Economy and Finance

In the year 2002, the economic situation of Cambodia reflected the challenges that the Royal Government of Cambodia had to face: political uncertainty, Iraqi war and the severe drought and flood that affected agricultural production, especially rice and other crops, which account for 15% of GDP.

Macroeconomic developments

In order to ensure economic growth as forecasted, the RGC launched measures to mitigate the effect of the drought and it accelerated the mobilization of local resources and those from bilateral donors and international financial institutions to continue the reforms and to accelerate economic and social development in Cambodia.

The RGC has continued to develop the implementation of its economic reform program by realizing a low inflation and stable economic growth. The RGC has forecasted that the GDP would increase 5% in 2002, compared to 5.5% projected earlier, due to the impact of the drought and flood on agriculture and slower increase in the production and exports of garment, and the negative effects of the SARS disease.

The main pillars of growth in 2002 were industry and service sector. Manufacturing and construction have been the main drive to sustain growth in the industrial sector. Garment exports increased by 22 percent to US$1.3 billion.

The government has pursued "the Locomotive Strategy" to support development by establishing a nation-wide road network linking various provinces to Phnom Penh, the Sihanoukville port and important border checkpoints; as the Minister of Finance, H.E. Keat Chhon said: "(…) we put a strong emphasis on the construction our infrastructure, particularly the roads. This was done because opening the country and ease the flow of goods was the priority in out National Strategy for Poverty Reduction". This will create the integration of different parts of Cambodia into a single market.

This strategy will help reduce transportation costs and facilitate trade. Infrastructure (road and bridge) construction financed by concessional loans from Japan, ADB, WB, other donors and government budget was on the rise in 2002. The Kizuna Bridge was inaugurated.

By the end of the 4th quarter of 2002 the inflation was 3.7% due to the government's continued prudent budget and monetary policy. The exchange rate RIEL-USD was broadly stable, around 3.950 Riels.

The current account deficit, excluding transfer, was -9.4% in 2001 and increased to-9.6% in 2002. At year-end, the reserve in the banking system increased from 551 million USD in 2001 to 629 million USD in 2002 covering 3.4 months of imports.

Medium Term Fiscal Framework

Achieving macroeconomic stability with high economic growth of 6-7 percent as stated earlier would require serious actions in implementing the reform programs and supporting policies. This includes no monetarization of fiscal deficit, sound financial system oversight, deepening banking reform, improvements in revenue, spending increase for social and economic sector, sound budget and treasury management, improving investment climate, civil service reform, legal and judicial reforms.

To this end, actions have been taken to strengthen tax policy and administration in order to (i) increase tax revenue, (ii) improve design of the tax system, (iii) enhance capacity for tax analysis, (iv) improve administration of the real regime, (v) improve administration of the estimated regime, and (vi) expand training and learning in tax administration.

Taxes, defined as taxes as percent of GDP, is expected to increase from 8.5 percent in 2002 to 8.8 percent by 2005 while non-tax revenue effort will remain around 3.5 percent from 2002 to 2005. Overall fiscal revenue as percent of GDP will grow steadily though slowly from 12.1 percent in 2002 to 13.9 percent in 2005. It is assumed that the significant increase in fiscal revenues in absolute terms will be driven mainly by high and sustained growth of the Cambodian economy and implementing reform measures rather than a dramatic improvement in revenue effort.

As percent of GDP, total expenditure is expected to increase moderately - from 18.9 percent in 2002 to 19.4 percent in 2005. The planned level of capital expenditures shows the commitment of the RGC to invest in physical infrastructure. Capital expenditures will account for about 7.1-7.8 percent.

Within this frame a blue print for the development of the financial and banking sector has been put in place by the Ministry of Finance and Economy, this latter shows the evolution expected of the sector until 2006.

Dollarization

Dollarization emerged as a consequence of low confidence and a persistent feeling of uncertainty with regard to the national currency. Cambodia is a highly but not a 'fully' dollarized economy. The government, through the MEF still remains the core institution that injects riel into circulation. Dollarization has provided both benefits and drawbacks for economic development and poverty reduction.

Partial dollarization has imposed some discipline on fiscal operations, and the commitments of the government to establish political and macroeconomic stability were and remain a crucial factor for a reform program to be a success. It is also in this context that both the autonomy of the central bank in carrying out its functions and the accompanying accountability must be recognized.

There is limited room for fiscal adjustment because dollarization puts constraint on the mechanism of deficit financing other than external debt or assistance or domestic borrowing at market-determined interest rate. In other words, dollarization may deprive fiscal benefit that can occur when the government runs a fiscal deficit through the central bank's expansion of money supply.

Monetary Developments

The principal mission of the National Bank of Cambodia (NBC) is to determine and direct the monetary policy with the aim of maintaining price stability in order to facilitate economic development within the framework of the economic and development policy. Prudent monetary policy and fiscal discipline have been successful in achieving and maintaining macroeconomic stability with low inflation (5%).

Since the end of 2000, claims on the government by the banking sector have been virtually eliminated. Credit from the central bank to the remainder of the banking system remains absent. The NBC has constantly accumulated its international reserves. Growth in the country's gross international reserves has kept pace with the continuous increase in total imports of goods and services and reached more than three months cover in recent years. Inflation has been kept within the target and in fact turned negative during recent period, while the value of the riel has largely been stabilized.

Concerning the current state of the banking system, the liquid asset ratio is close to 60%. However, due to the fact that a large proportion of bank assets are held in low yielding assets, the profitability of the banking sector is low.

The new banking systems

As the Governor of NBC, H.E. Chea Chanto explained, the main component of the Law on Banking and financial institutions passed in 1999 "was the requirement of a minimum capital (USD 13 million) to the banks and the imposition to provide the legal basis for supervision". Before the re-licensing, there were more than 30 commercial banks. Presently, there are thus only 17, operating in the country from which two are state-owned.

One of them, the Canadia Bank Ltd, founded by Pung Kheav Se, has in deposits 26% of the whole country's desposits and its loans are about 32% of country's total. It is also the first commercial bank in Cambodia to use the smart card system and it was chosen by the Ministry of Economy and Finance to run a small and medium enterprise project with KfW, a German financial institution. Actually, as the President of Canadia Bank, Pung Kheav Se underlined "The problem you encounter in Cambodia is that if you deposit 1 million, 48% to 52% of it must remain in the bank... So, our target is to find foreign financial institutions to have long-term local funds for economic development" and he added that the loan interest now is 12% and "This is very hard for local businessmen, we have to reduce the interest rate".

There is also an Association of banks in Cambodia, which currently has 23 members, consisting of local and foreign banks. "We began to organize ourselves in 1994 and are now fully recognized under the banking Act" explained its President, Khov Boun Chhay, who is also President and Chief executive officer of the MekongBank. The chief functions are to share information among members, to participate in joint activities such as training and to act as a single voice for the industry in dealing with the public and the Royal government. They are also members of the ASEAN Bankers Association "which has been of great benefit to individual banks and to the Cambodian banking system as a whole".
MekongBank, have also the ambition to become a leader in the region and worldwide, and began to establish many strategic partnership through the world, linking thus the Cambodian Banking sector to many relevant international actors, as its president Khov Boun Chhay explains us; "We have established correspondent relations with major international banks in Europe, Asia and the United States. For example, through our principle international correspondent and strategic partner, ABN-AMRO Bank, we have access to their global network of over 3,500 locations in 76 countries. Another critical element in MekongBank's international policy involves the establishment of strategic alliances with key financial institutions throughout the region."

An other major locally based bank, the SBC (Singapore Banking Corporation) (http://www.sbc-bank.com) Bank, it is investing in a VISA credit card system and as underlined his President, Andy Kun, "It's going to be the first in Indochina and one of the few in Southeast Asia to issue an EMV chip-based credit card". All this initiatives mark clearly the dynamism of the sector, which will be crucial for the development of the local economy.

In order to implement the economical reconstruction of the country, NBC and IMF have mainly a stabilization program called Poverty reduction and growth facility, involving around USD 84 million. With the Asian Development Bank (ADB), NBC works closely on the formulation of a long term plan development. The ADB, which has also provided the technical assistance to strengthen the micro finance supervision, the AFD (Agence Française de développement) collaborates in the field of strengthening micro-finance institutions, especially providing the small credit to farmers in the rural area.

The strengthening of the financial sector is also a priority of the Minister of Finance and Economy: "The financial sector is of course of strategic importance (…) This includes the development of our banking and insurance system as well as our leasing, capital markets and other financial products systems". Concerning the creation of the Cambodian Stock Exchange, NBC's board has set a list of priorities. The first one is to strengthen the banking sector to introduce a sound accounting system in the whole country, but the Governor doesn't expect the creation before 2008-2010.