cambodia country economic memorandum

8/14/2019 Cambodia Country Economic Memorandum

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Poverty Reduction and Economic Management Sector Unit

East Asia and Pacic Region

Prepared by the World Bank for the Royal Government of Cambodia

Sustaining Rapid Growth in aChallenging Environment

Cambodia Country Economic Memorandum

February 2009


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Executive Summary


SuStaining Rapid gRowth in a

Challenging enviRonment


pry Rc ecc m Scr u

East Asia and Pacic Region

prr by wr Bk fr Ry gr f Cb

Fbrry 2009


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Executive Summary

Sustaining Rapid Growth in a Challenging Environment

tb f Cs

acks ........................................................................................................................................

exc Sry .......................................................................... ............................................................. x

irc ................................................................ .......................................................................... .......... 1

paRt 1. leSSonS FRom a deCade oF Rapid gRowth ................................................................... 5

Cr 1. Frs f Cbs gr prfrc .................................................................. 6

A. Four Key Drivers of Growth and Poor Diversication.............................................................. 6

B. mcrcc Sby, Rs exrs, wk is ....................................................10

C. S u .......................................................................... ............................................................17

Cr 2. ex Cbs gr prfrc ............................................................... ...18

a. hsry gry ........................................................................ .........................................18

B. us f nr asss dsc Ss ................................................................ .............21C. Sector-Specic Governance...........................................................................................................22

d. S u .......................................................................... ............................................................26

Cr 3. trs gr Jbs pry Rc .....................................................27

a. pry Rc mrk ecy ...................................................................... ............27

B. Cbs drc trs ....................................................................... .....................29

C. ey trs ....................................................................... ...................................................30

d. prcy, ey, pry Rc ................................................................... ..32

e. S u .......................................................................... ............................................................33

paRt 2. SCoping CamBodiaS gRowth potential ....................................................................35Cr 4. o Cbs Cr a ..............................................................36

a. Cr a ....................................................................... .........................................36

B. Export Diversication ......................................................................................................................40

C. R ir .................................................................... ....................................................45

d. S u .......................................................................... ............................................................47

Cr 5. prscs exrc isrs .................................................................... ......................50

a. o gs .......................................................................... ............................................................50

B. m .......................................................................... ......................................................................56

C. S u .......................................................................... ............................................................60

Cr 6. Csrs gr .................................................................. ..........................................61

a. accss Fc .............................................................. ...............................................................61

B. Css f Fcrs .................................................................. ..............................................................63

C. arrby.................................................................................................................................68

d. t Cs f arcr .......................................................................... ........................................70

e. S u .......................................................................... ............................................................73

paRt 3. poliCieS to SuStain Rapid gRowth ..................................................................... ............77

Cr 7. mcrcc m Fc Scr d ..............................78

a. R gr mcrcc Sby .............................................................. ..............78

B. Support Competitiveness and Diversication .............................................................................80C. mbz Ss ................................................................ ..............................................................83


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Executive Summary


Cr 8. Cr us Fsc Sc.....................................................................................85

a. Fsc Sc Cb .................................................................. ...........................................85

B. Cr Fsc Sc ................................................................ .....................................................87

C. us Fsc Sc ........................................................................ ...................................................88

Cr 9. tr, Rry, isr pcs ........................................................................ ...95

a. Bsss er Crss-C Rfr effrs ............................................................95

B. Sr isr pcy ....................................................................... ................................96

C. isr pcy s prcss .............................................................. ......................................... 101

Cr 10. m Cs f R gr ...................................................................... 104

a. urbz ......................................................................... .......................................................... 104

B. iqy vrby ............................................................... ......................................... 106

C. er ............................................................... ...................................................................... 109

d. e ..................................................................... ..................................................................... 110

axs ...................................................................... .......................................................................... .... 111a. ms ............................................................... ........................................................................... ..... 113

B. prc Sc .................................................................... ........................................................... 122

C. Sry Sscs ....................................................................... ................................................ 129

d. Rfrcs ............................................................... ...................................................................... 144

ls f Bxs

Bx 1.1: t S f ecy 1992 ............................................................... ......................... 12

Bx 2.1: t gr Css Rr: hbs f Sccssf ecs .................................... 19

Bx 2.2: a t f tr Scrs ............................................................... ............................................ 24

Bx 3.1: lbr mrk pcs iss ..................................................................... .............. 32

Bx 4.1: t R f gr isry ................................................................. ........................ 41

Box 4.2: The Process of Diversication .............................................................. ................................... 45

Bx 4.3: t ecc trsfr f t ........................................................................ .... 49

Bx 5.1: tyc R Srs prc Sr ar ........................................ 53

Bx 6.1: t R f Fr is Cb ................................................................. ..... 66Bx 7.1: F drz, d-drz, r Ss Q? .......................................................... 81

Bx 7.2: d Sck mrks S ecs ................................................................... 84

Bx 9.1: Sccssf gr irs Crrc Cr ifr

Frs......................................................................................................................................100

Bx 9.2: t gr-pr Scr Fr .................................................................. .............103

Bx 10.1: t d f p p ................................................................... ......................105

Bx 10.2: asss, accss Fc, prcy ...................................................................... ..108


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Executive Summary


ls f Frs

Fr 1: t r r xrc Cb s s .................................................. 1

Fr 2: t Rcr Sry .................................................................... .................................. 2

Fr 1.1: Cbs cy s sr s rsfr ....................................................... 6

Fr 1.2: gr s r by jb cr rcy s ............................................ 7

Fr 1.3: i r sry, s rcy r -r

y r .................................................................... ............................................................... 9

Figure 1.4: Cambodias exports are poorly diversied.....................................................................10

Figure 1.5: Growth has been rapid and ination low ........................................................................10

Fr 1.6: exr s r frb -2008 ...............................................11

Fr 1.7: mcrcc cs b cc sby ............................................13

Fr 1.8: gr s b r ry by cs s by Fdi ...................14

Figure 1.9: The nancial system is catching up with countries at similar levels of

........................................................................ ...................................................15

Fr 2.1: Cb s r xrs r c r SRg crs s

f .................................................................. ..........................................18

Fr 2.2: gr s ccr r fr ss r b .....................20

Fr 2.3: is ss b crs, b r ....................................21

Fr 2.4: t rc f crr s , cr crs s

f .................................................................. ..........................................22

Fr 2.5: t rs sry s b k r cr fsr, b rc

sry s ................................................................. ....................................................23Fr 2.6: t rc f rc p p s r by r rcs, b y

y rs ....................................................................... ............................................................25

Fr 3.1: pry cc s b crs ............................................................... .............27

Fr 3.2: lrcy rs r r r s cs........................................28

Fr 3.3: Cb s y crs cy r ................29

Fr 3.4: ec ks ffrc rs, xc fr rcs r .............31

Fr 3.5: drcs, srcr rsfr, rcy crb

r ffr rs.............................................................................................33

Fr 4.1: l rcs r crs fr ............................................................... .......................37

Fr 4.2: grss scry r s xry cr r SRg crs ....37

Fr 4.3: ec s r crs fr ry bs rs f rrs

c crs .................................................................. ................................38

Fr 4.4: t ssc f Cbs xrs s ry s .................43

Fr 4.5: t sr f rcr gdp s ry f, s s b xrc by

r SRg crs ..............................................................................................................48

Fr 5.1: gr g bc srr ss fr f

rs c ...................................................................... ...................................................57

Fr 6.1: a cs r c fy s sr csrs r ...................61

Fr 6.2: is csrc s y crr r rs rs, b

s rb q s ................................................................ .............62


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Executive Summary


Fr 6.3: S r 2005 s ky r r

2008 ..................................................................................................................................63

Fr 6.4: Csrs bsss r c b 2003

2007, with corruption remaining rms main concern ...................................................64

Fr 6.5: pr ccss crcy s srs csr bssss ....................................65

Figure 6.6: Cambodia tends not to sustain its new ows of exports ..............................................66

Fr 6.7: tr s r r f rfrc c scr, -rfr

rms in garments comparable to top performers in competitor countries ................67

Fr 6.8: ds s rrss b 2003 2007, rry rcsss r

brs; rs rs r cy rsrs .......68

Fr 6.9: Frs srs s crs fr crc ss .........................69

Figure 6.10: Corruption remains a major concern for rms ................................................................69

Fr 7.1: afr r rc 2007, r s rc fsr

crrcs f r r-xr crs ....................................................80

Figure 8.1: The scal space contracted in 2002-07, largely at the cost of capital spending ..86

Fr 10.1: t c f rbz Cb s sr r SRg crs

s f .................................................................. .................... 104

Fr 10.2: mr rb rcs r rcr .......................................................................... ......... 104

Fr 10.3: gr s f srs ry ffr rs fr ffr rs .. 106

Fr 10.4: iqy s , crs ry .................................................................. . 107

ls f tbs

tb 1: urs a dc f R gr ................................................................ ..... x

tb 2: a Sry f pcy os ....................................................................... ................... x

tb 3: ls f Bckr prs .................................................................. ................................... 3

tb 1.1: prfrc icrs f Bk Sys ...............................................................16

tb 2.1: Ss is Ss R gr Crs .....................................22

tb 3.1: gr, iqy, pry (2004-07) ................................................................ ....29

tb 3.2: ar ec a ers (as 15-65, by Scr, 2007) .....31

tb 4.1: Cb ir-R tr ................................................................... .............46

tb 4.2: isr m-tr gr prscs ................................................................. ....48

tb 5.1: l Frrk o gs.......................................................................................51

tb 6.1: Bk l ds Rs (%) ........................................................................... ...........62

tb 6.2: Rc Ys, tcy us, ifrsrcr Cb R ....70

tb 8.1: Fsc Frrk (% gdp)..................................................................................................86

tb 8.2: exr acs (by Fc) ................................................................... .............89

Table 8.3: Expenditure Allocations (by Economic Classication) .....................................................90

tb 8.4: mr Rrs ( rs r ) f Rr ifrsrcr is ..........................94

tb 9.1: a F exs isr pcy isrs .................................................................. ....97


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Executive Summary


acrys abbrs

aC arbr Cc

adB as d Bk

aml a-my lraSean assc f S-es as ns

atm ac tr mc

BFC Br Fcrs Cb

CaRdi Cb arcr Rsrc & d is

Cad Cr a df

CaF Cr a F

CdC Cc fr d f Cb

CdCF Cb d Cr Fr

CdhS Cb drc & h Srys

CdRi Cb d Rsrc is

CiB Cb is Br

Cmt C-mk-tr

Cnpa Cb n pr ary

CSeS Cb Sc-ecc Sry

ddd d d d

dtiS dsc fr tr ir Sry

edC ecrc Cb

eia er ic assss

eiC ecc is f Cb

eiti exrc isrs trsrcy i

elC ecc l CcssemaF exr mrk accss F

eu er u

Fdi Fr drc is

FSap Fc Scr assss prr

FtC Fr-S tcc Cr

gdp grss dsc prc

gdmR gr dr f m Rsrcs

gmaC gr mfcrrs assc f Cb

gmS grr mk Sb-r

g-pSF gr-pr Scr Fr

haCCp hzr ayss & Crc Cr phv h v

iCa is C assss

iCt ifr Ccs tcy

iFapeR ir Fcry assss & pbc exr R

iFC ir Fc Crr

ilo ir lbr orz

imF ir mry F

lepnRm l er prc & nr Rsrcs m

maFF msry f arcr, Frsry, Fsrs

meF msry f ecy FcmFa m-Fbr arr

mFi mcr Fc is


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Executive Summary


mime msry f isry, ms ery

moC msry f Crc

mou mr f urs

mptC msry f pss tccs

mv m v

naa n a arynBC n Bk f Cb

niS n is f Sscs

noC n o Cy

npaR n pbc asr Rfr

npl n prfr l

nSdp n Src d p

nSw n S w

oCa or Cs ar

ODA Ofcial Development Aid

otC or-t-Cr

pFm pbc Fc mpFmRp pbc Fc m Rfr prr

pip pbc is p

pSa prc Sr ar

ppwSa p p wr Sy ary

RCa R Cr a

R&d Rsrc & d

REE Rural Electrication Enterprise

REF Rural Electrication Fund

ReR R exc R

RgC Ry gr f CbRS Rcr Sry

SeZ Sc ecc Z

Sme S m errs

SneC Sr n ecc Cc

Soa Sc or acs

SpS Sry py-Sry

SRg Ss R gr

Swap Scr w arc

tiR trsr ir Rr

uSaid u Ss acy fr ir d

wdi wr d icrswg wrk gr

wto wr tr orz

CuRRenCY eQuivalentS

(exc R effc Fbrry 19, 2009)

Crrcy u = Cb Rs (CR)

uS$1.00 = CR4,120

goveRnment FiSCal YeaR

Jry 1 dcbr 31


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Executive Summary


acks

1. TheanalysisoCambodiassourcesogrowththatledtothisreportwasinitiatedinFebruary2008,undertheguidanceoHisExcellencyHangChuonNaron(PermanentVice-Chairman

otheSupremeNationalEconomicCouncil,SNEC).TheconceptnoteandthenaldratwerereviewedwiththeSupremeNationalEconomicCouncil.

2. TheWorldBank teamwasledbyStphaneGuimbert.Theteamwas composedo:CraigAndrews, Caridad Araujo,Natasha Beschorner, Milan Brahmbhatt, Veasna Bun, MuditaChamroeun,VandanaChandra,HuotChea,TimConway,SophalEar,TomEasterling,VerenaFritz,FredericoGilSander,MohinderGulati,NaomiHalewood,JamesHanson,PeterJipp,KaiKaiser,SophornKith,MasamiKojima,AshishLall,ZhiLiu,SamsenNeak,IsraelOsorio-Rodarte,SanjoyRajan,RathaSann,StevenSchonberger,JamieSeward,RobertTaliercio,PengSengTan.SophornKithensuredtheproductionothereportandKathrynBiceeditedit.AdditionalbackgroundpaperswerepreparedbytheEconomicInstituteoCambodia(EIC),

the InternationalFood PolicyResearchInstitute (IFPRI, withBingxinYu,ShenggenFan,Anuja Saurkar, andRachaRamadan), andMitsuiMineralDevelopmentEngineeringCo.,Ltd.EricSidgwick(ADB),WisalHinandThierryNoyelle(UNDP),FredericMauretandGillesVernet (MunicipalitedeParis andFrenchEmbassy),andRichardErlebach(DFID)participatedinthepreparationothereport.TheteamworkedundertheguidanceoIanPorterandAnnetteDixon(CountryDirector),QimiaoFan(CountryManager),andMathewVerghis(LeadEconomist).PeerreviewersShadidYusu(WorldBank)andSandeepMahajan(WorldBank)providedextremelyvaluablecommentsandeedback.DFID,UNDP,andtheWorldBank,aswellastheDiagnosticFacilityorSharedGrowth(amulti-donortrustundadministeredbytheWorldBank),providednancialresourcestopreparethisanalysis.

3. ImportantinsightswereprovidedupstreamthroughanexternalpanelorganizedbySusannaLundstrom,inFebruary2008,andcomposedoLouiseCord,SophalEar,FranciscoFerreira,RicardoHausmann,KaiKaiser,RoyKatayama,KennethSimler,ChanSophal,AleUlloa,RodrigoWagner,andAndresZahler.VeryruituldiscussionswereheldwiththeOverseasDevelopmentInstitute(ODI)duringthepreparationotheirreportoncompetitivenessorSNEC(nancedbytheUNDP).

4. ConsultationswereheldonboththeconceptpaperandthediscussiondratwithGovernment,private sector, trade unions, research institutes, non-governmental organizations, anddevelopmentpartners.

5. Theconceptnote or thework programwas reviewed in February 2008.This reportwasreviewed inDecember2008within theWorldBankGroup.The executive summary wasreleasedattheSecondCambodiaDevelopmentCooperationForum,inDecember2008,andthenalreportwillbepresentedattheFebruary2009CambodiaEconomicForumorganizedbytheSNEC.

Acknowledgments


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Executive Summary x


exc Sry

1. Many countries succeed in generating high economic growthatsomepointintheirhistory.butonlyaveryewmanagetosustainrapidgrowthoranextendedperiod.Onlysucha

prolongedperiodorapidgrowthcanhaveasignicantimpactonincomepercapita,andsuchanimpactotenbringswithitmanyotherimportantchangestopeopleslives.

2. Cambodia has been one o the countries in this select group .Ithasmorethandoubleditsincomepercapitaoverthepastdecade,romUS$285in1997toUS$593in2007.Thisdoublinghasbeenaccompaniedbythetrappingsoaprooundstructuraltransormation:integrationintotheglobaleconomy;ashitojobsromagriculturetomanuacturing;ademographictransition;andmigrationromruraltourbanareas.Translatingintojobsandbetterservices,theseoutcomeshaveledtoasignicantreductioninpoverty,aswellasimprovementsinhealthandeducation.

3. Even so, the next episode in this story is very uncertain .TheachievementsothepastdecadeareveryragileandleavemanyCambodianspoorandwithewassets.Thebaseorthiseconomicgrowthappearsnarrow.AndthewindsthatonceservedCambodiawellglobaltradeandinvestmentfowshavelosttheirstrength,atleasttemporarily.

4. What will it take or Cambodia to continue on this trajectory,tobecomeamiddleincomecountryinadecadeorso,andlitmoreoitspeopleoutopoverty?ThisreportaimstocontributetopolicymakersandcitizensthinkingaboutgrowthinCambodiainthreeways:(i)itreviewstheexperienceothepastdecadeanddrawstheCambodia-speciclessonsothisperiod;(ii)itsketchesthemajorpotentialsourcesogrowthwiththeaimoassessingthebarrierstogrowth;and(iii)itoutlinespolicyoptionsoraddressingthesebarriers.

5. The analysis has three main messages.First,theeconomicgrowthothepastdecadeisaremarkableachievement,butitisunlikelytobesustainableinitscurrentorm.Thatsaid,theexperiencehasestablishedthatgrowthinsomesectorscanbestimulatedbygoodpoliciesandgovernancearrangements.Second,Cambodiahasapotentialtosustaingrowthiitincreasescompetitivenessanddiversies.Thisrequiresaocusedgrowthstrategy.Finally,Cambodiahasthreeimportantopportunities:harnessingregionalintegration;managingnaturalresourcesinasustainableway;andinvestinginitsuture(throughagriculture,inrastructure,education,andhighersavings).

6. This analysis builds on recent developments in thinking about growth,inparticularthe

2008ReportotheGrowthCommission.TheapproachusedhereistoundertakesomedetectiveworkonwhatworksanddoesnotworkintheCambodiancontext,toproposeadiagnosticonthekeyconstraintsongrowth,andtopinpointtheactionsthatholdmostpromiseorsustaininggrowth. It readilyacknowledges thatmuch remainsunknown about theprocesso growthanddevelopment(andthat, inCambodia,statisticsaresparse);and thus takestheviewthatexperimentation,monitoring,andevaluationwillbekeycomponentsoasuccessulstrategy.

urs dc f R gr

7. Four eatures o the rapid growth o this past decade are o particular signifcance(Chapter 1). First, over1998-2007, growth has been drivenby anopen economy anda

stablemacroeconomicenvironment.ThesemacroeconomiceaturesarevisibleintherapidincreasesinexportsandForeignDirectInvestment(FDI)andtherelativestabilityoinfation


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Executive Summaryx


(at4.7percentonaverageoverthedecade1997-2007)andtheexchangerate.Second,stablemacroeconomicmanagementhasbeenachievedwithveryewpolicyinstruments.Indeed,theeconomyislargelydollarized,leavingscalpolicyasthemaininstrumentinthepolicymix.Third,growthhasbeennarrowlybased.Theourleadingsectorshavebeengarments,tourism,construction,andagriculture.Verylittlediversicationhasoccurredbeyondthem:garment

productsaccountor88percentoallrecordedexports.Fourth,thelevelsodomesticsavingsandinvestmentarelow(13and21percentoGDPrespectively),thoughincreasing.WhilethiswastobeexpectedgiventheinitialconditionsoCambodiainthe1990s,itdiersromotherexperiencesorapidgrowth,inparticularinEastAsia.Relatedtothisistherecentandveryrapiddevelopmentothenancialsector,romaverylowbase,mobilizingwell-needednancingbutalsocreatingsignicantrisks.

8. How did this happen?Thedynamicbehindthisrapidprogresscanbeunderstoodalongthreedimensions.(Chapter2).Theyarenotmutuallyexclusiveandeachprovidesuseulinsightsortheuture(Table1):

Cambodiahasbeneted rom its recent history and its avorable geography.Thepastdecadehasseentheendothemulti-decadeconfictandtheestablishmentopoliticalstability,therapidgrowthoglobaltrade,andademographictransition.Geographically,it is a coastal country in dynamic South East Asia. In this history and geographyview, theachievementsthatunderlieCambodias sustainedgrowthare itspoliticalandmacroeconomicstability,andthepoliciesthathaveallowedittobecomeintegratedwithintheregion.Theseactorshaveenabledittoestablishatrackrecordochange,includingitsaccessiontotheWorldTradeOrganizationandtheapprovaloanumberosignicanteconomiclaws.Ontheotherhand,thisdimensionothestory(e.g.therelianceonoreignsavings)highlightshowvulnerableCambodiaistotherecentglobaleconomicturmoil.

Cambodiahashelpedtouelgrowthbydrawingonsomeoitsassets(orests,sheries,

land,AngkorWatsite),butatthecostoareductioninthelevelorqualityotheseassets.Arelatedissueisthelowalbeitincreasinglevelosavingsandsomemisallocationosavings.Evidenceorthisviewcanbeoundinenvironmentalconcerns(e.g.ontheAngkorWatsite),thedisproportionatelyhighreturnsonsomeclassesoassets(e.g.realestateandland),theincreaseininequality,andtheshorthorizonomanyinvestments.This dimension suggests a style o growth that is unsustainable and highlights theimportanceosustainablemanagementoassets.

Cambodiahasachievedrapidgrowthinanenvironmentopoorgovernancethroughsector-specicorproduct-specicarrangements.Thesearebestillustratedbythegarmentssector.The U.S.-Cambodia Trade Agreement negotiated in 1999 linked progressive

increasesinquotastoimprovementsinlaborstandards,monitoredbyathirdparty(theInternationalLabourOrganization programknown asBetterFactoriesCambodia,orBFC).ThishasgivenCambodiasoverallindustryaninternationalreputationorbeingable tomeet these standards.TheGarmentManuacturersAssociationoCambodia(GMAC)hasliaisedcloselywithgovernmentcounterparts,particularlyintheMinistryoCommerce(MOC),tocontinuallyaddressconstraintsonsustainedgrowthinthesector (this happened partly because GMAC chaired one o the working groups otheGovernment-PrivateSectorForum(G-PSF).TheBFCarrangementsandsectoralcollectiveactionanddialoguewerecrucialinsustaininggrowthevenatertheoriginalquotaschemewasphasedout.Indeed,theabsenceodevelopmentinmanyothersectorscanbeexplainedbytheabsenceosucharrangements.Whilesustainedrapidgrowth

hasshowntheeconomysresilience,amajorquestionorCambodiaisthereorehowtoreplicatesimilararrangementsinothersectors.


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Executive Summary x


9. This period o rapid growth prooundly transormed the economy(Chapter3).Povertyincidencewasreducedromanestimated45-50percentin1993-94to30percentin2007.ManyothersocialindicatorsconrmtheimprovementsinthewelareotheCambodianpeople.Keydriversotheseachievementswerethelabormarketchangesandthedemographictransition.Inthelabormarket,amajordevelopmentwasthecreationojobsoutsideoagriculture,inindustry

andservices:asthesesectorshavehigherlaborproductivitythanagriculture,thisreallocationolaborhadasignicantimpactongrowth.Demographictrendsrevealtwobabybooms,intheearly1980sand1990s,ollowedbyademographictransitioninthelate1990s:thereductionothedependencyratiooverthepastdecade(ewernon-workingageCambodiansoreachworking-ageCambodian)contributed1to2percentagepointsopercapitagrowthperannum.

Table 1: Understanding A Decade of Rapid Growth

10. Three conclusions emerge rom this review. First,thecurrentgrowthdynamicisunlikelytobesel-sustaining,because(i)theeconomicbaseisrelativelynarrowanddiversicationhasmadenoprogress;(ii)asignicantproportionopastgrowthwasdrivenbyevents,suchasthedemographictransitionandtheestablishmentopoliticalstability,whichwereeitherone-osorinwhichthemajorgainshavealreadybeenmade;(iii)somenaturalassets,suchas orestresources,havebeenusedin anunsustainableway;(iv)governancearrangementsaresector-based;and(v)inequalitieshaveincreasedsharplyinrecentyears.Despitetheeconomyspastresilience,theglobalnancialturmoilolate2008and2009,towhichCambodiaisnotdirectlyexposedgivenitssmallnancialsector,willsignicantlyweakentheexistingdriversogrowth.Second,someimportantconditionsorareshwindhavebeenestablished:theimportanceomacroeconomicstabilityhasbeeninstitutionalized;thegarmentsectorhasdemonstratedthatadequategovernancearrangements(andanadequateinvestmentclimate)candelivergrowth;theuseulnessoanindependentthird-partymonitor(BFC/ILO)hasbeenproven;theeciencyopartnershipsbetweenpublicandprivatesector(theGovernment-PrivateSectorForum)hasbeentested;andtherole(andlimits)oindustrialpolicyhavealsobeenproven.Third,Cambodiasdemographicsplayedamajorroleinitssustainedgrowth;butasustainedfowonewjobsis

requiredtoabsorbthe250,000orsoyoungCambodiansenteringthelabormarketeachyear,manywithhighexpectationspromptedbytherecentgrowth.

dss

1. hsry ry

2. ussbs f sss

3. Sector-specicrc

Benets from history(c , b

r, rcrs) ry(es as)

gr f by - s r rs fr rsrcs

gr r rryfcs ss ry b rc

ec

t f r crs r Fdi

drc rs(cy r)

h cs r, ss, rsqyh rrs scsss f sssussb f rrsrcs

gr sccss(x qs,r by BrFcrs Cb,ccy f bsssssc csrs r)Limited diversicationR f gr-pr Scr Fr

lsss lr

R f c cr sby

R f ss r cs

n fr ssb f rrsrcsn frr crssc /r frss

R f r-ryr (br srs rs), xrrrs, ssac r f r cr scrbsss r


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Executive Summaryx


Sc Cbs gr p

11. Inthiscontextohighlycommendablebutragileachievements,andsharpglobalslowdown,rom which quarters will Cambodias new wind blow? ReviewingCambodias growthpotential and options or diversication, the analysis highlights our potential sources o

growth(Chapter4and5).

12. First, Cambodia should make the most o its relatively abundant land, natural assets,and inexpensive labor.A growth strategyshouldbebuilton, rather thanruncounter to,thesecomparativeadvantages.Unortunately,atthemoment,distortionsarepushingupthepriceoland,andlackoplanningorareasawayrommajorpopulationcentersreducestheseareaspotentialasasourceogrowth.TherecentsharpappreciationotheCambodianriel(initiallyduetoinfation,thenduetotheappreciationotheUSdollar)hasalsoincreasedthecostolabor(aproblemcompoundedbypoorindustrialrelations,leadingtoahighincidenceostrikes).ItisimportanttocorrectthesedistortionstoenableCambodiatomakethemosto itscomparative advantages.I this can beachieved, itshould continueto perormwell

inagriculture,tourism,andlightmanuacturing.Cambodiashouldinparallelupgradeitsendowmentinparticularthrougheducation,health,andinrastructuretomakepossibleatransitiontoanewsetocomparativeadvantagesinthemediumterm.

13. Agriculture will continue to be important, but needs to be complemented by developmentin other sectors.ExperienceinCambodiaandothercountrieshasshownthecentralroleoagriculture-ledgrowth,inparticularinreducingpoverty(sincemorethan9outo10othepoorliveinruralareas).Cambodiahasthepotentialtosignicantlyincreaseyieldsinriceproductionandconsolidateoodsecurity,andthiscouldprovideasizeablegrowthdividendintheshortterm.Butexperiencehasalsoshownthatagricultureisunlikelytogrowbeyond5percentorsoperannum,hencecontributinglessthan2percentagepointsogrowthper

annum.Manuacturingwillremainveryimportantinabsorbingnewworkers:inparticular,inruralareas,non-armactivities(e.g.ricemilling,trade)shouldbemajorsourcesogrowth.Inaddition,theactthaturbanizationhasproceededslowly,whilevalue-addedperworkerinagricultureis similar toothercountries atthe same levelo development, suggeststhatCambodia isnot taking ull advantage o the agglomeration eects around urbancenters.Theseshouldnotbeignored,astheywillcontributegreatlytogrowth.Predominantlyurban-basedservicesarealsolikelytocontinuetodrivegrowth.

14. Second, Cambodia needs to build on its existing capabilities and develop new ones as astep towards diversiying its economy.Recentcross-countryresearchhasshownthatcountriesthatexportproductAtendtothenmovetoexportproductB,indicatingthatthecapability

toexportproductAisrelatedtothecapabilitytoexportproductB.Itisnosurprise,giventheabsenceodiversicationoverthepastdecade,thatthereareveryewproductssimilarincapabilitiestothosethatCambodianowexports.ThisleavesCambodiawithewoptionsordiversication.Oneobviousoptionwouldbetodevelopnewproductsinthegarmentsector,butotherproductsthatCambodiaisalreadyalthoughmarginallyexporting(suchasshandwoodproducts)couldalsobegivenpriority.

15. Third, diversifcation should also be a matter o new markets ,notonlynewproducts.Fromthatpointoview,Cambodiahasunderperormedinrelationtoitsregionalmarket(only13percentoitstradeisintra-regional,againstanaverageo49percent).MuchmorecouldbedonetointegrateurtherintotheEastAsiaregion.


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Executive Summary x


16. Fourth, sustainable management o natural resources, particularly minerals and energy,represents another growth opportunity.Althoughtheextentoitsreservesremainsunclear,Cambodiacoulddevelop a signicant extractive industry inoil, gas, andmining overthenextdecade.ToensureCambodiareapsthegrowthdividendsothissector,thereneedstobe a signicant upgrade o the sectorsmanagementwhich, at themoment, is ineective

andopaque.Thethreeprioritiesinthisareaare(i)toclariythelegislative,regulatory,andinstitutionalrameworktoincreaseaccountability;(ii)tobuildthestangtoimplementtheramework,recognizingthatthecapacityrequireddevelopsintandemwiththesectoritselovertime;and(iii)tomanageexpectationsinrelationtosubsidiesopetroleumandminingproductsordownstreamindustries.

17. These opportunities should help Cambodia to sustain growth o around 6 or 7 percentper annum in the medium term, i these changes are achieved,althoughtheshort-termoutlookislessencouraginggiventheglobalenvironment.Itisnotpossibleandunlikelytobedesirabletopinpointthroughsuchanalyticalworkwhichproductorwhichmarketwillemerge:areshwindmaycome,butpolicymakersandentrepreneurswillhavetoeelit.A

sustainedgrowthrateo6to7percentperannumwouldbeconsistentwith:(i)internationalexperiencebasedonthequalityosomedriversogrowth(suchaseducationandnancialsectordevelopment);and(ii)continuedinvestmentsinhumanandphysicalcapital.

ify Csrs

18. To realize this potential, it is important to clariy the constraints on growth(Chapter6).Inalow-income,low-governancecountrysuchasCambodia,itwouldbeeasytomakeacasethateverythingisaconstraint.However,notonlywouldthisbeatoddswiththeexperienceo rapidgrowth over the past decade, itwouldalso contribute little toa growth strategy.Themethodologyoridentiyingandprioritizingconstraintsconsistsoenquiringintowhy

entrepreneursdonotinvestmoreornewcapacityornewproducts,ortoimproveproductivity.Theanswercouldbeeitherthatthereturnsothepotentialinvestmentsaretooloworthatthecostonancingthemistoohigh.

19. Until recently, there was little evidence o fnance being a constraint at the aggregate level.Overall,thenancialsectorwasveryliquid(e.g.theloans-to-depositsratiois64percent),ithaddevelopedrapidlyinresponsetotheincreasingdemandothepastewyears,andrealinterestrateshadbecomenegative.Realinterestratesandtherateoinvestmentindurableequipmenthadbeenmovinginparallel,suggestingthatinvestmentisconstrainedbydemandratherthansupply.Twoexceptionsstillstandout.First,largeinvestmentshavebeendiculttoundertake:onlyalinkwithaoreigninvestormakesthempossible.Second,accesstonance

inagricultureremainsinsucientandaconstraintonarmersabilitytoimproveproductivity.Beyond thesetwo exceptions, thereis evidencethata largeparto the available nancingcomes romoreign savings (c. orexamplethe act thatgrowth and the currentaccounthaveparalleltrends),highlightingtheadverseimpactthattighterconditionsininternationalnancialmarketswillhaveongrowthinCambodia.

20. Hence, the question is why entrepreneurs cannot identiy projects with higher returns.Twohypotheses are possible:either there are simply tooew o thesehigh-returnprojects(becauseoexcessivecostsoinputsorcoordinationissues),orentrepreneursdoubtthattheycancapturesucientreturnsthemselves(becauseotherisksintheenvironmentorbecauseoocialorunocialtaxation).Itislikelythattheissueisnotprimarilythecostoinputs,but

oneocoordinationandappropriationoreturns.Indeed,astrikingeatureotheCambodianeconomyistheproductivityothetopperormers(inaewcasesonparwithmoreadvanced


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Executive Summaryx


countries),withawidedispersionoperormanceacrossrms inmostsectors,rmsonaverageworkat60percentorlessotheproductivityothetopperormer.

21. Coordination is a major issue. Production, especially o new products, requires thecoordinationoa largenumberoactorsalongthevaluechainand the establishmento a

largenumberorulesorregulationsorvarioustransactions.Thisisinparticularimportantorsel-discovery,i.e.ndingoutwhatCambodiaisgoodat.Evidenceothedicultiesinachievingthiscoordinationincludes:(i)thelackodiversicationintonewproductsoverthepastdecade;(ii)thesimplicityothevaluechainsomostproductsmadeinCambodia(orinstance,thevastmajorityogarmentrmsareCut-Make-Trim(CMT),thesimplestpartothevaluechain),and(iii)theactthatmostagriculturalproductsareexportedasrawcommodities(e.g.paddyrice,unshelledcashewnuts,unprocessedrubber).Thishighlightsdeep issuesin coordinatingmorecomplexvaluechains. Inthepast, thishashappened inCambodiamainlythroughdedicatedgovernancemechanisms(e.g.ingarments).

22. Appropriation issues are pervasive, at the macro and micro levels. Macroeconomic

uncertainty is only a recent concern and should be promptly addressed (other types oinstabilitycosts,suchascrimeorsecurity,arenowmuchlessoaconcernthantheywere10yearsago).Entrepreneursareunabletoappropriatethereturnsotheirinvestmentsduetotwotypesomicroeconomicissues:(i)disputes(bothcommercialandlabor)havebecomeamajorconcerngiventhelackoaneectivecourtsystem;and(ii)corruptionremainswidespread,initsmanyorms.Thelevelotaxitselasopposedtoitsadministrationisnotviewedasamajorconstraint.Itshouldbenotedthat,inrelationtobothissues,manyrmshaveoundmitigatingstrategies(suchaspre-payingsalestoavoidanydispute;movingtowardcollectivebargainingagreementtoreducetheincidenceolabordisputes;keepingbusinessesinormal;etc.),butmanyotherrmssimplyhavenotbeensetupbecauseotheseappropriationissues,partlyexplainingthelackodiversicationoverthepastdecade.

23. In relation to input costs, the high costs o electricity and logistics appear to be majorconstraints.Theirimportanceisevidentin(i)thewillingnessormstoproduce36percentotheirelectricityromexpensivegenerators;(ii)thelackoinvestmentinelectricity-intensivesectors(thegarmentindustryisratherlightinthatregard);(iii)theeortsbygarmentrmstoreducethecostsotransportandcustoms(overthepastouryears,thecostsoshippinggoodsthroughcustomswentdownorgarmentrms,butuporriceproducers);and(iv)thehighinventoriesthatrmsmaintain(41daysonthemaininput,againstlessthan30inmostcountries).Logisticsservicesare constrainedbypoor trade acilitation and complex cross-borderprocesses.LimitedruralroadcoverageconstrainsCambodiasagriculturepotentialinparticular.Thecostolaborremainslow,but,asnotedabove,therecentsharpappreciationo

theCambodianrielinrealtermsisweakeningthiscomparativeadvantage:unaddressed,itwillweakentheperormanceothegarmentsectorandpreventurtherdiversication.

a n w?

24. The Royal Government o Cambodia has a development strategy, the National StrategicDevelopment Plan (NSDP),whichelaboratesonthegoalsandpolicyprioritieslaidoutinitspoliticalplatorm(theRectangularStrategy,thesecondphaseowhichwaspresentedbythenewlyre-electedGovernmentinSeptember2008).Thesestrategydocumentsocusonthekeyelementsoagrowthstrategy.TheoregoinganalysiscontributestourtherunderstandingthedriversogrowthinCambodia,pastanduture,withaviewtone-tuningorprioritizing

actions to sustain rapid growth and to adjust the strategy to the recent global economicdevelopments.


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25. With this background, what actions in todays context could easibly help to extend therecent period o rapid growth?Thisreportocusesonthreeinstruments:macroeconomicpolicyandnancialsectordevelopment;scalpolicy;andregulatory,trade,andindustrialpolicy(seeTable2).Togetareshwind,threekeytacticscouldbeprioritized(Chapter7-9).

26. The frst priority is to deepen Cambodias integration, in particular in the East Asia region.Theslowdownoglobaltradegivesthisobjectiveanaddedsenseourgency.Obviously,progressintradeacilitation(attheborderandbehindtheborder)isimportant.ThereareopportunitiestomaketradewithintheGreaterMekongSubregion(GMS)mucheasier,makingCambodiathebridgebetweenHoChiMinhandBangkok,twoothelargestcitiesinSouthEastAsian.But thisrstpriority should ocusmoredeeply on insertingCambodiasrms intoglobalsupplychains:Thai,Chinese,andpossiblyVietnamesermsshouldincreasinglybelookingatCambodiaasaplacetolocatetheiractories.CambodiacouldusetheAssociationoSouth-EastAsianNations(ASEAN)asavehicleornewinitiativesinthisarea.Threetypesoactioncouldbeconsidered:

Themost pressingpriority is or Cambodia toaddress nancial sector risks (e.g.bytightening bank entry criteria and by renewing eorts to monitor non-perormingloans)andtomanagethepolicymix(withanappropriatescalpackage).Atthesametime,it is importanttomanage the exchange ratemoreactivelyas Cambodia,beingessentiallydollarized,isquicklylosingitscomparativeadvantageolowcostsastheUSdollarappreciates.Itisimportanttoaddressthissoon,aslargerevenuesromextractiveindustrieswouldexacerbatetheproblemintheuture.

Inaddition,Cambodiashouldpositionitseltotakeadvantageoopportunitiesoncetrade and investment fows start to rebound. Trade and investment can be urtheracilitated,mostlikelywithaocusonagri-businessandregionaltrade.Thiscouldbe

accomplishedbycreatingadedicatedunittoserviceagri-businessinvestorsandbycreatinganindependentmonitoroSanitaryandPhyto-Sanitarystandards(onthemodeloBFCorlaborstandards).Doublingriceyieldsrequiresacoordinatedapproachinordertocreatetheknowledgeandincentivesorarmerstoapplytheappropriatecombinationoseedsandertilizers.Makingtheexistingtaxincentivesmoreactivecouldalsogeneratea signicant return. Implementing existing cross-border transport agreements withneighboringcountrieswouldalsopayo.

Finally,thediagnosticoconstraintsongrowthstressestheimportanceocoordinationissues,especiallytheneedtointegrateCambodiaintomorecomplexvaluechains.Aswellastheinvestorservicingunitandthestandardsmonitor(previouspoint),consideration

couldbegiventosupportorbusinessassociations,moreproactivemanagementoSpecialEconomicZones,andincreasedaccesstonancialproducts(includingthroughawell-unctioningcreditbureau).AnimportantplatormoridentiyingandaddressingissuesocommonconcernistheGovernment-PrivateSectorForum(thiswouldrequiretheForumtopreparemoreresearchandanalysis).Inaddition,anumberobusinessassociations such asassociations or the hotelandgarment industries couldbesupported inidentiyingcommonissueshurtingproductivityandinproposingoptionsordiversiyingwithinthesectors(inparticular,theywouldhavearoleinaddressingvocationaltrainingissues).Indeed,thegovernmentandtheprivatesectorneedtoworkhandinhandtoprioritizekeyconstraintsandopportunities.Theroleosuchcoordinationinagricultureisparticularlyimportantandcantaketheormocontractarming,armersassociations

orcooperatives,andsel-helpgroups.SuchcreativesolutionstoprovidingpublicgoodswillbeacriticalactororCambodiassuccessinsustaininggrowth.


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Executive Summaryx


27. Second, management o natural resources must be sustainable.Cambodiacanbuilduponbothgoodexperience(e.g.developmentocommunityorestsandsheries)andbadexperience(e.g. illegal logging). The possible development o extractive industries provides both anopportunityandaseriesomajorchallenges.Prioritiesinthisareaincludetheollowing:

Amoredecisiveeorttomanageexistingresourcesshouldbeinitiatedthroughawell-conceivedlanduseandplanningpolicy,includingthedemarcationoorests,communityorestsandsheries,andmanagementostateland.Coordinationshouldalsobeimprovedintourism.

TheareaoextractiveindustriesiscriticalasitsetsthetoneortheoverallclimateorinvestorsinCambodia.Thelegalandscalregimeorbothpetroleumandminingshouldbeclariedurgently.TheRGCshouldbuilditscapacitytomanagethesector,includingthroughtraining,computerization,anddevelopmentoagoodcadastre,etc.Iandwhenthe revenuebase turnsout tobe large, externalmonitoringmechanisms comparabletoBFCwouldbeuseulinreinorcingaccountabilityinthesector(inparticular,orrevenue collection, the Extractive IndustryTransparency Initiative (EITI) provides a

processandlabeltostrengthenaccountabilityandtosignalCambodiascommitmenttotransparency).

Morebroadly,urtherexperimentationwithexternalmechanismsaddressinggovernanceconstraintsinasector-specicwayshouldbeencouraged.

28. Third, in the medium term, Cambodia should upgrade its endowment to move to thenext stages o development.Whileitisnotdesirabletooverlookitscurrentcomparativeadvantages,Cambodiashouldcontinuetodevelopitsinrastructureandhumancapacity,andmobilizemoresavingstoprepareorutureepisodesogrowth:

Priorities are the upgrading o rural roads, agriculture public goods (research and

extension), aordable access to electricity, and human capital (continuing to stressprimaryeducationtoexpandthebase).Inallcases,however,higherspendingwillnotbesucient:thequalityospending(includingaddressinginstitutionalissuesandelectricitypricing,themaintenanceoroads,andthequalityoteaching)willmattermorethantheleveloexpenditures.Thelimitedscalspacealsocallsorastrongeortatprioritizingexpendituresbasedongoodcost-benetanalyses(e.g.thereisevidencethatthereturnsonimprovementsinruralinrastructureintermsoriceyieldsvarygreatlyacrossregions).

Mobilizing domestic savings is likely to become increasingly important, including tonance inrastructure and education. Expanding the scal space, especially throughdevelopingtherevenuebase,willbeimportantinthisregard.

Tomanagethismedium-termagenda,anumberopublicsectorreormswilltakeonanincreasingimportance.

29. Finally, the report identifes three challenging areas or urther analysis(Chapter10).Althoughtheseareaswouldnotgenerateanimmediategrowthdividend,theydeservecloseranalysissothattheycanbeullyintegratedintothegrowthstrategy.Urban developmentneedstobe bettermanagedgiventhegrowthpotential ocities and the riskomismanagement(suchascongestion,poorservices,etc,whichwouldreduceincentivestoinvestandincreasecostsorexistingrms).Dependingonitsnature,rapidgrowthcoulduelinequality.Variousindicatorsshowthatinequalityhasindeedincreasedsignicantlyoverthepastouryears:suchrapidincreaseininequalityisnotonlypoliticallyandsociallyundesirable,italsotendstobe

inimicaltosustainedrapidgrowth.Ashighlightedbytherecentspikeinoodpricesandtheimpacto theglobalnancialturmoil,wellmanaged,welltargetedsocialsaetynetswillbe


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Executive Summary x


animportantinstrumenttomitigatetheimpactoeconomicshocksonthemostvulnerable.Finally,theenvironmentisanassetorCambodia,butrapidgrowthandglobaldevelopmentssuchasclimatechangeareputtingitunderstress.

30. Cambodia has made strong progress with a long episode o rapid growth.Theconditions

oranewepisodeogrowth,however,remainhighlyuncertain,becauseothenatureopastgrowthandthedepressedexternalenvironment.Thecountryhasthepotentialorurthergrowth and the oregoing analysis has sketchedwhat this potential could look like.Theongoingnancialcrisisshouldalsobeseenasanopportunity.Butitwilltakeresoluteactionstoachievethispotential:issuesidentiedthroughthisanalysisogrowthareotennotnew,butimplementationhasbeendecient.Whatneedstobedonecannotbeullyknowninadvanceandthediagnostic o constraintsongrowth should bean ongoing process o testingnewpolicies,scalingupthesuccessulones,and learningromailures.Thisprocesswillrequirecommittedleadershipandocusedattentionongrowthconstraintsandopportunities.Isuchaprocessisachieved,itisindeedpossibleorCambodiatopushitsdevelopmenttowardnewlevels,contributingtoanumberoimportantwelareandsocialoutcomes.


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Executive Summaryx


Table 2: A Summary of Policy Options

(*) in brackets identies the section which reviews the options. Note: These policy options are discussed throughout the report. Prioritization will depend on

nalizing the diagnostic of what is constraining growth (points in italics suggests 15 initial priorities based on the analysis in the report). The report also

includes a number of other options for further analysis.

pcy ar (*)

mcrcc(7.a-C, 8.B)

tr s(9.a-C)

Fc scr(7.a-C)

lbr (6.C)

ifrsrcr(8.C; 9.B)

ec (8.C)

arcr (6.d;9.B)

exrcsrs (5.a-B)

Rfr

pcy os

Design and implement scal package to respond to weaker growthwhile developing the growth potential in a framework consistent withlow inationIncrease revenue-to-GDP ratio (enforce property and capital gaintaxes; revise tax incentives; widen tax base; strengthen enforcement)Improve quality of macroeconomic monitoring and gradually introducenew policy instruments

Accelerate trade facilitation reform (e.g. roll out computerized customssystem; design and introduce Single Window; deepen coordination withother ASEAN countries) to partly offset the appreciation of the riel inreal termsCreate dedicated unit to serve agri-business investorsR xrc Sc ecc Zs (SeZ) rr f SeZ cyContinue efforts for regulatory simplication and transparency( r r rs), c r s rs fr xsraccr f crss-brr rsr rs t virc crc s rs cssS b srs

Further increase focus on banking supervision and improve t andproper tests for new entrantsir cr fr sys ys syseb srs (r cr rqrs, rcs, b-bk)S bs f scrs rfrc r Fc Scrassss prr (FSap)

Facilitate improvements in industry relationshipsFc rcy-bs y rccs (.. y by c)

Increase capital and maintenance spending from the budgetm f r r rjcs ccr f r rDevelop a focused strategy for rural electricationImprove management of public-private partnership in infrastructure, in

particular through disclosure and strong oversightImprove nancial strength of Electricite du Cambodge (EDC) andsr r rc css r ss csrsC xs f scry rry r rkSr cy rry fcs c scr nalize policies/laws

Fcs qy f rry cgry crs b fr scry cSr r scr r r c c /r

Adopt a time-bound plan to introduce standardsPilot innovative institutional mechanisms to introduce standards forselected products (possibly modeled on BFC)S b src fr r-bsss srsecr crc fr / sf- rsFz r s fr Sry arcr

wr, rcr rr scsRfr f ecc l Ccsss (elCs) srrsrcy src

Adopt and revise Petroleum Law and Mining Law, as well as associatedregulationsClarify scal framework for both sectorsSignicantly increase transparency in allocation of licenses andrevenue collectionIncrease capacity of agencies in charge of managing the sector

Create focal point in Government with focus on private investment,productivity, and growthCreate a capital project appraisal ofce and build its capacityir cr ky rs (.. srs, rs) s rf n pbc asr Rfr (npaR)Undertake public expenditure reviews and efciency reviews

d r f gr pr Scr Fr, by r rsrc ccy, s r fy csrs r

exc Rss

High growth and low inationhr r--gdp r

C r f rxrsDiversication of exportshr Fdi r-bsssS, rsr rryfrrk

C f nancial sector with acceptable( -r) rsks

mr cc rs fr srks

lr cs f crcyBr scsBr iCt srcsBr ccss rks rr rs

hr r shr rcy rs

C r rcr,with diversication and higher hr fr s

mr -qy s scrSsb f scr ( rs f crb r, y, r)


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Introduction


Introduction

1. Cambodia has gone through an unusual period of rapid growth over the past decade.Itisunusualvis--visboththecountrysdiculthistoryandtheglobalexperienceodevelopment

(Figure1).Cambodiaisoneotheewcountriesthathaveachievedsustainedrapidgrowth:o194 countrieswithdata,46haveachieved7percent annual growth onaverage or 14consecutive years. Over 1998-2007, Cambodias growth perormance ranks 6th across allcountriesintheworld.

Figure 1: The rapid growth experienced in Cambodia is unusual

2. Can Cambodia become a middle income country over the next decade?Sustainingrapidgrowthisanecessaryconditionortheachievementoawiderangeoobjectivesthatpeopleandsocietiescareabout(GrowthCommission,2008).ContinuingtocreatejobsiscriticalorCambodia,giventhe250,000orsoyoungpeoplejoiningthelabormarketeveryyear,withincreasinglevelsoeducationandexpectations,and,oten,withdecreasingaccesstolandasanalternativelivelihood.Inaddition,thearithmeticocompoundedratesogrowthmeansthatsustainingaewadditionalpercentagepointsogrowthrapidlymakesadierence.Attherateogrowthothepastdecade(7percentpercapitaperannum),itwilltakeonlyanothertenyearstoCambodiatodoubleitsincomepercapita,reachingmiddle-incomestatus;at2percentperannum,itwouldtakethreeandahaldecades1.

3. Yet, the odds of sustaining the rapid growth of the past decade are low.Only11othe46countriesinFigure12havesustained7percentannualgrowthoraseconddecade.AswillbediscussedinPart1,theachievementsothepastdecadeareragile:thebaseoeconomicgrowthhasbeennarrow,institutionstosustaingrowthremainunderdeveloped,andtheglobalenvironmentislesssupportivein2009.

4. The Royal Government of Cambodia (RGC) has a development strategy,theNationalStrategicDevelopmentPlan,whichelaboratesonthegoalsandpolicyprioritieslaidoutintheGovernmentspoliticalplatorm,theRectangularStrategy(RS),seeFigure2,thesecondphaseowhichwaspresentedbythenewlyre-electedGovernmentinSeptember2008.Thisstrategy

a/ Income per Capita (2007 $) b/ Growth Performance 1960-2007

-200

400

600

800

1,000

1,200

1,400

1,600

1950 1960 1970 1980 1990 2000 2010 2020

Middle Income Country

194

11

46

0

20

40

60

80

100

120

140

160

180

200

0 5 10 15 20 25 30

2007,

1998, 310

550

Note: projections made based on recent erormance (7.5% .a. er caita)and lower erormance (2% .a. er caita). Middle income countrylevel is defned as US$1,075 er caita. Source: NIS, national accounts,Madison or re-1993 estimates.

Note: Each bar shows the number o countries that have achieved a rate ogrowth o 7% .a. or x consecutive years (calculated with a geometricaverage). Cambodia is one o 46 countries that have achieved this eror-mance or 14 consecutive years. Source: WDI.

1 Dividing 72 by the growth rate of X gives the time it takes for X to double in size. 2 This includes Botswana, China, Hong-Kong, Indonesia, Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand. The Growth Commission (Box 2.1) adds Japan and Brazil (which are

not in this list, which is based on data starting in 1960); it also notes that India and Vietnam could join the list soon.


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Introduction


coversmanyaspectsoagrowthstrategy,withanappropriateocusongovernance,privatesectordevelopment,humandevelopment,andagriculture.

Figure 2: The Rectangular Strategy

Source: RGC.

5. The objective of this report is to contribute to the debate on growth in Cambodia,by(i)identiyingmajorsourcesogrowthandtheeasibilityosustaininganddiversiyingthemand(ii)refectingonhowconstraintsonrealizingthispotentialcouldbealleviated.Itstartswitha review o the past decade o growth togenerate lessons learned rom this unusualachievement(Part1).ThepointodepartureoPart2istheneedtostrengthenthegrowthpotential anddiversiy theeconomy: thisPart thereore analyzes thegrowthpotential,thesourcesodiversication,andtheactorsthatarehinderinginvestmentanddiversication.Part3discussessomeothepoliciesthattheRGCcouldimplementtoaddresstheseactors,andhencetostrengthenCambodiasgrowthpotentialandsustainrapidgrowth.

6. This report was initiated at the request of, and guided by, the RGCs Supreme NationalEconomic Council (SNEC).Itbenetedrominsightsandnancialsupportromseveraldevelopment partners. It was urther discussedwith a number o stakeholders, includingresearchinstitutes,non-governmentalinstitutions,andprivatesectorrms.Themainreporthowevercannotdojusticetothewealthoinormationandanalysisinthebackgroundpapersprepared during the process (Table 3).Thesepapers give amore detailed account o theinvestigationconductedinthisreporttoidentiysourcesogrowthandconstraintsongrowth.Theyprovidedetaileddatasourcesandmethodologies,aswellasurtherreerences.Someothemalsogodeeperinoutliningpolicysolutionstoalleviateconstraints.


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Introduction


Table 3: List of Background Papers

SourcesoGrowth,1998-2007,HuotChea

HowCanCambodianFarmersRespondtoRisingFoodPrices?,BingxinYu,Shenggen

Fan,AnujaSaukar,andRachaRamadan(IFPRI)ForeignAgribusinessInvestmentsinCambodia,TomEasterling

Cambodia:StructuralTransormationandEconomicGrowth:OptionsorCatchingUp,VandanaChandra,StephaneGuimbert,IsraelOsorio-Rodarte

Cambodia: Source oGrowth:Mining,MitsuiMineralDevelopmentEngineeringCo.,Ltd.

ProspectsandChallengesorOilandGas,MasamiKojima

PriceDistortioninCambodia:aCaseStudyoPaddy,MaizeandSoybeans,EkChan-boreth(EIC)

ReturnstoEducationinCambodia:Resultsromthe2007Socio-EconomicSurvey,AshishLall

FinancialSectorDevelopmentinCambodia,JamesHansonandJamieSeward

AgrarianStructureorCambodia,StevenSchonberger

KeyConstraintstoGrowthinCambodia,StephaneGuimbert

Cambodia:FiscalSpace,PublicExpenditurePolicy,andGrowth,RobTaliercio

Pour que Phnom Penh Devienne une Nouvelle Source de Croissance, FredericMauret

BrieonEducationandGrowthinCambodia,CaridadAraujoBrieonICTandGrowthinCambodia,NatashaBeschornerandNaomiHalewood

BrieonCambodiaPowerSector,VeasnaBunandMohinderGulati

BrieonTransportinCambodia,RathaSann

All these aers are available on the reorts website at www.worldbank.org/kh/growth


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Introduction



24/171

Part 1Lessons from a Decade

of Rapid Growth

Chapter 1. Features of Cambodias Growth Performance ................... 6

Chapter 2. Explaining Cambodias Growth Performance ..................18

Chapter 3. Translating Growth into Jobs and Poverty Reduction ......27


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Part 1: Lessons from a Decade of Rapid Growth


KEY MESSAGES:

Cambodias income pe capita has been inceasing at 7.6 pecent fo the past

decade, more than doubling. This is a signicant performance by comparison to

the past 50 years of development across countries. How did this happen and

what are the lessons for Cambodia on how to sustain rapid growth?

Chapte 1 reviews Cambodias growth experience and highlights:

The role o our key sectors (garments, tourism, construction, and agriculture) and lacko diversication;The openness o the economy, the stable macroeconomic environment (rom 1998 to2006), and the recent rapid growth o the nancial sector (since 2005); andThe low level o domestic savings and investment.

Chapte 2 Analyzes these achievements along three dimensions all

three suggesting limits to their sustainability:

A rst dimension (history and geography) is that Cambodia has seized the opportunityo its history (restoring stability) and geography (openness to a dynamic region) toharness growth.

Another dimension is that Cambodia has ueled its growth by using its assets, such as itsorests, lands, and heritage, but somewhat depleted them. The ocus on using assets hasalso distorted incentives in avor o less sustainable sources o growth.

A third dimension is that, in a challenging governance environment, sector-specicarrangements o governance have emerged to enable specic sectors to fourish (e.g.garments). Good governance in some sectors has translated into growth.

Chapte 3 reviews Cambodias experience in translating growth into

jobs and poverty reduction. It highlights:

Growth has had a proound impact toward a major structural transition (signicantpoverty reduction; improvement in most social indicators; nascent urbanization).

A major channel has been the creation o jobs, especially outside agriculture, andchanging demographics (with a signicant decrease in the dependency ratio the ratioo non-working age to working age population).

This rst part tells a story o remarkable achievements in a challenging environment. How-ever, it questions the sustainability o these achievements, especially at a time o considerableuncertainties in the global economy.

Pat 1Lessons fom a Decadeof Rapid Growth


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Part 1: Lessons from a Decade of Rapid Growth6


Chapter 1Features of Cambodias Growth

Pefomance

1.1. Cambodia has established a remarkable track record o growth over the past decade .Growth has averaged 9.8 percent per annum over the past decade, and was above 10 percentin the our consecutive years rom 2004 to 2007. This chapter reviews the eatures o thisperormance. Section A reviews the our key sectoral drivers o growth over this decade.Section B ocuses on the macroeconomic perormance, reviewing national accounts, balanceo payments, and scal and monetary developments. Section C sums up lessons learned romthis review.

A. Four Key Drivers of Growth and Poor Diversication

1.2. Most o the growth over the past decade has been driven by our sectors: garments, tourism,

construction and agriculture. The industry and services sectors accounted or 4.5 and 4.8points o growth per annum respectively (against 2.0 or agriculture, although the contributiono agriculture was above 2 percent over 2003-07)3. As a result, the economy has undergone aproound transormation, with agriculture by 2007 ranking behind both industry and servicesin terms o value-added (although still rst in terms o employment, Figure: 1.1). The pace othis transormation appears consistent with that o countries that experienced Sustained RapidGrowth (SRG) over the past hal-century (Box: 2.1).

Figure 1.1: Cambodias economy has started its transformation

Source: NIS, national accounts.

1.3. Agriculture remains a crucial part o Cambodias economy. Although it accounts or29 percent o the GDP in 2007, 59 percent o the population relies on this sector or theirlivelihood. Agriculture has been growing at 4.4 percent over the past decade, against 4.0 percentin Vietnam and 3.9 percent in Lao PDR. Growth in the sector is driven by crops (mainly rice)and, to a lesser extent, livestock and sheries:

Crops, accounting or 14 percent o 2007 GDP and 1.1 point o GDP growth over 1998-2007, are dominated by rice. Eighty percent o armers grow rice, 60 percent o them

a/Share of GDP (%) b/ Share of Employment (%)

3 The contribution of services includes the growth of tax on products net of subsidies.

Agriculture,29

Industry,30

Services,41

-

10

20

30

40

50

60

70

80

1993

1995

1997

1999

2001

2003

2005

2007

Agriculture,

56

Industry,15

Services,29

-

10

20

30

40

50

60

70

80

1993

1995

1997

1999

2001

2003

2005

2007


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Part 1: Lessons from a Decade of Rapid Growth 7


or subsistence. Rice covered 2.6 millionha in 2007 (two thirds o arable landand 90 percent o cultivated land) andproduction grew rom 3.4 to 6.7 milliontons between 1997 and 2007. Although

data are patchy, this would mean thatCambodia has been an exporter o ricesince 2004, with around 2 million tonsnow exported (around US$300 million)each year. Yields remain low, however, (at2.6 tons/ha, against 3.5-4.0 on average inthe region). Cassava is a promising crop,

with yields recently reaching 23 tons/ha(a level similar to Thailand and Vietnam) but only 3 percent o cultivated land isused or it. Other crops include cashew

nuts, maize, and jathropha. Cambodiahas historically produced rubber as

well: growth (and exports o aroundUS$175 million in 2006) o rubber haveaccelerated in recent years and recentsignicant investment in rubber willgenerate urther growth in the uture.Tobacco production has been drivenby the presence o a large internationalinvestor. Fruits and vegetables are grownonly on a small scale, despite a signicantpotential: as a result, Cambodia cannotmeet its demand (ueled by hotels) andimports vegetables.

Silk, now accounting or US$10 milliono exports, also has potential to develop.The domestic market is expanding withtourism, while exports could also growast.

Livestock (mainly pigs and poultry, tosell meat and eggs), accounting or 5

percent o 2007 GDP and 0.3 point o GDP growth over 1998-2007, remains a crucialpart o most arming activities and an important savings device. On the positive side, thestock o livestock has increased at an average o 2 percent per annum over the past decade.On the negative side, many issues o standards and trade prevent the sector rom realizingits potential (Box 2.2).

Fisheries, accounting or 7 percent o 2007 GDP and 0.2 point o GDP growth over 1998-2007, are an important, though declining source o growth. Inland sheries (in particulararound the Tonle Sap, an exceptionally rich reshwater environment) dominate the sector(with sh complementing rice in the Cambodian traditional diet), while marine sheries arelargely or export. Reorms since 2000 have attempted to promote better management o

the sh stock and the development o community sheries, but the declining size o the shstock remains a concern. Cambodia exports around US$100 million o sh each year, butexports are constrained by the absence o Sanitary and Phyto-Sanitary (SPS) standards.

Figure 1.2: Growth was driven by job creation and pro-

ductivity gains

a/ Contributions of Employment and

Labor Productivity to Growth (98-07)

b/Labor Productivity

(million 2000 riels)

c/ Cereal Yields (kg per ha)

-

2

4

6

8

Agriculture Industry Services Total

1998 2007

500

1,000

1,500

2,000

2,500

3,000

3,500

1960 1970 1980 1990 2000

Cambodia South-Eastern Asia

Sources: WDI, NIS, National Accounts.


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4 Employment data are weak because of the large informal sector. The data used here are based on census and household surveys. Based on the national accounts, some 80,000 jobs wouldhave been created on average per annum in agriculture.

Forestry, accounting or 2 percent o 2007 GDP and -0.1 point o GDP growth over1998-2007, played an important role in the 1990s, with signicant illegal logging. Sincestrong regulations were put in place around 2000, massive logging has been curbed andactivity in the sector relates more to community-level logging as orestry continues ormany communities to play a supporting role or rural livelihoods. Cambodias orests are

estimated to cover about 11 million ha (or 60 percent o the country), although there isconsiderable debate about this statistic.

1.4. Growth in agriculture has been driven by land and productivity gains even though yieldsremain low(Figure 1.2). Employment in the sector has been stable between 1998 and 2007. 4It has achieved productivity gains o around 2 percent per annum, with yields also starting toincrease since the mid-1990s. Regression analysis shows that the yields gains between 2004 and2007 can be largely explained by changes in the input mix and additional irrigation.

1.5. Industry is the astest growing sector. Its relative size nearly doubled, rom 17 to 30 percentbetween 1998 and 2007. Growing at an average o 16 percent per annum, it contributed 3.4

points o growth per annum over the decade. Growth in the sector is driven by manuacturing(mainly garments and ootwear) and construction:

Garments (and ootwear), accounting or 16 percent o 2007 GDP and 2.4 points o GDPgrowth over 1998-2007, is the countrys leading export sector and has been growing at anaverage o 28 percent per annum: exports went rom almost zero in 1994 to US$2.8 billionin 2007 (70 percent to the US market where Cambodia was the 8th largest supplier in2007 and 22 percent to the European Union. Cambodias exports are mainly low-endgarments and some ootwear, with no diversication to textiles or more complex garments.The majority o rms ocuses on CMT, i.e. the simplest part o the value chain. Thestory o the garment sectors initial development, survival at the end o the Multi-Fiber

Arrangement (MFA) in 2005, and recent challenges is reviewed in Box 2.2.Food manuacturing, accounting or only 2 percent o 2007 GDP and 0.1 point o GDPgrowth over 1998-2007, is an area o unmet potential.

Other manuacturingis also underdeveloped, with only a ew recent examples o assemblyactories (bicycles, cars, motorcycles).

Construction, accounting or 7 percent o 2007 GDP and 0.7 point o GDP growth over1998-2007, has been booming since 2002. But it signicantly decelerated in 2007 andinto 2008, with signs o overheating (rising prices o labor and construction materials)and concerns about a bubble in the real estate sector.

Electricity,gas and water, accounting or 1 percent o GDP and 0.1 point o GDP growth

over 1998-2007, has developed very rapidly, but without catching up with demand(Chapter 6).

Mining, accounting or 0.4 percent o 2007 GDP, has been growing ast in recent yearsbut rom a very low base. It remains mainly artisanal: its growth potential is explored inChapter 5.

1.6. Industrial growth has mainly translated into employment growth, with little productivitygrowth. Almost 100,000 new jobs were created each year between 1998 and 2007. Over thesame period, labor productivity was stable (with a decline rst and then a rebound). In garments,this translates into a level o labor productivity close to that o Vietnam and Lao PDR, butbelow China (Figure 1.3)


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5 The classication in the national accounts has no single sector for tourism. The contribution of tourism is mainly reected in hotel and restaurants, and to a lesser degree in transportservices.

1.7. Services have maintained a steady shareo Cambodias economy, at around40 percent o GDP. This sector spans a

wide range o activities rom nance andtelecoms, to trade and tourism, real estate

and inormal services:

Trade, accounting or 8 percent o2007 GDP and 0.5 point o GDPgrowth over 1998-2007, was drivenby both domestic and internationaltrade. International trade has been

well served by Cambodias variousinternational commitments to

ASEAN and the World Trade Organization (WTO). Domestic trade has beneted romthe decade o rapid growth in incomes or most Cambodians. Large parts o the sector

remain inormal, however, in part a response to disincentives to ormalizing. (such as redtape and corruption at border posts)

Real estate, accounting or 8 percent o 2007 GDP and 0.8 point o GDP growth over1998-2007, has been developing with the construction sector (see above 1.5).

Transport and communication, accounting or 6 percent o GDP and 0.6 point o GDPgrowth over 1998-2007, has been driven mainly by tourism and trade. Telecommunications which accounts or around 10 percent o this sub-sector has been growing very rapidly

with the development o cell phones and internet providers (see Section 4.A). AlthoughCambodia may not seem to be well-positioned to enter the international IT market,there are organizations such as Digital Data Divide (DDD), located in Phnom Penh and

Battambang, which is providing data processing and digitization services to clients suchas Harvard Crimson newspaper o Harvard University, Bain Capital, and MobiTel.

Hotels and restaurants,5 accounting or 4 percent o 2007 GDP and 0.5 point o GDPgrowth over 1998-2007, is largely driven by tourism. Cambodia was one o the astestgrowing tourist destinations in South-East Asia in the 1960s. Although it did not recoveruntil the mid 1990s, tourist arrivals have now risen to more than 2 million in 2007,

with two-thirds o visitors coming rom East Asia (South Korea in particular). The rapidgrowth o tourism is owed to Cambodias exceptional cultural heritage and its naturalendowment (and its location in a dynamic region), recent stability, and key policies (suchas the Open Sky Policy introduced in late 1997).

The nancial sector, accounting or 1 percent o 2007 GDP and 0.1 point o GDP growthover 1998-2007, has developed rom a very low base and expanded very rapidly (seeabove and Chapter 6). It remains dominated by the banking sector, with a very smallinsurance sector starting up and a ew investment unds created in 2007-08.

Public administration, accounting or 1 percent o 2007 GDP, is small, poorly paid, andnot very eective (Chapter 8).

Other services, accounting or 9 percent o 2007 GDP and 1.2 point o GDP growthover 1998-2007, include a variety o ormal (e.g. education and health) and inormal (e.g.household services) services that have been growing rapidly with the development othe economy.

China

Thailand

Philippines

IndonesiaCambodia Average

Bangladesh

Vietnam

Sri Lanka

Lao

-

1,000

2,000

3,000

4,000

5,000

6,000

- 500 1,000 1,500 2,000 2,500 3,000 3,500

Mean wage per worker ($)

)$(ytivitcudorprobalnaeM

Figure 1.3: In the garment industry, wages and produc-

tivity are not in the low range any more

Note: based on investment climate surveys; labor productivity and

wages are measured in 2004 US$. Source: World Bank(2008d).


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1.8. Growth in services has also led to employment creation, with services absorbing around100,000 jobs per annum over 1998-2007. As a result, labor productivity increased by around6 percent per annum over that period.

1.9. Consistent with this pattern, Cambodias exports are very poorly diversied (Figure

1.4). Cambodias ve main products account or more than 60 percent o its total exports, aconcentration signicantly higher than other countries.

Figure 1.4: Cambodias exports are poorly diversied

Source: World Bank, based on UN Contrade database.

B. Macroeconomic Stability, Rising Exports, Weak Investment

1.10. Cambodia has established a strong track record o growth and stable macroeconomicconditions (Figure 1.5). Growth accelerated in 1999 as the domestic political situation becameclearer and the external economic situation improved ollowing the 1997 Asian crisis. Growthaveraged 9.8 per annum, with infation largely remaining below 5 percent throughout theperiod.

Figure 1.5: Growth has been rapid and ination low

Note: The NIS has not yet updated population gures. Hence GDP per capita based on projections.

Source: NBC and NIS.

a/ Overt ime inCambodia(%) b/ Shareof5mainproduct sinexport sacrosscount ri esin2000-04(%)

a/ Growth (%, left) and GDP pe capita (US$, ight) b/ Inflation (%, left) and US$ ate (iels, ight)

0

10

20

30

4050

60

70

80

90

100

1990 1992 1994 1996 1998 2000 2002 2004

Shareof5largestexports Shareoftextile

0

10

20

30

40

50

60

70

China

Thailand

India

SriLanka

Malaysia

Pakistan

Vietnam

LaoPDR

Bangladesh

Cambodia

-2

0

2

4

6

8

10

12

14

1997 1999 2001 2003 2005 20072,600

2,800

3,000

3,200

3,400

3,600

3,800

4,000

4,200

0

2

4

6

8

10

12

14

1997 1999 2001 2003 2005 2007

-

100

200

300

400

500

600

700

10.2

285

593

10.8


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1.11. This perormance has largely beneted rom a very avorable external environment(Figure1.6.). The external environment generated a strong demand or exports and large capital fows(ocial and private) to nance the large current account decit. Until 2007, there were ewmajor terms-o-trade shocks6 : fuctuations in global prices o petroleum products had beensmoothed by a decision to use xed administered prices or the taxation o these imports, and

the end o the Multi-Fiber Arrangement (MFA) and its quota system, although much eared(see World Bank, 2004), did not generate any signicant shock to the garment sector.

Figure 1.6: External developments were favorable until mid-2008

Source: NBC and NIS.

1.12. However, perormance deteriorated signicantly in 2008. Although the limited development

o the nancial sector is shielding Cambodia rom the direct impact o the nancial turmoilin the global economy, this highly uncertain environment will exacerbate our pre-existingvulnerabilities:

First, the our drivers o growth (Section A) are subject to the uncertain environment.Garments and tourism will directly suer rom the global slowdown, especially in the USor garments and in South Korea or tourism. Construction was also weakening and willurther slow down as oreign investment in real estate slows down. On the other hand,agriculture could respond positively to higher prices o rice, although the supply responseremains uncertain, a question urther reviewed in Part 2.

Second, the large current account decitwas more than nanced by infows o private

and ocial capital. International reserves increased sharply in 2006-07, to more than

a/ Current AccountandFinancing(%GDP) b / ForeignDir ectInvest ment(US$mand%GDP)

6 Annual variations of terms of trade (measured by the implicit deators of imports and exports in the national accounts) were less than 3 percent since 1999.

0

100

200

300

400

500

600

700

800

900

1,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Other(inc.errors)FDIExternalassistanceChangeinreserves

2.8

8.4

4.4

1.6

6.0

10.1


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three months o imports. Although private fows are not short term (mainly FDI) andCambodia has limited debt obligations, the nancing o the current account is a signicantvulnerability.

Third, the rapid development o the nancial sectoris stretching the supervision capacity,and the slowdown in the economy, in real estate in particular, could stress the sector (see

below).Finally, concerns about rising infation have made the policy response complex. Althoughthis risk may already have been addressed in late 2008 as the original drivers (higherprices o ood and oil; depreciation o the dollar; and rapid growth o credit to the privatesector) are all being reversed it requires constant monitoring, especially given its impacton the real eective exchange rate and competitiveness (Chapter 7).

1.13. Although it has limited policy instruments available to it, the RGC has appropriatelymanaged the policy mix and structural reorms. In a largely dollarized economy, the policymix relies mainly on scal policy, which has been relatively conservative in recent years,preventing infationary pressures rom emerging until recently. The budget has generated anincreasing current surplus in recent years, leading to negative domestic nancing mainlythrough a reduction in arrears (Figure 1.7). Monetary policy and banking reorm have alloweda deepening o the nancial sector, although until mid-2007 at a pace consistent withmacroeconomic stability. Current and capital accounts are open and there is no restriction onthe exchange rate. Most sectors o the economy are liberalized (see also Box 1.1).

Box 1.1: The State of the Economy in 1992

A report rom development partners in 1992 concluded that with insucient resourcesto generate productive income, and isolated rom the mainstream o world trade, Cam-

bodia has run its physical capital down and has severely stretched its meager human re-sources. Transport inrastructure was dramatically lacking; only 20 percent o the PhnomPenh population had access to piped water; the delivery o social services, although sup-plemented by NGOs, was poor. The economy was subject to weather uncertainties andunreliable access to raw materials and spare parts. Only resilience in agriculture wasmaintaining some income and ood supply.

The report noted positive reorms, but stressed that these reorms had been undertakenas a partial and ad hoc response to diculties, hence with uneven results. Starting 1989,agricultural land had been returned to the tiller. Some autonomy had been given to state-owned enterprises in 1989, but with weak results.

Growth had responded positively, but with signicant variations (16, 2, 0 and 14 percentrespectively or GDP growth in 1988-1991). The budget, even ater almost stoppingall public investment and maintenance expenditures, and reducing public employment,had a nancing gap equivalent to 40 percent o expenditures. This was due to a declinein revenues, down to 4 percent o GDP in 1992, in part because o the liberalization othe economy. This translated into a major decit, while Cambodia had lost its access toa credit acility rom the Soviet Union and not yet gained access to development aid. Inturns, this had ed into infation (70, 157 and 121 percent in 1989-91).

The ocus o the strategy at that time was twoold: (i) absorb the returning reugees andsettle the internally displaced persons and demobilized troops; and (ii) stabilize the econ-omy, strengthen institutions, and prevent a urther degradation o basic public services.

Source: World Bank and others, 1993.


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1.14. Cambodia is still largely a dollarized, cash-based economy(see Im, Dabadie, and Sokha,2007). The local currency Cambodian Riels (CR) in circulation represents only about 6percent o GDP and is mainly used in the interior o the country and or small transactions.In the banking system, cash (almost all US dollars) represents an unusually large share o assets(about 5 percent). Total currency holdings, including dollars, can be assumed at about 60

percent o bank deposits.7

Over 90 percent o deposits (and loans) are denominated in dollars.The main exception is the public sector: riels must be used to pay taxes and other public sectorbills and the public sector pays in riels. The dollar is also used as a store o value throughoutthe country. This eature implies that (i) the fuctuations o the real exchange rate measured inriels have a diused impact on the economy (see also Chapters 6 and 7) and (ii) monetary andexchange rate policies have limited eectiveness.

Figure 1.7: Macroeconomic policies have been conducive to stability

Sources: MEF, NBC, NIS, Sta

1.15. Other important eatures o growth in Cambodia are the strong growth in consumption,the weak level o investment, and the small size o the public sector. Consumption hasbeen one o the main drivers o growth, contributing 5.7 points o growth per annum (Figure1.8). Exports have increased ast, but the contribution o net exports to growth has been verysmall (0.1 percentage point on average). On the investment side, it is a major achievementthat the investment-to-GDP ratio has increased rom 15 percent in 1997 to 21 percent in2007, contributing 2.4 points o growth per annum on average. However, this level is below

what other countries with rapid growth have typically achieved (Table 2.1) and, in a growthaccounting ramework, the contribution o physical capital accumulation to growth has been

limited. The composition o investment is also problematic: public investment is

cambodia country economic memorandum

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