T HE International Monetary Fund's recent cancellation of a US$20 million loan to

the Cambodian government could pose a serious threat to the economy.

The IMF canceled the fourth installment of a $120 million loan package because the

government failed to direct taxes from logging concessions to the Treasury.

The cancellation could reduce Cambodia's foreign reserves, hurt the US$/riel exchange

rate and the national budget, according to some analysts. The danger to the economy

would be compounded if other foreign donors follow the IMF's lead and cancel or reduce

their bilateral assistance.

The IMF's patience with Cambodia - after earlier warnings to clean up its logging

policy - appears to have finally snapped.

"We asked the government to modify its forestry policy in July. Unfortunately

there has been much less action than we would have hoped for," Michael Kuhn,

assistant director of the IMF's Central Asia Department, told Reuters Nov 14.

Speaking upon his departure after a 10-day mission to Phnom Penh, which included

concerted negotiations with government officials, Kuhn confirmed that the $20 million

loan would "lapse".

Payment of the loan had earlier been postponed since May.

Of the remaining loan installments totaling $40 million due to be paid over the next

year, Kuhn said he hoped that "determined policy and implementation in the [forestry]

area" would allow discussions with the government over their payment.

Kuhn said the government's actions - including passing a forestry code, adopting

international forestry guidelines and hiring an independent logging auditor - were

a step in the right direction.

"But the commitment and the words will now need to be matched with deeds,"

he said.

Kuhn added that he did not believe the IMF decision would destabilize the economy,

and that Cambodia's foreign reserves were "reasonably comfortable" for

the time being.

Some financial analysts were not so sure, suggesting that the IMF's action would

have economic consequences.

The $120 loan program, part of the IMF's Enhanced Structured Adjusted Fund (ESAF),

has so far seen three installments of $20 million disbursed to the National Bank

of Cambodia.

The ESAF was designed to help the Kingdom's balance of payments by covering the official

gross foreign reserves. In recent months, Cambodia's gross reserves - measured in

terms of the amount of imports they can cover in one month - have fallen to the equivalent

of 2.1 months of imports. That is down from the projected amount of 2.3 months in

1996. A 3-4 months cushion is considered safe.

Since low foreign reserves puts pressure on the US$/riel exchange rate, the IMF's

cancellation of the fourth installment could cause the riel to deteriorate, causing

lower revenues for the national budget. This would be particularly acute in Cambodia,

where 40-50 percent of the budget depends on foreign currency from international

aid. Moreover, 80 percent of that amount is comprised of grants.

Gross reserves are currently at a manageable level, financial analysts say. But if

the IMF does not reopen its spigot - paying the fifth and six installments of the

loan - the reserves could fall even further.

The effects of a sliding US$/riel exchange rate would be felt in 1997, which was

likely to be a "difficult year", one analyst said. There is the possibility

that the reserves would be used to cover the trade deficit, which is expected to

grow substantially. Further pressure on the US$/riel exchange rate would indirectly

affect the national budget.

The danger is compounded by the possibility that other foreign donors will follow

the IMF's lead. The World Bank - a sister institution of the IMF - has already delayed

a decision on $27 million in agricultural program funding. The Bank may also halt

financing several projects a year, affecting up to $100 million per year. Before

other donors determine whether or not to continue assistance, most will wait to see

how the Cambodian government responds to the IMF, several analysts said.

"As a major donor to the Cambodian government," said Mr Iso, the First

Secretary of the Embassy of Japan, "we have an interest in the natural resources

of Cambodia. We hope that the Royal Government will take the advice of the IMF seriously."

Minister of Finance Keat Chhon was unavailable for an interview. But, speaking briefly

to reporters at the National Assembly Nov 18, he urged the government to work "tirelessly"

to maintain an effective tax policy.

"Whoever rides in a Mercedes must dare to pay the bigger share [of taxes],"

said Chhon, who would not comment directly on the IMF loan cancellation.

How easy it will be to devise a compromise between the IMF and the Cambodian government

is unclear.

At the heart of the matter is ensuring that taxes from logging concessions are directed

into the national budget. The system works fine on paper, one critic said, but not

in reality

The Ministers of Commerce, Finance, and Agriculture sit on a committee to determine

the allocation and price of a logging concession. They also ensure that the license

is properly sold and that taxes are directed to the national budget.

In practice, the system is manipulated by political elites for their own political

or personal ends, one critic maintained. Logging companies continue to pay taxes,

at least to a certain extent, but political parties, government officials, and especially

the army either steal the taxes outright or demand bribes from the companies in exchange

for lower taxes.

It is the national budget which suffers. Taxes on logging concessions totaled 20

billion riel in 1996 - down dramatically from a projected 100 billion riel. Taxes

could have been even higher, another critic argued, if the government charged a "reasonable"

price per cubic meter. Logging companies currently pay $35/cubic meter, extremely

low compared to $100/ cubic meter obtained during a 1994 auction.

The situation can only be resolved by a political decision at the highest level,

analysts said. "It's the elites who decide [about the logging policy],"

one observed. "If they decide, nobody will be willing to go against them."

Another observer, however, complained that it is unlikely that difficult economic

decisions will be made before the elections.

While politicians dither, there is the possibility that the economy could spiral

downward. According to this worst-case scenario, political leaders will continue

to refuse to redirect the flow of all logging taxes to the budget. Faced with an

unaltered forest policy, the IMF may cancel the fifth and sixth loan installments,

which would worsen the US$/riel exchange rate and increase fiscal pressures. Other

foreign donors, finally realizing their aid is being sucked into a black hole might

reduce their commitments. A final outcome of this scenario could be that the increasingly

defensive government decides that it doesn't need the constricting advice or financial

help from international organizations and abandons any semblance of fiscal discipline.

"The IMF is playing a delicate game," said one observer. The organization

decided to do something to protest the continuing diversion of logging taxes, but

by doing so, it also may risk sacrificing its past macroeconomic and fiscal accomplishments,

he said.

Some suggest that the government leaders and the IMF will likely end up devising

a compromise solution where they both claim victory. In this scenario, they would

compromise on a certain percentage or amount of taxes from logging concessions to

be directed to the national budget. The IMF would approve, or at least turn a blind

eye to, the remainder that is directed to officials and political parties. This would

be a best-case scenario for Cambodia's pre-election politics - but not for the national

budget.