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Construction: the most dynamic engine of growth

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Phnom Penh’s skyline is dominated by construction sites. Heng Chivoan

Construction: the most dynamic engine of growth

While the World Bank projects that Cambodia’s GDP growth will slow to 6.9 per cent this year largely due to the underperformance of rice production, the competitive pricing pressure on the garment industry and a slowdown in tourism, the construction sector continues to boom – and is now the most dynamic driver of GDP growth. Last year, it outpaced garment and footwear for the first time, according The East Asia Pacific Economic Update that was published by the World Bank this Monday.
“Construction and real estate represented 2 per cent growth out of the 7.1 growth in GDP last year. This is the largest contributor. It is booming and quite hot,” said Sodeth Ly, country economist at the World Bank in Cambodia.

In 2013, construction and real estate only accounted for 1.3 per cent of GDP growth.

Considering the figures for construction and real estate sector imports, Ly predicts it will continue an upward trajectory.

For the first half of this year, 1.2 million metric tons of construction materials were imported with steel increasing by 32 per cent, cement by 8 per cent and general materials by 38 per cent.

“But there are both pros and cons of construction growth. And the risk associated with this growth is a [construction] bubble. But there is no bubble yet, but [it] is something we have to watch out for because our construction is driven by FDI,” said Ly.

The updated report also noted that domestic credit growth has further accelerated to 28.1 per cent spurred in part by the construction boom. Yet, private sector deposits moderated to 21.1 per cent.

“Credit is growing very fast and is likely to continue to grow by 30 per cent this year. But if you look at the deposit growth, because you can’t provide credit without deposits, it is likely that deposit and credit growth will slow down a little bit,” he said.
Meanwhile, Grant Knuckey CEO of ANZ Royal Bank, believes that credit is not a factor in the future expansion of the construction industry.

“The industry has been driven by many factors. One is simply that high developer margins, alongside the willingness of local buyers to put down large cash deposits, mean that developers are often taking relatively little financial risk,” he said.

Due to the fact that leverage is kept relatively low, developers are incentivized to keep developing, he added.

While the World Bank warned that the construction boom and rapid credit expansion warrants further strengthening of banking supervision, the report stated that “inter-ministerial coordination including close coordination with the monetary authorities is a positive step.”

Stephen Higgins, managing partner of Mekong Strategic Partners, explained that financial oversight should be increased to find a sustainable balance.

“The NBC (National Bank of Cambodia) needs to be vigilant that there isn’t too much lending going into the property sector, which has been a key factor in banking crisis around the world,” he said.

While he suggested that the NBC could put in place caps on the amount of lending each bank can have in various sectors “as it did for property in 2009” when the last bubble burst, he also said that the NBC could also simply utter a few stern words for those banks that could be deemed at risk.

“Given the power of the NBC…this can be surprisingly effective,” he said.

“As you saw, in other countries such as Spain and the US back in 2009 the sectors grew to bubbles that were connected to the financial sector, which makes it very important to improve the coordination and supervision of the financial sector [here],” said Miguel Eduardo Sánchez Martín, The World Bank Senior Economist for Cambodia and Thailand.

While the World Bank expected the construction boom to continue for the foreseeable future, Ly did warn that business confidence could wane during the next election cycle.

“We expect the construction boom to continue but likely to ease once Cambodia holds the next election. We do not know if the business confidence will be as strong as it is now because by 2018, there is likely to be stability issues so construction may suffer at that time,” he said.

While it is tempting to see that construction can continue to be a main factor in driving the Kingdom’s economy, both Knuckey and Higgins warned that an overreliance on the sector is largely problematic.

“Construction is definitely not a sustainable alternative to the share of GDP normally driven by sectors such as garments, tourism and agriculture. This is because the sustainability of property development is ultimately a function of the level of demand for real goods and services in an economy. If the construction is not driven by underlying growth in the real economy, it will eventually lead to excess supply and a correction,” Knuckey said.

Higgins explained that construction should not grow any faster than it is at the moment, adding that “manufacturing and services will be the key to Cambodia’s growth going forward.”

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