The economic downturn has supplied the National Bank of Cambodia with an opportunity to step up its agenda to return the shine on the riel while coping with Covid-19 challenges

Late May, an instruction by the National Bank of Cambodia (NBC) to financial institutions to call back smaller US dollar notes $1, $2 and $5, in three months ending August 31, 2020, created panic in the market as retailers and consumers alike thought the bills were no longer legal tender.

Overnight, scores of retailers including roadside food operators declined to accept the notes, fearing an income loss if the banks rejected their deposits.

The central bank’s move, the latest installation of strategies to raise the circulation of riel in the economy, prompted a clarification by Prime Minister Hun Sen that the notes are still legal for use.

Analysts say the announcement could have triggered a psychological effect in the economy, relating to the possibility that the small notes might be denied or its value discounted in transactions.

“This can have adverse effects, especially among the poor and low-income groups who might have kept small notes till now,” said Tokyo-based economics lecturer Associate Prof Samreth Sovannroeun. Regardless, it had to be done.

Hard-pressed by the need to de-dollarise the economy, the NBC has been instituting various policies to wean the economy off the US dollar over the last 15 years and reinstate the riel as the sole currency, giving rise to national pride.

The pace of implementing such policies has picked up in recent years after a few laggard starts, as the central bank struggles with implementing monetary policies due to the high level of dollarisation and lack of cooperation from stakeholders.

On its part, it is affected by the inability to set the policy rate because the market rate is tied to the US Federal Funds Rate, which diminishes its efforts to act as lender of last resort during economic shocks, including financial crises.

A more likely example is the untold vulnerability of Cambodia’s trading sector due to high dollarisation.

“That is, the positive interest rate shock in the US can lead to the appreciation of the dollar, thereby worsening Cambodia’s trade balance against its main trading partners such as the European Union.

“Policy actions that enhance the de-dollarisation process can reduce this vulnerability,” said Sovannroeun.

To circumnavigate the challenges, the central bank made it compulsory for financial institutions to have at least 10 per cent of the loan portfolio in riel, bills and taxes to be settled in riel, and called for the development of payment apps that promote riel transactions.

NBC also introduced the liquidity providing collateralised operation (LPCO) facility to banks to supply more riel to the banking system.

Ironically, the narrowing economic growth triggered by Covid-19 this year has presented an ambient opportunity for NBC to take stock of the situation and roll-out de-dollarisation policies.

“A gradual de-dollarisation makes sense [and] now is a good time to slowly de-dollarise the economy as not much trade is being done.

“Fewer transactions mean that policies can easily be implemented,” said economist Chheng Kimlong, who is director of the Centre for Governance Innovation and Democracy at the Asian Vision Institute.

In a recently finalised gross domestic product (GDP) forecast, revealed to The Post, growth is expected to contract to around -1.9 per cent for 2020.

This projection echoes the grim estimations made by the World Bank and Asian Development Bank.

For 2021, the government sees a likely expansion to 3.5 per cent, said Ministry of Economy and Finance spokesman Meas Soksensan.

So far, the economy has taken a beating with little income from two of its key growth drivers – the garment and footwear industry – which represented one-fifth of the GDP last year, and tourism, which contributed 18.7 per cent to real GDP in 2019.

About 190 to 260 garment factories have shut down due to frozen or cancelled orders from the West resulting in the suspension of some 200,000 workers. This does not include some tens of thousands of tourism-related workers who have either been suspended or are facing pay cuts.

The government has allocated $60-$100 million to compensate workers on top of $125 million in cash aid for poor and vulnerable people. The allocations will be dispensed in riel.

In the meantime, exports are expected to tumble. Last year, total exports rose to $25.2 billion, representing 7.8 per cent of the GDP, but it is forecast to be below 16 per cent in 2020.

This is to be expected, said Jayant Menon, a visiting senior fellow at the Institute of Southeast Asian Studies-Yusof Ishak Institute in Singapore.

“Most small, open economies are facing deterioration in their export income as a result of the slump in global growth. Cambodia is not an exception,” he pointed out.

Menon believes the fall in exports and tourism might have a multiplier impact on the rest of the domestic economy with the likelihood of current account deficit worsening, as a result.

Thus, here is where an economy that is powered by the local currency could have reduced the negative effects.

“But, because Cambodia is heavily dollarised, it means money supply will inevitably contract, at a time when monetary policies should be eased to help spur growth.

“This is [one of the] problems of being dollarised during a global growth slowdown,” said Menon.

Although critics argue that de-dollarisation could affect the trading sector where over 90 per cent of trade activities across all sectors are conducted in foreign currencies, including the US dollar, Kimlong said the government can be expected to provide support.

“The government has long maintained strong and prudential macroeconomic and monetary policies that provide the basis for exchange rate stability, despite allowing a floating exchange regime,” he said.

Monetary policy limitations

Dollarisation in Cambodia was never planned. It happened by chance. In the uneasy years of the 1980s and early 1990s, after the fall of the Khmer Rouge, public confidence in the Khmer riel was at its lowest.

History tells us that the riel was issued after Cambodia’s independence from the French in 1953 but its usage came to end in 1975 with Pol Pot’s regime. It was re-circulated on March 20, 1980, but it teetered throughout the troubled years.

With the arrival of the UN Transitional Authority in Cambodia in 1992, a surge of foreign aid and investment was recorded, which caused a shock to the riel. The NBC was unable to repair the situation.

This made the US dollar a convenient and valuable currency, more so in 1995 as Cambodia moved to a market economy from a centrally -planned one.

Before long, the dollar displaced the riel as a primary currency, the World Bank said in the ‘Dollarisation Dilemma Price Stability at the Cost of External Competitiveness’ report in June 2019.

“Macroeconomic instability coupled with political transition contributed to a rapid depreciation of the local currency which encouraged Cambodians to start substituting other currencies as a store of value or financial dollarisation,” it said.

The dollar also became a unit of account to determine prices and wages (“real dollarisation”), and a means of exchange (“transactional dollarisation”).

One estimate by the International Monetary Fund (IMF) in the last decade puts the share of dollars in the currency in circulation at around 90 per cent.

However, recent calculations reveal a dip to around 80 per cent, predominantly due to the NBC’s gregarious measures. Of course, more needs to be done.

In May, Moody’s Investors Service Inc, which considered the NBC’s history of delivering exchange rate and price stability against a high level of dollarisation, found that its role in monetary policy effectiveness was limited.

Challenges in curtailing credit growth and potential risks in the real estate and construction sectors were also compounded by stretched supervisory powers over a large banking system.

“It constrains the effectiveness of the monetary policy,” Moody’s said in the credit report.

That is to say that although dollarisation played a key role in economic growth in the past two decades, the over-reliance has resulted in the NBC’s inability to implement monetary policies and its loss as the lender of last resort.

The central bank also loses out on seigniorage – a difference pocketed from the cost of producing and distributing money, and the eventual income withdrawn from lending this money, otherwise known as revenue.

In the case of the US dollar bills, seigniorage is gained by the US Federal Reserve and the Treasury, the sovereign owner of the currency.

To give an idea, NBC’s report on Dollarisation in Cambodia (2007) estimated that a net annual income foregone (from seigniorage) was in the range of $20 million to $90 million annually.

Riel in numbers

Nevertheless, circulation of the riel has grown manifold over the years, with strong foreign direct investments (FDIs) and foreign reserves stabilising the local currency.

In the first 11 months of last year, 3.4 trillion riel or $838 million was supplied by the NBC to mostly commercial banks, an almost fourfold increase compared to 2018 via its LPCO facility, the World Bank’s latest economic update showed.

As of December 31, 2019, FDIs and the injection of local currency helped NBC to accumulate international reserves up to $18.8 billion or 28.3 per cent growth year-on-year, covering more than seven months of imports of goods and services. The ratio of the reserves to GDP was 69.8 per cent.

The IMF said foreign currency deposits in US dollars were 18.6 trillion riel in 2018, where 84.8 per cent was of broad money (meaning cash and bank deposits) and are projected to rise to 26.7 trillion riel this year.

The riel component of broad money amounted to 13.4 trillion in 2018 or 15.2 per cent of its total 88.4 trillion riel. In 2020, IMF expects it to grow to 19.9 trillion riel.

The World Bank which noticed the efforts to promote the use of the riel, said it has paid off.

“Riel in circulation grew 31.3 per cent year-on-year in 2019, up from 11.5 per cent in 2018, while the exchange rate of the riel against the US dollar remained stable,” it added.

For a long time now, the exchange rate has been maintained at 4,050 to $1 using the managed exchange rate regime that is neither fixed nor completely floated.

This year due to Covid-19, some pressure on the exchange rate is anticipated because of lower capital inflows and the decline of foreign exchange earnings caused by the downturn in tourism and export sectors.

“As the central bank conducts prudent market operations to stabilise the exchange rate, demand for US dollars will likely increase. Without additional foreign exchange injection, the riel is likely to depreciate against the dollar,” the World Bank said.

Dealing with glitches

So, the fact remains that de-dollarising an economy has some positive outcomes. In the past, countries such as Israel, Poland, Mexico, Egypt and Turkey, as mentioned in a report by Menon in 2007, had successfully come off a dollar-based economy.

In doing the same, Cambodia will need to prepare for some pinches to the economy, such as an uptick in inflation triggered by a strong riel due to higher demand in the market on the back of increased circulation over the dollar (to back the riel).

“Although a strong riel is beneficial to domestic factors of production, it can push up inflation, at least in the short to medium term,” said Kimlong.

Similarly for FDI, sources of inflows vis-à-vis foreign exchange must be kept in check because the source country might use US dollar as a national medium of exchange, placing the stronger currency at an advantage over a weaker riel.

The same can be expected for dollar-based loans as lenders or lending countries gain more if the rate appreciates.

“In the Cambodian case, a weaker riel can affect borrowers when the loan and interest repayments are made, analogous to a tax on the loans when borrowers convert riel into US dollar to pay the lender,” Kimlong said.

Meanwhile, Sovannroeun felt that measures to deal with possible negative consequences, where monitoring of economic transactions that use small-dollar notes are needed.

“Measures to ensure the notes are not denied or discounted in the transactions may also be necessary. Furthermore, enhancing services for more convenient access to dollar and riel exchange with an appropriate exchange rate for small dollar notes is also important,” he said.