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Poor prognosis for Cambodia's ailing economy

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24-Aug-2005
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Investors need reassurance that politicians are willing to, and capable of, meeting their commitments, writes Alan Boyd

  MONTHS of political upheaval have weakened foreign investor confidence in Cambodia's system of government so greatly that global development agencies now doubt its ability to nurse the ailing economy through deteriorating external conditions.
With a September deadline looming for ratification of World Trade Organisation (WTO) membership, the new coalition under Prime Minister Hun Sen faces a credibility crisis that could nullify any benefits from enhanced access to global markets.
Hopes that the resumption of parliamentary sittings after a 12-month impasse might bring investors back have dissipated in the face of an aggressive power grab by Hun Sen that has alienated the main opposition faction, shredded the constitution and jeopardised the monarchy.
"To my mind there is no longer a question purely and simply of reforming to keep the economy afloat. We have moved on to a point where investors need reassurance that the politicians are willing to, and indeed capable of meeting their commitments to their trading partners under the WTO," said a trade analyst at a foreign embassy in Phnom Penh.
Hun Sen's Cambodian People's Party (CPP) formed a coalition last month with the royalist Funcinpec faction, ending a stalemate that began when the CPP failed to win an outright victory in the 2003 general election and refused to accept the outcome.
Funcinpec joined the CPP after being given a share of cabinet posts, and Hun Sen then moved to quash the only other tangible threat to his leadership by accusing the opposition Sam Rainsy Party (SRP) of being behind an unsubstantiated coup plot aimed at overthrowing the government.
Shut out of the National Assembly law-making committees, the SRP's leaders have mostly gone into hiding amid reports of threats to their lives and a series of physical attacks on rural legislators.
Disillusioned over the constant bickering and miffed at not being consulted by Hun Sen, revered monarch King Norodom Sihanouk flew into exile in China, though he later reneged on a threat to abdicate. Sihanouk is expected to return home in late September and may be the only figure capable of smoothing the tensions.
The National Assembly reconvened just in time to approve Cambodia's membership to the WTO, which had been accepted by the global trading body at a meeting in Cancun, Mexico, last September.
Ratification was to have been completed in March, but the government was unable to act because of the political paralysis. It was granted a six-month extension that expires at the end of next month.
Without ratification, Cambodia will lose crucial access to international textile and garment markets once the existing quotas system is phased out next year, removing its competitive advantage against producers in China, Sri Lanka, Mexico and India.
Cambodia's 200 garment factories pay their workers only US$40-$50 a month, well below comparable rates in Asia and Latin America, but have higher port handling charges and pay more for raw materials, transport and electricity. As it is one of the two remaining least developed countries (LDCs) in the region -- together with Laos -- Cambodia already gets special treatment under the generalised system of preferences (GSP) and most favoured nation (MFN) schemes.
Almost 30 countries offer MFN/GSP privileges; however, these will not be available indefinitely. Even WTO membership may not provide the expected buffer unless there is a deeper political commitment.
In a report released this month, the International Monetary Fund (IMF) warned that Cambodia's garment manufacturers would probably continue to lose business to China, whose clothing is already 20% cheaper. Hundreds of European and North American firms are relocating to China to take advantage of the quota shakeup, offering even greater efficiency gains and lower production costs due to bigger economies of scale.
"It will take some time before Cambodia's exports could recover, even if all identified reforms are undertaken. Cambodia could earn some time if the US takes recourse in either the so-called 'product specific' safeguard against Chinese imports, available until 2013, or the 'special textiles' safeguard, which expires in 2008," the IMF report noted. "However, it would be highly risky for the government to formulate its economic strategy on the uncertain assumption that the US will adopt either of these two options."
There are wider economic ramifications as the clothing industry last year accounted for more than 90% of all Cambodia's export earnings, mostly in US and European markets, while providing a livelihood for a quarter of a million people.
Shipment value has soared from $28 million in 1995 when Cambodia was still struggling to rebuild its ravaged economy after more than a decade of civil war, to $1.5 billion in 2003. A key factor was the implementation of a 1996 bilateral trade agreement with the United States that in effect reduced the average US tariff rate for Cambodian garments from 50-70% to 10-20%, boosting US imports from $1.0 million in 1996 to $1.1 billion in 2003.
But Cambodia's overall export performance has been declining since the United States began offering preferential access to Latin American nations under trade agreements and brought other low-cost Asian producers such as Vietnam into the MFN/GSP schemes.
Agriculture, which employs 75% of Cambodia's workforce, is operating well below the potential. While industrial employment averaged growth of more than 43% a year from 1997-2001, the farming sector managed only 2.0% because of low productivity, complex land-ownership laws and inadequate infrastructure.
International aid, mostly from Japan, Australia and Western Europe, accounts for 12% of gross domestic product (GDP), but commitments are waning as the government fails to heed reform pressures. In any case, most has been earmarked for technical assistance.
Foreign direct investment has been falling steadily since 1999, and global development agencies have forecast that it will not return until the political and investment environments have been improved through sweeping bureaucratic and institutional reforms.
The World Bank identified Cambodia as one of the most corrupt and inefficient countries in Asia in a study released last week, noting that market impediments had left labour productivity 62% below industry levels in China and even 10% below those in Bangladesh.
"To benefit from [WTO membership], the Cambodian government must implement reforms to decrease corruption, strengthen the rule of law, and build the institutions that will attract businesses and allow them to flourish in the global economy," the report stated.
Corruption in Cambodia is endemic, with "unofficial payments" there ranking the highest among countries analysed by the World Bank. The regulatory system is laborious and costly; import clearances require 45 separate documents and can take months.
WTO commitments will require the government to adopt 46 individual pieces of legislation, ranging from judicial reform to trade-related property rights. Though Cambodia appears likely to make the deadline, there is widespread skepticism that these edicts will be properly enforced.
The latest reforms package, belatedly passed by the National Assembly after it reconvened this month, did not address underlying structural defects and has probably come too late to avert a drastic economic slowdown. With Asian growth in general expected to level off as higher oil prices bite, the IMF forecast growth of only 1.9% for Cambodia next year, when the garment quotas are phased out, and said the medium-term outlook was grim. GDP is expected to expand by 4.3% this year, compared with 5.2% in 2003.
"Even under the best-case scenario, growth could reach the annual target of 6.0-6.5% only by 2009. This achievement presumes that various challenges, including those noted in this statement, are properly met," the IMF cautioned. "Otherwise, a recovery from the negative shock of the quota elimination may not be possible, and growth could be limited to 2-4% annually in the medium term."
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