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Achieving sustainable, inclusive growth

Chinese and Cambodian flags hang from the side of a large Chinese construction site in Phnom Penh last month.
Chinese and Cambodian flags hang from the side of a large Chinese construction site in Phnom Penh last month. Pha Lina

Achieving sustainable, inclusive growth

Cambodia is a fast-growing, highly open economy, and just attained lower-middle-income status this year. The country’s strategic location, China’s changing trade patterns, and ongoing regional integration provide further opportunities.

The good news is that government has taken important steps (for example, investing in the energy sector to reduce the cost of doing business and improving services in trade, payment, and business registration) that will help Cambodia capitalise on these opportunities. Nonetheless, further policy actions are needed to promote sustained and inclusive growth.

Resilient growth but rising risks. Growth is expected to remain robust at around 7 percent for 2016–17, supported by strong garments exports, real estate and construction activity. Over the medium term, growth is projected to slow to around 6.3 percent by 2021 due to gradual slowdown in foreign direct investment (FDI) and some moderation in credit growth. Export diversification will remain a challenge and may weigh on growth.

Inflation is expected to rise modestly to 3.2 percent by the end of this year as food prices have picked up. The current account deficit (CAD) is projected to narrow in 2016 to 9.7 percent of GDP, from 10.7 percent in 2015, due to robust garments exports and reduced imports.

The main downside risk to the outlook arises from rapid credit growth, increasingly concentrated in real estate, which could undermine economic and financial stability. External risks include a significant slowdown in China, US dollar appreciation, weaker-than-anticipated growth in Europe, increased uncertainty from the Brexit referendum result, and a sharper-than-anticipated tightening in global financial conditions.

As explained in the recently published 2016 IMF staff report on Cambodia, the key policy challenges are to secure sustained growth and mitigate growing financial sector vulnerabilities. Also continued efforts are needed to meet the sustainable development goals to ensure sustained and inclusive growth.

Containing growing macro-financial risks. Private sector credit growth averaged nearly 30 percent (year-on- year) over the past three years and the credit-to-GDP ratio doubled to 62 percent by end-2015. This is higher than the median Emerging Markets’ level and about twice the median Low Income Countries’ level. In addition, there is growing concentration of credit in the real estate, mortgage and construction sectors, as well as increasing reliance on foreign funding. Lending by micro-finance institutions has been growing sharply, with some of these institutions playing a systemic role.

To boost the resilience of the banking sector, the National Bank of Cambodia (NBC) has recently introduced the Basel-III-compliant Liquidity Coverage Ratio and higher minimum capital requirement. However, further measures are needed to reduce macro-financial risks, and avoid a hard landing of the credit cycle.

For example, the 2016 Staff Report recommends building capital and liquidity buffers using a well-coordinated and sequenced set of micro- and macro-prudential policy tools, and developing a crisis management framework. Also important is upgrading financial regulation and supervision, including of non-bank financial institutions.

Maintaining fiscal sustainability and supporting development. The fiscal deficit is projected to widen to 2.6 percent of GDP this year from 1.6 percent of GDP in 2015, though remain well below the budget target. This is because rising expenditure more than offsets gains from revenue mobilisation efforts. Strong revenue performance is expected to continue as the result of improved tax administration.

Amid rising spending pressures, however, the government needs to maintain fiscal sustainability while supporting development needs by further boosting revenues and prioritising development and capital expenditures.

Structural reforms to improve business climate and boost competitiveness. Rapid growth over the past two decades has significantly reduced the poverty rate, which has fallen from 50 percent in 2005 to 18 percent in 2012. However, a large share of the population remains vulnerable and close to the poverty line.

Cambodia also faces many structural constraints and vulnerabilities, including a narrow economic base, weak business climate, high dollarisation, and underdeveloped financial markets. In order to unleash its growth potential and enhance resilience from shocks, Cambodia should continue focusing on lowering the cost of doing business to boost competitiveness and diversify the economy to higher value-added industries.

Priority actions include accelerating implementing infrastructure projects, especially in energy and transportation, and addressing skills gaps via improving the quality of education and promoting technical and vocational training.

Additionally, strengthening the rule of law, and increasing transparency of business regulations will help create a more conducive business environment and encourage long-term investment. Reforms should also be geared towards increasing usage of the local currency and financial markets development, to facilitate macro-economic management and enhance resilience.

The IMF maintains strong engagement with Cambodia, which includes regular policy dialogue as well as intensive technical assistance on topics ranging from liquidity management, financial stability, to public finance management, revenue mobilisation strategy, as well as economic statistics. Now that Cambodia has become a lower-middle income country, IMF remains committed to supporting Cambodia to successfully reach the next phase of development.

Sonali Jain-Chandra is IMF’s mission chief for Cambodia (based in Washington) and Yong Sarah Zhou is IMF’s resident representative for Cambodia (based in Phnom Penh).

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