CAMBODIA STAYING COMPETITIVE ECONOMIC THROUGH IMPROVING UPDATE PRODUCTIVITY April 2017 Selected Issue: Investing in Public Infrastructure and Services CAMBODIA ECONOMIC UPDATE Staying competitive through improving productivity April 2017 Selected Issue: Investing in public infrastructure and services APRIL 2017 CAMBODIA ECONOMIC UPDATE 3 PREFACE AND ACKNOWLEDGEMENTS The Cambodia Economic Update (CEU) We received valuable inputs, comments is a product of the staff of the World Bank and suggestions from Nikola L. Spatafora, Group. It was prepared by Sodeth Ly and East Asia and Pacific Chief Economist Unit, incorporates contributions by Miguel Eduardo and Colleen Mascenik, Finance and Markets Sánchez Martín, both at the Macroeconomics GP. The poverty section was contributed and Fiscal Management Global Practice by Kimsun Tong, Poverty GP. The report (MFM GP). Linna Ky served as research also benefited from the advice, comments assistant, while Runsinarith Phim, STC, provided and views of various stakeholders in the comments, inputs and suggestions for the Royal Government of Cambodia (RGC), selected issue section. The section on Public the private sector, development partner Investment Management, part of the selected institutions and academia. The team is very grateful for their time and inputs. issue entitled “Investing in Public Infrastruc- ture and Services” was contributed by Tuan We are also grateful to the Cambodian Minh Le (MFM GP) and Jay-Hyung Kim (Gov- authorities, in particular the Ministry of ernance GP). The team worked under the Economy and Finance and the National guidance of Mathew A. Verghis, Practice Bank of Cambodia for their cooperation and Manager, MFM GP. The team is grateful for support in the preparation of this CEU. the comments, advice and guidance pro- vided by Ulrich Zachau, Country Director, The World Bank Cambodia Office Commu- Inguna Dobraja, Country Manager and nications Team, comprising Saroeun Bou Shabih Ali Mohib, Program Leader. and Sophinith Sam Oeun, prepared the media release, web display and dissemination. The CEU is produced bi-annually to provide up-to-date information on macroeconomic For information about the World Bank and developments in Cambodia. It is published its activities in Cambodia, please visit our and distributed widely to the Cambodi- website at www.worldbank.org/cambodia. an authorities, the development partner community, the private sector, think tanks, To be included in the email distribution list civil society organizations and academia. of the CEU and related publications, please The update is timed to coincide with the contact Linna Ky (lky@worldbank.org). For six-monthly publication of the East Asia and questions on the content of this publication, Pacific Economic Update by the East Asia please contact Saroeun Bou (sbou@world- MFM GP of the World Bank. bank.org). 4 CAMBODIA ECONOMIC UPDATE APRIL 2017 CONTENTS PREFACE AND ACKNOWLEDGEMENTS...................................................................................... 4 A. EXECUTIVE SUMMARY........................................................................................................... 7 B. RECENT ECONOMIC DEVELOPMENTS.................................................................................. 13 The real sector........................................................................................................................13 a) Garment and footwear sector.................................................................................13 b) Construction and real estate....................................................................................15 c) Tourism.........................................................................................................................16 d) Agriculture...................................................................................................................18 Poverty.....................................................................................................................................19 The external sector.................................................................................................................20 a) Merchandise exports.................................................................................................20 b) Transfer receipts – workers’ remittances..................................................................21 c) Merchandise imports.................................................................................................21 d) The current account..................................................................................................22 Inflation....................................................................................................................................22 The monetary sector..............................................................................................................23 a) Monetary aggregates, interest rates and exchange rates...................................23 b) The banking sector......................................................................................................25 c) Microfinance...............................................................................................................26 d) Indebtedness..............................................................................................................27 The fiscal sector......................................................................................................................29 a) Domestic revenue......................................................................................................29 b) Public expenditures....................................................................................................30 c) Fiscal balance.............................................................................................................30 d) 2017 Budget................................................................................................................31 C. OUTLOOK AND RISKS............................................................................................................ 33 D. KEY MESSAGES AND POLICY OPTIONS................................................................................ 36 E. SELECTED ISSUE: INVESTING IN PUBLIC INFRASTRUCTURE AND SERVICES.......................... 39 Motivation...............................................................................................................................39 Public spending trends..........................................................................................................40 Spending and allocation efficiency with regional comparisons.....................................41 Public investment management (PIM)................................................................................44 a) Roles of capital investment.......................................................................................44 b) Cambodia’s current PIM practices..........................................................................44 c) Steps towards improving Cambodia’s PIM.............................................................45 Conclusions.............................................................................................................................46 F. CAMBODIA: KEY INDICATORS.............................................................................................. 47 APRIL 2017 CAMBODIA ECONOMIC UPDATE 5 6 CAMBODIA ECONOMIC UPDATE APRIL 2017 A. EXECUTIVE SUMMARY Growth remained strong at 6.9 percent in 2016, after 7.0 percent in 2015. Cambodia’s economic activity continues to expand at a robust pace. Construction remained one of the main drivers of growth. Garment exports eased slightly as the country’s external competitiveness was eroded by US dollar appreciation, rising labor costs and increasing competition from other regional low-wage countries. Better weather conditions last year resulted in increased agricultural production, although agricultural commodity prices remain depressed. Real growth is projected to remain strong, expanding at 6.9 percent in 2017 and 2018, partly underpinned by government spending. Downside risks to this outlook include the fallout from further rises in US interest rates, a slower-than- expected economic recovery in Europe, and uncertainties over global trade. Poverty reduction is expected to continue over the next few years, driven mainly by the garment, construction and services sectors, together with increases in remittances. RECENT DEVELOPMENTS weather conditions last year, although agriculture commodity prices remain subdued. Preliminary estimates indicate that growth remained strong, achieving 6.9 percent While remaining strong, growth in garment in 2016, after 7.0 percent in 2015. Growth exports eased, expanding at 8.4 percent continued to be underpinned by resilient (in value terms) year-on-year in 2016, construction activity, despite the fact that compared with 12.3 percent in 2015. Rising garment exports moderated. A further labor costs, driven in part by the increasing easing in tourist arrivals was offset by an cost of living, US dollar appreciation, and expansion of the agriculture sector, in rice competition from other regional low-wage production in particular, thanks to improved countries, in particular Myanmar, continue APRIL 2017 CAMBODIA ECONOMIC UPDATE 7 to exert downward pressure on prices Cambodia’s external position improved due of exported garment products. As the to resilient export growth and depressed completion phase of many modern high- oil prices. The current account deficit rise residential and commercial construction (excluding official transfers) is estimated to projects that have fueled the construction have narrowed to 9.5 percent of GDP in 2016, boom is now approaching, imports of basic compared with 10.6 percent in 2015, mainly construction materials have softened. Steel financed by FDI inflows, which rose to 10.2 imports (in volume terms) eased, growing percent of GDP in 2016 versus 9.1 percent in at 28 percent year-on-year by end-2016, 2015. As a result, gross international reserves compared with 32.8 percent in 2015. accumulated further, reaching US$6.4 billion (or about 5.4 months of prospective imports) Agricultural production improved largely by end-2016, compared with US$5.6 billion due to better weather conditions after the in 2015. country experienced severe droughts for a number of years. Rainy season rice production Positive macro-financial developments expanded, rising to 7.3 million tons in 2016, include some easing in still strong credit or an 8.9 percent increase on 2015. However, growth, accompanied by an acceleration in agricultural commodity prices remain private sector deposits. Supporting economic depressed, limiting growth in total agricultural growth, broad money expanded, growing exports. Tourist activity continued to ease, at 17.9 percent year-on-year by end-2016, with arrivals growing 5.0 percent year-on- compared with 14.7 percent in 2015, thanks year in 2016, compared with 6.1 percent to rising foreign currency deposits. However, in 2015. So far, there has only been limited domestic credit growth moderated, partly success in diversifying tourist attraction sites reflecting softer economic activity and, beyond the Angkor complex. consequently, lower demand for credit from the wholesale, manufacturing and Rural households have increasingly agriculture sectors. Macro-prudential diversified their livelihoods, tapping into both measures introduced by the central bank the rural off-farm economy and remittances last year may have also contributed towards to help sustain poverty reduction. Declining slower domestic credit growth. As such, the commodity prices, coupled with severe banking sector’s credit growth decelerated weather events in 2013 and 2015, has resulted to 25.8 percent year-on-year by end- in a slowdown and stagnation in agricultural 2016, compared with 28.6 percent in 2015. GDP in recent years. By 2015, non-agriculture Improved confidence in the banking wage incomes made up more than one- sector has helped to attract private sector third of rural incomes, compared with less deposits, which accelerated to 19.3 percent than one-fifth in 2007. During the same year-on-year by end-2016, up from 16.6 period, agricultural incomes including percent in 2015. The non-performing loan agricultural wages declined to only 43 percent (NPL) ratio rose slightly to 2.7 percent in 2016, of total rural incomes from 63 percent. up from 2.3 percent in 2015. 8 CAMBODIA ECONOMIC UPDATE APRIL 2017 Inflationary pressures have been building a fiscal balance in 2015. Cambodia’s debt up as a result of continued strong domestic distress rating in the latest World Bank/IMF demand led by household consumption Debt Sustainability Analysis conducted in driven by rising wages. Growth in the 2016 remained low, largely underpinned by consumer price index (CPI) accelerated the overriding principle of borrowing only on to 4.3 percent year-on-year in March 2017, concessional terms. compared with 2.8 percent at end-2015, fueled by strong domestic consumption. OUTLOOK In particular, vehicle imports expanded at 21.4 percent year-on-year (in value terms), Growth is projected to remain strong, compared with 20 percent in 2015, and expanding at 6.9 percent this year and next, diesel imports surged to 14.2 percent year- but is expected to decelerate slightly to 6.7 on-year in 2016, compared with 3.6 percent percent in 2019. Economic activity is partly in 2015. The Cambodian riel (CR) has recently buoyed by rising government spending. appreciated against the US dollar, the Thai However, some signs of moderation, in baht and the Vietnamese dong. The riel/ particular in the construction sector, are US dollar exchange rate reached CR 3,990 emerging. A slight easing in garment in March 2017, compared with CR 4,050 in exports is expected to be offset by a December 2016. gradual expansion of the agriculture sector, thanks to concerted efforts to revitalize the Driven by rising public sector wages, the sector. The tourism sector may also recover fiscal deficit has widened but remains low. gradually due in part to newly established The fiscal expansion is mainly aimed at regional direct flights and a number of boosting public sector wages, which are initiatives to boost tourist arrivals, such as the estimated to have risen to 7.4 percent of “China Ready” initiative. GDP in 2016, up from 6.5 percent of GDP in 2015. Meanwhile, public capital spending The growth outlook in the medium term continued its declining trend, dropping to remains favorable, largely underpinned by 7.2 percent of GDP from 7.8 percent of GDP, export diversification. However, boosting largely due to a gradual reduction in the productive investments in physical development partner-funded component. infrastructure, underpinning the pro-growth In 2016, public outlays are estimated to have (and pro-poor) policy under the 2014-18 risen to 21.4 percent of GDP, compared National Strategic Development Plan will be with 20.5 percent of GDP in 2015. Revenue crucial, given that inadequate infrastructure collection remained strong, at 18.5 percent has long been one of Cambodia’s key of GDP, slightly below 18.7 percent of GDP constraints and is seen as a major bottleneck. collected in 2015 due to the decline in After recent increases in public spending in non-tax revenue. The overall fiscal deficit the social sectors, the important next step (including grants), therefore, widened to will be to enhance spending efficiency. 1.4 percent of GDP in 2016, compared with Improving labor productivity, as well as the APRIL 2017 CAMBODIA ECONOMIC UPDATE 9 performance of the public sector, will be and more sophisticated manufacturing. fundamental for Cambodia if it is to remain Investing now in further improvements in competitive, given rising competition from learning outcomes, coupled with increased other low-wage garment exporting countries. secondary school attainment, will be essential for the future success of the diversification of Poverty reduction is expected to continue the economy. over the next few years, driven mainly by the garment, construction and services Public administration reforms to bring about sectors, together with increases in remittances. an improvement in public service delivery The rural non-farm (garment, services and will be important, especially after the recent remittances) economy could be a significant boost in civil servants’ wages. Given that contributor to poverty reduction and shared the public sector is a major service provider prosperity in Cambodia in years to come. and facilitator, it is crucial to link the public Cambodia is similar to Vietnam in that sector’s significant wage increases to livelihood diversification in rural areas has improvements in service delivery. Raising contributed to poverty reduction and public sector productivity underpins private shared prosperity. sector development in driving growth and reducing poverty. Downside risks to the outlook include the fallout from further rises in US interest rates, a In the context of a declining development slower-than-expected economic recovery in partner-funded capital budget, Cambodia Europe, and uncertainties over global trade. will need to enhance public investment Domestically, potential election-related management (PIM) to scale up government- uncertainty may also occur during and after financed capital spending. Pro-growth the general election, which is scheduled and pro-poor investments, especially to be held in mid-2018. in physical infrastructure, could benefit from additional allocations to compensate KEY MESSAGES AND POLICY for the reduction in the development OPTIONS partner-funded budget. However, enhancing the legal framework for PIM Staying competitive by enhancing labor and capacity building at core and line productivity will be key in compensating for agencies and ministries should be the first rapidly rising private sector wages. A top priority, and is a prerequisite for improving priority will be to improve the quality of basic investment efficiency. For more details education and promote vocational and on PIM, see the selected issue section technical skills, while reducing energy costs on “Investing in Public Infrastructure and to attract and compete in high value-added Services”. 10 CAMBODIA ECONOMIC UPDATE APRIL 2017 THE CAMBODIAN ECONOMY AT A GLANCE Real growth remains healthy... ...but key exports have eased. Garment exports and fabric imports contribution to growth (Percent) 10.0 ) 10.0 50 Y/Y change fabric (%) Y/Y change garment (%) 7.1 7.3 7.4 8.0 7.1 7.0 8.0 40 6.1 6.9 6.0 6.0 30 4.0 4.0 20 2.0 2.0 10 0.0 0.0 0 Agriculture Indus-garment Indus-construction Serv-real estate -2.0 -2.0 -10 Indus-others Serv-trade Serv-others Taxes less subsidies GDP growth -20 -4.0 -4.0 2010 2011 2012 2013 2014 2015 2016 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 s Source: the Cambodian authoritie Source: the Cambodian authorities Gross international reserves have risen on the ...narrowing the current account deficit, financed by back of an improved external position... strong FDI. Current account, trade balance and FDI (Percent of GDP) 7,000.0 6.0 15.0 Current accounts balance Trade balance FDI 6,000.0 5.0 10.0 5,000.0 4.0 4,000.0 5.0 3.0 3,000.0 0.0 2.0 2,000.0 -5.0 1,000.0 GIR (current, million USD) 1.0 GIR in months of imports (RHS) -10.0 0.0 0.0 Jan-05 Aug-05 Mar-06 Oct-06 May-07 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10 Nov-10 Jun-11 Jan-12 Aug-12 Mar-13 Oct-13 May-14 Dec-14 Jul-15 Feb-16 Sep-16 -15.0 2010 2011 2012 2013 2014 2015 2016e Source: the Cambodian authorities and World Bank staff estimates Source: the Cambodian authorities Strong collection has narrrowed fiscal deficits... ... but public capital investment has shrunk while wages Overall fiscal deficit (Percent of GDP) have risen. Captial and wage spending (Percent of GDP) 2.0 12.0 0.0 10.0 -2.0 8.0 -4.0 6.0 -6.0 4.0 Capital Wage -8.0 2.0 -10.0 Deficits (incl grants) Deficits (excl grants) 0.0 -12.0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016e 2008 2009 2010 2011 2012 2013 2014 2015 2016e Source: the Cambodian authorities and World Bank staff estimates Source: the Cambodian authorities and World Bank staff estimates APRIL 2017 CAMBODIA ECONOMIC UPDATE 11 12 CAMBODIA ECONOMIC UPDATE APRIL 2017 B. RECENT ECONOMIC DEVELOPMENTS THE REAL SECTOR Suggesting stronger efforts to maintain market share, Cambodia’s garment exports a) Garment and footwear sector volume further expanded, increasing to 12.3 While still remaining strong, garment exports percent year-on-year in 2016, compared have nonetheless eased since the second with an 8.9 percent increase in 2015 (Figure 2). half of last year. Rising labor costs, driven in Growing competition slashed garment part by the increasing cost of living, US dollar export prices to all major destinations. appreciation and competition from other Exports prices to the US market were hardest regional low-wage countries, in particular hit, dropping by 7.2 percent in 2016 (Figure 3). Myanmar, continue to exert downward Cambodia’s garment exports to the US pressure on the prices of exported garment peaked in 2013, when the total garment products. As a result, year-on-year garment exports value reached US$2.03 billion. exports growth (in value terms) decelerated to Since then, exports to the US have steadily 8.4 percent (Figure 1), amounting to US$6.6 declined, falling to US$1.7 billion in 2016 billion in 2016, compared with 12.3 percent (Figure 4). growth in 2015. Figure 2: Rising garment export volume but easing Figure 1: While remaining strong, garment exports garment export value reflects increased competition. have eased. (US$ million) (y/y, change, percent) 8,000.0 30.0 Garment exports Garment Exports (Value) 7,000.0 25.0 growth rate (RHS) Garment exports (volume) 6,000.0 20.0 5,000.0 15.0 4,000.0 10.0 3,000.0 5.0 2,000.0 0.0 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 1,000.0 0.0 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Source: the Cambodian authorities Source: the Cambodian authorities APRIL 2017 CAMBODIA ECONOMIC UPDATE 13 Figure 3: Average garment exports prices (US$ per theless, Cambodia’s footwear exports dozen) are in decline. remained strong, growing at 15.6 percent 4.0% year-on-year, reaching US$763 million in 2.0% 2016. Footwear exports to the EU market, 0.0% -2.0% which absorbed 43 percent of total foot- -4.0% wear exports, grew at 9.2 percent year-on- -6.0% -8.0% US market EU market year in 2016, compared with 30.2 percent in -10.0% 2015. This is partly explained by the fact that -12.0% 2014 2015 2016 footwear exports are much more recent and were starting from a very low base. Source: the Cambodian authorities A further moderation in garment exports was Figure 4: Garment exports to the US have declined. Garment exports by main destinations (US$ million) observed during first few months of this year. However, it is too early to conclude whether 3,000.0 European Union United States or not this will affect the 2017 growth projection. 2,500.0 2,037 1,889 1,888 2,000.0 1,711 1,500.0 Figure 5: FDI in the garment sector is declining. 1,000.0 (Total fixed assets, in US$ billion) 500.0 0.40 0.37 0.36 0.0 2013 2014 2015 2016 0.35 0.30 Source: the Cambodian authorities 0.25 0.21 0.20 While annual FDI inflows to the garment 0.15 0.14 sector have gradually slowed, declining 0.10 0.05 from US$490 million in 2012 to US$160 million - in 2016 (Figure 5), total garment exports 2013 2014 2015 2016 nonetheless continued to grow. However, a Source: the Cambodian authorities further decline of FDI inflows into the sector does not bode well for future garment Figure 6: Expansion of footwear exports has eased, while the average footwear export price levelled off sector expansion, as the industry is currently due to rising competition. moving towards higher value-added 60.0 Growth (% Y/Y) 8.0 Average price (US$/pair, RHS) products and will need to become more 7.0 50.0 capital intensive if it is to confront increasing 6.0 40.0 labor costs by improving productivity. 5.0 30.0 4.0 3.0 As in the case of garment exports, footwear 20.0 2.0 exports are also facing tougher price 10.0 1.0 competition. As a result, average footwear - 0.0 2011 2012 2013 2014 2015 2016 prices stagnated in 2016 (Figure 6). None- Source: the Cambodian authorities 14 CAMBODIA ECONOMIC UPDATE APRIL 2017 b) Construction and real estate The recent construction and real estate boom has largely been fueled by rising Construction activity continued to be vibrant foreign direct investment (FDI) inflows as investor appetite for residential and and domestic credit expansion (Figure 9). commercial property remained strong, wit- Approved FDI (in fixed assets) in the nessed by continual growth in the number construction sector reached US$1.3 billion and value of construction projects approved in 2016. Domestic credit provided to the in 2016 (Figure 7).1 Following the large sector has grown rapidly over the past five surge in 2016, the total value of approved years, averaging 32 percent annually. The construction projects fell in the first quarter of total FDI (stock) in the construction sector 2017, compared to the same period of the in the period 2000-15 is estimated to have previous year, while approved construction projects’ total square meters also dipped, reached US$3.5 billion3 (or 19 percent of according to the latest data available.2 This GDP), while outstanding domestic credit signals potential moderation in construction provided to the construction sector amounts activity in the short and medium term. to US$3.0 billion (or 17.4 percent of GDP) at the end of 2016. Figure 7: Total number and value of approved Figure 8: Steel imports have eased while imports of construction projects increased partly due to a number materials (fixtures, fittings, and furnishings) continue to of mega projects approved in April 2016. (US$ million) be strong.(Y/Y change, percent) 9,000.0 Total approved value 3,000.0 80.0 8,000.0 Total approved projects (RHS) 2,500.0 60.0 7,000.0 6,000.0 2,000.0 40.0 5,000.0 1,500.0 20.0 4,000.0 3,000.0 1,000.0 0.0 2,000.0 500.0 -20.0 Other materials for construction 1,000.0 Steel imports Cement imports -40.0 Source: the Cambodian authorities Dec-13 Dec-14 Dec-15 Dec-16 Source: the Cambodian authorities On the other hand, as many modern high-rise Figure 9: FDI inflows and domestic credit to the construction projects are nearing completion, construction sector have underpinned the construction boom. (US$ million) basic construction material imports growth 5,000 700 Approved project value have decelerated. In particular, steel imports 4,500 Approved FDI 600 (in value terms) slowed down, growing at 9 4,000 Domestic credits (RHS) 3,500 500 percent year-on-year by end-2016, compared 3,000 with 35.4 percent in 2015. In contrast, imports of 2,500 400 other materials for construction, such as fixtures, 2,000 300 1,500 fittings and furnishings, continued to surge 200 1,000 (Figure 8), rising by 54.3 percent year-on-year 500 100 in 2016, compared with 38.5 percent in 2015. 0 2012 2013 2014 2015 2016* -500 - Source: the Cambodian authorities and World Bank staff estimates * Excluding mega projects 1 Excluding a number of mega projects approved in April 2016, construction project number and value still grew by about 30 percent year-on-year in 2016 (estimat- ed based on a monthly approved value between US$300 to US$600 million). 2 Approved construction projects’ total value registering a 22.1 percent year-on-year decline in the first quarter of 2017, while approved construction projects’ total square meters also dipped, recording a 45.4 percent year-on-year drop, according to Q1 2017 Progress Report, Ministry of Land, Urbanization and Construction. 3 Foreign Direct Investment Survey, July 2016, the National Bank of Cambodia APRIL 2017 CAMBODIA ECONOMIC UPDATE 15 c) Tourism Figure 10: Cambodia's international arrivals have eased.(Millions of visitors) Tourist arrivals growth eased further, regis- Arrival by air Arrival by land Total (y/y, RHS) S. Reap air arrival (y/y, RHS) tering a 5.0 percent year-on-year increase, 9.00 30.0 compared with 6.1 percent in 2015 (Figure 8.00 25.0 7.00 10). International arrivals by air grew by 9.2 6.00 20.0 percent year-on-year in 2016, similar to the 5.00 15.0 4.00 increase seen in 2015. Asia continued to 3.00 10.0 be the major source of tourists and the top 2.00 5.0 1.00 five Asian countries which, similar to 2015, 0.00 0.0 2011 2012 2013 2014 2015 2016 accounted for about 60 percent of the Source: the Cambodian authorities market share in 2016. Vietnam, China, and Thailand are the main countries of origins, Figure 11: Both Thailand and Vietnam did well in attracting international arrivals in 2016. (Y/Y change, accounting for 19.1 percent, 16.6 percent, and percent) 7.8 percent of the total share, respectively. Thailand 35.0 Cambodia 30.0 Vietnam 25.0 Efforts have been made to attract additional 20.0 arrivals by establishing more direct flights 15.0 10.0 and introducing new initiatives such as the 5.0 0.0 “China Ready” initiative and joint tour pack- -5.0 ages. The role and organizational structure -10.0 -15.0 of the Ministry of Tourism have also been strengthened.4 The Ministry of Tourism has Source: the Cambodian authorities, TAT and Vietnamese authorities been given a leading role in managing and developing the tourism sector, including located in the northeastern province of human resource development, and has Siem Reap (Figure 10), despite the fact that also been tasked with collaborating with Cambodia is endowed with countless other government agencies and the private historical, cultural and natural tourist sector to implement the Law on Tourism and destinations. To this end, inter-agency the Tourism Development Strategic Plan. coordination, as well as collaboration with There are signs of a gradual recovery in the the private sector to develop and access tourism sector in early 2017. Arrivals from to new attraction sites and to improve Western Europe and North America have currently underdeveloped sites, will be picked up, although Asia continues to be essential. Given the recent construction the main tourism market for Cambodia.5 expansion, helping other emerging urban areas to become more tourist-friendly Diversification of tourist attraction sites destinations with improved tourism beyond the Angkor Archeological Park is infrastructure, facilities and accessibility would important. Currently, international arrivals help to support diversification in the tourism remain largely driven by the Angkor complex sector. 4 Sub-Decree dated December 16, 2016 on structure and functions of the Ministry of Tourism. 5 Tourism statistics report for January 2017, Ministry of Tourism. 16 CAMBODIA ECONOMIC UPDATE APRIL 2017 APRIL 2017 CAMBODIA ECONOMIC UPDATE 17 d) Agriculture The harvested area expanded by 1.1 percent, reaching 2.56 million ha, while yields rose by Rice production expanded last year, thanks 4.2 percent, averaging 3.2 tons per ha (98 to improved weather conditions. Rainy percent of the cultivated area has already season rice production, which accounts for been harvested).6 However, cultivation of almost 80 percent of Cambodia’s total rice dry season rice in 2017 has slowed as the production, grew significantly for the first cultivated area has declined by 11.3 percent, time since 2013 (Figure 12), increasing by compared with the same period last year, 0.38 million metric tons in 2016 (and reaching due to prolonged rainfall after the end of 7.5 million tons, or a 5.3 percent year-on- the normal rainy season. Plantations of other year increase). This is explained by harvested crops, such as cassava, corn, beans and area expansion of 0.08 million tons and an vegetables, have also been slow. increase in yields of 0.3 million tons. Most agricultural commodity prices remain Figure 12: Contribution to annual wet season low, although natural rubber prices picked rice production increase. (Million metric tons) up recently (Figure 13). Agriculture prices as by Land 0.60 by Yield 0.6 a whole are expected to rise by less than 0.50 wet rice production (RHS) 0.5 1 percent over 2017, but grain prices are 0.40 0.30 0.4 projected to decline by almost 3 percent on 0.3 0.20 an improving supply outlook.7 Natural rubber 0.10 0.2 0.00 0.1 prices rallied to US$1.92/kg in the fourth -0.10 0.0 quarter of 2016, up from US$1.57/kg in the -0.20 -0.30 -0.1 previous quarter. Prices were reportedly -0.40 2010 2011 2012 2013 2014 2015 2016 -0.2 supported by strong buying interest from Source: the Cambodian authorities China, while supply constraints were largely due to delayed tapping in Malaysia (and Figure 13: Prices of agricultural commodities, Thailand) caused by El Niño conditions earlier except natural rubber, remain subdued. in 2016. Key natural rubber producing Maize ($/mt) Rice, Thai ($/mt) 700 Sugar ($/kg, RHS) Rubber ($/kg, RHS) 6.0 countries, including Indonesia, Malaysia, 600 and Thailand, have agreed to undertake 5.0 500 supply control measures in an effort to 4.0 400 sustain high prices. 3.0 300 2.0 200 100 1.0 0 0.0 Jan-10 Jan-11 Jan-12 Jan-14 Jan-15 Jan-16 Jan-17 May-10 May-11 Jan-13 May-12 May-13 May-14 May-15 May-16 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-16 Sep-15 Source: World Bank 6 Weekly report by the Ministry of Agriculture, Forestry and Fisheries, January 19, 2016. http://www.maff.gov.kh/reports/69-cropingstatus/1771-weekly-report-18-01-17.html 7 Industrial Commodities Prices to Surge in 2017: World Bank. See http://www.worldbank.org/en/news/press-release/2017/01/24/industrial-commodities-prices-to-surge- in-2017-world-bank 18 CAMBODIA ECONOMIC UPDATE APRIL 2017 POVERTY BOX 1: PRODUCTIVTY As a newly emerging sector, the construction sector has played an increasingly important The importance of productivity as a concept role in providing an alternative source of cannot be understated, as it reflects the ef- income for workers migrating from rural ficiency with which an economy transforms households to be employed in urban areas. resources into outputs. With higher productiv- This is in addition to the income source from ity, a country can afford better living stand- the traditional garment and footwear sector. ards. Productivity growth often refers to an increase in outputs produced with the same Jobs created by the construction sector level of inputs and the same period of time. accounted for about 200,000 in 2016, a Using a growth decomposition tool (the 33.3 percent year-on-year increase.8 This Shapely method) and data from Cambodia represents 10 percent of total employment socio-economic surveys, annual growth per in the industry sector, equivalent to about capita value-added is decomposed into four components, namely contributions of produc- one-third of total employment generated tivity growth, employment growth, labor force by the garment and footwear sector. Wages growth, and change in working-age popula- of unskilled workers in the construction tion, for the period 2007-14. sector have risen to as high as US$200 The results show that annual growth per cap- a month, well above the garment and ita value-added during the period 2007-14 footwear industry’s minimum wage of US$153 is healthy. Annual productivity growth of 6.0 a month, which represents a 9.2 percent percent is found to be the largest contributing factor in annual growth per capita value-add- year-on-year increase. Wages of skilled ed of 4.2 percent (Table B1). The decline in the construction workers are twice as much as the employment rate, however, dragged down minimum wage, ranging from US$300 to growth per capita value-added by as much US$450 a month. as 2.8 percent, caused mainly by a decline in the agricultural employment rate. Diversification of livelihood portfolios is 1/http://globalpractices.worldbank.org/mfm/ helping to sustain poverty reduction in Pages/SitePages/MFM%20Online%20Tools.aspx Cambodia. By 2015, non-agriculture wage incomes made up more than one-third of Table B1: Decomposition of per capita value-added growth (by the Shapley rural incomes, compared with less than method), employment by major sector, one-fifth in 2007 (Figure 14). During the in the period 2007-14. Percent % same period, agricultural incomes including Contribution agricultural wages declined to only 43 Annual Growth per capita 4.26 100% Value Added percent of total rural incomes, down from 63 Change in Productivity 5.99 141% percent. Thus, poverty is expected to have Change in Employment rate -2.86 -67% continued to decline, despite agricultural Agriculture -3.69 -87% growth stagnating, the sector that had Industry 0.88 21% driven poverty reduction until 2012. This trend Services etc. -0.05 -1% means that the rural non-farm economic Change in Participation Rate 0.32 8% Change in Share of 0.81 19% activity such as garment, construction and Working Age Population Source: Bank staff computation 8 Annual report for 2016 and targets for 2017, Ministry of Land, Urbanization and Construction, January 13, 2017. APRIL 2017 CAMBODIA ECONOMIC UPDATE 19 services and, to a lesser extent, remittances could be a significant contributor to BOX 1: PRODUCTIVTY (CON’D) poverty reduction and shared prosperity in Cambodia in the years to come. In this regard, Cambodia is similar to Vietnam, Of the 6.0 percent increase in productivity in the period 2007-14, growth of productivity in where livelihood diversification in rural areas agriculture contributed the second-largest, has already made an important contribution after real estate (Table B2). Using employment to poverty reduction and shared prosperity. data by sector (and sub-sector), the fastest annual productivity growth rate is seen in real estate, which grew at an annual average rate Figure 14: Agriculture income only accounted for 43 percent of total rural incomes. Rural income (%) of 2.7 percent during the period 2007-14. This 100% 2 2 2 was likely boosted by the real-estate boom 3 3 3 2 5 8 90% 7 in Cambodia during the post-global financial 17 17 80% 26 crisis period. Productivity growth in agricul- 13 30 35 70% 15 ture was next, rising by an annual average of 60% 5 9 12 9 12 1.8 percent with the application of more ad- 50% 12 40% 9 vanced agricultural technology and inputs. 10 30% 58 56 The third-fastest productivity growth of 0.7 47 20% 39 33 percent was in trade (wholesale and retail). 10% 0% While the garment and footwear sector con- 2004 2009 2012 2014 2015 Net agriculture Agricultural wage tinued to be a main driver of growth, the sec- Net nonagriculture Non-agricultural wage Remittance Other tor’s annual average productivity growth was Source: The Cambodian authorities only a modest 0.16 percent. Table B2: Decomposition of per capita value THE EXTERNAL SECTOR added growth (by the Shapley method), employment by sector, in the period 2007-14. Percent % a) Merchandise exports Contribution Annual Growth per capita 4.26 100% Value Added Overall, merchandise exports remained solid, Change in Productivity 5.99 141% with continued garment and non-garment Agriculture 1.87 44% export growth. Merchandise exports are Mining & other manufacturing 0.05 1% estimated to have expanded at 11 percent Utilities 0.03 1% year-on-year in 2016, reaching 45.5 percent Garment & footwear 0.16 4% of GDP (Figure 15), driven by garment and Construction -0.27 -6% Trade 0.72 17% footwear exports, which rose by 8.4 percent Transport & 0.31 7% and 14.8 percent year-on-year, respectively. Communications This is compared with an 8.3 percent year-on- Real estate 2.70 63% year growth in 2015. Agricultural commodity Other Activities 0.02 0% Inter-sectoral 0.40 9% exports, in particular paddy rice exports, Reallocation Effect are believed to have been boosted by the Change in Employment rate -2.86 -67% expansion of wet season rice production, Change in Participation Rate 0.32 8% which increased by 5.3 percent year-on- Change in Share of Working Age Pop 0.81 19% year, or by almost 0.4 million metric tons in Source: World Bank staff calculations 2016. 20 CAMBODIA ECONOMIC UPDATE APRIL 2017 Figure 15: Trade deficit is narrowing. Exports, imports and trade deficit. (Percent of GDP) BOX 1: PRODUCTIVTY (CONT’D) Exports Imports Trade deficit (RHS) 50.0 -10.0 -10.5 30.0 Regional comparisons also show that -11.0 10.0 Cambodia’s annual growth per capita -11.5 -10.0 value-added during 2007-14 was relatively -12.0 -30.0 high (Table B3). Using data sources from World -12.5 -50.0 Development Indicators, annual growth per -13.0 -70.0 -13.5 capita value-added for Lao PDR, Vietnam, 2011 2012 2013 2014 2015 2016e Thailand and Indonesia were compared with Source: the Cambodian authorities that of Cambodia. Among the five countries, e = estimate Lao PDR had the highest annual growth per capita value-added of 6.1 percent. However, its productivity growth was only 5.1 percent b) Transfer receipts – workers’ remittances versus 6.0 percent in Cambodia. Nonetheless, it is worth mentioning that Cambodia is in at Workers’ remittances continue to be strong. an earlier stage of development than most In 2016, remittance inflows are estimated comparator countries with the exception to have reached US$431 million. 9 A large of Lao PDR. number of Cambodian migrant workers, attracted by high wages in Thailand, while Table B3: Annual growth per capita value added – regional comparisons in 2007-14 also being negatively affected by declining Cam- Lao Viet- Thai- Indo- agriculture commodity prices for their bodia PDR/1 nam/2 land/2 nesia Total 4.3 6.1 2.5 2.9 3.9 agricultural production at home, mainly contributed to the remittance inflows. This Productivity 6.0 5.1 1.8 2.5 3.2 has helped boost household remittances, Employment -2.9 0.0 0.0 0.1 0.5 especially in rural areas, since 2014 (Figure 16). rate Participation 0.3 -0.2 0.2 -0.3 0.0 rate Demograph- 0.8 1.1 0.6 0.6 0.3 Figure 16: Workers' remittances continued to be ic change strong. (US$ million) Source: World Bank staff calculations. 1/ 2007-10; 2/ 2007-13 500.0 450.0 400.0 350.0 300.0 c) Merchandise imports 250.0 200.0 150.0 Demand for imports has been contained, 100.0 due to a deceleration in imports of basic 50.0 0.0 construction materials, particularly steel 2012 2013 2014 2015 2016e (and cement), as the completion phase of Source: the Cambodian authorities and Bank staff estimates e = estimate many modern high-rise residential and com- mercial construction projects is nearing. In 9 Balance of payments statistics, the Central Bank APRIL 2017 CAMBODIA ECONOMIC UPDATE 21 addition, there has been a rapidly growing official transfers) is estimated to have nar- import substitution effort, with the expansion rowed to 9.5 percent of GDP in 2016, down of domestic production, especially for food from 10.6 percent in 2015 (Figure 18). and beverage products and cement. Im- Figure 18: FDI largely finances current account deficits port growth is estimated to have remained which are gradually narrowing. (In percent of GDP) at around 9 percent year-on-year in 2016, Current accounts balance Trade balance FDI equivalent to 56.9 percent of GDP. 15.0 10.0 However, reflecting continued strong do- 5.0 mestic consumption, a number of key im- 0.0 port products, such as motor vehicles, diesel -5.0 and foodstuffs, remained robust. Imports of -10.0 motor vehicles (not including motorcycles) -15.0 2010 2011 2012 2013 2014 2015 2016e continued to be buoyant, growing at 21.4 Source: The Cambodian authorities and Bank staff estimates percent year-on-year (in value terms) in 2016, compared with 21.1 percent in 2015 (Figure 17). Diesel imports rose, reaching Capital inflows and an improved current ac- 14.2 percent year-on-year in 2016, com- count position have contributed to rising in- pared with 3.0 percent in 2015. ternational reserves, which reached US$6.5 billion (equivalent to 5.4 months of prospec- Figure 17: Imports of vehicles, diesel and tive imports) last year. This occurred as net foodstuffs remained strong.(YoY ,% change) 50 foreign assets of the central bank accelerat- ed, expanding at 22.3 percent year-on-year 40 in 2016, compared with 20.4 percent in 2015. 30 20 INFLATION 10 0 Inflationary pressures have built up as a result -10 Passenger cars Diesel Food stuff of continued strong domestic demand led -20 by household consumption driven in part by Dec-13 Dec-14 Dec-15 Dec-16 Source: the Cambodian authorities the rise in wages. Inflation has accelerated, rising to 4.3 percent year-on-year in March d) The current account 2017, compared with 2.8 percent in 2015 (Figure 19). The food component, in particu- Overall, Cambodia’s external position fur- lar fish, meat, poultry, vegetables and fruit ther improved as trade deficits narrowed, prices, continued to drive inflation, while res- supported partly by resilient exports and taurant, health care, furnishings, and cloth- continued low international oil prices. Main- ing components combined (classified under ly financed by FDI inflows, which are estimat- “others”) also rose. The transportation com- ed to have amounted to 10.2 percent of ponent remained subdued, while a slow GDP in 2016, compared with 9.1 percent in recovery in international oil prices has been 2015, the current account deficit (excluding observed. 22 CAMBODIA ECONOMIC UPDATE APRIL 2017 Figure 19: The food component continues to drive Figure 21: Regional inflation has been creeping up. inflation. Contributions to 12-month inflation (Percent) (y/y change, percent) Others Transport sub-index Cambodia Vietnam Thailand 10 10 Food sub-index Housing & utilities sub-index Laos Singapore Malaysia Y/Y China 8.0 8 8 6 6 6.0 4 4 4.0 2 2 2.0 0 0 0.0 -2 -2 -2.0 -4 -4 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 -4.0 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Source: the Cambodian authorities and other countries' statistics Source: The Cambodian authorities The recent uptick in inflation is believed to THE MONETARY SECTOR have been driven largely by expanding domestic demand, boosted by rising a) Monetary aggregates, interest rates consumption as wages rise. This is very and exchange rates different from the period of global food and oil price shocks, followed by the 2007/08 Supporting economic growth, broad money global financial crisis, when imported has expanded, increasing by 17.9 percent inflation—with the “pass-through” from year-on-year by end-2016, compared with imported prices of oil and foodstuffs to 14.7 percent in 2015, thanks to rising foreign domestic inflation—was largely responsible currency deposits boosted by improved for rising domestic inflation (Figure 20). confidence in the banking system (Figure 22). However, the contributions from riel Figure 20: Post-global financial crisis, inflationary pressures have been largely contributed by deposits and riel in circulation to broad domestic consumption. money growth remain subdued, reflecting the 40.0% 40.0% 35.0% Average CPI (RHS, y/y) central bank’s prudent policy in maintaining 35.0% 30.0% Average pc consump (y/y) 30.0% exchange rate stability to help stabilize 25.0% 20.0% 25.0% domestic prices in the highly dollarized 20.0% 15.0% 15.0% 10.0% 5.0% 10.0% Figure 22: Broad money growth has been driven by 0.0% 5.0% rising foreign currency deposit. Contribution to -5.0% 0.0% broad money growth (in percent) 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 45 Riel in circulation Riel deposits Foreign currency deposits Source: the Cambodian authorities (CSES, NIS) and Bank staff estimates 40 35 30 Regional inflation has also been edging 25 20 up (Figure 21). Although inflation is still 15 expected to remain subdued for some time 10 5 to come, inflation expectations appear to 0 -5 be rising on the back of a sizeable energy Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 and commodity price recovery. Source: the Cambodian authorities APRIL 2017 CAMBODIA ECONOMIC UPDATE 23 economy. While rising foreign currency strong capital inflows, observed since early deposits reflect the increasing attractiveness 2016 with rising foreign currency deposits of Cambodia’s banking sector, it also (see also the discussion on FDI inflows under suggests rising capital inflows into the the external sector section above), while country. the contribution of the riel in broad money growth remained subdued. This may explain Despite the decline in credit growth, caused the recent appreciation of the riel. partly by more modest economic activity, short-term US dollar denominated lending Figure 24: The riel has appreciated against the US dollar, the Thai baht, and the Vietnamese dong. Riel per dong, and deposit rates have edged up (Figure baht, and USD indices (2005=100) and Riel per USD (RHS) 23). As the economy is highly dollarized, it is 140 4,300 130 4,250 strongly influenced by US Federal Reserves’ 4,200 120 monetary policy, which has recently been 110 4,150 4,100 tightened, with three interest rate increases 100 4,050 90 since the end of 2015.10 4,000 80 3,950 70 3,900 Index (Riels per USD) Index (Riels per Baht) Figure 23: Short-term US dollar interest rates have 60 Index (Riels per Dong) Riel per USD (official mid-point) 3,850 edged up despite the decline in credit growth. 50 3,800 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 20 6.34 7 Lending rate Deposit rate (RHS) Source: Central banks (Cambodia and Thailand) and Vietnam's ministry of finance 18 17.2 16.4 6 16.7 15.8 16 16.0 15.4 5.32 6 In addition, recent efforts to promote the 14 11.8 4.84 4.91 11.6 11.6 5 use of the riel by the central bank may have 12 11.4 11.5 4.44 4.29 4.44 4.45 4.43 strengthened trust in the local currency. The 4.27 4.30 5 10 central bank has built a good track record, 8 4 which includes avoidance of domestic Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 bank financing for the government’s fiscal Source: The Cambodian authorities deficit, while maintaining relatively low inflation (except during the period of oil The Cambodian riel (CR) has recently and food price shocks preceding the 2008- appreciated against the US dollar, the Thai 09 global financial crisis). The pegged riel baht and the Vietnamese dong (Figure 24). versus US dollar exchange rate regime, as The riel/US dollar exchange rate appreciated well as trade and financial dependence to CR 3,990 in March 2017, from CR 4,050 on the US dollar, however, continues to be in December 2016. As explained above, conducive to dollarization.11 Cambodia’s increased investor confidence resulted in external competitiveness is expected to be 10 The US Federal Reserve targets a “Fed fund rate”—the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight, using open market operations (decided by FOMC)—for the purchase and sale of US treasury securities (bills, notes, and bonds). Since 2006, there have been three increases in the interest rate: the first rate increase from 0.25 to 0.5 percent per year (December 20, 2015), the second to 0.75 percent (December 18, 2016) and the third increase to 1.0 percent (March 15, 2017). As of March 16, 2017, the effective Fed fund rate is now 0.91 percent and the bank prime loan rate is 4 percent. 11 Strengthening the role of local currencies in EU candidate and potential candidate countries, occasional paper series, the European Central Bank, No 170, April 2016. 24 CAMBODIA ECONOMIC UPDATE APRIL 2017 further eroded if the country maintains the Figure 25: Credit growth has decelerated since pegged exchange rate policy, if and when mid-2016, while deposit growth remained strong. (Y/Y % change) further dollar appreciation occurs. In the 50 Deposits by the private sector Credits to the private sector absence of an independent exchange rate 45 40 regime, the overvaluation of real effective 35 exchange rate, therefore, calls for policies to 30 25 improve productivity and competitiveness.12 20 15 10 b) The banking sector 5 0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 May-10 May-11 May-12 May-13 May-14 May-15 May-16 Sep-15 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-16 The banking sector’s credit growth has Source: The Cambodian authorities moderated slightly, partly reflecting more modest economic activity. Macro- towards non-tradable sectors, such as prudential measures recently introduced by construction and retail trade, and away the central bank may have also helped to from tradeable sectors, such as tourism- slow domestic credit growth. The banking related businesses and manufacturing sector’s credit growth decelerated to 25.8 (Figure 26). This trend may partly reflect percent year-on-year by end-2016, compared US dollar appreciation, which has had the with 28.6 percent in 2015 (Figure 25). effect of eroding competitiveness of the main tradeable sectors, namely garments Outstanding credit provided to the private and tourism. As a result, investors and sector rose to US$12.4 billion or 62.3 percent producers may be redirecting investment of GDP by end-2016, up from US$9.8 billion toward non-tradable sectors and services or 54.7 percent of GDP in 2015. Improved serving domestic demand rather than confidence in the economy has attracted towards exports. Given the country’s small additional private sector deposits, which domestic market, the shift does not bode accelerated to 19.3 percent year-on-year well for sustaining high levels of economic growth in 2016, compared with 16.6 percent growth. in 2015. The loan-to-deposit ratio remained high at 100 percent at the end of 2016. Figure 26: The share of credits to construction rose, while credit to manufacturing and tourism-related The non-performing loan (NPL) ratio for the businesses declined. (% of total) banking sector rose slightly to 2.7 percent in Manufacturing Wholesale Trade Retail Trade Hotels and Restaurants 2016, up from 2.3 percent in 2015. However, 25 Construction & real estate care should be taken in the interpretation 20 of NPL ratios, as inconsistencies in loan 15 classifications and the continuous rolling 10 over of loans may disguise deeper problems. 5 It is important to note that there has been 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 a shift in the allocation of domestic credit, Source: the Cambodian authorities 12 2016 IMF Article IV staff report APRIL 2017 CAMBODIA ECONOMIC UPDATE 25 c) Microfinance percent in 2016, up from 0.7 percent in 2015. In environments of rapidly increasing credit, After growing rapidly for several years, the as experienced in Cambodia over the past expansion of credit provided by micro- six years, the quality of portfolios is often finance institutions (MFI) and microfinance- masked by the pace at which portfolios deposit-taking institutions (MDI) stagnated in grow. Only with a shock or a major slowdown 2016. Credit growth of MFIs/MDIs peaked in do the underlying vulnerabilities—for 2014 at more than 50 percent year-on-year example, large numbers of borrowers taking (Figure 27), but then stalled abruptly in 2016. new loans to repay old ones—suddenly Outstanding credit provided by MFIs/MDIs become apparent. peaked in March 2016, when it reached US$3.3 billion, or 16.7 percent of GDP, but It is too early to be sure of the reasons behind has since declined. 13 By November 2016, the stalling of growth in MFI/MDI credit. Initial outstanding credit fell to US$3.1 billion, or observations indicate that there is stronger 15.5 percent of GDP. It is worth emphasizing competition from the growing number that the micro-finance credit market is of unregulated parallel microfinance highly concentrated, dominated as it is by operations offering credit, including a relatively small number MFIs/MDIs. The top private money-lenders. As competition 12 MFIs/MDIs account for 98 percent of the heats up, the criteria for obtaining loans microfinance market by loan portfolios and are being relaxed, in particular by informal 97 percent by borrowers. 14 and unregulated money-lenders. Many households therefore appear to be relying Figure 27: Domestic credit provided by MFIs/MDIs have abruptly stalled, while interest rates have increasingly on informal money-lenders for increased. quick, uncollateralized cash to make loan 90.00 42 repayments, cover medical expenses, or 80.00 41 70.00 40 make property repairs.15 However, some 60.00 39 MDIs attribute this stalling to slower demand 50.00 38 for credit by farmers and informal traders, 40.00 37 30.00 36 adversely affected by the difficulties 20.00 y/y change 35 in (informally) exporting agricultural 10.00 34 Max interest rate (RHS) commodities to neighboring countries 0.00 33 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 and continued depressed agricultural Source the Cambodian authorities commodity prices. Some reports have also The total number of households served by attributed the decline in outstanding credit MFIs/MDIs has also declined, dropping to from MFIs/MDIs to market saturation.16 The only 2.14 million households in 2016, down interest rate cap for MFI/MDI credit from 2.19 million households in 2015. The NPL introduced by the authorities in March ratio for the micro-finance sector rose to 1.5 2017 and effective since April 1, 2017 may 13 This was partly due to the reclassification of one of the MDIs as a commercial bank. 14 See April 2016 Cambodia Economic Update for detailed discussions on the micro-finance sector. 15 2015 Cambodia Socio-Economic Survey, October 2016, National Institute of Statistics, Ministry of Planning. 16 See MIMOSA, 2016 “Microfinance Index of Market Outreach and Saturation: Cambodia”, MIMOSA Project, May 2016 interim update. 26 CAMBODIA ECONOMIC UPDATE APRIL 2017 also serve to curtail credit growth (see the transpire, the policy may fail to provide following section). rural, poor borrowers with the protection and benefits that was intended. In addition, d) Indebtedness the policy notably excludes a number of commercial banks that are leaders in In March 2017, the central bank issued a microfinance lending. Prakas introducing a lending rate cap of 18 percent per year, effective April 1, 2017, for The 2015 Cambodia Socio-Economic credit provided by all MFIs/MDIs under its Survey (CSES) results show that credit supervision. 17 The intention of the lending provided by non-governmental organizations rate cap/ceiling policy is to bring down (NGOs), which may also include MFIs/MDIs, interest rates charged by central bank- accounted for only 20 percent of the total licensed MFIs/MDIs. Cheaper borrowing outstanding loan amount borrowed by all costs should then help to promote households in 2015, while those provided agricultural activities, attract investment, by banks represented the largest share, and expand domestic production, covering almost 60 percent (Figure 28). otherwise not feasible, in particular for This may limit the potential impact of the poor farmers and small businesses. The Prakas capping lending rates that applies policy can also be seen as an attempt to to only central bank-licensed MFIs/MDIs discourage aggressive lending practices when it became effective in April 2017. The and to rein in possible overheating in the average interest rate paid by households in consumer credit market (see the discussion Cambodia is as high as 2.4 percent a month below on the use of MFIs’ loan proceeds (or 32.9 percent a year) although households below). have increasingly availed themselves of bank credit, while reducing their reliance on However, it is not clear how many of the private money-lenders. licensed MFIs/MDIs will be able to lend at, or below, the celling rate. If many MFIs/MDIs Figure 28: Access to bank loans has risen rapidly at the expense of credit provided by NGOs (and cannot manage to lower their interest rates, MFIs/MDIs) and private money lenders. (Percent of total) the policy could severely curtail their new Bank NGO (MFI) Private money lender Relative 100 lending (unless they institute non-interest- 7.6 90 10.9 11.7 16.2 related charges to compensate for the 80 19.7 14.6 12.1 10.6 70 ceiling). The policy could therefore force 60 14.5 18.7 21.1 19.8 many MFIs/MDIs to leave the microfinance 50 33.1 40 31.6 39.5 market, while encouraging the proliferation 30 57.2 48.8 20 of private money-lenders and non-licensed 26.2 35.4 10 16.4 MFIs, among which responsible lending 0 2011 2012 2013 2014 2015 practices are not observed. If this were to Source: Cambodia socio-economic surveys 17 Prakas dated March 13, 2017, National Bank of Cambodia. APRIL 2017 CAMBODIA ECONOMIC UPDATE 27 The 2015 CSES does not, however, specify to 32 percent, down from 38.3 percent. The the proportion of the credit provided by average loan size increased more than four central bank-licensed MFIs/MDIs in the total times the rate of increase of GNI per capita credit figure, so it is difficult to quantify the over the same period.18 Rising consumption potential impact of the newly introduced due to increased access to domestic credit interest rate cap. may have also contributed inflationary pressures that, as we already noted, have Rural households appear to have faced built up recently. more challenging borrowing terms, as they pay the highest interest rate of 2.5 percent a Indebtedness has intensified since 2010, month (or 34.5 percent annually), versus 2.1 in particular for rural households (Figure 30). Average outstanding debt amounts percent a month (or 28.3 percent annually) per household as a percentage of annual paid by households in other urban areas disposable income in rural areas trended (and 2.4 percent a month paid by Phnom upwards, reaching 29 percent of average Penh households). annual income in 2015, except in 2013 when it peaked at 30 percent.19 Rising Indebted rural households represented 88 indebtedness may also result from a rapid percent of the total 1.25 million indebted expansion of financial products and services. households in Cambodia in 2015 (Figure 29), This includes leasing, which now covers up from 80 percent in 2009. During the durable goods such as motor vehicles, same period, the proportion of loan machinery, equipment, smart-phones and proceeds used by the rural households for more, provided by the bank and non-bank productive purposes, which may include sectors, taking advantage of rising domestic those classified as “agricultural activities” demand boosted in part by the construction and “non-agriculture activities”, declined and real estate sector boom. Figure 29: Share of indebted households by Figure 30: Household indebtedness is rising geographical domain (thousand, 2015) among other rural households. Outstanding . loan (% of annual disposable income) 45 Phnom Penh, 38 Phnom Penh household (3%) Other urban, 40 Rural household 113, (9%) Other urban 35 30 25 Other rural, 1,104, (88%) 20 15 2009 2010 2011 2012 2013 2014 2015 Source: 2015 Cambodia socio-economic survey Source: Cambodia socio economic surveys 18 MIMOSA Cambodia, June 2016 report. 19 Annual income and outstanding loan amounts are reported in the 2015 Cambodia Socio-Economic Survey (CSES). There is a discrepancy between the outstanding loan amount collected in the 2015 CSES and that recorded by the central bank. 28 CAMBODIA ECONOMIC UPDATE APRIL 2017 supported customs revenues. Rising domestic THE FISCAL SECTOR production and consumption fostered the collection of domestic taxes. The collection a) Domestic revenue of non-tax revenues, consisting primarily of royalties, revenue-sharing and fees boosted While revenue collection remains strong, largely by the introduction of a standardized the revenue-to-GDP ratio is stagnating after receipting system and inter-agency Prakas, rising rapidly during the past few years has now moderated. (Figure 31). Strong performance in direct and indirect tax collection continued, Combined GDCE and GDT continues to while non-tax collection declined in 2016. contribute roughly 80 percent of total Overall collection as a percentage of GDP collection (Figure 32). Improved collection now seems to have stagnated. This is not efforts by key revenue collecting agencies, surprising as the revenue-to-GDP ratio has namely the General Department of Customs experienced a rapid increase during the and Excises (GDCE) and the General past few years, thanks to improved revenue Department of Taxation (GDT), continue administration with the implementation to underpin overall revenue performance. of 2014-18 Revenue Mobilization Strategy While the GDCE remains the largest (RMS), rising imports and buoyant domestic contributor, mobilizing over 40 percent of consumption. Domestic revenue is estimated the total collection, the GDT’s revenue to have remained at 18.5 percent of GDP, is catching up, collecting 36 percent of compared with 18.7 percent of GDP in the total in 2016, compared with only 31 2015, caused primarily by a decline in non- percent in 2009. During the same period, tax revenue by 0.8 percent of GDP to 2.2 increasing revenue from direct taxes, rising percent of GDP in 2016. to 3.8 percent of GDP in 2016, up from 1.7 percent of GDP, is also encouraging, given The recent expansion of imports to feed Cambodia’s commitment to gradually the construction and real estate boom reduce its import tariffs under the ASEAN Free Trade Agreement (AFTA). Figure 31: While remaining strong, domestic collection appears to have stagnanted as a Figure 32: GDCE and GDT continue to be main percentage of GDP. revenue collecting agencies with combined collection accounting for 80 percent of total 20.0 Direct taxes Indirect taxes Trade taxes Non-tax and others collection. (Percent of total) 18.0 48% GDT GDCE 47% 16.0 44% 43% 43% 43% 44% 42% 14.0 36% 12.0 34% 31% 31% 32% 30% 30% 29% 10.0 8.0 9.2 8.1 8.4 6.0 6.8 6.8 5.4 5.7 6.0 4.0 2.0 2.9 3.3 3.8 1.7 1.7 1.8 2.3 2.5 - 2009 2010 2011 2012 2013 2014 2015 2016e 2009 2010 2011 2012 2013 2014 2015 2016e Source: the Cambodian authorities Soruce: the Cambodian authorities and Bank staff estimates APRIL 2017 CAMBODIA ECONOMIC UPDATE 29 b) Public expenditures This declining trend is mainly explained by the reduction in development partner- Fiscal expansion started in 2016, after sever- financed capital investment. An increase in al years of fiscal consolidation (Figure 33). In public infrastructure investment is needed 2016, public outlays are estimated to have to promote output both in the short term, by risen to 21.5 percent of GDP, compared with boosting aggregate demand, and also in the 20.5 percent of GDP in 2015. This expansion longer term, by expanding the productive was largely boosted by the rising public sec- capacity of an economy with a higher tor wage bill, with the minimum civil servants’ infrastructure stock. wage targeted to reach at least CR 1 million (equivalent to about US$250) a month by The National Strategic Development Plan 2018. Meanwhile, total capital investment 2014-18 (NSDP) targets capital investment expenditure is on a downward trend, as a expenditure of around 7.6 percent of GDP result of the gradual decline in the devel- to achieve a GDP growth target of about opment partner-funded component as a 7 percent. However, actual investment percentage of GDP. expenditure shrank to 7.1 percent of GDP in 2016 (Table 1). In the context of a declining Figure 33: Wages are rising but capital investment is development partner-funded capital shrinking below the level required by 2014-18 NSDP. (Percent of GDP) budget, which is not anticipated by the External fin capital Gov't-financed capital Wage NSDP (required capital) Non-wage NSDP, scaling up government-financed 20 capital spending to boost productive pro- 6.3 6.2 7.1 7.2 6.9 6.8 6.5 7.1 6.9 growth and pro-poor investments, especially 15 4.3 in physical infrastructure, is needed. 4.4 4.6 5.0 10 4.8 2.6 5.7 6.5 7.4 7.6 However, enhancing the legal framework for 2.4 2.1 2.1 2.4 1.9 2.6 2.4 2.4 Public Investment Management (PIM) and 5 6.4 7.3 8.2 7.0 7.0 6.3 5.2 4.7 4.8 capacity building at core and line ministries 0 2009 2010 2011 2012 2013 2014 2015 2016e 2017b would be needed first, as a prerequisite Source: the Cambodian authorities Note: e = estimates; b = budget for improving investment efficiency. For more details on PIM, see the selected issue The public sector wage bill is estimated to section on “Investing in Public Infrastructure have risen to 7.4 percent of GDP in 2016, and Services”. up from just over 4 percent of GDP in 2011, whereas during the same period public c) Fiscal balance capital investment expenditure shrank to 7.1 percent of GDP,20 down from 10.8 While helping to propel growth, fiscal percent of GDP. Although rising collection expansion has resulted in a widening of the has allowed an expansion of public sector overall fiscal deficit. However, sustained robust wages, the steady decline of capital collection has helped to contain the deficit. spending in recent years does not bode In 2016, the overall fiscal deficit (including well for improving competitiveness and grants) is estimated to have widened to sustaining high levels of economic growth. 20 Table 5.1 Capital investment required to achieve GDP growth targets and potential sources of financing for the needed investment: 2014-18, NSDP (2014-18), Royal Government of Cambodia. 30 CAMBODIA ECONOMIC UPDATE APRIL 2017 Table 1: Public capital investment expenditure d) 2017 Budget is trending downwards and below the NSDP required level. (Percent of GDP) The 2017 budget sees further expansion in 2014 2015 2016e 2017b 2018f NSDP public outlays, driven once again by the 7.5 7.4 7.6 7.6 7.3 rising public sector wage bill. The budgeted Domestic revenue appears below last year’s estimated 1.8 1.8 1.9 1.9 1.7 collection, resulting in a widening of the External overall fiscal deficit to 2.3 percent of GDP. 5.7 5.6 5.7 5.7 5.6 Budgeted public outlays for 2017 account Actual 8.2 7.8 7.1 7.2 7.0 for 21.7 percent of GDP, compared with the Domestic estimated outlays of 21.4 percent of GDP in 1.9 2.6 2.4 2.4 2.4 2016, as the public sector wage bill increases External further to 7.6 percent of GDP, up from 7.4 6.3 5.2 4.7 4.8 4.6 percent of GDP in 2016 (Table 2). As a result, Source: 2014-18 NSDP and World Bank staff estimates and projection the non-wage component continues to Note: e = estimates; b = budget; f = forecast be compressed, declining to 6.9 percent of GDP in the 2017 budget, down from 7.1 1.4 percent of GDP, compared with the percent of GDP in 2015. fiscal balance registered in 2015 (Figure 34). Excluding grants, the fiscal deficit rose to 3.0 With a slight reduction in domestic revenue percent of GDP in 2016, compared with 1.8 budgeted, the overall fiscal deficit (including percent of GDP in 2015. grants) is therefore wider by 0.9 percent of GDP, expanding to 2.3 percent in the 2017 Cambodia’s debt distress rating in the latest budget, from an estimated overall deficit of World Bank/IMF Debt Sustainability Analysis 1.4 percent of GDP in 2016. Excluding grants, conducted in 2016 remained low, largely the budgeted deficit for 2017 reaches 3.5 underpinned by the overriding principle of percent of GDP, compared with 3.0 percent borrowing only on concessional terms. of GDP in 2016. Table 2: 2017 budget versus 2016 estimates Figure 34: Sustained strong collection has resulted (Percent of GDP) in a reduction in fiscal deficits. (Percent of GDP) General Government 2016e 2017b 26.0 Revenue Expenditure Deficits (incl grants) Operations 22.0 Domestic revenue 18.4 18.2 18.0 14.0 Total expenditures 21.4 21.7 10.0 o/w wage 7.4 7.6 6.0 non-wage 7.1 6.9 2.0 Capital 7.2 7.2 -2.0 -6.0 Overall deficit -1.4 -2.3 2008 2009 2010 2011 2012 2013 2014 2015 2016e Source: The Cambodian authorities and Bank staff estimates Source: the Cambodian authorities and World Bank staff estimates e = estimates and b = budget APRIL 2017 CAMBODIA ECONOMIC UPDATE 31 32 CAMBODIA ECONOMIC UPDATE APRIL 2017 C. OUTLOOK AND RISKS Growth is projected to remain diversify tourism attraction beyond from the Angkor robust, at 6.9 percent both this complex to boost tourist arrivals. year and next, but is expected to decelerate slightly to 6.7 Table 3: Selected economic indicators, projections for 2017-19 percent in 2019 (Table 3). While growth is partly buoyed by rising 2015 2016e 2017p 2018 f 2019 f government spending, some Real GDP growth, at 7.0 6.9 6.9 6.9 6.7 constant market prices signs of moderation, in particular Real GDP growth, at 6.9 6.8 6.8 6.8 6.6 in the construction sector, are constant factor prices now starting to emerge. The Agriculture 0.2 1.2 1 0.8 0.7 slight easing in performance of Industry 11.7 10.4 9.8 8.9 8.8 the garment sector is expected Services 7.1 6.8 7.1 8 7.2 to be offset by a gradual Public Sector (% of GDP) General government 18.7 18.4 18.2 17.7 17.1 expansion of the agriculture domestic revenues sector (thanks to recent efforts General government 20.5 21.4 23.3 22.5 21.6 to revitalize the sector) and expenditures Fiscal balance including -1.8 0.0 -1.4 -3.5 -3.4 other manufacturing, such as grants foodstuffs, beverages and agro- Inflation (period average) 1.3 3.5 3.7 4.2 5.2 processing. The tourism sector Current Account Balance -9.7 -10.6 -9.5 -9.2 -8.9 (% of GDP) may also recover gradually in part FDI (% of GDP) 9.1 10.2 9.4 7.7 6.5 due to newly established direct External debt (% of GDP) 32.1 32.9 33.5 33.8 33.6 flights and a number of initiatives Sources: The Cambodian authorities, the World Bank and IMF and promotional efforts to Note: e = estimates; p=projection; f = forecast APRIL 2017 CAMBODIA ECONOMIC UPDATE 33 The outlook for growth remains favorable in revenue gains that Cambodia experienced the medium term, largely underpinned by until recently may slowly diminish. This is export diversification. However, as discussed likely to occur unless tax policy measures in the selected issue section below, boosting are introduced to expand the tax base and productive investments, especially in further strengthen revenue administration in physical infrastructure, underpinning pro- the short and medium term. growth and pro-poor commitments under the 2014-18 NSDP, while also enhancing The rural non-farm economy could be a spending efficiency, will be crucial, given significant contributor to poverty reduction that inadequate infrastructure has long been and shared prosperity in Cambodia in one of Cambodia’s key constraints and is the years to come. Cambodia is similar to seen as a major bottleneck. Improving labor Vietnam, where livelihood diversification productivity, as well as the performance of in rural areas has already contributed the public sector, will be fundamental for significantly to poverty reduction and shared Cambodia to remain competitive, given prosperity, and non-wage agriculture rising competition from other low-wage income constituted about 36 percent of garment exporting countries. incomes for the bottom 40 percent in 2015. Cambodia’s external position is expected to Downside risks to this outlook include the be sustained, with rising FDI inflows, depressed fallout from further rises in US interest rates, oil prices, and slower imports in the short a slowdown in the economic recovery term. Adjustments in the construction sector in Europe, and uncertainties over global after the post-global financial crisis boom trade. Domestically, potential election- will ease imports in the short term, as the related uncertainty may occur during completion phase of many modern high- and after the general election, which rise residential and commercial construction is scheduled to be held in mid-2018. US projects is nearing. Gradual progress in monetary policy tightening is expected to promoting domestic production will also result in the US dollar appreciating vis-à-vis help to substitute imports in the medium the Euro and other currencies, which would term. make Cambodia’s exports and tourism relatively more expensive for the rest of The expansionary fiscal policy will likely the world, and therefore less competitive. continue at least until 2018, as a rising Continued interest rate hikes in the US may public sector wage bill, election-related weaken prospects of further capital inflows expenditures, and the need to boost public to Cambodia. Any disruption in global investment, are likely to keep public outlays trade flows will have substantial negative on the rise. In contrast, with the adjustments impacts on Cambodia, given its high level of the construction and real estate sector of dependence on exports, particularly resulting in softer demand for domestic garments and footwear, as one of main consumption and imports, the robust drivers of economic growth. 34 CAMBODIA ECONOMIC UPDATE APRIL 2017 APRIL 2017 CAMBODIA ECONOMIC UPDATE 35 D. KEY MESSAGES AND POLICY OPTIONS Staying competitive by enhancing labor improvements in service delivery. Raising productivity will be key in compensating for public sector productivity underpins private rapidly rising real wages. A top priority will be sector development as it helps to promote to improve the quality of basic education investment and facilitate trade to drive and promote vocational and technical growth and reduce poverty. skills, while reducing energy costs to attract and compete in high value-added In the context of a declining development and more sophisticated manufacturing. partner-funded capital budget, Cambodia Investing now in further improvements in will need to enhance Public Investment Management (PIM) to scale up government- learning outcomes, coupled with increased financed capital spending. Pro-growth and secondary school attainment, will be pro-poor investments, especially in physical essential for future success for diversification infrastructure, could benefit from additional of the industry sector. allocations in order to compensate for the reduction in development partner-funded Public administration reforms to bring about budget. However, enhancing the legal an improvement in public service delivery framework for PIM and capacity building at will be important, especially after the core and line ministries will be needed first, recent boost in civil servants’ wages. Given as a prerequisite for improving investment that the public sector is a major service efficiency. For more details on PIM, see the provider and facilitator, it is crucial to link the selected issue section on “Investing in Public public sector’s significant wage boost with Infrastructure and Services”. 36 CAMBODIA ECONOMIC UPDATE APRIL 2017 A recent assessment calls for improving Further attention to improving consumers’ all stages of PIM—project pre-appraisal, financial literacy, in particular for the appraisal, project prioritization, and poorly educated portion of the population, budgeting supported by upstream should be a priority. In addition, to avoid decision-making. It is important to establish unsustainable over-indebtedness, limitations on consumer lending relative to portfolio standardized guidelines and effective size may be warranted, in order to rein in cost controls in downstream project possible overheating in the consumer credit implementation, while upgrading the market. It is likely that the newly introduced capacity of ministries and agencies to lending rate cap helps to reduce borrowing prepare and assess effective and efficient costs, beneficial for productive purposes, investment projects connected with their in particular for poor farmers and small strategic priorities in the Budget Strategic businesses. However, it may also curtail Plan (BSP) and Medium-Term Expenditure access to finance in under-served areas. Framework (MTEF). APRIL 2017 CAMBODIA ECONOMIC UPDATE 37 38 CAMBODIA ECONOMIC UPDATE APRIL 2017 E. SELECTED ISSUE: INVESTING IN PUBLIC INFRASTRUCTURE AND SERVICES MOTIVATION by providing a better-trained labor force. Through the provision of both social and Investing in key public goods and services economic infrastructure, public expenditure such as infrastructure, health and education in the key sectors can serve as an important is fundamental for economic growth. catalyst for economic growth.22 Investing in infrastructure is necessary for any economy to function effectively. An To ensure value for money, efficient public increase in public infrastructure spending— spending is key, and the challenge is physical capital spending—affects output particularly daunting when it comes to both in the short term, by boosting aggregate ensuring efficient public capital investment. demand, and in the long term, by expanding Capital spending is often a long-term public the productive capacity of the economy investment to build physical infrastructure and its competitiveness. Investing in public such as roads and bridges. It is therefore health (including prevention) can be essential to select the most viable projects cost-effective and give higher returns on that maximize social and economic benefits. human health and services financing.21 Not only upfront capital investment costs, but Funding education builds human capital, also operations and maintenance funding contributing to long-term economic benefits is very important. Borrowing for physical 21 The case for investing in public health, World Health Organization 2014. For more details, see http://www.euro.who.int/__data/assets/pdf_file/0009/278073/ Case-Investing-Public-Health.pdf 22 Why Public Investment Matters, IMF. For more details, see http://www.imf.org/external/np/fad/publicinvestment/ APRIL 2017 CAMBODIA ECONOMIC UPDATE 39 infrastructure projects without properly most, rising to 3.3 percent and 1.9 percent assessing economic and technical feasibility of GDP in 2016, respectively, from 2.6 is likely to result in subpar outcomes (e.g., a percent and 1.6 percent of GDP in 2007 road of poor quality that rapidly deteriorates (Figure S2). Unlike education spending, under heavy truck traffic). Improvements in which was largely boosted by domestic public investment management (PIM) could financing (government’s funding), public therefore significantly enhance the returns of spending on transportation was driven by public investments. Countries with stronger 23 both domestic and external (development PIM institutions have been shown to have partner-funded) sources. more predictable, credible, efficient, and Figure S1: Large increase as a percentage of GDP productive public investments. in domestically financed education spending. Public spending on key sectors (Percent of GDP) PUBLIC SPENDING TRENDS 2.4 1.5 1.5 To improve access to, and the quality and 1.3 1.2 1.1 1.1 1.0 1.0 1.0 0.9 0.9 0.9 coverage of, public services, Cambodia 0.7 0.7 0.4 has substantially scaled up its domestically financed (i.e., government-funded) public 2007 2016 2007 2016 spending during the past decade, partly DOM - FIN EXT - FIN Education Health Agriculture Transports offsetting the decline in the externally Source: The Cambodian authorities. DOM - FIN = domestic financing; EXT - FIN = External financing financed (i.e., development partner-funded) budget. Supported by continued rapidly Figure S2: Higher education and transport spending boosted by domestic financing. (Percent of GDP) increasing revenue collection, efforts have been made to promote domestically 3.5 3.0 financed spending by boosting annual 2.5 Dom-Fin Ext-Fin budget appropriations for a number of key 2.0 1.5 sectors, while also attempting to enhance 1.0 spending efficiency through the introduction 0.5 - of full program-based budgeting, which 2007 2016 2007 2016 2007 2016 2007 2016 Education Health Agriculture Transports promotes linkages between inputs and Source:The Cambodian authorities. outputs, as well as budget and policy. - FIN = External financing DOM-FIN = domestic financing; EXT As a result, domestically financed Notwithstanding the substantial boosts in appropriations for education and total resource allocation, the capital budget transportation rose to 2.3 percent and 0.9 remains compressed and in decline. The percent of GDP in 2016, respectively, from boosts in resource allocation by the authorities 1.5 percent and 0.4 percent of GDP in 2007 discussed above have mainly taken (Figure S1). 24 Total public expenditure on place in recurrent spending (Figure S3), education and transportation grew the and in public sector wages in particular, leaving 23 Making public investment more efficient, IMF, June 2015. 24 Public spending on education includes MoEYS and MLVT allocations while spending on agriculture covers MAFF, MoRAM, and MRD appropriations. 40 CAMBODIA ECONOMIC UPDATE APRIL 2017 domestically financed physical capital Cambodia continues to underinvest. investments largely unchanged. For instance, Although the 2014-18 NSDP targets total domestically financed capital budget capital investment of over 26 percent of allocations for education and public GDP, actual total capital investment has health remain at less than 5 percent of the remained below 22 percent of GDP. 25 totals of their respective budgets. SPENDING AND ALLOCATION Figure S3: Recent allocation boosts in particular for EFFICIENCY WITH REGIONAL transport are biased torwards recurrent spending. (Percent) COMPARISONS 100% 90% Regional comparison shows that Cambodia’s 80% 70% overall sectoral expenditure (including 60% 50% externally financed budget) on education, 40% 30% health, agriculture and transportation, 20% 10% remains broadly comparable with those 0% 2007 2016 2007 2016 2007 2016 2007 2016 in other countries in the region (Table S1). Education Health Agriculture Transports During the past decade, the largest Source: The Cambodian authorities. Recurrent Capital sectoral spending boosts, increasing by 0.8 percent and 0.7 percent of GDP, were for Figure S4: Cambodia's general government capital transportation and education, respectively. In expenditure is declining and below that of its peers. (Percent of GDP) contrast, public health spending declined 20 by 0.7 percent of GDP. 18 16 14 12 Assessing a number of indicators shows that 10 8 Cambodia’s public spending efficiency 6 appears mixed.26 However, using just a Cambodia Vietnam 4 2 Lao PDR Mongolia few indicators to evaluate overall sectoral 0 2010 2011 2012 2013 2014 2015 2016e public spending efficiency appears Source: World Bank and IMF. insufficient. This is largely because of the limited number of indicators available, and the fact that they can often be influenced A decline in public capital spending over by many factors beyond simply allocation the past five years has been observed and efficiency. For instance, reducing the Cambodia’s general government capital stunting rate in children under 5 depends expenditure is declining and now below not only on pubic access to health services that of its peers (Figure S4). Looking at total but also on nutrition. Likewise, returns on capital investment, which includes both capital spending do not only depend on public and private capital investment, initial physical capital investment largely 25 Actual capital investment under the national account statistics is gross fixed capital formation, which remained below 22 percent of GDP. For required capital investment, see Chapter V, Costs, Resources, and Programing, 2014-18 NSDP (pages 202-209). 26 Following IMF Staff report on “Making Public Investment more Efficient”, this section presents some proxies for inputs (level of spending) and outputs/outcomes (roads, maternal mortality), in an effort of assessing efficiency. It is worth noting important data limitations in the selection of indicators. Another caveat is that the proxies are not completely or uniquely attributable to spending levels. APRIL 2017 CAMBODIA ECONOMIC UPDATE 41 Table S1: Sectoral spending - regional enrolment rate for lower secondary comparisons school, while improved during the period % of GDP Education Health* Agriculture Transport 2007-14, remains significantly below its 2016 or latest available years regional peers (Figure S6). Cambodia 3.3 2.0 2.0 1.9 Philippines 3.4 1.6 1.0 2.6 Singapore 3.0 2.1 0.0 0.9 Figure S5: Net enrolment rate (adjusted), primary(%) Thailand 3.8 5.6 1.6 1.4 2014 2007 Malaysia 5.0 2.3 0.7 1.3 LDC Korea, Rep 3.4 4.0 0.8 1.2 Lower middle income Bangladesh 2.0 0.8 1.3 1.1 Vietnam Thailand 2007 Philippines Cambodia 2.5 2.7 1.8 1.2 Malaysia Philippines 2.4 1.4 1.0 1.8 Cambodia Singapore 3.9 1.0 0.1 2.3 60.0 80.0 100.0 Thailand 3.7 4.6 1.0 0.6 Source: The World Bank EdStats Malaysia 5.5 2.0 0.9 2.0 Korea, Rep 2.9 3.3 1.0 1.6 Bangladesh 1.8 1.0 0.6 0.5 Figure S6: Net enrolment rate (adjusted), lower secondary (%) Increase or decrease 2014 2007 Cambodia 0.7 -0.7 0.1 0.8 Bangladesh Philippines 1.0 0.2 0.0 0.7 Thailand Singapore -0.9 1.1 -0.1 -1.4 Philippines Thailand 0.2 1.0 0.6 0.8 Malaysia Malaysia -0.6 0.3 -0.2 -0.7 Lao PDR Korea, Rep 0.5 0.7 -0.2 -0.4 Cambodia Bangladesh 0.2 -0.2 0.7 0.6 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 100.0 Source: Asian Development Bank and the Cambodian authori- ties. * World Development Indicator Source: The World Bank EdStats. financed by development partners but also • Despite being among the highest public on operations and maintenance funded by health spenders in the region, the domestically financed budget. Cambodia has been less successful than • Cambodia’s net enrolment rate Vietnam and Mongolia in reducing for primary education is broadly stunting and the mortality rate of comparable with those of many regional children under 5 years of age, although countries and better than the average it does nonetheless perform better than a performance of the least developed number of countries, including Lao PDR, and lower middle-income countries Indonesia and the Philippines (Figures S7 (Figure S5). However, Cambodia’s net and S8). 42 CAMBODIA ECONOMIC UPDATE APRIL 2017 Figure S7: Stunting in children aged under 5 border management reforms, although Mongolia the country has not been successful in Vietnam reducing its cost to export, rendering the Thailand 2014 country less competitive. Cambodia’s cost 2007 Philippines to export per container remained relatively Malaysia Lao PDR unchanged between 2005 and 2014 Indonesia (Figure S10). Bangladesh Cambodia 0 10 20 30 40 50 Figure S9: Paved roads (percent of total roads) Source: World Health Organization. Beginning period End Period 82.8 80.4 75.9 Figure S8: Mortality rate, under 5 (per 1,000 live births) 56.9 57 47.6 Lao PDR 66.7 97.2 Myanmar 50 28.2 70.5 Cambodia 28.7 2015 65.4 2005 10.5 9.9 Indonesia 27.2 6.3 41.4 Vietnam 21.7 28.5 Cambodia Phillippines Vietnam Indonesia Malaysia Thailand 12.3 (2004-15) (2003-14) (2007-13) (2009-11) (2006-10) 17.8 7 Source: World Development Indicators Malaysia 8.2 0 10 20 30 40 50 60 70 80 90 100 Source: World Health Organization Figure S10: Cost to export (US$ per container) Guatemala • Despite relatively large public investments Bangladesh in transportation, Cambodia has only Nicaragua 2014 2005 been able to make limited progress in Cambodia improving the percentage of paved Philippines Myanmar roads in total roads (Figure S9). Similarly, Vietnam the relative score for Cambodia’s Thailand road quality, ranked by the Global 0 500 1000 1500 2000 Competitiveness Index, declined to Source: World Development Indicators. 3.4 in 2016, from 3.8 in 2010. 27 While Cambodia has performed relatively well in improving its logistics performance index (LPI) ranking, reflected in an increase in Cambodia’s LPI score during the period 2010-16. This is a result of its success in implementing basic 27 Global Competitiveness index reports, 2010-11 and 2016-17. APRIL 2017 CAMBODIA ECONOMIC UPDATE 43 PUBLIC INVESTMENT at around 2.0 to 2.5 percent of GDP in the MANAGEMENT (PIM) period 2009-16. Therefore, going forward, Cambodia would need to prepare to scale a) Roles of capital investment up government-financed investment and it is therefore crucial for Cambodia to enhance While there is evidence that capital spending the efficiency and effectiveness of public boosts growth more than recurrent spending, investment management (PIM). In 2011, an the fiscal multiplier effect of capital spending index of public investment efficiency ranked may not be as large as expected if there are Cambodia among the bottom 40 percent leakages. IIzetzki et al. (2011) find that, in of developing economies, mainly due to developing countries, the multiplier effect weaknesses in investment project selection of government investment is significantly and appraisal (Dabla-Norris et al., 2011). higher than that of government consumption over a two-year time horizon. 28 This suggests b) Cambodia’s current PIM practices that capital expenditure is a crucial factor in driving growth in developing countries. A recent assessment found that the existing However, the fiscal multiplier effect of capital legal and regulatory framework for PIM is spending may not be as large as only very loosely governed by a diverse set expected if there are leakages. Waste of budget and investment laws, and other due to inefficiencies in some developing government regulations.30 While there is economies is estimated to be as high as 50 or some relevant legislation, such as the Annual 60 percent of the funds invested—levels that Budget Law, the Public Finance System Law, would severely hamper any fiscal stimulus and the Procurement Law, PIM-specific efforts (Riera-Crichton et al., 2014). The regulation appears to be inadequate. The positive stimulus from fiscal policy is far larger Budget Law does not provide a dedicated in developed industrial countries than in chapter or any articles on regulating developing economies, and this can be capital expenditure and PIM, while the explained by the fact that developed Public Finance System Law makes only one economies are often more efficient in reference to capital budgeting and PIM allocating and executing spending. processes. As a result, the division of roles and responsibilities among key stakeholders For Cambodia, declining investment is loose or, simply put, legally non-binding. would have important implications Several challenges are apparent in the for its competitiveness, as inadequate upstream stages of project preparation, pre- infrastructure has long been one of screening, appraisal, and budgeting. For Cambodia’s key constraints and is seen domestically financed investment projects as a major bottleneck.29 The recent boost in particular, there are no standardized in public spending by the government PIM. The non-standardization and absence appears biased towards raising public of a centrally developed, uniform set of sector wages, while domestically financed guidelines, manuals, and templates for capital expenditure has remained modest, the preparation of project proposals and 28 IMF working paper (2011), How Big (Small?) Are Fiscal Multipliers? https://www.imf.org/external/pubs/ft/wp/2011/wp1152.pdf 29 Key constraints Cambodia faces include high energy costs, infrastructure bottlenecks, and regulatory impediments to doing business (Doing Business 2016, World Bank). 30 World Bank Cambodia PIM Assessment, 2017. 44 CAMBODIA ECONOMIC UPDATE APRIL 2017 appraisals, and the monitoring of execution, of independent review in upstream have resulted in vastly different practices decision-making for project pre- across line ministries. In addition, the appraisal, appraisal, project prioritization, function of independent review (of project and budgeting. documents) has not been formalized; an b. Standardized guidelines. Establishing effective gatekeeping role for the allocation standardized guidelines and effective and use of the capital budget is therefore cost controls in downstream project non-existent. implementation. Instead of developing completely new guidelines and The quality of capital budget execution procedures governing PIM, a more and monitoring in the downstream stages desirable strategy may be to review has been found to be inadequate, partly and possibly adopt key principles of the due to the lack of any centrally developed existing Standard Operating Procedures standardized operation guidelines. This (SOP) whenever feasible. Gradually problem can be observed in the stages applying unified governing guidelines of project implementation, adjustment, and procedures for both domestically facility operation, and ex-post review. While financed and externally financed public development partner-funded projects follow investment guidelines and procedures Standard Operations Procedures, there is a will also underpin the authorities’ efforts lack of standardized operation guidelines to achieve budget integration and for government-funded investment, which policy-budget linkages. results in a wide variation of practices among spending agencies. In such an environment, c. Capacity upgrade. Upgrading the there is no effective instrument or tool at capacity of ministries and agencies hand to ensure effective monitoring that to prepare and assess effectively could help ascertain whether financing of and efficiently investment projects, public investment is being used efficiently strictly connected with their strategic and appropriately. As such, the new legal priorities in the Budget Strategic Plan (BSP) and Medium-Term Expenditure procurement framework would need to be Framework (MTEF) to achieve the goal complemented with secondary PIM-specific of moving towards the establishment regulations to ensure that it can achieve of effective linkages across policy, value for money in capital projects. planning and budgeting. In this regard, c) Steps towards improving the further strengthening of budget Cambodia’s PIM comprehensiveness will also lend itself to supporting improved public In order to address these challenges investment efficiency by fully integrating going forward, broad and comprehensive domestically and externally financed recommendations for strategic reforms are budgets. suggested. These include institutional and procedural developments supplemented All three main recommendations highlighted with the prioritized reform actions over the above would serve the central objective of short to medium term in all stages of PIM. PIM reform in Cambodia by establishing a centralized independent review or gate- a. Gatekeeping role. Introduction of a keeping function at the Ministry of Economy gatekeeping role with the function and Finance. APRIL 2017 CAMBODIA ECONOMIC UPDATE 45 CONCLUSIONS Given that Cambodia’s public spending on al capacity and governance challenges. key sectors is now comparable with its peers, Strategic reforms at all stages of PIM are improving public spending efficiency is the needed to strengthen both the upstream next important step. In addition, the recent decision-making for project pre-appraisal, efforts to promote domestically financed appraisal, project prioritization, and budgeting, spending in key sectors such as education, and also downstream to establish standard- health, transportation and agriculture have ized project implementation and monitoring been biased towards increasing recurrent by possibly adopting key principles of exist- spending, mainly on public sector wages. ing Standard Operating Procedures (SOP) It is therefore necessary to ensure sufficient whenever feasible. allocations for operations and maintain- Towards this end, it will be necessary to ance. continue building capacity to be able to Sustained investment in physical capital, so prepare and assess more effective and effi- far mainly financed by development part- cient investment projects, strictly connected ners, would therefore underpin the coun- to the BSP and MTEF. Such projects should try’s growth prospects, as it is fundamental fully integrate externally and domestically for maintaining Cambodia’s competiveness financed budgets, in order to achieve the going forward. Inadequate infrastructure goal of moving towards the establishment has long been one of Cambodia’s key con- of effective linkages across policy, planning straints and is seen as a major bottleneck. and budgeting. In the absence of the Me- Given its small, open economy, Cambo- dium-Term Expenditure Framwork (MTEF), dia’s growth prospects hinge upon its com- adequate resources are not earmarked for petitiveness, which has been constrained infrastructure operations and maintenance, by rising wages and input costs, an ap- which likely leads to higher capital expendi- preciation of the US dollar, and institution- ture in the long term and also results in poor public investment efficiency. 31 31 Guidelines for Public Expenditure Management, Barry H. Potter and Jack Diamond, IMF. 46 CAMBODIA ECONOMIC UPDATE APRIL 2017 F. CAMBODIA: KEY INDICATORS 2014 2015e 2016p 2017f 2018f 2019f Output, Domestic Demand and Prices Real GDP (% change yoy) 7.1 7.0 6.9 6.9 6.9 6.7 Domestic demand (% change yoy) 10.1 8.5 9.5 10.3 10.2 10.7 Consumer price index (annual 1.7 1.3 3.5 3.7 4.2 5.2 avg, % change yoy) Public Sector (% of GDP) General government domestic revenues 17.7 18.7 18.4 18.2 17.7 17.1 General government 21.6 20.5 21.4 23.3 22.5 21.6 expenditures Overall fiscal balance excluding grants -4.2 -1.8 -3.0 -5.1 -4.8 -4.5 (including grants) -1.8 0.0 -1.4 -3.5 -3.4 -3.3 Foreign Trade, BOP and External Debt Trade balance (millions US$) -2,023.6 -2,261.8 -2,276.0 -2,451.1 -2,570.7 -2,690.1 Exports of goods (millions US$) 7,636.0 8,280.2 9,115.2 10,044.2 10,994.9 12,026.7 (% change yoy) 10.9 8.4 10.1 10.2 9.5 9.4 Key export (% change yoy) 1/ 11.7 14.5 12.0 11.5 10.8 10.8 Imports of goods (millions US$) 9,659.6 10,542.0 11,391.2 12,495.2 13,565.6 14,716.9 (% change yoy) 8.7 9.1 8.1 9.7 8.6 8.5 Current account balance -1,630.5 -1,925.0 -1,911.4 -2,036.1 -2,204.8 -2,470.6 (millions US$) 2/ (% GDP) -9.7 -10.6 -9.5 -9.2 -8.9 -8.9 Foreign direct investment 1,679.9 1,668.8 2,036.0 2,078.3 1,904.2 1,795.0 (millions US$) External debt (millions US$) 5,555.4 5,860.9 6,578.1 7,426.9 8,338.3 9,295.2 (% GDP) 33.0 32.1 32.9 33.5 33.8 33.6 Debt service ratio (% exports 1.2 1.5 1.6 1.9 2.1 2.3 of g&s) Foreign exchange reserves, gross 4,657.9 5,672.1 6,457.0 6,980.8 7,407.7 7,810.9 (millions US$) (prospective months of -4.6 -5.2 -5.4 -5.4 -5.3 -5.1 imports of g&s) Financial Markets Domestic credit (% change yoy) 28.4 28.6 25.8 23.2 21.5 20.2 Short-term interest rate (% p.a.) 11.5 11.6 11.8 11.8 11.9 11.9 Exchange rate (Riel/US$, annual 4,030.0 4,025.0 4,058.0 4,062.0 4,067.0 4,075.0 average) Memo: Nominal GDP (millions US$) 16,809 18,241.7 20,020.2 22,157.7 24,663.3 27,623.3 Sources: The Cambodian authorities, World Bank and IMF Note: e = estimates; f = forecast; p = projection 1/ Garment and footwear exports 2/ Excluding official transfers. APRIL 2017 CAMBODIA ECONOMIC UPDATE 47 The World Bank Cambodia Country Office Exchange Square Building Floor 10th IBRD and 11th IFC Streets 51-61 and Streets 102 -106 Sangkat Wat Phnom, Khan Daun Penh Phnom Penh, Cambodia Website: www.worldbank.org/cambodia