100537 Adapting to Stay Competitive @ All rights reserved This Cambodia Economic Update is a product of the World Bank. The findings, interpretations, and conclusions expressed in this update are those of World Bank staff, and do not necessarily reflect the views of its management, Executive Board, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. Preface and Acknowledgements The Cambodia Economic Update (CEU) is a product of the staff of the World Bank. It was prepared by Sodeth Ly and incorporates comments by Miguel Eduardo Sánchez Martín, both at the Macroeconomics and Fiscal Management Global Practice (MFM GP). Linna Ky served as research assistant. The team worked under the guidance of Mathew A. Verghis, Practice Manager, MFM GP. Sergiy Zorya, Agriculture GP, contributed the selected issue on Cambodian Agriculture in Transitions: Opportunities and Risks. The team is grateful for the comments, advice and guidance provided by Ulrich Zachau, Country Director, and Alassane Sow, Country Manager. The CEU is produced bi-annually to provide up-to-date information on macroeconomic developments in Cambodia. It is published and distributed widely to the Cambodian authorities, the development partner community, the private sector, think tanks, civil society organizations, non-government organizations, and academia. The update is timed to coincide with the six-monthly publication of the East Asia and Pacific Economic Update by the East Asia MFM GP of the World Bank. We received valuable inputs, comments and suggestions from Ahmad Ahsan, East Asia and Pacific Chief Economist Unit, Ratchada Anantavrasilpa, Finance and Markets GP, Munichan Kung, Urban, Rural, Social Development GP, and Leah April, Governance GP. The report also benefited from the advice, comments, and views of various stakeholders in the Royal Government of Cambodia (RGC), the private sector, development partner institutions and academia. The team is very grateful for their time and inputs. We are very grateful to the Cambodian authorities, in particular the Ministry of Economy and Finance, and the National Bank of Cambodia for their cooperation and support in the preparation of this CEU. The World Bank Cambodia Office Communications Team, comprising Saroeun Bou and Sophinith Sam Oeun prepared the media release, web display, and dissemination. For information about the World Bank and its activities in Cambodia, please visit our website at www.worldbank.org/cambodia. To be included in the email distribution list of the CEU and related publications, please contact Linna Ky (lky@worldbank.org). For questions on the content of this publication, please contact Saroeun Bou (sbou@worldbank.org). Table of Contents A.Executive Summary .......................................................................................................................... …1 B. Recent Economic Developments .......................................................................................................... 5 An overview.......................................................................................................................................... 5 The real sector....................................................................................................................................... 6 a) Construction and real estate .......................................................................................................... 6 b) Garments ....................................................................................................................................... 8 c) Tourism ......................................................................................................................................... 9 d) Agriculture .................................................................................................................................. 11 e) Income, consumption and employment ...................................................................................... 12 The external sector.............................................................................................................................. 13 a) Exports ........................................................................................................................................ 14 b) Imports ........................................................................................................................................ 15 Inflation............................................................................................................................................... 15 The monetary sector............................................................................................................................ 16 a) Monetary aggregates, interest rates, and exchange rates ............................................................ 16 b) The banking sector ...................................................................................................................... 17 The fiscal sector .................................................................................................................................. 18 a) Revenue composition.................................................................................................................. 18 b) Expenditure composition ............................................................................................................ 20 c) Fiscal balance.............................................................................................................................. 21 C. Key Messages and Recommendations ............................................................................................... 22 D. Selected Issue – Cambodian Agriculture in Transition: Risks and Opportunities............................. 24 Introduction......................................................................................................................................... 24 The past decade’s agricultural growth story is one of many successes… .......................................... 24 …but there are also challenges ........................................................................................................... 26 What worked in the past will no longer be sufficient in the future .................................................... 27 Recommendations............................................................................................................................... 29 A. Executive Summary are fueling a boom in construction and real estate. Imports of construction materials continue expanding at a strong pace in the first half of 2015: growth rates reached 38.9 percent year-on-year for Robust GDP growth continues, and real growth for 2014 construction material imports and 32.7 percent has been revised up by the authorities to 7.1 percent from year-on-year for steel imports. an earlier estimate of 7.0 percent. Strong domestic demand, boosted by a construction boom and accommodated by high Continued broad money growth, together domestic credit growth, helps offset the moderation in export with rapid expansion of the banking and growth with the slowdown of the garment, tourism and financial sector, has accommodated agriculture sectors observed in the first half of 2015. As an economic growth. Primarily driven by foreign oil importer, the country benefits from the slump in oil currency deposits, rapid broad money growth prices, contributing to savings on petroleum imports. In this continued at 20.6 percent year-on-year by June setting, growth is projected to ease slightly, to 6.9 percent in 2015. Private sector deposits growth also 2015. Downside risks to this outlook include potential remained healthy at 21.1 percent year-on-year, renewed labor discontent, further appreciation of the US supporting high private sector credit growth of dollar, a delay in economic recovery in Europe, and a hard 28.1 percent year-on-year by June 2015. landing of the Chinese economy. On the external side, US dollar appreciation Recent developments continues eroding competitiveness, resulting in the moderation of growth in the garment GDP growth is increasingly dependent on and tourism sectors. The appreciation of the US consumption and investment. In a context of dollar respect to the Euro and other Asian low oil prices and upbeat business confidence, currencies, the emergence of low wage internal demand strengthens. This has driven competitors in the region, such as Myanmar, and continued strong final consumption, uncertainty surrounding wage negotiations are accommodated by rapid consumption credit dampening external competitiveness. As a result, growth and leading to the expansion in wholesale garment exports eased slightly to a year-on-year and retail businesses. Robust gross fixed capital growth rate of 7.8 percent in value terms during formation growth, at 9.1 percent year-on-year in the first six months of 2015, compared with 9.2 2014, has been driven largely by durable percent in 2014. Meanwhile, the tourism sector equipment and construction. has continued to underperform, with arrivals during the first half of 2015 decelerating to 4.6 Despite strong domestic demand, inflation percent year-on-year (reaching 2.3 million has eased further after a sharp drop in 2014, visitors), compared with 6.9 percent in 2014. reflecting subdued food and oil prices. Year- on-year inflation declined to 0.8 percent in August The slump in oil prices helped contain import 2015, compared with 1.2 percent at the end of growth during the first six months of 2015, 2014, with dampened foods and petroleum prices. contributing to a slight improvement in the current account deficit. Weaker exports and In this setting, the construction and real estate tourism receipts resulted in a slight deterioration sector has become the most dynamic engine in the current account deficit which widened to of economic growth. The return of business and 10.8 percent of GDP in 2014. On the other hand, consumer confidence and the anticipation of foreign direct investment (FDI) inflows remained opportunities arising from the regional integration healthy, largely financing the current account under the ASEAN Economic Community (AEC) deficit. Continued FDI inflows have contributed Cambodia Economic Update October 2015 >> 1 to the increase in gross international reserves, could somewhat dampen growth prospects, which reached US$5.2 billion, or 4.1 months of mainly due to potentially lower Chinese tourist imports, by mid-2015. arrivals and investment inflows, while export dependency is low. There is a risk that the US Delayed cultivation caused by intermittent policy rate “lift-off” may trigger abrupt market rainfall and lower export prices have caused a reactions, causing currencies to depreciate sharply, slowdown in the agriculture sector. It is worth bond spreads to rise steeply, capital inflows to fall mentioning that in the period 2004-12, agricultural sharply, and liquidity to tighten. Nonetheless, in a GDP grew by an annual average of 5.3 percent, context of limited capital markets, Cambodia among the highest in the world. This was driven should be relatively shielded from financial not only by crop production, mainly of paddy rice, volatility. It would still suffer from the loss of but also maize, cassava, sugarcane, and vegetables. competitiveness associated to the expected At the same time, over the past decade, the appreciation of the US dollar, which would further agriculture sector has undergone significant dampen growth prospects. structural transformation, as the share in GDP and total labor force declined, although land and Challenges and recommendations labor productivity increases were achieved. There is a pressing need to enhance external On fiscal performance, consolidation is competitiveness. Cambodia may have to rely on sustained as high revenue growth and largely addressing key bottlenecks constraining contained expenditure continue to curb the productivity growth, as well as export cost overall fiscal deficit. During the first seven reduction. A better trained and skilled workforce months of 2015, domestic revenue continues to will certainly help. Improving the overall business perform well, growing at around 18 percent year- environment would enhance competitiveness on-year, thanks to improved revenue across sectors. Finally, it is essential to support administration. Disbursements recently picked up diversification in the manufacturing sector as and are expected to meet the budgeted target, after envisaged in the recently announced Industrial an initial slow start in a context of transition to a Development Policy (IDP), while also being well program-based budgeting system. Cambodia’s prepared to take advantage of the single market debt distress rating in a recent World Bank/IMF and production base goal set by the AEC. To Debt Sustainability Analysis remained low. strengthen the business environment, international experience points out to a key Outlook attribute -- a legal and regulatory framework that is predictable and based on international norms is Growth is projected to ease slightly to 6.9 a central element. percent in 2015. Strong domestic demand, boosted by a construction boom and low oil As externally financed capital investment prices, and accommodated by high domestic declines, it will be important to boost domestically financed public investment. credit growth, is expected to offset the moderation in export growth with the slowdown Continued buoyant collection helps to make this of the garment, tourism and agriculture sectors. affordable. It is necessary to further strengthen the rules and regulations governing the management Downside risks to the outlook include potential of capital investment projects as envisaged under renewed labor discontent, further appreciation of the Public Financial Management Reform the US dollar, a delay in economic recovery in Program (PFMRP). Building up institutional Europe, and a hard landing of the Chinese quality and capacity to better manage public economy. A hard landing of the Chinese economy investment projects will serve to enhance the effectiveness of fiscal policy. International Cambodia Economic Update October 2015 >> 2 experience indicates the importance of adherence supervisory powers; (ii) responsibilities and to the following four broad principles in order to accountabilities among supervisory authorities; successfully scaling up public investment: (i) and (iii) appropriate prudential regulations. A achieving “allocative efficiency”; (ii) being number of preconditions for effective banking grounded in a sound macro-fiscal framework; (iii) supervision are: (i) a well-established framework having sound public investment management for financial stability policy formulation; (ii) a clear system; and (iv) having appropriate capacity of the framework for crisis; and (iii) an appropriate level construction sector to absorb. of systemic protection (or public safety net). To safeguard stability in the rapidly Revitalizing agricultural growth and expanding banking and construction sectors, supporting further structural transformation further supervision and coordination is in the agriculture sector are possible with four needed. Improved supervisory capacity and the sets of policies. The first is maintaining a private- establishment of a crisis management framework, sector-friendly agricultural policy environment, supported by strengthened accounting and with added attention to lowering the regulatory auditing practices with close inter-agency burden of farm input sectors. The second is coordination, are necessary. Better understanding strengthening the environmental sustainability of of the “transmission channels” of potential shocks agricultural production. The third is improving the to the economy, and the linkages between the quality of agricultural public programs and, as financial sector and the real sector, in particular feasible within Cambodia’s total government the construction and real estate sector, will help to budget, increasing allocations to the more strengthen resilience against external volatility, as effective programs. The fourth is helping to well as to avoid a potential construction and real develop the agribusiness and agro-processing estate sector bubble. International experience industry. The selected issue section on points to a framework of minimum standards for “Cambodian Agriculture in Transition: sound banking supervisory practices universally Opportunities and Risks” provides further details. applicable which includes: (i) a clearly defined Cambodia Economic Update October 2015 >> 3 THE CAMBODIAN ECONOMY AT A GLANCE Sustained high GDP growth … …now more dependent on rising internal demand… Contribution to real GDP growth.(In percent) Rising final consumption and captial formation accommodated by domestic credit growth (yoy 8 change in percent, at current prices) 25.0% 7.3 7.4 7.5 7.1 7.1 20.0% 7 6.9 15.0% 6.5 10.0% 6 5.5 5.0% 5 0.0% 2011 2012 2013 2014 2015p 2012 2013 2014 p= projection Final Consumption Expenditure Gross Fixed Capital Formation …as upbeat confidence drives construction boom… …offsetting moderation in exports and tourism... Garment, tourism and agriculture have eased. Construction is the most dynamic. Contribution to Contribution to real growht (in percentage point) annual real growth (in percentage point) 2.5 3.5 3.0 2.0 2.5 1.5 2.0 1.5 1.0 1.0 0.5 0.5 0.0 0.0 2011 2012 2013 2014 2011 2012 2013 2014 Construction and Real Estate Crop Textile, Apparel & Footwear Hotel and Restaurant …while healthy FDI finances the external gap … …and rising collection enables fiscal consolidation. FDI largely finances current account deficits. Trade balance, current account balance, and FDI (In percent of Steadily declining general government fiscal deficits. GDP) (In percent of GDP) 15 0.0 -1.0 10 -2.0 5 -3.0 -4.0 0 -5.0 -5 -6.0 -7.0 -10 -8.0 -15 -9.0 Deficits (incl grants) Deficits (excl grants) -10.0 -20 2011 2012 2013 2014 2015b 2015p 2012 2013 2014 2015p Current account excl off. transfers Trade balance FDI p= projection b = budget; p = projection Cambodia Economic Update October 2015 >> 4 B. Recent Economic Developments Table 2: The construction and real estate sector made the largest contribution, at 2 percentage points, in 2014. Contribution to annual real GDP growth (in percentage point) Key contributing sector 2011 2012 2013 2014 Crop 0.6 0.7 0.1 0.1 An overview Garment & footwear 3.1 1.1 1.8 1.2 GDP growth is dependent on internal Construction and real estate 0.6 1.6 1.3 2.0 demand. The return of business and consumer Trade 0.4 0.5 0.7 0.8 confidence has driven domestic demand. As a Hotel and restaurant 0.3 0.6 0.7 0.4 result, consumption, accommodated by fast Source: The authorities. domestic credit growth, has risen significantly, buoying up economic expansion. In a context of As illustrated in Table 2 above, the contribution low oil prices and increasing confidence of crops to GDP growth noticeably declined in underpinning the construction and real estate 2013, while the moderation in tourism growth, as boom, internal demand keeps strengthening. The reflected in the hotel and restaurant sectors, was latest data available indicates that consumption observed in 2014. grew at a healthy rate of 4.3 year-on-year (at constant prices) in 2014, fueled by domestic As a result, growth is projected to ease slightly demand (Table 1). Gross fixed capital formation to 6.9 percent in 2015 (Figure 1). growth was robust at 9.1 percent year-on-year (at constant prices) in 2014, driven largely by durable Fig 1: Agriculture contribution to real growth has been declining. equipment and construction. Contribution to annual real GDP growth (in percent) Agriculture Industry Services Taxes on products less subsidies Table 1: Rising consumption expenditure and gross fixed capital Real GDP growth 7.3 7.4 formation continued. (Growth rates, in percent, at constant 2000 8 6.7 7.1 7.1 6.9 8 prices) 6.0 6 6 2011 2012 2013 2014 Final consumption 10.2 4.7 5.7 4.3 4 4 Households 10.5 4.6 5.8 4.5 Government 7.8 5.7 5.2 2.4 2 2 Gross capital 0 0.1 0 formation 10.8 17.4 15.3 9.1 Durable -2 -2 Equipment 7.9 15.7 12.9 11.9 Construction 12.8 18.6 16.9 7.5 -4 -4 2008 2009 2010 2011 2012 2013 2014 2015p Source: The authorities Source: The authorities and Bank staff estiamtes Downside risks, however, include potential Rising consumption and investment renewed labor discontent, further appreciation of underpinned by strong internal demand, the US dollar, a delay in economic recovery in accommodated by high credit growth, help Europe, and a hard landing of the Chinese offset the moderation in export growth with economy. A hard landing of the Chinese economy the slowdown of the garment, tourism and could somewhat dampen growth prospects, agriculture sectors. Besides the construction mainly due to potentially lower Chinese tourist and real estate sector which remains vibrant arrivals and investment inflows, while export (Table 2), garment exports, capturing almost three dependency is low. There is a risk that the US quarters of total merchandise exports have eased. policy rate “lift-off” may trigger abrupt market The tourism sector has also moderated while reactions, causing currencies to depreciate sharply, agriculture growth remains weak. bond spreads to rise steeply, capital inflows to fall sharply, and liquidity to tighten. The countries Cambodia Economic Update October 2015 >> 5 Cambodia Economic Update October 2015 >> 6 Construction remains the most dynamic engine of Although generally small in size compared to growth in the first half of 2015. The construction other sectors, its activity has a large impact on sector continues to expand due largely to the output and employment of the whole economy return of business and consumer confidence and given its close inter-linkages with other sectors.4 the anticipation of opportunities arising from regional integration under the AEC.3 Risks associated with the construction and Construction activity, largely financed by foreign real estate boom are increasing, given that it direct investment, focusing in particular on has fueled land and housing prices across Phnom modern high-rise residential and commercial Penh and other urban centers, as well as a rapid buildings located in the capital, Phnom Penh credit expansion that could eventually lead to the remains strong. This is evidenced by the rapid emergence of a bubble inflated by speculation. expansion in imported construction materials, National accounts data show that real estate (and including cement and steel products (Table 3). business) sector growth (at current prices) peaked The value of approved construction projects at 25.9 percent year-on-year in 2014, compared during the first six months of 2015, however, has with 9.9 percent year-on-year in 2013. eased. Cambodia’s liberal trade and investment Table 3: Construction material imports are rising as a result regime is currently attracting businesses and of continued construction boom. Jan-Jun 2014 Jan-Jun 2015 investment that are anticipating the Imported items opportunities arising from the regional Volume Volume (metric YoY% (metric YoY% integration envisaged under the ASEAN ton) change ton) change Economic Community (AEC). As discussed Construction materials 220,929 41.0 306,855 38.9 above, this has fueled a boom in modern Cement 751,813 72.3 814,884 8.4 residential and commercial development located Steel 77,882 28.2 103,339 32.7 in Phnom Penh. In December 2015, the AEC will Source: The authorities be formally established. The associated regional integration process has already had several In 2014, out of 7.1 percent real growth, the important beneficial effects: ASEAN tariffs have construction and real estate sector accounted for been significantly reduced, regional trade has been the largest contribution, at 2 percentage points facilitated, trade in services has been liberalized, (Table 2). and FDI has been boosted. There are large potential gains from fully implementing and International experience indicates that extending the AEC integration program5 (see Box construction plays a unique role in economic 2 for more details on the 2015 AEC). growth and is often a key barometer of economic conditions. Construction increases a country’s physical infrastructure, critical factor for long- term growth. The performance of the construction sector both affects and is influenced by general economic conditions. 3 According to AEC blueprint declaration, all ASEAN member countries will abide by and Sensitive List (SL) into the CEPT Scheme and reduce tariffs on these products to 0-5% by January implement the AEC by 2015. The AEC will be the goal of regional economic integration by 2015 1, 2010 for ASEAN-6, by January 1, 2013 for Viet Nam, by January 1, 2015 for Lao PDR and which envisages: (i) a single market and production base,3 (ii) a highly competitive economic region, Myanmar, and by January 1, 2017 for Cambodia, in accordance with the provisions of the Protocol (iii) a region of equitable economic development, and (iv) a region fully integrated into the global on Special Arrangements for Sensitive and Highly Sensitive Products. economy (see Box 2 for more details on the AEC). With the following import tariff elimination schedules: (i) eliminate import duties on all products, except for those phased in from the Sensitive 4The Driving Force behind the Boom and Bust in Construction in Europe, Yan Sun, Pritha Mitra, and Highly Sensitive Lists by 2010 for ASEAN-6 and by 2015, with flexibilities for some sensitive and Alejandro Simone, IMF Working Paper, WP/13/181 products by 2018, for Cambodia, Lao PDR, Myanmar and Vietnam in accordance with the provisions of the Protocol to Amend the Common Effective Preferential Tariff (CEPT) Scheme Agreement for the Elimination of Import Duties; and (ii) complete the phasing in of the remaining products in the 5 Staying the course, East-Asia and Pacific Economic Update, Oct 2015, the World Bank. Cambodia Economic Update October 2015 >> 7 b) Garments appreciating US dollar. In particular, prices of garment exports to the EU, which is Cambodia’s largest export market absorbing 40 percent of all Cambodian garment exports (Figure 6), dropped by 15.7 percent to US$35.4 per dozen in mid- 2015, from US$ 42.0 per dozen in 2011 (Table 4). Appreciation of the US dollar and the emergence of low-wage regional competitors, such as Myanmar, together with uncertainty surrounding minimum wage negotiations, continue to exert pressure on the garment sector. Fig 6: The prices of garment products exported to the EU market have declined rapidly. (US$ per dozen) 50.0 Productivity improvement and competitiveness enhancement can simply begin with punctual, responsible, honest, and hardworking employees. 45.0 US market EU market Garment exports, one of the key drivers of 40.0 growth, eased slightly to a year-on-year growth rate of 7.8 percent, (or US$2.8 billion) in value 35.0 terms, and 7.9 percent in volume terms during the 30.0 first six months of 2015, compared with 9.2 25.0 percent and 11.2 percent in 2014, respectively (Figure 5). As presented in Table 1, in 2014, out 20.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 of 7.1 percent real growth, the garment and footwear sector was the second-largest Source: The authorities and Bank staff estimates contributor, at 1.2 percentage points, second only to the construction and real estate sector. Table 4: Garment export prices have declined in all main export markets due to increased price competition. Garment product Fig 5: Year-on-year garment export growth has been declining export prices (US$/dozen) (YTD, Y/Y % change) US EU Japan 50.0 2011 29.7 42.0 66.7 40.0 2012 29.0 43.7 59.9 30.0 20.0 2013 28.0 41.9 68.8 10.0 2014 26.8 38.0 65.5 0.0 2015 26.3 35.4 60.1 -10.0 Source: World Bank staff calculation using data from the authorities -20.0 -30.0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Cambodia currently enjoys the EU’s Everything- Garment Exports (Value) Garment exports (volume) But-Arms (EBA) preferential treatment for its garment exports. 6 However, much more intense Prices of exported garment products, which competition is expected once garment tariff account for 72.5 percent of total merchandise liberalization is effective under an agreement on exports, continue to decline, as they adjust to free trade between the EU and Vietnam.7 In this tighter competition in the context of an 6 Ten least developed countries in Asia namely, Afghanistan, Bangladesh, Bhutan, Lao PDR, Maldives, Cambodia, Myanmar, Nepal, Timor-Leste, and Yemen are the beneficiaries of the EU’s EBA (for more details, see http://trade.ec.europa.eu/doclib/docs/2013/april/tradoc_150983.pdf). 7The agreement in principle reached on August 4, 2015 for a free trade deal includes the elimination The reinstatement in July 2013 of the EU GSPs allowed Myanmar to enjoy the EU’s EBA of nearly all tariffs (over 99%). Vietnam will liberalize tariffs over a 10-year period and the EU will preferential treatment (For more details, see http://eeas.europa.eu/delegations/myanmar/documents/page_content/gsp_guidance_en.pdf. Cambodia Economic Update October 2015 >> 8 context, with the aim of diversifying the The tourism sector in Cambodia continues to manufacturing sector beyond garments and underperform, despite some recovery in increasing industrialization by 2025, the regional activity (Figure 7). Tourist arrivals authorities launched the Cambodia Industrial during the first half of 2015 grew by only 4.6 Development Policy (IDP) 2015-2025 in August percent year-on-year (reaching 2.3 million (see Box 1 on IDP for more details). visitors), compared with 6.9 percent in 2014. Arrivals by air moderated most, increasing by 7.3 A moderate recovery in high-income percent year-on-year during the first half of 2015, countries is ongoing, positively impacting the compared with 12.7 percent in 2014. International Cambodian economy as the United States and tourists visiting the Angkor Archaeological Park, the European Union (EU) are the two main the largest tourist attraction site in Cambodia, export markets, absorbing 32 percent and 23.5 during the first eight months of 2015 increased percent of total exports, respectively. In the marginally, rising by 1.9 percent year-on-year to United States, growth should strengthen modestly 1.4 million visitors. Gross revenue from the Park’s to 2.7 percent on average in 2015–16. The US entrance fees was almost flat, increasing by a mere economy grew by a robust 3.7 percent in Q2 0.03 percent year-on-year to US$39.8 million.9 (quarter-on-quarter seasonally adjusted annualized rate [qoq SAAR]). While Euro Area growth eased After experiencing double-digit arrival growth to 1.6 percent (qoq SAAR) in Q2, following a 2.2 since 2010, the tourism sector started to ease percent expansion in Q1, it has been supported by in 2014, when it grew by only 6.9 percent with the the European Central Bank’s quantitative easing average length of stay decreasing to 6.5 days from program, which helped improve credit conditions 6.8 days in 2013. Consequently, the average hotel and weaken the euro and shelter peripheral occupancy rate shrank to 67.5 percent in 2014 economies from contagion risks from Greece.8 down from 69.5 percent 2013.10 Average daily expenditure per tourist also contracted to US$93.4 c) Tourism in 2014 from US$120.7 in 2013. Despite this easing in Cambodia, it is worth noting that world tourism receipts increased.11 The contribution to real growth in 2014 by the hotel and restaurant sector which is mainly influenced by tourism arrivals also eased (Table 1). Recent initiatives on bilateral collaboration with Thailand under "Two Kingdoms-One Destination" and multilateral/regional tourism cooperation, as well as newly established direct flights including the preparation of a Tourism Ecotourism is helping diversify the tourism sector and protect the Marketing Strategy 2015-2020 by the authorities, environment. are expected to help boost arrival numbers. Public-private sector collaboration has been liberalize tariffs over a 7-year period. See http://ec.europa.eu/trade/policy/countries-and- billion, reaching US$377 billion (euro 284 bln). In the Americas, (22% share), receipts increased by regions/countries/vietnam/ for more details. US$10 billion to a total of US$274 billion (Euro 206 billion). In the Middle East, (4% share) tourism receipts increased by an estimated US$4 billion to US$ 49 billion (Euro 37 billion) and in Africa (3% share) by US$1 billion to US$36 billion (Euro 27 billion). See http://media.unwto.org/press- 8 Staying the course, East Asia and Pacific Economic Update, October 2015, the World Bank. release/2015-04-15/exports-international-tourism-rise-us-15-trillion-2014 9According to the Apsara Authority. For more details, see http://apsaraauthority.gov.kh/?page=detail&ctype=article&id=974&lg=kh 10 2014 and 2013 Annual Reports, Ministry of Tourism. 11International tourism receipts grew in all regions: Europe, which accounts for 41% of worldwide international tourism receipts, saw an increase in tourism earnings in absolute terms of US$17 billion to US$509 billion (Euro 383 billion). Asia and the Pacific (30% share) saw an increase of US$16 Cambodia Economic Update October 2015 >> 9 Box 1: Cambodia Industrial Development Policy 2015 – 2025 Box 2: The ASEAN Economic Community (AEC) at a Glance Establishing a single market and production base appears to be Policy and strategy one of the most important objectives envisaged under the AEC. Officially launched in August 2015, the Cambodia Industrial Achieving this objective requires successful implementation of the Development Policy (IDP) 2015 – 2025 strategically aims to: (i) attract following five core elements: (i) free flow of goods; (ii) free flow of investment; (ii) modernize small and medium-sized enterprises; (iii) services; (iii) free flow of investment; (iv)freer flow of capital; and (v) improve the regulatory framework; and (iv) coordinate supporting free flow of skilled labor. It will also facilitate the development of policies. production networks in the region and enhance ASEAN’s capacity to serve as a global production center and/or as a part of the global Key targets supply chain. (i) Increasing the GDP share of the industrial sector to 30 percent in Free flow of trade in services. There will be almost no restrictions 2025 from 24.1 percent in 2013 while increasing annual on ASEAN services suppliers providing services and establishing manufacturing sector growth to 20 percent in 2025 from 15.5 companies across national borders within the region, subject to percent by 2013; domestic regulations. (ii) Increasing exports of manufacturing products (non-textile Freer flow of capital. Strengthening ASEAN’s capital market products) to 15 percent of total exports by 2025 (from 1 percent development and integration with greater harmonization and in 2013) and increasing exports of processed agricultural products standardization. to 12 percent by 2025 (from 7.9 percent in 2013); and Free flow of skilled labor. Facilitating the issuance of visas and (iii) Officially registering 80 to 95 percent of the country’s small and employment passes for ASEAN professionals and skilled labor who medium-sized enterprises (SMEs) by 2025, of which 50 to 70 are engaged in cross-border trade and investment-related activities. percent will also have accurate accounts and balance sheets. Cambodia is likely to benefit significantly from the AEC, if the Priority sectors single market and production base target is achieved. This will (i) New industries with the capability to break into new markets with provide economies of scale, through which Cambodia’s small high value addition, creative and highly competitive products, domestic market will no longer be such an issue. Together with the focusing not only on consumer products but also on machinery free flow of skilled labor, an expansion of higher value-added assembly, mechanical/electronic/electrical equipment assembly, domestic production including the agro-processing industry will be transport means, and natural resource processing; further developed and enhanced while Cambodia’s relatively cheap (ii) SMEs to produce drugs, medical, and packaging equipment for unskilled labor should also be able to continue to support its labor- export, and construction materials; intensive industrial sector such as in garments and footwear. (iii) Agro-industrial production for export- and domestic markets; Cambodia’s already open trade and investment regime is unlikely to (iv) Support industry for the agriculture, tourism, and textile sectors, be significantly affected by the free flow of trade in services and and support regional and global value chains serving both forward capital. However, it is likely that Cambodia’s skilled labor will have to and backward linkages; and compete with a potential influx of highly skilled personnel from other (v) Industries to serve regional production lines and strategic ASEAN members. It is, therefore, important to improve the quality industries such as ITC, energy, heavy industries and others. of education and the appropriateness of skill sets in Cambodia’s labor force in order to be ready for regional competition. With good Leadership, coordination, and implementation investment targeting as envisaged in the Industrial Development (i) Strengthen leadership of the Council for Development of Policy, the free flow of skilled labor should be seen as an opportunity Cambodia; to lower production costs and become more competitive. (ii) Improve functions and capacity of the Cambodia Investment Board; Research suggests large potential gains from fully implementing and (iii) Streamline functions of the Cambodian Rehabilitation and extending the AEC integration program.1 In particular, implementing Development Board; the AEC could lead by 2025 to an increase in GDP of 7.1 percent (iv) Strengthen the Government and Private Sector Forum; and compared with the baseline, with the largest gains for lower-income (v) Develop monitoring and evaluation mechanisms. ASEAN members. Likewise, employment in the six ASEAN Source: Cambodia Industrial Development Policy 2015-2025. economies of Cambodia, Indonesia, Lao PDR, the Philippines, Thailand, and Vietnam could increase by 14 million, or 2 percent further strengthened with the establishment of (Indonesia) to 10 percent (Cambodia) of the labor force. working groups to regularly improve products, marketing, and management in the tourism 1Staying the Course, East-Asia and Pacific Economic Update, October 2015, the World Bank. sector.12 Source: http://www.asean.org/communities/asean-economic-community improving stability in the neighboring country, Arrivals from Vietnam, China, and South compared with 2014.13 Korea continue to lead. All three markets combined accounted for more than 45 percent of the total arrivals. Thai national tourist arrivals to Cambodia rose by 30.8 percent year-on-year during the first six months of 2015, boosted by 12For more details, see 13 This happened before the August 2015 Bangkok bombing. http://www.tourismcambodia.org/news/index.php?view=detail&nw=233#comp Cambodia Economic Update October 2015 >> 10 Fig 7: Arrivals to Cambodia remain moderate while those to In 2015, the late onset of monsoon rainfall has Thailand initially recovered by mid-2015. Arrivals to Vietnam are in negative territory. (3mma, YoY % change) slowed wet season rice cultivation (Table 5). Rice harvest in the rainy season also declined. 40.0 30.0 Cultivation of other crops (except cassava), such 20.0 as corn, soybean, and vegetables has also been 10.0 slowed. To mitigate this, efforts have been made 0.0 to speed up cultivation after adequate rainfall -10.0 -20.0 Cambodia began in July, while technical advice and support -30.0 Thailand Vietnam has been provided to contain damage caused by -40.0 the earlier drought. Jan-07 Nov-07 Feb-09 Oct-10 Jan-12 Nov-12 Feb-14 Mar-06 Aug-06 Jun-07 Jul-09 Mar-11 Aug-11 Jun-12 Jul-14 May-10 May-15 Apr-08 Apr-13 Sep-08 Dec-09 Sep-13 Dec-14 Source:The authorities, Tourism Authority (Thailand), and Ministry of Culture, Sports and In 2014, late arrival of rainfall affected wet season Tourism (Vietnam). rice cultivated areas and a subsequent drought lowered yields. As a result, average yield of wet d) Agriculture season rice production dropped by 3.8 percent to 2.81 (metric) tons per hectare (Figure 8), reducing its production by 1.75 percent to 7.14 million tons.14 Total 2014 rice production during both monsoon and dry seasons decreased to 9.33 million tons, from 9.39 million tons a year earlier. Crop contribution to real GDP growth sharply declined during the period 2013-14 (Table 2). Fig 8: Wet season rice cultivation, production, and yield dropped in 2014. (YoY, % change) 10 Waterways are the cheapest means of transportation. 8 6 The agriculture sector remains sluggish as 4 crop production remains heavily reliant on 2 rainfall. Despite efforts made to improve 0 Cambodia’s irrigation system, the agriculture -2 sector depends largely on wet season rice -4 Cultivated area Production production, which is in turn heavily reliant on -6 Yield rainfall. 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: The authorities Table 5: Slower agriculture plantation and production in 2015. As of July As of July Change 2014 2015 (%) Rice prices declined in 2015. Falling agriculture Wet season rice planted (ha) 1,842,460 1,737,046 -5.7 commodity prices have been negatively affecting Rice harvested (metric tons) 284,390 191,263 -32.7 agriculture production and export earnings, in particular for rice and rubber. As shown in Table Cassava planted (ha) 477,679 527,705 10.5 6, “free on board” (FOB) prices of various milled Other (industrial) crops (ha) 152,705 130,734 -14.4 rice varieties have been in decline. Source: The authorities 14 For more details, see Annual Report for Agriculture Forestry and Fisheries 2014-2015 and Direction 2015-2016 Cambodia Economic Update October 2015 >> 11 Over the past decade, Cambodia’s agriculture estimated to have reached CR1,236,000 in 2013, sector has undergone a significant structural representing a 21-percent increase over 2012 transformation. Although it still plays a major (Table 7).15 Among the three geographically role, the agriculture sector has become relatively classified groups, namely “Phnom Penh”, “other less “important” in overall GDP and the total urban”, and “other rural” household groups, the labor force, but more “productive”, i.e., incomes of the “other urban” grew fastest, rising agricultural land and labor productivity has by 40.4 percent during the period.16 increased. This transformation has been driven by vibrant and pro-poor agricultural growth. In the High income growth has boosted consumption period 2004-12, annual growth in gross which rose by 15 percent in 2013 over 2012 (Table production was 8.7 percent. Agricultural GDP 8). The consumption of “Phnom Penh” grew by an annual average of 5.3 percent during households grew fastest, rising 21 percent during this period. This exceptional growth rate—among the period. The construction and real estate sector the highest in the world—was driven by crop boom is occurring largely in Phnom Penh and this production, mainly of paddy rice (annual average may have fueled rapid consumption growth there. growth of 9 percent), but also maize (20 percent), cassava (51 percent), sugarcane (22 percent), and Table 7: Incomes of “other urban” households have increased the vegetables (10 percent). Growth in livestock and most. Household incomes (average monthly, in ‘000 riel) fisheries, on the other hand, was modest. 2009 2010 2011 2012 2013 See the Selected Issue section on “Cambodian Cambodia 747.0 901.0 888.0 1,019.0 1,236.0 Agriculture in Transition: Opportunities and (% change) 20.6 -1.4 14.8 21.3 Phnom Penh 2,039.0 1,987.0 1,819.0 1,886.0 2,517.0 Risks” to learn more about the opportunities and (% change) -2.6 -8.5 3.7 33.5 challenges facing the agriculture sector. Other urban 1,101.0 1,504.0 1,172.0 1,504.0 2,112.0 (% change) 36.6 -22.1 28.3 40.4 Other rural 563.0 697.0 728.0 816.0 931.0 Table 6: FOB milled rice prices are declining (US$ per metric ton). (% change) 23.8 4.4 12.1 14.1 Aug- Jan-14 Mar-14 Jun-14 Sep-14 Dec-14 Jan-15 Mar-15 Jun-15 15 Source: Cambodia Socio-Economic Survey 2013 Phnom Penh Fragrant 5 870 880 850 885 815 795 800 790 830 Table 8: Consumption of Phnom Penh households increased the fastest. Monthly consumption (in ‘000 riel). Mixes 5 490 470 460 470 460 450 450 440 430 2010 2011 2012 2013 IRRI66 5 490 460 440 452 460 435 435 425 420 Cambodia 3,273 3,483 3,794 4,365 Sihanoukville (% change) 6 9 15 Fragrant 5 875 885 855 890 820 805 810 800 840 Phnom Penh 688 794 721 876 (% change) 15 -9 21 Mixes 5 495 475 465 475 465 458 460 450 440 Other urban 478 431 665 625 IRRI66 5 495 565 445 457 465 443 445 435 430 (% change) -10 54 -6 FOB = free on board, Fragrant 5 = Fragrant rice variety with 5 percent broken Source: Rice monitor report, 2015, the World Bank. Other rural 2,107 2,258 2,409 2,864 (% change) 7 7 19 e) Income, consumption and Source: Cambodia’s Socio-Economic Survey 2013 employment Cambodia is experiencing a rapidly growing labor force, accommodating expansion of Robust income and consumption growth was domestic production. Cambodia’s relatively also found by the Cambodia’s Socio- young population gave rise to an increase in the Economic Survey (CSES) conducted in 2013, working age population (15-64 years age group) of consistent with the national accounts data. 2 million persons in the period 2004-13. The CSES 2013 findings reveal that the average Consequently, the dependency ratio declined to 83 monthly income of Cambodian households is Socio-Economic Survey 2013, National Institute of Statistics 15 Ministry of Planning, July 2014. 16 Note, however, that in other urban areas the sampling error is high. Cambodia Economic Update October 2015 >> 12 Cambodia Economic Update October 2015 >> 13 Fig 9: FDI largely finances current account deficits. Trade balance, current account balance, and FDI (In percent of GDP) 15 Current account excl off. transfers Trade balance FDI 10 5 0 -5 -10 -15 -20 Clearance times dropped from 6 days (2010) to just 1.4 days (2014) due to 2008 2009 2010 2012 2013 2014 2015p Source: The authorities and World Bank staff estimates automated customs procedures and infrastructure upgrading. p = projection a) Exports Total paddy and milled rice exports, second after garment exports, accounted for about 9.5 Despite some initial successes in export percent of total merchandise exports in 2014. product diversification, garment exports still The potential gains from exporting milled rice captured almost three quarters of total instead of paddy rice remain to be realized. In merchandise exports in 2014. Increased 2014, milled rice exports were 0.37 million destination market competition has held back the (metric) tons, generating US$210 million. The expansion of garment exports, while dampened country also informally exported paddy rice agriculture commodity prices have affected estimated at around 2.3 million tons or US$512 agriculture export earnings, in particular for rice million.21 If Cambodia were to mill the 2.3 million and rubber exports, resulting in slower tons of paddy and export this in the form of milled merchandize export growth in 2014. During the rice, this would generate as much as US$761 first six months of 2015, continued high export million. growth for footwear products and the resumption of robust milled rice and rubber export growth are The large portion of paddy exports (80 percent encouraging. However, their combined share in volume terms) in total rice exports, reflects remains small, accounting for about 11 percent of Cambodia’s strong export price total merchandise exports. competitiveness at the farm gate. Due to high milling and logistics costs, Cambodian rice often losses price competitiveness when exported in the form of milled rice. An appropriate rice export improvement measure could, therefore, focus on facilitating a reduction in milling and logistics costs, while continuing to allow paddy rice exports. Any attempt to abruptly impose restrictions on paddy rice exports in favor of milled rice exports will likely hurt rice farmers, rice production, and the economy. 21 Total rice export in 2014 was conservatively estimated at 2.86 million (metric) tons in paddy of the total formal milled rice exports, informal non-fragrant paddy rice export is estimated to equivalent. Of which 2.3 million tons informally exported in the form of paddy rice and 0.37 million account for 1.63 million tons (2.86 x 2/3 – 0.56 x 1/2) or US$325 million with the price US$200 per ton (or 0.56 ton paddy equivalent) was formally exported in the form of milled rice. Of the total 2.86 ton. Total informal rice (paddy) export is US$512 million (187 + 325). If Cambodia were to mill the million tons, fragrant rice variety covers a third. With fragrant rice already covering half of the formal 2.3 million tons paddy, and export it in the form of milled rice, it would receive US$761 million, of milled rice exports, informal fragrant paddy rice export is estimate to account for 0.67 million ton which US$321 million (0.67 million tons x 60% x $ 800 per ton) for fragrant rice and US$440 million (2.86 x 1/3 – 0.56 x 1/2) or US$187 million with the price of US$280 per ton. Of the total 2.86 (1.63 x 60% x $450 per ton) for non-fragrant rice. million tons, non-fragrant rice varieties account for two thirds. With non-fragrant rice capturing half Cambodia Economic Update October 2015 >> 14 b) Imports Fig 10: Transportion, housing, and utilities sub-indeces turned negative while food sub-index further subdued, thanks to lower food and petroleum prices. Contributions to 12-m inflation (In percent) 40.0 Others 35.0 Transport sub-index 30.0 Food sub-index Housing & utilities sub-index 25.0 Y/Y 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 May-06 May-07 May-08 May-09 May-10 May-11 May-12 May-13 May-14 May-15 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Automation and risk management help improve trade flows. Source: The authorities Strong domestic demand continues to drive Regional country inflation has also eased. import growth. While the current construction Inflation in some regional countries, namely boom has contributed to construction material Thailand and Singapore, had already turned imports growth, the recent decline in oil prices is negative by mid-2015 (Figure 11). This largely supporting rising demand for petroleum and reflects the overall decline in commodity prices vehicle imports (Table 10).22 Domestic demand is which include foods and petroleum. Lower also stimulating consumption goods imports such inflation in China, consistent with its slower as food and beverages. growth trend, has also helped to subdue regional inflation. Table 10: Rising imports of motor vehicles and petroleum products due to strong domestic demand and the decline in Fig 11: Regional country inflation has also eased. Regional petroleum prices. country inflation (YoY % change) 20 20 2013 2014 2015 (6 months) Cambodia Vietnam Imports Y-o-Y Thailand China 15 15 (US$ Y-o-Y % % Y-o-Y % Singapore Malaysia million) Value change Value change Value change The Philippines Motor 10 10 vehicles 543.9 25.8 645.4 21.0 398.5 77.9 Petroleum 5 5 products 1,052.0 10.6 1,036.6 0.5 554.7 11.0 0 0 Inflation -5 -5 Inflation has eased further after a sharp drop Feb-14 Jan-15 Feb-15 Jan-12 Feb-12 Jan-13 Feb-13 Jan-14 Oct-12 Oct-13 Oct-14 Nov-13 Mar-14 Jun-14 Jul-14 Nov-14 Mar-15 Jun-15 Mar-12 Jun-12 Jul-12 Nov-12 Mar-13 Jun-13 Jul-13 May-14 May-15 May-12 May-13 Aug-12 Aug-13 Aug-14 Apr-14 Apr-15 Apr-12 Apr-13 Sep-13 Dec-13 Sep-14 Dec-14 Sep-12 Dec-12 in 2014, reflecting depressed food and oil Source: The authorities and regional countries' stastistics prices. Year-on-year inflation was subdued, at just While helping to subdue inflation, falling 0.8 percent in August 2015, compared with 1.2 agriculture commodity prices negatively percent at the end of 2014 on the back of falling impact the incomes of Cambodian rice food and petroleum prices (Figure 10). All main producers and exporters. FOB prices of inflation sub-indices (except the food sub-index) fragrant rice exports (Table 6), which account for such as those for housing, utilities, and transport, about half of the total milled rice exports, have dipped into negative territory. been hit the hardest, dropping by 7 percent in June 2015 year-on-year. However, given that Cambodia is an importer, the recent sharp decline in 22Another main imported item is fabric used in the production of garments that are almost entirely for export. Cambodia Economic Update October 2015 >> 15 petroleum product prices has allowed households Both lending and deposit interest rates edged to spend less on transportation. up slightly in 2014 and the first half of 2015 due to rapid domestic credit growth. This trend has The monetary sector to be seen against a background in which heightened competition among banks has resulted in a significant drop in the short-term US dollar lending rate since 2012 (Figure 13). Consequently, the interest rate spread–-the difference between the nominal lending and deposit rates–-has narrowed substantially. Fig 13: Competition among banks leaves interest rates broadly stable against the backdrop of rapid credit growth. Weighted average 12-month US dollar interest rates. 20 Lending rate Deposit rate 20 Broad money growth continues to accommodate expansion of the real 16.7 16.4 17.2 sectors. 16.0 15.8 15 15.4 15 a) Monetary aggregates, interest rates, 11.5 11.5 11.6 11.4 and exchange rates 10 10 Accommodating economic expansion, broad 4.84 4.91 6.34 5.32 4.29 money growth continues, albeit at a slower 5 4.44 4.44 4.27 4.30 4.37 5 pace, with the rapid expansion of the banking and financial sector. While continuing its 0 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Jun-15 0 expansion, broad money growth decelerated to Source: The authorities 20.6 percent year-on-year in June 2015, compared with 29.9 percent in 2014, and this continues to be primarily driven by foreign currency deposits It is important to note that continued pressure (Figure 12). on short-term interest rates, rapid credit growth and rising import demand do not Fig 12: Broad money growth continues albeit at a slower pace, generate inflationary pressure in the context driven by rising foreign currency deposits. Contribution to broad of dollarization with US dollar appreciation. money growth (YoY % change) This, however, does not imply that there is room 70 for monetary policy easing, given persistently high 60 Riel in circulation Riel deposits domestic credit growth over the past few years. 50 Foreign currency deposits 40 The Cambodian riel versus the US dollar 30 exchange rate remains broadly stable, 20 supporting overall price stability. The riel 10 depreciated slightly, reaching CR 4,098 per dollar 0 by mid-2015, which has helped to mitigate some -10 of the losses in external competitiveness in Mar-07 Jun-07 Mar-08 Jun-08 Mar-09 Jun-09 Mar-10 Jun-10 Mar-11 Jun-11 Mar-12 Jun-12 Mar-13 Jun-13 Mar-14 Jun-14 Mar-15 Jun-15 Dec-06 Sep-07 Dec-07 Sep-08 Dec-08 Sep-09 Dec-09 Sep-10 Dec-10 Sep-11 Dec-11 Sep-12 Dec-12 Sep-13 Dec-13 Sep-14 Dec-14 agriculture commodities.23 Nonetheless, the riel Source: The authorities appreciated slightly against the Thai baht and the Vietnamese dong (Figure 14) during the first half of 2015. 23 Mainly agriculture commodities whose prices are denominated in local currency. Cambodia Economic Update October 2015 >> 16 Fig 14: Riel is appreciating against baht and dong but Fig 15: Private sector credit growth accelerated while private depreciating against the dollar. Nominal exchange rates of riel sector deposits growth moderated. (YoY % change) against dollar, baht, and dong Rapid growth Global financial crisis Recovery 210.0 4,250 100 200.0 4,200 190.0 80 Riel per Baht 4,150 Deposits by the private sector 180.0 Riel per 1000 dong 60 Credits to the private sector 170.0 Riel per US$ (RHS) 4,100 160.0 4,050 40 150.0 4,000 20 140.0 3,950 130.0 0 120.0 3,900 -20 Jan-12 Jul-12 Nov-12 Jan-13 Jul-13 Nov-13 Jan-14 Jul-14 Nov-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 May-12 May-13 May-14 May-15 Sep-12 Sep-13 Sep-14 Nov-06 Nov-11 Apr-07 Apr-12 Jan-06 Sep-07 Feb-08 Dec-08 Oct-09 Jan-11 Sep-12 Feb-13 Dec-13 Oct-14 Jun-06 Jul-08 May-09 Mar-10 Aug-10 Jun-11 Jul-13 May-14 Mar-15 Source: The authorites, Bank of Thailand, and Vietnam's statistics office Source: The authorities As shown in Figure 16, the construction and b) The banking sector real estate sector has received an increasingly large share of total domestic credit in the post- global financial crisis period. The sector captured 19 percent of total domestic credit by mid-2015, compared with only 16 percent in 2010. The share, however, remains below the peak of 23 percent in 2008, in the run up to the global financial crisis when a housing bubble eventually burst. Supporting the authorities’ 2010 Rice Policy, the share of domestic credit provided to the agriculture sector has picked up, reaching 11.6 Domestic credit provided by the banking sector has contributed to the percent in June 2015 from 6.8 percent in 2010. construction and real estate boom. The share of domestic credit provided to the manufacturing sector, however, has steadily Rapid financial deepening continues. Private sector credit growth accelerated further, reaching declined, accounting for 7.9 percent in June 2015, 28.1 percent year-on-year or US$8.6 billion, by down from 11.5 percent in 2013. This does not June 2015, compared with 24.8 percent year-on- bode well for the targeted advancement of the year at the end of 2014 (Figure 15). Private sector manufacturing sector as envisaged by the deposits growth, however, moderated to 21.1 Industrial Development Policy (IDP). The retail percent year-on-year, or US$9.6 billion by June and wholesale, construction, agriculture, and 2015, compared with 30.6 percent year on year at manufacturing sectors combined cover almost the end of 2014. The loan-to-deposit ratio, three quarters of total domestic credit, spurred by therefore, rose to 89 percent. vibrant business activity. Cambodia Economic Update October 2015 >> 17 Fig 16: Loans to the construction and real estate sector have The fiscal sector been rising since post-global financial crisis period. Domesitc credit by type of business (% of total). Construction, real estate, and mortgages 40% Retail & wholesale Agriculture 35% Manufacturing 30% 25% 23% 19% 19% 19% 20% 17% 17% 17% 16% 15% 10% 5% 0% 2008 2009 2010 2011 2012 2013 2014 2015 Studying outside of normal school hours can help to improve test scores. Source: The authorities. The expansion of the banking sector has Fiscal consolidation has been sustained as contributed to a decline in net foreign assets high revenue growth and largely contained of banks, as the rise in foreign liabilities more than expenditure continue to curb the overall fiscal offsets the increase in foreign assets (Figure 17). deficit. During the first seven months of 2015, Unrestricted foreign currency deposits by banks at domestic revenue continued to perform well, the central bank have also declined. FDI inflows growing at around 18 percent year-on-year. It is have largely contributed to increasing the central projected that revenue collection will reach 17 bank’s gross international reserves, which reached percent of GDP (Figure 18) and expenditure will US$5.2 billion (or 4.1 months of prospective marginally increase to 21 percent of GDP (Figure imports) by June 2015.24 This compares with 20), driven largely by an increase in the wage bill, US$4.6 billion at the end of 2014. resulting in a slightly wider overall fiscal deficit including grants of 1.6 percent of GDP (Figure 21). Fig 17: Banks' net foreign assets are declining as the rise in foreign liabilities more than offsets the increase in foreign assets. (In millions of USD) a) Revenue composition 6,000 NBC's GIR 2,000 DMB's NFA (RHS) 5,000 DMB's unrestricted FC deposits (RHS) 1,500 4,000 1,000 3,000 500 2,000 0 1,000 0 -500 Feb-08 Feb-13 Jan-06 Nov-06 Oct-09 Jan-11 Nov-11 Oct-14 Jun-06 Jul-08 Mar-10 Jun-11 Jul-13 Mar-15 May-09 Aug-10 May-14 Apr-07 Apr-12 Sep-07 Dec-08 Sep-12 Dec-13 Revenue collection through the banking system has reduced leakages and Note: FC: foreign currency, GIR: gross internatinal reserves, NFA: net foreign assets, and DMB: deposit money banks. improved transparency. Source: The authorities Continued improvements in revenue administration have enabled high domestic revenue growth to be sustained. As a result, 24 Includes all foreign exchanges including Chinese Yuan used as reserves. Cambodia Economic Update October 2015 >> 18 domestic revenue reached 16.6 percent of GDP in Box 3: Public Financial Management Reform Program 2014, compared with 15.1 percent of GDP in (PFMRP) 2013, overachieving the annual target increase of Go-live of FMIS 0.5 percent of GDP under the PFMRP. The The Financial Management Information System (FMIS) is a introduction and implementation of the revenue modern budgeting, accounting and reporting tool providing a set mobilization strategy (2014-18) appropriately set of automation solutions enabling the authorities to plan, execute and monitor the budget. The solution can assist the Royal out key priority areas, namely revenue Government of Cambodia (RGC) in the prioritization, execution administration and good governance, given the and reporting of expenditures, as well as the custodianship, use existing capacity of the revenue collecting and reporting of revenues. agencies. “Go-Live 1” of FMIS was successfully launched on July 20, 2015. It represents an achievement of the first major operational Fig 18: Domestic revenue markedly improved in 2014 and milestone with the go-live of the General Ledger and Budget Allocation projected to perform well in 2015 as well. General govt revenue Modules for a number of key general departments within the (In percent of GDP) Ministry of Economy and Finance. As a result, all in year budget 18.0 changes such as transfers and other in–year changes will be Direct taxes Indirect taxes 16.0 Trade taxes Non-tax and others performed directly in the FMIS system. 14.0 “Go-live 2”, the second major milestone scheduled for October 12.0 21, 2015, will involve Account Payable, Purchase Order, Account 10.0 Receivables, and Cash Management modules. After the second go-live the core functionality in the FMIS related to budget execution will 8.0 7.9 8.2 be implemented. At this stage, end users in participating 7.4 6.0 6.6 6.8 departments will start using the system for the performance of 6.0 4.0 5.4 5.7 their day-to-day work, and key revisions to the way they perform 2.0 their business processes will be implemented. 2.2 2.5 2.9 2.8 3.0 1.7 1.7 1.8 - 2009 2010 2011 2012 2013 2014 2015b 2015p What Benefits Can FMIS Provide? b = budget; p = projection Source: The authorities and Bank staff estimates The FMIS supports the streamlining and processing/recording of payments, revenue collection and receipts, and accounting and reporting of the central and provincial treasuries. Spending The overall structure of domestic revenue has ministries at the center, and spending departments in the significantly changed with a rising share of provinces, will submit their payment requests and revenue receipts direct taxes, albeit from a low base. The share to the central treasury, or the corresponding provincial treasuries, for processing. Ministries and departments will have easier and of direct taxes in domestic revenue has more than timelier access to financial information, from which they will be doubled over the past decade.25 Its share rose to able to generate financial and management reports. The system 17.5 percent in 2014, up from 7.1 percent in 2004 will provide better program and financial information to program managers, enabling them to redirect or allocate resources more (Figure 19), despite the fact that generous tax effectively, efficiently and transparently; and to facilitate the timely incentive provisions under the Law on Investment receipt of funds by, for example, provincial and district education have remained unchanged. Although direct tax offices, as well as by clinics and hospitals. Overall, the FMIS will generate immediate benefits by improving the way the RGC collection remains relatively low at around 3.0 monitors, adjusts, and reports on its budget each year. percent of GDP (3.8 percent of GDP collected in Lao PDR, 5.6 percent of GDP in Indonesia, and Source: The authorities and World Bank staff. 7.4 percent of GDP in Thailand), the rapid improvement indicates good progress in from 23.2 percent.27 The authorities’ efforts to administration.26 While continuing to be the gradually transform the previous tax structure, largest component, the share of indirect taxes heavily dependent on trade taxes, to a more increased only slightly to 47.5 percent from 40.5 advanced tax system based on direct and domestic percent during the same period, whereas the share taxes will help to sustain collection as the country of trade taxes actually dropped to 16.3 percent 25 In the Cambodian tax system, direct taxes include: corporate income taxes (profit taxes), payroll 27Indirect taxes cover turnover taxes, value-added taxes, and excises. Trade taxes mainly consist of taxes, and property taxes. import and export taxes. 26 FY 2012/13 for Lao PDR, FY 2013 for Indonesia, and FY 2013/14 for Thailand. See 2014 and 2015 IMF Article IV Consultation- Staff Reports for Lao PDR, Indonesia, and Thailand. Cambodia Economic Update October 2015 >> 19 pursues free trade policy objectives, such as those A civil service reform initiative aimed at envisaged under the AEC. containing the costs of public sector employment Fig 19: Direct tax collection improved significantly, albeit from a through retrenchment and restructuring including low base, while trade tax collection shrank during the past decade. (% of total domestic revenue) establishment control currently being introduced 23.2 as part of the effort to improve public sector Direct taxes Trade taxes performance, is a step in the right direction. 17.5 16.3 International experience shows that the following institutional factors may improve public sector performance: (i) well defined roles, 7.1 responsibility, and accountability; (ii) appropriate human resource management practices; and (iii) in the education and health sectors, there is evidence 2004 2014 that increasing the scale of operations may Source: The authorities improve efficiency.29 b) Expenditure composition On the other hand, capital expenditure has shrunk, due to a decline in the externally financed component, since the end of the fiscal expansionary policy, which had been introduced to mitigate the negative impacts of the global financial crisis. This may pose a challenge in the future, since improved infrastructure is needed in order to enhance the country’s competitiveness and achieve a more balanced economic development. Learning to compete regionally and globally is essential. It is worth noting that a series of efforts has Although total spending remains contained, a been made to improve spending efficiency rapid expansion of the wage bill could and results. For instance, this has been seen with jeopardize the fiscal consolidation effort. the introduction of full program budgeting pilots Following a rise in the minimum salary, the wage at 10 key ministries30 and the introduction of the bill was budgeted at 6.4 percent of GDP in 2015, Financial Management Information System compared with 5.5 percent in 2014. Wages are (FMIS). The FMIS aims to achieve the timely and likely to remain on the rise as the minimum basic comprehensive recording and reporting of salary is targeted to gradually increase and reach up government budget performance and results, to CR 1 million (equivalent to US$ 250) by 2018.28 based on international public sector accounting It is, therefore, important to ensure the standards, among other measures under the Public affordability of the rising wage bill, and to link this Financial Management Reform Program to improvements in human resource management (PFMRP).31 See Box 3 for more recent and public service delivery. achievements under the PFMRP. The resulting spending efficiency will support any efforts to scale up domestically financed capital investment. 28 A comprehensive and well sequencing civil service reform aiming at containing the costs of public sector employment through retrenchment and restructuring including establishment control (subdecree 114 dated September 7, 2015) is being implemented. 30 The 10 ministries are education, health, rural development, agriculture, women’s affairs, labor, 29 Improving Public Sector Efficiency: Challenges and Opportunities by Teresa Curristine, et land, public works, and finance. For more details, see www.pfm.org.gov. all , OECD Journal on Budgeting Volume 7 – No. 1, 2007 Cambodia Economic Update October 2015 >> 20 Fig 20: Development partner-financed public investment is Fig 21: The fiscal deficit has been improving gradually as a declining while the wage bill is rising. General government result of fiscal consolidation efforts after the end of fiscal expenditures (In percent of GDP) stimulus period mitigating impacts of the global financial crisis. Government government fiscal deficit (In percent of GDP) 2.0 20 Deficits (incl grants) Deficits (excl grants) 0.0 -2.0 15 4.3 -4.0 4.4 5.0 4.8 4.5 5.5 6.5 10 6.4 -6.0 -8.0 5 -10.0 7.3 8.2 6.4 6.8 7.0 6.4 2008 2009 2010 2011 2012 2013 2014 2015b 2015p 5.0 5.2 b=budget; p = projection 0 Source: The authorities 2009 2010 2011 2012 2013 2014 2015b 2015p Donor-financed capital Gov't-financed capital Wage Non-wage b=budget; p = projection The World Bank/IMF debt sustainability Source: The authorities analysis (DSA) indicates that Cambodia’s debt distress rating remains low, with all debt c) Fiscal balance burden indicators projected to remain below their respective thresholds. The results also indicate While buoyant revenue collection continues, a that debt sustainability continues to be vulnerable marginally wider fiscal deficit (excluding to growth, exports, and fiscal shocks, calling for grants) of 3.7 percent of GDP is projected for continued structural reforms to increase the 2015, compared with 3.5 percent of GDP in 2014, economy’s resilience to external shocks, and to due to rising current expenditure. Including mobilize domestic revenues. At the end of 2014, grants, the fiscal deficit is projected to reach 1.6 the estimated stock of Cambodia’s external public percent of GDP in 2015, compared with 0.3 debt, including arears, stood at around US$ 5.5 percent of GDP in 2014. The fiscal deficit billion or 33 percent of GDP. continues to be financed by external funds. Meanwhile, government deposits reached 8.7 percent of GDP, or US$1.4 billion at the end of June 2015. The accumulation of government deposits provides a cushion that the government can use at times of shocks. For instance, Cambodia introduced a fiscal stimulus, amounting to about 2 percent of GDP to mitigate negative impacts of the global financial crisis. Fiscal policy has been largely the sole policy instrument to maintain macroeconomic stability and to mitigate shocks as the country’s monetary policy is constrained by its high level of dollarization. Cambodia Economic Update October 2015 >> 21 C. Key Messages and capital investment as Cambodia moves towards joining the lower middle-income group. First and Recommendations foremost, this entails pursuing additional domestic revenue. With continued buoyant collection, prioritized public investment project There is a pressing need to enhance external funding may be affordable, and can therefore be competitiveness. In the context of an appropriated in the short term. In addition, appreciating US dollar (and Cambodian riel) vis-à- efficiently scaling up domestically financed vis the Euro and neighboring currencies, and investment requires appropriate measures and facing increasing competition, Cambodia needs to capacity. Thus, it is crucial within a short- to address key bottlenecks constraining productivity medium-term time frame, to strengthen the rules growth as well as export cost reduction. A better and regulations, i.e., budgetary, procurement, and trained and more skilled workforce will certainly auditing rules governing the management of help to improve competitiveness in the short public investment projects with a focus on term. A recent initiative to set up a large scale improving appraisal, implementation and garment training institution is encouraging. In evaluation to achieve value for money, as addition, further improving the overall business appropriately envisaged under the PFMRP. environment through the simplification and Institutional quality and capacity also need to be automation of business registration and trade further strengthened to better manage public facilitation processes, and an enhanced investment. This is a time consuming task that investment law, would help sharpen Cambodia’s requires a high level of commitment and political competitive edge across sectors. Finally, it is leadership. International experience indicates essential to support diversification in the the importance of adherence to the following four manufacturing sector as envisaged by the broad principles in order to successfully scaling up Industrial Development Policy, while preparing public investment: (i) achieving “allocative Cambodia to take advantage of opportunities as efficiency” by shifting resources from less they arise in the medium term under the single productive sectors to more productive ones; (ii) market and production base goal envisaged by the being grounded in a sound macro-fiscal AEC. From the medium- to long-term framework to prevent real exchange rate perspective, addressing the unreliability and high appreciation from an investment spending boom; cost of electricity with additional power supply (iii) the public investment management system available from hydro and coal-fired power plants should be sound; and (iv) the construction sector is a priority. International experience attaches a has to be able to effectively respond and meet strong business environment to a number of these increasing demands.33 attributes: (i) a legal and regulatory framework that is predictable and based on international norms, a The further strengthening of supervision and central element; and (ii) a favorable investment coordination in order to safeguard stability in environment as well as trade facilitation and the rapidly expanding banking and logistics, key determinants of competitiveness.32 construction sectors is essential. While Cambodia is likely to be shielded from financial Boosting domestically financed public volatility due limited capital markets, bank flows investment is necessary. This is to compensate in the form of foreign currency deposits remain for the decline in development partner-financed sensitive to public confidence and perceptions.34 Further action to enhance banking supervision 32 Cambodia Trade Integration Strategy 2014-18, 2014 by RGC, World Bank, UNDP, and ADB 33 Mongolia: Improving Public Investments to Meet the Challenge of Scaling up Infrastructure, World Bank, 2013. 34 During the period covering June – August 2013, bank deposits (mostly US dollar deposits) dropped by about US$600 million caused by election-related political uncertainty. Cambodia Economic Update October 2015 >> 22 supported by strengthened accounting and This will help avoid a potential bubble from auditing practices with improved data integrity developing in the construction and real estate and availability is a priority. More importantly, sector. International experience points to a establishing a crisis management framework framework of minimum standards for sound underpinned by close inter-agency coordination is banking supervisory practices universally fundamental. Looking ahead, better applicable which includes: (i) a clearly defined understanding of the “transmission channels” of supervisory powers; (ii) responsibilities and potential external volatility, including a hard accountabilities among supervisory authorities; landing of the Chinese economy, on Cambodia’s and (iii) appropriate prudential regulations. A economy, as well as the linkages between the number of preconditions for effective banking financial sector and the real sector, will help supervision are: (i) a well-established framework strengthen the economy’s resilience to shocks. A for financial stability policy formulation; (ii) a clear recent effort to improve coordination between framework for crisis; and (iii) an appropriate level public institutions regulating the banking sector, of systemic protection (or public safety net).35 the construction sector and urbanization, and the real estate service sector with collaboration by major construction firms and real estate developers is a welcome first step. 35 Basel Committee on Banking Supervision, Core Principles for Effective Banking Supervision September 2012, Bank for International Settlements. Cambodia Economic Update October 2015 >> 23 D. Selected Issue – Cambodian Agriculture in Transition: Risks and Opportunities36 Introduction The agriculture sector has been the most important Agricultural GDP, Cambodia contributor to pro-poor, shared growth in Cambodia in the 7% 2000s. During 2004-12, agricultural GDP growth averaged 5.3 6% Annual growth, % percent per year. However, in 2013-15 this growth rate has 5% 4% slowed to just 1.0 percent. Does this mean that the country is in 3% an irreversible transition towards slower agricultural growth? 2% Cambodia can ill afford such a scenario because agricultural 1% 0% growth remains critical to continued poverty reduction and 2006 2007 2008 2009 2010 2011 2012 2013 2014 shared prosperity. Market- and private-investment-friendly policies and targeted public sector investments in irrigation, agricultural extension, and other “public good” agricultural services, as feasible within the Government’s total budget, can help to secure continued robust agricultural growth. The past decade’s agricultural growth story is one of many successes… Over the past decade, Cambodia’s agriculture sector has undergone a significant structural transformation, as reflected in the national accounts and observed in the field during the 2005 and 2013 World Bank surveys. Although it still plays a major role, the agriculture sector has become relatively less “important” in overall GDP and the total labor force, but more “productive”, i.e., agricultural land and labor productivity has increased. This transformation has been driven by vibrant and pro-poor agricultural growth. Agricultural growth in Cambodia used to be high. In the period 2004-12, annual growth in gross production was 8.7 percent. Agricultural GDP grew by an annual average of 5.3 percent during this period. This exceptional growth rate—among the highest in the world—was driven by crop production, mainly of paddy rice (annual average growth of 9 percent), but also maize (20 percent), cassava (51 percent), sugarcane (22 percent), and vegetables (10 percent). Growth in livestock and fisheries, on the other hand, was modest. Agricultural growth was pro-poor. Cambodia’s poverty headcount declined from 50 percent in 2007 to 21 percent in 2011, with the Poor people (million) Key Drivers of Poverty Reduction 2004-2011 number of poor declining from 6.9 Unexplained 7 million to 3 million. Most 14% Urban salaries poverty reduction took place in 4% Rice price rural areas. More than 60 3 Non-farm 24% percent of the poverty business 19% Farm Rice production reduction was attributed to the wage 16% 23% agriculture sector: higher rice 2004 2011 prices stimulated larger rice This annex is based on the World Bank report “Cambodian Agriculture in Transition: Risks and Opportunities”, Economic and Sector Work, Report No. 96308-KH. 36 The full report can be accessed at http://documents.worldbank.org/curated/en/2015/08/24919384/cambodian-agriculture-transition-opportunities-risks. Cambodia Economic Update October 2015 >> 24 production, which in turn increased farm wages. Further poverty reduction will continue to depend on the success of agriculture for many years to come, due to the sector’s major role in the labor force, in value added, and in exports, as well as the fact that many farmers are among Cambodia’s poorest and more vulnerable citizens. Agricultural wages are converging with nonagricultural wages. Agricultural wages grew by 265 percent between the World Bank surveys conducted in 2005 and 2013, while nonfarm wages increased by 60 percent. As a result, the ratio between per worker nonagricultural to agricultural valued-added at current prices fell to 2.1 in 2012, down from 3.2 in 2004. Returns to farm labor have been increasing. The diversification of crop production has started. Gross Margins and Returns to Labor, 2013 Although production still mainly focuses on paddy, the crop 1600 12 mix has been changing, driven by higher profitability of non- 1400 Return to labor, $/day 10 Gross margins, $/ha 1200 rice crops. In 2013, average farm gross margins (and returns to 1000 8 800 6 labor) were US$506/ha (US$9.4/day) for cassava, US$303/ha 600 4 (US$8.8/day) for maize, and US$1,393/ha (U$$7.2/day) for 400 200 2 vegetable production, compared with US$245/ha 0 0 Cassava Maize Wet Dry Vegetables (US$4.6/day) for wet season rice and US$296/ha (US$9.6/day) Season Season Rice Rice for dry season rice. Dry season rice competes well with non- Gross Margin, $/ha Returns to Labor, $/day rice crops in terms of returns to labor but its expansion is constrained by limited irrigation. The share of total area planted under paddy declined from 86 percent in 2002 to 74 percent in 2011, while the share of planted area for maize and cassava production increased significantly. Even the paddy segment has started to diversify. Triggered by the demand from modernized rice mills, more farmers are now growing more profitable aromatic paddy, estimated at 10 percent of the rice cultivated area and 30 percent of total production. Further expansion of farmland under aromatic paddy is possible with improvements in the quality of seed supply, agricultural extension, and irrigation. Yields increased for most crops. With annual growth in cultivated land areas at 4.7 percent and agricultural gross production at 8.7 percent, average growth of yields was 4 percent during 2004-12. This growth in yields was triggered by the widespread adoption of improved technologies, expanded (albeit still limited) irrigation, greater use of modern inputs, and better access to mechanized services, pointing to advances in commercialization. Farmers also have better access to markets. Cambodian farm products remain price competitive at the farm gate. A domestic resource cost analysis of competitiveness shows that despite rising labor costs and prices of farm inputs, the value-added generated by farmers exceeds the costs of domestic factors of production (land, labor, and capital). This high competitiveness explains the significant increase in agricultural exports over the past decade. However, the competitiveness of ordinary rice produced during the wet season has worsened in recent years and many small farmers producing ordinary rice have started to lose their competitive edge. Past agricultural growth was driven by several factors. Among the major factors were open trade and, in general, a market-oriented agricultural policy. Cambodia was one of the few developing countries that did not overact to the 2008 global food price spike, but instead saw higher food prices as an opportunity to leverage agricultural growth. Other net-exporting countries such as India and Vietnam used export restrictions to limit transmission of the global food price spike into their markets. Higher agricultural prices in Cambodia made farmland expansion profitable. In addition, the agriculture sector benefited from: (i) improved access to overseas markets through the Everything-But-Arms Agreement with the European Union and open cross-border trade with neighbors; (ii) better availability and wider use of mechanization Cambodia Economic Update October 2015 >> 25 services triggered by the higher cost of rural labor; (iii) better farm access to finance; and (iv) private sector investment in rice mills. …but there are also challenges A large share of the past agricultural growth was driven by farmland expansion. The average contribution (weighted by crop areas) of land expansion to the change in farm gross margins in real terms between 2005 and 2013 was 60 percent (Table 1). Farmland expanded annually by 4.7 percent, with very large increase (128 percent) for cassava. Table 1: Annual changes in farm gross margins, in real terms, 2005-13, % Change in cultivated Change in per ha Change in total areas gross margin gross margin Wet season rice 2.1 2.4 4.5 Dry season rice 6.7 2.1 8.8 Cassava 128.1 15.1 143.2 Maize 17.2 -10.3 6.9 Vegetables 6.4 44.5 50.9 Weighted average 4.7 3.4 8.2 Note: Gross margin is defined as gross revenue less intermediate inputs, including hired labor. The farm gross margin includes rice, cassava, maize, and vegetables. Source: 2005 and 2013 World Bank surveys. The average increase in per hectare gross margin was solid, at 3.4 percent per year. But this nonetheless varied between 2.1 percent for dry season rice to 44.5 percent for vegetables. Maize’s per hectare margin even declined. In many cases, farmers who expanded their land areas received higher incomes, but farmers with unchanged land areas were unable to substantially increase their incomes. The period of relatively high food prices was largely used to expand land areas rather than to build a strong foundation through productivity increases. While poverty reduced significantly, the number of vulnerable people also increased significantly. Most people who escaped poverty did so only by a small margin. The loss of only CR 1,200 per day (the cost of two small water bottles) would cause Cambodia’s poverty rate to double to 40 percent. This high rate of vulnerability is a sign of still modest agricultural productivity increases. Nutritional security has also lagged behind the reduction in poverty: although the prevalence of stunting among children under five declined by 7 percent between 2010 and 2014, it remained at the high rate of 33 percent. Cambodia Economic Update October 2015 >> 26 Near poor people Poor people (million) (million) 6.9 8.1 4.6 3 2004 2011 2004 2011 Poor are those living below $1.15 per day (poverty line) Near poor or vulnerable are those living above $1.15 per day, but below $2.30 per day Vulnerability is greatest among the smallest farms. Small farmers, with land areas of less than one hectare, reported difficulties in expanding and integrating into emerging modern food value chains. The share of such farms in the total number of rural households owning land was 48 percent in 2011. Over the past decade, there has been a trend in Cambodia for large farms (above 3 ha) to become larger and small farms (less than 1 ha) to become smaller. The average size of the surveyed farms with less than 1 ha in land declined from 0.99 ha in 2008 to 0.88 ha in 2012, while the average size of medium farms (between 1 and 3 ha) increased from 1.55 ha to 2.38 ha, while the larger farms (above 3 ha) increased from 3.61 ha to 7.03 ha. Despite the productivity improvements of some small farms in recent years, the productivity of most small traditional farms has remained low, as agricultural extension and other public services have not reached them to any great extent. It appears that the income increases for this group of farmers over the past decade have come largely from higher production values driven by high agricultural prices and the sale of their labor to larger farms at higher wages, rather than higher land and labor productivity. Except for rice, the agro-processing industry has played a limited role in agricultural growth. Almost all crops were exported to neighboring countries unprocessed. This indicates serious weaknesses in the value chain, particularly in the post-harvest system of supply chain management (collection of raw material, storage, finance, logistics, transportation, and information). What worked in the past will no longer be sufficient in the future With global food prices declining and the land frontier diminishing, Cambodian agriculture is losing its two major growth drivers. Moreover, agricultural labor is becoming scarcer and more expensive, adding to production costs. Global agricultural prices are projected to decline over the next decade, and selling low-quality ordinary rice on domestic and foreign markets will become less and less profitable. Relying on higher domestic demand driven by the increase in GDP and higher global demand alone, without more efficient use of resources, will not be enough to maintain the high rate of Cambodia’s past agricultural growth. Cambodia will need to find new drivers to maintain agricultural growth at or close to 5 percent. The recent slowdown in agricultural growth in Cambodia may signal a potential longer-term growth decline. As global food prices have gradually fallen and the global rice market has become more competitive with the reentry of Thailand and Myanmar, so rice production in Cambodia has stalled. Along with this, total crop value-added declined, from 4.9 percent in 2012 to 0.6 percent in 2013. Growth in Cambodia Economic Update October 2015 >> 27 agricultural value-added slowed to 1.6 percent in 2013 after average growth of 5.3 percent in the period 2004-12. Returning to a high agricultural growth rate is important. Agriculture still accounts for a large share of GDP, trade, and the labor force, which means that it will remain the key to further reductions in poverty and vulnerability in the coming decade. If Cambodia’s structural transformation continues, with agricultural growth averaging 5 percent, by 2030 Cambodia will have a relatively smaller but more productive agriculture sector. Agriculture’s shares of GDP and the total labor force are projected to decline to 17 percent and 31 percent, respectively, in 2030, down from 26 percent and 51 percent in 2012. Meanwhile, land productivity will increase from US$1,300/ha to US$2,700/ha and labor productivity will rise from US$1,200/person to US$3,700/person in the same period (Table 2). By contrast, the cost of slow agricultural growth will be huge. If average agricultural growth is only 3 percent in the period 2012-30, agricultural value-added will be 29 percent lower by 2030 compared with a 5 percent growth scenario. This would have the effect of slicing overall GDP by 18 percent, keeping more people in agriculture, reducing agricultural labor productivity by 34 percent, and slowing any further income convergence between farmers and nonfarmers. Lower agricultural growth would also lead to a much slower reduction in poverty. Table 2: Impact of lower agricultural growth in Cambodia Indicators 2012 2030 3% Ag GDP growth 5% Ag GDP growth Share of agriculture in GDP, % 26 15 17 Share of agriculture in labor force, % 51 34 31 Agricultural labor productivity, 1,200 2,450 3,700 $/person Agricultural land productivity, $/ha 1,300 1,900 2,700 Labor productivity ratio of 2.1 2.1 1.6 agricultural to nonagricultural workers Source: World Bank staff estimates. A long-term vision for Cambodian agriculture would need to encompass elements of sustainability, productivity, competitiveness, and income growth, while shifting away from the still strong focus on production. Simulation of different scenarios of future agricultural development reveals that a rise in farm productivity would have the largest positive effect on farm incomes, especially if the shift from traditional to modern technologies is accompanied by greater efficiencies in modern input use and irrigation. Farmers producing fragrant rice, processing cassava into dry chips, and undertaking other value addition activities can increase their incomes further, illustrating the importance of the agro-processing industry. Lowering production costs through better use of existing resources (e.g., productivity increases) and minimizing declines in farm output prices through lower logistics costs are key to maintaining farm competitiveness. Continued land expansion also provides additional income but sustainability considerations will limit large expansions in the future. This constraint makes agricultural productivity, commercialization, and diversification even more critical in ensuring future agricultural growth that reduces poverty and boosts shared prosperity in Cambodia. Cambodia Economic Update October 2015 >> 28 Recommendations a) Continued rapid agricultural growth and further structural transformation in the agriculture sector are possible in Cambodia. Four sets of policies together can help support such continued agricultural growth during the next five years. The first is maintaining a private-sector-friendly agricultural policy environment, with added attention to lowering the regulatory burden in farm input sectors. The second is strengthening the environmental sustainability of agricultural production. The third is improving the quality of agricultural public programs and, as feasible within Cambodia’s total government budget, increasing allocations to more effective programs. The fourth is helping to develop the agribusiness and agro-processing industry. b) Maintaining a Private-Sector-Friendly Agricultural Policy Environment Cambodia’s market-oriented agricultural policy and open trade policy helped to achieve high past rates of agricultural growth. The private sector has benefited from minimal, if any, interventions in farm output and input pricing, from the strong commitment to open trade, including across the border, and from the reduction of export costs and time required for export processing. This has created conditions for farmers and other players to invest and generate profits. These open trade and market- oriented agricultural policies remain critical to future growth and need to be protected by all means possible. In addition to maintaining a non-distortive agricultural policy, reforms in the seed sector can make an important contribution to agricultural growth. Currently, only 10 percent of potential paddy seed demand is estimated to be met by the seed supply. Insufficient supply of seeds and their poor quality in Cambodia have been among the main reasons for relatively slow productivity improvements, placing significant constraints on future agricultural growth mainly because investments in fertilizers and machinery pay off only when combined with the use of improved seeds. Many policy distortions exist in the seed sector, ranging from a state monopoly in the supply of foundation seeds to the lack of clear and conducive regulations for trials, releases, production, and the import of seeds. The regulatory and legislative bottlenecks in the seed sector need to be addressed in the coming years. Regulations for inputs such as fertilizers can also be improved to reduce costs to farmers. Cambodia currently has burdensome requirements for importers of fertilizers to register products and apply for import licenses for each imported lot. The procedures should be simplified through the approval of import licenses on the basis of product suitability only, and once received all importers should be allowed to import any quantity of these registered inputs. c) Strengthening Environmental Sustainability Embedding environmental sustainability in agricultural policy will become increasingly important. The rapid farm land expansion, by 4.7 percent annually during 2005-2013, often at the expense of forests, is not sustainable. There is a need for a more sustainable expansion of cultivated land, through better land-use planning, strengthened land-tenure security, and maintenance of soil fertility through better use of available land and promotion of sustainable land management practices. International experience shows that the most effective way to promote such practices is to combine the enforcement of natural resource protection with agricultural extension and other public programs that increase land users’ awareness of the longer-term costs and benefits, and promote the adoption of modern technologies. Cambodia Economic Update October 2015 >> 29 With more farmers using agricultural chemicals for vegetable and other crop production, the Government would need to strengthen public health regulations related to their safe use and promote alternative programs that ensure safe, effective and environmentally sound pest management. These alternative programs include integrated pest management, where the pest population is controlled through biological controls, cultural practices and the development and use of crop varieties that are pest resistant or tolerant. d) Improving Agricultural “Public Goods” Investment Future agricultural growth will need to come from productivity improvements, commercialization, and diversification, all of which strongly depend on effective “public goods” investment in agriculture. The relatively small size of most farms in Cambodia and their large numbers (about 50 percent of farms in Cambodia are up to 1 ha) require more resources for service provisions than in countries with large farms and few farmers. Public programs proven worldwide to contribute to long-term agricultural growth include those for irrigation, research, extension, education, vocational training, food safety, and provision of market information. While these programs exist in Cambodia, they have little to show in terms of their contribution to past agricultural growth. The main reason for this is their low efficiency and effectiveness. Many programs are poorly designed and have a weak implementation record. Most expenditure goes towards capital and wages, with little spent on operations and maintenance. Relatively low funding levels are another reason for the weak record of some of these programs in Cambodia. Agricultural extension needs more attention. This program is critical to strengthen farmers’ skills and knowledge to adopt modern farm practices and diversify their rice-based farming systems. The recently adopted Agricultural Extension Policy creates the good enabling environment to pilot alternative approaches to deliver extension services, including through subcontracting of private sector for service provision. Moreover, extension needs to become more gender sensitive as female-headed households and women in male-headed households have different needs than men due to the different roles they play in agricultural production, and given women’s time constraints and limited mobility that affects their access to training. Irrigation investments deserve special attention. Without reliable access to affordable water in a tropical country such as Cambodia, it is hard to expect intensification and commercialization. Farmers’ access to water in the dry season, when it is mostly needed, has improved only marginally. Irrigation coverage in Cambodia is among the lowest in Asia, despite the fact that most resources allocated to irrigation investments have been spent on primary infrastructure. While irrigation coverage needs to be further expanded, this expansion needs to go hand-in-hand with the extension of secondary canals, the rehabilitation and upgrading of the existing systems, investments in participatory management of irrigation and drainage infrastructure and better coordination of irrigation/flood management with the delivery of other agricultural public services. Cambodia Economic Update October 2015 >> 30 Greater attention is also merited to the integrating of small farms into modern food value chains. Public extension services are especially important for these farms because they are unlikely to receive sufficient extension services from the private sector, while without improved farm management skills and information they will stay poor and vulnerable, disconnected from economic transformation processes. Small farms, including households participating in social land concessions, can be supported through public services to facilitate stronger links with the agribusiness and agro-processing industry, through productive partnerships (e.g., contract farming and farmer organizations), training in business and other skills, and the provision of market information. e) Helping Develop the Agribusiness and Agro-processing Industry Although development of the agribusiness and agro-processing industry should be considered part of the improvement in the overall business environment in Cambodia, several areas with a strong impact on agribusiness development will involve government action. These include investments in: (i) increased access to and reduced costs of electricity (one kilowatt of electricity in Cambodia costs between US$0.16 and US$0.23 compared to US$0.13 in Thailand and US$0.08 in Vietnam), to increase profit margins in the processing industry and stimulate private investments; (ii) better food safety and sanitary and phytosanitary capacity, to help Cambodian firms meet importers’ requirements and capture foreign markets and help them to compete with the increasing food imports triggered by Cambodians’ rising incomes and demand for more diversified diets; (iii) export logistics, to reduce transaction costs; and (iv) improved access to finance, including through warehouse receipts, to create new investment opportunities for the processing and trade industry. Future agricultural growth at the previous high rates and further structural transformation are possible in Cambodia. Slower agricultural growth cannot become the new normal. More attention to sustainability, the quality of agricultural services, an enabling policy environment, and implementation will be critical in turning these possibilities into reality. It is well worth trying. Cambodia Economic Update October 2015 >> 31 Cambodia: Key Indicators 2012 2013 2014 2015p 2016f 2017f Output, Domestic Demand and Prices Real GDP (% change yoy) 7.3 7.4 7.1 6.9 6.9 6.8 Domestic demand (% change yoy) 14.9 12.1 12.4 11.0 10.7 11.1 Consumer price index (eop, % change yoy) 2.5 4.6 1.2 1.5 2.0 2.0 Public Sector (% of GDP) Government revenues 15.3 15.1 16.6 16.9 16.5 17.0 Government expenditures 21.0 21.5 20.1 20.6 20.5 21.0 Government balance excluding grants -5.7 -6.4 -3.5 -3.7 -4.0 -4.0 Government balance including grants -3.3 -2.7 -0.3 -1.6 -2.0 -2.3 Foreign Trade, BOP and External Debt (in millions of US dollars, unless otherwise indicated) Trade balance -2,455.7 -2,598.4 -3,010.7 -3,129.1 -3,536.0 -4,058.1 Exports of goods 5,632.8 6,890.2 7,569.1 8,289.2 9,135.1 10,033.2 (% change yoy) 7.9 22.3 9.9 9.5 10.2 9.8 Key export (% change yoy) 1/ 7.0 17.6 11.7 12.0 14.0 14.0 Imports of goods 8,088.5 9,488.6 10,579.8 11,418.3 12,671.1 14,091.3 (% change yoy) 20.6 17.3 11.5 7.9 11.0 11.2 Current account balance 2/ -1,376.0 -1,639.0 -1,793.7 -1,920.4 -2,033.2 -2,274.7 (% GDP) -9.7 -10.7 -10.8 -10.5 -10.3 -10.6 Foreign direct investment 1,697.9 1,826.1 1,676.9 1,549.5 1,652.9 1,747.7 External debt 4,547.4 5,110.7 5,555.4 6,020.0 6,469.3 6,894.5 (% GDP) 32.1 33.3 33.4 32.8 32.8 32.2 Debt service ratio (% exports of g&s) 1.0 1.1 1.3 1.3 1.5 1.7 Foreign exchange reserves, gross 3,463.0 3,642.5 4,657.9 5,665.2 6,398.7 6,847.7 (prospective months of imports of g&s) 3.1 3.5 4.1 4.5 4.5 4.4 Financial Markets Domestic credit (% change yoy) 29.6 28.6 28.4 27.0 25.8 25.0 Short-term interest rate (% p.a.) 11.6 11.3 11.5 12.0 12.2 11.8 Exchange rate (Riel/US$, eop) 3,995.0 3,995.0 4,075.0 4,054.0 4,058.0 4,062.0 Real effective exchange rate (2010=100) 105.4 109.9 112.1 113.5 115.5 117.8 (% change yoy) 0.5 4.3 2.0 1.3 1.7 2.0 Memo: Nominal GDP (in millions of US dollars) 14,188 15,362 16,623 18,363 19,711 21,412 Sources: The authorities, IMF, and World Bank staff estimates f = forecast p = projection 1/ Garments 2/ Excluding official transfers. Cambodia Economic Update October 2015 >> 32 The World Bank Cambodia Country Office 113 Norodom Blvd., Phnom Penh, Cambodia Tel: (855-23) 861 300 Fax: (855-23) 861 301/302 Website: www.worldbank.org/cambodia