Public Information Notice No. 02/20

Public Information Notice: IMF Concludes 2001 Article IV Consultation with Cambodia

March 1, 2002

On February 6, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Cambodia.¹

Background

Cambodia has made significant strides in the first two years of the government's reform program supported by a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) for SDR 58.5 million (about US$72.5 million; 67 percent of quota) approved by the Executive Board of the IMF on October 22, 1999. The PRGF-supported program aims at fostering economic growth, accelerating economic and institutional reconstruction, and reducing poverty. These objectives are to be achieved through a strengthening of fiscal revenue in tandem with a restructuring of expenditure away from defense, improved governance, and key reforms in banking and payments systems, forestry management, the trade regime, and private sector development.

Economic stabilization under the first two years of the government's program has generally been in line with expectations. Economic growth in 2000-01 has averaged 5 percent annually, despite severe flooding in 2000 and the slowing in the global economy in 2001. Economic recovery has been led by buoyant garment exports and tourist arrivals. Inflation in 2000-01 has been well below 5 percent, reflecting continued fiscal restraint and prudent monetary management.

Fiscal reform has been the cornerstone of the government's program. The budgetary outcome during 2000-01 has been consistent with the need to increase revenue, restructure expenditure away from defense and toward education, health and rural development. As a result, in both years the overall fiscal deficit (excluding grants) has been contained below 5 percent of GDP, while the current surplus has been maintained at 1½ percent of GDP. However, difficulties in fully meeting targets for social sector spending have primarily stemmed from inadequate government cash management procedures at the national and provincial levels. The avoidance of domestic financing of the budget since 1999 has allowed for a sustained expansion in private credit.

The monetary program has been consistent with low inflation and a stable exchange rate. The increase in broad money has been largely accounted for by an increase in net foreign assets, while net domestic assets of the banking system have declined, owing to the improved fiscal position. Within the context of a flexible exchange rate policy, the riel has been relatively stable in 2000-01, both vis-à-vis the U.S. dollar and in real effective terms. The external current account deficit improved in 2001 reflecting strong export performance and is expected to reach 9 percent of GDP (excluding official transfers). At the same time, official international reserves have increased steadily. Discussions are underway with the United States and the Russian Federation to resolve outstanding debt issues.

Steady implementation of the structural reform agenda has also taken place during the first two years of the program, despite delays in several important areas. Bank restructuring has been successfully implemented since late 1999, and a major overhaul of fiscal management has been initiated. Strengthening governance and combating corruption have received high priority on the government's reform agenda, with the implementation of the donor-endorsed Governance Action Plan (GAP) and the establishment of the National Audit Authority (NAA) in mid-2001. The full military demobilization program was successfully launched in late 2001 and reforms in forestry management have contributed to a significant dampening of illegal logging. Liberalization of the trade regime has been initiated in the context of meeting requirements for membership in the World Trade Organization (WTO). Cambodia has complied with the requirements under the IMF's Safeguards Assessment and has recently accepted the obligations of Article VIII. Efforts to upgrade the country's statistical framework are also underway.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They commended the authorities for the maintenance of macroeconomic stability and growth momentum in the face of unexpected external shocks, and the progress made in key areas of structural reform. Directors stressed, however, that to sustain high economic growth and reduce poverty, reform efforts will need to be maintained in the areas of bank restructuring, tax administration and expenditure management, and the civil service. The restructuring of forestry concessions and completion of military demobilization will also be important.

Directors broadly agreed that, in the period immediately ahead, the growth prospects are likely to weaken owing to a decline in garment exports and tourism receipts, as a result of the global slowdown. The authorities should therefore pursue, with renewed energy, their efforts to implement the reform program. Because of the high degree of dollarization of the economy, which reduces the efficacy of traditional monetary instruments, fiscal policy must be the focus for maintaining macroeconomic stability, and further improvements in expenditure management and tax administration are required.

Directors noted the progress made in enhancing revenue collection in 2001, and urged the authorities to further improve revenue performance in 2002 and over the medium term. While welcoming the formation of the large taxpayers unit, they emphasized the importance of strengthening tax administration and the collection of outstanding tax arrears, and in particular, of improving customs administration.

Directors commended the authorities for the progress made in 2001 in directing expenditure to priority social sectors and away from defense. They noted that completing the demobilization program by end-2002 will free resources for other budget priorities. Regarding administrative reform, Directors welcomed the completion of the automated payroll system in all provinces. They stressed that public sector wage increases should be consistent with fiscal constraints. Civil service reform should be pursued in coordination with the World Bank and other donors. Directors agreed that technical assistance will continue to be needed to overcome Cambodia's capacity constraints. They encouraged the authorities to make effective use of such technical assistance, especially with respect to public accounting, cash management, and budget execution.

Directors welcomed the orderly liquidation of nonviable banks and underscored the importance of taking timely actions against banks not meeting the requirements under Memoranda of Understanding. They also urged the authorities to reform the Foreign Trade Bank to prepare it for privatization, and to move forward with plans to develop the payments system.

To strengthen growth prospects, Directors recommended that the environment for private sector investment be improved, especially through enhanced governance, a strong effort to fight corruption, and legal and judicial reform. Some Directors, calling attention to the falloff in foreign direct investment in Cambodia between 1999 and 2001, recommended that the authorities take a critical look at the Law on Investment with a view to improving the investment climate. Comprehensive reform of the civil service would also help to eliminate petty corruption in the public sector.

Directors noted the recent assistance of multilateral institutions to facilitate trade sector reform and Cambodia's plan to accede to the WTO, and underscored the role of trade reform and trade facilitation in supporting the medium-term growth objectives. They were encouraged that Cambodia is a pilot country under the Integrated Framework for Trade and Development. Directors also noted that Cambodia's exports, including garment exports, would be helped by improved market access.

Directors welcomed the maintenance of a flexible exchange rate policy and the authorities' recent acceptance of the obligations of Article VIII, sections 2, 3, and 4 of the Articles of Agreement. However, they also noted the need to take steps to eliminate the margin between the official and market rate in the future. Directors encouraged the authorities and Cambodia's key bilateral creditors to intensify their collaboration on efforts to resolve outstanding issues in their debt rescheduling negotiations, and urged the authorities to pursue a prudent external debt management policy. In that connection, several Directors drew attention to the desirability, for Cambodia's medium-term sustainability and poverty reduction efforts, of securing highly concessional debt rescheduling agreements in line with Cambodia's limited fiscal capacity. More generally, Directors underlined Cambodia's need for substantial donor support on highly concessional terms.

Directors observed that the quality and timeliness of statistics are adequate for surveillance purposes, but emphasized the need for further improvement. In this respect, Directors welcomed the authorities' decision to participate in the Fund's General Data Dissemination Standard (GDDS) and stressed the need to use effectively the technical assistance being provided while building local capacity.

The Joint Staff Assessment of the authorities' PRSP preparation status report highlights the areas that need support to develop an effective national poverty reduction strategy. In this regard, Directors emphasized, in particular, the importance of broadening the participatory process and fully costing priority reforms in the context of a medium-term expenditure framework as critical inputs for completing the full PRSP by October 2002.

It is expected that the next Article IV consultation with Cambodia will be held on the standard 12-month cycle.