Planning for success in Cambodia

October 14, 2017

by Jayant Menon

https://blogs.adb.org/blog/planning-success-cambodia

Weak human capital is arguably the biggest challenge for Cambodia to reach middle-income status.

Cambodia recently made the transition from a low income to a lower middle-income country, according to the World Bank’s rankings.

This is good news, but it poses a question: Does Cambodia need to rethink its model of export-driven economic growth, as preferential access for its exports to developed countries is gradually reduced or as aid flows diminish? Not necessarily, at least for now. But it should start preparing immediately.

Cambodia still has least developed country or LDC status as defined by the United Nations, and will likely retain its trade privileges for a while yet. But it will likely transition out of LDC status by around 2030 if it maintains current growth rates. With adequate advance planning, Cambodia can avoid being a victim of its own success when it does so.

That means stronger efforts to improve the tax collection mechanism, and curbing tax avoidance and evasion. Strengthening institutions to improve tax collection, and creating a culture where businesses and citizenry feel an obligation to contribute towards the provision of public goods and services, can take years, so it needs to start now.

Weak human capital is top challenge for Cambodia to reach middle-income status

Cambodia also needs to expand the tax base, and hasten the move from direct to indirect sources of tax collection, while reducing its reliance on trade taxes. These initiatives are essential to mobilize domestic resources to fund development, given that overseas development aid and concessional financing will wane as the country gets more prosperous.

Cambodia also has several domestic obstacles to overcome, not only to prepare for a transition to upper middle income status, but to speed up that journey.

Arguably the most important challenge is weak human capital, as well as a skills mismatch. To fix this requires a much greater investment in education – not only in vocational or higher education but also at primary and secondary school. The enormity of the task that lies ahead is underscored by the World Economic Forum’s Global Human Capital Report 2017, that placed Cambodia at the bottom of the list in ASEAN.

The goal is making sure all Cambodians have at least 10 years of schooling, forming the basic building block for a much more productive workforce. Then we can talk about specialized vocational or tertiary education, and matching employee skills to employer needs.

At this stage, and based on interviews with Japanese firms operating in the Phnom Penh Special Economic Zone (PPSEZ), what employers are seeking is not necessarily “trained” labor, but “trainable” labor, as skills required are quite job-specific and usually provided on-site.

Agriculture to remain backbone of Cambodia’s economy

Other challenges include the elevated cost of electricity, one of the highest in Asia. Apart from the skills constraint, the cost and unreliable supply of power is the other key factor limiting industry’s progression up the value chain from simple assembly to production of parts and components. If the former is labor intensive, the latter is energy-intensive, and remains uneconomical at current tariffs.

Agriculture, however, will remain the backbone of the country’s economy for years to come, and during the transition to the next income bracket. Most Cambodians continue to be employed in this sector – either directly or indirectly.

To further reduce poverty and inequality, the agriculture sector must become more productive. To do this requires better irrigation systems, more fertilizer usage, and easier access to high-yielding varieties of crops. The size of farms and variety of their produce should also be enhanced to exploit economies of scale and scope, respectively. Land reform will be essential here.

 

Another option is to pursue agro-processing to raise value-addition. Agro-processing combines agriculture and manufacturing. We can see this in products like pepper, cassava or coffee, which add value along the supply chain and boost economic returns.

Cambodia is making good progress towards upper middle-income status by diversifying its economy. There is a lot of new investment from Japanese firms in the PPSEZ that is plugging it into regional supply chains for the first time.  This trend will only continue to grow in the future, creating good jobs for more of the workforce.

Cambodia must plan carefully to preserve economic gains for next generation

While agriculture will remain important for some time yet, there is no denying the long-term trend decline in its share of economic output, and the increasing shares of services and manufacturing. These structural transformations will require reskilling of the labor force to reduce adjustment costs and unemployment.

The challenges in the labor market extend further, however, and involve demographic transitions in a young population seeking productive employment; the much-vaunted demographic dividend will only be realized if the jobs are there to be filled.

These structural changes will also result in rising urbanization as rural-urban migration increases. This must be managed by better town planning to prevent urban slums and create livable cities. One only needs to look at how Phnom Penh’s infrastructure has been stretched over recent years to appreciate the magnitude and importance of this challenge.

Cambodia’s socio-economic achievements since the early 1990s peace settlement have been remarkable. But success brings with it new challenges.If Cambodia plans carefully for graduation from LDC status, it would ensure that the hard-won economic gains are preserved for the next generation.

Tags:

Jayant Menon, Cambodia, lower middle-income economy, middle-income status, middle-income transition, export-driven economic growth, LDC status, tax collection, tax base expansion, weak human capital, skills mismatch, special economic zones, cost of electricity, agro-processing, value chain, structural transformation, labor market

ADB Predicts Stronger 2018 for Developing Economies

September 28, 2017

by  http://www.asiasentinel.com

 

Asia’s developing economics have performed better than forecast earlier, according to the latest assessment by the Asian Development Bank in its mid-term review of the 2017 Asian Development Outlook. Some further slight improvement is forecast for 2018. However, much depends on external circumstances which have largely driven better-than-forecast 2017 performance.

Among Southeast Asian countries, Malaysia’s public finances look less healthy than most of its peers.

 

Most notable has been a strong pickup in electronics exports after a weak 2016. This has been the main driver of the sharpest growth pick, Malaysia, where the forecast for GDP growth for the full year has been raised by a full percentage point to 5.4 percent, with electronics and palm oil exports as drivers plus consumption growth driven by higher wages.

Malaysia’s economy had appeared to shrug off negative effects of the sharp fall in the ringgit in 2015-16, though there was an inflation spike. Now stable, the currency seems unlikely to rebound much further unless the current account surplus surges. The ADB’s one and rather understated caveat looking ahead is the government deficit, which has surged to over 5 percent of GDP against an official target of 3 percent. Much of the government debt is foreign owned. A tax increase is necessary before long, the outlook warns.

Among Southeast Asian countries, Malaysia’s public finances look less healthy than most of its peers. Government deficits in the Philippines, Indonesia and Thailand are all around 2 percent of GDP as revenues have been rising almost fast enough to accommodate increased infrastructure spending. Progress in the Philippines in particular has brought investment up to 25 percent of GDP. This is not the result of a particularly strong 2017 but of a continuing surge since 2012. However, ambitious further spending on infrastructure will be dependent on revenues, and on progress in implementing public/private partnerships (PPPs).

 

In theory, according to the development outlook, the Philippines has an advanced framework for such projects, but few have been realized. Much too will depend on the progress of proposed tax reforms and whether the reforms have a positive net impact on revenues and investment. Private sector credit growth will also have to slow down after an 18 percent leap this year.

The development outlook is silent on the costs of rebuilding Marawi City after the recent battle but will inevitably set back other spending. It also avoids mentioning foreign investor disquiet over President Rodrigo Duterte’s drug war and threats of martial law. Meanwhile a continuing rise in remittances up 8.7 percent in the first half of 2017 is underpinning consumption and feeding through to the food processing and building materials sectors of manufacturing.

While manufacturing in the Philippines is performing adequately by its own modest standards, Indonesia’s manufacturing sector is a drag on an economy continuing to jog along at 5 percent growth. The development outlook’s 2017 forecast is unchanged at 5.1 percent despite a fall in the current account deficit and increased government spending on infrastructure which could push the budget deficit close to its 3 percent of GDP ceiling. Inflation remains low by local standards at 4 percent. Foreign investment has been flowing strongly but its impact on manufacturing remains modest and investment in mining is restrained by policy uncertainties.

The ADB outlook warns of the need to maintain flexible exchange rate policy to absorb possible shocks from international markets, be they commodity prices or interest rates.

Slightly higher GDP growth is forecast for 2018 partly to a spending boost from the Asian Games to be held in Jakarta and Palembang but there is not much sign of the 6.5-7.0 percent growth which Indonesia should be able to achieve.

Thailand should in principle be able to do a lot better than its 3.5 percent growth. Tourism, agricultural prices and other exports have done well and created a massive current account surplus of 8.5 percent of GDP this year and probably over 6 percent in 2018. The surplus has underpinned a strong currency and inflation below 1 percent. But private investment remains very weak, reflecting political and other uncertainties.

Although Thailand’s own population increase is now almost static, workers from Cambodia and Myanmar continue to undergird the labor force and Bangkok’s service industries to benefit from growth in Myanmar and Vietnam. But capital is leaving for better or safer projects elsewhere. Government infrastructure spending will continue to rise. The budget deficit, now 2.8 percent of GDP, has room to rise as government debt is only 32 percent of GDP. But, though the development outlook doesn’t say so,  the traditionally conservative finance ministry is likely to keep a  rein on spending regardless of the pronouncements of the political leaders.

Fiscal conservatism can also go too far in Singapore, suggests the ADB’s outlook in one of its rare critiques of government. It states: “policy makers should consider placing a high priority on reining in persistent current account surpluses, which are primarily the product of an unusually high savings rate. Even a modest adjustment to this perennial macroeconomic imbalance would boost domestic demand and raise the economy’s potential growth rate. To this end, the government has ample resources for fiscal expansion.”

Fiscal austerity remains a necessity in Vietnam.

Fiscal austerity however remains a necessity in Vietnam. This year the government deficit will be about 4 percent of GDP but with total debt over 65 percent there is scant room for a surge in public spending and a repeat of past cycles of inflation and devaluation.

There is pressure for more spending to offset what has been a slightly disappointing year so far, with GDP growth likely to be 6.3 percent against an earlier 6.5 percent projection with a small pickup in 2018. Vietnam has been hit by declining coal and oil output and prices partly offsetting strong manufacturing growth driven by foreign investment, and tourism. However both may ease off in 2018. The currency has been firm despite a small deterioration in the current account, and inflation is only around 4.5 percent.

Failure to resolve old non-performing loans remains a drag on the financial sector. There has been no consolidation in the banking sector and sale of equity by state firms has been slow despite a buoyant stock market driven in part by foreign portfolio flows.

Asian Development Bank at 50 and Japan’s puzzle

June 16, 2017

by Dr. Titli Basu

http://www.asiaforum.org

ADB President Takehiko Nakao

Competition for infrastructure financing is heating up in Asia. China is investing billions in mega-infrastructure projects under President Xi’s Belt and Road Initiative (BRI) as well as designing new financing mechanisms beyond the Bretton Woods institutions. Against this backdrop, the Asian Development Bank (ADB) now faces the challenge of reforming itself and remaining competitive as it commemorates its 50^th anniversary.

 

In the face of growing Chinese investment, Japan has stepped up its game through Prime Minister Abe’s Extended Partnership for Quality Infrastructure and by further augmenting the ADB’s role in catering to the infrastructure appetite of emerging economies.

As the ADB debates its ‘Strategy 2030’,which will be in place by 2018, it must facilitate institutional and organisational reforms necessary to maintain its relevance. As Obama administration’s and Japan’s attempts to steer the initial debate on the AIIB failed to stop US allies from joining the China-led bank,the need to reform existing Bretton Woods institutions, including the ADB, has intensified.

The ADB remains under the control of Asia’s traditional regional actors including Japan and the United States with 15.6 percent shareholding each in 2016. There is a need to revisit this approach and create more space for emerging economies in the bank’s governance structure. China, India and Indonesia have 6.4 percent, 6.3 percent and 5.4 percent of shareholdings respectively in 2016. As the US-led international economic order has failed to reflect the shifting alignments, the ADB must grow in order to respond to the varying needs and ambitions of its developing member countries.

While international attention was focused on Beijing’s recent Belt and Road Forum (BRF) on 14–15 May, a week earlier Japan celebrated the ADB’s 50th anniversary in Yokohama. Since infrastructure financing often translates into expanding geo-political influence, Japan has committed US$40 million over a two year period to a high-technology fund to support the application of innovative solutions throughout the project cycle of ADB-financed and administered sovereign and non-sovereign projects.The fund will be effective by July and will focus on critical areas including climate change, smart grids and renewable energy.

Two years ago, weighing the impact of the AIIB, Abe designed the Partnership for Quality Infrastructure and argued that Japan in cooperation with the ADB will provide ‘high-quality and innovative’ infrastructure and pledged US$110 billion over five years — a 30 percent increase from earlier funding. At the Yokohama meeting, Japan called for promoting infrastructure projects to be the mainstay of ADB operations and to further muster private sector financing together with public-private partnerships.

In February 2017, the ADB estimated that Asia will need US$26 trillion for infrastructure from 2016–2030.Economic rationale dictates that the ADB has enough space to operate alongside new development banks while addressing the infrastructure financing gap. ADB has adjusted with new realities and opened up to co-financing with the AIIB. The two banks signed a memorandum of understanding aimed at strengthening cooperation including co-financing in May 2016. They are co-financing the National Motorway M-4 Project in Pakistan, each financing 36.6 percent individually of the total project cost of US$273 million. ADB has approved co-financing with AIIB in Bangladesh and Myanmar.

In the run up to the BRF, ADB President Takehiko Nakao argued the merits of cooperating with the BRI design. While Japan’s national leadership refrained from attending the summit, Liberal Democratic Party (LDP) secretary general, Toshihiro Nikai and the Keidanren chief, Sadayuki Sakakibara were both present. This decision has been shaped by larger geo-political and geo-strategic variables. President Trump’s evolving Asia policy, fluidity in US–China relations and the North Korea conundrum are making Japan weigh up its options carefully.

AIIB membership has expanded since its inception. Japan has learnt it the hard way during the initial AIIB membership debate about the demerits of non-engagement and losing the opportunity to shape decisions from within. The United States and Japan are the only two G7 countries that kept out of the AIIB. At a time when BRF witnessed representation from over hundred nations and domestic debate over the AIIB is intensifying in Japan, Tokyo needs to revisit its stance on the China-led bank on one hand and drive the debate to facilitate pertinent reforms in ADB on the other.

For 50 years, the ADB has worked towards inclusive economic growth, environmental sustainability and regional integration. It’s lending focuses on infrastructure, education, environment, health, financial sector and so on. In 2016, the bank approved US$17.5 billion in financing, disbursed US$12.5 billion and attracted US$13.9 billion in co-financing. While it has fuelled Asia’s growth, garnering resources for infrastructure, poverty mitigation and supporting financial inclusion will remain ADB’s priorities.

Developing its lending capacity, the bank has merged the Asian Development Fund with the Ordinary Capital Resources. Moving ahead, ADB has agreed on a new procurement design and is firming up on delivering knowledge solutions and facilitating innovation and integration of high-level technology in projects.

The call for re-evaluating ADB’s voting rights is not new. Critics argue that present international institutions should permit space to developing nations and that failure to do so will hurt the relevance of these institutions.The emerging economies have long argued for representative governance, rationalising operations, easing the ADB’s internal processing time and encouraging public-private partnership investments. Japan must take the lead to facilitate governance reforms against the backdrop of AIIB and other new multilateral development banks. Failure to implement internal reforms will impact the ADB’s influence.

Developing Asian nations will be the beneficiaries of this race for infrastructure financing. Productive competition will diversify emerging economies’ options to choose the most favourable financing terms. Long-term, this will support the larger purpose of empowering emerging Asian economies to augment national growth and enhance Asia’s ability to compete in the global economy.

Titli Basu is an Associate Fellow at the Institute for Defence Studies and Analyses (IDSA), New Delhi.