Report on “Capacity Building on External Debt Management

in Cambodia and Lao PDR in the Era of Globalization”

________________________________________________

Tarun Das1
Resource Person, UN-ESCAP

March 2006

1
This report expresses personal views of the author and should not be attributed to the
views of the Ministry of Finance, Government of India or the UN-ESCAP, Bangkok. The
author would like to express his gratitude to the UN-ESCAP, particularly the Poverty and
Development Division, for providing an opportunity to prepare this report and the
Ministry of Finance, Government of India for granting necessary permission for that.

1
 Contents

1. Introduction

2. Scope and objectives of Report

3. Methodology

4. Cambodia

4.1 Cambodia’s Macroeconomic Developments in 2005

4.2 External debt situation in Cambodia
4.3 Institutional arrangement for external debt management
4.4 Evaluation by international organizations
4.5 Major areas of concern and recommendations

5. Lao PDR

5.1 Macro-economic developments in Lao PDR

5.2 External debt situation in Lao PDR
5.3 Major areas of concern and recommendations

6. Concluding observations

Selected References

2
 Report on “Capacity Building on External Debt Management
in Cambodia and Lao PDR in the Era of Globalization”

Tarun Das, Resource Person, UN-ESCAP, Bangkok

1. Introduction

A wider project on management of external debt in heavily indebted Asian countries for
poverty reduction and achievement of the United Nations Millennium Development
Goals (UN-MDG) is being executed by the Poverty and Development Division (PDD),
UN-ESCAP, Bangkok. As a part of this project, two consecutive “National Workshops on
Capacity Building for External Debt Management in the Era of Rapid Globalisation”
were held in Cambodia and Lao PDR during 20-24 February 2006. The first was held
jointly by the UN-ESCAP and the Ministry of Economy and Finance, Government of
Cambodia at the Economics and Finance Institute, Phnom Penh during 20-21 February
2006, followed by the second held jointly by the UN-ESCAP and the Ministry of
Finance, Government of Lao PDR at the Lao Plaza Hotel, Vientiane during 23-24
February 2006.
.
Both these workshops were participated by government departments and other
organizations concerned with the management of external debt in the respective
countries. The workshops were highly interactive in nature with presentations made by
both the UN-ESCAP officials and consultant, country experts and multilateral
organizations. This Report by the resource person contains major conclusions and
recommendations with respect to the management of external debt in Cambodia and Lao
PDR following the presentation and wide ranging discussions in the workshops and is
now submitted to the Poverty and Development Division of UN-ESCAP.

2. Scope and Objectives of the Report

The aim of the workshops in Phnom Penh, Cambodia and Vientiane, Lao PDR was to
assist the respective governments and in particular the Ministry of Finance to improve
capacity building in external debt management in the light of international best practices.

At the outset, it must be noted that the report deals primarily with the management of
external debt and does not deal with all aspects of public debt consisting both domestic
and external debt. Much of the international best practices dealing with sovereign debt
(such as the IMF Guidelines for Public Debt Management1- the “IMF Guidelines”) is
concerned with the management of public debt in total, not just external debt. Likewise,
most of the country laws deal with the totality of sovereign debt. This is evidenced by the
titles of such laws in many countries (common titles 2 include Fiscal Responsibility Law

1
Prepared by the Staffs of the International Monetary Fund and the World Bank, and dated 21 March 2001.
2
http://www1.worldbank.org/publicsector/pe/countrybudgetlaws.cfm.

3
2000 of Brazil, Fiscal Responsibility and Budget Management Act 2003 of India,
National Treasury Management Agency Act 1990 of Ireland, Fiscal Responsibility Act
1994 and Public Finance Act 1989 of New Zealand, Public Finance Act 1998 of Poland,
and Finance Act 1998 of the United Kingdom).

3. Methodology

As stated above, main methodology consisted of organizing interactive workshops with

presentation made by the UN-ESCAP officials and resource persons and local experts.
There were participants representing the Ministry of Finance, the Central Bank and a
number of other government ministries and agencies and multilateral organizations. The
workshop was led by Dr. Amarakoon Bandra of the Poverty and Development Division
of the UN-ESCAP and was supported by Dr Tarun Das, UN-ESCAP resource person. In
addition, other experts from the government in both the countries and the World Bank in
Cambodia assisted in the workshop and made valuable presentations.

The Workshops were inaugurated by the senior level officers for management of external
debt in both the countries. There were presentations on the state of the economy, future
economic outlook and debt scenario, legal and institutional set up and policies for debt
management. The presentation of these persons, together with the active involvement of
the participants, helped to ensure that the results of the workshop were relevant in the
context of, and indeed driven by, the respective country situations and experiences.

4. Cambodia
4.1 Cambodia’s Macroeconomic Developments in 2005

Cambodia has made significant economic progress since the establishment of the Royal
Government of Cambodia in 1993 and the resumption of long denied external assistance.
There had been a steady improvement in economic environment with higher growth,
better fiscal discipline and management, and accelerated integration with the region and
the rest of the world. Measurable improvements in various social indicators include sharp
reduction in poverty levels; expansion of primary education; reduction in mortality rates
for both infants and under-five year olds; reduction in communicable diseases and
incidence of HIV/AIDS; improved urban access to safe water, and rural access to
sanitation; and, reduction in gender disparity in many fields.

A sound macroeconomic policy framework helped Cambodia to achieve impressive growth

during the last 10 years. Annual GDP growth rate averaged around 5.6 percent since 1993 and 7
per cent since 1999 with growth in per capita income around 4½ percent per annum. Economic
growth in 2005 is estimated to be 7 percent, reflecting stronger agricultural growth,
continued expansion of exports, tourism and construction activities. However, the economy
still suffers from a number of weaknesses. Reforms in governance have not progressed at the
required pace. Economic growth has been uneven over sectors and regions, leaving it
vulnerable to external shocks and unsustainable over time. Growth has been largely urban
based, underlining need for more rural focus in the future. Despite significant reduction of
poverty ratio at the macro level from 47 per cent in 1994 to 35 per cent in 2004, there is high
incidence of poverty in rural areas. In 2004, about 91 per cent of the poor lived in rural areas

4
and, among the poor, a larger share was closer to the poverty line. Poor households in
rural areas have higher dependency burden and lack human capital: they tend to be
uneducated, unskilled and unhealthy, while urban poor are subject to insecurity of
housing rights and lack of opportunities for gainful income generation.

Fiscal Policy

Basic objectives of fiscal policy are to maintain a sustainable fiscal balance with gradual
increase in budget allocation for social and economic sectors through curtailing and
rationalizing public expenditure and by broadening tax base, preventing tax evasion and
leakage in expenditure, and strengthening tax administration for higher revenue
realization. Furthermore, prudent fiscal policy has been recognized as key to ensuring
price stability in Cambodia's highly polarized economy.

Fiscal performance in 2005 was good, with improved revenue mobilization and
expenditure restraint. The 2005 Budget was implemented with extreme prudence and
caution to make room for additional expenditure for financing important reform
programs, such as the civil service reform, improvements in physical infrastructure,
especially roads and bridges, while trying to avoid high inflation.

Domestic revenue
increased from 11.3
percent of GDP in
2004.to 11.7 percent
of GDP in 2005. The
tax revenue increased
from 8.4 percent of
GDP in 2004 to 8.7
percent of GDP in
2005. However, the
non-tax revenue is
expected to be at
around 2.5 percent of
GDP.

Monetary Policy and Performance

Broad money recorded a robust growth of 20 percent in 2005, due to the increase in
foreign currency deposits and credit to the private sector. Foreign currency deposits, the
largest component of broad money, recorded an increase of 20 percent, witnessing a firm
confidence in the banking sector and in the economic policy of the Royal Government of
Cambodia. Credit to private sector rose by 40%, driven by the construction of hotels and
houses. Capital and reserves of the banking system continued to rise, up by 9.6% in 2005,
reflecting the banks' efforts to strengthen their capital base in compliance with the recent
requirements of the law. Gross official reserves rose by 12 percent reflecting continued

5
strong export performance, sustained tourist arrivals, and other forms of capital flows,
including FDI.

Despite high oil prices, the government was successful in maintaining inflation under
check and ensuring a stable exchange rate. Inflation rate reached 5.8 percent at the end of
2005, higher than the last 5 years due to the impacts of higher oil prices. The Cambodian
riel-US dollar exchange rate depreciated by 2.48 percent, up from 4,035 riels per US
dollar at the end of 2004 to 4,135 riels per US dollar at the end of 2005. There was
increased inflow of foreign investment in oil refinery, hotels, ports and cement, tobacco
and cigarette industries.

External sector performance

The external sector performed well in 2005, despite high oil prices and higher trade
deficit. Provisional BOP data for 2005 indicated that the current account deficit,
excluding official transfers, increased from -9.9 percent of GDP in 2004 to -10.3 percent
of GDP in 2005, reflecting the impact of higher petroleum prices and net income debits.

Nearly the entire current account deficit was attributable to an increased deficit in the
trade balance. While exports increased by 9.8 percent, imports increased by 17.6 percent.
Exports of textile, clothing and footwear, which accounted for more than 70 percent of
Cambodia’s exports, continued to expand. Non-garment exports were estimated to have
increased at a faster pace than the garment sector, and produced 13 percent of Cambodia's
total export earnings. This group includes traditional agricultural commodities such as
rubber, wood products, fishery products, and paddy rice. In order to reduce the
dependence of the economy on a single commodity and to utilize the country's
agricultural potential in a more dynamic way, the government has encouraged private
investment in the agricultural sector and the agro-industries.

The overall balance increased from a surplus a surplus of 0.9 percent of GDP in 2004 to
1.1 percent of GDP in 2005 due to larger inflows on capital and financial accounts. On
the whole, a positive overall surplus was achieved, while gross international reserves
expanded further to cover more than 2.5 months of import of goods and services.

4.2 External Debt Situation in Cambodia

In the latest issue of Global Development Finance (2005), the World Bank classified
Cambodia as a moderately indebted low income (MILI) country. Its major problem is
the low level of income. Policy prescriptions include improvement in real economic
growth, continuation of sound macro-economic policies and strengthening legal and
institutional set up for management of public debt including external debt.

As evidenced by major external debt statistics summarized in Table-1, positive aspects of

Cambodian external debt include favourable debt service ratio, low share of short-term
debt and high share of concessional debt in total debt. However, there had been mixed
trends of external debt sustainability indicators in Cambodia in recent years. As judged

6
by some indicators, external indebtedness of Cambodia improved to some extent in 1999-
2003. External debt service (to exports) ratio declined significantly from 2.1 percent in
1999 to 0.9 percent in 2003 and the external debt to exports ratio declined from 162
percent to 115 percent over the same period due to substantial growth of exports. The
share of exports in GNI improved from 46 percent to 68 percent in 1999-2003, the share
of multilateral debt in total debt improved from 13 percent to 26 percent, and the share of
concessional loan in total external debt remained more or less stable around 89 percent
over the same period. On the other hand, there was deterioration in some debt indicators.
The external debt to GNI ratio increased from 75 percent in 1999 to 77 percent in 2003,
the ratio of short-term debt to total debt increased from 6 percent to 7 percent over the
same period and the country has foreign exchange reserves, equivalent to only 3.7
months imports cover.

Table-1: External Debt in Cambodia (in US$ million)

Items 1990 1999 2000 2001 2002 2003
Total Debt stock (EDT) 1846 2518 2628 2697 2900 3139
Long term debt 1683 2293 2328 2393 2587 2814
Public & guaranteed 1683 2293 2328 2393 2587 2814
Private non-guaranteed 0 0 0 0 0 0
Use of IMF credit 27 73 73 80 96 104
Short-term debt 136 152 227 224 217 221
Total debt service (TDS) 30 32 32 22 21 25
Interest payments (INT) 30 14 18 9 8 9
Interest on long term debt 29 12 12 5 6 8
Interest on IMF loan 0 1 1 1 1 1
Interest on short term debt 1 1 5 4 1 0
Gross national income (GNI) 1115 3354 3461 3571 3831 4060
Exp.of goods and services (XGS) … 1555 1997 2263 2525 2741
Workers remittances 0 106 121 133 140 138
Imp.of goods & services (MGS) … 2033 2457 2635 2907 3216
International reserves (RES) … 509 611 697 913 982
Current account balance … -188 -135 -86 -55 -125
Sustainability Debt indicators (in percent)
EDT/ XGS … 162 132 119 115 115
Long term debt/ XGS … 147 117 106 102 103
Public & guaranteed / XGS … 147 117 106 102 103
Private non-guaranteed/ XGS … 0 0 0 0 0
Use of IMF credit/ XGS … 5 4 4 4 4
Short-term debt/ XGS … 10 11 10 9 8
EDT/ GNI 166 75 76 76 76 77
Long term debt/ GNI 151 68 67 67 68 69
Public & guaranteed / GNI 151 68 67 67 68 69
Private non-guaranteed/ GNI 0 0 0 0 0 0
Use of IMF credit/ GNI 2.4 2.2 2.1 2.2 2.5 2.6
Short-term debt/ GNI 12.2 4.5 6.6 6.3 5.7 5.4
TDS/ XGS … 2.1 1.6 1.0 0.8 0.9
INT/ XGS … 0.9 0.9 0.4 0.3 0.3
INT/ GNI 2.7 0.4 0.5 0.3 0.2 0.2
RES/ EDT … 20 23 26 31 31

7
RES/ MGS (months) … 3.0 3.0 3.2 3.8 3.7
Short-term debt/ Total debt 7.4 6.0 8.6 8.3 7.5 7.0
Concessional debt/ EDT 91 90 88 88 89 89
Multilateral debt/ Total debt 0.1 13 14 16 21 26
XGS/ GNI ratio … 46 58 63 66 68
MGS/ GNI ratio … 61 71 74 76 79
C/A Balance as % of GNI … -5.6 -3.9 -2.4 -1.4 -3.1
Source: Global Development Finance 2005, World Bank

8
External debt - of which about 60 percent is owed to the United States and the Russian
Federation - constitutes 94 percent of Cambodia’s public debt. At end-2004, Cambodia’s
total external public debt was $3.1 billion (64 percent of GDP), while domestic debt
amounted to 4.1 percent of GDP, denominated entirely in local currency.

Cambodia’s two largest creditors are the Russian Federation and the United States.
Cambodia is not servicing its debt to either creditor and is making efforts to conclude
agreements with both creditors under the framework of the Paris Club. It is trying to have
a debt restructuring agreement with the US and Russia in 2006. As a consequence,
Cambodia’s net present value (NPV) of external debt to GDP ratio would drop from 47.0
percent at end-2005 to 24.5 percent in 2006.

At present, the Cambodia’s authorities are conducting negotiations with the Russian
Federation and the United States on the rescheduling of its pre-1993 financial obligations.
Technical discussions have taken place with a view to reconciling outstanding issues. The
government is currently reviewing documentation from the United States to determine
the exact amount of claims. The U.S. insisted that they would not write off any debts
contracted by Cambodia during the war of 1970-75.

The U.S. and Cambodia have disputed the total amount of principal. While the U.S.
suggested that there are sufficient evidence that the total amount of US$162 million is
Cambodia’s obligation. Cambodia claims that some documents are unclear and the part of
the claim are not Cambodia’s obligation. The U.S. claims that, after agreeing on the total
principal amount, Cambodia and the U.S. need to sign the bilateral agreement based on
the 1995 Paris Club agreement (i.e., flow rescheduling on Naples terms assuming a 40-
year maturity, 16-year grace period, and an interest rate of 3 percent).

After signing the bilateral agreement, both need to calculate arrears up to now and, if
necessary, Cambodia need to ask rescheduling those arrears through the Paris Club.
Cambodia and the Russian Federation have discussed rescheduling with a stock
operation. They have agreed that (1) after applying the stipulated exchange rate and the
70 percent upfront discount, the total debt is US$457 million, and (2) interest rate for the
precut-off-date debt is about 0.8 percent with concessional repayment schedule.
However, the countries have disagreed on (1) classification of US$40 million as either
pre-cut-off-date or post-cut-off-date debt and the interest rate on the post-cut-off-date
debt. The latest bilateral discussion was held in Moscow in June 2005. No agreement was
reached. The assumption for the macroeconomic framework is (1) the disputed US$40
million is classified as pre-cut-off-date debt, and (2) the interest rate for the post-cut-off-
date is about 3 percent, in line with the Russian claim.

Cambodian authorities are making best efforts to reach a debt rescheduling agreement
with the United States and the Russian Federation. Restructuring is critical for
Cambodia’s debt sustainability. Agreement on debt rescheduling with the U.S. and Russia
may reduce amortization payments, but it could increase interest obligations. Cambodia’s

9
external debt repayment will have significant impact on budget execution and thereby on
poverty reduction goals.

By 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt is

estimated to be about 39.4 percent of GDP, and debt service will equal 1.3 percent of
exports of goods and services. However, the fiscal burden of the debt is heavy, given the
low revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debt
management policy and strictly avoid non-concessional financing.

In the 1980s Russia granted interest-free loans for the rehabilitation of Cambodia from
the scourges of war and genocide. The Russian Federation participated in the Paris Club
as a creditor. Countries that have obtained, or will obtain in the future, a concessional
rescheduling from Paris Club creditors receive an up-front discount of 70 percent on all
pre-1992 debts to Russia before the application of Paris Club terms.

The amounts remaining after the up-front discount are denominated in a mutually agreed
currency and are considered commercial debt (non-concessional) for Paris Club purposes.
The remaining amount after the exchange rate uncertainty reduction, Russia applied
Naples Terms under the Paris Club Agreement for most of the countries, including the
non-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term of
loan (interest rate, grace period and payment modality).
The amounts remaining after the up-front discount are denominated in a mutually agreed
currency and are considered commercial debt (non-concessional) for Paris Club purposes.

The remaining amount after the exchange rate uncertainty reduction, Russia applied
Naples Terms under the Paris Club Agreement for most of the countries, including the
non-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term of
loan (interest rate, grace period and payment modality).

Agreement on debt rescheduling with the U.S. and Russia may reduce amortization
payments, but it could increase interest obligations. Cambodia’s external debt repayment
will have significant impact on budget execution and thereby on poverty reduction goals.
By 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt is
estimated to be about 43 percent of GDP, and debt service will equal 2.6 percent of
exports of goods and services. However, the fiscal burden of the debt is heavy, given the
low revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debt
management policy and strictly avoid non-concessional financing.

4.3 Institutional arrangements for external debt management

Institutions engaged in the management of external debt in Cambodia include the

Parliament, Treasury Bills Commission (TBC), Ministry of Economy and Finance,
National Treasury (NT), Investment and Cooperation Department and the National Bank
of Cambodia (NBC) with distinctive roles and responsibilities.

10
Parliament is the final authority for approval of annual budget and makes laws to regulate
public finance and public debt from both domestic and international sources. It also
checks the proper use of resources including debt to avoid mismanagement of public
debt.

The Treasury Bill Commission is chaired by the Secretary of State, Ministry of Economy
and Finance (MEF) with the Deputy Governor, NBC as Vice-Chairman, and
Deputy. Sec. Gen, Chief of NT, and Directors, Operations Department, Finance Industry,
Budget, AEF Department in the MEF as members. It takes policy decisions on issues
related to public finance including domestic debt and cash management and issues
appropriate instructions to NT and NBC for effective enforcement of the policies. It also
prepares draft bills for parliament approval and issues terms, amount and timing for
Treasury Bills.

National Treasury builds and presents financial consolidated report and ensures general
balance of accounts. It is in charge of settlement of expenses, payrolls, collection of
revenues foreseen by finance law, balance and control revenues and expenditure. It
manages cash flow, national budget, autonomous budgets and reserve accounts. It also
manages the treasury accounts deposited with NBC. In conformity with the international
best practices, NT is moving from cash to accrual accounting.

Investment and Cooperation Department manages public investment and makes liaison
with IFI, which prepare all public agreement regarding economic and financial
assistance, loan contracts, guarantees and on-lending operations. It records all debt
agreements and its corresponding transactions and settlement. It makes projections for
external debt services and disbursement for budgetary purpose, and orders the payment
for external debt services.

National Bank of Cambodia participates in the management of external debt and claims.
It assist in the debt management by conducting securities operation, perform open market
operations in the secondary market and provides guarantees to foreign creditors for
domestic borrowers

4.4 Evaluation by the International Financial Institutions

Under the Multilateral Debt Relief Initiative, the IMF Executive Board approved in
December 2005 debt relief for Cambodia. The IMF will provide 100 percent of debt relief
on all debt incurred by Cambodia to the IMF before January 1, 2005 amounting to US$82
million. The international community has made these additional resources available to
help Cambodia make progress toward the Millennium Development Goals (MDGs).

Cambodia has qualified for IMF debt relief because of its satisfactory overall economic
performance in recent years with progress in poverty reduction and improvements in
public expenditure management. Since 1999, Cambodia enjoyed robust economic
expansion, with annual growth rates averaging over 7 percent and inflation being kept
under control.

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During this period, the Royal Government has shown strong commitment to
implementing its National Poverty Reduction Strategy, and improving public
administration, in particular public expenditure management. Performance in these areas
provides assurance that resources made available under the Multilateral Debt Relief
Initiative will be used effectively.

4.5 Major Areas of Concerns and Recommendations

• At present Cambodian external debt is manageable with favourable external debt

service ratio, low share of short term debt and high share of concessional debt in
total external debt, but its sustainability in the long term may create problems unless
appropriate macro economic and financial policies are put in place to improve
revenues and exports and overall economic development.

• There are down side risks due to low revenue/GDP ratio and its pressure on the
government budget.

• There is lack of a proper mechanism to monitor and manage external debt. A full-
fledged debt office with independent front, back, middle and head offices may be
established in the medium term as per international best practices.

• There is instability of economic growth over the years, as real GDP growth declined
from 5.7 per cent in 2001 to 4.3 percent in 2004 although it is expected to increase to
6 per cent in 2005. In order to achieve broad based growth in the medium and long
term it is desirable to improve investment climate, to diversify the economy, to
reduce transactions cost for doing business, to increase productivity for private sector
development, and to improve human and physical infrastructure.

• The health of public finance remains weak. Budget deficit declined from 6.6 per
cent in 2002 to 5.5 percent in 2005 but still remained high. Revenue/GDP ratio is
low at 12 per cent in 2005. It is desirable to continue with sound fiscal and monetary
policy for realizing sound public debt management. Tax reforms need to continue
and tax administration further strengthened for enhancing revenue realizations.

• There is high dependency on exports of garments and wood products, which makes
the country vulnerable to external shocks. It is desirable to diversify exports and
continue reforms for encouraging private investment and public-private partnership.

• Trade balance is deteriorating and the current account deficit is rising (from 1.5 per
cent of GDP in 2002 to 4.9 per cent in 2005). Trade balance should be improved to a
significant degree in order to reduce external vulnerability.

• Current account balance at 10.3 per cent of GDP in 2005 is high and is a matter of
concern. The deteriorating current account balance, mainly caused by poor

12
 macroeconomic performance, needs to be arrested by broad basing economic growth
and removal of impediments to the private sector development.

• Given a flexible exchange rate regime, exchange rate volatility is another area of
concerns. Although a flexible exchange rate regime helps cushion the external and
domestic shocks, it may create problems for financing debt services in the case of
excessive depression of domestic currency. Exchange rate fluctuations may also
create contingent liabilities for the government in future. It is desirable to fix
benchmarks for composition, interest rates and maturity of public debt.

• Government apparatus is weak and overloaded reflecting the negative effects of the
war. Institutional mechanism is yet to be in full gear to facilitate growth and
development. It is desirable to strengthen institutional and legal systems and to
ensure good governance.

• A dollarised economic system has both advantages and disadvantages. It deprives

the country to make use of domestic monetary and fiscal policies for the country’s
development. There is a need to have a long-term mechanism to give the local
currency a larger role in the economy. For this, steps are needed to build the public
confidence on the local currency as a store of value and a medium of exchange.

• There is slow financial sector development and legal and institutional reforms
remain inadequate despite reform efforts. It is desirable to achieve a sound banking
and financial system by further progress made in the regulation and supervision
systems and through an active use of global standards for capital adequacy
requirements, accounting, auditing, and disclosure.

• As in the most developing countries, the bond market is weak and needs to be
developed for encouraging both savings and investment.

• Debt rescheduling may reduce amortization payments, but it could increase interest
obligations. As a result budgetary pressures could be high, particularly in view of the
low revenue/GDP ratio. Negotiations are taking place for rescheduling the country’s
pre-1993 debt obligations with Russia and the United States. If debt rescheduling
goes ahead as intended, Cambodia’s medium term debt stock is sustainable,
particularly in view of the high concessionality of the debt stock. Therefore,
Cambodia needs to pursue a strong debt management strategy and avoid non-
concessional borrowing.

• Even after rescheduling NPV of public debt would be still high at 230 per cent of
total revenue as revenue ratios are low. Debt servicing could be under strain and
could have negative implications on the country’s investor perception and the
development process. Anticorruption rules and regulation and increase transparency
in both public and private sector. It is necessary to take measures to increase revenue
thereby reducing the pressure on the budget.

13
• Increasing debt/GNI ratio from 75% in 1999 to 77% in 2003 is a matter of concern.
It is advisable to improve public expenditure management, in particular lending to
SOEs and government guarantees, thereby contain the growth in debt.

• Most of the external debt is denominated in dollars and rubles. It is necessary to fix
currency mix and interest rate mix.

• There is no single institutional body for management of external debt in Cambodia.

Operational debt management functions are scattered among different institutions.
There is lack of coordination, no communication in some cases and inconsistency in
actions. There is need to have a good coordination between the fiscal and monetary
policy advisers and the debt management function.

• There is also lack of qualified and sufficient staff and proper performing computer
based debt management system. There is no systematic analysis of public debt.

There is need to introduce a legal framework for management of public debt, to

strengthen institutional arrangement with clear rules and responsibilities, and to
coordinate debt management functions among various authorities. It is necessary to
strengthen capacity of staff to undertake specific debt analysis including risk.

• There is absence of a proper mechanism to monitor and manage debt, which may
have adverse impact on governance and sustainability of debt in future. It is
advisable to establish urgently an institutional framework (UNCTAD-DMFAS or
similar arrangement) to record and manage debt and to put in place a debt
management strategy and risk management framework.

In the absence of a proper framework, monitoring of external debt appears to be weak. It

is advisable to put in place well articulated and clearly defined role of responsibilities for
staff, clear monitoring and control policies and reporting arrangements. It is also
necessary to assess debt sustainability regularly and take corrective measures in time.

It is necessary to set up Middle Office for external debt to perform debt sustainability
analysis and to incorporate it into debt choice for annual budget.

5. Lao PDR
5.1 Economic Development in LAO PDR

In recent years Lao PDR has made significant economic progress. Real GDP growth rate
has improved from 5.8 per cent in 2000-01 to 6.5 percent in 2004-05 and rate of inflation
has decelerated from 26.9 per cent to 9 per cent over the same period.

14
 Table-2: Trends of growth rates and inflation rates in Lao PDR since 2000-01
2000-01 2001-02 2002-03 2003-04 2004-05
GDP growth rate (%) 5.8 5.9 5.9 6.2 6.5
Inflation rate (%) 26.9 8.9 11 15 9

Monetary Policy

Bank of Laos (BOL) conducts its monetary policy trough open-market operation to
stabilize the value of the kip. However, there are severe limitations for conducting
independent monetary policy due to the existence of a highly dollarised economy and
widespread use of hard currencies for domestic transactions.

During 2004-05, broad money supply (M2) grew by 9.2 per cent, inflation was moderate
at 6.5 per cent, exchange rate was almost stable with marginal depreciation of Kip by
0.16 per cent in terms of US $ and the foreign exchange reserve amounted to 3.5 months
of imports.

Fiscal Performance and Outlook

The Budget outcome for FY 2003/04 was satisfactory with achievement of revenue
targets, while total expenditure and net lending amounted to only 74.3 per cent of the plan
due to the shortfall of capital expenditure and on-lending by 58.5% of plan.

Fiscal reforms in 2004-05 includes amendments of the Tax Law for revision of the
turnover tax rates, increase of the minimum threshold for payroll tax, reduction of the
maximum rate of payroll tax, consolidation of the tax rate on rental income and
strengthening of the tax administration. Because of these reforms, government revenue is
expected to reach 15 per cent of GDP by 2010.

The Customs Law was also amended to meet international standards and best practices,
to provide greater clarity on the rights and roles of central and provincial custom offices
and to introduce the concept of regional offices.

Expenditure reforms aimed at enhancing policy consistency, transparency and

accountability in public expenditure management.
A Public Expenditure Management Strengthening Program (PEMSP) is operational for
fiscal planning and budget preparation, execution, accounting and financial reporting,
improving capacity building and strengthening the
Financial Legislation and Regulatory Framework.
Public Expenditure Reviews and Public Expenditure Tracking Surveys were conducted
regularly as a part of. Monitoring and Evaluation System for PEMSP,

Performance of State Owned Commercial Banks or SOCBs has been improving

gradually, but many challenges remain for improving quality of assets and loan portfolio,
delineation of non-performing loans and strengthening of management and supervision of

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Boards, recapitalization of weak banks and general improvement of audit and accounting
systems as per international best practices.

The government is making an attempt to adjust the balance between current and capital
expenditures, move from project support to programmatic approach in PEM support area
and to appoint International Banking Adviser(s).

Medium Term Outlook

Medium term scenario envisages the economy growing at 7.5 to 8% per annum induced
by large foreign invested projects in the mining and hydropower sectors. Inflation rate is
expected to remain at one digit level, provided that monetary and fiscal policies remain
prudent. Strong export growth, mainly from mining sector, is expected to offset the high
oil price risk.

Despite an increase in the external current deficit, primarily caused by imports for big
economically viable project, the underlying external position remains manageable.
Current account deficit is expected to be financed by the capital inflows consisting of
mainly increased inflow of FDI and continuance of concessional medium and long-term
borrowings.

5.2 External debt situation in Lao PDR

In the latest issue of Global Development Finance (2005), the World Bank classified
Lao PDR as a severely indebted low income (SILI) country. Like Cambodia, its major
problem is the low level of income. Policy prescriptions for both these countries include
improvement in real economic growth, continuation of sound macro-economic policies
and strengthening legal and institutional set up for management of public debt including
external debt.

As is evidenced by the World Bank statistics summarized in Table-3, positive aspects of

Lao PDR external debt, similar to those in Cambodia, include favourable debt service
ratio, low share of short-term debt and high share of concessional debt in total debt.
However, there were mixed trends of external debt sustainability indicators in Lao PDR
in recent years. As judged by some indicators, external indebtedness of Lao PDR
improved to some extent in 1999-2003. The external debt to GNI ratio declined from 177
percent in 1999 to 142 percent in 2003, the share of multilateral debt in total debt
improved from 42 percent to 50 percent and that of concessional loan in total external
debt remained more or less stable around 98 percent over the same period. Level of short-
term debt remained negligible and the country had foreign exchange reserves, equivalent
to 5.5 months imports cover in 2003 compared to 2.6 months import cover in 1999. On
the other hand, there had been deterioration in some other debt indicators. External debt
service (to exports) ratio increased significantly from 7.7 percent in 1999 to 10.4 percent
in 2003 and the external debt to exports ratio increased from 528 percent to 592 percent
over the same period due to poor performance of exports. The share of exports in GNI
declined from 34 percent to 24 percent in 1999-2003.

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 Table-3 External Debt in Lao PDR (in US$ million)
Items 1990 1999 2000 2001 2002 2003
Total Debt stock (EDT) 1768 2527 2502 2495 2665 2846
Long term debt 1757 2471 2453 2456 2620 2801
Public & guaranteed 1757 2471 2453 2456 2620 2801
Private non-guaranteed 0 0 0 0 0 0
Use of IMF credit 8 53 42 37 43 44
Short-term debt 3 3 7 2 2 1
Total debt service (TDS) 9 37 41 44 45 50
Interest payments (INT) 3 9 10 10 11 12
Interest on long term debt 3 9 10 10 11 12
Interest on IMF loan 0 0 0 0 0 0
Interest on short term debt 0 0 0 0 0 0
Gross national income (GNI) 866 1428 1657 1715 1694 2004
Exp.of goods and services (XGS) 105 479 513 483 434 481
Workers remittances 11 1 1 1 1 1
Imp.of goods & services (MGS) 215 629 638 599 505 557
International reserves (RES) 8 135 144 151 216 257
Current account balance -55 90 -8 -82 … …
Sustainability Debt indicators (in percent)

EDT/ XGS 1684 528 488 517 614 592

Long term debt/ XGS 1673 516 478 508 604 582
Public & guaranteed / XGS 1673 516 478 508 604 582
Private non-guaranteed/ XGS 0 0 0 0 0 0
Use of IMF credit/ XGS 8 11 8 8 10 9
Short-term debt/ XGS 3 1 1 0 0 0
EDT/ GNI 204 177 151 145 157 142
Long term debt/ GNI 203 173 148 143 155 140
Public & guaranteed / GNI 203 173 148 143 155 140
Private non-guaranteed/ GNI 0 0 0 0 0 0
Use of IMF credit/ GNI 0.9 3.7 2.5 2.2 2.5 2.2
Short-term debt/ GNI 0.3 0.2 0.4 0.1 0.1 0.0
TDS/ XGS 8.6 7.7 8.0 9.1 10.4 10.4
INT/ XGS 2.9 1.9 1.9 2.1 2.5 2.5
INT/ GNI 0.3 0.6 0.6 0.6 0.6 0.6
RES/ EDT 0.5 5 6 6 8 9
RES/ MGS (months) 0.4 2.6 2.7 3.0 5.1 5.5
Short-term debt/ Total debt 0.2 0.1 0.3 0.1 0.1 0.0
Concessional debt/ EDT 99 98 98 98 98 98
Multilateral debt/ Total debt 15 42 42 42 46 50
XGS/ GNI ratio 12 34 31 28 26 24
MGS/ GNI ratio 25 44 39 35 30 28
C/A Balance as % of GNI -6.4 6.3 -0.5 -4.8 … …
Source: Global Development Finance 2005, World Bank Debt Sustainability

Laos faces risks from a high debt burden. Even in high case projection, the NPV of public
external debt is above the threshold level for eligibility from debt relief under the Highly
Indebted Poor Countries (HIPC) initiatives and others.

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IMF defines debt sustainability as” a situation in which a borrower is expected to be able
to continue servicing its debts without an unrealistically large future correction to the
balance of income and expenditure”
Lao PDR is trying to restructure the
Bilateral debt for reduction of debt burden and uncertainty, to enhance access to export
markets in order to increase debt service capacity and to sstrengthening institutional set
up for debt management.

5.3 Major Areas of Concerns and Recommendations

• Medium term debt service burden of Lao PDR is manageable with favourable debt
service ratio, low share of short-term debt and high share of concessional debt.
However, sustainability of debt requires that the country should continue with sound
economic policies and reforms, particularly for fiscal reforms and attraction of
foreign investment.

• Lao PDR falls under the high debt stock-high risk category among low-income
countries and needs to be prudent in utilization of debt for high return projects.

• External debt service/exports ratio increased from 7.7% in 1999 to 10.4% in 2003
and is a matter of concern. It is desirable to diversify exports and to encourage non-
debt creating financial flows.

• Lao PDR is potentially eligible for debt relief under HIPC. It is advisable for the
country to avail of such facilities from multilateral financial institutions.

• Despite relatively high economic growth in the recent past, savings and investment
ratios of Lao PDR remain low at 17 per cent and 21 per cent of GDP, respectively. It
is desirable to encourage savings by creating a conducive macroeconomic
environment and establishing efficient institutional set up. It is also necessary to
encourage investment by reducing regulatory and entry barriers and the transactions
cost for doing business.

• Government revenue at 12.5 per cent of GDP is low and puts constraints on public
expenditures, which is also low at 17 per cent of GDP. It is desirable to continue with
sound fiscal and monetary policies to encourage private participation including
foreign investment. It is also necessary to take appropriate tax reforms and to
strengthen tax administration for enhancing revenue collections.

• Trade deficit at 15 per cent of GDP in 2004 is also high and vulnerable to external
shocks needs to be reduced by encouraging exports.

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• Current account balance at 10.3 per cent of GDP in 2005 is also high and needs to
be reduced to avoid external shocks by broad basing exports and flows on invisibles
account.

• Despite significant reduction in recent years, current inflation rate at more than 9 per
cent is high as it hurts everybody particularly the poor whose incomes are not
indexed to prices. Containment of inflation should remain high on the agenda of the
government. Government should adopt anti-inflationary fiscal and monetary policies.

• Given a flexible exchange rate regime, exchange rate volatility is one area of
concern. It is necessary to manage exchange rate by appropriate monetary policies
for orderly movement of exchange rates.

• Foreign reserves could be increased to more comfortable levels over the medium
term and should be monitored regularly.

• There is high dependency on a limited number of exportable products, which makes

the country vulnerable to external shocks. It is necessary to diversify exports and to
encourage trade creating foreign investment.

• It is desirable to develop human resources and institutional framework to take the

country forward in a globalised setting.

• Debt recording system is defunct and it is desirable to urgently get the system back
on track to enable proper recording and monitoring of external debt.

• Financial and capital markets are still at an early stage of development despite
improvements made during the past two decades. It is advisable to achieve a sound
banking and financial system with more efficient regulation, supervision and legal
systems and active use of global standards for capital adequacy requirements,
accounting, auditing and disclosure.

• Weak bond market needs to be developed to boost both savings and investment.

• Most of the external debts are highly concessional. Yet the external debt has
increased sharply in recent years from 69 per cent of GDP in 2003 to 82 percent of
GDP in 2004. The rising debt stock and debt service ratios are matter of concern. It is
desirable to tighten, streamline and prioritize new borrowings for development
needs.

• External debt is denominated mostly in dollars. Exchange rate depreciation in terms

of US dollar may create problems for financing debt services and contingent
liabilities for the government. It is advisable to set benchmarks for composition of
public debt in terms of domestic and external debt, interest rates and maturity of
external debt.

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• Lao PDR is reluctant to benefit from the HIPC initiative due to fear that it may loose
concessional loans/grants provided by some bilateral donors. It will be beneficial for
the country to avail of HIPC facilities from multilateral organizations as it will
improve capability of the country to take structural reforms and stabilization policies
for enhancing efficiency, productivity and competitiveness of industries and to
impart dynamism to overall growth process.

6. Concluding Observations

International best practices for management of external debt leads to the following broad
conclusions:

(a) Management of external debt is closely related to the management of domestic

debt, which in turn depends on the management of overall fiscal deficit.
(b) Debt management strategy is an integral part of the wider macro economic
policies that act as the first line of defense against any external financial shocks.
(c) For an emerging economy, it is better to adopt a policy of cautious and gradual
movement towards capital account convertibility.

(d) At the initial stage, it may be prudent to encourage non-debt creating financial
flows (Foreign Direct Investment and Equity Portfolio) followed by liberalization
of long-term and medium-term external debt.

(e) Big bullet loans are bad for small economies, as these can create refinancing risk
that many countries would be well advised to avoid.
(f) It is not enough to manage the government balance sheet well; it is also necessary
to monitor and make an integrated assessment of national balance sheet and to put
more attention on surveillance of overall debt- internal and external, private and
public. In each of the major Asian crisis economies- Indonesia, Korea and
Thailand- weakness in the government balance sheet was not the source of
vulnerability, rather vulnerability stemmed from the un-hedged sort-term foreign
currency debt of banks, finance companies and corporate sector.
(g) It is not sufficient to manage the balance sheet exposures, it is equally important
manage off balance sheet and contingent liabilities. Emerging as well as advanced
economies have experienced how bad banks can lead to large costs to the
economy and an unexpected weakening of the government’s balance sheet.
Government guarantees of private debt can also have similar adverse impact.
(h) It is necessary to adopt suitable policies for enhancing exports and other current
account receipts that provide the means for financing imports and debt services.

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(i) Detailed data recording and dissemination are pre-requisites for an effective
management and monitoring of external debt and formulation of appropriate debt
management policies.

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 (j) There is a need to set up an independent Public Debt Office with the following
functions:

• To deal with both domestic & external debt

• To set bench marks on interest rate, maturity mix, currency mix,
composition of debt in terms of domestic and external debt
• Identification and measurement of contingent liabilities
• Policy formulation for debt management
• Monitoring risk exposures
• Building Models in ALM framework
i.

(k) It is vital that external contingent liabilities and short-term debt are kept within
prudential limits.

(l) It is important to strengthen public and corporate governance and enhance

transparency and accountability.

(m)It is also necessary to strengthen the legal, regulatory and institutional set up for
management of both internal and external debt.

(n)
(o) A sound financial system with well developed debt and capital market is an
integral part of a country’s debt management strategy.

Selected References

Bandera, Amarakoon (2006a) Regional overview and importance of strengthening debt

management strategy, presentations made in Phnom Penh, Cambodia on 20 February
2006 and in Vientiane, Lao PDR on 23 February 2006.

________ (2006b) Recommendations and conclusions on the management of external

debt in Cambodia, presentation made in Phnom Penh, Cambodia on 21 February 2006.

________ (2006c) Recommendations and conclusions on the management of external

debt in Lao PDR, presentation made in Vientiane, Lao PDR on 24 February 2006.

Chhon, Keat (2006) Opening remarks at the National Workshop on Capacity Building
for Management of External Debt in the Era of Rapid Globalisation, Phnom Penh,
Cambodia 20 February 2006.

22
Das, Tarun (2006a) Conceptual issues and debt sustainability, presentations made in
Phnom Penh, Cambodia on 20 February 2006 and in Vientiane, Lao PDR on 23 February
2006.

_______ (2006b) Intercountry comparisons of external debt and international best

practices for management of external debt, presentations made in Phnom Penh,
Cambodia on 21 February 2006 and in Vientiane, Lao PDR on 24 February 2006.

_______ (2006c) Management of external debt in India and lessons for developing
countries, presentations made in Phnom Penh, Cambodia on 21 February 2006 and in
Vientiane, Lao PDR on 24 February 2006.

________ (2006d) Management of External Debt- International Experiences and

Best Practices, Best Practices series No.9, UNITAR, Geneva.

________ (2006e) Management of Public Debt- International Experiences and Best

Practices, Best Practices series No.10, UNITAR, Geneva

ESCAP (2005) Implementing the Monterrey Consensus in the Asian and Pacific Region-
Achieving Coherence and Consistency, United Nations, New York, 2005.

International Monetary Fund (2003) External Debt Statistics- Guide for Compilers
and Users, 2003, IMF, Washington D.C.

_______ And the World Bank (2003) Guidelines for Public Debt Management:
Accompanying Document and Selected Case Studies, 2003, Washington D.C.

Naron, Hang Chuon (2006a) Situation analysis and current issues of Cambodian
economy with special emphasis on fiscal and debt issues, presentation made in Phnom
Penh, Cambodia on 20 February 2006.

_______ (2006b) Debt management strategies and issues relating to legal and
institutional framework, presentation made in Phnom Penh, Cambodia on 20 February
2006.

Saysamone Xaysouliane (2006) Macroeconomic performance, fiscal sustainability and

debt management in Lao PDR, presentation made in Vientiane, Lao PDR on 23 February
2006.

Taliercio, Rob (2006) External debt and risk management, presentation made in Phnom
Penh, Cambodia on 21 February 2006.

Thirong, Pen (2006) Issues of external debt management in Cambodia, presentation

made in Phnom Penh, Cambodia on 21 February 2006.

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World Bank (2000) Sovereign Debt Management Forum: Compilation of Presentations,
November 2000, World Bank, Washington D.C.

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