A fter withholding $60 million of payments to the Cambodian government for nearly

a year, the International Monetary Fund's patience ran out last month: it confirmed

the "expiry" of its financial support program to Cambodia and the withdrawal

of its representative to Phnom Penh. Earlier, at the July 1 Consultative Group donors'

meeting in Paris, IMF senior official Hubert Neiss gave a frank warning

to Cambodia to improve its economic governance. The following is his full speech

to the Consultative Group.

Over the past four years, the government of Cambodia has made remarkable progress

in economic and social recovery under its medium-term reform program. Most significantly,

the macroeconomic situation has been kept stable, thanks to responsible budgetary

and monetary policy efforts - Minister Keat Chhon deserves special commendation -

as well as large-scale financial support from the international community. Growth

has been robust, inflation has fallen into single digits, and the external position

has improved significantly. Progress has also been made in advancing the wide-ranging

agenda of structural reform, though with delays and some backtracking, particularly

in civil service and tax reform. But we should not ask for ideal economic performance,

especially not in a country in as difficult a situation as Cambodia.

As true friends of Cambodia, we should, however, insist that Cambodia's well known

problems of governance not be allowed progressively to mount to an extent that seriously

threatens the economic future of the country. This, unfortunately, is now a reality

in Cambodia. The rapid depletion of the natural resource base and the massive diversion

of revenues from the national budget are clear writings on the wall.

Uncontrolled and illegal logging activities in recent years have resulted in rapid

depletion of the country's valuable forestry resources with little benefit to the

government budget. While there are of course no precise data, our rough estimates

suggest that losses to budget arising from illegal activities in forestry were well

over $100 million in 1996, more than one third of total budgetary revenue collected

in that year.

Forestry is not the only area of illegal activity. Corruption is spread over a wide

area, which includes: (1) concessions, such as monopoly rights and land leases, given

to foreign investors without payments to the budget; (2) tax and tariff exemptions

granted to domestic and foreign companies, including those that arise from improper

exemptions granted under the overly generous Investment Law; (3) noncollection of

taxes by tax officials; and (4) nonpayment of taxes on commercial activities by the

military, including leases of government land. This list is, by no means, exhaustive.

The amount of resources diverted from the budget by these activities could be even

larger than the losses from activities in forestry.

Estimates of the total impact of corrupt activities are, by necessity, difficult

and to some extent conjectural, and we wanted to be deliberately conservative so

as not to exaggerate things. Our results are, nevertheless, alarming. Overall, the

diversion of public resources has probably reached the same amount as actual budget

revenue collections, or nearly 10 percent of GDP. Obviously, this trend has to be

reversed to save the country's economy from serious damage. Such damage simply cannot

be ignored by IFIs [International Financial Institutions] and donors who must take

a longer-term view on economic viability. The IMF has clearly distanced itself from

these practices in several messages from the Managing Director to the two Prime Ministers,

and our programs have consistently built in safeguards.

At various stages Cambodia's ESAF [the Enhanced Structural Adjustment Facility program

agreed between the IMF and the government] has been delayed and disbursement disrupted

because of the non-observance of these safeguards. In particular, the mid-term review

under the second annual ESAF arrangement could not be completed as scheduled in December

1996, and the associated disbursement of some $20 million lapsed. The program for

1997, to be supported by the third-year ESAF, is still on hold since agreed prior

actions to safeguard against illegal activity in forestry have so far not been implemented,

and there is evidence of backsliding in other areas, notably tax administration.

In the meantime, we are discussing remedial actions with the authorities. First and

foremost, these actions include measures to improve forestry management. Despite

the reimposition of the ban on log exports late last year, the depletion of the country's

most valuable natural resource continues at a rapid pace, with the direct involvement

of the highest levels of government. This remains the single most critical issue

in Cambodia. Credible government steps to implement its longstanding commitments

to stop illegal logging and log exports, establish an effective monotoring and control

system, and to bring the full benefits from the exploitation of forestry resources

into the budget remain a precondition for a resumption of IMF financial support.

We should not overlook the efforts that have already been made and as a result, a

structure for managing forestry is gradually being put in place. However the challenge

is to make this administrative structure effective, by keeping it free from improper

and counter productive interference. The emphasis in IMF management's messages to

the two Prime Ministers has been exactly on this point.

The IMF has endorsed government policies to ensure effective implementation of the

export ban, including destruction of all equipment and materials used in illegal

logging activities and seizure of illegal logs, but these procedures have only been

sporadically enforced. Further, the government has not yet been able to follow through

with its plan to secure the services of an international firm to assist its efforts

to put in place an effective monitoring and control system for logging activities.

To ensure the timely transfer to the budget of all proceeds from forestry, we have

advised that the Ministry of Economy and Finance be given full responsibility for

the financial management of forestry contracts, but this has so far not been done

and forestry continues to provide little revenue to the budget.

Second, and equally important, are measures to contain corruption in non-forestry

areas where, as mentioned earlier, serious governance issues have arisen. Following

through with policy commitments by the government in these areas is also a precondition

of further IMF financial support. While we must understand that Cambodia's weak institutional

capacity limits the government's effectiveness in public resource management, the

main problem has, again, been improper interference. A significant strengthening

of policies to combat corruption is, therefore, feasible, provided there is cooperation

and strong political support for such policies by both Prime Ministers. In this respect,

our proposal to give the Ministry of Economy and Finance full financial control over

all contracts involving state assets is of critical importance.

In addition to strengthening governance, fiscal measures are urgently needed to put

the budget on a sound footing over the medium term. The much needed increases in

social spending can only be financed through a significant further improvement in

revenue mobilization (the revenue ratio of 9 percent of GDP is still among the lowest

in the world). The 1997 budget is to achieve a major revenue collection effort through

enactment of new tax reform legislation and a strengthening of tax administration,

combined with the implementation of measures to bring extrabudgetary revenue into

the budgetary process. Full implementation of the corresponding provisions of the

Law on Taxation and approval of strict implementing regulations for the Law on Investment

would be an essential part of a new Fund program. The revenue effort will have to

be combined with measures to restrain expenditures, in particular on the military

and the civilian wage bill, and to reorient expenditures toward education and health,

and basic infrastructure. Civil service reform, which has suffered a setback stemming

from large-scale new hiring for political purposes, will have to be revitalized.

I have spoken candidly this morning, because there is so much at stake. The international

community has so far spent well over $3 billion to support Cambodia's emergence as

an economically viable and democratic state. It is essential that the government

complement the efforts of donors with determined and sustained actions to contain

the massive diversion of public resources in forestry and other areas, which erode

the productive base of the country and jeopardize its economic future. As I have

already pointed out, as long as there are no clear indications that determined efforts

are being made by the government to reverse the serious deterioration in governance,

the IMF will not resume its financial support.

While there are crucial political problems to be addressed in the immediate future,

there is also a vital economic objective, which, I am sure, everybody present here

shares: that Cambodia steers through the pre-election period without a breakdown

of macroeconomic stability, and without a further serious erosion of its economic

resource base. The IMF is ready to do its utmost to support the govermment's efforts

toward achieving this objective. For this purpose, we are maintaining our dialogue

with the authorities, at all levels. It is my sincere hope that ways will be found

in the coming months that will make it possible to continue the IMF program with

Cambodia and to work together with the government for lasting progress.