment finance. - While successful bank restructuring during 2000-02 contributed to financial deepening, bank loans in percent of GDP remain well below those in other countries in the region. - NBC agreed to closely monitor credit expansion given weak bank credit risk assessment capacity, incomplete legal infrastructure for enforceability of financial contracts, and lack of reliable borrower information. - Legal and accounting reforms expected to help: - Passage of the Negotiable Instruments and Payment Transactions Law, the Secured Transaction Law, the Insolvency Law, and the Securities and Exchange Law is expected to reduce payment system risks and provide a legal basis for collateral-based lending. - Early completion of the implementation of the new chart of accounts and the accounting law will provide banks better information on potential borrowers. ### Private sector regulatory environment and governance - Constraints on private sector activity: - Private sector activities are deterred by the high costs of inputs and governance problems, as confirmed in a recent World Bank analysis. - High input cost associated with poor infrastructure and human capital needs to be addressed. - In the short run, authorities will consider revisiting provisions for overtime, nightshift, and holiday pay—while upholding core labor standards—to reduce labor costs. - Greater wage flexibility is needed; the minimum wage was segmenting the labor market, hindering growth in employment. - Governance and judiciary: - Establishing an independent and well functioning judiciary within a transparent legal framework is considered a basic prerequisite to creating a conducive business environment. - Strong political commitment is required to urgently address administrative impediments to investment and the high informal fees. - WTO accession and legal framework: - Most laws to strengthen the legal and judicial system are still in draft form. - Once the accession package is adopted by the National Assembly, Cambodia will become, along with Nepal, one of the first low-income countries to join the WTO. - Accession requires adoption of 46 pieces of legislation over the next several years, ranging from judicial reform to trade related property rights. - In view of the political impasse, the WTO has granted an extension to September 2004, by which time the accession package needs to be adopted by parliament. ### Legal and judicial reform (Box 4 summary) - Current state: - Cambodia’s legal system is based on civil law; the Constitution adopted in 1993 provides for separation of powers and establishes the judiciary as an independent institution. - Cambodia’s judicial institutions comprise provincial and municipal courts, Appeals Court, Supreme Court, and military courts; there are no specialized commercial courts or independent arbitration, except the recently established labor arbitration council whose decisions are neither mandatory nor subject to enforcement. - There are currently 195 judges and prosecutors (“magistrates”). - Judges have little expertise or experience to handle commercial disputes, are widely perceived to lack independence from political influence, and enforcement of court decisions is unpredictable and costly. - Recent developments: - Salaries of judges were raised in 2003 from $25-30 a month to $200-400 a month. - The Royal School of Judges and Prosecutors was established and enrolled the first 55 students in November 2003, for graduation in 24 months. - In June 2003, the government adopted the Strategy for Legal and Judicial Reform; working groups were tasked to produce an action plan that will prioritize reform measures by mid-2004. - Short-term measures recommended that require little or no donor assistance: - Adopting the law on the status of judges and prosecutors to establish appointment process and terms and conditions of service, including a code of conduct. - Taking concrete steps to ensure the independence and transparency of the operation of the Supreme Council of the Magistracy to enable it to fulfill its constitutional functions. - Establishing a commercial court that will specialize in commercial dispute resolution; a law on the commercial court is currently being prepared and is expected to be passed in 2005. - Passing an anti-corruption law that establishes an effective framework for investigation and prosecution of corruption offences and provides for declaration of income and assets by government officials; and preparing the implementing regulations. - Publishing all court decisions and creating a repository of all laws in Khmer and in English. ### Rural development, agriculture, and aid allocation - Agricultural development and land use: - Progress in agricultural development has been slow. - Cultivated land area had not increased since the late 1990s despite ample unused land. - The mission recommended auditing already awarded land concessions and reviewing the transfer process of ownership of de-mined and de-forested land. - Combined with limited land use and low agricultural productivity, population growth is estimated to have worsened poverty. - Authorities noted progress in distributing land to farmers and did not agree that poverty was on the rise; they were concerned about demographic developments bringing large inflows of young people into the labor market. - Market access and organization: - Lack of roads and information on prices limits small scale farmers’ ability or incentive to sell produce in competitive markets. - Absence of a clear land registration system has weakened incentives to improve land productivity by building irrigation systems. - Authorities would consider helping farmers set up agricultural associations and cooperatives to improve access to market information, bargaining position, and financial resources. - Rural finance and donor support: - The mission endorsed the NBC’s strategy to reduce lending rates in rural areas through increased competition among lending institutions. - The AsDB is providing assistance in commercialization of agriculture, diversification of crops, and land management; the World Bank is focusing on land concessions and titling. - Aid allocation: - Authorities saw a need to review, together with donors, the current allocation of foreign aid flows. - Weak administrative capacity may have required about 50 percent of all aid flows to be used for technical cooperation, but a re-allocation may be needed to more directly address poverty and boost long-term growth. - The enormous investment needs of the agricultural sector argue for greater allocation of resources for building infrastructure to support irrigation systems and roads to markets. - Forestry and environment: - Unsustainable logging has destroyed a valuable source of income and contributed to soil erosion. - Although the ban on logging remains in place, monitoring of log transportation and other forest crime prevention schemes remains weak. - Authorities reiterated commitment to retain the ban on logging until sustainable forest management plans are put in place. - A plan for community based forestry to safeguard livelihoods of local communities is being considered. - More forceful action is required by the government to incidents reported by the Société Générale de Surveillance, the new independent forestry monitoring firm. ### Other issues - External debt negotiations: - Authorities are continuing dialogue with the Russian Federation and the United States to reach agreement on debt rescheduling. - The latest proposal from the Russian Federation involves an upfront cash payment and substantial debt cancellation; Cambodian authorities are seeking further clarification and intend to intensify negotiation with the United States. - Tariff classification and levels: - In accordance with Cambodia’s commitment under ASEAN, its tariff lines were recently reclassified to the ASEAN Harmonized Tariff Nomenclature (AHTN). - The authorities confirmed that even after the conversion to AHTN, their unweighted average tariff remained unchanged at 15 percent. *Source: _cr04328 - 19. The authorities agreed that computerization of the revenue departments will* ### 16.5 percent in 2003 to 15 percent under the old tariff nomenclature. ### _cr04328 - 16.5 percent in 2003 to 15 percent under the old tariff nomenclature. ### Aid composition (average 1999-2003) - Technical assistance, 45% - Investment, 39% - Budgetary support, 8% - Food aid, 7% ### Statistical framework and capacity - Cambodia’s statistical framework is being upgraded but substantial weaknesses remain. - Authorities agreed on the need to start relying more on their own resources and training to strengthen technical capacities. - The revenue situation makes it unlikely that any meaningful amount of resources would be allocated to statistics from the budget. - Staff recommendation: rely more on domestic resources and training; if donor financing is lacking, consider shifting resources within the current budget. ### Anti–money laundering (AML) - A draft comprehensive anti-money laundering law is being prepared with the assistance of LEG and MFD. - An interministerial working group, headed by the NBC, was charged with preparing the draft law. - The Prime Minister has instructed that a Financial Investigation Unit be set up at the NBC. - Mission outlook: welcomes progress on the AML law and looks forward to its adoption. ### Ex-Post Assessment (EPA) — authorities’ reactions and observations - Authorities welcomed the draft EPA as a useful review and foundation for future reform plans; they agreed the EPA: - Gave appropriate consideration to adverse initial conditions. - Provided a good description of developments under Fund-supported programs. - Presented a balanced assessment of policy strengths and weaknesses. - Agreed findings and intentions: - Poverty remained pervasive and governance problems widespread. - Support for the EPA’s strategy for future engagement with the Fund; desire to start discussions on a new PRGF soon. - Need to maintain stability to achieve high growth and reduce poverty; fiscal policy will continue to play a central role. - Intention to enhance revenue and strengthen expenditure control. - Agreement on steps to achieve de-dollarization, while noting limited impact of flexible exchange rate while market remains shallow and dollarization widespread. - Intention to gear policy efforts toward meeting the NPRS goals, particularly by expediting structural reforms to enhance growth’s impact on poverty reduction. - Recognition that governance problems extend beyond the public sector (corporate sector and NGOs). - Focus on short-term agricultural measures (enhancing marketing channels, institutionalizing micro-finance in rural areas). - Need to enhance the informational database to analyze aid effectiveness; actual aid inflows may be less than recorded because they include donors’ overhead costs. - View that technical cooperation aid was adequate given depleted human capital, but greater use of local staff by donors would promote ownership and save financial resources. - Noted progress in donor coordination efforts, including developing a framework to enhance public sector financial management in consultation with Bank, Fund, and other donors. ### Authorities’ request to the Fund - Continue to provide policy advice, more focused technical assistance, and financial support. - Desire to start discussions on an economic program supported by a PRGF arrangement. - An arrangement would help strengthen Cambodia’s official international reserve position and contain possible adverse effects from the forthcoming elimination of the garment quota. - An arrangement would also underpin a framework for donor coordination and encourage domestic reform efforts. - Emphasis on ensuring technical assistance is used effectively by choosing the right counterparts and training local trainers. ### Staff appraisal — key findings and policy recommendations - Progress and challenge - Cambodia has rebuilt its economy substantially since civil strife, but poverty remains pervasive and recent narrow-based growth has not addressed it. - Nurturing the agricultural sector is urgent, especially given loss of reliance on the garment sector after the elimination of the quota system in early 2005. - Agriculture and land - Limited access to arable land is a key impediment to agricultural growth. - Staff urges focus on land issues: audit awarded economic concessions; review transfers of ownership of de-mined and de-forested land; speed up land registration. - Recommend reviewing current allocation of foreign aid flows with donors to refocus on agricultural development. - Growth and competitiveness - Need to attract foreign investment; reduce high input costs from poor infrastructure and human capital; establish a sound regulatory environment. - Short-run scope: cut cumbersome red tape and high informal fees; allow greater wage flexibility—especially important in a dollarized environment where exchange rate cannot be used to improve competitiveness. - Judicial and governance reforms - Accelerate judicial reform to address governance problems rooted in economic activities. - Weakness of judiciary evident: no reported prosecutions for business-related activities or corruption since reconstruction began in early 1990s. - Staff looks forward to adoption of the anti-corruption law and the law on the status of judges and prosecutors, and establishment of a commercial court. - WTO accession will help create required legal framework, but benefits depend on proper and forceful enforcement. - Fiscal policy and revenue mobilization - Macroeconomic stability has supported robust growth; fiscal policy must continue to play a central role. - Attaining medium-term fiscal objectives hinges critically on success of additional revenue mobilization. - To meet the 2004 revenue target, additional tax policy measures equivalent to 0.8 percent of GDP (inclusive of measures announced last December) will be needed in the second half of this year. - Over the medium term, meeting NPRS targets for higher social spending and rural infrastructure requires commitment to improve revenue collection through additional tax policy measures and strengthening tax and customs administration. - Computerization in the revenue departments and passage of the Law on Customs are crucial to strengthen enforcement capabilities. - Public financial management and procurement - Agenda for fiscal management reform is large; establishment of the MEF reform committee offers opportunity to promote ownership and internalization of technical assistance. - Staff recommends the National Audit Authority audit operations of existing contract holders with significant fiscal implications to verify compliance; audit reports should be made public. - Civil service reform - Overhauling the civil service and its wage structure is essential to improve government effectiveness. - Early completion of ongoing studies (substantially delayed) is critical to prepare a comprehensive civil service reform strategy in consultation with the World Bank. - Exchange rate and de-dollarization - Staff supports NBC policy of intervening in the foreign exchange market to stabilize excessive fluctuations. - Suggest maintaining a broadly stable exchange rate, barring fundamental market changes. - Staff agrees with NBC that Cambodia would benefit from de-dollarizing in the long run. - Possible de-dollarization initiatives: require all government transactions in domestic currency; issue a larger denomination note. - Warning: forceful and abrupt administrative measures or political uncertainty could immediately translate into capital flight. - Financial sector legal infrastructure - Strengthen legal infrastructure to promote sound financial intermediation. - Staff looks forward to early passage of: Negotiable Instruments and Payment Transactions Law, Secured Transaction Law, Insolvency Law, and Securities and Exchange Law. - Early completion of implementation of the new chart of accounts and the accounting law will provide banks better information on potential borrowers. - Risks of delay - Failure to push reform agenda—particularly business environment improvements and accelerated agricultural reforms—will jeopardize attaining NPRS targets. - Governance reforms, especially judiciary reform, require strong political commitment; further delays could reduce donor financing and threaten fiscal sustainability. - Debt rescheduling - Staff welcomes continued dialogue with the United States and the Russian Federation to seek ways to complete debt rescheduling negotiation and looks forward to an early completion. - Statistical capacity and AML (reaffirmed) - Cambodia’s statistical framework is being upgraded but substantial weaknesses remain; need to rely more on domestic resources and training; if donor financing lacking, shift resources within current budget. - Progress noted in preparation of a new comprehensive anti-money laundering law; mission looks forward to its adoption. *Source: _cr04328 - 16.5 percent in 2003 to 15 percent under the old tariff nomenclature.* ### 54. It is recommended that the next Article IV consultation take place on the ### _cr04328 - 54. It is recommended that the next Article IV consultation take place on the ### Recommendation on Article IV consultation - It is recommended that the next Article IV consultation take place on the standard 12-month cycle. - The Executive Board concluded the last Article IV consultation on February 20, 2003. - Cambodia is subject to the provisions on consultation cycles approved on July 15, 2002. ### Key macroeconomic and external statistics (selected) - Nominal GDP (2002): $3,996 million - Population (2002): 13.5 million - GDP per capita (2002): $296 - Fund Quota: SDR87.5 million - Gross official reserves (selected years, in millions of U.S. dollars): 422, 484, 548, 663, 696, 737, 782 - Net international reserves (selected years, in millions of U.S. dollars): 349, 411, 468, 567, 604, 633, 670 - Exchange rate (riels per dollar; end of period examples): 3,775; 3,910; 3,900; 3,935; 4,095; 3,980 - Public external debt (selected, in millions of U.S. dollars): 2,315; 2,394; 2,489; 2,735; 1,671; 2,981; 2,088 - Public external debt (in percent of GDP, selected): 66.5; 66.8; 67.2; 68.4; 39.8; 70.8; 46.3 - Current account (excl. official transfers, selected years, in percent of GDP): -13.2; -11.7; -9.4; -9.0; -10.4; -10.2; -10.8 - Current account (incl. official transfers, selected years, in percent of GDP): -5.2; -2.9; -1.2; -1.2; -3.0; -2.4; -3.3 - CPI Inflation (end of period, selected years): -0.5; -0.8; 0.7; 3.7; 3.7; 0.5; 3.2 - Broad money (12-month percent change, selected): 17.3; 26.9; 20.4; 31.1; 15.3; 14.1 ### Performance indicators and projections (1998–2004 and medium term) - Real GDP growth (selected series): 10.8; 7.0; 5.7; 5.5; 5.0; 5.2; 4.3 - National saving (selected, percent of GDP): 11.8; 14.4; 20.1; 21.3; 13.9; 18.6; 16.7 - Domestic investment (selected, percent of GDP): 17.0; 17.3; 21.2; 22.2; 16.9; 21.0; 20.0 - Government saving (selected, percent of GDP): 1.6; 1.4; 1.1; 1.2; 1.1; -0.6; 1.2 - Overall budget balance (including grants, percent of GDP, selected): -1.3; -2.1; -2.8; -3.8; -3.4; -4.5; -3.8 - Net foreign financing (selected, percent of GDP): 3.9; 5.1; 5.2; 7.0; 6.5; 6.0; 6.1 - Current account projections (2004–09, in millions of U.S. dollars and percent of GDP): - Current account (excluding official transfers) projections (2004–09, in millions of U.S. dollars): -489; -545; -565; -567; -566; -567 - Current account (including official transfers) projections (2004–09, in millions of U.S. dollars): -151; -197; -206; -198; -190; -183 ### Fiscal sector and budgetary indicators - Total revenue (2000–04, in percent of GDP examples): 10.2; 10.4; 10.7; 11.2; 10.4; 11.8; 11.9 - Tax revenue (percent of GDP, selected): 7.4; 7.6; 7.8; 7.9; 8.5; 7.3; 8.2 - Total expenditure (percent of GDP, selected): 15.3; 16.3; 17.8; 17.2; 19.0; 17.4; 18.0 - Current expenditure (percent of GDP, selected): 8.5; 8.9; 9.6; 10.1; 11.4; 11.0; 10.7 - Capital expenditure (percent of GDP, selected): 5.5; 6.5; 6.7; 7.9; 7.3; 7.3; 7.3 - Overall balance (including grants, percent of GDP): -2.1; -2.8; -3.8; -2.4; -4.5; -1.8; -3.8 ### Fiscal reform agenda (Table 6) — key measures and timing - I. Tax Policy Reforms - Implement measures in 2004 H2 to yield 0.8 percent of GDP (Timing: 2004) - Enforce Tax Law amendments on depreciation, withholding on payments to non-residents, and provisions related to NGOs and IFIs (Timing: 2004) - Introduce additional measures to reach revenue target of 14 percent of GDP (Timing: 2006-09) - II. Revenue Administration - Tax Administration: Collect tax arrears, including through escalating penalty measures (Timing: 2004-07); Adopt new organization structure, expand staff and training, and add Appeals Unit (Timing: 2004-06); Complete de-registration program and implement new audit program (Timing: 2003-07); Extend Large Taxpayer Unit procedures to medium taxpayers (Timing: 2004-06); Establish new computerization program for collection, audit, and cross-checking (Timing: 2004-05); Provide training on international audit and tax avoidance (Timing: 2006-07). - Customs administration: Adopt Law on Customs and promulgate supporting regulations (Timing: 2004); Strengthen anti-smuggling efforts (Timing: continuous); Automate Customs systems and procedures (Timing: 2004-05); Reduce number of required inspections to facilitate trade (Timing: 2004-05); Implement new organization structure (Timing: 2005-06); Establish Customs Fraud Investigation Unit (Timing: 2005-07). - Nontax revenue administration: Consolidate various non-tax revenue units in one department (Timing: 2004-05); Identify and start collecting nontax arrears (Timing: 2004-06); Audit operations of contracts and leases to verify compliance (Timing: continuous); Review financial terms of contracts with significant fiscal implications (Timing: 2005-07). - III. Expenditure Policy - Reduce arrears: Make provisions in annual budgets for eliminating arrears by 2008 (Timing: 2004-08). - Social spending: Raise spending to reach NPRS target of 37 percent of current expenditure (Timing: 2005); Reduce the share of spending on executive functions and overheads (Timing: 2005-07). - Defense: Reduce spending to meet NPRS target of 19.4 percent of current expenditure (Timing: 2005). - Civil service: Based on studies completed in 2004, begin implementation of reforms, including decompressing the wage structure (Timing: 2005-07). - IV. Budgetary Process - Budget system: Establish an Interdepartmental Committee to implement reforms (Timing: 2004); Adopt first phase reform program under an enhanced framework of donor coordination (Timing: 2004); Use input from revenue departments and line ministries on monthly projections (Timing: 2003-07); Gradually unify the budget system, including foreign currency units (Timing: 2003-06). - MTEF: Synchronize preparation of MTEF with annual budget cycle (Timing: 2004-07); Expand coverage of MTEF to include all ministries (Timing: 2005-06); Integrate MTEF with the medium-term wage framework and public investment program (Timing: 2005-06). - Treasury reform: Introduce new chart of accounts and revise coding system (Timing: 2003-06); Transfer the banking function of the NT to banks (Timing: 2004-06). - Cash management: Develop financial control and internal audit within ministries (Timing: 2004-06). - Procurement: Strengthen legal framework and create Central Procurement Monitoring Office (Timing: 2004-05). ### Legal and WTO-related legislative schedule (Table 7) — highlights - Several laws adopted or expected for WTO conformity; note: "Due to the political impasse, the expected dates of enactment are now delayed by about a year." - Examples of adopted laws: Ratification of the New York Convention on the Enforcement of Foreign Arbitral Awards; Law on Trademarks and Acts of Unfair Competition; Law on Protection of Patent, Utility Models, and Industrial Designs; Law on Copyrights and Related Rights; Sub-decree on Animal Quarantine; Sub-Decree on Plant Quarantine; Accounting Law; Forestry Law; Land Law. - Examples of expected laws: Law Establishing the Commercial Court; Commercial Arbitration Law; Civil Code; Civil Procedure Code; Criminal Code; Criminal Procedure Code; Law on Geographical Indications Including Appellation of Origin; Laws on Layout Designs of Integrated Circuit; Law on Plant Variety Protection; Law on Protection of Undisclosed Information; Custom Code; Law on Rule of Origin; Law on Anti-dumping Measures and on Countervailing Measures; Law on Export Processing Zones; Negotiable and Payment Transaction Law; Insolvency Law; Secured Transaction Law; Securities and Exchange Law; Commercial Leasing Law; Water Supply Law; Water Resources Management Law; Telecommunication Law; Tourism and Entertainment Law; Civil Aviation Law; Merchant Shipping Law; Land Traffic Law (Highway Code); Fisheries Law; Commercial Contracts Law; Commercial Agency Law; Competition Law; Law on Safeguard Measures; Law on Business Enterprises. ### Fund relations, technical assistance, and safeguards - Membership Status: Joined: 12/31/1969; Article XIV. - Quota: 87.50 (SDR Million), Percent Quota 100.00. - Net cumulative SDR allocation: 15.42 (SDR Million), Percent Allocation 100.00; Holdings 0.15. - Outstanding PRGF arrangements: 65.50 (SDR Million), Percent Quota 74.86. - Financial arrangements history: ESAF/PRGF approval 10/22/1999, expiration 03/05/2003, amount approved 58.50 (SDR Million), amount drawn 58.50 (SDR Million); ESAF 05/06/1994–08/31/1997, amount approved 84.00 (SDR Million), amount drawn 42.00 (SDR Million). - Projected obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs), forthcoming by year (selected): 2004 Principal 2.80; 2005 Principal 5.87; 2006 Principal 4.18; 2007 Principal 7.52; 2008 Principal 10.86. Charges/Interest forthcoming examples: 2004 0.30; 2005 0.58; 2006 0.55; 2007 0.52; 2008 0.47. - Safeguards assessment: National Bank of Cambodia (NBC) subject to a full safeguard assessment for a possible successor PRGF Arrangement; assessment completed on March 24, 2004; specific measures proposed to address a few weaknesses. - Exchange rate arrangement (as of July 25, 2004): official exchange rate CR 4,024 per U.S. dollar; market rate CR 4,038 per U.S. dollar. Since November 8, 1992, two-rate arrangement: official (for government and state enterprises) and market (for other transactions); official rate adjusted to limit spread to no more than 1 percent on a daily basis. Cambodia accepted obligations of Article VIII, Sections 2, 3, and 4 on January 1, 2002; maintains an exchange system free of restrictions on payments and transfers for current international transactions. - Technical Assistance: Comprehensive Technical Cooperation Action Plan (TCAP) adopted in May 2001; TCAP arrangement ended in mid-2004 following a six-month extension. Fund technical assistance remains intensive but will be gradually phased out (Annex VI). A resident Treasury Advisor assigned in June 2004 for 6 months. An FAD review mission scheduled for October 2004 to review revenue administration reforms and assist in defining future reform framework. - Resident Representative: Resident representative office reopened end-October 1999; Mr. Hagemann is currently the Resident Representative. *Source: _cr04328 - 54. It is recommended that the next Article IV consultation take place on the (IMF staff report content provided).* ### 1. Under the staff’s baseline scenario, Cambodia’s debt is expected to be ### 1. Under the staff’s baseline scenario, Cambodia’s debt is expected to be sustainable. ### A. The Current Situation - Cambodia’s total external public debt was $3.0 billion (71 percent of GDP) at end-2003, of which $1.9 billion was owed to the United States and the Russian Federation. - Other external debts were owed largely to multilateral creditors on highly concessional terms. - Domestic public debt, all denominated in local currency, accounted for about 5 percent of GDP. - Restructuring the debts to the United States and the Russian Federation, which together account for 64 percent of total external debt, is critical for securing debt sustainability. - Baseline assumptions for restructuring: - Agreement with the U.S. by mid-2004 on comparable terms to the 1995 Paris Club agreement (i.e., flow rescheduling on Naples terms). - Terms assumed: 40-year maturity, a 16-year grace period, and an interest rate of 3 percent. - Similar terms assumed on the debt owed to the Russian Federation, after an initial upfront discount of 70 percent. - Projected debt after restructuring: - The restructured debt would amount to $1.7 billion at the end of 2004. - The total stock of outstanding debt at the end of 2004 would amount to $2.1 billion (46 percent of GDP), or 29 percent of GDP in net present value (NPV) terms. - Baseline macro assumptions underpinning the outlook: - Sustained real GDP growth of 6 percent. - Export growth of 9 percent. - Broadly stable foreign aid in nominal U.S. dollars. - Budgetary consolidation beginning with the 2004 budget, requiring discretionary tax revenue measures and improvements in tax and customs administration. ### B. Public Debt Sustainability - Projected path: - Cambodia’s stock of public debt is projected to decline after an initial increase from 34 percent of GDP in 2004 to 35 percent of GDP in 2006 in NPV terms. - In the baseline scenario, total public sector debt in NPV terms is expected to fall to 16 percent by 2023 if the primary deficit is kept to about 2½ percent of GDP over the medium term and to about 3 percent of GDP in the longer run. - Fiscal vulnerabilities: - The NPV of the debt-to-revenue ratio at 237 percent in 2004 is high, reflecting the weak revenue base. - Failure to improve revenue collection steadily over time would undermine public debt sustainability. - Methodology note: - Standard Fund templates for low income countries and sensitivity tests are used to assess Cambodia’s debt dynamics. Tests involve applying temporary deviations of key variables from the baseline with magnitudes based largely on historical deviations. ### Sensitivity Tests — Public Debt - A one-time 30 percent real depreciation in 2004 (test B5): - Would increase the NPV of the debt-to-GDP ratio from 34 percent of GDP in the baseline to over 50 percent of GDP. - Would increase the NPV of the debt-to-revenue ratio to more than 300 percent in the medium term. - A 10 percent of GDP increase in debt-creating flows in the first projected year (test B6), such as might arise from an unexpected realization of contingent liabilities: - Would increase the NPV of the debt-to-GDP and debt-to-revenue ratios to 40 percent and 270 percent, respectively. - A fall in real GDP growth by two standard deviations from its recent average (test B4), which corresponds broadly to the difference between the GDP growth shown in the non-adjustment scenario and the baseline presented in the main text: - The NPV of the debt-to-revenue ratio would reach about 240 percent in the medium term. - Overall sensitivity conclusion: - Debt dynamics are vulnerable to a real depreciation, to debt-creating flows in the medium term, and to lower GDP growth in the long term. ### C. External Debt Sustainability - Baseline projections: - All debt indicators are projected to improve over time. - The NPV of the debt-to-GDP ratios are expected to fall below 20 percent. - The NPV of the debt-to-exports ratios to fall below 30 percent. - The debt service-to-exports ratio would decline to below 2 percent in the long run. - Vulnerabilities: - Debt dynamics are most vulnerable to a real depreciation and export decline. - Sensitivity tests — external: - A one-time 30 percent real depreciation: - Would push up the NPV of the debt-to-GDP ratio to about 45 percent in the near term. - A one-time two standard deviation shock in exports (about twice as large as the shock assumed in the non-adjustment scenario in the main text): - Would raise the debt service-to-exports ratio to 4.8 percent compared with 3.4 percent in the baseline scenario. - Would raise the NPV of the debt-to-exports ratio to 91 percent compared with 58 percent in the baseline scenario in 2013. - Even then, these ratios are not high enough to threaten external viability. ### D. Conclusion - Under the staff’s baseline scenario, Cambodia’s debt is expected to be sustainable, conditional on: - Successful restructuring of U.S. and Russian debts on the assumed concessional terms. - Sustained real GDP growth of 6 percent and export growth of 9 percent. - Broadly stable foreign aid in nominal U.S. dollars. - Implementation of budgetary consolidation beginning with the 2004 budget, including discretionary tax revenue measures and improvements in tax and customs administration. - Key risks that could undermine sustainability include a large real depreciation, significant debt-creating flows, lower-than-expected GDP growth, and failure to improve revenue collection. *IMF staff assessment as presented in the source document.* ### 8. The key vulnerability in Cambodia’s debt dynamics is its weak fiscal revenue ### 8. The key vulnerability in Cambodia’s debt dynamics is its weak fiscal revenue base ### Main vulnerability and risks - The revenue base is "currently at 11 percent of GDP", which may pose difficulties in servicing debt despite a nominal stock of debt and service payments that are modest relative to GDP. - A one-time real depreciation is identified as a significant risk because it "increases the size of the stock of debt relative to GDP and fiscal revenue." - Fiscal-revenue sensitivity illustrated in baseline and stress tests: the NPV of public sector debt-to-revenue ratio is reported as 446.0 (2000), 445.1 (2001), 439.4 (2002), 495.8 (2003) and a projected 236.5, 233.7, 231.3, 227.7, 216.3, 176.8, 113.3 for subsequent years in the table (Table 1 / Table 2 context). ### Key public debt and fiscal figures (selected from debt sustainability tables) - Public sector debt (total): 68.8, 69.0, 72.2, 75.3 (historical estimates). - o/w foreign-currency denominated public sector debt: 66.8, 67.2, 68.4, 70.8. - Change in public sector debt (yearly): -0.6, 0.2, 3.2, 3.1. - Identified debt-creating flows (examples): 4.5, -0.1, 0.5, 1.6. - Primary deficit (percent of GDP): 2.0, 2.7, 3.6, 2.0 and projections including 1.2, 4.3, 3.2, 3.1, 3.1, 2.7, 2.5, 3.1, 2.5, 3.3, 2.8 (various rows). - Revenue and grants (percent of GDP): 13.2, 13.5, 14.1, 12.9 and projected path 14.2, 14.6, 15.1, 15.3, 15.5, 15.2, 14.5 (selected entries). - of which: grants: 2.8, 2.7, 2.9, 2.5 and projections 2.2, 2.3, 2.2, 2.0, 1.8, 1.2, 0.5 (selected entries). - Primary (noninterest) expenditure (percent of GDP): 15.2, 16.1, 17.7, 17.2 and projected 17.4, 17.7, 18.1, 18.0, 17.9, 17.8, 17.8. - Automatic debt dynamics contribution (percent of GDP): -0.8, -3.5, -4.2, -3.7 and projected -4.8, -1.1, -2.4, -3.0, -3.2, -2.8, -1.6. - Contribution from real exchange rate depreciation (percent of GDP): 4.9, 1.5, 0.2, 0.7 and projected 0.0 in later projection years (table entries). - Residual, including asset changes: -5.1, 0.4, 2.7, 1.5 and later projections -1.3, -0.7, 0.2, -0.6, -0.8, -1.8, -3.5. - NPV of public sector debt (percent of GDP): 58.9, 59.9, 62.1, 63.9 and projection series 33.5, 34.2, 34.8, 34.8, 33.5, 26.9, 16.4. - o/w foreign-currency denominated NPV: 56.9, 58.0, 58.2, 59.4 and projected 28.8, 30.2, 31.5, 32.3, 31.7, 25.9, 15.4. - Gross financing need (percent of GDP): 2.3, 3.2, 4.1, 5.0 and projected 4.4, 4.3, 4.3, 4.0, 3.9, 4.1, 4.1. - Debt service-to-revenue ratio (in percent): 2.6, 3.8, 3.7, 5.1 and projected 8.8, 8.3, 8.4, 8.7, 9.3, 10.0, 6.1 (selected entries). - Primary deficit that stabilizes the debt-to-GDP ratio (percent of GDP): 2.6, 2.4, 0.4, 1.2 and projected 6.1, 1.8, 2.2, 3.6, 4.1, 4.6, 5.1. ### Macroeconomic and fiscal assumptions used in simulations (selected) - Real GDP growth (in percent) historical and projections: 7.0, 5.7, 5.5, 6.5 and projected 2.7, 5.2, 4.3, 1.9, 4.3, 5.5, 5.9, 4.5, 6.0, 6.0, 6.0 (table entries). - Average nominal interest rate on forex debt (in percent): 0.3, 0.3, 0.3, 0.3 and projections 0.0, 0.4, 0.8, 1.6, 1.6, 1.5, 1.5, 1.2, 1.4, 1.3, 1.3. - Real exchange rate depreciation (in percent, + indicates depreciation): 7.7, 2.5, 0.3, 1.5 and projections 3.8, 1.1, -2.4, -0.2, 0.0, 0.0, 0.0, -0.2, -0.1, -0.1, -0.1. - Inflation rate (GDP deflator, in percent): -1.7, -0.3, 2.1, 3.0 and projections 5.7, 1.6, 2.0, 2.9, 2.5, 2.9, 3.0, 2.5, 3.0, 3.0, 3.0. - Growth of real primary spending (deflated by GDP deflator, in percent): 17.0, 12.2, 16.0, 14.1 and projections 2.7, 2.0, 5.3, 4.0, 6.7, 4.5, 5.7, 4.7, 6.0, 6.0, 5.9. - Grant element of new external borrowing (in percent) projected rows: 49.3, 47.6, 48.8, 48.0, 49.2, 50.1, 48.8, 51.3, 51.0, 51.1 (table entries). ### Stress tests and sensitivity scenarios (highlights) - Alternative and bound tests include: - A1. Real GDP growth and primary balance at historical averages. - A2. Primary balance unchanged from 2003. - B1. Real GDP growth at baseline minus two standard deviations. - B2. Primary balance at baseline minus one standard deviation. - B5. One-time 30 percent real depreciation in 2004 — this scenario yields notably higher debt ratios in simulation outputs (table entries labeled B5 show large jumps). - B6. 10 percent of GDP increase in other debt-creating flows in 2004. - Stress test outcomes reported for NPV of debt-to-GDP, NPV of debt-to-exports, debt service-to-exports, debt service-to-revenue (multiple tables and charts illustrate sizable adverse effects under large depreciation and primary balance shocks). ### Policy recommendations and reform priorities (drawn from Executive Board assessment and accompanying analysis) - Strengthen revenue mobilization: - Take additional tax policy measures and further strengthen tax and customs administration to meet 2004 revenue and medium-term NPRS targets. - Broaden the tax base by reducing exemptions and strengthen enforcement by computerizing revenue departments and passing the Law on Customs. - Recognize the potential contribution of good management of natural resources to the revenue base. - Improve public expenditure management: - Overhaul public financial management and complete reform measures to ensure timely reporting by line ministries and reduce year-end bunching of commitments. - National Audit Authority to audit operations of fiscally-important contract holders and make audit reports public. - Civil service and public administration reform: - Complete delayed studies on civil service reform and implement decompression of salaries coupled with average salary increases to improve public sector performance and reduce corruption incentives. - Legal, judicial, and governance reforms: - Accelerate judicial reform, adopt Anti-Corruption Law and the Law on the Status of Judges and Prosecutors, and establish a commercial court. - Implement governance measures to reduce corruption and improve the business climate. - Support agricultural and land reforms: - Prioritize agricultural and land reform (audit awarded economic concessions, review transfers of de-mined and de-forested land, speed up land registration) to address poverty, since most poor households are rural. - Promote private sector development and competitiveness: - Improve business climate by cutting cumbersome red tape and high informal fees, and allow greater wage flexibility to attract foreign investment and diversify exports. - Financial sector and macro policy: - Strengthen financial supervision and pass laws to facilitate sound intermediation, reduce payment system risks, and provide legal basis for collateral-based lending. - Continue prudent debt management and pursue debt rescheduling negotiations with the United States and the Russian Federation. - Maintain broadly stable exchange rate relative to the U.S. dollar; pursue de-dollarization gradually and cautiously to avoid capital flight. - Donor coordination and statistical capacity: - Use a new Fund arrangement to underpin donor coordination and encourage reforms. - Strengthen statistical frameworks with domestic capacity building and training; recognize potential need to reallocate budgetary resources for statistical improvements if donor financing is lacking. *Source: IMF staff estimates, projections, and Executive Board assessment as presented in the Public Sector Debt Sustainability Framework and accompanying annexes for Cambodia.* ### Introduction ### _cr04328 - Introduction ### Authorities' appreciation and policy commitment - Expressed appreciation to IMF staff, management, Executive Board, development partners, and donor community for advice and continued support. - Found the Staff Report for the 2004 Article IV balanced and the Ex Post Assessment of Longer-Term Program Engagement useful and comprehensive. - Reiterated continued commitment to sound macroeconomic management and reform agenda consistent with the objectives of NPRS and SEDP. - New administration (formed July 2004) announced the “Rectangular Strategy” focusing on: (i) promotion of economic growth, (ii) generation of employment, (iii) implementation of the Governance Action Plan to ensure equity and social justice, and (iv) enhancing efficiency and effectiveness of the Royal Government in implementing reform programs. ### Recent economic developments and prospects for 2004 - Real GDP grew by 6.7 percent per annum during 1999 - 2002. - Growth drivers were narrowly based: garments, tourism, and construction. - 2003 growth remained strong at 5.2%. - 2003 agricultural rebound reflected favorable weather; SARS impacts on tourism were less severe with a sharp rebound in tourist arrivals toward end-2003. - Authorities more sanguine than staff on 2004 prospects due to strong recovery in tourism, strong performance in the garment industry, and expected strong agricultural growth (authorities believe Avian flu has smaller impact than staff projections). - Inflation: - 12-month average inflation in 2003 was 1.2 percent. - Year-on-year inflation rate in December 2003 was 0.5 percent. - CPI inflation declined from 3.7% at end – 2002 to 0.5% at end – 2003. - External position: - Gross official reserves increased steadily to US$ 737 million at the end of 2003, sufficient to cover 3 months of imports of goods and services. ### Fiscal policy: performance and priorities - Continued pursuit of prudent fiscal policy and fiscal reforms to support macroeconomic stability and NPRS targets. - Structural measures implemented to strengthen tax and customs administration, broaden tax base, and prevent leakages. - Government revenue increased steadily to 11.2 percent of GDP in 2002. - Revenue collection in 2003 declined partly due to delayed tax payments. - Revenue target for fiscal year 2004 set at 11.9 percent of GDP. - Current budget surplus expected to increase to 1.2 percent of GDP (compared with a deficit of 0.6 percent of GDP in 2003). - To meet 2004 revenue target, government actions include vigorous collection of tax arrears and further improvements in tax and customs administration; greater caution in awarding government contracts to private sector. - Expenditure management: - Significant expenditure restraints to provide scope for priority spending and budget reallocation. - Reallocation to social and economic sectors; military demobilization to divert resources from defense and security to social sector. - Defense and security spending expected to decline from 3.8 percent of GDP in 1999 to 2.4 percent of GDP in 2004. - Social sector spending budgeted to increase from 1.8 percent to 3.8 percent of GDP over the same period. - Government accounts centralized at the National Treasury to strengthen budget management. - External debt: continued efforts to resolve outstanding debts with bilateral creditors, in particular the United States and the Russian Federation. ### Monetary and exchange rate policy; financial sector reform - Monetary restraint and NBC foreign exchange intervention, supported by prudent fiscal policy and lower imported inflation, contributed to lower inflation in 2003. - NBC policy: intervene in foreign exchange market to stabilize excessive exchange rate fluctuations; objective to stabilize riel inflation at a low level by maintaining a broadly stable exchange rate. - In a highly dollarized economy, exchange rate policy has limited short-term effects on competitiveness and limited role as a shock absorber; exchange rate adjustment will be considered if significant fundamental changes occur. - NBC committed to further improve monetary policy instruments and requests Fund cooperation and assistance. - De-dollarization: - Authorities acknowledge long-run benefits of de-dollarization for effective independent monetary policy. - Will consider requiring all government domestic transactions be paid in local currency. - Demand for riel growing, mainly in rural areas and for government transactions; riel in circulation rose from almost 2.5 percent of GDP in 1994 to over 5 percent in 2003. - Financial sector reform progress: - Successful bank restructuring during 2000 – 02 strengthened banking soundness. - Banking system well capitalized with capital adequacy ratios reaching 36% as at end-July 2004. - Comprehensive regulatory and supervisory regime; upward trend in deposits and credits. - Remaining challenges: limited financial intermediation (especially rural) and need to strengthen NBC supervisory capacity. - Recent prakas issued on Prepaid Payments on Rentals and Leases, Requirement in compliance with Fact and Substance, and Payments of Dividends in advance to contain potential access to banks’ assets. - Authorities pursuing early passage of: Negotiable Instruments and Payment Transactions Law, Secured Transaction Law, Insolvency Law, and Securities and Exchange Law. - New chart of accounts introduced; full bank compliance expected by end of 2004. - NBC working to reduce rural lending rates through increased competition and promoting microfinance. ### Governance and other structural reforms - Strengthening reforms in governance, civil service, and agricultural sector seen as key to sustaining growth, competitiveness, and poverty reduction. - Governance Action Plan (GAP) covers four crosscutting reform areas: (i) combating corruption, (ii) judicial and legal reforms, (iii) public administration reform, and (iv) demobilization of armed forces and natural resources management. - Anti-corruption measures: - Adoption of Anti-corruption Law submitted to Parliament. - Establishment of Supreme Council Against Corruption and mechanisms to strengthen law enforcement. - Continued promotion of transparency and accountability in public finances via strengthened audit process and public procurement. - Law on Audit introduced and National Audit Authority (NAA) established in 2000; intention to ratify the new United Nations anti-corruption convention. - Judicial reform priorities: - Judicial reform urgent for improving investment climate and rule of law. - Royal School of Judges and Prosecutors established in 2002; remuneration for judges and prosecutors increased beginning in 2003. - Government to prepare action plan focusing on finalization and submission of draft basic laws to the National Assembly; commercial transaction laws to proceed to fulfill WTO commitments. - Acknowledged constraints: limited human and financial resources; external assistance remains warranted. - Administrative reform measures: - National Program for Administrative Reform adopted to transform administration and civil service. - Public service provision to be simplified via elimination of overlapping work, streamlining bureaucracy, and decentralization; gradual computerization to improve transparency and reduce corruption. - Special attention to civil service management; recent increases in civil servant salaries (noted that civil service wages are approximately only one-third of average private sector formal wages). - Agricultural sector reform: - Urgent reform essential given poor dependence on agriculture. - Short-term shift from “expansionary”/“extensive” agriculture to “deepening”/“intensive” agriculture to increase yields on existing land. - Support measures: agricultural research, market development, seed and fertilizer distribution, supply of rural credit, enhanced marketing channels, institutionalized micro-finance in rural areas. - Continued implementation of Law on Land Management and land policy covering land restoration and distribution, land tenure security, eradication of illegal settlements and land grabbing, and control of land ownership concentration for speculative purposes. ### Measures to improve business climate - Government to promote good governance, strengthen legal frameworks, regulations, and institutional capacity to facilitate business and private investment. - Steering Committee for Private Sector Development established with three operational subcommittees. - Specific measures to reduce costs and time for company registration and export-import operations: - Cost of registration to be reduced from USD615 to USD177 beginning in September this year. - Time spent on paperwork to be reduced from 30 to 10.5 days. - Government intends to improve effectiveness of government–private sector forum. ### Removal of quotas on textiles and clothing exports - Authorities aware that phasing out of Multi-Fiber Agreement (MFA) will affect garment industry; difficult to predict market-share impact. - Authorities more sanguine than staff on decline in value of garment exports and impact on GDP growth. - Over the last 19 months, 22 companies have expanded production capacities. - To dampen potential impact, government to redouble efforts to improve competitiveness by reducing operating costs (labor and administrative costs). - Authorities seeking preferential duty treatment from the US government analogous to African poorest countries under the African Growth and Opportunity Act; Cambodia’s record on core labor standards cited as incentive. ### Ex Post Assessment of Longer-Term Program Engagement (EPA) - Authorities appreciate the EPA as a useful review and foundation for future reform plans. - Agree with EPA finding that despite favorable macroeconomic developments and progress under Fund-supported programs, poverty remains pervasive and governance strengthening is crucial. - Caution against unqualified cross-country comparisons of poverty indicators due to differences in data quality and methodologies. - Note that technical cooperation aid has helped promote ownership by using more local staff; underscore importance of training local trainers. - Agree with key elements of EPA-proposed strategy for future engagement with the Fund. ### Conclusion and request for Fund support - Cambodia has made considerable progress under Fund-supported programs despite capacity constraints and unfavorable external factors. - Authorities renewed commitment to strengthen governance and institutional capacity; recognize absence of these measures could undermine investment and business climate. - Success depends on continued international community support. - Authorities request the Fund to continue to provide policy advice, more focused technical assistance, and financial support. - Authorities wish to start discussion on an economic program to be supported by a PRGF program to help strengthen official reserves and contain possible adverse impacts from the phasing out of garment quotas, underpin donor coordination, and encourage domestic reform efforts. *Source: _cr04328 - Introduction* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04328.pdf_