Garment workers walk past clothing stall in Cambodia. The country’s robust garment exports have contributed to strong growth (photo: Corbis/Reuters/Samrang Pring)
ECONOMIC HEALTH CHECK
Cambodia’s impressive economic performance over two decades has resulted in a substantial reduction in poverty, and noteworthy progress in achieving the Millennium Development Goals.
Looking ahead, further regional integration with the countries of the Association of Southeast Asian Nations (ASEAN), and Cambodia’s strategic location close to fast-growing major economies provide opportunities to boost growth further.
“However, to capitalize on these opportunities, and achieve sustainable and inclusive growth for the next stage of development, reform efforts should be stepped up, and vulnerabilities addressed,” said Sonali Jain-Chandra, the IMF’s mission chief for Cambodia.
Strong growth, but growing risks
Cambodia’s economic growth has been one of the fastest among Asia’s developing economies in recent years driven by vibrant garment exports, real estate, and construction activity.
The near-term outlook remains broadly favorable, and growth is projected to remain robust at 7 percent in 2015, and rise modestly to 7.2 percent in 2016, supported by lower oil prices, and the same factors that contributed to past growth.
This outlook is nevertheless subject to substantial risks, both domestic and external, the report says. Domestic risks include rising financial sector vulnerabilities stemming from rapid credit growth, fiscal pressures, and erosion of competitiveness from wage increases, and the uncertainty related to wage policy and labor disputes.
External risks arise from a stronger U.S. dollar, growth slowdown in Europe constraining garments exports, and weaker-than-expected growth in China having negative spillovers through foreign direct investment, banking, and tourism channels.
“Going forward, with Cambodia increasingly integrated into the global economy, domestic risks, and the evolving external environment underscore the need to decisively address financial sector vulnerabilities, build policy buffers, and foster economic diversification and inclusion,” said Jain-Chandra.
Addressing financial sector vulnerabilities
Private sector credit has grown by nearly 30 percent on average in the past three years, and the credit-to-GDP ratio doubled over this period. The speed of financial deepening has been striking, with credit growing much more rapidly than in other Asian economies.
This is the result of new foreign bank entry, increased foreign funding of domestic banks, and buoyant domestic activity. There is also evidence of increasing credit concentration in the real estate and construction sectors. These developments point to rising financial sector vulnerabilities, the report says.
“It is important for Cambodia to adopt a proactive approach to manage and mitigate risks to financial stability while protecting growth,” said Jain-Chandra.
The recent expansion in the coverage of reserve requirements to include banks’ foreign borrowing is a step in the right direction. But additional measures are needed. Raising reserve requirements and introducing well-designed macro-prudential policies would help moderate the pace of credit growth and curtail risks.
Also strengthening the crisis management framework is critical to manage systemic risks, and should be expedited. Given that supervisory capacity is stretched, the National Bank of Cambodia should consider a moratorium on new bank licenses until supervisory capacity improves, says the report.
Building policy buffers while meeting development needs
The adoption of the Revenue Mobilization Strategy has led to a large increase in revenues, and the replenishment of government deposits, which is the main fiscal buffer. “Going forward, continued efforts to mobilize higher revenues will be needed to create fiscal space for social spending and capital expenditure while maintaining a strong fiscal buffer,” said Jain-Chandra.
In light of upward pressure on the public wage bill, it is crucial for future public wage increases to be contingent on fiscal performance, and be accompanied by deeper, efficiency-enhancing civil service reforms, says the report.
Promoting competitiveness, diversification, inclusiveness
The changing patterns of China’s trade and further regional integration through the ASEAN Economic Community provide opportunities for Cambodia to diversity and expand its exports, and further integrate into global supply chains.
“Much needs be done to capitalize on these opportunities,” said Jain-Chandra. This includes greater investment in human capital, and a reduction in the overall cost of doing business. Upgrading infrastructure, in particular ensuring cheaper and more reliable electricity supply, and greater connectivity, also should remain a key priority, says the report.
