China and Cambodia: Getting by with a Lot of Help from a Friend

Over the past decade, Cambodia’s market economy became one of the fastest growing among Southeast Asia’s developing economies. Four sectors have underpinned recent economic development: garments and footwear, construction and real estate, tourism and agriculture. Agriculture has been playing a diminishing role – accounting for 20.7 percent of GDP in 2019, down from 34.6 percent in 2011. Services are 39 percent of GDP and industry is 34.2 percent. The largest source of growth is services, including wholesale and retail trading, real estate services, and tourism-related activities. All this has triggered remarkable socioeconomic progress, with more jobs and higher incomes translating into better living standards for Cambodians.

From 1998 to 2007, the Cambodian economy grew at an average annual rate of almost 10 percent. From 2010 to 2015, it averaged about 7 percent GDP growth. Between 2008 and 2017, output doubled. The prolonged expansion over the past decade lifted per-capita gross national income over the US$1,045 threshold, pushing this nation, which in the 1970s was beset by civil war and then by the brutal rule of a nihilist genocidal regime, into low middle-income status. The fiscal deficit narrowed from over 8 percent in 2009 to less than 1 percent in 2017. According to the International Monetary Fund (IMF), this gradual narrowing of budgetary deficits was supported by stronger revenues owing to improved tax enforcement and customs administration as well as larger grants.

As it has done around the world, the pandemic is doing severe damage, with the Asian Development Bank (ADB) estimating that the Cambodian economy will contract by 5.5 percent this year. It may not return to pre-virus levels until at least 2022.

Due to poverty, a historic dependence mindset, and underdevelopment, however, Cambodia has continued to rely heavily on external funding and technical assistance for its national development. The country’s worrying politics, presided over by Hun Sen, prime minister since 1985, are isolating it from the international community. In August, the EU reinstated tariffs on a fifth of Cambodian exports as a response to perceived backsliding on democracy.

In recent years, Cambodia has tethered itself more tightly to China, a shift that has raised concerns among some fellow ASEAN member states. Beijing’s contribution to Cambodia’s economic development over the past decade is indisputable; in 2016, it invested more in the country than domestic sources. China is the biggest investor in Cambodia, accounting for up to 44 percent of the US$19.2 billion in foreign direct investment (FDI) between 1994 and 2014, according to the National Bank of Cambodia and the National Institute of Statistics.

The Belt and Road Initiative (BRI), Beijing’s flagship development assistance program focused on funding and building infrastructure in developing economies across the world, fueled a significant construction boom in Cambodia, generating jobs and stimulating growth in manufacturing. Three years ago, Minister of Transport Sun Chanthol said that 70 percent of Cambodia’s national roads and bridges had been built with some US$2 billion in concessionary loans issued by China since 2004.

The growing dependence on China could portend a shift in the national account balances. The proportion of Cambodia’s debt owed to China is unclear: By some estimates, it makes up 40 percent of Cambodia’s total public debt of US$4 billion, exceeding the combined debt that Phnom Penh owes to the World Bank and the Asian Development Bank (ADB).

The human-capital challenge

With the sharp global economic contraction due to the pandemic, the question is whether Cambodia has the resilience to return to the high-growth path it has been on in recent years. Cambodia, which has a population of 17 million people, is a Covid-19 success story, with just 273 cases and no deaths as of 25 August. Despite its weak public-health system, the country’s strong performance in controlling the coronavirus has been attributed to swift and early action to shut down borders, a robust testing and contact tracing program, the closure of schools and entertainment venues, and domestic travel restrictions.

Phnom Penh also had support from the World Health Organization (WHO), other international organizations and agencies, and donor countries including China, Japan and Vietnam. Government coordination with the business community and other domestic stakeholders was a significant boost, as was the fact that some 80 percent of the population lives in low-density rural areas. Mask wearing was already common prior to Covid-19 due to poorly maintained roads and the resulting dust kicked up by traffic.

If Cambodia is able to recover quickly, the economy will still have to face the same key structural challenges confronting it before the pandemic, in China’s embrace or not: how to build greater capacity to wean itself of dependence on external sources of growth and to navigate a volatile, more competitive global market, especially in its position as one of the smaller, lower-income ASEAN economies.

An educated, healthy and adequately fed labor force is essential to improving all economic sectors. In 2019, Cambodia had an unemployment rate of just 0.7 percent. It has now shot up to about 20 percent, according to the World Bank. Many of the employed, however, possess low education and skill levels, and underemployment is not uncommon. Cambodia’s efforts to transition from a lower middle-income to upper middle-income status by 2030 have driven increased funding to improve the education sector. The government implemented an education strategy plan from 2014 to 2018, which aimed to expand early childhood education and access to good-quality secondary and post-secondary education, non-formal education, technical and vocational education.

Despite such government initiatives, Cambodia faces four key problems in providing basic education. First, pre-school is largely inaccessible and remains underfunded. Second, there is a big disparity in access and quality of education among regions and income groups and between genders. Third, there are no institutionalized methods of assessing student performance, which inhibits the ability of policymakers and educational institutions to make informed policy plans to improve education. Lastly, schools lack good-quality teaching, particularly in rural, remote and disadvantaged areas. This lack of teacher training and teacher resources harms student retainment and performance rates.

In 2019, Cambodia’s exports reached US$14.5 billion, up 12.7 percent from the year before. Imports amounted to US$22.2 billion, a rise of 18.6 percent from 2018. Despite domestic minimum wage increases for garment workers, the price of exported garment products has been declining. Rising wages along with increasing export competition led to pressure to cut costs. Initiatives such as the Garment Training Institute in the Phnom Penh Special Economic Zone have helped to upgrade the skills of workers and at the same time lower their cost of living.

Looking forward, there is substantial growth potential in banking and financial intermediation. Cambodians living on an average income in major urban centers represent a big potential market. About 50 percent of the population has access to at least one financial service. Despite the pandemic, lending in the first half of 2020 grew by 20.7 percent, while inflation has remained low and deposits have increased. But there are ominous signs of trouble. Bank liquidity had already been tight before Covid-19, and public debt had risen over 100 percent of GDP last year for the first time, having grown nine-fold over the past dozen years, the fastest increase among East Asian economies. Still, in December 2019, a joint World Bank-IMF debt sustainability analysis reckoned Cambodia’s overall risk of debt distress to be low.

Shaping national priorities

The Cambodian government has garnered the support of banks, donors, and other economic partners to develop five areas that have been identified as priorities: transport, water supply, sanitation and urban development, agriculture and natural resources, education, and finance. These areas require long-term commitment and sustained government support. Their development of course will be hampered by the need to revive the economy post pandemic. In Cambodia’s current development stage, it is still possible to identify positive outcomes arising in the short term, especially in improving the economic and social environment. Any growth recovery and sustainability strategy must be linked to a sober public-sector management approach. This is particularly important given that investors and the international community perceive Cambodia as a corrupt place where the rule of law is flouted.

In line with long-term development priorities, local banks and other financial institutions work directly with donors to address the needs of urban and rural Cambodians, as well as attending to the ever-increasing financing requirements of micro-, small and medium-sized enterprises (MSMEs) in the country. Direct financial assistance boosts economic prospects because it enhances the access of MSMEs to longer-term finance, which is critical to support poverty alleviation through income and employment generation in rural areas. This inclusive approach lets everybody win. The government generates income through duties, fees, services and taxes; the private sector satisfies its need for low-cost financing; and the people enjoy better financial services along with increased job opportunities and fewer hurdles.

Structural reforms required

Prior to the pandemic, the government had been focused on implementing a project to decentralize rural sanitation service delivery to strengthen the capacity of districts to administer services in the provinces. Improved management of roads reduced travel time from 2 hours to 1.5 hours per 100 kilometres. These gains, together with the simplification of import and export procedures and border processes, were part of an effort to improve integration into regional and global markets. As a result, between 2010 and 2015, customs clearance dropped from 6 to 1.5 days: a logistical accomplishment much appreciated by the private sector.

Such an improvement has had significant positive impact for trade facilitation and productivity, boding well for further gains in other areas of the economy. Cambodia has had mixed results. In the World Economic Forum’s 2019 Global Competitiveness Report rankings, a broad measure of productivity, Cambodia came in at 106th place, up four positions from the year before. Meanwhile, the Heritage Foundation’s annual Economic Freedom Index ranked the country at 113th in 2020, down eight places. Cambodia’s score has been in decline since 2017. The decrease was in the areas of property rights, labor freedom, and fiscal health. The effects of the lack of property rights and systematized education have been amplified by pervasive corruption within the government. Cambodia ranked 162nd of 180 countries on Transparency International’s Corruptions Perceptions Index in 2019.

Long-term social change is dependent on deep structural reforms, the implementation smart growth strategies, and policy measures to create a truly independent judiciary system and uphold the rule of law. In the context of the pandemic, it will be a challenge to pursue such a necessary comprehensive program.

China and Covid-19

The Covid-19 pandemic threatens to destroy 30 years’ worth of Cambodian development by crippling the tourism, manufacturing exports, and construction industries. Together, these three industries contribute to 70 percent of Cambodia’s economic growth and 39.4 percent of total paid employment. The unemployment wrought by this pandemic may leave 1.3 million Cambodians in poverty once again. The fiscal deficit is predicted to reach its highest level in 22 years, registered growth is forecast to be the slowest since 1994. The devastation is already evident.

That act of solidarity spoke volumes about where the Cambodian leadership reckons it will find both moral and monetary support for its economic ambitions. Over a decade ago, before China was in a position to claim major-power status and pose an economic and security challenge for the United States, its commercial engagement with Cambodia was only just beginning. The relationship has transformed from a cooperative one to a dependency based on assistance and investment, particularly through the BRI. It has been deepened by a shared view of authoritarian governance, frequent joint military exercises, and now the conclusion of a free-trade agreement. One thing is clear: Phnom Penh has cast its lot with Beijing. The question is whether this will mean a brighter future for a vulnerable economy seriously weakened by Covid-19 and the people of this small country in a region where the neighbors are all struggling to come to terms with the still-growing giant to the north.

This article is adapted from “Cambodia: Growth with a Red Flag”, a chapter by Sophal Ear and Sigfrido Burgos in Southeast Asia and the ASEAN Economic Community, edited by Roderick Macdonald and published by Palgrave Macmillan in 2019.