Cambodia’s ballooning private debt a risk or sign of growth?

• Feb 27, 2023

While there are concerns over the high ratio of private debt in the Kingdom compared to other countries in the region, some industry leaders believe that it is still at a manageable level. Khmer Times probes to find out why the private debt is going up, whether it is under control or urgent action is required to rein it in.

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With a rise of over 20 percent in one year and the total ballooning to 180 percent of the GDP, Cambodia’s private debt has started raising concerns along with its rising Non-Performing Loans (NPLs).

According to National Bank of Cambodia’s (NBC’s) 2022 annual report, the private sector loans reached $56.1 billion last year, increasing by 20.2 percent compared to 2021.

The central bank attributed the rising private debt, especially in 2022, to a jump in economic activities and this can be mainly due to the recovery measures taken in the aftermath of Covid-19.

While commercial banks’ loans to the private sector accounted for more than $46 billion, loans from microfinance institutions touched $9.7 billion. Commercial bank loans grew by 19.3 percent and micro-finance loans by 25 percent last year compared to 2021.

According to NBC’s report, a major chunk, around 32 percent, of the private loans were consumed by the housing, construction and real estate sector.

Interestingly, amidst this sharp growth in private debt, Cambodia’s public debt continues to be one of the lowest in the Asean region – just $9.9 billion by the end of 2022. This is the lowest among the 10-member grouping in the region after Brunei.

“The public debt situation remained “sustainable” and “low-risk” of debt distress despite being impacted by the Covid-19 pandemic and other external factors,” said Cambodia Public Debt Statistical Bulletin published recently.

But a booming demand, especially from a growing middle class, has contributed to a sharp rise in Cambodia’s private debt. As such this may not be a matter of concern as a rise in business activity can result in a higher demand for loans. It can be a sign of robust economic activity. But on occasion, it can raise the risk of economic instability. In that way, the rising private debt can be considered a double-edged sword.

According to Anthony Galliano, President of the American Chamber of Commerce (AmCham) in Cambodia, research suggests that when private debt enters the range of 100 to 150 percent of GDP, it hampers economic growth by chipping away at the margin of growth trends, and even worse, if it increases rapidly, it can result in a financial crisis.

“Private debt as a percentage of nominal GDP for Cambodia has historically moderately increased at approximately 10 percent per annum from 2012 to 2019.  From 2019 to 2020, the increase was 29 percent and between 2020 and 2022 it was 20 percent. The escalation till 2019 was partially due to robust economic growth and the bubbling real estate market,” Anthony told Khmer Times.

In 2020 and 2021, policies by the NBC to restructure loans in order to maintain financial stability, support economic activity, and ease the burden of debtors contributed to the rise, he said, adding that since December 2021, the NBC has taken measures to reinitiate provisioning requirements and additionally the central bank has strengthened supervision.

“The discontinuation of accommodative policies instituted during Covid-19, the recent sharp rise in interest rates creating much less supportive financial conditions and curtailing ample and cheap liquidity, the downturn of the global economy, and a cooling real estate market, should result in a peak in the sharp increase in the last five years, and consequently a dip. If required the NBC has a number of tools at its disposal, including raising provisioning requirements, requiring lenders with potential solvency troubles to increase capital and intensifying supervision,” Anthony said.

While briefing the media about the findings of the Article 1V Consultation process in Cambodia, last year, Alasdair Scott, the head of the IMF Mission, also expressed serious concern over the rising private debt.

The IMF Mission noted that restructured loans of private borrowers in Cambodia have gone up to 13 percent of GDP as of June 2022 and non-performing loans (NPLs) have risen to nearly 4.5 percent of the GDP.

The NPLs constituted only 2.1 percent of the GDP in December 2020 and only 1.8 percent in 2019. The Mission attributed the rapid rise in NPLs to the Covid-19 economic woes but at the same time, it urged NBC to take action to control the trend.

“The level of private debt is very high, raising concerns about the drag on the economy if borrowers struggle to meet repayments. Credit growth has outstripped growth in nominal GDP for several consecutive years. The ratio of outstanding private sector credit is notably above those of other countries in the region. Moreover, these numbers do not account for credit issued by unsupervised lenders (such as real estate developers and pawn shops), which could be sizeable,” said the IMF Mission.

“The NBC needs to continue to normalise prudential conditions to pre-pandemic settings so that the financial system is able to withstand future shocks. In May 2020, NBC introduced a policy to facilitate restructuring of loans; since December 2021, it has taken the welcome step of reintroducing provisioning requirements.

It should continue with heightened supervision, including rigorous onsite inspections. It should be prepared to raise provisioning requirements and instruct lenders facing solvency problems to proactively increase capital. The potential for high debt levels to persist emphasizes the importance of implementing corporate insolvency, debt and bank restructuring, and deposit protection frameworks,” it said.

To help rein in credit growth, the Mission urged NBC to complement these measures by gradually restoring monetary conditions to pre-crisis levels. “Minimum reserve requirements on financial institutions should be increased, with the priority to raise the minimum reserve ratio for foreign currency above that for local currency,” the Mission said.

Along with rising private debt, the Mission listed developments in China, tightening of monetary policy by foreign powers, the ongoing Russia-Ukraine war, rise in the prices of commodities and a weakening external demand as some of the current concerns for the country.

But the IMF Mission was happy with the level of public debt in the country. “Cambodia’s public debt remains low and continues to be at the sustainable level,” Scott said.

In the longer term, public spending would have to be increased to cover the rising costs of education, healthcare, infrastructure development and energy demands. The government would also need to address climate change concerns with additional expenditure, it said.

For private debt, the Mission recommended that NBC step up its supervision. “NBC should gradually restore monetary conditions to the pre-pandemic era such as minimum requirement levels for banks,” Scott said.

According to recent media reports, Chea Serey, Assistant Governor and Director General of NBC said that many indicators can determine whether the level of private debt in the banking system is something to be worried about or not. At least three of those are regularly checked by NBC.

The first indicator is debt rate growth. “If the growth rate jumps from 50 percent to 180 percent dramatically, then it’s definitely concerning,” Serey said.

The second indicator is whether the quality of the credit is good or not, referring to the ability of the creditors to pay back their debts. Lastly, the credit diversification of the banks and microfinance institutions is regularly looked at by NBC to see what sectors receive the credits more.

But some industry leaders believe that the private debt size is still at a manageable level in the Kingdom. Vichet Lor, Phnom Penh President of Global Real Estate Association (GRA), told Khmer Times that while the rising private debt is alarming, it is still manageable in Cambodia.

But he insisted that it is important for banks and lending institutions to look closely at their loan policies and procedures in the wake of rising concerns about the size of the debt. “In view of rising concerns, the banks should put in place appropriate steps for assessing the ability of the loanees to repay the debt,” he said.

But he also added that private debt has positive aspects as well. Private debt will push the economic activities and growth of Cambodia because borrowers need to earn more or work more to get extra income to finance their increasing debt, Lor reasoned.

“The increasing economic activity and continued employment spur continued economic growth and expansion. On the other hand, if borrowers are unemployed due to company layoffs or due to business losses, then NPLs will rise,” he said.

“The composition of the loans is also important. If most of the loans are for SME businesses, then it’s ok. If the loans are mostly for consumer products like cars or electronics, then it can be a worrying factor,” Lor said.

But he took exceptions to suggestions that private debt should be controlled by raising the interest rates. “This will not solve the situation but only worsen it amidst rising inflation in the wake of the Ukraine-Russia war,” Lor said.

Ky Sereyvath, Director General of the Institute of China Studies at the Royal Academy of Cambodia, also shared the view that hiking the interest rate was not a good solution. “The private debt, though at an alarming level, is still manageable,” he also said.

Sereyvath called for strict observance of rules and regulations by banks and MFIs while extending loans to private parties. “Debt repayment ability of the customer should be the key,” he suggested.

Meanwhile, credit rating agency S&P’s Country-by-Country Outlook for 2023 forecasted that credit losses for Cambodian banks will increase to about 120 to 140 basis points (bps) in 2023, from about 68 bps in 2021, reflecting additional provisioning costs for higher expected NPLs.

According to S&P Global, foreign parent banks will continue to provide support for Cambodian banks. This would mitigate pressure on funding conditions as a result of rate hikes by the US Federal Reserve and tightening liquidity in emerging markets.

The agency expects “continued brisk credit expansion” in Cambodia in 2023 too, noting that banks have aggressively grown their balance sheets from a low base and amid high GDP growth.

“The recession in 2020 resulted in a temporary slowdown in loan growth, but we believe credit expansion will remain brisk,” it said.

“We believe the risks to the microfinance sector, which accounts for 13 percent of systemwide loans, are elevated, reflecting inherently higher credit risks and more aggressive lending practices,” the S&P report said.

Notwithstanding the risks, Cambodia is growing and the banking system will continue to contribute to this growth in an immense way.

Source: https://www.khmertimeskh.com/501245808/cambodias-ballooning-private-debt-a-risk-or-sign-of-growth/