CAMBODIA ECONOMIC WATCH APRIL

Transcription

1 CAMBODIA ECONOMIC WATCH APRIL 2006 Issue 4

2 CAMBODIA ECONOMIC WATCH APRIL 2006 ECONOMIC INSTITUTE of CAMBODIA

3 Research Director: Sok Hach Project Team Leaders: Oum Sothea and Dourng Kakada English Editor: Jessica Frommer Authors: Chea Samnang (Chapter 1 and 5) Dourng Kakada (Chapter 3) Khieng Sochivy (Chapter 8, 10, and 12) Lim Visal (Chapter 4) Neak Samsen (Chapter 6, 7, and 9) Neou Seiha (Chapter 2 and 4) Sieng Deline (Chapter 10, 11)

4 TABLE OF CONTENTS List of Abbreviations and Acronyms iii List of Tables and Figures v Foreword vii Executive Summary ix Part I: Recent Economic Developments and Outlook 1 1. Global Economic Trend: An Overview World GDP Growth Global Trade Flow Trade in Textile and Clothing Poverty Rate 9 2. Cambodian Economic Growth Agriculture Industry Services Trade, Investment, and Productivity External trade and Capital movement Private Investment and Stock of capital Productivity Prices and Monetary Developments Inflation Exchange Rate Money Supply Interest Rate Fiscal Development and External Debt Budget Revenue Budget Expenditure Budget Financing Foreign Aid and External Debts 38 i

5 6. Labor Force, Incomes, and Poverty Labor force and under-employment Incomes Poverty 44 Part II: Structural Reforms: Current Implementation and Prospects Banking and Financial Sector Reform Banking Sector Rural Finance Public Financial Management Reforms Current Implementation and Major Achievements Remained Issues and Major Challenges Trade Reforms Public Administrative Reforms Central Administration Reform Decentralization and Deconcentration (D&D): A Gradual and Momentous Reform at Sub-national levels of governance Current Implementation and Achievements Remaining Issues and Challenges Legal and Judicial Reforms to Improve Governance Legal Reforms Judicial Reforms and Law Enforcement Land and Natural Resources Management Reforms Land Management Reforms Forestry Management Reforms Fisheries Management Reforms 87 Concluding Remarks 91 Bibliographic References 93 Appendix: Key Economic Indicators 97 ii

6 LIST OF ABBREVIATIONS AND ACRONYMS ACLEDA ADB AFTA ANZ ASEAN Camcontrol CAMELS CAMINCO CAR CDC CED CEPT CG CLJR COAs CoM CR CSF D&D EIC EPSCB EPZs EU FA FDI FTB GDP ILO IMC IMF IPsCC LAMC MDG MDP MEF MFA MFI Association of Cambodian Local Economic Development Agencies Asian Development Bank ASEAN Free Trade Area Australia New Zealand Banking Group Association of Southeast Asian Nations Cambodia Import Export Inspection and Fraud Repression Department Capital Protection, Asset Quality, Management Competence, Earning Strength, Liquidity Risk Exposure Cambodian National Insurance Company Council for Administrative Reform Council for the Development of Cambodia Customs and Excise Department Common Effective Preferential Tariff Consultative Group Council for Legal and Judicial Reform Chart of Accounts Council of Ministers Cambodian Riel Commune/Sangkat Fund Decentralization and Deconcentration Economic Institute of Cambodia Economic and Public Service Capacity Building Project Export Processing Zones European Union Forest Authority Foreign Direct Investment Foreign Trade Bank of Cambodia Gross Domestic Product International Labour Organization Inter-Ministerial Committee International Monetary Fund Intellectual Property Rights Coordinating Committee Law on Administration and Management of Communes/Sangkats Millennium Development Goals Management Development Program Ministry of Economy and Finance Multi-Fiber Agreement Microfinance Institutions iii

7 MIME MLMUPC MoC MoH MoJ MoT MOUs MPDF MPTC MTEF NA NBC NES NGOs NIS NPAR ODA OWS PAP PDP PMG RCAF RGC RSM SCCA SCM SEZ SMEs SNCAC SWAP TA TRIM TRIPS TWGs UNDP VAT WB WTO Ministry of Industry, Mines and Energy Ministry of Land Management, Urban Planning, and Construction Ministry of Commerce Ministry of Health Ministry of Justice Ministry of Tourism Memorandum of Understandings Mekong Private Sector Development Facility Ministry of Post and Telecommunication Medium Term Expenditure Framework National Assembly National Bank of Cambodia National Export Strategy Non Governmental Organizations National Institute of Statistics National Program for Administrative Reform Official Development Assistance One-Window Services Priority Action Program Professional Development Program Priority Mission Group Royal Cambodian Armed Forces Royal Government of Cambodia Royal School of Magistracy State Secretariat of Civil Aviation Supreme Council of Magistracy Special Economic Zone Small and Medium Enterprises Supreme National Council for Anti-Corruption Sector Wide Approach Technical Assistance Trade-Related Investment Measures Trade-Related Intellectual Property Rights Technical Working Groups United Nations Development Programs Value Added Tax World Bank World Trade Organization iv

8 LIST OF TABLES Table 1.1 Global and Regional Economic Trend Table 1.2 World Trade Flow (% Change) Table 1.3 World Poverty Rate (%) Table 2.1 Cambodia's Economic Growth (%, 2000 prices) Table 2.2 Value Added of Agriculture Sectors (% increase, 2000 prices) Table 2.3 Value Added of Industry Sectors (% increase, 2000 prices) Table 2.4 Cambodia s Garment Exports (% increase, year average) Table 2.5 Value Added of Service Sectors (% increase, year average, 2000 prices) Table 2.6 Foreign Tourist Arrivals in Cambodia (% increase, year average) Table 3.1 Cambodia s Balance of Payments (% GDP) Table 3.2 Private Investment Projects Approved, Table 3.3 Productivity of Workers (% increase, 2000 prices) Table 4.1 Cambodia's Monetary Survey (End of Period, % of GDP) Table 4.2 Interest Rates on Loans of ACLEDA Bank and Selected MFIs Table 5.1 Cambodia's Government Revenue (Billion Riel) Table 5.2 Cambodia's Government Expenditure (Billion Riel) Table 5.3 Cambodia's Financing Budget (Billion Riel) Table 5.4 Allocation of Aid Flow (Million US$) Table 6.1 Poverty estimates by region, 1993/94 and 2004 (samples limited to geographical areas included in 1993/94 SESC) Table 7.1. Recent Developments in the Banking Sector, 2005 Table 7.2. Recent Developments in the Rural Finance Sector Table 8.1. Major Progress in the Implementation of the Public Financial Management Reform Program Table 8.2. Major Challenges and Priority Actions Table 9.1. Status of Laws for WTO Conformity as of March 2006 Table 9.2. Average times and costs of processing imports and exports Table 9.3. Impacts of the implementation of the twelve-point plan in 2005 Table Civil Reforms Table Legal and Judicial Reforms LIST OF FIGURES Figure 1.1 Change in textile exports to the developed world, first half of 2005 Figure 2.1 Cambodia s Garment Exports to US market (Million Dozens) Figure 4.1 Cambodian Riel Against US$, Thai Baht, and Vietnamese Dong (December 2002 = 100) Figure 6.1 Number of job creations by registered investment project, v

9 Figure 6.2 Real Terms of Daily Average Earning of Vulnerable Workers (Constant November 2000 Prices) Figure 6.3 Percentage of Population Living Below the Poverty Line 1993/94 and 2004 (Same Geographical Comparable Sample) Figure 6.4 Average Annual Reduction of Poverty in Selected Countries Figure 6.5 Gini coefficient, 1993/94 and 2004 (same comparable sampling frame) vi

10 FOREWORD With an aim to provide a broad-based economic analysis to policy makers and all stakeholders, the Economic Institute of Cambodia (EIC) launched the first issue of its Cambodia Economic Watch in late The publication series not only serves as a policy oriented research paper but also as a reference for all readers who wish to have a snapshot of the Cambodian economy or to monitor its development. Following the success of previous issues, EIC has the great pleasure to present the Cambodia Economic Watch Issue 4. In similar fashion to the previous issues, the current economic performance, prospects for the coming years, and reform policies are highlighted. In addition, a new chapter on the Global Economy is introduced in line with the integration of Cambodia into the world economy. In contrast to the slowdown of the world economy, Cambodia continues to sustain a high economic growth. Preliminary results forecast a double-digit economic growth rate of 10 percent in This growth has been made possible by the strong growth in the agriculture sector thanks to favorable weather conditions, unexpected strong growth in garment exports, and a rapid increase in the number of foreign visitors. Thanks to good labor practices in Cambodia and safeguard measures imposed on China s garment exports, Cambodia s export of garments increased by 20.6 percent in quantity and 11.5 percent in value. However, fierce competition has forced Cambodian producers to lower their prices by 7.5 percent on average; and as a result, garment workers earnings followed the same trend. We would like to thank the World Bank for its generous support. Special thanks to Chea Huot and the World Bank team for their invaluable comments, to Tuy Chak Riya and EIC research assistants for their excellent assistance, to all EIC staff for their enthusiasm, and to other institutions and individuals too numerous to list. Sok Hach, Director Economic Institute of Cambodia vii

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12 EXECUTIVE SUMMARY Global economic growth slowed visibly in 2005 to 3.2 percent, compared with 3.8 percent in Part of the global slowdown has resulted from higher oil prices, resourcesector capacity constraints, tightening monetary policy in some countries, the saturation of the investment cycle following a year of very fast growth, avian bird flu-h5n1, natural disasters, and terrorism. While global economic growth slowed noticeably in 2005, Cambodia's economic growth continued to be unexpectedly strong, with a phenomenal growth rate at 10 percent compared with its 7.7 percent growth rate in 2004, the highest since 1999 and double the rate previously projected by the Economic Institute of Cambodia. It was in parallel with the continuous robust economic growth of the ASEAN community and East Asia Pacific with the average rate of more than 5 and 7 percent, respectively. The growth is due to the synchronization of the three favorable progress industries namely the garment industry, tourism and agriculture Agricultural growth rebounded to 11.9 percent in 2005 after a 2.1 percent decline in 2004, due to favorable climate conditions at the end of the year, expansion of cultivated areas, and the rebounding of fish production. The industrial sector achieved a significant growth of 11.7 percent, about 4 percent down from 2004, as the garment industry was ranked 7th in the countries which gained from the end of the quota system by increasing its market share about 17 percent in the first half of The construction was up by 4.6 percent in 2005, though the rate was lower than in The services sector, excluding public administration, increased by more than 7 percent in The most significant growth among sub-service sectors were in tourism, hotels and restaurants, which grew by 16.7 percent due to the annual record of 1.3 million tourist arrivals into the country, 34.2 percent higher than in Data compiled from the National Bank of Cambodia (NBC) and EIC reveal that total exports increased by 18 percent and up to US$2.9 billion in 2005, while total imports increased to US$3.8 billion. These figures of exports and imports made up 53 percent and 69 percent of nominal GDP respectively, leading to merchandise trade deficit at 16 percent of GDP. The pattern of imports and exports are still dominated by garment products, raw materials, refined oil products, and motor vehicles and machineries. Private investments jumped up unexpectedly both in terms of the number of projects and fixed assets approved, recovering from a decline in The Council for the Development of Cambodia approved 102 investment projects and US$695 million of fixed assets, increased by 200 percent compared to the year It is worthy to note that the increase of fixed assets were significantly pushed by that of US$181 million, accounting for 26 percent of total fixed assets, invested by a cement factory in August Most approved investment projects in Cambodia are in the industry sector, which saw 82 approved investment projects of which 53 in the garment industry. ix

13 According to the National Institute of Statistics, the inflation rate of 2005 was 6.6 percent compared to 5.6 percent in 2004 and 0.5 percent in The higher inflation rate was mainly driven by higher food and transportation prices. The price index of food rose by 12 percent, which caused a 10.6 percent increase in the price of cereal, 17.4 percent in the price of meat and poultry, 17 percent increase in the price of fish, and 18.7 percent in vegetable prices. The price index in transportation was up by 9.1 percent, mainly due to the 21.3 percent increase in the price of fuel, and 8.6 percent increase in passenger transportation costs. The Cambodian Riel showed some sign of weakness against the US dollar in The official year-average rate depreciated 1.9 percent in 2005, compared with This depreciation was more significant for the market rate, reaching 2.1 percent during the same period. According to data released by the National Bank, the average value of the Riel at the market rate in Phnom Penh in early 2005 was relatively flat at around CR4,040 per US dollar, before it depreciated in May 2005 and reaching CR4,209 per US dollar in October However, the Riel appreciated slightly again at the end of the year. Total money supply continued to expand by 16 percent in 2005 though lower compared to the 30 percent in 2004, and reached 22 percent of GDP. Officially, more than 70 percent of money supply was dominated by the US dollar, while liquidity in Riel was still limited. Riel liquidity increased by 15 percent compared to 2004, and reached 5.7 percent of GDP. Foreign currency deposits continued also to expand by 17 percent compared to 2004, reaching 16 percent of GDP. This growth also reflects strong activity in sectors such as tourism and garments. Credit for the private sector increased by 21 percent in 2005 compared with However, a large amount of foreign currency, especially the US dollar, was sent back to respective countries since many big investors are foreigners and the domestic banking system is not able to expand their loans domestically. In 2005, the total domestic revenue of the national budget accounted for CR 2,626 billion [US$642 million], which increased about 24 percent compared with the year before. The actual revenue collection is 14 percent higher than it was projected in the national budget law 2005, due largely to the 21 percentage point increase in tax revenue. Both collections of excise tax and VAT increased by 25 and 22 percent respectively compared to the previous year. The profit tax went up considerably to almost 50 percent compared with 2004 which reflects the growth of the private sector. The total budget expenditure in 2005 accounted for CR3,330 billion [US$813 million] which increased by 12.4 percent compared to 2004, but its share of GDP slightly reduced to 14.8 percent. The actual expenditure was higher than its target 7 percent due to sharp increases in capital expenditure. On average, spending on priority sectors (health, education, agriculture, and rural development) rose by 12 percent compared to 8 percent a year before and spending by the remaining civil ministries increased by 18 percent. Nevertheless, average expenditure on defense and security rose by 7 percent in 2005, while the growth rate was just 3 percent in x

14 In spite of the narrowed base, economic growth in the past decade has had some positive impacts on people s livelihoods through the improvement in physical infrastructure such as roads, schools, and health care and a moderate reduction in child mortality rate and illiteracy rates. However, it is interesting to note that the recent release of "Cambodia - Poverty Assessment 2006", which suggests a reduction in poverty rate from 47 percent in 1994 to 35 percent in 2005, yielded celebrations across the board. Unfortunately, the absolute number of people living under the poverty line slightly increased from 4.6 million to 4.8 million during the same period. Moreover, income distribution became wider. Estimates of the Gini coefficient, with geographically comparable areas, increased from 0.35 in 1993 to 0.4 in This overall widened gap is primarily caused by rural disparity where the Gini index rose from 0.27 to The remedies to these setbacks have been identified through repeated pledges by the Government to conduct broad-based reforms. But the results, though with some progress, somewhat fall short of expectations. Anti-corruption, the most striking factor that prevents both the private sector to develop and invites wastage and misallocation of resources, has gained little success. Reforms in the land and natural resource management have been accelerated only after reaching their alarming levels (large deforestation and degradation in fishery production) under the realm of international assistance. The reforms of the banking and financial sectors are clearly guided by the Banking and Financial Sector Blueprint Currently, the Blueprint is being revised because some of its components have lagged behind schedule. Many of fundamental laws and regulations for prudential regulations have been promulgated and implemented while few laws are currently at an advanced stage. However, more efforts should be made to reduce delays to approve draft laws, so that promises made with WTO accession will not miss the deadline again. Also, faster improving the capacity of the supervision department in terms of staffing and equipment should be established to effectively execute its roles as a regulatory and supervisory agent. In the Public Financial Management Reform Program (PFM), two major achievements have been made. Firstly, the Government indicated that major precondition such as political decisions, ownership, and provision of better staff incentives, improved internal government coordination, donors' harmonization are already put in place. Secondly, while a good foundation has been prepared for the subsequent priority activities to take deeper root, much progress has been observed. However, success in the public financial management is a fundamental factor to determine the success of the overall reform programs of the country. The significant results can only be seen through the proportional increase in revenue collections (14-20 percent of GDP) and better use of public finances, a prerequisite for a sufficient and high quality of public service delivery the majority of the public servants are still living with empty stomachs. xi

15 In the trade reforms, the Government made more progress in implementing the plan. The reform has delivered positive results as evidenced by substantial reductions of both time and costs associated with imports and exports compared to two years ago. However, the reform has not yet been able to eliminate corruption (but has been significantly reduced). Incidences of over-charging official fees and of informal payments inferred that trade-related agencies still have opportunities to take bribes in the absence of Risk Management Strategy, Single Administrative Document, and Single Window. Reform in public administration has been gradually improved. The Government is on the right track to introduce a merit-based payment and meritocratic system in promotion of its bureaucrats and to put an end to extravagant political appointments in order to attract well qualified human resources back into the public sector. However, focus should be paid on the practical guarantee of transparency and effectiveness of the recruitment or appointment process of the PMG in each ministry/institution to ensure that the selection is made on a basis of quality regardless of party affiliation. Starting with the successful election of 1,621 Commune Councilors (CCs) in February 2002, Cambodia's decentralization policy reform is now in its fourth year of implementation. The first mandate of the commune councils as elected local democratic institutions will end in the first quarter of Remarkable achievements have been observed although it would not have been possible without constant technical and financial support from the Seila program, which in turn received core technical support from the Partnership for Local Governance Project. However with the program coming to an end this year, the donors want the Government to have a new successor program in place by the third quarter of Currently, the Government's Inter-ministerial Committee is drafting an organic law for provincial, municipal and district governance systems. It is expected to be completed by the end of March The implementation of this Organic law will need momentous restructuring and reformation of current provincial, municipal and district governance system. On the legal and judicial reforms, at this early stage of reform, priority given in the current legal reform agenda appears to be a pre-condition for real judicial reform to get started. The Parliament has ratified and adopted 19 out of 47 laws and regulations for compliance with WTO regulations, and signed a number of agreements within the ASEAN framework. During the year 2005 alone, a total of 45 laws were approved by the National Assembly. Nonetheless, the eight priority draft laws which include the civil code, penal code, civil procedure code, penal procedure code, law on the organization and functioning of the courts, law on the statute of judges and prosecutors, amendment of law on the Supreme Council of Magistracy, and anti-corruption law, have not been adopted. These laws are fundamental for the justice system and public administration reform and conducive to the other reform areas. For land management reforms, major progress however has been made in areas of legal frame work development. Yet, continued widespread prevalence of land disputes and xii

16 land grabbing, forested land encroachment and slow process of land registration continue to make access to land insecure which are a hindrance to legal access to use land more productively. Successful implementation of these Sub-decrees depends on a sufficient regulatory framework, detailed guidelines and technical resources and capacity as well as smooth coordinated assistance both at the national and sub-national government levels with regard to policy formulation. The forestry reforms are however at a juncture now. The Sub-decree on Community Forestry is expected to offer opportunities for local communities to participate in forestry management and utilization. However, this Sub-decree has not yet been implemented since a much needed guideline is being prepared and not yet completed. Recent studies reveals that community forestry provides very limited benefit to local community because it is often allowed to set up in an areas where forests are already degraded and thus not able to provide access to timber and other non-timber forest products. Effective and efficient community based natural resources management including community forestry and ecotourism can provide protection of natural resources critical to their survival and enhancing the rural livelihoods of rural people. With the commitment to improve the governance of fisheries policy reforms, civil society organizations and local communities are consulted in the formulation of the legal framework. Fisheries Forum Meetings are regularly held. Four drafts of Prakas to give detailed guidelines to the Sub-Decree on Management of Fishing Community in mid March this year. The long awaited draft Law on Fisheries will likely be discussed at the National Assembly very soon. The number of fishing communities has increased from 388 in mid-2005 to 440 in December 2005 and has provided benefits to households in 19 provinces and 3 municipalities. In addition, the reform also includes research on post harvest fisheries which involves processing and packaging, trade and distribution of fish aiming at maximizing the value of fish and its overall contribution to the livelihood improvement and rural development. xiii

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18 Part I Recent Economic Developments and Outlook 1

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20 Cambodia s economic growth in 2005 can be attributed to various factors. The continuation of favorable conditions which sustained the export of Cambodia s garment products to the US and the boost in private investment, in combination with favorable weather conditions for agricultural production and unabated inflows of tourists helped the country s economic growth in 2005 reach the exceptional rate of 10 percent, the highest since 1999, and double the rate previously estimated by the Economic Institute of Cambodia. The remaining concentrated growth on the main three sub-sectors (paddy, garment, and tourism), especially the one-off yields in agriculture will temporarily improve the livelihoods of the rural poor. Moreover, a recent World Bank report on Cambodia Poverty Assessment 2006 compiled from the Socioeconomic Survey 2004/2005 revealed encouraging achievements to the delight of the Government and stakeholders. The headcount poverty rate was reduced from 47 percent in 1993 to 35 percent in However, a closer look suggests that there has been no significant impact on the number of people living under the poverty line. In fact, in 1993/94 with a population of 9.7 million, the 47 percent poverty headcount translated into 4.6 million of the poor living under the poverty line. The 35 percent poverty rate of 13.7 million in 2004 put the poor at 4.8 million. Given this simple calculation, concern is warranted. Another disturbing factor is the widening gap of inequality. Estimates of the Gini coefficient, with geographically comparable areas, increased from 0.35 in 1993 to 0.4 in This wider gap is primarily caused by the disparity within the rural areas where the Gini index rose from 0.27 to This reflects the difficulties some of the poorer people living in rural areas are having in seizing the opportunities offered by economic growth. Their inability to be part of increased economic abundance is most likely due to the fact that they remain voiceless and powerless and vulnerable to natural, economic and social external forces which can impact deeply on their lives. The objective of this Economic Watch issue is to provide the latest estimates on the country s economic growth in 2005 and prospects for 2006, and to detail the current progress of the Government s reforms. The sectoral growths of the economy are thoroughly analyzed by taking into account factors, both external and internal, to determine their growths. The country s other main economic areas such as movement in consumer prices, imports and exports, the execution of the fiscal and monetary policy, income distribution and poverty are presented based on the most recent data. The identifiable progress of reforms is documented prior to the arguments, and some recommendations are then drawn upon for further discussions. 3

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22 Chapter 1 Global Economic Trend: An Overview Cambodia has been isolated from the world for several decades in terms of international politics and trade and still needs to establish itself in the contemporary world. Taking this into consideration, the objective of this chapter is to highlight Cambodia s economic outlooks in comparison with the development of the world and regional economies, international trade flows and free trade agreements (FTAs), and the significance of economic development and poverty reduction World GDP Growth According to the global economic prospects of 2006, global economic growth slowed visibly in 2005 to 3.2 percent, compared with 3.8 percent in Moderate growth at around 3.2 percent is expected in 2006 before it rebounds in Part of the global slowdown has resulted from higher oil prices, resource-sector capacity constraints, tightening monetary policy in some countries, the saturation of the investment cycle following a year of very fast growth, avian bird flu-h5n1, natural disasters, and terrorism. Supply constraints in the oil market, the threat of even higher oil prices, and the possibility that interest rates may rise pose major threats to economic expansion. Table 1.1: Global and Regional Economic Trend e World High income Developing countries in East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and N. Africa South Asia Sub-Saharan Africa Source: The World Bank s Global Economic Prospects

23 While global economic growth slowed noticeably in 2005, Cambodia's economic growth was quite strong, with a 10 percent growth rate compared with the estimated 7.8 percent growth rate in East Asia Pacific. The country s economic growth is due to the synchronization of the three favorable progress industries; the garment industry, tourism and agriculture. However, more than one third of the population lives under the national poverty line, with less than US$0.50 per day, and the human development indicators are still alarming compared with the region and the world. On the international level, growth among high-income countries in 2005 was estimated at 2.5 percent, substantially lower than the 3.1 percent in 2004, with no recovery expected in 2006 in almost all developed countries. High oil prices, rising short-term interest rates and an unusually disruptive hurricane season contributed to slowing growth in the United States to an estimated 3.5 percent, compared with 4.2 percent in Growth will decrease to a further 3.1 percent in the United States, while a lackluster performance will still prevail in Europe, with growth reaching a meager 2.1 percent in Japan's recovery since 2005 is still expected to continue this year, albeit at a very modest pace of around 2 percent. Despite a slowdown of almost a full percentage point, growth in developing economies remained very robust at an estimated 5.9 percent in In part this reflects the strong performances from China and India, where output continues to expand at rapid rates in excess of 9 percent and about 7 percent, respectively. For 2006 and 2007 growth in developing regions is expected to be restrained by a combination of high oil prices, rising interest rates, and building inflationary pressures. Developing countries will experience stronger growth than developed countries Global Trade Flow The growth of the world merchandise trade decelerated moderately in 2005 both in terms of volume of trade and the value of the dollar. The growth of the volume of merchandise exports slowed to 7.1 percent in In dollar value terms, world trade increased by 12.9 percent in The higher growth in terms of value is due to the rise of the price of merchandise, which grew by 5.5 percent, mainly reflecting higher prices for primary commodities, as the average price of traded manufactured products remained flat. Even though the general trend saw a slow down in global exports, many developing countries and economies still kept a high growth rate compared with developed economies. In 2005, China's export growth 6

24 remained very high, about 27 percent in terms of volume and 29 percent in terms of dollar value. Table 1.2: World Trade Flow (% Change) e Dollar value of exports World Developed economies Japan Developing countries China Cambodia Volume of exports World Developed economies Japan Developing countries China Source: United Nations, World Economic Situation and Prospect 2006, EIC estimates for Cambodia. Despite a good macro economic performance, Cambodia's external trade slowed to about 18 percent compared with 23 percent the year before. This rate is in line with the average external trade of developing countries, although Cambodia s GDP growth is much higher Trade in Textile and Clothing The removal of the quota system under the ATC of the Multi-fiber Agreement (MFA) in 2005, saw a considerable change for the countries benefiting from this system. Some developing countries increased their clothing and textile markets share whilst others have lost some of their competitiveness. 7

25 In Cambodia s case, it ranked 7 th in the countries who gained from the end of the quota system by increasing its market share by percent in the first half of Vietnam kept its market share but with only a few percentage points increase, however Vietnam will most likely gain important benefits when the country accedes to the WTO, expected in late In contrast to Cambodia and Vietnam, the textile sectors in Kenya, Myanmar, Nepal, the Philippines, and Tajikistan saw the dollar value of their exports decline by 4 percent or more. However, many of these countries are not large textile exporters. Figure 1.1: Change in textile exports to the developed world, first half of 2005 Tajikistan Myanmar Nepal Kenya Philippines Mexico Mongolia Mauritius South Africa Vietnam Tunisia Lesotho Madagascar Moldova Albania Macedonia, FYR Pakistan Morocco Thailand Swaziland Indonesia Romania Bulgaria Lao PDR Egypt, Arab Rep. Bangladesh Cambodia Peru Jordan Turkey Sri Lanka India China Source: The World Bank, IMF, U.S Department of Commerce and Euro Stat. A significant factor since the quotas system came to an end is that though Cambodia s garment exports increased generally, the country only gained market share in the United States. The country s market share of European exports fell 11 percent, similar to most countries exporting to

26 Europe, except for the likes of China, India, and Turkey. Nevertheless, China will face great challenges to keep its US$18 billion market share in Europe because Chinese clothing is no longer considered in the new European GSP scheme for the period from Poverty Rate There are positive signs concerning Cambodia s poverty rate. Poverty projections based on real per capita income growth rates and the (re)distribution of income within the population indicate that over the next 15 years the share of the population living in extreme poverty is expected to decline in all developing regions. With the exception of Sub-Saharan Africa, all regions are expected to achieve their Millennium Development Goal of reducing poverty by 50 percent from its 1990 level. In East Asia, the target has already been achieved. Moreover, based on the current long-term forecast, extreme poverty will be almost eliminated by 2015 in both East Asia and the Pacific and the European and Central Asia regions. Overall, the percentage of people living on US$1 a day or less will fall to around 10 percent (620 million people) from 28 percent (or 1.2 billion people) in 1990 and an estimated 21 percent (1 billion people) in Table 1.3: World Poverty Rate (%) Less than US$1/day Less than US$2/day p p East Asia and Pacific China Rest of East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa Total Source: The World Bank s Global Economic Prospects Despite these heartening prospects, there is no room for complacency. The percent of the population in developing economies 9

27 living at or below US$2 a day is projected to remain disturbingly high. Moreover, notwithstanding the inroads that have been made recently, the rate of extreme poverty in Sub-Saharan Africa in 2002 was actually higher than in While current projections suggest 8 percent of the sub-continent's population will be lifted above the extreme poverty line by 2015, some 38 percent of Africans will still be living in extreme poverty. Worse, the absolute number of Africans living at or below the US$1 a day level is projected to increase. Furthermore, because per capita incomes elsewhere are projected to grow faster, the continent will continue to fall further behind the rest of the world unless steps are taken to improve economic growth in Africa. Cambodia has set itself a goal to alleviate poverty by 2015, according to its Millennium Development Goal. Remarkably, according to the latest results from the Socioeconomic Survey 2004/2005 and the World Bank's assessment report, Cambodia had made progress in reducing poverty. The percentage of people living under the poverty line declined from 47 percent in 1994 to 35 percent in 2004 or approximately one percent p.a. Besides, reduction of poverty happened in both urban and rural areas with the average annual rate of 1.5 percent and 0.9 percent respectively 1. 1 See chapter 6, section 6.3 below for more details. 10

28 Chapter 2 Cambodian Economic Growth For 2005, the Economic Institute of Cambodia estimated that the country s economic growth jumped to 10 percent 2, the second highest growth for the last 10 years after 12.5 percent in Compared to 2004, the growth rate was more than 2 percent higher. This was caused by a sudden growth in the agricultural sector especially crops and fisheries, while garment exports and a record number of foreign arrivals to Cambodia continued to grow at a considerable rate. However, some critical reforms and the investment climate did not see significant improvement. Table 2.1: Cambodia's Economic Growth (%, 2000 prices) e 2006p Agriculture -2.8% 12.0% -2.1% 11.9% 2.5% Paddy -7.8% 22.3% -12.3% 30.8% -1.6% Industry & Construction 17.7% 12.3% 16.5% 11.7% 9.6% Garments 21.2% 16.9% 24.9% 17.6% 13.4% Services 4.4% 0.1% 9.2% 7.0% 6.4% Tourism 18.8% -10.3% 23.6% 16.9% 13.3% Total GDP 5.2% 7.0% 7.7% 10.0% 6.0% Sources: NIS for , EIC Projection for For the year 2006, the EIC expects the economy to fare well in certain sectors. The number of foreign tourist arrivals to Cambodia is expected to increase steadily. The growth of garment exports will be prolonged, but with a slower rate, thanks to the effective actions imposed by the US and EU restricting imports from China until In addition, residential construction and real estate are also expected to continue their growth, according to EIC s ad-hoc 2005 survey. In contrast the agricultural sector remains dependent on weather conditions. Based on this prospect and economic trends, economic growth in 2006 is expected to be about 6 percent, assuming that weather conditions will not seriously damage crops. 2 This economic growth estimation for 2005 is 5 percentage points higher than that of the EIC previous estimation in October 2005, because unexpected favorable climate condition at the end of the year, and higher exports of garment. 11

29 The country's economic growth in 2006 could be speeded up if there is significant reform progress in some critical areas. Irrigation renovation and natural resource management reform are vital for agricultural growth. These reforms could reduce damage caused by weather conditions especially droughts, and could stop the decline of natural resources. Other reforms such as multi-faced reforms in trade and investment, in public finance, and in the legal and judicial system, are crucial for industry and service sector development. These reforms, together with effective anti-corruption policies, could provide a preferred environment and opportunity for higher economic growth. However, these changes are unlikely to be achieved in the short term without strong political commitment Agriculture Cambodia s agricultural sector is very important to the economy because of its immediate affect on the living conditions of Cambodia s rural poor. The agricultural sector s most significant shares are crops and fisheries. For 2005, agricultural growth rebounded to 11.9 percent after a 2.1 percent decline in 2004, due to favorable climate conditions at the end of the year, expansion of cultivated areas, and recovery of fish production. In spite of this very significant growth, the country s agriculture in 2005 was still a natural resource-based sector and depended largely on geographical and weather conditions. An effective irrigation system and natural resource management are still urgent measures needed to maintain the growth. Table 2.2: Value Added of Agriculture Sectors (% increase, 2000 prices) e 2006p Paddy -7.8% 22.3% -12.3% 24.8% -1.6% Other Crops -0.9% 29.0% 6.1% 9.6% 8.1% Livestock -1.2% 5.1% 4.3% 3.7% 4.1% Fishery 0.6% 1.7% -3.3% 11.8% 0.9% Rubber & Forestry -7.6% -5.3% -1.5% -0.2% 0.0% Total Agriculture -2.8% 12.0% -2.1% 11.9% 2.5% Source: NIS for , and EIC model projection for

30 In 2005 the supply of crop production was still dependent on weather conditions because of limited effective irrigation systems. According to data from MAFF, the weather conditions in 2005 were much more favorable compared to a whole year of drought in saw full rains at the end of the year after half a year of droughts. Cultivated areas also increased by about 3 percent up from 2.37 million hectares in As a result, for 2005, paddy value added sharply augmented by about 25 percent and those of other crops also increased about 10 percent compared to Though crop production increased in 2005, the expected low government budget disbursement for 2006 will decrease prospects for a rapid improvement in agricultural infrastructure. By assuming moderate climate conditions, rice production growth for 2006 is then expected to decline slightly, about 1.6 percent, compared to rice production in Nevertheless, the non-rice crops are expected to contribute more substantially to growth, but with a slower rate, thanks to the expansion of cultivated areas. Another contributor to the agricultural sector, livestock production, continued to grow with a slower rate, about 3.7 percent in 2005 compared to 4.3 percent in Cambodia is still importing a large amount of livestock from neighboring countries since domestic production remained very low. This was due to a lack of capital and inaccessibility to credit. Nonetheless, livestock remains a potential income source which farmers should be encouraged to work in. Since irrigation systems are still limited, farmers should diversify their sole income source from unpredictable crop cultivation to livestock 3 (cattle, pigs, and poultry) rearing. As an incentive for livestock production, the Government should provide farm animals, which should be prohibited to be resold, and technical skills to initiate farmers in livestock production. Another agricultural sector which showed some positive sign, was the fishery sector which reached a 11.8 percent growth jump after a 3.3 percent decline in This was due to the return of small fish which were used for the production of popular salt fish pâté, while normal fish production remained low. However, the number of illegal fishing complaints, the use of illegal fishing instruments and the destruction of essential fish rearing areas, remain important concerns for the sector to grow properly. These practices led to demolished fish stocks and fewer 3 Repeatedly, the EIC s Cambodia Poverty Assessment: Regional Case Studies, sponsored by the World Bank (forthcoming). Most focus groups consulted by EIC agreed that raising cattle and pigs are their main supplement sources of incomes and saving 13

31 places for the fish to give birth. Thus, the prospect of the reemergence of fish stock in the coming year is slim. A more disturbing picture in 2005 was the continued decline of the forestry sector. This was mainly because of the Government s moratorium on commercial logging and processing since 1999, in combination with illegal deforestation. In contrast, rubber production increased slightly, about 1 percent, after more than a 10 percent declined in However, the growth rate of the forestry and rubber sectors was still negative. Based on this trend, the growth rate is expected to have a positive increase for the next few years, but still remains at a very low rate. Although the agricultural sector witnessed a sudden growth in 2005, the gains from this growth were restrained by two main factors. The first factor concerns the higher input costs of agricultural products, fueled by the increasing price of fertilizers and, especially, petroleum. The second is farmers limited capacity to gain product market information. They remain dependent on traders who set the prices and they do not produce on demand, simply producing without prior contracts making this production somewhat redundant. Due to a lack of market information, traders and exporters easily manipulate the price of agricultural products to the farmers' disadvantage, who are then forced to sell their products far below the market price. These two major constraints in addition to the lack of initial capital, a landless poor, and the inaccessibility to access credit excluded many of the rural poor from the benefits of the agricultural sector s growth. One way to prevent the further economic alienation of the rural poor is to promote contract farming as an effective measure to prevent the impact of price decline, supply surplus and re-capture margins lost to traders. Once again 5, the starting point for the landless poor is simply to give them land for cultivation for their survival and grants in animal stock for them to prosper, provided that re-sale of these lands and grants are not allowed for a certain period of time. Land reforms, natural resources management and also agro-industry developments are the decisive factors in achieving the Government s goal for poverty reduction through strong and stable growth in agriculture Industry The country's industrial sector in 2005 achieved a significant growth of 11.7 percent in 2005, about 4 percent down from It was still driven mainly by the development of the garment industry, which posted a relatively 4 General Equilibrium Model of EIC 5 Economic Watch October

32 high growth rate, about 17.6 percent compared to 24.9 percent in The electricity and water sectors increased their growth to 7.4 percent, whereas the growth rate of the construction and mining sectors slowed down compared to 2004 because many big road projects were completed. For the food, beverage and tobacco sectors, their growth rebounded to 1.6 percent since there was a sharp increase in agricultural production. Table 2.3: Value Added of Industry Sectors (% increase, 2000 prices) e 2006p Garments 21.2% 16.9% 24.9% 17.6% 13.4% Food, Beverage & Tobacco -1.2% 5.6% -2.1% 1.6% 2.0% Other Manufacturing 7.8% 0.7% 3.1% 3.7% 3.5% Electricity, Gas and Water 17.1% 15.7% 4.7% 5.8% 5.7% Construction & Mining 27.0% 11.0% 13.0% 4.6% 4.4% Total Industry & Construction 17.7% 12.3% 16.5% 11.7% 9.6% Source: NIS for , and EIC model projection for The industrial sector s main contributor, the garment industry, remained strong although the quota system came to an end in late The quantity of garment exports of 2005 increased by 20.6 percent. Surprisingly, the quantity of garment exports to EU markets 6 declined 11.7 percent. The growth was then boosted by increasing exports to US markets 7 up to 32.5 percent and a 14.5 percent increase in exports to the rest of the world (excluding EU and US markets). This growth is mainly a consequence of the safeguarding measures imposed by the US and the EU to restrain China s imports and the labour compliance project monitored by the ILO. 8 Cambodia s WTO membership and reducing bureaucracy of transaction exports, such as the One Window Service, also helped maintain the sector s growth. 9 Nonetheless, fiercer competition in the world garment market, especially in the US market, caused a decrease in the average price of Cambodian garments in 2005, by more than 7 percent compared with prices in Total growth of garment exports valued in US dollars in 6 Represent more than 20 percent of Cambodia s garment exports. 7 Represent more than 70 percent of Cambodia s garment exports. 8 Van Sou Ieng, Chairman of GMAC, remarked in the Roundtable on Garment Industry after the end of the quotas system. 9 Idem 15

33 2005 increased only about 11.5 percent compared to 24.6 percent in The lowering of prices of Cambodian garment products in the world market has reduced investors profit margins. In addition, Vietnam s pending membership to the WTO will increase competition in foreign investment; the ability to attract more investors in the garment industry would then be reduced. Table 2.4: Cambodia s Garment Exports (% increase, year average) Quantity e 2006p USA 15.8% 10.2% 20.6% 32.5% 16.4% EU 11.0% 19.3% 34.2% -11.7% 0.0% Others 65.1% 146.8% 71.1% 14.5% 12.0% Total 15.3% 14.7% 25.7% 20.6% 13.2% Prices USA -0.6% 6.7% -5.5% -8.7% -4.2% EU 3.9% -4.2% 6.3% -2.0% -2.0% Others -4.9% 13.5% -4.2% 16.0% 5.0% Total 0.4% 4.7% -1.6% -7.5% -3.8% Source: Ministry of Commerce for , EIC estimates for 2006, based on the expert opinions. However, the most worrying of competitors, China, has been restrained which gives some room for continued growth. Under the new graduation mechanism established in the new EU GSP scheme for a period of , Chinese textiles will not be included. 10 Thus, some countries, including Cambodia, are expected to gain some garment investors from China. Moreover, the safeguarding measures imposed by the US and the EU to restrain China s imports remain valid until The labour compliance project monitored by the ILO also helps to conserve big orders from US buyers. 11 As a result, garment exports are expected to continue to grow, but at the slower rate of 13 percent. Prospects of the garment industry s growth rate for 2006 will speed up if Cambodia is granted dutyfree exports to the US markets. Cambodia's perceived garment export growth remains purely based on external factors such as the EU and US safeguard measures against 10 World Economic Situation and Prospect 2006, United Nation, New York, According to Van Sou Ieng, Chairman of GMAC, and additional opinion surveys with several General Managers of garment factories. 16

34 China which are not sustainable because their effectiveness will expire in Based on the current situation, the possibility to compete with China is minimal since raw materials and most factory owners are Chinese. Cambodia has one advantage, which is its foray to create a niche market for Cambodian garment products with the good reputation of its labor standards inspected by the ILO, unique in the word. The recent data of Cambodia s garment exports to US markets showed that the impact of good labor standards maintained the level of exports. Figure 2.1: Cambodia s Garment Exports to US market (Million Dozens) , ,457 2, Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Source: Ministry of Economy and Finance Data collected from the MEF showed that Cambodia s garment exports to US markets during October 2004 and April 2005 was relatively flat, fluctuating around the average 2.5 million dozens. After May 2005, Cambodia s garment exports to US markets started to grow around more than 50 percent per month compared to the flat period at the beginning of year. US safeguard measures to restrain Chinese imports were imposed on March of The flat period reflected the impact of Cambodia's good labor standards which could maintain demands of big buyers from the US, while the growth from April 2005 revealed the strong impact of the US safeguard measures against imports from China. In contrast to US exports, EU markets were not favorable to the impact of good labor standards. 12 In addition, the reputation of labor standards also increased production costs, which made the price of garment products in Cambodia higher than in Bangladesh, China, Vietnam and other main competitors. The prospect to have future price 12 Van Sou Ieng, Chairman of GMAC, remarked in the Roundtable on Garment Industry after the end of the quotas system on March 14 th, 2006, organized by EIC under the support from CCLSP project. 17

35 competitiveness with other countries is doubtful. Cambodia s good labor standards, which have enabled the sector to remain relatively stable, may help maintain key buyers from the US. However, the growth prospect is expected to be flat after Regarding construction, which is the second biggest industrial subsector, its growth rate significantly slowed to 4.6 percent in 2005 down from 13 percent in The lower rate of growth is a result of a slow down in public constructions since many big roads have almost been completed. Lower government disbursements of capital expenditure in 2005 and fewer hotel constructions are also the reason, despite continuous strong growths in garment factories and private constructions, especially flats and apartments. Moreover, the growth of construction is expected to be the same in 2006, in line with the financial assistance committed by donors at the recent Consultative Group meeting in March 2006 along with government programs to build and renovate the country's irrigation system. The expected growths of other industrial sub-sectors such as food, beverage, tobacco, electricity, gas, water and other manufacturing sectors for 2006 are relatively the same rate as those of 2005 for each. As a result, based on this prospect and economic trend, the growth of the industry sector in 2006 is projected to slow down to less than 10 percent. Repeatedly, the growth may be speeded up if there is a significant reform progress in some critical areas such as multi-faced reforms in trade and investment, in public finance, and in the legal and judicial system Services The service sector s share is still the biggest in the Cambodian economy. For 2005, the service sector, excluding public administration, increased by more than 7 percent. The most significant growth among subservice sectors are tourism, hotels and restaurants, which grew by 16.7 percent due to the annual record of million tourist arrivals into the country. Following the increase of tourists into the country, were the growing transportation, communication, and trade sectors which saw a 7 percent increase in 2005, slightly higher than that of Other private services such as rentals and real estate increased moderately at about 4 percent because of the slower expansion in residential and apartment constructions. Finance and banking also expanded both in areas of coverage and financial service operations. 13 Compiled from discussion in the Roundtable on Garment Industry after the end of the quotas system on March 14 th, 2006, organized by EIC under the support from CCLSP project. 14 Excluded spot visitors to Preah Vihea Temple. 18

36 The service sector was affected considerably by the number of foreign tourists, which went up by 34.2 percent in 2005 compared to 40.2 percent growth in The gains were the result of the country s security and airway infrastructure improvement. More frequent flights from regional countries to Cambodia, especially direct flights to Siem Reap, were factors leading to these higher tourist numbers. Based on this trend, the number of foreign tourists is expected to continue to increase at a slower rate. Table 2.5: Value Added of Service Sectors (% increase, year average, 2000 prices) Transport & Communication 7.6% 2.3% 6.2% 6.9% 5.5% Trade 0.6% 2.2% 6.3% 6.7% 5.5% Hotel & Restaurants 18.8% -10.3% 23.6% 16.7% 13.3% Other Private Services 1.8% 2.2% 11.2% 4.2% 4.9% Total Private Services 4.7% 0.4% 10.3% 7.2% 6.5% Public Administration -0.3% -4.3% -6.8% 1.8% 5.6% Total Services 4.4% 0.1% 9.2% 7.0% 6.4% Source: NIS for , and EIC model projection for Apart from the positive tourist numbers, the average growth rate of the services during 2006 is expected to slow down to 6.4 percent growth with moderate gains from all of the services sub-sectors. The forecast assumes moderate growth in the agricultural and industrial outputs, imports, exports, and the projected foreign tourist arrivals all of which utilise services. Moreover, the growth s prospect for the sector may be overturned by the increase in the price of petroleum, the depreciation of the Riel and inflation pressures. These factors make financial services, transportation and trade more expensive. Table 2.6: Foreign Tourist Arrivals in Cambodia (% increase, year average) Through Phnom Penh 5.3% -22.6% 17.4% 31.4% 15.0% Through Siem Reap 42.4% -1.4% 66.1% 42.2% 35.0% By Land & Boat 34.0% -7.2% 47.3% 29.9% 20.0% Total 21.3% -12.5% 40.8% 34.2% 23.4% Number (000 s) ,325 1,635 Source: Ministry of Tourism for , EIC estimates for 2006, based on the professional opinions. 19

37 20

38 Chapter 3 Trade, Investment, and Productivity 3.1. External trade and Capital movement Trade remains a decisive component of the country's economic activity. Data compiled from the National Bank of Cambodia (NBC) and EIC reveals that total exports 15 increased by 18 percent and up to US$2.9 billion in 2005 while total imports increased to US$3.8 billion. These figures of exports and imports made up 53 percent and 69 percent of nominal GDP respectively, leading to a merchandise trade deficit at 16 percent of GDP. The export growth is slightly lower compared to 2004 due to the lower growth of garment exports, the biggest foreign currency earner accounting for more than 80 percent of total merchandise exports. The garment exports only grew by 11.6 percent and up to US$2.2 billion in 2005 while its growth accounted for 23.7 percent in Admittedly, garment export value to the EU declined by 13.5 percent, but total garment exports were backed by the higher garment export growth to the US, by 21 percent. Concerning imports, garment raw materials amounted to US$1.5 billion, which are mostly imported from China, Taiwan, Hong Kong and South Korea. Another main import component is oil and gas imports which totaled US$1 billion in Total import growth was recorded at a lower speed due to lower import growth of garment inputs in parallel with lower growth of garment exports. The balance of services recorded an estimated surplus at 7.5 percent of nominal GDP. This surplus was reflected in a surplus of tourism thanks to the strong momentum of tourist arrivals, increasing by 34 percent. Transportation recorded a deficit by 4.6 percent due to the fact that airlines and other transportation means serving tourism arrivals to Cambodia are mostly foreign-owned companies. The income balance registered a deficit reflecting a large outflow payment to foreigners through profits, dividends and interests generated by their FDIs and portfolio investment, and employees compensations. However, Cambodia is enjoying a surplus of private transfers by overseas Cambodians and government transfers through grants provided by donors to the Government. All this added to a deficit of current accounts at 5.6 percent of nominal GDP. 15Including unrecorded exports 21

39 Table 3.1: Cambodia s Balance of Payments (% GDP) e 2006p Exports of Goods 43.0% 46.5% 50.6% 53.2% 52.6% Imports of Goods 56.8% 58.8% 65.3% 69.4% 69.9% Trade Balance -13.8% -12.2% -14.7% -16.2% -17.3% Agriculture 2.4% 4.1% 1.8% 4.8% 4.7% Textiles & Garments 10.3% 11.9% 13.3% 13.4% 13.5% Oil & Gas -9.0% -10.1% -14.0% -17.8% -17.9% Other Goods -17.6% -18.2% -15.9% -16.6% -17.8% Balance of Services 5.6% 3.1% 6.1% 7.5% 8.9% Transportation -3.1% -3.4% -3.8% -4.6% -5.5% Travel (Tourism) 10.2% 8.1% 11.4% 14.0% 16.7% Others -1.5% -1.6% -1.5% -1.8% -2.2% Balance of Incomes -4.3% -4.7% -4.9% -5.4% -5.8% Current Transfers (net) 11.0% 10.9% 9.0% 8.5% 8.5% Private Transfers 1 4.8% 4.7% 4.3% 4.0% 3.7% Government Transfers 2 6.2% 6.2% 4.7% 4.5% 4.8% Current Accounts -1.5% -3.0% -4.4% -5.6% -5.7% Capital & Financial 6.9% 4.1% 6.9% 8.3% 7.5% Official Loans 3 3.4% 3.6% 3.5% 2.9% 2.0% Foreign Direct Investment 3.6% 1.9% 2.7% 4.5% 4.6% Others (net) -0.1% -1.5% 0.7% 0.9% 0.8% Change in Foreign 5.4% 1.1% 2.4% 2.8% 1.8% 4 At the National Bank -2.4% 3.4% -1.8% 0.4% 0.3% Outside NBC 7.8% -2.3% 4.2% 2.4% 1.5% Source: NBC , EIC s projection for Money transferred by Cambodian overseas. 2 Grants provided by donors to the government. 3 Net of debt amortization. 4 Overall balances reflect change in country's foreign reserves. As Cambodia is a dollarized economy, and private individuals and institutions can hold foreign currencies, the overall change of the balance of payments not only affects the foreign reserves of the National Bank, but also other economic agencies, such as private financial institutions, businesses and households. The capital account declined due to a decrease of government borrowing; but the foreign direct investments in garments and tourism 22

40 activities increased. Finally, the overall balance of payment caused changes in reserves, increasing from 2.4 percent to 2.8 percent of nominal GDP. In sum, the economic growth is partially sustained by the growth of garment exports, despite lower growth speed. The level of employment in the industry is also maintained, helping prevent garment workers from going back to rural areas, which could cause important social problems. The sector is nonetheless vulnerable to various external forces, especially exports to Europe. Cambodia s garment sector does not fully enjoy the EU s preferential tariff due to the constraint of the 'rule of origin'. The total garment exports to the EU covered by the special treatment of everything-but-arms act (EBA) are only 63 percent. For 2006, the external trade is expected to grow due to the continuous growth of garment exports while this sector is still capitalizing on the above factors. Main import components such as garments and textile raw materials and oil and gas have to increase to accommodate the demand arising from current private investment influx in garment and other industries. The deficit of current accounts will be financed by capital account surplus and slightly by foreign reserve. This will lead to a negative change in foreign reserve requiring a higher amount of foreign currencies to finance the deficit and causing theoretically the depreciation of the Riel Private Investment and Stock of capital For any developing country, an increase in private investment can help establish a thriving economy. According to the recent data from the Council for the Development of Cambodia (CDC), private investments jumped up unexpectedly both in terms of number of projects and fixed assets approved, recovering from a decline in The CDC approved 102 investment projects and US$695 million of fixed assets, increased by 200 percent compared to the year It is worthy to note that the increase of fixed assets were significantly pushed by that of US$181 million, accounting for 26 percent of total fixed assets, invested by a cement factory in August The country's industry sector had the most approved investment projects, which saw 82 approved investment projects of which 53 in the garment industry. This prospectively reflects the continuous growth of garment exports. The investments in agriculture, services and tourism are relatively low. With the exception of the year 2003, the number of new 16 The figure excluded three mega projects whose registered fixed assets are over US$3.5 billion. However, these projects are long term so that they will not affect the growth prospects of the economy in the short-run. 17 Kampot Cement Co.,Ltd 23

41 investments in hotels has stagnated and the value of fixed assets has fluctuated since This stagnation is because the number of hotels in Siem Reap has obviously reached saturation level. This is a significant issue as a recent EIC study found that the saturation level of hotel constructions in Siem Reap will cause the loss of thousands of construction jobs and household incomes in districts around Siem Reap town. 18 Table 3.2: Private Investment Projects Approved, Number of Investment Projects Approved Total Garment Hotel Others Fixed Assets Approved (millions of dollars) Total Garment Hotel Others Source: CDC, Cambodian Investment Board, * excluding registered investments of 3 mega projects in oil refinery, iron and steel mining, and alumni melting in February 2005 whose combined fixed assets is more than US$ 3.5 billion. Nevertheless, the soar of investment projects is questionable. The increase came probably after the phase out of 2 percent of registered fixed assets as investment guaranteed deposit since early This would induce the likelihood for speculative investors 19, with the ability not to commit to the approved investment projects. 18 EIC s poverty assessment study in Puok district, which is close to Siem Reap town, in 2005 found that construction works in town absorbed 3,300 jobs from the district of 21,600 households and the income from those construction works made up approximately 19% of households income in the whole district. This study was commissioned by the World Bank as part of Cambodia: Poverty Halving by 2015? An assessment of poverty Those investors who have no genuine incentives to invest but to get investment licenses and then resell to others in order to make short term profits, commonly known in Khmer proverb as tver num at msau or making cakes without powders. 24

42 In addition, Vietnam s accession 20 to the WTO will threaten FDI influx, given the current investment climate. This requires urgent reforms in all areas to keep inflow of FDI, especially trade facilitation and improving the investment climate. The US$10 million grant provided by the World Bank to enhance trade facilitation and competitiveness would help speed up these reform priorities. The capital stock increased across all sectors with an overall estimated increase of 9.3 percent. This growth was higher than in 2004 due to a strong garment investment influx. The agriculture and industry productivity grew by 3.2 percent and 13.6 percent respectively while service grew by 9.5 percent, slightly slower than in The garment stock of capital increased by 23.2 percent, 9 point percent higher than growth in 2004 while capital stock of hotels and restaurants increased by 19 percent, 8 point percent lower than growth in Productivity The high economic growth can reduce poverty substantially since it is done through increasing productivity (value added per worker) by which real wage increases. This means that economic growth must create productive employment. Table 3.3: Productivity of Workers (% increase, 2000 prices) e 2006p Agriculture -2.5% 8.9% -4.6% 9.0% 0.0% Paddy -7.1% 18.9% -14.7% 21.5% -4.1% Industry 8.9% 6.4% 8.1% 5.3% 3.7% Textile & Garment 14.2% 10.9% 11.4% 6.5% 3.7% Private Services(*) 2.0% -1.3% 6.8% 2.0% 4.4% Tourism 10.3% -7.7% 8.3% 6.1% 4.9% Total (*) 4.0% 3.7% 4.0% 6.6% 3.1% Source: EIC s Estimates. (*) Excluding Public Administration. 20 Vietnam concluded the bilateral negotiation with Australia on 3rd March 2006 on Vietnam s accession to the WTO. After Australia, Vietnam has to complete WTO negotiation with remaining four countries and is expected to finish all bilateral talk on its WTO accession before the summit of the Asia-Pacific Economic Cooperation (APEC) slated for November in the country. 25

43 EIC estimated that worker productivity grew across sectors which adds to a total productivity increase by 6.6 percent, reaching US$830 per laborer, thanks to productivity gains in agriculture. The good weather condition pushed agricultural productivity growth by 9 percent and paddy productivity increased by 21 percent. Looking back over the last several years, the agricultural productivity from year to year has fluctuated since the sector has been dependent on the weather; thus the key strategy to keep steady productivity growth is to invest in the irrigation system. Labor productivity in the industry and service sector (excluding public administration) continues to grow by 5 percent and 2 percent, respectively. The productivity of the garment industry will increase due to growing learning experiences and additional trainings for factory middle management level The Garment Industry Productivity Center funded by USAID/Cambodia has been created to train the middle management level of garment factories. This project came after a result of the study on measuring competitiveness and labor productivity in Cambodia s garment industry which explored the possibility of increasing productivity by percent. 26

44 Chapter 4 Prices and Monetary Developments The growth of Cambodia's economy will be substantial if inflation and the Riel remain stable. Cambodia's inflation has been on the upward trend since 2004 after a moderate reduction and stability during The sudden surge in inflation is mainly due to higher food and petroleum prices. The Riel still showed signs of weakness against the US dollar during 2005 after a 2 percent decline in In the coming years, the Riel will continue to be under pressure as some deterioration in the balance of payments is expected Inflation The year 2005 saw a significant increase in inflation affecting various sectors, impeding economic growth. According to the National Institute of Statistics, the inflation rate of 2005 was 6.7 percent compared to 5.6 percent in 2004 and 0.5 percent in The higher inflation rate was mainly driven by higher food and transportation prices. The price index of food rose by 12 percent, which caused a 10.6 percent increase in the price of cereal, 17.4 percent in the price of meat and poultry, 17 percent increase in the price of fish, and 18.7 percent in vegetable prices. The price index in transportation was up by 9.5 percent, mainly due to the 21.3 percent increase in the price of fuel, and 8.6 percent increase in passenger transportation costs. At the end of 2005, other market sectors also showed signs in price increase. The price index for clothing and footwear, and that of personal care and effect increased to around 5 percent. This is in contrast to the growth of other commodity prices which were basically flat. The price of food rose considerably since July 2005, although there were significant increases in agricultural production, especially crops, livestock and fish. The increase in food price was most likely caused by market distortions such as artificial shortages created for profiteering, and higher cost of inputs and transportation fueled mainly by the increase in prices of gasoline. The depreciation of the Riel against the US dollar could also be the reason for the increase in prices because the majority of production input was imported. The price of gasoline in Cambodia also rose significantly since May 2005, mainly due to the continuous increase in crude oil prices on the international market. The price of gasoline was kept high compared to neighboring countries because higher import taxes were imposed by the Government. 27

45 Cambodia's growing inflation can be traced to the continued important dependence on significant imports. The inflation was feasibly pushed by higher input costs, of which most were imported such as petroleum. Therefore this inflation would not benefit either domestic producer nor end consumer. Producers saw domestic production become less competitive compared with import products. This higher inflation rate is then more likely to reflect in the higher cost of living. This in turn has a detrimental affect on people in the lower economic echelons of society, as their income cannot keep up with the rise in prices. In 2005, inflation was pushed by higher input costs. These input costs are generally reflected by costs of production and transportation, and the prevalence of unofficial costs otherwise known as corruption. The inputs are generally derived from natural resources and imports, while the transportation costs fluctuated with the prices of gasoline and diesel fuel. Thus, natural resource management, reducing the price of gasoline and diesel, and fighting corruption are crucial in order to reduce the inflation rate, and increase competitiveness of domestic products. For the country to become less hindered by rising inflation rates, the total dependence of oil imports should be significantly considered. Again, there are significant impacts of the price of oil on consumers welfare and cost competitiveness of exporting sectors. Cambodia should establish a national reserve of oil in order to cope with oil shocks. The Government should also rethink its high taxes on petroleum which are the main cause of increasing oil prices, which are higher than that of neighboring countries Exchange Rate The Cambodian economy was still nearly completely dollarized. The Cambodian Riel showed some sign of weakness against the US dollar in The official year-average rate depreciated 1.9 percent in 2005, compared with This depreciation was more significant for the market rate, reaching 2.1 percent during the same period. According to data released by the National Bank, the average value of the Riel at the market rate in Phnom Penh in early 2005 was relatively flat at around Riel 4,037 per US dollar, before it depreciated in April 2005 and reaching Riel 4,215 per US dollar in July However, the Riel appreciated slightly again at the end of the year. In the same period, the Riel also depreciated against the Vietnamese dong the same trend as against US dollar, but strongly fluctuated versus the Thai baht. The Riel continuously depreciated against the Thai currency 28

46 during January to March, but significantly recovered during March to July. During July to October, the Riel then started to re-depreciate, and reappreciated again during the last three months of It should be noted that Cambodians living in the western part of the country primarily use the Thai baht, rather than the Riel or US dollars. The weakening of the Riel against the US dollar was caused mainly by a strong demand for foreign currencies especially the US dollar due to predominant dollarization, currency speculations, increase in the supply of the Riel, and by the widening of trade deficits in 2005 compared with Surges in imports especially for construction materials and vehicles and higher prices of imported petroleum were factors causing stronger demand for foreign exchange, especially the US dollar. Moreover, the sending of the US dollar abroad and speculations are also behind the fluctuations of the Riel against the US dollar Figure 4.1: Cambodian Riel Against US$, Thai Baht, Figure and 4.2: Vietnamese Cambodian Dong Riel (December Against US$, 2002=100) Thai Baht, and Vietnamese Dong (December 2002=100) Riel Against Thai Baht Riel Against US$ Riel Against Vietnamese Dong Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Source: EIC, Compiled from the International Finance Statistics of the IMF. Source: EIC, Compiled from the International Financial Statistics of the IMF In general, domestic currency depreciation would encourage domestic product exports. Given the strong dependency to import intermediate products, local Cambodian exporters are unlikely to gain from the Riel s depreciation, especially against the US dollar. As well as having a dollarized economy, the depreciation of the Riel against the US dollar will put an additional burden on small consumers, especially the rural poor, since a devaluing Riel means higher costs for basic imported goods and also for imported input-based domestic goods. Only the stability of the Riel against the US dollar provides benefits for the whole economy. 29

47 Effective measures to stabilize and to strengthen the exchange rate should be taken in order to protect those who hold Riel from loss. Low budget deficit and low liquidity are vital to avoid pressure on the Riel and speculation. The Central Bank should be more active to adjust to the fluctuation of the Riel against the US dollar in the market. Only with the stability of the Riel combined with regulatory measures, then will Rieldenominated transactions be feasible. The confidence in the Riel as a medium of exchange in the economy will enable the Central Bank to retain its monetary policy Money Supply For 2005, total money supply continued to expand by 16 percent though lower compared to the 30 percent in 2004, and reached 22 percent of GDP. Officially, more than 70 percent of money supply was dominated by the US dollar, while liquidity in Riel was still limited. Relative to nominal GDP, both local currency in circulation and foreign currency deposits in the market were relatively stable in 2005 compared with Table 4.1: Cambodia's Monetary Survey (End of Period, % of GDP) Total Money Supply 19.2% 22.1% 22.4% 23.3% Local Currency in Circulation 5.2% 5.7% 5.7% 5.9% Foreign Currency Deposits 13.3% 15.7% 16.0% 16.6% Other Liquidity 0.6% 0.7% 0.7% 0.7% Total Money Demand 19.2% 22.1% 22.4% 23.3% Credit to Private Sector 7.7% 9.3% 9.8% 10.4% Credit to Public Sector -0.7% -1.1% -1.9% -2.4% Other Money Demand (*) 12.2% 13.9% 14.4% 15.3% Credit to private sector on deposits 58% 59% 61% 63% Source: National Bank of Cambodia for , EIC model projection for (*) This item represents mostly the money sent abroad. Riel liquidity increased 15 percent compared to 2004 and reached 5.7 percent of GDP. The Riel is generally used by the rural poor and to some extent, by the Government to pay the meager salaries of civil servants, representing about 710 billion Riel (or 55 percent of total liquidity 30

48 in Riel). The increase of Riel liquidity has put some pressure on the exchange rate during Foreign currency deposits continued also to expand by 17 percent compared to 2004, reaching 16 percent of GDP. This growth also reflects strong activity in sectors such as tourism and garments. However, a large amount of foreign currency, especially the US dollar, was sent back to respective countries since many big investors are foreigners and Cambodia s banking system is inadequate. On the demand side, a large proportion of total amount of money was sent abroad, especially foreign currency deposits. Credits to public sectors continued to decline due to an increase in government deposits. Credit for the private sector continued to increase significantly in 2005 compared with 2004 (21 percent increase), reaching almost 10 percent of GDP. This credit expansion was the result of lower interest rates in 2005 compared with 2004, the growths in manufacturing and service sectors, and private banking system expansion. These trends are expected to carry over into 2006, but at a slightly lower pace Interest Rate According to the NBC 22, the average nominal interest rate on 12- month loans offered by commercial banks stood at 18.6 percent per annum, nominal interest rate on 12-month deposits stood at 6.6 percent. Interest rates on dollar denominated loans and deposits stood at 16.7 and 3.7 respectively. Obviously, banks have set a risk premium to hedge against the depreciation of the Cambodian Riel. The risk premiums were quite reasonable ones given the real currency depreciation of 2.4 percent in 2005 and 1.2 percent in Even though there is a downward long-term trend, interest rates are still high compared to neighboring countries. For example, in Thailand, interest rates on 12-month deposits and 12-month loans offered by commercial banks averages 2.2 percent and 7.3 percent, respectively. It is quite natural for countries in the early stage of development such as Cambodia to have comparatively high interest rates. Since less developed countries are relatively in short supply of capital, its cost of capital, thus interest rate, must be comparatively high. Capital liberalization can only work to converge interest rates in different countries to a certain extent. Convergence cannot be fully achieved if factors such as country risk and investors home-biased behavior remain. 22 NBC (2005), National Bank of Cambodia Quarterly Bulletin, Issue No. 14,

49 Furthermore, interest spread is still high. This reflects operational inefficiency and / or lack of competition. Operational inefficiency may be due in large part to the high cost of doing business such as high telecommunication costs, high electricity costs etc. In addition, interest rates on loans offered by microfinance institutions (MFI) are even higher. EIC surveys with MFIs found that interest rates on small loans average 3.6 percent per month (see table 4.2). However, the interest rate is projected to gradually decline together with increasing domestic savings, improving infrastructure, increasing competition, and improving efficiency through economy of scale and learning by doing. A stable Riel and low inflation rate can also to a certain extent reduce interest rates on loans by reducing costs of fund and the gap between real and nominal interest rates. Lower interest rates would spur investment, thus, economic growth in rural area. Table 4.2: Interest Rates on Loans of ACLEDA Bank and Selected MFIs MFI Min Max Criteria for Minimum Rate Criteria for Maximum Rate ACLEDA 1.2% 4.0% > 10,000 Dollar loan < 5 million Riel loan AMRET 2.5% 3.5% > 5 million Riel loan in USD < 5 million Riel loan PRASAC 3.0% 3.5% Installment Payment End-of-Term Payment CEB 2.0% 3.5% > 2,000 Dollar loan All Riel denominated loan VFC 2.0% 4.0% CREDIT 2.0% 3.5% Up to 5,000 USD Individual Loan USD Loan from $4,000 to $10,000 Small Riel Loan < $225 < 6 million Riel loan AMK 2.8% 3.0% Installment Payment End-of-Term Payment Average 2.2% 3.6% Mode 2.0% 3.5% Source: EIC Interviews with ACLEDA Bank and Selected MFIs. 32

50 Chapter 5 Fiscal Development and External Debt Fiscal policy assumes an important role not only for the provision of public goods and services, but also for the improvement of the country s competitiveness, human development in order to achieve a sustainable economic development and optimize the benefit of opening up the economy. Meanwhile, with AFTA/CEPT and also under the presence of the Bretton Woods Institution in Cambodia, import tariffs have been gradually declining, with the maximum tariff already fixed during the WTO accession negotiations Budget Revenue The Royal Government of Cambodia's main source of budget income is from taxes. This includes profit tax, excise taxes, value added taxes, trade taxes and other tax revenues, which generally represent more than 70 percent of total domestic revenue while non-taxes represent less than 30 percent which includes service charges from public utilities, rental of public assets, concession fees from exploitations of natural and cultural resources, and other revenues from public service deliveries. The non-tax revenue needs to be strengthened due to the decline in share of Trade Tax (import duty) which is one of the most important sources of national budget revenue. In 2005, the total domestic revenue accounted for Riel 2,626 billion [US$642 million], which increased about 24 percent compared with the year before. The actual revenue collection is 14 percent higher than it was projected in the national budget law 2005, due largely to the 21 percentage point increase in tax revenue. Both collections of excise tax and VAT increased by 25 and 22 percent respectively compared to the previous year. The profit tax went up considerably to almost 50 percent compared with 2004 which reflects the growth of the private sector. Although tax collection saw a noteworthy increase, most public property income items such as forest exploitation, enterprise leases, tourism income civil aviation, royalties, post and telecommunication, were far below the budget target. Total non-tax revenue did reach its budget 33

51 target due mainly to the important increase in quota and export licenses and other non-tax revenues. Table 5.1: Cambodia's Government Revenue (Billion Riel) e 2006p Total Domestic Revenue 1,762 1,765 2,127 2,626 2,850 Tax Revenue 1,249 1,220 1,577 1,911 2,190 Profit Taxes Excise Taxes Value Added Taxes Trade Taxes Other Tax Revenue Non-tax Revenue (1) Contribution from Tourism (2) Quota & Export Licenses Posts & Telecommunication Other Non-tax Revenue (1) Memorandum Items Taxes on Petroleum Products Tax Department Revenue Customs Department Revenue ,173 1,335 1,560 Total Domestic Revenue (% of GDP) 11.0% 10.2% 10.8% 11.7% 11.6% Source: Ministry of Economy and Finance for , EIC estimates for The Government failed in its promise to increase the revenue from 9 percent of GDP to 14 percent in 2005, reflecting inefficiencies in revenue collection in tandem with growths in economic activities. Even total budget revenue increased about 24 percent points, still the ratio of total budget revenue to GDP increased only to 11.7 percent, one of the lowest compared with other developing countries. What needs to be addressed, is the continued large leakages in revenue even though improvements have been made. These leakages are mainly due to smuggling and tax evasion. For example, while the estimated import of petroleum by the NIS was more than US$600 million in 2004, total tax revenue from petroleum products was just US$97 million. This revenue included the collection of VAT tax, excise duties and other taxes (compound tax rate was 108 percent for gasoline and 52 percent for 34

52 diesel 23 ). Revenue from visas was about US$20 million in 2005, while the number of tourist arrivals was about 1.3 million (visa fee is US$20 per person and fees to visit Angkor Wat complex per person is US$20 per day and US$35 for three days). Moreover, there are other potential budget revenues that the Government has yet to consider. Even if the tariff has already been fixed during the WTO accession, there is still some flexibility that can be used to tax peak rates for luxury products, beer, wine, cigarettes and other products, which are neither necessary nor harmful for development and reduce the rate for some necessary products such as petroleum. There are some loopholes in tax exemptions and unnecessary tax holidays that cost the country millions of US dollars, which are considered to be a subsidy for the parent company. Yet, revenue from taxes on largescale idle lands 24 and property are negligible. Weak enforcement of tax laws is one of the factors which encourage land speculations and land grabbing. The national budget law of 2006 was passed by the National Assembly on December 23, 2005 when the Government promised to accelerate the speed of development and implement the Rectangular Strategy, and achieve sustainable economic growth. With theses purposes, the budget law of 2006 was adopted to increase the total domestic revenue by 22 percent by focusing on main institutions namely the tax department, customs department with the growth rate of 25 and 22 percent respectively Budget Expenditure Many studies have confirmed that Cambodia s weak production capacity, which is a result of inadequate public goods and services, particularly soft and hard infrastructures, has become the main restraint hampering economic development. It is especially limiting the potential benefits from international trade that Cambodia recently gained through bilateral, regional and multilateral trade agreements. There is a disconnection between poor farmers and trade due to deficient infrastructure such as irrigation, hydroelectricity, power supply, roads, and ports and so on. The Government and donors share the same view on the importance of priority sectors including the social sector and infrastructure. Therefore, the Government has made consistent commitments to increase 23 IMF (2004). Cambodia Selected Issues. p Ministry of Economy and Finance. Prakas No. 162 on Establishment of Working Group on Stamp Tax and Taxes on Unused Lands dated 15/03/2005. No actual enforcement is identifiable. 35

53 spending in four main areas: Education, health, agriculture and rural development. In 2005, the total expenditure accounted for Riel 3,331 billion [US$812 million] which increased by 12 percent compared to 2004, but its share of GDP was reduced to 14.8 percent. The actual expenditure was higher than its target 7 percent due mainly to an increase in capital expenditure. On average, spending on priority sectors rose by 12 percent while it rose only 8 percent a year before and spending by the remaining civil ministries increased by 17.6 percent. Nevertheless, average expenditure on defense and security rose by 7 percent while the growth rate was just 3 percent last year. Table 5.2: Cambodia's Government Expenditure (Billion Riel) p Total Expenditure 2,770 2,757 2,962 3,331 3,760 Current Expenditure 1,579 1,586 1,769 2,004 2,300 Civil Administration 1,192 1,175 1,346 1,553 1,780 Priority Sector, of which Education Health Agriculture & Rural Other Civil Ministries Defense & Security Defense Security Capital Expenditure 1,191 1,171 1,193 1,327 1,460 Through National Treasury Direct External Financed ,012 1,100 Memorandum Items Wages Non-Wages Operating Costs ,130 1,293 1,460 Total Expenditure (% of GDP) 17.3% 15.9% 15.1% 14.8% 15.3% Source: Ministry of Economy and Finance for , EIC estimates for

54 As a share of GDP, the budget released for defense and security declined from 2.2 percent in 2004 to 2.0 percent in The share of spending on priority sectors remains 2.9 percent of GDP. The country's overall poor expenditure is generally linked to the inadequate operational funds and low salaries of civil servants. Low wages have discouraged qualified Cambodians from serving in the public sector and encouraged existing qualified public servants to leave the public sector and seek employment opportunities elsewhere. In the 2006 national budget law, the Government still keeps spending in four priorities sector in order to effectively implement the Rectangular Strategy. In terms of GDP share, the Government will increase spending to 3.7 percent for the social sector, decrease to 2 percent on defense and security, increase to 1.4 percent administration spending, and increase to 1 percent spending on other economic activities Budget Financing Cambodia's budget deficit remained because budget revenue cannot cover public expenditures. The budget deficit is generally financed through domestic and international borrowing and foreign assistance. Table 5.3: Cambodia's Financing Budget (Billion Riel) p Total Domestic Revenue 1,762 1,765 2,127 2,626 2,850 Total Expenditure 2,770 2,757 2,962 3,331 3,760 Total Deficit (cash basis) -1, Foreign Financing (1) 1, ,126 1,175 Grants Loans (net) Domestic Financing Banks Others Memorandum Items Net Foreign Reserves at the National 2,267 2,539 2,707 2,785 2,863 Source: Ministry of Economy and Finance for , EIC estimates for (1) Including only project aid. In 2005, the budget deficit amounted to Riel 705 billion [US$171 million] which declined about 15.6 percent compared with 2004 due to a 37

55 Type of Assistance Free-Standing Technical Cooperation lower increase in expenditure than revenue. The deficit was 3.1 percent of GDP down from 4.3 percent in The main sources of deficit financing in 2005 are from foreign grants which accounted for Riel 655 billion [US$159 million] and from foreign loans which accounted for Riel 471 billion [US$114 million] Foreign Aid and External Debts Since 1992, foreign aid flowed into Cambodia with an average share of 12 percent of GDP. From 1992 to 2005, Cambodia has been receiving a large inflow of foreign aid which amounted to about US$6.3 billion of which 38 percent is contributed by Non-EU countries, 28 percent UN agencies and international financial institutions, 25 percent by EU countries and the European Commission and the rest by NGOs. In addition, the donors have pledged US$601 million for 2006, according to the Consultative Group Meeting with the Royal Government of Cambodia on 2 3 March, Table 5.4: Allocation of Aid Flow (Million US$) Yearly Total Disbursements Term of Average Assistance Million % 2002 US $ Grants , % Loans % Total , % Investment-Related Grants % Technical Loans % Cooperation Total % Investment Project Assistance Budgetary Aid/Balance of Payment Support Grants , % Loans , % Total , % Grants % Loans % Total % Food Aid, Grants % Emergency Loans % Relief Assistance Total % Grants % Not Report Loans % Total % Grants , % TOTAL Loans , % Total , % Source: Development Cooperation Report for the year 2004 and

56 According to the Development Cooperation Report 2004 and 2005, about 77.3 percent of aid flows are in the form of official grants and the rest are concessional loans from bilateral and multilateral donors. The share of loans to total ODA (Official Development Assistance) has been increasing in recent years. Grants are largely provided by bilateral donors, while the bulk of concessional loans comes from the World Bank and the Asian Development Bank. Terms of aid deliveries have shifted from grants to loans as the share of grants in the total aid decreased from 89 percent in 1993 to 71 percent in Loans increased from 13 percent of the total aid flows to 29 percent during the same period. Japan remains the main country, providing about 21 percent of total aid to Cambodia from 1992 to 2005, followed by UN agencies, the United States and France, the European Commission, Australia and Sweden. Most assistance in the past decade focused on multifaceted institutional and technical assistance (TAs), and the rest on social sectors and infrastructure rehabilitation. Due to a lack of government technical capacity, TAs increased from 19 percent of total aid in 1992 to 45 percent in 2005, most of which was spent on personnel expenses of technical assistance advisors. Investment projects accounted for about 36 percent of the total aid flows. On average, 50 percent of the total aid went to health, education, and infrastructure development, while aid to agriculture was less than 10 percent per year. These assistances have greatly contributed to the reconstruction of Cambodia, boosting economic growth, financing trade and budget deficits and, to some extent, to alleviating poverty. However, the effectiveness of assistance has been raised by both the donor community and the Government. Poverty is believed to remain widespread. Both the physical and social infrastructure of the country are still lagging behind neighboring countries. More emphasis should be given to investment in agricultural development, irrigation, hydro-electricity, both rural and national road construction, ports, health care, and education. Technical assistance should be reduced and be done either by Cambodian professionals or in partnership between foreign and local experts. According to the IMF, total public external debt was estimated to be at US$3 billion (including debt owed to the US and Russia before 1993) by 2003 and debt services equaled US$71 million. Cambodia is negotiating with the US and Russia for debt forgiveness and rescheduling. But as Cambodia is starting to pay interest on loans borrowed after 1993, more funds are needed for debt services. This will exacerbate the current scarcity of funds for development unless domestic revenue is strengthened to reach around 15 percent of GDP or more, annually. 39

57 40

58 Chapter 6 Labor Force, Incomes, and Poverty 6.1. Labor force and under-employment Cambodia s labor force has grown significantly in the last decade. The latest data from the Cambodia Socio Economic Survey (2004) estimated that the total labor force was 7.5 million in 2004, around 55 percent of the country s 13.7 million population. The workforce number increased approximately 320,000 p.a. since 1999 when the workforce was registered at 5.5 million in the Cambodia Socio Economic Survey (1999). Out of this average annual increase, new labor market entrants were estimated to be 200, ,000 during The remaining number was 150,000 of former Khmer Rouge soldiers with extended family members. In addition, the average new entrants are projected, according to Sok Hach (2003), to be around 230,000 per year during This tremendous workforce supply was the result of a baby boom during the 1980s and 1990s. Figure 6.1: Number of job creations by registered investment project, Jobs (in 000) Sources: CDC, various yearly investment reports. To accommodate this tremendous work force, the country s policies for sustainable socio-economic development must succeed in absorbing 25 Many studies estimated that annually 200, ,000 new workers entered the country labor market. Economic Institute of Cambodia (2005) estimated 210,000 new laborers entered the market per year during World Bank (2005) wrote 220, ,000 were entering job markets each year. World Bank (2004) put new entrants figure 200, ,000, Danida and DFID (2005) also put the number of new workers to 250,000 each year. Acharya et al. (2003) claimed an approximate 200,000 workers joined the labor force each year in 1990s. Sok Hach (2003) estimated around 200,000 new entrants during

59 this vast number of potential workers. Yet, the formal sector played a very limited role in the absorption of the new entrants. The registered investment projects (new and expansion investment) at the Council for the Development of Cambodia reported that about 67,000 jobs p.a. could be created during which translated into a 27 percent absorption capacity of 250,000 new entrants each year. This calculation is under the assumption that all registered investment projects were implemented and the number of expected job creations was not overstated. In fact, many investment projects have not been implemented; thus leaving the above estimation of job creations in figure 6.1 might be overestimated. Nonetheless, it is estimated 70 percent of the young labor force has to engage in subsistence agriculture sector and/or informal activities of industry and service sectors. These workers are therefore generally considered underemployed. Although most recent estimates of the underemployment rate have not been published, the latest estimate in 2000 and 2001 by the National Institute of Statistics Labor Force Survey showed that approximately percent of the workforce was underemployed Incomes With more than 70 percent of the worker force involved in the informal economy, incomes are uncontrolled and tend to be inadequate. Many are either working in agriculture or are self-employment or are wage workers, with low incomes which in many cases are barely enough to survive. In general, incomes of rural dwellers are just enough to survive because 92 percent of people living below the poverty line live in rural areas. Out of this amount, according to the World Bank (2005), percent is sourced from agriculture; percent from fisheries and forestry-based resources and percent from business and wage labor. Yet, the wage rate is low. Workers in rural areas are reported to receive Riel 3,500-4,000 [US$0.86-US$0.98] per day for agricultural work and Riel 3,800-4,200 [US$0.92-US$1.02] per day for non-farm work (World Bank, 2005). This amount is well over the rural poverty line of Riel 1,753 [US$0.44] per day per person in Given the characteristic of a rural household, consisting of 4-5 dependent family members, incomes of rural people are just enough to survive. 26 The estimation of underemployment rate of NIS put the rate to 28 percent in 2000 (or 1.5 million workers) and 38 percent in 2001 (2.4 million workers) respectively. 42

60 Incomes in urban areas tend to be higher than the bare minimum wages offered in rural areas. Data on wage rates are presented in figure 6.2. Incomes from these wage rates were higher than the urban poverty lines (Riel 2,351 [US$0.59] in Phnom Penh and Riel 1,952 [US$0.49] in other urban areas). However, the wage rates are unstable given the informal type of jobs they possess. Wages varied according to the jobs. Some types of vulnerable workers received wage rates in 2005 lower than in 2004, while some types received higher. For example, cyclo drivers, porters, small vegetable sellers, waitresses, rice field workers, skilled construction workers, all experienced daily earnings in 2005 lower than in Skilled construction worker, motodop and scavengers had earnings in 2005 higher than Figure 6.2: Real Terms of Daily Average Earnings of Vulnerable Workers (constant November 2000 prices) Ski. Cons. Workers Unski. Cons.w orkers Motodop Rice-field w orkers Waitresses Scavengers Small. Veg. sellers Porters Cyclo drivers 0 3,000 6,000 9,000 12,000 15,000 Cambodian Riel Source: Cambodia Development Review, Vol. 9, Issue 4, Table 8, p.19. The wage rates of these workers were strongly correlated with both supply and demand factors. The decline in wages, according to regular surveys by the Cambodian Development Resource Institute, of cyclo drivers, small vegetable traders, waitresses, and construction workers was mainly due to the increasing workforce supply in these groups sourced from rural-urban migration. The decline in wages of rice field workers was due to the rising number of workers who suffered from droughts. The rise in wage earnings of scavengers, moto-taxi drivers and unskilled workers was associated with prices and demand. Due to higher prices in rubbish, scavengers could earn more. Due to high gasoline prices and increasing 43

61 numbers of foreign visitors, moto-taxi drivers could earn more by charging higher prices. Due to the boom of residence housing, unskilled workers earned more as contractors preferred to hire unskilled workers Poverty Prior to releasing the results of the Cambodia Poverty Assessment (2006) by the World Bank which is based on the Cambodia Social Economic Survey in 2004, there have been a lot of debates on the rate of poverty. Many reports estimated or asserted that poverty has been increasingly measured by either the national or international poverty line. They estimated the rate somewhere between percent increased from 36 percent in For instance, percent by the WB (2004) using the international poverty line of US$1 a day; percent by the UNDP (2004) based on the national poverty line; 51 percent in 1999 by Mahmood (2005); 42 percent by Oum Sothea et al. (2005) based on US$1 per day international poverty line; 41.5 percent in 1999 to 45.5 percent in 2003 by EIC (2003) based on the World Bank estimate using US$1; 45.5 percent in 2003 by Sok Hach (2004), based on the World Bank s Strong Fundamentals to the Fore: Regional Overview published in April Figure 6.3: Percentage of population living below the poverty line 1993/94 and 2004 (same geographical comparable sample) 1993/ % 5% 37% 21% 43% 34% 50% 40% 30% 20% 10% 0% Phnom Penh Other urban Rural Source: The World Bank (2006), Figure 2.2. p. 23. The debate on the increasing poverty rate ceased after the World Bank released its poverty assessment report in February 2006, citing that Cambodia had made progress in eradicating poverty. The percentage of people living under the poverty line declined from 47 percent in 1994 to 35 percent in 2004 or approximately one percent p.a. Besides, the reduction of poverty happened in both urban and rural areas with the average annual rate of 1.5 percent and 0.9 percent respectively (figure 6.2). 44

62 Yet, it is worth noting that the absolute number of people living in poverty has not fallen. The 9.7 million population and the 47 percent headcount index in 1993/94 translated to 4.6 million people living in poverty. In 2004, with a 13.7 million population and 35 percent poverty rate, put the people living under the poverty line to 4.8 million. The rate of poverty reduction of one percent is not so impressive when compared to the reduction rates in other low-income countries during similar periods between the early 1990s and early 2000s (figure 6.4). 27 Two Asian neighbors, Laos and Vietnam, attained rates of 1.3 and 3.2 respectively. Another two members of LDCs in Africa, Mozambique and Uganda, both achieved more than two percent p.a. Figure 6.4: Average annual reduction of poverty in selected countries Tajikistan 4.5% Vietnam 3.2% Uganda Mozambique 2.6% 2.5% Lao PDR Cambodia 1.3% 1.1% Nicaragua 0.5% 0% 1% 2% 3% 4% 5% Source: The World Bank (2006). Similarly, the progress was strongly biased towards urban areas. During the last ten years, the reduction rate in urban areas fell 16 percent while rural areas fell nine percent (figure 6.2). As a result, incidence of poverty is still a rural phenomenon in which in 2004 around 91 percent of the population lived under the poverty line (or 4.4 million in real terms). Within the comparable sampling frame, the proportion of the rural poor to the total poor increased, making poverty a severe problem in rural areas. Estimations using the headcount index showed that the number of rural poor rose from 87 percent in 1994 to 88 percent in 2004, and so do the other two indices (Table 6.1). 27 Cambodia between 1994 and 2004; Nicaragua: 1993 and 2001; Lao PDR: 1993 and 2003; Mozambique: 1997 and 2003; Uganda: 1992 and 2000; Vietnam: 1993 and 2002; Tajikistan: 1999 and

63 Table 6.1: Poverty estimates by region, 1993/94 and 2004 (samples limited to geographical areas included in 1993/94 SESC) Poverty measure Population distribution 1993/ / Poverty headcount index % 88.3% Poverty gap index % 86.40% Poverty severity index % 84.80% Note: Population distribution of poverty measure are percentage of all poor Population distribution of poverty gap are percentage of all poverty gaps Population distribution of poverty severity are percentage of all squared poverty gaps Source: Knowles (2005), Table 15. While there is a reduction of poverty, inequality has widened. Estimates of the Gini coefficient 28, with geographically comparable areas, increased from 0.35 in 1993 to 0.4 in This overall widened gap is primarily caused from disparity within the rural areas where the Gini index rose from 0.27 to Deeper analysis of inequality by decomposing inequality changes into within-group and between-group changes found that the increase of inequality was due to an 86 percent increase in inequality within rural areas and 14 percent increase in inequality between rural and urban areas. This reflects that some poor in rural areas have not been able to seize the opportunities from growth. This is probably due to the fact that they are powerless and voiceless and vulnerable to natural, economic and social disasters. Figure 6.5: Gini coefficient, 1993/94 and 2004 (same comparable sampling frame) Rural Urban Phnom Penh Cambodia 1993/ Source: The World Bank (2006), Figure 2.12, P Gini coefficient is used to measure inequality in income or consumption distribution. T he value of Gini is zero means perfect equality of distribution while the value of one means perfect inequality of distribution. 46

64 To sum up, there has been a huge surplus of labor supply in Cambodia where approximately a quarter of a million young laborers enter the job market every year. This abundance of workers could not be absorbed by employment creation by formal sectors, leaving 175,000 new entrants engaging in informal sectors including agriculture related activities. Incomes of the poor including huge numbers of rural dwellers were just at survival level or merely above it. Poverty rate declined from 47 percent to 35 percent. Yet, the country still has an estimated 4.8 million living under the poverty line, of which 4.4 million are in rural areas. Inequality is rising, especially within rural areas. Thus, more actions have to be taken to enable the poor, especially the rural poor to be better off. On the one hand, establishing safety nets for the poor is the best approach to temporarily protecting them from being vulnerable to external shocks. In the Cambodian context, maintaining access to common pool resources is a good existing option. Strengthening and creating social welfare programs is also an important assistance for the poor. On the other hand, creating jobs for the poor is the means to achieve sustainable poverty reduction. Jobs for the poor can only be created if growth led by the private sector occurs in rural areas. This has to be initiated by public investment on such precondition factors as irrigation, energy, roads, clean water, schools and health centers. Growth in the private sector has to start with peace, security and be corruption-free. 47

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66 Part II STRUCTURAL REFORMS: CURRENT IMPLEMENTATION AND PROSPECTS 49

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68 Though the country s poverty situation is still worrying, the latest political compromises between the coalition government, the opposition and civil society have brought further political stability and democracy. In addition, the apparent sustainable growth of the garment industry, tourism, and investment coupled with further financial support from development partners will continue to boost economic growth in the short-run, paving the way for real reforms for sustainable development. The proclaimed new former-commitments by the Government which consist of combating corruption, reform of the judicial system, strengthening of public services and natural resource management, and the initiation of a constructive partnership between the Government and civil society will establish a foundation for effective scrutiny, transparency and accountability of government policies. The Government should seize these favorable opportunities to address shortcomings in the reform process to bring about effective and efficient use of natural resources to serve the common good. This can also effectively curb the mismanagement and wasting of public finances and international aid. The core part that will determine the overall success of the reforms lies in public financial management. Significant results can only be seen through the proportional increase in revenue collections (14 20 percent of GDP) and better use of public finances, a prerequisite for a sufficient and high quality of public service deliveries. One of the most alluded resonances is that reforms can never be successful when the majority of the public servants are still living with empty stomachs. The Government is on the right track as it introduces a merit-based payment and meritocratic system for civil servant promotion and to put an end to extravagant political appointments in order to attract well qualified human resources for the public sector. 51

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70 Chapter 7 Banking and Financial Sector Reforms Cambodia s banking and financial sector reforms are clearly guided by the Banking and Financial Sector Blueprint Currently, the Blueprint is being revised because some of its components have lagged behind schedule. Despite the final revision that remains to be finished (expected to be released in June 2006), this chapter will review the progress in implementation of reforms within these sectors. It tracks the progress made in 2005 and assesses the prospects with restriction to banking and rural finance sectors Banking Sector Further progress in laying out the regulatory and supervisory framework was made in The National Bank of Cambodia (NBC) issued one Prakas and three Circulars to ensure prudential regulations 29 toward bank operations. For example, Prakas on Loan Policies, Procedures and Lending Authority intended to make certain that commercial and specialized banks have clear policies and procedures to provide credits while Circular on Loan Installment Classification advice on ways to determine non-performing loans. Another two Circulars attempted to ensure that accounting records and financial reports be tracked and accurate. In contrast to progress made in issuing regulations by the NBC, seeking approval on some pieces of draft laws which conform to the WTO accession and which ensure sound banking and financial systems, achieved slow progress. In 2005, the Laws on Negotiable Instruments and Payment Transactions and Company Law were promulgated whereas Secured Transaction Law, Law on Money Laundering and Combat Terrorism Financing, and Securities and Exchange Law experienced a delay again. The draft of the Secured Transaction Law is waiting for the Parliament s 29 Prakas on Loan Policies, Procedures and Lending Authority (10 March 2005) to ensure conformity to sound and prudent credit policies, practices and procedures in giving loans; Circular on Installment Loans Classification and Provisioning (21 January 2005) to guide on when an installment should be classified as non-performance loan; Circular on Requirements for Bank and Financial Institutions To have a System of Checks and Balances (25 January 2005) to ensure accuracy of accounting records to have internal control system and to minimize operational risks; Circular on Multi-Currency Accounting following Implementation of Uniform Chart of Accounts (10 February 2005) to guide on approach in adopting multi-currency accounting for transactions involving foreign currencies; Circular on the Selection of Independent Auditors by Banks and Financial Institutions (15 June 2005) to required banks and financial institutions to have independent auditor to audit financial reports. 53

71 approval while the draft Law on Money Laundering and Combat Terrorism Financing awaits approval from the Council of Ministers (CoM). Insufficient parliamentary sessions and prolonged time spent by the Council of Ministers have slowed down the approval process. In the area of banking supervision, progress was also made. The NBC regularly carried out off-site surveillance and on-site inspection of commercial banks. The staff members of bank supervision departments of the NBC monitored all commercial banks through surveillance approach. Ten commercial and specialized banks (out of 18) and two foreign bank branches were supervised through site inspections, according to officials interviewed and the NBC (2006). The team from the supervision department found some shortcomings and made corrections respectively on such issues as a short fall in net worth, deficiency in the capital guarantee deposits, high ratio of investment in fixed assets, and high prepayment for rents and leases. However, the supervision per se had some difficulties due to a shortage of staffing and instruments/equipments which have yet to be satisfactorily resolved. This led to incomplete on-site inspection for all banks and microfinance institutions during the year. In the restructuring of the banking industry, another significant progress was the long-awaited privatization of the state-owned Foreign Trade Bank was done in November The leading local bank Canadia Bank and the lesser-known local firm ING Holding bought the shares, 46 percent and 44 percent respectively. These investments replaced the shares of the NBC who used to have 20 percent and reduced the share of MEF to 10 percent from 80 percent. But, there was little progress in repaying money to depositors of liquidated banks 30 five years after implementing the bank re-licensing program. According to the NBC Annual Report in 2005 and Targets for 2006, the NBC could only repay depositors from the First Overseas Bank out of five closed banks. The NBC liquidated remaining fixed assets of the First Overseas Bank and the money claimed from borrowers to pay depositors. Yet, only 60 percent of total deposits have been repaid. As of March 2006, the banking industry consisted of 15 commercial banks of which 12 are locally incorporated banks and three are branches of foreign banks. At the same time, the industry consisted of four specialized banks of which one is a state-owned. 30 Those five liquidated banks were First Overseas Bank, Cambodia Farmers Banks, Rich Nation Bank, Peace Commercial Bank, and Cambodia Agriculture Commercial Bank.. 54

72 Table 7.1: Recent Developments in the Banking Sector, 2005 Progress Remaining Issues Issued more Prakas and Circulars Drafted Commercial Leasing Law and Prakas on Credit Information Sharing System Liquidation of insolvency bank Privatized FTB with three shareholders Canadia Bank (46%), ING Holding (44%), MEF (10%) Implemented full on-site supervision in 2004 with well trained staff using CAMELS methodology Carried out off-site surveillance by examining on financial reports and annual auditing report and on commercial banks compliance with NBC s legislation, regulations and instructions Compensation to depositors of liquidated banks Delaying enactment of Secured Transaction Law, Bankruptcy Law, Law on Money Laundering and Combat Terrorism Financing, and Securities and Exchange Law Lacking staff and equipments in the Supervision Department of the NBC Revision of the Blueprint by readjusting schedules of some components Obtained increasing public confidence in banking services and improved financial intermediary services Sources: NBC Annual Report 2006 (2006a), Consultations, Cambodia Daily (2005a) and Cambodia Daily (2005b) Rural Finance Rural finance as becoming an increasingly important topic for the Government as it attempts to establish sustainable economic development and reduce the rate of poverty. The Government, on 11 January 2006, announced 2006 as a Year of Microfinance. Many actors applauded this innovative approach to rural development as relevant government ministries and agencies, development partners, practitioners, users, researchers, and academics throughout the country highlighted the crucial role of micro-credit in contributing to the reduction of poverty. Thus, it is vital to closely track the reform progress in 2005 and assess the prospects. As new regulations were being considered for the sector, it was observed that there was a lack of Prakas or Circulars to protect depositors in the licensed MFIs and registered NGOs. In reality, some of those rural credits operators have gone far beyond their means as they have accepted deposits, on a voluntary basis, from customers. Nevertheless, after implementing the existing law on banking and financial institutions, the Blueprint and prudential regulations, the sector 55

73 experienced mixed progress in The NBC further encouraged rural credit operators to obtain licenses. As a result, as of the end of 2005, the number of licensed MFIs 31 increased from 11 to 16 while the number of registered NGOs decreased from 31 to 23, (Box 7.2). In contrast, encouraging NGOs to register with the NBC seemed to have little actual output. Many rural credit operators continued on an informal basis, as the number of unregistered operators numbered about 60 as of December 2005, according to the latest figure in the NBC-published Cambodia Microfinance. Concerning the supervision of rural finance operators, the Government made little progress last year. The NBC supervision teams, due to limited staff and other resources, were still unable to conduct onsite inspections on each licensed MFIs and registered NGOs. In 2005, the team could only inspect half of total of 16 licensed MFIs and 23 registered operators. Table 7.2: Recent Developments in the Rural Finance Sector Progress Remaining Issues Commercialized and transformed rural credit operators to obtain license and to register with NBC As of the end of 2005 number of licensed MFIs is 16, up from 11 as of June 2005 or 9 as of September 2004 As of the end of 2005, number of registered NGOs was 23, dropped from 31 due to their transformation to licensed MFIs Implemented on-site inspection on 8 licensed MFIs and 10 registered NGOs Regulations to protect depositors have not yet developed. Registration of all rural credit operators is not yet completed Improving regulation and supervision capacity of NBC Full on-site inspection on all licensed MFIs and registered NGOs Revision of Blueprint which some components of rural finance were behind the schedule Encouragement of commercial banks to engage in rural credit operations Sources: NBC Annual Report 2006 (2006a), NBC (2006b) and Consultations. Although the Blueprint is being revised to set new targets for some components, implementing the existing roadmap is continuing. The Government has so far made progress in reforming the banking and rural finance sectors. Many of the fundamental laws and regulations for prudential regulations have been promulgated and implemented while few 31 Prasac Microfinance Institution, Farmer Union Development Fund, Cambodia Business Integrate in Rural Development, Maxima Mikroheranhvatho, Intean Poalroath Rongroeung, CHC Limited, and Kristhan Pisith Akphiwat Sethakech. 56

74 laws are currently at the advanced stage. The follow-up works by the NBC in tracing the implementation of these regulations have been observed. However, more efforts should be made to reduce delays to approve the draft laws, so that the commitment to approve laws for WTO conformity will not miss the schedule again. Equally, the improvement of the capacity of supervision departments in terms of staffing and equipments should take place to effectively execute its roles as a regulatory and supervisory agent. Besides, faster and full compensation to depositors of liquidated banks will also help increase public confidence in the banking services and to increase voluntary savings at MFIs. Given these recent developments, the efforts in reform demonstrate that enhancing the prospects of the banking and microfinance sectors will establish a sound system. 57

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76 Chapter 8 Public Financial Management Reforms Launched by H.E Samdech Prime Minister Hun Sen on the eve of the 2004 Cambodia Consultative Group Meeting (CG), the Public Financial Management Reform Program (PFM) of the Royal Government of Cambodia enters its second year of implementation now. The Government fully acknowledged that weakness in the public expenditure and financial management system not only have high costs in terms of allocative and operational efficiency, but also create unacceptably high levels of fiduciary risk to public funds 32. Archiving the Public Financial Management Reform Program is therefore very critical in enhancing the efficiency and quality of the public service delivery. During the CG Meeting in early March 2006, the Government indicated that the implementation of the PFM is on the right track and progressive efforts have been made, particularly, in achieving a more credible national budget. The Ministry of Economy and Finance seems to be dedicated to a wide-ranging reform of the PFM. The Government however called for a thorough review of the implementation to take stock of real progress and lessons learnt during the past year and to speed up its implementation for the years a head Current Implementation and Major Achievements Having made and notified two major achievements, both the Government and development partners, particularly the World Bank and the IMF, seem to be optimistic that the implementation of the PFM will be smoother, more effective and accelerated for the coming years. Firstly, the Government indicated that major preconditions such as political decisions, ownership, and provision of better staff incentives, improved internal government coordination, donors harmonization are already put in place. Secondly, while a good foundation has been prepared for the subsequent priority activities to take deeper root, much progress has been observed. During the CG Meeting, the donors 33 remarked the following major progresses regarding the PFM program implementation as summarized below. 32 Public Financial Management Reform, Royal Government of Cambodia, December 2004 page Statement on Public Financial Management by Nisha Agrawal, Country Manager, World Bank Cambodia on behalf of the Development Partners, and Concluding Remarks by CG Co-Chair Ian C. Porter Country Director, World Bank during the CG Meeting March 2-3,

77 Table 8.1: Major Progress in the Implementation of the Public Financial Management Reform Program High standard of functions has been observed regarding planning, monitoring and decision making arrangements established by the Reform Committee. Merit Based Pay Initiative (MBPI) not only became operational but is also bringing positive reforms in many ministries. There is constant and substantial political commitment from the Government. Improved disbursement profiles have been observed which has led to improved cash management There has been an increase in tax revenue The procurement process has been more efficient. Five internal audit departments are created in five line ministries The new chart of accounts and budget classification are in place for implementation Tax and costumes administration are improving. Source: The World Bank Statement during the CG Meeting, March Remaining Issues and Major Challenges Weak public financial management has often been referred to as one of the major constraints in achieving efficient allocation of the government limited budget. Public expenditure is still very low and while there has been an increase in total revenues, it is still far below 14 percentthe target set in the National Poverty Reduction Strategy ( ). At the CG Meeting in early March 2006, donors also indicated three major challenges and actions to be solved and taken as a mater of priority. Firstly, the budget execution process needs to be streamlined to facilitate the smooth progress of service delivery starting from the Ministry of Economy and Finance followed by line ministries and at the sub-national administration. Secondly, to improve budget comprehensiveness, integration and realism, the use of the banking system should be encouraged and increased. The cash-based payment system should be discouraged and expenditure arrears should be reduced. In fact, the Government has already identified cash-based payment systems as one of the major constraints. Several complaints were made about delays in budget execution and the unpredictable release of funds due to cash constraints. Thirdly, transparency and accountability should be strengthened in all budget execution agencies. 60

78 During the CG Meeting, NGOs also expressed deep concern about the on-going and persistent problem related to cash constraints and delays in releasing of budgets which need to be addressed quickly. They believed that if disbursements are adequate and made in a timely manner, it would help to enhance better provision of services for two particularly important sectors - health and education. If this issue can be overcome it would serve as a catalyst for reform for better planning at sub-national administrations, better staff motivation and promoting transparency 34. A recent World Bank funded study 35, Decentralization: Provincial Budget Operations, revealed that the budget systems for both the Sala Khet 36 and provincial-level national budgets do not give appropriate incentives or adequate accountability for the provision of priority, locallybased services to the local population. This issue raises the question how governors, as head of provincial administration, play effective roles and functions in delivering services to the local population. The unclear expenditure responsibilities at the provincial level together with double reporting lines responsibility for budget management have already undermined accountability outcomes. To promote effective accountability at the sub-national level 37, it is recommended that clear lines of responsibility be defined and maintained. Recognizing major challenges and priorities ahead, and in order to ensure that reform is on the right track, the donors highlighted at the CG Meeting many specific actions that need to be accelerated. These are summarized in the table below: 34 The NGOs Statement to the CG Meeting in 2006 provided several recommendations to improve public financial management reform with regard to budgetary allocation and distribution of funds for two particular sector-health and education. 35Rural Investment for Local Governance, Decentralization: Provincial Budget Operations by Ann Bartholomew and Mary Betley December Sala Khet is used to refer to provincial governor s cabinet. 37Sub-national levels refers to provincial, district and commune. 61

79 Table 8.2 Major Challenges and Priority Actions Developing capacity of the line ministries including oversight roles, as well as subnational level in the management of procurement system, taking into account the evolving decentralization and deconcentration strategic frame work; Streamlining of budget execution processes in the Ministry of Economy and Finance, line ministries, and sub-national administration-provincial; district and commune 38. Discouraging cash-based payment system by promoting the use of the banking system for tax and customs collections, for the Treasury s payments to suppliers, and for civil service wage payments; Making more commitment to solve the problem of expenditure arrears; Improving non-tax revenue mobilization, including collection arrears, at all levels of government; Consolidating donor and government bank accounts, and transferring government accounts to the NBC; Designing an appropriate intergovernmental fiscal system to support the Government s decentralization and deconcentration reforms; Furthering implementation of the new functional structure of the Tax Department; and, Improving civil service establishment control in the Ministry of Economy and Finance. Source: The World Bank Statement during the CG Meeting, March However, successful reform in the above actions alone cannot ensure that the government will achieve its long term vision for Public Financial Management in Real success depends significantly on the government s sustained political will and decisions to reform other key pillars of good governance-legal and judicial system, civil service and promoting good governance including transparency and accountability. 38 Here, province is used to also include municipality, while district and commune include Khen and Sangkat respectively. 62

80 Chapter 9 Trade Reform This chapter will examine the progress in the enactment of laws for WTO conformity and in the implementation of the twelve-point plan to improve the investment climate and trade facilitation. It tracks the progress made since October 2005 and assesses the prospects. Since October 2005, there has been extremely slow progress in approving laws conforming to WTO accession. As of March 2006, only the Commercial Arbitration Law was enacted by the Parliament. This law will settle disputes quicker and allow for the establishment of a commercial court. The other 29 pieces of legislation, many of which were scheduled to get approval since 2004, remained in draft forms as of March However, many of these laws were at an advanced stage. Draft laws are either in the hands of respective responsible ministries or awaiting approval from the Council of Ministers or from the National Assembly. These delays, from drafting to promulgation, were partly due to a shortage of financial and technical resources and capacity, and a lack of coordination among government ministries, according to government officials interviewed by the research team. In addition, insufficient parliamentary sessions, holidays and political agendas also impeded the finalization of the laws. Thus, the prospects for the adoption of 29 laws to reach their initial schedules, , are unlikely to be met. However, it is now crucial for the executive and legislative branches to prioritize such acts as the Law Establishing Commercial Court, Secured Transaction Law, Civil Code, Civil Procedure Code, Criminal Code, and Criminal Procedure Code. Table 9.1: Status of Laws for WTO Conformity as of March 2006 Status of Progress Judicial Reform 1. Law Establishing the Commercial Court Draft law being discussed between MOC and MOJ 2. Civil Code Draft law being discussed at COM 3. Civil Procedure Code Draft law at NA 4. Criminal Code Draft law awaiting COM approval 5. Criminal Procedure Code Draft law at COM 63

81 Trade-Related Intellectual Property Rights (TRIPS) 6. Law on Geographical Indications Including Appellation of Origin 7. Laws on Layout Design of Integrated Circuit Draft law being discussed at the ministerial level and expected to be completed at the end of Draft law at department of industrial techniques, MIME. To be submitted to COM at the end of Laws on Plant Variety Protection Draft law is at department of industrial techniques, MIME. To be submitted to COM at the end of Law on Protection of Undisclosed Information Working to prepare draft law Custom Valuation 10. Custom Code Draft law at NA 11. Law on Rule of Origin Working to prepare draft at MEF 12. Law on Anti-dumping Measures and on Countervailing Measures Working to prepare draft law at MOC Trade-Related Investment Measures (TRIM) 13. Law on Export Processing Zones Working to prepare draft law (but sub-decree on export processing zone already issued) Financial Intermediation 14. Insolvency Law Draft law at COM 15. Secured Transaction Law Draft law at NA 16. Securities and Exchange Law Draft law at COM 17. Commercial Leasing Law Working to prepare draft law at NBC Other Areas 18. Water Supply Law Information is not available 19. Water Resources Management Law Information is not available 20. Telecommunication Law Draft law is being discussed at COM and expected to submit to NA at the end of March, Tourism and Entertainment Law Working to prepare draft law 22. Civil Aviation Law Waiting for Technical Assistance 64

82 23. Merchant Shipping Law Draft law at MTPW 24. Land Traffic Law (Highway Code) Draft law at NA 25. Fisheries Law Draft law at NA 26. Commercial Contracts Law Draft law at MOC 27. Commercial Agency Law Draft law at MOC 28. Competition Law Working to prepare draft law 29. Law on Safeguard Measures Information not available Source: Based on consultation with various government ministries and agencies. In the area of trade facilitation and the investment climate, further progress in the implementation of the twelve-point plan has been made. The Risk Management Strategy for import and export clearance, which is one of the most crucial elements for improving trade facilitation, was adopted in And, a sub-decree to implement the risk management strategy (called the facilitation of trade through risk management) and its implementation guidelines were issued on March 1, Although the development of the Single Administrative Document (SAD) and pilot-testing this document at Sihanoukville port lagged behind the initial schedule of 1 December 2004, there has been progress in designing this SAD, according to consultation with a World Bank staff member. After several consultations and a workshop in February 2006, the Customs and Excise Department (CED) and a mission from the World Bank basically completed the SAD. The SAD will be soon introduced into the system through ASYCUDA automation. There has been some significant impact on the trading process although the Government has not fully completed the 12 points in the trade facilitation plan. An assessment by Emerging Market Consulting in August last year found that the time and costs of shipments of import and export goods have been substantially reduced (Table 9.2). 39 Exporters spent less than a day (only 20.2 hours) in 2005 compared with 15 days in 2003 while importers spent around two days (45.5 hours) compared with 11 days in The average total cost per processing export (through border police, veterinary and phyto-sanitary fee, customs clearance, Camcontrol, and VAT 39 By employing Reform Score Card Approach (face to face interview to obtain data on perception), the study undertook survey in two major routes - Phnom Penh International Airport and Port Autonomous of Sihanoukville - through perception interview with 60 importers and 60 exporters. 65

83 rebate departments) was reduced from US$942 in 2003 to US$598-US$612 in 2005 whereas imports were reduced from US$2,477 to US$673. Table 9.2: Average times and costs of processing imports and exports Times and Costs of Exports 20.2 hours US$ days US$942 Times and Costs of Imports 45.5 hours US$ days US$2,477 Source: Emerging Markets Consulting, Performance Measurement System (2005). Similarly, problems issuing from administrative demands have been reduced. Roughly speaking, in 2005 just around 10 percent of interviewed firms said they still have problems with importing and exporting documentation (Emerging Market Consulting, 2005). This improvement is mainly due to the good efficient dissemination by the authorities of the required documentation. In spite of some positive outcomes above, there have been three critical constraints. Firstly, the authorities set official fees higher than actual official fees set by the Government (Emerging Market Consulting, 2005). Secondly, in addition to charging over-stated official fees, informal payments have increased. According to Emerging Market Consulting (2005), around 41 percent of interviewed firms said that they always pay unofficial fees in 2005 while only 20 percent reported to do this in To process export shipments across agencies, firms paid US$228 (around 33 percent of total export processing costs) while to process imports firms paid US$164 (about 25 percent of total import processing costs). In addition, the perceptions of trading firms towards government agencies and services were negative. Very few firms were willing to give high rating scores to these agencies. A great number of firms rated them between slightly bad and slightly good. 66

84 Table 9.3: Impacts of the implementation of the twelve-point plan in 2005 Documentation Problems: There has been a sharp drop in the number of firms reporting problems with their documentation during the importing and exporting process. The percentage of shipments encountering documentation problems was reduced from 42 percent in 2003 to 12 percent in 2005 for exporting firms and from 56 percent in 2003 to 13 percent for importing firms for the same period. Costs: The average costs have decreased from US$2,477 per import transaction in 2003 to about US$673 per transaction in 2005, and from US$942 in 2003, to US$598 per export transaction in 2005; Processing times: The private sector s perception of the amount of time required to process import/export transactions has also improved, with respondents reporting both imports and exports currently taking less than 80 percent of the time that they did in 2003; Information dissemination: Concerning government s dissemination of information an important capability assessed via the survey 84 percent and 91 percent of respondents said they were at least adequately informed about import fees and documentation respectively; Informal fees: The incidence of informal payment increased in Forty-two percent said they always made informal payments in 2005 compared with only 20 percent in But the amount of payment dropped from 5 percent to 2 percent of total cost. Although unofficial costs have been reduced, 39 percent of respondents cited reducing corruption as the key means to improve government services; Government obstacles: In evaluating government agencies or services for overall honesty/integrity very few firms rated any of the services as very good. Only 9 percent and 11 percent of respondents rated Customs and CAMCONTROL respectively as good. The agencies perceived as the most honest were the Port Autonomous of Sihanoukville, CAMS and Source: Emerging Freight Forwarding Markets Consulting, Companies. Performance Measurement System (2005) In short, the Government made more progress in implementing the twelve-point plan. As a result, the reforms have delivered positive results shown by the substantial reduction of both time and cost associated with imports and exports compared with two years ago. However, the reform has not yet been able to eliminate corruption (but has been significantly reduced). Incidence of over-charging officials fees and of informal payments inferred that trade-related agencies still have opportunities to take bribes in the absences of the Risk Management Strategy, Single Administrative Document, and Single Window. The prospects for further reducing time and costs are as the Government intends to take immediate steps to fully complete the twelvepoint plan. According to a speech by the Senior Minister Keat Chhon of MEF during a Risk Management Strategy Workshop on 20 December 2005, the Prime Minister Samdech Hun Sen again urged the Sub-Steering Committee on Trade Facilitation to speed up the implementation of the plan. Furthermore, the intention to introduce SAD into automated system will improve trading activities. 67

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86 Chapter 10 Public Administrative Reform Central Administration Reform Considering the complexity of the challenges and the cross-cutting nature of the work, public administration appears not to be an easy task to reform. To make it become a truly effective governing engine, many steps need to be reached and much effort needs to be made. At this early stage of reform however, the Government has put into priority the improvement of human resource capacity and the increase of public servant remuneration through the setting up of various strategies and action plans and, together with its development partners, through joint monitoring indicators agreed upon in each CG meeting. In 2005, a number of training courses and seminar awareness were conducted aiming at capacity building. The first promotion of management development program (MDP) and professional development program (PDP), parts of the Economic and Public Sector Capacity Building Project (EPSCB), were recently completed. Both programs trained 155 staff from various institutions countrywide in the area of management and professional development including development policy, governance and applied economic development. In addition, the Council for Administrative Reform (CAR) has recently prepared a term of reference for the recruitment of public administrative officials and procurement assistants to fulfill positions within the EPSCB project. Another priority area which can help promote both the wage reform and human capacity building was also set up as main indicator, relating to the strengthening of meritocratic practices in the civil service. In this area, some improvement has been made on the policy framework which was recently strengthened by the announcement of the Prime Minister in February 2006, mentioning that the practice of political appointments to civil service positions will no longer be accepted. However, more efforts need to be made in order to transform the policy into concrete action. Concerning the reform of wages, progress has been especially made related to the strategic, planning and policy framework. A comprehensive National Program for Administrative Reform (NPAR) has been developed by CAR. The average basic salary and allowance was increased by 44 69

87 percent in mid-2002 which resulted just from a civil census and better control of the work force database. In January 2005, the Government increased the index value by 15 percent from 300 Riel to 345 Riel as a stipulated commitment of the Rectangular Strategy. The index value is a tool to define civil servants basic salaries and civil servants have index numbers which range from 100, at minimum in category D, to 550 at maximum in category A. Furthermore, in August 2005 the Government increased the functional allowances of staff in middle and senior administration and priority sectors (education and health). Up to the 8 th CG meeting in 2006 however, all acknowledged that the current wage level remains low and, without adequate incentive, the civil service will not be able to attract and retain high quality staff and thereby service delivery will not be efficiently improved 40. Importantly, the Government is thus to develop a new wage policy. It is recommended that the policy should focus more on a targeted approach in which high priority sectors and functions are raised up to competitive salary levels, considering fiscal constraints 41. In this area, the Government has already taken steps with some critical achievements through the Priority Mission Program (MPG) since Currently, the CAR has examined and adjusted MPG proposals submitted by three ministries, including the Ministry of Land Management, Urban Planning and Construction, the Ministry of the National Assembly and Senate Relation and Inspection and the Ministry of Health. As a pilot scheme, the CAR and the Ministry of Economy and Finance (MEF) have agreed to establish the MPG/MBPI (Merit-Based Pay Initiative) to cover an initial 300 centrally located civil servants working on high priority PFM reform activities. The CAR and the Treasury also reached an agreement on the use of the private banking system to reduce cash transactions in the payment of salaries. The next candidates have been proposed as the Ministry of Commerce, the Ministry of Land and the Ministry of Health. 40 Statement delivered by Danish Ambassador Public Administration Reform, 8 th CG Meeting, March Ibid. 70

88 Table 10.1: Civil Reforms Progress Remaining Issues NPAR phase I was completed. The key accomplishments include census and removal of irregulars, computerized personnel management and payroll system, and wage, employment and fiscal balance simulation. Failure to complete a set of studies to make civil service reform plan consistent with Medium Term Expenditure Framework. The medium term civil service pay is underdeveloped. Implementation of new remuneration and classification system. In early 2005, the Government increased civil servant salaries by changing the index value from 300 CR up to 345 CR. In August 2005, the government increased functional allowances for middle and senior administration and priority sectors. The MOU of PMG/MBPI was signed between CAR and MEF for PFM reform program. By schedule, failure to recruit 1,000 PMG members by the end In 2005, 1,205 PMG members and budget of US$ 1.5 million are planned to implement. Most of ministries have not sent yet their lists of staff to join PMG, even their proposals. Code of Ethics has not been approved yet. Agreement reached between treasury and CAR on the use of the private banking system to reduce cash transactions in the payment of salary. The CAR has reviewed and adjusted PMG proposals submitted by three ministries, including MLMUPC, MONASRI and MOH. A strategy for phasing out salary supplementation practices has been prepared through a collaborative process within the Public Administrative Reform (PAR) TWG based on sub-decree 98 of Source: EIC, compiled from various government sources, interviews and international NGOs, March It should be particularly noted that all of the above initiatives are closely linked to the strategy for phasing out salary supplementation practices, which was one of the foremost priorities during the 7 th CG Meeting and remains a critical indicator for this 8 th CG Meeting. A strategy for phasing out salary supplementation practices has been prepared through a collaborative process within the Public Administrative Reform (PAR) TWG based on sub-decree 98 of

89 On the whole, achievements appear to be impressive in the area of public administration reform. Yet, public service delivery could not serve people much better. The salary increase for civil servants is still not adequate. Functional allowances increases only benefit marginally those in middle and senior management, which are already better off, and two priority sectors. A large number of civil servants are suffering from low salaries, which forces them to become involved in corruption and inefficient service delivery. Besides technical problems with proposals which cause implementation delays, PMG is suffering from the ignorance of senior government in the relevant ministries. One might sat these PMG programs do not benefit the individual in charge of them. Furthermore, the salaries for PMG staff will be lower than salaries planned before. They will get only US$130, US$87.5 and US$47.5 for category A, B and C respectively; while they had planned US$150, US$100 and US$50 in 2002 for those respective categories. 42 Nonetheless, the idea of implementing the PMG program appears to be critical for this early stage of reform since it could help improve the public administration performance where the priority demand is. Focus should be given on practical guarantees of transparency and effectiveness of the recruitment or appointment process of the PMG in each ministry/institution to ensure that the selection is made on quality basis regardless of party affiliation Decentralization and Deconcentration (D&D): A Gradual and Momentous Reform at the Sub-national levels of governance The Government of Cambodia s National Strategic Development Plan (NSDP) highlights the importance of popular participatory decision making and local development in promoting better service delivery and strengthening democratic governance at the local level 43. For the past four years of decentralization, the Government is convinced that decentralization increases the efficiency of delivering public services and responsiveness of the local democratic institutions for the needs of the people. It also helps to promote and give the opportunity for people to participate and have a voice in the social and economic development process. While the Government has built up momentum for the strengthening and consolidation of democratic governance and promoting development at the local level, major remaining agendas still need to be done. 42 With exchange rate: $1=4,000 Riel 43 National Strategic Development Plan (NSDP) , Key Strategies and Actions on Governance 72

90 10.3. Current Implementation and Achievements: While Cambodia has no previous experience of democratic governance and election at the local level, the first four years of decentralization policy reform can be characterized as a legal framework formulation, capacity building, establishment, and learning by doing stage. However, it is has been recognized that in the last four years of implementing decentralization reform considerable momentum has been gained as well as experienced substantial challenges to further development and autonomous growth. Starting from a successful election of 1,621 Commune Councils (CCs) in February 2002, CCs have been carrying out their new and challenging roles and functions for the past four years. Their first five-year mandate will end in the first quarter of During the past four years, over 6,500 contracts have been implemented by CCs throughout the country with a value of more than US$30 million 44. Currently, the Ministry of Interior s Department of Local Administration which is the Secretariat of the National Committee to Support Commune (NCSC) is developing a guideline for CCs to carry out an internal evaluation of their performances and results and impacts of the five-year Commune Development Plan 45. During this year s CG Meeting, the donors indicated that the establishment of elected local democratic institutions-the Commune Councils- is one of the most successful reforms of the Royal Government of Cambodia 46. They believe that the Government s commitment for poverty reduction through directing over 60 percent of resources to rural development, strengthening management capacity of CCs and effective reform in D&D will be one of the essential components required to fully and timely achieve the goals and objectives of the NSDP. The draft of the Organic Law is expected to be completed by the end of March The implementation of this law will need momentous restructuring and reformation of the current provincial and district governance system. The Inter-Ministerial Committee on D&D will produce a preliminary and provisional implementation strategy in late March and public consultations with government agencies, development partners, and civil society organizations will be held. The Government therefore initiated an independent study to identify options and approaches with regard to specific funding 44 Project Implementation Database, Seila Program. 45 Interview with Official of the Department of Local Administration(DoLA), Ministry of Interior 46 Join Donors Statement on Decentralization and Deconcentration at the CG Meeting 2-3 March

91 arrangements and support the Government will need 47. It is expected that the study will provide appropriate policy options regarding fiscal procedures and mechanisms to safeguard donor funding Remaining Issues and Challenges Cambodia s decentralization policy reform stands today at a critical juncture. Gradually, the entire governmental system at all levels has also entered a stage that requires fundamental policy reforms and institutional rearrangements at both national and sub-national levels. While significant progress has been made on decentralization, in contrast, progress on deconcentration has been very slow. Inescapably, CCs need technical support from provincial technical departments. Therefore, deconcentration is not only seen as complementary to but also as critical to the success of the decentralization reforms. The Government s intention to review and amend certain components of the Law on the Administration and Management of Commune is a timely opportunity. In addition, for the executive to refine and establish the final draft and for the legislative to discuss and approve this draft law, it is very important for both bodies to consider three major issues. Firstly, a synergy and common identity between the D&D policy framework and the Organic Law(s) need to be maintained. Secondly, compatibility and proper cohesion between the separate Laws need to be ensured. Finally, adequate flexibility for policy development; and internal unity, certainty, clarity and precision within each Law need to be ensured. Furthermore, the Government should take into account major challenges and resistances to the D&D reforms in view of the fast evolving D&D strategic framework and reforms agenda. A recent study 48 offers important situation analysis and identified several high risks which could lead to resistance. These risks include confusion and misunderstanding of the D&D policy and underlying concepts, mismatched expectations and organizational and institutional inertia. In addition, while the Seila progam has been a catalyst for decentralization reform, and for institutional and local capacity building and rural development, the program s closure at the end of this year raises both concerns and opportunities. Donors suggested that the Government should have a new successor program to replace the Seila program in the third quarter of 2006; otherwise it would be difficult for them to provide 47 Interview with H.E Prum Sokha, Secretary of State, Ministry of Interior and Chairman of the IMC s Technical Working Group on D&D 48 Partnership for Decentralization and Deconcentration Reform, Project Framework Document, DFID, SIDA and UNDP, April

92 timely support to annual investment at the local level as well as the D&D reforms. They also warned that failure to do so may cause disruption in funding which will undermine all the work done by CCs, put off the on going D&D reforms and consequently slow down service delivery. According to one of the three major objectives of the Government s decentralization policy, decentralization is supposed to improve living conditions, people s quality of life and foremost contribute to poverty reduction. However, to a large extent actual results and impacts and their scales from these projects on local people (the voters) are however not yet clearly known. Learning about successes and failures through monitoring and evaluation and critical reflection is fundamental for guiding the councils intervention towards achieving maximum impact with their limited resources. Therefore, in order to know results and impacts of the implementation of the five-year Commune Development Plan, empirical studies and evaluation are deemed necessary. It is why, CCs are obligated to carry out an evaluation of results and impacts of the implementation of the five-year commune development plan. Regional experience shows that civil society organizations (CSOs) are indispensable partners in the decentralization reform process. Currently, there are a number of civil society organizations working to support the government s decentralization policy reform and CCs. They play significant roles in strengthening social capital through facilitating dialogues among local development actors, promoting self help through interaction and partnership among members of local communities, and between communities with local authorities. For instance, for the past four years, CSO have played many active roles in providing support to both the Government s national and sub-national level. They provide policy analysis and experience from the field and participate in policy dialogue and formulation. They also provide capacity development, training of CCs and empowering local people through local mediation development and prompting people s participation in the development planning process. However, currently there is a lack of clearly defined roles and policy framework that provide direction and guidance on how the Government and a successor program to Seila should support CSO activities. Given their critical roles in building social capital and promoting transparency and accountability, it is therefore important that a suitable policy framework and strategy to promote collaboration and partnership with CSO be identified. 75

93 The implementation of a strategic framework on D&D, particularly the Organic Law will require considerable support from donors. Enormous and concerted efforts and well coordinated cooperation are needed at the national level to achieve these reforms. While the Government has already clarified and defined its long-term policy and strategy for implementing D&D reforms, the next major step is to speed up reform at the subnational levels. 76

94 Chapter 11 Legal and Judicial Reform to Improve Governance In the Cambodian context where the rule of law has been set as the country s basis, legal and judicial reforms appear to be fundamental to the reestablishment of the country towards a real democratic and freemarket economy regime. A credible, predictable and transparent legal framework together with an independent and capable judiciary will help Cambodia s democracy-based government to make its other reform agendas successful, achieved in the right direction for poverty reduction and sustainable economic growth. Looking back at the last decade, positive results have been impressive in this reform area but a fundamental legal framework remains to be completed and more efforts need to be made Legal Reform In the legal reform process, the Government has made notable progress in the area of reform policy and strategy. In mid-2002, a specialized Council for Legal and Judicial Reform (CLJR) was established to initiate, encourage and coordinate the reform process. In June 2003, the legal and judicial strategy was completed, followed by an action plan adopted by the Council of Ministers in April Through priorities and timelines provided in these instructive instruments, some positive results have been achieved in recent years (See box 10.1 for recent development). All laws and regulations are regularly published in the official gazette. The Parliament has ratified and adopted 18 out of 47 laws and regulations for compliance with WTO regulations, and signed a number of agreements within the ASEAN framework. During the year 2005 alone, a total of 45 laws were approved by the National Assembly. Nonetheless, all of these recently approved texts did not include any of the eight priority draft laws 49 which appear to be quite fundamental for the justice system and public administration reform and conducive to the other reform areas. Though, progress has been made upon several of them: the civil procedure draft law is now before the National Assembly awaiting 49 These draft laws consist of the civil code, penal code, civil procedure code, penal procedure code, law on the organization and functioning of the courts, law on the statute of judges and prosecutors, amendment of law on the Supreme Council of Magistracy, and anti-corruption law. 77

95 discussion and approval, the penal procedure is in its final stage of approval at the Council of Ministers and will be sent to the National Assembly soon, and the draft anti-corruption law was recently sent from the line ministry back to the Council of Ministers for reconsideration; while the other draft texts are still within the Ministry of Justice. As agreed during the 8 th CG Meeting in early March 2006, the top priority continues to be given to completing the drafting and approval of the remaining fundamental laws by the Government according to timeframes to be agreed by the Legal and Judicial Technical Working Group. In addition, the Council of Ministers has promised to establish timeframes to complete the remaining WTO-related laws and regulations by the end April 2006 and to review the timeframes for other laws every six months. Special focus is particularly made on the finalization of the draft anti-corruption law by the government that was, during this CG meeting, committed to the approval of the draft by the end of June 2006 and to preparing an implementation plan to enforce and manage the implementation of the anti-corruption law by October Still, compliance of the anti-corruption law with international best-practice standards remains a critical issue. Concern is expressed over the independence of the anti-corruption body, timely access to asset declaration documents and harmonization of criminal offences with UNCAC and draft penal and criminal procedure codes 50. By contrast, the issue of whether the law would be realistically appropriate to the Cambodian corrupt practices seemed to be modestly discussed. Rightfully based on international standards and good practices, the Government together with donor countries would profitably need to do more impact studies within the law-making process in order to let those good practices fit well with the Cambodian environment. Though a great delay has already been made in the drafting process, the final text of the law should not be the result of a rushed work. As noted by the US ambassador during the 8 th CG Meeting, it is time to do it; but it is also time to do it right. 50 Consultative Group Remarks delivered by US Ambassador Concrete Steps For Fighting Corruption, 8 th CG Meeting, March

96 Table 11.1 Legal and Judicial Reforms Legal Reform Progress Remaining Issues Council of legal and judicial reform was established to coordinate reform efforts. In mid-2003, legal and judicial strategy was completed, followed by a draft action plan thereof; the official action plan for implementing the legal and judicial reform strategy was adopted in April Public procurement is competitively bid for all ministries except for the Royal Palace. Failure to adopt anti-corruption law. It is long unmet pledge sine Tokyo CG meeting in Fundamental legal framework such as civil code, penal code and code of penal procedures has not submitted yet to the National Assembly. Twenty eight laws and regulations need to be ratified and adopted for compliance with WTO regulation. The National Assembly ratified and adopted nineteen laws and regulations for compliance with WTO regulations, and approved the commercial arbitration law Civil procedure code was sent to the National Assembly. A total of 45 laws was approved by the National Assembly in 2005 Judicial Reform Progress Establishment of Professional Training Centre for Lawyers and Royal School of Magistracy (RSM). Remaining Issues The draft law on the statute of judges and prosecutors has not been approved yet by the Council of Ministers. Separation of budget of judiciary from that of Ministry of Justice. Recently emergency campaign Iron Fist to strengthen judicial integrity. Removal of the Secretariat of the Supreme Council of Magistracy by Sub-decree dated May 05, A rotation system was introduced for judges, prosecutors and court official across the country every four years. The draft law on organization of the courts has not yet sent to the Council of Ministers. The law on the Organization and Functioning of Supreme Council of Magistracy (SCM) has not passed; hence the SCM has not been restructured. No specialized court has been established and the municipal and provincial courts still overlap concerning dispute resolution in most areas. Source: EIC, compiled from various government sources, IMF, World Bank, and interviews. 79

97 Relating to progression of the legal reform process as a whole, the achievement made is generally marked by a relative tardiness and leaves some critical actions to repeatedly remain within the reform agenda if compared to what has been scheduled. The reasons for this tardiness are various and divers. It is particularly noted that there was a delay due to a recent political deadlock and a lack of political will, technical competency and financial assistance; the consultation within and between ministries takes a relatively longer time and each individual ministry tends to protect its own interests 51. Some failures to adopt the legal texts on time derives from the underestimation of timeframe on account of their complexity and important dimension and the necessity of making them all coherent, especially while the drafting of these codes were originally entrusted to different foreign legal experts. Yet, from more than a decade of experience, it seems time for the Government together with donor countries to turn to identify and concretely remove weaknesses which may delay the reform process. This can be achieved by strengthening the means to accelerate the reform progression, rather than focus only on the ambitious result-oriented method. The absence of an official guideline clearly determining procedures at every stage of the law-making process presents a big constraint on the legal reform progression. Despite the fact that the significance of public consultation in the law-making area is repeatedly recognized by government s strategic policy, this necessity has not yet been officially incorporated within any positive rules. Furthermore, among the various priorities scheduled on the CG Meeting indicators, nothing is mentioned related to the law-making procedure. As revealed by the CLJR however, a kind of guideline for legal law making process is being prepared by the Government to ensure participation and transparency. This text will be produced in the form of a circular which will give instructions to all government ministries related to the (draft) law-making process. However, it seems hard to have a good law-making process when the legal department in each ministry has few or no staff with legal backgrounds. Each legal unit of the government ministries and especially of the Parliament should have more staff with young Cambodian legal professionals and be provided with appropriate technical assistances which will sustainably transfer a real legal knowledge and know-how to the Cambodian staff. To make this happen, the Government itself should first be able to define the actual weakness of its legal resources and ensure the 51 Economic Institute of Cambodia (EIC) Cambodia Economic Watch, April 2005, p

98 recruitment or appointment process be made in a transparent manner and on capacity basis regardless of party affiliations Judicial Reform and Law Enforcement Improvement has been made in the area of judicial infrastructure. The Professional Training Centre for Lawyers and the Royal School of Magistracy (RSM) were established presently two promotions of judges have been trained. A pilot court in Kandal province was set up in order to introduce some best practices in handling cases and upgrade the court. The integrity of the judiciary is being enhanced. In 2003, the Government started separating the judiciary s budget from that of the Ministry of Justice; this presents a remarkable step towards a genuine separation of power. More recently, a rotation system was introduced for judges, prosecutor and court official across the country in an attempt to help eliminate corruption in the judiciary and preventing court officials from building close relationship with locals, which can lead to bias decision making 52. Regarding alternative dispute resolution outside the court, an important step was achieved by the approval of the Commercial Arbitration law by the National Assembly in March After official promulgation, the law will provide a foundation for the establishment of arbitration mechanisms which hopefully will discharge a great number of commercial litigation from the court. However, the reform of the fundamental legal framework in the judicial area has seen slow progress and much remains to be finished. Deficiency in the legal foundation in this area unavoidably provides the Government with much discretion in intervening in judicial affairs. With an emergency campaign called Iron Fist, the Government vows to re-arrest armed robbers who are not in prison as a result of bribery, and to arrest corrupt judges and prosecutors. In July 2005, the Supreme Council of Magistracy (SCM) imposed sanctions on a number of judges and prosecutors involved, some of whom were to be removed from duty. It should be particularly noted that the Secretariat of the SCM was recently removed by the government s sub-decree dated May 05, A large part of these activities may just be seen as occasional measures, while the reform of core and supplementary legal instruments relating to the organisation and functioning of the judicial system is currently blocked by the tardiness of the legal reform. In reply to this tardiness, no specialized court has been established so far and the 52 Cambodia Daily 2006.Judges Rotated in Effort to Clean Up System, January 9,

99 municipal and provincial courts are still overloaded with dispute resolutions in almost all areas. The Supreme Council of Magistracy has not been restructured and thereby key reforms to enhance the judiciary s integrity have not been met. At this early stage of reform, priority given in the current legal reform agenda appears to be a pre-condition for a real judicial reform to get started. Without an appropriate legislative framework, occasional actions taken may somewhere form a kind of discretionary power and thus restrict the essence of the rule of law. But attentive actions undertaken with full spirit of the rule of law would be, where legally appropriate, much beneficial to this transition period to avoid that the slowness of the legal framework reform be doubled by inactivity. Once the core legal framework has been appropriately completed, the government needs to provide incentive for law enforcement. Actions need to be firmly taken recognizing in particular that corruption and interference from other state sectors in the judicial branch have been seen as the main obstacle to law enforcement mechanism in the Cambodian people. In this regard, the reinforcement of the Supreme Council of Magistracy is critical if its independence is adequately installed. This supreme independency will help guarantee the separation of powers and eliminate the culture of interference in the judiciary by other state s branches. Sufficient and appropriate legal instruments together with independent law enforcement body will lead the country to a real state of law where social and economic welfare can prosper as citizen and investor s confidence in state governance is secured. 82

100 Chapter 12 Land and Natural Resources Management Reforms While some progress has been made over the past year on the development of a legal framework for natural resources and land management, continued population growth, lack of clearly defined property rights which often leads to land grabbing and conflicts, demand for agricultural land and land speculation have contributed to making access to natural resources under growing pressure. Illegal logging, forest encroachment and land grabbing are still coming to light despite the Prime Minister repeated warnings Land Management Reforms Land continues to be a primary productive asset in Cambodia s rural areas as more than 85 percent of the population lives in rural areas and directly depends upon natural resources, agriculture and connected activities for their livelihoods. However, continued widespread prevalence of land disputes and land grabbing, forested land encroachment and the slow process of land registration continue to make access to land insecurity which is a hindrance to the legal access to use land more productively. Over the past six months, land disputes have been one of dominant issues in the local media. Acknowledging these as serious issues which need to be resolved immediately, the Prime Minster declared the Royal Government s commitment to combating illegal land encroachment 53. At the CG Meeting in March 2006, while donors appreciate some progress made by the Government regarding land management reforms, they also expressed concerns over the continued problems of land grabbing and land speculation. They also provided some recommendations regarding land disputes including the widespread illegal sales of forest and state land in the Northeastern province 54. Donors suggest that economic land concessions, which often become sources of conflict and forest encroachment and have no major 53 I would like here to make an early warning for those individuals who always collude with one another to violate the law by taking any opportunity to encroach forest lands secretly, grab the land that belongs to the government, take farmers land, and destroy the forest and conduct illegal fishing.. Prime Minister Hun Sen s Speech at the Opening of the National Conference on Land Management, February Joint Donor Statement on Natural Resources Management, Land and Agriculture, Cambodia Consultative Group Meeting, March 2-3,

101 benefits, be converted to social land concessions and distributed to the landless poor for rural poverty alleviation. The donors also demand transparency on mining and land use by the military as a precondition for promoting pro-poor land policy reforms and cutting off the opportunities for the rich and powerful to grab land and natural resources. Major progress however has been made in areas of the legal frame work development. The long awaited, Sub-decrees on State Land Management, Sub-Decree on Economic Land Concession and Sub- Decree on Managing State Owned land were passed by the Council of Ministers in late In these Sub-decrees the Government delegates certain power to the sub-national authorities. The governor is the Chair of Provincial 55 Land Management Committee which consists of the Chief of the Provincial Department of Land Management Urban Planning, Construction and more than 10 line departments as members. A District State Land Working Group is also established to help the provincial committee in State Land Identification and Mapping. The Social Land Concession Program is being implemented aiming at providing land for poor landless. Three detailed guideline related to this program were developed namely the Guidelines on Land Selection, The Guidelines on Targeted Land Recipients and the Guideline on Integration of Qualification for Land Development. It is expected that these guidelines will help to use allocated land more productively for improving rural livelihoods 56. However, lack of land availability raises questions on the successful implementation of this program. In addition, it is doubtful whether these policies will be implemented successfully given major constraints related to the current provincial governance system. There is an absence of organic law on provincial and district governance and the practice of provincial governance by Sub-decree and Prakas is not suited to the current and emerging roles of the provinces. In addition, although the governor is often the chair of several committees, and or programs in the provinces, relationships are unclear between governor and line department and between the governor and central government. Vertical and horizontal coordination is weak in the planning, development and mobilization of resources 57. Furthermore, the provincial administration has very low 55 Unless otherwise specified, the use of Province, District and Commune also include Municipality, Khan and Sangkat respectively. 56 During EIC s meeting with a Commune Chief in Tamoung Commune, Memut District, Kampong Cham Province on January 9, 2006, he also expressed the same idea and requested the government to review non performing economic land concession. 57 Review of Decentralization Reform in Cambodia: Policy and Practices, National Committee to Support Communes

102 capacity and insufficient human recourses and the governors new roles as chair of land management committee are not supported by financial resources. According to the Land Law and the Sub-decree on Social Land Concession, the commune councils have a significant involvement in participatory land use planning, natural resources and environmental management. In fact this is already one of five core sectors identified in the five-year commune development plan. In addition, commune councils and village chiefs also have essential roles in various dispute resolutions, particularly, land disputes, land registrations, social land concession and creation of cadastral maps. It is important to note that effective land disputes, land administration and management as well as distribution depend primarily on proper demarcation and delineation of land within the villages and communes. Since commune councils and village chief are much closer to their constituencies and local communities thus are they able to know local conditions better than the provincial and district authorities. It is therefore very important to ensure that they understand their functions and duties well in regard to land administration and management. At the same time their capacity must be properly developed and necessary resources and support should be provided as the Prime Minster recommended 58. Successful implementation of these Sub-decrees depends on a sufficient regulatory framework, detailed guidelines and technical resources and capacity as well as smooth coordinated assistance both at the national and sub-national government levels with regard to policy formulation. The Government has mobilized considerable technical and financial supports from donors including the World Bank, GTZ, Danida/DFID, Sida, CIDA, and IDA/JICA for land reforms. It is however important for both donors and the Government to ensure these resources will be used effectively and in a transparent manner if the objectives of the Land Management Policy are to be achieved. 58 The Ministry of Land Management, Urban Planning and Construction must cooperate with Ministry of Interior to train, build capacities and supply material to commune administration on their role and responsibilities in land registration. These include how to do the land use map in commune to determine the private land, state land and appropriate land for social land concession program or economic land concession in order to build base for commune development in line with law on Commune Administrative Management : Prime Minster Hun Sen s speech at the opening of the Conference of the Ministry of Land Management, Urban Planning and Construction Taking Stock of Performance in 2005 and Set Future Direction for

103 12.2. Forestry Management Reforms Forestry is a valuable natural resource to the national economy and an important source of income for the 80 percent of Cambodians living in rural areas. However, failure to effectively manage and sustain this important resource can only result in disaster in the years ahead. Although privately run forest concessions which are neither environmentally sound nor economically viable have been cancelled, forests are still subject to illegal logging in collusion of certain military cadres. In addition, the allocation and continued promotion of concessions in the protected areas without full consultation with local communities 59 are barring local and poor households from an important source of food, materials and income for their livelihoods. Building new roads and population growth, with expanding households alongside and conversion of forested land to agriculture have also led to fast forest degradation. The forestry reforms are however at a juncture now. The Subdecree on Community Forestry is expected to offer opportunities for local communities to participate in forestry management and utilization. However, this Sub-decree has not yet been implemented since a much needed guideline is being prepared and not yet completed. Recent studies reveals that the community forestry provides very limited benefit to the local community because it is often allowed to set up in an area where forests are already degraded and thus not able to provide access to timber and other non-timber forest products 60. During the CG Meeting in March 2006, Prime Minister Hun Sen vowed to move the forestry reform forward: In forestry, the Royal Government has committed to implement policy and concrete measures to ensure continuous and sustainable resources use, including inspection and prevention of logging and illegal log trade. During this meeting, the World Bank and many other donors demanded retaining of a Joint Monitoring Indicators on independent forest monitoring if the Government is to ensure its commitment to bring illegal logging, forest encroachment, land grabbing and endemic corruption under control. The new independent monitoring of forest crime -SGS- seems to have different attitudes, operational strategy and role from its predecessor- 59 A recent CDRI s policy research on the Value of Forest Resources to Rural Livelihoods in Cambodia has also indicated the importance of local people s participation in the decision making process in forest management 60 See, for instance, Poverty Alleviation through Community Forestry in Cambodia, Laos, and Vietnam: An Assessment of the Performance and Prospects William D. Sunderlin and Alexander Hinrichs and Catherine Mckenzie, Cambodia Result of the Independent Review of Strategic Forest Management Plans prepared by Concession Companies operating in Cambodia, August

104 Global Witness- towards the Government and forest crime. Its major roles seem to focus mainly on reporting forest related crime to the Forestry Administration and building the Administration s capacity 61. While Global Witness used to get considerable support from donors, a lack of financial support for SGS from donors suggests a lack of donor confidence. It is worth noting that the SGS is funded only by the Government. This may reflect its lack of interest in accusation of individuals involved in forest crime and make it less critical of the Government s ineffectiveness. This raises the question of how effectively and independently the SGS act as the country s forestry monitor. However, despite theses concerns, the Prime Minister indicated a position had been taken to extend a contract to SGS, whilst requesting donor support. Experiences from the field show that when managed well and effectively, community-based natural resources management including community forestry and ecotourism can provide protection of natural resources critical to their survival and enhance rural livelihoods. According to USAID s experience in various countries, the management of community-based natural resources and a strengthened natural resources management local government capacity often offer opportunities for strengthening democracy at the grassroots level. It is important to note that over 85 percent of the population lives in rural areas and forests continue to provide essential sources for their livelihoods. Given its high potential for rural economy and livelihood improvement and poverty alleviation, forestry sector reform, therefore, is critical and an urgent priority for the Government and donors Fisheries Management Reforms The far reaching vision the Department of Fisheries (DoF) tries to achieve is the management, conservation and development of sustainable fisheries resources to contribute to ensuring people s food security and to socio-economic development in order to enhance people s livelihood and the nation s prosperity. To achieve this vision the DoF needs to put effort and greater commitment to implement seven policy reforms. These include the management and development of fisheries, conservation of fishery resources, community fisheries and family fisheries, aquaculture, fish processing, research and institutional development and budget and fishery infrastructure. During the CG Meeting in March 2006, fisheries reform was identified as one of the six actions needed to improve livelihoods of the 61 According to Phnom Penh Post s Interview with SGS March 10-23,

105 rural poor, reduce poverty and enhance security and nutrition. Fish and fish products, which comprise around 40 to 60 percent of the animal protein dietary intake of rural Cambodians, has significant contributed to the national development. The recent fishery policy reform has implemented the transfer from commercial fishing lots to community based fishery management. This policy offers a promising opportunity in promote a secure access to rights and services for improving rural livelihoods through active involvement of local communities. The number of fishing communities has increased from 388 in mid-2005 to 440 in December 2005 and has provided benefits to households 62 in 19 provinces and 3 municipalities. It also allows the community to actively participate and play a greater role in the management of fishery resources to ensure sustainability and the equal share of benefits. In addition, the reform also includes research on post harvest fisheries which involves processing and packaging, trade and distribution of fish aiming at maximizing the value of fish and its overall contribution to improvement livelihood and rural development. With the commitment to improve the governance of the fisheries policy reforms, the DoF has engaged more participation of civil society organizations and local community in the formulation of the legal framework. Four drafts of Prakas to give detailed guidelines to the Sub- Decree on the Management of Fishing Communities were put into public consultation in mid-march 63. In addition, Fisheries Forum Meetings are regularly held. The long awaited draft Law on Fisheries will soon likely be discussed at the National Assembly 64. According to the draft law, the DoF will need to be restructured into a Fisheries Administration like the Forestry Administration. There will be major challenges for the DoF in the implementation of the Law on Fisheries. Firstly, the Fisheries Administration (FA) needs to have an appropriate system in place including sufficient human resources and skills to effectively implement the law. Secondly, there will be a number of legal frameworks and subsequent legislations the FA needs to develop and ensure they are coherent, and practical. Finally, it is very important to take a broader and more long-term view in restructuring the FA in a way that correspond to adjustment to roles of sub-national administration in view of the evolving decentralization and deconcentration strategic framework. 62 Statistic from the DoF, December Interview with Mr. Eng Cheasan, Deputy Director of DoF. 64 The Department of Fisheries is optimistic that this Law will be discussed by the National Assembly quite soon 88

106 The Law on Commune Administration and Management provides commune councils (CCs) with both legislative and executive powers. Therefore, for sustainability of CF and legitimacy, it is important that CF operates within the realm of the commune administration. Although the Sub-decree on Community Fisheries Management enables CCs to cooperate in the establishment of the CF, CCs may feel reluctant to play an active role since they do not have clear and direct roles and responsibilities. A policy analysis on livelihood importance and the value of the Tonle Sap Lake Fisheries highlighted the importance of assessing the effectiveness of the fisheries policy reforms for two reasons. Firstly, community s livelihoods are susceptible to ecological changes which affect the natural productivity of the Lake. Secondly, the reforms which bring about institutional arrangement can create new opportunities and threats to local communities. However, the fisheries sector reform continues to face many challenges and threats and concerns are being raised. Over exploitation of fish; fish stocks are decreasing rapidly, use of destructive gear such as electricity shocks; eutrophication caused by deforestation in the upstream of Tonle Sap Lake, and clearance of swamp (flooded) forests around the Lake, have caused fears that Cambodia s largest lake which supplies 40 percent of the country s fish protein, is being depleted rapidly. Construction of dams and increased conflict will greatly affect aquatic resources if immediate action is not taken. In addition, a lack of proper and good system of watershed management and illegal and over exploitation of fish will lead to a decline in the size and abundance of freshwater fish and threaten the livelihood of over two million people. Furthermore, since the privatization of the fisheries sector, rural communities have been facing limited access and rights to aquatic resources which used to be a common pool resource for them. Despite economic growth and livelihood improvement, the fisheries sector in Cambodia still plays a significant role in provision of income and employment for more than two million people, the majority of whom live in rural areas. If their livelihoods are to be improved, the Government needs to have better governance and arrangement of natural resources management, particularly, aquatic resources. Local community and poor people need to be empowered and given proper incentives, rights and access to information to enable them to participate more actively and meaningfully in the planning, and monitoring of natural resources management which, directly or indirectly, affects their livelihoods and the next generation s. 89

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108 Concluding Remarks Economic growth in Cambodia, which reached about 10 percent in 2005 and is projected to be at 6 percent in 2006, is still heavily dependent on external and unpredictable factors such as weather conditions and special treatment for the garment industry, country s main exporting sector. However, a solid foundation for growth is good governance which requires a public sector that can facilitate private sector development and promote social justice. The garment industry has survived and expanded after the quota phase-out in 2005 and continues to grow in the short-run until the force of competition can no longer afford to hold the so-called labor compliance against the cheaper costs from Cambodia s competitors. Assuming that that an irrigation system is not in place soon, economic growth will be solely dependent on tourism. This would establish a very narrow growth base that is too fragile to realize the ideal goal of poverty reduction. In spite of this narrowed base, economic growth in the past decade has had some positive impacts on people s livelihoods through improvement in physical infrastructure such as roads, schools, and healthcare and a moderate reduction in the child mortality rate and illiteracy rates. However, it is interesting to note that the recent release of the World Bank s Cambodia Poverty Assessment 2006 which suggests a reduction in the poverty rate from 47 percent in 1994 to 35 percent in 2005 yielded celebrations across the board. Unfortunately, the absolute number of people living under the poverty line slightly increased from 4.6 million to 4.8 million during the same period. This unsatisfactory distribution of economic growth is attributed to the concentration of growth and lack of growth participation, which experts have been warning of for a long time. For instance, growth in the garment industry is retained mainly in the country as a form of labor income for the absence backward linkages. Likewise, a large proportion of tourism income is leaked due to the huge repatriations of turnovers to intermediate imports of goods and services. The poverty-stricken agricultural sector has continued to experience low and unstable growth. The unstoppable land concentration and the increase in the incidence of landlessness and land-poor have helped perfectly exacerbated the situation. 91

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110 Bibliographic References Acharya, S, Kim Sedara, Chap Sotharith and Meach Yady Off-farm and non-farm employment: A perspective on job creation in Cambodia. CDRI working paper 26. February. Alexander Hinrichs and Catherine Mckenzie, (August 2004) Cambodia Result of the Independent Review of Strategic Forest Management Plans prepared by Concession Companies operating in Cambodia. Ann Bartholomew and Mary Betley (2004) Rural Investment for Local Governance, Decentralization: Provincial Budget Operations, Final Report. Asian Development Bank Financial Sector Blueprint for It is also available at CAM_Blueprint/ Asia Insurance Review Country Profile Cambodia. Singapore: Ins Communication Pte. Ltd. Cambodia - Community Forestry Program, Concern Worldwide US, Cambodia Daily Officials Seek To Reduce Number of Soldiers, September 16, PM: Judiciary To Be Fixed By Iron Fist, March 4, Judges Rotated in Effort to Clean Up System, January 9, Cambodia Development Resource Institute Cambodia development review, Vol.9, issue 2. April-June PM: Judiciary To Be Fixed By Iron Fist, March 4, Criticisms of Anti Corruption Law Discuss, August 19, CGAP Country Level Effectiveness and Accountability Review: Cambodia. Chan, Vuthy and Sok, Klara Cambodia Competitiveness Report Phnom Penh: Economic Institute of Cambodia. Council for Administrative Reform Priority Mission Group (PMG) a. National Program for Administrative Reform b. Priority Action Plan c. Report on Administrative Reform of CAR in 1 st semester Council for Development of Cambodia Development Cooperation Report 2002 and

111 .Various years ( ). Annual investment reports. Council for Legal and Judicial Reform Plan of Action for Implementing the Legal and Judicial Reform Strategy Legal and Judicial Reform. Danida and DFID Natural resource management and livelihood programme Draft report for external consultation. September. Danida Programme Document, October 2005, Human Rights, Democratization and Good Governance Program ( ) Eric Baran (2005): Cambodian Inland Fisheries: Facts, Figures and Context. Economic Institute of Cambodia Paths to Poverty Reduction in Cambodia: A Tale of four districts, Economic Review, Vol. 3, No b. Cambodia Economic Watch, April Phnom Penh: Economic Institute of Cambodia Survey on Social Justice and WTO Membership. In Cambodia Economic Report, p Economic Institute of Cambodia. Fisheries Sector Sub-component, Natural Resource Management and Livelihoods Program Cambodia ( ) Danid and DFID, February GTZ and Oxfam Poverty and Social Impact Assessment of Social Land Concession in Cambodia: Landlessness Assessment. International Monetary Fund. 2004a Article IV Consultation. IMF Country Report No. 04/ cr04328.pdf. 2004b. Cambodia: Selected Issues. IMF Country Report No. 04/ John Kurien and et al (2006), Cambodia s Aquarian Reform: The Emerging Challenges for Policy and Research Keath Chhon Opening remarks at the workshop on Risk Management Strategy, 20 December Le Royal Hotel, Phnom Penh. Knowles, C. J A new set of poverty estimate in Cambodia, 1993/94 to Report to EAS Units of the World Bank Washington DC. Draft report. July. Mahmood, M Generating decent work for poverty reduction in Cambodia. Working paper No. 48. Policy Integration, Department. National Policy Group, International Labor Organization. Geneva. April. 94

112 Meier, G.M., and Rauch, J.E. (2000). Leading Issues in Economic Development. p.375, 7 th Ed. New York and Oxford: Oxford University Press. Ministry of Agriculture, Forestry and Fisheries, Department of Fishery. Report of the First Semester Statistical Table for Ministry of Economy and Finance, Insurance Division Law, Subdecrees and Regulations on Insurance. Phnom Penh: MEF.. Prakas No. 162 on Establishment of Working Group on Stamp Tax and Taxes on Unused Lands dated 15/03/ Prakas No. 386 dated 20/10/2004. Procedures in Exchange of State Fixed Assets for Ministries, Institutions, Cities and Provinces. Ministry of Commerce. 2005a. Work Program of Royal Government of Cambodia Resulting from Cambodia Accession to the World Trade Organization. Revised at MoC as of May b. National Export Strategy , Draft Report. Phnom Penh: Ministry of Commerce and International Trade Center. Ministry of Land Management, Urban Planning, and Construction Report on Achievement during and Prospects. Ministry of National Assembly and Senate Relation and Inspection, Draft Law on Anti-Corruption, June 2005 Ministry of Planning (MOP), National Institute of Statistics (NIS) Socioeconomic survey of Cambodia 1993/94. Phnom Penh: National Institute of Statistics. September Cambodia socio-economic survey of Cambodia 2004, draft report. Phnom Penh: National Institute of Statistics. National Bank of Cambodia Annual Report Phnom Penh: NBC.. NBC Quarterly Review No. 13, 12 &11. Phnom Penh: NBC. National Institute of Statistics National Accounts of Cambodia, Consumer Price Index, various issues. Official Gazettes January-September Royal Government of Cambodia National Poverty Reduction Strategy Circulation No. 05 dated 01/07/2005 on Awarding Economic Land Concession for Investment in the framework to implement Order No. 02 dated 13/06/2005 on Strengthening Management of State Assets. 95

113 Secretariat of Government-Donor Coordination Committee (GDCC) Summary of TWG s Progress Report for the Period of June-August Fourth GDCC Meeting. Available at default.htm Sen, Amartya Development as Freedom. Oxford University Press. Sok, Hach Measuring Competitiveness and Labor Productivity in Cambodia s Garment Industry. EIC Economic Review, Volume 2, No. 2, April June, 2005, p Supreme Council for State Reform Draft Governance Action Plan II William D. Sunderlin, Poverty Alleviation through Community Forestry in Cambodia, Laos, and Vietnam: An Assessment of the Performance and Prospects World Bank Cambodia Country Assistance Strategy of the World Bank Group World Bank: Cambodia Land Management and Administration Project, January 29, Global Economic Prospects, Economic Implications of Remittances and Migration Consumer Price Index, various issues. 96

114 Appendix Appendix V KEY ECONOMIC INDICATORS 97

115 98

116 Table A1: Main Economic Indicators Nominal GDP (million US$) 577 1,404 3,651 3,787 4,079 4,355 4,888 5,477 Real GDP (% increase) 4.8% 0.9% 8.4% 5.5% 5.2% 7.0% 7.7% 10.0% GDP per Capita (US$) GDP per Capita (% increase) - 7.1% 2.0% 1.9% 5.7% 4.8% 10.1% 10.0% Riel/Dollar Parity (year average) ,859 3,924 3,921 3,975 4,016 4,100 Inflation in Riel (year average) 4.0% 141.0% -0.7% -0.9% 0.0% 1.2% 3.9% 5.8% Inflation in Dollar (year average) 4.0% 0.4% -1.8% -2.5% 0.1% -0.1% 2.8% 3.6% Budget Revenue (% GDP) 19.7% 3.1% 10.2% 10.5% 11.0% 10.2% 10.8% 11.7% Budget Expenditure (% GDP) 29.2% 15.9% 15.0% 16.1% 17.3% 15.9% 15.1% 14.8% Current Public Deficit (% GDP) -3.8% -11.9% 1.3% 1.1% 1.0% 0.9% 1.7% 2.1% Overall Public Deficit (% GDP) -9.5% -12.8% -4.8% -5.6% -6.3% -5.7% -4.3% -3.1% Export of Goods (% GDP) 13.8% 7.8% 40.6% 42.1% 42.1% 47.4% 48.3% 50.7% Import of Goods (% GDP) 20.4% 24.3% 50.2% 52.5% 53.2% 56.3% 61.0% 65.3% Trade Balance (% GDP) -6.6% -16.5% -9.6% -10.4% -11.2% -8.9% -12.8% -14.6% Current Account Balance (% GDP) -7.9% -16.7% -6.7% -7.6% -8.3% -6.9% -10.4% -11.9% Net Foreign Reserves (million US$) Money - M1 (% GDP) 12.5% 5.3% 3.5% 4.1% 4.8% 5.2% 5.7% 5.6% Money - M2 (% GDP) 36.2% 7.1% 12.9% 15.0% 18.0% 19.2% 22.0% 22.1% Population (million) Labor Force (% Population) 43.9% 41.7% 42.8% 43.6% 44.3% 45.0% 45.8% 46.6% Source: , EIC. Compiled from government and international organizations primary data EIC model projection. 99

117 Table A2: Budget Operations (Billion Riel) Domestic Revenue ,442 1,561 1,762 1,765 2,127 2,626 Current Revenue ,412 1,552 1,746 1,733 2,107 2,474 Tax Revenue ,059 1,129 1,249 1,220 1,577 1,911 Direct Taxes Indirect Taxes ,116 VAT Excise duties Others International Trade Taxes Imports Exports Others Non tax revenue Fishery & Forestry Civil Aviation Royalties PTT Other non tax revenue Capital Revenue Expenditures ,120 2,387 2,770 2,757 2,962 3,331 Capital Expenditures ,191 1,171 1,193 1,327 Through Nat'l Treasury Direct Foreign financed ,012 Current Expenditures ,223 1,391 1,579 1,586 1,769 2,004 Defense and Security Salaries Other Civil Administration ,192 1,175 1,346 1,553 Salaries Other ,003 1,148 Current deficit Overall deficit , Financing , Foreign financing , ,126 Grants Loans (net) Domestic financed Banks Others Source: MEF EIC projection 100

118 Table A3: Balance of Payment (million US$) Exports of Goods N/A N/A 1,397 1,571 1,755 2,027 2,476 2,915 Imports of Goods N/A N/A 1,936 2,094 2,318 2,560 3,193 3,831 Trade Balance N/A N/A Agriculture N/A N/A Textiles & Garments N/A N/A Oil & Gas N/A N/A Other Goods N/A N/A Balance of Services N/A N/A Transportation N/A N/A Travel (Tourism) N/A N/A Others N/A N/A Balance of Incomes N/A N/A Current Transfers (net) N/A N/A Private Transfers N/A N/A Government Transfers N/A N/A Current Accounts N/A N/A Capital & Financial Accounts N/A N/A Official Loans N/A N/A Foreign Direct Investment N/A N/A Others (net) N/A N/A Change in Foreign Reserves N/A N/A Source: EIC and NBC EIC projection. 101

119 Table A4: Monetary Survey (billion Riel) Net Foreign Assets 4 3 2,589 3,077 3,737 4,027 4,797 5,475 Foreign Assets ,047 3,583 4,279 4,741 5,482 6,142 Foreign Liabilities Net Domestic Assets Domestic Credit ,209 1,608 1,783 Net Claims on Government Claims on Government Deposits of Government State Enterprises Private Sector ,059 1,337 1,817 2,204 Other Items (net) ,663-1,733-1,791-1,907-2,075-2,233 Total Liquidity ,831 2,240 2,888 3,329 4,329 5,025 Narrow Money ,153 1,323 Currency outside Banks ,115 1,282 Demand Deposits Quasi-Money 2 0 1,291 1,600 2,075 2,391 3,176 3,702 Times and Savings Deposits Foreign Currency Deposits 0 0 1,245 1,546 2,001 2,310 3,079 3,589 Source: , EIC and NBC. 2005, EIC model projection. 102

120 Table A5: Investment and Saving (million US$) Total Investment Public investment Domestic financed Foreign financed Private investment Domestic financed Foreign financed Total Domestic financed Total Foreign financed Agriculture Products Equipment Construction Total Saving National saving Government Non Government Foreign saving Grants Non Grants Source: , EIC and NIS. 2005, EIC model projection. 103

121 Table A6: GDP by Industry Origin at Current Prices (million US$) Agriculture ,330 1,302 1,333 1,475 1,548 1,749 Paddy Other Crops Livestock Fishery Rubber & Forestry Industry ,003 1,120 1,315 1,423 Garment Food, Beverage & Tobacco Other Manufacturing Electricity, Gas & Water Construction & Mining Services ,541 1,609 1,743 1,761 2,025 2,305 Transport & Communication Trade Hotel & Restaurants Other Private Services Public Administration Total GDP 577 1,404 3,651 3,787 4,079 4,355 4,888 5,477 Source: , EIC and NIS. 2005, EIC model projection. 104

122 Table A7: GDP by Industry Origin at Constant 2000 Prices (million US$) Agriculture ,330 1,367 1,329 1,487 1,457 1,630 Paddy Other Crops Livestock Fishery Rubber & Forestry Industry ,023 1,149 1,338 1,494 Garment Food, Beverage & Tobacco Other Manufacturing Electricity, Gas & Water Construction & Mining Services 1, ,541 1,616 1,702 1,703 1,878 2,017 Transport & Communication Trade Hotels & Restaurants Other Private Services Public Administration Total GDP 2,910 1,834 3,651 3,852 4,054 4,339 4,673 5,141 Source: , EIC and NIS. 2005, EIC model projection. 105

123 Table A8: GDP by Expenditure Categories at Current Price (million US$) Private Consumption 369 1,302 2,961 3,079 3,321 3,498 4,107 4,641 Government Expenditure Gross Domestic Formation Gross Fixed Capital Formation Public Private Exports of Goods & NFS ,716 1,836 1,973 2,286 2,654 3,167 Goods FOB ,481 1,596 1,717 2,066 2,359 2,778 Domestic exports ,231 1,341 1,467 1,816 2,109 2,528 Re-exports NFS Imports of Goods & NFS ,946 2,112 2,306 2,585 3,151 3,793 Goods FOB ,833 1,989 2,172 2,454 2,982 3,578 Retained imports ,583 1,734 1,922 2,204 2,732 3,328 Re-exports NFS Total GDP 577 1,404 3,651 3,787 4,079 4,355 4,888 5,477 Source: , EIC and NIS. 2005, EIC model projection. 106

124 Table A9: GDP by Expenditure Categories at Constant 2000 Prices (million US$) Private Consumption 1,389 1,643 2,961 3,189 3,385 3,579 4,050 4,511 Government Expenditure 1, Gross Domestic Formation Gross Fixed Capital Formation Public Private Exports of Goods & NFS ,716 1,932 2,098 2,405 2,709 3,122 Goods FOB ,481 1,675 1,820 2,169 2,403 2,732 Domestic exports ,231 1,408 1,555 1,907 2,148 2,487 Re-exports NFS Imports of Goods & NFS ,946 2,257 2,508 2,763 3,260 3,791 Goods FOB ,833 2,125 2,363 2,623 3,086 3,576 Retained imports ,583 1,853 2,091 2,356 2,827 3,326 Re-exports NFS Total GDP 2,910 1,834 3,651 3,852 4,054 4,339 4,673 5,141 Source: , EIC and NIS. 2005, EIC model projection. 107

125 Table A10: Employment by Sector (000's) Agriculture 1,922 2,962 3,625 3,839 3,827 3,934 4,039 4,148 Paddy 1,522 1,997 2,559 2,730 2,708 2,785 2,862 2,941 Other Crops Livestock Fishery Rubber & Forestry Industry Garment Food, Beverage & Tobacco Other Manufacturing Electricity, Gas& Water Construction & Mining Services ,001 1,023 1,061 Transport & Communication Trade Hotel & Restaurants Other Private Services Public Administration Total 2,320 3,932 5,082 5,337 5,372 5,512 5,684 5,868 Source: , EIC. Compiled from government and international organizations primary data EIC model projection. 108

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