In a dollarised economy, changing the reserve requirement is one of the only options available

ON July 11, 2008, the price of a barrel of oil hit a record US$147.55, and most natural resource and food commodities were setting new highs and increasing inflation. In Cambodia there were stories of people switching from cars and motorbikes to bicycles or even walking.

As gas approached 5,700 riels ($1.36) per litre, commuting in a vehicle was too expensive.

With food prices rising sharply, there was concern that discretionary income would not be able to support basic needs, potentially leading to unrest.

Property prices in Cambodia were continuing their serial rise, up 60 percent in 2006, 80 percent in 2007 and 30 percent in the first quarter of 2008.

Speculators were flipping real estate with quick profits, which were partially funneled back in the economy, sometimes into luxury goods, but mostly into the next potential property flip.  

In May of 2008, the National Bank of Cambodia (NBC), mindful of the sobering reality of sharply rising inflation and its damaging impact on the economy, doubled the reserve requirement to 16 percent. The reserve requirement is one of the few tools available to the NBC in managing monetary policy in this dollarised economy. It allows the central bank to influence the amount of liquidity in the banking system.

In 2009, the world will experience economic conditions of historic proportions.

The reserve requirement is a percentage of deposits that must be deposited in the central bank and is therefore unavailable to the bank to lend. The higher the rate, the less banks have available to lend.

As banks were dramatically growing their lending portfolios in 2007 and 2008, a good deal of credit was fuelling property investment and contributing to a home-grown real estate boom. The NBC also restricted real estate lending. Higher reserve requirements and limits on real estate lending helped stall real estate prices and control inflation.

Growing Crisis

Unfortunately, the economy started to come under pressure as the global environment deteriorated. What at first looked like a deep recession has now gone beyond that, causing concern that in 2009 we may very well enter a depression.  

Over the last year, property prices have declined and have severely impacted vehicle and jewellery sales. Liquidity in the property market has vanished and construction curtailed, impacting building supplies companies. The global contagion has hit the garment industry, and tourism is falling.

In January, the NBC cut the reserve requirement from 16 percent to 12 percent and lifted property lending restrictions. The intent is to stimulate lending, increase liquidity and boost growth. Lower reserve requirements may make over US$80 million available to banks to lend back. While this is a welcome move, other factors will limit the impact.

Falling property prices and tight liquidity means that speculators are holding positions that are likely unprofitable and difficult to sell. Some property investors borrowed heavily and are struggling to make loan repayments.

Creditworthiness has deteriorated, especially in construction, building materials, hospitality and real estate.

Banks will be more inclined to lend to industries that are less affected by the slowdown. Bank deposits are falling as media report global bank nationalisations and huge losses, leading some depositors to resort to the mattress even though Cambodian banks are not exposed to subprime loans.

Fewer deposits means less liquidity and less available to lend.  

Finally, the global economic crisis has truly spread, and while lower reserve requirements will partially offset the impact of the crisis, Cambodia is unlikely to avoid a contraction in the economy.

In 2009 the world will experience economic conditions of historical proportions, not seen in generations. Global governments are mustering every tool to confront the crisis and attempting to contain it.

The Cambodian government has announced some measures and recognises that no country is immune. The reserve requirement reduction will help contain the economic difficulties, and a further reduction would be greeted positively by banks that would welcome additional liquidity to lend into the economy.                 

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Anthony Galliano is head of corporate and institutional banking, ANZ Royal Cambodia. Email [email protected].