## 1. Proactive Policy Reform and Weak Reform Scenarios (_cr16340) ## Source details **Canonical URL:** [1. Proactive Policy Reform and Weak Reform Scenarios (_cr16340)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16340.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16340.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16340.pdf.json) --- ### Context and macro outlook - Cambodia attained lower-middle income status this year. - Average real GDP growth was around 8 percent over the last two decades. - Real GDP growth: 7 percent in 2015; projected 7 percent for 2016–17; medium-term projected to decline to around 6¼ percent by 2021. - Inflation: 2.8 percent end-2015; projected to rise to 3.2 percent by end 2016. - Garment exports: accounted for 74 percent of exports and grew around 15 percent (y/y) in 2015. - Key government steps: energy-related investments; measures to facilitate trade, payments and business registration. - Remaining needs: reforms to improve the business climate and policies to mitigate rising financial sector vulnerabilities. ### Developments, risks, and constraints - Credit and financial deepening: - Private sector credit growth averaged nearly 30 percent (y/y) over the past three years. - Credit-to-GDP ratio doubled to 62 percent by end-2015. - Real estate and mortgage lending averaged 50 percent in 2015 and H1 2016. - Deposit growth: 25 percent in H1 2015 → 19 percent in H1 2016. - Average loan-to-deposit (LTD) ratio: 108.5 percent in June 2016 (from 79 percent in 2010). - Foreign currency deposits: 95 percent of total deposits. - External sector: - Current account deficit: 10.6 percent of GDP in 2015; projected to narrow to 10.2 percent of GDP in 2016. - Medium-term CAD forecast: around 8½ percent of GDP. - Gross official reserves projected to increase to US$6.3 billion as of end-2016 (around 4½ months of total imports). - External position: assessed as moderately weaker than suggested by fundamentals and desirable policies. - Exchange rate arrangement: de jure managed float; de facto “other managed”; policy keeps the riel broadly stable against the U.S. dollar. - Selected risks: - External: significant slowdown in China; surge in the US dollar; weaker growth in Europe; redirection of garment orders to Vietnam from TPP. - Macro-financial: rising financial sector vulnerabilities amid a credit boom; potential funding squeeze and credit crunch from global liquidity tightening or slowdown in China. - Real estate oversupply: potential disorderly price correction, rising defaults, and higher NPLs. - Domestic: fiscal pressures; erosion of competitiveness from wage hikes outstripping productivity. - Upside: faster structural reforms and better credit allocation could yield faster, more durable growth. - Policy response constraints: - High dollarization, lack of monetary instruments, and projected limited fiscal space. - Need to bolster crisis management: deposit insurance, robust bank resolution framework, stronger lender of last resort function at the NBC. ### Authorities’ views (summary) - Broad agreement with staff’s assessment of outlook and risks. - Short-term priority: expand US GSP access to other garments. - Consider minimum wage negotiations the biggest near-term risk to competitiveness. - Reserve accumulation in 2016 exceeded authorities’ expectations and is projected to remain strong. ### Key policy focus - Main challenges: secure sustained growth and mitigate growing financial sector vulnerabilities, meet sustainable development goals, and promote inclusion. - Policy focus areas: - (i) containing growing macro-financial risks, - (ii) maintaining fiscal sustainability, - (iii) boosting competitiveness and diversification, - (iv) expediting financial market development. - Strategy highlights: - Tighten macroeconomic policies to secure buffers despite low debt levels. - Fiscal policy: boost revenues and rationalize expenditure to maintain fiscal sustainability amid rising wage pressures and needed capital and development spending. - Financial sector: secure a soft landing of the credit cycle and build capital and liquidity buffers using coordinated micro- and macroprudential tools; upgrade regulation and supervision. - Structural reforms: promote diversification, enhance competitiveness, and improve the business climate. --- ### A. Containing Growing Macro-Financial Risks — key points - Excessive credit growth: - Credit boom began around end-2011 and significantly exceeds average past boom durations. - Credit growth projected around 25 percent over 2016–17. - Credit/GDP ratio projected to rise to over 80 percent by 2017. - Credit-to-GDP gap above the pre-crisis 2008 peak by end-2015 and projected to breach the 10-percent threshold by end 2017. - Credit intensity: 3.8 in 2015 (up from 3 in 2011–14 average). - Real estate concentration and oversupply risk: - New construction permits continue to rise; condominium over-supply risk acute. - Phnom Penh land price increases in 2015: residential +26 percent (y/y), office +19 percent (y/y) (real estate agency data). - Since 95 percent of loans in Cambodia are collateralized against land, real estate shocks could raise negative equity and defaults. - Reliance on foreign funding: - Average LTD ratio: 108.5 percent in June 2016. - 20 banks had LTD ratios over 100 percent; 14 banks over 200 percent. - Nonbank sector risks: - MFIs’ credit stock and flows are at 20 percent and 25 percent, respectively, of those in the banking system. - Several MFIs larger than some mid-sized commercial banks and accept deposits while facing looser regulation. - Large deposit-taking MFIs are heavily reliant on foreign funding, even more so than banks. --- ### Financial Soundness Indicators (FSIs) — key findings and recommendations ### Key FSI findings (2011–15) - System NPL ratio: under 2 percent (2015: 1.59), but lack of detailed guidance on treatment of restructured loans could underestimate NPLs. - Aggregate capital adequacy ratio (Regulatory capital to risk-weighted assets): - 2011: 26.23 - 2012: 25.00 - 2013: 24.23 - 2014: 20.41 - 2015: 21.04 - Asset quality — Nonperforming loans to total gross loans: - 2011: 2.13 - 2012: 2.01 - 2013: 2.30 - 2014: 1.62 - 2015: 1.59 - Earnings and profitability: - Return on equity (annualized): 2011: 9.74; 2012: 10.25; 2013: 12.15; 2014: 15.54; 2015: 16.34 - Return on assets (annualized): 2011: 1.76; 2012: 1.72; 2013: 2.40; 2014: 2.87; 2015: 3.98 - Interest margin to gross income: 2011: 64.27; 2012: 66.65; 2013: 68.60; 2014: 72.94; 2015: 63.07 - Liquidity: - Liquid assets to total assets: 2011: 16.16; 2012: 15.37; 2013: 17.93; 2014: 16.21; 2015: 16.61 - Liquid assets to short-term liabilities: 2011: 22.96; 2012: 21.21; 2013: 24.24; 2014: 23.13; 2015: 25.42 - Source: National Bank of Cambodia. Note: 1/ Annualized. ### Recent NBC actions and remaining vulnerabilities - NBC actions: - Introduced a Basel-III compliant Liquidity Coverage Ratio (to be met by September 2016). - Raised minimum capital requirements in March 2016 (to be in full effect in two years). - Plans to impose bank-specific prudential measures on institutions engaged in excessive risk-taking. - Remaining vulnerabilities: - Aggregate capital adequacy above 20 percent may mask solvency vulnerability at many banks to higher loan losses. - Liquid assets relative to total assets or short-term liabilities appear low, raising liquidity vulnerability. - Supervisory capacity improved but gaps remain due to limited number and technical capabilities of supervisors. - Other measures: - Government tightened licensing and supervision on real estate developers. - Improved efficiency and coverage of stamp duty on real estate transactions can be used as counter-cyclical tools. ### Policy recommendations to build resilience and engineer a soft landing - General sequencing: implement a coordinated range of tools across government agencies in a well-designed and sequenced way (detailed sequencing referenced in source). - Raise reserve requirements (RR): - Increase RR, particularly on short-term foreign currency deposits and foreign borrowing, to boost NBC’s liquidity buffer. - Strengthen microprudential policies: - Revisit loan classification and align provisioning with international best practices. - Improve asset classification regulation and ensure consistent enforcement by banks. - Focus on sound underwriting standards and prudent valuations. - Upgrade capital adequacy regulations (currently based on Basel I). - Crisis management framework: - Strengthen prompt corrective action framework. - Build on the 2014 MOU (NBC, MEF, SECC) to provide explicit inter-agency coordination (information exchange, contingency planning, legal reforms per 2010 FSAP recommendations). - Consider triggers for domestic systematically important banks on asset quality and liquidity as part of prompt corrective action. - Introduce macroprudential policies: - Sectoral tools: sectoral concentration limits and/or higher risk weights for real-estate loans; enable LTV and DTI limits via better data collection. - Liquidity tools: limits on LTD ratios to ensure more stable funding and temper credit growth. - Capital tools: implement counter cyclical capital requirements tailored to Cambodia. - Strengthen non-bank regulation: - Revise capital adequacy regulations for MFIs; standardize asset classification; raise RR; monitor systemic linkages between MFIs and banks. - Complementary fiscal measures: - Use targeted fiscal tools (stamp duties and a capital gains tax) to dampen excessive real estate price inflation, especially when capital inflows bypass the banking system. - Additional regulatory details: - Provide detailed guidance on restructured loans (limits on restructurings, formal new terms, board-approved policies, higher risk weights). - Adopt liquidity risk management framework in 2016; refine solvency ratio during 2017. - Further capacity building for supervisors; NBC requested IMF assistance in a number of areas. ### Authorities’ actions and stance on FSIs - Aim to engineer a soft landing by strengthening regulation and institutional capacity, monitoring credit quality and sectoral allocation, and increasing credit to productive sectors. - Implemented measures: reserve requirements on non-resident borrowings; liquidity coverage ratio; increase in minimum registered capital. - NBC working on revising regulations on asset classification and provisioning, prompt corrective action framework, and plans to upgrade solvency regulation. - Considering targeted bank-by-bank regulation to curb credit. - Launched a Financial Literacy Program to support financial stability. - MEF and SECC established financial stability working groups; MEF, SECC, and NBC committed to set up a national financial stability committee and to improve crisis management and oversight. --- ### Authorities’ views, fiscal stance, and structural issues ### Fiscal and expenditure policy views - Authorities agreed on need to boost revenues to maintain fiscal sustainability while balancing job creation and efficiency. - Committed to continue implementing the Revenue Mobilization Strategy (RMS) and improving revenue administration. - Plan to implement tax policy reforms over the medium term and develop a MTFF to improve expenditure allocation efficiency. - Continue civil service reforms; noted constraints to speedy implementation. - Significant progress in increasing development spending, especially in health, primary education, and social assistance. - Plan to use PPPs to enhance infrastructure and social spending; acknowledged need to develop a well-designed PPP framework. ### Structural constraints and diagnosis - Poverty reduction: from 50 percent in 2005 to 18 percent in 2012; Gini coefficient fell from 0.41 in 2007 to 0.31 in 2012. - Financial access: population with accounts rose from 3.7 percent in 2011 to 22.2 percent in 2014, but remains low. - Structural vulnerabilities: - Narrow economic base: exports reliant on low value-added garments; IDP launched in 2015 with slow progress. - Weak business climate and eroding competitiveness: rising minimum wages, stalled productivity, uncertainty from labor disputes; high costs from inadequate transport, elevated energy costs, and nontransparent/onerous government procedures. - Dollarization: increases banks’ vulnerability and limits exchange rate and monetary policy scope. - Underdeveloped financial markets: no government bond market; thin FX market centered on small retail money changers; limited instruments impede policy effectiveness. ### Business climate and financial market development recommendations - Business climate: - Lower costs of doing business to boost competitiveness and create higher value-added employment. - Priorities: reduce energy costs and improve reliability; enhance transportation links; address skills gaps via education and technical and vocational training. - Accelerate implementation of the IDP. - Strengthen rule of law and increase transparency of business regulation and tax compliance requirements. - Financial market development and de-dollarization: - Increase usage of local currency and develop interbank, government bond, and FX markets. - Specific measures: - (i) Expedite issuing shorter-term Negotiable Certificates of Deposits (NCD) to make interbank market more liquid and move towards auction pricing. - (ii) Restructure the FX market and encourage banks to play a greater role. - (iii) Develop government bond markets in line with the Financial Sector Development Strategy (2011–2020). - (iv) Ensure proper supervision and regulation. - (vi) Adopt measures to encourage de-dollarization, potentially based on the draft national strategy. - Authorities’ actions: - Committed to implementing and accelerating the IDP. - Law on Investment and Law on Special Economic Zones under revision. - Government prepared rules/regulations for a government bond market (to be finalized by 2018). - NBC supporting greater usage of NCDs and launched an electronic payments and FAST system to facilitate riel transactions. - National strategy to increase local currency usage drafted by the NBC and at the Economic and Financial Policy Committee for consideration. --- ### Scenario analysis and debt sustainability (DSA) — highlights ### Box 1 — Proactive policy reform vs Weak reform scenarios - Proactive policy reform scenario: - Assumes implementation of key structural reforms (including investment law), timely management of planned infrastructure projects, and investments in education and skills. - Projected to boost growth potential and reduce risk of a hard landing. - Predicted to generate economic growth that averages 7 percent or above. - By 2021, GDP would be about 8 percent higher than in the weak reform scenario, with much reduced risk of a hard landing/financial crisis. - Weak reform scenario: - Assumes no significant supply-side reforms and continuing rapid credit growth. - Credit-to-GDP ratio would continue to grow over the medium term, to around 125 percent by 2021. - Risk of sharp slowdown of growth or financial crisis would continue to grow, quantified using the BIS framework for crisis probability in a credit boom. ### External sector assessment (Box 2) — key metrics - External position: moderately weaker than implied by fundamentals and desirable policy settings. - REER: assessed to be moderately overvalued by around 5–10 percent. - Current account balance 2015: -10.6 percent of GDP. - Cyclically-adjusted current account deficit: 2.6 percentage points of GDP weaker than norm (EBA-lite), translating to a REER overvaluation of around 5.7 percent. - Since end-2015, REER appreciated by around 8 percent (y/y). - Reserve coverage Dec 2015: about 4 months of prospective imports of goods and services. - Foreign currency deposits exceed gross official reserves by more than two times, limiting central bank lender-of-last-resort capacity. - Optimal level of reserves (Jeanne and Ranciere, 2006 model): ranges from 28 to 30 percent of GDP, equivalent to additional reserves of US$250 to US$480 million. - Recommendation: continue to accumulate reserves beyond traditional metrics to enhance resilience. ### Spillovers from China (Box 3) - Cambodia’s growth elasticity to China’s growth: around 0.2 percent (double magnitude compared to 10 years ago). - Slowdown in Chinese growth tightens credit conditions in Cambodia and leads to declining credit growth; effect strengthened since the global financial crisis. - Policy implication: strengthen policy frameworks, move toward greater monetary flexibility, widen and deepen financial safety nets, enhance surveillance of cross-border financial flows. ### Box 4 — Upgrading nonbank regulations (MFIs) - Rapid growth of deposit-taking MFIs rendered them systemically important. - Key statistics: - Bank assets-to-GDP: 55 percent in 2010 → 110 percent in 2015. - MFI assets-to-GDP: 4 percent → 20 percent. - Largest deposit-taking MDI equivalent in assets to the 7th largest bank. - Financial stability risks: credit risk, liquidity risk, FX risk, systemic interconnectedness between MFIs and banks. - Regulatory principles: align MDI regulations broadly with commercial banks while tailoring for microfinance; supervision proportionate to risk. - Recommendations (selected): 1. Align CAR with Basel II and III principles; consider higher minimum CAR for MDIs if warranted. 2. Standardize asset classification for banks and MFIs. 3. Adjust RR, including on foreign currency deposits, for MDIs to be in line with banks; apply based on maturity profile of borrowings with gradual implementation. 4. NBC to evaluate currency mismatch management and consider restricting MDI net open positions if risks rise. 5. Identify systemically important MDIs and strengthen routine monitoring of interlinkages. ### Box 6 — Public investment, efficiency, and growth - Infrastructure gaps large despite increasing public investment; lagging relative to Emerging and Developing Asia on electricity, public education, public health outcomes. - Public investment (percent of GDP) increased and converged to EDA average, but public capital stock and private investment still lag. - PIMA weaknesses: multi-year budgeting; protection and monitoring of assets; budget comprehensiveness and fiscal rules; PPP management. - Financing constraints: limited domestic financing; projected decline in donor support with LMIC status; options tied to boosting revenues and implementing well-structured PPPs. - Growth impact (quantitative scenario): - Scaling up public investment by around 2 p.p. of GDP over 8 years, financed by improved revenue collection and learning-by-doing productivity improvements, would increase Cambodia’s real GDP growth by around 2 percentage points with little risk to long-term public debt sustainability. --- ### Appendix I — Risk Assessment Matrix and DSA summary ### DSA summary and overall assessment - DSA: Cambodia at low risk of debt distress; all debt burden indicators below indicative thresholds. - PV of external debt follows a downward trend in the medium term. - Downside risks: external arrears, materialization of contingent liabilities, growth, exports, adverse revenue shocks. - CPIA rating: “medium performer.” - Prepared by IMF and World Bank staff; Approved September 28, 2016. ### Public external debt (end-2015) - Total external public debt (including arrears): US$5,645 million; 100 percent of external debt; 32.1 percent of GDP. - Multilateral: US$1,656 million; 29.3 percent of total external debt; 9.5 percent of GDP. - Bilateral: US$3,989 million; 70.7 percent of total external debt; 22.6 percent of GDP. - PV of external debt: 22.1 percent of GDP at end-2015. - Major creditor: China accounts for around 80 percent of the total bilateral debt stock, including arrears. - Arrears: Cambodia remains in arrears to the Russian Federation and the United States (nearly 16 percent of total debt or 4 percent of GDP); assumed no restructuring with arrears continuing to build up over projection period. - Public domestic debt: negligible; bonds of US$3.2 million issued in early 2000s and old claims equal to 0.5 percent of GDP with no interest. ### Contingent liabilities, PPPs, and fiscal transparency - Authorities adopted an annual ceiling on PPP guarantees at 4 percent of GDP. - MEF actions: June 2016 policy on PPPs; central PPP unit for risk management being established. - Recommendation: list all contingent liabilities in the annual budget law. ### Macroe framework underlying baseline (selected) - GDP growth: expected 7.0 percent in 2016; projected to slow to around 6.3–7.0 percent until 2021. - CPI average inflation: 1.2 percent in 2015; expected to rise slightly to 3.2 percent at end-2016; medium-term average 3 percent. - Current account deficit (including official transfers): 10.6 percent of GDP in 2015; non-interest CAD around 10.2 percent of GDP in 2016; medium-term CAD around 8½ percent of GDP. - Gross official reserves: projected to rise to around 5.7 months of prospective imports through to 2021. - External bilateral debt disbursement: projected to average about US$700 million annually during 2015–21 (about 4 percent of GDP on average). - Debt-to-GDP ratio: projected to be just over 35 percent by 2021, then decline thereafter. ### Stress tests and vulnerabilities (selected) - Decline in export growth shock: PV of debt-to-GDP would reach 39 percent in 2018 (just below threshold of 40 percent), then decline to 18 percent long-term. - One-off large depreciation shock: PV of debt-to-GDP would reach about 35 percent in 2018, then decline to 21 percent long-term. - If primary balance unchanged at 2015 level: PV of public debt-to-GDP would increase to about 27 percent by 2020. ### Policy implications (selected) - Continue structural reforms to increase resilience to external shocks and mobilize fiscal revenues. - Continue strengthening contingent liability monitoring and fiscal transparency. - Maintain revenue mobilization efforts under the RMS and pursue tax administration measures. - Safeguard government deposits while managing development and wage/social spending pressures. - Strengthen institutional capacity for PPP risk management. --- *Source: IMF staff report excerpt and related boxes from content unit _cr16340.* ### 1. Proactive Policy Reform and Weak Reform Scenarios __________________________________________20 ### 1. Proactive Policy Reform and Weak Reform Scenarios ### Context - Cambodia attained lower-middle income status this year. - Over the last two decades, average real GDP growth was around 8 percent. - Key government steps: energy-related investments, measures to facilitate trade, payments and business registration. - Remaining needs: reforms to improve the business climate and policies to mitigate rising financial sector vulnerabilities. ### Developments, Outlook, and Risks - Growth and inflation: - Real GDP growth was 7 percent in 2015. - Growth projected at 7 percent for 2016–17. - Medium-term growth projected to decline to around 6¼ percent by 2021. - Inflation was 2.8 percent end-2015 and is projected to rise to 3.2 percent by end 2016. - Garment exports accounted for 74 percent of exports and grew around 15 percent (y/y) in 2015. - Credit cycle and financial deepening: - Private sector credit growth averaged nearly 30 percent (y/y) over the past three years. - Credit-to-GDP ratio doubled to 62 percent by end-2015. - Real estate and mortgage lending averaged 50 percent in 2015 and H1 2016. - Deposit growth fell to 19 percent in H1 2016 from 25 percent in H1 2015. - Average loan-to-deposit (LTD) ratio reached 108.5 percent in June 2016, from 79 percent in 2010. - Foreign currency deposits constitute 95 percent of total deposits. - External sector outlook: - Current account deficit projected to narrow to 10.2 percent of GDP in 2016 (from 10.6 percent in 2015). - Medium-term CAD forecast to decline to around 8½ percent of GDP. - Gross official reserves projected to increase to US$6.3 billion as of end-2016 (around 4½ months of total imports). - External sector assessment: - External position assessed as moderately weaker than suggested by fundamentals and desirable policies. - The de jure exchange rate arrangement is a managed float; the de facto arrangement is “other managed.” - Current regime of keeping the riel broadly stable against the U.S. dollar is considered appropriate given high dollarization. - Risks (selected): - External risks: significant slowdown in China; surge in the US dollar; weaker growth in Europe; redirection of garment orders to Vietnam from TPP. - Macro-financial risks: rising financial sector vulnerabilities amid a credit boom. - Specific shocks could cause a funding squeeze and credit crunch (examples: global liquidity tightening, slowdown in China). - Real estate oversupply may trigger disorderly price correction, rising defaults, and higher NPLs. - Other domestic risks: fiscal pressures; erosion of competitiveness from wage hikes outstripping productivity. - Upside risk: faster structural reforms and better credit allocation could yield faster, more durable growth. - Policy response constraints: - Limited options due to high dollarization, lack of monetary instruments, and projected limited fiscal space. - Need to bolster the crisis management framework: deposit insurance, robust bank resolution framework, stronger lender of last resort function at the NBC. ### Authorities’ Views - Authorities broadly shared staff’s assessment of outlook and risks and project growth to fall absent further diversification. - Short-term priority: expand US GSP access to other garments. - Authorities considered minimum wage negotiations the biggest near-term risk to competitiveness. - Reserve accumulation in 2016 exceeded authorities’ expectations and is projected to remain strong. ### Key Policy Issues - Main challenges: secure sustained growth and mitigate growing financial sector vulnerabilities, meet sustainable development goals, and promote inclusion. - Policy focus areas: - (i) containing growing macro-financial risks, - (ii) maintaining fiscal sustainability, - (iii) boosting competitiveness and diversification, - (iv) expediting financial market development. - Strategy: - Tighten macroeconomic policies to secure buffers despite low debt levels. - Fiscal policy: boost revenues and rationalize expenditure to maintain fiscal sustainability amid rising wage pressures and needed capital and development spending. - Financial sector: secure a soft landing of the credit cycle and build capital and liquidity buffers using coordinated micro- and macroprudential tools; upgrade regulation and supervision. - Structural reforms: promote diversification, enhance competitiveness, and improve the business climate. ### A. Containing Growing Macro-Financial Risks - Excessive credit growth: - Current credit boom began around end-2011 and significantly exceeds average past boom durations. - Credit growth projected around 25 percent over 2016–17. - Credit/GDP ratio projected to rise to over 80 percent by 2017. - Credit-to-GDP gap was already above the pre-crisis 2008 peak by end-2015 and is projected to breach the 10-percent threshold by end 2017. - Credit intensity was 3.8 in 2015 (up from 3 in 2011–14 average). - Intensifying credit risk in real estate: - New construction permits continue to rise; concentration of lending in real estate is growing. - Over-supply risk particularly acute for condominiums; risk of large disorderly price adjustment with spillovers to banking sector and the economy. - Phnom Penh’s land price for residential and office space increased 26 percent and 19 percent, respectively, year-on-year in 2015 (real estate agency data). - Since 95 percent of loans in Cambodia are collateralized against land, a negative shock in real estate could increase negative equity and defaults. - Increasing reliance on foreign funding: - Average LTD ratio was 108.5 percent in June 2016. - 20 banks had LTD ratios over 100 percent, and 14 banks over 200 percent. - Rising risks from the nonbank sector: - MFIs’ credit stock and flows are at 20 percent and 25 percent, respectively, of those in the banking system. - Several MFIs are larger than some mid-sized commercial banks and accept deposits while facing looser regulation. - Large deposit-taking MFIs are heavily reliant on foreign funding, even more so than banks. *Source: IMF staff report excerpt, "1. Proactive Policy Reform and Weak Reform Scenarios."* ### 15. Financial Soundness Indicators. Financial soundness indicators (FSIs) appear healthy, ### 15. Financial Soundness Indicators. Financial soundness indicators (FSIs) appear healthy ### Financial soundness indicators — key findings - FSIs suggest adequate capitalization levels, low nonperforming loans (NPLs), and high profitability. - System NPL ratio is under 2 percent—suggesting robust asset quality—but lack of detailed guidance on the treatment of restructured loans could possibly underestimate the NPL ratio and overstate capital adequacy. - Aggregate capital adequacy ratio is above 20 percent, but the solvency ratio of many banks, including large ones, may be vulnerable to higher loan losses should defaults unexpectedly increase. - Liquid assets relative to total assets or short-term liabilities appear to be low, rendering many banks vulnerable to liquidity risks. - Lack of clarity in classification of restructured loans may mask build-up of credit risk in individual banks. ### Selected Financial Soundness Indicators (FSIs), 2011–15 (In percent) - Capital Adequacy — Regulatory capital to risk-weighted assets: - 2011: 26.23 - 2012: 25.00 - 2013: 24.23 - 2014: 20.41 - 2015: 21.04 - Asset Quality — Nonperforming loans to total gross loans: - 2011: 2.13 - 2012: 2.01 - 2013: 2.30 - 2014: 1.62 - 2015: 1.59 - Earnings and Profitability: - Return on equity (annualized): - 2011: 9.74 - 2012: 10.25 - 2013: 12.15 - 2014: 15.54 - 2015: 16.34 - Return on assets (annualized): - 2011: 1.76 - 2012: 1.72 - 2013: 2.40 - 2014: 2.87 - 2015: 3.98 - Interest margin to gross income: - 2011: 64.27 - 2012: 66.65 - 2013: 68.60 - 2014: 72.94 - 2015: 63.07 - Liquidity: - Liquid assets to total assets: - 2011: 16.16 - 2012: 15.37 - 2013: 17.93 - 2014: 16.21 - 2015: 16.61 - Liquid assets to short-term liabilities: - 2011: 22.96 - 2012: 21.21 - 2013: 24.24 - 2014: 23.13 - 2015: 25.42 - Source: National Bank of Cambodia. - Note: 1/ Annualized. ### Containing growing financial risks — recent NBC actions and vulnerabilities - NBC actions taken: - Introduced a Basel-III compliant Liquidity Coverage Ratio (to be met by September 2016). - Raised minimum capital requirements in March 2016 (to be in full effect in two years). - Plans to impose bank-specific prudential measures on institutions deemed to be engaged in excessive risk-taking. - Expected effects and remaining vulnerabilities: - Liquidity Coverage Ratio is expected to dent credit momentum and help build buffers against liquidity shocks, though it is too early to assess the impact. - Despite capital adequacy being above 20 percent at the aggregate level, many banks remain vulnerable to liquidity and solvency shocks. - Supervisory capacity has improved, but gaps remain due to limited number and technical capabilities of supervisors. - Other measures: - Government tightened licensing and supervision on real estate developers. - Efficiency and coverage of stamp duty on real estate transactions improved; these can be used as counter-cyclical tools. ### Policy recommendations — measures to build resilience and engineer a soft landing - General approach: - Implement a range of tools coordinated among multiple government agencies in a well-designed and sequenced way. - Recommended sequencing of specific measures is contained in the table on page 12 of the source. - Raise reserve requirements (RR): - RR should be raised, particularly on short-term foreign currency deposits and foreign borrowing, to increase NBC’s liquidity buffer. - Strengthen microprudential policies: - Revisit loan classification and align provisioning rules with international best practices. - Improve asset classification regulation and ensure consistent enforcement by banks. - Focus on sound underwriting standards and prudent valuations. - Upgrade capital adequacy regulations (currently based on Basel I) to ensure adequate buffers commensurate with risk profiles. - Put in place a comprehensive crisis management framework: - Strengthen the existing prompt corrective action framework to enable early action. - Build on the 2014 MOU among NBC, MEF, and SECC to provide explicit inter-agency coordination mechanisms (information exchange, contingency planning, legal reforms in line with 2010 FSAP recommendations). - Consider introducing triggers for domestic systematically important banks regarding asset quality and liquidity position as part of prompt corrective action. - Introduce macroprudential policies: - Sectoral tools: consider imposing sectoral concentration limits and/or higher risk weights for real-estate loans; expedite collection of real-estate data and household balance sheets to enable LTV and DTI limits. - Liquidity tools: funding requirements such as limits on LTD ratios to ensure banks hold more internal and stable liabilities and to temper excessive credit growth. - Capital tools: implement counter cyclical capital requirements (tailored to Cambodia) to build buffers for downturns. - Strengthen non-bank regulation: - Address systemic relevance of large MFIs by revising capital adequacy regulations, standardizing asset classification in line with banks, raising RR, and better monitoring systemic linkages between MFIs and banks. - Implement complementary prudential measures across government agencies: - Deploy well-designed and targeted fiscal measures, such as stamp duties and a capital gains tax, to augment monetary prudential measures and dampen excessive real estate price inflation, particularly when capital inflows bypass the domestic banking system. - Additional specific recommendations (regulatory detail): - Provide more detailed guidance on restructured loans (limit the number of restructurings, require formal new terms, board-approved policies, higher risk weights for restructured loans). - Adopt a liquidity risk management framework in 2016, improve regulations on asset classification and provisioning, and refine solvency ratio during 2017. - Further capacity building for supervisors; NBC has requested IMF assistance in a number of areas. ### Authorities’ views and actions - Authorities broadly agreed with staff’s assessment and stressed efforts to incorporate prior recommendations. - Authorities’ priorities and actions: - Aim to engineer a soft landing of the credit cycle by strengthening regulation and institutional capacity, monitoring credit quality and sectoral allocation, and increasing credit to productive sectors. - Broad agreement with proposed sequencing of measures, with timing contingent on assessment of past measures and impacts on credit growth and economic activity. - Implemented measures: reserve requirements on non-resident borrowings, liquidity coverage ratio, increase in minimum registered capital. - NBC working on revising regulations on asset classification and provisioning, prompt corrective action framework, and plans to upgrade solvency regulation. - Considering targeted bank-by-bank regulation to curb credit. - Launched a Financial Literacy Program to support financial stability. - MEF and SECC established financial stability working groups to improve information sharing; MEF, SECC, and NBC committed to set up a national financial stability committee to establish a crisis management framework and strengthen oversight. *Source: IMF staff chapter on Financial Soundness Indicators in the IMF country report.* ### 23. Authorities’ views. The authorities broadly agreed with staff’s assessment and key policy ### 23. Authorities’ views. The authorities broadly agreed with staff’s assessment and key policy ### Authorities’ views (fiscal, expenditure, PPPs) - Agreed with staff on need to continue to boost revenues to maintain fiscal sustainability, while striking a balance to meet other objectives such as promoting job creation and efficiency. - Committed to continue implementing the RMS and improving the institutional framework for revenue administration. - Plan to implement tax policy reforms over the medium term. - Agreed on importance of developing a MTFF to improve expenditure allocation efficiency; currently reviewing the public expenditure framework. - Plan to continue civil service reforms to improve public services, but noted constraints to speedy implementation. - Highlighted significant progress in increasing development spending, especially in health, primary education, and social assistance. - Plan to use PPPs to enhance infrastructure and social spending, and acknowledged the need to develop a well-designed PPP framework. ### Structural constraints and diagnosis - Rapid growth reduced poverty from 50 percent in 2005 to 18 percent in 2012, with associated reduction in inequality (Gini coefficient falling from 0.41 in 2007 to 0.31 in 2012). - Large share of population remains vulnerable just above the poverty line. - Despite rapid credit growth, financial access remains limited: percentage of population having accounts increased from 3.7 percent in 2011 to 22.2 percent in 2014, but remains low. - Structural vulnerabilities identified: - Narrow economic base: exports remain reliant on low value-added garments; Industrial Development Policy (IDP) launched in 2015 to attract FDI into non-garments labor-intensive manufacturing, with slow progress so far. - Weak business climate and eroding competitiveness: rising minimum wages, stalled productivity, uncertainty from labor disputes; high costs from inadequate transportation, elevated energy costs, and nontransparent/onerous government procedures. - Dollarization: high dollarization increases banks’ vulnerability to solvency and liquidity risks and limits scope for exchange rate and monetary policies. - Underdeveloped financial markets: no government bond market; thin foreign exchange market centered on small retail money changers; limited instruments impede resource allocation, risk sharing, and effective monetary/fiscal policy. ### Policy recommendations: business climate and financial market development - Business climate reforms: - Lower costs of doing business to boost competitiveness and create higher value-added employment. - Priorities: reduce energy costs and improve reliability; enhance transportation links; address skills gaps via improving education quality and promoting technical and vocational training. - Accelerate implementation of the IDP. - Strengthen rule of law and increase transparency of business regulation and tax compliance requirements. - Financial market development and de-dollarization: - Increase usage of the local currency and accelerate development of interbank, government bond, and foreign exchange markets. - Specific measures: - (i) Expedite issuing shorter-term Negotiable Certificates of Deposits (NCD) to make the interbank market more liquid and move towards auction pricing. - (ii) Restructure the FX market and encourage banks (instead of money changers) to play a greater role. - (iii) Develop government bond markets in line with the authorities’ Financial Sector Development Strategy (2011–2020). - (iv) Ensure proper supervision and regulation. - (vi) Adopt measures to encourage de-dollarization, potentially based on the draft national strategy to promote increased usage of local currency. - Authorities’ actions: - Committed to implementing the IDP and accelerating implementation. - Law on Investment and Law on Special Economic Zones under revision to improve business environment and support diversification. - Government has implemented measures to promote securities market development and prepared rules/regulations for a government bond market (to be finalized by 2018). - NBC supporting greater usage of NCDs to develop the interbank market; launched a new electronic payments and FAST (Fast and Secure Transfer) system to better facilitate riel transactions. - National strategy to increase local currency usage drafted by the NBC and at the Economic and Financial Policy Committee for consideration. ### Staff appraisal — macro outlook and risks - Economic setting: - Growth projected to remain strong, driven by garments exports, real estate and construction activity and the reduction in oil prices, despite weaker contributions from agriculture and tourism. - Inflation has increased slightly but is expected to remain well contained. - Private sector credit growth has been and is projected to remain high, increasingly concentrated in real estate and construction. - Medium-term growth projected to moderate somewhat due to gradual reduction in FDI, challenges in diversification, and moderation in the credit cycle. - External position assessed to be moderately weaker than suggested by fundamentals and desirable policies. - Risks: - External: significant slowdown in China; surge in the US dollar and/or weaker growth in Europe; sharper-than-anticipated tightening in global financial conditions. - Domestic: ongoing credit boom posing significant macro-financial stability and growth risks; fiscal pressures; erosion of competitiveness from wage hikes outstripping productivity gains. ### Staff appraisal — financial sector and macroprudential policy - Secure a soft landing of the credit cycle and build capital and liquidity buffers through well-coordinated and sequenced prudential policy tools. - Micro-prudential strengthening needed on asset classification, provisioning, and sectoral loan classification. - Gradual introduction of well-designed macro-prudential tools, including implementing countercyclical capital buffers and provisions, imposing concentration limits and higher risk weights for real-estate loans, and instituting limits on LTD ratios. - Strengthen prompt corrective action framework and put in place a crisis management framework with explicit inter-agency coordination mechanisms. - Monetary and other prudential tools to contain rapid credit growth: - Raise reserve requirements, particularly on short-term foreign currency deposits and foreign borrowing. - Use well-designed and targeted fiscal measures (stamp duties, a capital gains tax, tightening issuance of new construction permits) to manage the real estate cycle. - Supervision and financial market development: - Expedite implementation of FSAP recommendations, including supervisory capacity building. - Strengthen regulation for large MFIs to prevent regulatory arbitrage. - Reduce dollarization and develop interbank, government bond, and foreign exchange markets to build an effective monetary policy framework. ### Staff appraisal — fiscal policy and structural reforms - Fiscal policy: - Sustain recent revenue gains by modernizing tax policy and improving revenue administration. - Tax policy reforms to improve productivity, efficiency and transparency of taxes, rationalize tax incentives, improve business taxation, and reform excise and property taxes. - Tax administration reforms to build a strong institutional framework to entrench administrative improvements and implement future reforms. - Develop a medium-term budget framework to systematically allocate expenditures and improve spending efficiency. - Establish an appropriately structured institutional framework for PPPs to limit contingent liabilities. - Ensure wage increases are fiscally sustainable and accompanied by civil service reform. - Structural reforms: - Promote diversification, enhance competitiveness, and improve business climate and inclusiveness. - Accelerate implementation of the Industrial Development Policy to boost investor confidence. - Implement key infrastructure projects (energy and transportation), strengthen rule of law and transparency/predictability of business regulation, and further invest in education and skills building. ### Box 1 — Proactive policy reform and weak-reform scenarios (medium-term growth projections) - Proactive policy reform scenario: - Assumes implementation of key structural reforms (including investment law), timely management of planned infrastructure projects, and investments in education and skills. - Policies projected to boost growth potential and reduce risk of a hard landing. - Predicted to generate economic growth that averages 7 percent or above. - By 2021, GDP would be about 8 percent higher than in the weak reform scenario, with much reduced risk of a hard landing/financial crisis. - Weak reform scenario: - Assumes no significant supply-side reforms and continuing rapid credit growth. - ‘Credit-to-GDP ratio’ would continue to grow over the medium term, to around 125 percent by 2021. - Risk of sharp slowdown of growth or financial crisis would continue to grow, quantified using the BIS framework for crisis probability in a credit boom. ### Box 2 — External sector assessment: key metrics - External position assessed to be moderately weaker than implied by fundamentals and desirable policy settings. - Real effective exchange rate (REER) assessed to be moderately overvalued by around 5–10 percent. - Current account balance in 2015: CA balance of -10.6 percent of GDP. - Cyclically-adjusted current account deficit: 2.6 percentage points of GDP weaker than the norm using the macro balance approach (EBA-lite), translating into a REER overvaluation of around 5.7 percent. - Since end-2015, the REER has appreciated by around 8 percent (year-on-year). - Reserve coverage: - In December 2015, reserves equivalent to about 4 months of prospective imports of goods and services. - Foreign currency deposits are still more than two times gross official reserves, limiting central bank lender-of-last-resort capacity. - Customizing the Jeanne and Ranciere (2006) model suggests optimal level of reserves ranges from 28 to 30 percent of GDP, equivalent to additional reserves of US$250 to US$480 million. - Recommendation: continue to accumulate reserves beyond traditional metrics to enhance resilience against financial sector vulnerabilities and rapid capital flow reversals. ### Box 3 — Spillovers from China - Cambodia’s growth elasticity to China’s growth is around 0.2 percent, double the magnitude compared to 10 years ago. - A slowdown in Chinese growth tightens credit conditions in Cambodia and leads to declining credit growth; this effect has strengthened since the global financial crisis. - Policy implication: strengthen policy frameworks, including moving towards greater monetary flexibility, widen and deepen financial safety nets, and enhance surveillance of cross-border financial flows to close data gaps. *Source: IMF staff report (content unit: _cr16340 - 23. Authorities’ views. The authorities broadly agreed with staff’s assessment and key policy).* ### Box 4. Cambodia: Upgrading Nonbank Regulations ### Box 4. Cambodia: Upgrading Nonbank Regulations ### Context and systemic importance - Rapid growth of deposit-taking micro-finance institutions (MFIs) have rendered them systemically important. - Regulations need to be tightened and be brought in line with banks to adequately contain potential risks and prevent regulatory arbitrage. - Regulators face the twin challenges of closing regulation gaps between banks and MFIs and mitigating stability risks from rapidly growing MFI lending. ### Key statistics - Bank assets-to-GDP ratio: grown from 55 percent in 2010 to 110 percent as of 2015. - MFI assets-to-GDP ratio: grown from 4 percent to 20 percent. - The largest deposit-taking MFI (MDI) is equivalent in terms of total assets to the 7th largest bank. ### Financial stability risks identified - Credit risk (risk of highly-indebted households rolling over debt). - Liquidity risk (sudden withdrawals of deposits and/or squeeze in foreign borrowing). - FX risk (currency mismatch between deposits in U.S. dollars and lending in local currency). - Systemic risks due to increased interconnectedness between MFIs and banks. ### Regulatory principles - Regulations on deposit-taking MFIs should be broadly in line with those of commercial banks though some principles require tailoring. - Primary aims: ensure the stability of the financial system and protect depositors without imposing undue compliance burdens or stifling lending. - Balance industry flexibility for innovation and growth with rules to protect low-income and vulnerable clients (CGAP, 2012). - Regulations should aim to (i) reduce risk of regulatory arbitrage and (ii) minimize costs created by additional regulation for MFIs. - Supervision should be proportionate to the risks involved, while keeping in mind stretched supervisory capacity. ### Recommendations 1. The CAR should be aligned with Basel II and III principles. While current regulations apply equally to MDIs and banks, actual CARs are, on average, lower than that of banks. If MDIs’ ability to raise additional capital is limited compared to banks, or they exhibit a more pronounced risk profile, the minimum CAR should be set higher than that for banks. 2. Asset classification should be standardized for all banks and MFIs. 3. Reserve requirements (RR), including on foreign currency deposits, for MDIs should be adjusted to be in line with banks. Since MFIs are more reliant on foreign financing, RR on foreign borrowings should be instituted to all MFIs and applied based on the maturity profile of borrowings (short term borrowings). To limit the impact on the financial system and financial inclusion, implementation should be gradual. 4. The NBC must constantly evaluate how effectively MFIs are managing potential currency mismatches, including cross-border financing arrangements with international lenders, and consider further restricting MDI’s net open position should risks abruptly rise. 5. Clear identification of systemically important MDIs is needed and routine monitoring of interbank, inter-MFIs, inter-financial institutions linkages should be strengthened. *Prepared by Mari Ishiguro.* ### Box 6. Cambodia: Public Investment, Efficiency, and Growth ### Box 6. Cambodia: Public Investment, Efficiency, and Growth ### Key findings on infrastructure and public investment - Infrastructure gaps are large despite increasing public investment. - Cambodia compares unfavorably on infrastructure outcomes relative to Emerging and Developing Asia (EDA); lagging areas include electricity, public education, and public health outcomes. - Over the last two decades public investment (as percent of GDP) increased and converged to the EDA average, but Cambodia’s public capital stock and private investment still lag the EDA average. - Low public investment efficiency has hampered public capital accumulation. ### Public Investment Management Assessment (PIMA) weaknesses - Improvement is needed across all areas of the PIMA framework including: - (i) moving to multi-year budgeting, - (ii) protection of investment and monitoring of assets, - (iii) budget comprehensiveness and fiscal rules, - (vi) the management of PPPs. - Strengthening the PPP framework requires: - better managing and monitoring fiscal risks related to PPPs, - fully integrating PPPs into the government’s overall investment strategy, medium-term fiscal framework, and budget cycle. ### Financing constraints and options - Limited domestic financing sources constrain attempts to boost public capital spending. - A projected decline in donor support with the attainment of LMIC status and limited progress in developing local debt markets mean options for increasing public investment going forward are tied to: - success in boosting revenues, and - implementing well-structured PPPs. ### Growth impact and fiscal implications (scenario/quantitative result) - Public investment is estimated to have a strong positive effect on growth in Cambodia. - A gradual scaling up of public investment by around 2 p.p. of GDP over 8 years, in which investment is financed by improved revenue collection and learning-by-doing productivity improvements, would: - increase Cambodia’s real GDP growth by around 2 percentage points, - do so with little risk to long-term public debt sustainability. - The analysis for Cambodia adopted the DIG model from Buffie, Edward F., and others, 2012, “Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces,” IMF Working Paper 12/144. ### Context and provenance - Prepared by Manuk Ghazanchyan. - This box is based on the forthcoming IMF Working Paper, “Public Investment and Growth: Experience of Selected Asian Frontier Markets” by Manuk Ghazanchyan, Ricardo Marto, Jiri Jonas and Kaitlin Douglass. Cambodia is a pilot case in the Fund’s initiative on infrastructure investment under the “Infrastructure Policy Support Initiative.” *Source: Box 6, _cr16340 - Box 6. Cambodia: Public Investment, Efficiency, and Growth_* ### Appendix I. Cambodia—Risk Assessment Matrix ### Appendix I. Cambodia—Risk Assessment Matrix ### DSA summary and overall assessment - The DSA shows Cambodia is at low risk of debt distress; all debt burden indicators remain below the respective indicative thresholds. - The PV of external debt follows a downward trend in the medium term. - Downside risks highlighted: external arrears, materialization of contingent liabilities, growth, exports, and adverse revenue shocks. - CPIA rating: “medium performer.” - Prepared by Staff of the International Monetary Fund and the World Bank; Approved by Markus Rodlauer and Steve Barnett (IMF), and Paloma Anós Casero (WB). Date: September 28, 2016. ### Cambodia’s public external debt—levels and composition (end-2015) - Total external public debt (including arrears): US$5,645 million; 100 percent of external debt; 32.1 percent of GDP. - Multilateral: US$1,656 million; 29.3 percent of total external debt; 9.5 percent of GDP. - Bilateral: US$3,989 million; 70.7 percent of total external debt; 22.6 percent of GDP. - Present value (PV) of external debt: 22.1 percent of GDP at end-2015. - Historical trend: debt-to-GDP was 27 percent in 2008 and has been steadily increasing since 2008. - Major creditor: China accounts for around 80 percent of the total bilateral debt stock, including arrears. - Arrears: Cambodia remains in arrears to the Russian Federation and the United States (nearly 16 percent of total debt or 4 percent of GDP); the country is not servicing these debts and this DSA assumes no restructuring with arrears continuing to build up over the projection period. - Public domestic debt: negligible; bonds of US$3.2 million issued in the early 2000s and old claims equal to 0.5 percent of GDP with no interest. ### Contingent liabilities, PPPs, and fiscal transparency - Authorities adopted an annual ceiling on PPP guarantees at 4 percent of GDP. - MEF actions: June 2016 adoption of a policy on PPPs outlining legal, regulatory and institutional frameworks; a central PPP unit for risk management is being established in the MEF. - Recommendation: list all contingent liabilities in the annual budget law to enhance fiscal transparency. - Continued close monitoring and strengthened capacity for contingent liability management are needed to safeguard fiscal space. ### Macroeconomic framework underlying the baseline - Growth and inflation: - GDP growth: expected at 7.0 percent in 2016; projected to slow to around 6.3–7.0 percent until 2021. - CPI average inflation: 1.2 percent in 2015; expected to rise slightly to 3.2 percent at end-2016. - Medium-term inflation expectation: average 3 percent. - External sector: - Current account deficit (including official transfers): 10.6 percent of GDP in 2015. - Non-interest current account deficit: around 10.2 percent of GDP in 2016. - Medium-term current account deficit: around 8½ percent of GDP, expected to be fully financed by FDI and official loans. - Gross official reserves: projected to rise to around 5.7 months of prospective imports through to 2021. - External bilateral debt disbursement: projected to average about US$700 million annually during 2015–21 (about 4 percent of GDP on average). - Debt-to-GDP ratio: projected to be just over 35 percent by 2021, then decline thereafter. - Fiscal sustainability: - Tax revenues: rose to 14.6 percent of GDP in 2015 from 13.7 percent of GDP in 2014 (+0.5 percent of GDP) due to Revenue Mobilization Strategy (RMS). - Wage bill: increased by 0.9 percent of GDP in 2015. - Capital spending: compressed by 0.7 percent of GDP in 2015. - Fiscal deficit: widened from 1.3 percent of GDP in 2014 to 1.6 percent of GDP in 2015. - Government deposits: rose to 9.1 percent of GDP by end-2015; projected to stay around 9.3 percent of GDP in 2016. - Fiscal deficit projection for 2016: projected to widen to 2.6 percent of GDP (but remain below the budget target) due to increases in current expenditure (wage bill by 0.2 percent of GDP and non-wage current expenditures by 1 percent of GDP) more than offsetting revenue gains. - Medium-term pressures: wage pressures and rising social spending despite continued strong revenue performance from RMS measures. - Policy guidance: anchor medium-term fiscal policy to safeguarding government deposits and long-term fiscal debt sustainability while balancing development needs and rising wage/social spending. - Domestic debt issuance scenario: - Government bonds issuance starting from ¼ ppt of GDP annually in 2021, gradually increasing to about ½ ppt of GDP in 2035. - Resulting domestic debt stock: about 3.7 percent of GDP by 2035. - Comparison: remains low relative to LIC average domestic debt of about 15 percent of GDP. ### External and public debt sustainability results and stress tests - Baseline results: - External DSA: risk of debt distress is low; PV of debt-to-GDP, debt-to-exports, and debt-to-revenue ratios never breach policy-dependent indicative thresholds and decline over the projection period. - Debt service-to-exports and debt service-to-revenue ratios: remain well below thresholds throughout the projection period, aided by concessional debt. - Stress tests and vulnerabilities: - A decline in export growth shock: - PV of debt-to-GDP would reach 39 percent in 2018 (just below the indicative threshold of 40 percent), then decline to 18 percent in the long-term. - A large one-off depreciation shock: - PV of debt-to-GDP would reach about 35 percent in 2018, then decline to 21 percent in the long-term. - Public debt and shocks: - One-off real depreciation shock: PV of public debt-to-GDP would reach 33 percent in 2018, then decline over time. - If primary balance remains unchanged at the 2015 level: PV of public debt-to-GDP would increase to about 27 percent by 2020, with debt modestly rising over the long-term. - Key risk sources identified: large exchange rate depreciation, weak revenue growth, decline in export growth, accumulation of contingent liabilities from PPPs, and potential financial sector stress (banking crisis). ### Policy implications and authorities’ stance - Continued structural reforms to increase resilience to external shocks and mobilize fiscal revenues are reinforced by the findings. - Recommended actions: - Continue strengthening contingent liability monitoring and fiscal transparency (list contingent liabilities in annual budget law). - Maintain revenue mobilization efforts under the RMS and pursue tax administration measures to generate revenue gains. - Safeguard government deposits while managing development and wage/social spending pressures. - Strengthen institutional capacity for PPP risk management (central PPP unit in MEF). - Authorities’ view: - MEF’s debt management unit conducts internal DSA and concurs with low risk of debt distress. - Authorities assume a similar loan disbursement profile and current account deficits but are slightly more optimistic on medium-term real GDP growth. - MEF concerned about PPP contingent liabilities and has imposed annual ceilings on PPP guarantees. *Prepared by Staff of the International Monetary Fund and the World Bank; Approved by Markus Rodlauer and Steve Barnett (IMF), and Paloma Anós Casero (WB); September 28, 2016.* ### 12. Cambodia remains at low risk of debt distress. The baseline projections and the standard ### Cambodia remains at low risk of debt distress ### Overall assessment - Baseline projections and the standard stress tests show limited risk to external debt: none of the indicators breach their thresholds. - Downside risks to the baseline scenario include the materialization of contingent liabilities and issues arising from external arrears. - The most extreme stress tests indicate vulnerability to shocks in the exchange rate, economic growth, exports, and the fiscal position. - Policy emphasis: preserve macroeconomic stability, diversify the economy and exports to increase resilience to external shocks, and successfully implement the revenue mobilization strategy. ### Technical assistance and institutional measures - Authorities have requested IMF technical assistance on PPPs using the Fiscal Risk Assessment Model (P-FRAM) to: - (i) evaluate the PPP management framework; - (ii) provide capacity building in assessing fiscal risks and contingent liabilities arising from PPPs; - (iii) identify mitigating measures among other priorities currently under discussion. - Development partners’ support noted: - ADB: supporting Cambodia in establishing a legal and institutional framework for development of PPPs. - World Bank: providing technical assistance to determine the size of contingent liabilities related to PPPs. ### Stress tests and scenario findings (high-level) - The most extreme stress test is defined as the test that yields the highest ratio on or before 2026; in many panels this corresponds to an Exports shock, and in one panel to a One-time depreciation shock. - Selected scenario outcomes (sensitivity analysis, 2016–2035) show: - PV of debt-to-exports ratio (baseline → most extreme): 31.0, 32.1, 32.8, 33.6, 34.2, 34.5, 34.2, 33.6, 27.1, 16.3. - PV of PPG external debt (Billions USD, baseline series): 21.7, 22.5, 23.3, 24.1, 24.8, 25.2, 25.2, 24.2, 21.6, 14.7. - PV of PPG external debt (in percent of government revenues, baseline series): 126.9, 125.3, 129.3, 132.3, 135.2, 137.7, 137.8, 132.9, 111.0, 68.9. - Debt service-to-exports ratio (in percent, baseline series): 1.1, 1.3, 1.4, 1.4, 1.7, 1.9, 2.0, 2.3, 2.4, 1.9, 1.3, 1.5. - PPG debt service-to-revenue ratio (in percent, baseline series): 4.9, 5.0, 5.7, 5.4, 6.6, 7.4, 7.8, 9.1, 9.5, 7.6, 5.5, 6.3. ### Key macroeconomic and financing assumptions (selected) - Real GDP growth (in percent, selected series): 7.4, 7.1, 7.0, 7.0, 2.9, 7.0, 6.9, 6.8, 6.8, 6.5, 6.3, 6.7, 6.4, 6.8, 6.6. - GDP deflator in U.S. dollar terms (change in percent, selected values): 0.9, 2.8, -0.9, 3.8, 4.0, 1.8, 1.1, 1.7, 1.9, 1.9, 1.9, 1.7, 2.1, 2.2, 2.1. - Effective interest rate (percent, selected values): 1.1, 1.2, 1.2, 1.0, 0.2, -0.6, -0.3, 0.1, 1.6, 1.9, 1.9, 0.8, 0.8, 2.2, 1.4. - Growth of exports of G&S (U.S. dollar terms, in percent, selected series): 13.6, 12.2, 10.7, 12.7, 13.6, 9.3, 9.4, 9.6, 9.6, 9.7, 9.4, 9.5, 10.3, 10.7, 10.4. - Growth of imports of G&S (U.S. dollar terms, in percent, selected series): 13.5, 13.2, 9.0, 12.6, 11.1, 8.2, 10.2, 10.5, 10.2, 9.5, 9.0, 9.6, 10.1, 10.6, 10.0. - Grant element of new public sector borrowing (in percent, selected series): 26.7, 28.4, 28.0, 27.8, 27.8, 29.0, 27.9, 29.2, 26.0, 28.0. - Government revenues (excluding grants, in percent of GDP, selected series): 15.1, 17.1, 17.1, 18.0, 18.0, 18.2, 18.3, 18.3, 18.3, 19.4, 21.3, 20.1. ### Public sector debt dynamics and financing needs (selected) - Public sector debt (in percent of GDP, baseline series): 32.1, 32.3, 32.5, 32.4, 32.7, 33.0, 33.6, 34.2, 34.5, 21.9 (2035). - Identified net debt-creating flows (selected series): -2.1, -0.8, -0.4, -1.0, -1.8, -2.2, -2.8, -2.4, -2.2, -1.5, 0.0. - Non-interest current account deficit (selected series): 12.0, 11.8, 10.3, 7.6, 4.1, 10.4, 9.5, 8.9, 7.7, 7.9, 8.0, 9.0, 10.5, 9.4. - Gross financing need (Billions of U.S. dollars, selected series): 0.1, 0.4, 0.4, 0.4, 0.3, 0.3, 0.1, 0.2, 0.3, 0.4, 2.6. - PV of public sector debt (selected series): 22.1, 22.9, 23.6, 24.4, 25.0, 25.5, 25.8 (history → projections), with 18.4 and 14.7 noted in later projections for specific partitions. ### Policy recommendations (implied by analysis) - Preserve macroeconomic stability to limit materialization of vulnerabilities identified by stress tests. - Diversify the economy and exports to reduce vulnerability to exports and growth shocks. - Successfully implement the revenue mobilization strategy to strengthen debt metrics and fiscal buffers. - Strengthen PPP fiscal risk assessment and management (P-FRAM workstream and partner technical assistance). *Sources: Cambodian authorities; IMF staff estimates and projections.* ### 1. Real GDP growth is at historical average minus one standard deviations in 2017-20181151191231261351381481481461451431 ### _cr16340 - 1. Real GDP growth is at historical average minus one standard deviations in 2017-20181151191231261351381481481461451431 ### Debt sustainability scenarios and projections - Baseline: 5666886677777777 - A. Alternative scenarios: - A1. Real GDP growth and primary balance are at historical averages: 5666775566666666 - A2. Primary balance is unchanged from 2016: 56668886677888889 - A3. Permanently lower GDP growth 1/: 5667886788999101010 - B. Bound tests: - B1. Real GDP growth is at historical average minus one standard deviations in 2017-2018: 56778977889999999 - B2. Primary balance is at historical average minus one standard deviations in 2017-2018: 56678886677777777 - B3. Combination of B1-B2 using one half standard deviation shocks: 5667886777788888 - B4. One-time 30 percent real depreciation in 2017: 575991112891010111111111111 - B5. 10 percent of GDP increase in other debt-creating flows in 2017: 56789967989999988 ### Specific shock scenarios (labels and values as reported) - B2. Primary balance is at historical average minus one standard deviations in 2017-2018: 11511611611612112211611310910610310096928985 - B3. Combination of B1-B2 using one half standard deviation shocks: 115115113114121123126124121120118116113110107105 - B4. One-time 30 percent real depreciation in 2017: 115157150145148146136132128124120117112108104100 - B5. 10 percent of GDP increase in other debt-creating flows in 2017: 11514914614314814813813412912512011611110610298 ### Debt and fiscal ratios referenced - PV of Debt-to-GDP Ratio (label present; numerical projections embedded above) - PV of Debt-to-Revenue Ratio 2/ (label present) - Debt Service-to-Revenue Ratio 2/ (label present) ### Notes and data sources (verbatim) - Sources: Cambodia authorities; and IMF staff estimates and projections. - 1/ Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period. - 2/ Revenues are defined inclusive of grants. ### Key macroeconomic findings and outlook (verbatim passages and numbers) - Growth: - Cambodia’s economy remains strong, with growth projected to be around 7.0 percent in 2016 and 2017. - Poverty decline: from 50 percent in 2005 to 18 percent in 2012. - Inflation: - Headline inflation picked up to 3.2 percent at end-2016 from 2.6 percent in 2015. - Headline inflation is projected to remain low and average around 3 percent over the medium term. - Credit growth: - 34 percent in 2014 - 30 percent in 2015 - projected to slow to around 25 percent in 2016 and 2017. - External sector: - Authorities expect the current account deficit to narrow (statement cut off in source). ### Policy recommendations and priorities (verbatim themes) - Sustaining growth: - Improve business climate, reduce infrastructure, energy, and skills bottlenecks, promote private sector development and economic diversification, improve governance and delivery of public services, support rural development. - Managing public finances and debt: - Prudent fiscal management, continued improvements in revenue collection, prioritized spending, better monitoring of contingent liabilities, strengthen budgetary and public debt management framework, further progress in budgetary transparency. - Safeguarding financial system stability and monetary policy effectiveness: - Implement key recommendations of the 2010 FSAP: moratorium on new bank licenses, strengthen coordinated supervision, develop the foreign exchange market, improve supervisory capacity, enhance payment system efficiency and stability, improve quality of financial data, encourage close coordination among financial regulators. - Manage financial stability risks from buoyant real estate markets through strengthened supervision and improved data collection. - Develop an interbank market for transition to more effective market-based monetary policy. - Improving governance: - Emphasized as critical to improving service delivery and fostering private sector development. ### IMF and partner engagement (verbatim activities and figures) - Fund relations (as of August 31, 2016): - Quota: 175.00 SDR Million, 100.0 Percent Quota - Fund holdings of currency (Exchange Rate): 153.13 87.50 - Reserve Tranche Position: 21.88 12.50 - SDR Department net cumulative allocation: 83.92 100.00; Holdings: 88.34 105.27 - Latest financial arrangements (listed with dates and amounts in source). - Multilateral Debt Relief Initiative: forgiving of SDR 56.8 million (about US$82 million) incurred before January 1, 2005. - Asian Development Bank lending, grants, and technical assistance as of June 30, 2016: - Cambodia has received $2.38 billion in AsDB lending, grants, and technical assistance. - Cumulative disbursements: $1,670.0 million. - Active lending/grants/TA totaling $1,071.1 million sector composition: - Agriculture, Natural Resources and Rural Development $284.2 million (27 percent) - Transport and Communications $197.8 million (18 percent) - Water Supply and Urban Infrastructure $181.5 million (17 percent) - Multisector $137.0 million (13 percent) - Education $101.4 million (9 percent) - Industry and Trade $83.0 million (8 percent) - Energy $45.0 million (4 percent) - Public Sector Management (PSM) $30.1 million (3 percent) - Health, Nutrition and Social Protection $10.0 million (1 percent) ### Statistical issues and data quality (verbatim points) - General: Data provision is broadly adequate for surveillance; shortcomings remain in macroeconomic data. - National accounts: Quality hampered by lack of comprehensive and reliable source data; EC2011 processing requires further improvements to follow SNA concepts; progress has stalled partly due to resource constraints. - Price statistics: CPI geographic coverage expanded to Phnom Penh plus five provinces; need for a producer price index (PPI) but no funds allocated. - Government finance statistics (GFS): Reforms since 2007; progress in submitting annual and monthly GFS data on cash basis; priorities include compiling financial balance sheet and extending institutional coverage to extrabudgetary entities and social security funds; next steps include improving CoA, mapping PAE to GFSM 2014 classifications, and reporting to the World Bank-IMF Public Sector Debt Statistics database. - Monetary and financial statistics: NBC reports standardized monetary data monthly; compiles monthly core FSIs and several encouraged FSIs and began reporting to IMF regularly since February 2016; some data deficiencies and inconsistencies remain. - External sector statistics: Quarterly balance of payments and IIP compiled per BPM5; shortcomings in coverage, accuracy, timeliness; inward FDI gaps, especially real estate acquisitions by nonresidents not included in FDI; recent improvements in ITRS and draft FDI survey; TA mission on FDI data collection planned for September 2016. - Data Standards: Cambodia participates in the IMF’s General Data Dissemination System. No data ROSC available. *Source: Cambodia authorities; and IMF staff estimates and projections as presented in the supplied document.* ### 9.7 percent in 2016 from 10.6 percent of GDP in 2015, due to reduced imports following the ### _cr16340 - 9.7 percent in 2016 from 10.6 percent of GDP in 2015, due to reduced imports following the ### Current account and external sector - Current account deficit: 9.7 percent in 2016 from 10.6 percent of GDP in 2015, due to reduced imports following the completion of major hydropower projects, low commodity prices and increasing remittances. - Medium-term projection: current account deficit projected to narrow further to around 8 percent of GDP, supported by the completion of several hydropower projects, and increased export and tourism receipts. - Gross official reserves: increased to US$8 billion at end-August, covering 4.6 months of total imports. - Authorities’ stance: encouraged by sustained FDI inflows; committed to reforms to enhance the business environment and prioritize public investments in agriculture and transportation infrastructure to promote economic diversification. - Downside external risks highlighted: China’s rebalancing (expected to result in lower growth in the near-term), appreciation of the US dollar, weaker growth in Europe, and a sharper-than-anticipated tightening in global financial conditions. ### Fiscal policy - Fiscal deficit projection: widen to 2.6 percent of GDP in 2016 from 1.6 percent of GDP in 2015, due to higher capital spending and public sector wage bill. - Tax revenue projection: increase to 14.9 percent of GDP in 2016 from 14.6 percent of GDP in 2015, supported by strengthening enforcement of the Revenue Mobilization Strategy (RMS). - Revenue and expenditure strategy: - Authorities committed to implement the RMS, rationalize investment incentives, and review other tax policies. - Reviewing the public expenditure framework and developing a medium term fiscal framework to improve expenditure allocation efficiency. - Wage bill increases implemented cautiously to allow for capital expenditure for infrastructure investment. - Contingent liabilities: ongoing improvement in monitoring, particularly from public-private partnerships; a contingency fund account designated for contingent liabilities related to enterprises in the power sector. - Debt stance: public debt has increased moderately; staff’s Debt Sustainability Analysis indicates Cambodia’s risk of debt distress remains low. - Market development: authorities open to developing the bond market and committed to maintaining adequate government deposits to ensure debt sustainability and stronger fiscal buffers. ### Monetary policy - Structural characteristics: high degree of dollarization and cash-based economy limit NBC’s ability to implement monetary policy effectively. - Exchange rate: stabilization against the US dollar continues to serve as an important nominal anchor to keep inflation low and stable. - Local currency development: NBC committed to developing interbank and money markets and the foreign exchange market to promote use of Khmer Riel; policies and action plans being developed to promote greater use of the local currency and reduce dollarization in the long term. - Reserve requirement ratios: kept unchanged since end of 2012 with ratios of 12.5 percent for the foreign currency deposits and 8 percent for the local currency. - Market instruments: since 2013 NBC issued negotiable certificate of deposits (NCDs) in US dollar and Khmer Riel to help develop the interbank market, facilitate banks’ liquidity management and market-based monetary policy operations. - Capital flow management: reserve requirement on banks’ foreign borrowing re-imposed in March 2015 to better manage short-term capital inflows to the banking system. ### Financial stability - Credit growth: averaging nearly 30 percent (year on year) over the past three years. - Financial soundness: core indicators remain healthy with adequate capitalization levels and high profitability; credit quality remains sound. - Credit distribution and vulnerabilities: credit largely directed to productive sectors but growing exposure to real estate and construction sectors represents potential pockets of vulnerabilities. - Pre-emptive measures introduced to enhance resilience and rein in credit growth: - Re-introduction of the reserve requirement on bank borrowing from non-residents. - Raising the minimum registered capital of banking and financial institutions. - Implementing a Basel-III compliant liquidity coverage ratio. - Regulatory improvements planned or underway: - Strengthening regulations on asset classification and provisioning. - Plans to upgrade solvency regulation. - Considering imposing prudential measures on institutions deemed to be engaged in excessive risk-taking. - Microfinance sector: becoming more systemically important; authorities stepped-up efforts to enhance supervisory framework for microfinance institutions and committed to a risk-based supervisory approach consistent with FSAP recommendations. - Crisis management and cooperation: MoU on establishing information sharing signed between the Ministry of Economy and Finance, the NBC, and SECC in 2014; authorities continue to build capacity and welcome further technical assistance from the Fund. ### Continuing the reform agenda - Infrastructure and rural development: focus on public investments in roads, railways, bridges and irrigation to promote rural development, inclusive growth, and to crowd in private investment. - Hydropower projects: completion of several projects expected to provide affordable electricity and enhance business climate and competitiveness. - Social sector priorities: continued improvements and prioritization of maternal health, early childcare and primary education programs in rural areas. - Human capital and skills: promotion of technical and vocational training to address skill mismatches, strengthen productivity and promote inclusive growth. ### Conclusion and authorities’ commitments - Authorities committed to preserving macroeconomic and financial stability, promoting sustainable and inclusive growth, and stand ready to implement measures deemed appropriate. - Authorities appreciative of the Fund’s continued support in providing high-quality policy advice and technical assistance, particularly in fiscal, monetary and financial sector policies. - Going forward, authorities will continue to improve macroeconomic policy and financial sector regulatory frameworks in line with the Fund’s policy recommendations. *Source: _cr16340 - 9.7 percent in 2016 from 10.6 percent of GDP in 2015, due to reduced imports following the* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16340.pdf_