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Reflections on Cambodia's Fiscal Crisis

Any economist studying the situation in Cambodia might come up with the same analysis

of the causes of the current problems. It's the proscriptions that may well vary.

In Cambodia I think one can say there is one central problem from which everything

else flows or is interconnected: the growing unfunded budget deficit. Everyone agrees

that infrastructure and social services have been starved of investment and are close

to collapse. Moreover, repairs to keep the system ticking have gone down lately.

To set the scene: the lifting of the international embargo was a major accomplishment-particularly

for trade and investment-of the Paris Peace Accords. But before that, the State of

Cambodia (SOC) took steps beginning in l985 and accelerating in l989, to liberalize

the economy. This major policy switch took place with virtually no relevant models

to follow.

Given the circumstances, the SOC administration is to be applauded for its initial

decision to undertake a massive switch from a command to a market economy, and for

persevering in it. However, because of the total lack of understanding and expertise,

the SOC did not think through the implications of what should be done to insure that

the process stayed on the rails. It certainly appears that they thought they could

have a market economy by command.

Sadly for Cambodia, this desirable initiative was suddenly made more difficult by

the upheaval in Eastern Europe and the Soviet Union. The main aid and financial support

for which Cambodia was almost totally dependent dried up as a consequence. Soviet

concessions on fuel and fertilizer and Soviet aid to top up the deficit had been

major contributing factors in keeping inflation rates at a respectable level, certainly

in comparison with that of Vietnam.

The abrupt ending of Soviet Bloc assistance handed the Cambodian administration a

shock financing problem in l990. At the same time, rapid unregulated privatization

meant that existing sources of state revenues dried up. As the SOC had not devised

ways to capture revenue from excess profits generated in the private sector, they

were caught with an acute funding problem.

To use an American expression: they were faced with a "double whammy."

To compound the problem, with the withdrawal of Vietnamese troops the administration

felt obliged to increase defense spending, until this took the lion's share of budgetary

expenditures, thereby crowding out necessary expenditures on social and physical


In dealing with this problem, the only thing the administration felt capable of controlling

was the money supply. Trying to meet rising expectations and desiring to do well

in period before the elections, expenditures have outrun revenues.

Since l989 the gap has grown sharply. We're talking about a deficit that is currently

40 per cent or more of expenditures. Basically, this has been met in four ways: by

printing money, by delaying payments, by trying to collect more customs revenue from

the increased imports, and by asset stripping.

The massive increase in the money supply has had a direct impact on inflation which

has been running at the three-digit level.

For me, the unfunded budget deficit is the most immediate problem in the run-up to

the elections.

What can be done about it?

While the options in the short-term are very limited, they could be made more manageable

if Western donors could be persuaded to finance the unfunded deficit. But that is

a big "IF." At the moment practically all NGOs and donor governments have

rehabilitation projects which they have developed and are prepared to finance.

However, despite the seriousness of the economic situation, many are reluctant to

support the administration in its current budgetary dilemma because of reasons which

I think don't hold water. The reasons are political: they do not want to risk being

accused of supporting one political faction.

Whatever the political reasons, it is a fact that the SOC is the de facto administration

and it is recognized as such under the Paris Peace Agreements.

Starving it of essential financing in one crucial area does not make economic sense.

It is analogous to a different sort of embargo. Unless changed-and the U.N. Secretary-General

has been pushing for significant budgetary support-it's the people under the Phnom

Penh regime's administrative control (about 85 per cent of the total area) who will


Financial support should be given to bridge the gap. This should not be difficult

to do under a system of strict controls and stringent monitoring to avoid any accusations

that such funding will be used for partisan political purposes.

Undermining the existing administration and thereby giving political debating points

to the other factions can hardly be called being impartial!

Funding the deficit would not have to be long term and it certainly would be more

cost effective than a lot of sectoral projects that are being mooted at present.

At the same time, such financing, in my opinion, should be tied to urgent technical

assistance targeted to increasing domestic revenue in the shortest possible time.

In any developing country where you have a very poor infrastructure, the main point

of revenue focus is necessarily on the trade side; this means the import regime and

customs collection. Such revenues are the easiest to collect and the most visible.

Since l989 customs revenues have been growing fast. They finance about 14-15 percent

of budget expenditures. If their yield can be brought in line with the current growth

of inflation, then it will at least show donor governments that the administration

is, itself, making its best efforts to narrow the gap.

Another problem faced by the Phnom Penh administration is that they don't really

feel that they've gotten the "peace dividend." Defense expenditures are

still high, inspite of the presence of UNTAC. There's still a high level of uncertainty

in the country. Hopefully this will change once UNTAC completes its military mandate.

We all want economic liberalization to succeed. We all want the seeds of Cambodian

democracy to be planted in fertile soil. If this calls for substantial budgetary

support, so be it.

To the extent possible, all those who have the best interests of

Cambodia at heart should at least try to persuade Western donors to change their

prevailing attitude.

The whole U.N. operation and the fulfillment of UNTAC's very

substantial mandate will be judged not just by its success in bringing about free

and fair elections, but also by the extent to which they will have reduced the number

of mind-boggling problems that a newly elected government will face when it takes

office next year.

- Robin Davies is a visiting Professor at the Institute of Economics and Head

of the International Organization for Migration's office in Phnom Penh. Previously,

he served for 27 years as a senior official in the GATT Secretariat in Geneva.



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