CAMBODIA ECONOMIC WATCH. April ECONOMIC INSTITUTE of CAMBODIA. Public Disclosure Authorized. Public Disclosure Authorized

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized CAMBODIA ECONOMIC WATCH April 2008 ECONOMIC INSTITUTE of CAMBODIA

Research Director: Project Team Leaders: Authors: Sok Hach Neou Seiha Chhun Dalin, Dourng Kakada, and Neou Seiha

TABLE OF CONTENTS List of Abbreviations and Acronyms iii List of Tables and Figures vi Foreword ix Executive Summary xi Part I: Recent Economic Developments and Outlook 1 1. Cambodian Economic Growth 3 1.1. Agriculture 4 1.2. Industry 6 1.3. Service 10 2. Trade, Investment, and Productivity 13 2.1. External Trade and Capital Movements 13 2.2. Private Investment and Stock Capital 15 2.3. Productivity 17 3. Price and Monetary Development 19 3.1. Inflation 19 3.2. Exchange Rate 20 3.3. Money Supply 22 3.4. Interest Rates 23 4. Fiscal Development and External Debt 25 4.1. Budget Revenue 25 4.2. Budget Expenditure 26 4.3. Budget Financing and External Debt 28 5. Labor Force, Incomes, and Poverty 31 5.1. Employment 31 5.2. Incomes 32 5.3. Poverty 33 EIC - Cambodia Economic Watch April 2008 i

Part II: Structural Reforms: Current Implementation and Prospects 35 6. Banking and Financial Sector Reform 37 6.1. Banking 37 6.2. Microfinance 39 7. Public Financial Management 43 7.1. Progress Achievements of the Program 43 7.2. Perspective for the Platform 2 of the PFMRP 46 8. Trade Reform 49 8.1. WTO Commitments 49 8.2. Trade Facilitation and Private Sector Development 51 9. Administration Reform 53 9.1. Central Administration Reform 53 9.2. Sub-National Administrative Reform 55 10. Legal and Judicial Reform 57 10.1. Progress and Achievement of the Reform 57 10.2. Judicial Reform Outlook 58 11. Land and Natural Resource Reform 61 11.1. Land Reform 61 11.2. Forestry Reform 63 11.3. Fishery Reform 64 Bibliographic References 65 Appendix 1: Key Economic Indicators 67 Appendix 2: Key Structural Reforms 81 ii EIC - Cambodia Economic Watch April 2008

LIST OF ABBREVIATIONS AND ACRONYMS BSP CAMEX CAR CDC CDCF CDRI CIS CLJR CMA CMDG COBRA CoM CR CSOs D&D EIC ELC EU FMIS FSDS GDCC GDP HRD HRM HRMIS IFC ILO IMF Budget Strategic Plan Cambodia Stock Exchange Market Council for Administrative Reform Council for the Development of Cambodia Cambodia Development Cooperation Forum Cambodia Development Resource Institute Credit Information Sharing Council for Legal and Judicial Reform Cambodia Microfinance Association Cambodia Millennium Development Goals Cambodian Offsite Bank Reporting for Prompt Corrective Action Council of Minister Cambodian Riel Civil Society Organizations Decentralization and Deconcentration Economic Institute of Cambodia Economic Land Concession European Union Establishment of Financial Management Information System Financial Sector Development Strategy Government Donor Committee Coordination Gross Domestic Product Human Resource Development Human Resource Management Human Resource Management Information System International Finance Corporation International Labour Organization International Monetary Fund EIC - Cambodia Economic Watch April 2008 iii

IRR JMI MAFF MBPI MDP MDTF MEF MFI MIS MLMUPC MoC MoH MoJ MoT MTEF NA NBC NCDD NIS NLA NLDA NPAR NSDP OWOs PAP PDP PFMRP PMG PPD RGC Internal Rule and Regulation Joint Government-Donors Monitoring Indicators Ministry of Agriculture, Forestry and Fisheries Merit Based Pay Initiative Management Development Program Multi-Donor Trust Fund Ministry of Economy and Finance Microfinance Institutions Management Information System Ministry of Land Management, Urban Planning, and Construction Ministry of Commerce Ministry of Health Ministry of Justice Ministry of Tourism Medium Term Expenditure Framework National Assembly National Bank of Cambodia National Committee for D&D National Institute of Statistics National Authority National Authority for Land Dispute Resolution National Program for Administrative Reform National Strategic Development Plan One-Window Offices Priority Action Programs Professional Development Program Public Financial Management Reform Program Priority Mission Group Public Procurement Department Royal Government of Cambodia iv EIC - Cambodia Economic Watch April 2008

RSM SAD SCM TWGFE WB WEF WTO Royal School of Magistracy Single Administrative Document Supreme Council of Magistracy Technical Group on Forestry and Environment World Bank World Economic Forum World Trade Organization EIC - Cambodia Economic Watch April 2008 v

LIST OF TABLES Table 1.1: Table 1.2: Table 1.3: Table 1.3b: Table 1.4: Table 2.1: Table 2.2: Table 2.3: Table 3.1: Table 3.2: Table 4.1: Table 4.2: Table 4.3: Table 5.1: Table 6.1: Cambodia's Real GDP Growth by Sector (%, 2000 prices) Trends in the Agriculture Sector (% increase, 2000 prices) Trends of Industry Sectors (% increase, 2000 prices) Imports of Cement and Steel (000 s tons) Trends of Service Sectors (% Increase, 2000 prices) Cambodia's Balance of Payments (Millions of US Dollar) Approved Private Investment Projects* Productivity of Workers (% Increase, US$2000 price) Cambodia s Monetary Survey (Billions of Riel) Cambodia s Interest Rates (% per annum, end of period) Cambodia s Government Revenue (Billions of Riel) Cambodia s Government Expenditure (Billions of Riel) Financing Cambodia s Budget (Billions of Riel) Cambodia s Population and Labor Force (% Change) Financial Sector Development Strategy (2006-2015) Immediate Priorities on Non-Bank Finance Table 6.2: Recent Developments in the Banking Sector, 2007 Table 7.1: Progress on Consolidated Action Plan Activities in 2006 Table 8.1: An Accomplishment of WTO Laws Approved in 2007 Table 8.2: Table 10: Progress of Remaining Law for WTO Recent Development of the Eight Fundamental Laws LIST OF FIGURES Figure 1.1: Figure 3.1: Figure 3.2: US Textile Import of Top Trading Partners (% increase) Cambodia s Consumer Price Index (December 2002=100) Cambodian riel against US$, Thai baht, and Vietnamese dong (December 2002=100) vi EIC - Cambodia Economic Watch April 2008

Figure 5.2: Real Terms of Daily Average Earnings of Vulnerable Workers (November 2000 prices, Cambodian Riel) EIC - Cambodia Economic Watch April 2008 vii

viii EIC - Cambodia Economic Watch April 2008

FOREWORD With the aim of providing a broad-based economic analysis to policy makers and stakeholders, the Economic Institute of Cambodia (EIC) has great pleasure in presenting the latest issue of Cambodia Economic Watch. This EIC series of publications not only serves as a policy-oriented research paper, but also as a reference for all readers who wish to gain a snapshot of the Cambodian economy or monitor its development. As in previous issues, this edition presents the latest economic performance and prospects based on the analysis of current data from many reliable sources. It takes an indepth look at the trends of the main economic indicators and the progress of reform policies. It also highlights the urgent measures that need to be taken to address any of the problems encountered. In 2007, Cambodia once again realized another double digit economic growth rate of 10.1 percent, after achieving 10.8 percent in 2006 and 13.3 percent in 2005. This growth was mainly boosted by tourism, garment exports and agro-business. With a moderate increase of 5.3 percent, the construction sector seems to be no longer the engine of growth in 2007, according to a preliminary estimation of the National Institute of Statistics. Together with high economic growth, inflation rate has jumped back to a peak level of about 10.8 percent in 2007, up from 2.8 percent in 2006. The inflation figure for 2007 was boosted mainly by the 20 percent increase in food prices and the 13 percent increase in transportation and communication costs. The dramatic increase of money supply was another factor contributing to high inflation. For 2008, EIC foresees that the tourism, garment and agro-business sectors will continue to expand steadily, while the construction sector will be on the downward trend. As a result, GDP growth will be more moderate, at 7 percent, and inflation rate will remain relatively high at 8 percent. We would like to thank the World Bank for its generous support. Special thanks to Chea Huot and his team for their invaluable comments, to Dane Hor, Chhim Rothsothea, 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 EIC - Cambodia Economic Watch April 2008 ix

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EXECUTIVE SUMMARY In 2007, Cambodia once again realized another double digit economic growth rate of 10.1 percent, after achieving 10.8 percent in 2006 and 13.3 percent in 2005. This growth was mainly boosted by tourism, garment exports and agro-business. With a moderate increase of 5.3 percent, the construction sector seems to be no longer the engine of growth in 2007, according to a preliminary estimation of the National Institute of Statistics (NIS). Together with high economic growth, inflation rate has jumped back to a peak level of about 10.8 percent in 2007, up from 2.8 percent in 2006. The inflation figure for 2007 was boosted mainly by the 20 percent increase in food prices and the 13 percent increase in transportation and communication costs. The dramatic increase of money supply (+63 percent) was another factor contributing to high inflation. For 2008, the Economic Institute of Cambodia (EIC) foresees that the tourism, garment and agro-business sectors will continue to expand steadily, while the construction sector will be on the downward trend. As a result, GDP growth will be more moderate, at 7 percent, and inflation rate will remain relatively high at 8 percent. Economic Growth According to the NIS, Cambodia s GDP growth for 2007 reached 10.1 percent, which came after growths of 10.8 percent in 2006, 13.3 percent in 2005 and 10.3 percent in 2004. Nonetheless, the real economy (excluding domestic tax revenue component) grew only by 8 percent in 2007 compared to 11 percent in 2006 and 13.8 percent in 2005. It is worth noting that the component revenue from domestic tax less subsidy of the GDP increased by 49.8 percent in 2007, compared to only 7 percent in 2006 and 4.4 percent 2005. Unlike 2006, the 2007 growth was mainly boosted by the expansion of garment exports, tourist activities, and crop productions; despite increases in prices during the year. Construction significantly slowed down. The growth of the agricultural sector expanded moderately to a 5.2 percent, whereas that of non-agricultural sectors was 12.1 percent in 2007. Cambodia s economic growth rate for 2007 is one of the highest in East Asia, compared with an expected rate of 7 percent in Lao PDR, 4 percent in Thailand, and 8 percent in Vietnam, but was slightly lower than the 11 percent in China. Based on current economic trends, the garment industry appears to be questionable in 2008. Some external factors, such as current recession of US economy and the arrival to year-end of safeguarding measures imposed by US and EU against China export will affect the growth of Cambodia s garment industry. The growth is expected to slowdown slightly. EIC - Cambodia Economic Watch April 2008 xi

Residential construction is expected to slightly decline, given housing loan credit restriction and higher prices of imported construction materials. Nevertheless, the number of foreign tourist arrivals in Cambodia will continue to increase steadily. If the agricultural sector were not to meet any serious problem such as severe drought or inundation, Cambodia would achieve an economic growth of around 7 percent during the next few years. Compared with other countries in the region, the Cambodian economic growth during 2008 will be relatively moderate. In the long run, the successful establishment of upcoming Cambodia Stock Exchange Market (CAMEX) and the revenue from oil and gas will substantially attract big investors to Cambodia. Thus, Cambodia s economic growth could be speeded up if some critical reforms were in significant progress. These reforms, together with effective anticorruption policies, could provide a preferred environment and opportunity for higher economic growth. Trade and Investment The total exports in 2007 increased by about 9.4 percent, while the total imports increased by 13.2 percent, resulting in an increase of trade deficit by 26.5 percent in 2007. The continued higher oil price contributed to the higher import cost. However, the customs data showed a decline of imports of construction material, such as cement and steel, as a result of a slowdown in the construction sector. Thanks to the surplus in tourism, the current accounts deficit was relatively stable, which was financed by increasing foreign aid under the form of grants, loans, and foreign direct investment. Overall, the balance of payments for 2007 improved, reaching 4.2 percent of GDP, from 3.4 percent in 2006. In 2007, the Council for the Development of Cambodia (CDC) approved 130 investment projects, representing US$ 2.7 billion of fixed assets. Compared to 2006, the number of investment projects increased by 31.3 percent, but the fixed assets were relatively the same, if the World City project (US$2 billion) is excluded. Most investment projects belonged to the garment (US$170 million), tourism (US$1.1 billion), and agroindustry sectors (US$160 million). For 2008, the growth of investment in garment factories will remain strong, because Cambodia could host many foreign investors moving out from Vietnam and China. Nonetheless, investment in construction and real estate sectors will be slim. xii EIC - Cambodia Economic Watch April 2008

Prices, Money and Exchange Rate Together with high economic growth, inflation has jumped back to a peak level of about 10.8 percent in 2007, up from 2.8 percent in 2006. Inflation rate for 2007 was boosted mainly by 19.8 percent increase of food costs and 13 percent increase of transportation and communication. Other costs increased at the moderate pace of about only 5 percent. Higher food prices were linked to a worldwide increase of agricultural products, such as rice and meats. Higher price of imported foods is also the result of a weak dollar and the riel against other currencies. Higher transportation costs were pushed by the increase in crude oil prices on the international market. Dramatic increase in the money supply also contributed to higher inflation. Overall liquidity increased by 63 percent in 2007, while bank deposits as well as credit to the private sector rose by 76 percent. This sharp increase of money supply has pushed the National Bank of Cambodia (NBC) to tighten the amount of credit to private sectors, by strictly imposing a prudential ratio (bank nominal capital on loans) of 15 percent. Nevertheless, based on the current situation and recent past trends, inflation rate for 2008 would remain high reaching 8 percent on year on year basis, and 9 percent in year average. The riel in 2007 was slightly appreciated against the US dollar and the Vietnamese dong by about 1.2 percent and 1.8 percent, respectively, but depreciated against the Thai baht by 8.4 percent. Together with a prudent monetary policy of the NBC, the riel is expected to remain relatively stable against the US dollar at 4,000 riel/us$. Beside fixed-rate with the US dollar, fluctuation of the riel against other trade partner currencies, such Thai baht, should also be taken into consideration. Cambodia s main import partners are Thailand, Vietnam and Singapore. The riel depreciation against the Thai baht encouraged Cambodia trading with Thailand, but yet it also increased the domestic consumer prices because of limited local production capacity that forced Cambodians to use higher price imported products. Fiscal Development The central Government s revenue reached CR4,015 billion in 2007, about 38 percent more than that in 2006, and about 22 percent higher than the initial budget plan. This successful story came from a significant increase in tax paid by the private sector. Relative to GDP, the central government revenue rose to 11.5 percent of GDP, up from 9.8 percent in 2006. EIC - Cambodia Economic Watch April 2008 xiii

The main source of state income remained taxation in 2007, representing about 85 percent of the total domestic revenue. The share of domestic tax in the total tax revenue has increased gradually due to a good performance in the private sector. For 2008, the central government has planned to raise its revenue to CR3,987 billion. Given the projected economy for 2008, and the Government s recent record in terms of collecting state revenue, the target would be reachable. The total state revenue for 2008 is expected to reach CR4,726 billion, an increase of 17.8 percent on 2007. It is about 11.7 percent of GDP, which remains low compared to that of other countries. To improve revenue collection, more effective measures must be taken to enforce the Law on Taxation: extension of the tax base to the informal sector, and strengthening of the tax audit in order to reduce revenues loss through corruption. On the expenditure side, in 2007 the central government expenditure reached CR5,041 billion, 11.5 percent higher than that of the plan. As a share of GDP, it reached to about 14.4 percent in 2007, up from 13.8 percent in 2006. Spending on civil administration rose by 16.3 percent, while that on defense and security increased by 31 percent. Expenditure on priority sectors rose only by 16.2 percent in 2007, it was the same pace as in other ministries. For 2008, the Government expects to expand disbursement to about CR5,673 billion, or 12.5 percent higher than the actual 2007 disbursement. It was planned that the civil administration disbursement would decrease by 6.2 percent, while that for defense and security would increase slightly by 1.4 percent in 2008. Except that of rural development, spending on other priority sectors in 2008 was lower than the average growth of other sectors. Nonetheless, the unallocated budget increased by 158.8 percent in 2008, reaching about 23.4 percent of the total planned expenditure. Budget revenue remains low compared to its expenditure. The deficit reached CR1,026 billion in 2007 attaining 2.9 percent of GDP. This was bankrolled mainly through foreign financing, amounting to about CR 1,615 billion in 2007 (65 percent was loans) since Cambodia is trying to avoid domestic debt financing. This trend will extend to 2008. The public debt stock is estimated at about US$3 billion. Reflecting to continued strong economic growth and the highly concessional structure of Cambodia s lending, Cambodia s debt is on a sustainable path. But, its moderate risks do remain, given the current low level of government revenues, the continued existence of external arrears and the potential for contingent liabilities. Progress of Structure Reform Some progress has been made in the Banking Reform. The National Bank of Cambodia (NBC) signed a Memorandum of Understanding on Cooperation with the State Bank of Vietnam in December 2007. Law on Anti-Money Laundering and Terrorist Financing have come xiv EIC - Cambodia Economic Watch April 2008

into effect and the Financial Intelligent Unit will be established under the control of the NBC. In addition, with a technical assistance from ADB, the NBC has also been drafting Prakas to allow Microfinance Institutes an adequate ability in receiving deposit from clients, and checking the harmonization in the chart of account with the commercial bank. Beside, the Ministry of Economy and Finance also signed an agreement with South Korea s stock exchange, the fourth largest exchange in Asia in January 2008, to accelerate the establishment of stock market by 2009 In the Public Financial Management Reform, progress is mixed up with some delay. Platform 1 of budget credibility was just finished in December 2007, but some actions do remain. Thus, incomplete actions in platform 1 will be included in the action plan of platform 2 (financial accountability) which will start in March-April 2008. An initiative to the amendment of the Organic Budget Law was substituted by the new law named Draft Law on Public Financial System. It was already in hand of the National Assembly since March 2008. The Law on Finance for 2008 Management was already promulgated in December 2007 and is being implemented. For trade reform, two additional WTO commitment laws, Insolvency Law and Civil Code, were adopted by the National Assembly in October 2007. Up to day, the National Assembly has thus approved only 27 laws out of 46 laws and regulations for the WTO conforming. Some progress was also made in the Trade Facilitation and Competitiveness Project. Much progress of the ASYCUDA project was achieved: the finalization of the ASYCUDA prototype version 1.0 as well as many other technical and legal preparations for the project implementation at the Pilot Site-Sihanoukville Port Customs, which will hopefully start from the first semester of 2008. For the public administrative reform, the index of basic salary of civil servants increased significantly, reaching CR600 in 2008. According to Joint Monitoring Indicators on remuneration and employment policy, the Government commits to increase salary by 20 percent per annum. The Draft Royal Decree on Special Operating Agencies was approved by the Council of Ministers (CoM) in March 2008 and is being sent to the National Assembly. The Special Operating Agency is the unit which acts as the public service delivery under individual structural ministry. For D&D reform, three draft laws were sent to the National Assembly since March 2008. They are Draft Law on Administration of Capital, Province, Municipality, District and Khan, Draft EIC - Cambodia Economic Watch April 2008 xv

Law on Election of Council for Capital, Province, Municipality, District and Khan, and Draft Law on Public Financial System. For the Legal Reform, many draft laws were put to the agenda and debated in the National Assembly meeting in early 2008. Among them, Law on Insolvency, Civil Code, Law on Education, Law on Finance for 2008 Management, and ASEAN Charter were already adopted. However, some draft laws, such as Draft Law on Peaceful Demonstration, Draft Law on Seed Management and Plant Breeder, and Draft Law Civil Aviation are being studied in the each specialized committee. For the Judicial Reform, up to early 2008, only three laws had been promulgated and other five draft laws are in several stages of progress. The Draft Criminal Code, Draft Law on Anti- Corruptions, and Draft Law on the Statute of Judges and Prosecutors are in the Council of Ministers. Draft Law on the Organization and Functioning of the Courts is still in the Ministry of Justice. Draft Law on the Amendment of the Organization and Functioning of the Supreme Council of Magistracy is in the Supreme Council of Magistracy. xvi EIC - Cambodia Economic Watch April 2008

Part I Recent Economic Developments and Outlook EIC - Cambodia Economic Watch - April 2008 1

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Chapter 1 Cambodian Economic Growth In 2007, once again, Cambodia realized another double digit economic growth rate, about 10.1 percent; it came after a growth of 10.8 percent in 2006, 13.3 percent in 2005 and 10.3 percent in 2004. It is worth noting that revenue from net domestic tax (excluding subsidy) increased by about 49.8 percent in 2007, compared to only 7 percent and 4.4 percent in 2006 and 2005, reflecting the growth in private sectors. Nonetheless, the real economy (excluding domestic tax revenue) grew only by 8 percent in 2007 compared to the 11 percent and 13.8 percent in 2006 and 2005, respectively. Table 1.1: Cambodia's Real GDP Growth by Sector (%, 2000 prices) 2003 2004 2005 2006 2007e 2008p Agriculture 10.2% -1.0% 15.5% 5.5% 5.2% 5.0% Paddy 22.3% -12.2% 43.7% 4.3% 7.5% 4.5% Industry 12.4% 17.0% 12.9% 18.4% 8.0% 5.6% Garments 16.8% 24.9% 9.2% 20.4% 10.0% 8.3% Services 5.9% 13.2% 13.1% 10.1% 10.2% 9.4% Tourism -16.7% 23.4% 22.3% 13.7% 10.3% 11.0% Sub-Total 9.0% 9.4% 13.8% 11.0% 8.0% 7.0% Taxes less Subsidies -0.8% 29.4% 4.4% 7.0% 49.8% 7.4% Total GDP 8.5% 10.3% 13.3% 10.8% 10.1% 7.0% Non-Agriculture 7.7% 15.8% 12.3% 13.0% 12.1% 7.8% Sources: Compiled from NIS for2003-2007, EIC projection for 2008 Unlike 2006, the 2007 growth was mainly boosted by the continued expansion of garment exports, tourist activities, and an impressive increase in paddy and other crops production, despite the consequences of sharp increases in the prices during the year. Construction was significantly slowed down in 2007. The growth of the agricultural sector expanded moderately, whereas that of non-agricultural sectors was 12.1 percent in 2007, about 1 percent lower than in 2006. The country s overall economic growth rate for 2007 remained high, compared with an expected rate of 7.1 percent in Lao PDR, 4.8 percent in EIC - Cambodia Economic Watch - April 2008 3

Thailand, and 8.5 percent in Vietnam, but was slightly lower than the 11.4 percent expected for China. 1 Based on current economic trends, the main Cambodian economic growth-supporting industry, the garment industry, appears to be questionable in 2008. Some external factors, such as the current recession of the US and the arrival to year-end of safeguarding measures imposed by the US and EU against China export will affect the growth of Cambodia s garment industry. The growth prospected for the garment industry will thus be slightly slowed down in 2008 and the next coming years. In addition, the residential construction growth is also expected to continue to slow-down significantly or even have negative, along with bubble risks, given higher prices of imported construction materials and housing loan credit restriction. Nonetheless, the number of foreign tourist arrivals in Cambodia is expected to continue to increase steadily. By contrast, the agricultural sector remains unpredictable since it is still dependent on weather conditions. The investment in agro-industry remains slim in 2008. If, and only if, this sector were not to meet any serious problems as a result of severe drought or inundation, Cambodia would only enjoy moderate economic growth during the next few years, beginning with an expected growth rate of about 7 percent for 2008. Compared with that of other countries in the region, Cambodian economic growth of 2008 is lower than the 9 per cent, 8.5 percent and 8.2 percent of China, Vietnam and Laos PDR, respectively. In addition, the growth remains narrow-based. However, it seems that the upcoming Cambodia Stock Exchange Market (CAMEX) and the exploitation of the Extractive Industry such as oil and gas in medium term are attracting the attention of many big investors to Cambodia. Thus, Cambodia s economic growth could be speeded up if some critical reforms are seen in significant progress. These reforms, together with effective anti-corruption policies, could provide a preferred environment and opportunity for higher economic growth. 1.1. Agriculture 2007 was another rainy year, following an equally wet year both in 2006 and in 2005. The agricultural sector remained natural resource-based and achieved only 5.2 percent growth in 2007, down from the 5.5 percent in 2006. This growth was mainly boosted by the expansion of cultivated areas, higher exported agricultural product prices, and a continued increase in livestock production. 1 East Asia Update - April 2008, The World Bank. 4 EIC - Cambodia Economic Watch April 2008

Effective irrigation and natural resource management systems are still urgently required in order to achieve sustainable agricultural growth and thus poverty reduction, since the agricultural sector is the main source of income for the country s poorest inhabitants. Based on current trends, the growth of the agricultural sector remains slim for the next coming years, with about 5 percent in 2008. Crops, especially paddy, remained the main source of income for Cambodian farmers. The weather conditions in 2007 were considered as favorable as those in the last two years. Cultivated areas kept increasing in 2007, by about 32,000 ha for paddy, even though some places were flooded by rains and much cultivated land was sold to speculators. The sale prices increased higher than its cost of production, thanks to the impressive increase of demand from neighboring countries. As a result, during 2007, paddy value added increased significantly by about 7.5 percent compared with a 4.3 percent increase in 2006, and that of other crops also continued to grow at a significant rate of about 9 percent compared with the 6.5 percent in 2006. Based on the current situation, the paddy is expected to continue to increase in 2008 with a moderate rate, it is expected to be only 4.5 percent, whereas the growth rate of other crops remains strong. Livestock is a potential source of income for Cambodian farmers, besides the revenue they receive from crop cultivation. During 2007, the value added of livestock increased slightly by 3.7 percent, 4.5 percent lower than that of 2006, despite the fact that the government suspended many imported livestock products. Table 1.2: Trends in the Agriculture Sector (% increase, 2000 prices) 2003 2004 2005 2006 2007e 2008p Paddy 22.3% -12.2% 43.7% 4.3% 7.5% 4.5% Other Crops 21.5% 9.5% 12.2% 6.5% 9.0% 10.1% Livestock 5.7% 3.9% 5.6% 8.2% 3.7% 6.6% Fishery 1.7% -1.7% 5.6% 3.8% 0.8% 0.8% Rubber & Forestry -3.8% -0.3% 3.5% 6.6% 3.8% 1.2% Total Agriculture 10.2% -1.0% 15.5% 5.5% 5.2% 5.0% Sources: NIS for2003-2007, EIC projection for 2008. EIC - Cambodia Economic Watch - April 2008 5

The limited initial capital, together with higher interest rate or inaccessibility of credit, would be the major constraints on livestock growth. Investment in this sector remained slim despite significant increase in local consumption. Cambodia continued to import large quantities of livestock products from neighboring countries. Based on the current situation in the last few years, the growth rate of livestock for the next few years will increase, but will remain moderate; it is expected to be about 6.6 percent in 2008. Investment incentive for Small and Medium Enterprises could speed up investment in this sector. Fishery production in 2007 was relatively the same as in 2006. In 2007, marine fish and aquaculture increased slightly by 5 percent and 3.1 percent respectively, whereas inland fish decreased by 6.4 percent. The fisheries value added is expected to grow slightly, by about 0.8 percent in 2007, down from the 3.8 percent in 2006. Small fish, used for the production of a popular salt fish pâté, remained abundant, while normal fish production continued to be 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 sustainable growth of the sector. These practices have led to the decline of fish stocks and a fewer number of places for the fish to breed. Thus, the prospects for expanding fish stocks in the coming years are slim. Regarding other agricultural sectors, the forestry sector growth was expected to be about 3.3 percent in 2007, down from the 7 percent in 2006. The growth prospected for forestry sector is still slim for the next coming years. Besides, the rubber sector is expected to grow at a significant rate, about 9.4 percent in 2007 due to the rubber price increase in the world market. However, the old-rubber trees were cut and were replaced by new-rubber trees, which are still young to provide the raw rubber. The rubber growth is thus expected to be flat in 2008. 1.2. Industry For the industry sector, its double-digit growth rate could not be maintained in 2007 due to the significant slower growth of the garment and construction sectors. The industrial growth rate grew only by about 8 percent in 2007, about 10 percent lower than in 2006. This growth continues to be boosted mainly by the expansion of the garment industry, combined with a moderate growth in other industries. Based on the current trend, the prospects for growth in the industrial sector will be moderate in the coming years. For 2008, industrial production 6 EIC - Cambodia Economic Watch April 2008

is expected to reach about 5.6 percent in 2008, given assumption of a slower growth for the garment industry and a negative growth for construction. Table 1.3: Trends of Industry Sectors (% increase, 2000 prices) 2003 2004 2005 2006 2007e 2008p Garments 16.8% 24.9% 9.2% 20.4% 10.0% 8.3% Food, Beverages & Tobacco 4.7% -5.3% 9.0% 3.3% 3.1% 5.5% Electricity, Gas and Water 8.7% 11.3% 12.7% 31.5% 11.7% 12.2% Construction 11.2% 13.2% 22.1% 20.0% 5.3% -2.5% Other industries 4.3% 9.3% 17.4% 14.1% 5.7% 8.0% Total Industry 12.4% 17.0% 12.9% 18.4% 8.0% 5.6% Sources: Compiled from NIS for2003-2007, EIC projection for 2008. The garment industry, the industrial sector s main contributor, remained strong in 2007, but the growth was significantly slowed down. According to the Customs Department of Ministry of Economy and Finance (MEF), the quantity of garment exports for 2007 increased by only 11.7 percent from 2006, of which those to the US and EU markets grew by 10.9 and 4 percent respectively. This growth is mainly a consequence of the safeguarding measures imposed by the US and EU to restrain Chinese exports, and the labor compliance project monitored by the ILO, which created a niche market for Cambodian garment products. Cambodia s WTO membership and the reduction of export transaction bureaucracy also helped to maintain the sector s growth. It is worth noting that the growth of the quantity of the garment export in 2007 was significantly slowed down from that of the 32.5 percent in 2006, of which those to the US and EU markets were slowed-down from 34.3 percent and 23.6 percent respectively. In addition, the overall unit prices of Cambodian garment products on the world market during 2007 continued their slight decline, of about 3.1 percent, due to the emergence of many big competitors, especially China and Vietnam. Cambodia clothing exports to the US directly compete with most of those from Vietnam (88 percent) and China (70 percent). The US economic recession could be also the reason Cambodia garment exports slow down. In total, Cambodia s garment industry posted another slower growth rate in 2007, of about 10 percent, compared with the 20.4 percent in 2006. The growth prospected for the Cambodian garment industry is very slim in the next coming years since the safeguarding measure, which is the EIC - Cambodia Economic Watch - April 2008 7

main factor for the growth of the Cambodian garment export, will be expired at the end of 2008. Rising competitors such as China as well as Vietnam would be a big concern for the Cambodian garment industry because Cambodia is seen as weak in term of international competitiveness compared to those countries. 2 Data compiled from the US department of Commerce revealed that Cambodia was ranked 10 th textile importer behind China, India and Vietnam that were the 1 st, 3 rd and 4 th textile importer to US market respectively. In term of growth rate, the Cambodian garment product was ranked 3 rd during 2007 after Vietnam and China which were ranked 1 st and 2 nd respectively. In addition, it is worth noting that the Cambodian garment product growth rate to the US market is on a downward trend, which is not by contrast the case for those from Vietnam and China. The growth of garment products exported from China and Vietnam to the US market is on the upward trend, which means that garment products produced in Vietnam and China are more competitive than those produced in Cambodia. Figure 1.1: US Textile Import of Top Trading Partners (% increase) Vietnam China Cambodia Nicaragua Italy Indonesia Bangladesh El Salvador Honduras India Malaysia Thailand Sri Lanka Pakistan 2007 2006 Taiwan Mexico Philippines Korea, South Hong Kong Total -30.0% -20.0% -10.0% 0.0% 10.0% 20.0% 30.0% 40.0% Sources: US department of Commerce, Census Bureau, Foreign Trade Division. 2 World Economic Forum report 2006-2007 8 EIC - Cambodia Economic Watch April 2008

However, Cambodian garment products already created its niche market by a positive evaluation of the labor compliance project monitored by the International Labor Organization (ILO). Together with efforts of the Government to reduce bureaucracy of transaction export, such as one Window Service, and the World Trade Organization (WTO) membership, Cambodia seems to be able to keep its big clients/buyers in EU and US. In total, the Cambodian garment industrial growth will fluctuate to the trend of the global demand in the coming years. In addition, due to a recent increase of minimum wage of garment workers in Vietnam and China, hundreds of garment factories are expected to move elsewhere. Cambodia seems to be a potential place for them. Nonetheless, given the current US economic recession, and the validity of safeguarding measures of EU and US against China exports, the growth prospected for the Cambodian garment industry for 2008 is moderate; it is expected to be about only 8.3 percent. The growth may be speeded up if, and only if, Cambodia could get the US duty free under the US New Partnership for Development Act. For the construction sector, the growth was also slowed-down, even if the number and value of construction projects increased significantly. Construction projects were almost doubled in Phnom Penh; however, most of them were long term projects. According to data compiled from MEF, the imported cement and steel sectors decreased by 6 percent and 1.4 percent in term of quantity, while prices increased by 23.2 percent and 8.9 percent, respectively during 2007. Table 1.3b: Imports of Cement and Steel (000 s tons) 2006 2007 %change Cement 1,407 1,322-6.0% Steel 147.1 145.1-1.4% Sources: Cambodia s Customs Department Thus, the growth rate for the construction sector was expected to be at only about 5.3 percent in 2007, down from an increase of 20 percent in 2006. The slowed-down trend of this sector will continue in 2008, given the continual increase of its import raw material. The construction projects are thus likely to decrease in 2008 compared to those of 2007. The expected growth of other industrial sub-sectors, such as food, beverage and tobacco, grew at a slower rate in 2007 given the investment in EIC - Cambodia Economic Watch - April 2008 9

these sectors remain limited. Normally, the depreciation of the riel against the Thai baht would help increase the competitiveness of local products against those imported from Thailand. But, Vietnamese products seem to replace Thai products in the Cambodian market. The growth rate is expected to slightly slow down reaching 3.1 percent in 2007, compared with the 3.3 percent in 2006. The growth of electricity, gas, water and other manufacturing sectors for 2007 was also significantly slowed-down compared to that of 2006. Growth prospected for these sectors is still moderate, as Cambodia starts to import more and more electricity from neighboring countries. 1.3. Service Last but not least, the service sector could maintain its significant growth in 2007. The service sectors, excluding public administration, expanded by about 10.2 percent in 2007, slightly down from the 10.6 percent in 2006 and 13.4 percent in 2005. This is mainly due to annual increases in the number of foreign tourist arrivals in Cambodia and a significant expansion of the economic activity, especially trade, transportation, communication, and financial service sectors. Based on current trends, the growth of the service sector in 2008 will remain strong; it is expected to be about 9.4 percent. Table 1.4: Trends of Service Sectors (% increase, 2000 prices) 2003 2004 2005 2006 2007e 2008p Transport & Communication 3.2% 9.5% 14.5% 2.1% 7.2% 6.2% Trade 3.7% 5.9% 8.5% 7.1% 9.5% 8.5% Hotels & Restaurants -16.7% 23.4% 22.3% 13.7% 10.3% 11.0% Other Private Services 17.4% 19.2% 13.5% 14.8% 12.2% 11.0% Total Private Services 6.5% 14.3% 13.4% 10.6% 10.5% 9.7% Public Administration -4.5% -6.7% 5.9% -1.3% 0.1% 2.7% Total Services 5.9% 13.2% 13.1% 10.1% 10.2% 9.4% Sources: NIS for2003-2007, EIC projection for 2008. The hotel and restaurant sector contributed significantly to the service sector s growth, expanding by about 10.3 percent in 2007, about 3 percent less than in 2006. This is due to the increasing number of international tourist arrivals in Cambodia; up by about 18.3 percent in 2007, (to around 1.9 million), compared to an increase of 20 percent in 2006. 10 EIC - Cambodia Economic Watch April 2008

Based on this trend, the number of foreign tourist arrivals in the coming year will continue to grow significantly. Thus, the hotel and restaurant sector will remain strong; it is expected to be about 11 percent in 2008. Trade makes up the most significant share of the service sector, followed by transport and communication. Because of the good performance of economic activities the last few years, the growth rate of these sectors continued to grow at a faster pace despite the high increase in oil prices. It is expected to be about 7.2 percent for trade and 9.5 percent for transport and communication in 2007, compared to a growth of only 2.1 percent and 7.1 percent respectively in 2006. However, the physical infrastructure remains poor, in particular roads and railways. Further rehabilitation and reconstruction of roads is still essential, in order to open up trading opportunities in remote areas of the country. Increased mobility of people, goods and services will in turn create a positive circle of market dynamics. In 2008, nonetheless, the growth of trade and transportation activities remains strong. Finally, during 2007 the financial and real estate sectors continued to grow significantly, by about 22.2 percent and 10.8 percent respectively, which was relatively the same as that of 2006, because of the continued increase in economic activities and bank trust. Other service sectors remained strong, but grew at slightly slower rates in 2007, averaging around 12 percent, according to the NIS. However, financial services are still basic and major providers are concentrated in Cambodia s main cities. Credit in rural areas is available through a few commercial banks and specialized microfinance institutions, but its dominant source appears to be informal lending (usurers). Nonetheless, based on the current trend and economic activities, the growth prospect for these sectors remains strong for the next coming years. EIC - Cambodia Economic Watch - April 2008 11

12 EIC - Cambodia Economic Watch April 2008

Chapter 2 Trade, Investment and Productivity External trade and FDI have contributed largely towards boosting the Cambodian economy during the last ten years. Exports of garment products and tourism have also made substantial contributions to the country s balance of payments during that period. Cambodia s FDI seems to have been on an upward trend since 2002, thanks to investments in the construction, hotel and garment sectors, and the up-coming Cambodia stock exchange market and impressive potential revenue from extractive industries. 2.1. External Trade and Capital Movements Data compiled from the National Bank of Cambodia revealed that the total exports (including re-exports) in 2007 increased only by 9.4 percent, to about US$4 billion, reflecting a slower growth in the export of garments. The export of agricultural products significantly increased, but remained low. Meanwhile, imports increase was also slowed-down to 13.2 percent and reached about US$5.4 billion. Imports of petroleum and raw materials, especially those related to the garment sector, made up the lion s share of that figure. As a result, the total trade deficit widened, reaching more about US$1.3 billion in nominal terms, or about 15.5 percent of GDP, up from the 14.5 percent in 2006. Due to the significant increase in the number of foreign tourist arrivals in Cambodia, the income generated from tourist spending (travel) is estimated to have reached about US$1.1 billion in 2007, representing 17.8 percent up on 2006. Unfortunately, revenue from tourist transportation remained low, reaching only about US$210 million, since Cambodia does not yet have a stake in any of the airlines or other transportation industries serving the international markets funneling tourist arrivals into the country. To sum up, the surplus in the service sector continued to improve significantly in 2007, up by 29.2 percent from 2006, and reaching 7.5 percent of GDP. The income account for 2007 was in deficit by about US$360 million, and represented about 4.2 percent of GDP, up from 4 percent of GDP in 2006. This was mainly due to large outflows of income, such as dividends and the profits of foreign investments in the country, especially the garment EIC - Cambodia Economic Watch - April 2008 13

industry, and payments for foreign technical assistance by donors, which reached US$90 million. Table 2.1: Cambodia's Balance of Payments (Million of US Dollar) 2003 2004 2005 2006 2007p 2008p Exports of Goods 2,087 2,589 2,910 3,694 4,042 4,527 Imports of Goods 2,668 3,269 3,928 4,749 5,377 6,513 Trade Balance -581-681 -1,018-1,056-1,335-1,986 Agriculture 258 179 350 401 532 674 Textiles & Garments 827 1,082 1,173 1,409 1,393 1,536 Oil & Gas -428-610 -842-1,123-1,306-1,956 Other Goods -1,239-1,332-1,698-1,742-1,953-2,239 Balance of Services 114 291 471 504 651 851 Transportation -157-194 -233-271 -297-383 Travel 353 556 743 841 1,012 1,274 Others -82-72 -38-65 -64-40 Balance of Incomes -179-221 -254-290 -360-430 Balance of Transfers 480 497 535 764 797 809 Private Transfers 153 176 209 315 381 383 Government Transfers 326 321 326 449 416 426 Current Accounts -167-115 -265-77 -247-756 Financial Accounts 244 219 335 324 605 714 Official Loans (net of amortization) 149 154 144 123 120 125 Foreign Direct Investment (FDI) 141 279 381 408 475 558 Others -46-214 -190-206 11 31 Change in Foreign Reserves 77 105 70 246 359-42 At the National Bank (NBC) 74 70 109 182 277 240 Outside NBC 3 35-39 65 82-282 Sources: Compiled from NBC for 2003-2007, EIC projection for 2008. During the same period, net private transfers increased by 20.8 percent and reached US$381 million in 2007. Combined with the large inflow of foreign aid, Cambodia s transfers accounted for a surplus of about US$797 million in 2007, 9.2 percent of GDP. As a result, the current 14 EIC - Cambodia Economic Watch April 2008

account deficit, including official transfers, increased to US$247 million and accounted for about 2.9 percent of GDP. Nevertheless, the financial accounts were in surplus by about US$605 million, reaching 7.1 percent of GDP in 2007. This surplus was almost doubled compared with 2006, because of a significant increase in foreign investment in Cambodia. To sum up, the overall balance of payments was in surplus by US$356 million in 2007, a 45 percent increase on 2006, and reached 4.2 percent of the GDP. It is worth noting that since Cambodia is a dollarized economy, with individuals and institutions able to hold foreign currencies, the overall change in the balance of payments reflects not only the NBC s foreign reserves, but also the foreign currency held by other economic agencies as well as households. For 2008, the growth of the external trade (both export and import) is expected to slow-down because of a slower increase of Cambodian garment exports, a slower growth of the importation of raw material used in the garment industry and the construction industry. 3 Nevertheless, the trade deficit is expected to significantly deteriorate, because of sharp increase in prices of oil and other construction materials in the international markets. Therefore, Cambodia s trade deficit may reach 19.6 percent of GDP in 2008, up from 15.5 percent in 2007. Despite the continuous improvement of balance of services, thanks to the expansion in the tourism sector, the deficit of current accounts is expected to reach 7.5 percent of GDP in 2008, up from only 2.9 percent in 2007. The deficit was partly financed by foreign aid, under the form of grants and loans, and foreign private investment in Cambodia, which represented about 7 percent of GDP. Overall, the Cambodia s balance of payments for 2008 is expected to be slightly in deficit, for the first time since 2001. 2.2. Private Investment and Stocks of Capital In 2007, the Council for the Development of Cambodia (CDC) approved 130 investment projects and about US$2.7 billion of fixed assets. Compared to 2006, the number of investment projects increased by 31.3 percent, but the fixed assets involved was relatively the same, (excluding the World City project with US$2 billion of fixed assets in 2006). 3 Beside, the cement could be produced in Cambodia. EIC - Cambodia Economic Watch - April 2008 15

Most investment projects belonged to the garment, mining, tourism, and agro-industry, which accounted for 39, 19, 11 and 10 respectively of approved investment projects and US$170 million, US$31 million, US$1.1 billion and US$160 million of fixed assets. This was reflected in the high growth of garment exports, tourism and mining during 2007. It is worthy noting that investment in agro-industry has been increasing in recent years reflecting a higher price and high production of agriculture during these years. Table 2.2: Approved Private Investment Projects* 2002 2003 2004 2005 2006 2007 Number of Approved Investment Projects Total 37 66 60 104 99 130 Garments 16 31 35 53 49 39 Hotels 4 11 3 4 4 11 Others 17 24 22 47 45 80 Fixed Assets Approved (Millions of US Dollars) Total 240 314 231 695 4,451 2,667 Garments 18 75 85 118 212 171 Hotels 47 114 23 65 22 1,101 Others 175 125 123 512 2,217 1,395 Source: Compiled from CDC, Cambodian Investment Board, (*) Excluding registered investments of mega-projects of more than US$1 billion. Regarding the actual investment projects in 2008, the growth of investment in garment factories seems to increase in 2008, despite the approaching end of the validity of US and EU safeguard measures, because Cambodia could host many foreign investors moving out from Vietnam and China. Nonetheless, investment prospected in the construction sector is slim in 2008, because of the continued increase of imported raw materials used for construction. In addition, given a limited infrastructure development and a lack of skilled human resources, projected growth for the agro-industry is still moderate. Nonetheless, the coming Cambodian Stock Market and massif money exploited from oil and gas industry is still catching the attention of many foreign investors. To sum up, the growth of investment projects implemented in 2008 keeps increasing, but at a slower pace compared to that of 2007. The updated data from the CDC for January revealed that 6 investment projects were approved with US$27 million of fixed assets. 16 EIC - Cambodia Economic Watch April 2008

Four of the six approved projects in January 2008 were those of the garment sector. 2.3. Productivity Productivity is the key to increased competitiveness and better businesses that are attractive to investors. According to an EIC estimate, the total productivity of workers (value-added per worker) in Cambodia increased by about 5.1 percent per annum during the last decade, while real GDP growth rose by 9.6 percent per annum. This growth has allowed Cambodia to keep its competitiveness relatively strong. Table 2.3: Productivity of Workers (% Increase, US$2000 price) 2003 2004 2005 2006 2007e 2008p Agriculture 7.7% -3.1% 13.0% 3.3% 3.5% 3.5% Paddy 19.3% -14.2% 40.5% 2.2% 5.6% 3.0% Industry 6.5% 7.4% 2.3% 6.2% 2.3% 1.1% Textile & Garment 10.8% 9.4% -0.7% 5.6% 1.7% 0.3% Private Services 2.4% 8.6% 5.1% 3.6% 6.5% 7.3% Tourism -14.3% 8.2% 7.9% 5.1% 3.9% 4.1% Total (*) 6.2% 6.1% 9.6% 7.0% 5.5% 5.0% Source: EIC Estimates. (*) Excluding Public Administration. The growth of the agricultural production in 2007, mainly paddy production, has increased the growth rate of its productivity. The labor productivity in the agriculture sector grew by 3.5 percent in 2007, up from 3.3 percent in 2006. Again, the agricultural sector remains almost totally dependent on weather conditions. The key strategy to keep steady productivity growth is to invest in the irrigation system. Based on the performance of the agricultural sector in 2008, the labor productivity is expected to increase by the same pace as the 3.5 percent in 2008. In the mean time, the productivity of the garment industry increased only by about 2.3 percent in 2007, down from the 6.2 percent increase in 2006. This is because of a slower growth of garment product exports, despite growing learning experiences and additional trainings at the factory middle management level. Labor productivity of the construction sector increased at a slower rate, while that of other industrial sectors continued their growth with a moderate rate. Based on the EIC - Cambodia Economic Watch - April 2008 17

performance of the industrial sector in 2008, the labor productivity is expected to increase by only 1 percent in 2008. In contrast, the labor productivity in the service sector (excluding public administration) increased at a faster rate of about 6.5 percent in 2007, up from the 3.6 percent increase in 2006. This is largely due to the significant increase of labor productivity in the real estate and financial sector, combined moderate growth of other service sectors. To sum up, the total annual worker productivity growth slowed down to 5.5 percent, reaching US$1,037 per worker in real term. Based on the economic performance in 2008, the growth of the total labor productivity is expected to carry on with 5 percent and reach US$1,089 in 2008, mainly supported by a 7.3 percent increase in labor productivity in the private service sector. 18 EIC - Cambodia Economic Watch April 2008

Chapter 3 Price and Monetary Development The growth of Cambodia s economy will be substantial if inflation and the Riel remain stable. Cambodia s inflation is reaching the peak in 2007 after slowing down in 2006 due to a significant continued increase in transportation and communication prices, and the increase in food prices. The Riel was slightly appreciated against the US dollar because of the prudent monetary policy of the NBC and especially the US economic recession. The trend is expected to slow-down for the coming years. 3.1. Inflation Together with a high economic growth, inflation (December to December) has jumped to the peak level of about 10.8 percent in 2007, after slowing down by about 2.8 percent in 2006. Unlike 2006, 2007 s inflation figure was boosted mainly by high food costs and high energy costs. Impressive increase of credit for the private sector was also the reason. Figure 3.1: Cambodia s Consumer Price Index (December 2002=100) Source: Compiled from National Institute of Statistics. The transportation and communication index rose by 13 percent in December 2007, up from the 7.4 percent in December 2006. The price of food rose by about 19.8 percent in December 2007 compared to only 2 percent in December 2006. In contrast, other costs continued to increase EIC - Cambodia Economic Watch - April 2008 19

at the moderate pace of about only 5 percent in December 2007 compared to the 2 percent in December 2006. Although the production of some food-based agricultural products, such as crops and livestock, is growing fast, food prices in Cambodia keep increasing significantly. This increase in prices at the local market is mainly due to over-exportation of local production to neighboring countries. In general, Cambodia exports unprocessed agricultural products, but imports finished goods. The Investment climate is yet good for investment in modern food processing. The growth of the price of transportation also increased significantly mainly due to the consecutive growth of the price of gasoline. This is mainly caused by the increase in crude oil prices on the international market during that period as well as the rigid decline in domestic gasoline prices. Other prices grew at a moderate rate in 2007, higher than in 2006. Based on the current situation and trends from previous years, the overall inflation in 2008 remains high and is expected to be about 9 percent in year average, 4 percent higher than that of 2007. Natural resource management for higher and sustainable growth of agricultural production and a stable exchange rate are crucial in order to reduce the inflation rate, and increase competitiveness of domestic products. 3.2. Exchange Rate In a dollarized economy, the country s economic situation will depend largely on the US economic policy because local monetary policy is useless. The riel was relatively stable in 2006 and was slightly appreciated against the US dollar in year average by about 1.2 percent in 2007. The riel fluctuated at around the average exchange rate in 2007 about CR 4,056 per US dollar, compared to that of about 4100 per US dollar in 2006. The riel depreciated slightly in the first nine months of 2007 and reappreciated from October 2007 to about less than CR4,000 per US dollar. Together with the prudent monetary policy of the NBC and the expansion in economic activities in rural areas for the last three years, especially activities related to agricultural products, the relative strength of the riel was mainly a result of the US economic recession. The riel is largely used in informal sectors that are mostly located in the rural and in some urban areas. In contrast, the slower growth expected in the agricultural sector, will lead to a slower increase in demand for the riel in coming years. 20 EIC - Cambodia Economic Watch April 2008

Figure 3.2: Cambodian Riel against US$, Thai baht, and Vietnamese dong (December 2002=100) Source: Compiled from the International Financial Statistics of the IMF. On the other hand, surges in imports, especially of construction materials and vehicles, along with higher prices for imported petroleum, are factors that will lead to a stronger demand for foreign exchange, especially the US dollar. Furthermore, the sending of US dollars abroad, as well as the expected slowdown in the growth of the garment export industry, which accounts for the most significant inflow of US dollars into the country, will cause a shortage of that currency in Cambodia. To sum up, an expected strong demand for US dollars and shortage in their supply, as well as a slower increase in demand of the riel will then put some pressure on the riel against the dollar in 2008. Currency speculation during the election period could also reason in the depreciation of the riel in the coming years. Nonetheless, the extent of the US economic recession into 2008 would continue to weaken the US dollar and the surplus of the balance of payment would enable the government capacity to maintain a stable exchange rate of the Riel against the US dollar. Beside the US dollar, the Thai baht and Vietnamese dong are also widely used in Cambodian border provinces, because of strong border trade activities. The riel was slightly appreciated against the Vietnamese dong by about 1.8 percent in year average of 2007, trading at around CR25 for 100 dongs. But the riel significantly depreciated against the Thai baht, by about 8.4 percent in year average of 2007 compared to that of 2006. The appreciation of the Thai baht should thus be beneficial for border trading to Cambodian farmers. EIC - Cambodia Economic Watch - April 2008 21

A stable exchange rate is highly appreciated in the context of Cambodia situation since our export partner is the US 4. Even so, Cambodia import partners are the ASEAN countries, mainly Thailand, Vietnam and Singapore. The riel depreciation against the Thai baht encouraged Cambodia trading with Thailand, but it also increased the domestic consumer prices because of limited local production capacity that forced Cambodia to use higher imported products. Thus, the fluctuation of the riel against other trade partner currencies, such the Thai baht and the Vietnamese dong, must also be taken into consideration in the government monetary policy. 3.3. Money Supply During 2007, the money supply increased significantly by 62.9 percent, reaching CR11,311 billion by December. This surge was due to an impressive increase in foreign currency deposits that reflected strong activity in sectors such as tourism, garments, and construction. As a proportion of GDP, the total money supply reached 32.3 percent in 2007, an increase from only about 23.3 percent in 2006. During 2007, the total money continued to be dominated by foreign currency, which represented about 80.8 percent of the total money supply and reached 26.1 percent of GDP. The riel liquidity remained limited during the same period, representing only about 17.6 percent of the total money supply recorded by the NBC and only 5.7 percent of GDP. Riel liquidity increased by 24.9 percent in December 2007 compared to December 2006, whereas foreign currency deposits expanded even more sharply, by about 75.9 percent in the same period. This trend is expected to continue into 2007, but at a slower pace because of an expected slower growth in the garment and construction industry. On the demand side, credit to the public sector continued to decline radically due to an increase in government deposits. Credit to the private sector increased by 76 percent in December 2007 compared to December 2006. This credit expansion was the result of the continued decline of interest rates, growth in the manufacturing and service sectors, and the expansion of the private banking system. However, a large amount of foreign currency, especially US dollars, was sent abroad, since many major investors are foreigners and Cambodia s banking system is inadequate. These trends are expected to continue in 2008, but at a slightly slower pace. 4 The US is main market for about 70 percent of Cambodian garment products, which represent a lion share of total Cambodia export. 22 EIC - Cambodia Economic Watch April 2008

Table 3.1: Cambodia s Monetary Survey (Billions of Riel) 2003 2004 2005 2006 2007p 2008p Total Money Supply 3,329 4,329 5,025 6,942 11,311 14,216 Local Currency in Circulation 908 1,115 1,282 1,600 1,990 2,204 Foreign Currency Deposits 2,310 3,079 3,589 5,196 9,138 11,791 Other Liquidity 111 135 153 147 183 222 Total Money Demand 3,329 4,329 5,025 6,942 11,311 14,216 Credit to Private Sector 1,337 1,817 2,394 3,628 6,385 8,401 Credit to Public Sector -128-209 -421-951 -1,815-1,061 Other Money Demand 2,120 2,721 3,052 4,266 6,741 6,876 Source: Compiled from NBC for 2003-2007, EIC projection for 2008. 3.4. Interest Rates According to the National Bank of Cambodia (NBC), the average nominal interest rate on 12-month deposits in riel and in dollar were 7.1 percent and 4.9 percent respectively in December 2007, which was higher than the 6.4 percent and 4.8 percent in December 2006, respectively. Such a slight increase resulted from a shortage of cash deposit to respond to recent impressive increase of credit demand of the private sector. The need of credit for housing loans and land speculation were the main reasons behind the increase of the total credit demand. Table 3.2: Cambodia s Interest Rates (% per annum, end of period) 2003 2004 2005 2006 2007 Riel 12-month Deposit Rate 7.0 6.6 6.8 6.4 7.1 US$ 12-month Deposit Rate 4.0 3.7 4.0 4.8 4.9 Riel 12-month Lending Rate 21.1 18.7 18.6 23.1* 22.3* US$ 12-month Lending Rate 17.3 16.7 16.2 16.7 16.0 Inflation rate in riel (year on year) 0.5 5.6 6.7 2.8 10.8 Inflation rate in US$ (year on year) -0.6 4.6 4.1 3.5 12.6 Source: Compiled from NBC and NIS. * The higher figure shown in the table reflects the revised methods used by the NBC. EIC - Cambodia Economic Watch - April 2008 23

Beside, the nominal interest rate for loans in riel and dollar continues to decrease gradually, from 23.1 percent and 16.7 percent in December 2006 to 22.3 percent and 16 percent in December 2007, respectively. This was due to an increasing competition among banks and other credit providers, despite an expansion of credit demand from private sectors. Interest rates in riel were higher than for US dollars, mainly due to depreciation risks and the lack of riel loan credits. With gradually rising confidence in the financial system and economic expansion over the last decade, both deposit and lending rates would appear to decrease slightly on a regular basis. However, higher inflation expected for 2008 would, to a certain extent, keep interest rates, as well as the gap between real and nominal interest rates, high. Lending rates were more than 10 percent above deposit rates and were still high, because of a shortage of local deposits required to satisfy a strong demand for credit (resulting from economic expansion), and owing to the high risk of lending. The informality of businesses, the lack of infrastructure or a legal framework, and poor law enforcement are factors behind this high level of risk and uncertainty, forcing banks to charge higher rates. In addition, to avoid the high risk of unpaid loans, a large amount of local deposits have gone overseas, and are therefore unavailable for lending to local borrowers. In the construction sector, a significant part of credits for local borrowers come from development fund overseas. Thus, most Cambodians have limited access to credit, and annual interest rates on loans or deposits in riel and US dollars are quite high compared to those of neighboring countries. Cambodians, particularly those in rural areas, are mostly short of initial capital and unable to benefit from the economic growth. Lower interest rates would encourage them to invest, thereby contributing towards economic growth in these areas. 24 EIC - Cambodia Economic Watch April 2008

Chapter 4 Fiscal Development and External Debt Overall, the Government has made significant improvements in the implementation of the 2007 revenue collection, since the economic activities are doing well. The total budget execution was done as planned, but was not yet conforms to what was planned for each ministry during 2007. For 2008, the Government planned to increase its revenue by about 21.5 percent and this remains relatively weak compared to the level of nominal GDP, as well as that of Government expenditure. The deficit will be mainly financed by foreign assistance, of which external loans account for about 45 percent. Cambodia s debt situation remains on a sustainable path with a moderate risk of debt distress. 4.1. Budget Revenue The Government implemented well in terms of collecting the state revenue that it had planned during 2007. The central Government revenue was estimated to reach CR 4,015 billion in 2007, about 22.3 percent higher than the 2007 planned budget. This good performance was likely due to a better achievement in the economic growth. The expected economic growth rate in the planned budget for 2007 was only 7 percent, about 3 percentage point lower than that realized during the period. The main source of government income in 2007 was taxation, which represented about 85 percent of the total domestic revenue, whereas other sources of state income, non-tax revenues, only accounted for around 15 percent. The share of domestic tax in the total tax revenue has also increased gradually due to a good performance in the private sector. Due to an impressive increase on what had been planned in the state revenue in 2007, the amount of revenue in share of GDP increased to about 11.5 percent, which was about only 10 percent for the last few years. This reflected that the performance of the state revenue collection improved moderately in 2007 compared to that of previous years. Nevertheless, Cambodia government revenue (relative to GDP) remains among the lowest in Asia. For 2008, the central government has planned to raise its revenue to CR3,987 billion, a 21.5 percent increase on the 2007 planned budget, but slightly lower than the outturn for the year. EIC - Cambodia Economic Watch - April 2008 25

Therefore, EIC forecasts that total government revenue for 2008 should reach CR 4,729 billion, or about 18 percent higher than the planned budget. Table 4.1: Cambodia s Government Revenue (Billions of Riel) 2003 2004 2005 2006 2007e 2008p Total Domestic Revenue (1) 1,765 2,127 2,626 2,918 4,015 4,729 Tax Revenue 1,220 1,577 1,911 2,271 3,396 4,053 Profit Taxes 110 117 172 262 388 481 Excise Taxes 198 304 380 418 731 898 Value Added Taxes 460 598 730 870 1,143 1,396 International Trade Taxes 395 513 573 645 1,020 1,143 Other Tax Revenue 57 44 56 76 114 135 Non-tax Revenue 545 549 715 647 619 675 Tourism Activity (2) 83 118 160 190 224 275 Quota & Export Licenses 146 76 123 123 123 123 Post & Telecommunications 120 94 123 83 77 111 Other Non-tax Revenue (1) 196 261 310 251 196 167 Memorandum Items Taxes from Petroleum Products 445 442 461 525 565 600 Tax Department Revenue 345 405 556 727 1,029 1,319 Customs Department Revenue 875 1,173 1,355 1,544 2,367 2,735 Sources: Compiled from MEF for 2003-2007, and EIC for 2008. (1) Including Capital Revenue, but excluding MDRI of CR 341 billion from IMF. (2) Including Tourism Income, Civil Aviation and Visa Fees. However, it remains low as a proportion of 2008 s projected GDP compared to that of other countries. To improve revenue collection, more effective measures must be taken to enforce the Law on Taxation, the tax base to the informal sector must be extended, and especially, the tax audit is to be strengthened in order to reduce revenues lost through corruption. Furthermore, anti-smuggling measures should be strengthened at each border checkpoint, since large-scale smuggling continues, especially petroleum, due to the high level of tax imposed in Cambodia compared to that of neighboring countries. 4.2. Budget Expenditure Regarding expenditure, the Government was expected to expense only the amount of its state budget disbursement plans since the Government is restricting its expenditure. Nonetheless, in 2007, the actual central government expenditure was expected to be about 11.5 26 EIC - Cambodia Economic Watch April 2008

percent higher than what was planned and reached CR5,041 billion, about 10 percent higher than the 2008 planned budget. As a share of GDP, it reached to about 14.4 percent in 2007, up from the 13.8 percent in 2006. On average, spending on civil administration rose by 16.3 percent, while that on defense and security increased by 31 percent, 15 percent higher than 2006 s increase. Expenditure on priority sectors rose by only 16.2 percent in 2007, the same pace as that of other ministries and 6.4 percent lower than the 2006 increase. Table 4.2: Cambodia s Government Expenditure (Billions of Riel) 2003 2004 2005 2006 2007e 2008p Total Expenditure 2,757 2,962 3,182 4,112 5,041 6,413 Current Expenditure 1,586 1,769 1,967 2,592 3,091 4,073 Civil Administration 1,175 1,346 1,516 2,072 2,410 3,095 Priority Sectors 529 573 644 791 919 1,035 Other Civil Ministries 646 773 872 1,281 1,491 2,060 Defense & Security 411 423 451 520 681 978 Defense 270 272 289 344 505 730 Security 141 151 162 176 176 248 Capital Expenditure 1,171 1,193 1,215 1,520 1,950 2,340 Through National Treasury 333 296 315 379 440 806 Externally Financed Directly 838 896 900 1,141 1,510 1,534 Memorandum Items Wages 615 640 711 822 1,243 1,621 Non-Wages Operating Costs 971 1,130 1,256 1,770 1,847 2,452 Sources: Compiled from MEF for 2003-2007, and EIC for 2008. For 2008, the Government expects to expand its budget expenditure to about CR 5,673 billion, which represents 22.7 percent higher than the 2007 plan or 12.5 percent higher than the actual 2007 disbursement. Compared to 2007 s expenditure, it was planned that civil administration disbursement would decrease by 6.2 percent, while that for defense and security would increase slightly by 1.4 percent during 2008. Also, spending for health, education, agriculture, and rural development would increase by 9 percent, 5.1 percent, 10.6 percent, and 25.9 percent, respectively, compared to the spending of these sectors in 2007. It is worth noting that the increase of these priority sectors, except that of rural development, in 2008 is lower than the average growth of other EIC - Cambodia Economic Watch - April 2008 27

sectors. In addition, the unallocated budget is increased by 158.8 percent in 2008, reaching about 23.4 percent of the total planned expenditure. Nonetheless, EIC expects that the total government expenditure for 2008 will be about 13 percent higher than the Government s target, due to a better revenue collection, and the necessity of adjusting the salary of civil servants to high inflation. Budget disbursement on priority sectors may reach 2.6 percent of GDP, and expenditure on wages will increase slightly. However, the degree to which the public may benefit from this additional spending could remain limited, since expenditure, particularly on the priority sector, slightly increased and thus remains insufficient for Cambodian needs. In addition, the actual budget allocated to the priority sector is, as experienced from previous years, lower than what have been planned. Thus the budget expenditure policy will probably achieve little in terms of poverty reduction. 4.3. Budget Financing and External Debt Despite significant improvement in tax collection, 2007 s budget revenue was still lower than expenditure. The deficit reached CR1,026 billion, representing 2.9 percent of GDP. This deficit was largely -financed by the foreign aid (CR1,615 billion), of which 45 percent was grants and 65 percent was loans. For 2008, the government budget deficit is expected to increase, but totally financed by foreign aid. Table 4.3: Financing Cambodia s Budget (Billions of Riel) 2003 2004 2005 2006 2007e 2008p Total Domestic Revenue 1,765 2,127 2,626 2,918 4,015 4,729 Total Expenditure 2,757 2,962 3,182 4,112 5,041 6,413 Total Deficit (cash basis) -992-835 -556-1,194-1,026-1,684 Foreign Financing 886 894 984 1,584 1,615 1,684 Grants 382 372 538 790 730 749 Loans (net) 504 522 446 794 885 935 Domestic Financing 106-59 -428-390 -589 0 Banks -3 25-199 -333-1,114 0 Others 109-84 -229-57 525 0 Memorandum Items Net Foreign Reserves at National Bank 2,532 2,836 3,336 4,388 5,496 6,458 Sources: MEF for 2003-2007, and EIC projection for 2008. 28 EIC - Cambodia Economic Watch April 2008

No update data on the public debt yet is available. Nonetheless, the public debt stock was revised to about US$2.4 billion by the end of 2006, thanks to the reduction from US$1,5 billion to US$457 million of the debt owed to the Russian Federation. As percentage to nominal GDP, the public debt accounted for about 33.2 percent in 2006, down from about the 37.1 percent in 2005. Based on Joint IMF/World Bank Debt Sustainability Analysis 2007, the ration debt to GDP is expected to further decline in 2007. External debt constitutes about 95 percent of public debt and about 35 percent of the external debt was owed to the Russian Federation and United States. 5 With regards to the continued strong economic growth and the highly concessional structure of Cambodia s lending, debt is on a sustainable path. However, its moderate risks do remain, particularly given the current low level of government revenues, the continued existence of external arrears and the potential for contingent liabilities. If Cambodia reaches debt-rescheduling agreements with the two creditors and begins servicing debts in 2007, the risk of debt distress will decline further, though low revenue collections will continue to pose risks to debt sustainability. 6 5 IMF, Cambodia 2007 Article IV Consultation 6 IMF, Cambodia 2007 Article IV Consultation EIC - Cambodia Economic Watch - April 2008 29

30 EIC - Cambodia Economic Watch April 2008

Chapter 5 Labor Force, Incomes and Poverty 5.1. Labor Force and Under-Employment The latest data from the Cambodia Socio Economic Survey of 2004 revealed that the total labor force was about 7.5 million in 2004 or 56 percent of the total population. And there are more than 0.2 million persons entering into the labor market per year. Based on this trend, EIC estimated that the total labor force would reach about 8.4 million in 2007 and 8.6 million in 2008, of which about 20 percent are under eighteen. With a narrow definition of employment, which is, a person is considered to have job if he or she works at least one hour during the past reference survey week, the employment rate was more than 99 percent in 2004. Thus, it should be noted that, this rate included under-employment rate. Table 5.1: Cambodia's Population and Labor Force (% change) 2003 2004 2005 2006 2007p 2008p Population 1.7% 1.7% 2.1% 2.4% 2.0% 1.6% Labor Force 3.4% 3.4% 3.4% 3.3% 2.9% 2.6% Employment 2.6% 3.2% 3.7% 3.7% 2.2% 2.0% Formal Sectors 0.7% 6.4% 5.3% 6.6% 4.2% 4.2% Textile 5.4% 14.1% 9.9% 14.0% 8.2% 8.0% Tourism -2.9% 14.0% 13.4% 8.2% 6.2% 5.9% Others -1.3% 0.8% 0.9% 1.0% 0.6% 0.5% Informal Sectors 2.9% 2.7% 3.5% 3.2% 1.9% 1.6% Agricultural Sector 2.4% 2.2% 2.2% 2.1% 1.7% 1.4% Others 5.5% 4.6% 9.0% 7.9% 2.6% 2.3% Sources: EIC model projections Based on the good performance of the garment industry and tourism, jobs created in these two sectors continue their growth at a significant rate in 2007. For the garment industry, Garment workers employed in the GMAC factories members reached about 350,000 in 2007, about 7.6 percent higher than that of 2006. In total, garment workers are expected to increase by about 8.2 percent in 2007, about 5.8 percent lower than that in 2006 due to the slower growth rate of Cambodia garment product demand on the international market. At the same time, employment in the tourism sector EIC - Cambodia Economic Watch - April 2008 31

is expected to increase by about 6.2 percent in 2007, 2 percent lower than that of 2006. Nonetheless, despite a higher growth rate in the agricultural sector, new employments created in agriculture remains low because this sector hides significant numbers of under-employment. It is expected to be about only 1.7 percent in 2007, down from the 2.1 percent in 2006. The underemployment rate is still high. Most of the workers continue to migrate to Phnom Penh and other urban areas in other sectors which require lower skill, such as the garment factory, construction and tourism, as well as some other service sectors at the borders of the country. In sum, the total employment is expected to grow by about 2.9 percent in 2007, 1 percent lower than that of 2006. On the other hand, new jobs created in 2007 could absorb only about 57 percent of the new labor force. In terms of number, the new entrants in the labor market during the last five years averaged about 250,000 people per year, while new jobs created during the same period was estimated at about 150,000 jobs per year. The formal sectors, such as garment and tourism, contributed to about 25 percent of total new jobs created. Thanks to high economic growth, new jobs created in 2005 and 2006 reached the peak of 200,000 jobs per year. For 2008, based on the expected economic slowdown, employment is expected to increase by 2 percent compared to that in 2007, representing about 120,000 new jobs. 5.2. Incomes There are no updated data to examine the picture on the income for the whole of Cambodia or region by region. However, the regular daily earning surveys conducted by the Cambodian Development Research Institute provide a perspective on wage evolution for a number of vulnerable workers. Figure 5.2 depicts the daily earnings of vulnerable workers between 2006 and 2007. In real terms, the daily earnings of all vulnerable workers increased, except those of unskilled construction workers whose daily earnings decreased slightly. Daily earnings of motorcycle-taxi drivers increased significantly, by about 34 percent in average in 2007 compared to those of 2006; followed by those of small vegetable sellers and porters, whose daily earnings increased by about 25 percent and 20 percent in 2007 compared to those of 2006 respectively. The daily earnings of rice field workers and waitresses in 2007 were relatively the same as those of 2006. 32 EIC - Cambodia Economic Watch April 2008

Figure 5.2: Real Terms of Daily Average Earnings of Vulnerable Workers (November 2000 prices, Cambodian Riel) Source: Data compiled from CDRI 5.3. Poverty Based on national poverty line, poverty rate in Cambodia has dropped from about 47 percent in 1994 to about 35 percent in 2004. The number of absolute poor declined from about 5 million to 4.7 million during the same period. On average, poverty has been reduced by about 1 percent, representing 30,000 persons per annum. This reduction pace is perceived slower than the 1.3 percent in Lao PDR or 3.2 percent in Vietnam, given its higher economic growth rate. At the same time, Gini coefficient increased from 0.347 in 1993 to 0.403 in 2004. This means that inequality in Cambodia has been high and rising. The slower reduction pace and higher inequality in Cambodia was well reflected to the pattern of the current economic growth. The growth has been mainly generated from the garment and tourism industries. Thus, the growth was concentrated mainly in the capital Phnom Penh and its peripherals, and the tourist town, Siem Reap-Angkor. The growth of the rural-based and agricultural sector, which is the main income source for the poorer and poorest, has been seen as very slow. This pattern of growth may lead to a slower rate of poverty reduction and an increase in inequality. EIC - Cambodia Economic Watch - April 2008 33