WELDING THE CRACKS

A builder works on the $10 million Parkway Mall. 'I'd like to be optimistic,' says one diplomat, 'but I can't.'

LOCAL and foreign monetary experts give Cambodia till the

end of the year to form a government to attract international aid and investors.

If not, they say, prospects are grim. The economic nosedive Cambodia took after last

year's July fighting will worsen: aid will dry up; investors and technocrats will

leave; the riel collapse; and there will be inflation, stagnation, empty government

coffers, and unpaid soldiers and police adding to a soaring crime rate that will

strangle Cambodia's tourist industry.

"If a government is formed by the end of the year, then I am hopeful,"

says Sok Hach, economic advisor at the Ministry of Economy and Finance. "But

if not, I prefer not to think about it."

Sok Hach says between 1993 and 1996, economic growth averaged 6%. "The CDC [Cambodian

Development Council] and the CIB [Cambodian Investment Board] did well to attract

investors. It was not just the July events in 1997 but the earlier grenade attack

in March that saw the reduction of foreign currency deposits in banks and passenger

arrivals at Pochentong.

Passenger arrivals fell by 5,000 from a peak of 33,000 before March to 9,000 in July

and only recovered to 20,000 in August 1998.

Foreign currency deposits in all banks dropped from $231 million in March to $202

million in April, then plummeted further to $173 million in July, 1997. Deposits

in August 1998 were an anemic $145 million. "This was the same level we had

back in 1995," Hach says.

The riel held steady at 2500-2700 to the dollar throughout 1996 and the first half

of 1997 but fell past 3,000 after July 1997 and hovers at 3,800 now.

"The Asian crisis and the outflow of dollars have had an indirect effect,"

says Hach, "but the main cause of the financial deficit is the printing of money.

"In 1997 we had expenditure under control. But 1998 is worrisome. Expenditure

rose with election costs, integrating Anlong Veng [theKhmer Rouge stronghold) and

security costs.

"In the first six months of 1997, we went through nine months of budgeted expenditure.

And with no budget support from the World Bank or IMF [both cut off in 1996], the

national bank printed money.

"I'm afraid if the political situation is not resolved by the end of this year,

[the value of the riel] will be a big, big problem," he says.

"What will happen to the riel?" asks one Southeast Asian diplomat. "It

will go the way of the Indonesian currency. A top banker told me this will happen

in months, not years. Cambodia needs recognition and aid which may lead then to private

investment [but that] will be slow, if at all."

He says that the big investors hotels, for example, who are suffering 10-30% occupancy

rates are staying put, though they are losing money. But the small ones are getting

out. "Last year was bad," he says. "1999 will be worse."

This was because of the problems after the elections and the failure of rice crops

in the eastern provinces, he says.

Last year, Cambodia exported a small amount of rice. This year however they are looking

for 200,000 tons of rice aid.

The key, he agrees, is to form a government. "Unless they do they will not get

aid, will not integrate into the region, will have no UN seat, no ASEAN membership,

no IMF, no big funding back. This means serious trouble. Aid is the key to sustain

them and get them going."

"Right now the government coffers are empty. For three months the military and

police have not been paid. This is why crime is up. A businessman told me that an

army colonel came to see him, begging for $200 so his men could eat. The Chinese

business community is frightened of kidnapping which are getting down to the small

fry a bakery manager kidnapped for $1000 ransom."

The Naga casino is being sued by the Singaporean owners of their ship. An industrial

park near the Japanese bridge has failed. The $1.3 billion Malaysian investment in

Sihanoukville was terminated.

What is left now is the garment industry and Chinese investments quick in and quick

out.

Outstanding for its audacity in this climate is the $10 million Parkway Mall, funded

by Singaporeans.

"I'd like to be optimistic but I can't," the diplomat says. "The situation

is serious and getting worse. Even investments in entertainment a cowboy country,

cheap wine, women, gambling are suffering. Teng Boonma [reputedly Cambodia's richest

businessman] and a half dozen dragons are in trouble. They overextended in the boom

years. It's inevitable they would fail now. They made political donations and got

nothing in return," he says.

"Economists are getting fed up. The government can't pay their salaries, so

they are not only moonlighting, they're daylighting. No decisions are being made.

Nobody wants to do anything. Economists have no confidence in the country and are

leaving. Half the nationals of my own country have already left for home."

Dusit Manapan, First Secretary of the Royal Thai Embassy says there are between 500

to 600 Thai businesses in Cambodia. He says "most Thai people are staying but

there are no new faces since July 1997. Still, Thailand moved to the position of

number one investor in Cambodia, ahead of Singapore, last year.

"Two way trade was $320 million, with a balance in our favor of $65 million.

Thailand sends cement, construction materials, consumer products, bicycles, motorcycles,

spare parts. I see an increase in 1998 but not by much. This is not counting the

border trade which is not registered or regulated."

Manapan agrees, though, that the riel could fall in a matter of months. "The

exchange level does not reflect the true picture of the economy," he says, "it's

artificial. They are selling dollars to support the riel. Who knows where the riel

would float otherwise? What happens when they run out of dollars? What happened to

us when we used up hard currency to defend the baht?

"The Indonesian rupiah went from 3,000 to 9,000 to the dollar. I think this

could happen here too. If the political situation goes on longer than this, who knows?

Justice and fairness are important, but more important is to eat this is the Thai

attitude. You have farmers sleeping in the streets. There's a need to adjust the

mentality to anattitude of compromise... In December there is an ASEAN summit in

Hanoi. If there is no government, the Cambodians can't even go to the meeting, much

less apply for membership."

Foreign aid, with such donors as the World Bank and the United Nations' CARERE (Cambodia

Area Rehabilitation and Regeneration Project), is complicated by the political impasse.

Most pressing is the meeting of a new Consultative Group (CG) between donors and

the government which will determine the scope and direction of future aid. The last

CG was held in Paris on July 1-2, 1997.

"The date of the new CG has to be decided in consultation with the new government,"

says a World Bank official. "We're waiting for the policies and commitment of

a new government."

World Bank-funded aid projects in agriculture, disease control and health were ongoing

despite the fighting last July. A water supply project for Phnom Penh was approved

this February by major World Bank shareholders including the United States. Four

new Bank projects in roads, rural development, biodiversity conservation and education

are now being prepared.

"When technical details are worked out, then it is time to sign with the new

government," the World Bank official says. "This is a time- consuming process

because of the huge sums involved, ranging between $17-40 million. After preparation,

we need a political decision from the government. We lose time if we can't get approval.

The fiscal year for the World Bank is July-June, for the government January-December.

Two projects must be approved before June. It's difficult to speculate what will

happen if there is a prolonged period before Cambodia has a government. Much depends

upon the political perspectives of the major shareholders.

"I don't feel a sense of threat to the projects, not a panic situation. But

the longer the delay, the longer it takes to implement. When you sign, you don't

get money in your pocket. There is a start-up period before delivery. Political difficulties

are prolonging the economic recovery in the country. The sooner the government is

formed, the better for the country. The situation as it is now is helping no-one."

Scott Leiper, Program Manager of CARERE, says: "Donors are lining up, waiting

for and wanting a new government to form. The delay in this isholding up the processing

of new money. We are arranging a $12-14 million loan now and need to have government

approval."

"Our investment in 1998 was $8-9 million. In 1999, we'll be lucky to get $4

million. In 2000, I hope to get $9 million. The drop is due to politics and the donor

cycle, broken in July 1997. The effect of July was not a cutoff in aid, except for

USAID, but a holding off of new projects until a new election and government. The

old projects are running out now. Now we're at a standoff, waiting...

"[For CARERE] the past three years have been devoted to capacity building and

systems development. Before Cambodia had more aid funds than it could absorb. Now

they can absorb more than we have [to give].

"1999 will be the year of the gap. This is part of a global turndown in aid.

For the year 2000 I see better prospects. My big fear is if a new government has

not been formed by the end of 1998. Even by November, some donor countries the Netherlands

for example might allocate money to other countries if Cambodia does not have a government

to approve and disburse funds."

The irony, Leiper says, is that just as new areas in the northeast have come under

government control and open to development representing "the poorest of the

poor" aid is stuck in a holding pattern. Just this week four delegations from

Sweden, the Netherlands, the World Bank and the International Fund for Agricultural

Development traveled to CARERE project areas to see how the new system is working.

"My biggest fear is that we will lose money if the delay in forming a government

lasts another two or three months," Leiper says.

Alex Traun, General Manager of Naga Cement, opened a cement factory in Kampot on

behalf of the Swiss multinational Holderbank, the world's largest supplier of cement

and concrete, two and a half years ago. The factory employs 400 workers.

The Cambodian Development Resource Institute says that two economic bright spots

in a generally gloomy picture were the garment industry whose exports rose 63% in

1998 and the cement industry, both supposedly maintaining "a boom".

"I would be happy to have a boom, but this is not the case," says Traun.

"We're producing 120,000 tons a year, but could do 300,000 if themarket was

there. The problem is the price. We can't compete with smuggled cement from Thailand

and to a lesser extent Vietnam. We pay taxes, they don't. I think we have a 20% share

of the market but there's no way to know. We sell to Phnom Penh, Takeo, Sihanoukville,

Kam-pong Speu, but to the north we can't compete. The more we sell, the more we lose.

"You're penalized if you keep to the law and do business right. A stable government

is needed to fix this. I'd like to be optimistic but in this political situation

I'm not. I see a difficult first half in 1999 and likely the whole year, because

of the lack of a stable government. I don't understand why politicians ran outside

the country. They stayed for the vote when they knew it would be difficult to try

for the government. They should either stay or leave it to Hun Sen. Why make a game

of this?"

Traun is surprised the riel has lasted so long. He expected it to crash before the

election. "We stopped credit before the election and are still running after

money. Collection is a big problem. But despite negative information about the courts

here, I find they work fine in litigation. No kickbacks, fast and efficient, at least

in Kampot and Takeo. Collection is a problem for the banks too. That's why they're

in trouble."

Siam City Bank, for example, is pulling out. Sitting in her empty bank, manager Chiraporn

Sumetheeprasit acknowledges the difficulties of doing business in Cambodia. The decision

to close was made in Bangkok on Aug 14, as part of a scheme of regional downsizing.

"Our main customers here were Thai going into joint ventures," Chiraporn

says. "Lending to Cambodians was difficult to control because of problems of

collateral, legal action, collection of debts. And since last July, how can you earn

money? Our old investors are repaying loans and not taking out any new credit lines.

Remittances are down."

Two new regulations will further hinder the banking industry here. The first, from

three months ago, says that all overseas currency transfers must be performed by

the National Bank of Cambodia which takes a service charge of 2.75%, compared to

Siam City Bank's 0.25%. The second, and more ominous, regulation was issued on Oct

1 and backdated to Sept 30. It says commercial banks must deposit one dollar in the

National Bank for every dollar deposit.

"This was a big surprise," Chiraporn says. "At what interest and whatexchange

rate? Can we withdraw the principal? How and when? It comes down to low interest

and high risk."

Yet another provision requires banks to lend money to Cambodians with collateral

in Cambodia, especially in agricultural.

"We could do this if we had a guarantee from the Ministry of Agriculture,"

Chiraporn says. "We had only one such loan, a cattle scheme in Kompong Cham

near Vietnam. The scheme failed, most of the cattle were stolen, and we had no legal

recourse there, no way of monitoring, no legal accountability. The risk is higher

than acceptable."

She thinks the reason for the new regulations is to keep money in Cambodia, and that

the central bank will disburse funds to local banks to lend to Cambodian businesses.

"The Thai Banker Club [Krung Thai, Thai Farmers, Bangkok Bank, Siam City] sent

a letter to the government through the Thai Embassy saying that the new regulations

were not good for the banking system and that they will discourage deposits and lending.

I can only hope that they are temporary."

For the future, veteran observers like Sok Hach and Scott Lieper are hopeful.

"We have a system in place, with key ministries involved, where it's easy to

absorb funds now," says Leiper. "This is a new chance for development.

If a new government is formed to tackle the big issues the environment, taxation,

revenue and the big donors see this, they will engage with government agencies. The

system will keep going, the level of assets will be accessed, and things will be

all right."

Hach says the decline can only be stopped when a new government is formed. The ministry

can prepare a good budget for 1999.

"We can get money from the World Bank and the IMF," he says, and follow

the IMF's reform programs. "If the new government does not do real reform, then

it's the same as not having a government at all."