91023 CLEAR SKIES C AMBODIA E CONOMIC U PDATE O CTOBER 2014 @ All rights reserved This Cambodia Economic Update is a product of the World Bank. The findings, interpretations, and conclusions expressed in the 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 Enrique Aldaz-Carroll, Macroeconomics and Fiscal Management Global Practice (MFM GP), Cambodia Country Office, the World Bank. Linna Ky served as research assistant. The team worked under the guidance of Mathew A. Verghis, Practice Manager, MFM GP. Munichan Kung, Urban Rural and Social Development GP, contributed to the selected issue on the ‘Cambodia Rice Sector’ for the update and Julian Latimer Clarke, Trade and Competitiveness GP, contributed to the selected issue on the ‘Investment Climate Assessment.’ 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 Economic Update by the East Asia MFM GP of the World Bank. We received valuable comments and suggestions from colleagues, namely Shabih Ali Mohib, Country Management Unit, Sergiy Zorya, Agriculture GP, and Samsen Neak, Poverty GP. We are also grateful for insightful comments and suggestions provided by Ratchada Anantavrasilpa and James Seward, Finance and Markets GP. The report 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 the CEU. The Cambodia 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 Cambodia Economic Update 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 Executive Summary ...................................................................................................................................... 1 Recent Economic Developments .................................................................................................................. 1. Real sector ............................................................................................................................................. a) Garments ........................................................................................................................................... b) Construction and real estate .............................................................................................................. c) Tourism ............................................................................................................................................. d) Agriculture ........................................................................................................................................ 2. External sector..................................................................................................................................... a) Exports ............................................................................................................................................ 1 b) Imports ............................................................................................................................................13 3. Inflation ............................................................................................................................................... 1 4. Monetary sector................................................................................................................................... 1 a) Monetary aggregates, interest rates, and exchange rates ................................................................ 1 b) The banking sector .......................................................................................................................... 1 5. Fiscal sector......................................................................................................................................... 1 a) Revenue composition...................................................................................................................... 1 b) Expenditure composition ................................................................................................................ 1 c) Fiscal balance .................................................................................................................................. 1 Key messages and recommendations ......................................................................................................... 1 Selected Issue 1 – Making the most of the Cambodian Rice Sector .......................................................... 2 1. Motivation ........................................................................................................................................... 2 2. Rice production and processing .......................................................................................................... 2 3. Rice exports......................................................................................................................................... 2 4. Export procedures and logistics .......................................................................................................... 2 5. Rice prices........................................................................................................................................... 2 6. Conclusion .......................................................................................................................................... 2 Selected Issue 2 – Creating Opportunities for Firms: Findings from the Investment Climate Assessment 2 1. Motivation ........................................................................................................................................... 2 2. Progress and remaining constraints..................................................................................................... 2 3. Proposed next steps in reforming the business environment .............................................................. 2 Cambodia: Key Indicators .......................................................................................................................... Executive Summary in 2011. However, the pace of poverty reduction in 2011-12 is slower than that seen during 2004- 11, when poverty fell by 4.7 percentage points per year on the back of increases in rice prices, Economic growth has held up well despite which helped the rural poor. domestic uncertainty and instability in neighboring countries. Real growth for 2014 is This year’s continued healthy economic estimated to reach 7.2 percent, driven by the growth is underpinned by stable external garment, construction, and services sectors. sector performance on the back of rising FDI Overall macroeconomic management has been inflows that help largely finance a slightly good with fiscal consolidation underpinned by widened current account deficit contributing improved revenue administration. In 2015, with to an increase in international reserves. the expectation of renewed confidence and the Garment export growth has continued while FDI return of political stability after ending a year- inflows are rising due to the return of relative long political deadlock in July 2014, bolstered by labor market stability and investors’ renewed a strengthening global economy, Cambodia’s real appetite for the construction and real estate economic growth rate is expected to reach 7.5 sector, leading to growing construction materials percent, similar to that of 2013. The downside imports. Consumption goods imports have also risks to the projected robust growth are a picked up, driven largely by vehicle and potential recurrence of labor unrest, natural petroleum products. The current account deficit disasters, especially the possibility of heavy is projected to reach 11.3 percent of GDP, floods, as well as regional political uncertainty. slightly larger than the 10.7 percent estimated for 2013, largely financed by FDI. Gross Recent Economic Developments international reserves, therefore, rose to US$4.2 billion or about 3.5 months of imports by mid- Garments continue to be Cambodia’s key 2014, from US$3.6 billion or 3.4 months at the engine of growth, while construction end of 2013. overtook the decelerating tourism and crops sectors as the second most important growth Though there has been a slight increase in driver. The garment sector grew at a year-on- inflation, price stability remains within year growth rate of 14.1 percent by mid-2014, acceptable levels fostering economic supported by an improved global economic expansion and supporting poverty reduction. environment and greater labor market stability. Inflation rose to 4.9 percent year-on-year by mid- Construction has picked up on the back of 2014, slightly higher than the 4.6 percent at the renewed domestic confidence, overtaking end of 2013. The prices of most staple food tourism and crops. Services sector growth items remain stable, although prices of some remains robust although tourism sector growth food items, such as meat and fruit, and other has decelerated with a year-on-year arrival growth non-food items, such as utilities, are inching up rate of only 5.2 percent during the first six gradually. Regional and other developing-country months, owing to political turmoil in neighboring inflation remains benign. Thailand and tensions between Vietnam and China. Agricultural growth has also decelerated, Private sector deposit growth has picked up as world agricultural prices have been easing. swiftly thanks to renewed confidence on the economy, contributing to greater stability in Poverty reduction continued, thanks to the banking sector. Private sector deposits strong growth, but at a slower pace than picked up sharply, reaching US$8.09 billion or a before. The poverty rate fell to 18.6 percent in 22.2 percent year-on-year increase by mid-2014, 2012, down 1.9 percentage points from its level compared with US$6.88 billion, or 14.2 percent 1 year-on-year growth by the end of 2013. Credit Outlook, Emerging Challenges and growth also moderated, falling to 21.8 percent Recommendations year-on-year from 26.7 percent during the same period. Increased deposit growth together with The outlook for growth appears promising moderated credit growth, resulted in the loan-to- with renewed domestic political stability, deposit ratio decreasing to 82.2 percent by mid- strengthened recovery in the United States 2014, down from 90 percent at the end of 2013. (US), and returning stability in Thailand all The short-term borrowing rate declined slightly, supporting GDP growth to reach 7.5 percent reaching 11.2 percent by April 2014, compared in 2015, similar to that of 2013. The prospects with 11.3 percent at the end of 2013, as a result for garment exports remain positive, while of heightened competition among banks. vibrant activity in the construction and services sectors is also expected, as well as a recovery of The riel continues to hover around riel the tourism sector thanks to greater stability in 4,000/US$ due to exchange rate targeting, Thailand. Agricultural sector growth, however, resulting in a slight appreciation of the real will likely continue to be affected by dampened effective exchange rate. The riel reached agricultural commodity prices in the international 4,040/US$ by mid-2014, compared with riel market. 3,995/US$ at the end of last year. The exchange rate targeting around riel 4,000/US$ has resulted However, there are downside risks to in a slight appreciation of the real effective forecast growth. These include potential exchange rate, due to the US dollar’s recent renewed labor unrest, rainy season floods, which appreciation against other major currencies such may have a greater negative impact on crops than as the Euro and the Chinese Yuan, which are normal due in part to the El Niño weather also the currencies of Cambodia’s major trading pattern, the further dampening of rice prices with partners. the resumption of Thai rice exports in the third quarter of the year, and potential regional Fiscal performance has been further political uncertainty. strengthened thanks to improved revenue administration; providing additional How can Cambodia maintain and boost financing to support rising essential public economic growth and reduce poverty further? spending without undermining The key challenge will be to stimulate the macroeconomic stability. The overall fiscal agricultural and tourism sectors once again. deficit (including grants) is projected to decline to As highlighted in Selected Issue 1, rice 2.5 percent of GDP in 2014, down from 2.7 production growth has decelerated since 2012 percent in 2013. This improvement is being led and given the land area constraint, its recovery by enhanced revenue collection, which has will depend from now on more on increases in expanded rapidly by rising 21 percent during the rice productivity and quality than on area first four months while expenditure, which was expansion. Measures to increase agricultural initially slow, will likely remain as budgeted. The productivity – including increased public deficit continues to be over-financed by external investment in farm advisory services, seed funds. Government savings, therefore, rose to development and irrigation infrastructure – US$931 million by mid-2014, compared with enhance shock resilience, and open up new US$700 million at the end of 2013. Cambodia’s markets would help the agricultural sector debt distress rating, as assessed by the joint rebound. Improving rice milling and logistics World Bank/IMF debt sustainability analysis costs would help address the two main reasons (DSA) conducted in 2013, remains low. for Cambodian rice losing the competitiveness that it has at farm gate prices. Improved access to finance for rice producers and millers and 2 reduced costs of doing business would help reach a conclusive and transparent process in increase milling volumes and reduce milling tripartite minimum wage negotiations for the costs. Improving logistics will also enhance the garment sector. This will also help attract competitiveness of agricultural production and additional foreign investment projects relocating exports helping Cambodia get closer to its one from more advanced economies in the region. million rice milled export target. Improved road transportation, together with greater coordination Safeguarding stability in the financial sector of efforts between central and local governments, through enhanced banking supervision will the private sector and local communities, would help prevent a bubble in the construction and help promote diversification of tourist real estate sectors, while also strengthening the destinations beyond the Angkor Archeological country's resilience in facing possible higher Park. volatility in international financial markets. Facilitating the growth of the manufacturing More broadly, increasing capital investment, sector will also be instrumental to maintain deepening structural reforms, and improving and boost economic growth. As highlighted in formal and vocational education will help the Selected Issue 2, the latest Enterprise Survey Cambodia return to a higher growth path. of the forthcoming Investment Climate Further broadening the tax base and Assessment indicates that the business strengthening tax administration will help finance environment continues to hamper the this much needed development spending. The competitiveness of firms in Cambodia. The key successful implementation of reforms would help constraints for firms continue to be electricity investment increase by more than 5 percentage cost and access, informal payments and points of GDP and allow Cambodia to attain a uncompetitive practices. The survey also shows GDP growth path above 8 percent. that Special Economic Zones (SEZ), which were meant to provide an improved business The development of very specific reform environment, are not yet delivering the benefits agendas with targets linked to priority expected by foreign investors. The present robust reforms and a strong monitoring framework economic growth therefore presents an would help enhance the effectiveness of opportunity to improve the business government implementation. The Royal environment by addressing the high cost of Government of Cambodia’s (RGC) new five-year electricity with transparent solicitation; Rectangular Strategy (RS) III, clearly identifies continuing the automation of business processes; the development challenges and priorities for the improving trade facilitation; increasing the country. The development of very specific and attractiveness of SEZs; completing competition detailed action plans linked to the priorities and and investment laws that enhance the investment the establishment of a strong monitoring system climate; and simplifying business registration. To to check regularly performance, would help further strengthen exports by maximizing the Cambodia address development challenges and benefits from the global recovery, it is also meet its priorities more effectively. important to maintain political stability and to 3 Recent Economic Developments preferential treatment provided by the European Union (EU) and the return of labor market stability; continued strong construction activity; and robust services sector growth with an 1. Real sector expected rebound in the tourism sector. However, there are downside risks to forecast 1. Economic growth remains robust and growth, including rainy season floods that may real growth for 2014 is estimated to reach 7.2 have a greater negative impact than normal due percent as earlier projected, which is below in part to the El Niño weather pattern, the the 2013 growth rate of 7.4 percent (Figure 1). resumption of Thai rice exports in the third Garment export growth has continued with a quarter of the year that may further dampen rice year-on-year growth rate of 14.1 percent by mid- prices, and potential regional political tensions. 2014 supported by an improved global economic environment and greater labor market stability. Renewed confidence and the return of greater Figure 1 labor market stability fueled construction sector growth with the value of approved construction permits reaching US$2.5 billion, or a 30.5 percent year-on-year increase by mid-2014. Economic activity in the services sector remains robust, although tourism sector growth decelerated with a year-on-year arrivals rate of only 5.2 percent during the first six months, owing to instability in neighboring countries. The agriculture sector has expanded only moderately with easing agricultural prices and a slowdown in growth of rice yields and cultivated area. 2. Owing to renewed domestic and regional political stability, and strengthened recovery in the US, the real growth rate for 3. High economic growth is still 2015 is expected to fully recover and reach 7.5 contributing to poverty reduction but at a percent, similar to that of 2013. The favorable slower pace than before. The poverty rate fell outlook is predicated on an anticipated garment to 18.6 percent in 2012, down 1.9 percentage export expansion thanks to consumer growth in points from its level in 2011. However, the pace the US, the “Everything But Arms” (EBA)1 of poverty reduction in 2011-12 is slower than that seen during 2004-11, when poverty fell by 1 4.7 percentage points per year on the back of The EU’s “Everything But Arms” (EBA) arrangement was established in 2001 to give all least developed countries (LDCs) full duty free and increases in rice prices, which helped the rural quota-free access to the EU for all their exports with the exception of poor. arms and armaments. There are currently 49 beneficiaries under this arrangement. A new Generalized Scheme of Preferences (GSP) was established in the EU as of 1 January 2014. Under the new GSP, the a) Garments effectiveness of the EBA scheme has been strengthened. By focusing preferences on those that need them most (lower-income economies and LDCs), the new GSP now has fewer beneficiaries. When countries 4. The garment sector has held up well successfully move up the development ladder, their efforts are recognized despite labor-force instability and political and they are no longer considered ‘least developed’ by the UN. Thus, EBA preferences are no longer required. The smooth progression into uncertainty earlier this year (Figure 2). this change in status is guaranteed by a transition period of three years, Garment production, which is almost entirely during which time EBA preferences will continue to apply. This helps mitigate possible trade flow shocks. (Source: exported, has continued to expand and the sector http://trade.ec.europa.eu/doclib/docs/2013/april/tradoc_150983.pdf). It is difficult to estimate the date when Cambodia will exit EBA as the UN determines graduation from ‘least developed’ status based on the vulnerability (Economic Vulnerability Index). Cambodia could exit the evolution of three indicators: GNI per capita, a measure of human EBA arrangement around the early 2020s. development (Human Assets Index) and a measure of economic 5 continues to attract investment. Strong garment Cambodia (CDC) (Figure 4) surged, reaching exports continue, reaching US$2.6 billion, or a US$2.5 billion, or a 30.5 percent year-on-year 14.1 percent year-on-year increase by June 2014, increase, and US$258 million, or a 144 percent compared with US$2.3 billion, or a 17.4 percent year-on-year increase, by mid-2014, respectively. year-on-year increase over the same period last The expansion of the construction and services year. In value terms, the share of garment exports sectors against the backdrop of moderated to the EU of 37 percent of total garment export tourism sector growth reflects a substantial boost value surpassed that of the US, at 36 percent, in investors’ confidence in the economy. during the first half of 2014. In volume terms, the share of garment exports to the US remains 6. It is crucial, however, to mitigate the highest, at 46 percent of total garment export potential risks associated with construction volume, while the EU share is second, at 34 and real estate growth. The expansion of the percent. This continues to reflect the strategy of sector has just started and is being financed exporting high-end garment products to the EU largely by FDI inflows with a diminishing role of to benefit from the EU’s EBA preferential domestic credit, which grew at a slower pace treatment. during the first half of 2014 (see the section on the monetary sector below for more details). Garment export growth continues to underpin real While the recent recovery in the construction and Figure 2 economic growth. Garment exports (YTD, US$ million) real estate sector is a welcomed development, this expansion poses potential key risks associated with: (1) the intrinsic cyclicality of construction; (2) the high FDI share – vulnerability if and/or when FDI recedes; (3) speculative bubbles; and (4) typical challenges facing land policy for growth, transparent land management, poverty reduction, and shared prosperity. International experience shows construction driven growth is volatile and less equitable, which suggests the desirability of guarding against an unsustainable construction boom. b) Construction and real estate Figure 3 Renewed appetite for construction projects in 2014. Construction approval permits (YTD, y/y % change) 5. As political stability has returned, investors’ renewed appetite for medium-to large-scale construction projects in the services sector, especially in the retail and financial sub-sectors, as well as office and residential development, has emerged. This has contributed to the recent significant expansion of the construction and real estate sector. The value of construction permits (Figure 3) issued by the Ministry of Land, Construction and Urbanization, and that of investment projects (fixed assets) in the tourism sector approved by the Council for the Development of 6 Figure 4 Tourism projects (fixed assets) are rising after 8. Chinese and South Korean tourist negative growth last year. Approved tourism sector arrival growth has slowed significantly while related projects (YTD, y/y % change) arrival growth from Japan has been sustained (Figure 6). This appears to reflect a recent development that Cambodia has become more attractive to Japanese tourists and investors. Figure 6 Japanese arrivals have posted gradual growth while South Korean and Chinese arrivals have slowed significantly. (Year on year, % change) c) Tourism 7. Due to the recent political turmoil in Thailand and the tensions between Vietnam and China, tourist arrival growth has moderated, reaching only 5.2 percent during the first half of 2014, compared with 19 percent during the same period last year Source: Ministry of Tourism (Figure 5). The negative impacts have largely affected arrivals by land, which account for about d) Agriculture half of total arrivals. As a result, during the first half of 2014, Vietnamese tourist arrivals (97 9. Agriculture growth has continued, but percent of whom arrive by land), which grew by at a slower pace, as expansion of cultivated 9 percent in 2013, stagnated, while Chinese areas and yields, particularly in the case of tourist arrivals (90 percent of whom arrive by rice, has slowed during the past two years air), which grew by 55 percent in 2013, (Figure 7). In 2013, growth became negative for moderated, growing at 19.1 percent. Cambodia is dry season rice, which accounts for about 23 more often than not just one part of a regional percent of total rice production. Lower tourist’s visit (combined with Thailand and/or agricultural prices, especially for rice, not Vietnam). With both Vietnam and Thailand compensated by reductions in production and becoming uncertain destinations, this has also marketing costs, adversely affect agriculture made trips to Cambodia less attractive. sector growth and rice exports. Other key agricultural commodities, such as rubber and Figure 5 cassava, have also been affected by softer agriculture commodity prices. Rice prices are not expected to increase substantially in the near future because international price volatility for most commodities has now returned to historical norms. See Selected Issue 1: Making the most of the Cambodian Rice Sector, for an in-depth discussion on rice prices, production, processing, and exports. 7 Figure 7 Development of the tourism sector Box 1 Cambodia has only started to fully realize the potential of its tourism sector since the past decade or so. Although the country is endowed with countless attraction sites, which include historical, cultural, and natural destinations, the development of Cambodia’s tourism sector has been relatively new. In 1993, a newfound peace with the first general election helped Cambodia attract about 100,000 visitors (Figure B1.1), representing only 2 percent of the total international arrivals visiting Thailand (Figure B1.2). Cambodia arrivals, however, have risen rapidly during the past 10 years, reaching 15 percent of the total of Thailand’s arrivals by 2013. It is estimated that the tourism sector directly creates 300,000 jobs and indirectly generates another 10. It is important to uncover the reasons 700,000 jobs. Therefore, the combined direct and indirect employment created by the sector covers 15 percent of the behind the deceleration in dry season rice total employment in Cambodia or more than half of the total production. Dry season rice production growth, jobs employed by the services sector. The year-on-year which peaked in 2011, has decelerated since and arrival growth of Cambodia appears to follow Thailand’s at became negative last year (Figure 8). As this has least during the past decade, although it reflects some level occurred against a backdrop of continued efforts to of uncertainty for international arrivals during general election years (Figure B1.3). Unlike Thailand, where 80 improve irrigation and agricultural extension— percent of tourists prefer sea-sun-sand and nature-based among the key priorities under the RGC’s new five- destinations, Cambodia’s most attractive site is the Angkor year RS III—additional analysis would be needed to Archeological Park (AAP), the magnificent remains of the uncover the reasons behind this deceleration. A different capitals of the Khmer Empire, from the 9th to the study conducted jointly by the World Bank, 15th century. Tourists traveling by air account for only about 50 percent of total arrivals for Cambodia. Arrivals from AusAID, and the RGC in 2011 recommended Vietnam have been the largest (20.3 percent in 2013) (arrivals improving funding for agricultural research, from China and South Korea are next) and almost all of the increasing the effectiveness of irrigation investments Vietnamese tourists (97 percent) arrive by land. This by rehabilitating tertiary canals, and providing highlights the importance of building and maintaining sufficient investment for maintenance of irrigation adequate infrastructure linking Cambodian-Vietnamese border crossings to tourist attraction sites such as Angkor systems and for agricultural extension.2 However, it Wat. For Thailand, however, tourist arrivals by air have been is not clear to what extent the recommendations as high as 65 percent; and arrivals from China (Malaysia and have been successfully implemented. Russia are next) have been the largest (17.3 percent in 2013). Figure 8 Cambodia’s total tourism receipts (direct contribution) are estimated to reach US$2.5 billion (or 16 percent of GDP) in 2013 or US$605 per tourist while Thailand’s is US$39.2 billion (or 10 percent of GDP) or US$1,479 per tourist. Visitors coming to Cambodia only stay an average of 6.7 days and spend US$120 per day whereas those visiting Thailand stay 9.8 days and spend US$150 per day. Return tourists cover only 16 percent for Cambodia versus 50 percent for Thailand (Table B1.1). The main reasons why international tourists return to Thailand are: (i) destination attractions, including opportunities for adventure, exciting entertainment, friendly people, safety, and attractive sightseeing; and (ii) food attractions that cover a variety of food, cultural experiences, local ingredients, tasty, nourishing and unique food, and high levels of food hygiene. 2 Cambodia More Efficient Government Spending for Strong and Inclusive Growth, Integrated Fiduciary Assessment and Public Expenditure Review, November 2011, The World Bank. 8 Box 1 Development of the tourism sector (continued) There is plenty of room to further develop the tourism sector to increase its contribution to growth, shared prosperity and poverty reduction, and the public sector is well placed to undertake or help facilitate this development. As the experience of Costa Rica shows, the diversification of tourist sites to tap the huge potential of coastal areas as well as the potential for eco-tourism in rural areas will help expand the tourism sector and share its benefits across the country, generating jobs for local communities and contributing to reduce poverty and vulnerability. Implementing successfully the key activities and targets set in Cambodia’s 2012-2020 Tourism Development Strategic Plan (TDSP) will provide a sound basis, though more can be done to ensure greatest impact. While the TDSP’s focus on connecting and facilitating air travel will help increase tourist arrival numbers, a larger impact can be obtained by simultaneously developing physical infrastructure, particularly publicly financed paved and rural roads, as half of total arrivals is via land. Facilitating the development of privately financed hospitality and logistics support services will also be key to support tourism diversification and expansion. It is thus important to clearly define the roles of the public sector, local authorities, private sector and local communities, and to establish a well-functioning coordination arrangement to prioritize, implement, and monitor key activities and targets. For instance, efforts have been made to rehabilitate and expand a number of highways linking Cambodia to Thailand and Vietnam, but without sufficient coordination and prioritized resource allocation, maintaining the rehabilitated and expanded highways including its tourist information, rest stops, and toilet facilities in decent shape will likely remain a challenge. Similarly, central and provincial authorities have been making good efforts to strengthen safety, security, and the environment to attract tourists, but without the active participation of the local community those efforts may not be as effective. Coordination also at the regional level will help increase the attractiveness of joint tour packages. For instance, combining eco-tourism, cultural and beach packages with neighboring countries will attract tourists visiting the region to also come to Cambodia. As shown in Figure B1.2, the dependency of Cambodia‘s relatively new tourism sector on Thailand’s more developed tourism sector points out to the importance of close cooperation between ministries, agencies and private sector of the two countries. Closely follows (and reflects its dependency on) the trend Figure B1.1 Cambodia’s international tourist arrival Figure B1.2 & seasonal patterns of Thailand's arrivals. continues to rise. (In million of tourists) Arrivals to Cambodia (KHM) and Thailand (THA) 3.0 0.55 30 (In million of tourists) 2.5 25 Cambodia Thailand THA KHM (RHS) 0.45 2.0 20 0.35 1.5 15 0.25 1.0 10 0.15 0.5 5 0.0 0.05 - Jan-05 Nov-05 Feb-07 Oct-08 Jan-10 Nov-10 Feb-12 Oct-13 Jun-05 Jul-07 Mar-09 Aug-09 Jun-10 Jul-12 May-08 Mar-14 May-13 Apr-06 Apr-11 Sep-06 Dec-07 Sep-11 Dec-12 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Figure B1.3 It is increasing as a share of Thailand's Table B1. 1 international tourist arrival. Tourism sector highlights Cambodia Thailand Total arrivals (2013, in million of tourists) 4.2 26.5 18 by air (percent of total) 50.0 65.0 Estimated tourism receipts/direct 16 contribution (2013, in US$ mln) 2,547.0 39,282.3 14 Cambodia arrival (as % Thailand arrival) In percent of GDP 16.0 10.0 Per visitor 605.0 1,479.7 12 Per day 120.7 150.2 10 Estimated tourism indirect contribution 8 (2012, in US$ mln) 3,600.0 61,000.0 In percent of GDP 25.4 16.7 6 Length of stay (days) 6.7 9.8 4 Return visitors (percent of total) 16.0 50.0 2 Employment ('000 jobs) 1,083.4 6,838.6 0 Direct 320.1 2,019.9 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Indirect 763.3 4,818.7 Source: Ministry of Tourism, Cambodia; Ministry of Tourism and Sports, Thailand; World Travel and Tourism Council (Travel and Tourism Economic Impact 2013 Thailand); and Bank staff estimates 9 Box 2 Cambodia Joins the Olympians of Growth Cambodia has grown at a yearly average growth rate of 7.7 percent for two decades now making it the sixth fastest growing country in the world over that time period. Cambodia’s performance is impressive as very few countries in the world have experienced consistently high growth rates over several decades. The more typical pattern is for countries to experience phases of growth, stagnation, or decline of varying length. 1 In fact, as noted by the Growth Commission (2008), since 1950 only 13 economies in the world have grown at an average rate of above 7 percent a year for 25 years or longer. At such a pace of growth, the economy almost doubles in size every decade. 2 Cambodia’s high growth is all the more impressive because of its resilience. In addition to growing at a fast average rate, it has maintained a fairly constant growth over the period. This sets Cambodia apart from countries such as Equatorial Guinea, Liberia, Angola and Cape Verde that are among the top 5 fastest growing countries over the past 20 years but have not experienced such constant growth, and instead puts it in the same group as China, which is among the top 5 fastest and has also experienced constant growth. This box measures the growth resilience of fast growing countries and categorizes those most resilient as the “Olympians of growth”. Countries with resilient growth are considered to be those with medium-run growth rates that rank among the highest in the world every year for a two decade period. Those with a consistent ranking among the top 40 (the top quartile of the sample) are named the Olympians of growth. The medium-run GDP yearly growth rate (also known as growth trend) is estimated by calculating yearly growth rates on five-year moving average GDP data.3 Moving averages are used to smooth out short-term GDP fluctuations and show medium-run trends. GDP is measured in constant 2005 US$ for 160 countries from 1993 to 2013. The attractiveness of this proposed definition of dynamism is that it looks at a country’s growth relative to that of other countries and thus controls for periods of global crisis when countries typically experience lower growth. To use a metaphor, a fast and resilient runner is one who outruns other runners come rain or shine. Resilient fast growth over a period is more desirable from a development perspective than high growth over a period achieved with intermittent growth. The two main reason for this are firstly, that resilient growth provides more time for institutions to adapt to change, for resources to be better deployed, and for technological change to be better mastered (Growth Commission 2008), and secondly that intermittent growth is likely to be less poverty reducing as the poor are more vulnerable to growth shocks than the non-poor population because they have less shock cushion (savings and assets). Thanks to its high resilient growth over the last two decades Cambodia is part of the select group of “Olympian s of growth.” Cambodia is among the group of eight countries and is accompanied in the region by China, Lao PDR and Vietnam (Figure B2.1). Figure B2.1 Medium-run GDP yearly growth rates of the Olympians of growth China Lao PDR Mozambique Bhutan Cambodia India Vietnam Uganda 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: World Development Indicators. 1 Commission on Growth and Development (2008) The Growth Report: Strategies for Sustained Growth and Inclusive Development. Washington, D.C.: World Bank. Hausmann, Pritchett, and Rodrik (2005). "Growth Accelerations", Journal of Economic Growth, Springer, vol. 10(4), pages 303-329. 2 Average growth rates in this box are measured using geometric averages. 10 Box 2 Cambodia Joins the Olympians of Growth (continued) Cambodia’s growth has been driven by four engines. These four engines of growth are: garment exports, tourism, crops and construction/real estate. Growth was spurred by both factor accumulation and productivity gains, which were favored by an expansion of international trade and sustained investment. Growth decomposition shows that factor accumulation contributed, on average, about 4 percentage points to potential GDP growth, with roughly equal contributions from capital (2 percentage points) and labor accumulation (2 percentage points) over the 1987 –2011 period. Growth in productivity contributed about 3 percentage points to potential GDP growth on average, and has been a relatively stable source of growth for Cambodia.4 Cambodia’s dynamism has slowed since the global financial crisis, raising questions over the continuity of its high growth path. Cambodia's medium-term growth, which ranked consistently among the top 10 fastest countries before the 2008/9 global crisis, has fallen down into the top 20 after the crisis, with a slower pace of growth than the above 8 percent growth experienced before (Table B2.1). This is in contrast to the case of its neighbor, Lao PDR, which has seen its medium-term growth and rankings further improve to the top 10 on the back of increased investment, unlike Cambodia, which has experienced a slowdown in investment growth (Figure B2.2). Table B2.1 Cambodia’s GDP growth rate, its growth trend and its global ranking 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Cambodia's annual GDP 6.4% 5.4% 5.6% 5.0% 11.9% 8.8% 8.0% 6.7% 8.5% 10.3% 13.3% 10.8% 10.2% 6.7% 0.1% 6.0% 7.1% 7.3% growth Cambodia's growth trend 6.6% 6.2% 7.0% 7.5% 8.0% 8.0% 8.6% 8.5% 9.6% 10.1% 10.7% 10.0% 7.6% 6.4% 5.9% 5.5% 5.7% 6.8% Ranking of Cambodia's growth trend among rest of 27 17 12 7 9 10 7 10 10 8 8 9 14 26 34 36 29 20 the world Source: World Bank staff calculations using World Development Indicators data. Figure B2.2 Gross capital formation as a share of GDP decreased in Cambodia after the 2008 crisis, unlike in Lao PDR where it is increasing 50 China 40 Cambodia Lao PDR 30 Vietnam 20 10 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -10 3 The analysis was replicated with a three-year moving average (instead of a five-year moving average) and the results were not significantly different. 4Based on growth decomposition performed by Phurichai Rungcharoenkitkul (2012) “Modeling with Limited Data: Estimating Potential Growth in Cambodia,” IMF Working Paper WP/12/96, www.imf.org/external/pubs/ft/wp/2012/wp1296.pdf The potential GDP growth is estimated modeling output as a simple Cobb-Douglas aggregate production function with physical capital stock, labor input and a Hicks-neutral productivity term. 11 Box 2 Cambodia Joins the Olympians of Growth (continued) Cambodia aims to shift its economy towards an 8-percent-GDP growth track over the next decade. Some refer to such a pace as a “growth miracle” but, as the Growth Commission (2008) notes, fast sustained growth should not be considered a miracle; it is attainable by countries that possess favorable factors, and deploy the right set of policies to seize opportunities and overcome challenges. Increasing factor accumulation (particularly capital and skilled labor) and factor productivity is key for greater growth. Implementing Cambodia’s development reform agenda with renewed vigor, particularly on the business climate, would help the capital-to- GDP ratio to increase by the 5 percentage points needed to achieve a GDP growth rate of 8 percent (see business climate recommendations in the Selected Issue 2 Creating Opportunities for Firms: Findings from the Investment Climate). Trade deficit widens due to rising imports 2. External sector Figure 9 more than offsetting export growth. (USD million) 11. This year’s continued healthy 10,000 Other exports garment export 0 economic growth is underpinned by stable Trade deficit (RHS) -500 external sector performance on the back of 8,000 -1,000 rising FDI inflows that help largely finance a 6,000 slightly widened current account deficit -1,500 contributing to an increase in international 4,000 -2,000 reserves. The current account deficit (excluding -2,500 official transfers) which remains relatively large is 2,000 projected to reach 11.3 percent of GDP due to -3,000 rising imports and slower (travel) services 0 -3,500 2008 2009 2010 2011 2012 2013 2014p receipts more than offsetting export growth. Source: National Bank of Cambodia and World Bank staff projections Although this year’s current account deficit is slightly larger than the 10.7 percent of GDP estimated for 2013, it continues to be financed year increase, the fastest growth rate seen during largely by FDI (Figures 9 and 10) which is the post-crisis period. GIR were previously considered as less volatile than other forms of stagnant, averaging around US$3.6 million (or 3.4 capital inflows such as portfolio and short-term months of imports) in 2013 due in part to inflows. FDI inflows are increasing with the political uncertainty. return of greater labor market stability and investors’ renewed appetite for the construction and real-estate sector, leading to rising construction materials imports. Consumption goods imports have also picked up, driven largely by vehicle and petroleum product imports. The increased FDI contributed to an increase in gross international reserves (GIR). GIR are often used by the central bank to maintain exchange rate stability (see Monetary sector below for more details). GIR have surged, reaching a record level of US$4.2 billion, or about 3.5 months of imports, by mid-2014, or a 17 percent year-on- 12 Figure 10 Widened current account deficit continues to rising imports of vehicles, petroleum products, be largely financed by FDI inflows. and construction materials, as consumers and Current account and FDI (In percent of GDP) investor confidence has returned. Import growth appears slower than export growth during the first six months but is projected to accelerate during the second half of the year as confidence in the economy was restored with the end of the political deadlock in July this year. 3. Inflation 13. Thought there has been a slight increase in inflation, price stability remains within acceptable levels fostering economic expansion and supporting poverty reduction. Inflation picked up slightly and reached 4.9 a) Exports percent year-on-year by mid-2014, higher than its 4.6 percent value by the end of 2013 (Figure 11). 12. The country’s macroeconomic Prices of most staple food items, which are the stability is maintained partly by its stable main driver of Cambodia’s consumer price index external position backed by continued robust (CPI) covering 43.3 percent weight, remain export growth. Export growth has continued stable. Some food items such as meat and fruit thanks to the steady performance of the labor- and non-food items such as utilities, however, intensive manufacturing exports such as continue to exert inflationary pressure due largely garments and footwear. Exports have been to rising demand. supported by an improved global economic environment, the preferential treatment Figure 11 Contributions to 12-month inflation are Cambodia receives under the EU's EBA scheme, largely driven by food sub-index. (CPI, Phnom Penh) and favorable external financing conditions including increased foreign investment. In value terms, agricultural commodity exports such as rice and rubber, however, continue to be adversely affected by dampened global agriculture commodity prices although their exports continue to grow in volume terms. Nevertheless, total export value in US dollar terms is estimated to have grown by more than 18 percent year-on-year by mid-2014, compared with only 14.5 percent in 2013, thanks to continued healthy garment exports. b) Imports 14. Easing regional country inflation also helps contain inflation in Cambodia. Regional 12. Given Cambodia’s early stage of and other developing country inflation has eased economic development, the rising imports since the second quarter of 2014 (Figure 12). The play an important role in supporting the decline mainly reflects lower inflation in China in rapidly growing service and manufacturing line with slower growth. Stable commodity prices sectors. Import growth is picking up, driven by 13 helped ease inflation among low-income Figure 13 FCD share in BM rose to 84% in June 2014 from 82% at the end of 2013. countries, while policy tightening also contributed to subdued inflation. For several middle-income countries, inflation remains high reflecting pass-through of earlier depreciation. Food price risks related to El Niño weather conditions could also push up inflation. Figure 12 16. The role of the national currency, the riel, has diminished since late 2013 against the backdrop of rising broad money, further undermining the conduct of monetary policy. The contribution to BM growth of 20.8 percent year-on-year by mid-2014 is largely driven by FCD (18.1 percentage points) while the contribution by RIC is only 1.6 percentage points, and the rest is contributed by RD (1.1 4. Monetary sector percentage points) (Figure 14). As confidence in the banking sector returned, FCD growth rapidly a) Monetary aggregates, interest rates, accelerated, reaching 21.8 percent year-on-year and exchange rates by mid-2014, compared with 13.4 percent at the end of 2013. RIC growth, however, decelerated 15. The return of confidence in the to only 12 percent year-on-year from 18.6 economy and the banking system has led to percent during the same period; this reflects a the increase in broad money. Broad money diminishing role of the riel, compared with the (BM) growth picked up, rising by 20.8 percent US dollar—a step backwards on the road year-on-year by mid-2014, compared with only towards dedollarization. 14.6 percent at the end of 2013 (Figure 13). During the same period, the foreign currency 17. The diminishing role of the riel deposit (FCD) share in the BM rose to 84 further undermines the conduct of monetary percent from 82 percent as confidence in the policy. The highly dollarized Cambodian banking system was restored while the share of economy constrains the monetary authorities the riel in circulation (RIC) dropped to 12 from exercising monetary policy needed for percent from 14 percent. The riel deposit (RD) macroeconomic management. Exchange rate share remains at around 4 percent of BM. targeting, which appears appropriate to stabilize prices denominated in local currency, does not encourage dedollarization, and in the present 14 context where Asian currencies are depreciating versus the US dollar, this also hurts Cambodia’s Figure 15 export competitiveness. Although gross international reserves reached a record level of US$4.2 billion, or about 3.5 months of imports, by mid-2014, they remain low by regional standards and particularly in a context where the central bank cannot serve as a lender of last resort due to high dollarization. FCD growth is accelerating as confidence in the Figure 14 banking sector returns. Contribution to broad money growth (y/y % change) Global financial crisis July 2013 election 19. The nominal and real effective exchange rates have experienced a slight appreciation during the first half of 2014. Exchange rate targeting has contributed to a stable riel versus US dollar exchange rate which has hovered at around riel 4,000/US$ for several years. The targeting, however, has resulted in an initial appreciation of the nominal effective 18. Heightened competition among exchange rate (NEER) and real effective exchange rate (REER), as the US dollar has banks has contributed to easing domestic US dollar interest rates, and therefore, reducing recently appreciated against other major currencies such as the Euro and Chinese Yuan, borrowing costs, despite gradual Fed tapering.3 The US dollar (12-month) lending rate the currencies of Cambodia’s major trading partners (Figure 16). The NEER index declined slightly, reaching 11.2 percent by April 2014, compared with 11.3 percent at the end of (2010=100) dropped to 103.3 in May 2014 from 103.9 at the end of 2013, while the REER index 2013 (Figure 15). Although the interest rate spread (the difference between the nominal also shrank to 109.5 from 109.9 during the same period. As the US dollar strengthened, so the lending rate and deposit rate) remains wide, it has been shrinking as result of heightened riel/US$ exchange rate has slightly depreciated, reaching riel 4,040/US$ by mid-2014, compared competition among banks. Capital inflows swiftly recovered after political instability declined earlier with riel 3,995/US$ at the end of 2013. this year and helped ease borrowing costs. 3 According to the Minutes of the Federal Open Market Committee July 29–30, 2014 of the Federal Reserve System (Fed), the Committee agreed that, beginning in August, it would add to its holdings of agency MBS at a pace of $10 billion per month rather than $15 billion per month, and it would add to its holdings of Treasury securities at a pace of $15 billion per month rather than $20 billion per month. 15 Figure 16 Figure 17 21. The financial and banking sector b) The banking sector continues to support the services sector (an important engine of GDP growth), in 20. Private sector deposit growth picked particular, wholesale and retail businesses. up swiftly thanks to renewed confidence, Wholesale and retail businesses continue to contributing to greater stability in the absorb about one third of the total credit flowing banking sector. Private sector deposits reached into the private sector. Other than that, credit US$8.09 billion, or a 22.2 percent year-on-year does not appear to be highly concentrated in a increase, by mid-2014, compared with US$6.88 single or a few sectors (Figure 18). billion, or a 14.2 percent year-on-year increase, at the end of 2013 (note that private sector deposits declined during the post-election period, covering Figure 18 July to August 2013, contracting from US$6.5 billion in June to US$5.9 billion in August, but recovering in November). Credit growth, which was exceptionally high during the past few years, has moderated, falling to 21.8 percent year-on- year with an outstanding credit amount of US$7.58 billion by mid-2014, down from 26.7 percent with an outstanding credit amount of US$6.91 billion at the end of 2013. Increased deposit growth together with moderated credit growth have resulted in the loan-to-deposit ratio decreasing to 82.2 percent by mid-2014, down from 90 percent at the end of 2013 (Figure 17). 5. Fiscal sector Fiscal performance has been further strengthened; providing additional financing 16 to support rising essential public spending Box 3 Improving revenue administration without undermining macroeconomic stability. Revenue collection has expanded The RGC, under the Public Financial rapidly, rising by 21 percent during the first four Management Reform Program (PFMRP), is months while expenditure, which was initially working to strengthen revenue administration. slow, will likely remain as budgeted. The overall Revenue enhancement measures include fiscal deficit (including grants) improved, establishing the medium-term revenue mobilization strategy 2014-18, strengthening the reaching 2.7 percent of GDP in 2013 and is automated system for customs data (ASYCUDA), projected to further reduce to 2.5 percent of and improving the customs risk-management GDP in 2014. database system with better functions, risk indicators, and post-clearance audits. Other a) Revenue composition revenue enhancement activities consist of: inter- ministerial working groups to discuss and 22. The general government domestic coordinate on issues related to revenue revenue is projected to increase to 16 percent mobilization from oil and gas, rollout of the non- of GDP, or US$2.68 billion, in 2014 thanks to tax revenue receipting system to subnational improved revenue administration (Figure 19). administrations, further strengthened and In 2013, domestic revenue fell to 15.1 percent of expanded self-assessed system of taxpayers, GDP, down from 15.3 percent of GDP in 2012, strengthened and expanded payment through as the increase in indirect tax collection was more banking system for medium-size taxpayers in the than offset by the drop in non-tax and provincial provinces, and further development of the code of conduct for tax officers. A legal and regulatory revenues. Cambodia’s domestic revenue is framework for revenue administration is also heavily reliant on indirect taxes. Value-added tax being defined, including draft laws on state alone contributed to more than one third of total property management and casinos. tax revenue in 2013, while trade taxes (including excise on imports) contributed about 20 percent. Source: 2014 PFMRP progress, Ministry of Economy and Finance Direct taxes, which cover mainly corporate income tax, continue to be modest due to b) Expenditure composition generous tax incentives. Domestic revenue in 2014 is projected to increase thanks to 23. Total general government improvements in revenue administration (Box 3) expenditure is projected to be in line with the and expansion of economic activity including budgeted 20.4 percent of GDP in 2014, or imports. US$3.4 billion (Figure 20). This is well below Figure 19 the 21.5 percent of GDP disbursed in 2013, which was an election year. Thanks to grants and concessional borrowing, Cambodia has been able to allocate most of its domestic revenue during the previous years to cover its recurrent spending amounting to about 12 percent of GDP (55 percent of the total outlays), while also maintaining large capital spending at around 8 percent of GDP (45 percent of the total outlays) of which three-quarters are externally financed. 17 Figure 20 25. While expansionary fiscal policy is not limited to making use of government savings, the accumulation of savings can provide a cushion in times of shock, avoiding the need to resort to domestic bank financing or borrowing—all helping to maintain macroeconomic stability. Fiscal policy continues to be the main instrument for implementing macroeconomic policy due to the high dollarization, which constrains the conduct of monetary policy. A joint World Bank/IMF debt sustainability analysis (DSA) conducted in 2013 showed that Cambodia’s debt distress rating remained low with all debt burden indicators Of the current spending component, the wage projected to remain below their respective bill is rising rapidly, reaching 5.6 percent of GDP thresholds. in 2014, compared with only 2.8 percent in 2006. Figure 21 c) Fiscal balance 24. The reduced fiscal deficit resulting from better revenue collection helps improve Cambodia’s fiscal position and promote sustainable fiscal performance while also improving public sector service delivery. The overall fiscal deficit (including grants) has improved, reaching 2.7 percent of GDP in 2013 and is projected to further reduce to 2.5 percent of GDP in 2014 (Figure 21). The deficit continues to be over financed by external funds (Figure 22). Government savings (deposits) therefore rose to US$931 million by mid-2014, compared with US$700 million at the end of 2013. 18 whether the earlier findings that recommended Figure 22 improving funding for agricultural research, increasing the effectiveness of irrigation investments by rehabilitating tertiary canals, and providing sufficient investment for irrigation systems maintenance and for agricultural extension remain valid and require addressing. More cost-efficient and faster logistics for exporting agricultural products would further stimulate rice sector growth and also help diversify agricultural exports. Enhanced preparedness for potential floods and droughts would increase the resilience of the agricultural sector, which is currently already facing weaker prices. Agriculture sector expansion and resilience to shocks have a direct positive impact on poverty as the majority of Cambodians remain dependent on the sector for their livelihoods. Key messages and recommendations 28. Further developing the tourism sector would help it rebound. There is plenty of room 26. Cambodia is on track to post another to further develop the tourism sector, and the year of high growth thanks to the incipient public sector is well placed to undertake or help recovery in developed economies and the facilitate this development by engaging further waning of domestic uncertainty. Investor with the private sector. Cambodia’s ecotourism is confidence has returned after a period of underdeveloped and has a huge potential uncertainty that started in July 2013 and lasted together with the development of coastal areas. until earlier this year, and with it investment has As the experience of Costa Rica shows, the been revitalized. Maintaining peace and labor promotion of a diversified tourism could help market stability will be critical to continue to raise arrival numbers and increase the impact of attract foreign investment, support the expansion tourism on shared prosperity and poverty of the manufacturing sector and benefit to the reduction through increased jobs in rural areas. greatest extent possible from the global recovery. As 50 percent of tourist arrivals are by land, the Reaching a conclusive and transparent process of rehabilitation and development of roads tripartite minimum wage negotiation will be connecting tourist attraction sites to the borders instrumental in promoting the continued would have a significant impact on tourist development of the garment sector. arrivals. Greater coordination between national government, local government, private sector 27. The relative weights of Cambodia’s and local communities would help increase the usual engines of growth have changed, diversification efforts. Promoting stability, suggesting a need to stimulate the regional cooperation, enhanced partnerships with agriculture and tourism sectors, which have neighboring countries, hospitality and safety experienced a growth slowdown. A review of would all help to further expand the sector. the allocation and the effectiveness of agricultural investments would be instrumental, especially for 29. Facilitating the growth of the irrigation and extension, as rice production manufacturing sector will also be growth has been slow. This will help to ascertain instrumental to maintain and boost economic growth. As highlighted in the 19 Selected Issue 2, the latest Enterprise Survey of Cambodia return to a GDP growth path of the forthcoming Investment Climate Assessment above 8 percent. indicates that the business environment continues to hamper the competitiveness of firms in Cambodia. The key constraints for firms continue to be electricity cost and access, informal payments and uncompetitive practices. The survey also shows that Special Economic Zones (SEZ), which were meant to provide an improved business environment, are not yet delivering the benefits expected by foreign investors. 30. Further efforts to increase revenues and efficiency in spending will allow increased social spending and public investment. Continued broadening of the tax base and strengthening tax administration will boost revenue collection, which in turn will allow for more public investments in key social and economic sectors such as education, skills development, and infrastructure. 31. Enhancing banking supervision to strengthen the financial sector and moves to regain monetary policy independence will support macro-financial management. The recently introduced risk-based supervision process is an important step towards promoting financial stability. The Central Bank is currently promoting the use of the riel and also implementing its Financial Sector Development Strategy 2011-2020. 32. Focusing on implementation. Most of the messages above are not new to Cambodia and are rightly identified in the RGC’s new five- year RS III; the key challenge for Cambodia is developing a reform agenda and effectively implementing it4, which will require increased inter-ministerial coordination, leadership, and most importantly, the monitoring of specific targets linked to those reforms. Successful implementation of the reforms could help 4 An example of implementation not reaching the expected speed is the similarity between the actions included in the updated 12 action plan for trade facilitation of 2014 and of 2004. 20 Selected Issue 1 – Making the most of the Cambodian Rice Sector 1. Motivation 2. Rice production and 1. Rice is important for Cambodia in many respects. Rice production accounts for 15 processing percent of agricultural value added and paddy occupies 75 percent of the cultivated land. Rice 2. The majority of the rice farms in production, processing, and marketing are Cambodia are smaller than 1 hectare (ha), estimated to employ 3 million people, more than have not yet obtain a formal land title and one-fifth of the country's population. In the last still use traditional methods. Access to credit is decade, half of the poverty reduction has been not significantly affected by the lack of a formal driven by higher rice prices, increased rice title as a soft title (letter of certification from production, and higher farm wages.5 Given the village or commune chief) is also recognized by criticality of rice, the RGC developed in 2010 a local micro-financial institutions as collateral. Rice Policy to further develop the sector and set Many of the smaller farms still follow traditional an export target of one million tons of milled methods with minimal use of purchased inputs. rice. Among the notable achievements are the But more and more farmers, especially those with doubling of paddy production, from 4.3 million larger farms from 2 to 5 ha, are modernizing their tons in 2003 to 9.3 million tons in 2013, and the production by using improved seed varieties, significant increase in formal rice export, from applying fertilizers, following good agricultural 12,600 tons in 2009 to 378,800 tons in 2013. practices, and hiring mechanized services.6 There has also been increased international 3. Despite some disruption from the recognition with Cambodian jasmine rice Mekong River flood last year, Cambodia’s receiving the best in the world award the past 2013 rice production slightly improved two years. This Special issue therefore reviews compared with that of 2012. Total paddy the latest progress in rice production, processing production in 2013 is estimated at 9.3 million and exports and provides some tons (Figure S1.1), of which 77 percent (7.2 recommendations for further development. million tons) was from the wet season. The Figure S1.1 Cambodia rice production, 2008-13 Source: Ministry of Agriculture, Forestry, and Fisheries 5 World Bank. 2013. “Where Have All The Poor Gone?-Cambodia Poverty Assessment 2013.” A World Bank Country Study, November 6 World Bank. 2014. “Cambodia Agriculture in Transition: Opportunities 2013. and Risks.” February 6, 2014. 21 average yield for 2013 was 3.12 tons per hectare export growth stagnated, compared with the (ha): 2.8 tons per ha in the wet season and 4.33 same period last year. tons/ha in the dry season. It is estimated that there is more than 30 percent fragrant rice; 35 Figure S1.2 Increase of milling and polishing capacity for percent traditional non-fragrant rice; and about larger mills 2009-13 (ton/hour) 30 percent high-yield IR rice. In general, the production trend was up for fragrant and IR rice and down for traditional non-fragrant rice. 4. A more aggressive move to higher production of fragrant and high-quality white rice would help to secure Cambodia’s competiveness going forward. Limited access to quality rice seed, knowledge about proper farming techniques, high-quality inputs and mechanization services, and irrigation are the remaining constraints to the further development of rice production. 5. Cambodia’s rice milling capacity has 7. The formal rice exports in 2013 were increased remarkably in the past four years. 84 percent higher than in 2012, and more than Its modern rice milling (i.e. the larger mills) triple those of 2010, achieving about 75 percent capacity increased sevenfold, from 96 tons per of the 2013 target of 0.5 million tons. While the hour (tph) hour in 2009 to over 700 tph in late 2013 European Union (EU) remained the primary (Figure S1.2). The polishing capacity of mills also market, accounting for about 63 percent of the jumped, from 72 tph in 2009 to 564 tph in 2013, with volume, Cambodia has expanded its rice market an average milling rate of 64 percent. All of the to include some new destinations in Asia and investment in large mills came from the private sector Africa (Figure S1.3). This acceleration in and at least 35 percent was from joint ventures with Cambodia’s formal rice exports is not seen as foreign investors. In theory, the existing milling stable, however, as Cambodian prices are not capacity could process almost the entire paddy surplus very competitive relative to Vietnamese prices, in Cambodia. However, the high cost of fuel and and its market expanded primarily during a time electricity renders Cambodia’s average milling cost when Thai rice exports were in decline. The about 30 percent higher than that of Thailand and volume of formal rice exports in the first half of Vietnam. Moreover, rice mills lack the working capital to purchase paddy. 2014 is quite similar to 2013, but the share of rice exported to the EU has increased significantly. 3. Rice exports 6. Rice exports in 2013 are estimated at 1.5 million tons in milled rice equivalent, of which 378,850 tons were exported through formal channels, exclusively as milled rice. Almost half (47 percent) of the formal exported volume was fragrant rice. The rest of the rice exports were exported informally through cross- border trade with Thai and Vietnamese traders, mostly in the form of paddy. In the first half of 2014, while informal paddy rice export growth maintained its usual pace, formal milled rice 22 Figure S1.3 9. Cambodia’s informal rice exports EBA rice export to the EU, tons, 2005/06-2012/13 went to Vietnam and Thailand via cross- border trade. This informal trade is known to all stakeholders, but its volume remains a rough estimate. It is believed that more than 1.7 million tons of paddy were exported to Vietnam during 2013, while around 0.25 million tons of paddy and 0.3 million tons of low-quality milled rice went to Thailand. It appears that the limited working capital of local millers and traders is seen as the main cause of this informal flow. On the positive side, informal exports provide rice farmers with a stable market, technology Source: European Union transfers, and a source of motivation, although less value-added stays in country. 4. Export procedures and logistics 10. Cambodia’s infrastructure and 8. Cambodia’s export procedures were logistics have improved but do not yet fully somewhat simplified by the establishment of facilitate rice exports. Cambodia’s rank in the the Secretariat of the One Window Services Logistic Performance Index moved to 83 in for Rice Exports (SOW-REF). Although the 2014, up 46 places from 2010, a spectacular time and cost for obtaining necessary approvals increase albeit still far behind Thailand and have been significantly reduced, there is still Vietnam (Table S1.2). A Road transport cost per room for improvement in this area (Table S1.1). container saw a 15 percent decline, but is still The recent commitments and reforms made by more than double the cost per kilometer than in some relevant government ministries on this Vietnam. Virtually all of Cambodia's formal rice matter are quite promising. exports are moved via container—a mode for which Cambodia is at a relative disadvantage. It also contrasts with global trends. Most of the Table S1.1 Cambodia: Time and cost in rice export procedures, 2012 and 2013 non-aromatic rice and one third of the aromatic Services Processing Costs Processing Time rice is transported as break bulk cargo in the rest 2012 2013 2012 2013 of the world. The first phase of the extended Sanitary and Phytosanitary $150/case $35/case 2 days 1 day Phnom Penh Mekong River Port has been Certificate completed and the port started operating in early Fumigation Certificate $20/ container $35/ container 1 day 1 day 2013. The physical capacity upgrading of the sea Certificate of $250/case $141/case 1 day 1 day port is ongoing. Reconstruction of the 256-km Origin Custom $25/ $6.50/ 2 days ½ day railway between Phnom Penh and the port of the Certificate container container Sihanoukville is complete but some additional CamControl $25/ $52.50/ 2 days ½ day Certificate container container structures are still needed for the railway to be GMO $150/sample $80/sample 3-4 days 2-3 days advantageous for rice exports. Certificate Average $20/ton $14/ton 8 days 4 days total* Source: World Bank team’s estimates based on information from key rice exporters and SOWS-REF. *The average services fee per ton is lower for the larger export size. 23 declined during December 2013 and the first half of Table S1.2 Cambodia’s Logistic Performance Index compared with neighbors, 2010-14 2014. Logistic rank in LPI 2014 2010 2012 2014 12. The 2013 regional rice trade pattern was Thailand 38 35 quite similar to that of 2012 but showed some signs of change. Vietnam’s total rice export volume Vietnam 53 48 in 2013 was 13 percent lower than in 2012, despite Cambodia 129 101 83 the fact that its rice price quotes are always the lowest Myanmar 129 145 in the region. The trend continues in 2014 as Vietnamese rice exports in the first half of 2014 (3.62 Source: World Bank million tons) were 12 percent down compared with 2013 (4.1 million tons). Thailand’s rice market was disadvantaged by its rice pledging scheme, which was terminated in 2014 and is struggling to regain its Rice prices in selected Asian countries, US$/ton, position in 2014. Myanmar is in the recovery stage of Figure S1.4 2006-13 returning to the world rice market with its recent reforms, and is encouraged by the “Everything but Arms” (EBA) status from the EU. India remains robust as the world’s lead rice exporter. 6. Conclusion 13. Rice production growth decelerated in 2013 highlighting the importance of revitalizing the rice sector so it becomes once again a key engine of GDP growth. Given the land area constraint, future rice production increases will depend more on the increase of rice productivity and quality than area expansion. 14. While the milled-rice export market is Source: FAO GIEWS. steadily expanding and increasing the number of Note: Mixed rice wholesale prices in Cambodia, 5% broken FOB Thailand, and 5% broken FOB Vietnam. destination markets, the milling and transport costs of Cambodian rice make it loose the competitiveness it has at farm gate prices. This is 5. Rice prices illustrated in Figure S1.5, which compares Cambodia’s 11. The price of rice in Cambodia continues white rice prices at the farm gate, miller and FOB to follow the price of rice in Thailand and with those of Vietnam and Thailand. Vietnam (Figure S1.4). In 2013 and early 2014, Prices of white rice per ton in 2013 at the farm Cambodia’s paddy prices were influenced more by Figure S1.5 gate, miller and FOB Vietnamese prices than by Thai prices. The 2013 farm gate price of paddy was comparable to that of 2011 and 2012, and lower than the price in neighboring countries, as it typically is. Transportation costs often push down the farm gate paddy price in remote areas while non-fragrant quality paddy tends to experience more seasonal volatility than other varieties. At around US$270/ton, the ex-farm prices for Cambodian fragrant rice in 2013 were quite stable throughout the year, and lower than Vietnam’s prices. The Thai price was high for almost the whole year but Source: Staff calculations based on World Bank 2014 Rice Monitoring Note. 24 overcome with the support of the RGC to fully tap the potential of Cambodia’s water ways. The 15. RGC has set a very legitimate target of establishment of a national logistics task force would one million tons of milled rice exports that help identify low hanging fruit and medium term matters tremendously for poverty reduction and actions, coordinate efforts between different shared prosperity. The status quo in terms of farm ministries and stakeholders, assign implementers and productivity, milling, and logistics prevents Cambodia effectively monitor implementation for greatest from meeting this target. Cambodia can increase the impact. effectiveness of its liberal policy environment by increasing public investment in farm advisory services, technology development (especially seeds), rural transport, and irrigation infrastructure. In addition increasing the competitiveness of the milled- rice supply chain would enable Cambodia to significantly increase its presence in the global rice market. Better access for rice producers and processers to finance, lower electricity costs, and reduced costs of doing business would help increase the competitiveness of the milling industry. Improving logistics would also critically contribute to meeting the export target. Two important actions to reduce Cambodia’s high logistics costs are the transport of milled rice in bulk cargo, and not only by container, and making use of the Tonle Sap and the Mekong river, which experience from neighboring countries indicates could be half as expensive as transport by road. The private sector has already piloted the transport by river, but faced hurdles mostly of a bureaucratic nature that could be 25 Selected Issue 2 – Creating Opportunities for Firms: Findings from the Investment Climate Assessment faced by firms found in the ICA report are 1. Motivation shown in Figure S2.1. 1. The Royal Government of  Electricity is now seen by firms as the number Cambodia’s (RGC) new five-year one constraint on the business environment. Rectangular Strategy III (RS III) continues Worries about electricity are 50 percent higher than to prioritize improving the business they were in the 2007 survey. Not only is electricity environment to help diversify and increase more expensive in Cambodia than in almost value-added in production. Cambodia has seen a resurgence of foreign direct investment (FDI) every other country in the region, but the in the wake of the global financial crisis. This supply is inefficient and intermittent. FDI has mostly been attracted by its low wages, Cambodia’s electric power transmission and openness, “Everything But Arms” free access to distribution losses as a percentage of output are the EU, and tax holidays, which help compensate higher than in any comparator country. In for the high cost of doing business in the addition to having the highest loss rate in the country. Despite this FDI and some initial signs region, Cambodia’s proportion of losses in its of diversification (such as the establishment of Japanese firms involved in electronic parts and output has more than doubled since 2004. components), manufacturing and exports still Manufacturers are forced to rely on electrical remain for the most part heavily concentrated. generators for a substantial amount of their Addressing the key constraints in the business power needs. This problem is particularly acute environment will help to promote foreign and in the border regions where the special domestic investment in non-traditional areas, economic zones (SEZs) are located. While the thereby helping to diversify and increase value- added in production. RGC has made strong efforts to increase the availability of power supply through domestic 2. Progress and remaining production (hydropower plants) and imports, it constraints is not yet clear how electricity will be made available at a more affordable price in the near- 2. Progress has been greatest on trade term for the manufacturing sector. facilitation. This is reflected in the impressive improvements in Cambodia’s ranking on the Figure S2.1 Major or severe constraints faced by all firms World Bank’s Logistics Performance Index (registered and unregistered) in Cambodia, 2012 (LPI). Cambodia has improved 46 places in the LPI rankings to 83 from 129 in 2010. Customs clearance times have fallen from 5.9 days in 2010 to only 1.4 days in 2014, while the percentage of consignments selected for inspection has fallen from 29 percent in 2010 to only 17 percent in 2014. 3. But despite such progress, the business environment continues to hamper the competitiveness of firms in Cambodia, as reflected in the forth-coming World Bank and ADB Investment Climate Assessment (ICA) 2014. The major or severe constraints Note: Data is from the World Bank Enterprise Survey 2012. Source: ICA 2014. 27  Informal payments are seen as the third expected by foreign investors. While the zones most important constraint among all firms, offer several benefits in terms of One-Stop- after macroeconomic uncertainty7, and as Shops and enhanced border clearance the second most important constraint for procedures, investors continue to express registered firms. Informal payment practices disappointment that their expectations for a remain widespread in Cambodia. While the benign investment environment inside the zones amount of informal fees paid has declined as a are not being fulfilled. proportion of overall sales, the incidence of informal practices has not diminished, implying 5. The second key finding is that there is that while official may be demanding informal a “missing middle” in the composition of fees less frequently, the proportion of firms Cambodian companies involved in exports. paying informal fees has not diminished (and Compared with countries at the same level of there are indications that for certain activities Gross Domestic Product (GDP), very few such as importing goods, the proportion of medium-size firms actively export from firms paying gifts at the time of the survey had Cambodia. The existence of a missing middle is increased). In contrast, in Lao PDR informal likely to be associated with a costly business payments are perceived to be decreasing as a environment that favors large businesses and major constraint between 2009 and 2012 (the encourages small firms to remain small and date of the latest ICA), as well as the bribery informal in order to remain hidden from the incidence. regulatory environment.  Uncompetitive practices, which are closely 6. The current period of robust growth related to informal payments, rank fifth, represents an opportunity to make after transport. The level of informality in improvements to the business environment Cambodia is still high. Informal firms are that will attract long-term investors. Many perceived to have a price advantage over formal investors are attracted by the “Everything But firms and face fewer regulatory obstacles in Arms” initiative (EBA) that allows duty-free conducting their activities. This competitive access to the European Union market and to tax edge appears to prevent formal firms from holidays, but these preferential treatments will operating on a level playing field. The not last forever. Improvements to the investment persistence of these constraints over several climate now will pay off in anchor investment ICA surveys indicates that they are deeply that is more likely to remain in Cambodia when embedded in the local business culture and are the preferential treatments are eventually therefore challenging for policymakers to withdrawn. address and alleviate. Rather than attempting to repress informality, the RGC may wish to 3. Proposed next steps in consider fostering firms in the informal sector reforming the business to grow by adopting enabling policies such as incentives to become formal which may include environment fast-track registration, licensing, and approval a) Address the high cost of electricity with a processes, thereby contributing to fiscal comprehensive national plan comprising the revenues, higher wages for workers and better review of energy sources (including renewable) knowledge transfers. and identify specific practices (e.g. non- transparent solicitation of power purchase 4. In addition to presenting the key agreements) that may be contributing to the constraints, the ICA includes two key high cost of energy. Improving existing findings. The first is that Special Economic agreements with neighboring countries would Zones (SEZs) are not delivering the benefits ensure the steady and reliable provision of electricity to the SEZs located near 7 The identification of macroeconomic uncertainty as a key bottleneck is Cambodia’s borders. A regional approach surprising; it may be capturing the uncertain external macroeconomic environment post 2008/9 global financial crisis. towards addressing constraints currently faced 28 by the power sector may be more appropriate, made by Customs leave no room for as an isolated power sector expansion will complacency as there are still cumbersome likely require difficult trade-offs between and time-consuming procedures to be economic growth and environmental completed manually through several agencies challenges. before import-export permits and licenses can be obtained. By streamlining and automating b) Automate government processes. Corrupt these procedures, in the framework of the and informal practices proliferate in opaque National Single Window (NSW), Cambodia environments that often require face-to-face could improve its trade performance contact between investors and government dramatically by contributing to decreased trade officials. Automation of key government costs and improved firm competitiveness. processes could help to eliminate these practices by reducing personal contact e) Completing the draft Competition Law and between parties and by creating a transparent setting up an independent Competition online portal for information about rules and Agency would go a long way in ensuring a processes required by firms. Automation has level playing field across all firms. the added advantage of creating a traceable f) Design and implement a system of record of transactions between the incentives for business registration Government and the private sector. To this encouraging companies to become formal, end, the swift passing of the e-Commerce Law with a strong impact on fiscal revenues and by the National Assembly as soon as possible enterprise productivity that would have an would enable firms to perform e-payments for impact on firms’ capacity to grow and to government services. Both the Ministry of access foreign markets. Experience in other Economy and Finance (MEF) and Ministry of countries indicates that lowering the cost and Commerce (MOC) are implementing complexity of registration is a necessary, but automation in the areas of customs and border often not sufficient step, and that improved reform, new company registration and enforcement is also needed to encourage Certificate of Origin (CO) that can serve as companies to be formal.8 models for other ministries. g) Focus on implementation and c) Encourage new investment, particularly in the SEZs. It is important that the revision of enforcement. Cambodia’s regulatory the current Investment Law is completed as environment often follows international best soon as possible to modernize the existing practice and appears to comply with the regime. A system of smart incentives and RGC’s international commitments and more effective investment protection can pave obligations. However, informal practices are the way for foreign investors deciding to move still prevalent with poor implementation often into Cambodia, taking advantage of its hindering the stated objectives of the competitive labor cost and its favorable geographical location at the center of the regulations. ASEAN Economic Community (AEC). The RGC could also consider designing and implementing a Zero-Corruption Strategy to curb corruptive practices within the SEZs. Policing this strategy would be feasible in the controlled environment of the SEZs, and have a strong resonance in terms of building a positive image for Cambodia as an FDI destination. d) Continued improvements to trade facilitation. The important improvements 8 Bruhn and McKenzie (2013) “Entry regulation and formalization of microenterprises in developing countries”, p.17. 29 Cambodia: Key Indicators 2012 2013 2014p 2015f 2016f Year Year Year Year Year Output, Domestic Demand and Prices Real GDP (% change yoy) 7.3 7.4 7.2 7.5 7.2 Domestic demand (% change yoy) 14.9 12.1 12.4 11.0 10.7 Consumer price index (eop, % change yoy) 2.5 4.6 5.0 5.5 6.0 Public Sector Government revenues (% GDP) 15.3 15.1 16.1 16.4 16.4 Government expenditures (% GDP) 21.0 21.5 20.4 20.9 21.3 Government balance excluding grants (% GDP) -5.7 -6.4 -4.3 -4.5 -4.9 Government balance including grants (% GDP) -3.3 -2.7 -2.5 -3.5 -3.3 Foreign Trade, BOP and External Debt Trade balance (million US$) -2,455.7 -2,598.4 -2,908.3 -2,955.7 -2,856.1 Exports of goods (million US$) 5,632.8 6,890.2 8,193.4 9,700.2 11,571.6 (% change yoy) 7.9 22.3 18.9 18.4 19.3 Key export (% change yoy) 1/ 7.0 17.6 15.0 15.5 15.0 Imports of goods (million US$) 8,088.5 9,488.6 11,101.7 12,655.9 14,427.7 (% change yoy) 20.6 17.3 17.0 14.0 14.0 Current account balance (million US$) 2/ -1,366.0 -1,639.0 -1,849.1 -1,989.0 -1,834.0 (% GDP) -9.6 -10.7 -11.3 -11.2 -9.6 Foreign direct investment (million US$) 1,404.8 1,298.8 1,380.0 1,400.0 1,450.0 External debt (million US$) 4,559.3 5,124.1 5,630.6 6,019.1 6,380.5 (% GDP) 32.1 33.3 34.4 33.9 33.3 Short-term debt (million US$) - - - - - Debt service ratio (% exports of g&s) 1.1 1.1 1.2 1.1 1.3 Foreign exchange reserves, gross (million US$) 3,463.0 3,642.5 4,300.0 4,600.0 5,100.0 (months of imports of g&s) 3.1 3.4 3.5 3.3 3.2 Financial Markets Domestic credit (% change yoy) 29.6 26.7 20.0 19.5 18.0 Short-term interest rate (% p.a.) 11.6 11.3 11.2 11.0 11.0 Exchange rate (Riel/US$, eop) 3,995.0 3,995.0 4,065.0 4,076.0 4,050.0 Real effective exchange rate (2010=100) 105.4 109.9 112.1 113.5 115.5 (% change yoy) 0.5 4.3 2.0 1.3 1.7 Memo: Nominal GDP (million US$) 14,188 15,373 16,367 17,759 19,173 Sources: National data sources and World Bank staff estimates and projections. f = forecast p = projection 1/ Garments 2/ Excluding official transfers. 30