Thailand
Cambodia: IMF sounds alarm bells over risks of private debt, raising concerns on the economy
DC: An International Monetary Fund (IMF) team led by Alasdair Scott held meetings with the Cambodia authorities for the 2022 Article IV consultation [1] during September 7-20, 2022. At the end of the mission, Scott said that “The Cambodian economy has been recovering, but faces new challenges.
“GDP growth rebounded in the second half of 2021, driven mainly by exports of goods. But this year the economy has been buffeted by developments in China, the slowdown in consumer demand in advanced countries—the US and Europe are significant markets for Cambodian manufactures—and tighter global financial conditions (mainly via external demand, but also funding costs for some financial institutions). Inflation hit 7.8 percent year-on-year in June 2022, following significant increases in fuel and fertilizer costs, although it receded to 4.9 percent in August. Export orders for the second half of the year have weakened, and the real estate market is slowing.
“The authorities have largely continued with crisis policy responses, such as loans and guarantees, tax breaks, wage subsidies and retraining, and cash transfers (while withdrawing some Covid-19-related spending as the health situation improves). The National Bank of Cambodia (NBC) has maintained reserve requirements and the level of the capital conservation buffer, but has ended forbearance on restructurings from July this year.
“Despite the new pressures, the recovery is projected to continue. Real GDP growth is forecast to be 5 percent in 2022, after the strong export performance earlier in the year, and nearly 5½ percent in 2023, supported by the continued recovery of tourism and ongoing policy support, although dampened by external pressures and the impact of rising prices on real disposal income. Inflation is expected to peak this year, be lower in 2023, and decline further thereafter, assuming it remains mostly confined to imported goods.
“The public finances are expected to gradually improve. Spending pressures and lower-than-expected tax revenue resulted in a fiscal deficit of just over 7 percent of GDP in 2021. The deficit is expected to narrow to just over 4 percent of GDP in 2022 with a strong bounce-back in revenues, widen somewhat in 2023, and decrease further thereafter. Public debt-carrying capacity remains vulnerable to further shocks to exports and growth, but risks of external and overall debt distress remain low, so long as public debt is constrained in the future and the increase in private debt is not associated with an increase in contingent liabilities of the sovereign.
“Uncertainty around the outlook is particularly high, and risks are tilted to the downside. The most pressing risks are from rising private debt; conditions in key large economies; and inflation.
“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. Consequently, outstanding private sector credit reached 170 percent of GDP by end-2021, a ratio 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. Restructured loans in June 2022 are estimated to be about 13 percent of GDP, and non-performing loans have already risen to nearly 4½ percent of GDP.
“The NBC needs to continue to normalize prudential conditions to pre-pandemic settings, so that the financial system is able to withstand future shocks. In May 2020, the 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.
“To help rein in credit growth, the NBC should 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.
“Current fiscal plans appropriately balance some continued stimulus in the near term, providing insurance against downside risks to aggregate demand, with steady reductions in the deficit over the medium term. However, given high inflation, wide external imbalances, strong credit growth, and weak monetary transmission, fiscal support needs to be well targeted. Social protection measures should continue to be used to protect the poor against the effects of inflation, but with some offsetting cuts elsewhere (in particular, Covid-19 support measures no longer needed).
Fiscal support should be wound back if there are signs of second-round effects on domestic inflation; additional spending such that a clear reduction in deficits would no longer be likely should be avoided. In case of downside risks materializing in the near term, however, the country currently has fiscal space to provide targeted support.
“Demands on public spending increased during the pandemic and will likely increase further to meet existing infrastructure spending needs, increased demands on healthcare and for education, and climate change adaptation.
Revenue mobilization (including rationalizing exemptions) and diversification are therefore paramount; simplification of the tax system would encourage compliance. A debt anchor in nominal terms, combined with an overall deficit ceiling, would provide a credible framework, especially important as Cambodia seeks to develop a market for sovereign debt.
“The current account deficit has widened significantly, and the external position is estimated to remain substantially weaker than the level implied by medium-term fundamentals and desirable policies. Financial inflows overall have been steady, although investment approvals are noticeably down from previous years. Nonetheless, the exchange rate has remained steady. FX reserves fell slightly in 2021, but are adequate, covering 8 months of projected imports.
“ Structural measures are needed to boost productivity, not only to raise living standards but also to durably restore external balances, given the pegged nominal exchange rate. To this end, the authorities’ efforts, including establishing new free trade agreements and introducing a “One-Stop” mechanism for both domestic and foreign investors under the new Investment Law, are particularly welcome.
“The investment environment will also be improved with continued efforts on governance. The Anti-Corruption Institution adopted its 2020-2025 action plan and implemented key actions, and all but one of the requests by the Financial Action Task Force have been fulfilled. However, some vulnerabilities and governance challenges remain—for example, whistleblower and transparency laws are still pending, and digitization of the asset declaration system should be pursued. In addition, some investigative and monitoring agencies do not have sufficient human and technological resources.
“Data issues complicate policy setting. Macroprudential tools would help to dampen credit cycles, but data are needed on household financial burdens, such as debt servicing to income ratios. Substantially revised GDP data are likely to be released at the start of 2023. Data for imports and exports of gold have been extremely volatile, and a large proportion of short-term financial inflows are unexplained, making external sustainability assessment difficult. The IMF will continue to provide technical assistance to help improve data accuracy, and in many other areas of capacity development.
The IMF team held discussions with senior officials of the Royal Government of Cambodia, National Bank of Cambodia, and other public agencies, as well as a wide range of stakeholders, including representatives of the business and banking sectors, and development partners. IMF