KINGDOM OF CAMBODIA

The external balance is expected to improve in 2004. Petroleum prices are expected to return to the 2002 level and tourism growth to resume, allowing the current account deficit (excluding transfers) to narrow to 10.1 percent of GDP. Together with the expected increase in foreign direct investment, due to improved political stability, gross international reserves are expected to increase to US$726 million (2.6 months of imports) at the end of 2004.

Agreement on debt rescheduling with the U.S. and Russia may reduce amortization payments, but it could increase interest obligations. Cambodia’s external debt repayment will have significant impact on budget execution and poverty reduction goals. After the rescheduling of its pre-1993 financial obligations, Cambodia's external debt could reach as high as 45 percent of GDP and debt service ratio could increase to 2.3 percent of GDP per annum in 29908. Thus, the fiscal burden of the debt is heavy (given the low revenue to GDP ratios), with debt service amounting to about 17 percent of projected revenue in 2008. Favorable rescheduling terms are needed to lower these later ratios to more manageable levels. In this regard, Cambodia intends to pursue prudent external debt management policy and strictly avoid non-concessional financing.

However, even with reforms, the trade balance will continue to deteriorate through 2008 and a sizeable current account deficit will remain. Even if reforms aiming to enhance competitiveness begin in 2004, garment exports are expected to decline due to the quota phasing out in 2005 and not to resume growing before 2007. Once the cost of doing business in Cambodia declines, new export industries will gradually emerge. The trade deficit would be expected to widen in 2005 and continue widening over the medium term. In turn, the current account deficit is expected to be contained to around 10.1 percent of GDP (excluding transfers), given the projected strong performance of the tourism industry. Assuming that foreign assistance grows at the same rate as industrial country GDP, and that there is some small increase in FDI in response to the improved business environment, gross international reserves could increase slightly to about 2.8 months of import in 2008.

3.10. Alternative Macroeconomic Scenarios

[1] Estimates based on the report by the establishment registration provided by the Ministry of Industry, Mine and Energy, Kingdom of Cambodia.

[2] Ministry of Tourism, Kingdom of Cambodia.

environment and agricultural productivity, which would allow Cambodia to fully capitalize on economic cooperation agreements with its neighbors.

Slower growth could be seen in the case of exogenous shocks or policy failures. Adverse exogenous shocks could stem from a number of sources. Low rainfall or floods could affect agricultural output. Another SARS outbreak or an episode of global terrorism would affect tourism. Developments in trading country partners, such as a global recession or higher oil prices, could lower growth prospects. Finally, continued improvements in competitiveness of Chinese products could make it difficult for Cambodian products to compete, even when policies aimed at improving competitiveness have been implemented without delay.

If reforms as outlined in the section on creating enabling environment for the private sector were delayed, growth is likely to remain below 3 percent. Without reforms to improve competitiveness, garment exports would not be able to recover after 2005. Firms accounting for about 30 percent of output would be forced to shut down. In the absence of improvements in the private sector environment, investments in other manufacturing and services would be placed on hold, and construction and other economic activity would also slow down to about half the growth rate in the reform scenario. The impact of slower reforms is shown in the alternative scenario projections. The scenario also shows the impact on growth if the reforms geared toward boosting agricultural productivity are postponed, thereby not allowing for agricultural growth rates to increase over the average of the last four years.

If there is slower growth, this would have an unfavorable impact on the poor. The slower overall growth of the manufacturing and service sector will indirectly slow down the pace of poverty reduction as there will be fewer jobs in urban areas. Moreover, slower agricultural growth will make it impossible to improve conditions for the poor and reduce poverty in the rural areas, where it is most entrenched.

The financial system in Cambodia is characterized by very high currency and asset substitution, mainly in US dollars and to some extent Thai baht. Dollar-denominated deposits account for nearly 70 percent of measured broad money, and dollars in circulation are estimated to be much greater than measured broad money. Such low trust in the domestic currency and the banking system is a legacy of civil wars during the past three decades.

The banking sector maintains excess liquidity with the percentage of cash to total assets at about 19 percent. Roughly 33 percent of total assets are non-earning assets. The high risk and operating costs associated with bank lending are reflected in high interest rate spread and short-term lending. The spread between loan and deposit interest rates is estimated at around 13 percent points, as loan interest rates are around 20 percent per annum or more. Typical loan maturity is three to six months because banks are reluctant to provide loans with terms of one year or more.

Uncertainties regarding enforceability of secure interests impede bank lending and contribute to poor asset quality. The present collateral registration system is unreliable because of the absence of a legal basis for secured transactions and an inadequate public registration system that specifies lenders’ positions and priority ranking in secured property. Moreover, lack of reliable borrower information impedes banking lending and leads to poor asset quality. Cambodia lacks a credit bureau or arrangements for sharing information among financial institutions with credit histories that can be assessed and shared by all banks. Thus, banks are unable to lend based on cash-flow analysis as they lack clients’ financial information. Consequently, banks are compelled to lend against collateral as the primary source of repayment.

Lack of liquidity management mechanisms resulting from underdeveloped financial markets incurs substantial opportunity costs to banks. The banking sector maintains an abnormally high level of liquidity because of the lack of inter-bank markets.

During the past few years, Cambodia has witnessed the rapidly changing landscape of financial sector development. The country has embarked on financial sector reform aimed at reducing or eliminating distortions in financial markets, deepening the financial sector, and strengthening financial institutions. The reform actions comprise two main elements. The first direction of the reform is financial sector liberalization through improved market structure and competition by removing price and quantity distortions. The second element is to promote institutional infrastructure development by strengthening individual financial institutions, prudential regulations and supervision.

Strengthening the financial infrastructure involves developing a legal framework for the central bank, the banking system, as well as laws and regulations defining the rights and obligations of financial agents. Strengthening individual financial institutions requires better bank supervision, plus the restructuring and privatization of banks. Institutional development is critical to financial reform because without high-quality technical capabilities and general institutional efficiency, resource mobilization and efficient allocation remain weak.

Many important laws were passed and subsequently enforced, including the Banking and Financial Institution Law and the Insurance Law. In the next two years, the Royal Government of Cambodia will intensify financial sector reform with a view to establishing a sound banking system and insurance regime, promoting savings, setting up a modern payments system and increasing the confidence of the public in finance-related businesses. Development of the financial sector is reliant on the level of growth and activity within the real economy. Conversely, the financial sector development will further fuel the real economy through improved mobilization of resources and the channelling of savings into productive investment opportunities.

The financial sector reform underway in Cambodia is inextricably linked to a broader reform agenda adopted by the RGC two years ago, namely the economic and judicial reforms. The government will continue strengthening the legal framework supporting the insurance business in Cambodia by adopting a comprehensive commercial code including secured transactions and an insolvency framework. In this regard, the RGC is willing to facilitate the development of financial sector intermediaries and infrastructure. Legal and judicial reforms will be instrumental for strengthening the rule of law and ensuring the integrity of the courts.

Monetary developments in 2002 have reflected the improved fiscal position. Broad money supply grew by 31 percent in 2002, largely owing to increased foreign currency deposits, while continued fiscal restraint has provided room for private credit to increase by 6.2 percent. Gross international reserves reached the equivalent of over 3 months of import coverage at the end of 2002. The market exchange rate has been broadly stable against the U.S. dollar and in real effective terms. Despite the increase of garment exports in the last quarter and tourism receipts in the year, the income payment has brought down the current account deficit in 2002 (excluding official transfers) only slightly below the previously projected (10.7 percent of GDP).

Prudent monetary policy and fiscal discipline pursued by the government have been successful in maintaining low inflation and stable exchange rate and in supporting economic growth. Despite the shrinkage in the number of banks following the introduction of the bank-restructuring program, money supply continued to expand at a reasonable pace, as public preference for monetary assets persisted. Liquidity of the banking sector recorded a robust growth of 20.7 percent, out of which 4.3 percent was contributed by local components, as compared to 1.5 percent a year earlier. Domestic currency outside banks accelerated faster than expected as the National Bank of Cambodia has bought the dollars to strengthen its reserve. Foreign currency deposits, the largest component of broad money, recorded an increase of 30%, indicating strong confidence in the banking sector and in the economic policies of the RGC in spite of the general slowdown globally following the September events. Credit to the private sector rose by 13%, while government's recourse to bank financing remained negligible. Capital and reserves of the banking system, however, remained unchanged compared to last year, generally, reflecting the completion of the banks' efforts to strengthen their capital base in compliance with the recent requirements of the law.

The RGC adopted in 2001 its Governance Action Plan (GAP), which identifies two categories of reform where action will be critical to Cambodia's development over the near- and the medium-term. The first category involves reforms in four cross-cutting areas: (1) judiciary and law; (2) public finance; (3) civil administration; and (4) anti-corruption. The RGC has also identified two specific policy issues: (a) natural resource management, including land management and forestry management, and (b) demobilization of the armed forces.

The first Governance Action Plan (GAP-I) was implemented successfully. We have seen that GAP implementation is important for improving management and promoting development in Cambodia. Thus, the RGC has prepared GAP-II, focusing on continued implementation of legal and judicial, civil service reforms, decentralization and local governance, fiscal reform, demobilization, sustainable utilization of natural resources with a view to increasing the efficiency of public services, ensuring transparency, predictability and combating corruption. Detailed work programs have been prepared and improved for dissemination and consultation. The RGC is conscious that building institutions are critical for continuous and rigorous implementation of all reform programs.

Much more action remains to improve public governance. In the short term, it will be essential to improve the civil service and legal and judicial system to facilitate the implementation of governance reforms, enhance the environment for private investment and reduce trade facilitation costs. Therefore, public sector reforms will play a critical role in improving service delivery and generating economic growth.

The challenge for Cambodia is to successfully implement the legal and judicial reforms. The RGC is conscious that institutions - rules, laws and regulations - are instrumental for sustainable development. Weak institutions constitute the main obstacle preventing national modernization. However, institutional changes do take time, require capacity and willingness to formulate and effectively implement laws and regulations. Moreover, Cambodia is required by the membership in ASEAN and the preparation for accession to the WTO to modify its legal framework to be consistent with the international practices.

As compared to other countries, Cambodia still has a substantial proportion of the country under forest cover. During the years of wars and isolation, especially in 1970s and the first half of the 1980s the pressures for timber were kept at a minimum level. The country relied on foreign aid to finance its budget. However, in 1986 as overseas assistance begun to dry up, the Cambodian government looked at timber as an increasingly important source of financing public expenditure. Between 1986-1990, on average a total of 250,000-300,000 cubic meters of timber were exported annually. However, by the end of the 1980s and the early 1990s, illegal logging and illegal exports of log were estimated at two to three times this rate (WB. 1992:65). Forest products accounted for 1.5 to 2% of GDP. During this period, GDP growth averaged 7%, but fluctuated drastically from one year to another. Moreover, rapid liberalization, especially privatization of state-owned enterprises, which contributed almost half of revenue to the budget, undermined the revenue base. The contribution of state-owned enterprises to the budget declined from 36% in 1989 to 22% in 1991. Under such circumstances, the government resorted to logging as an alternative source of financing.

To address the abuse of natural resources it is crucial to have a comprehensive national forest policy to tackle Cambodia's development challenges in a systematic way. Following the 1998 general elections, the RGC embarked on forestry reforms to combat illegal logging. The RGC had endeavored to prevent and tackle forest mismanagement, and improve the regulatory framework governing the forest sector. Prime Minister Hun Sen issued a Declaration dated 22 January 1999 consisting of 17 measures in order to ensure forestry management and eradication of illegal logging (see Box 1).

1. Purchase, sales, and transportation of illegally cut logs should be ended immediately. The Department of Forestry and Wildlife (DFW) should monitor this.

2. Only forestry authorities at all levels are responsible for forestry management. Other officials and agencies should abstain from interfering in the forestry sector.

3. No "transportation permits" should be granted.

4. No "collection permits" for illegally cut logs should be given. Existing permits are cancelled.

5. Now new concessions shall be granted.

6. All concession contracts shall be reviewed; those that have not been implemented, as well as those that operate in violation of the contract or Cambodian law, will be cancelled.

7. Concessions complying with the contract shall be encouraged to equip themselves with machinery to increase the value added of their operations and products.

8. The ban on exports of logs and sawn timber will be continued.

9. There will be a crack down on poaching, hunting, and transporting wild life.

10. Felling trees to transform the land into private ownership is prohibited.

11. Reforestation will be encouraged in degraded areas.

12. Local authorities, military, and police shall cooperate with the Ministry of Agriculture, Forestry and Fisheries (MAFF) to enforce the above measures. Military and police forces might be requested to intervene using all means.

13. The practice of collecting unofficial fees should be entirely stopped.

14. Disciplinary sanctions will be taken against any individual, unit, or agency that lends its support to illegal activities. Awards will be given to those who have cracked down on such activities.

15. The Law on Forest Protection and Management should be adopted as soon as possible to provide a legal framework for forestry management and underpin the government's actions.

16. The MAFF shall report regularly to the government on the implementation of this declaration.

17. The Ministry of Environment shall establish as monitoring system to follow the implementation of this declaration.

Source: The Declaration of the Prime Minister of the Royal Government of Cambodia

The RGC’s objective in forestry is the development of an environmentally sustainable, socially responsible and economically viable sector. All 17 measures have been taken to curtail illegal activity, strengthen governance, and improve overall monitoring. These measures have been reinforced by overhauling concession management, formulating a legal framework for forestry, establishing a permanent forest estate, strengthening inter-sectoral oversight and accountability. With the strong commitment of the Prime Minister, illegal logging activity outside of official concessions has been sharply reduced since early 1999. This was achieved through the concerted effort of all elements of society including the military, police, provincial authorities, and local communities.

Recognizing the urgency of the situation, the RGC, for the first time, introduced forest policies in 1999 aimed at safeguarding Cambodia's natural resources while supporting sustainable logging. Law enforcement, the legal framework, concession management, community forest management and forest revenue system are the main measures implemented (IMF 2000:11). In order to halt illegal logging activities, the RGC began to mobilize all elements of society including the military, police, provincial authorities and local communities to fight forest crimes. The RGC also introduced a log export ban. To promote efficient processing and marketing of timber, the log export ban policy will be reviewed commensurate with improvements in the enforcement of forest law. Efforts also have included confiscation of sawing machines and illegally collected logs and timber, and destruction of trucks and saw mills. These efforts have succeeded in virtually eliminating illegal logging activity outside of the concession system (IMF 2000:12).

The implementation of forest sector reform has reached a critical stage in 2003, where all stakeholders should pay attention to the strengthening of institutional capacity and improving coordination to ensure smooth implementation of policies. Following is the overview of some of the Government’s most important accomplishments in the forest sector.

In keeping with existing commitments, the RGC did not issue new forestry management concessions. Arrangements were made for small salvage operations (collection of stumps) and other works provided for in Cambodian law and regulation. The government initiated forest concession cancellations on the basis of technical and legal reviews supported by the World Bank and the Asian Development Bank, by the exercise of the Government’s legal rights to punish illegal logging, and through voluntary abandonments.

The RGC signed a contract with Société Générale de Surveillance (SGS) to act as the Royal Government’s officially recognized Independent Monitor of Forest Crime Reporting. SGS will mobilize immediately and their Team Leader is already on station in Cambodia. An early major activity under the project will be a public inception workshop.

Strategic Forest Management Plans and Environmental and Social Impact Assessments that were submitted by concessionaires were publicly disclosed in November 2002, an unprecedented display of transparency, and consultations with affected communities were initiated and will continue through the subsequent levels of planning. Revised version of the plans, that have resulted from the World Bank-assisted Forest Concession Management and Control Pilot Project, are also due to be made available for public inspection.

Forest concession system and individual concessions have been radically restructured to make them more accountable and responsive to the public interest. The RGC will continue with further reforms, including consummation of revised contracts with the remaining concessionaires, further measures to improve community consultations and to avoid social problems and adverse environmental impacts and to raise the technical standard of practice by concessionaires and the Government agencies involved in concession management.

On the legislative front, the RGC has developed a plan for the completion of additional regulatory instruments and guidelines required for the implementation of the new 2002 Forest Law. In November 2003, Prime Minister Samdech Hun Sen signed into effect a Sub-Decree on Community Forestry. This Sub-Decree enables Government to put public forest assets under the stewardship of local communities in the framework of approved management plans and benefit sharing arrangements. The Sub-Decree was the product of over six years of consultation and work with many stakeholders and advisers and compliments other measures, such as the Sub-Decree on Social Land Concessions, that Government is pursuing to make the country’s land resources more productive and better managed.

Government has already been working in partnership with various donor agencies and non-governmental organizations piloting community forestry in different parts of the country. Nearly 80,000 hectares had been developed under community forestry arrangements. The RGC will continue these partnerships under the framework of the new Sub-Decree. The government is in the process of developing an arrangement with USAID which will provide $2 million in support to civil society organizations in Cambodia working on community forestry.

Illegal logging, wildlife smuggling, corruption and encroachment on forest land have been reduced from the crisis proportions prior to the Government’s reform program. The Government’s crackdown on illegal logging has consisted of measures across the full spectrum of forest law enforcement, prevention, detection and suppression. The RGC's entire approach to resource management, including concession management reform, community forestry and protected areas management is aimed in large part at preventing crime by crowding out illegal activities with good practice. While expansion of scientific management is time consuming and expensive, the RGC is also addressing the other areas of law enforcement.

Forest crime monitoring and reporting efforts have continued unabated throughout disruption in international technical assistance projects and well known disputes with the previously recognize official Independent Monitor, Global Witness. This reporting program, which needs to be further strengthened and improved, provides Government the basis for strategically applying its scarce enforcement resources to priority problems for the most impact.

Despite the Government’s decision to engage a new Independent Monitor, it continues to welcome the work in Cambodia of Global Witness and other NGOs and civil society organizations concerned with forest law enforcement. Conservation International, WildAid and other groups constitute a new and vibrant architecture for monitoring forest crime in Cambodia and we welcome the additional and more constructive and objective scrutiny they put on Government’s efforts. The RGC is also redoubling its efforts to obtain additional expert technical advice on forestry law enforcement and have approached the members of the donor Working Group on Natural Resource Management for assistance.

The Royal Government of Cambodia is conscious that the institutionalization of codes of conduct and laws and regulations that shape human interaction in society matters a great deal in our nation’s quest for sustainable development. Indeed, reforms to strengthen the government’s institutional capacity is a fundamental prerequisite to long-term social and economic growth. Institutional efficiency reduces uncertainty and transaction costs, promoting increased inflows of capital and technology into Cambodia, which in turn will fuel economic growth.

Based on this philosophy, the Royal Government has embarked on a long-term agenda of major reforms in the legal and judicial system. Since 1993 a total of 154 laws have been enacted. Another 23 draft laws are awaiting adoption by the National Assembly. Attention is also being directed to economic and investment laws, particularly those related to Cambodia’s impending membership in the World Trade Organization.

A Council for Legal and Judicial Reform (LJR Council) was established reporting directly to the Supreme Council of State Reform chaired by me. The Council meets regularly to steer and monitor the reform program, and it is supported by permanent structures acting as the implementation mechanism. The LJR prepared the Strategy for Legal and Judicial Reform has been approved by the RGC in June 2003. Important laws were enacted to complement the legal framework, from laws relating to human rights to laws on investment, trade and commerce and laws in support for natural resources management. Starting from January 2003, the government increased remuneration of judges and prosecutors. The Civil Code and Procedures and the Penal Code and Procedures are being readied for submission to the National Assembly and Senate. The Royal School of Magistracy and the Lawyer Training Center are operational. A pilot court was established in Kandal province in order to introduce some best practices in handling cases and upgrade the court. Needs and improvement measures have also been identified to improve its performance. Preparation is underway to establish a Commerce Court, a Juvenile Court and are Administrative Court are underway. Core support institutions such as the Senior Council of the Magistracy, the Council of Jurists, the Ministry of Justice and support mechanisms to the Council for Legal and Judicial Reform are being strengthened. Resources are being mobilized to undertake projects in order to significantly improve access to legal and judicial services. But so far most of the resources are coming from the government budget.

To implement Cambodia's commitments under the WTO, various laws related to commercial transactions will go through the legislative process. This process will create a predictable business environment based on the rule of law. The government will take further efforts to improve the capacity of the judiciary, for example through professional training at the newly established institutions.

Although all the donors realize the importance of the reform of the court systems, only a few have put the money where the mouth is. Efforts are more focus on criticism rather than concrete actions. Judicial reform has been identified by the Investment Climate Survey as critical for providing enabling environment for private sector development and poverty reduction. Improved access to justice and judicial services for the poor constitutes a remedy to address injustice and reverse their poverty situation.

The complexity of the problems is also caused by the three decades of wars, with the warrior's mentality of some segments of the population, rapid transformation of the society leading to the change in values and virtues, and more importantly the change in legal system from a mixed French and Cambodian laws into the Anglo-Saxon laws. There are only a small number of Cambodian legal experts who are working in the sector. Thus, this requires substantial technical and financial assistance from the international community and the efforts of the Cambodian government. However, donors and human rights organizations have adopted the attitude of criticizing, rather than giving a helping hand to build up institutional capacity of the sector. With so low budget for the court, one cannot expect too much in terms of improved efficiency. Moreover, law enforcement is still a challenge. It is difficult to enforce laws predictably and transparently when the salary of the enforcement officers is much lower than a minimum subsistence level.

Human resources are crucial in our efforts to overhaul the judicial system. Thirty new judges have just been appointed. To boost the performance of the Courts, a Trade Tribunal and an Administrative Tribunal shall be established. Furthermore, a “model” court will be piloted to promote integrity, impartiality and professionalism of judges. In Judiciary as elsewhere carefully selected people have to be trained to fully comprehend and properly administer laws, regulations and rules in a transparent and fair manner. This necessarily involves evolutionary time for traditions and precedents to build but we are determined to fast track the process.

Civil services affect the performance of the economy by their effect on the costs of exchange and production. Together with the technology, the civil service system sets the transaction costs in the economy. It creates a predictable framework and reduces uncertainty and thereby exerts downward pressures on transaction costs.

Thus, the RGC’s commitment to sustainable development requires a public sector able to deliver adequate and appropriate basic services across the nation. Civil servants are the link between resources and services. However, the problems of the civil service in Cambodia include low pay, low skills, and thus low capacity. Therefore, comprehensive civil service reform will have to be carried out to improve service delivery.

Progress in civil service reforms in 2000-2003 has been accelerated with the adoption of concrete action plans. The National Program for Administrative Reform is designed to turn the Administration and the Civil Service into forceful partners in the implementation of the Government agenda. It is articulated in three phases: setting the foundations to sustain the course, reorganization and redeployment, strengthening capacity and developing human resources.

Under stage 1, a comprehensive program has been put in place on: (a) improving civil service pay to attract and retain skilled staff who work where and when as expected, and (b) civil service management to ensure that human resources are wisely deployed in high priority sectors and functions, and that human resource expenditures are subject to controls adequate for managerial and fiduciary accountability.

The initial stages of the NPAR have been successfully implemented: (i) completion of a database and identification of 9,000 ghost employees; (ii) automation of the payroll; (iii) introduction of a new employee classification system and salary grid; (iv) design of Priority Mission Groups (PMG) and adoption of an implementing legal framework; and (v) development and introduction of a Human Resource Management Information System (HRMIS). Phase 1 of the program is for all practical purposes completed. It was designed to achieve five major results: to document and control the composition and distribution of the Civil Service workforce, to develop essential instruments to manage and motivate personnel, to assess needs of ministries relating to corporate services (back office), to complete preparatory work to move the Administration closer to citizens, and, strengthen the capacity to plan and manage the reform.

So far, the NPAR has made laudable progress in the following areas: (a) civil service remuneration, in which average pay increased by 44 percent (in nominal terms) to US$28 per month as a result of the introduction of a new classification system in 2002, as per the Strategy to Rationalize the Civil Service (SRCS), 2002-2006; and (b) documentation and control of the workforce by carrying out a census that identified a reported 9,000 "ghost" workers and issuing civil service identification cards, by developing an automated payroll system (with automatic production of payroll lists), as part of the HRMIS, and by solidifying the legal framework with the approval of particular statutes to cover all civil servants under a Common Statute.

The remuneration and classification regimes have been overhauled. Targeted allowances more conducive to performance were introduced to address urgent needs in education, health and senior management. Further initiatives, such as the Priority Mission Group program, have been readied for implementation. The Council for Administrative Reform has undertaken sets of studies to investigate ways and means to accelerate pay and employment reforms to improve the quality and access of public services. Pilots are underway to significantly improve access to administrative public services (e.g. One Stop Windows). The review of Capacity Building Strategy for the Civil Service is underway and the strategy expects to be articulated and approved in the following years.

Study on developing service delivery policy including user fees is completed and the policy strategy will be prepared in order to accelerate the improvement in service delivery. In addition, policy and program for de-concentration has been drafted and in 2004 there will be a consultation on this matter and then seeking for its approval.

In 2004, the PMG program will begin to address major service delivery bottlenecks. The PMGs are groups of civil servants tasked with identified "priority missions". The PMG program is meant to be an interim, short-term measure to enable progress in strategic areas of service delivery while more long-term solutions are set up. The PMGs will not, nor are they intended, to resolve the problem of low remuneration. Rather, they are intended to facilitate implementation of a select number of key reform initiatives, and this is the standard against which they should be evaluated. To motivate the PMGs, they will be provided with special monthly allowances ranging from CR190,000 to CR520,000 (approximately US$48 to $130) for a pre-determined time period (approximately twelve to eighteen months). The Government plans to create PMGs comprising a total of 1,000 civil servants in 2003.

To professionalize the civil service system, it is important to ensure competitive examinations. In this regard, merit-based recruitment and promotion needs to be strengthened significantly. Moreover, merit-based promotions would enhance performance and provide civil servants with greater incentives to undertake professional development.

Staff are appointed to a particular category according to educational qualifications. The only way a civil servant can change category is by acquiring the necessary level of education through attendance at college or university. Progress from one grade to another should be done in three ways. The first way is an assessment of the employee's abilities and performance upon a formal request from the civil servant. Cambodia should start to introduce an evaluation process. For example, each year in January, civil servants fill in a professional evaluation form, which is, in turn, annotated by the Chief of the Office. The form is then passed on to the State Secretariat for Civil Service (SSCS), which forms an opinion of the quality of the employee and checks that this promotion corresponds to a vacancy in the relevant grade and that it is within the limits of the ministry's budget.

The second way is for the civil servant to undertake long-term training at the Royal School of Administration. Finally, promotions can be achieved through an internal examination supervised by the SSCS. All grade promotions have to be ratified by this body. In this regard, ensuring the integrity and impartiality of the SSCS is critical in the civil service reform. Progression from one class to another is automatic with every two years spent in the civil service.

The RGC is conscious that an economy will not reach its growth potential, and develop at an adequate pace, without an active contribution from the financial sector and it is committed to strengthening it. In accord with this commitment, the Ministry of Economy and Finance worked closely with the National Bank of Cambodia (NBC) in order to strengthen the financial system, which is critical for accelerating economic growth. To this end, the RGC adopted August 24, 2001 the " Vision and Financial Sector Development Plan for 2001-2010", which outlines a long-term vision and strategy for sequencing policy reforms to develop a modern financial system over three phases across ten years in order to enhance resource mobilization and sustainable economic growth. Over the next ten years the MEF and the NBC will strive to develop:

§ First, a competitive, integrated, and efficient banking system that is properly regulated and supervised and effectively mobilizes savings to provide financing to support the growth of the private sector, a reliable payment system, and a banking safety. To this end, the NBC will take the lead in strengthening a framework for monetary policy, enhancing supervision, and building up institutional capacity.

Having rigorously implemented the Law on Banking and Financial Institutions, which requires a recapitalization of commercial banks, the NBC has re-licensed banks. As a result, some banks did not meet the new qualification criteria and either voluntarily closed or liquidated. Through this process, the number of banks reduced from 31 to 18, including 14 commercial banks and 4 specialized banks. At the same time, the RGC has announced the privatization of the Foreign Trade Bank (FTB), by proposing to establish a joint venture with the private sector in order to improve management. Recapitalization of commercial banks is designed to develop a strong banking system, to promote saving and increase public confidence in the banking system.

§ Second, a viable, pro-poor, and effective rural finance system for providing affordable financial services to enable the poor to enhance rural income and reduce poverty. To achieve this goal the MEF has worked with the NBC to act on: (i) implementing the policy actions specified in the Rural Credit Policy; (ii) strengthening supervision and regulation; (iii) facilitating institutional transformation of NGOs into licensed micro-finance institutions; and (iv) building sustainable institutions.

In the area of microfinance, only three micro-finance institutions have been licensed. At the same time some 90 NGOs have offered micro-finance services to about 420,000 households. The government's policy is to reduce interest rates, expand opportunities and alleviate poverty.

§ Third, an insurance sector that protects businesses and individuals from catastrophic events and a pension system that provides a secure retirement, both of which provide capital for long-term investment in the real sector. To tackle the current weak legal and supervisory capacity, the plan aims at establishing regulatory and supervisory framework for insurance and compulsory insurance, encouraging private sector participation, building up capacity of insurance regulators and supervisors, creating a multi-pillar pension system consisting of a mandatory public pension program, a mandatory privately managed funded pension system, and voluntary retirement savings programs.

The RGC has implemented strict measures aimed at developing the insurance industry, which is still at its infancy in Cambodia. In this sense, the RGC has issued license to two state-owned companies to undertake insurance and re-insurance business. Another three private insurance companies will also be licensed to do business in Cambodia.

§ Fourth, non-banking financial products and institutions that create more balanced financial structure, increase the depth of financial market, and promote competition. These include leasing business, money market and capital market intermediaries, and development finance institutions. To this end, MEF will cooperate with other related agencies to prepare specific leasing laws and regulations and provide procedures for banks to participate in the leasing business. In 2003, the RGC is ready to launch Treasury Bills in order to mobilize additional resources for investment purposes.

§ Fifth, a money market that enables an inter-bank market to provide banks, companies, and individuals with the means for effective liquidity management.

§ Sixth, an efficient and transparent capital market with a critical mass of issuers that mobilizes funds for long-term investment.

§ Seventh, legal infrastructure and accounting systems that promotes the rule of law in commercial and financial transactions and support good governance by promoting transparency, accountability, and predictability.

5.2.2. Banking Reform

Financial sector development is important to the speed and direction of economic growth, since a strong and well-functioning financial sector can break down the limitations of self-financing, mobilize idle financial resources for productive investment needs. To link up saving, investment and economic growth, the financial sector development must go together with private sector development and governance, forming one the three pillars to support the government policy of generating growth, which is seen as the major means to reduce people poverty, the ultimate goal of the government economic policy.

The banking sector in particular needs strengthening, given its current low level of development and its dominant position in the present financial system. Cambodia's banking system was thus transformed from a mono banking into a two tier banking system by separating the central bank functions from commercial banking activities. To support the reform, legislative framework has been improved. The new central bank law is promulgated in January 1996, providing better clarification of the Bank's status, ownership and capital structure, and laying a more solid foundation for its operations. Along with re-defining the new role of the National Bank of Cambodia (NBC), the government is fully aware of the need to address the remainders of the financial system with a view to establish a modern and efficient financial sector. The Law on Banking and Financial Institutions, enacted in November 1999, represents therefore a great asset for the nascent financial sector. This new law responds to the need to promote a sound financial structure and orderly financial markets by providing appropriate legal framework for the licensing, organization, operation, and supervision of a broad range of financial services companies. In addition, the Insurance Law was passed in June 2000.

Substantial efforts have been undertaken to improve prudential and administrative regulations aimed at supporting the supervisory implementation of the Banking and Financial Institutions Law. This includes the setting of prudential limits for capital adequacy, solvency, liquidity and other parameters which form a regulatory framework for the banking sector. The NBC will consider additional regulations to ensure policies and procedures related to granting of loans and making investment, evaluating the quality of assets and the adequacy of loan loss provisions and reserves and write-off of bad debts, information systems, risk management systems and internal control systems.

Lack of human resource capacity and key legal infrastructure, as well as weak public confidence is a major impediment to the development of the financial sector. The lack or inadequacy of laws pertaining to accounting, insurance, negotiable instruments, secured transactions, commercial enterprises, bankruptcy, contracts and commercial credit, also hamper the effective functioning of the financial sector. To address these bottlenecks, the RGC has taken strides to upgrade banking supervision capabilities and introduce a modern payments system. Dollar clearing and settlement was initiated from January 2001 to facilitate payment operations and shorten availability times. To this end, a draft Payments Law is being prepared by the NBC to provide a legal basis for the payment system. An inter-bank market arrangement will be established to ensure sound liquidity management. Moreover, the RGC is determined to adopt a comprehensive commercial code by the end of 2002.

As part of the policy to strengthen the banking system and corporate governance, the NBC proceeded to implement bank re-licensing, in compliance with the Law on Banking and Financial Institutions, with a view to closing inactive banks. The re-licensing of commercial banks is designed to establish a viable banking system, promote savings and instil public confidence in the banking sector. Four viable banks and 15 potentially viable banks were re-licensed and Memoranda of Understanding, which detail the timetable for capital injections and corrective actions, were signed with the potentially viable banks. Eleven nonviable banks will be liquidated. Of these, seven banks applied for voluntary liquidation. Independent auditors are nominated for the liquidation of these closing banks. With these actions, the government has in mind to bring up all existing banks to a higher standard, improving the soundness and reliability of the banking system, which is crucial for confidence building.

The state-owned Foreign Trade Bank (FTB) has also been subjected to the bank-restructuring scheme. FTB was separated from the NBC and now acting as an independent commercial entity. The NBC transferred CR 10.3 billion to FTB to meet an initial capital requirement. A working group, whose members are drawn from the Ministry of Economy and Finance (MEF) and the NBC, has been established to introduce a recapitalization bond. This issue will fully recapitalize the FTB to CR 50 billion. Banking supervision will be further upgraded.

While much progress has been made in recent years in financial sector reform, still many things remain to be done to support increased investment and high and sustainable growth rate. Creating a modern and efficient financial system is not an easy task. The government needs to fully understand what it needs, which direction to go and how to get there.

The substantial progress that has been made in bank restructuring will further fuel the real economy through improved mobilization of financial resources and the channelling of savings into investments. Lack of human resource capacity and key legal infrastructure, as well as weak public confidence is a major impediment to the development of the financial sector. The lack or inadequacy of laws pertaining to accounting, insurance, negotiable instruments, secured transactions, commercial enterprises, bankruptcy, contracts and commercial credit, also hamper the effective functioning of the financial sector. To address these bottlenecks, the RGC has taken strides to upgrade banking supervision capabilities and introduce a modern payments system. Dollar clearing and settlement was initiated from January 2001 to facilitate payment operations and shorten availability times. To this end, a draft Payments Law is being prepared by the NBC to provide a legal basis for the payment system. An inter-bank market arrangement will be established to ensure sound liquidity management. Moreover, the RGC is determined to adopt a comprehensive commercial code by the end of 2002.

Banking sector reform showed notable results with the reduction in the number of banks yielding a strengthened commercial bank system to foster public confidence in its services. The recapitalization measure and improved banking supervision were aimed at bank management improvement to increase customers' protection. These reforms were also aimed at strengthening the financial sector to avoid fund shortages and to mobilize financial resources to serve investment sector needs.

In an effort to promote development of interbank and money markets, the first step is to introduce legal framework to underpin the interbank/money market activities. The introduction of the law on negotiable instruments and payment transactions will provide a good basis for improved payment system and liquidity management. Several workshops including consensus-building seminars were conducted; feedbacks were carefully incorporated in the draft law. After a long process of consultation with all the stakeholders, the final draft was discussed and approved by the plenary session of the Council of Ministers on May 09, 2003. The draft law is now waiting for the review and approval by the National Assembly.

The banking sector has been continuously strengthened through reforms in various areas. In 2002, the outdated supervisory regulations were revised and replaced by new regulations that are consistent with international standards. To enforce prudential regulations the NBC has moved to carry out the task of full scope inspection of banks, and up to now on-site inspection for six commercial banks has been successfully completed.

The completion of bank re-licensing program introduced by the NBC has been successfully revamped the banking system. Since 2002 16 commercial banks were de-licensed and put under liquidation, a majority on a voluntary basis. The whole process of liquidation of the closed banks is progressing well. As for the liquidation of insolvent banks, the NBC has made various efforts to protect depositors' savings. During 2002-2003, the performance of licensed banks improved greatly in terms of profitability. The banking intermediation and public confidence has improved which resulted in an upward trend in deposits and credit. Progress has also been achieved in restructuring the NBC's branches. They now act as banks for the provincial treasury of the MEF, and contribute thereby to improve cash management.

To help effective bank supervision, the new chart of accounts (COA) was made available to banks by mid January 2003. For effective implementation of the COA banks are classified into 3 tiers according to their accounting systems. By September 2003 all tier I banks were almost completed to implement COA, while a number of tier II and tier III banks still faced difficulties in complying with the COA. The NBC has continuously examined the bank compliance with conditions for implementation of the new COA. Corrective measures were promptly introduced to the non-compliant banks with the aim of ensuring a full compliance by year-end 2003.

Restructuring the state-owned commercial bank has made considerable progress. The Ministry of Economy and Finance (MEF) is the major shareholder of FTB, holding 80% of shares, while the NBC still maintain 20% of the bank’s equity. The new board of directors was appointed to reflect the new ownership. The Bank management and operations have been strengthened and improved by the Reform Commission to achieve a commercial bank status with the aim of privatization in 2004. The statement of intent for privatization of FTB was announced January 24, 2003 to make it known to public of FTB future plan. For the NBC to completely divest from FTB the NBC has requested that MEF should include the 20% of NBC stakeholder in FTB in the MEF budget so that MEF could take over 100% of FTB.

To further promote financial intermediation, the government will take the following actions:

The Royal Government has undertaken serious strides to implement its Financial Sector Blueprint 2001-2010, which envisages the development of a sound, market-based banking system; non-bank financial institutions that will increase the depth of the financial sector; money/ inter-bank and capital markets, diversification of banking services and introduction of new financial instruments for the banking industry.

This includes the development of legal infrastructure for capital markets. In this regard, the Ministry of Economy and Finance (MEF) prepared a draft Law and sub-decree on Government Securities and has taken the first step to make a Diagnostic and Policy Review for the establishment of a Non-Government Securities Market. MEF expects that this law will be adopted in 2004 and implemented over the next few years, allowing for the issuance and trading of Non-government Securities and establishment an Independent Regulatory and Supervisory Agency. To prepare a legal framework for this purpose, the MEF is drafting the Non-Government Securities Issuance and Trading Law. This will pave the way for the establishment of a stock market in Cambodia by 2007.

To protects businesses and individuals from catastrophic events, the MEF has taken actions to revise the present law and sub-decree on insurance for complying with the International Standard (IAIS core principles), adopt three compulsory insurance on Motor vehicle; Passenger transport on land and constructor's all risk liability and establish the National Bureau and the Insurance Association for the implementation of the ASEAN Protocol 5. A new Reinsurance Cooperation, Cambodia Re, commenced its operations in 2003 in order to provide reinsurance and value-added services tailored to the needs of Cambodia and thereby reduce the outward flow of insurance premiums.

The MEF also gives priority to the establishment of an accounting system with the view to promoting the rule of law in commercial and financial transactions. In this regard, an Accounting Law was adopted in compliance with the International Accounting System and Standards and established the National Accounting Council (NAC) and the Khmer Institute of Certified Public Accountants and Auditors (KICPAA) was established in 2003. Moreover, the MEF has also promoted training in Certified Accounting Technicians (CAT) and Certified Public Accountants (CPA).

To further promote financial intermediation, the government will take the following actions:

Access to credit in rural areas is key to broad-based economic expansion. The RGC has several measures in this area: (i) transforming NGOs into formal microfinance institutions (MFIs) or registered finance operators; (ii) improving supervision to mobilize resources; and (iii) reducing interest rates to increase access by the poor to credit.

The NBC continued to transform NGOs in Cambodia into formal licensed MFIs or registered rural financial operators. In the first nine months of 2003 the NBC gave licenses to five MFIs and registered four NGOs as rural credit operators. Presently, there are more than 100 rural financial operators including licensed micro finances, registered and non-registered NGOs in which most of them are in small size.

The introduction of an on-site and off-site inspection manual for MFIs in earlier 2003 has contributed to improvement in supervision of MFIs. To strengthen off-site supervision by ensuring the quality and consistency of the financial information submitted by financial institutions, a standardized new chart of accounts has also been prepared. The new chart of accounts is gradually being implemented by the licensed MFIs and those NGOs that intend to apply for a license in the future. Likewise, the NBC has developed simplified reporting formats for both registered and licensed institutions. For prudential purposes on-site inspection has been conducted before granting license and registration certificate as rural finance operators. The NBC has at the same time started an eighteen-month cycle of on-site inspections for licensed institutions.

With the aim of reducing the interest rate on loans and therefore to improve access of rural poor to banking services, the NBC has issued guidelines to MFIs on the methodology to calculate the interest rate. All MFIs are free to set interest rates according to a market mechanism. However, their inability in properly calculating interest rates has led to high interest rates prevailing in the market. Thus, this guideline is designed only to improve financial analysis. The NBC is conscious that administrative measures could lead to unsustainable microfinance institutions.

In fact, rural finance operators are requested to calculate their lending rate taking into account the repayments of principal already made on that loan and should base the calculation only on the loan outstanding. Customer, in turn, shall have credit amortization table. The huge gap between demand and supply of funds represents a major constraint to low lending rate in micro finance sector. The regulation on the licensing and registration of MFIs aims therefore to upgrade their legal status and strengthen their operations that will enable them to attract more resources, either in the form of refinance assistance from the Rural Development Bank (RDB) or as equity participation. Building the institutional capacity of the NGOs that have become licensed MFIs is critical for their sustainability.

There is a growing recognition of the critical role that institutions can play in promoting development and reducing poverty. Therefore, the RGC is striving to foster suitable social, economic, and political institutions in the context of a poverty reduction strategy. Nobel laureate economist Douglas North defines institutions as "the humanly devised constraints that structure political, economic, and social interactions.” Such constraints include formal rules - such as constitutions, laws, and regulations - as well as informal constraints - such as customs and norms of behavior.

In this sense, the RGC clearly understands that institutions matter in promoting sustainable development with equity. Hence, during the past decade, in preoccupation with growth and its stages and with the provision of capital and skills, the Royal Government of Cambodia (RGC) has also paid much attention to institutional and structural problems and to the power of historical and cultural forces in the development process. The efforts concentrated on resolving the problems associated with inadequate and inappropriate development of institutions, and people's lack of access to institutions. The focus was on developing institutions that the people can use to nurture their abilities, assert their interests, and access resources. Only when the people and their interests are represented in institutions at the national and local levels, policies will work.

Experiences from other countries show that there is a significant correlation between effective legal systems and economic growth. Legal change is necessary to support the evolutionary process of social and economic change. As government strategy opens an economy to the rest of the world, the substance of laws in such areas as property rights and cross-border transactions changes to fit international standards. The legal systems should be adjusted to support the new economic strategy. Hence, the RGC has attempted put in place economic policies that reduce direct state management of economic activities and to ensure that rule-based law can play an effective role in economic development.

In this sense, special attention is given by the RGC to promote efficiency, effectiveness and accountability in the public administration at both central and provincial levels to address effectively the challenges of national transformation, respond better to the population’s needs and deliver services more efficiently by:

a. Strengthening government capacity to plan, implement, monitor and coordinate public administration reforms;

c. Adoption of the necessary laws and regulatory texts for decentralization and deconcentration by the relevant authorities;

d. Improved central and local policy dialogue and connectivity for informed national policy and legislative reforms;

e. Enhanced fiscal deconcentration and budget processes based on the budget priorities;

f. Improved capacity of local institutions to meet poverty-reduction and gender justice needs through effective mobilization, allocation and management of resources;

g. Enhanced capacity of the rural and urban communities in the monitoring and implementation of local development projects;

Indeed, a country's potential for economic growth is greatly influenced by its physical resource endowment (its land, minerals, and other raw materials) and by its endowment of human resources (both number of people and their level of skills). In the realm of human resource endowments, not only are sheer numbers of people and their skill levels are important but so also are their cultural looks, attitude toward work, and desire for self-improvement. Moreover, the level of administrative skills often determine the ability of public sector to alter the structure of production and the time in which such structural alteration can occur. Thus, the nature and character of a country's human resources are important determinants of its economic structure. Human resources of a nation, not its capital or its material resources, that ultimately determine the character and pace of its economic and social development. Clearly, a country that is unable to develop the skills and knowledge of its people and to utilize them effectively in the national economy will be unable to develop anything else. Human resources are the determinants of the institutional capacity of the country.

In response to the above policies, considerable efforts have been deployed by the RGC to increase investment in this sector by increasing budget allocations for education, mobilizing foreign aid and encouraging contribution from the society. Over the last four years, the RGC increased more than two folds the spending for education from CR 102 billion in 1998 to CR223 billion in 2001. In 2002, the RGC is committed to increase education budget to CR292 billion. Thus, only over a period of five years education spending will increase more than threefold.

Capacity-building efforts should focus on institutional strengthening, including the design of new organizational structures to improve the "goodness of fit" between the policy context for sustainable development and enacting institutions in both the public and private sectors. These institutions include education and training institutions as well as extension agencies, research institutions, NGOs and community organizations among others. A multiplier effect can be achieved if strong linkages among education institutions, NGOs, research organizations, public and private extension services and others are fostered. This approach recognizes that there are multiple sources of technology development and dissemination and that integrated institutional network capacity building is required.

Cambodia has made some progress in ensuring macro-fiscal sustainability during 1999-2002 by: (i) improving domestic resource mobilization to finance economic growth; and (ii) increasing public expenditures on economic services, especially agriculture, roads, education and health sectors. In order to promote growth without reducing priority spending on the social sectors, the RGC will increase revenues to finance greater levels of public spending. Without significant increases in revenues, there are serious risks to both medium term macro-fiscal sustainability and the RGC’s poverty reduction program.

Despite progress made in the last few years, Cambodia's production base still remains narrow, the revenue to GDP ratio low, and governance problems pervasive. The RGC recognizes that institutional capacity building is the key to revenue mobilization and that it should draw on good examples of such from the experiences of other developing countries. Thus, the Ministry of Economy and Finance has embarked on fiscal reforms by joining efforts with some donors, notably the United Nations Development Program (UNDP), the International Monetary Fund (IMF), the Asian Development Bank (ADB), the United Kingdom and the Netherlands to strengthen Cambodia’s economic and financial management through the Technical Cooperation Action Plan (TCAP). The TCAP program ended at the end of 2003. A new program is being designed to provide technical assistance for fiscal reforms.

6.1.1. The Objectives of Fiscal Reforms in 1999-2003

The Royal Government of Cambodia (RGC), formed in November 1998, was determined to undertake fiscal reforms. On November 30, 1998, Samdech Prime Minister presented the Royal Government of Cambodia’s (RGC’s) "Economic Government" policy announced to the National Assembly a policy agenda, which reflected profound reform measures. It mainly focused on income mobilization, the rationalization and strengthening of budget expenditure management, forestry management, demobilization, administrative reform, strengthening governance and fighting corruption. The main target of the reform program is to accelerate economic growth, sustainable development, human resource development and institutional capacity building in order to alleviate poverty and to improve the welfare of the Cambodian people.

The objectives of the reform programs are to raise economic growth and per capita income, and reduce poverty. The main challenges are to rebuild the economy and institutions, and to address impediments that impede sustainable development. Accordingly, the reforms focus on major efforts to: (i) strengthen revenue to support increased government expenditure; (ii) reduce military spending and implement administrative reforms of the military and the civil service to provide additional funds for social services and public investment; (iii) strengthen public resource management, particularly in forestry; and (iv) build the legal framework and economic institutions for the private sector.

Fiscal reform is the cornerstone of the reform programs. Given the extremely low revenue ratio to GDP and the pressing need to rebuild infrastructure, a revenue effort on the order of 4 percent of GDP during 1998-2002 is required. This revenue effort will come primarily from: the strong implementation of VAT, improved customs administration, a rationalization of investment incentives, and other measures to broaden the tax base.

Fiscal policy is driven by three main thrusts: (i) increased revenue collection by improving the mobilization of taxes and the governance of