Wednesday, 31 August 2011

Review of Cambodia's Economy and Finance (Up to 2011)

 Source: Cambodian Development and Research Institute, 2010 (Figure 1)

Recently, Cambodia has pursuit a high-growth development by making considerable investment in the public and private sector. Over the period of 2004-2007, Cambodia has achieved a double-digit growth rate of more than 10% per year (Ministry of Economy and Finance, 2010). According to Figure 1, this is the high-growth period for Cambodia. This exceptional GDP growth has resulted in accumulation of domestic saving and financial investment. In 2009, domestic investment accounted for 40% of the total investment in Cambodia, especially in construction sector, small and medium businesses, food-processing factories, and service industry (CDRI, 2009). Beside the large amount of foreign direct investment in the garment sector, small and medium enterprises in Cambodia are thriving due to the growth in number of microfinance institutions which provide low-interest loans to the local SMEs. Before the end of 2008, Cambodia’s international reserve already reached 2.2 billion USD due to strong economic growth and increased confidence in the banking and financial sector (NBC, 2008). However, economic growth is narrowly based on garment sector and tourism industry. Every year, Cambodia experiences trade deficit, which result from too much import and a slim export. So, we can see that Cambodia heavily depend on foreign direct investment to develop its economy since domestic industry cannot gain self-financing through issuance of securities (stocks and bonds). 

Despite these progress, there are a lot of things that Cambodia need to improve to enhance to the macroeconomic performance and investor’s confidence on its economy, and probably its financial market in the near future. A good regulatory environment is useful if it is consistently applied and effectively enforced. The problem for Cambodia is a chronic lack of skilled resources in the financial and banking sector. Some progress is being made but there is still a long way to go. Transparency has improved considerably so far in the government and private sectors.

The government has used market-friendly approach to drive economic growth through providing tax break and many incentives to foreign firms to invest in Cambodia, especially in several special economic zones in Phnom Penh, along the border, and in the coastal cities of Sihanoukville, and Koh Kong. Although Cambodia has sustainable macroeconomic situation with average inflation rate, market inefficiency is a major problem in which prompted government to use interventionist policy. During financial reform in the 1990, the National Bank of Cambodia (NBC) has liquidated small and failed banks to raise the confidence level on banking and financial sectors. However, this policy is important for controlling the inefficient financial market since easy regulation could lead to the financial crisis.   

To make a long-term strategy for banking and financial sector development in Cambodia, The Financial Sector Development Blueprint for 2001-2010 was approved by the Government as the guiding strategic document for directing reforms in banking and financial sectors from 2001 onward. With the Financial Sector Development Blueprint for 2001-2010, the banking and financial sectors in Cambodia have experienced remarkable progress. The structural reform of the banking sector (completed in 2002) has expanded the scope of the banking system in terms of the number of banks, the level of financial sector depth and the increasing level of credits and deposits. At the same time, Cambodia also encourages competition in the banking sector through prudent liberalization and the opening of an appropriate competition environment between local and foreign banks.

In connection to high economic growth, changes in the implementation environment, and other common challenges, the Financial Sector Development Blueprint for 2001-2010 has been updated to the Financial Sector Development Strategy 2006-2015 in order to respond to actual circumstances and the urgent needs of the country, resulting in the establishment of Cambodia Stock Exchange (CSX) on 11 July 2011. So far, the operation of the stock tradings in the CSX has not started yet. Hence, this document plays not only a guiding role but also provides a framework for facilitating cooperation between concerned local and international institutions who wish to support the transformation of financial sector infrastructure in Cambodia to be a strong, efficient and balanced system.

The results of the reform were achieved through the creation of fundamental principles for banking supervision and its prudential supervisory system, the adoption of a new uniform chart of accounts for commercial banks, the strengthening of the management of the microfinance sector supervision, the establishment of a regulatory framework for the money market and payment system, and the adoption of a credit information sharing system and rapid progress in IT industry in Cambodia. Recently, Cambodia has completed installation and put into operation its parts of fiber-optic link (Greater Mekong Information Superhighway) that connect Cambodia to neighboring countries and China with a high speed telecommunication network (Phnom Penh Post, 6 July 2010). It is expected that increased telecommunication speed will bring economic boom to Cambodia since exchange of information become more reliable and faster for customers, business, industries, and banks, and the government. On financial integration in the ASEAN Plus Three (China, Japan, South Korea) framework, Cambodia has put 120 million USD and other countries also put different amounts of fund to jointly create the Chiang Mia Initiative Multilateralization (CMIM) with a total reserve pooling of 120 billion USD to address short-term liquidity need in time of financial crisis (ASEAN Secretariat, 2010). The CMIM already come into effect since the beginning of this year. So, the effort by Cambodian government has strengthened the banking and financial sector in Cambodia, which smooth the way for the preparation of the establishment of stock market by 2011. These achievements have contributed to boosting the public confidence and foreign investors’ confidence in the Cambodian banking and financial sectors.

The recent monetary policy of the National Bank of Cambodia (NBC) is aimed at maintaining price stability through conducting a managed floating exchange rate regime, accumulating more international reserves and strengthening the confidence of the public. Therefore, the National Bank of Cambodia has made a bold decision to tighten the monetary supply by increasing the reserve requirement rate for foreign currency deposits from 8 percent to 16 percent from June 27, 2008 to contain the high inflation rate (NBC, 2008). Due to political stability and good macroeconomic stability in Cambodia during the global financial crisis, the growth of foreign currency deposits year-on-year rose to 28 percent by October 2009 (CDRI, 2010).

However, a disadvantage of capital account openness is vulnerability to deterioration in the competitiveness and exposure to the external shock. Net FDI in Cambodia experienced a precipitous drop upon the deepening of the global crisis in the middle of 2008. The credit crunch, gloomy market conditions and heightened risk perceptions has affected the capacity and propensity to invest. The garment industry’s market concentration in the US, the center of the crisis, and erosion of competitiveness in the post-quota environment also negatively affect new investments in Cambodia. So, Cambodia has to diversify its economy through promotion of non-textile industries, SMEs, and industrialization. In doing this, it must develop its own financial market to channel huge domestic savings to the private sector, which engine of economic growth. Furthermore, there has been no local credit rating agency, which is also an important stakeholder of the security market. So these rating agencies should be established with the help investors and NBC to monitor and evaluate each financial institution’s performance in Cambodia.  

Figure 2:  Source: National Bank of Cambodia (2008)
As a small, open economy, Cambodia is particularly sensitive to price developments in the world economy, and due to its dependence on externally-supplied energy sources, the hike in the global oil price in 2007 and 2008 is having an impact on our inflation performance (See Figure 2). During this period, inflation has reached almost 25%, which is too high. Recently, the National Institute of Statistics (NIS) also released the current CPI of 7.1% as of July 2011 (NIS, 2011), which means that price volatility is still lingering, but within the control limit. However, the Government tries to achieve energy security by building more hydro-power plants along some rivers and other mountainous areas. Another power plant using coals is being constructed in Sihanoukville province in order to meet the increasing demand for energy for economic development. However, high inflation could distort investors’ decision on financial investment since they would get less return on their invested stock or bonds in Cambodia. Although NBC has inflation targeting policy to raise investors ‘confidence and stabilize macroeconomic situation, it would be difficult for getting good future perspective of the Cambodia Stock Exchange due to high inflation.

There are still some of the initiatives which are being implemented in Cambodia since she has struggled to maintain monetary stability and support sustainable economic growth. Cambodia is a small and open economy, with capital account liberalization. Cambodian economy is highly dependent on a sustained international trade expansion and foreign capital inflow. More than 90% of the banking transactions are dollarized. This means that Cambodia cannot use interest rate policy and exchange rate to influence the economy. With free capital flow, foreign exchange intervention has been used by NBC to stabilize the exchange rate and to increase international reserve position. Reserve requirement for commercial bankings was increased from 8% to 16%, while commercial bank's exposure to high risk sector was capped. In order to cope with the aftermath of the global financial crisis, NBC has decided to reduce the reserve requirement to 12%, lift lending restriction and increase spending to boost domestic demand. In addition, the central bank has made further efforts to improve supervision and regulation by tightening rules and regulations and enhancing onsite supervision. Particular attention has been made to the banks solvency and liquidity conditions. Further regulatory and supervisory measures will be implemented to strengthen risk management and corporate governance in the banking sector to overcome adverse economic conditions and market trends. However, according to government's forecast and Asian Development Bank, Cambodia can still maintain a healthy annual GDP growth around 6-9% in the next few years.


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