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Sustaining growth in Cambodia

Cambodia’s robust economic performance over the past two decades has resulted in a substantial reduction in poverty and led to its imminent transition to a lower middle-income country. Looking ahead, further regional integration through the ASEAN Economic Community (AEC) and Cambodia’s strategic location close to fast-growing major economies can provide tailwinds as Asia rebalances and production networks further integrate.

However, to capitalise on these opportunities and achieve sustainable and inclusive growth, many obstacles must be overcome and vulnerabilities addressed.

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Growth has been stable, lifting per capita income substantially. Averaging 7 per cent in the past five years, Cambodia’s growth has been one of the fastest among Asia’s developing economies in recent years.

Economic activity remained steady at 7 per cent in 2014, driven by garment exports, construction and real estate. Inflation declined sharply owing to strong external disinflationary pressures from lower food and oil prices.

The current account deficit remains stable, largely financed by FDI and official loans. The fiscal deficit narrowed thanks to strong revenue collection as the Revenue Mobilisation Strategy was implemented.

Credit growth has been rapid. Private sector credit has grown by nearly 30 per cent on average in the past three years and the credit-to-GDP ratio doubled over this period to over 50 per cent. At the same time, the loan-to-deposit ratio reached 100 per cent in 2015. There is also evidence of increasing credit concentration in the real estate and construction sectors.

The short-term outlook remains broadly favourable. Growth is projected to remain robust at 7 per cent in 2015, while inflation is projected to rise gradually to about 2 per cent by end of this year.

The current account deficit is expected to narrow mostly due to lower oil prices. The fiscal deficit is projected to rise modestly to 2 per cent in 2015 (below the budget target of 4.2 per cent). However, the spending mix has deteriorated as the public sector wage bill rose while capital spending declined.

This outlook is nevertheless subject to substantial downside risks, both domestic and external. Domestic risks include rising financial sector vulnerabilities from rapid credit growth, and fiscal pressures and erosion of competitiveness from wage increases.

External risks arise from further strengthening of the US dollar, a slowdown in Europe constraining garments exports and weaker-than-expected growth in China having negative spillovers through the FDI, banking and tourism channels.

If global financial market stress re-emerges, funding costs for Cambodian banks and micro-finance institutions, which rely increasingly on external funding, would increase leading to liquidity pressures and a credit crunch.

As explained in the recently published 2015 IMF staff report on Cambodia, going forward, with Cambodia increasingly integrated into global economy, domestic risks and the evolving external environment underscore the need to act decisively to address financial sector vulnerabilities, safeguard policy buffers, and foster economic diversification.

Safeguarding macro and financial stability. Rapid credit growth, increasing bank flows from abroad, and greater exposure to the real estate and construction sectors pose macro-financial risks.

It is important to adopt a proactive approach to manage and mitigate risks to financial stability while protecting growth. The National Bank of Cambodia (NBC) expansion of reserve requirements to banks’ foreign borrowings in March 2015 is a welcome step.

But additional measures are needed. Raising reserve requirements and introducing well-designed macro-prudential policies would help to moderate the pace of credit growth. Better monitoring of real estate developments, including enhanced data collection, is key to containing risks.

Securing a strong fiscal buffer while meeting development needs. The adoption and implementation of the Revenue Mobilisation Strategy has led to a large increase in revenues and the replenishment of government deposits.

Going forward continued efforts to mobilise higher revenues will be needed to create fiscal space for social spending and capital expenditure.

This is important in view of spending pressures from a higher wage bill and an expected fall in official assistance.

Also, it is crucial for future public wage increases be contingent on fiscal performance and be accompanied by deeper, efficiency enhancing civil-service reforms.

Continuously strengthening public finance management will help to ensure spending effectiveness and enhance budget accountability and transparency.

Promoting competitiveness, diversification and inclusiveness. The changing pattern of China’s trade and further regional integration through the AEC provide opportunities for Cambodia to diversity and expand its exports, and further integrate into global supply chains.

Upgrading infrastructure, in particular ensuring cheaper and more reliable electricity supply, remains a key priority. Greater investment in human capital and a reduction in the overall cost of doing business are also critical to sustain robust growth and enhance competitiveness, economic diversification, and promote inclusiveness.

The IMF maintains strong engagement with Cambodia, which includes regular policy dialogue as well as an intensive technical assistance program (which ranges from financial supervision, to fiscal management as well as economic statistics).

Cambodia is now poised to become a lower-middle income country, and IMF is remains committed to supporting Cambodia to successfully reach the next phase of development.

Sonali Jain-Chandra is IMF’s mission chief for Cambodia (based in Washington) and Yong Sarah Zhou is IMF’s resident representative for Cambodia (based in Phnom Penh).



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