KINGDOM OF CAMBODIA

Cambodia is also committed to promoting other economic cooperation like the ASEAN Investment Area (AIA), Liberalization of Trade in Services, and ASEAN Industrial Economic Cooperation (AICO), in the region. With AFTA, Cambodia will be able to increase our competitiveness against other regional groupings, to increase trade and investments amongst ASEAN members and to the third counties to achieve higher growth of the economy. Moreover, Cambodia enjoys bilateral trade benefits, the Generalized System of Preferences (GSP) granted by the United States in 1997 and the EU Preferential Rules of Origin for ASEAN members provided by the European Commission in 1999.

Cambodia applied for WTO membership in October 1994, and submitted a Memorandum on its Foreign Trade Regime to the WTO Working Party in June 1999. In September 2003, Cambodia joint the WTO at the Ministerial Conference in Cancun.

Cambodia has overhauled the legal framework, procedures and institutional structures in line with the international standards, including the implementation of the harmonized customs nomenclature adopted by the Cabinet in August 1999 and ratified by the Senate on November 30 2002. By January 20 2003, the Royal Kram on “ Harmonized Customs Nomenclature ” has been promulgated. A comprehensive customs code which sets new import and export procedures is being revised to conform to the WTO standards. Further modernization and liberalization of the trade regime is expected as part of the WTO accession process. To bring customs operations in line with international standards, Cambodia is committed to (i) reviewing, streamlining and simplifying procedures related to cargo reporting and control, transit movement, dispatch processing, physical inspection and revenue collection; and (ii) improving trade statistics, computerization of customs operations and communications by establishing a telecommunication links between the computers at the Customs and Excise Department and the main customs posts to enable timely data exchange.

Trade liberalization, particularly within ASEAN, could have significant benefits, as Cambodia’s preferential access can be used to generate export growth and investment from other countries. Over the medium term, the tariff reforms and rationalization being undertaken will allow for a more rational allocation of resources by avoiding costly domestic protection. In this context, the government is formulating a trade strategy linked to the poverty reduction objectives. This strategy is expected to focus on a number of sectoral action plans for key export products and services, and identify needs and gaps in existing institutional capacity.

A combination of factors, such as increased garment exports, higher prices of petroleum products and expanded tourist activities has affected the external trade sector in 2002. Booming exports underpinned a stronger external position. Merchandise exports grew by 11.3 percent to US$1.75 billion in 2002. Of these figures, garment exports were estimated at US$1,355 million. Imports also grew by 10.5 percent to US$2.3 billion, reflecting increased inputs to support the growth of manufacturing exports and the impact of increased world oil prices. As a result, Cambodia has experienced a deficit in merchandise trade balance, albeit with increased export growth the trade balance deficit increased from –11.8 percent of GDP in 1998 to –14 percent in 2002. However, the current account deficit (excluding official transfers) declined from –12.3 percent of GDP in 1998 to –11 percent of GDP in 2002.

Cambodia’s major export items are textile and apparel, footwear, wood and wood articles, plastics, gems, live animal and rubber. Garments and footwear are the dominant exports, accounting for 82 percent of total exports in 2002.

The country’s major import items include textile and fabric for garment factories (35 percent of total imports), oil products (15 percent), machinery and electrical appliances (11 percent), foodstuffs (8 percent), pharmaceutical products (6 percent), motor vehicles (5 percent), pulp and paper (3 percent) and plastics (2 percent).

Cambodia’s merchandise trade is not diversified as a significant portion of imports is concentrated in a few markets. Cambodia’s major export partners are the United States, the European Union, Hong Kong, Singapore, Thailand and Vietnam. The United States are Cambodia’s main export market for garment products. Only about 6 percent of Cambodia’s export went to ASEAN.

However, the country’s imports come mainly from Asia, such as Hong Kong (18 percent of all imports), Thailand (15 percent), Taiwan (12 percent), China (8 percent), Singapore (7 percent), Vietnam (6 percent), EU (6 percent) and the United States (2 percent). ASEAN countries are Cambodia’s major import partners, representing 39 percent of all imports.

Re-exports presently account for a sizeable portion of Cambodia’s merchandise trade and they are an important source of revenue. However, the importance of re-exports has gradually declined since 1996, when re-exports totalled US$350 million, accounting for 33 percent of total imports or half the value of retained imports and equal the size of domestic exports. Most of Cambodia’s re-exports are destined toward Vietnam. In 2002, re-exports declined by a further 5 percent from 2001 to US$171 million. Cambodia’s re-exports mainly consist of cigarettes, gold, pulp and paper, alcohol, soft drinks and motor cycles, electrical appliances and motor vehicles.

Cambodia has pursued a flexible market-based exchange rate policy. Given low inflation, the exchange rate remained stable with a further build up of international reserves to retain import coverage of about 3 months of imports. The government’s policy is to unify the official exchange rate with the market rate by keeping the spread below one percent.

Fighting to attract FDI will be critical for Cambodia's future growth, especially after the abolition of export quota for garment products. Cambodia will have to compete with her neighboring countries, especially Vietnam and Laos to attract investors. To do so we look at governance indicators and the determinants of growth in Cambodia vis-à-vis Vietnam and Laos.

To retain the market share, concrete actions should be taken to substantially reduce costs. However, the high costs of transportation, utilities and handling of containers at the ports identified in the NPRS have not been addressed. Cambodia also has high minimum wage and more number of public holidays compared to other developing countries. This is being reviewed in consultation with stakeholders. The government will also pay more attention to vocational training in order to increase the level of skills and productivity of Cambodian workers.

Cambodia’s accession to the WTO in September 2003 can be seen as an important step forward in attracting FDI. Cambodia will use this membership to implement a comprehensive policy reform agenda aimed at the achievement of sustainable development. In order to effectively integrate the country into the regional and world economy and market, Cambodia must deepen reforms in all sectors, especially in institutional capacity building and human resource development, a process which takes time and requires strong commitment and political will at all levels.

The RGC recognizes that strong efforts are needed for Cambodia to improve basic economic infrastructure, the delivery of government services, and the overall governance environment. The impediments of high transaction costs, poor infrastructure, and hidden costs need to be addressed.

In 2002, Cambodia had an overall balance of payments surplus of US$174 million against US$ 76 million in 2001. As a result, gross foreign reserves have increased and would be sufficient to finance about 3.2 months of total imports of goods and services. The data on external transactions for 2002 show that deficit on current account (excluding official transfers) increased by 15% to US$409 million, and represented 10.2% of GDP. The main contributing factors were increase in deficit on both trade balance (8 percent) and investment income account (24percent). In 2002, the value of domestic exports amounted to US$2,350 million, an increase of 11.3% over last year. Retained imports increased by 10.5% in 2002. During the same period, estimates by the Ministry of Tourism and the Ministry Interior suggested a sustained development in the tourism sector as passenger arrivals in Cambodia continued to rise by about 25%. This reflected the confidence of foreign tourists in the political stability and safety within Cambodia In 2002, receipts of official transfers were estimated to be US $ 311 million, a slight increase of 0.3 percent relative to 2001. Foreign investment flows were estimated at US $ 131 million, 15% up from 2002 due to global economic recovery. Capitalization of the banking sector rose by US $ 27 million, showing the bank’s efforts to comply with the provisions of the law concerning the new minimum capital requirements.

Economic performance during the first half of 2003 has been affected by the political developments in the lead-up to the national elections and the SARS outbreak and unfavorable external environment. Real GDP growth in 2003 is expected to decline to 4¾ - 51/2 percent, reflecting the slowdown in tourism activity and investment as a result of anti-Thai riots, SARS and the uncertain climate associated with the elections. Lower investment has been partially compensated by higher consumption induced by higher public spending. And the weakness in the service receipts is being partly offset by continued strong growth in garment exports, leaving net exports of goods and services broadly unchanged.

On the production side, within agriculture, crop production is expected to rebound in 2003 following negative growth in 2002, and livestock and fisheries to pick up to 2½ percent reflecting the favorable weather conditions. Continued strong performance of garment exports (30 percent higher in first half of the year than the low level of the first half of 2002) will contribute to double-digit growth in manufacturing and sustained construction expenditure. In 2003 about 40,000 employments were created in the manufacturing and the SME sectors, while around 200,000 new workers have entered the labor market.[1] Clearly developing agriculture, promoting labor intensive industries and expanding the service sector is critical to absorbing labor surplus.

Although tourism activity has recovered in the past 5 months, it is expected to be about 12 percent lower for the year, resulting in no growth for services overall. The tourism, trade and transport sectors have borne the brunt of the SARS outbreak, thus having a severe impact on the collection of non-tax revenues. Tourist arrivals during the first half of 2003 declined by 17 percent, compared to the same period of 2002. [2]

The slowdown in economic activities has led to the decline in foreign exchange inflow, exerting pressure on the Riel-dollar exchange rates. The riel depreciated slightly by 2 percent against the dollar, but stabilized quickly to around 4,000 riels. The monetary stability was temporarily disrupted in April by a rapid drawdown of government deposits held at the NBC, as spending in riel exerted pressure on the foreign exchange market, pushing down the value of riel against the dollar. The drawdown of government deposits was necessitated by sluggish revenue collection and the carry-over of payments due from 2002.

With implementation of the reform agenda described in section 4 on governance reform and section 5 on structural reform, real GDP growth could reach 6-6½ percent. Such growth rates would require political and macroeconomic stability to underpin sustained private sector growth and continued donor support equivalent to about 10 percent of GDP. Over the medium term, domestic savings are expected to improve by about 2 percentage points of GDP—reflecting increase in budget surplus and moderation of consumption due to the decline in garment export receipts—that would help support domestic investment at 17 percent of GDP. Inflation is expected to remain below 5 percent, and international reserves to remain broadly equivalent to about 2 ¾ months (23 percent) of imports of goods and services.

Sluggish growth during the first half of 2003, coupled with some political ambiguity due to the disturbances in late January, as well as low economic activities in the election year has constrained revenue collection. Unavoidably, the preparations for the elections have driven up spending even as the Royal Government has established mechanisms for expenditure control.

These projected growth rates assume early implementation of key structural reforms. Improvements in competitiveness will contain the extent of relocation of garment producers after 2005 and attract foreign investment into low-skilled labor intensive manufacturing and tourism-related services. The RGC has taken serious strides to attract garment factories from Thailand into an Industrial Estate to be established in Koh Kong Province near the border areas. The contribution to growth from agriculture is expected to improve, boosted by recent infrastructure investment and policies directly aimed at reducing poverty in the rural area. Longer term productivity growth is expected to come from education particularly agricultural research technology, agro-industrial development, extension, and agriculture education and a redirection of investment to rural infrastructure.

Cambodia is facing serious challenges in the coming years, due to the narrow-based economic growth. During the last decade, rapid growth came mostly from robust garment exports and the tourism sector. However, there appears to be a declining trend in garment exports, due to the US granting preferential trade arrangements to other countries, including Vietnam. Moreover, the phasing out for the quotas under the WTO Agreement on Clothing and Textiles (ACT) in 2005 will mean massive changes in the Cambodian garment industry.

The current trends in the Cambodian garment industry show a slowdown in market growth, which could cause damage to the industry if measures are not taken to address this backward trend. Moreover, attention should be paid to labor costs in Cambodia in the next three years. Electricity prices, transportation and port handling costs in Cambodia, are high when compared to other countries in Asia.

It is crucial that Cambodia maintains its competitive advantage as a low-cost production centre by tackling high costs of transportation, utilities and handling of containers at the ports. Mechanisms to mitigate any wage increases should also be focused upon. Within the industry itself, expansion of both product range and markets is essential if the industry is to continue and grow. Attention should be given to the further expansion of garment products outside of the quota system.

The Cambodian economy is increasingly dependent on the development of tourism sector. Thus, it has become more vulnerable to external shocks, such as geopolitical developments, the outbreak of epidemic diseases. During the first half of 2003, SARS outbreak in the region has severely affected our tourism-related industries such as the airlines, travel agencies, hotels, restaurants, transportation and trade. Tourist arrivals in March and April 2003 declined by 22% and 37% respectively compared to last year. Hotel occupancy has reduced sharply. The number of tourists visiting Siem Reap reduced by 46%. Trade and transportation sectors have been negatively affected.

The slowdown in economic activities has led to the decline in foreign exchange inflow, exerting increasing pressure on the Riel-dollar exchange rate.

The demographic profile of Cambodia is characterised by high fertility and a high population growth rate. This means large families and a rapidly growing population – both closely related to poverty. Households need enough resources to feed, clothe, educate and take care of large numbers of children. Poor children who do not have the opportunities for education, good health care and adequate nutrition cannot contribute effectively to the economic growth of the society, and simply replenish the poverty burden. Households who cannot provide for all their children themselves tend to become impoverished, trying to spread the little they have among too many hungry mouths and minds. Similarly, at a macro level, the country cannot afford to invest in education, health and labor infrastructure quickly enough to provide full opportunities to its rapidly growing population.

While high fertility rates are resulting in an estimated population growth of 2.5 percent, the urban population is projected to grow at an even faster pace of around 3.4 percent, due to rural-to-urban immigration.

Because the population is so young, there are many new entrants preparing to enter the workforce. The Royal Government estimates the workforce to grow at an annual rate of 3.2 percent per year with 228,000 new entrants each year through 2005.

With so many people to employ in the coming years, the country will rely on the private sector to generate growth and employment. Total employment has grown by an average of 2.2 percent from 1997 to 2001 with most of the new jobs coming from agriculture, manufacturing and tourism.

The RGC recognises the central, critical and crosscutting role of population as is reflected in three primary programs with priority focus on:

Attracting FDI is crucial to ensuring successful implementation of economic policies. In this regard, addressing the constraints facing the private sector development is the most critical issue for the government.

Over the next decade, China's growth and increasing integration into the world economy would have major effects on the region. Countries in the region will feel the impact of China's WTO accession through: (i) expansion of markets in China for their exports; (ii) increased imports from China into their domestic markets; (iii) competition with China in third markets; and (iv) expansion of foreign direct investment in China and, potentially, outward 'foreign investment' from China.

China's accession to the WTO will be accompanied by cuts in its export prices, increasing China's appeal as an efficient supplier. Countries that import intermediate products from China for use in their own production processes will be able to raise these imports, with consequent gains in terms of production volumes and welfare.

Competition with China in third markets will intensify because of China's accession. This will present a challenge for many countries, especially those with a similar comparative advantage in labor-intensive goods.

Looking ahead, competition is set to intensify for two reasons: (i) North America and the European Union will abolish their import quotas on Chinese textiles and apparel by 2005. China will become a formidable competitor especially in the apparel sector, pushing prices down in these important third markets; (ii) China will lower its own import tariffs on inputs for manufacturing; the effect of these tariff reductions on the real exchange rate will lower the costs of both traded and non-traded inputs for China's manufacturers. This will make China's products more competitive as imports, putting pressure on domestic producers in the countries that import them.

WTO accession is likely to increase foreign direct investment into China. Trade liberalization will lower production costs and raise the returns to capital in China. Better market access for Chinese goods will raise output prices. Moreover, improved resource allocation will raise efficiency. Meanwhile, the liberalization of rules on investment should ease flows of FDI into previously restricted sectors such as services. The new FDI flows are likely to raise China's productivity. In apparel and footwear (textiles), for example, the adoption of foreign technology raises productivity by 30-62% in collective enterprises and 20-59% in state enterprises.

China will be subject to additional textile safeguard quotas until 2007, but these will be applicable for only one year at a time, unlike the existing quotas, which were put in place for an indefinite period. Impact on Cambodia

The impacts of China's WTO accession will have an impact on Cambodia, as the country is particularly vulnerable because of its concentration in apparel exports.

For Cambodia, China's WTO accession poses a potential threat to both the balance of payments, from lost exports, and too many households, from lost jobs and lower wage incomes. Cambodia's exports are already highly correlated with China's, and many of Cambodia's leading exports are precisely in the apparel and textile categories where China is currently quota-constrained.

The US makes up more than half of Cambodia's export market. Cambodia's exports to the US have been very concentrated, with 94% of them in textiles and apparel. Five products-all apparel-accounted for nearly half of total exports in 1995-99. It is true that a high proportion (68%) of Cambodian exports to the US has unit values that are not close to those of their Chinese competitor products, and hence the share of exports that are at risk at the 10% share threshold appears low.

Once the quota restrictions on China are lifted, its exports to the EU and North America are likely to capture more than 10% of these markets. If Cambodia's exports in these categories are viewed as being in a category with a high Chinese import share, the picture changes dramatically: roughly 30% of Cambodia's exports show themselves to be at risk.

Cambodian manufacturers continue to hope they can compete in a number of niche markets. However, they face some significant administrative hurdles and government interventions that tend to negate Cambodia's comparative advantage against its regional competitors, particularly in the context of low labor input costs.

Cambodia's benefits from China's import tariff reductions will be quite limited, 42 but some of Cambodia's top exports--especially rubber and wood-will benefit from the reduction of quantitative restrictions. The "Early Harvest" under the ASEAN-China agreement also gives Cambodia in MFN treatment, as noted above. Growth in China overall is expected to be a powerful source of external demand for Cambodia, including for cross-border activity that may not be well captured in official statistics.

37.4. Policy Responses to the Development Challenges

The macroeconomic framework reflected the following issues: real GDP growth rate will dip in 2005 as Cambodia will initially lose garment market share following the phasing out of the quotas. Against this background, economic growth in 2005 will drop to a range of 3.6 - 4.6 percent, and pick up again in 2007-2008 to 6 percent once the government reform programs will start to gain grounds. This assumption is based on the need to implement reform programs in 2004. Recent and expected developments are explained below. Better performance of the agricultural sector, following the implementation of sound policies and increased investment, may provide a boost to real GDP growth and substantially contribute to poverty reduction.

It is important to promote the development of ancillary industries in order to reduce Cambodia's dependence on imported inputs. In this case, supporting industries that produce garment accessories and the initial processing of imported grey fabric.

Although there is an apparent abundance of labor in Cambodia, there is insufficient level of skills when it comes to the use of many high-speed machines used in the industry. Far too little has been spent on training of staff with skills that are transferable across the industry. Better skilled staff will lead to a happier staff and more productive staff, which in turn will lead to an increase in production.

Diversification within the garment industry as well as the development of new industries is also essential. The development of new industries should however, be strategic, sustainable and evaluated in terms of their benefit to Cambodian people. Diversifying product range is essential. The development of high quality products will require investments in technology, training, and quality control.

Moreover, the RGC needs to urgently diversify toward other industries to reduce its dependence on the garments and textile trade. On 15 May 2002, while meeting investors, Prime Minister Samdech Hun Sen unveiled the RGC’s strategy to diversify the Cambodian economy. He emphasized that apart from assisting in the adjustment and further development of the garment industry, the RGC will give priority to the development of other labor-intensive enterprises, such as toys, footwear and assembly of electrical and electronics appliances for domestic and industrial uses.

Thus, the RGC has set out a comprehensive policy to increase Cambodia’s international competitiveness by focusing on development and improvement in physical infrastructure to effectively respond to the increasing needs for basic services, such as low-cost water and power supply, financial, information and telecommunications services.

· First, continue to develop labor-intensive industry, such as garment, toys and footwear industries;

· Second, promote the development of agribusiness by strengthening legal framework for longer-term land management. Moreover, the government will provide tax incentives to establish factories to process agricultural products, such as cotton, jute, sugar, palm oil, cashew nuts, rubber, cassava and fruits;

· Third, develop industries based on the utilization of basic natural resources, mainly by processing the existing natural resources in the country such as fish, meat, cement production, brick and tile;

· Fourth, promote small and medium enterprises (SMEs), micro-enterprises, and handicraft;

· Fifth, promote industries that produce appliances and electronics products for domestic and industrial uses and improve product quality. It is necessary to establish a system of quality control of export products to meet international standards and enforce the intellectual property laws.

· Sixth, establish industrial and export processing zones by developing infrastructure, improving service quality and encouraging investments. These zones can be established on the outskirt of Phnom Penh, Sihanoukville, Banteay Meanchey, or Koh Kong. The RGC will build road network, develop power and water supply, ensure waste management and environmental protection, provide education and vocational training, upgrade health services, establish warehouses and reduce customs procedures and other actions to ensure an environment conducive to business profitability and growth;

· Seventh, increase the production of goods for import substitution to some extent by encouraging the development of paper, chemical industries, such as the production of fertilizers, acid, as well as daily consumption goods such as soap, paint, electrical appliance, water pump, and agricultural inputs, etc.; and

· Finally yet importantly, the RGC’s policy is to promote “cultural and natural tourism” development in Cambodia.

Cambodia will need to compete with its neighboring countries on a level playing field. Accordingly, strategic areas of intervention include measures to strengthen government capacity, enhance the business environment, and improve financial intermediation, would be important for achieving sustainable growth in the medium term. In addition, specific policies directly aimed at reducing poverty in rural area are needed to ensure a more broad-based growth. Enhancing income opportunities in rural area will also help address absorb the growing number of new entrants into the labor market every year.

3.8. Overall Growth Outlook for 2004-2008

For 2004, growth is expected to increase to around 6 percent, as tourism recovers and garment exports continue to increase but at a slower rate. Tourism is expected to rebound to over 20 percent growth, boosting services growth to over 6 percent. At the same time, garment export growth is expected to continue but at a slower rate (12 percent) reflecting some quota removal, and contributing to a slowdown in manufacturing growth to 10 percent. Agricultural crop growth is projected at the average growth level of 3 percent per annum.

The end of the garment quota system will adversely affect growth in 2005-06, with GDP slowing to between 3½ and 4½ percent. The slowdown is expected to adversely affect services and construction, but will be somewhat offset by continued strong growth in tourism. Improved performance of the agricultural sector could also offset the decline. Logging is expected to resume, but because of the excess exploitation in the past, after a modest rebound in 2005, average annual growth rates are not expected to exceed 5 percent.

By 2007, growth is expected to be over 6 percent. The gains in competitiveness, stemming from policy reforms in 2004-06, could allow for a gradual recovery in garment exports and prompt investment in other manufacturing and service activity. Agricultural growth is expected to continue to improve toward 4 percent average annual growth with gradual productivity gains and with spillover effects for food and beverage sector, trade, and other services.

The projected growth rates would allow for per capita GDP to increase by about 23 percent by 2008 relative to the level in 2002. More importantly, the structural and agricultural reforms will provide the foundation for sustained higher and more broad-based growth rates after 2006. However, improvements in agricultural productivity and rural income opportunities in the short-term will ensure that rural poverty will be reduced even during 2005-06 when overall economic growth declines.

Box 3.1: Sectoral growth outlook in 2004-08

Garment sector – a significant decline is expected in 2005, with up to 1/3 of firms closing and some of the larger ones taking over some of the lost market share. The takeover by the largest firms is made possible by existing comfortable profit margins allowing the larger firms to sell at lower prices. Reforms introduced in 2004-05 are expected to improve competitiveness by reducing operating costs (labor and administrative costs). Cambodia’s good record of adherence to core labor standards is also expected to help mitigate the sharp decline. Moreover, there will be relocation of some garment factories to Cambodia from Thailand, which has graduated from the GSP trading status. After 2006, and especially for products not directly competing with Chinese products and currently exported to the US outside of the quota system (40 percent of Cambodia's exports to the US in 2002), some further growth may be seen in the garment sector, with positive spillover effects for investments in other light manufacturing.

Tourism – is expected to grow at around 15 percent annually in the medium term so long as political stability and security is maintained, reflecting Cambodia’s attractiveness as a relatively new tourist destination. Eventually, growth rates will decline to reflect global trends once the novelty of the destination has worn off.

Agriculture – rural road and infrastructure investment is expected to improve market access for agricultural goods in the coming years, aided by policies to improve land property rights and expansion agricultural land. In the immediate future, productivity improvements could be derived from introduction of improved seed varieties and more diversified crops (particularly vegetables and fruit trees which are currently imported) and newly developed community fishery programs. A slight increase in rice yield from 2 to 3 tons per ha can provide a huge impact on both national income and poverty reduction. Moreover, the increase of added value along the chains of agricultural products through food processing, small-scale agro-industry, marketing etc, is another great potential source of income generation.

In addition, there could be a positive supply response in agriculture in response to the promotion of value added to agricultural commodities at the level of the farm households and investment in storage facilities and agro-processing. These policies are supported by current donor programs, including an agricultural program loan to be presented this year to the AsDB board, and by cooperation agreements with neighboring countries.

Therefore, agriculture should become a "backbone" of poverty reduction strategy. It is obvious that action for developing agriculture, through intensification, diversification and water control etc. will have much larger impact for reducing poverty. Since the large majority of the poor people are farmers, action against poverty should address the problems of farmers first.

Construction – could continue to grow but at half the exceptionally high annual rate of growth in the past 4 years financed by large inflows, reflecting continued donor support and private investment. The decline in income generated from the garment sector in 2005-06 will likely be accompanied by slower growth in construction-related activity in those two years.

The overall balance of payments is expected to have deteriorated in 2003. The current account deficit is expected to have widened to 11.2 percent of GDP in 2003 reflecting the impact of higher petroleum prices and lower tourist arrivals. At the same time, political uncertainty had an adverse impact on foreign direct investment. Reflecting the growing fiscal imbalance, the foreign exchange rate depreciated by 2 percent in April-May and official reserves declined by 10 percent in July following intervention to support the currency. Improved fiscal control following the elections has been accompanied by a gradual return of foreign currency deposits; gross official reserves are now expected to be maintained at the same level as 2003.