Cambodian Economy: Charting the Course of a Brighter Future - A Survey of Progress, Problems and Prospects

3. Macroeconomic Performance – Historical Trends and Key Features of Structural Adjustment

51 Chapter 3 Macroeconomic Performance – Historical Trends and Key Features of Structural Adjustment 3.1. Phases of Economic Growth Since 1989 Cambodia has embarked on a series of reforms to replace central planning with the fundamentals of a market economy. These include the introduction of private ownership of property, rapid price and trade liberalization, current account convertibility, the opening of domestic markets to entry by private businesses, privatization of stateowned companies, demonopolization of industries and services, and the reform of accounting standards, the tax system, the legal system and the financial sector. Economic development in Cambodia can be divided into three distinct phases: • The rehabilitation phase, 1989-1998; • The reconstruction phase, 1999-2003; • The economic take-off phase, 2004-2008; The rehabilitation phase, 1989-1998: The rudiments of a market economy were established, with the introduction of private property, privatization of state-owned companies and decollectivization of agriculture, thus paving the way for national reconciliation and the general elections in 1993. However, efforts to implement market reforms were undermined by macroeconomic imbalances caused by the following factors (World Bank, 1992): • Economic liberalization starting in 1989 acted to hinder revenue mobilization. Privatization of State-Owned Enterprises (SOEs) and enterprise reform combined with price and trade liberalization slashed economic rents formerly captured by the public sector enterprises. This loss of revenue was not made up by fiscal revenues mobilized from the emerging private sector. The contribution made by public enterprises to budget revenues fell from 36% of total expenditure in 1989 to 22% in 1991. The introduction of new taxes made only a small contribution to the budget. Non-tax revenue declined from 5.5% of budget expenditure in 1989 to less than 1% in 1991. 52 However, elimination of customs duties exemptions increased customs revenues from 8.5% of expenditures in 1989 to 37% in 1991; • On the expenditure side, removal of price control considerably increased the unit cost of the goods and services procured for operations and investments. The government’s policy to protect wages and defense expenditures crowded out public investment and operations and maintenance. Their share in the budget declined from 41% in 1989 to 16% in 1991; • The elimination of Cambodia’s credit facility under the 1986-1990 trade and payments agreement with the Soviet Union. Commodity aid received under this agreement financed 15% of budgetary expenditures in 1989. Humanitarian assistance from donors amounted to only US$20-30 million a year in 1991-92. Box 3.1. The “Washington Consensus” The term “Washington consensus” consists of 10 principles governing the conduct of macroeconomic policy: • Fiscal policy discipline to avoid inflationary pressure and flight of capital. • Redirection of public spending from subsidies (“especially indiscriminate subsidies”) toward the broad-based provision of key pro-growth, pro-poor services (primary education, primary health care, and infrastructure investment). • Tax reform broadening the tax base and adopting moderate tax rates. • Positive Interest rates to encourage savings and discourage flight of capital. • Competitive exchange rates. • Trade liberalization and elimination of fees on intermediate products entering into the production of goods for export. • Liberalization of inward foreign direct investment. • Privatization of state enterprises. • Deregulation so as to abolish impediments to market entry or exit, as well as sources of corruption. • Legal security for property rights. Source: Williamson, J. (2000) “What Should the Bank Think About the Washington Consensus?” World Bank Research Observer, Vol. 15, No. 2, August, p. 251-264. 53 • Under such circumstances, the government resorted to monetary financing of the budget deficit. Monetary financing covered more than half of the budgetary gap in 1991 and the budget was in arrears for the remaining 20% of expenditures. Wage payments became sporadic. Monetary financing resulted in high inflation, running at average rates of 70% in 1989, 157% in 1990 and 121% in 1991. These developments contributed to the lack of public confidence in national currency and high dollarization. The formation of the RGC in 1993 led to the end of the economic embargo imposed on Cambodia since 1979 and resulted in the inflows of Foreign Direct Investment (FDI) and Official Development Assistance (ODA) for economic rehabilitation. During 1993-1998, Cambodia was not fully at peace. The RGC of the first mandate could not give full priority to economic development and poverty reduction, as it was required to combat the Khmer Rouge forces scattered across the country. Defense and security spending amounted to 6.3% of GDP in 1994, while social spending...