Policy Note Creating Opportunities for Firms: Findings from the Investment Climate Assessment 92599 1. Motivation are located. While the RGC has made strong efforts to in- crease the availability of power supply through domestic 1. The Royal Government of Cambodia’s (RGC) new production (hydropower plants) and imports, it is not yet five-year Rectangular Strategy III (RS III) continues to clear how electricity will be made available at a more af- prioritize the business environment as a means of di- fordable price in the near-term for the manufacturing sector. versifying exports and increasing value-added in pro- duction. Cambodia has seen a resurgence of foreign direct investment (FDI) in the wake of the global financial crisis. This FDI has mostly been attracted by its low wages, openness, 50% “Everything But Arms” initiative (EBA) access to the EU, and Percent of firms saying issue is a “ major ” or 40% tax holidays, which help compensate for the high cost of doing business in the country. Despite this FDI and some “ severe ” constraint 30% initial signs of diversification (such as the establishment of 20% Japanese firms involved in electronic parts and compo- 10% nents), manufacturing and exports still remain for the most 0% part heavily concentrated in the garment sector. Addressing tit Cos du ... Cr Tra nd P ons ef gul s ns r ad solu s A ess tion o and gu Ta nce ol s fin on p ng om Cor tion nc tion in tion sp ices El inty ty on un rde t Ta t R tion ry ate E cy Re rmi ci ys Te t an atio e i t of ati i m anc i a i es to L cc tra la x R t ta ic rup ta tri / C mm iso nd ng a ulat fin Tr rac c ca c e or er P ec is d i the key constraints in the business environment will help to m ens Reg e d st al an U m to & sto Lic or im de fli or lls A cc o b i x nf te lec th ki La promote foreign and domestic investment in non-traditional Re on S e, iv & Ec sa m ic ro pe om areas, thereby helping to diversify and increase value-added ac om on M lS Cu i-c Ec ga nt Le in production. 2. Progress and remaining constraints A 2. Progress has been greatest on trade facilitation. This is reflected in the impressive improvements in Cambodia’s ranking on the World Bank’s Logistics Performance Index • Informal payments are seen as the third most im- (LPI). Cambodia has improved 46 places in the LPI rank- portant constraint among all firms, after macroeco- ings to 83 from 129 in 2010. Customs clearance times have nomic uncertainty1, and as the second most impor- fallen from 5.9 days in 2010 to only 1.4 days in 2014, while tant constraint for registered firms. Informal payment the percentage of consignments selected for inspection has practices remain widespread in Cambodia. While the fallen from 29 percent in 2010 to only 17 percent in 2014. amount of informal fees paid has declined as a proportion of overall sales, the incidence of informal practices has not 3. But despite such progress, the business environ- diminished, implying that while officials may be demanding ment continues to hamper the competitiveness of informal fees less frequently, the proportion of firms paying firms in Cambodia, as reflected in the forthcoming informal fees has not diminished (and there are indications World Bank & ADB Investment Climate Assessment that for certain activities such as importing goods, the pro- (ICA) 2014. The major or severe constraints faced by firms portion of firms paying gifts at the time of the survey had found in the ICA report are shown in Figure 1. increased). • Electricity is now seen by firms as the number one • Uncompetitive practices, which are closely related constraint on the business environment. Worries to informal payments, rank fifth, after transport. The about electricity are 50 percent higher than they were in level of informality in Cambodia is still high. Informal firms the 2007 survey. Not only is electricity more expensive in are perceived to have a price advantage over formal firms Cambodia than in almost every other country in the region, and face fewer regulatory obstacles in conducting their ac- but the supply is inefficient and intermittent. Cambodia’s tivities. This competitive edge appears to prevent formal electrical power transmission and distribution losses as a firms from operating on a level playing field. The persis- percentage of output are higher than in any comparator tence of these constraints over several ICA surveys indi- country. In addition to having the highest loss rate in the cates that they are deeply embedded in the local business region, Cambodia’s proportion of losses in its output has more than doubled since 2004. Manufacturers are forced to rely on electrical generators for a substantial amount of 1 The identification of macroeconomic uncertainty as a key bottleneck is surpris- their power needs. This problem is particularly acute in the ing, it may be capturing the uncertain external macroeconomic environment post border regions where the special economic zones (SEZs) 2008/9 global financial crisis. Policy Note Findings from the Investment Climate Assessment culture and are therefore challenging for policymakers to government officials. Automation of key government pro- address and alleviate. Rather than attempting to repress cesses could help to eliminate these practices by reduc- informality, the RGC may wish to consider fostering firms ing personal contact between parties and by creating a in the informal sector to grow by adopting enabling policies transparent online portal for information about rules and such as incentives to become formal which may include processes required by firms. Automation has the added fast-track registration, licensing, and approval processes, advantage of creating a traceable record of transactions thereby contributing to fiscal revenues, higher wages for between the Government and the private sector. To this workers and better knowledge transfers. end, the swift adoption of the e-Commerce Law by the 4. In addition to presenting the key constraints, the National Assembly would enable firms to pay for govern- ICA includes two key findings. The first is that Special ment services electronically. Both the Ministry of Economy Economic Zones (SEZs) are not delivering the bene- and Finance (MEF) and Ministry of Commerce (MOC) are fits expected by foreign investors. While the zones offer implementing automation in the areas of customs and several benefits in terms of One-Stop-Shops and enhanced border reform, new company registration and Certificate border clearance procedures, investors continue to express of Origin (CO) that can serve as models for other minis- disappointment that their expectations for a benign invest- tries. ment environment inside the zones are not being fulfilled. c) Encourage new investment, particularly in the SEZs. 5. The second key finding is that there is a “missing It is important that the revision of the current Investment middle” in the composition of Cambodian companies Law is completed as soon as possible to modernize the involved in exports. Compared with countries at the same existing regime. A system of smart incentives and more level of Gross Domestic Product (GDP), very few medium- effective investment protection can pave the way for for- size firms actively export from Cambodia. The existence eign investors to move into Cambodia, taking advantage of a missing middle is likely to be associated with a costly of its competitive labor cost and its favorable geographi- business environment that favors large businesses and en- cal location at the center of the ASEAN Economic Com- courages small firms to remain small and informal in order to munity (AEC). The RGC could also consider designing remain hidden from the regulatory environment. and implementing a Zero-Corruption Strategy that curbs corrupt practices within the SEZs. Policing this strategy 6. The current period of robust growth should be seen would be feasible in the controlled environment of the as an opportunity to make improvements to the busi- SEZs, and have a strong resonance in terms of building a ness environment that will attract long-term investors. positive image for Cambodia as an FDI destination. Many investors are attracted by the EBA that allows duty- free access to the European Union market and to tax holi- d) Continued improvements to trade facilitation. The days, but these preferential treatments will not last forever. important improvements made by Customs leave no Improvements to the investment climate now will pay off in room for complacency as there are still cumbersome and anchor investment that is more likely to remain in Cambodia time-consuming procedures to be completed manually when the preferential treatments are eventually withdrawn. through several agencies before import-export permits and licenses can be obtained. By streamlining and auto- mating these procedures, in the framework of the National 3. Proposed next steps in reforming the Single Window (NSW), Cambodia could improve its trade business environment performance dramatically by contributing to decreased trade costs and improved firm competitiveness. a) Address the high cost of electricity with a comprehen- e) Completing the draft Competition Law and setting up sive national plan comprising the review of energy sources an independent Competition Agency would go a long way (including renewable) and identify specific practices (e.g. in ensuring a level playing field across all firms. non-transparent solicitation of power purchase agree- ments) that may be contributing to the high cost of energy. f) Design and implement a system of incentives for Priority should also be given to improving existing agree- business registration encouraging companies to be- ments with neighboring countries to ensure the steady come formal, with a strong impact on fiscal revenues and and reliable provision of electricity to the SEZs located enterprise productivity that would have an impact on firms’ near Cambodia’s borders. A regional approach towards capacity to grow and to access foreign markets. addressing constraints currently faced by the power sec- g) Focus on implementation and enforcement. Cam- tor may be more appropriate, as an isolated power sec- bodia’s regulatory environment often follows international tor expansion will likely require difficult trade-offs between best practice and appears to comply with the RGC’s in- economic growth and environmental challenges. ternational commitments and obligations. However, infor- b) Automate government processes. Corrupt and infor- mal practices are still prevalent with poor implementation mal practices proliferate in opaque environments that of- often hindering the stated objectives of the regulations. ten require face-to-face contact between investors and The World Bank Office For further information, Funding from the ADB and the Trade Related please contact: Assistance Cambodia Multi-Donor Trust Fund from No. 113 Norodom Blvd. Phnom Penh - Cambodia the EU, DANIDA and UNIDO is gratefully Tel: (855 23) 861 300 Julian Clarke acknowledged Fax: (855 23) 861 301/302 Senior Economist Visit our website: (jclarke1@worldbank.org) http://www.worldbank.org/cambodia This note reflects the views of the authors and not necessarily those of the World Bank and the donors.