Experts warn that Cambodia’s imminent move up to lower-middle income status could lead to a drop in foreign aid and economic assistance

For more than two decades, Cambodia has notched up stunning economic growth, while efforts to alleviate poverty and increase industrial activity are beginning to pay dividends. If it continues on course, the county is set to make the transition from a least developed economy (LDC) to a lower-middle income country by next year.

While the status upgrade would affirm Cambodia’s economic openness, higher wages and increasing foreign investment, it could also lead developed countries to scale back their foreign aid and economic assistance, economists warn.

As per the World Bank’s criteria, a least developed country has a gross national income (GNI) per capita of less than $1,045, middle-income countries are in the range of $1,045 to $12,746, and high-income countries are above that level.

Cambodia’s draft national budget for 2016, passed by the Council of Ministers this week, projects GDP per capita to reach $1,325 next year – more than double what it was 10 years earlier.

While GDP measures the total economic output of a country, the World Bank bases a country’s income status on GNI per capita, which is a nation’s total income divided by its population.

In its East Asia and Pacific Economic Update released in April the World Bank projected Cambodia’s GNI per capita – pegged at $1,020 in 2014 – would reach $1,096 in 2015, putting the country beyond the threshold of a middle-income country.

“The figures show that Cambodia is moving into the low-middle income territory, and if the momentum of growth continues, it can,” said independent economist Srey Chanthy.

He said while the migration to the new bracket will not happen overnight, it is important for Cambodia to prepare for that eventuality.

“Cambodia must be prepared for this as donors would reduce developmental aid and grants, including concessional or soft loans, and give it less favourable trade deals, et cetera,” he said.

Moving to middle-income status would take Cambodia out of the company of countries such as North Korea, Afghanistan and Nepal, and put it squarely with most of its fellow ASEAN member states, save for Laos and Myanmar.

But being a least-developed country has benefited the Kingdom, especially with its inclusion in the European Union’s Everything But Arms (EBA) policy, which gives LDC countries duty- and quota-free trade access to the economic bloc.

The privilege has boosted Cambodian trade with the European Union, which has become the Kingdom’s top export destination with a 36.7 per cent market share on the back of duty-free garments and rice consignments.

However, the European Union assesses income brackets using a United Nations measure that is a combination of a country’s GNI, the level of its human capital and its vulnerability to economic shocks. By this measure, Cambodia could have another six or seven years until its LDC status expires.

Alain Vandersmissen, chargé d’affaires of the Delegation of the European Union to Cambodia, said once the UN stopped classifying Cambodia as an LDC, the Kingdom will have a three-year transitional period to “alleviate any adverse effects caused by the removal of the tariff preferences granted under EBA”.

He added that Cambodia was expected to migrate to middle income by 2022, which is when the three-year transition period will begin.

“However, Cambodia would likely be entitled to benefit from the standard Generalised Scheme of Preferences, which provides tariff reductions, though on less preferential terms than under the EBA,” he added.

According to Vandersmissen, the EU is collaborating with the Cambodian government to strengthen its current and future economic competitiveness, as well as study the impacts of removal of the country’s preferential market access.

Making this jump to a low-middle income country should be a matter celebration for Cambodia, said Stephen Higgins, managing partner at investment firm Mekong Strategic Partners. But, he added, its visible effects will be slow to materialise.

“Cambodia isn’t going to wake up one day and suddenly face a whole new world just because it is classified as middle income,” he said.

But it will face new challenges. The middle-income trap – an economic term coined to describe the difficulty in transitioning from a middle-income to high-income country – will be a real concern for Cambodia as it moves forward, Higgins added.

High wages, which will impact low-cost manufacturing, and under-investment in infrastructure and education, Higgins said, could see the country getting stuck in the middle-income trap. “In Cambodia, both of those issues are present, so we need to see a lot more investment going into education and infrastructure.”

Miguel Eduardo Sanchez-Martin, senior country economist for the World Bank in Cambodia, said the country’s transition to low-middle income would be officially recorded by the World Bank in July 2016.

He added that this migration would likely result in donors scaling back their grants to Cambodia, but that the government was aware of this and in response was scaling up revenue generation.

“In fact, domestic revenue has been improving during the past several years, thanks to the Public Financial Management Reform Program,” Sanchez-Martin said.

He added that revenue collection improved markedly after the government introduced its five-year national revenue mobilisation strategy last year.