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IMF Identifies Three Downside Risks for a Gradual Return to 6.5 Percent Robust Recovery

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Phnom Penh: After two weeks of talks with Cambodian authorities, the appraisal made by the staff of the International Monetary Fund (IMF) in Washington, they have identified three downside risks for a gradual return to 6.5 percent growth in the medium term.

“Future growth depends heavily on the course of the pandemic,” their report says, highlighting bank loans and climate change as the main risks. A risk-assessment matrix annexed to the report released last week says the likelihood of uncontrolled local Covid outbreaks and a global resurgence of the pandemic is “medium” from 10 to 30 percent.

While vaccination has been proceeding rapidly, “a resurgence of domestic cases due to vaccination-resistant variants could pose significant threat to the recovery, with effects felt across all economic sectors. And “lower growth abroad due a resurgence of the pandemic could affect exports and remittances, and compromise the return to international travel, with significant effects on domestic GDP and current account balances.”

On the other hand, the assessment notes that foreign direct investment has “remained stable” and that depreciation pressures on the riel "seem contained” after slight downward pressure earlier this year — possibly related to rising Covid infections and subsequent restrictions on economic activity. The risk of a disorderly economic transformation is also assessed as medium.

"Permanent changes in international travel patterns could damage the tourism industry,” the assessment adds. “Labour reallocation away from services may be difficult, and result in a large fraction of the labour force reverting to low- productivity agricultural production.”

At the same time, “private debt has been increasing rapidly and many households and businesses would be at severe risk of debt distress if loan forbearance were cut abruptly.” Greater risks are seen in the areas of financial vulnerabilities and more frequent and severe natural disasters related to climate change, which both have a “high” probability of between 30 and 50 percent.

The real estate and construction sectors are “reputed to draw substantially on credit provided by developers” — who fall outside the supervision of the National Bank of Cambodia.

“Substantial loan forbearance in 2020 may have left many financial institutions with weak balance sheet positions,” the assessment warns. To minimise the adverse impacts, it welcomes the establishment of the Non-Bank Financial Services Authority last year as a significant step in the direction of broader supervision of the financial system.

Its crucial to have a timely collection and disclosure of data on loan performance . Exit from loan forbearance should be timed carefully.

As for climate change, “floods, droughts and changing monsoon patterns pose a severe threat to agricultural production, a crucial source of income for the most vulnerable segments of the population as well as an important source of exports.

“Urban areas located close to riverbanks have experienced flooding, which threaten industrial production and housing. Forced migration of large segments of the population may pose social and fiscal challenges.”

To address these challenges, the assessment highlights the importance of continued focusing on adaptation through investment in climate-resilient infrastructure, reforestation and securing agricultural production and food security.

In the long run, it is crucial to budget for support to households and firms affected by extreme weather. Among other possible risks, the dangers of higher international commodity prices and cyber attacks are rated as medium. “Rising commodity prices could reduce households’ purchasing power and increase relative poverty,” the assessment warns. And “government and private sector information systems are vulnerable to security breaches.”

But the risk of widespread social discontent and political instability is “low”, with a probability of less than 10percent.

“The political situation has been stable in recent years,” the assessment says.Government control over political institutions is strong. Moreover, the government has enacted several fiscal measures to protect the most vulnerable segments of population during the pandemic.

Cambodia also has a low chance of being affected by intensified geopolitical tensions and security risks or a “de-anchoring” of inflation expectations in the United States that would lead to higher interest rates and risk premiums.

In the United States, long-term inflation expectations have increased but remain close to historic averages and thus appear well-anchored.But with supply disruptions and stronger demand lasting longer than expected,risks of a further acceleration of inflation are materialising. While such supply-demand imbalances are likely to ease next year, a singular focus of monetary policy on supporting recovery may well fuel substantial and persistent inflationary pressures, with some risk of de-anchoring inflation expectations.

For Cambodia, however, the impacts of such risks are seen as low. “The government does not borrow extensively at market rates and the banking sector is largely funded through domestic deposits,” the IMF staff assessment says.

Vulnerable to funding obtained from abroad are the microfinance institutions, posing risks to small and medium-sized enterprises and the informal sector of the economy. Moreover, the funding of property developers , which often lend to buyers is not well understood and could be a risk. To address microfinance risk, the IMF assessment has urged enhanced supervision of the sector. The new Non-Bank Financial Services Authority set up last year is meanwhile a “positive development toward supervision of property developers.”

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