Rising political strife in Cambodia threatens to derail a decade of strong economic growth. The government and opposition must work together to resolve this impasse and reform key institutions.
Rising political strife in Cambodia threatens to derail a decade of strong economic growth. Tensions have gone up after the 2013 elections, when the Cambodian People’s Party retained power but the opposition cried foul. The latter hit the streets, encouraged by growing ranks of politically conscious youth. Workers have also joined the protests, demanding a doubling of minimum wages among other things. This protest in turn has hit the manufacturing sector, especially textiles.
The government and opposition must come together to resolve this impasse and prevent further damage to the economy. Their working together should serve as an opportunity to reform key institutions and take Cambodia to the next level of socioeconomic development.
Strong economic growth in 2013
Since the start of the new millennium, Cambodia’s economy has expanded at a fast pace, with growth averaging about 8 percent a year during 2002–12. Last year was no different, with real GDP estimated to have grown 7.0–7.5 percent. One of the key drivers of the economy is textiles and footwear, whose exports amount to a third of nominal GDP. Exports from the sector rose 22 percent year over year in the first 11 months of 2013 to $5.1 billion. Tourism also continued to flourish last year, with the January–November period witnessing a 5 percent rise in tourist arrivals relative to the whole of 2012. Receipts from tourism currently amount to about 15 percent of GDP, and this could go up as the government tries to promote unexplored parts of the country.
Construction is yet another prominent sector and is a major recipient of foreign direct investment (FDI). While the residential and hospitality spaces dominate construction, infrastructure is fast gaining ground as the government focuses on power generation, oil and gas, and diversification in manufacturing. This strong momentum across key sectors is likely to continue into 2014–16, thereby ensuring growth of 6.5–7.5 percent. However, the current political strife poses downside risks, especially if the protests drag on for the next three to four months. This will dent both textiles and tourism, and likely drag down GDP growth by two to three percentage points.
Hydrocarbons are a potential game changer for Cambodia.
Betting on oil and gas
Hydrocarbons are a potential game changer for Cambodia: The sector is expected to rake in FDI, drive economic growth, and aid public finances. In fact, FDI is already flowing in, with Chevron investing more than $160 million.1 Although commercial oil extraction has been delayed, the company expects commercial production to start by 2016.2 Encouragingly, Cambodia is also planning investments in a refinery in partnership with China’s Sinopec. A major beneficiary of any viable oil and gas production will be public finances. According to the International Monetary Fund, the government is expected to earn about $174 million in revenues annually when production starts, with the figure set to rise to as much as $1.7 billion when production peaks.3
However, the development of the oil and gas sector is not without its challenges. First, the quantum of reserves is not yet clear. While initial estimates had put recoverable crude reserves at around 500 million barrels, it appears post exploration that some deposits will be difficult to tap. Second, lack of an agreement with Thailand has prevented Cambodian exploration in an area in the Gulf of Thailand that is estimated to hold 11 trillion cubic feet of gas and an unknown amount of crude. Third, there are worries about transparency in the government’s management of oil and gas resources. Perhaps a good first step for the government would be to sign the Extractive Industries Transparency Initiative, something it has refused to do so far.
The need to reform public finances
Cambodia urgently needs to reform public finances. In 2013 total tax revenues were $881 million, just above 5 percent of nominal GDP. This figure is much below corresponding levels in developing- and emerging-economy peers and is the main cause of persistent budget deficits. It is also unsustainable in the long term, given the need to invest in infrastructure, health, and education. Transparency is another aspect of public finances that needs addressing. For example, in the budget for 2014, more than $1.5 billion of funds remain unallocated or are placed under “miscellaneous” expenses. Critics allege that this nebulous allotment encourages corruption, something on which Cambodia rates high. In Transparency International’s recent annual corruption index, the country ranks 160 among 177 nations; sadly, it has the lowest rank in Southeast Asia.4
Dollarization’s challenges for the central bank
Prudent central bank regulation in Cambodia faces challenges from high dollarization. A prolonged period of conflict in the 1970s and ’80s, followed by high FDI inflows and tourism in the last decade, has ensured that the US dollar dominates transactions in Cambodia. The dollar accounts for 90 percent of currency in circulation and 95 percent of banking deposits. Foreign investors find this ratio favorable because it helps them avoid exchange rate fluctuations. Dollarization also helps consumers avoid any impact of Cambodian riel weakness on import prices and hence inflation. However, the overwhelming presence of a foreign currency restrains the effectiveness of monetary policy in regulating the banking system and the wider economy. This is particularly true in the current context, where credit growth is high, especially in sectors such as real estate and construction. Regulation of the banking system is also difficult because of the existence of a large informal economy and low banking penetration—only 13 percent of the population has deposits in the formal banking system.
Political differences must be contained
The current bout of political disagreement must not degenerate into irreversible economic damage. The deadlock over minimum wages has carried on for too long. While the government’s offer of $100 per month falls short of the workers’ demand for $160, surely there must be a middle path. Losses from the protests have been estimated at more than $100 million. If the protests don’t end, investor sentiment will be hit hard. This is particularly worrying given that Cambodia faces challenges from competitors in Southeast Asia. For example, after years of isolation, Myanmar is actively courting foreign investors; Cambodia’s low-cost industries, especially textiles, are at risk.
To ensure strong yet sustainable economic growth in the long term, Cambodia needs to focus more on infrastructure, education, health, and the environment. The country also needs to create strong, accountable, and transparent institutions that enable and oversee economic transformation. However, all the above are not possible without critical economic reforms, which can happen only when the government and opposition mend fences and work together. Ironically the current political crisis provides such an opportunity, and both sides should grab it.
EndnotesView all endnotes
- “Chevron talks oil production,” Phnom Penh Post, August 2011.
- Economist Intelligence Unit, Country report: Cambodia, January 2014; “Chevron aims for 2016,” Phnom Penh Post, July 2012
- International Monetary Fund, “Cambodia: Selected issues and statistical appendix,” August 2007.
- Transparency International, “Corruption perceptions index,” 2013.