A Chat With the IMF Representative

KHMER TIMES
MAY KUNMAKARA

Yong Sarah Zhou says reforms have been welcome. KT/Fabien Mouret

Many international financial institutions – including the World Bank (WB), Asian Development Bank (ADB) and International Monetary Fund (IMF) – as well as the government have forecast that Cambodia will continue enjoying strong economic growth in 2017, making the country one of the fastest growing economies in the region.

However global uncertainty – from the strong slowdown of emerging market economies including China and potential implications from Brexit – is bearing a negative impact on Cambodia’s growth potential.

According to the IMF, global growth was projected to slow to 3.1 percent in 2016 before recovering to 3.4 percent in 2017. The forecast, revised down by 0.1 percentage points for 2016 and 2017 relative to April, reflected a more subdued outlook for advanced economies following the UK vote in June in favor of leaving the European Union and weaker-than-expected growth in the United States. Growth in emerging markets and developing economies was expected to strengthen slightly in 2016 to 4.2 percent after five consecutive years of decline.

KT: What are suitable policy responses from the Cambodian government for the country to maintain its growth inclusively and sustainably? Yong Sarah Zhou, the resident representative of the IMF for Cambodia, spoke with Khmer Times’ May Kunmakara about the issues.

In November, the IMF’s report said that although Cambodia still enjoyed robust growth of seven percent this year, the outlook is subject to substantial downside risks, especially external risks, which include a significant slowdown in China, US dollar appreciation and structurally weaker growth in Europe coupled with increased uncertainty from the Brexit referendum. Can you tell me what is an appropriate policy response from the local government?

Ms. Zhou: In the face of large external shocks, Cambodia has limited policy tools to support growth given high dollarization and lack of government debt markets. In view of this limitation, the appropriate policies are to contain financial sector risks before they materialize, and to build buffers preemptively.

In the near term, that means to preserve macroeconomic stability, maintain adequate reserves, and strengthen supervision and regulation of the financial system. Over the medium to long term, structural reforms to boost competitiveness, diversify the economy, and to increase potential growth are key to enhancing resilience to shocks.

KT: Regarding credit growth and growth of the real estate sector, I have observed that the National Bank of Cambodia (NBC) has also taken action and their report also shows that non-performing loans are still low. Why is this a concern?

Ms. Zhou: Credit growth in Cambodia has been very rapid. In fact, it is one of the fastest in the world. Private sector credit growth has averaged nearly 30 percent over the past three years, doubling the credit-to-GDP ratio to 62 percent by end-2015.

In particular, while credit to the manufacturing and agricultural sectors has slowed, real estate and mortgage lending continue to grow rapidly, averaging 50 percent in 2015 and the first half of 2016. At the same time, banks are relying more on foreign borrowing to maintain credit growth, and the microfinance institutions (MFI) have become increasingly important in the financial system. It is true that the NBC’s tighter regulations have resulted in some slowdown in credit growth recently, but still high at over 20 percent.

These developments are creating significant financial vulnerabilities. If the credit growth continues at this rapid pace, macroeconomic shocks (such as a sharper-than-anticipated global liquidity tightening) could potentially lead to a funding squeeze and result in a credit crunch. Also, vulnerability in certain banks or MFIs and in the real estate market may also lead to financial system-wide shock, which could spill over to the macroeconomy.

KT: Cambodia’s economy is almost 90 percent dominated by the US dollar. However, the central bank is now focusing on promoting the circulation of local currency. What do you think about this measure?

Ms. Zhou: We welcome the measures taken by the NBC to increase local currency usage. High dollarization has become entrenched and has persisted as the foreign currency deposits have risen to around 95 percent of total deposits. More efforts are needed to reduce dollarization. Recognizing the need to make progress on this front, the NBC has drafted the national strategy to increase local currency usage, which is currently at the Economic and Financial Policy Committee for consideration.

Our advice on promoting the use of the local currency and reducing dollarization has focused on market-oriented measures, for example, issuing regulation that requires all prices in the market to be denominated in riel, using riel for all accounting and financial reporting as well as official purposes, and offering more convenient and lower-cost services for riel.

KT: In recent years, Cambodia has been trying to diversify its exports to other countries in the region especially after looking at the slowdown in China’s economy and how rising labor costs there have made some factories move away. Will Cambodia benefit from China’s shift in production?

Ms. Zhou: The recent IMF study showed that China has started to move up the value chain while exiting some low-end, labor-intensive sectors. This evolution has created opportunities for low-wage countries, including Cambodia. In fact, Cambodia, together with Vietnam and Bangladesh, has seen its global share of labor-intensive exports increase significantly in the past decade. Labor costs, however, are only part of the story. Cambodia will need to improve its infrastructure, education, and governance, and also run sound macro policies, in order to fully capitalize on the opportunities presented by China’s changing trade patterns.

KT: After the 2013 general election, the Cambodian government has conducted many reforms at their ministries and state agencies. What do you see as the outcome of the reforms?

Ms. Zhou: Important and welcome economic reforms have been undertaken on many fronts since late 2013. For example, Revenue Mobilization Strategy, launched in September 2014, has helped to raise tax revenues significantly. In just one year tax revenue increased from 11.8 to 14.6 percent as a share of GDP. This provides resources to much-needed infrastructure and social services. Also the Industrial Development Policy, adopted in 2015, aims to diversify the economy away from garments.

Although progress still remains slow. The education sector has been undergoing many positive changes, and there are also notable improvements in trade, payments and business registration.

Cambodia’s business climate and competiveness would be improved further, if more efforts are put in place to accelerate and deepen the reforms, especially on infrastructure, education and governance.

KT: The IMF report also mentioned that the current account deficit (CAD) is projected to narrow to 9.7 percent of GDP in 2016. What is the main factor causing the CAD to fall?

Ms. Zhou: The lower current account deficit in 2016 is due to reduced imports following the completion of major hydropower projects. Low global commodity prices, robust remittances and strong garment exports also contributed.

KT: What will happen to Cambodia after Brexit as most of our garment and textiles go to the UK under the Everything But Arms trade scheme?

Ms. Zhou: Cambodia’s export exposure to the UK is the highest in Asean at close to six percent of GDP. In the near term, however, the expected UK exit from the EU would not have a large direct impact on Cambodian exports in our view, since those goods are mostly low-end garment products, which are less sensitive to income changes in trading partners.

KT: What are the challenges remaining for the Cambodian economy and what are appropriate policies responses? What is your outlook for 2017?

Ms. Zhou: Growth is expected to remain robust at around 6.9 percent for 2017, supported by strong garment exports and real estate and construction activity despite weaker agriculture and tourism growth.