COUNCIL FOR THE DEVELOPMENT OF CAMBODIA (CDC)

2.3 MONETARY AND FISCAL PERFORMANCE

71. During the second mandate, 1998-2003, a prudent monetary policy and fiscal discipline pursued by the Royal Government has been successful in maintaining low inflation and stable exchange rate and in supporting economic growth. Monetary developments in 2003 reflected the Royal Government’s efforts to maintain a stable fiscal position despite political uncertainty. Banking liquidity in 2003, as measured by M2, rose 15 percent after having increased by 31 percent in 2002. The major sources of liquidity growth included an increase of 15 percent in residents' foreign currency deposits and 18 percent increase in currency held outside banks. Net foreign assets increased moderately while net domestic assets of banks rose significantly. The increase in NDA was due to a surge in credit to the private sector, which grew by 27 percent or US$72 million in 2003.

72. Monetary stability was temporarily disrupted in April 2003 because of the issuance of treasury bills and the injection of CRs into the economy that pushed down the value of the Cambodian CR against the US Dollar. The CR depreciated slightly, by 2 percent, against the dollar but stabilized quickly at 4,000 CRs. Monetary stability was quickly restored, and overall the exchange rate remained stable during 2003 at around CR 3,995-CR 4,050 to the dollar.

73. Balance of payments: The overall balance of payments deteriorated in 2003, with the current account deficit increasing to 10.2 percent of GDP reflecting the impact of higher petroleum prices and lower tourist arrivals and foreign direct investment due to SARS and political uncertainty. The growing fiscal imbalance was linked to the depreciation by 2 percent of the CR to the US dollar during April – May 2003, with official reserves declining by 10 percent in July 2003 as a result of the interventions in the market by the National Bank of Cambodia to support the CR. Improved fiscal control following the July 2003 elections has encouraged the gradual return of foreign currency deposits, resulting in gross official reserves being increased from US$663 million in 2002 to US$ 737 million in 2003 .

74. The external balance is expected to slightly deteriorate in 2004 because of the increases in petroleum prices that have risen to more than 50 US$ a barrel in 2004. As a result, the current account deficit (excluding transfers) is expected to increase from 10.2 percent of GDP in 2003 to 10.8 percent of GDP in 2004. However, together with the expected increase in foreign direct investment due to improved political stability, gross international reserves are expected to increase to US$782 million, or 2.8 months of imports, by the end of 2004.

75. Agreement on debt rescheduling with the U.S. and Russia are expected to reduce amortization payments, but could potentially result in increased debt obligations. Cambodia’s external debt repayment will have significant impact on budget execution and thereby on poverty reduction goals. By 2008, after rescheduling of the pre-1993 obligations, Cambodia's external debt is estimated to be about 48.9 percent of GDP, and debt service charges will equal 2.6 percent of exports of goods and services. The fiscal burden of the debt is relatively heavy in view of the low revenue to GDP ratios. The Royal Government will be pursuing a prudent external debt management policy and will strictly avoid non-concessional financing in the near future.

REVENUES

76. During the second mandate of the Royal Government, 1998-2003, progress in the implementation of structural reforms, in particular in revenue administration and public expenditure management, has yielded remarkable results. Domestic revenues steadily increased from 8.1 percent of GDP in 1998 to 10.5 percent in 2001 and 11.1 percent of GDP in 2002. In 2002, total domestic revenues collected had increased to 1,744.1 billion CRs (US$ 445.2 million) from 1529.4 billion CRs (US$ 389.8 million) in 2001 -- an increase of 14.0 percent. The domestic revenues in 2002, consisted of 1,227.2 billion CRs (US$ 313.2 million) in tax revenues, 500.6 billion CRs (US$ 127.8 million) in non-tax revenues, and 16.3 billion CRs (US$ 4.2 million) in capital revenues from privatization and other sources.

77. In 2003, however, the momentum in revenue growth had slowed due to General Elections related uncertainties, outbreak of SARS in the region, the Iraq war, and continuing inefficiencies in revenue collection. In 2003, the total revenues collected, 1,764.6 billion CRs (US$ 442.9 million), consisted of 1220.1 billion CRs (US$ 306.3 million) in tax revenues, 513.1 billion CRs (US$ 128.8 million) in non-tax revenues, and 31.4 billion CRs (US$ 7.9 million) in capital revenues.

78. While the total amount of domestic revenues collected increased slightly in 2003 to 1,764.6 billion CRs from 1744.1 billion CRs in 2002 -- an increase of just over one percent -- domestic revenues as a percent of GDP declined from 11.1 percent of GDP in 2002 to 10.5 percent of GDP in 2003. Tax revenues declined from 7.8 percent of GDP in 2002 to 7.3 percent of GDP in 2003, while non-tax revenues fell from 3.2 percent to 3.1 percent of GDP (Table 2).

79. Over the last five years, the Royal Government has taken a number of measures to enhance revenue collection and to strengthen public financial management. Some of these measures have included:

Improving enforcement of the 10 percent tax on entertainment services.
Implementing a stamp system for taxes on cigarettes.
Establishing a Large Taxpayers Unit (LTU), with direct tax payment by cheque or transfer to the National Treasury accounts at the NBC for the largest taxpayers.
Reducing the number of tariff bands from 12 to 4 and lowering the maximum tariff rate to 35 percent, with associated increase in excise rates in the context of tariff restructuring.
Treating all diesel sales as final sales for VAT purposes.
Expanding VAT coverage to include 150 additional firms.
Strengthening inter-agency cooperation to reduce smuggling.
Reinforcing procedures to collect tax and non-tax arrears, especially the arrears on telecommunications and from state assets.
Improving collection of visa fees and introducing sticker visas.
Reviewing the contract on the sale of tickets to the Angkor temple complex.
Establishing a taskforce of the officials from the MEF and the line ministries to serve as a monitoring mechanism for leases of state assets and increase efforts to collect arrears and payments due on leases of state assets.
Developing an inventory of state assets.

PUBLIC EXPENDITURE

80. During its second mandate, the Royal Government has vigorously implemented its fiscal reforms program and a stringent budget management has kept public expenditures in line with revenue collection to achieve macroeconomic stability. A prudent implementation of Royal Government's fiscal policy has been key to ensuring price stability. Specific actions taken by the Royal Government to improve public expenditure management have included:

Removing ghost workers and ghost soldiers from civilian, defense and security payroll.
Improving spending priorities by providing adequate funding for spending on social and economic sectors, such as health, education, agriculture and rural development.
Improving the implementation of the Priority Action Program (PAP) to increase budget disbursement to the priority sectors.
Increasing public investment in rural infrastructure.
Repairing and maintaining national roads and bridges and strengthening institutional capacity.

81. Over the last five years, overall, the Royal Government has managed to contain total expenditure below targets, thus minimizing the need for domestic financing. Through out this period, total current public expenditures were lower than total domestic revenues collected both in nominal terms and as a percent of GDP. Total current expenditure constituted 8.0 percent of GDP in 1998, 8.35 percent of GDP in 1999, 8.8 percent in 2000, 9.7 percent in 2001, 10.05 percent in 2002, and 10.5 percent in 2003.

82. The composition of expenditures on defense and security and the civil administration has changed significantly over the 1998-2003 period. Public expenditures on defense and security have declined from 3.9 percent of GDP in 1998 to 2.45 percent of GDP in 2003, while expenditures on civil administration have increased from 4.1 percent of GDP in 1998 to 8.0 percent in 2003.

83. In 2002, the total expenditure (budget out-turn) was 2963.2 billion CRs (US$ 756.3 million), which included 1574.9 billion CRs (US$ 402.0 million) on current expenditures and 1388.3 billion CRs (US$ 354.3 million) on total capital expenditures.

84. The composition of the total current expenditure of 1,574.9 billion CRs in 2002 on civil administration, defense and security, and interest on loan, was as follows:

Expenditures on the civil administration totaled 1,140.5 billion CRs (US$ 290.1 million), representing 72.4 percent of total current expenditure.
Expenditures on defense and security totaled 406.7 billion CRs (US$ 103.8 million), representing 25.8 percent of total current expenditure.
Interest on loans totaled 27.6 billion CRs (US$ 7.0 million), representing 1.8 percent of total current expenditure.

85. In terms of changes in the composition of the total current expenditure in 2002, actual expenditures for:

Defense and security declined by 2.5 percent from the 2001 level.
General administration declined by 7.5 percent from 2001 level.
Social sectors increased by 27.2 percent from 2001 level. The ministries included in the "social sector" are: Information; Health; Education; Culture and Fine Arts; Environment; Social Affairs, Labor and Vocational Training; Public Worship and Religion; and Women and Veteran Affairs. The expenditure by the Ministry of Education increased by 36.5 percent and the Ministry of Health by 26.2 percent over the 2001 levels.
Economic sectors increased by 6.6 percent from the 2001 level.

86. In 2003, the total expenditure (budget out-turn) was 2946.5 billion CRs (US$ 739.6 million), which included 1,758.1 billion CRs (US$ 441.3 million) on current expenditures and 1,188.4 billion CRs (US$ 298.3 million) on total expenditures.

87. The composition of total current expenditure of 1,758.2 billion CRs on civil administration, defense and security, and interest on loan, was as follows:

Expenditures on the civil administration totaled 1,347.1 billion CRs (US$ 338.1 million), representing 74.7 percent of total current expenditure.
Expenditures on defense and security totaled 411.0 billion CRs (US$ 103.2 million), representing 23.4 percent of total current expenditure.
Interest on loans totaled 34.1 billion CRs (US$ 8.6 million), representing 1.9 percent of total current expenditure.

88. In terms of changes in the composition of the total current expenditure in 2003, actual expenditures for:

Defense and security increased by 1.1 percent from the 2002 level;
General administration increased by 33.7 percent from 2002 level;
Social sectors increased by 5.6 percent from 2002 level. The expenditure by the Ministry of Education increased by 3.7 percent and the Ministry of Health by 5.2 percent;
Economic sectors increased by 4.9 percent from the 2002 level.

89. The public expenditure level in 2003 has risen because of higher than planned General Elections related expenditures and payment of compensation for losses to Thai enterprises arising from violent demonstration in Phnom Penh in early 2003. The higher public expenditure level and lower than expected domestic revenues resulted in the fiscal deficit (excluding grants) of 7.0 percent of GDP in 2003. To ensure that this imbalance is corrected, the Ministry of Economy and Finance will be taking the following actions:

strengthen the role of the Cash Management Committee (CMC);
establish a Taskforce on non-tax revenue collection to ensure full transfer of non-tax revenue to the budget;
improve revenue collection by enhancing customs and tax administration, combating smuggling and recovering arrears;
contain current and capital government spending strictly to the budgeted amount;
increase transparency of signed contracts;
constrain domestically financed capital spending; and
ensure effective implementation of PFM reform.

90. Attaining fiscal sustainability by narrowing the primary deficit to below 2 percent of GDP is a challenge for the RGC. The Royal Government recognizes that both expenditure restraint in non-priority areas and the collection of additional revenues are needed, especially if domestic arrears are to be reduced over the medium term. To reduce budget deficit the Royal Government will ensure substantial expenditure compression, while increasing revenues to at least 11.9 percent of GDP in 2004. This will require additional tax policy measures to raise an amount equal to about 0.8 percent of GDP.