CAMBODIA CONSULTATIVE GROUP MEETING

JUNE 19-21, 2002

PHNOM PENH, CAMBODIA

MACROECONOMIC AND STRUCTURAL REFORM UPDATE

THE WORLD BANK

I. Introduction

Despite the less favorable international economic environment, Cambodia’s economy has continued to demonstrate resilience. The macroeconomic outcome has been broadly favorable. Economic growth in 2001 was estimated at 6.3 percent. Inflation was close to zero in 2001 and continues to be low so far this year. The budgetary performance continued to improve in 2001. Monetary and external developments were broadly on track.

Progress in implementing structural reforms has been uneven. Since the last CG meeting in June 2001, the Government has made significant progress in some key structural reform areas, including submission of the revised Law on Investment to the National Assembly, completion of bank re-licensing, adoption of the Land Law, establishment of the National Audit Authority, submission of the Forestry Law to the National Assembly, and demobilization of 1 5,000 soldiers. However, the implementation of some important structural reforms has been delayed significantly in the area of governance, in particular, legal and judicial reform, anti—corruption legislation, forestry crime monitoring, and forestry concession restructuring.

To help reduce pervasive poverty, improving public service delivery is essential. The major challenge facing the Government now is to formulate and implement the second generation of reform, emphasizing, in particular, improvements in public financial management and public administration, moving toward good governance, and strengthening of government capacity for poverty- focused policy formulation and implementation.

II. Macroeconomic Developments

Real Sector Developments. Economic growth in 2001 was driven by booming tourism and robust garment exports. Garment production, the key driver of growth over the last several years has leveled off since mid-2001 due to slower external demand. Garment production grew at a robust rate of 27 percent in real terms in 2001, after registering 79 percent growth in 2000. The very high growth rates experienced in 2000—01 are not likely to be repeated due to a decline in external demand, as well as the impact of quota and tariff restrictions to major export markets. Growth in the tourism sector has been maintained.

Table 1: Macroeconomic Indicators, 1998-2001

Source Data provided by the Cambodian authorities

Fiscal Developments. The budgetary outturn was broadly positive. Revenue moderately increased to 11.7 percent 0f GDP in 2001, and total expenditure was contained within budget limits. The current budget surplus reached 1.2 percent of GDP, and the overall deficit was limited to 6 percent of GDP. Progress was made in expenditure reorientation. While outlays for defense and security declined to 3.1 percent in terms of GDP in 2001 from 3.5 percent in 2000, outlays for the tour priority sectors (health, education, agriculture, and rural development) increased to 2.9 percent of GDP in 2001 from 2.3 percent in 2001. So far this year, while higher revenue has been generated by increased taxes on petroleum products and beer, performance was largely boosted by non—tax revenue from the auction of garment quotas and the annual transfer of profits from the National Bank of Cambodia. On the expenditure side, total spending was well within budget targets, and the disbursement of funds for the social sectors was higher than in previous years, but will still need to be accelerated to meet annual targets.

Monetary Developments. Monetary policy in 2001 continued to be prudent. Broad money growth for 2001 was 20.4 percent, due largely to a slowing of private sector credit growth, partly reflecting the on-going bank restructuring process. So far this year, the increase in net foreign assets and broad money has been larger than initially targeted. While growth in private sector credit continued to be modest, it is expected to regain momentum as the bank relicensing process has been completed and economic activity is expected to increase in the latter half of the year. Inflation was subdued at 0.7 percent for 2001, but rebounded to around 3 percent so far this year 20O2 mainly reflecting an adjustment in housing and utility prices.

External Sector Developments. Due to buoyant exports in the first three quarters of 2001 led by garments, the current account deficit was contained at 9.4 percent of GDP (excluding grants). Foreign direct investment remained stagnant. Gross international reserves increased to $627 million (about 3.4 months of imports) as of end-May 2002. The exchange rate has remained stable against the U.S. dollar.

III. Progress in Structural Reform and the Agenda Going Forward

1.  Revenue Mobilization

While progress has been made, revenue mobilization in Cambodia, currently at 11.7 percent of GDP, is among the lowest in the world. The Government needs to step up efforts to substantially enhance revenue mobilization to reduce pervasive poverty, particularly through strengthening of tax, customs, and non-tax administration.

Tax Administration. The following tax and administrative measures have been adopted or are underway: excise taxes on petroleum and beer have been increased: the real regime is being extended to 5 additional provinces; and some initial success in collecting tax arrears has been achieved. Efforts to strengthen the Tax Department need to focus on the steady collection of outstanding tax arrears from the largest accounts, with performance monitored against collection targets. Tax auditing strategy and capabilities need to be enhanced through a comprehensive program.

Customs Administration. Strengthening the enforcement capabilities of the Customs and Excise Department is crucial. In particular, more effective anti—smuggling operations are needed. Following the recent establishment of an anti—smuggling unit in Phnom Penh, similar units need to be established in key border provinces, and inter-agency cooperation needs to be strengthened. Facilitating trade through increased transparency in customs procedures and more effective use of pre-shipment inspection will be needed, in particular by using reconciliation procedures to resolve valuation differences.

Non—tax Revenue Administration. Some initial progress has been made in non-tax revenue enhancement: the proportion of garment export quotas subject to auction has increased; contract terms regarding the sale of entrance tickets at the Angkor temple complex have been revised to improve revenue transfer to the government: and the collection of revenue from the issuance of visas has been strengthened. More transparency and public disclosure regarding the financial terms governing the use of state assets, particularly regarding telecommunications services and the administration of the airports, will be needed.

2. Expenditure Management

Enhancing the effectiveness of public expenditures is key to reconstructing infrastructure, developing human resources, and improving the accessibility of public services to the poor. Building on the improvement made in recent years, the Government needs to: (a) closely link policy, planning, and budgeting: (b) increase key social sector outlays: (c) effectively implement the PAP: (c) strengthen cash management to ensure more even disbursement over the year; (d) strengthen procurement procedures: and (e) effectively move toward decentralization/ deconcentration.

Linking Policy, Planning, and Budgeting. Effective links between policy, planning, and budgeting will be critical going forward. There is a critical need to have an integrated policy, planning, and budgeting process to ensure that expenditures are driven by policy priorities and disciplined by budget realities. Moving toward a medium-term expenditure framework (MTEF) is a promising way of ensuring the close link. The Government is currently developing a MTEF which would initially focus on health and education, in parallel with developing a better balance between policies and resources at the intersectoral level. The MTEF is expected to help with costing the policy actions under the PRSP.

Expenditure Reorientation. Progress has been made in expenditure reorientation away from defense and security toward key social sectors. Despite the recent improvement, spending for key social sectors is lagging behind when compared with the average for developing countries, and needs to be increased significantly to reduce pervasive poverty.

Table 2. Expenditure Reorientation. 1999-2001

*health, education, agriculture, and rural development

Priority Action Programs. The PAP moves budgeting a major step toward the standard developed country model of advance payment, post audit, and program-based budgeting. While its major goal is for PAP agencies to gain access to the full budget allocation approved for them, the implementation of the PAP has been slower than envisaged due to unfamiliarity with the new financial management procedures and insufficient coordination. As a result, release of the quarterly PAP funds has often been delayed. The effectiveness of the PAP needs to be enhanced through training managers of operational programs on the new financial management and procurement procedures, and internal audit, and by strengthening coordination between the Ministry of Economy and Finance and PAP agencies and provinces.

Improving Cash Management Capacity. Cumbersome budgetary procedures, deficiencies in overall cash management, and lack of effective coordination have adversely affected the implementation of the budget, resulting in large disbursements at the end of the year and thus undermining the credibility and effectiveness of government expenditures. The Government needs to strengthen the recently established Cash Management Unit with a view to ensuring effective coordination between the treasury and budget departments.

Strengthening Procurement Procedures. Currently, public procurement is governed by the 1995 Sub-Decree Governing Public Procurement and a detailed set of regulations. However, the Sub-Decree has not been effectively followed. The Government recently issued a Prime Minister’s Decision requiring full implementation of public procurement procedures in the four priority ministries (Health, Education, Agriculture, and Rural Development) for certain categories of expenditures. The Government needs to further extend the coverage of procurement procedures to include additional line ministries and goods and services. Capacity building of procurement staff at MEF, line ministries, and provinces will also be critical to strictly enforcing the 1995 Sub-Decree and related regulations.

Decentralization. The assignment of fiscal responsibilities to different levels of government determines the responsiveness and incentives in the provision of public services according to the diversified needs in different regions. Cambodia is moving toward decentralization. The creation of 1.621 commune councils in February 2002 marks the first step in a process of decentralizing implementation authority and expenditure management to elected local governments. The introduction of local commune councils puts inter-government resource allocation and management issues on the agenda, requiring line ministries to reconsider their roles and the design of ongoing service delivery programs. However, the institutional and policy framework for the decentralization process is yet to be clearly defined, notably regarding the establishment and funding of the Commune Revenue Fund (CRF), the design of commune expenditure and financial management procedures, the structure of a local own-source, revenue system, and the integration of decentralization initiatives at the commune level with progress on sectoral deconcentration to provinces.

3. Forestry Management

Forestry reform moved ahead unevenly during 2001/2002. On the positive side, the Government made important progress with the submission of comprehensive forestry legislation to the National Assembly in August 2001.Similarly, in December 2001, the Prakas of the Ministry of Agriculture. Forestry and Fisheries that made effective the planning and approval requirements of the Sub-Decree on Forest Concession Management was an important positive development. Other important progress was achieved with wide consultations on community forestry and with circulation of a draft forest policy. Unfortunately, however, progress was slow in the introduction of effective forest management, and some worrisome problems emerged in terms of illegal logging and the effectiveness of the Government’s forest crime monitoring. The Government needs to redouble its reform efforts in forestry management.

Forest Legislation. The draft Forestry Law submitted to the National Assembly marked the culmination of several years of discussion, drafting and consultation involving assistance from numerous agencies and other stakeholders. The draft, which is now awaiting action at the National Assembly, would establish a national forest estate, authorize a comprehensive forest administration, and provide for a range of forest management arrangements including concessions and community forestry. The draft is consistent with the recently approved Land Law and resolves jurisdictional ambiguities regarding the authorities of the Ministries of Environment and of Agriculture, Forestry and Fisheries.

Forest Crime Monitoring. Illegal logging has continued to be a problem in both concessions and protected areas. As documented by Global Witness, large-scale illegal logging involved concessionaires, military elements, and others. The Government’s success in suppressing and prosecuting illegal logging has been rather limited, and particularly disappointing have been problems in crime monitoring and detection. Compounded by problems with the mobilization and delivery of technical assistance to the Forest Crime Monitoring Project, efforts by the Government have been limited and the resurgence of widespread illegal logging has not been duly recognized. Efforts of the Department of Forestry and Wildlife, either through crime monitoring efforts or through routine management activities, to independently detect large-scale illegal logging, were not effective. Moreover, responses to well documented reports provided by Global Witness and others have not been adequate.

Forest Concession Restructuring. Developments in concession forestry were slower than hoped and reflect the strength of entrenched interests, the need for determined multi-sectoral leadership and capacity limitations. In the fall of 2001, logging operations for several concessions were approved on the basis of permits granted in 2000. None of these operations were guided by approved management plans and environmental and social assessments, but the approvals were justified on the basis that the permits granted earlier applied to the calendar year. This was clearly inconsistent with the provisions of the Sub-Decree on Forest Concession Management, and was hard to reconcile with the Government’s commitment to requiring adequate plans and controlled operations and to suspend or terminate non—performing concessions. The Government recently cancelled three concessions.

The Government issued in December, 2001 a Prakas of the Ministry of Agriculture. Forestry and Fisheries that halted logging on December 31, 2001 and-reaffirmed the planning and approval process requirements of the Sub-Decree on Forest Concession Management. In anticipation of the volume of’ felled logs that would remain in concession areas-after the cessation of logging, the Prakas specified that log transport following January 1, 2002 would be permitted only after full inventories of logs by the Department of Forestry and Wildlife, receipt of full royalty payments, and approval of a log transport plan, all intended to assure that illegally felled logs did not become commingled with logs harvested before the December 31 deadline.

An inventory was conducted, indicating that nearly 100,000 cubic meters of logs were in concessions and transport was suspended until early March 2002. At that time, despite assurances that log transport would be carefully controlled and that the Department of Forestry and Wildlife was exploring technical options (such as use of optical barcodes), log transport was approved and logs began to move, sometimes at night, without public notification and without detailed plans. It has later been clarified that the approvals were granted within the scope of the December Prakas, partly because of concerns about log degradation and value loss. Approval is said to have been granted for movement of approximately 45.000 cubic meters and royalties were reportedly received on some 55.000 cubic meters. It was revealed that only a part of the collected royalties has been received in the National Treasury and the remaining balance having been improperly disbursed. It was later showed that most of this was for genuine obligations of Government, but that according to accepted budgetary procedures should have been channeled through the Ministry of Economy and Finance. The Government is taking remedial measures.

The Government needs to target the remainder of this year to reach defined targets in the concession system restructuring process. The recent cancellation of three concessions on the basis of well documented defaults is a positive development, but there are many other instances of similar nonperformance. The Government needs to pursue its remedies, including cancellation, against non-performing concessions and demand greater urgency and speed from remaining concessionaires in the preparation and submission of forest management plans and environmental and social assessments. Logging must not be permitted to resume in the absence of complete and adequate plans, including medium-term and annual operation plans as well as long term plans. The Government needs to move ahead with consultations on management plan evaluation criteria, introduce credible supervision of concession areas, and resume and either finalize or terminate contract restructuring negotiations with remaining concessionaires.

It is time for the Government to much more realistically and innovatively approach planning for the future “post-concession” forestry sector. Since 1999, the concession system has declined from 40 concessions covering more than 6 million hectares to 15 concessions on less than 3 million hectares. Given the past record of abuse, over-harvesting and disinterest in sustainable management, it is unlikely that the future concession system will involve more than half of either current numbers or current area. It is unrealistic and undesirable for these areas to be left unused and unallocated. In a few relatively small instances, resources may, on the basis of criteria described in the Sub-Decree on Concession Management, be found suited to retendering as concession areas. More commonly alternative institutional arrangements, including community forestry, various forms of Government management (such as tendering of short term cutting rights on the basis of long term management plans), protection, conversion or other arrangements, will be needed.

4. Civil Service Reform

Strategy to Reform Civil Service. The Government has made important progress in civil service reform since the last CG meeting. The Council of Ministers approved a Strategy to Reform Civil Service (SRCS) in late 2001. The SRCS provides an overall direction and framework to guide reform activities, covering a broad range of issues regarding civil service reform, including: (i) the size, composition and remuneration of the civil service; (ii) a classification and remuneration system of civil servants; (iii) change management through a Priority Mission Group program; (iv) human resource development and management; and (v) organization and functions of the civil service towards improved service delivery.

One of the key developments was the adoption of a medium-term pay and employment scenario in 2002-2006. The main thrust of the scenario comprises: (i) raising average base salaries across the service from $24 per month in 2001 to $52 per month in 2006; (ii) increasing education employees by 14,000 (16%) and reducing non-education employees by 13,500 (18%) between 2001-2006 thereby maintaining constant the total level of employment: and (iii) largely self-financing the wage bill, with some subsidization through the priority mission group scheme. In addition, the Government is enhancing its current allowance system to provide allowances to compensate for special conditions associated with selected positions, such as risk, remoteness, and other difficulties. Allowances of $200 with the introduction of Category AA will also complement take-home pay of some 500 senior officials. The Government adopted a new classification and remuneration regime, and started implementing a new structure of remuneration by improving salaries on average by 38% in 2002.

Priority Mission Groups. One important element of the SRCS is the introduction of the priority mission group (PMG) program. The creation of PMGs aims to offer a tool to help ministries and councils accelerate their reform agenda through mobilization of a highly motivated cadre of civil servants who can rise above current civil service performance standards to implement key development programs with greater energy, skill, and dedication. In particular, the program is seen as a means by which to kick-start crucial anti-poverty initiatives. Notable progress has been made to articulate a framework for the PMG program. The Government aims to manage the PMG program to be flexible in order to accommodate the needs of individual ministries and potential external partners. According to the current plan, the Government would select up to 1,000 PMG members in 2002 and additional 500 members each year from 2003 and 2005. Their main task would be to implement the Government’s key reform agenda such as Governance Action Plan, SEDPII and PRSP, and to improve the delivery of public services. PMG members will be paid incentive allowances financed by the Government, aimed at raising on-the-job performance that is to be clearly specified in their contracts. The amounts of incentive allowances would be $150 for grade A, $100 for grade B, and $50 for grade C.

The PMG program could be a useful stimulus to civil service performance if it is well designed and tightly focused. The primary objective assigned to PMGs should be to catalyze change rather than to become mechanisms for modest pay reform. PMGs need to act primarily as change catalysts, working as small teams from within individual ministries to trigger better management practices and more effective approaches to service delivery. This role is best suited for the relatively small number of staff to be mobilized in PMGs. It also makes sense to carry this out on a limited, pilot basis in a few critical areas.

Toward a More Fundamental Civil Service Reform. Although the Government has taken an important initial step toward reform by laying out a multi-year framework and providing moderate pay raises to civil servants, there remains a concern as to whether the current scenario would go far enough to address the low pay problem, a fundamental issue for Cambodia’s civil service reform. It is widely recognized that the most serious obstacle to improving civil service performance is the lack of adequate incentives to motivate and retain talented, capable staff within Cambodia’s public administration. Extremely low remuneration across grade levels saps morale throughout the civil service and leads to high absenteeism, corruption and, particularly for skilled professionals, brain drain.

The Government’s current scenario proposes some employment redistribution but no reduction, along with modest pay improvements. This degree of pay raise and decompression does not appear go far enough, and would leave the civil service with largely similar incentives. In particular, the vertical decompression under the current scenario is not sufficient to retain and motivate senior level officials to do their assigned work, which is the critical gap in formulating and implementing reform programs.

To address the low pay problem, the Government could consider a combination of the following two options:

•           Self-financing: One option involves a modest cut in employment over the next five years to release funds for salary relief to achieve competitiveness at higher civil service levels. This approach would be self-financed within the expenditure envelope

•           Donor financing: An alternative approach would be pooling donor resources now applied to salary supplements for a carefully designed program of budget support and civil service management improvements. The basic premise of this approach is that rationalization of the current ad hoc salary supplementation could form an important pillar of a major program of civil service adjustment that could be put in place on a sunset basis.

Building on activities already underway or planned, the Government is now engaged in developing an action plan to accelerate the civil service reform and prepare for follow-up measures to the SRCS now being implemented. This plan consists of a program of analytic work. I including functional analysis, labor market and pay comparator studies, development of departure and safety net programs for employment transition, and analysis of possible financing options for civil service pay improvements. The result of the program would be a refined medium-term civil service reform plan that can be implemented in the post-electoral period. The common objectives of this action plan are to: (a) improve civil service pay so that it offers a broadly competitive wage in the labor market; (b) ensure that the size and shape of the civil service are financially sustainable and meet organizational requirements (needs and means); (c) ensure that pay proposals have an agreed financing plan; and (d) ensure that the Government has the administrative machinery needed to implement its strategy (e.g.. separation mechanisms, training, public information campaign taking account of political, social, and other requirements).

5. Good Governance

Progress has been made in implementing the Governance Action Plan (GAP) and establishing a National Audit Authority but progress has been slow in legal and judicial reform and anti— corruption legislation.

Implementation of Governance Action Plan. The Government held a National Forum in December 2001, chaired by the Prime Minister, to launch a dissemination campaign of GAP and anti-corruption diagnostic study for broad stakeholders in the Government and civil society. The Forum gathered ministers, senior officials from all over the country, and external stakeholders. It was followed by four workshops in provinces targeting public officials, external stakeholders NGOs, academia, and the press) in the first half of 2002. The Government started implementing GAP since its official adoption in March 2001 .A number of key actions have been already completed, and several others are being implemented. Such key actions include, among others, the establishment of a National Audit Authority, the promulgation of a new Land Law, launch of a full demobilization program, the establishment of commune councils, in addition to several achievements in civil service and public finance reform. The progress of actions in GAP was reported to the public in the Government’s biannual GAP Progress Reports in June and December 2001. For the GAP to evolve into a more effective, pragmatic instrument to strategically plan, monitor and coordinate wide-ranging governance reform, objective and monitorable indicators and realistic benchmarks need to be set on a consensual basis. Also the GAP reports can serve better as a planning and coordinating tool if they include information regarding financing requirements (costs) for each action in GAP. Such information will help managers and donors strategically plan future actions within available resource envelopes and better coordinate donor activities. The forthcoming GAP II needs to address these issues

National Audit Authority. The Government has made progress towards operationalizing the national audit authority (NAA). In the past Year, heads of NAA were appointed, new premises were obtained, the 2002 National Budget allocated a budget for NAA, and staff was recruited. Staff training is now under way. Audit activities are expected to start in 2002 from the budget realization statement for FY2001, which would be followed in 2003 by audits of NBC, MEF, Ministry of Posts and Telecommunications, and other ministries and public agencies. A major challenge is to strengthen NAA to carry out its mandate under the Audit Law. Also, modification of the role of the Department of Financial Inspection at MEF would be required as the Department used to be responsible for audits in all government institutions.

Legal and Judicial Reform. Progress in legal and judicial reform has been very slow. After a long delay, the Government has taken steps in 2002 to formulate a draft Legal and Judicial Reform (LJR) Strategy and a corresponding LJR action plan. Following deliberations since March 2002, the Council of Jurists completed its formulation of a preliminary draft legal and judicial reform strategy and corresponding action plan in May 2002. These documents were then provided to the Supreme Court and the Ministry of Justice for their review and comments. In addition, the new Council for Legal and Judicial Reform has just been established. Made up of senior representatives of all key Government institutions directly implicated in Cambodian legal and judicial reform activity, one of this Council’s first responsibilities will he to help ensure that consensus is reached within Government on the draft strategy and action plan. Once this consensus is reached, the Government is expected to send the draft documents to the donor community and others for comment, by around September 2002.

Anti-corruption Legislation. Little progress has been made in addressing anti-corruption. There were three separate draft laws available on anti-corruption. Legislation to fight corruption needs to be pursued urgently. The Government is urged to take such action within a clearly defined timeframe by carrying out consultations of the draft law to build a broad-based consensus.

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